SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------------------------- FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________. COMMISSION FILE NUMBER 1-13796 ---------------------------------------- GRAY COMMUNICATIONS SYSTEMS, INC. (Exact name of registrant as specified in its charter) GEORGIA 52-0285030 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4370 PEACHTREE ROAD, NE ATLANTA, GA 30319 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (404) 504-9828 --------------------------------------- Securities registered pursuant to Section 12(b) of the Act: CLASS A COMMON STOCK (NO PAR VALUE) NEW YORK STOCK EXCHANGE CLASS B COMMON STOCK (NO PAR VALUE) NEW YORK STOCK EXCHANGE Title of each class Name of each exchange on which registered SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE ---------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 11, 1999: CLASS A AND CLASS B COMMON STOCK; NO PAR VALUE - $128,319,479 The number of shares outstanding of the registrant's classes of common stock as of March 11, 1999: CLASS A COMMON STOCK; NO PAR VALUE - 6,832,042 SHARES; CLASS B COMMON STOCK, NO PAR VALUE - 5,125,465 SHARES DOCUMENTS INCORPORATED BY REFERENCE: NONE
PART 1 ITEM 1. BUSINESS AS USED HEREIN, UNLESS THE CONTEXT OTHERWISE REQUIRES, THE "COMPANY" MEANS GRAY COMMUNICATIONS SYSTEMS, INC. AND ITS SUBSIDIARIES. THE COMPANY CONSUMMATED THE BUSSE-WALB TRANSACTIONS (AS HEREINAFTER DEFINED) ON JULY 31, 1998. EXCEPT WITH RESPECT TO HISTORICAL FINANCIAL STATEMENTS AND UNLESS THE CONTEXT INDICATES OTHERWISE, THE BUSSE-WALB TRANSACTIONS (AS HEREINAFTER DEFINED) ARE INCLUDED IN THE DESCRIPTION OF THE COMPANY. UNLESS OTHERWISE INDICATED, THE INFORMATION HEREIN HAS BEEN ADJUSTED TO GIVE EFFECT TO (I) A THREE FOR TWO STOCK SPLIT OF THE COMPANY'S CLASS A COMMON STOCK, NO PAR VALUE (THE "CLASS A COMMON STOCK"), EFFECTED IN THE FORM OF A STOCK DIVIDEND DECLARED ON OCTOBER 2, 1995 AND (II) A THREE FOR TWO SPLIT OF THE COMPANY'S CLASS A COMMON STOCK AND THE COMPANY'S CLASS B COMMON STOCK, NO PAR VALUE, (THE "CLASS B COMMON STOCK") EFFECTED IN THE FORM OF A STOCK DIVIDEND DECLARED ON THE RESPECTIVE CLASS OF COMMON STOCK ON AUGUST 20, 1998. UNLESS OTHERWISE INDICATED, ALL STATION RANK, IN-MARKET SHARE AND TELEVISION HOUSEHOLD DATA HEREIN ARE DERIVED FROM THE NIELSEN STATION INDEX, VIEWERS IN PROFILE, DATED NOVEMBER 1998, AS PREPARED BY A.C. NIELSEN COMPANY ("NIELSEN"). GENERAL The Company currently owns ten network-affiliated television stations in nine medium-size markets in the southeastern ("Southeast") and midwestern (`Midwest") United States. In seven of the nine markets served by the Company, its stations are ranked number one in their respective markets and has the second ranked station in the remaining two markets. The Company has the leading local news operation in eight of the nine markets in which it operates. Seven of the stations are affiliated with the CBS Television Network, a division of CBS, Inc. ("CBS"), and three are affiliated with the NBC Television Network, a division of the National Broadcasting Company, Incorporated ("NBC"). In connection with the First American Acquisition (as hereinafter defined), the Company will be required under current regulations of the Federal Communications Commission (the "FCC") to divest of WJHG-TV ("WJHG"), its NBC affiliate in Panama City, Florida. For a discussion of the Company's plans regarding such divestiture, see "Divestiture Requirements." The Company also owns and operates four daily newspapers, a weekly advertising only publication ("shopper"), a paging business and a transportable satellite uplink business, located in the Southeast and the Midwest. In 1993 after the acquisition of a large block of the Class A Common Stock by a new investor, the Company implemented a strategy to foster growth through strategic acquisitions and certain select divestitures. Since January 1, 1994, the Company's significant acquisitions have included nine television stations, three newspapers, a transportable satellite uplink business and a paging business located in the Southeast and Midwest and the divestiture of two stations in the Southeast. As a result of the Company's acquisitions and in support of its growth strategy, the Company has added certain key members of management and has greatly expanded its operations in the television broadcasting and newspaper publishing businesses. ACQUISITIONS AND DIVESTITURES ACQUISITION OF THE GOSHEN NEWS On March 1, 1999, the Company acquired substantially all of the assets of THE GOSHEN NEWS from News Printing Company, Inc. and affiliates thereof, for aggregate cash consideration of approximately $16.7 million including a non-compete agreement. THE GOSHEN NEWS is a 17,000 circulation afternoon newspaper published Monday through Saturday and serves Goshen, Indiana and surrounding areas. The Company funded this acquisition through its $200.0 million bank loan agreement (the "Senior Credit Facility.") 2
ACQUISITIONS AND DIVESTITURES (CONTINUED) OPTION TO ACQUIRE INVESTMENT IN SARKES TARZIAN, INC. On January 28, 1999, Bull Run Corporation ("Bull Run"), a principal stockholder of the Company, acquired 301,119 shares of the outstanding common stock of Sarkes Tarzian, Inc. ("Tarzian") from the Estate of Mary Tarzian (the "Estate") for $10.0 million. The acquired shares (the "Tarzian Shares") represent 33.5% of the total outstanding common stock of Tarzian (both in terms of the number of shares of common stock outstanding and in terms of voting rights), but such investment represents 73% of the equity of Tarzian for purposes of dividends as well as distributions in the event of any liquidation, dissolution or other termination of Tarzian. Tarzian has filed a complaint in the United States District Court for the Southern District of Indiana, claiming that it had a binding contract with the Estate to purchase the Tarzian Shares from the Estate prior to Bull Run's purchase of the shares, and requests judgment providing that the Estate be required to sell the Tarzian Shares to Tarzian. Bull Run believes that a binding contract between Tarzian and the Estate did not exist, prior to Bull Run's purchase of the Tarzian Shares from the Estate, and in any case, Bull Run's purchase agreement with the Estate provides that in the event that a court of competent jurisdiction awards title to the Tarzian Shares to a person or entity other than Bull Run, the purchase agreement is rescinded and the Estate is required to pay Bull Run the full $10.0 million purchase price, plus interest. Tarzian owns and operates two television stations and four radio stations: WRCB-TV Channel 3 in Chattanooga, Tennessee, an NBC affiliate; KTVN-TV Channel 2 in Reno, Nevada, a CBS affiliate; WGCL-AM and WTTS-FM in Bloomington, Indiana; and WAJI-FM and WLDE-FM in Fort Wayne, Indiana. The Chattanooga and Reno markets rank as the 87th and the 108th largest television markets in the United States, respectively, as ranked by Nielsen. The Company has executed an option agreement with Bull Run, whereby the Company has the option of acquiring the Tarzian investment from Bull Run. Upon exercise of the option, the Company will pay Bull Run an amount equal to Bull Run's purchase price for the Tarzian investment and related costs. The option agreement currently expires on May 31, 1999; however, the Company may extend the option period at an established fee. In connection with the option agreement, the Company granted to Bull Run warrants to purchase up to 100,000 shares of the Company's Class B Common Stock at $13.625 per share. The warrants vest immediately upon the Company's exercise of its option to purchase the Tarzian investment. Neither Bull Run's investment nor the Company's potential investment is presently attributable under the ownership rules of the FCC. If the Company successfully exercises the option agreement, the Company plans to fund the acquisition through its Senior Credit Facility. BUSSE-WALB TRANSACTIONS On July 31, 1998, the Company completed the purchase of all of the outstanding capital stock of Busse Broadcasting Corporation ("Busse"). The purchase price was $120.5 million less the accreted value of Busse's 11 5/8% Senior Secured Notes due 2000 ("Busse Senior Notes"). The purchase price of the capital stock consisted of the contractual purchase price of $112.0 million, associated transaction costs of $2.9 million and Busse's cash and cash equivalents of $5.6 million. Immediately following the acquisition of Busse, the Company exercised its right to satisfy and discharge the Busse Senior Notes, effectively prefunding the Busse Senior Notes at the October 15, 1998 call price of 106 plus accrued interest. The amount necessary to satisfy and discharge the Busse Senior Notes was approximately $69.9 million. Based on the preliminary allocation of the purchase price, the excess of the purchase price over the fair value of net tangible assets acquired was approximately $122.8 million. Immediately prior to the Company's acquisition of Busse, Cosmos Broadcasting Corporation acquired the assets of WEAU-TV ("WEAU") from Busse and exchanged them for the assets of WALB-TV, Inc. ("WALB"), the Company's NBC affiliate in Albany, Georgia. In exchange for the assets of WALB, the Company received the assets of WEAU, which were valued at $66.0 million, and approximately $12.0 million in cash for a total value of $78.0 million. The Company recognized a pre-tax 3
ACQUISITIONS AND DIVESTITURES (CONTINUED) BUSSE-WALB TRANSACTIONS (CONTINUED) gain of approximately $70.6 million and estimated deferred income taxes of approximately $27.5 million in connection with the exchange of WALB. The Company funded the remaining costs of the acquisition of Busse's capital stock through its Senior Credit Facility. As a result of these transactions, the Company added the following television stations to its existing broadcast group: KOLN-TV("KOLN"), the CBS affiliate serving the Lincoln-Hastings-Kearney, Nebraska market; its satellite station KGIN-TV ("KGIN"), the CBS affiliate serving Grand Island, Nebraska; and WEAU, a NBC affiliate serving the La Crosse-Eau Claire, Wisconsin market. These transactions also satisfied the FCC's requirement for the Company to divest itself of WALB. The transactions described above are referred to herein as the "Busse-WALB Transactions." WITN ACQUISITION In August 1997, the Company acquired substantially all of the assets of WITN-TV ("WITN"), a NBC affiliate serving the Greenville-New Bern-Washington, North Carolina market (the "WITN Acquisition"). The purchase price for the WITN Acquisition was approximately $41.7 million, including fees, expenses, and working capital and other adjustments. GULFLINK ACQUISITION In April 1997, the Company acquired all of the issued and outstanding common stock of GulfLink Communications, Inc. ("GulfLink") of Baton Rouge, Louisiana (the "GulfLink Acquisition"). The GulfLink operations included nine transportable satellite uplink trucks. The purchase price for the GulfLink Acquisition approximated $5.2 million, including fees, expenses, and certain assumed liabilities. Subsequent to the GulfLink Acquisition, certain other satellite uplink truck operations of the Company were combined with GulfLink and the operating name was changed to Lynqx Communications. THE FIRST AMERICAN ACQUISITION In September 1996, the Company purchased from First American Media, Inc. (the "First American Acquisition") substantially all of the assets of two CBS-affiliated stations, WCTV-TV ("WCTV") serving Tallahassee, Florida-Thomasville, Georgia and WKXT-TV ("WKXT") in Knoxville, Tennessee, a satellite uplink business and a paging business. The purchase price for the First American Acquisition was approximately $183.9 million, including fees, expenses, and working capital and other adjustments. Subsequent to the First American Acquisition, the Company rebranded WKXT with the call letters WVLT ("WVLT'). AUGUSTA ACQUISITION In January 1996, the Company acquired substantially all of the assets of WRDW-TV ("WRDW"), a CBS affiliate serving Augusta, Georgia (the "Augusta Acquisition"). The purchase price of the Augusta Acquisition was approximately $37.2 million, including fees, expenses, and certain assumed liabilities. KTVE SALE In August 1996, the Company sold the assets of KTVE Inc. ("KTVE"), its NBC affiliate serving Monroe, Louisiana-El Dorado, Arkansas (the "KTVE Sale") for approximately $9.5 million in cash plus the amount of accounts receivable on the date of the closing to the extent collected by the buyer to be paid 4
ACQUISITIONS AND DIVESTITURES (CONTINUED) KTVE SALE (CONTINUED) to the Company within 150 days following the closing date (approximately $829,000). The Company recognized a pre-tax gain of approximately $5.7 million and estimated income taxes of approximately $2.8 million. PRO FORMA OPERATING RESULTS For the year ended December 31, 1998, on a pro forma basis giving effect to the Busse-WALB Transactions as if they had occurred on January 1, 1998, the Company had net revenues, Media Cash Flow, as defined herein, Operating Cash Flow (defined as Media Cash Flow less corporate expenses) and a net loss of $133.7 million, $49.0 million, $46.0 million and $4.6 million, respectively. On a pro forma basis giving effect to the Busse-WALB Transactions, the WITN Acquisition and the GulfLink Acquisition as if they had occurred on January 1, 1997, the Company had net revenues, Media Cash Flow, as defined herein, Operating Cash Flow and a net loss of $118.0 million, $44.9 million, $42.4 million and $6.6 million, respectively. DIVESTITURE REQUIREMENTS In connection with the First American Acquisition, the FCC ordered the Company to divest itself of WALB in Albany, Georgia and WJHG in Panama City, Florida to comply with regulations governing common ownership of television stations with overlapping service areas. The Company complied with the FCC order regarding WALB on July 31, 1998. The FCC is currently reexamining these regulations, and if it revises them in accordance with the interim policy it has adopted, divestiture of WJHG would not be required. Accordingly, the Company requested and in July 1997 received an extension of the divestiture deadline for WJHG, conditioned upon the outcome of the rulemaking proceedings. At this time, it can not be determined when the FCC will complete its rulemaking on this subject. 5
TELEVISION BROADCASTING THE COMPANY'S STATIONS AND THEIR MARKETS AS USED IN THE TABLES FOR EACH OF THE COMPANY'S STATIONS AND IN THIS SECTION (I) "TOTAL MARKET REVENUES" REPRESENT GROSS ADVERTISING REVENUES, EXCLUDING BARTER REVENUES, FOR ALL COMMERCIAL TELEVISION STATIONS IN THE MARKET, AS REPORTED IN INVESTING IN TELEVISION 1998 MARKET REPORT, FOURTH EDITION NOVEMBER 1998 RATINGS PUBLISHED BY BIA PUBLICATIONS, INC. (THE "BIA GUIDE"), EXCEPT FOR REVENUES IN WYMT-TV'S ("WYMT") 18-COUNTY TRADING AREA WHICH IS NOT SEPARATELY REPORTED IN THE BIA GUIDE; (II) "IN-MARKET SHARE OF HOUSEHOLDS VIEWING TELEVISION" REPRESENTS THE PERCENTAGE OF THE STATION'S AUDIENCE AS A PERCENTAGE OF ALL VIEWING BY HOUSEHOLDS IN THE MARKET FROM 6 A.M. TO 2 A.M. SUNDAY THROUGH SATURDAY, INCLUDING VIEWING OF NON-COMMERCIAL STATIONS, NATIONAL CABLE CHANNELS AND OUT-OF-MARKET STATIONS BROADCAST OR CARRIED BY CABLE IN THE MARKET AS REPORTED BY NIELSEN FOR NOVEMBER 1998; (III) "STATION RANK IN DMA" IS BASED ON NIELSEN ESTIMATES FOR NOVEMBER 1998 FOR THE PERIOD FROM 6 A.M. TO 2 A.M. SUNDAY THROUGH SATURDAY; (IV) AVERAGE HOUSEHOLD INCOME, EFFECTIVE BUYING INCOME AND RETAIL BUSINESS SALES GROWTH PROJECTIONS ARE AS REPORTED IN THE BIA GUIDE; AND (V) ESTIMATES OF POPULATION ARE AS REPORTED BY THE SEPTEMBER 1998, NIELSEN STATION INDEX-U.S. TELEVISION HOUSEHOLD ESTIMATES PUBLISHED BY NIELSEN. <TABLE> <CAPTION> Total In-Market Commercial Station Market Share of DMA Stations Rank Television Revenues in Households Station Market Rank(1) in DMA(2) in DMA Households(3) DMA for 1998 Viewing TV ------- ------ ------- --------- ------ ------------- ------------ ---------- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> <C> <C> WVLT Knoxville, TN 63 6 2 447,000 $68,000 25% WKYT Lexington, KY 67 6 1 408,000 54,100 40 WYMT(4) Hazard, KY 67 N/A 1 167,000 5,600 30 KOLN/ Lincoln-Hastings KGIN (5) -Kearney, NE 101 5 1 255,000 24,800 55 WITN Greenville- New Bern- Washington, NC 105 4 2 238,000 31,000 30 WRDW Augusta, GA 111 4 1 228,000 34,000 36 WCTV Tallahassee, FL- Thomasville, GA 114 4 1 225,000 24,500 61 WEAU La Crosse- Eau Claire, WI 129 4 1 179,000 25,100 39 WJHG(6) Panama City, FL 157 4 1 120,000 11,700 49 </TABLE> (1) Ranking of DMA served by a station among all DMAs is measured by the number of television households based within the DMA in the November 1998 Nielsen estimates. (2) Includes independent broadcasting stations and excludes satellite stations. (3) Based upon the approximate number of television households in the DMA as reported by Nielsen for November 1998. (4) The market area served by WYMT is an 18-county trading area, as defined by Nielsen, and is included in the Lexington, Kentucky DMA. WYMT's station rank is based upon its ratings position in the 18-county trading area. (5) KGIN is a VHF station located in Grand Island, Nebraska and is operated primarily as a satellite station of KOLN which is located in Lincoln, Nebraska. (6) The Company is required to divest WJHG under current FCC regulations. For a discussion of the Company's plan, see "Divestiture Requirements." 6
TELEVISION BROADCASTING (CONTINUED) THE COMPANY'S STATIONS AND THEIR MARKETS (CONTINUED) The percentage of the Company's total revenues contributed by the Company's television broadcasting segment was approximately 70.6%, 69.8% and 69.3% for each of the years ended December 31, 1998, 1997 and 1996, respectively. In the following description of each of the Company's stations, information set forth below concerning Total Market Revenues, average household income, projected effective buying income and projected retail business sales growth has been derived from the BIA Guide. Estimates of population have been obtained from the September 1998 Nielsen Station Index-U.S. Television Household Estimates. WVLT, THE CBS AFFILIATE IN KNOXVILLE, TENNESSEE WVLT, acquired by the Company in September 1996, began operations in 1988. Knoxville, Tennessee is the 63rd DMA in the United States, with approximately 447,000 television households and a total population of approximately 1.2 million. Total Market Revenues in the Knoxville DMA in 1998 were approximately $68.0 million. According to the BIA Guide, the average household income in the Knoxville DMA in 1996 was $35,651, with effective buying income projected to grow at an annual rate of 5.4% through 2001. Retail business sales growth in the Knoxville DMA is projected by the BIA Guide to average 6.1% annually during the same period. The Knoxville DMA has six licensed commercial television stations, four of which are affiliated with major networks. The Knoxville DMA also has two public broadcasting stations. MARKET DESCRIPTION. The Knoxville DMA, consisting of 22 counties in eastern Tennessee and southeastern Kentucky, includes the cities of Knoxville, Oak Ridge and Gatlinburg, Tennessee. The Knoxville area is a center for education, manufacturing, healthcare and tourism. The University of Tennessee's main campus is located within the city of Knoxville. Leading manufacturing employers in the area include: Lockheed Martin Energy Systems, Inc., DeRoyal Industries, Aluminum Company of North America, Phillips Consumer Electronics North America Corp., Clayton Homes and Sea Ray Boats, Inc. Area tourist attractions are the Great Smokey Mountains National Park and Dollywood, a country-western theme park sponsored by Dolly Parton. WKYT, THE CBS AFFILIATE IN LEXINGTON, KENTUCKY WKYT, acquired by the Company in September 1994, began operations in 1957. Lexington, Kentucky is the 67th largest DMA in the United States, with approximately 408,000 television households and a total population of approximately 1.1 million. Total Market Revenues in the Lexington DMA in 1998 were approximately $54.1 million. According to the BIA Guide, the average household income in the Lexington DMA in 1996 was $33,507, with effective buying income projected to grow at an annual rate of 4.4% through 2001. Retail business sales growth in the Lexington DMA is projected by the BIA Guide to average 4.3% annually during the same period. The Lexington DMA has six licensed commercial television stations, including WYMT, WKYT's sister station, five of which are affiliated with major networks. The Lexington DMA also has one public television station. MARKET DESCRIPTION. The Lexington DMA consists of 39 counties in central and eastern Kentucky. The Lexington area is a regional hub for shopping, business, healthcare, education, and cultural activities and has a comprehensive transportation network and low commercial utility rates. Major employers in the Lexington area include Toyota Motor Corp., Lexmark International, Inc., GTE Corporation, Square D Company, Ashland, Inc., the University of Kentucky and International Business Machines Corporation. 7
TELEVISION BROADCASTING (CONTINUED) WKYT, THE CBS AFFILIATE IN LEXINGTON, KENTUCKY (CONTINUED) Eight hospitals and numerous medical clinics are located in Lexington, reinforcing Lexington's position as a regional medical center. The University of Kentucky's main campus is also located in Lexington. WYMT, THE CBS AFFILIATE IN HAZARD, KENTUCKY WYMT, acquired by the Company in September 1994, began operations in 1985. WYMT has carved out a niche trading area comprising 18 counties in eastern and southeastern Kentucky. This trading area is a separate marketing area of the Lexington, Kentucky DMA with approximately 167,000 television households and a total population of approximately 452,000. WYMT is the only commercial television station in this 18-county trading area. Total Market Revenues in the 18-county trading area for the year ended December 31, 1998, were approximately $5.6 million. WYMT is the sister station of WKYT and shares many resources and simulcasts some local programming with WKYT. MARKET DESCRIPTION. The mountain region of eastern and southeastern Kentucky where Hazard is located is on the outer edges of four separate markets: Bristol-Kingsport-Johnson City, Charleston-Huntington, Knoxville and Lexington. Prior to 1985, mountain residents relied primarily on satellite dishes and cable television carrying distant signals for their television entertainment and news. Established in 1985, WYMT is the only broadcast station which can be received over the air in a large portion of its 18-county trading area and may now be viewed on area cable systems. The trading area's economy is centered around coal and related industries and some light manufacturing. In recent years, the coal industry has undergone a major restructuring due to consolidation in the industry and advances in technology. KOLN\KGIN, THE CBS AFFILIATES IN LINCOLN-HASTINGS-KEARNEY, NEBRASKA KOLN and KGIN, acquired by the Company in July 1998, began operations in 1953 and 1961, respectively. KOLN is a full power VHF television station located in Lincoln, Nebraska. KGIN is a full power VHF television station located in Grand Island, Nebraska and is operated primarily as a satellite station to KOLN in order to serve the western portion of the Lincoln-Hastings-Kearney DMA. Lincoln-Hastings-Kearney, Nebraska is the 101st largest DMA in the United States, with approximately 255,000 television households and a total population of approximately 660,000. Total Market Revenues in the Lincoln-Hastings-Kearney DMA in 1998 were approximately $24.8 million. According to the BIA Guide, the average household income in the Lincoln-Hastings-Kearney DMA in 1996 was $38,800, with effective buying income projected to grow at an annual rate of 4.6% through 2001. Retail business sales growth in the Lincoln-Hastings-Kearney DMA is projected by the BIA Guide to average 4.3% annually during the same period. The Lincoln-Hastings-Kearney DMA has five licensed commercial television stations, all of which are affiliated with major networks. The Lincoln-Hastings-Kearney DMA also has one public television station. MARKET DESCRIPTION. The Lincoln-Hastings-Kearney DMA consists of 51 counties covering a large portion of the western two thirds of Nebraska and the northern tier of Kansas. The city of Lincoln is the primary economic center of the region, the capital of Nebraska and home to the University of Nebraska. The Lincoln-Hastings-Kearney economy centers around state government, education, medical services and agriculture. Leading employers in the area include: the State of Nebraska, the University of Nebraska, the Lincoln Public School System and several area hospitals. 8
TELEVISION BROADCASTING (CONTINUED) WITN, THE NBC AFFILIATE IN GREENVILLE-NEW BERN-WASHINGTON, NORTH CAROLINA WITN, acquired by the Company in August 1997, began operations in 1955. Greenville-New Bern-Washington, North Carolina is the 105th largest DMA in the United States, with approximately 238,000 television households and a total population of approximately 678,000. Total Market Revenues in the Greenville-New Bern-Washington DMA in 1998 were approximately $31.0 million. According to the BIA Guide, the average household income in the Greenville-New Bern-Washington DMA in 1996 was $36,500, with effective buying income projected to grow at an annual rate of 4.8% through 2001. Retail business sales growth in the Greenville-New Bern-Washington DMA is projected by the BIA Guide to average 5.2% annually during the same period. The Greenville-New Bern-Washington DMA has four licensed commercial television stations, all of which are affiliated with major networks. The Greenville-New Bern-Washington DMA also has three public television stations. MARKET DESCRIPTION. The Greenville-New Bern-Washington DMA consists of 15 counties in eastern North Carolina. Greenville, North Carolina (located 100 miles east of Raleigh) is the primary economic center of the region and home to East Carolina University. The Greenville-New Bern-Washington economy centers around education, manufacturing, and agriculture. Leading employers in the area include: East Carolina University, Catalytica Pharmaceuticals, Inc., PCS Phosphate, Rubber Maid Cleaning Products, Inc., and Weyerhauser Co. WRDW, THE CBS AFFILIATE IN AUGUSTA, GEORGIA WRDW, acquired by the Company in January 1996, began operations in 1954. Augusta, Georgia is the 111th largest DMA in the United States, with approximately 228,000 television households and a total population of approximately 639,000. Total Market Revenues in the Augusta DMA in 1998 were approximately $34.0 million. According to the BIA Guide, the average household income in the Augusta DMA in 1996 was $34,238, with effective buying income projected to grow at an annual rate of 3.9% through 2001. Retail business sales growth in the Augusta DMA is projected by the BIA Guide to average 2.9% annually during the same period. The Augusta DMA has four licensed commercial television stations, all of which are affiliated with a major network. The Augusta DMA also has two public television stations. MARKET DESCRIPTION. The Augusta DMA consists of 19 counties in eastern Georgia and western South Carolina, including the cities of Augusta, Georgia and North Augusta and Aiken, South Carolina. The Augusta, Georgia area is one of Georgia's major metropolitan/regional centers, with a particular emphasis on health services, manufacturing and the military. The federal government employs military and civilian personnel at the Department of Energy's Savannah River Site, a nuclear processing plant, and Fort Gordon, a U.S. Army military installation. Augusta has eight large hospitals which collectively employ approximately 20,000 and reinforce Augusta's status as a regional healthcare center. Augusta is also home to the Masters Golf Tournament, which has been broadcast by CBS for 43 years. WCTV, THE CBS AFFILIATE IN TALLAHASSEE, FLORIDA-THOMASVILLE, GEORGIA WCTV, acquired by the Company in September 1996, began operations in 1955. Tallahassee Florida-Thomasville, Georgia is the 114th largest DMA in the United States, with approximately 225,000 television households and a total population of approximately 628,000. Total Market Revenues in the Tallahassee-Thomasville DMA in 1998 were approximately $24.5 million. According to the BIA Guide, the average household income in the Tallahassee, Florida-Thomasville, Georgia DMA in 1996 was $35,338, with effective buying income projected to grow at an annual rate of 5.3% through 2001. Retail business sales growth in the Tallahassee, Florida-Thomasville, Georgia DMA is projected by the BIA 9
TELEVISION BROADCASTING (CONTINUED) WCTV, THE CBS AFFILIATE IN TALLAHASSEE, FLORIDA-THOMASVILLE, GEORGIA (CONTINUED) Guide to average 5.8% annually during the same period. The Tallahassee-Thomasville DMA has four licensed commercial television stations, all of which are affiliated with major networks. The Tallahassee-Thomasville DMA also has one public television station. MARKET DESCRIPTION. The Tallahassee-Thomasville DMA, consisting of 17 counties in the panhandle of Florida and southwest Georgia, includes Tallahassee, the capital of Florida, and Thomasville, Valdosta and Bainbridge, Georgia. The Tallahassee-Thomasville economy centers around state and local government as well as state and local universities which include Florida State University, Florida A&M University, Tallahassee Community College, Thomas College and Valdosta State University. Florida State University is the largest university located in the DMA and its main campus is located within the city of Tallahassee. WEAU, THE NBC AFFILIATE IN LA CROSSE-EAU CLAIRE, WISCONSIN WEAU, acquired by the Company in July 1998, began operations in 1953. La Crosse-Eau Claire, Wisconsin is the 129th largest DMA in the United States, with approximately 179,000 television households and a total population of approximately 490,000. Total Market Revenues in the La Crosse-Eau Claire, Wisconsin DMA in 1998 were approximately $25.1 million. According to the BIA Guide, the average household income in the La Crosse-Eau Claire, Wisconsin DMA in 1996 was $34,150, with effective buying income projected to grow at an annual rate of 3.6% through 2001. Retail business sales growth in the La Crosse-Eau Claire, Wisconsin DMA is projected by the BIA Guide to average 4.6% annually during the same period. The La Crosse-Eau Claire, Wisconsin DMA has four licensed commercial television stations, all of which are affiliated with major networks. The La Crosse-Eau Claire, Wisconsin DMA also has one public television station. MARKET DESCRIPTION. The La Crosse-Eau Claire, Wisconsin DMA, consists of 10 counties in west central Wisconsin and 2 counties in eastern Minnesota. The La Crosse and Eau Claire, Wisconsin economy centers around skilled industry, medical services, agriculture, education and retail businesses. The University of Wisconsin maintains a 10,000 student campus in Eau Claire. Leading employers include Hutchenson Technologies, the University of Wisconsin at Eau Claire and several area hospitals. WJHG, THE NBC AFFILIATE IN PANAMA CITY, FLORIDA WJHG, acquired by the Company in 1960, began operations in 1953. Panama City, Florida is the 157th largest DMA in the United States, with approximately 120,000 television households and a total population of approximately 324,000. Total Market Revenues in the Panama City DMA in 1998 were approximately $11.7 million. According to the BIA Guide, the average household income in the Panama City DMA in 1996 was $34,256, with effective buying income projected to grow at an annual rate of 6.0% through 2001. Retail business sales growth in the Panama City DMA is projected by the BIA Guide to average 6.2% annually during the same period. The Panama City DMA has four licensed commercial television stations, three of which are affiliated with major networks. In addition, a CBS signal is provided by a station in Dothan, Alabama, an adjacent DMA. The Panama City DMA also has one public television station. MARKET DESCRIPTION. The Panama City DMA consists of nine counties in northwest Florida. The Panama City market stretches north from Florida's Gulf Coast to Alabama's southern border. The Panama City economy centers around tourism, military bases, manufacturing, education and financial services. Panama City is the county seat and principal city of Bay County. Leading employers in the area 10
TELEVISION BROADCASTING (CONTINUED) WJHG, THE NBC AFFILIATE IN PANAMA CITY, FLORIDA (CONTINUED) include: Tyndall Air Force Base, the Navy Coastal Systems Station, Sallie Mae Servicing Corp., Stone Container Corporation, Arizona Chemical Corporation and Gulf Coast Community College. SATELLITE TRANSMISSION AND PRODUCTION SERVICES The Company's satellite transmission and production services business, Lynqx Communications, operates C-band and Ku-band transportable satellite uplink units and provides production management services. Clients include The Golf Channel, USA Network, Turner Cable Network Services, NBC, CBS, ABC, Home Box Office, MTV, The Children's Miracle Network and many other broadcast and cable services. Subsequent to the GulfLink Acquisition, certain other satellite uplink truck operations of the Company were combined with GulfLink and the operating name was changed to Lynqx Communications. INDUSTRY BACKGROUND There are currently a limited number of channels available for broadcasting in any one geographic area, and the license to operate a television station is granted by the FCC. Television stations which broadcast over the very high frequency ("VHF") band (channels 2-13) of the spectrum generally have some competitive advantage over television stations which broadcast over the ultra-high frequency ("UHF") band (channels above 13) of the spectrum, because the former usually have better signal coverage and operate at a lower transmission cost. However, the improvement of UHF transmitters and receivers, the complete elimination from the marketplace of VHF-only receivers and the expansion of cable television systems have reduced the VHF signal advantage. Television station revenues are primarily derived from local, regional and national advertising and, to a much lesser extent, from network compensation and revenues from studio and tower space rental and commercial production activities. Advertising rates are based upon a variety of factors, including a program's popularity among the viewers an advertiser wishes to attract, the number of advertisers competing for the available time, the size and demographic makeup of the market served by the station and the availability of alternative advertising media in the market area. Rates are also determined by a station's overall ratings and in-market share, as well as the station's ratings and share among particular demographic groups which an advertiser may be targeting. Because broadcast stations rely on advertising revenues, they are sensitive to cyclical changes in the economy. The size of advertisers' budgets, which are affected by broad economic trends, affect the broadcast industry in general and the revenues of individual broadcast television stations. All television stations in the country are grouped by Nielsen, a national audience measuring service, into approximately 210 generally recognized television markets that are ranked in size according to various formulae based upon actual or potential audience. Each DMA is an exclusive geographic area consisting of all counties in which the home-market commercial stations receive the greatest percentage of total viewing hours. Nielsen periodically publishes data on estimated audiences for the television stations in the various television markets throughout the country. Four major broadcast networks, ABC, Inc. ("ABC"), NBC, CBS, and Fox dominate broadcast television. Additionally, United Paramount Network ("UPN") and Warner Brothers Network ("WB") have been launched as new television networks. An affiliate of UPN or WB receives a smaller portion of each day's programming from its network compared to an affiliate of the four major networks. 11
