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MORRIS PUBLISHING GROUP LLC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements as of and for the three-month and six-month periods ended June 30, 2011 and 2010 and with our consolidated financial statements as of December 31, 2010 and 2009 and for each of three years in the period ended December 31, 2010, filed on Form 10-K with the United States Securities and Exchange Commission ("SEC"). Information availability Our quarterly reports on Form 10-Q, annual reports on Form 10-K, current reports on Form 8-K and all amendments to those reports are available free of charge on our Web site, www.morris.com, as soon as feasible after such reports are electronically filed with or furnished to the SEC. In addition, information regarding corporate governance at Morris Publishing Group, LLC ("Morris Publishing", "we", "our") and our affiliate, Morris Communications Company, LLC ("Morris Communications"), is also available on this Web site. The information on our Web site is not incorporated by reference into, or as part of, the Report on Form 10-Q filed with the SEC. Critical accounting policies and estimates Critical accounting policies are those that are most significant to the portrayal of our financial position and results of operations and require difficult, subjective and complex judgments by management in order to make estimates about the effect of matters that are inherently uncertain. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts in our condensed consolidated financial statements. We evaluate our estimates on an on-going basis, including those related to our allowances for bad debts, asset impairments, self-insurance and casualty, management fees, income taxes and commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Although actual results have historically been reasonably consistent with management's expectations, the actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions. We believe there have been no significant changes during the six months ended June 30, 2011 to the items that we disclosed as our critical accounting policies and estimates herein and in the Management's Discussion and Analysis of Financial Condition and Results of Operations in our annual report dated December 31, 2010 filed on Form 10-K filed with the SEC. Cost allocations-In this report certain expenses, assets and liabilities of Morris Communications have been allocated to us. These allocations were based on estimates of the proportion of corporate expenses, assets and liabilities related to us, utilizing such factors as revenues, number of employees, salaries and wages expenses, and other applicable factors. The costs of these services charged to us may not reflect the actual costs we would have incurred for similar services as a stand-alone company. Morris Publishing and Morris Communications have executed various agreements with respect to the allocation of assets, liabilities and costs. Prior to March 1, 2010: The management fee was the greater of 4.0% of our annual total operating revenues or the amount of actual expenses allocable to the management of our business by Morris Communications (such allocations to be based upon time and resources spent on the management of our business by Morris Communications).The technology and shared services fee was based on the lesser of 2.5% of our total net operating revenue or the actual technology costs allocated to us based upon usage. -19--------------------------------------------------------------------------------- Table of Contents March 1, 2010 through September 6, 2011: On January 6, 2010, we entered into the "Fourth Amendment to Management and Services Agreement", effective March 1, 2010 , which changed the fees payable by Morris Publishing to an allocation of the actual amount of costs of providing the services, but the fees shall not exceed $22.0 million in any calendar year. Subsequent to September 6, 2011: · Subsequent event: On July 7, 2011, we entered into a Master Services Agreement (the "NIIT MSA") with NIIT Media Technologies, LLC, a Delaware limited liability company ("NIIT Media"), where NIIT Media will provide services to Morris Publishing and Morris Communications that relate to, among other things, technology, back office and shared services, and advertisement production. Many of the services to be provided by NIIT Media have historically been performed by Morris Publishing's affiliate and Morris Communications' subsidiary, MStar Solutions, LLC ("MStar"), under the Management and Services Agreement with Morris Communications and MStar (the "Morris Communications Services Agreement"). MStar contributed substantially all of its assets to NIIT Media in return for a 40% membership interest in NIIT Media. By entering into the NIIT MSA, Morris Publishing expects to reduce its costs of operations and services, while maintaining or improving the quality, function, efficiency and accountability of the services. Morris Communications will also receive similar services from NIIT Media under the NIIT MSA. Morris Publishing and Morris Communications are each and jointly a "Customer" to the NIIT MSA with NIIT Media being the sole "Provider." NIIT Media is controlled by NIIT Technologies, Inc. ("NIIT USA") by virtue of its 60% membership interest in NIIT Media. NIIT USA is a wholly-owned subsidiary of NIIT Technologies Limited, a global information technology services organization, headquartered in New Delhi, India. NIIT USA may become a party to the NIIT MSA if the Customer elects to have NIIT USA step in as the Provider in the event that NIIT Media dissolves, liquidates or files for bankruptcy. The NIIT MSA has a term of five years from July 7, 2011, and the Customer has the right to renew the agreement for an additional five-year term, subject to renegotiation of the charges in good faith. In addition, the NIIT MSA provides for automatic successive annual renewal terms if neither party chooses to terminate the agreement following the term. As with the renewal option, any annual automatic renewal will be subject to a good faith renegotiation of the charges. The Customer has the right to terminate the NIIT MSA for several reasons, including for convenience and without cause, but if terminated for convenience and without cause, the Customer will have to pay certain termination fees and wind-down costs to NIIT Media. The "NIIT MSA Services" to be provided are in the areas of technology services (such as asset control, cross-functional services, end user computing, help desk services, network administration, project management office, security administration, server and database management, systems application management and development and data processing), shared services (such as cross functional services, procure-to-pay, record-to-report, order-to-cash, strategic sourcing and category management, fixed assets, hire-to-retire, call center, and circulation) and advertising production (such as ad services, creative services and provider reporting). The parties may add additional new services and projects from time to time upon mutual agreement. The Provider may only perform the services from sites and facilities approved by the Customer, which approval shall not be unreasonably withheld or delayed. The Customer has approved the performance of the NIIT MSA Services from Augusta, Georgia and the National Capital Region of Delhi, India. The parties have agreed upon a transition plan for the transition and migration of the NIIT MSA Services to the Provider, which will include the migration of certain functions offshore to India. The NIIT MSA also provides for disengagement assistance to transition the NIIT MSA Services back to the Customer following termination of the agreement. -20--------------------------------------------------------------------------------- Table of Contents · Costs and cost allocations: The Provider will commence services on a "Commencement Date", which will be within 60 days after the July 7, 2011 effective date