UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

ý                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2004

 

OR

 

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

 

For the transition period from                                to                               .

 

Commission File Number : 000-26076

 

SINCLAIR BROADCAST GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

 

10706 Beaver Dam Road
Hunt Valley, Maryland 21030

(Address of principal executive offices)

 

(410) 568-1500

(Registrant’s telephone number, including area code)

 

None

(Former name, former address and former fiscal year-if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities 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 ý                        No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý                        No o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

 

 

SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

 

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2004

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 6. EXHIBITS
SIGNATURE
EXHIBIT INDEX

 

2

 

PART I.  FINANCIAL INFORMATION

ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		September 30, 2004			December 31, 2003
		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	9,096		$	28,730
Accounts receivable, net of allowance for doubtful accounts of $4,269 and $4,809, respectively		124,233			139,761
Current portion of program contract costs		60,719			61,053
Taxes receivable		411			1,952
Prepaid expenses and other current assets		10,131			14,091
Deferred barter costs		3,563			2,763
Deferred tax assets		12,441			12,443
Total current assets		220,594			260,793
PROGRAM CONTRACT COSTS, less current portion		33,439			34,218
LOANS TO AFFILIATES		16			1,381
PROPERTY AND EQUIPMENT, net		360,284			355,817
OTHER ASSETS		87,992			106,749
GOODWILL, net		1,118,534			1,118,534
BROADCAST LICENSES, net		443,900			429,507
DEFINITE-LIVED INTANGIBLE ASSETS, net		246,954			257,583
Total assets		$	2,511,713		$	2,564,582
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	6,219		$	8,301
Accrued liabilities		62,815			70,609
Current portion of notes payable, capital leases and commercial bank financing		40,043			38,986
Current portion of notes and capital leases payable to affiliates		4,873			3,296
Current portion of program contracts payable		127,322			120,873
Deferred barter revenues		3,659			3,153
Total current liabilities		244,931			245,218
LONG-TERM LIABILITIES:
Notes payable, capital leases and commercial bank financing, less current portion		1,635,171			1,664,534
Notes and capital leases payable to affiliates, less current portion		21,135			25,641
Program contracts payable, less current portion		76,398			92,299
Deferred tax liabilities		206,812			190,614
Other long-term liabilities		90,824			114,705
Total liabilities		2,275,271			2,333,011
MINORITY INTEREST IN CONSOLIDATED ENTITIES		3,071			2,566
SHAREHOLDERS’ EQUITY:
Series D Preferred Stock, $0.01 par value, 3,450,000 shares authorized, 3,337,033 and 3,450,000 issued and outstanding, liquidation preference of $166,851,650 and $172,500,000, respectively		33			35
Class A Common Stock, $0.01 par value, 500,000,000 shares authorized, 45,531,252 and 44,598,278 shares issued and outstanding, respectively		455			446
Class B Common Stock, $0.01 par value, 140,000,000 shares authorized, 39,606,995 and 41,213,653 shares issued and outstanding, respectively		396			412
Additional paid-in capital		751,746			762,720
Additional paid-in capital - deferred stock compensation		(7		)	(132		)
Accumulated deficit		(519,252		)	(533,916		)
Accumulated other comprehensive loss		—			(560		)
Total shareholders’ equity		233,371			229,005
Total liabilities and shareholders’ equity		$	2,511,713		$	2,564,582

 

The accompanying notes are an integral part of these unaudited consolidated statements.

 

3

 

SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data) (Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
REVENUES:
Station broadcast revenues, net of agency commissions		$	164,169		$	161,290		$	502,413		$	488,687
Revenues realized from station barter arrangements		14,455			15,725			45,784			46,229
Other operating divisions revenue		2,845			2,422			10,779			10,973
Total revenues		181,469			179,437			558,976			545,889
OPERATING EXPENSES:
Station production expenses		38,165			35,787			117,261			111,467
Station selling, general and administrative expenses		39,719			36,865			120,515			108,673
Expenses recognized from station barter arrangements		13,375			14,844			42,353			43,121
Amortization of program contract costs and net realizable value adjustments		25,367			26,470			74,406			79,019
Stock-based compensation expense		317			391			1,298			1,487
Other operating divisions expenses		3,506			2,620			12,656			12,059
Depreciation and amortization of property and equipment		12,574			11,767			38,073			34,374
Corporate general and administrative expenses		4,559			4,171			15,495			13,954
Amortization of definite-lived intangible assets and other assets		4,759			4,811			14,369			14,480
Total operating expenses		142,341			137,726			436,426			418,634
Operating income		39,128			41,711			122,550			127,255
OTHER INCOME (EXPENSE):
Interest expense and amortization of debt discount and deferred financing costs		(31,963		)	(33,405		)	(97,180		)	(94,777		)
Subsidiary trust minority interest expense		—			—			—			(11,246		)
Interest income		23			64			140			469
Loss on sale of assets		(12		)	(2		)	(45		)	(389		)
Unrealized gain from derivative instruments		1,602			9,241			20,576			8,094
Loss from extinguishment of securities		—			—			(2,453		)	(15,187		)
(Loss) income from equity and cost investees		(3,124		)	(266		)	255			581
Other income		183			190			572			978
Total other expenses		(33,291		)	(24,178		)	(78,135		)	(111,477		)
Income before income taxes		5,837			17,533			44,415			15,778
INCOME TAX PROVISION		(2,329		)	(11,070		)	(17,807		)	(9,993		)
NET INCOME		3,508			6,463			26,608			5,785
PREFERRED STOCK DIVIDENDS		2,503			2,588			7,678			7,763
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS		$	1,005		$	3,875		$	18,930		$	(1,978	)
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE		$	0.01		$	0.05		$	0.22		$	(0.02	)
Weighted average common shares outstanding		85,311			85,666			85,733			85,623
Weighted average common and common equivalent shares outstanding		85,319			85,806			85,883			85,742
Dividends per common share		$	.025		$	—		$	.050		$	—

 

The accompanying notes are an integral part of these unaudited consolidated statements.