TELEVISION BROADCASTING (CONTINUED) INDUSTRY BACKGROUND (CONTINUED) The affiliation of a station with one of the four major networks has a significant impact on the composition of the station's programming, revenues, expenses and operations. A typical affiliate of a major network receives the majority of each day's programming from the network. This programming, along with cash payments ("network compensation"), is provided to the affiliate by the network in exchange for a substantial majority of the advertising time sold during the airing of network programs. The network then sells this advertising time and retains the revenues. The affiliate retains the revenues from time sold during breaks in and between network programs and programs the affiliate produces or purchases from non-network sources. In acquiring programming to supplement programming supplied by the affiliated network, network affiliates compete primarily with other affiliates and independent stations in their markets. Cable systems generally do not compete with local stations for programming, although various national cable networks from time to time have acquired programs that would have otherwise been offered to local television stations. In addition, a television station may acquire programming through barter arrangements. Under barter arrangements, which are becoming increasingly popular with both network affiliates and independents, a national program distributor may receive advertising time in exchange for the programming it supplies, with the station paying a reduced fee for such programming. Most successful commercial television stations obtain their brand identity from locally produced news programs. In contrast to a station affiliated with a network, a fully independent station purchases or produces all of the programming that it broadcasts, resulting in generally higher programming costs. An independent station, however, retains its entire inventory of advertising time and all the revenues obtained therefrom. As a result of the smaller amount of programming provided by its network, an affiliate of UPN or WB must purchase or produce a greater amount of its programming, resulting in generally higher programming costs. These affiliate stations, however, retain a larger portion of the inventory of advertising time and the revenues obtained therefrom compared to stations affiliated with the major networks. Cable-originated programming has emerged as a significant competitor for viewers of broadcast television programming, although no single cable programming network regularly attains audience levels amounting to more than a small fraction of any single major broadcast network. The advertising share of cable networks has increased as a result of the growth in cable penetration (the percentage of television households which are connected to a cable system). Notwithstanding such increases in cable viewership and advertising, over-the-air broadcasting remains the dominant distribution system for mass market television advertising. NETWORK AFFILIATION OF THE STATIONS Each of the Company's stations is affiliated with a major network pursuant to an affiliation agreement. Each affiliation agreement provides the affiliated station with the right to broadcast all programs transmitted by the network with which the station is affiliated. In return, the network has the right to sell a substantial majority of the advertising time during such broadcasts. In exchange for every hour that a station elects to broadcast network programming, the network pays the station a specific network compensation payment which varies with the time of day. Typically, prime-time programming generates the highest hourly network compensation payments. Such payments are subject to increase or decrease by the network during the term of an affiliation agreement with provisions for advance notices and right of termination by the station in the event of a reduction in such payments. The NBC affiliation agreement for WJHG renews automatically every five years unless the station notifies NBC otherwise. 12
TELEVISION BROADCASTING (CONTINUED) NETWORK AFFILIATION OF THE STATIONS (CONTINUED) The NBC affiliation agreements with WITN and WEAU expire on June 30, 2006 and December 31,2005, respectively and the WEAU agreement renews automatically every five years unless the station notifies NBC otherwise. The CBS affiliation agreements expire as follows: (i) WVLT, WKYT, WYMT and WCTV, on December 31, 2004, (ii) WRDW on March 31, 2005 and (iii) KOLN and KGIN on December 31, 2005. NEWSPAPER PUBLISHING At December 31, 1998, the Company owned and operated four publications comprising three newspapers and a shopper, all located in the Southeast. The percentage of total company revenues contributed by the newspaper publishing segment was approximately 22.8%, 23.7% and 28.8% for each of the years ended December 31, 1998, 1997 and 1996, respectively. THE ALBANY HERALD The Albany Herald Publishing Company, Inc. ("The Albany Herald"), located in Albany, Georgia, publishes THE ALBANY HERALD, which is the only seven-day-a-week newspaper that serves southwest Georgia. The Albany Herald also publishes two other weekly editions in Georgia, THE LEE COUNTY HERALD AND THE WORTH COUNTY HERALD, which both provide regional news coverage. Other niche publications include FARM AND PLANTATION, an agricultural paper; and a monthly coupon clipper. The Company introduced these weeklies and other niche product publications in order to better utilize The Albany Herald's printing presses and infrastructure (such as sales and advertising). THE ROCKDALE CITIZEN AND THE GWINNETT DAILY POST THE ROCKDALE CITIZEN and the GWINNETT DAILY POST are six-day-a-week newspapers that serve communities in the metro Atlanta area with complete local news, sports and lifestyles coverage together with national stories that directly impact their local communities. The Rockdale Citizen Publishing Company is located in Conyers, Georgia, the county seat of Rockdale County, which is 19 miles east of downtown Atlanta. Rockdale County's population is estimated to be approximately 65,000. The Gwinnett Daily Post, which was purchased by the Company in January 1995, is located north of Atlanta in Gwinnett County, one of the fastest growing areas in the nation. Since the purchase of the Gwinnett Daily Post, the frequency of publication has increased from three to six days per week. In 1997, the Gwinnett Daily Post entered into an agreement with CableVision Communications, Inc. ("Cable Vision"), a local cable provider, that resulted in a subscription to the GWINNETT DAILY POST being included in the basic cable package purchased by cable subscribers. As a result, the GWINNETT DAILY POST'S paid circulation tripled to 49,000 in 1997, and the Company started a local Gwinnett TV news channel, Gwinnett News and Entertainment Television ("GNET"), which is produced by the Company and broadcast on the local cable system. Effective March 1, 1998 the Gwinnett Daily Post entered into a similar agreement with Genesis Cable Communications LLC ("Genesis") increasing paid circulation for the GWINNETT DAILY POST to approximately 64,000. 13
NEWSPAPER PUBLISHING (CONTINUED) THE GOSHEN NEWS The Company acquired THE GOSHEN NEWS on March 1, 1999. It is a 17,000 circulation afternoon newspaper published Monday through Saturday and serves Goshen, Indiana and surrounding areas. INDUSTRY BACKGROUND Newspaper publishing is the oldest segment of the media industry and, as a result of the focus on local news, newspapers in general, remain an important media for local advertising. Newspaper advertising revenues are cyclical and have generally been affected by changes in national and regional economic conditions. Financial instability in the retail industry, including bankruptcies of larger retailers and consolidations among large retail chains can result in reduced retail advertising expenditures. Classified advertising, which makes up approximately one-third of newspaper advertising expenditures, can be affected by an economic slowdown and its effect on employment, real estate transactions and automotive sales. However, growth in housing starts and automotive sales, although cyclical in nature, generally provide continued growth in newspaper advertising expenditures. PAGERS AND PAGING SERVICES THE PAGING BUSINESS The paging business, acquired by the Company in September 1996 is based in Tallahassee, Florida and operates in Columbus, Macon, Albany, Thomasville, and Valdosta, Georgia, in Dothan, Alabama, in Tallahassee, Gainesville, Orlando and Panama City, Florida and in certain contiguous areas. In 1998, the Company's paging and specialized mobile radio ("SMR") business had approximately 86,000 units in service compared to approximately 67,000 units in service in 1997. The percentage of total Company revenues contributed by the paging segment was approximately 6.6%, 6.5% and 1.9% for each of the years ended December 31, 1998, 1997 and 1996, respectively. The Company's paging system operates by connecting a telephone call placed to a local telephone number with a local paging switch. The paging switch processes a caller's information and sends the information to a link transmitter which relays the processed information to paging transmitters, which in turn alert an individual pager by means of a coded radio signal. This process provides service to a "local coverage area." To enhance coverage further to its customer base, all of the Company's local coverage areas are interconnected or networked, providing for "wide area coverage" or "network coverage." A pager's coverage area is programmable and can be customized to include or exclude any particular paging switch and its respective geographic coverage area, thereby allowing the Company's paging customers a choice of coverage areas. In addition, the Company is able to network with other paging companies which share the Company's paging frequencies in other markets, by means of an industry standard network paging protocol, in order to increase the geographic coverage area in which the Company's customers can receive paging service. A subscriber to the Company's paging services either owns a pager, thereby paying solely for the use of the Company's paging services, or leases a pager, thereby paying a periodic charge for both the pager and the paging services. Of the Company's pagers currently in service, approximately 75% are customer owned and maintained ("COAM") with the remainder being leased. In recent years, prices for pagers have fallen considerably, and thus there has been a trend toward subscriber ownership of pagers, allowing the Company to maintain lower inventory and fixed asset levels. COAM customers historically stay on service longer, thus enhancing the stability of the subscriber base and earnings. The Company is 14
PAGERS AND PAGING SERVICES (CONTINUED) THE PAGING BUSINESS (CONTINUED) focusing its marketing efforts on increasing its base of COAM users. The Company's goal is to increase the number of pagers in service, revenues and cash flow from operations by implementing a plan that focuses on improved operating methods and controls and innovative marketing programs. The Company's paging business has grown in recent years by: (i) acquiring smaller independent paging operations; (ii) expanding its resale program; (iii) increasing its retail operations, and (iv) increasing the Company's geographical coverage. INDUSTRY BACKGROUND Paging is a method of wireless communication which uses an assigned radio frequency to contact a paging subscriber within a designated service area. A subscriber carries a pager which receives messages by the broadcast of a radio signal. To contact a subscriber, a message is usually sent by placing a telephone call to the subscriber's designated telephone number. The telephone call is received by an electronic paging switch which generates a signal that is sent to radio transmitters in the subscriber's service area. The transmitters broadcast a coded signal that is unique to the pager carried by the subscriber and alerts the subscriber through a tone or vibration that there is a voice, numeric, alphanumeric or other message. Depending upon the topography of the service area, the operating radius of a radio transmitter typically ranges from three to 20 miles. Three tiers of carriers have emerged in the paging industry: (i) large nationwide providers serving multiple markets throughout the United States; (ii) regional carriers, like the Company's paging business, which operate in regional markets such as several contiguous states in one geographic region of the United States; and (iii) small, single market operators. The Company believes that the paging industry is undergoing consolidation. The paging industry has traditionally marketed its services through direct distribution by sales representatives. In recent years, additional channels of distribution have evolved, including: (i) carrier-operated retail stores; (ii) resellers, who purchase paging services on a wholesale basis from carriers and resell those services on a retail basis to their own customers; and (iii) sales agents who solicit customers and are compensated on a salary and commission basis. ADDITIONAL INFORMATION ON BUSINESS SEGMENTS Reference is made to Note J of Notes to Consolidated Financial Statements of the Company for additional information regarding business segments. COMPETITION TELEVISION INDUSTRY Competition in the television industry exists on several levels: competition for audience, competition for programming (including news) and competition for advertisers. Additional factors that are material to a television station's competitive position include signal coverage and assigned frequency. AUDIENCE. Stations compete for audience on the basis of program popularity, which has a direct effect on advertising rates. A substantial portion of the daily programming on each of the Company's 15
COMPETITION (CONTINUED) TELEVISION INDUSTRY (CONTINUED) stations is supplied by the network with which each station is affiliated. During those periods, the stations are totally dependent upon the performance of the network programs to attract viewers. There can be no assurance that such programming will achieve or maintain satisfactory viewership levels in the future. Non-network time periods are programmed by the station with a combination of self-produced news, public affairs and other entertainment programming, including news and syndicated programs purchased for cash, cash and barter, or barter only. Independent stations, whose number has increased significantly over the past decade, have also emerged as viable competitors for television viewership shares. In addition, UPN and WB have been launched recently as new television networks. The Company is unable to predict the effect, if any, that such networks will have on the future results of the Company's operations. In addition, the development of methods of television transmission of video programming other than over-the-air broadcasting, and in particular cable television, has significantly altered competition for audience in the television industry. These other transmission methods can increase competition for a broadcasting station by bringing into its market distant broadcasting signals not otherwise available to the station's audience and also by serving as a distribution system for non-broadcast programming. Historically, cable operators have not sought to compete with broadcast stations for a share of the local news audience. Recently, however, certain cable operators do compete for such audiences and the increased competition could have an adverse effect on the Company's advertising revenues. Other sources of competition include home entertainment systems, "wireless cable" services, satellite master antenna television systems, low power television stations, television translator stations and direct broadcast satellite ("DBS") video distribution services. PROGRAMMING. Competition for programming involves negotiating with national program distributors or syndicators that sell first-run and rerun packages of programming. Each station competes against the broadcast station competitors in its market for exclusive access to off-network reruns (such as SEINFELD) and first-run product (such as ENTERTAINMENT TONIGHT). Cable systems generally do not compete with local stations for programming, although various national cable networks from time to time have acquired programs that would have otherwise been offered to local television stations. Competition exists for exclusive news stories and features as well. ADVERTISING. Advertising rates are based upon the size of the market in which the station operates, a station's overall ratings, a program's popularity among the viewers that an advertiser wishes to attract, the number of advertisers competing for the available time, the demographic makeup of the market served by the station, the availability of alternative advertising media in the market area, aggressive and knowledgeable sales forces and the development of projects, features and programs that tie advertiser messages to programming. Advertising revenues comprise the primary source of revenues for the Company's stations. The Company's stations compete for such advertising revenues with other television stations and other media in their respective markets. The stations also compete for advertising revenue with other media, such as newspapers, radio stations, magazines, outdoor advertising, transit advertising, yellow page directories, direct mail and local cable systems. Competition for advertising dollars in the broadcasting industry occurs primarily within individual markets. 16
COMPETITION (CONTINUED) NEWSPAPER INDUSTRY The Company's newspapers compete for advertisers with a number of other media outlets, including magazines, radio and television, as well as other newspapers, which also compete for readers with the Company's publications. One of the Company's newspaper competitors is significantly larger than the Company and operates in two of its newspaper markets. The Company differentiates its publications from the other newspaper by focusing on local news and local sports coverage in order to compete with its larger competitor. The Company also seeks to establish its publications as the local newspaper by sponsoring special events of particular community interest. PAGING INDUSTRY The paging industry is highly competitive. Companies in the industry compete on the basis of price, coverage area offered to subscribers, available services offered in addition to basic numeric or tone paging, transmission quality, system reliability and customer service. The Company competes by maintaining competitive pricing of its product and service offerings, by providing high-quality, reliable transmission networks and by furnishing subscribers a superior level of customer service. The Company's primary competitors include those paging companies that provide wireless service in the same geographic areas in which the Company operates. The Company experiences competition from one or more competitors in all locations in which it operates. Some of the Company's competitors have greater financial and other resources than the Company. The Company's paging services also compete with other wireless communications services such as cellular service. The typical customer uses paging as a low cost wireless communications alternative either on a stand-alone basis or in conjunction with cellular services. However, future technological developments in the wireless communications industry and enhancements of current technology could create new products and services, such as personal communications services and mobile satellite services, which are competitive with the paging services currently offered by the Company. Recent and proposed regulatory changes by the FCC are aimed at encouraging such technological developments and new services and promoting competition. There can be no assurance that the Company's paging business would not be adversely affected by such technological developments or regulatory changes. FEDERAL REGULATION OF THE COMPANY'S BUSINESS TELEVISION BROADCASTING EXISTING REGULATION. Television broadcasting is subject to the jurisdiction of the FCC under the Communications Act of 1934, as amended (the "Communications Act") and the Telecommunications Act of 1996 (the "Telecommunications Act"). The Communications Act prohibits the operation of television broadcasting stations except under a license issued by the FCC and empowers the FCC, among other things, to issue, revoke and modify broadcasting licenses, determine the locations of stations, regulate the equipment used by stations, adopt regulations to carry out the provisions of the Communications Act and the Telecommunications Act and impose penalties for violation of such regulations. The Communications Act prohibits the assignment of a license or the transfer of control of a licensee without prior approval of the FCC. LICENSE GRANT AND RENEWAL. Television broadcasting licenses generally are granted or renewed for a period of eight years but may be renewed for a shorter period upon a finding by the FCC that the "public interest, convenience, and necessity" would be served thereby. The broadcast licenses for each station are 17
FEDERAL REGULATION OF THE COMPANY'S BUSINESS (CONTINUED) TELEVISION BROADCASTING (CONTINUED) effective through the following dates: WVLT - August 1, 2005; WKYT - August 1, 2005; WYMT August 1, 2005; KOLN and KGIN - June 1, 2006; WITN - December 1, 2004; WRDW - April 1, 2005; WCTV - April 1, 2005; WEAU - December 1, 2005 and WJHG - February 1, 2005, respectively. The Telecommunications Act requires a broadcast license to be renewed if the FCC finds that: (i) the station has served the public interest, convenience and necessity; (ii) there have been no serious violations of either the Telecommunications Act or the FCC's rules and regulations by the licensee; and (iii) there have been no other violations, which taken together would constitute a pattern of abuse. At the time an application is made for renewal of a television license, parties in interest may file petitions to deny, and such parties, including members of the public, may comment upon the service the station has provided during the preceding license term and urge denial of the application. If the FCC finds that the licensee has failed to meet the above-mentioned requirements, it could deny the renewal application or grant a conditional approval, including renewal for a lesser term. The FCC will not consider competing applications contemporaneously with a renewal application. Only after denying a renewal application can the FCC accept and consider competing applications for the license. Although in substantially all cases broadcast licenses are renewed by the FCC even when petitions to deny or competing applications are filed against broadcast license renewal applications, there can be no assurance that the Company's stations' licenses will be renewed. The Company is not aware of any facts or circumstances that could prevent the renewal of the licenses for its stations at the end of their respective license terms. MULTIPLE OWNERSHIP RESTRICTIONS. Currently, the FCC has rules that limit the ability of individuals and entities to own or have an ownership interest above a certain level (an "attributable" interest, as defined more fully below) in broadcast stations, as well as other mass media entities. The current rules limit the number of radio and television stations that may be owned both on a national and a local basis. On a national basis, the rules preclude any individual or entity from having an attributable interest in co-owned television stations whose aggregate audience reach exceeds 35% of all United States households. On a local basis, FCC rules currently allow an individual or entity to have an attributable interest in only one television station in a market. In addition, FCC rules and the Telecommunications Act generally prohibit an individual or entity from having an attributable interest in a television station and a radio station, daily newspaper or cable television system that is located in the same local market area served by the television station. Proposals currently before the FCC could substantially alter these standards. For example, in a pending rulemaking proceeding, the FCC suggested narrowing the geographic scope of the local television cross-ownership rule (the so-called "duopoly rule") from Grade B to Grade A contours for stations in adjacent markets and possibly permitting some two-station combinations within certain markets. The FCC has also proposed eliminating the TV-radio cross-ownership restriction (the so-called "one-to-a-market" rule) entirely or at least exempting larger markets. In addition, the FCC is seeking comment on issues of control and attribution with respect to local marketing agreements entered into by television stations. It is unlikely that this rulemaking will be concluded until late 1999 or later, and there can be no assurance that any of these rules will be changed or what will be the effect of any such change. The Telecommunications Act also directs the FCC to extend its one-to-a-market (TV-Radio) waiver policy from the top 25 to any of the top 50 markets. In addition, the Telecommunications Act directs the FCC to permit a television station to affiliate with two or more networks unless such dual or multiple networks are composed of (i) two or more of the four existing networks (ABC, CBS, NBC, or FOX) or, (ii) any of the four existing networks and one of the two emerging networks (UPN or WBN). The Company believes that Congress does not intend for these limitations to apply if such networks are not operated simultaneously, or if there is no substantial overlap in the territory served by the group of stations comprising each of such networks. The Telecommunications Act also directs the FCC to revise 18
FEDERAL REGULATION OF THE COMPANY'S BUSINESS (CONTINUED) TELEVISION BROADCASTING (CONTINUED) its rules to permit cross-ownership interests between a broadcast network and cable system. The Telecommunications Act further authorizes the FCC to consider revising its rules to permit common ownership of co-located broadcast stations and cable systems. Expansion of the Company's broadcast operations in particular areas and nationwide will continue to be subject to the FCC's ownership rules and any changes the FCC or Congress may adopt. Any relaxation of the FCC's ownership rules may increase the level of competition in one or more of the markets in which the Company's stations are located, particularly to the extent that the Company's competitors may have greater resources and thereby be in a better position to capitalize on such changes. Under the FCC's ownership rules, a direct or indirect purchaser of certain types of securities of the Company could violate FCC regulations if that purchaser owned or acquired an "attributable" or "meaningful" interest in other media properties in the same areas as stations owned by the Company or in a manner otherwise prohibited by the FCC. All officers and directors of a licensee, as well as general partners, uninsulated limited partners and stockholders who own five percent or more of the voting power of the outstanding common stock of a licensee (either directly or indirectly), generally will be deemed to have an "attributable" interest in the licensee. Certain institutional investors which exert no control or influence over a licensee may own up to 10% of the voting power of the outstanding common stock before attribution occurs. Under current FCC regulations, debt instruments, non-voting stock, certain limited partnership interests (provided the licensee certifies that the limited partners are not "materially involved" in the management and operation of the subject media property) and voting stock held by minority stockholders in cases in which there is a single majority stockholder generally are not subject to attribution. The FCC's cross-interest policy, which precludes an individual or entity from having a "meaningful" (even though not "attributable") interest in one media property and an "attributable" interest in a broadcast cable or newspaper property in the same area, may be invoked in certain circumstances to reach interests not expressly covered by the multiple ownership rules. In January 1995, the FCC released a Notice of Proposed Rule Making ("NPRM") designed to permit a "thorough review of [its] broadcast media attribution rules." Among the issues on which comment was sought are (i) whether to change the voting stock attribution benchmarks from five percent to 10% and, for passive investors, from 10% to 20%; (ii) whether there are any circumstances in which non-voting stock interests, which are currently considered non-attributable, should be considered attributable; (iii) whether the FCC should eliminate its single majority stockholder exception (pursuant to which voting interests in excess of five percent are not considered cognizable if a single majority stockholder owns more than 50% of the voting power); (iv) whether to relax insulation standards for business development companies and other widely-held limited partnerships; (v) how to treat limited liability companies and other new business forms for attribution purposes; (vi) whether to eliminate or codify the cross-interest policy; and (vii) whether to adopt a new policy which would consider whether multiple "cross interests" or other significant business relationships (such as time brokerage agreements, debt relationships or holdings of nonattributable interests), which individually do not raise concerns, raise issues with respect to diversity and competition. At this time, the Company is unable to predict when this inquiry will be completed and there can be no assurance that any of these standards will be changed. Should the attribution rules be changed, the Company is unable to predict what, if any, effect it would have on the Company or its activities. To the best of the Company's knowledge, no officer, director or five percent stockholder of the Company currently holds an attributable interest in another television station, radio station, cable television system or daily newspaper that is inconsistent with the FCC's ownership rules and policies or with ownership by the Company of its stations. 19
FEDERAL REGULATION OF THE COMPANY'S BUSINESS (CONTINUED) TELEVISION BROADCASTING (CONTINUED) ALIEN OWNERSHIP RESTRICTIONS. The Communications Act restricts the ability of foreign entities or individuals to own or hold interests in broadcast licenses. Foreign governments, representatives of foreign governments, non-citizens, representatives of non-citizens, and corporations or partnerships organized under the laws of a foreign nation are barred from holding broadcast licenses. Non-citizens, collectively, may directly or indirectly own or vote up to 20% of the capital stock of a licensee. In addition, a broadcast license may not be granted to or held by any corporation that is controlled, directly or indirectly, by any other corporation more than one-fourth of whose capital stock is owned or voted by non-citizens or their representatives or by foreign governments or their representatives, or by non-U.S. corporations, if the FCC finds that the public interest will be served by the refusal or revocation of such license. The Company has been advised that the FCC staff has interpreted this provision of the Communications Act to require an affirmative public interest finding before a broadcast license may be granted to or held by any such corporation and the FCC has made such an affirmative finding only in limited circumstances. The Company, which serves as a holding company for wholly-owned subsidiaries that are licensees for its stations, therefore may be restricted from having more than one-fourth of its stock owned or voted directly or indirectly by non-citizens, foreign governments, representatives of non-citizens or foreign governments, or foreign corporations. RECENT DEVELOPMENTS. Congress has recently enacted legislation and the FCC currently has under consideration or is implementing new regulations and policies regarding a wide variety of matters that could affect, directly or indirectly, the operation and ownership of the Company's broadcast properties. In addition to the proposed changes noted above, such matters include, for example, the license renewal process (particularly the weight to be given to the expectancy of renewal for an incumbent broadcast licensee and the criteria to be applied in deciding contested renewal applications), spectrum use fees, political advertising rates, potential advertising restrictions on the advertising of certain products (hard liquor), the rules and policies to be applied in enforcing the FCC's equal employment opportunity regulations, cable carriage of digital television signals, viewing of distant network signals by direct broadcast satellite services, and the standards to govern evaluation of television programming directed toward children and violent and indecent programming (including the possible requirement of what is commonly referred to as the "v-chip," which would permit parents to program television sets so that certain programming would not be accessible by children). Other matters that could affect the Company's broadcast properties include technological innovations and developments generally affecting competition in the mass communications industry, such as the recent initiation of direct broadcast satellite service, and the continued establishment of wireless cable systems and low power television stations. The FCC presently is seeking comment on its policies designed to increase minority ownership of mass media facilities. Congress also recently enacted legislation that eliminated the minority tax certificate program of the FCC, which gave favorable tax treatment to entities selling broadcast stations to entities controlled by an ethnic minority. In addition, a recent federal appeals court decision has cast doubt upon the continued validity of many of the FCC's programs designed to increase minority employment in the broadcast industry. DISTRIBUTION OF VIDEO SERVICES BY TELEPHONE COMPANIES. Recent actions by the FCC, Congress and the courts all presage significant future involvement in the provision of video services by telephone companies. The Company cannot predict either the timing or the extent of such involvement. THE 1992 CABLE ACT. On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act"). The FCC began implementing the requirements of the 1992 Cable Act in 1993 and final implementation proceedings remain pending 20
