SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

(Mark One)

 

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

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007

 

or

 

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

 

For the transition period from:    Not Applicable        

 

Commission file number 1-14776

 

Hearst-Argyle Television, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

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 twelve 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  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer   o                       Accelerated filer   x                           Non-accelerated filer   o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o No  x

 

Shares of the registrant’s common stock outstanding as of October 31, 2007: 93,808,916 shares (consisting of 52,510,268 shares of Series A Common Stock and 41,298,648 shares of Series B Common Stock).

 

 

HEARST-ARGYLE TELEVISION, INC.

 

Index

 

		Page No.
Part I	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2007 (unaudited) and December 31, 2006	1
	Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited)	2
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (unaudited)	3
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 4.	Controls and Procedures	21
Part II	Other Information
Item 1.	Legal Proceedings	22
Item 2.	Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities	22
Item 6.	Exhibits	23
Signatures		24

 

 

PART I 

FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

HEARST-ARGYLE TELEVISION, INC.

Condensed Consolidated Balance Sheets

 

		September 30, 2007			December 31, 2006
		(Unaudited)
		(In thousands)
Assets
Current assets:
Cash and cash equivalents		$	55,568		$	18,610
Accounts receivable, net		152,984			161,783
Program and barter rights		87,065			67,949
Deferred income tax asset		4,672			4,672
Other		6,288			5,671
Total current assets		306,577			258,685
Property, plant and equipment, net		300,195			295,094
Intangible assets, net		2,514,830			2,520,040
Goodwill		816,728			816,724
Other assets:
Deferred financing costs, net		8,303			9,648
Investments		41,157			40,454
Program and barter rights, noncurrent		9,928			15,227
Other assets		1,398			2,216
Total other assets		60,786			67,545
Total assets		$	3,999,116		$	3,958,088
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt		$	90,028		$	90,048
Accounts payable		12,570			18,208
Accrued liabilities		42,356			66,515
Program and barter rights payable		86,159			65,473
Payable to Hearst Corporation, net		5,858			7,317
Other		7,759			2,693
Total current liabilities		244,730			250,254
Program and barter rights payable, noncurrent		17,573			22,411
Long-term debt		777,110			777,122
Note payable to Capital Trust		134,021			134,021
Deferred income tax liability		830,496			838,229
Other liabilities		90,050			53,244
Total noncurrent liabilities		1,849,250			1,825,027
Commitments and contingencies
Stockholders’ equity:
Series A common stock		571			563
Series B common stock		413			413
Additional paid-in capital		1,334,125			1,309,578
Retained earnings		716,190			716,146
Accumulated other comprehensive loss, net		(33,109		)	(33,109		)
Treasury stock, at cost		(113,054		)	(110,784		)
Total stockholders’ equity		1,905,136			1,882,807
Total liabilities and stockholders’ equity		$	3,999,116		$	3,958,088

 

See notes to condensed consolidated financial statements.

 

1

 

HEARST-ARGYLE TELEVISION, INC.

 

Condensed Consolidated Statements of Income

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2007			2006			2007			2006
		(Unaudited)
		(In thousands, except per share data)
Total revenue		$	176,775		$	182,993		$	539,177		$	550,974
Station operating expenses:
Salaries, benefits and other operating costs		101,831			99,574			305,073			294,016
Amortization of program rights		18,679			17,751			57,329			49,034
Depreciation and amortization		13,310			14,634			42,492			46,103
Corporate, general and administrative expenses		12,534			7,868			29,201			22,766
Operating income		30,421			43,166			105,082			139,055
Interest expense		15,926			16,427			47,846			48,942
Interest income		(555		)	(1,736		)	(1,309		)	(4,983		)
Interest expense, net – Capital Trust		2,438			2,438			7,313			7,313
Other expense		—			—			—			2,501
Income before income taxes and equity earnings		12,612			26,037			51,232			85,282
Income tax expense		2,138			9,531			18,656			30,807
Equity in loss (income) of affiliates, net of tax		733			(37		)	1,564			(102		)
Net income		$	9,741		$	16,543		$	31,012		$	54,577
Income per common share – basic		$	0.10		$	0.18		$	0.33		$	0.59
Number of common shares used in the calculation		93,643			92,721			93,459			92,703
Income per common share – diluted		$	0.10		$	0.18		$	0.33		$	0.59
Number of common shares used in the calculation		94,172			93,154			94,152			93,177
Dividends per common share declared		$	0.07		$	0.07		$	0.21		$	0.21

 

See notes to condensed consolidated financial statements.

 

2

 

HEARST-ARGYLE TELEVISION, INC.

 

Condensed Consolidated Statements of Cash Flows

 

		Nine Months Ended September 30,
		2007			2006
		(Unaudited)
		(In thousands)
Operating Activities
Net income		$	31,012		$	54,577
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		37,282			41,505
Amortization of intangible assets		5,210			4,598
Amortization of deferred financing costs		1,345			1,453
Amortization of program rights		57,329			49,034
Deferred income taxes		9,653			10,587
Equity in loss (income) of affiliates, net		1,564			(102		)
Provision for (benefit from) doubtful accounts		1,081			(593		)
Stock-based compensation expense		6,180			5,764
Investment write-off		—			2,501
(Gain) or loss on disposition of assets		(4		)	(812		)
Program payments		(55,044		)	(48,816		)
Changes in operating assets and liabilities:
Decrease (increase) in Accounts receivable		6,718			13,208
Decrease (increase) in Other assets		9			7,925
(Decrease) increase in Accounts payable and accrued liabilities		(28,851		)	4,090
(Decrease) increase in Other liabilities		13,248			9,363
Net cash provided by operating activities		86,732			154,282
Investing Activities
Purchases of property, plant and equipment, net		(42,103		)	(38,288		)
Acquisition of WKCF-TV		—			(217,385		)
Cash proceeds from insurance recoveries		1,000			1,594
Investment in affiliates and other, net		(1,874		)	(10,681		)
Net cash used in investing activities		(42,977		)	(264,760		)
Financing Activities
Borrowings on credit facility		—			100,000
Dividends paid on common stock		(19,640		)	(19,464		)
Series A Common Stock repurchases		(2,270		)	(2,780		)
Principal payments and repurchase of long term debt		(12		)	(10,035		)
Proceeds from employee stock purchase plan and stock option exercises		15,125			3,496
Net cash (used in) provided by financing activities		(6,797		)	71,217
Increase (decrease) in cash and cash equivalents		36,958			(39,261		)
Cash and cash equivalents at beginning of period		18,610			120,065
Cash and cash equivalents at end of period		$	55,568		$	80,804

