20-F/A 1 t10706e20vfza.txt FORM 20-F/A ================================================================================ AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 17, 2003 ------------ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------ FORM 20-F/A (AMENDMENT NO. 1) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 Commission File Number: 0-22346 ------------ HOLLINGER INC. (Exact name of Registrant as specified in its charter) ONTARIO, CANADA (Jurisdiction of incorporation or organization) 10 TORONTO STREET TORONTO, ONTARIO CANADA M5C 2B7 (Address of principal executive office) Securities registered pursuant to Section 12(g) of the Act: RETRACTABLE COMMON SHARES Number of outstanding shares of each of the Registrant's classes of capital or common stock at December 31, 2002: 4,580,979 SERIES II PREFERENCE SHARES 10,147,225 SERIES III PREFERENCE SHARES 32,352,047 RETRACTABLE COMMON SHARES Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark which financial statement item the Registrant has elected to follow: Item 17 Item 18 X ----- ----- ------------ INDEX TO EXHIBITS ON PAGE _____ ================================================================================ Page 1 of Pages ----- TABLE OF CONTENTS EXPLANATORY NOTE............................................................. 2 ITEM 3. KEY INFORMATION............................................... 5 ITEM 4. INFORMATION ON THE COMPANY.................................... 16 ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS.................. 29 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS............. 57 ITEM 18. FINANCIAL STATEMENTS..........................................F-1 ITEM 19. EXHIBITS...................................................... 64 SIGNATURES................................................................... 65 1 EXPLANATORY NOTE This report is being filed to amend and restate "Item 3A. Selected Financial Data", "Item 3D. Risk Factors", "Item 4D. Business Strategy", "Item 4G. Property, Plants and Equipment", "Item 5A. Operating Results", "Item 5B. Liquidity and Capital Resources", "Item 7A. Major Shareholders", "Item 7B. Related Party Transactions", "Item 18. Financial Statements" and "Item 19. Exhibits" contained in our annual report on Form 20-F for the year ended December 31, 2002 originally filed with the Securities and Exchange Commission on June 27, 2003. Item 3A Selected Financial Data As described below under "Item 18 Consolidated Balance Sheets", Selected Financial Data was amended to conform with the presentation of amounts due to related parties and amounts due from related parties in the Company's consolidated balance sheet. As a result, for the years ended December 31, 1998, 1999, 2000, 2001 and 2002, the total assets increased by $275,000 to $5,704,776,000 by $175,000 to $5,650,609,000, by $1,185,000 to $4,671,372,000, by $26,874,000 and $23,640,000 to $3,656,116,000 and $3,639,861,000, respectively. In addition, footnote 2 to the Selected Financial Data table was amended to disclose the impact on the Company's reported Canadian Generally Accepted Accounting Principles ("GAAP") consolidated statement of earnings for the years ended December 31, 1998, 1999, 2000 and 2001 and the United States GAAP consolidated statement of earnings for the years ended December 31, 2000 and 2001 in respect of goodwill and intangible assets not being amortized. The Company amended the Selected Financial data to include footnote 5 to "Diluted earnings (loss) per share". Effective January 1, 2001, the Company adopted, retroactively, with restatement, the recommendations of the CICA Section 3500, with respect to earnings per share. As a result, the diluted earnings (loss) per share were increased from $3.01 per share to $3.09 per share in 1998, from $3.83 per share to $4.39 per share in 1999 and $4.48 per share to $5.05 per share in 2000. As described below under "Item 18. Note 26 Schedule of Reconciliation to United States Generally Accepted Accounting Principles (GAAP)", retractable common shares under U.S. GAAP were retroactively reclassified outside of shareholders' deficiency for the year ended December 31, 2001 and 2002. Therefore, footnote 9 to "Capital Stock" was included in Selected Financial Data. Item 3D Risk Factors The Company amended Risk Factors to reflect the change in subsequent events as reported below under "Item 18 Note 29 Subsequent Events". Items 4D and 4G of this Form 20-F/A for the year ended December 31, 2002 have