FEDERAL REGULATION OF THE COMPANY'S BUSINESS (CONTINUED) TELEVISION BROADCASTING (CONTINUED) regarding certain of the rules and regulations previously adopted. Certain statutory provisions, such as signal carriage, retransmission consent and equal employment opportunity requirements, have a direct effect on television broadcasting. Other provisions are focused exclusively on the regulation of cable television but can still be expected to have an indirect effect on the Company because of the competition between over-the-air television stations and cable systems. The signal carriage, or "must carry," provisions of the 1992 Cable Act require cable operators to carry the signals of local commercial and non-commercial television stations and certain low power television stations. Systems with 12 or fewer usable activated channels and more than 300 subscribers must carry the signals of at least three local commercial television stations. A cable system with more than 12 usable activated channels, regardless of the number of subscribers, must carry the signals of all local commercial television stations, up to one-third of the aggregate number of usable activated channels of such system. The 1992 Cable Act also includes a retransmission consent provision that prohibits cable operators and other multi-channel video programming distributors from carrying broadcast stations without obtaining their consent in certain circumstances. The "must carry" and retransmission consent provisions are related in that a local television broadcaster, on a cable system-by-cable-system basis, must make a choice once every three years whether to proceed under the "must carry" rules or to waive that right to mandatory but uncompensated carriage and negotiate a grant of retransmission consent to permit the cable system to carry the station's signal, in most cases in exchange for some form of consideration from the cable operator. Cable systems must obtain retransmission consent to carry all distant commercial stations other than certain "super stations" delivered via satellite. Under rules adopted to implement these "must carry" and retransmission consent provisions, local television stations are required to make an election of "must carry" or retransmission consent at three year intervals. Stations that fail to elect are deemed to have elected carriage under the "must carry" provisions. Other issues addressed in the FCC rules are market designations, the scope of retransmission consent and procedural requirements for implementing the signal carriage provisions. Each of the Company's stations has elected "must carry" status on certain cable systems in its DMA; on others the Company's stations have entered into retransmission consent agreements. This election entitled the Company's stations to carriage on those systems until at least December 31, 1999. DIGITAL TELEVISION SERVICE. The FCC has proposed the adoption of rules for implementing advanced television ("DTV") service in the United States. Implementation of digital DTV will improve the technical quality of television signals receivable by viewers and will provide broadcasters the flexibility to offer new services, including high-definition television ("HDTV"), simultaneous broadcasting of multiple programs of standard definition television ("SDTV") and data broadcasting. The FCC must adopt DTV service rules and a table of DTV allotments before broadcasters can provide these services enabled by the new technology. On July 28, 1995, the FCC announced the issuance of a NPRM to invite comment on a broad range of issues related to the implementation of DTV, particularly the transition to digital broadcasting. The FCC announced that the anticipated role of digital broadcasting will cause it to revisit certain decisions made in an earlier order. The FCC also announced that broadcasters will be allowed greater flexibility in responding to market demand by transmitting a mix of HDTV, SDTV and perhaps other services. In February 1998, the FCC acted on numerous petitions for reconsideration and issued a new table of allotments that expands the channels (2-51) available for permanent digital broadcasting operations. 21
FEDERAL REGULATION OF THE COMPANY'S BUSINESS (CONTINUED) TELEVISION BROADCASTING (CONTINUED) The Telecommunications Act directs the FCC, if it issues licenses for DTV, to limit the initial eligibility for such licenses to incumbent broadcast licensees. It also authorizes the FCC to adopt regulations that would permit broadcasters to use such spectrum for ancillary or supplementary services. The FCC will assign all existing television licensees a second channel on which to provide DTV simultaneously with their current NTSC service. It is possible after a period of years that broadcasters would be required to cease NTSC operations, return the NTSC channel to the FCC, and broadcast only with the newer digital technology. Some members of Congress have advocated authorizing the FCC to auction either NTSC or DTV channels; however, the Telecommunications Act allows the FCC to determine when such licenses will be returned and how to allocate returned spectrum. Under certain circumstances, conversion to DTV operations would reduce a station's geographical coverage area but the majority of stations will obtain service areas that match or exceed the limits of existing operations. Due to additional equipment costs, implementation of DTV will impose some near-term financial burdens on television stations providing the service. At the same time, there is a potential for increased revenues to be derived from DTV, partially from operations or expanded channel capacity through multicasting. Although the Company believes the FCC will authorize DTV in the United States, The Company cannot predict precisely the overall effect the transition to DTV might have on the Company's business. DIRECT BROADCASTING SATELLITE SYSTEMS. The FCC has authorized DBS, a service which provides video programming via satellite directly to home subscribers. Local broadcast stations and broadcast network programming are not carried on DBS systems. Proposals recently advanced in the Telecommunications Act include a prohibition on restrictions that inhibit a viewer's ability to receive video programming through DBS services. The FCC has exclusive jurisdiction over the regulation of DBS service. The Company cannot predict the impact of this new service upon the Company's business or the impact of possible legislation on the growth of DBS service. PAGING AND SMR FEDERAL REGULATION. The Company's paging and SMR operations, acquired by the Company in September 1996, are subject to regulation by the FCC under the Communications Act. The FCC has granted the Company licenses to use the radio frequencies necessary to conduct its paging and SMR operations. Licenses issued by the FCC to the Company set forth the technical parameters, such as signal strength and tower height, under which the Company is authorized to use those frequencies. LICENSE GRANT AND RENEWAL. The FCC licenses granted to the Company are for varying terms of up to 10 years, at the end of which renewal applications must be approved by the FCC. The Company holds various FCC radio licenses which are used in connection with its paging and SMR operations. The license expiration dates for these licenses are staggered, with only a portion of the licenses expiring in any particular calendar year. The largest group of licenses will expire during calendar year 1999. Licensees in the paging and SMR services normally enjoy a license renewal expectancy and the vast majority of license renewal applications are granted in the normal course. Although the Company is unaware of any circumstances which could prevent the grant of renewal applications, no assurance can be given that any of the Company's licenses will be free of competing applications or will be renewed by the FCC. Furthermore, the FCC has the authority to restrict the operations of licensed facilities or to revoke or modify licenses. None of the Company's licenses have ever been revoked or modified involuntarily, and such proceedings by the FCC are rarely undertaken. 22
FEDERAL REGULATION OF THE COMPANY'S BUSINESS (CONTINUED) PAGING AND SMR (CONTINUED) Pursuant to Congressional mandate, the FCC has adopted rules regarding the award of site-by-site and market area license authorizations by competitive bidding. Pursuant to those rules, the FCC may award licenses for new or existing services by auction, as done with the 800 MHz and 900 MHz SMR bands, and as it has proposed to do so with the paging services. Accordingly, there can be no assurance that the Company will be able to procure additional spectrum, or expand its existing paging and SMR networks into new service areas. The winner of the geographic area license has the right to use a certain frequency or block of frequencies throughout the licensed service area, may construct and operate its transmitters in its authorized service area without prior FCC approval, provided that the construction of the transmitter would not constitute a major environmental action under the FCC rules. The market area licensee is required, however, to protect incumbent licensees from the potential for harmful co-channel interference. The FCC has completed auctions to license various radio services on a market area basis including the first phase of the 800 MHz trunked SMR auction, which concluded in December 1997. In these auctions, successful bidders have made significant auction payments in order to obtain spectrum. The Company was the high bidder for the Tallahassee, Florida; Albany and Columbus, Georgia and Auburn, Alabama Economic Area Markets. The Company has received grants of its market area licenses. The FCC has conditioned the continued validity of these licenses on the Company meeting certain coverage benchmarks, which the Company believes will be attained. In this regard, the Company enterd into an asset purchase agreement with Nextel South Corporation (Nextel) for the purchase and sale of its 800MHz geographic area licenses covering the Tallahassee, Florida; Albany and Columbus, Georgia Economic Areas. Prior FCC consent to the proposed transaction is required before the Company may consumate the sale to Nextel. The Company anticipates that it will obtain the FCC's consent to the transaction in the normal course, although it is possible a competitor could file a protest against the transaction. In the event a protest is filed, any grant of the FCC's consent would be delayed, or could possibly be withheld. With respect to its paging operations, the Company may choose to participate in the market area licensing auctions for the paging services. The first such auction, for the 900 MHz paging band is tentatively scheduled for calendar year 1999. The lower paging bands, e.g., the exclusive 150 Mhz frequencies on which the Company is licensed, are likely to be the subject of market area licensing auctions in calendar year 2000. There is no assurance that the Company will be able to successfully bid on its existing frequencies; however, the market area licensee will be required to protect the Company and any other incumbent licensees from the potential for harmful co-channel interference. EMPLOYEES As of March 11, 1999, the Company had 1,233 full-time employees, of which 757 were employees of the Company's stations, 393 were employees of the Company's publications, 70 were employees of the Company's paging operations and 13 were corporate and administrative personnel. None of the Company's employees are represented by unions. The Company believes that its relations with its employees are satisfactory. 23
ITEM 2. PROPERTIES The Company's principal executive offices are located at 4370 Peachtree Road, NE, Atlanta, Georgia, 30319. The types of properties required to support television stations include offices, studios, transmitter sites and antenna sites. The types of properties required to support newspaper publishing include offices, facilities for the printing press and production and storage. A station's studios are generally housed with its offices in business districts. The transmitter sites and antenna are generally located in elevated areas to provide optimal signal strength and coverage. The following table sets forth certain information regarding the Company's properties. TELEVISION BROADCASTING <TABLE> <CAPTION> Station/Approximate Owned or Property Location Use Leased Approximate Size Expiration of Lease - -------------------------------------------------------------------------------- -------------------- <S> <C> <C> <C> <C> WKYT Lexington, KY Office, studio and Owned 34,500 sq. ft. -- transmission tower site building on 20 acres WYMT Hazard, KY Office and studio Owned 21,200 sq. ft. -- building on 2 acres Hazard, KY Transmission tower site Leased -- June 2005 Hazard, KY Transmitter building and improvements Owned 1,248 sq. ft. -- WRDW North Augusta, SC Office and studio Owned 17,000 sq. ft. -- Transmission tower site Owned 143 acres -- WJHG Panama City, FL Office and studio Owned 14,000 sq. ft. -- Youngstown, FL Transmission tower site Owned 17 acres -- WVLT Knoxville, TN Office and studio Owned 18,000 sq. ft. -- Transmission tower site Leased Tower space Month to Month WCTV Tallahassee, FL Office and studio Owned 20,000 sq. ft. on Leased 37 acres Dec. 2014 Metcalf, GA Transmission tower site Leased 182 acres Nov. 1999 WEAU Eau Claire, WI Office and studio Owned 16,116 sq. ft. of -- buildings on 2 acres Township of Transmitter building Owned 2,304 sq. ft. -- Fairchild, WI & Transmission tower site building on 6 acres </TABLE> 24
TELEVISION BROADCASTING (CONTINUED) <TABLE> <CAPTION> Station/Approximate Owned or Property Location Use Leased Approximate Size Expiration of Lease - -------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> KOLN Beaver Crossing, NE Transmission tower site Owned 120 acres -- Lincoln, NE Office and studio Owned 28,044 sq. ft. -- building on 5 acres Bradshaw, NE Transmission tower site Owned 8 acres -- KGIN Heartwell, NE Transmission tower site Owned 71 acres -- Grand Island, NE Office and studio Leased 5,153 sq. ft. Dec. 1999 WITN Washington, NC Office and studio Owned 19,600 sq. ft. -- Grifton, NC Transmitter building Owned 4,190 sq. ft. -- Grifton, NC Transmission tower site Leased 9 acres Jan. 2000 Lynqx Communications Baton Rouge, LA Office and repair site Leased 6,800 sq. ft. Dec. 1999 Tallahassee, FL Office Owned 1,000 sq. ft. -- PUBLISHING Approximate Owned or Property Location Use Leased Approximate Size Expiration of Lease - -------------------------------------------------------------------------------------------------- The Albany Herald Publishing Company, Inc. Albany, GA Offices, printing Owned 83,000 sq. ft. -- press and production facility for The Albany Herald Publishing Company, Inc. The Rockdale Citizen Publishing Company Conyers, GA Offices for The Owned 20,000 sq. ft. -- Rockdale Citizen Conyers, GA Offices, printing Leased 20,000 sq. ft. May 2002 press and production facility for The Rockdale Citizen and the Gwinnett Daily Post Lawrenceville, GA Offices for the Leased 11,000 sq. ft. Nov. 1999 Gwinnett Daily Post 25
PAGING Approximate Owned or Property Location Use Leased Approximate Size Expiration of Lease - -------------------------------------------------------------------------------------------------- Albany, GA Sales Office Leased 1,500 sq. ft. May 2001 Columbus, GA Sales Office Leased 1,000 sq. ft. July 2001 Macon Road #2 Sales Office Leased 1,200 sq. ft. Jan. 2001 Veterans Parkway Sales Office Leased 300 sq. ft. Month to Month Cross Co. Sales Office Leased 1,374 sq. ft. June 2002 Lumpkin Road Sales Office Leased 2,800 sq. ft. May 2002 Dothan, AL Sales Office Leased 800 sq. ft. Feb. 2000 Macon, GA Sales Office Leased 1,260 sq. ft. July 1999 Tallahassee, FL Sales Office Leased 1,800 sq. ft. Sept. 2000 Tallahassee, FL General and Leased 2,400 sq. ft. Mar. 2002 Administrative Office Thomasville, GA Sales Office Leased 300 sq. ft. May 2000 Valdosta, GA Sales Office Leased 800 sq. ft. Oct. 2000 Panama City, FL Sales Office Leased 1,050 sq. ft. Jan. 2001 Gainesville, FL Sales Office Leased 1,100 sq. ft. Oct. 2000 Orlando, FL Sales Office Leased 2,000 sq. ft. Apr. 2001 Melbourne, FL Sales Office Leased 960 sq. ft. Sept. 2001 Kissimmee, FL Sales Office Leased 840 sq. ft. Nov. 2001 Tampa, FL Sales Office Leased 300 sq. ft. Month to month Lakeland, FL Sales Office Leased 300 sq. ft. Month to month </TABLE> The paging operations also lease space on various towers in Florida, Georgia and Alabama. These tower leases have expiration dates ranging from 1999 to 2002. ITEM 3. LEGAL PROCEEDINGS The Company is not party to any legal proceedings in which an adverse outcome would have a material adverse effect, either individually or in the aggregate, upon the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders of the Company during the fourth quarter of the fiscal year covered. 26
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Since June 30, 1995, the Company's Class A Common Stock, no par value, (the "Class A Common Stock') has been listed and traded on The New York Stock Exchange (the "NYSE") under the symbol "GCS." Since September 24, 1996, the date of its initial issuance, the Company's Class B Common Stock, no par value, (the "Class B Common Stock") has also been listed and traded on the NYSE under the symbol "GCS.B". The following table sets forth the high and low sale prices of the Class A Common Stock and Class B Common Stock as well as the cash dividend declared for the periods indicated. The high and low sales prices of the Class A Common Stock and the Class B Common Stock are as reported by the NYSE. On August 20, 1998, the Board of Directors declared a 50% stock dividend, payable on September 30, 1998, to stockholders of record of the Class A Common Stock and Class B Common Stock on September 16, 1998. This stock dividend effected a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. <TABLE> <CAPTION> CLASS A COMMON STOCK CLASS B COMMON STOCK ------------------------------------------------------------------- CASH CASH DIVIDENDS DIVIDENDS DECLARED DECLARED HIGH LOW PER SHARE HIGH LOW PER SHARE --------------------- ---------------------- ---------------------- <S> <C> <C> <C> <C> <C> <C> FISCAL 1998 First Quarter $19.67 $16.00 $0.013 $19.33 $15.75 $0.013 Second Quarter 21.75 19.33 0.013 20.58 19.00 0.013 Third Quarter 22.00 18.83 0.013 21.50 16.54 0.013 Fourth Quarter 19.00 16.63 0.020 16.63 12.50 0.020 FISCAL 1997 First Quarter $13.83 $11.75 $0.013 $13.00 $10.92 $0.013 Second Quarter 14.96 11.17 0.013 13.92 10.25 0.013 Third Quarter 17.08 13.54 0.013 17.00 12.58 0.013 Fourth Quarter 18.58 16.67 0.013 17.42 16.04 0.013 </TABLE> As of March 11, 1999, the Company had 6,832,042 outstanding shares of Class A Common Stock held by 1,111 stockholders and 5,125,465 outstanding shares of Class B Common Stock held by 951 stockholders. The number of stockholders includes stockholders of record and individual participants in security position listings as furnished to the Company pursuant to Rule 17Ad-8 under the Exchange Act. The Company has paid a dividend on its Class A Common Stock since 1967. In 1996 the Company amended its Articles of Incorporation to provide that each share of Class A Common Stock is entitled to 10 votes and each share of Class B Common Stock is entitled to one vote. The Articles of Incorporation, as amended, require that the Class A Common Stock and the Class B Common Stock receive dividends on a PARI PASSU basis. There can be no assurance of the Company's ability to continue to pay any dividends on either class of Common Stock. The Senior Credit Facility and the Company's Senior Subordinated Notes due 2006 (the "Notes") each contain covenants that restrict the ability of the Company to pay dividends on its capital stock. However, the Company does not believe that such convenants currently limit its ability to pay dividends at the recent quarterly rate of $0.02 per share. In addition to the foregoing, the declaration and payment of dividends on the Class A Common Stock and the Class B Common Stock are subject to the discretion of the Board of Directors. Any future payments of dividends will depend on the earnings and financial position of the Company and such other factors as the Board of Directors deems relevant. 27
ITEM 6. SELECTED FINANCIAL DATA Set forth below are certain selected historical consolidated financial data of the Company. This information should be read in conjunction with the Audited Consolidated Financial Statements of the Company and related notes thereto appearing elsewhere herein and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations of the Company." The selected consolidated financial data for, and as of the end of, each of the years in the five-year period ended December 31, 1998, are derived from the Audited Consolidated Financial Statements of the Company and its subsidiaries. Also see pro forma data for the Busse-WALB Transactions, WITN Acquisition, the GulfLink Acquisition, the First American Acquisition, the Augusta Acquisition and the KTVE Sale in Note B to the Company's Audited Consolidated Financial Statements included elsewhere herein. <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1998(1) 1997(2) 1996 (3) 1995 (4) 1994 -------------------------------------------------------- (IN THOUSANDS EXCEPT PER SHARE DATA) <S> <C> <C> <C> <C> <C> STATEMENTS OF OPERATIONS DATA Revenues $128,890 $103,548 $79,305 $ 58,616 $36,518 Operating income (5) 24,927 20,730 16,079 6,860 6,276 Income (loss) from continuing operations 41,659 (1,402) 5,678 931 2,766 Income (loss) from continuing operations available to common stockholders 40,342 (2,812) 5,302 931 2,766 Income (loss) from continuing operations available to common stockholders per common share (6)(7): Basic 3.38 (0.24) 0.65 0.14 0.39 Diluted 3.25 (0.24) 0.62 0.14 0.39 Cash dividends per common share (6)(7) $ 0.06 $ 0.05 $ 0.05 $ 0.05 $ 0.05 BALANCE SHEET DATA (AT END OF PERIOD): Total assets $468,974 $ 345,051 $298,664 $78,240 $68,789 Long-term debt (including current portion) 270,655 227,076 173,368 54,324 52,940 Total stockholders' equity $126,703 $ 92,295 $95,226 $ 8,986 $ 5,001 </TABLE> (1) The financial data reflects the operating results of the Busse-WALB Transactions, which were completed on July 31, 1998, as of their respective acquisition dates. See Note B to the Company's Audited Consolidated Financial Statements included elsewhere herein. (2) The financial data reflects the operating results of the WITN Acquisition and the GulfLink Acquisition, which were completed in 1997, as of their respective acquisition dates. See Note B to the Company's Audited Consolidated Financial Statements included elsewhere herein. (3) The financial data reflects the operating results of the Augusta Acquisition and the First American Acquisition, as well as the KTVE Sale, all of which were completed in 1996, as of their respective acquisition, or disposition dates. The Company also incurred an extraordinary charge in connection with the early extinguishment of debt. See Notes B and C to the Company's Audited Consolidated Financial Statements included elsewhere herein. (4) The financial data reflects the operating results of the acquisition of The Gwinnett Daily Post in January 1995. 28
(5) Operating income excludes gain on disposition of television stations of $70.6 million recognized for the exchange of WALB in 1998 and $5.7 million recognized for the sale of KTVE in 1996. (6) On August 20, 1998, the Company's Board of Directors declared a 50% stock dividend, payable on September 30, 1998, to stockholders of record of the Class A Common Stock and Class B Common Stock on September 16, 1998. This stock dividend effected a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. (7) On August 17, 1995, the Company's Board of Directors authorized a 50% stock dividend on the Company's Class A Common Stock payable October 2, 1995 to stockholders of record on September 8, 1995 to effect a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. THESE SUMMARIES SHOULD BE READ IN CONJUNCTION WITH THE RELATED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED UNDER ITEM 8. 29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS OF THE COMPANY INTRODUCTION The following analysis of the financial condition and results of operations of Gray Communications Systems, Inc. (the "Company") should be read in conjunction with the Company's Audited Consolidated Financial Statements and notes thereto included elsewhere herein. On July 31, 1998, the Company completed the purchase of all of the outstanding capital stock of Busse Broadcasting Corporation ("Busse"). The purchase price was $120.5 million less the accreted value of Busse's 11 5/8% Senior Secured Notes due 2000 ("Busse Senior Notes"). The purchase price of the capital stock consisted of the contractual purchase price of $112.0 million, associated transaction costs of $2.9 million and Busse's cash and cash equivalents of $5.6 million. Immediately following the acquisition of Busse, the Company exercised its right to satisfy and discharge the Busse Senior Notes, effectively prefunding the Busse Senior Notes at the October 15, 1998 call price of 106 plus accrued interest. The amount necessary to satisfy and discharge the Busse Senior Notes was approximately $69.9 million. Based on the preliminary allocation of the purchase price, the excess of the purchase price over the fair value of net tangible assets acquired was approximately $122.8 million. Immediately prior to the Company's acquisition of Busse, Cosmos Broadcasting Corporation acquired the assets of WEAU-TV ("WEAU") from Busse and exchanged them for the assets of WALB-TV, Inc. ("WALB"), the Company's NBC affiliate in Albany, Georgia. In exchange for the assets of WALB, the Company received the assets of WEAU, which were valued at $66.0 million, and approximately $12.0 million in cash for a total value of $78.0 million. The Company recognized a pre-tax gain of approximately $70.6 million and estimated deferred income taxes of approximately $27.5 million in connection with the exchange of WALB. The Company funded the remaining costs of the acquisition of Busse's capital stock through its $200.0 million bank loan agreement (the "Senior Credit Facility"). The transactions described above are referred to herein as the "Busse-WALB Transactions." On August 1, 1997 the Company purchased substantially all of the assets of WITN-TV ("WITN"), the NBC affiliate in the Greenville-New Bern-Washington, North Carolina market (the "WITN Acquisition"). The WITN Acquisition purchase price of approximately $41.7 million consisted of $40.7 million cash, $600,000 in acquisition related costs and approximately $400,000 in liabilities that were assumed by the Company. On April 24, 1997, the Company purchased all of the issued and outstanding common stock of GulfLink Communications, Inc. (the "GulfLink Acquisition"), which is in the transportable satellite uplink business, a business in which the Company was already engaged. The GulfLink Acquisition purchase price of approximately $5.2 million consisted of $4.1 million cash, $127,000 in acquisition related costs and approximately $1.0 million in liabilities that were assumed by the Company. During 1998, the Company consolidated all of its transportable satellite uplink operations under the name Lynqx Communications, Inc. In September 1996, the Company acquired substantially all of the assets of WKXT-TV ("WKXT"), WCTV-TV ("WCTV"), a satellite uplink and production services business and a communications and paging business (the "First American Acquisition"). The purchase price of approximately $183.9 million consisted of $175.5 million cash, $1.8 million in acquisition related costs and the assumption of approximately $6.6 million of liabilities. Subsequent to the First American Acquisition, the Company rebranded WKXT with the call letters WVLT ("WVLT"). On January 4, 1996, the Company purchased substantially all of the assets of WRDW-TV (the "Augusta Acquisition"). The purchase price of approximately $37.2 million included assumed liabilities of approximately $1.3 million. The First 30
RESULTS OF OPERATIONS OF THE COMPANY (CONTINUED) INTRODUCTION (CONTINUED) American Acquisition and the Augusta Acquisition are collectively referred to as the "1996 Acquisitions." The Company sold the assets of KTVE Inc. (the "KTVE Sale"), its NBC-affiliated television station, in Monroe, Louisiana-El Dorado, Arkansas on August 20, 1996. The sales price included $9.5 million in cash plus the amount of the accounts receivable on the date of closing to the extent collected by the buyer, to be paid to the Company within 150 days following the closing date (approximately $829,000). The Company recognized a pre-tax gain of approximately $5.7 million and estimated income taxes of approximately $2.8 million in connection with the sale. As a result of these acquisitions, the proportion of the Company's revenues derived from television broadcasting has increased significantly. The Company anticipates that the proportion of the Company's revenues derived from television broadcasting will increase further as a result of the completed acquisitions. As a result of the higher operating margins associated with the Company's television broadcasting operations, the profit contribution of these operations as a percentage of revenues, has exceeded, and is expected to continue to exceed, the profit contributions of the Company's publishing and paging operations. Set forth below, for the periods indicated, is certain information concerning the relative contributions of the Company's television broadcasting, publishing and paging operations (dollars in thousands). <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------------- 1998 1997 1996 ------------------- -------------------- -------------------- PERCENT PERCENT PERCENT AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL ---------- -------- --------- ---------- ---------- --------- <S> <C> <C> <C> <C> <C> <C> BROADCASTING Revenues $91,007 70.6% $72,300 69.8% $54,981 69.3% Operating income(1) 23,327 83.1% 19,309 82.9% 16,989 84.0% PUBLISHING Revenues $29,330 22.8% $24,536 23.7% $22,845 28.8% Operating income(1) 3,579 12.8% 2,810 12.1% 3,167 15.7% PAGING Revenues $ 8,553 6.6% $ 6,712 6.5% $ 1,479 1.9% Operating income(1) 1,161 4.1% 1,181 5.0% 71 0.3% </TABLE> (1) Represents income before miscellaneous income (expense), allocation of corporate overhead, interest expense, income taxes and extraordinary charge. Operating income excludes gain on disposition of television stations of $70.6 million recognized for the exchange of WALB in 1998 and $5.7 million recognized for the KTVE Sale in 1996. The Company derives its revenues from its television broadcasting, publishing and paging operations. The operating revenues of the Company's television stations are derived from broadcast advertising revenues and, to a much lesser extent, from compensation paid by the networks to the stations for broadcasting network programming. The operating revenues of the Company's publishing operations are derived from advertising, circulation and classified revenue. Paging revenue is derived primarily from the leasing and sale of pagers. 31
RESULTS OF OPERATIONS OF THE COMPANY (CONTINUED) INTRODUCTION (CONTINUED) In the Company's broadcasting operations, broadcast advertising is sold for placement either preceding or following a television station's network programming and within local and syndicated programming. Broadcast advertising is sold in time increments and is priced primarily on the basis of a program's popularity among the specific audience an advertiser desires to reach, as measured by Nielsen Media Research ("Nielsen"). In addition, broadcast advertising rates are affected by the number of advertisers competing for the available time, the size and demographic makeup of the market served by the station and the availability of alternative advertising media in the market area. Broadcast advertising rates are the highest during the most desirable viewing hours, with corresponding reductions during other hours. The ratings of a local station affiliated with a major network can be affected by ratings of network programming. Most broadcast advertising contracts are short-term, and generally run only for a few weeks. Approximately 52% of the gross revenues of the Company's television stations for the year ended December 31, 1998, were generated from local advertising, which is sold primarily by a station's sales staff directly to local accounts, and the remainder represented primarily by national advertising, which is sold by a station's national advertising sales representative. The stations generally pay commissions to advertising agencies on local, regional and national advertising and the stations also pay commissions to the national sales representative on national advertising. Broadcast advertising revenues are generally highest in the second and fourth quarters each year, due in part to increases in consumer advertising in the spring and retail advertising in the period leading up to and including the holiday season. In addition, broadcast advertising revenues are generally higher during even numbered election years due to spending by political candidates, which spending typically is heaviest during the fourth quarter. The Company's publishing operations' advertising contracts are generally entered into annually and provide for a commitment as to the volume of advertising to be purchased by an advertiser during the year. The publishing operations' advertising revenues are primarily generated from local advertising. As with the broadcasting operations, the publishing operations' revenues are generally highest in the second and fourth quarters of each year. The Company's paging subscribers either own pagers, thereby paying solely for the use of the Company's paging services, or lease pagers, thereby paying a periodic charge for both the pagers and the paging services. The terms of the lease contracts are month-to-month, three months, six months or twelve months in duration. Paging revenues are generally equally distributed throughout the year. The broadcasting operations' primary operating expenses are employee compensation, related benefits and programming costs. The publishing operations' primary operating expenses are employee compensation, related benefits and newsprint costs. The paging operations' primary operating expenses are employee compensation and telephone and other communications costs. In addition, the broadcasting, publishing and paging operations incur overhead expenses, such as maintenance, supplies, insurance, rent and utilities. A large portion of the operating expenses of the broadcasting, publishing and paging operations is fixed, although the Company has experienced significant variability in its newsprint costs in recent years. 32