 

See notes to condensed consolidated financial statements.

 

3

 

		Nine Months Ended September 30,
		2007			2006
		(Unaudited)
		(In thousands)
Supplemental Cash Flow Information:
Business acquired in purchase transaction:
Acquisition of WKCF-TV:
Fair market value of assets acquired		$	—		$	244,072
Fair market value of liabilities assumed		$	—		$	(26,687	)
Net cash paid for WKCF-TV		$	—		$	217,385
Cash paid during the period for:
Interest		$	37,911		$	37,745
Interest on Note payable to Capital Trust		$	4,875		$	7,313
Taxes, net of refunds		$	34,963		$	26,656
Non-cash investing and financing activities:
Accrued property, plant & equipment purchases		$	337		$	7,645

 

See notes to condensed consolidated financial statements.

 

4

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

1.              Basis of Presentation

 

The condensed consolidated financial statements include the accounts of Hearst-Argyle Television, Inc. and its wholly-owned subsidiaries (the “Company” or “we” or “us” or “our”), except for the Company’s wholly-owned subsidiary trust (the “Capital Trust”) which cannot be consolidated under the Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN 46(R)”).  With the exception of the unconsolidated subsidiary trust, all significant intercompany accounts have been eliminated in consolidation.

 

The accompanying unaudited condensed consolidated financial statements do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements and should be read in conjunction with the Company’s consolidated financial statements included in the Annual Report on our Form 10-K for the year ended December 31, 2006.  In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are normal and recurring in nature.  Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the full year.

 

2.              Recent Developments and Accounting Pronouncements

 

On August 24, 2007, Hearst Broadcasting, Inc. (“Hearst Broadcasting”), an indirect wholly-owned subsidiary of The Hearst Corporation (“Hearst”), announced its intentions to launch, and on September 14, 2007, launched, a tender offer to acquire the outstanding shares of the Company’s Series A Common Stock that it did not already own for $23.50 per share (the “Offer”).  On August 27, 2007, our Board of Directors appointed a special committee of directors unaffiliated with Hearst to consider the Offer (the “Special Committee”).  The Special Committee engaged a financial advisor to advise it with respect to the Offer.  On September 27, 2007, the Special Committee determined that the Offer was inadequate and recommended that the Company’s shareholders reject the Offer.  On October 12, 2007, the Offer expired and Hearst announced that it would return to shareholders all of the shares that were tendered in the Offer.  For the three months ended September 30, 2007, the Company recognized approximately $3.6 million of expense related to the Offer.

 

On August 31, 2006, the Company purchased the assets related to broadcast television station WKCF-TV, a CW affiliate in Orlando, Florida.  The pro-forma results of operations and related per share information have not been presented as the amounts are considered immaterial.

 

In 2006 Sprint Nextel Corporation (“Nextel”) was granted the right from the FCC to reclaim from broadcasters in each market across the country the 1.9 GHz spectrum to use for an emergency communications system.  In order to reclaim this signal, Nextel must replace all analog equipment currently using this spectrum with digital equipment.  All broadcasters have agreed to use the digital substitute that Nextel will provide.  The transition will be completed on a market-by-market basis.  As the equipment is exchanged and put into service in each of our markets beginning in the fourth quarter of 2007, we expect to record gains to the extent that the fair market value of the equipment we receive exceeds the book value of the analog equipment we exchange.

 

In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS 159 on its financial position, cash flows, and results of operations.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which applies whenever other standards require (or permit) assets or liabilities to be measured at fair value.  SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop the assumptions that market participants would use when pricing an asset or liability.  SFAS 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We do not believe the adoption of SFAS 157 will have a material impact on our financial position, cash flows or results of operations.

 

5

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS 158”), which requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements.  It requires employers to recognize an asset or liability for a plan’s overfunded or underfunded status, measure a plan’s assets and obligations that determine its funded status as of the end of the employer’s fiscal year and recognize in comprehensive income changes in the funded status of a defined benefit postretirement plan in the year in which changes occur.  The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective for fiscal years ending after December 15, 2006.  We have adopted the requirement to recognize the funded status of a benefit plan as of December 31, 2006.  As a result, Accumulated other comprehensive loss increased by $26.4 million, net of tax, as of December 31, 2006.  Additionally, the requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year end is effective for all years ending after December 15, 2008.