 

4

 

SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004

(in thousands) (Unaudited)

 

		Series D Preferred Stock			Class A Common Stock			Class B Common Stock			Additional Paid-In Capital			Deferred Stock Compensation			Accumulated Deficit			Accumulated Other Comprehensive (Loss) Income			Total Shareholders’ Equity
BALANCE, December 31, 2003		$	35		$	446		$	412		$	762,720		$	(132	)	$	(533,916	)	$	(560	)	$	229,005
Dividends declared on Common Stock		—			—			—			—			—			(4,280		)	—			(4,280		)
Dividends paid on Series D Preferred Stock		—			—			—			—			—			(7,664		)	—			(7,664		)
Class A Common Stock issued pursuant to employee benefit plans and stock options exercised		—			3			—			3,316			—			—			—			3,319
Class B Common Stock converted to Class A Common Stock		¾			16			(16		)	—			¾			¾			¾			—
Amortization of deferred compensation		—			—			—			—			125			—			—			125
Repurchase of 970,500 shares of Class A Common Stock		—			(10		)	—			(9,540		)	—			—			—			(9,550		)
Repurchase of Series D Preferred Stock		(2		)	—			—			(4,750		)	—			—			—			(4,752		)
Net income		—			—			—			—			—			26,608			—			26,608
Amortization of derivative instruments, net of tax provision of $304		—			—			—			—			—			—			560			560
BALANCE, September 30, 2004		$	33		$	455		$	396		$	751,746		$	(7	)	$	(519,252	)	$	—		$	233,371
Other comprehensive income:
Net income		$	—		$	—		$	—		$	—		$	—		$	26,608		$	—		$	26,608
Amortization of derivative instruments, net of tax provision of $304		—			—			—			—			—			—			560			560
Comprehensive income		$	—		$	—		$	—		$	—		$	—		$	26,608		$	560		$	27,168

 

The accompanying notes are an integral part of these unaudited consolidated statements.

 

5

 

SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands) (Unaudited)

 

		Nine Months Ended September 30,
		2004			2003
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income		$	26,608		$	5,785
Adjustments to reconcile net income to net cash flows from operating activities:
Amortization of debt discount		(811		)	(568		)
Depreciation and amortization of property and equipment		38,073			34,374
Recognition of deferred revenue		(3,693		)	(3,706		)
Accretion of capital leases		532			562
Income from equity and cost investees		(255		)	(581		)
Loss on sale of property		45			389
Amortization of deferred compensation		125			378
Unrealized gain from derivative instruments		(20,576		)	(8,094		)
Amortization of definite-lived intangible assets and other assets		14,369			14,480
Amortization of program contract costs and net realizable value adjustments		74,406			79,019
Amortization of deferred financing costs		2,185			2,248
Extinguishment of debt, non-cash portion		1,289			3,705
Amortization of derivative instruments		963			1,243
Deferred tax provision related to operations		17,115			8,138
Net effect of change in deferred barter revenues and deferred barter costs		(278		)	(204		)
Changes in assets and liabilities, net of effects of acquisitions and dispositions:
Increase in minority interest		(183		)	(86		)
Decrease in receivables, net		15,065			18,020
Decrease in taxes receivable		1,541			37,522
Decrease in prepaid expenses and other current assets		4,367			15,225
Decrease in other long term assets		514			1,139
Decrease in accounts payable and accrued liabilities		(9,134		)	(15,552		)
(Decrease) increase in other long-term liabilities		(1,029		)	591
Dividends and distributions from equity investees		1,320			288
Payments on program contracts payable		(83,186		)	(79,584		)
Net cash flows from operating activities		79,372			114,731
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Acquisition of property and equipment		(36,529		)	(54,496		)
Consolidation of variable interest entity		239			—
Payment for acquisition of television station licenses and related assets		—			(18,000		)
Contributions in investments		(4,620		)	(4,633		)
Proceeds from sale of property		23			138
Loans to affiliates		(828		)	(858		)
Proceeds from loans to affiliates		2,182			552
Net cash flows used in investing activities		$	(39,533	)	$	(77,297	)

 

6

 

		Nine Months Ended September 30,
		2004			2003
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Proceeds from commercial bank financing and notes payable		$	511,000		$	318,336
Repayments of notes payable, commercial bank financing and capital leases		(543,400		)	(129,100		)
Redemption of High Yield Trust Originated Preferred Securities		—			(200,000		)
Repurchase of Series D Preferred Stock		(4,752		)	—
Repurchase of Class A Common Stock		(9,550		)	(1,544		)
Proceeds from exercise of stock options		1,152			443
Payments for deferred financing costs		(953		)	(7,258		)
Dividends paid on Series D Preferred Stock		(7,678		)	(7,763		)
Dividends paid on Class A Common Stock		(2,143		)	—
Repayments of notes and capital leases to affiliates		(3,149		)	(2,968		)
Net cash flows used in financing activities		(59,473		)	(29,854		)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(19,634		)	7,580
CASH AND CASH EQUIVALENTS, beginning of period		28,730			5,327
CASH AND CASH EQUIVALENTS, end of period		$	9,096		$	12,907

 

The accompanying notes are an integral part of these unaudited consolidated statements.