RESULTS OF OPERATIONS OF THE COMPANY (CONTINUED) INTRODUCTION (CONTINUED) The following table sets forth certain operating data for the broadcast, publishing and paging operations for the years ended December 31, 1998, 1997 and 1996 (in thousands). YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------------------------------- Operating income (1) $24,927 $20,730 $16,079 Add: Amortization of program license rights 4,251 3,501 2,743 Depreciation and amortization 18,117 14,519 7,663 Corporate overhead 3,063 2,528 3,219 Non-cash compensation and contribution to 401(k) plan, paid in Common Stock 476 412 1,125 Less: Payments for program license liabilities (4,210) (3,629) (2,877) ------- ------- ------- Media Cash Flow (2) $46,624 $38,061 $27,952 ======= ======= ======= (1) Operating income excludes gain on disposition of television stations of $70.6 million recognized for the exchange of WALB in 1998 and $5.7 million recognized for the KTVE Sale in 1996. (2) Of Media Cash Flow, $38.4 million, $30.5 million and $22.6 million was attributable to the Company's broadcasting operations in 1998, 1997 and 1996, respectively; $5.2 million, $4.9 million and $5.0 million was attributable to the Company's publishing operations in 1998, 1997 and 1996, respectively; and $3.0 million, $2.7 million and $401,000 was attributable to the Company's paging operations in 1998, 1997 and 1996, respectively. "MEDIA CASH FLOW" IS DEFINED AS OPERATING INCOME, PLUS DEPRECIATION AND AMORTIZATION (INCLUDING AMORTIZATION OF PROGRAM LICENSE RIGHTS), NON-CASH COMPENSATION AND CORPORATE OVERHEAD, LESS PAYMENTS FOR PROGRAM LICENSE LIABILITIES. THE COMPANY HAS INCLUDED MEDIA CASH FLOW DATA BECAUSE SUCH DATA ARE COMMONLY USED AS A MEASURE OF PERFORMANCE FOR MEDIA COMPANIES AND ARE ALSO USED BY INVESTORS TO MEASURE A COMPANY'S ABILITY TO SERVICE DEBT. MEDIA CASH FLOW IS NOT, AND SHOULD NOT BE USED AS, AN INDICATOR OR ALTERNATIVE TO OPERATING INCOME, NET INCOME OR CASH FLOW AS REFLECTED IN THE COMPANY'S AUDITED CONSOLIDATED FINANCIAL STATEMENTS, AND IS NOT A MEASURE OF FINANCIAL PERFORMANCE UNDER GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND SHOULD NOT BE CONSIDERED IN ISOLATION OR AS A SUBSTITUTE FOR MEASURES OF PERFORMANCE PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. CASH FLOW PROVIDED BY (USED IN) OPERATING, INVESTING AND FINANCING ACTIVITIES The following table sets forth certain cash flow data for the Company for the years ended December 31, 1998, 1997 and 1996 (in thousands). YEAR ENDED DECEMBER 31, -------------------------------------- 1998 1997 1996 -------------------------------------- Cash flows provided by (used in) Operating activities $ 20,074 $ 9,744 $ 12,092 Investing activities (55,299) (57,498) (205,068) Financing activities 34,744 49,071 193,467 33
RESULTS OF OPERATIONS OF THE COMPANY (CONTINUED) BROADCASTING, PUBLISHING AND PAGING REVENUES As discussed in the INTRODUCTION, the Company exchanged the assets of WALB for the assets of WEAU and acquired Busse which included KOLN-TV("KOLN") and KGIN-TV ("KGIN") during 1998. The Company completed the WITN Acquisition and the GulfLink Acquisition during 1997. WEAU, KOLN and KGIN are collectively referred to as the "Busse Stations." Set forth below are the principal types of broadcasting, publishing and paging revenues earned by the Company's television stations, publishing and paging operations for the periods indicated and the percentage contribution of each of the Company's total broadcasting, publishing and paging revenues, respectively (dollars in thousands): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------------- 1998 1997 1996 ------------------- -------------------- -------------------- AMOUNT % AMOUNT % AMOUNT % --------- --------- ---------- --------- ---------- --------- <S> <C> <C> <C> <C> <C> <C> BROADCASTING Net Revenues: Local $ 47,258 36.7% $ 40,486 39.1% $30,046 37.9% National 23,824 18.5% 21,563 20.8% 15,611 19.7% Network compensation 5,549 4.3% 4,977 4.8% 3,661 4.6% Political 7,876 6.1% 137 0.1% 3,612 4.6% Production and other 6,500 5.0% 5,137 5.0% 2,051 2.5% -------- ------ -------- ------ ------- ------ $ 91,007 70.6% $ 72,300 69.8% $54,981 69.3% ======== ====== ======== ====== ======= ====== PUBLISHING Revenues: Retail $ 14,159 11.0% $ 11,936 11.5% $11,090 14.0% Classifieds 9,106 7.1% 7,344 7.1% 6,150 7.8% Circulation 5,315 4.1% 4,779 4.6% 4,271 5.4% Other 750 0.6% 477 0.5% 1,334 1.6% ------- ----- ------- ----- ------- ----- $ 29,330 22.8% $ 24,536 23.7% $22,845 28.8% ======= ===== ======= ===== ======= ===== PAGING Revenues: Paging lease, sales and service $ 8,553 6.6% $ 6,712 6.5% $ 1,479 1.9% ======== ===== ======== ===== ======= ===== TOTAL $128,890 100.0% $103,548 100.0% $79,305 100.0% ======== ===== ======== ===== ======= ===== </TABLE> YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997 REVENUES. Total revenues for the year ended December 31, 1998 increased $25.3 million, or 24.5%, over the same period of the prior year, from $103.5 million to $128.9 million. This increase was primarily attributable to the net effect of (i) increased revenues resulting from the acquisition of the Busse Stations and the WITN Acquisition, (ii) increased political revenue, (iii) increased publishing revenues and (iv) increased paging revenues partially offset by decreased revenues resulting from the disposition of WALB. Broadcast net revenues increased $18.7 million, or 25.9%, over the same period of the prior year, to $91.0 million from $72.3 million. The acquisition of the Busse Stations and the WITN Acquisition accounted for $9.3 million and $5.5 million of the broadcast net revenue increase, respectively. On a pro forma basis, assuming the Busse-WALB Transactions had been effective on January 1, 1997, broadcast net revenues for the Busse Stations for the year ended December 31, 1998, increased $1.9 million, or 10.1%, over the same period of the prior year, to $20.9 million from $19.0 million. On a pro forma basis, 34
YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997 (CONTINUED) assuming the WITN Acquisition had been effective on January 1, 1997, broadcast net revenues for WITN for the year ended December 31, 1998 increased $939,000, or 12.0%, over the same period of the prior year, to $8.8 million from $7.8 million. Broadcast net revenues, excluding the acquisition of the Busse Stations, the WITN Acquisition and the GulfLink Acquisition and excluding the operating results of WALB, increased $6.1 million, or 10.6%, over the same period of the prior year, to $63.6 million from $57.5 million. This increase was due primarily to an increase in political advertising revenue of $5.4 million. The disposition of WALB resulted in a decrease in net broadcast revenue of approximately $3.3 million. Publishing revenues increased $4.8 million, or 19.5%, over the same period of the prior year, to $29.3 million from $24.5 million. The increase in publishing revenues was due primarily to an increase in retail advertising, classified advertising, circulation and other revenue of $2.2 million, $1.8 million, $536,000 and $273,000, respectively. The increase in retail advertising and classified advertising revenue was due primarily to linage increases. Paging revenue increased $1.8 million or 27.4%, over the same period of the prior year, to $8.6 million from $6.7 million. The increase was attributable primarily to an increase in the number of pagers in service. The Company had approximately 86,000 pagers and 67,000 pagers in service at December 31, 1998 and 1997, respectively. OPERATING EXPENSES. Operating expenses for the year ended December 31, 1998 increased $21.1 million, or 25.5%, over the same period of the prior year, to $104.0 million from $82.8 million, due primarily to the acquisition of the Busse Stations, the WITN Acquisition, increased expenses at the Company's existing television stations (exclusive of the Busse Stations and WALB) and the expense associated with the increase in circulation at the Gwinnett Daily Post. The acquisition of the Busse Stations, the WITN Acquisition, increased expenses at existing television stations and the cost associated with the increase in circulation at the Gwinnett Daily Post accounted for $4.1 million, $3.4 million, $4.1 million and $4.1 million (exclusive of depreciation and amortization), respectively, of the operating expense increase. The increase in operating expenses was partially offset by the disposition of WALB which reduced operating expenses by approximately $1.5 million. Broadcast expenses increased $11.0 million, or 26.2%, over the year ended December 31, 1998, to $53.0 million from $42.0 million. The acquisition of the Busse Stations and the WITN Acquisition accounted for $4.1 million and $3.4 million of the broadcast expenses increase, respectively. On a pro forma basis, assuming the Busse-WALB Transactions had been effective on January 1, 1997, broadcast expenses for the Busse Stations for the year ended December 31, 1998, increased $802,000, or 9.2%, over the same period of the prior year, to $9.5 million from $8.7 million. On a pro forma basis, assuming the WITN Acquisition had been effective on January 1, 1997, broadcast expenses for WITN for the year ended December 31, 1998 increased $668,000, or 14.5%, over the same period of the prior year, to $5.3 million from $4.6 million. Broadcast expenses, excluding the acquisition of the Busse Stations, the WITN Acquisition and the GulfLink Acquisition and excluding the operating results of WALB, increased $4.1 million, or 11.9%, over the same period of the prior year, to $38.6 million from $34.4 million. This increase was due primarily to an increase in payroll expense and other expenses of $2.6 million and $1.3 million, respectively. The increase in broadcast expenses was partially offset by the disposition of WALB which reduced broadcast expenses by approximately $1.5 million. Publishing expenses for the year ended December 31, 1998 increased $4.4 million, or 22.5%, from the same period of the prior year, to $24.2 million from $19.8 million. This increase resulted primarily from an increase in the expense associated with the increase in circulation at the Gwinnett Daily Post to 35
YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997 (CONTINUED) 64,000 at December 31, 1998 from 49,000 at December 31, 1997. Paging expenses increased $1.6 million or 38.7%, over the same period of the prior year, to $5.6 million from $4.1 million. The increase was attributable primarily to an increase in payroll and other costs associated with an increase in the number of pagers in service. Corporate and administrative expenses increased $535,000 or 21.1%, over the same period of the prior year, to $3.1 million from $2.5 million. This increase was primarily attributable to increased payroll expense. DEPRECIATION AND AMORTIZATION. Depreciation of property and equipment and amortization of intangible assets was $18.1 million for the year ended December 31, 1998, as compared to $14.5 million for the same period of the prior year, an increase of $3.6 million, or 24.8%. This increase was primarily the result of higher depreciation and amortization costs resulting from the WITN Acquisition and the acquisition of the Busse Stations. GAIN ON DISPOSITION OF TELEVISION STATIONS. The Company recognized a pre-tax gain of approximately $70.6 million and estimated deferred income taxes of approximately $27.5 million in connection with the exchange of WALB. INTEREST EXPENSE. Interest expense increased $3.6 million, or 16.4%, to $25.5 million for the year ended December 31, 1998 from $21.9 million for the year ended December 31, 1997. This increase was attributable primarily to increased levels of debt resulting from the financing of the acquisition of the Busse Stations and the WITN Acquisition. INCOME TAX EXPENSE (BENEFIT). Income tax expense for the year ended December 31, 1998 primarily reflects the provision of approximately $27.5 million of deferred income taxes recognized in conjunction with the exchange of WALB. NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS. Net income available to common stockholders of the Company was $40.3 million for the year ended December 31, 1998, as compared with a net loss available to common stockholders of $2.8 million for the same period of the prior year, reflecting the $43.1 million gain net of related tax provisions on the exchange of WALB. YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 REVENUES. Total revenues for the year ended December 31, 1997, increased $24.2 million, or 30.6%, over the year ended December 31, 1996, from $79.3 million to $103.5 million. This increase was attributable to the net effect of (i) increased revenues as a result of the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition, (ii) increases in total non-political revenues of the Company (excluding the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition) and (iii) increased publishing revenue, all of which were partially offset by decreased political revenues and decreased revenues as a result of the KTVE Sale. The net increase in revenue due to the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition less the effect of the KTVE Sale was $23.4 million, or 96.7% of the $24.2 million increase. Broadcast net revenues increased $17.3 million, or 31.5%, over the prior year, from $55.0 million to $72.3 million. The First American Acquisition, the WITN Acquisition and the GulfLink Acquisition accounted for $16.5 million, $3.3 million and $1.4 million, respectively, of the broadcast net revenue increase. On a pro forma basis, assuming the First American Acquisition had been effective on January 1, 36
YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 (CONTINUED) 1996, broadcast net revenues for the First American Acquisition for the year ended December 31, 1997, decreased $700,000, or 3.0%, over the year ended December 31, 1996, from $23.9 million to $23.2 million. On a pro forma basis, assuming the WITN Acquisition had been effective on January 1, 1996, broadcast net revenues for the WITN Acquisition for the year ended December 31, 1997, decreased $600,000, or 7.0%, over the year ended December 31, 1996, from $8.4 million to $7.8 million. On a pro forma basis, political revenue for the First American Acquisition and the WITN Acquisition decreased $1.3 million and $650,000, respectively, over the prior year. The KTVE Sale resulted in a decrease in broadcast net revenues of $3.0 million. Broadcast net revenues, excluding the First American Acquisition, the WITN Acquisition and the GulfLink Acquisition and the operating results of KTVE, decreased $800,000, or 1.8%, over the prior year. This decrease of $800,000 resulted primarily from decreased political spending of $3.1 million partially offset by increased local advertising spending and national advertising spending of $1.5 million and $600,000, respectively. Publishing revenues increased $1.7 million, or 7.4%, over the prior year, from $22.8 million to $24.5 million. Retail advertising, classified advertising and circulation revenue increased approximately $850,000, $1.2 million and $500,000, respectively, which was partially offset by a decrease in other revenue of $860,000. The increase in retail advertising and classified advertising was primarily the result of increased rates partially offset by decreased linage. The increase in circulation revenue was attributable primarily to the increase in subscribers at the Gwinnett Daily Post from 13,000 at December 31, 1996, to 49,000 at December 31, 1997. The increases in retail advertising, classified advertising and circulation revenue were offset by a decrease of $800,000 in commercial printing and events marketing revenue. Paging revenue increased $5.2 million, or 353.8%, from $1.5 million to $6.7 million primarily due to the First American Acquisition. On a pro forma basis, assuming the First American Acquisition had been effective January 1, 1996, paging revenue for the year ended December 31, 1997, increased $1.2 million, or 21.6%, over the year ended December 31, 1996, from $5.5 million to $6.7 million. The increase was attributable primarily to an increase in the number of units in service. The Company had approximately 67,000 units in service at December 31, 1997, and 49,500 units in service at December 31, 1996. OPERATING EXPENSES. Operating expenses for the year ended December 31, 1997, increased $19.6 million, or 31.0%, over the year ended December 31, 1996, from $63.2 million to $82.8 million. This increase was attributable to the net effect of (i) increased expenses resulting from the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition, (ii) increased publishing expenses, (iii) decreased broadcast expense of the Company (excluding the WITN Acquisition, the GulfLink Acquisition, the First American Acquisition and the effects of the KTVE Sale), (iv) decreased expenses resulting from the KTVE Sale and (v) decreased non-cash compensation. The net increase in operating expenses (exclusive of depreciation and amortization) due to the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition less the effects of the KTVE Sale was $13.7 million. Broadcast expenses increased $9.5 million, or 29.4%, over the prior year, from approximately $32.4 million to approximately $42.0 million. The increase was attributable primarily to the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition partially offset by the KTVE Sale. The First American Acquisition, the WITN Acquisition and the GulfLink Acquisition accounted for $9.9 million, $1.9 million and $1.2 million, respectively, of the broadcast expense increase. On a pro forma basis, assuming the First American Acquisition had been effective on January 1, 1996, broadcast expense for the First American Acquisition for the year ended December 31, 1997, increased $1.2 million, or 9.8%, over the year ended December 31, 1996, from $12.2 million to $13.4 million. On a pro forma basis, assuming the WITN Acquisition had been effective on January 1, 1996, broadcast expense for the WITN Acquisition for the year ended December 31, 1997, decreased $200,000, or 4.2%, over the year ended 37
YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 (CONTINUED) December 31, 1996, from $4.8 million to $4.6 million. The KTVE Sale resulted in a decrease in broadcast expenses of $2.2 million. Broadcast expenses, excluding the results of the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition and the KTVE Sale, decreased $1.3 million, or 4.9%, as a result of lower payroll and other costs. Publishing expenses increased $1.8 million, or 10.1%, over the prior year, from approximately $17.9 million to approximately $19.8 million. This increase resulted primarily from an increase in expenses associated with an expansion of the news product and circulation at one of the Company's properties partially offset by a decrease in work force related costs and improved newsprint pricing. Average newsprint costs decreased approximately 14.4% while newsprint consumption increased approximately 27.7%. Paging expenses increased $3.0 million, or 275.8%, over the prior year, from $1.1 million to $4.1 million primarily due to the First American Acquisition. On a pro forma basis, assuming the First American Acquisition had been effective January 1, 1996, paging expenses for the year ended December 31, 1997, increased $220,000, or 5.7%, over the year ended December 31, 1996, from $3.8 million to $4.1 million. This increase was attributable primarily to increased payroll expenses. Corporate and administrative expenses decreased $700,000, or 21.5%, over the prior year, from $3.2 million to $2.5 million. This decrease was attributable primarily to a reduction of compensation expense at the corporate level. DEPRECIATION AND AMORTIZATION. Depreciation of property and equipment and amortization of intangible assets was $14.5 million for the year ended December 31, 1997, compared to $7.7 million for the prior year, an increase of $6.8 million, or 89.5%. This increase was primarily the result of higher depreciation and amortization costs related to the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition. NON-CASH COMPENSATION. Non-cash compensation for the year ended December 31, 1996, resulted from the Company's employment agreement with its former President, Ralph W. Gabbard, who died unexpectedly in September 1996. GAIN ON DISPOSITION OF TELEVISION STATIONS. During 1996, the Company recognized a pre-tax gain of approximately $5.7 million as a result of the KTVE Sale. INTEREST EXPENSE. Interest expense increased $10.2 million, or 87.0%, from $11.7 million for the year ended December 31, 1996, to $21.9 million for the year ended December 31, 1997. This increase was attributable primarily to increased levels of debt resulting from the financing of the WITN Acquisition, the GulfLink Acquisition and the First American Acquisition. INCOME TAX EXPENSE (BENEFIT). Income tax expense for the year ended December 31, 1996 primarily reflects the provision of approximately $2.8 million of income taxes recognized in conjunction with the KTVE Sale. EXTRAORDINARY CHARGE: An extraordinary charge of $5.3 million ($3.2 million after taxes) was recorded for the year ended December 31, 1996, in connection with the early retirement of the Company's former bank credit facility and the $25.0 million senior secured note with an institutional investor. 38
YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 (CONTINUED) NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS. Net loss available to common stockholders for the Company was $2.8 million for the year ended December 31, 1997, compared with net income available to common stockholders of $2.1 million for the year ended December 31, 1996, a decrease of $4.9 million, or 231.2%. INTEREST RATE RISK Based on the Company's floating rate debt outstanding at December 31, 1998, a 100 basis point increase in market rates would increase interest expense and decrease income before income taxes by approximately $1.1 million. The amount was determined by calculating the effect of the hypothetical interest rate on the Company's floating rate debt. The fair market value of long-term fixed interest rate debt is also subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The estimated fair value of the Company's total long-term fixed rate debt at December 31, 1998 was approximately $170.4 million which exceeded its carrying value by approximately $10.4 million. A hypothetical 100 basis point decrease in the prevailing interest rates at December 31, 1998 would result in an increase in fair value of total long-term debt by approximately $7.0 million. Fair market values are determined from quoted market prices where available or based on estimates made by the investment bankers. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital was $10.2 million and $10.1 million at December 31, 1998, and 1997, respectively. The Company's cash provided from operations was $20.1 million, $9.7 million and $12.1 million in 1998, 1997 and 1996, respectively. Management believes that current cash balances, cash flows from operations and the available funds under its Senior Credit Facility will be adequate to provide for the Company's capital expenditures, debt service, cash dividends and working capital requirements. The agreement pursuant to which the Senior Credit Facility was issued contains certain restrictive provisions, which, among other things, limit additional indebtedness and require minimum levels of cash flows. Additionally, the effective interest rate of the Senior Credit Facility can be changed based upon the Company's maintenance of certain operating ratios as defined by the Senior Credit Facility, not to exceed the lender's prime rate plus 0.5% or LIBOR plus 2.25%. The Company's 10 5/8 % Senior Subordinated Notes due 2006 contain restrictive provisions similar to the provisions of the Senior Credit Facility. The amount borrowed by the Company and the amount available to the Company under the Senior Credit Facility at December 31, 1998, was $109.5 million and $90.5 million, respectively. The Company's cash used in investing activities was $55.3 million, $57.5 million and $205.1 million in 1998, 1997 and 1996, respectively. The amount of cash used in 1998 resulted primarily from the acquisition of Busse partially offset by the exchange of WALB. The decrease of $147.6 million from 1996 to 1997 was primarily due to the net impact of the WITN Acquisition and the GulfLink Acquisition in 1997 offset by the 1996 Acquisitions in 1996. The Company was provided $34.7 million, $49.1 million and $193.5 million in cash by financing activities in 1998, 1997 and 1996, respectively. In 1998, net cash provided by financing activities resulted primarily from borrowings on long-term debt (net of repayments) of $43.5 million partially offset by redemptions of preferred stock of $7.6 million. In 1997, the decrease in cash provided by financing activities resulted primarily from the funding obtained for the 1996 Acquisitions in 1996 partially offset by the borrowings for the WITN Acquisition and the GulfLink Acquisition, purchase of treasury stock and increased payments on long-term debt in 1997. The cash provided in 1996 resulted primarily from (i) 39
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) the issuance of $160.0 million principal amount of 10 5/8 % Senior Subordinated Notes due 2006, (ii) borrowings under the Company's revolving credit agreements, (iii) public sale of Class B Common Stock and (iv) the private placement of preferred stock, partially offset by the repayment of certain long-term debt and the purchase of Class B Common Stock by the Company. During 1998, 1997 and 1996, the Company purchased 30,750 Class A Common Stock Shares, 259,350 Class A Common Stock shares and 258,450 Class B Common Stock shares, respectively. The 1998, 1997 and 1996 treasury shares were purchased at prevailing market prices with an average effective price of $18.95, $13.33 and $10.60 per share, respectively. Effective July 31, 1998, the Senior Credit Facility was modified to increase the committed credit limit of $125.0 million to $200.0 million. This modification also allows for an additional uncommitted $100.0 million in available credit which is in addition to the committed $200.0 million credit limit. This $100.0 million in uncommitted available credit can be borrowed by the Company only after approval of the bank consortium. The modification also extended the maturity date from June 30, 2004 to June 30, 2005. The modification required a one-time fee of approximately $750,000. As discussed in the INTRODUCTION, on July 31, 1998, the Company completed the Busse-WALB Transactions. These transactions resulted in a net increase in long-term debt of approximately $43.4 million. At December 31, 1998, the Company had approximately $109.5 million borrowed under the Senior Credit Facility with approximately $90.5 million available under the agreement. The interest rate on the balance outstanding was based on Prime and a spread over LIBOR of 1.75%. Subject to certain limitations, holders of the Series A Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors, out of funds of the Company legally available for payment, cumulative cash dividends at an annual rate of $800 per share. Subject to certain limitations, holders of the Series B Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors, out of the funds of the Company legally available for payment, cumulative dividends at an annual rate of $600 per share, except that the Company at its option may pay such dividends in cash or in additional shares of Series B Preferred Stock valued, for the purpose of determining the number of shares (or fraction thereof) of such Series B Preferred Stock to be issued, at $10,000 per share. The Company regularly enters into program contracts for the right to broadcast television programs produced by others and program commitments for the right to broadcast programs in the future. Such programming commitments are generally made to replace expiring or canceled program rights. Payments under such contracts are made in cash or the concession of advertising spots for the program provider to resell, or a combination of both. At December 31, 1998, payments on program license liabilities due in 1999, which will be paid with cash from operations, were approximately $4.6 million. In 1998, the Company made $9.3 million in capital expenditures, relating primarily to the broadcasting and publishing operations, and paid $4.2 million for program broadcast rights. The Company anticipates making $10.0 million in capital expenditures in 1999. In connection with the First American Acquisition, the Federal Communications Commission (the "FCC") ordered the Company to divest itself of WALB and WJHG-TV ("WJHG") by March 31, 1997 to comply with regulations governing common ownership of television stations with overlapping service areas. The FCC is currently reexamining these regulations, and if it revises them in accordance with the interim policy it has adopted, divestiture of WJHG would not be required. Accordingly, the Company requested and in July of 1997 received an extension of the divestiture deadline with regard to WJHG conditioned upon the outcome of the rulemaking proceedings. It can not be determined when the FCC 40
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) will complete its rulemaking on this subject. On July 31, 1998, the assets of WALB were exchanged for the assets of WEAU. This exchange transaction satisfied the FCC's divestiture requirement for WALB. The Company and its subsidiaries file a consolidated federal income tax return and such state or local tax returns as are required. As of December 31, 1998, the Company anticipates that it will generate taxable operating losses for the foreseeable future. Management does not believe that inflation in past years has had a significant impact on the Company's results of operations nor is inflation expected to have a significant effect upon the Company's business in the near future. On March 1, 1999, the Company acquired substantially all of the assets of THE GOSHEN NEWS from News Printing Company, Inc. and affiliates thereof, for aggregate cash consideration of approximately $16.7 million including a non-compete agreement. THE GOSHEN NEWS is a 17,000 circulation afternoon newspaper published Monday through Saturday and serves Goshen, Indiana and surrounding areas. The Company funded this acquisition through its Senior Credit Facility. On January 28, 1999, Bull Run Corporation ("Bull Run"), a principal stockholder of the Company, acquired 301,119 shares of the outstanding common stock of Sarkes Tarzian, Inc. ("Tarzian") from the Estate of Mary Tarzian (the "Estate") for $10.0 million. The acquired shares (the "Tarzian Shares") represent 33.5% of the total outstanding common stock of Tarzian (both in terms of the number of shares of common stock outstanding and in terms of voting rights), but such investment represents 73% of the equity of Tarzian for purposes of dividends as well as distributions in the event of any liquidation, dissolution or other termination of Tarzian. Tarzian has filed a complaint in the United States District Court for the Southern District of Indiana, claiming that it had a binding contract with the Estate to purchase the Tarzian Shares from the Estate prior to Bull Run's purchase of the shares, and requests judgment providing that the Estate be required to sell the Tarzian Shares to Tarzian. Bull Run believes that a binding contract between Tarzian and the Estate did not exist, prior to Bull Run's purchase of the Tarzian Shares from the Estate, and in any case, Bull Run's purchase agreement with the Estate provides that in the event that a court of competent jurisdiction awards title to the Tarzian Shares to a person or entity other than Bull Run, the purchase agreement is rescinded and the Estate is required to pay Bull Run the full $10.0 million purchase price, plus interest. Tarzian owns and operates two television stations and four radio stations: WRCB-TV Channel 3 in Chattanooga, Tennessee, an NBC affiliate; KTVN-TV Channel 2 in Reno, Nevada, a CBS affiliate; WGCL-AM and WTTS-FM in Bloomington, Indiana; and WAJI-FM and WLDE-FM in Fort Wayne, Indiana. The Chattanooga and Reno markets rank as the 87th and the 108th largest television markets in the United States, respectively, as ranked by A. C. Nielsen Company. The Company has executed an option agreement with Bull Run, whereby the Company has the option of acquiring the Tarzian investment from Bull Run. Upon exercise of the option, the Company will pay Bull Run an amount equal to Bull Run's purchase price for the Tarzian investment and related costs. The option agreement currently expires on May 31, 1999; however, the Company may extend the option period at an established fee. In connection with the option agreement, the Company granted to Bull Run warrants to purchase up to 100,000 shares of the Company's Class B Common Stock at $13.625 per share. The warrants vest immediately upon the Company's exercise of its option to purchase the Tarzian investment. Neither Bull Run's investment nor the Company's potential investment is presently attributable under the ownership rules of the FCC. If the Company successfully exercises the option agreement, the Company plans to fund the acquisition through its Senior Credit Facility. 41