 

In June 2006, the FASB issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”).  FIN 48 clarifies the accounting for uncertain tax positions by prescribing a minimum recognition threshold for recognition of tax benefits in the financial statements. FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of applying FIN 48, the amount of benefit recognized in the financial statements may differ from the amount taken or expected to be taken in a tax return. These differences are referred to as unrecognized tax benefits and represent financial statement liabilities. In the event unrecognized tax positions are ultimately allowed (for example, when the matter is settled with taxing authorities or statutes of limitations expire), the benefit is recognized, generally resulting in a reduction of tax expense in the period of recognition.   The adoption of FIN 48 on January 1, 2007 resulted in a decrease to Retained earnings of $11.3 million, a decrease in Deferred income tax liability of $15.8 million and an increase to Other liabilities of $27.1 million.  See Note 7 for further discussion regarding the adoption of FIN 48.

 

3.              Stock-Based Compensation

 

Stock-based compensation expense for the three and nine months ended September 30, 2007 was $2.1 million and $6.2 million, respectively, as compared to $1.9 million and $5.8 million in the three and nine months ended September 30, 2006, respectively.   The total deferred tax benefit related thereto was $0.8 million and $2.4 million for the three and nine months ended September 30, 2007, respectively, and $0.7 million and $2.3 million for the three and nine months ended September 30, 2006, respectively.  As of September 30, 2007, there was $10.3 million of total unrecognized compensation cost related to unvested share-based compensation awards granted under the equity compensation plans, which does not include the effect of future grants of equity compensation, if any.  Of the total $10.3 million, we expect to recognize approximately 17.9% in the remaining interim periods of 2007, 55.7% in 2008 and 26.4% in 2009.

 

4.              Long-Term Debt

 

Long-term debt as of September 30, 2007 and December 31, 2006 consisted of the following:

 

		September 30, 2007			December 31, 2006
		(Unaudited)
Revolving credit facility		$	100,000		$	100,000
Senior notes		407,110			407,110
Private placement debt		360,000			360,000
Capital lease obligations		28			60
Total debt		867,138			867,170
Less: Current maturities		(90,028		)	(90,048		)
Total long-term debt		$	777,110		$	777,122

 

The Company has the ability and intent to refinance its $125.0 million 7% senior notes due November 15, 2007 under its existing credit facility and therefore has continued to classify the debt as a long-term obligation.

 

6

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

5.              Earnings Per Share

 

The calculation of basic earnings per share (“EPS”) for each period is based on the weighted average number of common shares outstanding during the period.  The calculation of dilutive EPS for each period is based on the weighted average number of common shares outstanding during the period, including restricted stock issued to date, plus the effect, if any, from the assumed exercise of stock options and conversion of Redeemable Convertible Preferred Securities.  The following table sets forth a reconciliation between basic EPS and diluted EPS, in accordance with SFAS No. 128, Earnings Per Share:

 

		Three months ended September 30,						Nine months ended September 30,
		2007			2006			2007			2006
		(Unaudited)
Net income (Basic and Diluted)		$	9,741		$	16,543		$	31,012		$	54,777
Basic shares		93,643			92,721			93,459			92,703
Basic EPS		$	0.10		$	0.18		$	0.33		$	0.59
Diluted shares		94,172			93,154			94,152			93,177
Diluted EPS		$	0.10		$	0.18		$	0.33		$	0.59
Basic shares		93,643			92,721			93,459			92,703
Add: Shares issued upon assumed exercise of stock options		529			433			693			474
Diluted shares		94,172			93,154			94,152			93,177

 

The dilution test for the Redeemable Convertible Preferred Securities related to the Capital Trust is performed for all periods. This test considers only the total number of shares that could be issued if converted and does not consider either the conversion price or the share price of the underlying common shares. For the three and nine months ended September 30, 2007 and 2006, 5,128,205 shares of Series A Common Stock to be issued upon the conversion of 2,600,000 shares of Series B 7.5% Redeemable Convertible Preferred Securities are not included in the number of common shares used in the calculation of diluted EPS because to do so would have been anti-dilutive. When the securities related to the Capital Trust are dilutive, the interest, net of tax, related to the Capital Trust is added back to Net income for purposes of the diluted EPS calculation.

 

Options to purchase 5,595,522 and 6,003,133 shares of Series A Common Stock (before application of the treasury stock method), for the three months ended September 30, 2007 and 2006, respectively, were not included in the computation of diluted EPS because the exercise price was greater than the average market price of $23.34 and $21.92, respectively.

 

Options to purchase 3,422,872 and 5,984,133 shares of Series A Common Stock (before application of the treasury stock method), for the nine months ended September 30, 2007 and 2006, respectively, were not included in the computation of diluted EPS because the exercise price was greater than the average market price of $25.18 and $22.75, respectively.

 

7

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

6.              Goodwill and Intangible Assets

 

		September 30, 2007			December 31, 2006
		(Unaudited)
Total intangible assets subject to amortization, net		$	101,573		$	106,783
Intangible assets not subject to amortization – FCC licenses		2,413,257			2,413,257
Total intangible assets, net		$	2,514,830		$	2,520,040
Goodwill		$	816,728		$	816,724

 

Summarized below are the carrying values of intangible assets subject to amortization as of September 30, 2007 and December 31, 2006:

 

		September 30, 2007									December 31, 2006
		(Unaudited)
		Gross						Net			Gross						Net
		Carrying			Accumulated			Carrying			Carrying			Accumulated			Carrying
		Value			Amortization			Value			Value			Amortization			Value
Intangible assets subject to amortization:
Advertiser client base		$	124,035		$	77,360		$	46,675		$	124,035		$	73,967		$	50,068
Network affiliations		95,493			40,673			54,820			95,493			38,880			56,613
Other		743			665			78			743			641			102
Total intangible assets subject to amortization		$	220,271		$	118,698		$	101,573		$	220,271		$	113,488		$	106,783

 

The Company’s amortization expense for intangible assets was approximately $1.7 million and $5.2 million for the three and nine months ended September 30, 2007, respectively, and $1.6 million and $4.6 million for the three and nine months ended September 30, 2006, respectively.  Annual intangible asset amortization expense is estimated to be approximately $6.8 million in 2007 and $6.0 million in each of the next four years.