of the NIIT MSA. Following the first anniversary of the Commencement Date, the NIIT MSA provides for monthly charges to the Customer based on volume and types of services performed and a fee schedule to be agreed upon, provided that, so long as the current level of services required by Morris Communications and Morris Publishing do not change, the combined fees charged to Morris Publishing and Morris Communications will be subject to annual limits ranging from $16.1 million to $17.1 million during the remainder of the initial five-year term. During the first year following the Commencement Date, all services will be performed at a fixed fee of $19.3 million, to be allocated between Morris Publishing and Morris Communications based upon services received. Jointly, Morris Publishing and Morris Communications have agreed to exclusively procure the contemplated services from the Provider, and committed to minimum charge commitments totaling $55.3 million over the five years following the Commencement Date, with cumulative annual thresholds that must be met on each anniversary of the Commencement Date. Morris Publishing and Morris Communications will each be responsible to pay for the NIIT MSA Services provided to or related to their respective businesses (and their subsidiaries). On July 7, 2011, Morris Communications and Morris Publishing entered into a letter agreement (the "Letter Agreement"), acknowledged and accepted by NIIT Media, confirming that Morris Communications agrees to pay to the Provider, and to indemnify Morris Publishing, for any liabilities for NIIT MSA Services, or liabilities related to NIIT MSA Services, provided or attributable to Morris Communications or its subsidiaries or any affiliated entity, other than Morris Publishing and its subsidiaries. Similarly, Morris Publishing agreed to pay for any liabilities for services, or liabilities related to services, provided or attributable to Morris Publishing and its subsidiaries. The Fourth Amendment to Management and Services Agreement contains a limit of $22.0 million on the payments to be required by Morris Publishing for services under the Morris Communications Services Agreement in any calendar year. In order to maintain the benefit of this limit to Morris Publishing, the Letter Agreement also requires Morris Communications to indemnify Morris Publishing or pay the Provider for services, or liabilities related to services, provided or attributable to the Morris Publishing to the extent that payments for services during any calendar year would otherwise exceed $22.0 million for (i) services under the Morris Communications Services Agreement, plus (ii) NIIT MSA Services that were formerly provided under the Morris Communications Services Agreement. Under the Morris Communications Services Agreement, services were provided to Morris Publishing by both Morris Communications and MStar. Generally, under the NIIT MSA, NIIT Media is expected to provide substantially all of the services formerly provided by MStar under the Morris Communications Services Agreement, but Morris Communications is expected to continue services under the Morris Communications Services Agreement. Accordingly, on July 7, 2011, Morris Publishing, Morris Communications and MStar entered into the Fifth Amendment to Management and Services Agreement (the "Fifth Amendment"). The Fifth Amendment clarifies that services under the Fourth Amendment to Management and Services Agreement shall be suspended over time in phases to coincide with the provision of such services by NIIT Media under the NIIT MSA. Extinguishment of debt and original issue discount-On March 1, 2010 (the "Effective Date"), we restructured our debt through the consummation of a plan of reorganization confirmed by the U.S. Bankruptcy Court (the "Restructuring"), thereby reducing the total amount of our debt outstanding from $447.7 million, including accrued interest on the Original Notes (as described below), at December 31, 2009 to a face amount of approximately $107.2 million. The Restructuring consisted of the following transactions: The claims of the holders of the 7% Senior Subordinated Notes due 2013, dated as of August 7, 2003 (the "Original -21--------------------------------------------------------------------------------- Table of Contents Notes"), in an aggregate principal amount of $278.5 million, plus $35.4 million in accrued interest, were cancelled in exchange for the issuance of $100.0 million in aggregate stated principal amount of Floating Rate Secured Notes due 2014 (the "New Notes"). The Morris family, through their affiliated entities, made a non-cash capital contribution to Morris Publishing of $87.2 million and settled $24.9 million of intercompany indebtedness to us, resulting in the cancellation of $112.1 million (including accrued PIK interest) of the Tranche C senior secured debt outstanding under the Credit Agreement. We repaid from cash on hand, as required under the Indenture to the New Notes (the "New Indenture"), the entire $19.7 million principal amount of Tranche A senior secured debt, plus accrued interest and a $0.3 million prepayment fee, leaving only the $6.8 million (plus accrued PIK interest) Tranche B term loan remaining outstanding on the $136.5 million aggregate principal amount originally outstanding under the Credit Agreement. The Tranche B term loan became pari passu with the New Notes as of the Effective Date. The holders of the Original Notes were the only impaired class of creditors and there was no change in equity ownership interests as a result of the Restructuring. Under the accounting guidance for a debt extinguishment, the total maturities of the New Notes are recorded at fair value on the Effective Date of the Restructuring, and interest, as accrued on the aggregate stated principal amount outstanding New Notes, is recorded as an expense within the consolidated statements of operations. The excess of the stated aggregate principal amount of New Notes over fair value is original issue discount ("OID") and is accreted over the term of the New Notes. On March 1, 2010, the $100.0 million in aggregate principal amount outstanding on the New Notes was recorded at a fair value of $91.0 million (the average price of the corporate bond trades reported on or around the Effective Date), with the $9.0 million in OID being accreted as additional interest expense over the four and one-half year term of the New Notes. Income taxes-We are a single member limited liability company and are not subject to income taxes, with our results being included in the consolidated federal income tax return of our ultimate parent. However, we are required to provide for our portion of income taxes under a "Tax Consolidation Agreement" with our ultimate parent and other affiliated entities. Accordingly, we recognize an allocation of income taxes in our separate financial statements as if we filed a separate income tax return and remitted taxes for our current tax liability. On January 6, 2010, we entered into an Amended and Restated Tax Consolidation Agreement ("Amended Tax Agreement") with our parent entities, MPG Newspaper Holding, LLC ("MPG Holdings"), Shivers Trading & Operating Company ("Shivers"), and Questo, Inc. ("Questo"), and our affiliated entity, Morris Communications. The amendments in the agreement (1) clarify that we will not be liable for adverse consequences related to specified extraordinary transactions in 2009 primarily relating to our parent entity and other related entities, (2) provide that, in calculating our tax payment obligation, the indebtedness of our parent entity, MPG Holdings, will be treated as if it were our indebtedness and (3) provide that the Trustee of the New Indenture will have an approval right with respect to elections or discretionary positions taken for tax return purposes related to specified transactions or actions taken with respect to the indebtedness of MPG Holdings, if such elections, positions or actions would have an adverse consequence on the New Notes or Morris