 

7

 

SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.              SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements include the accounts of Sinclair Broadcast Group, Inc. and all of our consolidated subsidiaries and variable interest entities.  We own and operate, provide sales services or provide programming and operating services pursuant to local marketing agreements (LMAs) to 62 television stations in 39 markets throughout the United States.  The financial statements of Cunningham Broadcasting Corporation, Acrodyne Communications, Inc. and G1440, Inc. are consolidated for the three and nine months ended September 30, 2004 and 2003.  The financial statements for the unrelated third party owner of WNAB-TV in Nashville, Tennessee, a variable interest entity for which we are the primary beneficiary, are consolidated as of March 31, 2004.  (See Variable Interest Entities below).

 

Interim Financial Statements

 

The consolidated financial statements for the three and nine months ended September 30, 2004 and 2003 are unaudited.  In the opinion of management, such financial statements have been presented on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for these periods.

 

As permitted under the applicable rules and regulations of the Securities and Exchange Commission, these financial statements do not include all disclosures normally included with audited consolidated financial statements and, accordingly, should be read in conjunction with the consolidated financial statements and notes thereto as of December 31, 2003 and for the year then ended.  The results of operations presented in the accompanying financial statements are not necessarily representative of operations for an entire year.

 

Recent Accounting Pronouncements

 

In September 2004, the Emerging Issues Task Force (EITF) finalized Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share (Issue 04-8).  Issue 04-8 requires all issued securities that have embedded market price contingent conversion features be included in the diluted earnings per share (diluted EPS) calculation.  Issue 04-8 is effective for all periods ending after December 15, 2004.  We are currently in the process of evaluating its effect on our diluted EPS.

 

During March 2004, the Financial Accounting Standards Board (FASB) issued an Exposure Draft (ED), Share-Based Payment as an amendment to FASB Statement No. 123, Accounting for Stock-Based Compensation.  This ED would require all share-based payments, including grants of employee stock options and our employee stock purchase plan, to be recognized in the income statement as compensation expense based on their fair values.  Recently, the FASB delayed the effective date of this ED to reporting periods ending after June 15, 2005.  We are currently in the process of evaluating its effect on our financial position, consolidated results of operations and consolidated cash flows; and we do not plan to adopt this standard until its effective date.

 

Variable Interest Entities

 

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46).  FIN 46 introduces the variable interest consolidation model, which determines control and consolidation based on potential variability in gains and losses of the entity being evaluated for consolidation.  We adopted FIN 46 on March 31, 2004.

 

We have determined that the unrelated third-party owner of WNAB-TV in Nashville is a variable interest entity (VIE) and that we are the primary beneficiary of the variable interests as a result of the terms of our outsourcing agreement, put options and call options. As a result, we were required to consolidate the assets and liabilities of WNAB-TV at their fair market values as of March 31, 2004.  The consolidated assets of WNAB-TV consist of broadcast licenses of $14.4 million, network affiliation of $3.0 million and property and equipment of $1.9 million.  The consolidation of WNAB-TV did not have a

 

8

 

material impact on our results of operations.  We made payments to the unrelated third-party owner of WNAB-TV of $0.4 million related to our outsourcing agreement for both of the three months ended September 30, 2004 and 2003.  We made payments to the unrelated third-party owner of WNAB-TV of $1.2 million related to our outsourcing agreement for both of the nine months ended September 30, 2004 and 2003.  On January 2, 2003, we made an $18.0 million non-refundable deposit against the purchase price of the put or call option on the non-license assets.  We believe that our maximum exposure to loss as a result of our involvement with WNAB-TV consists of the fees that we pay related to the outsourcing agreement as well as any payments that we would be required to make under the put options held by the current owner related to the license and non-license assets.  (See Note 2, Commitments and Contingencies, WNAB Options).

 

We have determined that Cunningham Broadcasting Corporation (Cunningham) is a VIE and that we are the primary beneficiary of the variable interests.  We have been consolidating Cunningham’s financial statements since February 1, 2002; therefore, the implementation of FIN 46 did not have an effect on our financial statements with respect to our variable interest in Cunningham.  We made LMA payments to Cunningham of $1.2 million for both of the three months ended September 30, 2004 and 2003.  We made LMA payments to Cunningham of $4.6 million and $3.7 million for the nine months ended September 30, 2004 and 2003, respectively.  We received payments from Cunningham of $0.4 million and $0.1 million for the three months ended September 30, 2004 and 2003, respectively.  We received payments from Cunningham of $1.7 million and $0.3 million for the nine months ended September 30, 2004 and 2003, respectively.  The creditors of Cunningham have no recourse with respect to us.  We believe that our maximum exposure to loss as a result of our involvement with Cunningham consists of the fees that we pay related to the LMA agreements as well as payments that we would make as a result of exercising our option to acquire Cunningham, which provides for an option exercise price based on a formula that provides a 10% annual return to Cunningham.

 

We have determined that we have a variable interest in WTXL-TV in Tallahassee, Florida as a result of the terms of the outsourcing agreement with the unrelated third-party owner of WTXL-TV. However, we are not the primary beneficiary of the variable interests, and therefore, we are not required to consolidate WTXL-TV under the provisions of FIN 46. We believe that we do not have a material exposure to loss as a result of our involvement with WTXL-TV.