 

7.              Income Taxes

 

The income tax expense for the three and nine months ended September 30, 2007 was $2.1 million and $18.7 million, respectively, as compared to $9.5 million and $30.8 million for the three and nine months ended September 30, 2006, respectively.

 

The effective tax rate for the three and nine months ended September 30, 2007 was 17.0% and 36.4%, respectively, as compared to 36.6% and 36.1% for the three and nine months ended September 30, 2006, respectively.

 

On January 1, 2007, the Company adopted FIN 48 which clarifies the accounting for uncertain tax provisions by prescribing a minimum recognition threshold for recognition of tax benefits in the financial statements.  At the date of adoption, the total amount of unrecognized tax benefits was $35.4 million, and the associated interest and penalties were $8.6 million.    If recognized, these amounts (net of tax impact) would favorably affect the effective income tax rate in future periods.  The adopted provisions of FIN 48 will result in a certain amount of variability in the effective tax rate in interim periods due to the Company’s recording of associated interest expense, which is classified as a component of income taxes, as period costs.  Additionally, the Company’s effective income tax rate in a given financial statement period may be materially impacted by 1) changes in the level of earnings by taxing jurisdiction; 2) changes in the expected outcome of tax examinations; 3) the normal expiration of statutes of limitations; or 4) the amount of deductions or changes in the deferred tax valuation allowance.

 

The amount of unrecognized tax benefits is expected, on a net basis, to decrease within 12 months of the reporting date due to scheduled closings of examinations and normal expirations of statutes of limitations.

 

8

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

8.              Common Stock

 

Common Stock Repurchase

 

In May 1998, the Company’s Board of Directors authorized the repurchase of up to $300 million of its outstanding Series A Common Stock.  Such repurchases may be effected from time to time in the open market or in private transactions, subject to market conditions and management’s discretion. During the nine months ended September 30, 2007, the Company repurchased 109,100 shares of its outstanding Series A Common Stock for $2.3 million and an average price of $20.81. Between May 1998 and September 30, 2007, the Company repurchased approximately 4.6 million shares of Series A Common Stock at a cost of approximately $113.1 million and an average price of $24.78.  There can be no assurance that such repurchases will occur in the future or, if they do occur, what the terms of such repurchases will be.

 

Hearst and Hearst Broadcasting are authorized by the Hearst Board of Directors to purchase up to 25 million shares of the Company’s Series A Common Stock from time to time in the open market, in private transactions or otherwise.  During the nine months ended September 30, 2007, Hearst Broadcasting did not purchase any shares of Series A Common Stock.  Between December 2000 (the date of Hearst's first purchase authorization) and September 30, 2007,  Hearst purchased approximately 23.8 million shares of the Company’s outstanding Series A Common Stock.

 

As of September 30, 2007 and December 31, 2006, Hearst owned 73.4% and 73.8%, respectively, of the Company’s outstanding common stock.

 

Common Stock Dividends

 

During the nine months ended September 30, 2007, the Company’s Board of Directors declared a cash dividend on shares of our Series A and Series B Common Stock as follows:

 

Dividend Amount			Declaration Date		Record Date		Payment Date		Total Dividend
$	0.07		September 12, 2007		October 5, 2007		October 15, 2007		$	6,566
$	0.07		May 3, 2007		July 5, 2007		July 15, 2007		$	6,570
$	0.07		March 29, 2007		April 5, 2007		April 15, 2007		$	6,546

 

9.              Related Party Transactions

 

Hearst.    As of September 30, 2007, Hearst owned approximately 52.4% of our Series A Common Stock and 100% of our Series B Common Stock, representing in the aggregate approximately 73.4% of both the economic interest and outstanding voting power of our common stock, except with regard to the election of directors.  With regard to the election of directors, Hearst’s ownership of our Series B Common Stock entitles Hearst to elect 11 of 13 members of our Board of Directors. During the three and nine months ended September 30, 2007 and 2006, we were engaged in the following transactions with Hearst or parties related to Hearst:

 

•                Hearst Tower Lease.   On May 5, 2006 the Company entered into a Lease Agreement with Hearst to lease one floor of the newly constructed Hearst Tower in Manhattan for our corporate offices.  For the three and nine months ended September 30, 2007, we recorded $0.4 million and $1.2 million in rent expense, net of a portion of the $1.9 million tenant improvement allowance, which the Company is amortizing over the lease term.

 

•                Management Agreement.   We recorded revenue of approximately $1.1 million and $4.3 million in the three and nine months ended September 30, 2007, respectively, and $1.7 million and $4.7 million in the three and nine months ended September 30, 2006, respectively, relating to a management agreement with Hearst (the “Management Agreement”). Pursuant to the Management Agreement, we provide certain sales, news, programming, legal, financial, engineering and accounting management services for certain Hearst-owned television and radio stations.  Certain employees of these managed stations are also participants in our equity compensation plans.  We believe the terms of the Management Agreement are reasonable to both parties; however, there can be no assurance that more favorable terms would not be available from third parties.

 

9

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

•                Services Agreement.    We incurred expenses of approximately $1.6 million and $5.0 million in the three and nine months ended September 30, 2007, respectively, and $1.8 million and $4.4 million in the three and nine months ended September 30, 2006, respectively, relating to a services agreement with Hearst (the “Services Agreement”). Pursuant to the Services Agreement, Hearst provides the Company certain administrative services such as accounting, auditing, financial, legal, insurance, data processing, and employee benefits administration. We believe the terms of the Services Agreement are reasonable to both parties; however, there can be no assurance that more favorable terms would not be available from third parties.