Publishing. To the extent the terms of the Amended Tax Agreement require us to pay less than the amount of taxes that would have been required under the separate return method; such lesser amount will not reduce our income tax expense, but will be treated as a capital contribution by our parent. We account for income taxes under the provisions of the liability method as required by accounting guidance, which requires the recognition of deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. The recognition of future tax benefits is required to the extent that realization of such benefits is more likely than not. -22--------------------------------------------------------------------------------- Table of Contents Recently issued accounting standards In January 2010, the FASB issued Accounting Standards Update 2010-6, "Improving Disclosures about Fair Value Measurements" which discusses the level of disaggregation required for each class of assets and liabilities and for fair value measurements that fall within Level 2 or 3 of the fair value hierarchy. This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures concerning purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this pronouncement did not have a material impact on our financial statements. In October 2009, the FASB issued Accounting Standards Update No. 2009-13, "Revenue Recognition-Multiple Deliverable Revenue Arrangements," which amends previous guidance related to the accounting for revenue arrangements with multiple deliverables. The guidance is effective for fiscal years beginning on or after September 15, 2010, and applies to our 2011 financial statements. Under the new guidance, when vendor specific objective evidence or third party evidence of the selling price for a deliverable in a multiple element in an arrangement cannot be determined, a best estimate of the selling price is required to allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing of when revenue is recognized. The adoption of the new guidance did not have a material impact to our financial position, results of operations or cash flows. Overview Morris Publishing owns and operates 13 daily newspapers as well as non-daily newspapers, city magazines and free community publications in the Southeast, Midwest, Southwest and Alaska. Morris Publishing's newspapers include, among others, The Florida Times-Union, (Jacksonville, Fla.), The Augusta (Ga.) Chronicle, Savannah (Ga.) Morning News, Lubbock (Texas) Avalanche-Journal, Amarillo (Texas) Globe-News, Athens (Ga.) Banner Herald, Topeka (Kans.) Capital-Journal, and The St. Augustine (Fla.) Record. The majority of our daily newspapers are usually the primary, and sometimes, the sole provider of comprehensive local market news and information in the communities that we serve. Our products focus on the community from a content and advertising point of view. The longevity of our newspapers demonstrates the value and relevance of the comprehensive and in-depth local news and information that we provide; thus, creating strong reader loyalty and brand name recognition in each community that we serve. As a result, we believe that we have provided our advertisers a strong market reach through the high audience penetration rates in our markets. We operate in a single reporting segment, and the presentation of our financial condition and performance is consistent with the way in which our operations are managed. However, from time to time, each individual newspaper may perform better or worse than our newspaper group as a whole due to certain local conditions, particularly within the retail, auto, housing and labor markets. Revenue: While most of our revenue is generated from advertising and circulation from our newspaper operations, we also print and distribute periodical publications and operate commercial printing operations in conjunction with our newspapers. · Advertising revenue: During the second quarter of 2011 and 2010, advertising revenue, including both print and online media formats, represented 68.6% and 71.8%, respectively, of our total net operating revenue. We categorize advertising as follows: Retail*-local retailers, local stores for national retailers, department and furniture stores, grocers, niche shops, local financial institutions, local hospitals , restaurants and other small businesses. Classified*-local employment, automotive, real estate and other advertising. -23--------------------------------------------------------------------------------- Table of Contents National*-national and major accounts such as wireless communications companies, airlines and hotels. *On-line, included in all the categories above-banner, display, classified, behavioral targeting, search and other advertising on Web sites or mobile devices. Retail, classified and national advertising revenue represented 58.7%, 35.3% and 6.0%, respectively, of our second quarter of 2011 advertising revenue, compared to 57.8%, 35.4% and 6.8%, respectively, in the second quarter of 2010. Linage, the number of inserts, Internet page views, along with rate and mix of advertisement are the primary components of advertising revenue. The advertising rate depends largely on our market reach, primarily through circulation, and readership. Our advertising revenue tends to follow a seasonal pattern, with higher advertising revenue in months containing significant events or holidays, with our second and fourth fiscal quarters being our strongest quarters in terms of revenue. In addition, we have experienced declines in advertising revenue over the past few years, due primarily to the economic recession and secular changes in the industry. · Circulation revenue: During the second quarter of 2011 and 2010, circulation revenue represented 26.9% and 25.4%, respectively, of our total net operating revenue. Circulation revenue is based on the number of newspapers sold and is primarily derived from home delivery sales to subscribers and single copy sales at vending racks and retail stores. We also sell copies through our Newspapers in Education ("NIE") program which is a cooperative effort of newspapers working with local schools to encourage the use of the newspaper as a tool for instruction and to promote literacy. Recently, we began implementing a metered online model at some of our newspapers' Web sites, in which users who are not print subscribers are given free access to a limited number local news articles per month, and after that limit are required to have a paid print or online subscription in order to view additional locally produced articles. In addition, we offer paid online subscriptions at most of our newspapers for access to our content through e-reader platforms. Subscriptions are sold for one-month (EZ Pay), 13 week, 26 week and 52 week terms. We have increased the use of EZ Pay programs (a monthly credit or debit card payment program), door to door sales, kiosks, in-paper and online promotions to increase our circulation. Our call service center has an active stop-loss program for all expiring subscribers. · Other revenue: Our other revenue consists primarily of commercial printing, periodicals, and other online revenue. Printing and distribution: We currently own/lease and operate 11 print facilities with each producing the newspaper and other publications for their respective communities served. The St. Augustine newspaper is currently printed at the Jacksonville facility and Bluffton Today is currently printed at the Savannah facility. The distribution of our daily newspapers is typically outsourced to independent, locally based, third-party distributors that also distribute a majority of our weekly newspapers and non-newspaper publications. In addition, certain of our shopper and weekly publications are delivered via the U.S. Postal Service. · Newsprint: Newsprint, along with employee expenses, is a primary cost at each newspaper. We are a member of a consortium which enables us to obtain favorable pricing through the group's reduced negotiated rates. We generally