been revised. The Company has amended this Form 20-F/A to disclosure International's 100% ownership in the downtown Chicago facilities described therein. Item 5A Operating Results The Company amended under "Overview - Hollinger Inc." the change in subsequent events as reported below under "Item 18 Note 29 Subsequent Events". In addition, the "Outlook for International" was updated to reflect the current outlook as disclosed in the Company's interim consolidated financial statements for the six month period ended June 30, 2003. Under "The Company's Significant Transactions", an amendment was made to reflect the change in subsequent events as reported below under "Item 18 Note 29 Subsequent Events". As described below under "Item 18. Note 26 Schedule of Reconciliation to United States Generally Accepted Accounting Principles (GAAP)", the presentation of retractable common shares under U.S. GAAP differs from Canadian GAAP and therefore, the difference was included under "Canadian and United States Accounting Policy Differences". Item 5B of this Form 20-F/A for the year ended December 31, 2002 has been revised. Item 7 of this Form 20-F/A for the year ended December 31, 2002 has been revised. 2 Item 18 of this Form 20-F/A for the year ended December 31, 2002 has been revised for the following note disclosures: Consolidated Balance Sheets In the consolidated balance sheet as at June 30, 2003, the Company reclassified amounts due from related parties which were previously netted against amounts due to related parties. As a result, the consolidated balance sheets as at December 31, 2001 and December 31, 2002 were reclassified to conform with the current presentation of amounts due from related parties and amounts due to related parties. The net impact of the reclassification as at December 31, 2001 was to increase amounts due from related parties, total assets, amounts due to related parties and total liabilities and shareholders' deficiency by $26,874,000 to $26,874,000, $3,656,116,000, $72,793,000 and $3,656,116,000 respectively. As at December 31, 2002, the net impact of the reclassification was to increase amounts due from related parties, total assets, amounts due to related parties and total liabilities and shareholders' deficiency by $23,640,000 to $23,640,000, $3,639,861,000, $103,295,000 and $3,639,861,000 respectively. 23. Related Party Transactions In note 23d), the terms of the amount owing from Hollinger Canadian Publishing Holdings Co. ("HCPH Co.") to Ravelston Management Inc. ("RMI") were amended to appropriately reflect the interest rate and repayment terms. The amount owing to RMI by HCPH Co. is due on demand, is unsecured and is stated to bear interest at an annual rate of bankers' acceptance rate plus 4%. 26. Schedule of Reconciliation to United States Generally Accepted Accounting Principles (GAAP) In 2001 and 2002, the Company originally presented its retractable common shares as part of shareholders' deficiency. Under U.S. GAAP the retractable common shares do not qualify as permanent equity due to the retractable features being effective at the option of the holder. As a result, the retractable common shares are required to be reclassified outside of shareholders' deficiency. In addition, under U.S. GAAP loans receivable from employees relating to share purchases were originally presented in the consolidated balance sheet as a deduction from capital stock. As a result of the presentation of retractable common shares outside of shareholders' deficiency for U.S. GAAP purposes, the loans receivable from employees relating to share purchases are no longer required to be deducted from capital stock. The Company has retroactively restated its U.S. GAAP shareholders' deficiency in respect of these changes in presentation, the net impact of which was to increase the shareholders' deficiency in 2001 by $265,931,000 to $569,558,000. Accordingly, notes 26m) and 26v) have been amended to reflect the changes in the presentation of capital stock and loans receivable from employees relating to share purchases as required under U.S. GAAP. 29. Subsequent Events The Company had previously disclosed in note 29e), that effective April 30, 2003, US$15.7 million principal amount of subordinated debt owing to Hollinger International by NB Inc. was transferred by Hollinger International to HCPH Co., a subsidiary of Hollinger International, and subsequently transferred to RMI by HCPH Co. in satisfaction of loan due from HCPH Co. to RMI (note 