 

•                Interest Expense, Net – Capital Trust.  We incurred interest expense, net, related to the Subordinated Debentures issued to our wholly-owned unconsolidated subsidiary, the Capital Trust, of $2.4 million and $7.3 million for each of the three and nine months ended September 30, 2007 and 2006.  The Capital Trust then paid comparable amounts to its Redeemable Convertible Preferred Securities holders, including Hearst, which received $0.5 million and $1.5 million during the three and nine months ended September 30, 2007.

 

•                Dividends on Common Stock.    During the nine months ended September 30, 2007 and 2006, we paid the following dividends to Hearst:

 

Dividend Amount			Payment Date		Total Dividend			Hearst Portion
$	0.07		July 15, 2007		$	6,570		$	4,816
$	0.07		April 15, 2007		$	6,546		$	4,816
$	0.07		January 15, 2007		$	6,523		$	4,816
$	0.07		July 15, 2006		$	6,493		$	4,768
$	0.07		April 15, 2006		$	6,485		$	4,636
$	0.07		January 15, 2006		$	6,486		$	4,575

 

•                Radio Facilities Lease.    Pursuant to a lease agreement, Hearst paid us approximately $0.2 million and $0.6 million for each of the three and nine months ended September 30, 2007 and 2006. Under this agreement, Hearst leases from the Company premises for WBAL-AM and WIYY-FM, Hearst’s Baltimore, Maryland radio stations.

 

•                Retransmission Consent Agency Agreement.    We have agreements with Lifetime Entertainment Services (“Lifetime”), an entity owned 50% by an affiliate of Hearst and 50% by The Walt Disney Company, whereby (i) we assist Lifetime in securing distribution and subscribers for the Lifetime Television, Lifetime Movie Network and/or Lifetime Real Women programming services; and (ii) Lifetime acts as our agent with respect to the negotiation of certain of our agreements with cable, satellite and certain other multi-channel video programming distributors.  Amounts payable to us by Lifetime depend on the specific terms of these agreements and may be fixed or variable.  We recorded revenue from the agreements of $5.3 million and $15.6 million in the three and nine months ended September 30, 2007, respectively, and $4.7 million and $13.3 million in the three and nine months ended September 30, 2006, respectively.

 

•                Wide Orbit, Inc.  In November 2004, we entered into an agreement to license from Wide Orbit, Inc. (“Wide Orbit”) traffic sales and billing solutions software.  Hearst owns approximately 8% of Wide Orbit.  For the three and nine months ended September 30, 2007, we paid Wide Orbit approximately $0.4 million and $1.2 million, respectively, and for the three and nine months ended September 30, 2006, we paid $0.3 and $0.9 million, respectively, under the agreement.

 

•                  New England Cable News.  Two of our executive officers, David J. Barrett and Steven A. Hobbs, serve as Hearst’s representatives on the management board of New England Cable News, a regional cable channel, jointly owned by Hearst Cable News, Inc., an indirect wholly-owned subsidiary of Hearst, and Comcast MO Cable News, Inc. (NECN).  Hearst pays $4,000 per month to the Company as compensation for their service.  In addition, two of our television stations, WPTZ/WNNE and WMTW, provide office space to certain of NECN’s reporters in exchange for news gathering services.

 

10

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

•                Other Transactions with Hearst.    In the three and nine months ended September 30, 2007 and 2006, we recorded immaterial net revenue relating to advertising sales from Hearst.

 

Internet Broadcasting Systems, Inc.    As of September 30, 2007, we owned 36.1% of Internet Broadcasting Systems, Inc. (“Internet Broadcasting”).  We also have various agreements pursuant to which we have paid Internet Broadcasting $3.5 million and $8.7 million during the three and nine months ended September 30, 2007, respectively, and $2.0 million and $6.0 million during the three and nine months ended September 30, 2006, respectively.  In addition, Internet Broadcasting hosts our corporate Website for a nominal amount.  Harry T. Hawks, Terry Mackin and Steven A. Hobbs, three of our executive officers, serve on the Board of Directors of Internet Broadcasting, from which they do not receive compensation for their services.

 

Small Business Television.   The Company utilizes services of Small Business Television and related companies (“SBTV”) to provide television stations with additional revenue through the marketing and sale of commercial time to smaller businesses that do not traditionally use television advertising due to cost concerns. In the three and nine month periods ended September 30, 2007, these sales generated revenue of approximately $0.3 million and $1.0 million, respectively, of which approximately $0.1 million and $0.5 million, respectively, was distributed to SBTV. In the three and nine month periods ended September 30, 2006, these sales generated revenue of approximately $0.3 million and $1.1 million, respectively, of which approximately $0.1 million and $0.5 million, respectively, was distributed to SBTV. Dean Conomikes, the owner of SBTV, is the son of John G. Conomikes, a member of the Company’s Board of Directors.

 

NBC Weather Plus.  In 2004, we invested in Weather Network Affiliates Company, LLC (“WNAC”), which owns the NBC Weather Plus Network (“Weather Plus”).  We have launched Weather Plus in all of our NBC-affiliated markets.  Terry Mackin, one of our executive officers, serves as the past Chairman of the Board of the NBC Television Affiliates Association, the managing member and the owner of certain ownership interests in WNAC.  As past NBC Affiliate Chairman, Mr. Mackin serves as chairman of the NBC Affiliates “Futures” committee, which is responsible for developing strategic projects between NBC and the NBC Affiliates.  Mr. Mackin served as the Chairman of the NBC Television Affiliates Association Board from May 2004 to May 2006.  Additionally, since May 2006, Mr. Mackin has served as a member of the Board of Directors of NBC Weather Plus Network LLC.  Mr. Mackin does not receive compensation for his Board service.