 

Pro Forma Information Related To Stock-Based Compensation

 

As permitted under SFAS No. 123, Accounting for Stock-Based Compensation, we measure compensation expense for our stock-based employee compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and provide pro forma disclosures of income (loss) and income (loss) per share as if the fair value-based method prescribed by SFAS No. 123 had been applied in measuring compensation expense.

 

Had compensation expense for our 2004, 2003 and prior year grants for stock-based compensation plans been determined consistent with SFAS No. 123, our net income (loss) available to common shareholders for these three and nine month periods would approximate the pro forma amounts below (in thousands, except per share data):

 

		Three Months Ended September 30, 2004						Three Months Ended September 30, 2003
		As Reported			Pro Forma			As Reported			Pro Forma
Net income available to common shareholders		$	1,005		$	393		$	3,875		$	1,705
Basic and diluted net income per common share		$	0.01		$	—		$	0.05		$	0.02

 

		Nine Months Ended September 30, 2004						Nine Months Ended September 30, 2003
		As Reported			Pro Forma			As Reported			Pro Forma
Net income (loss) available to common shareholders		$	18,930		$	16,348		$	(1,978	)	$	(7,694	)
Basic and diluted net income (loss) per common share		$	0.22		$	0.19		$	(0.02	)	$	(0.09	)

 

9

 

We have computed for pro forma disclosure purposes the value of all options granted during the three and nine months ended September 30, 2004 and 2003, respectively, using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following weighted average assumptions:

 

		Three Months Ended				Nine Months Ended
		September 30, 2004		September 30, 2003		September 30, 2004		September 30, 2003
Risk-free interest rate		3.57%		3.23%		3.08%		2.97%
Expected lives		5 years		5 years		5 years		5 years
Expected volatility		44%		51%		44%		51%
Weighted average fair value		$4.07		$4.76		$5.63		$4.57

 

Adjustments are made for options forfeited prior to vesting.

 

Income Taxes

 

Our effective tax rate decreased to 40.1% for the nine months ended September 30, 2004 from 63.3% for the nine months ended September 30, 2003.  The decrease in the effective tax rate primarily results from the treatment of the intercompany dividend in 2003 related to HYTOPS in a quarter in which we did not experience earnings and profits.  The HYTOPS were redeemed in 2003 and no such dividend occurred in 2004.  For a detailed discussion of the treatment of the HYTOPS and earnings and profits, please refer to Note (a) in Footnote 6 to the financial statements found in the KDSM, Inc. Form 10-K for the year ended December 31, 2002 as filed with the United States Securities and Exchange Commission.

 

Impairment of Investments

 

Each quarter, we review our investments for impairment.  For any investments that indicate a potential impairment, we estimate the fair values of those investments using discounted cash flow models, third party valuations or industry comparables, based on the various facts available to us.  As a result of these calculations, we recorded a loss from equity investees of $4.0 million in the income statement for the three months ended September 30, 2004.

 

Of this amount, $3.5 million was related to our investment in VisionAir, a software application provider of public safety products.  We initially invested $3.0 million in VisionAir in 2000 and we made an additional $0.5 million investment in May 2003.  We considered recent forecasts for the remainder of 2004 and for 2005 together with a third party valuation performed in 2003 to determine the fair value of our investment.  As a result of our fair value calculations, along with other facts available to us, we determined that it was appropriate to write-off the entire investment as of September 30, 2004.

 

The remaining loss from equity investees of $0.5 million was related to our investment in AppForge, a mobile software tools and services developer.  We initially invested $0.5 million in 2000 and we made additional investments of $0.1 million in 2002 and 2003, respectively.  We considered a third party valuation performed recently to determine the fair value of our investment.  As a result of our fair value calculations, we determined that it was appropriate to write-off $0.5 million of this investment.  The remaining net book value of this investment was $0.2 million as of September 30, 2004.

 

Acquisitions

 

On March 31, 2004, we acquired the television broadcast license for WFGX-TV in Pensacola, Florida, which we had previously operated pursuant to a local marketing agreement.  The consideration for the broadcast license assets was $0.5 million which was paid in two installments, one in February 1996 and the other in January 1999.  We have been consolidating the results of operations related to this acquisition since April 1, 2004.

 

Reclassifications

 

Certain reclassifications have been made to the prior periods’ financial statements to conform to the current year’s presentation.

 

10

2.              COMMITMENTS AND CONTINGENCIES:

 

Litigation

 

Lawsuits and claims are filed against us from time to time in the ordinary course of business.  These actions, other than what is discussed below, are in various preliminary stages and no judgments or decisions have been rendered by hearing boards or courts.  After reviewing developments to date with legal counsel, management is of the opinion that the outcome of such matters will not have a material adverse effect on our consolidated financial position, consolidated results of operations or consolidated cash flows.

 

There has been some controversy surrounding the recent airing of a news program, POW Story: Politics, Pressure, and the Media.  On October 19, 2004, a shareholder derivative suit was filed by a nominal shareholder against us and our Directors in the Baltimore City Circuit Court.  The suit alleges mismanagement of our company by our Directors in allowing the controlling shareholders to impose their own political and personal agendas on our news programming.  As of November 5, 2004, no Director has been served in the Baltimore City litigation, we expect service of process to occur in the near future.  Outside counsel is formulating a response to the lawsuit and negotiating the terms for accepting service upon the individual Directors.  We are also in receipt of a formal letter demanding that we sue three of our Directors for insider trading.  Our outside counsel has responded to the letter by noting to its writer that the allegations supporting the claims of insider trading are objectively incorrect.  We have been advised that the action demanded by the letter, even if based upon accurate facts, may fail to support a shareholder derivative suit of action necessitating any action by us on the demand.  Lastly, certain parties filed formal complaints against us with the Federal Communications Commission (FCC) and the Federal Election Commission (FEC).  The complaint filed with the FCC has subsequently been withdrawn.  Through outside counsel, we are drafting a response to the complaints filed with the FEC.  At this time, and based on the facts currently alleged and available, we have no reason to believe that the Baltimore City suit, the demand letter or the complaints at the FEC have merit nor will they have a material adverse effect on our consolidated financial position, consolidated results of operations or consolidated cash flows.