23d)). Hollinger International and the Company previously reported that the committee of independent directors of International had agreed to the US$15.7 million offset to the remaining US$20.4 million of debt against amounts owed by International to RMI, and further stated that the offset was effected April 30, 2003. Although management of International and the Company believed final approval had been given to the offset by the committee of independent directors of International, the committee has advised that final approval of any offset remains subject to appropriate due diligence and receipt of a further independent fairness opinion. The due diligence process has not yet been concluded and accordingly, the offset has not been completed as at August 25, 2003. As a result, the Auditors' Report date has been double dated in respect of the update to note 29e) as of August 25, 2003. 3 In addition, Item 19 of this Form 20-F/A for the year ended December 31, 2002 has been revised to include certain currently dated certifications of our principal executive officer and principal financial officer. This Form 20-F/A continues to speak as of the date of the original filing and does not, and does not purport to, amend, update or restate the information in any other Item of the Form 20-F filed on June 27, 2003 or reflect any events that have occurred after such Form 20-F was filed, other than as required to reflect the amendments described above and set forth below. All information contained in this Form 20-F/A is subject to updating and supplementing as provided in our reports filed with the Securities and Exchange Commission subsequent to the date of the original filing of our annual report on Form 20-F on June 27, 2003. 4 ITEM 3. KEY INFORMATION A. SELECTED FINANCIAL DATA SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA The summary historical consolidated financial data as of December 31, 1998, 1999, 2000, 2001, and 2002 has been derived from the audited consolidated financial statements of the Company. The following data should be read in conjunction with "Item 5 - Operating Financial Review and Prospects" and the consolidated financial statements and notes thereto of the Company, included elsewhere in this report. Our consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("Canadian GAAP"). For a discussion of the material differences between Canadian GAAP and United States generally accepted accounting principles ("US GAAP"), see note 26 to our audited consolidated financial statements.
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------- 1998 1999 2000 2001 2002 ----------- ----------- ----------- ----------- ------------ (ALL AMOUNTS IN THOUSANDS OF CANADIAN DOLLARS) OPERATING DATA: Canadian GAAP: Revenue Sales......................... $ 3,319,188 $ 3,241,319 $ 3,158,280 $ 1,822,060 $ 1,628,198 Investment and other income.. 22,464 18,953 28,146 97,282 29,729 ------------ ------------ ------------ ------------ ------------ 3,341,652 3,260,272 3,186,426 1,919,342 1,657,927 ------------ ------------ ------------ ------------ ------------ Expenses Cost of sales and expenses(1). 2,620,177 2,647,465 2,586,183 1,730,108 1453,894 Depreciation and amortization(2)............. 209,498 228,802 219,932 144,716 88,193 Interest expense(3).......... 233,878 258,231 274,331 177,926 121,747 ------------ ------------ ------------ ------------ ------------ 3,063,553 3,134,498 3,080,446 2,052,750 1,663,834 ------------ ------------ ------------ ------------ ------------ Net earnings (loss) in equity accounted companies.......... (616) 1,211 (14,115) (18,571) (1,233) ------------ ------------ ------------ ------------ ------------ Net foreign currency gains (losses)..................... (2,230) 3,911 (12,288) (7,470) (19,741) ------------ ------------ ------------ ------------ ------------