 

Ripe TV. On June 29, 2007, the Company made an additional investment of $1.9 million in Ripe Digital Entertainment, Inc. (“Ripe TV”), resulting in a total investment of $11.0 million which represents a 24.7% ownership interest.  In the fourth quarter of 2006 the Company entered into a lease agreement with Ripe TV to sublet office space commencing January 1, 2007, for approximately $0.1 million a year.   Two of our executive officers, Steven A. Hobbs and Terry Mackin, serve on the Board of Directors of Ripe TV, from which they do not receive compensation for their Board service.

 

USDTV.  During the year ended December 31, 2006, we and Hearst each owned approximately 6.175% of USDTV.  In addition, our station KOAT-TV in Albuquerque, New Mexico, had an agreement to lease a portion of its digital spectrum to USDTV which the Company terminated effective April 15, 2007.  In July 2006, USDTV filed for Chapter 7 bankruptcy and the Company wrote off its investment of $2.5 million and included the write-off in Other expense in the accompanying condensed consolidated statements of income.  In September 2006, USDTV sold substantially all its assets to a third party.  From September 23, 2005 to June 20, 2006, Steven A. Hobbs, one of our executive officers, served on the Board of Directors of USDTV, from which he did not receive compensation for his Board service.

 

Other.    In the ordinary course of business, the Company enters into transactions with related parties, none of which were significant to our financial results in the nine months ended September 30, 2007 and 2006.

 

10.       Retirement Plans and Other Post-Retirement Benefits

 

Overview

 

The Company maintains seven defined benefit pension plans (the “Pension Plans”) and other post-retirement benefit plans (medical and life insurance) for active, retired and former employees.  In addition, the Company maintains

 

11

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

11 employee savings plans and participates in three multi-employer union pension plans that provide retirement benefits to certain union employees.

 

Pension Plans and Other Post-Retirement Benefits

 

Benefits under the Pension Plans are generally based on years of credited service, age at retirement and average of the highest five consecutive years’ compensation. The service cost of the Pension Plans is computed on the basis of the Project Unit Credit Actuarial Cost Method.  Prior service cost is amortized over the employees’ expected future service periods.

 

Net Periodic Pension and Post-Retirement Benefit Cost

 

The following schedule presents net periodic pension cost for the Company’s Pension Plans in the three and nine months ended September 30, 2007 and 2006:

 

		Pension Benefits						Pension Benefits
		Three Months Ended September 30,						Nine Months Ended September 30,
		2007			2006			2007			2006
		(Unaudited)						(Unaudited)
Service cost		$	2,645		$	2,496		$	7,935		$	7,488
Interest cost		2,700			2,355			8,100			7,065
Expected return on plan assets		(2,911		)	(2,779		)	(8,733		)	(8,337		)
Amortization of prior service cost		108			108			324			324
Amortization of transitional obligation		—			—			—			1
Amortization of net loss		924			967			2,772			2,901
Net periodic pension cost		$	3,466		$	3,147		$	10,398		$	9,442

 

The following schedule presents net periodic benefit cost for the Company’s other post-retirement benefit plans in the three and nine months ended September 30, 2007 and 2006:

 

		Post-Retirement Benefits						Post-Retirement Benefits
		Three Months Ended September 30,						Nine Months Ended September 30,
		2007			2006			2007			2006
		(Unaudited)						(Unaudited)
Service cost		$	41		$	29		$	123		$	88
Interest cost		175			122			525			366
Amortization of prior service cost		10			7			30			21
Amortization of initial net obligation		10			7			30			21
Amortization of net loss		9			6			27			18
Net periodic benefit cost		$	245		$	171		$	735		$	514

 

Contributions

 

During the three and nine months ended September 30, 2007, we contributed $2.6 million and $4.1 million, respectively, to our Pension Plans and $0.2 million and $0.5 million to our post-retirement benefit plans, respectively.  During the three and nine months ended September 30, 2006, we did not make any contributions to our Pension Plans and we contributed approximately $0.2 million and $0.6 million, respectively, to our post-retirement benefit plans.  During the year ending December 31, 2007, the Company expects to contribute $5.6 million to the Pension Plans and expects to contribute approximately $0.6 million to the post-retirement benefit plans.

 

12

 

Hearst-Argyle Television, Inc.

Notes to Condensed Consolidated Financial Statements

Tabular amounts in thousands, except per share data

 

 

11.       Other Commitments and Contingencies

 

Guarantees

 

The Company has guaranteed the payments by its Capital Trust on the Redeemable Convertible Preferred Securities in the amount of $134 million.  The guarantee is irrevocable and unconditional, and guarantees the payment in full of all (i) distributions on the Redeemable Convertible Preferred Securities to the extent of available funds of the Capital Trust; (ii) amounts payable upon redemption of the Redeemable Convertible Preferred Securities to the extent of available funds of the Capital Trust; and (iii) amounts payable upon dissolution of the Capital Trust.  The guarantee is unsecured and ranks (i) subordinate to all other liabilities of the Company, except liabilities that are expressly made pari passu; (ii) pari passu with the most senior preferred stock issued by the Company, and pari passu with any guarantee of the Company in respect of any preferred stock of the Company or any preferred security of any of the Company’s controlled affiliates; and (iii) senior to the Company’s Common Stock.

 

Legal Matters

 

Beginning on August 27, 2007, four putative class actions were filed in New York State Supreme Court and, beginning on September 4, 2007, five putative class actions were filed in Delaware State Chancery Court, in response to the announcement on August 24, 2007 by Hearst Broadcasting that it intended to launch a cash tender offer to acquire the outstanding shares of the Company’s Series A Common Stock that it did not already own for $23.50 per share.