 

On November 1, 2004, an organization calling itself “Free Press” filed a petition with the FCC to deny the license renewal applications of six of our stations (WXLV-TV, Winston-Salem, North Carolina, WUPN-TV, Greensboro, North Carolina, WLFL-TV, Raleigh, North Carolina, WRDC-TV, Durham, North Carolina, WLOS-TV, Asheville, North Carolina, and WMMP-TV, Charleston, South Carolina) and two Cunningham Broadcasting Corporation stations (WBSC-TV, Anderson, South Carolina and WTAT-TV, Charleston, South Carolina), which are programmed by us pursuant to LMAs.  The petition contains essentially the same allegations that have been brought in the past by the Rainbow/PUSH Coalition, which were dismissed or denied by the FCC, and several other allegations which we believe have no merit nor will they have a material adverse effect on our consolidated financial position, consolidated results of operations or consolidated cash flows.

 

Operating Leases

 

As of September 30, 2004, we had an outstanding letter of credit of $0.9 million under our revolving credit facility.  The letter of credit acts as a guarantee of lease payments for the property occupied by WTTA-TV in Tampa, Florida pursuant to the terms and conditions of the lease agreement.

 

Affiliation Agreements

 

Sixty of the 62 television stations that we own and operate, or to which we provide programming services or sales services, currently operate as affiliates of FOX (20 stations), WB (19 stations), ABC (9 stations), NBC (3 stations), UPN (6 stations) and CBS (3 stations).  The remaining two stations are independent.  The networks produce and distribute programming in exchange for each station’s commitment to air the programming at specified times and for commercial announcement time during the programming.

 

During July 2004, we entered into an affiliation agreement with ABC for WKEF-TV in Dayton, Ohio.  WKEF-TV (channel 22) switched from its NBC network affiliation to the ABC Television Network beginning August 30, 2004.  WKEF-TV’s current syndicated and local news programming continues to be aired on channel 22.  As of September 30, 2004, the corresponding net book value of the affiliation agreement was $14.0 million.  We tested the affiliation agreement of WKEF-TV for impairment in accordance with SFAS No.144, Accounting for the Impairment or Disposal of Long-Lived Assets.

 

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The NBC affiliation agreement with WICS/WICD-TV in Champaign/Springfield, Illinois expired on April 1, 2004.  We continue to program this station as an NBC affiliate without a formal agreement.  On February 25, 2004, NBC informed us that they intend to terminate our affiliation with WICS/WICD effective September 2005 in order to affiliate with another station in that market.  We have engaged in discussions with ABC Television Network regarding affiliating with ABC in that market because the station which is scheduled to acquire our NBC affiliation is currently the ABC affiliate in Champaign/Springfield.  As of September 30, 2004, the corresponding net book value of the affiliation agreement was $9.9 million.

 

The affiliation agreements of three ABC stations (WEAR-TV in Pensacola, Florida, WCHS-TV in Charleston, West Virginia and WXLV-TV in Greensboro/Winston-Salem, North Carolina) have expired.  We continue to operate these stations as ABC affiliates and we do not believe ABC has any current plans to terminate the affiliation agreements with any of these stations, although we can make no assurance that ABC will not do so.

 

The following affiliate agreements are scheduled to expire during 2004:

 

•                  The ABC affiliate agreements with WLOS-TV in Asheville, North Carolina and WSYX-TV in Columbus, Ohio were extended on the same terms through November 30, 2004.

 

•                  In order to allow us and UPN to continue good faith negotiations regarding their affiliation agreements, the UPN affiliate agreements for WRDC-TV in Raleigh, North Carolina, WUXP-TV in Nashville, Tennessee, WCGV-TV in Milwaukee, Wisconsin, WABM-TV in Birmingham, Alabama, WUPN-TV in Greensboro/Winston-Salem, North Carolina and WMMP-TV in Charleston, South Carolina, which expired on July 31, 2004, were extended through December 31, 2004.  Certain terms of these agreements were modified and apply through the extended expiration date.  These modifications do not have a material impact on our financial position, consolidated results of operations and consolidated cash flows.  As of September 30, 2004, the net book value of these UPN agreements was $4.1 million.

 

•                  The CBS affiliate agreements with KGAN-TV in Cedar Rapids, Iowa and WGME-TV in Portland, Maine are scheduled to expire on December 31, 2004.

 

We are currently engaged in negotiations with ABC, UPN and CBS regarding continuing our network affiliation agreements.  The non-renewal or termination of one or more of these or any of our other network affiliation agreements would prevent us from being able to carry programming of the relevant network. This loss of programming would require us to obtain replacement programming, which may involve higher costs and which may not be as attractive to our target audiences, resulting in reduced revenues.  Upon the termination of any of the above affiliation agreements, we would be required to establish new affiliation agreements with other networks or operate as an independent station.  At such time, the remaining value of the network affiliation asset could become impaired and we would be required to write down the value of the asset.  At this time we can not predict the final outcome of these negotiations and any impact they may have on our financial position, consolidated results of operations or consolidated cash flows.