5 Earnings (loss) before the undernoted................... 275,253 130,896 79,577 (159,449) (26,881) Unusual items................ 404,519 413,397 700,945 (295,434) (62,630) Income tax recovery (expense)(4)................ (300,929) (207,263) (260,091) 89,477 (124,025) Minority interest recovery (expense)................... (267,358) (182,215) (331,058) 233,508 124,896 ------------ ------------ ------------ ------------ ------------ Net earnings (loss)........... $ 111,485 $ 154,815 $ 189,373 $ (131,898) $ (88,640) ============ ============ ============ ============ ============ Dividends per retractable common share(5) $ 0.60 $ 0.60 $ 0.60 $0.60 $ 0.60 Basic net earnings (loss) per share $ 3.35 $ 4.43 $ 5.11 $ (3.91) $ (2.76) Diluted net earnings (loss) per share(6) $ 3.09 $ 4.39 $ 5.05 $ (4.17) $ (2.79) US GAAP: Revenue(7).................... $ 3,109,670 $ 1,774,255 $ 1,579,663 Net earnings (loss)........... $ 86,281 $ (82,047) $ (83,760) Basic earnings (loss) before cumulative effect of change in accounting principles, per share $ 1.52 $ (2.33) $ (2.32) Basic net earnings (loss) per share $ 1.52 $ (2.33) $ (2.70) Diluted earnings (loss) before cumulative effect of change in accounting principles, per share $ 1.42 $ (2.62) $ (2.35) Diluted net earnings (loss) per share $ 1.42 $ (2.62) $ (2.73) BALANCE SHEET DATA (AT PERIOD END): Canadian GAAP: Total assets.................. $ 5,704,776 $ 5,650,609 $ 4,671,372 $ 3,656,116 $ 3,639,861 Bank indebtedness............. $ 232,128 $ 307,961 $ 312,000 $ 129,475 $ 90,810 Long-term debt, including current portion(8)........... $ 2,412,749 $ 2,465,416 $ 1,276,920 $ 1,351,626 $ 1,789,321 Capital stock(9)................ $ 240,434 $ 315,229 $ 308,263 $ 271,774 $ 273,759 Net assets...................... $ (67,168) $ 138,888 $ (68,431) $ (263,470) $ (351,331) Weighted average number of common shares outstanding during the period (thousands)... 33,152 34,971 37,041 33,740 32,064
---------- (1) The Company adopted effective January 1, 1999, on a retroactive basis, a new Canadian accounting standard issued by The Canadian Institute of Chartered Accountants ("CICA") with respect to accounting for employee future benefits, including pension and non-pension post-retirement benefits. The Company elected not to restate the comparative figures for periods prior to 1999 for this change in accounting policy. The cumulative effect of adopting the new standard in 1999 under Canadian GAAP was to increase the deficit as at January 1, 1999 by $7.8 million. (2) Effective January 1, 2002, the Company implemented on a prospective basis CICA Handbook Section 3062 ("HB 3062"), "Goodwill and Other Intangible Assets", which is consistent with SFAS No. 142 in the U.S. The new standard requires that goodwill and intangible assets with indefinite lives no longer be amortized, but instead be tested for impairment at least annually. The transitional provisions of HB 3062 and SFAS No. 142 require the Company to assess whether goodwill is impaired as of January 1, 2002. The Company completed its transitional impairment testing for goodwill and recorded an impairment charge of $32.0 million in respect of the goodwill for the Jerusalem Post operation. Such loss, net of related minority interest, amounted to $12.1 million and was recorded as a charge to the opening deficit as at January 1, 2002 under Canadian GAAP (as a cumulative effect of a change in accounting 6 principle under US GAAP). At January 1, 2002, the Company has unamortized goodwill in the amount of $905.6 million, which is no longer being amortized. This amount is before any reduction for the transitional impairment. This change in accounting policy cannot be applied retroactively and the amounts presented for prior periods have not been restated for this change. If this change in accounting policy were applied to the reported Canadian GAAP consolidated statement of earnings for the years ended December 31, 1998, 1999, 2000 and 2001 and the U.S. GAAP consolidated statement of earnings for the years ended December 31, 2000 and 2001, the impact of the change, in respect of goodwill and intangible assets not being amortized, would be as follows:
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 1998 1999 2000 2001 ----------- ----------- ----------- ------------ (ALL AMOUNTS THOUSANDS OF CANADIAN DOLLARS EXCEPT PER SHARE AMOUNTS) Canadian GAAP Net earnings (loss), as reported.............. $111,485 $154,815 $189,373 $(131,898) Add goodwill and intangible asset amortization net of income taxes and minority interest... 31,113 36,829 31,384 16,978 -------- -------- -------- --------- Adjusted net earnings (loss).................. $142,598 $191,644 $220,757 $(114,920) ======== ======== ======== ========= Basic earnings (loss) per share -- as reported.................................... $ 3.35 $ 4.43 $ 5.11 $ (3.91) Basic adjusted earnings (loss) per share...... $ 4.29 $ 5.48 $ 5.97 $ (3.41) Diluted earnings (loss) per share -- as reported(6)................................. $ 3.09 $ 4.39 $ 5.05 $ (4.17) Diluted adjusted earnings (loss) per share.... $ 3.99 $ 5.36 $ 5.90 $ (3.64)