YEAR 2000 ISSUE The problems created by systems that are unable to interpret dates accurately after December 31, 1999 is referred to as the "Year 2000 Issue." Many software programs have historically categorized the "year" in a two-digit format rather than a four-digit format. As a result, those computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. The Year 2000 Issue creates potential risks for the Company, including potential problems in the Company's Information Technology ("IT") and non-IT systems. The Year 2000 Issue could cause a system failure, miscalculations or disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Company may also be exposed to risks from third parties who fail to adequately address their own Year 2000 Issue. The Company has implemented a multiphase program designed to address the Year 2000 Issue. Each phase of this program and its state of completion is described below: ASSESSMENT: This phase of the program includes the identification of the Company's IT and non-IT systems. After these systems have been identified, they are evaluated to determine whether they will correctly recognize dates after December 31, 1999 ("Year 2000 Compliant"). If it is determined that they are not Year 2000 Compliant, they are replaced or modified in the REMEDIATION phase of the program. The majority of the Company's systems are non-proprietary. The Company is in the process of obtaining from each system vendor a written or oral representation as to each significant system's status of compliance. The Company has commenced an ongoing process of contacting suppliers and other key third parties to assess their Year 2000 Compliance status. It appears that all of these third parties are currently Year 2000 Compliant or they plan to be Year 2000 Compliant prior to December 31, 1999. This phase is substantially complete and the Company has identified the majority of the systems that need to be replaced. REMEDIATION: For those systems which are not Year 2000 Compliant, a plan is derived to make the systems Year 2000 Compliant. These solutions have included modification or replacement of existing systems. The REMEDIATION phase is approximately 50% complete. TESTING: Test remediated systems to assure normal function when placed in their original operating environment and further test for Year 2000 Compliance. The TESTING phase of the program is approximately 25% complete and the Company anticipates that it will be completed by September 30, 1999. CONTINGENCY: As a result of the Company's Year 2000 Compliance program, the Company does not believe that it has significant risk resulting from this issue. However, the Company is in the process of developing contingency plans for the possibility that one of its systems or one of a third party's systems may not be Year 2000 Compliant. The Company believes that the most reasonable likely worst case scenario is a temporary loss of functionality at one or more of the Company's operating units. In the unlikely event that this were to occur, the Company would experience decreased revenue and slightly higher operating costs at the affected location. However, due to the decentralized nature of the Company's operations, it is not likely that all locations would be affected by a single non-functioning system. The Company does not presently believe that the estimated total Year 2000 project cost will exceed $750,000. Most of this cost will be realized over the estimated useful lives of the new hardware and 42
YEAR 2000 ISSUE (CONTINUED) software; however, any third party consulting fees would be expensed in the period the services are rendered. To date, the Company has identified several minor systems that are not Year 2000 Compliant and these systems are in the process of being replaced. However, the Company has not incurred significant expenses associated with the Year 2000 Issue. As of December 31, 1998, no IT projects have been deferred due to the Company's efforts related to the Year 2000 Issue. The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT This annual report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the words "believes," "expects," "anticipates," "estimates" and similar words and expressions are generally intended to identify forward-looking statements. Statements that describe the Company's future strategic plans, goals, or objectives are also forward-looking statements. Readers of this Report are cautioned that any forward-looking statements, including those regarding the intent, belief or current expectations of the Company or management, are not guarantees of future performance, results or events and involve risks and uncertainties, and that actual results and events may differ materially from those in the forward-looking statements as a result of various factors including, but not limited to, (i) general economic conditions in the markets in which the Company operates, (ii) competitive pressures in the markets in which the Company operates, (iii) the effect of future legislation or regulatory changes on the Company's operations and (iv) other factors described from time to time in the Company's filings with the Securities and Exchange Commission. The forward-looking statements included in this report are made only as of the date hereof. The Company undertakes no obligation to update such forward-looking statements to reflect subsequent events or circumstances. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Response to this item is included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA <TABLE> <CAPTION> PAGE ---- <S> <C> Audited Consolidated Financial Statements of Gray Communications Systems, Inc. Report of Independent Auditors ...................................................45 Consolidated Balance Sheets at December 31, 1998 and 1997 .......................46 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 ...............................................................48 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 ...........................................................49 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 ..................................................................51 Notes to Consolidated Financial Statements .......................................52 </TABLE> 44
REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders Gray Communications Systems, Inc. We have audited the accompanying consolidated balance sheets of Gray Communications Systems, Inc., as of December 31, 1998 and 1997 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Gray Communications Systems, Inc., at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Ernst & Young LLP Atlanta, Georgia January 26, 1999 45
GRAY COMMUNICATIONS SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> DECEMBER 31, -------------------------------- 1998 1997 -------------------------------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 1,886,723 $ 2,367,300 Trade accounts receivable, less allowance for doubtful accounts of $1,212,000 and $1,253,000, respectively 22,859,119 19,527,316 Recoverable income taxes 1,725,535 2,132,284 Inventories 1,191,284 846,891 Current portion of program broadcast rights 3,226,359 2,850,023 Other current assets 741,007 968,180 -------------- -------------- Total current assets 31,630,027 28,691,994 Property and equipment (NOTES B AND C): Land 2,196,021 889,696 Buildings and improvements 12,812,112 11,951,700 Equipment 65,226,835 52,899,547 -------------- -------------- 80,234,968 65,740,943 Allowance for depreciation (28,463,460) (23,635,256) -------------- -------------- 51,771,508 42,105,687 Other assets: Deferred loan costs (NOTE C) 8,235,432 8,521,356 Goodwill and other intangibles (NOTE B) 376,014,972 263,425,447 Other 1,322,483 2,306,143 -------------- -------------- 385,572,887 274,252,946 -------------- -------------- $468,974,422 $345,050,627 ============== ============== </TABLE> 46
GRAY COMMUNICATIONS SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) <TABLE> <CAPTION> DECEMBER 31, -------------------------------- 1998 1997 -------------------------------- <S> <C> <C> LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade accounts payable (includes $880,000 and $850,000 payable to Bull Run Corporation, respectively) $ 2,540,770 $ 3,321,903 Employee compensation and benefits 5,195,777 3,239,694 Accrued expenses 1,903,226 2,265,725 Accrued interest 5,608,134 4,533,366 Current portion of program broadcast obligations 3,070,598 2,876,060 Deferred revenue 2,632,564 1,966,166 Current portion of long-term debt 430,000 400,000 -------------- -------------- Total current liabilities 21,381,069 18,602,914 Long-term debt (NOTES B AND C) 270,225,255 226,676,377 Other long-term liabilities: Program broadcast obligations, less current portion 735,594 617,107 Supplemental employee benefits (NOTE D) 1,128,204 1,161,218 Deferred income taxes (NOTE G) 44,147,642 1,203,847 Other acquisition related liabilities (NOTE B) 4,653,788 4,494,016 -------------- -------------- 50,665,228 7,476,188 Commitments and contingencies (NOTES B, C AND I) Stockholders' equity (NOTES B, C AND E) Serial Preferred Stock, no par value; authorized 20,000,000 shares; issued and outstanding 1,350 and 2,060 shares, respectively ($13,500,000 and $20,600,000 aggregate liquidation value, respectively) 13,500,000 20,600,000 Class A Common Stock, no par value; authorized 15,000,000 shares; issued 7,961,574 shares, respectively 10,683,709 10,358,031 Class B Common Stock, no par value; authorized 15,000,000 shares; issued 5,273,046 shares, respectively 66,792,385 66,397,804 Retained earnings 45,737,601 6,603,191 -------------- -------------- 136,713,695 103,959,026 Treasury Stock at cost, Class A Common, 1,129,532 and 1,172,882 shares, respectively (8,578,682) (9,011,369) Treasury Stock at cost, Class B Common, 135,080 and 250,185 shares, respectively (1,432,143) (2,652,509) -------------- -------------- 126,702,870 92,295,148 -------------- -------------- $468,974,422 $345,050,627 ============== ============== </TABLE> See accompanying notes. 47
GRAY COMMUNCIATIONS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------- 1998 1997 1996 ---------------------------- -------------- <S> <C> <C> <C> Operating revenues: Broadcasting (less agency commissions) $ 91,006,506 $ 72,300,105 $54,981,317 Publishing 29,330,080 24,536,348 22,845,274 Paging 8,552,936 6,711,426 1,478,608 ------------ ------------ ----------- 128,889,522 103,547,879 79,305,199 Expenses: Broadcasting 52,967,142 41,966,493 32,438,405 Publishing 24,197,169 19,753,387 17,949,064 Paging 5,618,421 4,051,359 1,077,667 Corporate and administrative 3,062,995 2,528,461 3,218,610 Depreciation 9,690,757 7,800,217 4,077,696 Amortization of intangible assets 8,425,821 6,718,302 3,584,845 Non-cash compensation paid in common stock (NOTE D) -0- -0- 880,000 ------------ ------------ ----------- 103,962,305 82,818,219 63,226,287 ------------ ------------ ----------- 24,927,217 20,729,660 16,078,912 Gain on disposition of television stations (net of $780,000 paid to Bull Run Corporation in 1998) (NOTE B) 70,572,128 -0- 5,671,323 Miscellaneous income and (expense), net (241,522) (30,851) 33,259 ------------ ------------ ----------- 95,257,823 20,698,809 21,783,494 Interest expense 25,454,476 21,861,267 11,689,053 ------------ ------------ ----------- INCOME (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY CHARGE 69,803,347 (1,162,458) 10,094,441 Federal and state income taxes (NOTE G) 28,143,981 240,000 4,416,000 ------------ ------------ ----------- INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE 41,659,366 (1,402,458) 5,678,441 Extraordinary charge on extinguishment of debt, net of applicable income tax benefit of $2,157,000 (NOTE C) -0- -0- 3,158,960 ------------ ------------ ----------- NET INCOME (LOSS) 41,659,366 (1,402,458) 2,519,481 Preferred dividends (NOTE E) 1,317,830 1,409,690 376,849 ------------ ------------ ----------- NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $40,341,536 (2,812,148) $2,142,632 =========== ========== ========== Average outstanding common shares-basic 11,922,852 11,852,546 8,097,654 Stock compensation awards 481,443 -0- 340,668 ------------ ------------ ----------- Average outstanding common shares-diluted 12,404,295 11,852,546 8,438,322 =========== ========== ========== Basic earnings per common share: Income (loss) before extraordinary charge available to common stockholders $ 3.38 (0.24) $ 0.65 Extraordinary charge -0- -0- (0.39) ------------ ------------ ----------- NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 3.38 $ (0.24) $ 0.26 =========== ========== ========== Diluted earnings per common share: Income (loss) before extraordinary charge available to common stockholders $ 3.25 (0.24) $ 0.62 Extraordinary charge -0- -0- (0.37) ------------ ------------ ----------- NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 3.25 $ (0.24) $ 0.25 =========== ========== ========== </TABLE> See accompanying notes. 48
GRAY COMMUNICATIONS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY <TABLE> <CAPTION> GRAY COMMUNICATIONS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY CLASS A CLASS B PREFERRED STOCK COMMON STOCK COMMON STOCK RETAINED SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT EARNINGS ---------------------------------------------------- ----------- ------------- ------------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1995 -0- $ -0- 7,624,134 $ 6,795,976 -0- $ -0- $ 8,827,906 Net Income -0- -0- -0- -0- -0- -0- 2,519,481 Common Stock Cash Dividends: Class A ($0.05 per share) -0- -0- -0- -0- -0- -0- (357,598) Class B ($0.01 per share) -0- -0- -0- -0- -0- -0- (69,000) Purchase of Class B Common Stock (NOTE E) -0- -0- -0- -0- -0- -0- -0- Issuance of Class A Common Stock (NOTES E, F AND H): 401(k) Plan -0- -0- 19,837 262,426 -0- -0- -0- Directors' Stock Plan -0- -0- 33,750 228,749 -0- -0- -0- Non-qualified Stock Plan -0- -0- 55,275 358,417 -0- -0- -0- Preferred Stock Dividends -0- -0- -0- -0- -0- -0- (376,849) Issuance of Class A Common Stock Warrants (NOTES B AND E) -0- -0- -0- 2,600,000 -0- -0- -0- Issuance of Series A Preferred Stock in exchange for Subordinated Note (NOTES B AND E) 1,000 10,000,000 -0- (2,383,333) -0- -0- -0- Issuance of Series B Preferred Stock (NOTES B AND E) 1,000 10,000,000 -0- -0- -0- -0- -0- Issuance of Class B Common Stock, net of expenses (NOTES B AND E) -0- -0- -0- -0- 5,250,000 66,065,762 -0- Income tax benefits relating to stock plans -0- -0- -0- 132,000 -0- -0- -0- ---------------------------------------------------- ----------- ------------- ------------- Balance at December 31, 1996 2,000 20,000,000 7,732,996 7,994,235 5,250,000 66,065,762 10,543,940 Net Loss -0- -0- -0- -0- -0- -0- (1,402,458) Common Stock Cash Dividends ($0.05) per share -0- -0- -0- -0- -0- -0- (628,045) Preferred Stock Dividends -0- -0- -0- -0- -0- -0- (1,409,690) Issuance of Class A Common Stock (NOTES E AND F): Directors' Stock Plan -0- -0- 752 9,645 -0- -0- -0- Non-qualified Stock Plan -0- -0- 44,775 317,151 -0- -0- -0- Stock Award Restricted Stock Plan -0- -0- 183,051 1,200,000 -0- -0- -0- Issuance of Class B Common Stock (NOTES E AND H): 401(k) Plan -0- -0- -0- -0- 23,046 282,384 -0- Issuance of Series B Preferred Stock (NOTE E) 60 600,000 -0- -0- -0- -0- -0- Issuance of Treasury Stock (NOTES E, F, AND H): 401(k) Plan -0- -0- -0- -0- -0- 49,658 -0- Non-qualified Stock Plan -0- -0- -0- -0- -0- -0- (500,556) Purchase of Class A Common Stock (NOTE E) -0- -0- -0- -0- -0- -0- -0- Income tax benefits relating to stock plans -0- -0- -0- 837,000 -0- -0- -0- ---------------------------------------------------- ----------- ------------- ------------- Balance at December 31, 1997 2,060 $20,600,000 7,961,574 $10,358,031 5,273,046 $66,397,804 $ 6,603,191 <CAPTION> CLASS A CLASS B TREASURY STOCK TREASURY STOCK SHARES AMOUNT SHARES AMOUNT TOTAL ------------ ------------------------- ------------- --------------- <S> <C> <C> <C> <C> <C> Balance at December 31, 1995 (994,770) $(6,638,284) -0- $ -0- $8,985,598 Net Income -0- -0- -0- -0- 2,519,481 Common Stock Cash Dividends: Class A ($0.05 per share) -0- -0- -0- -0- (357,598) Class B ($0.01 per share) -0- -0- -0- -0- (69,000) Purchase of Class B Common Stock (NOTE E) -0- -0- (258,450) (2,740,137) (2,740,137) Issuance of Class A Common Stock (NOTES E, F AND H): 401(k) Plan -0- -0- -0- -0- 262,426 Directors' Stock Plan -0- -0- -0- -0- 228,749 Non-qualified Stock Plan -0- -0- -0- -0- 358,417 Preferred Stock Dividends -0- -0- -0- -0- (376,849) Issuance of Class A Common Stock Warrants (NOTES B AND E) -0- -0- -0- -0- 2,600,000 Issuance of Series A Preferred Stock in exchange for Subordinated Note (NOTES B AND E) -0- -0- -0- -0- 7,616,667 Issuance of Series B Preferred Stock (NOTES B AND E) -0- -0- -0- -0- 10,000,000 Issuance of Class B Common Stock, net of expenses (NOTES B AND E) -0- -0- -0- -0- 66,065,762 Income tax benefits relating to stock plans -0- -0- -0- -0- 132,000 ------------ ------------------------- ------------- --------------- Balance at December 31, 1996 (994,770) (6,638,284) (258,450) (2,740,137) 95,225,516 Net Loss -0- -0- -0- -0- (1,402,458) Common Stock Cash Dividends ($0.05) per share -0- -0- -0- -0- (628,045) Preferred Stock Dividends -0- -0- -0- -0- (1,409,690) Issuance of Class A Common Stock (NOTES E AND F): Directors' Stock Plan -0- -0- -0- -0- 9,645 Non-qualified Stock Plan -0- -0- -0- -0- 317,151 Stock Award Restricted Stock Plan -0- -0- -0- -0- 1,200,000 Issuance of Class B Common Stock (NOTES E AND H): 401(k) Plan -0- -0- -0- -0- 282,384 Issuance of Series B Preferred Stock (NOTE E) -0- -0- -0- -0- 600,000 Issuance of Treasury Stock (NOTES E, F, AND H): 401(k) Plan -0- -0- 8,265 87,628 137,286 Non-qualified Stock Plan 81,238 1,082,390 -0- -0- 581,834 Purchase of Class A Common Stock (NOTE E) (259,350) (3,455,475) -0- -0- (3,455,475) Income tax benefits relating to stock plans -0- -0- -0- -0- 837,000 ------------ ------------- ----------- ------------- --------------- Balance at December 31, 1997 (1,172,882) $(9,011,369) (250,185) $(2,652,509) $92,295,148 </TABLE> See accompanying notes. 49
GRAY COMMUNICATIONS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED) <TABLE> <CAPTION> GRAY COMMUNICATIONS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED) CLASS A CLASS B PREFERRED STOCK COMMON STOCK COMMON STOCK RETAINED --------------------------- -------------------------- ------------------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT EARNINGS --------------------------- -------------------------- --------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1997 2,060 $20,600,000 7,961,574 $10,358,031 5,273,046 $66,397,804 $6,603,191 Net Income -0- -0- -0- -0- -0- -0- 41,659,366 Common Stock Cash Dividends ($0.06) per share -0- -0- -0- -0- -0- -0- (715,209) Preferred Stock Dividends -0- -0- -0- -0- -0- -0- (1,317,830) Issuance of Treasury Stock (NOTES E, F, AND H): 401(k) Plan -0- -0- -0- -0- -0- 180,821 -0- Directors' Stock Plan -0- -0- -0- -0- -0- 30,652 -0- Non-qualified Stock Plan -0- -0- -0- -0- -0- 9,597 (491,917) Purchase of Class A Common Stock (NOTE E) -0- -0- -0- -0- -0- -0- -0- Issuance of Series B Preferred Stock (NOTE E) 51 509,384 -0- -0- -0- -0- -0- Purchase of Series B Preferred Stock (NOTE E) (761) (7,609,384) -0- -0- -0- -0- -0- Income tax benefits relating to stock plans -0- -0- -0- 325,678 -0- 173,511 -0- --------------------------- -------------------------- --------------------------------------- Balance at December 31, 1998 1,350 $13,500,000 7,961,574 $10,683,709 5,273,046 $66,792,385 $45,737,601 =========================== ========================== ======================================= <CAPTION> CLASS A CLASS B TREASURY STOCK TREASURY STOCK --------------------------- ------------------------- SHARES AMOUNT SHARES AMOUNT TOTAL --------------------------- ----------- ------------- --------------- <S> <C> <C> <C> <C> <C> Balance at December 31, 1997 (1,172,882) $(9,011,369) (250,185) $(2,652,509) $92,295,148 Net Income -0- -0- -0- -0- 41,659,366 Common Stock Cash Dividends ($0.06) per share -0- -0- -0- -0- (715,209) Preferred Stock Dividends -0- -0- -0- -0- (1,317,830) Issuance of Treasury Stock (NOTES E, F, AND H): 401(k) Plan -0- -0- 29,305 310,703 491,524 Directors' Stock Plan -0- -0- 84,300 893,763 924,415 Non-qualified Stock Plan 74,100 1,015,254 1,500 15,900 548,834 Purchase of Class A Common Stock (NOTE E) (30,750) (582,567) -0- -0- (582,567) Issuance of Series B Preferred Stock (NOTE E) -0- -0- -0- -0- 509,384 Purchase of Series B Preferred Stock (NOTE E) -0- -0- -0- -0- (7,609,384) Income tax benefits relating to stock -0- -0- plans -0- -0- 499,189 --------------------------- ----------- ------------- --------------- Balance at December 31, 1998 (1,129,532) $(8,578,682) (135,080) $(1,432,143) $126,702,870 =========================== =========== ============= =============== </TABLE> See accompanying notes. 50
GRAY COMMUNCIATIONS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ---------------------------------------------------- 1998 1997 1996 --------------- ------------------ ----------------- <S> <C> <C> <C> OPERATING ACTIVITIES Net income (loss) $ 41,659,366 $ (1,402,458) $ 2,519,481 Items which did not use (provide) cash: Depreciation 9,690,757 7,800,217 4,077,696 Amortization of intangible assets 8,425,821 6,718,302 3,584,845 Amortization of deferred loan costs 1,097,952 1,083,303 270,813 Amortization of program broadcast rights 4,250,714 3,501,330 2,742,712 Amortization of original issue discount on 8% subordinated note -0- -0- 216,667 Write-off of loan acquisition costs from early extinguishment of debt -0- -0- 1,818,840 Gain on disposition of television stations (70,572,128) -0- (5,671,323) Payments for program broadcast rights (4,209,811) (3,629,350) (2,877,128) Compensation paid in Common Stock -0- -0- 880,000 Supplemental employee benefits (252,611) (196,057) (855,410) Common Stock contributed to 401(K) Plan 491,524 419,670 262,426 Deferred income taxes 26,792,795 1,283,000 (44,000) Loss on asset sales 332,042 108,998 201,792 Changes in operating assets and liabilities: Trade accounts receivable (302,905) (369,675) (1,575,723) Recoverable income taxes 406,749 (384,597) (400,680) Inventories (344,393) (101,077) 254,952 Other current assets 342,674 (569,745) (21,248) Trade accounts payable (797,447) (2,825,099) 2,256,795 Employee compensation and benefits 1,283,150 (2,848,092) 2,882,379 Accrued expenses 79,644 1,279,164 (2,936,155) Accrued interest 1,074,768 (325,409) 3,794,284 Deferred revenue 625,149 201,657 710,286 --------------- ------------------ ----------------- Net cash provided by operating activities 20,073,810 9,744,082 12,092,301 INVESTING ACTIVITIES Acquisition of television businesses (122,455,774) (45,644,942) (210,944,547) Disposition of television business 76,440,419 -0- 9,480,699 Purchases of property and equipment (9,270,623) (10,371,734) (3,395,635) Proceeds from asset sales 318,697 24,885 174,401 Deferred acquisition costs -0- (89,056) -0- Payments on purchase liabilities (551,917) (764,658) (243,985) Other 220,390 (652,907) (139,029) --------------- ------------------ ----------------- Net cash used in investing activities (55,298,808) (57,498,412) (205,068,096) FINANCING ACTIVITIES Proceeds from borrowings on long-term debt 90,070,000 75,350,000 238,478,310 Repayments of borrowings on long-term debt (46,609,122) (22,678,127) (109,434,577) Deferred loan costs (854,235) (463,397) (9,410,078) Dividends paid (1,642,709) (1,428,045) (426,598) Common Stock transactions 499,189 1,163,796 719,166 Proceeds from equity offering - Class B Common Stock, net of expenses -0- -0- 66,065,762 Proceeds from offering of Series B Preferred Stock -0- -0- 10,000,000 Proceeds from settlement of interest rate swap agreement -0- -0- 215,000 Proceeds from sale of treasury shares 1,473,249 581,834 -0- Purchase of Class A Common Stock (582,567) (3,455,475) -0- Purchase of Class B Common Stock -0- -0- (2,740,137) Redemption of Preferred Stock (7,609,384) -0- -0- --------------- ------------------ ----------------- Net cash provided by financing activities 34,744,421 49,070,586 193,466,848 --------------- ------------------ ----------------- Increase (decrease) in cash and cash equivalents (480,577) 1,316,256 491,053 Cash and cash equivalents at beginning of year 2,367,300 1,051,044 559,991 --------------- ------------------ ----------------- Cash and cash equivalents at end of year $ 1,886,723 $ 2,367,300 $ 1,051,044 =============== ================== ================= </TABLE> See accompanying notes. 51
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS The Company's operations, which are located in ten southeastern and midwestern states, include ten television stations, a transportable satellite uplink business, three daily newspapers, a weekly advertising only publication and paging operations. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. REVENUE RECOGNITION The Company recognizes revenues as services are performed. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on deposit with a bank. Deposits with the bank are generally insured in limited amounts. INVENTORIES Inventories, principally newsprint and supplies, are stated at the lower of cost or market. The Company uses the last-in, first-out ("LIFO") method of determining costs for substantially all of its inventories. Current cost exceeded the LIFO value of inventories by approximately $13,000 and $15,000 at December 31, 1998, and 1997, respectively. PROGRAM BROADCAST RIGHTS Rights to programs available for broadcast under program license agreements are initially recorded at the beginning of the license period for the amounts of total license fees payable under the license agreements and are charged to operating expense on the basis of total programs available for use on the straight-line method. The portion of the unamortized balance expected to be charged to operating expense in the succeeding year is classified as a current asset, with the remainder classified as a non-current asset. The liability for the license fees payable under the program license agreements is classified as current or long-term, in accordance with the payment terms of the various license agreements. The capitalized costs of the rights are recorded at the lower of unamortized costs or estimated net realizeable value. PROPERTY AND EQUIPMENT Property and equipment are carried at cost. Depreciation is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Buildings, 52
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT (CONTINUED) improvements and equipment are depreciated over estimated useful lives of approximately 35 years, 10 years and 5 years, respectively. INTANGIBLE ASSETS Intangible assets are stated at cost and are amortized using the straight-line method. Goodwill is amortized over 40 years. Loan acquisition fees are amortized over the life of the applicable indebtedness. Non-compete agreements are amortized over the life of the specific agreement. Accumulated amortization of intangible assets resulting from business acquisitions was $21.2 million and $11.5 million as of December 31, 1998, and 1997, respectively. If facts and circumstances indicate that the goodwill, property and equipment or other assets may be impaired, an evaluation of continuing value would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with these assets would be compared to their carrying amount to determine if a write down to fair market value or discounted cash flow value is required. INCOME TAXES Deferred income taxes are provided on the differences between the financial statement and income tax basis of assets and liabilities. The Company and its subsidiaries file a consolidated federal income tax return. Consolidated state income tax returns are filed when appropriate and separate state tax returns are filed when consolidation is not available. Local tax returns are filed separately. CAPITAL STOCK On August 20, 1998, the Board of Directors declared a 50% stock dividend, payable on September 30, 1998, to stockholders of record of the Class A Common Stock and Class B Common Stock on September 16, 1998. This stock dividend effected a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. STOCK BASED COMPENSATION The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its stock options. Under APB 25, if the exercise price of the stock options granted by the Company equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized. CONCENTRATION OF CREDIT RISK The Company provides print advertising and advertising air time to national, regional and local advertisers within the geographic areas in which the Company operates. Credit is extended based on an evaluation of the customer's financial condition, and generally advance payment is not required. Credit losses are provided for in the financial statements and consistently have been within management's expectations. 53
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of long-term debt at December 31, 1998, and 1997 exceeded book value by $10.4 million and $13.2 million, respectively. The fair value of the Preferred Stock at December 31, 1998, and 1997 approximates its carrying value at that date. The Company does not anticipate settlement of long-term debt or preferred stock at other than book value. The fair value of other financial instruments classified as current assets or liabilities approximates their carrying values due to the short-term maturities of these instruments. RECLASSIFICATIONS Certain amounts in the accompanying consolidated financial statements have been reclassified to conform to the 1998 format. B. BUSINESS ACQUISITIONS AND DISPOSITIONS The Company's acquisitions have been accounted for under the purchase method of accounting. Under the purchase method of accounting, the results of operations of the acquired businesses are included in the accompanying consolidated financial statements as of their respective acquisition dates. The assets and liabilities of acquired businesses are included based on an allocation of the purchase price. RECENT AND PENDING ACQUISITIONS On March 1, 1999, the Company acquired substantially all of the assets of THE GOSHEN NEWS from News Printing Company, Inc. and affiliates thereof, for aggregate cash consideration of approximately $16.7 million including a non-compete agreement. THE GOSHEN NEWS is a 17,000 circulation afternoon newspaper published Monday through Saturday and serves Goshen, Indiana and surrounding areas. The Company financed the acquisition through its $200.0 million bank loan agreement (the "Senior Credit Facility"). On January 28, 1999, Bull Run Corporation ("Bull Run"), a principal stockholder of the Company, acquired 301,119 shares of the outstanding common stock of Sarkes Tarzian, Inc. ("Tarzian") from the Estate of Mary Tarzian (the "Estate") for $10.0 million. The acquired shares (the "Tarzian Shares") represent 33.5% of the total outstanding common stock of Tarzian (both in terms of the number of shares of common stock outstanding and in terms of voting rights), but such investment represents 73% of the equity of Tarzian for purposes of dividends as well as distributions in the event of any liquidation, dissolution or other termination of Tarzian. Tarzian has filed a complaint in the United States District Court for the Southern District of Indiana, claiming that it had a binding contract with the Estate to purchase the Tarzian Shares from the Estate prior to Bull Run's purchase of the shares, and requests judgment providing that the Estate be required to sell the Tarzian Shares to Tarzian. Bull Run believes that a binding contract between Tarzian and the Estate did not exist, prior to Bull Run's purchase of the Tarzian Shares from the Estate, and in any case, Bull Run's purchase agreement with the Estate provides that in the event that a court of competent jurisdiction awards title to the Tarzian Shares to a person or entity other than Bull Run, the purchase agreement is rescinded and the Estate is required to pay Bull Run the full $10.0 million purchase price, plus interest. Tarzian owns and operates two television stations and four radio stations: WRCB-TV Channel 3 in Chattanooga, Tennessee, an NBC affiliate; KTVN-TV Channel 2 in Reno, Nevada, a CBS affiliate; WGCL-AM and WTTS-FM in Bloomington, Indiana; and WAJI-FM and WLDE-FM in Fort Wayne, Indiana. The Chattanooga and Reno markets rank as the 87th and the 108th largest television markets in the United States, respectively, as ranked by A. C. Nielsen Company. 54
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) B. BUSINESS ACQUISITIONS AND DISPOSITIONS (CONTINUED) RECENT AND PENDING ACQUISITIONS (CONTINUED) The Company has executed an option agreement with Bull Run, whereby the Company has the option of acquiring the Tarzian investment from Bull Run. Upon exercise of the option, the Company will pay Bull Run an amount equal to Bull Run's purchase price for the Tarzian investment and related costs. The option agreement currently expires on May 31, 1999; however, the Company may extend the option period at an established fee. In connection with the option agreement, the Company granted to Bull Run warrants to purchase up to 100,000 shares of the Company's Class B Common Stock at $13.625 per share. The warrants vest immediately upon the Company's exercise of its option to purchase the Tarzian investment. Neither Bull Run's investment nor the Company's potential investment is presently attributable under the ownership rules of the Federal Communications Commission ("FCC"). If the Company successfully exercises the option agreement, the Company plans to fund the acquisition through its Senior Credit Facility. 1998 ACQUISITIONS AND DISPOSITION On July 31, 1998, the Company completed the purchase of all of the outstanding capital stock of Busse Broadcasting Corporation ("Busse"). The purchase price was $120.5 million less the accreted value of Busse's 11 5/8% Senior Secured Notes due 2000 ("Busse Senior Notes"). The purchase price of the capital stock consisted of the contractual purchase price of $112.0 million, associated transaction costs of $2.9 million and Busse's cash and cash equivalents of $5.6 million. Immediately following the acquisition of Busse, the Company exercised its right to satisfy and discharge the Busse Senior Notes, effectively prefunding the Busse Senior Notes at the October 15, 1998 call price of 106 plus accrued interest. The amount necessary to satisfy and discharge the Busse Senior Notes was approximately $69.9 million. Based on the preliminary allocation of the purchase price, the excess of the purchase price over the fair value of net tangible assets acquired was approximately $122.8 million. Immediately prior to the Company's acquisition of Busse, Cosmos Broadcasting Corporation acquired the assets of WEAU-TV ("WEAU") from Busse and exchanged them for the assets of WALB-TV, Inc. ("WALB"), the Company's NBC affiliate in Albany, Georgia. In exchange for the assets of WALB, the Company received the assets of WEAU, which were valued at $66.0 million, and approximately $12.0 million in cash for a total value of $78.0 million. The Company recognized a pre-tax gain of approximately $70.6 million and estimated deferred income taxes of approximately $27.5 million in connection with the exchange of WALB. The Company funded the remaining costs of the acquisition of Busse's capital stock through its Senior Credit Facility. As a result of these transactions, the Company added the following television stations to its existing broadcast group: KOLN-TV("KOLN"), the CBS affiliate serving the Lincoln-Hastings-Kearney, Nebraska market; its satellite station KGIN-TV ("KGIN"), the CBS affiliate serving Grand Island, Nebraska; and WEAU, an NBC affiliate serving the La Crosse-Eau Claire, Wisconsin market. These transactions also satisfied the FCC's requirement for the Company to divest itself of WALB. The transactions described above are referred to herein as the "Busse-WALB Transactions." The Company's Board of Directors has agreed to pay Bull Run a fee of approximately $2.0 million for services performed in connection with the Busse-WALB Transactions. Of this fee, $1.1 million had been paid to Bull Run and $880,000 remained in accounts payable at December 31, 1998. Unaudited pro forma operating data for the years ended December 31 , 1998 and 1997 are presented below and assumes that the Busse-WALB Transactions and the 1997 Broadcasting Acquisitions (as 55