 

Changes in the Rules on Television Ownership and Local Marketing Agreements

 

Certain of our stations have entered into what have commonly been referred to as local marketing agreements or LMAs.  One typical type of LMA is a programming agreement between two separately owned television stations serving the same market, whereby the licensee of one station programs substantial portions of the broadcast day and sells advertising time during such program segments on the other licensee’s station subject to the ultimate editorial and other controls being exercised by the latter licensee.  We believe these arrangements allow us to reduce our operating expenses and enhance profitability.  Under the new FCC ownership rules, which have been stayed and are on remand to the FCC, we would be allowed to continue to program most of the stations with which we have an LMA.  In the absence of a waiver, the new rules would require us to terminate or modify three of our LMAs in markets where both the stations we own and the station with which we have an LMA are ranked among the top four stations in their particular designated market area.  The FCC’s new ownership rules include specific provisions permitting waivers of this “top four restriction.”  Although there can be no assurances, we have studied the application of the new rules to our markets and believe we are qualified for waivers.  Because the new ownership rules have been remanded, it is not clear if we will be required to terminate or modify our LMAs in markets where we have such arrangements.

 

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When the FCC decided to attribute LMAs for ownership purposes in 1999, it grandfathered our LMAs that were entered into prior to November 5, 1996, permitting the applicable stations to continue operations pursuant to the LMAs until the conclusion of the FCC’s 2004 biennial review.  The attribution of several other of our LMAs was stayed by the Court of Appeals.  As part of the 2004 biennial review, the FCC stated it would conduct a case-by case review of grandfathered LMAs and assess the appropriateness of extending the grandfathering period.  Recently, the FCC invited comments as to whether, instead of beginning the biennial review in 2004, it should begin review of the grandfathered LMAs in 2006.  We cannot predict when the FCC will begin its review of those LMAs.

 

Because the effectiveness of the new rules has been stayed and the FCC concluded the old rules could not be justified as necessary to the public interest, we have taken the position that an issue exists regarding whether the FCC has any current legal right to enforce any rules prohibiting the acquisition of television stations.  The FCC, however, dismissed our applications to acquire certain LMA stations.  We filed an application for review of that decision, which is still pending.

 

If we are required by the FCC to terminate or modify our LMAs, our business could be affected in the following ways:

 

•                  Losses on investments.  As part of our LMA arrangements, we own the non-license assets used by the stations with which we have LMAs.  If certain of these LMA arrangements are no longer permitted, we could be forced to sell these assets, restructure our agreements or find another use for them.  If this happens, the market for such assets may not be as good as when we purchased them and therefore, we cannot be certain that we will recoup our original investments.

 

•                  Termination penalties.  If the FCC requires us to modify or terminate our existing LMAs before the terms of the LMAs expire, or under certain circumstances, we elect not to extend the term of the LMAs, we may be forced to pay termination penalties under the terms of some of our LMAs.  Any such termination penalty could be material.

 

WNAB Options

 

We have entered into an agreement with a third party to purchase certain license and non-license television broadcast assets of WNAB-TV at our option (the call option) and additionally, the third party may require us to purchase these license and non-license broadcast assets at the option of the third party (the put option).  On January 2, 2003, we made an $18 million non-refundable deposit against the purchase price of the put or call option on the non-license assets in return for a reduction of $0.1 million in our monthly profit sharing arrangements.  Upon exercise, we may settle the call or put options entirely in cash or, at our option, we may pay up to one-half of the purchase price by issuing additional shares of our Class A Common Stock. The call and put option exercise prices vary depending upon the exercise dates and have been adjusted for the deposit. The license asset call option exercise price is $5.0 million prior to March 31, 2005, $5.6 million from March 31, 2005 until March 31, 2006 and $6.2 million from March 31, 2006 through its expiration on May 1, 2007. The non-license asset call option exercise price is $8.3 million prior to March 31, 2005, $12.6 million from March 31, 2005 until March 31, 2006 and $16.0 million from March 31, 2006 through its expiration on May 1, 2007. The license asset put option price is $5.4 million from July 1, 2005 to July 31, 2005, $5.9 million from July 1, 2006 to July 31, 2006 and $6.3 million from July 1, 2007 through its expiration on July 31, 2007. The non-license asset put option price is $7.9 million from July 1, 2005 to July 31, 2005, $12.4 million from July 1, 2006 to July 31, 2006 and $16.0 million from July 1, 2007 through its expiration on July 31, 2007.

 

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3.              SUPPLEMENTAL CASH FLOW INFORMATION (in thousands):

 

During the nine months ended September 30, 2004 and 2003, our supplemental cash flow information was as follows:

 

		Nine Months Ended September 30,
		2004			2003
Capital lease obligations incurred		$	4,727		$	2,699
Income taxes paid from continuing operations		$	1,737		$	1,996
Income (taxes paid) tax refunds received related to sale of discontinued operations		$	(256	)	$	339
Income tax refunds received		$	1,340		$	38,378
Subsidiary trust minority interest payments		$	—		$	10,979
Interest payments		$	99,289		$	85,522
Payments related to extinguishment of debt		$	1,168		$	11,482

 

4.              COMPREHENSIVE INCOME:

 

Total comprehensive income was as follows (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
Net income		$	3,508		$	6,463		$	26,608		$	5,785
Amortization of derivative instruments, net of taxes		—			280			560			840
Total comprehensive income		$	3,508		$	6,743		$	27,168		$	6,625

 