YEAR ENDED DECEMBER 31, ------------------------ 2000 2001 ---------- ----------- U.S. GAAP Net earnings (loss), as reported............................ $ 86,281 $ (82,047) Add goodwill and intangible asset amortization net of income taxes and minority interest............................... 38,668 17,548 -------- --------- Adjusted net earnings (loss)................................ $124,949 $ (64,499) ======== ========= Basic earnings (loss) per share -- as reported.............. $ 1.52 $ (2.33) Basic adjusted earnings (loss) per share.................... $ 2.56 $ (1.81) Diluted earnings (loss) per share -- as reported............ $ 1.42 $ (2.62) Diluted adjusted earnings (loss) per share.................. $ 2.46 $ (2.10)
Adjusted net earnings (loss), noted above, in respect of both US and Canadian GAAP, reflects only the reduction in amortization expense of intangibles now classified as goodwill and does not give effect to the impact that this change in accounting policy would have had on the gains and losses resulting from the disposal of operations during 1998, 1999, 2000 and 2001, nor the expensing of the costs previously capitalized under Canadian GAAP to increase long-term readership in 1998, 1999, 2000 and 2001. (3) Total interest expense is the sum of interest on long-term debt and other interest. (4) The Company adopted effective January 1, 2000, on a retroactive basis, a new Canadian accounting standard issued by the CICA with respect to accounting for income taxes. The Company elected not to restate the comparative figures for periods prior to 2000 for this change in accounting policy. The cumulative effect of adopting the new standard in 2000 under Canadian GAAP was to increase the deficit as at January 1, 2000 by $291.0 million. (5) Effective January 1, 2001, the Company adopted, retroactively with restatement, the recommendations of the CICA Section 3500 with respect to earnings per share. Under the revised standard, the treasury stock method is used instead of the imputed earnings approach for determining the dilutive effect of options, issued warrants or other similar instruments. The change in the method of calculation of earnings per share did not impact the previously reported basic earnings per share for 1998, 1999 and 2000. Diluted earnings per share for 1998 were increased from $3.01 per share to $3.09 per share, for 1999 were increased from $3.83 per share to $4.39 per share and for 2000 were increased from $4.48 per share to $5.05 per share. (6) Dividends include stock dividends. Based on the average foreign exchange rate for the period, the US dollar equivalent of the dividends per retractable common share is US$0.40, US$0.40, US$0.40, US$0.39 and US$0.38 for the years ended December 31, 1998, 1999, 2000, 2001 and 2002. (7) Under Canadian GAAP, the Company is required to proportionately consolidate its 50% interest in its joint ventures, resulting in higher revenues under Canadian GAAP than under US GAAP. (8) Long-term debt including current portion, excludes retractable preference shares. (9) For Canadian GAAP, common shares which are retractable at the option of the holder are included in shareholders' deficiency, whereas, under U.S. GAAP, the retractable common shares would be excluded from shareholders' deficiency. EXCHANGE RATE The following table sets out, for each period indicated, the high and low exchange rates for one U.S. dollar expressed in Canadian dollars, the average of such exchange rates on the last day of each month during such period, and the exchange rate at the end of such period, based upon the noon rate of exchange as reported by the Federal Reserve Bank of New York (the "Noon Rate"):
FISCAL YEAR ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 2001 2002 ------ ------ ------ ------ ------ High............................... 1.5720 1.5302 1.5600 1.6023 1.6126 Low................................ 1.4075 1.4440 1.4435 1.4933 1.5108 Average............................ 1.4902 1.4827 1.4871 1.5519 1.5702 Period End......................... 1.5375 1.4400 1.4995 1.5925 1.5800
7 The following table sets out for the last six months the high and low exchange rates for one U.S. dollar expressed in Canadian dollars, based upon the Noon Rate:
DECEMBER JANUARY FEBRUARY MARCH APRIL MAY -------- ------- --------- ------ ----- --- 2002 2003 2003 2003 2003 2003 ---- ---- ---- ---- ---- ---- High........... 1.5800 1.5750 1.5315 1.4905 1.4831 1.4221 Low............ 1.5478 1.5220 1.4880 1.4659 1.4336 1.3446