maintain a company average of 22 to 28 day inventory of newsprint which is a readily available commodity. -24--------------------------------------------------------------------------------- Table of Contents Current Initiatives In the long term, we see significant revenue opportunities in the highly fragmented local media industry. As a result, we are currently focused on transforming our business to a multi-media revenue business by building on our print based foundation to create new competitive advantages through a true digital solution. Our transformation includes: · Pursuing digital revenue growth to offset print declines. · Leveraging our print audience to build new platform choices for our customers. · Centralizing information into a digital services solution; Search, Social and Mobile. · Focusing on content and audience creations. · Encouraging more audience engagement. · Focusing on selling these audiences to advertisers. · Improving the efficiency in our operations to increase print profitability. Financial summary for the three months ended June 30, 2011 compared to June 30, 2010 Financial Summary. The following table summarizes our consolidated financial results for the three-month periods ended June 30, 2011 and 2010: Three months ended June 30, (Dollars in thousands) 2011 2010 Total net operating revenues $ 55,719 $ 60,354 Total operating expenses 54,937 56,863 Operating income 782 3,491 Interest expense and loan amortization cost 2,561 3,584 Expense from cancellation of debt - 1,035 Other (87 ) (38 ) Other expenses, net 2,474 4,581 Loss before taxes (1,692 ) (1,090 ) Income tax benefit (453 ) (936 ) Net loss $ (1,239 ) $ (154 ) Compared to the second quarter of 2010, our total net operating revenue was $55.7 million, down $4.7 million, or 7.7%, from $60.4 million, and total operating expenses were $54.9 million, down $2.0 million, or 3.4%, from $56.9 million. As a result, our operating income was $0.8 million during the second quarter of 2011, down $2.7 million, or 77.6%, from $3.5 million during the same quarter last year. During the second quarter of 2010, we expensed $1.0 million in legal and consultant costs directly related to the restructuring of our then-senior creditors and of certain of the holders of the Original Notes ("Debt Restructuring Costs"). -25--------------------------------------------------------------------------------- Table of Contents Interest and loan amortization expense is summarized in the table below: Three months ended June 30, (Dollars in thousands) 2011 2010 New Notes Stated interest @ 10.0% $ 1,963 $ 2,417 Accretion of original issue discount 442 919 2,405 3,336 Credit Agreement Tranche B - 75 - 75 Other 21 98 Total interest expense 2,426 3,509 Loan amortization 135 75 Interest and loan amortization expense $ 2,561 $ 3,584 Our loss before taxes was $1.7 million during the second quarter of 2011, compared to a net loss before taxes of $1.1 million during the second quarter of 2010. For the second quarter of 2011 and 2010, our income tax benefit was $0.5 million and $0.9 million, respectively. Our net loss was $1.2 million during the second quarter of 2011, compared to a net loss of $0.2 million during same quarter last year. Results of operations for the three months ended June 30, 2011 compared to June 30, 2010 Net operating revenue. The table below presents the total net operating revenue for the three-month periods ended June 30, 2011 and 2010: Percentage (Dollars in thousands) Three months ended June 30, change 2011 2010 2011 vs. 2010 Net operating revenues Advertising Retail $ 22,460 $ 25,055 (10.4 %) National 2,274 2,928 (22.3 %) Classified 13,505 15,331 (11.9 %) Total advertising revenues 38,239 43,314 (11.7 %) Circulation 14,969 15,338 (2.4 %) Other 2,511 1,702 47.5 % Total net operating revenues $ 55,719 $ 60,354 (7.7 %) Advertising revenue. Advertising revenue was $38.2 million, a decrease of $5.1 million, or 11.7%, from $43.3 million during the second quarter of 2010. Print and online advertising revenue totaled $26.7 million, down $4.6 million, or 14.4%, from $31.3 million during the same quarter last year. Compared to the second quarter of 2010, total online page-views were 181.1 million, down 1.9 million, or 1.04%, and unique online visitors were 20.2 million, up 2.0 million, or 10.7%, reflecting our customers' migration to the Internet platform. In addition, insert advertising revenue was $9.9 million, down $0.5 million, or 5.3%, from $10.4 million in the second quarter of 2010 and advertising revenue from specialty products printed by us, but not a part of main newspaper product, was $1.5 million, down $0.1 million, or 6.3%, from $1.6 million last year. -26--------------------------------------------------------------------------------- Table of Contents Our advertising results exhibit that from time to time, each individual newspaper may perform better or worse than our newspaper group as a whole due to certain local or regional conditions. Compared to the second quarter of 2010, advertising revenue from our daily newspapers was down $4.7 million, or 11.9%. Advertising revenue from Jacksonville was down $1.7 million, or 14.6%, and St. Augustine was down $0.3 million, or 20.2%. Augusta was down $0.6 million, or 12.5%, Savannah was down $0.5 million, or 13.1%, Lubbock was down $0.5 million, or 11.6%, Topeka was down $0.2 million, or 7.5%, Athens was down $0.3 million, or 15.6%, and Amarillo was down $0.4 million, or 9.5%. Our five other daily newspapers were, together, down $0.2 million, or 4.1%. Our non-daily publications were down $0.4 million, or 9.8%, primarily due to significant declines from Effingham Now, the Alaska non-daily publications and the Jacksonville Sun publications. Retail advertising revenue: Retail advertising revenue was $22.4 million, down $2.7 million, or 10.4%, from $25.1 million during the prior year, with significant declines from our seven largest daily newspapers. Insert retail advertising revenue was $9.0 million, down $0.4 million, or 4.5%, from $9.4 million, while print and online retail advertising revenue was $12.0 million, down $2.2 million, or 14.8%, from $14.2 million during 2010. Retail advertising revenue from specialty products printed by us, but not a part of main newspaper product, was $1.4 million, down $0.1 million, or 5.5%, from $1.5 million in the second quarter of 2010. Classified advertising revenue: Total classified advertising revenue was $13.5 million, down $1.8 million, or 11.9%, from $15.3 million in 2010. Jacksonville was down $0.7 million, or 19.7%, contributing approximately 40% of the net decrease. National advertising revenue: Total national advertising revenue was $2.3 million, down $0.6 million, or 22.3%, from $2.9 million last year, with Jacksonville contributing 80.0% of the net decrease. Circulation revenue. Circulation revenue was $15.0 million, down $0.3 million, or 2.4%, from $15.3 million during the second quarter of 2010, with the price increases in many of our markets being offset by the decrease in circulation volume. Average daily and Sunday circulation volume, excluding the NIE editions, was down 8.3% and 3.8%, respectively, with Jacksonville contributing about 33.4% of the weekly circulation decline. During 2010, we converted most of our NIE print editions to lower priced electronic editions, resulting in a significant increase in NIE circulation volume. Other revenue. Other income was $2.5 million, up $0.8 million, or 47.6%, from $1.7 million during the second quarter of 2010 primarily due to the increase in other online revenues. -27--------------------------------------------------------------------------------- Table of Contents Net operating expenses. The table below presents the total operating expenses for the three-month periods ended June 30, 2011 and 2010: Percentage (Dollars in thousands) Three months ended June 30, change 2011 2010 2011 vs. 2010 Operating expenses Labor and employee benefits $ 23,173 $ 23,918 (3.1 %) Newsprint, ink and supplements 5,611 6,691 (16.1 %) Other operating costs 