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5.              EARNINGS (LOSS) PER SHARE:

 

The following table reconciles income (numerator) and shares (denominator) used in our computations of earnings (loss) per share for the three and nine months ended September 30, 2004 and 2003 (in thousands, except per share data):

 

		Three Months Ended September 30,
		2004			2003
Income (Numerator)
Net income		$	3,508		$	6,463
Preferred stock dividends payable		(2,503		)	(2,588		)
Net income available to common shareholders		$	1,005		$	3,875
Shares (Denominator)
Weighted-average number of common shares		85,311			85,666
Dilutive effect of outstanding stock options		8			140
Weighted-average number of common equivalent shares outstanding		85,319			85,806

 

		Nine Months Ended September 30,
		2004			2003
Income (Numerator)
Net income		$	26,608		$	5,785
Preferred stock dividends payable		(7,678		)	(7,763		)
Net income (loss) available to common shareholders		$	18,930		$	(1,978	)
Shares (Denominator)
Weighted-average number of common shares		85,733			85,623
Dilutive effect of outstanding stock options		150			119
Weighted-average number of common equivalent shares outstanding		85,883			85,742

 

Basic earnings (loss) per share (EPS) are calculated using the weighted average number of shares outstanding during the period.  Diluted earnings (loss) per share (diluted EPS) includes the potentially dilutive effect, if any, which would occur if outstanding options to purchase common stock were exercised using the treasury stock method.  Stock options to exercise eight thousand incremental shares of common stock were outstanding during the quarter ended September 30, 2004, and stock options to exercise 0.1 million incremental shares of common stock were outstanding during the quarter ended September 30, 2003.  Stock options to exercise 0.2 million incremental shares of common stock were outstanding during the nine months ended September 30, 2004.  Stock options to exercise 0.1 million incremental shares of common stock were outstanding during the nine months ended September 30, 2003, but were not included in the computation of diluted EPS as the effect would be anti-dilutive.  The remaining options to purchase shares of common stock that were outstanding during the three and nine months ended September 30, 2004 and September 30, 2003 were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares.

 

6.              2002 BANK CREDIT AGREEMENT AMENDMENT:

 

On June 25, 2004, we amended and restated our Bank Credit Agreement (the 2002 Bank Credit Agreement), lowering our annual interest rate.  As part of the amendment, we fully redeemed our $460.9 million Term Loan B Facility with borrowings under our revolving credit facility and with new lower priced, $150.0 million Term Loan A and $250.0 million Term Loan C Facilities.

 

The Term Loan A Facility is repayable in quarterly installments, amortizing as follows:

•                  1.25% per quarter commencing March 31, 2005 to March 31, 2007

•                  2.50% per quarter commencing March 31, 2007 and continuing through its maturity on June 30, 2009

 

The Term Loan C Facility is repayable in quarterly installments, amortizing 0.25% per quarter, commencing March 31, 2005 through its maturity on December 31, 2009.  We did not make any changes to the terms of our $225.0 million Revolving Credit Facility commitment, of which $55.0 million was outstanding as of September 30, 2004.

 

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The applicable interest rate on the Term Loan A Facility is London Interbank Offered Rate (LIBOR) plus 1.75% with step-downs tied to a leverage grid.  The applicable interest rate on the Term Loan C Facility is LIBOR plus 1.75%.

 

As a result of amending the 2002 Bank Credit Agreement, we incurred debt acquisition costs of $1.8 million and recognized a loss of $2.5 million.  This loss represents the write-off of certain debt acquisition costs associated with indebtedness replaced by the new facilities.  The loss was computed in accordance with EITF No. 96-19, Debtors Accounting for a Modification or Exchange of Debt Instruments.

 

7.              DERIVATIVE INSTRUMENTS:

 

We enter into derivative instruments primarily to reduce the impact of changing interest rates on our floating rate debt and to reduce the impact of changing fair market values of our fixed rate debt.  As of September 30, 2004, we held the following derivative instruments:

 

•                  We hold two interest rate swap agreements with financial institutions that have a notional amounts totaling $575.0 million that expire on June 5, 2006.  In June 2003, we assigned $200.0 million of the notional amount to a second financial institution.  These swap agreements require us to pay a fixed rate, which is set in the range of 6.25% to 7.00% and receive a floating rate based on the three month LIBOR (measurement and settlement is performed quarterly).  These swap agreements are reflected as a derivative obligation based on their fair value of $33.5 million and $54.1 million as a component of other long-term liabilities in the accompanying consolidated balance sheets as of September 30, 2004 and December 31, 2003, respectively.  These swap agreements do not qualify for hedge accounting treatment under SFAS No. 133; therefore, changes in their fair market values are reflected currently in earnings as unrealized gain (loss) from derivative instruments.  We incurred an unrealized gain of $1.6 million for the quarter ended September 30, 2004 and an unrealized gain of $9.2 million during the quarter ended September 30, 2003, related to these instruments.  The instrument with a notional amount of $375.0 million contains a European style (that is, exercisable only on the expiration date) termination option and can be terminated partially or in full by the counterparty on June 3, 2005 at its fair market value.  The interest rate swap agreement with a notional amount of $200.0 million does not have an option to terminate before it expires.  We estimate the fair market value of the $375.0 million and $200.0 million agreements at September 30, 2004 to be $21.7 million and $11.8 million, respectively, based on quotations from the counterparty. These amounts are reflected as a component of other long-term liabilities on our consolidated balance sheet as of September 30, 2004.