On December 31, 2002, the Noon Rate was Cdn. $1.5800 = U.S.$1 and on June 12, 2003, the Noon Rate was Cdn. $1.3492 = U.S.$1. D. RISK FACTORS Holders and prospective purchasers of the Company's Series II preference shares, Series III preference shares and retractable common shares should consider carefully all of the information set forth in this Annual Report and, in particular, should evaluate the following risks in connection with an investment in the Series II preference shares, Series III preference shares and retractable common shares. Information contained or incorporated by reference in this Annual Report contains forward-looking terminology such as "believes", "expects", "may", "will", "should" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or discussions of strategy. Such statements include, without limitation, the Company's beliefs about trends in the industry and its views about the long-term future of the industry and the Company. See "Item 5. Operating and Financial Review and Prospects" and "Item 4. Information on the Company." No assurance can be given that the future results covered by the forward-looking statements including certain risks and uncertainties that could cause actual results in the future to vary materially from the future results covered in such forward-looking statements. Other factors could also cause actual results in the future to vary materially from the future results covered in such forward-looking statements. RISKS RELATED TO THE COMPANY'S CASH FLOWS AND CAPITAL STRUCTURE THE COMPANY DEPENDS ON THE FINANCIAL SUPPORT OF RMI TO SATISFY CERTAIN OF ITS OBLIGATIONS. On a non-consolidated basis, the Company has experienced a shortfall between the dividends and fees received from its subsidiaries and its operating costs, including interest and dividends on its preference shares, and such shortfalls are expected to continue in the future. Accordingly, the Company is dependent upon the continuing financial support of RMI to fund such shortfalls and, therefore, pay its liabilities as they fall due. Prior to March 10, 2003 such shortfalls were funded by Ravelston and RMI on an informal basis. On March 10, 2003, concurrent with the issue by the Company of US$120.0 million Senior Secured Notes due 2011, RMI entered into a Support Agreement with the Company. Under the agreement, RMI has agreed to make annual support payments in cash to the Company on a periodic basis by way of contributions to the capital of the Company (without the issuance of additional shares of the Company) or subordinated debt. The annual support payments will be equal to the greater of (a) the Company's negative net cash flow (as defined) for the relevant period (which does not extend to outlays for retractions or redemptions), determined on a non-consolidated basis, and (b) US$14.0 million per year (less any payments of management services fees by International directly to the Company or NB Inc. and any excess in the net dividend amount that the Company and NB Inc. receive from International over US$4.65 million per year), in either case reduced by any permanent repayment of debt owing by Ravelston to the Company. Pursuant to this arrangement, RMI has made payments to the Company in respect of the period from March 10 to June 30, 2003 in the amount of US$6.2 million. Under the terms of the Senior Secured Notes if in any quarterly period after April 1, 2003, the Company fails to receive in cash, a minimum aggregate amount of at least US $4.7 million from a) payments made by RMI pursuant to the Support Agreement and b) dividends paid by International on its shares held by the Company and NB Inc., the Company would be in default under its Senior Secured Notes and they could become due and payable immediately. RMI DEPENDS ON CONTINUING TO RECEIVE SUFFICIENT FEES FROM INTERNATIONAL PURSUANT TO THE SERVICES AGREEMENTS TO CONTINUE TO PROVIDE THE REQUIRED FINANCIAL SUPPORT TO THE COMPANY UNDER THE SUPPORT AGREEMENT. 