24,060 23,922 0.6 % Depreciation and amortization 2,093 2,332 (10.2 %) Total operating expenses $ 54,937 $ 56,863 (3.4 %) Labor and employee benefits. Total labor and employee benefit costs were $23.2 million, down $0.8 million, or 3.1%, from $24.0 million during 2010, with these costs being favorably impacted by reductions in head count. Compared to 2010, our salaries and wages, including severance costs, totaled $17.2 million, down $0.3 million, or 1.7%, from $17.5 million. Severance costs were $1.0 million and $0.1 million for the second quarter of 2011 and 2010, respectively. Our average full time equivalents ("FTE") were down 198, or 9.7%, and our average pay rate, excluding severance costs, was up 3.6%. Commissions and bonuses were $2.3 million, down $0.5 million, or 19.4%, from $2.8 million during 2010, primarily due to the decline in advertising revenues. Employee medical insurance cost was $2.2 million, up $0.2 million, or 12.5%, from $2.0 million during the second quarter last year. Other employee costs totaled $1.5 million, down $0.2 million, or 9.9%, from $1.7 million last year. Newsprint, ink and supplements cost. Newsprint, ink and supplements costs were $5.6 million, down $1.1 million, or 16.2%, from $6.7 million during 2010. Compared to 2010, total newsprint expense was $4.9 million, down $1.1 million, or 17.8%, from $6.0 million, with a 1.2% decrease in the average cost per ton of newsprint and a 16.6% decrease in newsprint consumption. Supplements and ink expense totaled $0.7 million, unchanged from the second quarter of 2010. Other operating costs. Other operating costs were $24.0 million, up $0.1 million, or 0.4%, from $23.9 million in 2010. The combined technology and shared services fee from Morris Communications and management fee charged by Morris Communications under the management agreement totaled $5.2 million, down $0.3 million, or 4.8%, from $5.4 million in the second quarter of 2010, with the combined fees not to exceed $22.0 million in any calendar year. Professional fees totaled $3.6 million, up $0.6 million, or 20.5%, from $3.0 million during the same period last year. Bad debt expense totaled $0.2 million, up $0.6 million from a net bad debt recovery of $0.4 million last year. During the second quarter of 2010, we reduced our bad debt reserve by $0.5 million. Depreciation and amortization. Depreciation and amortization expense was $2.1 million, down $0.2 million, or 10.2%, from $2.3 million in 2010. -28--------------------------------------------------------------------------------- Table of Contents Depreciation expense was $2.0 million, down $0.2 million, or 12.1%, from $2.2 million during the same quarter last year. Amortization expense was $0.1 million, unchanged from last year. Financial summary for the six months ended June 30, 2011 compared to June 30, 2010 Financial Summary. The following table summarizes our consolidated financial results for the six-month periods ended June 30, 2011 and 2010: Six months ended June 30, (Dollars in thousands) 2011 2010 Total net operating revenues $ 110,635 $ 119,819 Total operating expenses 108,381 113,738 Operating income 2,254 6,081 Interest expense and loan amortization cost 5,707 10,769 Income from cancellation of debt, net - (218,164 ) Other (38 ) (71 ) Other expenses (income), net 5,669 (207,466 ) (Loss) income before taxes (3,415 ) 213,547 (Benefit) provision for income taxes (1,026 ) 8,632 Net (loss) income $ (2,389 ) $ 204,915 Compared to the first six months of 2010, our total net operating revenue was $110.6 million, down $9.2 million, or 10.9%, from $119.8 million, and total operating expenses were $108.3 million, down $5.4 million, or 4.7%, from $113.7 million. As a result, our operating income was $2.3 million during the first six months of 2011, down $3.8 million, or 62.9%, from $6.1 million during the same quarter last year. On March 1, 2010, the Effective Date of our Restructuring, the $100.0 million in aggregate stated principal amount outstanding on the New Notes was recorded at a fair value of $91.0 million (the average price of the corporate bond trades reported on or around the Effective Date), with the $9.0 million in original issue discount ("OID") being accreted as additional interest expense over the four and one-half year term of the New Notes. The table below summarizes the components (*cash and non-cash) of our cancellation of debt income ("COD" income) during the first six months of 2010: (Dollars in thousands) Cancellation of debt Cancellation of Original Notes $ 278,478 Cancellation of interest accrued on Original Notes 35,427 313,905 Issuance of debt Issuance of New Notes (100,000 ) Original issue discount 9,000 (91,000 ) Other costs Debt Restructuring Costs-1/1/2010 through 6/30/2010* (1,620 ) Write-off of deferred loan costs (3,121 ) (4,741 ) Cancellation of debt income $ 218,164 On the Effective Date of the Restructuring, we wrote-off $3.1 million in unamortized deferred loan costs associated with the Original Notes. In addition, we incurred $1.6 million in Debt Restructuring Costs during the first six months of 2010. -29--------------------------------------------------------------------------------- Table of Contents Interest and loan amortization expense is summarized in the table below: Six months ended June 30, 2011 2010 Original Notes Stated interest @ 7.0% $ - $ 3,249 Default Interest @ 1% compounded - 910 - 4,159 New Notes Stated interest @ 10.0% 4,061 3,250 Accretion of original issue discount 1,375 1,081 5,436 4,331 Credit Agreement Tranche A, including $300 prepayment penalty - 801 Tranche B 339 Tranche C - 914 - 2,054 Other, net 23 4 Total interest expense 5,459 10,548 Loan amortization 248 221 Interest and loan amortization expense $ 5,707 $ 10,769 Our loss before taxes was $3.4 million during the first six months of 2011, compared to income before taxes of $213.5 million during the same period last year. Excluding the $218.1 million in COD income, our loss before taxes was $4.6 million during the first six months of 2010. For the first six months of 2011 and 2010, our income tax (benefit) provision was ($1.0) million and $8.6 million, respectively. Our net loss was $2.4 million during the first six months of 2011, compared to net income of $204.9 million during same period last year. Results of operations for the six months ended June 30, 2011 compared to June 30, 2010 Net operating revenue. The table below presents the total net operating revenue for the six-month periods ended June 30, 2011 and 2010: (Dollars in thousands) Six months ended June 30, Percentage change 2011 2010 2011 vs. 2010 Net operating revenues Advertising Retail $ 44,182 $ 49,286 (10.4 %) National 4,895 6,106 (19.8 %) Classified 26,551 29,464 (9.9 %) Total advertising revenues 75,628 84,856 (10.9 %) Circulation 30,309 31,133 (2.6 %) Other 4,698 3,830 22.7 % Total net operating revenues $ 110,635 $ 119,819 (7.7 %) -30--------------------------------------------------------------------------------- Table of Contents Advertising revenue. Advertising revenue was $75.6 million, a decrease of $9.3 million, or 10.9%, from $84.9 million during the first six months of 2010. During the first six months of 2011 and 2010, advertising revenue, including both print and online media formats, represented 68.4% and 70.8%, respectively, of our total net operating revenue. Retail, classified and national advertising revenue represented 58.4%, 35.1% and 6.5%, respectively, of our second quarter of 2011 advertising revenue, compared to 58.1%, 34.7% and 7.2%, respectively, in the second quarter of 2010. Print and online advertising revenue totaled $52.9 million, down $7.7 million, or 12.7%, from $60.6 million during the same period last year. Compared to the first six months of 2010, total online page-views were 350.5 million, down 3.8 million, or 1.0%, and unique online visitors were 40.3 million, up 5.1 million, or 14.5%, reflecting our customers' migration to the Internet platform. In addition, insert advertising revenue was $19.0 million, down $1.4 million, or 