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) B. BUSINESS ACQUISITIONS AND DISPOSITIONS (CONTINUED) 1998 ACQUISITIONS AND DISPOSITION (CONTINUED) defined in 1997 ACQUISITIONS) were completed on January 1, 1997. The above described unaudited pro forma operating data excludes a pre-tax gain of approximately $70.6 million and estimated deferred income taxes of approximately $27.5 million in connection with the disposition of WALB. This unaudited pro forma operating data does not purport to represent the Company's actual results of operations had the Busse-WALB Transactions and the 1997 Broadcasting Acquisitions been completed on January 1, 1997, and should not serve as a forecast of the Company's operating results for any future periods. The pro forma adjustments are based solely upon certain assumptions that management believes are reasonable under the circumstances at this time. Unaudited pro forma operating data for the years ended December 31, 1998 and 1997, are as follows (in thousands, except per common share data): <TABLE> <CAPTION> DECEMBER 31, ------------------------------- 1998 1997 --------------- --------------- (UNAUDITED) <S> <C> <C> Revenues, net $ 133,661 $ 117,981 ========== ========== Net loss available to common stockholders $ (4,562) $ (6,647) ============ ============ Loss per share available to common stockholders: Basic $ (0.38) $ (0.56) ============= ============= Diluted $ (0.38) $ (0.56) ============= ============= </TABLE> The pro forma results presented above include adjustments to reflect (i) the incurrence of interest expense to fund the respective acquisitions, (ii) depreciation and amortization of assets acquired, (iii) the elimination of the corporate expense allocation net of additional accounting and administrative expenses and (iv) the income tax effect of such pro forma adjustments. 1997 ACQUISITIONS On August 1, 1997, the Company purchased the assets of WITN-TV ("WITN"). The purchase price of approximately $41.7 million consisted of $40.7 million cash, $600,000 in acquisition related costs, and approximately $400,000 in liabilities which were assumed by the Company. The excess of the purchase price over the fair value of net tangible assets acquired was approximately $37.4 million. The Company funded the costs of this acquisition through its Senior Credit Facility. WITN operates on Channel 7 and is the NBC affiliate in the Greenville-New Bern-Washington, North Carolina market. In connection with the purchase of the assets of WITN ("WITN Acquisition"), the Company paid Bull Run a fee of $400,000 for services performed. On April 24, 1997, the Company acquired all of the issued and outstanding common stock of GulfLink Communications, Inc. ("GulfLink") of Baton Rouge, Louisiana. The GulfLink operations included nine transportable satellite uplink trucks. The purchase price of approximately $5.2 million consisted of $4.1 million cash, $127,000 in acquisition related costs, and approximately $1.0 million in liabilities which were assumed by the Company. The excess of the purchase price over the fair value of net tangible assets acquired was approximately $3.6 million. The Company funded the costs of this acquisition through its Senior Credit Facility. In connection with the purchase of the common stock of GulfLink Communications, Inc. (the "GulfLink Acquisition"), the Company paid Bull Run a fee equal to 56
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) B. BUSINESS ACQUISITIONS AND DISPOSITIONS (CONTINUED) 1997 ACQUISITIONS (CONTINUED) $58,000 for services performed. The WITN Acquisition and the GulfLink Acquisition are hereinafter referred to as the "1997 Broadcasting Acquisitions." Unaudited pro forma operating data for the year ended December 31, 1997, and 1996 are presented below and assumes that the 1997 Broadcasting Acquisitions, the First American Acquisition (as defined in 1996 ACQUISITIONS AND DISPOSITION) and the KTVE Sale (as defined in 1996 ACQUISITIONS AND DISPOSITION) occurred on January 1, 1996. This unaudited pro forma operating data does not purport to represent the Company's actual results of operations had these transactions occurred on January 1, 1996, and should not serve as a forecast of the Company's operating results for any future periods. The pro forma adjustments are based solely upon certain assumptions that management believes are reasonable under the circumstances at this time. Unaudited pro forma operating data for the years ended December 31, 1997 and 1996, are as follows (in thousands, except per common share data): <TABLE> <CAPTION> DECEMBER 31, ------------------------------- 1997 1996 --------------- --------------- (UNAUDITED) <S> <C> <C> Revenues, net $ 109,099 $ 108,908 ========== ========== Net loss available to common stockholders $ (3,769) $ (2,397) ============ ============ Loss per share available to common stockholders: Basic $ (0.32) $ (0.20) ============= ============= Diluted $ (0.32) $ (0.20) ============= ============= </TABLE> The pro forma results presented above include adjustments to reflect (i) the incurrence of interest expense to fund the 1997 Broadcasting Acquisitions, and the First American Acquisition (as defined in 1996 ACQUISITIONS AND DISPOSITION), (ii) depreciation and amortization of assets acquired, (iii) the reduction of employee compensation related to severance and vacation compensation for 1996, (iv) the elimination of the corporate expense allocation net of additional accounting and administrative expenses for the WITN Acquisition and the First American Acquisition, (v) increased pension expense for the First American Acquisition, and (vi) the income tax effect of such pro forma adjustments. Average outstanding shares used to calculate pro forma earnings per share data for 1996 include the 5,250,000 Class B Common shares issued in connection with the First American Acquisition. 1996 ACQUISITIONS AND DISPOSITION On September 30, 1996, the Company purchased from First American Media, Inc. substantially all of the assets used in the operation of two CBS-affiliated television stations, WCTV-TV ("WCTV") serving Tallahassee, Florida-Thomasville, Georgia and WKXT-TV ("WKXT") in Knoxville, Tennessee, as well as those assets used in the operations of a satellite uplink and production services business and a communications and paging business (the "First American Acquisition"). Subsequent to the First American Acquisition, the Company rebranded WKXT with the call letters WVLT ("WVLT"). The purchase price of approximately $183.9 million consisted of $175.5 million cash, $1.8 million in acquisition related costs, and the assumption of approximately $6.6 million of liabilities. The excess of the purchase price over the fair value of net tangible assets acquired was approximately $160.2 million. The Company paid Bull Run, a fee equal to approximately $1.7 million for services performed in 57
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) B. BUSINESS ACQUISITIONS AND DISPOSITIONS (CONTINUED) 1996 ACQUISITIONS AND DISPOSITION (CONTINUED) connection with this acquisition. The First American Acquisition and the early retirement of the Company's existing bank credit facility and other senior indebtedness, were funded as follows: net proceeds of $66.1 million from the sale of 5,250,000 shares of the Company's Class B Common Stock; net proceeds of $155.2 million from the sale of $160.0 million principal amount of the Company's 10 5/8% Senior Subordinated Notes due 2006; $16.9 million of borrowings under the Senior Credit Facility; and $10.0 million net proceeds from the sale of 1,000 shares of the Company's Series B Preferred Stock with warrants to purchase 750,000 shares of the Company's Class A Common Stock at $16 per share. The shares of Series B Preferred Stock were issued to Bull Run and to J. Mack Robinson, Chairman of the Board of Bull Run and President and Chief Executive Officer of the Company, and certain of his affiliates. The Company obtained an opinion from an investment banker as to the fairness of the terms of the sale of such Series B Preferred Stock with warrants. In connection with the First American Acquisition, the FCC ordered the Company to divest itself of WALB in Albany, Georgia and WJHG-TV ("WJHG") in Panama City, Florida by March 31, 1997 to comply with regulations governing common ownership of television stations with overlapping service areas. The FCC is currently reexamining these regulations, and if it revises them in accordance with the interim policy it has adopted, divestiture of WJHG would not be required. Accordingly, the Company requested and in July of 1997 received an extension of the divestiture deadline with regard to WJHG conditioned upon the outcome of the rulemaking proceedings. It can not be determined when the FCC will complete its rulemaking on this subject. On July 31, 1998, the assets of WALB were exchanged for the assets of WEAU. This exchange transaction satisfied the FCC's divestiture requirement for WALB. Condensed unaudited balance sheets of WALB and WJHG are as follows (in thousands): <TABLE> <CAPTION> WALB WJHG DECEMBER 31, DECEMBER 31, -------------------------- 1997 1998 1997 -------------- -------------------------- (UNAUDITED) (UNAUDITED) <S> <C> <C> <C> Current assets $2,379 $1,163 $1,053 Property and equipment 1,473 1,323 848 Other assets 471 148 346 ------ ------ ------ Total assets $4,323 $2,634 $2,247 ====== ====== ====== Current liabilities $ 994 $ 583 $ 350 Other liabilities 215 118 127 Stockholder's equity 3,114 1,933 1,770 ------ ------ ------ Total liabilities and stockholder's equity $4,323 $2,634 $2,247 ====== ====== ====== </TABLE> 58
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) B. BUSINESS ACQUISITIONS AND DISPOSITIONS (CONTINUED) 1996 ACQUISITIONS AND DISPOSITION (CONTINUED) Condensed unaudited income statement data of WALB and WJHG are as follows (in thousands): <TABLE> <CAPTION> WALB WJHG --------------------------------------------------------------------- SEVEN MONTHS YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, ENDED ---------------------------------------------------------- JULY 31, 1997 1996 1998 1997 1996 1998 --------------------------------------------------------------------- (UNAUDITED) <S> <C> <C> <C> <C> <C> <C> Broadcasting revenues $6,773 $10,090 $10,611 $5,057 $4,896 $5,217 Expenses 3,130 4,770 5,070 4,038 3,757 4,131 --------- --------- --------- ----- ----- ----- Operating income 3,643 5,320 5,541 1,019 1,139 1,086 Other income (expense) (33) 3 7 1 (5) 6 --------- --------- --------- ----- ----- ----- Income before income taxes $ 3,610 $5,323 $5,548 $1,020 $1,134 $1,092 ======= ====== ====== ====== ====== ====== Net income $ 2,238 $3,295 $3,465 $ 632 $ 737 $ 685 ======= ====== ====== ===== ===== ===== </TABLE> On January 4, 1996, the Company purchased substantially all of the assets of WRDW-TV, a CBS television affiliate serving the Augusta, Georgia television market (the "Augusta Acquisition"). The purchase price of approximately $37.2 million which included assumed liabilities of approximately $1.3 million, was financed primarily through long-term borrowings. The assets acquired consisted of office equipment and broadcasting operations located in North Augusta, South Carolina. The excess of the purchase price over the fair value of net tangible assets acquired was approximately $32.5 million. In connection with the Augusta Acquisition, the Company paid a fee of $360,000 to Bull Run for services performed. Funds for the Augusta Acquisition were obtained from the modification of the Company's existing bank debt on January 4, 1996 (the "Bank Loan") to a variable rate reducing revolving credit facility (the "Old Credit Facility") and the sale to Bull Run of an 8% subordinated note due January 3, 2005 in the principal amount of $10.0 million (the "8% Note"). In connection with the sale of the 8% Note, the Company also issued warrants to Bull Run to purchase 731,250 shares of Class A Common Stock at $11.92 per share. Of these warrants, 450,000 vested upon issuance with the remaining warrants vesting in five equal annual installments commencing on the first anniversary of the date of issuance. Approximately $2.6 million of the $10.0 million of proceeds from the 8% Note was allocated to the warrants and increased Class A Common Stock. The Old Credit Facility provided for a credit line up to $54.2 million. This transaction also required a modification of the interest rate of the Company's $25.0 million senior secured note with an institutional investor (the "Senior Note") from 10.08% to 10.7%. As part of the financing arrangements for the First American Acquisition, the Old Credit Facility and the Senior Note were retired and the Company issued to Bull Run, in exchange for the 8% Note, 1,000 shares of Series A Preferred Stock. The warrants issued with the 8% Note were retired and the warrants issued with the Series A Preferred Stock will vest in accordance with the same schedule described above provided the Series A Preferred Stock remains outstanding. The Company recorded an extraordinary charge of $5.3 million ($3.2 million after taxes or $0.39 per basic common share and $0.37 per diluted common share for 1996) in connection with the early retirement of the $25.0 million Senior Note and the write-off of loan acquisition costs from the early extinguishment of debt. The Company sold the assets of KTVE Inc. (the "KTVE Sale"), its NBC-affiliated television station, in Monroe, Louisiana-El Dorado, Arkansas on August 20, 1996. The sales price included $9.5 million in 59
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) B. BUSINESS ACQUISITIONS AND DISPOSITIONS (CONTINUED) 1996 ACQUISITIONS AND DISPOSITION (CONTINUED) cash plus the amount of the accounts receivable on the date of closing to the extent collected by the buyer, to be paid to the Company within 150 days following the closing date (approximately $829,000). The Company recognized a pre-tax gain of approximately $5.7 million and estimated income taxes of approximately $2.8 million in connection with the sale. Unaudited pro forma operating data for the years ended December 31, 1996 and 1995 is presented below and assumes that the Augusta Acquisition, the First American Acquisition, and the KTVE Sale occurred on January 1, 1995. This unaudited pro forma operating data does not purport to represent the Company's actual results of operations had the Augusta Acquisition, the First American Acquisition, and the KTVE Sale occurred on January 1, 1995, and should not serve as a forecast of the Company's operating results for any future periods. The pro forma adjustments are based solely upon certain assumptions that management believes are reasonable under the circumstances at this time. Unaudited pro forma operating data for the years ended December 31, 1996 and 1995, are as follows (in thousands, except per common share data): <TABLE> <CAPTION> DECEMBER 31, ------------------------------- 1996 1995 --------------- --------------- (UNAUDITED) <S> <C> <C> Revenues, net $ 97,540 $ 90,637 =========== =========== Net loss available to common stockholders $ (1,388) $ (6,073) ============ ============ Loss per share available to common stockholders: Basic $ (0.11) $ (0.51) ============ ============ Diluted $ (0.11) $ (0.51) ============ ============ </TABLE> The pro forma results presented above include adjustments to reflect (i) the incurrence of interest expense to fund the First American Acquisition and the WRDW Acquisition, (ii) depreciation and amortization of assets acquired, (iii) the reduction of employee compensation related to severance and vacation compensation for 1996, (iv) the elimination of the corporate expense allocation net of additional accounting and administrative expenses for the First American Acquisition, (v) increased pension expense for the First American Acquisition, and (vi) the income tax effect of such pro forma adjustments. Average outstanding shares used to calculate pro forma earnings per share data for 1996 and 1995 include the 5,250,000 Class B Common shares issued in connection with the First American Acquisition. C. LONG-TERM DEBT Long-term debt consists of the following (in thousands): <TABLE> <CAPTION> DECEMBER 31, ------------------------------- 1998 1997 --------------- --------------- <S> <C> <C> 10 5/8 % Senior Subordinated Notes due 2006 $ 160,000 $ 160,000 Senior Credit Facility 109,500 65,630 Other 1,155 1,446 -------------- -------------- 270,655 227,076 -------------- -------------- Less current portion (430) (400) -------------- -------------- $ 270,225 $ 226,676 =========== =========== </TABLE> 60
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) C. LONG-TERM DEBT (CONTINUED) On September 20, 1996, the Company sold $160.0 million principal amount of the Company's 10 5/8% Senior Subordinated Notes (the "Senior Subordinated Notes") due 2006. The net proceeds of $155.2 million from this offering, along with the net proceeds from (i) the KTVE Sale, (ii) the issuance of Class B Common Stock, (iii) the issuance of Series B Preferred Stock and (iv) borrowings under the Senior Credit Facility, were used in financing the First American Acquisition as well as the early retirement of the Senior Note and the Old Credit Facility. Interest on the Senior Subordinated Notes is payable semi- annually on April 1 and October 1, commencing April 1, 1997. The Senior Credit Facility included scheduled reductions in the $125.0 million credit limit which commenced on March 31, 1997, interest rates based upon a spread over LIBOR and/or the lender's prime rate, an unused commitment fee of 0.50% applied to available funds and a maturity date of June 30, 2003. Effective September 17, 1997, the Senior Credit Facility was modified to reinstate the original credit limit of $125.0 million which had been reduced by the scheduled reductions. The modification also reduced the interest rate spread over LIBOR and/or Prime. The modification also extended the maturity date from June 30, 2003 to June 30, 2004. The modification required a one-time fee of $250,000. Effective July 31, 1998, the Senior Credit Facility was modified to increase the committed credit limit from $125.0 million to $200.0 million. This modification also allows for an additional uncommitted $100.0 million in available credit which is in addition to the committed $200.0 million credit limit. This $100.0 million in uncommitted available credit can be borrowed by the Company only after approval of the bank consortium. The modification also extended the maturity date from June 30, 2004 to June 30, 2005. The modification required a one-time fee of approximately $750,000. At December 31, 1998, the Company had approximately $109.5 million borrowed under the Senior Credit Facility with approximately $90.5 million available under the agreement. The interest rate on the outstanding balance was based on the lender's prime rate and a spread over LIBOR of 1.75%. Additionally, the effective interest rate of the Senior Credit Facility can be changed based upon the Company's maintenance of certain operating ratios as defined by the Senior Credit Facility, not to exceed the lender's prime rate plus 0.50% or LIBOR plus 2.25%. The effective interest rate on the Senior Credit Facility at December 31, 1998 and 1997 was 7.1% and 7.9%, respectively. The Company is charged a commitment fee on the excess of the aggregate average daily available credit limit less the amount outstanding. At December 31, 1998, the commitment fee was 0.50% per annum. The Company's $200.0 million Senior Credit Facility, as amended, is comprised of a term loan (the "Term Commitment") of $100.0 million and a revolving credit facility (the "Revolving Commitment") of $100.0 million. As of December 31, 1998, the Company had $9.5 million borrowed under the Senior Credit Facility's Revolving Commitment. The Revolving Commitment will automatically reduce as follows: 10% in 2000, 15% in 2001, 15% in 2002, 20% in 2003, 25% in 1994 and 15% in 2005. As of December 31, 1998, the Company had $100.0 million borrowed under the Senior Credit Facility's Term Commitment. The amount outstanding under the Term Commitment will become fixed as of December 30, 1999 and it will be reduced as follows: 2.5% in 1999, 10.0% in 2000, 10.0% in 2001, 17.5% in 2002, 17.5% in 2003, 21.2% in 2004 and 21.3% in 2005. The agreement pursuant to which the Senior Credit Facility was issued contains certain restrictive provisions, which, among other things, limit additional indebtedness and require minimum levels of cash flows. The Senior Subordinated Notes also contained similar restrictive provisions as well as limitations on restricted payments. 61
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) C. LONG-TERM DEBT (CONTINUED) The Senior Subordinated Notes are jointly and severally guaranteed (the "Subsidiary Guarantees") by all of the Company's subsidiaries (the "Subsidiary Guarantors"). The obligations of the Subsidiary Guarantors under the Subsidiary Guarantees is subordinated, to the same extent as the obligations of the Company in respect of the Senior Subordinated Notes, to the prior payment in full of all existing and future senior debt of the Subsidiary Guarantors (which will include any guarantee issued by such Subsidiary Guarantors of any senior debt). The Company is a holding company with no material independent assets or operations, other than its investment in its subsidiaries. The aggregate assets, liabilities, earnings and equity of the Subsidiary Guarantors are substantially equivalent to the assets, liabilities, earnings and equity of the Company on a consolidated basis. The Subsidiary Guarantors are, directly or indirectly, wholly-owned subsidiaries of the Company and the Subsidiary Guarantees are full, unconditional and joint and several. All of the current and future direct and indirect subsidiaries of the Company will be guarantors of the Senior Subordinated Notes. Accordingly, separate financial statements and other disclosures of each of the Subsidiary Guarantors are not presented because management has determined that they are not material to investors. The Senior Subordinated Notes and the Senior Credit Facility are secured by substantially all of the Company's existing and hereafter acquired assets. Aggregate minimum principal maturities on long-term debt as of December 31, 1998, were as follows (in thousands): MINIMUM PRINCIPAL YEAR MATURITIES --------------- ------------------------- 1999 $ 430 2000 330 2001 209 2002 62 2003 27,067 Thereafter 242,557 ------------ $ 270,655 ============ The Company made interest payments of approximately $22.9 million, $21.3 million, and $7.6 million during 1998, 1997 and 1996, respectively. In the year ended December 31, 1996, the Company recorded an extraordinary charge of $5.3 million ($3.2 million after taxes or $0.39 per basic common share or $0.37 per diluted common share) in connection with the early retirement of the Senior Note and the write-off of unamortized loan acquisition costs of the Senior Note and the Old Credit Facility resulting from the early extinguishment of debt. D. SUPPLEMENTAL EMPLOYEE BENEFITS AND OTHER AGREEMENTS The Company had an employment agreement with its former President, Ralph W. Gabbard, which provided for an award of 183,051 shares of the Company's Class A Common Stock if his employment with the Company continued until September 1999. Mr. Gabbard died unexpectedly in September 1996. The Company awarded these shares to the estate of Mr. Gabbard. Approximately $880,000 of expense was recorded in 1996. The Company has entered into supplemental retirement benefit and other agreements with certain key employees. These benefits are to be paid primarily in equal monthly amounts over the employees' life for a period not to exceed 15 years after retirement. The Company charges against operations 62
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) D. SUPPLEMENTAL EMPLOYEE BENEFITS AND OTHER AGREEMENTS (CONTINUED) amounts sufficient to fund the present value of the estimated lifetime supplemental benefit over each employee's anticipated remaining period of employment. The following summarizes activity relative to certain officers' agreements and the supplemental employee benefits (in thousands): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ----------------------------------------------- 1998 1997 1996 ------------ ----------------- --------------- <S> <C> <C> <C> Beginning liability $ 1,526 $ 3,158 $ 2,938 --------- ---------- --------- Provision 180 161 918 Forfeitures (61) -0- -0- -------- --------- --------- Net expense 119 161 918 Payments (202) (1,793) (698) -------- --------- --------- Net change (83) (1,632) 220 -------- --------- --------- Ending liability 1,443 1,526 3,158 Less current portion (315) (365) (1,801) -------- --------- --------- $ 1,128 $ 1,161 $ 1,357 ======== ========= ========= </TABLE> E. STOCKHOLDERS' EQUITY During 1996, the Company amended its Articles of Incorporation to increase to 50,000,000 the number of shares of all classes of stock which the Company has the authority to issue, of which, 15,000,000 shares are designated Class A Common Stock, 15,000,000 shares are designated Class B Common Stock, and 20,000,000 shares are designated "blank check" preferred stock for which the Board of Directors has the authority to determine the rights, powers, limitations and restrictions. The rights of the Company's Class A and Class B Common Stock are identical, except that the Class A Common Stock has 10 votes per share and the Class B Common Stock has one vote per share. The Class A and Class B Common Stock receive cash dividends on an equal per share basis. As part of the financing for the Augusta Acquisition in 1996, funding was obtained from the 8% Note, which included the issuance of detachable warrants to Bull Run to purchase 731,250 shares of Class A Common Stock at $11.92 per share. Of these warrants 450,000 vested upon issuance, with the remaining warrants vesting in five equal annual installments commencing on the first anniversary of the date of issuance. Approximately $2.6 million of the $10.0 million of proceeds from the 8% Note was allocated to the warrants and increased Class A Common Stock. This allocation of the proceeds was based on an estimate of the relative fair values of the 8% Note and the warrants on the date of issuance. The Company amortized the original issue discount on a ratable basis in accordance with the original terms of the 8% Note through September 30, 1996. The Company recognized approximately $217,000 in amortization costs for the $2.6 million original issue discount. In September 1996, the Company exchanged the 8% Note with Bull Run for 1,000 shares of liquidation preference Series A Preferred Stock yielding 8%. The warrants issued with the 8% Note were retired and the warrants issued with the Series A Preferred Stock will vest in accordance with the same schedule described above provided the Series A Preferred Stock remains outstanding. The holder of the Series A Preferred Stock will receive cash dividends at an annual rate of $800 per share. The liquidation or redemption price of the Series A Preferred Stock is $10,000 per share. As part of the financing for the First American Acquisition in 1996, the Company also issued 1,000 shares of Series B Preferred Stock, with warrants to purchase an aggregate of 750,000 shares of Class A Common Stock at an exercise price of $16.00 per share. Of these warrants 450,000 vested upon issuance, with the remaining warrants vesting in five equal annual installments commencing on the first anniversary 63
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) E. STOCKHOLDERS' EQUITY (CONTINUED) of the date of issuance. The shares of Series B Preferred Stock were issued to Bull Run and to J. Mack Robinson, Chairman of the Board of Bull Run and President and Chief Executive Officer of the Company, and certain of his affiliates. The Company obtained a written opinion from an investment banker as to the fairness of the terms of the sale of such Series B Preferred Stock with warrants. The holders of the Series B Preferred Stock will receive dividends at an annual rate of $600 per share, except the Company at its option may pay these dividends in cash or in additional shares. The liquidation or redemption price of the Series B Preferred Stock is $10,000 per share. In August 1998 and September 1997, the Company issued 50.9 shares and 60.0 shares of Series B Preferred Stock, respectively, as payment of dividends to the holders of its then outstanding Series B Preferred Stock. During 1998, the Company redeemed 760.9 shares of Series B Preferred Stock at a cost of $7.6 million. On September 24, 1996, the Company completed a public offering of 5.25 million shares of its Class B Common Stock at an offering price of $13.67 per share. The proceeds, net of expenses, from this public offering of approximately $66.1 million were used in the financing of the First American Acquisition. The Company is authorized by its Board of Directors to purchase up to two million shares of the Company's Class A or Class B Common Stock to either be retired or reissued in connection with the Company's benefit plans, including the Capital Accumulation Plan and the Incentive Plan. During 1998, 1997 and 1996, the Company purchased 30,750 Class A Common Stock Shares, 259,350 Class A Common Stock shares and 258,450 Class B Common Stock shares, respectively, under this authorization. The 1998, 1997 and 1996 treasury shares were purchased at prevailing market prices with an average effective price of $18.95, $13.33 and $10.60 per share, respectively, and were funded from the Company's operating cash flow. F. LONG-TERM INCENTIVE PLAN AND STOCK PURCHASE PLAN The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123 "Accounting for Stock-Based Compensation" ("Statement 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized. The Company has a long-term incentive plan (the "Incentive Plan") under which 300,000 shares of the Company's Class A Common Stock and 600,000 shares of the Company's Class B Common Stock are reserved for grants to key personnel for (i) incentive stock options, (ii) non-qualified stock options, (iii) stock appreciation rights, (iv) restricted stock and (v) performance awards, as defined by the Incentive Plan. Shares of Common Stock underlying outstanding options or performance awards are counted against the Incentive Plan's maximum shares while such options or awards are outstanding. Under the Incentive Plan, the options granted typically vest after a two year period and expire three years after full vesting. Options granted through December 31, 1998, have been granted at a price which approximates fair market value on the date of the grant. On December 11, 1998, the Company repriced certain Class B Common Stock grants made under the Incentive Plan, at a price which approximated the market price of the Class B Common Stock on that day. The Company also has a Stock Purchase Plan which grants outside directors up to 7,500 shares of the Company's Common Stock. Under this Stock Purchase Plan, the options granted vest at the beginning of the upcoming calendar year and expire at the end of January following that calendar year. 64
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) F. LONG-TERM INCENTIVE PLAN AND STOCK PURCHASE PLAN (CONTINUED) Prior to 1996, grants under the Incentive Plan and the Stock Purchase Plan were made with the Company's Class A Common Stock. In 1996, the Company amended its Incentive Plan and Stock Purchase Plan for grants to be made with Class A or Class B Common Stock. Pro forma information regarding net income and earnings per share is required by Statement 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of Statement 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 4.57%, 5.82% and 5.43%; dividend yields of 0.55%, 0.32% and 0.50%; volatility factors of the expected market price of the Company's Class A Common Stock of 0.28, 0.28 and 0.33; and a weighted-average expected life of the options of 4.0, 4.5 and 2.0 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and which are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands, except per common share data): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ---------------------------- 1998 1997 1996 --------- -------- --------- <S> <C> <C> <C> Pro forma income (loss) before extraordinary charge available to common stockholders $39,523 $(3,174) $5,190 Pro forma income (loss) before extraordinary charge per common share: Basic $ 3.31 $(0.27) $ 0.64 Diluted $ 3.20 $(0.27) $ 0.62 </TABLE> 65
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) F. LONG-TERM INCENTIVE PLAN AND STOCK PURCHASE PLAN (CONTINUED) A summary of the Company's stock option activity for Class A Common Stock, and related information for the years ended December 31, 1998, 1997, and 1996 is as follows (in thousands, except weighted average data): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------------ 1998 1997 1996 ------------------- --------- --------- --------- ---------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE --------- --------- --------- --------- --------- ---------- <S> <C> <C> <C> <C> <C> <C> Stock options outstanding -- beginning of year 92 $ 7.43 297 $ 8.74 394 $ 8.26 Options granted 19 17.81 -0- -0- Options exercised (74) 7.08 (127) 7.17 (78) 6.62 Options forfeited (1) 8.89 -0- (9) 8.29 Options expired -0- (78) 12.83 (10) 6.78 ------- -------- -------- Stock options outstanding -- end of year 36 $ 13.71 92 $ 7.43 297 $ 8.74 ======= ======= ======= Exercisable at end of year 16 $ 8.89 92 $ 7.43 246 $ 8.71 Weighted-average fair value of options granted during the year $ 5.59 </TABLE> Exercise prices for Class A Common Stock options outstanding as of December 31, 1998, ranged from $8.89 to $17.81 for the Incentive Plan. The weighted-average remaining contractual life of the Class A Common Stock options outstanding for the Incentive Plan is 3.2 years. A summary of the Company's stock option activity for Class B Common Stock, and related information for the years ended December 31, 1998, 1997, and 1996 is as follows (in thousands, except weighted average data): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------------------------------------ 1998 1997 1996 ------------------- --------- ---------- -------- ---------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE --------- --------- --------- ---------- -------- ---------- <S> <C> <C> <C> <C> <C> Stock options outstanding -- beginning of year 630 $15.80 102 $10.58 -0- Options granted 589 14.43 528 16.80 102 $ 10.58 Options exercised (86) 11.05 -0- -0- Options forfeited (474) 16.95 -0- -0- ------- ----- ----- Stock options outstanding -- end of year 659 $14.36 630 $15.80 102 $ 10.58 ======= ===== ===== Exercisable at end of year 84 $14.65 79 $10.58 -0- Weighted-average fair value of options granted during the year $ 3.95 $ 5.40 $2.15 </TABLE> 66
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) F. LONG-TERM INCENTIVE PLAN AND STOCK PURCHASE PLAN (CONTINUED) Exercise prices for Class B Common Stock options outstanding as of December 31, 1998, ranged from $10.58 to $14.50 for the Incentive Plan and $14.00 to $16.13 for the Stock Purchase Plan. The weighted-average remaining contractual life of the Class B Common Stock options outstanding for the Incentive Plan and Stock Purchase Plan is 4.0 and 0.5 years, respectively. G. INCOME TAXES The Company uses the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Federal and state income tax expense (benefit) included in the consolidated financial statements are summarized as follows (in thousands): YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 --------- ---------- ----------- Current Federal $ 414 $ (1,620) $1,462 State and local 937 577 841 Deferred 26,793 1,283 (44) -------- -------- ------- $ 28,144 $ 240 $2,259 ======== ======== ======= The total provision for income taxes for 1998 included a deferred tax charge of $27.5 million which related to the exchange of WALB's assets for the assets of WEAU. For income tax purposes, the gain on the exchange of WALB qualified for deferred capital gains treatment under the "like-kind exchange" provision of Section 1031 of the Internal Revenue Code of 1986. The total provision for income taxes for 1996 included a tax benefit of $2.2 million which related to an extraordinary charge on extinguishment of debt. 67