 

•                  In March 2002, we entered into two interest rate swap agreements with notional amounts totaling $300.0 million which expire on March 15, 2012, for which we receive a fixed rate of 8% and pay a floating rate based on LIBOR (measurement and settlement is performed quarterly).  These swaps are accounted for as a hedge of our 8% Senior Subordinated Notes in accordance with SFAS No. 133 whereby changes in the fair market value of the swaps are reflected as adjustments to the carrying amount of the 8% Senior Subordinated Notes.  These swaps are reflected in the accompanying balance sheet as a derivative asset and as a premium on the 8% Senior Subordinated Notes based on their fair value of $17.3 million.

 

•                  In November 2003, we entered into two interest rate swap agreements with notional amounts totaling $100.0 million, which expire March 15, 2012, for which we receive a fixed rate of 8% and pay a floating rate based on LIBOR (measurement and settlement is performed quarterly).  These swaps are accounted for as a hedge of our 8% Senior Subordinated Notes in accordance with SFAS No. 133, whereby changes in the fair market value of the swaps are reflected as adjustments to the carrying amount of the 8% Senior Subordinated Notes.  These swaps are reflected on the accompanying balance sheet as a derivative liability and as a discount on the 8% Senior Subordinated Notes based on their fair value of $1.0 million.

 

The counterparties to these agreements are international financial institutions. We estimate the net fair value of these instruments at September 30, 2004 to be a liability of $15.2 million.  The fair value of the interest rate swap agreements is estimated by obtaining quotations from the financial institutions, party to each derivative contract. The fair value is an estimate of the net amount that we would pay on September 30, 2004 if we cancelled the contracts or transferred them to other parties.

 

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8.              CONDENSED CONSOLIDATING FINANCIAL STATEMENTS:

 

Sinclair Television Group, Inc. (STG) is a 100% owned subsidiary of Sinclair Broadcast Group, Inc. (BBG) and was incorporated in 2003.  On September 30, 2003, we completed the creation of a modified holding company structure, whereby we transferred substantially all of our television broadcast assets and liabilities to STG. As such, STG has become the primary obligor under our 2002 Bank Credit Agreement, the 8.75% Senior Subordinated Notes due 2011 and the 8% Senior Subordinated Notes due 2012.  Our Class A Common Stock, Class B Common Stock, Series D Convertible Exchangeable Preferred Stock and the 4.875% Convertible Senior Subordinated Notes remain at SBG and are not obligations or securities of STG.

 

SBG and KDSM, LLC, a 100% owned subsidiary of SBG have fully and unconditionally guaranteed all of STG’s obligations.  Those guarantees are joint and several.  There are no significant restrictions on the ability of SBG, STG or KDSM, LLC to obtain funds from their subsidiaries in the form of dividends or loans.

 

Although the modified holding company structure using STG was created on September 30, 2003, we have presented balance sheets, statements of operations and cash flows as if STG was in existence in prior periods.

 

The following condensed consolidating financial statements present the financial position, results of operations, and cash flows of SBG, STG, KDSM LLC, the direct and indirect non-guarantor subsidiaries of SBG and the eliminations necessary to arrive at our information on a consolidated basis.  These statements are presented in accordance with the disclosure requirements under Securities and Exchange Commission Regulation S-X, Rule 3-10.

 

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SINCLAIR BROADCAST GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

AS OF SEPTEMBER 30, 2004

(in thousands) (unaudited)

 

					Guarantor Subsidiaries
		Sinclair Broadcast Group, Inc.			Sinclair Television Group, Inc.			KDSM, LLC			Non- Guarantor Subsidiaries			Eliminations			Sinclair Consolidated
Cash		$	—		$	7,753		$	23		$	1,320		$	—		$	9,096
Accounts receivable		175			119,802			1,095			3,161			—			124,233
Other current assets		2,883			78,743			796			4,843			—			87,265
Total current assets		3,058			206,298			1,914			9,324			—			220,594
Property and equipment, net		10,975			341,043			5,258			3,008			—			360,284
Investment in consolidated subsidiaries		330,748			—			—			—			(330,748		)	—
Other long-term assets		57,166			71,407			572			10,513			(18,211		)	121,447
Total other long-term assets		387,914			71,407			572			10,513			(348,959		)	121,447
Acquired intangible assets		—			1,755,966			5,789			47,633			—			1,809,388
Total Assets		$	401,947		$	2,374,714		$	13,533		$	70,478		$	(348,959	)	$	2,511,713
Accounts payable and accrued liabilities		$	7,006		$	54,926		$	429		$	6,673		$	—		$	69,034
Current portion of long-term debt		2,183			9,233			—			33,500			—			44,916
Other current liabilities		—			128,385			1,567			1,029			—			130,981
Total current liabilities		9,189			192,544			1,996			41,202			—			244,931
Long-term debt		159,387			1,494,648			2,271			—			—			1,656,306
Other liabilities		—			387,842			1,060			6,414			(18,211		)	377,105
Total liabilities		168,576			2,075,034			5,327			47,616			(18,211		)	2,278,342
Preferred stock		33			—			—			—			—			33
Common stock		851			—			—			—			—			851
Additional paid-in capital		751,739			588,620			20,295			65,179			(674,094		)	751,739
Accumulated deficit		(519,252		)	(288,940		)	(12,089		)	(42,317		)	343,346			(519,252		)
Total shareholders’ equity		233,371			299,680			8,206			22,862			(330,748		)	233,371
Total Liabilities and Shareholders’ Equity		$	401,947		$	2,374,714		$	13,533		$	70,478		$	(348,959	)	$	2,511,713

 

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