7.0%, from $20.5 million in the first six months of 2010 and advertising revenue from specialty products printed by us, but not a part of main newspaper product, was $3.7 million, down $0.2 million, or 3.5%, from $3.8 million last year. Compared to the first six months of 2010, advertising revenue from our daily newspapers was down $8.7 million, or 11.3%. Advertising revenue from Jacksonville was down $3.0 million, or 13.2%, and St. Augustine was down $0.6 million, or 19.2%. Augusta was down $1.1 million, or 10.6%, Savannah was down $1.2 million, or 15.2%, Lubbock was down $0.8 million, or 9.7%, Topeka was down $0.4 million, or 7.4%, Athens was down $0.5 million, or 14.6%, and Amarillo was down $0.7 million, or 9.0%. Our five other daily newspapers were, together, down $0.4 million, or 0.5%. Our non-daily publications were down $0.6 million, or 6.8%, primarily due to significant declines from Effingham Now, the Alaska non-daily publications and the Jacksonville Sun publications. Retail advertising revenue: Retail advertising revenue was $44.2 million, down $5.1 million, or 10.4%, from $49.3 million the prior year, with significant declines from our seven largest daily newspapers. Insert retail advertising revenue was $17.3 million, down $1.1 million, or 6.0%, from $18.4 million, while print and online retail advertising revenue was $23.5 million, down $3.8 million, or 14.0%, from $27.3 million during 2010. Retail advertising revenue from specialty products printed by us, but not a part of main newspaper product, was $3.4 million, down $0.2 million, or 5.4%, from $3.5 million in 2010. Classified advertising revenue: Total classified advertising revenue was $26.5 million, down $3.0 million, or 9.9%, from $29.5 million in 2010. Jacksonville was down $1.2 million, or 16.2%; contributing 39.7% of the net decrease. National advertising revenue: Total national advertising revenue was $4.9 million, down $1.2 million, or 19.8%, from $6.1 million during 2010 with Jacksonville down $1.0 million. -31--------------------------------------------------------------------------------- Table of Contents Circulation revenue. Circulation revenue was $30.3 million, down $0.8 million, or 2.6%, from $31.1 million last year, with the price increases in many of our markets being offset by the decrease in circulation volume. Other revenue. Other income was $4.7 million, up $0.9 million, or 22.6%, from $3.8 million during the same period last year primarily due to the increase in other online revenues. Net operating expenses. The table below presents the total operating expenses for the six-month periods ended June 30, 2011 and 2010: (Dollars in thousands) Six months ended June 30, Percentage change 2011 2010 2011 vs. 2010 Operating expenses Labor and employee benefits $ 45,646 $ 48,878 (6.6 %) Newsprint, ink and supplements 11,411 12,173 (6.3 %) Other operating costs 47,078 47,825 (1.6 %) Depreciation and amortization 4,246 4,862 (12.7 %) Total operating expenses $ 108,381 $ 113,738 (4.7 %) Labor and employee benefits. Total labor and employee benefit costs, including severance payments, were $45.6 million, down $3.2 million, or 6.6%, from $48.9 million during 2010, with these costs being favorably impacted by reductions in head count. Compared to 2010, our salaries and wages, including severance payments, totaled $33.6 million, down $1.4 million, or 4.0%, from $35.0 million. Severance costs were $1.1 million and $0.2 million for the first six months of 2011 and 2010, respectively. Our average FTE was down 187, or 9.1%, and our average pay rate, excluding severance costs, was up 2.7%. Commissions and bonuses were $4.5 million, down $1.7 million, or 26.5%, from $6.2 million during 2010, primarily due to the decline in advertising revenues. Employee medical insurance cost was $4.1 million, up $0.2 million, or 5.3%, from $3.9 million during the second quarter last year due to the increase in medical claims. Payroll tax expense and other employee costs totaled $3.4 million, down $0.3 million, or 10.4%, from $3.7 million during 2010. Newsprint, ink and supplements cost. Newsprint, ink and supplements costs were $11.4 million, down $0.8 million, or 6.3%, from $12.2 million during 2010. Compared to 2010, total newsprint expense was $10.0 million, down $0.8 million, or 7.0%, from $10.8 million, with a 6.8% increase in the average cost per ton of newsprint and a 13.8% decrease in newsprint consumption. Supplements and ink expense totaled $1.4 million, unchanged from the first six months of 2010. Other operating costs. Other operating costs were $47.1 million, down $0.7 million, or 1.6%, from $47.8 million in 2010. The combined technology and shared services fee from Morris Communications and management fee charged by Morris Communications under the management agreement totaled $10.4 million, up $0.8 million, or 8.1%, from $9.6 million in last year with the combined fees not to exceed $22.0 million in any calendar year. -32--------------------------------------------------------------------------------- Table of Contents Depreciation and amortization. Depreciation and amortization expense was $4.2 million, down $0.6 million, or 12.7%, from $4.8 million in 2010. Depreciation expense was $4.0 million, down $0.6 million, or 12.3%, from $4.6 million in 2010. Amortization expense was $0.2 million, unchanged from the first six months last year. Liquidity and capital resources Our unrestricted cash balance was $5.2 million at June 30, 2011, compared with $2.6 million at December 31, 2010. At June 30, 2011, our sources of liquidity were the cash flow generated from operations, our cash balances and a $10.0 million senior secured Working Capital Facility (as described below). Our primary short term needs for cash were funding operating expenses, capital expenditures, income taxes, working capital and the quarterly interest payments and any required monthly Excess Free Cash Flow redemptions on the New Notes. As permitted by the New Indenture, we intend to maintain a $10.0 million senior secured Working Capital Facility for the foreseeable future. Going forward, we intend to continue to renew or replace this Working Capital Facility from time to time. If at any time we do not have a Working Capital Facility, we would intend to retain cash flow generated from operations in order to maintain cash balances of up to $7.0 million to provide liquidity, as permitted by the New Indenture, but we would be required to use monthly excess free cash flow to redeem New Notes to the extent our cash balances exceed $7.0 million. Operating activities. Net cash provided by operations was $12.4 million for the first six months of 2011, down $4.3 million from $16.7 million for the same period in 2010. Excluding current maturities of long-term debt, current assets were $34.6 million and current liabilities were $27.9 million as of June 30, 2011 compared to current assets of $36.7 million and current liabilities of $23.1 million as of December 31, 2010. Investment activities. Net cash used in investing activities was $1.5 million for the first six months of 2011, compared to $0.4 million used in investing activities for the first six months of 2010. During the first six months in 2011 and 2010, we spent $1.5 million and $0.5 million on property, plant and equipment, respectively. We anticipate our total capital expenditures to range from $2.5 million to $3.0 million during 2011. Financing activities. Net cash used in financing activities was $8.4 million for the first six months of 2011, compared to $35.1 million used in financing activities ($19.7 million and $7.4 million of which was used to repay our Tranche A and Tranche B indebtedness) for the same period in 2010. Redemptions and Refinancing We were required to use part of our available cash after the repayment of the Tranche A senior secured debt to redeem $3.2 million of the aggregate stated principal amounts outstanding on the New Notes and repay $0.2 million on the amount outstanding on the Tranche B term loan. Under the New Indenture, we