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) G. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax liabilities and assets are as follows (in thousands): <TABLE> <CAPTION> DECEMBER 31, ----------------------- 1998 1997 ---------- ----------- <S> <C> <C> Deferred tax liabilities: Net book value of property and equipment $ 6,597 $ 2,670 Goodwill and other intangibles 45,546 6,281 Other 122 120 ---------- --------- Total deferred tax liabilities 52,265 9,071 Deferred tax assets: Liability under supplemental retirement plan 528 526 Allowance for doubtful accounts 465 499 Difference in basis of assets held for sale 1,106 941 Federal operating loss carryforwards 3,825 4,412 State and local operating loss carryforwards 2,534 1,952 Other 457 290 ---------- --------- Total deferred tax assets 8,915 8,620 Valuation allowance for deferred tax assets (798) (753) ---------- --------- Net deferred tax assets 8,117 7,867 ---------- --------- Deferred tax liabilities, net $ 44,148 $ 1,204 ========== ========= </TABLE> Approximately $11.3 million in federal operating loss carryforwards will expire by the year ended December 31, 2012. Additionally, the Company has approximately $56.0 million in state operating loss carryforwards. A reconciliation of income tax expense at the statutory federal income tax rate and income taxes as reflected in the consolidated financial statements is as follows (in thousands): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, --------------------------------- 1998 1997 1996 --------- ----------- ---------- <S> <C> <C> <C> Statutory rate applied to income (loss) $ 24,431 $ (395) $ 1,625 State and local taxes, net of federal tax benefits 3,472 572 (7) Permanent difference relating to sale of KTVE -0- -0- 602 Other items, net 241 63 39 -------- ------ ------- $ 28,144 $ 240 $ 2,259 ======== ====== ======= </TABLE> The Company made income tax payments of approximately $1.5 million, $275,000 and $3.6 million during 1998, 1997 and 1996, respectively. At December 31, 1998 and 1997, the Company had current recoverable income taxes of approximately $1.7 million and $2.1 million, respectively. H. RETIREMENT PLANS PENSION PLAN The Company has a retirement plan covering substantially all full-time employees. Retirement benefits are based on years of service and the employees' highest average compensation for five 68
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) H. RETIREMENT PLANS (CONTINUED) PENSION PLAN (CONTINUED) consecutive years during the last ten years of employment. The Company's funding policy is to contribute annually the minimum amounts deductible for federal income tax purposes. The following summarizes the plan's funded status and related assumptions (dollars in thousands): <TABLE> <CAPTION> DECEMBER 31, -------------------- 1998 1997 --------- ---------- <S> <C> <C> CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year $7,053 $6,483 Service cost 616 429 Interest cost 496 443 Actuarial losses 203 31 Change in benefit obligation due to change in discount rate 303 -0- Benefits paid (349) (333) ------ ------ Benefit obligation at end of year $8,322 $7,053 ====== ====== CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $6,926 $6,241 Actual return on plan assets 618 644 Company contributions 212 374 Benefits paid (349) (333) ------ ------ Fair value of plan assets at end of year $7,407 $6,926 ====== ====== COMPONENTS OF ACCRUED BENEFIT COSTS Underfunded status of the plan $ (915) $ (134) Unrecognized net actuarial (gain) loss 297 (58) Unrecognized net transition amount (188) (242) Unrecognized prior service cost (3) (4) ------ ------ Accrued benefit cost $ (809) $ (438) ====== ====== WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31 Discount rate 6.8% 7.0% Expected long-term rate of return on plan assets 6.8% 7.0% Estimated rate of increase in compensation levels 5.0% 5.0% </TABLE> The net periodic pension cost includes the following components (in thousands): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------- 1998 1997 1996 ---------- ---------- --------- <S> <C> <C> <C> COMPONENTS OF NET PERIODIC PENSION COST Service cost $ 616 $ 429 $ 360 Interest cost 496 443 409 Expected return on plan assets (475) (433) (393) Amortization of prior service cost (1) (1) (1) Amortization of transition (asset) or obligation (54) (54) (54) ------ ------ ------ Pension cost $ 582 $ 384 $ 321 ====== ====== ====== </TABLE> 69
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) H. RETIREMENT PLANS (CONTINUED) CAPITAL ACCUMULATION PLAN Effective October 1, 1994, the Company adopted the Gray Communications Systems, Inc. Capital Accumulation Plan (the "Capital Accumulation Plan") for the purpose of providing additional retirement benefits for substantially all employees. The Capital Accumulation Plan is intended to meet the requirements of section 401(k) of the Internal Revenue Code of 1986. On November 14, 1996, the Company amended its Capital Accumulation Plan to allow an investment option in the Company's Class B Common Stock. The amendment also allowed for the Company's percentage match to be made by a contribution of the Company's Class B Common Stock, effective in 1997. On December 13, 1996, the Company reserved 300,000 shares of the Company's Class B Common Stock for issuance under the Capital Accumulation Plan. Employee contributions to the Capital Accumulation Plan, not to exceed 6% of the employees' gross pay, are matched by Company contributions. Until 1997, the Company's percentage match was made by a contribution of the Company's Class A Common Stock. Since 1997, the Company's percentage match has been made by a contribution of the Company's Class B Common Stock. The Company's percentage match amount is declared by the Company's Board of Directors before the beginning of each plan year. The Company's percentage match was 50% for the three years ended December 31, 1998. The Company contributions vest, based upon each employee's number of years of service, over a period not to exceed five years. Company matching contributions aggregating $491,524, $419,670 and $262,426 were charged to expense for 1998, 1997 and 1996, respectively, for the issuance of 29,305 and 31,311 Class B shares and 19,837 Class A shares, respectively. I. COMMITMENTS AND CONTINGENCIES The Company has various operating lease commitments for equipment, land and office space. The Company has also entered into commitments for various television film exhibition rights for which the license periods have not yet commenced. Rent expense resulting from operating leases for the years ended December 31, 1998, 1997 and 1996 were $1.8 million, $1.4 million and $501,000, respectively. Future minimum payments under operating leases with initial or remaining noncancelable lease terms in excess of one year and obligations under film exhibition rights for which the license period have not yet commenced are as follows (in thousands): LEASE FILM TOTAL ---------- ---------- --------- 1999 $1,411 $1,550 $ 2,961 2000 877 3,656 4,533 2001 661 2,428 3,089 2002 344 1,535 1,879 2003 137 302 439 Thereafter 714 421 1,135 ------ ------ ------- $4,144 $9,892 $14,036 ====== ====== ======= The Company is subject to legal proceedings and claims which arise in the normal course of its business. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not materially affect the Company's financial position. 70
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) J. INFORMATION ON BUSINESS SEGMENTS The Company operates in three business segments: broadcasting, publishing and paging. The broadcasting segment operates ten television stations located in the southeastern and midwestern United States at December 31, 1998. The publishing segment operates three daily newspapers in three different markets, and an area weekly advertising only publication in Georgia. The paging operations are located in Florida, Georgia, and Alabama. The following tables present certain financial information concerning the Company's three operating segments (in thousands): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, -------------------------------- 1998 1997 1996 --------- ----------- ---------- (IN THOUSANDS) <S> <C> <C> <C> Operating revenues: Broadcasting $ 91,007 $ 72,300 $ 54,981 Publishing 29,330 24,536 22,845 Paging 8,553 6,712 1,479 -------- -------- -------- $128,890 $103,548 $ 79,305 ======== ======== ======== Operating income: Broadcasting (1) $ 21,113 $ 17,509 $ 14,106 Publishing 2,867 2,206 1,980 Paging 947 1,015 (7) -------- -------- -------- Total operating income (1) 24,927 20,730 16,079 Gain on disposition of television stations 70,572 -0- 5,671 Miscellaneous income and (expense), net (242) (31) 33 Interest expense (25,454) (21,861) (11,689) -------- -------- -------- Income (loss) before income taxes $ 69,803 $ (1,162) $ 10,094 ======== ======== ======== </TABLE> Operating income is total operating revenue less operating expenses, excluding gain on disposition of television stations, miscellaneous income and expense (net) and interest. Corporate and administrative expenses are allocated to operating income based on net segment revenues. <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, -------------------------------- 1998 1997 1996 -------- ----------- ---------- (IN THOUSANDS) <S> <C> <C> <C> Depreciation and amortization expense: Broadcasting $14,713 $11,024 $ 5,554 Publishing 1,554 1,973 1,730 Paging 1,773 1,480 329 ------- ------- ------- 18,040 14,477 7,613 Corporate 77 42 50 ------- ------- ------- Total depreciation and amortization expense $18,117 $14,519 $ 7,663 ======= ======= ======= </TABLE> 71
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) J. INFORMATION ON BUSINESS SEGMENTS (CONTINUED) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, -------------------------------- 1998 1997 1996 -------- ----------- ---------- (IN THOUSANDS) <S> <C> <C> <C> Media cash flow: Broadcasting $ 38,446 $ 30,519 $ 22,594 Publishing 5,214 4,856 4,957 Paging 2,964 2,686 401 -------- -------- -------- $ 46,624 $ 38,061 $ 27,952 ======== ======== ======== Media cash flow reconciliation: Operating income (1) $ 24,927 $ 20,730 $ 16,079 Add: Amortzation of program license rights 4,251 3,501 2,743 Depreciation and amortization 18,117 14,519 7,663 Corporate overhead 3,063 2,528 3,219 Non-cash compensation and contribution to 401(k) Plan, paid in Common Stock 476 412 1,125 Less: Payments for program license liabilities (4,210) (3,629) (2,877) -------- -------- -------- $ 46,624 $ 38,061 $ 27,952 ======== ======== ======== Capital expenditures: Broadcasting $ 6,718 $ 5,000 $ 2,674 Publishing 934 4,235 692 Paging 1,461 975 -0- -------- -------- -------- 9,113 10,210 3,366 Corporate 158 162 30 -------- -------- -------- Total capital expenditures $ 9,271 $ 10,372 $ 3,396 ======== ======== ======== DECEMBER 31, -------------------------------- 1998 1997 1996 -------- --------- ----------- (IN THOUSANDS) Identifiable assets: Broadcasting $410,039 $287,254 $245,614 Publishing 17,196 19,818 16,301 Paging 25,563 23,950 23,764 -------- -------- -------- 452,798 331,022 285,679 Corporate 16,176 14,029 12,985 -------- -------- -------- Total identifiable assets $468,974 $345,051 $298,664 ======== ======== ======== </TABLE> (1) Operating income excludes gain on disposition of television stations of $70.6 million recognized for the exchange of WALB in 1998 and $5.7 million recognized for the KTVE Sale in 1996. 72
GRAY COMMUNICATIONS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) K. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) <TABLE> <CAPTION> FISCAL QUARTERS ----------------------------------------- FIRST SECOND THIRD FOURTH --------- -------- ---------- --------- (IN THOUSANDS, EXCEPT FOR PER SHARE DATA) <S> <C> <C> <C> <C> YEAR ENDED DECEMBER 31, 1998: Operating revenues $27,982 $32,061 $31,845 $37,002 Operating income (1) 4,868 7,210 5,020 7,829 Net income (loss) (1,483) 837 41,830 475 Net income (loss) available to common stockholders (1,842) 478 41,484 221 Basic income (loss) per share (0.16) 0.04 3.48 0.02 Diluted income (loss) per share $ (0.16) $ 0.04 $ 3.31 $ 0.02 YEAR ENDED DECEMBER 31, 1997: Operating revenues $22,761 $25,499 $25,984 $29,304 Operating income 4,337 6,124 4,271 5,998 Net income (loss) (461) 622 (1,162) (401) Net income (loss) available to common stockholders (811) 272 (1,513) (760) Basic income (loss) per share (0.07) 0.02 (0.13) (0.06) Diluted income (loss) per share $ (0.07) $ 0.02 $ (0.13) $ (0.06) </TABLE> (1) Operating income excludes $70.6 million gain on exchange of television station recognized from the disposition of WALB. Because of the method used in calculating per share data, the quarterly per share data will not necessarily add to the per share data as computed for the year. The third quarter of 1998 includes the Busse-WALB Transactions. As a result of the exchange of WALB for WEAU, the Company recognized a pre-tax gain of approximately $70.6 million and estimated deferred income taxes of approximately $27.5 million (SEE NOTE B). On August 20, 1998, the Board of Directors declared a 50% stock dividend, payable on September 30, 1998, to stockholders of record of the Class A Common Stock and Class B Common Stock on September 16, 1998. This stock dividend effected a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. 73
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 74
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Set forth below is certain information with respect to the directors and executive officers of the Company as of March 11, 1999: <TABLE> <CAPTION> EXECUTIVE DIRECTOR OFFICER NAME SINCE SINCE AGE POSITION - ------------------------ ---------- ----------- ------ ----------------------------------------- <S> <C> <C> <C> <C> J. Mack Robinson 1993 1996 75 Director, President and Chief Executive Officer Robert S. Prather, Jr. 1993 1996 54 Director and Executive Vice President Robert A. Beizer N/A 1996 59 Vice President for Law and Development and Secretary James C. Ryan N/A 1998 38 Vice President - Finance and Chief Financial Officer Thomas J. Stultz N/A 1996 47 Vice President and President-Publishing Division Wayne M. Martin N/A 1998 52 Regional Vice President - Television William E. Mayher, III 1990 N/A 60 Chairman of the Board of Directors Richard L. Boger 1991 N/A 52 Director Hilton H. Howell, Jr. 1993 N/A 37 Director Zell Miller 1999 N/A 66 Director Howell W. Newton 1991 N/A 52 Director Hugh Norton 1987 N/A 66 Director Harriett J. Robinson 1997 N/A 68 Director </TABLE> J. MACK ROBINSON has served as a director of the Company since 1993 and as the Company's President and Chief Executive Officer since 1996. Mr. Robinson has served as Chairman of the Board of Bull Run Corporation, a principal stockholder of the Company since 1994, Chairman of the Board and President of Delta Life Insurance Company and Delta Fire and Casualty Insurance Company since 1958, President of Atlantic American Corporation, an insurance holding company, from 1988 until 1995 and Chairman of the Board of Atlantic American Corporation since 1974. He serves as a director of the following companies: Bankers Fidelity Life Insurance Company, American Independent Life Insurance Company, Georgia Casualty & Surety Company, American Southern Insurance Company and American Safety Insurance Company. He is director EMERITUS of Wachovia Corporation. He is a member of the Executive Committee and Management Personnel Committee of the Company's Board of Directors. Mr. Robinson is the husband of Harriett J. Robinson. ROBERT S. PRATHER, JR. has served as a director of the Company since 1993 and as Executive Vice President of the Company since 1996. He has served as President and Chief Executive Officer and a director of Bull Run Corporation since 1992. He serves as a director of the following companies: Host Communications, Inc., Capital Sports Properties, Inc., Universal Sports America, Inc., Rawlings Sporting Goods Company, Inc. and The Morgan Group, Inc. He is a member of the Executive Committee and Management Personnel Committee of the Company's Board of Directors. ROBERT A. BEIZER has served as Vice President for Law and Development and Secretary of the Company since 1996. From June 1994 to February 1996 he was of counsel to Venable, Baetjer, Howard & Civiletti, a law firm, in its regulatory and legislative practice group. From 1990 to 1994, Mr. Beizer was a partner in the law firm of Sidley & Austin and was head of their communications practice group in Washington, D.C. He is a past president of the Federal Communications Bar Association and has served as a member of the ABA House of Delegates. 75
JAMES C. RYAN has served as the Company's Vice President-Finance and Chief Financial Officer since October 1998. He was the Chief Financial Officer of Busse Broadcasting Corporation from 1987 until its acquisition by the Company in 1998. THOMAS J. STULTZ has served as Vice President of the Company and President of the Company's Publishing Division since 1996. Prior to joining the Company, he served as Vice President of Multimedia, Inc. from 1988 to 1995, having responsibility for developing and coordinating Multimedia's newspaper marketing initiatives and directly supervising several Multimedia daily and non-daily publications. WAYNE M. MARTIN has served as the Company's Regional Vice President-Television since July 1998. He was also appointed President of WVLT-TV, the Company's subsidiary in Knoxville, Tennessee. Since 1993, Mr. Martin has served as President of Gray Kentucky Television, Inc., a subsidiary of the Company, which operates WKYT-TV, in Lexington, Kentucky and WYMT-TV, in Hazard, Kentucky. Wayne has over twelve years of experience in the broadcast industry. WILLIAM E. MAYHER, III has served as a director of the Company since 1990 and was a neurosurgeon in Albany, Georgia from 1970 to 1998. He also serves as a director of the following: Medical College of Georgia Foundation, American Association of Neurological Surgeons, Gaston Loughlin, Inc. and Palmyra Medical Centers. Dr. Mayher is a member of the Executive Committee and Management Personnel Committee of the Company's Board of Directors and has served as Chairman of the Company's Board of Directors since August 1993. RICHARD L. BOGER has served as a director of the Company since 1991. Mr. Boger has also been President and Chief Executive Officer of Export Insurance Services, Inc., an insurance organization, and a director of CornerCap Group of Funds, a "Series" investment company since prior to 1992. Mr. Boger is a member of the Executive Committee of the Company's Board of Directors and he is Chairman of the Management Personnel Committee of the Company's Board of Directors. HILTON H. HOWELL, JR. has served as a director of the Company since 1993. Mr. Howell has served as President and Chief Executive Officer of Atlantic American Corporation, an insurance holding company, since 1995 and Executive Vice President from 1992 to 1995. He has been Executive Vice President and General Counsel of Delta Life Insurance Company and Delta Fire and Casualty Insurance Company since 1991, and Vice Chairman and Executive Vice President of Bankers Fidelity Life Insurance Company and Georgia Casualty & Surety Company since 1992. He has been a director, Vice President and Secretary of Bull Run Corporation since 1994. He also serves as a director of the following companies: Atlantic American Corporation, Bankers Fidelity Life Insurance Company, American Independent Life Insurance Company, Delta Life Insurance Company, Delta Fire and Casualty Insurance Company, Georgia Casualty & Surety Company, American Southern Insurance Company, and American Safety Insurance Company. Mr. Howell is a member of the Audit Committee of the Company's Board of Directors. He is the son-in-law of J. Mack Robinson and Harriett J. Robinson. ZELL MILLER has served as a director of the Company since January 1999. Mr. Miller was Governor of the State of Georgia from January 1991 to January 1999. He also serves as a director of the following companies: Post Properties, Inc., Georgia Power Company, United Community Banks, Inc. and Law Companies Group. He is a professor at Young Harris College and Emory University. HOWELL W. NEWTON has served as a director of the Company since 1991. He has been President and Treasurer of Trio Manufacturing Co., a textile manufacturing company since 1978. Mr. Newton is Chairman of the Audit Committee of the Company's Board of Directors. 76
HUGH NORTON has served as a director of the Company since 1987. Mr. Norton has served as President of Norco, Inc., an insurance agency since 1973. He is one of the founders and directors of Community Bank of Georgia. Mr. Norton is also a real estate developer in Destin, Florida. He is a member of the Management Personnel Committee of the Company's Board of Directors. HARRIETT J. ROBINSON has served as a director of the Company since 1997 and she has been a director of Atlantic American Corporation since 1989. Mrs. Robinson has also been a director of Delta Life Insurance Company and Delta Fire and Casualty Insurance Company since 1967. Mrs. Robinson is the wife of J. Mack Robinson and mother-in-law of Hilton H. Howell, Jr. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the directors, executive officers and persons who own more than ten percent of a registered class of a company's equity securities to file with the Securities and Exchange Commission ("SEC") initial reports of ownership (Form 3) and reports of changes in ownership (Forms 4 and 5) of such class of equity securities. Officers, directors and greater than ten percent shareholders of the Company are required by SEC regulation to furnish the Company with copies of all such Section 16(a) reports that they file. To the Company's knowledge, based solely on its review of the copies of such reports furnished to the Company during the year ended December 31, 1998, all Section 16(a) filing requirements applicable to its officers, directors and ten percent beneficial owners were met. 77
ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth a summary of the compensation of the Company's President and Chief Executive Officer and the other executive officers whose annual compensation exceeded $100,000 during the year ended December 31, 1998 (the "named executives"). SUMMARY COMPENSATION TABLE <TABLE> <CAPTION> LONG TERM COMPENSATION AWARDS -------------------------- SECURITIES ANNUAL COMPENSATION RESTRICTED UNDERLYING NAME AND ------------------------------------ STOCK OPTIONS ALL OTHER PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) AWARDS SARS (#) (1) COMPENSATION ($) - -------------------- ------ ---------- --------- -------- ----------------- ---------------- <S> <C> <C> <C> <C> <C> <C> J. Mack Robinson,(3) 1998 72,308 -0- -0- 125,000 (2) 13,000 (4) President, Chief 1997 -0- -0- -0- 75,000 (5) 14,620 (4) Executive 1996 -0- -0- -0- 11,250 (6) 9,300 (4) Officer and a Director Robert S. Prather, 1998 -0- -0- -0- 125,337 (2) 13,000 (4) Jr., (7) Executive Vice 1997 -0- -0- -0- 75,000 (5) 14,620 (4) President and a 1996 -0- -0- -0- 11,250 (6) 8,800 (4) Director Robert A. Beizer, 1998 215,000 -0- -0- 21,000 (2) 13,080 (9) Vice President-Law 1997 210,000 -0- -0- 10,500 6,619 (9) & Development 1996 169,231 -0- -0- 22,500 -0- James C. Ryan, (10) 1998 34,269 5,000 -0- 22,500 (2) 15,603 (11) Vice President- Finance and Chief Financial Officer Thomas J. Stultz, 1998 196,000 35,000 -0- 22,500 (2) 7,166 (8) Vice President, 1997 187,000 25,000 -0- 22,500 (5) 59,199 (8) President-Publishing 1996 152,788 150,000 -0- -0- -0- Division Wayne M. Martin,(12) 1998 219,326 170,454 -0- 11,250 (2) 8,829 (13) Regional Vice President-Television Joseph A. Carriere, (14) 1998 125,524 -0- -0- -0- (2) 203,766 (15) Vice President- 1997 187,000 -0- -0- 7,500 (16) 6,245 (17) Television 1996 172,692 100,000 -0- -0- 5,698 (17) </TABLE> (1) On August 20, 1998, the Company's Board of Directors declared a 50% stock dividend, payable on September 30, 1998, to stockholders of record of the Class A and Class B Common Stock on September 16, 1998. This stock dividend was effected by means of a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. (2) These awards are set forth below in detail in the table titled "Option/SAR Grants in 1998." (3) Mr. Robinson was appointed President and Chief Executive Officer of the Company in September 1996, but received no salary for this position until September 1998. Mr. Robinson is compensated at an annual salary of $200,000. 78
(4) Represents compensation paid for services rendered as a member of the Company's Board of Directors. (5) Represents stock options to purchase Class B Common Stock pursuant to the Company's 1992 Long Term Incentive Plan. This 1997 stock option grant was replaced by a repricing grant, effective December 11, 1998. The December 11, 1998 grant repriced the 1997 grant at a price which approximated the market price of the Company's Class B Common Stock on December 11, 1998. The repriced grant was included in 1998 stock options granted as a 1998 grant. (6) Represents stock options to purchase Class B Common Stock under the Company's Non-Employee Director Stock Option Plan. (7) Mr. Prather became an officer of the Company in September 1996. (8) $4,000, $1,963 and $1,203 represent payments or accruals by the Company in 1998 for matching contributions to the Company's 401(k) plan, term life insurance premiums and long term disability premiums, respectively. $54,700, $3,596 and $903 represent payments or accruals by the Company in 1997 for relocation costs, matching contributions to the Company's 401(k) plan and long term disability premiums, respectively. (9) $4,000, $5,589 and $3,491 represent payments or accruals by the Company in 1998 for matching contributions to the Company's 401(k) plan, term life insurance premiums and long term disability premiums, respectively. $4,000 and $2,619 represent payments or accruals by the Company in 1997 for matching contributions to the Company's 401(k) plan and long term disability premiums, respectively. (10) Mr. Ryan joined the Company on October 1, 1998, compensated at an annual salary of $135,000. (11) Represents payments or accruals by the Company for relocation costs. (12) Mr. Martin has served as the Company's Regional Vice President-Television since July 1998. He was also appointed President of WVLT-TV, the Company's subsidiary in Knoxville, Tennessee. Prior to his appointment as an executive officer, Mr. Martin has served as President of Gray Kentucky Television, Inc., a subsidiary of the Company, which operates WKYT-TV, in Lexington, Kentucky and WYMT-TV, in Hazard, Kentucky. (13) $4,000, $3,249 and $1,580 represent payments or accruals by the Company for matching contributions to the Company's 401(k) plan, term life insurance premiums and long term disability premiums, respectively. (14) Mr. Carriere resigned from the Company, effective August 1, 1998. (15) $190,000, $2,919, $5,291 and $5,556 represent payments or accruals by the Company for consulting, matching contributions to the Company's 401(k) plan, term life insurance premiums and health insurance premiums, respectively. (16) Upon Mr. Carriere's resignation, this unvested stock option grant was forfeited. (17) $4,000 and $2,245 represent payments or accruals by the Company in 1997 for matching contributions to the Company's 401(k) plan and term life insurance premiums, respectively. $3,750 and $1,948 represent payments or accruals by the Company in 1996 for matching contributions to the Company's 401(k) plan and term life insurance premiums, respectively. 79
STOCK OPTIONS GRANTED The following table contains information on stock options granted to the Company during the year ended December 31, 1998. Under the Company's 1992 Long Term Incentive Plan (the "Incentive Plan"), all officers and key employees are eligible for grants of stock options and other stock-based awards. Options granted are exercisable over a three-year period beginning on the second anniversary of the grant date and expire one month after termination of employment. The total number of shares issuable under the Incentive Plan is not to exceed 900,000 shares of which 300,000 are Class A Common Stock and 600,000 are Class B Common Stock, subject to adjustment in the event of any change in the outstanding shares of such stock by reason of a stock dividend, stock split, recapitalization, merger, consolidation or other similar changes generally affecting shareholders of the Company. The Incentive Plan is administered by the Incentive Plan Committee which consists of members of the Management Personnel Committee of the Board of Directors who are not eligible for selection as participants under the Incentive Plan. The Incentive Plan is intended to provide additional incentives and motivation for the Company's employees. The Incentive Plan Committee, by majority action thereof, is authorized in its sole discretion to determine the individuals to whom the benefits will be granted, the type and amount of such benefits and the terms thereof; and to prescribe, amend and rescind rules and regulations relating to the Incentive Plan, among other things. On August 20, 1998, the Board of Directors declared a 50% stock dividend, payable on September 30, 1998, to stockholders of record of the Class A Common Stock and Class B Common Stock on September 16, 1998. This stock dividend was effected by means of a three for two stock split. All applicable share and per share data have been adjusted to give effect to the stock split. <TABLE> <CAPTION> OPTION/SAR GRANTS IN 1998 POTENTIAL REALIZABLE INDIVIDUAL GRANTS VALUE AT ASSUMED -------------------------------------------- ANNUAL RATES OF NUMBER OF % OF TOTAL STOCK PRICE CLASS SECURITIES OPTIONS EXERCISE APPRECIATION FOR OF UNDERLYING GRANTED OR OPTION TERM (1) COMMON OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION ------------------ NAME STOCK GRANTED 1998 ($/SHARE) DATE 5% ($) 10% ($) - ----------------- --------------------- -------------- ---------- ---------- -------- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> J. Mack Robinson Class A 10,000 (2) 1.8 17.81 11/19/03 49,213 108,747 Class B 40,000 (2) 7.1 14.00 11/19/03 154,718 341,886 Class B 75,000 (3) 13.3 14.50 9/25/02 234,363 504,709 Robert S. Class A 9,337 (2) 1.7 17.81 11/19/03 45,950 101,537 Prather, Jr. Class B 41,000 (2) 7.3 14.00 11/19/03 158,586 350,433 Class B 75,000 (3) 13.3 14.50 9/25/02 234,363 504,709 Robert A. Beizer Class B 10,500 (4) 1.9 16.08 2/12/03 46,647 103,079 Class B 10,500 (5) 1.9 14.50 2/12/03 42,064 92,950 James C. Ryan Class B 11,250 (6) 2.0 16.13 10/5/03 50,119 110,750 Class B 11,250 (5) 2.0 14.50 10/5/03 45,068 99,589 Thomas J. Stultz Class B 22,500 (3) 4.0 14.50 9/25/02 70,309 151,413 Wayne M. Martin Class B 11,250 (3) 2.0 14.50 9/25/02 35,154 75,706 Joseph A. Carriere N/A N/A N/A N/A N/A N/A N/A </TABLE> (1) Amounts reported in these columns represent amounts that may be realized upon exercise of options immediately prior to the expiration of their term assuming the specified compounded 80
rates of appreciation (5% and 10%) on the Class A or Class B Common Stock over the term of the options. These numbers are calculated based on rules promulgated by the SEC and do not reflect the Company's estimate of future stock price growth. Actual gains, if any, on stock option exercises and Class A or Class B Common Stock holdings will be dependent on the timing of such exercise and the future performance of the Class A or Class B Common Stock. There can be no assurance that the rates of appreciation assumed in this table can be achieved or that the amounts reflected will be received by the option holder. (2) Stock options granted effective November 19, 1998 pursuant to the Company's Incentive Plan. (3) Effective December 11, 1998, the Company repriced certain 1997 Class B Common Stock grants made pursuant to the Incentive Plan, at a price which approximated the market price of the Company's Class B Common Stock on that day. These repriced grants effectively replaced the stock option grants made on September 25, 1997. (4) Stock options granted effective February 12, 1998 pursuant to the Company's Incentive Plan. This stock option grant was replaced on December 11, 1998, by a repricing grant as described in (5). (5) Effective December 11, 1998, the Company repriced certain 1998 Class B Common Stock grants made pursuant to the Incentive Plan, at a price which approximated the market price of the Company's Class B Common Stock on that day. These repriced grants effectively replaced the earlier 1998 stock option grant. (6) Stock options granted effective October 5, 1998 pursuant to the Company's Incentive Plan. This stock option grant was replaced on December 11, 1998, by a repricing grant as described in (5). 81
STOCK OPTIONS EXERCISED The following table sets forth information about stock options that were exercised during 1998 and the number of shares and the value of grants outstanding as of December 31, 1998 for each named executive. <TABLE> <CAPTION> AGGREGATED OPTION EXERCISES IN 1998 AND DECEMBER 31, 1998 OPTION VALUES NUMBER OF SECURITIES VALUE OF UNEXERCISED CLASS SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OF ACQUIRED OPTIONS AT 12/31/98 OPTIONS AT 12/31/98 ($) (1) COMMON ON VALUE -------------------------- ----------------------------- NAME STOCK EXERCISE REALIZED$ EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ----- -------- -------- ----------- ------------- ------------ -------------- <S> <C> <C> <C> <C> <C> <C> <C> J. Mack Robinson (2) Class A -0- -0- -0- 10,000 -0- 5,000 Class B 11,250 61,875 -0- 115,000 -0- -0- Robert S. Prather, Jr. (2) Class A -0- -0- -0- 9,337 -0- 4,669 Class B 11,250 61,875 -0- 116,000 -0- -0- Robert A. Beizer Class B -0- -0- 22,500 21,000 69,845 12,469 James C. Ryan Class B -0- -0- -0- 11,250 -0- -0- Thomas J. Stultz Class B -0- -0- -0- 22,500 -0- -0- Wayne M. Martin (3) Class A 6,750 68,531 -0- -0- -0- -0- Class B -0- -0- -0- 11,250 -0- -0- Joseph A. Carriere (3) Class A 5,625 65,547 -0- -0- -0- -0- </TABLE> (1) Value is based on the closing price of the Company's Class A and Class B Common Stock of $18.31 and $13.69, respectively at December 31, 1998, less the exercise price. (2) On December 12, 1996, the Company granted Messrs. Robinson and Prather an option to purchase 11,250 shares each of the Company's Class B Common Stock, at an exercise price of $10.58 per share, pursuant to the Company's Non-employee Director Stock Option Plan. The options were exercised in 1998. (3) On March 30, 1995, the Company granted Messrs. Martin and Carierre an option to purchase 6,750 and 5,625 shares of the Company's Class A Common Stock, respectively, at an exercise price of $8.89 per share, pursuant to the Company's Incentive Plan. The options were exercised in 1998. SUPPLEMENTAL PENSION PLAN The Company has entered into agreements with certain key employees to provide these employees with supplemental retirement benefits. The benefits will be disbursed after retirement in contractually predetermined payments of equal monthly amounts over the employee's life, or the life of a surviving eligible spouse, for a maximum of 15 years. The Company maintains life insurance coverage on these individuals in adequate amounts to fund the agreements. RETIREMENT PLAN The Company sponsors a defined benefit pension plan, intended to be tax qualified, for certain of its employees and the employees of any of its subsidiaries which have been designated as participating 82