 

On September 7, 2007, the New York actions were consolidated under the caption In re Hearst-Argyle Television, Inc. Shareholder Litigation, Index No. 07-602881, and, on September 20, 2007, the New York plaintiffs filed a consolidated amended complaint (the “New York Consolidated Amended Complaint”), purportedly on behalf of all holders of the Company’s Series A common stock.  On September 19, 2007, the Delaware plaintiffs in three of the Delaware actions filed a consolidated amended class action complaint (the “Delaware Consolidated Amended Complaint”), purportedly on behalf of all public stockholders of the Company.  On September 24, 2007, those three Delaware actions were consolidated with the remaining Delaware actions under the caption In re Hearst-Argyle Television, Inc. Shareholder Litigation, Civ. A. No. 3205-CC, with the Delaware Consolidated Amended Complaint becoming the operative complaint.

 

The New York Consolidated Amended Complaint and Delaware Consolidated Amended Complaint (together, the “Consolidated Amended Complaints”) each named the Company and members of its Board of Directors, as well as Hearst and certain of its affiliates, as defendants and alleged, among other things, that the Offer price was inadequate and unfair to the Company’s shareholders and purported to state claims for, among other things, breach of fiduciary duty in connection with the Offer.  The Consolidated Amended Complaints sought orders enjoining the consummation of the Offer, as well as reasonable attorneys’ fees and costs and other equitable relief.  The Delaware Consolidated Amended Complaint also sought damages in an unspecified amount.   On October 12, 2007, Hearst announced that the Offer had expired, without Hearst having purchased any shares in the Offer.  Subsequently, plaintiffs’ counsel in New York and Delaware agreed that the defendants, including the Company, did not need to file responses to the Consolidated Amended Complaints and informed defendants that they intended to file motions to voluntarily dismiss the actions without prejudice.  The Delaware actions were dismissed on November 6, 2007.

 

We believe that these matters will not have a materially adverse effect on our financial condition.

 

13

 

Item 2.                 Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Organization of Information

 

Management’s Discussion and Analysis provides a narrative on our financial performance and condition that should be read in conjunction with the accompanying condensed consolidated financial statements.  It includes the following sections:

 

•                  Forward-Looking Statements

•                  Executive Summary

•                  Results of Operations

•                  Liquidity and Capital Resources

 

Forward-Looking Statements

 

This report includes or incorporates forward-looking statements.  We base these forward-looking statements on our current expectations and projections about future events.  These forward-looking statements generally can be identified by the use of statements that include phrases such as “anticipate”, “will”, “may”, “likely”, “plan”, “believe”, “expect”, “intend”, “project”, “forecast” or other such similar words and/or phrases. For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.  The forward-looking statements contained in this report, concerning, among other things, trends and projections involving revenue, income, earnings, cash flow, liquidity, operating expenses, assets, liabilities, capital expenditures, dividends and capital structure, involve risks and uncertainties, and are subject to change based on various important factors.  Those factors include the impact on our operations from

 

•               Changes in Federal regulations that affect us, including changes in Federal communications laws or regulations;

 

•                  Local regulatory actions and conditions in the areas in which our stations operate;

 

•                  Competition in the broadcast television markets we serve;

 

•                  Our ability to obtain quality programming for our television stations;

 

•                  Successful integration of television stations we acquire;

 

•                  Pricing fluctuations in local and national advertising;

 

•                  Changes in national and regional economies;

 

•                  Our ability to service and refinance our outstanding debt;

 

•                  Changes in advertising trends and our advertisers’ financial condition; and

 

•                  Volatility in programming costs, industry consolidation, technological developments, and major world events.

 

For a discussion of additional risk factors that are particular to our business, please refer to the Risk Factors section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.  These and other matters we discuss in this report, or in the documents we incorporate by reference into this report, may cause actual results to differ from those we describe.  We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Executive Summary

 

Hearst-Argyle Television, Inc. and its subsidiaries (hereafter “we” or the “Company”) own and operate 26 network-affiliated television stations.  Additionally, we provide management services to two network-affiliated stations and one independent television station and two radio stations owned by The Hearst Corporation (“Hearst”) in exchange for management fees.  We are a leader in the convergence of local broadcast television and the Internet through our investment in, and operating agreement with, Internet Broadcasting, which operates a nation-wide network of television Websites.  Our stations’ Websites typically provide news, weather, community information, user-generated content and entertainment content to our audience.  Also, 16 of our stations broadcast additional channels on a multicast stream with their main digital channel. 

 

14

 

Trends and Highlights

 

•                  Political advertising decreases in odd-numbered years, such as 2007, consistent with the decrease in the number of candidates running for political office in the interim national election cycle, as well as select state and local elections. 

 

•                  Revenue from Olympic advertising occurs exclusively in even-numbered years, such as 2006, with the alternating Winter and Summer Games occurring every two years. Consequently, our 10 NBC stations aired the 2006 Winter Olympics in February 2006 and will not record any advertising revenue associated with the Olympics in 2007.

 

•                  The housing downturn has impacted the Company's largest markets and contributed to the slowdown in consumer purchases of autos, financial services and home furnishings, resulting in a reduction of advertising expenditures in these three important categories.

 

•                  Results for the three months ended September 30, 2007 reflect a $16.5 million decrease in net political advertising revenue resulting from the normal, cyclical nature of the television broadcasting business, partially offset by an increase in advertising revenue resulting from our acquisition of WKCF-TV on August 31, 2006.  Additionally, the results for the quarter ended September 30, 2007 reflect continued focus on digital media and the positive impact of retransmission consent revenue.