were permitted to incur "Refinancing Indebtedness", as defined in and contemplated by the New Indenture, within 150 days after March 1, 2010, in order to refinance the Tranche B term loan under the Credit Agreement. During the second quarter of 2010, in connection with, and immediately prior to entering into a working capital facility, we repaid the Tranche B term loan under the Credit Agreement in the amount of $6.8 million (plus accrued PIK interest) with $7.1 million of Refinancing Indebtedness from CB&T, a division of Synovus -33--------------------------------------------------------------------------------- Table of Contents Bank (the "Bank") and we entered into a senior, secured Loan and Line of Credit Agreement with the Bank, providing for a revolving line of credit in the amount of $10.0 million (the "Working Capital Facility"). As required by the New Indenture, upon entering into a working capital facility, we used part of our available cash to fully repay this Refinancing Indebtedness immediately upon its issuance. We were required to use part of our available cash upon entering into the Working Capital Facility to redeem $1.8 million of the aggregate stated principal amounts outstanding on the New Notes. In addition, we are required by the New Indenture to use our monthly positive operating cash flow (if any), net of permitted cash flow adjustments, ("Excess Free Cash Flow") to first repay any amounts outstanding on the Working Capital Facility, and then to redeem (on a pro rata basis) New Notes; provided, however, that no payment or redemptions are required if Excess Free Cash Flow is less than $0.25 million. During first six months of 2011 and 2010, we redeemed an additional $8.4 million and $1.0 million, respectively, in aggregate stated principal amounts outstanding on the New Notes from our Excess Free Cash Flows. Subsequent to June 30, 2011, we redeemed a total of $0.6 million in face amount of aggregate stated principal amounts outstanding on the New Notes as a result of the June 2011 Excess Free Cash Flow. The total amount outstanding on the New Notes at July 31, 2011 was $77.5 million of stated principal. The following table summarizes the above (cash* and non-cash) transactions, along with the Restructuring, and reflects our total outstanding debt on June 30, 2011, December 31, 2010 and December 31, 2009: (Dollars in thousands) Non-cash New Notes Outstanding Capital Non-cash and on New Outstanding Additional Repayments Contribution Cancellation Original Notes at as of Accrued or to Morris of Original Issue End of Long-term debt 12/31/2009 Interest-Non-Cash Settlement Publishing Notes Discount Periods Credit Agreement Tranche A $19,700 $- $(19,700) * $- $- $- $- Tranche B 7,021 339 (7,360) * - - - - Tranche C 111,192 914 (24,862) (87,244) - - - 137,913 1,253 (51,922) (87,244) - - - Original Indenture Original Notes 278,478 - - - (278,478) - - Accrued interest 31,268 4,159 - - (35,427) - - 309,746 4,159 - - (313,905) - - New Indenture Issuance of New Notes on Restructuring Date - - - - - 100,000 100,000 Original issue discount at the Restructuring Date - - - - - (9,000) (9,000) Accretion of OID-3/1/2010 through 12/31/2010 - - - - - 2,607 2,607 Redemptions-3/1/2010 through 12/31/2010 - - - - - (13,492) * (13,492) Outstanding at 12/31/2010 - 80,115 80,115 Accretion of OID-1/1/2011 through 6/30/2011 - - - - - 1,375 1,375 Redemptions-1/1/2011 through 6/30/2011 - - - - - (8,397) * (8,397) Outstanding at 6/30/2011 - - - - - 73,093 73,093 Totals $447,659 $5,412 $(51,922) $(87,244) $(313,905) $73,093 $73,093 Period Summary Total Debt-At June 30, 2011, our total debt was $73.1 million ($78.1 million in aggregate principal outstanding on the New Notes less $5.0 million of OID). At December 31, 2010, our total debt was $80.1 million ($86.5 million in aggregate principal outstanding on the New Notes less $6.4 million of OID). The average interest rate on our total aggregate principal amount of debt outstanding, excluding effective rate of the OID on the New Notes, was 10% at June 30, 2011 and December 31, 2010. -34--------------------------------------------------------------------------------- Table of Contents The current maturities of long-term debt as of June 30, 2011 and December 31, 2010 totaled $10.0 million and $13.0 million, respectively. The current maturities of long-term debt reflect our estimate of required redemptions of New Notes utilizing Excess Free Cash Flows within the following twelve-month period. New Note Summary-The table below summarizes our interest payments and redemptions of aggregate stated principal outstanding on the New Notes utilizing our monthly Excess Free Cash Flows and Excess Cash during 2011: Beginning Ending Principal Principal Principal(dollars in thousands) Outstanding Redeemed Interest Paid Outstanding Payment Due Date 2011 Quarterly interest payment $ 86,508 $ - $ 2,163 $ 86,508 1/3/11 Excess Free Cash Flow-December 2010 86,508 - - 86,508 1/21/11 Excess Free Cash Flow-January 2011 86,508 4,269 55 82,239 2/16/11 Excess Free Cash Flow-February 2011 82,239 3,227 68 79,012 3/16/11 Total-First Quarter 2011 7,496 2,286 Quarterly interest payment 79,012 - 1,975 79,012 4/1/11 Excess Free Cash Flow-March 2011 79,012 579 3 78,433 4/21/11 Excess Free Cash Flow-April 2011 78,433 - - 78,433 5/16/11 Excess Free Cash Flow-May 2011 78,433 322 6 78,111 6/15/11 Total-Second Quarter 2011 901 1,984 Total-Six Months Ended June 30, 2011 8,397 4,270 Quarterly interest payment 78,111 - 1,953 78,111 7/1/11 Excess Free Cash Flow-June 2011 $ 78,111 563 3 $ 77,548 7/19/11 Total-Subsequent to Second Quarter 2011 563 1,956 Total-Year-to-Date 2011 8,960 6,226 Total-2010 13,492 5,594 Total-To-Date $ 22,452 $ 11,820 During the first quarter of 2010, we deferred $0.6 million in loan costs related to the issuance of the New Notes and are amortizing those costs over the four and one-half year maturity of the New Notes. Working Capital Facility Summary-There were no borrowings against the Working Capital Facility at the end of the second quarter of 2011. During the second quarter of 2010, we deferred the $0.5 million in debt issuance costs associated with the loan and are amortizing these costs ratably through May 15, 2011, the original maturity date of the Working Capital Facility. Credit Agreement Summary-The interest rates on the Tranche A, Tranche B and Tranche C term loans under the Credit Agreement were 15%, 15%, and 5%, respectively. The interest on both the Tranche B and C term loans was PIK. New Indenture On March 1, 2010, the Effective Date of the Restructuring, we entered into the New Indenture with respect to the New Notes. Under the terms of the New Indenture, the New Notes bear 10% interest commencing March 1, 2010 and payable in cash quarterly. The New Notes mature on October 1, 2014. -35--------------------------------------------------------------------------------- Table of Contents The New Notes are secured by a lien on substantially all of our assets. The New Notes, and the liens securing the New Notes, will be subordinated to any of our senior debt, which included the Refinancing Indebtedness and includes the Working Capital Facility. Under certain conditions, the notes may be redeemed at the option of the Issuers. Upon certain sales or dispositions of assets or events of loss unless the proceeds are reinvested in accordance with the New Indenture, the Issuers must offer to use proceeds to redeem the Notes. Upon a change of control of Morris Publishing, the Issuers must offer to repurchase all of the New Notes. The New Indenture contains various representations, warranties and covenants generally consistent with the Original Indenture, including requirements to provide reports and to file publicly available reports with the SEC (unless the SEC will not accept the reports) and limitations on dividends, indebtedness, liens, transactions with affiliates and capital expenditures. In addition, the New Indenture contains financial covenants requiring us to meet certain financial tests on an on-going