companies under the plan. A participating employee who retires on or after attaining age 65 and who has completed five years of service upon retirement may be eligible to receive during his lifetime, in the form of monthly payments, an annual pension equal to (i) 22% of the employee's average earnings for the highest five consecutive years during the employee's final 10 years of employment multiplied by a factor, the numerator of which is the employee's years of service credited under the plan before 1994 and the denominator of which is the greater of 25 or the years of service credited under the plan, plus (ii) .9% of the employee's monthly average earnings for the highest five consecutive years in the employee's final 10 years of employment added to .6% of monthly average earnings in excess of Social Security covered compensation, and multiplied by the employee's years of service credited under the plan after 1993, with a maximum of 25 years minus years of service credited under (i) above. For participants as of December 31, 1993, there is a minimum benefit equal to the projected benefit under (i) at that time. For purposes of illustration, pensions estimated to be payable upon retirement of participating employees in specified salary classifications are shown in the following table: <TABLE> <CAPTION> PENSION PLAN TABLE YEARS OF SERVICE ------------------------------------------------------------------------- REMUNERATION (1) 10 15 20 25 30 35 - ---------------------- ------------------------ ----------- ----------- ------------------------ <S> <C> <C> <C> <C> <C> <C> $ 15,000 $ 1,335 $ 1,995 $ 2,655 $ 3,315 $ 3,300 $ 3,300 25,000 2,225 3,325 4,425 5,525 5,500 5,500 50,000 5,016 7,216 9,416 11,616 11,000 11,000 75,000 7,991 11,291 14,591 17,891 16,500 16,500 100,000 10,966 15,366 19,766 24,166 22,000 22,000 150,000 16,916 23,516 30,116 36,716 33,000 33,000 200,000 19,416 28,216 37,016 45,816 36,667 37,714 250,000 and above 20,262 29,908 39,554 49,199 40,191 41,339 </TABLE> (1) Five-year average annual compensation. Employees may become participants in the plan, provided that they have attained age 21 and have completed one year of service. Average earnings are based upon the salary paid to a participating employee by a participating company. Pension compensation for a particular year as used for the calculation of retirement benefits includes salaries, overtime pay, commissions and incentive payments received during the year and the employee's contribution to the Capital Accumulation Plan (as defined herein). Pension compensation for 1998 differs from compensation reported in the Summary Compensation Table in that pension compensation includes any annual incentive awards received in 1998 for services in 1997 rather than the incentive awards paid in 1999 for services in 1998. The maximum annual compensation considered for pension benefits under the plan in 1998 was $160,000. As of December 31, 1998, the named executive officers of the Company have the following years of credited service: NAME YEARS OF CREDITED SERVICE - -------------------- --------------------------- Thomas J. Stultz 2 Robert A. Beizer 2 Wayne M. Martin 4 Joseph A. Carriere 4 83
CAPITAL ACCUMULATION PLAN Effective October 1, 1994, the Company adopted the Gray Communications Systems, Inc. Capital Accumulation Plan (the "Capital Accumulation Plan") for the purpose of providing additional retirement benefits for substantially all employees. The Capital Accumulation Plan is intended to meet the requirements of Section 401(k) of the Internal Revenue Code of 1986, as amended. Contributions to the Capital Accumulation Plan are made by the employees of the Company. The Company matches a percentage of each employee's contribution which does not exceed 6% of the employee's gross pay. The percentage match is declared by the Board of Directors before the beginning of each Capital Accumulation Plan Year and was made with a contribution of the Class A Common Stock through the year ended December 31, 1996 and thereafter has been and will be made with Class B Common Stock. The percentage match declared for the year ended December 31, 1998 was 50%. The Company matching contributions vest based upon an employee's number of years of service, over a period not to exceed five years. COMPENSATION OF DIRECTORS The standard arrangement for directors' fees is set forth in the table below. DESCRIPTION AMOUNT - ----------------------------------------------------------------------------- Chairman of the Board annual retainer fee $18,000 Director's annual retainer fee 12,000 Director's fee per Board of Directors' meeting 1,000 Chairman of the Board fee per Board of Directors' meeting 1,200 Committee Chairman fee per committee meeting 1,200 Committee member fee per Committee meeting 1,000 Directors are paid 40% of the above fee arrangement for participation by telephone in any meeting of the Board of Directors or any committee thereof. EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT Robert A. Beizer and the Company entered into an employment agreement dated February 12, 1996, for a two-year term which automatically extends for three successive one-year periods, subject to certain termination provisions. The agreement provides that Mr. Beizer shall be employed as Vice President for Law and Development of the Company with an initial annual base salary of $200,000 and a grant of options to purchase 22,500 shares of Class A Common Stock with an exercise price of $12.917 per share under the Incentive Plan at the inception of his employment. In December 1996, the Board of Directors approved an amendment to Mr. Beizer's contract which replaced this option with the grant of an option to purchase 22,500 shares of Class B Common Stock with an exercise price of $10.583 per share. The amended Agreement provides that Mr. Beizer's base salary shall be increased yearly based upon a cost of living index and he will receive non-qualified options to purchase 10,500 shares of Class B Common Stock annually during the term of the agreement at an exercise price per share equal to the fair market value of the Class B Common Stock on the date of the grant. Accordingly, on February 12, 1997, 1998, and 1999 , he was granted options to purchase an additional 10,500 shares of Class B Common Stock at $12.50, $16.08 and $14.1875 per share, respectively. All options granted are exercisable over a three-year period beginning upon the second anniversary of the grant date. If there is a "change of control" of the Company, Mr. Beizer will be paid a lump sum amount equal to his then current base salary for the remaining term of the agreement and will be granted any remaining stock options to which he would have been entitled. For purposes of the agreement, "change of control" is defined as any change in the control of the Company that would be required to be reported in response to Item 6(e) of Schedule 14A 84
promulgated under the Securities Exchange Act of 1934. Mr. Beizer has agreed that during the term of his agreement and for two years thereafter, he will be subject to certain non-competition provisions. The Management Personnel Committee recommended, and Mr. Beizer agreed, to amend his employment contract to provide for options for Class B Common Stock rather than Class A Common Stock since it had converted the Company's matching contribution under the Capital Accumulation Plan and the non-employee director options to Class B Common Stock. In an effort to make all future options consistent, the Management Personnel Committee has recommended that all future officer and employee executive stock options entitle the holders thereof to purchase Class B Common Stock COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Richard L. Boger, William E. Mayher, III, Robert S. Prather, Jr., Hugh Norton and J. Mack Robinson are the members of the Management Personnel Committee which serves as the Compensation Committee of the Company. Messrs. Robinson and Prather are President and Chief Executive Officer and Executive Vice President of the Company, respectively. J. Mack Robinson, President of the Company serves on the Compensation Committee of Bull Run Corporation ("Bull Run"). Mr. Robinson and Robert S. Prather, Jr., President of Bull Run and Executive Vice President of the Company serve on the Compensation Committee of the Company. Gray Kentucky Television, Inc., a subsidiary of the Company ("Gray Kentucky"), is a party to a rights sharing agreement with Host Communications, Inc. ("Host") and certain other parties not affiliated with the Company, pursuant to which the parties agreed to exploit Host's rights to broadcast and market certain University of Kentucky football and basketball games and related activities. Pursuant to such agreement, Gray Kentucky is licensed to broadcast certain University of Kentucky football and basketball games and related activities. Under this agreement, Gray Kentucky also provides Host with production and certain marketing services and Host provides accounting and various marketing services. During the year ended December 31, 1998, the Company received approximately $100,000 from this joint venture. See Item 13 "Certain Relationships and Related Transactions" for a description of certain relationships between Messrs. Prather and Robinson and the Company, Bull Run, Host and CSP (as defined below). Bull Run currently owns 51.5% of the outstanding common stock of Capital Sports Properties, Inc. ("CSP"). CSP's assets consist of all of the outstanding preferred stock of Host and 49.0% of Host's outstanding common stock. Bull Run's direct common equity ownership in Host, plus Bull Run's indirect common equity ownership in Host through its investment in CSP, was 32.6% as of December 31, 1998. Robert S. Prather, Jr., Executive Vice President and a member of the Company's Board of Directors, is a member of the Board of Directors of both CSP, Bull Run and Host. The Company's Board of Directors approved payments to Bull Run of a finders fee of approximately $1,980,000 in connection with the acquisition of all of the outstanding capital stock of Busse Broadcasting Corporation ("Busse"). The purchase price was $112,000,000 plus Busse's cash balance as of June 30, 1998. The purchase price includes the assumption of Busse's indebtedness, including its 11 5/8% Senior Secured Notes dues 2000. Immediately prior to the Company's acquisition of Busse, Cosmos Broadcasting Corporation ("Cosmos") acquired the assets of WEAU-TV ("WEAU") from Busse in exchange for the assets of WALB-TV, Inc. ("WALB"), the Company's NBC affiliate in Albany, Georgia. In exchange for the assets of WALB, the Company received the assets of WEAU, which were valued at $66,000,000 and approximately $12,000,000 in cash for a total value of $78,000,000. The finders fee was allocated, at $1,200,000 for the Busse transaction and $780,000 for the WALB transaction. 85
ISSUANCE OF PREFERRED STOCK AND WARRANTS The Company paid cash dividends on the Series A Preferred Stock and Series B Preferred Stock of $800,000 and $63,750, respectively to Bull Run in 1998. Bull Run is the only owner of the Series A Preferred Stock of the Company and owns 50% of the outstanding Series B Preferred Stock of the Company. Mr. Robinson and certain affiliates own the remaining 50% of the Series B Preferred Stock of the Company. In addition, the Company issued 25.4692 shares of Series B Preferred Stock to Bull Run and 25.4692 shares of Series B Preferred Stock pro rata to Mr. Robinson and certain affiliates as dividends on the Series B Preferred Stock in 1998. Each share of Series B Preferred Stock is valued at $10,000 per share. Of the total amount of 1,110.9384 Series B Preferred Shares outstanding during 1998, the Company redeemed 760.9384 shares pro rata at a total redemption price of $7,609,384. The Company executed an Option Agreement with Bull Run in March 1996, whereby the Company has the option to purchase Bull Run's investment in the common stock of Sarkes Tarzian, Inc. Upon exercise of the option, the Company will pay Bull Run an amount equal to Bull Run's purchase price for the Tarzian investment plus related costs. In connection with the Option Agreement, the Company granted to Bull Run warrants to purchase up to 100,000 shares of the Company's Class B Common Stock at $13.625 per share. The warrants will vest immediately upon the Company's exercise of its option to purchase the Tarzian investment. The option currently expires May 31, 1999 but may be extended month to month by the Company upon payment of an established fee through December 31, 2001. 86
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information regarding the ownership of Class A Common Stock and Class B Common Stock as of March 11, 1999 by (i) any person who is known to the Company to be the beneficial owner of more than five percent of the Class A Common Stock or the Class B Common Stock, (ii) all directors, (iii) all executive officers named in the Summary Compensation Table herein and (iv) all directors and executive officers as a group. <TABLE> <CAPTION> CLASS A CLASS B COMMON STOCK COMMON STOCK COMBINED BENEFICIALLY OWNED BENEFICIALLY OWNED VOTING PERCENT --------------------- --------------------- OF COMMON NAME SHARES PERCENT SHARES PERCENT STOCK - --------------------------------------- ----------- -------- ----------- -------- --------------- <S> <C> <C> <C> <C> <C> Robert A. Beizer (1) -0- 0.0% 33,509 * * Richard L. Boger (1) 11,651 * 13,744 * * Joseph A. Carriere 6,075 * -0- 0.0% * Hilton H. Howell, Jr. (1), (2), (3), (4) 3,523,782 45.4% 24,750 * 42.6% Wayne M. Martin 362 * 517 * * William E. Mayher, III (1) 13,500 * 18,750 * * Zell Miller (1) -0- 0.0% 7,500 * * Howell W. Newton (1) 2,625 * 9,500 * * Hugh Norton (1) 13,500 * 18,750 * * Robert S. Prather, Jr. (2), (5) 3,140,073 40.6% 24,200 * 38.1% Harriett J. Robinson (1), (2), (4), (6) 4,472,082 55.8% 103,900 2.0% 52.5% J. Mack Robinson (1), (2), (4), (7) 4,472,082 55.8% 103,900 2.0% 52.5% James C. Ryan -0- 0.0% 2,019 * * Thomas J. Stultz 2,250 * 1,474 * * Bull Run Corporation (8) 2,921,397 37.8% 11,750 * 35.4% The Capital Group Companies, Inc. (9) -0- 0.0% 401,600 7.8% * Mario J. Gabelli (10) -0- 0.0% 1,183,200 23.1% 1.6% Mellon Bank Corporation (11) -0- 0.0% 450,000 8.8% * George H. Nader (12) 359,998 5.3% -0- 0.0% 4.9% Shapiro Capital Management Company, Inc. (13) 27,598 * 1,562,993 30.5% 2.5% Standish Ayer and Wood, Inc. (14) -0- 0.0% 474,100 9.2% * All directors and executive officers as a group 4,836,756 60.7% 241,722 4.6% 57.3% </TABLE> * Less than 1%. (1) Includes options to purchase Class B Common Stock as follows: each of Messrs. Boger, Howell, Mayher, Newton, Norton, Miller and Mrs. Robinson - 7,500 shares of Class B Common Stock; Mr. Beizer - 33,000 shares of Class B Common Stock. (2) Includes 2,017,647 shares of Class A Common Stock and 11,750 shares of Class B Common Stock owned by Bull Run Corporation and warrants to purchase 903,750 shares of Class A Common Stock by Bull Run Corporation as described in footnote (8) below, because Messrs. Howell, Prather and Robinson are directors and officers of Bull Run Corporation and Messrs. Prather and Robinson are principal shareholders of Bull Run Corporation and Mrs. Robinson is the spouse of Mr. Robinson and, as such, may be deemed to have the right to vote or dispose of such shares. Each of Messrs. Howell, Prather, Robinson and Mrs. Robinson disclaims beneficial ownership of the shares owned by Bull Run Corporation. 87
(3) Includes 58,575 shares of Class A Common Stock owned by Mr. Howell's wife, over which he disclaims beneficial ownership. Excludes 97,500 Class A shares held in trust for Mr. Howell's wife. (4) Includes as to Messrs. Robinson and Howell and Mrs. Robinson, an aggregate of 480,060 shares of Class A Common Stock and 6,000 shares of Class B Common Stock owned by certain companies of which Mr. Howell is an officer and a director. Mr. Robinson is also an officer, director and a principal or sole shareholder and Mrs. Robinson is also a director of these companies. Also includes warrants to purchase 28,500 shares of Class A Common Stock by one of the above described companies. (5) Includes 225 shares of Class A Common Stock owned by Mr. Prather's wife, over which he disclaims beneficial ownership. (6) Includes an aggregate of 366,875 shares of Class A Common Stock and 66,250 shares of Class B Common Stock owned by Mrs. Robinson's husband directly. Also includes warrants to purchase 85,500 shares of Class A Common Stock held by Mrs. Robinson and warrants to purchase 57,000 shares of Class A Common Stock held by Mrs. Robinson's husband. Includes 243,750 shares of Class A Common Stock and 10,000 shares of Class B Common Stock held as trustee for their daughters. Includes warrants to purchase 114,000 shares of Class A Common Stock held as trustee for their daughters. Does not include warrants held by Mrs. Robinson's husband and certain of his affiliates to purchase shares of Class A Common Stock which are not vested and therefore are not exercisable within 60 days. Does not include 1,000 shares of Series A Preferred Stock owned by Bull Run Corporation, none of which is voting or convertible. Also does not include 350 shares of Series B Preferred stock none of which is voting or convertible owned by Mr. Robinson and certain of his affiliates. See "Issuance of Preferred Stock and Warrants." Mrs. Robinson's address is 3500 Tuxedo Road, NW, Atlanta, Georgia 30305. (7) Includes an aggregate of 418,750 shares of Class A Common Stock and 12,400 shares of Class B Common Stock owned by Mr. Robinson's wife directly and as trustee for their daughters, over which he disclaims beneficial ownership. Also includes warrants to purchase 57,000 shares of Class A Common Stock held by Mr. Robinson and warrants to purchase 85,500 shares of Class A Common Stock held by Mr. Robinson's wife. Includes warrants to purchase 114,000 shares of Class A Common Stock owned held by Mr. Robinson's wife as trustee for their daughters. Does not include warrants held by Mr. Robinson and certain of his affiliates to purchase shares of Class A Common Stock which have not vested and therefore are not exercisable within 60 days. Does not include 1,000 shares of Series A Preferred Stock owned by Bull Run Corporation, none of which is voting or convertible. Also does not include 350 shares of Series B Preferred stock none of which is voting or convertible owned by Mr. Robinson and certain of his affiliates. See "Issuance of Preferred Stock and Warrants." Mr. Robinson's address is 4370 Peachtree Road NE, Atlanta, Georgia 30319. (8) Owned by Bull Run Corporation through its wholly-owned subsidiary, DataSouth Computer Corporation. Includes warrants to purchase 903,750 shares of Class A Common Stock which are exercisable within 60 days. Does not include 1,000 shares of Series A Preferred Stock and 175 shares of Series B Preferred Stock none of which is voting or convertible. Does not include warrants to purchase shares of Class A Common Stock which are not vested and therefore are not exercisable within 60 days. See "Issuance of Preferred Stock and Warrants." The address of Bull Run Corporation is 4370 Peachtree Road NE, Atlanta, Georgia 30319. 88
(9) This information was furnished to the Company on a Schedule 13G filed by The Capital Group Companies, Inc. and Capital Guardian Trust Company. Capital Guardian Trust Company, a wholly owned subsidiary of The Capital Group Companies, Inc., is the beneficial owner of these shares as a result of its serving as the investment manager of various institutional accounts, but has authority to vote only 167,750 Class B shares. The address of The Capital Group Companies, Inc. and Capital Guardian Trust Company is 333 South Hope Street, Los Angeles, California 90071. (10) This information was furnished to the Company on a Schedule 13D filed by Gabelli Funds, Inc. and also by Mario J. Gabelli and various entities which he directly or indirectly controls or for which he acts as chief investment officer. The Schedule 13D reports the beneficial ownership of Class B Common Stock as follows: Gabelli Funds, Inc.-522,000 shares; GAMCO Investors, Inc.-634,950 shares; and Gabelli International Limited-26,250 shares. Mr. Gabelli is deemed to have beneficial ownership of all of the securities listed. Gabelli Funds, Inc. is deemed to have beneficial ownership of all of the shares. GAMCO Investors, Inc. only has the authority to vote 604,200 of the shares beneficially held by it. The address of Mr. Gabelli and Gabelli Funds, Inc. is One Corporate Center, Rye, New York 10580. (11) This information was furnished to the Company on a Schedule 13G filed by Mellon Bank Corporation. The Dreyfus Corporation, a subsidiary of Mellon Bank Corporation, is the beneficial owner of these shares of Class B Common Stock as the result of its serving as an investment adviser. The address of Mellon Bank Corporation is One Mellon Bank Center, Pittsburgh, Pennsylvania 15258. (12) Mr. Nader's address is P.O. Box 271, 1011 Fifth Avenue, West Point, Georgia 31833. (13) This information was furnished to the Company by a representative of Shapiro Capital Management Company, Inc., an investment adviser, and also by Samuel R. Shapiro, President, Director and majority shareholder of Shapiro Capital Management Company, Inc. The address of Shapiro Capital Management Company, Inc. is 3060 Peachtree Road NW, Atlanta, Georgia 30306. (14) This information was furnished to the Company on a Schedule 13G filed by Standish, Ayer & Wood, Inc., One Financial Center, Boston, Massachusetts 02111-2662. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. J. Mack Robinson, President, Chief Executive Officer and a director of the Company, is Chairman of the Board of Bull Run Corporation ("Bull Run") and the beneficial owner of approximately 29.6% of the outstanding shares of common stock, par value $.01 per share ("Bull Run Common Stock"), of Bull Run Corporation (including certain shares as to which such beneficial ownership is disclaimed by Mr. Robinson). Robert S. Prather, Jr., Executive Vice President-Acquisitions and a director of the Company, is President, Chief Executive Officer and a director of Bull Run Corporation and the beneficial owner of approximately 13.3% of the outstanding shares of Bull Run Common Stock (including certain shares as to which such beneficial ownership is disclaimed by Mr. Prather). Bull Run is the owner of 17.0% of the total outstanding common stocks of the Company. Mr. Prather is also a member of the Board of Directors of CSP and Host. Hilton H. Howell, Jr., a director of the Company, is Vice President, Secretary and a director of Bull Run. See "Compensation Committee Interlocks and Insider Participation" for a description of certain business relationships between the Company and Messrs. Prather and Robinson, Host, CSP and Bull Run as set forth in Item 11 hereof. 89
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (A) (1) AND (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. (1) FINANCIAL STATEMENTS. The following consolidated financial statements of Gray Communications Systems, Inc. are included in item 8: Report of Independent Auditors Consolidated Balance Sheets at December 31, 1998 and 1997 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements (2) FINANCIAL STATEMENT SCHEDULES. The following financial statement schedule of Gray Communications Systems, Inc. and subsidiaries is included in Item 14(d): Schedule II - Valuation and qualifying accounts. All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (B) REPORTS ON FORM 8-K. A report on Form 8-K was filed on August 14, 1998, reporting the exchange of the assets of WALB-TV for the assets of WEAU-TV. This report on Form 8-K also reported the acquisition of all of the outstanding common and preferred stock of Busse Broadcasting Corporation. A current report on Form 8K/A was filed on October 14, 1998 as an amendment to the current report on Form 8-K that was filed on August 14, 1998. (C) EXHIBITS. <TABLE> <CAPTION> EXHIBIT NO. DESCRIPTION PAGE - ------------ ----------- ------ <S> <C> <C> 3.1 Restated Articles of Incorporation of Gray Communications Systems, Inc., (incorporated by reference to Exhibit 3.1 to the Company's Form 10-K for the fiscal year ended December 31, 1996) 90
EXHIBIT NO. DESCRIPTION PAGE - ------------ ----------- ------ 3.2 By-Laws of Gray Communications Systems, Inc. as amended (incorporated by reference to Exhibit 3.2 to the Company's Form 10-K for the year ended December 31, 1996) 3.3 Amendment of the Bylaws of Gray Communications Systems, Inc., 97 January 6, 1999 4.1 Indenture for the Company's 10 5/8% Senior Subordinated Notes due 2006 (incorporated by reference to Exhibit 4.1 to the Company's registration statement on Form S-1 (Registration No. 333-4338) (Exhibit 4.1 to the "Note S-1") 4.2 Amended and Restated Loan Agreement by and among Gray Communications Systems, Inc. as Borrower, NationsBank, NA as Syndication Agent and Administrative Agent, Key Corporate Capital Inc., as Documentation Agent and The Financial Institutions Listed Herein as of July 31, 1998 with NationsBanc Montgomery Securities LLC, as Lead Arranger. ( incorporated by reference to Exhibit 10.5 to the Company's Form 10-Q for the quarter ended June 30, 1998) 4.3 Amended and Restated Borrower Security Agreement dated July 31, 98 1998 by and between Gray Communications Systems, Inc. and NationsBank N.A. as Administrative Agent 4.4 Subsidiary Security Agreement dated September 30, 1996 between Gray Communications Systems, Inc., its subsidiaries and KeyBank National Association (incorporated by reference to Exhibit 4(iii) to the Company's Form 8-K, filed October 15, 1996) 4.5 Amended and Restated Borrower Pledge Agreement dated July 31, 1998 117 between Gray Communications Systems, Inc. and NationsBank N.A. as Administrative Agent 4.6 Subsidiary Pledge Agreement dated September 30, 1996 by and among WRDW-TV, Inc., WJHG-TV, Inc., Gray Kentucky Television, Inc. and KeyBank National Association (incorporated by reference to Exhibit 4(v) to the Company's Form 8-K, filed October 15, 1996) 4.7 Subsidiary Guarantee dated September 30, 1996 between Gray Communications Systems, Inc., its subsidiaries and KeyBank National Association (incorporated by reference to Exhibit 4(vi) to the Company's Form 8-K, filed October 15, 1996) 4.8 First Amendment to Amended and Restated Loan Agreement dated as of 141 the 13th day of November, 1998, by and among Gray Communications Systems, Inc., as Borrower, the Banks (as defined in the loan agreement) and NationsBank, N.A., as administrative agent (the "Administrative Agent') on behalf of the Banks 4.9 Second Amendment to Amended and Restated Loan Agreement dated as of 156 the 3rd day of March, 1999, by and among Gray Communications Systems, Inc., as Borrower, the Banks (as defined in the loan agreement) and NationsBank, N.A., as administrative agent on behalf of the Banks 91
EXHIBIT NO. DESCRIPTION PAGE - ------------ ----------- ------ 4.10 Consent Agreement entered into as of the 26th day of February, 1999 167 by and among Gray Communications Systems, Inc., as Borrower, the Banks (as defined in the Loan Agreement) and NationsBank N.A. as administrative agent on behalf of the Banks 10.1 Supplemental pension plan (incorporated by reference to Exhibit 10(a) to the Company's Form 10 filed October 7, 1991, as amended January 29, 1992 and March 2, 1992) 10.2 Long-Term Incentive Plan (incorporated by reference to Exhibit 10(e) to the Company's Form 10-K for the fiscal year ended June 30, 1993) 10.3 Warrant, dated January 4, 1996, to purchase 487,500 shares of Class A Common Stock (incorporated by reference to the Note S-1) 10.4 Employment Agreement, dated February 12, 1996 between the Company and Robert A. Beizer (incorporated by reference to the Note S-1) 10.5 Form of Preferred Stock Exchange and Purchase Agreement between the Company and Bull Run Corporation (incorporated by reference to the Note S-1) 10.6 Form of Warrant to purchase 500,000 shares of Class A Common Stock (incorporated by reference to the Note S-1) 10.7 Form of amendment to employment agreement between the Company and Robert A. Beizer, dated December 12, 1996 ( incorporated by reference to Exhibit 10.19 to the Company's Form 10-K for the year ended December 31, 1996) 10.8 Amendment to the Company's Long-Term Incentive Plan (incorporated by reference to Exhibit 10.19 to the Company's Form 10-K for the year ended December 31, 1996) 10.9 Asset Purchase Agreement by and among the Company and Raycom-U.S., Inc. and WITN-TV, Inc. (incorporated by reference to Item 10 of the current report filed on Form 8-K (Registration No. 001-13796) on August 14, 1997) 10.10 Stock Purchase Agreement by and Among Busse Broadcasting Corporation, South Street Corporate Recovery Fund I, L.P., Greycliff Leveraged Fund 1993, L.P., South Street Leveraged Corporate Recovery Fund, L.P. and Gray Communications Systems, Inc., as dated February 13, 1998 ( incorporated by reference to Exhibit 10.15 to the Company's Form 10-K for the year ended December 31, 1997) 92
EXHIBIT NO. DESCRIPTION PAGE - ------------ ----------- ------ 10.11 Amended and Restated Stock Purchase Agreement by and among Busse Broadcasting Corporation, South Street Corporate Recovery Fund I, L.P., Greycliff Leveraged Fund 1993, L.P., South Street Leveraged Corporate Recovery Fund, L.P., South Street Corporate Recovery Fund I (International), L.P. and Gray Communications Systems, Inc. dated as of June 22, 1998 (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended June 30, 1998) 10.12 Asset Purchase Agreement by and among Busse Broadcasting Corporation, WEAU License, Inc. and Cosmos Broadcasting Corporation dated as of June 22, 1998 (incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended June 30, 1998) 10.13 Exchange Agreement by and among Gray Communications Systems, Inc., WALB-TV, Inc., WALB Licensee Corporation, Cosmos Broadcasting Corporation, Busse Broadcasting Corporation, and WEAU License, Inc. dated as of June 22, 1998 (incorporated by reference to Exhibit 10.3 to the Company's Form 10-Q for the quarter ended June 30, 1998) 10.14 Escrow Agreement by and among WALB-TV, Inc. WALB Licensee Corporation, Cosmos Broadcasting Corporation and NationsBank, N. A. dated as of June 22, 1998 (incorporated by reference to Exhibit 10.4 to the Company's Form 10-Q for the quarter ended June 30, 1998) 10.15 Asset Purchase Agreement by and among WALB-TV, Inc., WALB-TV Licensee Corp. and Cosmos Broadcasting Corporation dated as of June 22, 1998 (incorporated by reference to Exhibit 10.6 to the Company's Form 10-Q for the quarter ended June 30, 1998) 10.16 Asset Purchase Agreement by and among Gray Communications Systems, 179 Inc., Gray Communications of Indiana, Inc., News Printing Company, Inc., Jane Gemmer and John Gemmer dated as of February 28, 1999 21 List of Subsidiaries 229 23 Consent of Ernst & Young L.L.P. for the financial statements of Gray 230 Communications Systems, Inc. 27 Financial Data Schedule for Gray Communications Systems, Inc. 231 - ------------------------------------------------------------------------------------------------ </TABLE> (D) FINANCIAL STATEMENT SCHEDULES - The response to this section is submitted as a part of (a)(1) and (2). 93
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. <TABLE> <CAPTION> <S> <C> GRAY COMMUNICATIONS SYSTEMS, INC. Date: March 19, 1999 By: /s/ J. MACK ROBINSON ------------------------------------------ J. Mack Robinson, PRESIDENT AND CHIEF EXECUTIVE OFFICER Date: March 19, 1999 By: /s/ JAMES C. RYAN ------------------------------------------ James C. Ryan, VICE PRESIDENT-FINANCE & CHIEF FINANCIAL OFFICER Date: March 19, 1999 By: /s/ JACKSON S. COWART, IV ------------------------------------------ Jackson S. Cowart, IV, CHIEF ACCOUNTING OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 19, 1999 By: /s/ WILLIAM E. MAYHER, III ------------------------------------------ William E. Mayher, III, CHAIRMAN OF THE BOARD Date: March 19, 1999 By: /s/ J. MACK ROBINSON ------------------------------------------ J. Mack Robinson, PRESIDENT AND CHIEF EXECUTIVE OFFICER AND DIRECTOR Date: March 19, 1999 By: /s/ RICHARD L. BOGER ------------------------------------------ Richard L. Boger, DIRECTOR Date: March 19, 1999 By: /s/ HILTON H. HOWELL, JR. ------------------------------------------ Hilton H. Howell, Jr., DIRECTOR Date: March 19, 1999 By: /s/ HOWELL W. NEWTON ------------------------------------------ Howell W. Newton, DIRECTOR Date: March 19, 1999 By: /s/ HUGH NORTON ------------------------------------------ Hugh Norton, DIRECTOR Date: March 19, 1999 By: /s/ ROBERT S. PRATHER, JR. ------------------------------------------ Robert S. Prather, Jr., DIRECTOR Date: March 19, 1999 By: /s/ HARRIETT J. ROBINSON ------------------------------------------ Harriett J. Robinson, DIRECTOR Date: March 19, 1999 By: /s/ ZELL MILLER ------------------------------------------ Zell Miller, DIRECTOR </TABLE> 94
REPORT OF INDEPENDENT AUDITORS We have audited the consolidated financial statements of Gray Communications Systems, Inc. as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated January 26, 1999. Our audits also included the financial statement schedule listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Ernst & Young LLP Atlanta, Georgia January 26, 1999 95
GRAY COMMUNICATIONS SYSTEMS, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS <TABLE> <CAPTION> COL. A COL. B COL. C COL. D COL. E - ------------------------------- ----------- ----------------------- ------------ ------------ ADDITIONS ----------------------- BALANCE AT CHARGED CHARGED TO BALANCE AT BEGINNING TO OTHER END OF OF PERIOD COSTS AND ACCOUNTS DEDUCTIONS PERIOD DESCRIPTION EXPENSES (1) ----------- ---------- ------------ ------------------------- <S> <C> <C> <C> <C> <C> YEAR ENDED DECEMBER 31, 1998 Allowance for doubtful accounts $1,253,000 $831,000 $ 61,000(2) $933,000 $1,212,000 YEAR ENDED DECEMBER 31, 1997 $1,450,000 $188,000 $ 31,000(2) $416,000 $1,253,000 Allowance for doubtful accounts YEAR ENDED DECEMBER 31, 1996 $ 450,000 $894,000 $583,000(2) $477,000 $1,450,000 Allowance for doubtful accounts </TABLE> - --------------------- (1) Deductions are write-offs of amounts not considered collectible. (2) Represents amounts recorded in connection with acquisitions. 96