 

•                  On August 24, 2007, Hearst Broadcasting, Inc., an indirect wholly-owned subsidiary of Hearst, announced its intentions to launch, and on September 14, 2007, launched, a tender offer to acquire the outstanding shares of the Company’s Series A Common Stock that it did not already own (the “Offer”).  On October 12, 2007, the Offer expired and Hearst announced that it would return to shareholders all of the shares that were tendered in the Offer.  For the three months ended September 30, 2007, the Company recognized $3.6 million of expense related to the Offer.

 

Results of Operations

 

Results of operations for the three and nine months ended September 30, 2007 and 2006 include (i) the results of our 25 television stations, which were owned for the entire period presented, and the management fees derived by the three television and two radio stations managed by us for the entire period presented; (ii) the results of operations of WKCF-TV, after our acquisition of the station on August 31, 2006.

 

Three Months Ended September 30, 2007

Compared to Three Months Ended September 30, 2006

 

		For the three months ended September 30,
		2007			2006			$ Change			% Change
		(In thousands)
Total revenue		$	176,775		$	182,993		$	(6,218	)	-3.4	%
Station operating expenses:
Salaries, benefits and other operating costs		101,831			99,574			$	2,257		2.3	%
Amortization of program rights		18,679			17,751			$	928		5.2	%
Depreciation and amortization		13,310			14,634			$	(1,324	)	-9.0	%
Corporate, general and administrative expenses		12,534			7,868			$	4,666		59.3	%
Operating income		30,421			43,166			$	(12,745	)	-29.5	%
Interest expense		15,926			16,427			$	(501	)	-3.0	%
Interest income		(555		)	(1,736		)	$	1,181		-68.0	%
Interest expense, net – Capital Trust		2,438			2,438			$	—		0.0	%
Income before income taxes and equity earnings		12,612			26,037			$	(13,425	)	-51.6	%
Income tax expense		2,138			9,531			$	(7,393	)	-77.6	%
Equity in loss (income) of affiliates, net of tax		733			(37		)	$	770		-2081.1	%
Net income		$	9,741		$	16,543		$	(6,802	)	-41.1	%

 

15

 

Total revenue.    Total revenue includes:

 

(i)    cash advertising revenue, net of agency and national representatives’ commissions;

(ii)   retransmission consent revenue;

(iii)  net digital media revenue, which includes primarily Internet advertising revenue and, to a lesser extent, revenue from advertising on multicast weather channels;

(iv)  network compensation; and

(v)   other revenue, primarily barter and trade revenue and management fees earned from Hearst. 

 

		For the three months ended September 30,
		2007			2006			$ Change			% Change
		(In thousands)
Net local and national ad revenue (excluding political)		$	146,355		$	138,643		$	7,712		5.6	%
Net political revenue		6,960			23,429			(16,469		)	-70.3	%
Retransmission consent revenue		5,561			4,722			839			17.8	%
Net digital media revenue		5,246			3,677			1,569			42.7	%
Network compensation		2,144			2,610			(466		)	-17.9	%
Other revenue		10,509			9,912			597			6.0	%
Total revenue		$	176,775		$	182,993		$	(6,218	)	-3.4	%

 

Total revenue in the three months ended September 30, 2007 was $176.8 million as compared to $183.0 million in the three months ended September 30, 2006, a decrease of $6.2 million or 3.4%. This decrease was primarily attributable to the following factors:

 

(i)    a $16.5 million decrease in net political advertising revenue; and

(ii)   a decrease in the automotive, movies, and furniture and housewares categories; partially offset by

(iii)  an increase in net ad revenue due to the inclusion of results of operations from WKCF-TV;

(iv)  an increase in the telecommunications packaged goods and retail categories.

(v)   a $1.6 million increase in net digital media revenue; and

(vi)  a $0.8 million increase in retransmission consent revenue.

 

Salaries, benefits and other operating costs.    During the three months ended September 30, 2007, salaries, benefits and other operating costs were $101.8 million, as compared to $99.6 million in the three months ended September 30, 2006, an increase of $2.3 million or 2.3%.  This increase was primarily due to:

 

(i)    an increase in expenses due to the inclusion of the results of operations from WKCF-TV; and

(ii)   a $2.0 million increase in digital media expenses.

 

Amortization of program rights.  Amortization of program rights was $18.7 million in the three months ended September 30, 2007, as compared to $17.8 million in the three months ended September 30, 2006, an increase of $0.9 million or 5.1%. This increase was primarily due to an increase in amortization due to the purchase of WKCF-TV.  Programming expense is a more significant component of operating expense for WKCF-TV because the CW network provides fewer hours of programming than ABC, NBC or CBS.

 

Depreciation and amortization.   Depreciation and amortization expense was $13.3 million in the three months ended September 30, 2007, as compared to $14.6 million in the three months ended September 30, 2006, a decrease of $1.3 million or 8.9%. Depreciation expense was $11.6 million in the three months ended September 30, 2007, as compared to $13.0 million in the three months ended September 30, 2006, a decrease of $1.4 million or 10.8%.  The decrease in depreciation expense is primarily due to depreciation in full of certain fixed assets, partially offset by additional depreciation from WKCF-TV. 

 

Corporate, general and administrative expenses.    Corporate, general and administrative expenses were $12.5 million in the three months ended September 30, 2007, as compared to $7.9 million in the three months ended September 30, 2006, an increase of $4.7 million or 59.5%. This increase was primarily due to:

 

(i)    $3.6 million in legal and investment banking expenses related to the Offer;

(ii)   a $0.6 million increase in employee costs and related benefits; and

(iii)  a $0.4 million increase in recruitment and relocation costs.

 

16