basis, including a total leverage ratio and a cash interest coverage ratio, based upon our consolidated financial results. At June 30, 2011, we were in compliance with all financial covenants under the New Indenture. In addition, the holders of the New Notes, as permitted by the New Indenture, appointed an observer to our Board of Directors and each of our subsidiaries. Credit Agreement On October 15, 2009, the Original Credit Agreement was amended and restated under the Credit Agreement, as a condition precedent to the Restructuring. The amendment and restatement immediately followed the acquisition by Tranche Holdings, LLC, a third party in which our affiliates held a transitory interest, of all outstanding loans under the Original Credit Agreement and the conversion of the entire $136.5 million principal amount outstanding under the Original Credit Agreement into the three tranches of term loans (the "Senior Refinancing Transaction"): Tranche A - $19.7 million; Tranche B - $6.8 million; and Tranche C - $110.0 million The entire Tranche B term loan was acquired by our affiliate, MPG Revolver Holdings, LLC ("MPG Revolver"), and the entire Tranche C term loan was acquired by Morris Communications and MPG Revolver, after which our affiliates no longer had an interest in Tranche Holdings, LLC. The parties to the Credit Agreement were (1) Morris Publishing as borrower, (2) Morris Communications, as guarantor, (3) Tranche Manager, LLC as administrative agent, and (4) Tranche Holdings, LLC, MPG Revolver, and Morris Communications as lenders. All existing defaults under the Original Credit Agreement were eliminated upon the consummation of the Senior Refinancing Transaction. Prior to the Effective Date, all three tranches of debt under the Credit Agreement remained senior to the Original Notes. Pursuant to the Escrow Agreement, MPG Revolver and Morris Communications deposited the Tranche C term loan, which had an aggregate principal amount of $110.0 million plus accrued PIK interest, into an escrow account for cancellation upon the consummation of the Restructuring. Pursuant to the Escrow Agreement, upon the Restructuring, the relevant Morris Publishing affiliates agreed to cancel the Tranche C term loan which had an aggregate principal amount of $110.0 million plus accrued PIK interest in settlement of intercompany indebtedness having an aggregate principal amount of approximately $24.5 million, plus accrued and unpaid interest from September 30, 2009 until the date on which the Restructuring was consummated, to Morris Publishing and as a contribution to capital of approximately $85.5 million plus the amount of any PIK interest that accrued on the Tranche C term loan after the date -36--------------------------------------------------------------------------------- Table of Contents of the Credit Agreement. The Credit Agreement contained various representations, warranties and covenants generally consistent with the Original Credit Agreement. Financial covenants in the Credit Agreement required us to meet certain financial tests on an on-going basis, including a minimum interest coverage ratio, minimum fixed charge coverage ratio, and maximum cash flow ratios, based upon the combined consolidated financial results of Morris Publishing and Morris Communications. The financial covenants were to be calculated as if the Restructuring had been completed. Prior to and on the Effective Date, we were in compliance with all financial covenants (as amended on October 15, 2009) under the Credit Agreement. The loans under the Credit Agreement continued to be guaranteed by all of our subsidiaries, as well as Morris Communications and all of its wholly-owned, domestic subsidiaries, and secured by substantially all of the assets of such guarantors and Morris Publishing. The Tranche B term loan remaining after the Restructuring ranked pari passu with the New Notes and ceased to be secured by the liens securing the Credit Agreement, and shared in the same collateral securing the New Notes on a second priority basis. On or prior to 150 days from the date of the Restructuring, we were permitted to refinance the Tranche B term loan, with a term loan and/or revolver provided by a commercial bank unaffiliated with Morris Publishing at an annual interest rate no greater than LIBOR plus 970 basis points. Such refinanced debt would be senior to the New Notes and secured by a first lien on substantially all of our assets. Working Capital Facility The parties to the Working Capital Facility are Morris Publishing, as borrower, all of our subsidiaries and our parent, as guarantors, and the Bank. Interest will accrue on outstanding principal at the rate of LIBOR plus 4%, with a minimum rate of 6%. The Working Capital Facility is secured by a first lien on substantially all of our assets and the assets of our subsidiaries. Liens on such assets were previously granted to the Collateral Agent for the holders of the New Notes pursuant to the New Indenture. Pursuant to the New Indenture and an Intercreditor Agreement between the Collateral Agent and the Bank, the New Notes (and their related liens) are subordinated to the Working Capital Facility. The Working Capital Facility contains various customary representations, warranties and covenants, as well as financial covenants similar to the financial covenants in the New Indenture. On May 13, 2011, we reached an agreement with the Bank to extend the $10.0 million Working Capital Facility an additional twelve months to May 15, 2012, with no other changes to the provisions to the original agreement. While the Working Capital Facility currently expires in May 2012, we are permitted by the New Indenture to either renew or replace the Working Capital Facility. If at any time we do not have a working capital facility, we would intend to retain cash flow generated from operations in order to maintain cash balances of up to $7.0 million to provide liquidity, as permitted by the New Indenture, but we would be required to use monthly excess free cash flow to redeem New Notes to the extent our cash balances exceed $7.0 million. Intercompany loan receivable permitted under the Original Indenture At December 31, 2009, Morris Communications owed us $25.0 million, including accumulated interest on the intercompany loan. During 2010, we reported the $0.1 million in accrued loan receivable interest as contra equity (unrecognized interest). The average annual interest rate in 2010 was 3.3% on an average gross loan balance of $25.5 million. As part of the Restructuring, the reduction of our bondholder debt was accompanied by the cancellation of $110.0 million in aggregate principal amount, plus accrued PIK interest, of our Tranche C term loan outstanding under the Credit Agreement, as a repayment of intercompany indebtedness of $24.5 million plus -37--------------------------------------------------------------------------------- Table of Contents interest at 3.5% from September 30, 2009, and as a capital contribution. On March 1, 2010, the effective date of the Restructuring, Morris Communications settled $24.9 million of the intercompany loan receivable, with the unrecognized accumulated accrued interest being canceled, in effect, as a capital contribution. On March 1, 2010, the $1.1 million remaining balance on the intercompany loan was reclassified to a non-interest bearing receivable. The following table summarizes the Restructuring transaction: (Dollars in thousands) Reclassified as non-interest bearing Settled by short-term cancellation of Capital receivable from Outstanding as Net increase Tranche C term contribution to Morris Intercompany loan receivable of 12/31/2009 during 2010 loan Morris Publishing Communications Due from Morris Communications $ 25,000 $ 1,000 $ (24,862 ) $ - $ 1,138 Unrecognized accumulated accrued interest (6,691 ) (134 ) - 6,825 - Due from Morris Communications, net $ 18,309 $ 866 $ (24,862 ) $ 6,825 $ 1,138 -38--------------------------------------------------------------------------------- Table of Contents |