8 RMI currently derives all of its income and operating cash flow from the fees paid pursuant to Services Agreements with International and its subsidiaries. RMI's ability to provide the required financial support under the Support Agreement with the Company is substantially dependent on RMI continuing to receive sufficient fees pursuant to those Services Agreements. The Services Agreements may be terminated by either party by giving 180 days notice. The fees in respect of the Services Agreements are negotiated annually with and approved by the audit committee of International. The fees to be paid to RMI for the year ending December 31, 2003 amount to approximately US $22.0 million to US $24.0 million and were approved in February 2003. The fees in respect of the periods after December 31, 2003 have not yet been negotiated or approved. As described more fully in note 12 to the June 30, 2003 unaudited interim consolidated financial statements, a shareholder of International has requested that the Board of International investigate and, if determined to be advisable, take corrective action in respect of certain matters, including the payment of fees by International pursuant to management services agreements with RMI. Although the Board of International has established a special committee of the Board of Directors to conduct an independent review and investigation of the matters, the timing and outcome of the process and the impact on the Company and RMI is uncertain at this time. Based on the Company's current investment in International and the current quarterly dividend paid by International of US$0.05 per share: (i) the minimum support payment required to be made by RMI to avoid a default under the terms of the Senior Secured Notes is approximately US$14.0 million annually and (ii) the Company estimates the support payment required by RMI to fund its negative net cash flow will approximate US$20.0 million for the twelve months ending June 30, 2004. This amount assumes payment by the Company of preference share dividends of approximately US$5.0 million which have yet to be considered by the Board of Directors and which depend on the Company having the ability under corporate law to pay such dividends. The Company's ongoing liquidity, on a non-consolidated basis, continues to depend to a large degree on support payments from RMI which in turn depends on fees received pursuant to its services agreements with International. If the Company does not receive support payments of a least US$15.0 million for the twelve months ending June 30, 2004, based on the above assumptions, then it will be required to dispose of assets or seek financing in order to meet its non-consolidated obligations as they fall due. The Company is contemplating a variety of initiatives to address the potential matters referred to above, however at this time there can be no certainty that such initiatives will be completed. In addition, Publishing's Senior Credit Facility agreement limits the amount of fees payable pursuant to Services Agreements by Publishing and its subsidiaries, excluding the Canadian Newspaper Group, (together, the "Restricted Group") in any fiscal year as not to exceed the greater of US$ 22.0 million or 2.5% of total revenue of the Restricted Group. INTERNATIONAL DEPENDS ON THE CASH FLOW OF ITS SUBSIDIARIES TO SATISFY ITS OBLIGATIONS, INCLUDING DIVIDENDS AND PAYMENTS UNDER THE SERVICE AGREEMENTS. THE AMOUNT OF DIVIDENDS THE COMPANY RECEIVES FROM INTERNATIONAL MAY CHANGE. International is a holding company and owns no significant assets other than its equity interest in Publishing. Therefore, International is largely dependent upon the cash flow of its subsidiaries, principally Publishing and its subsidiaries, to meet its obligations, including the payment of dividends and amounts under the Services Agreements. International's subsidiaries and affiliated companies are under no obligation to pay dividends to International. In the case of Publishing and its principal United States and foreign subsidiaries, those companies are subject to statutory restrictions and restrictions in Publishing's Senior Credit Facility and the Senior Notes due 2010 (the "Publishing Notes") that limit their ability to pay dividends to International and are subject to restrictions in Publishing's Senior Credit Facility that limit their ability to pay fees under the Services Agreements. Recently, International reduced its dividends from US$0.11 per share per quarter in June 2002 to US$0.05 per share per quarter commencing September 2002 and future quarterly dividends could be further decreased. Reductions in the International dividend will increase the minimum support payment required to be made by RMI to fund the Company's negative net cash flow. Any failure by RMI to receive from International and its subsidiaries amounts under the Services Agreement, either in conjunction with a decrease in International dividends or not, could have a material adverse effect on the Company. THE ASSETS AND CASH FLOW OF INTERNATIONAL AND ITS SUBSIDIARIES ARE SUBJECT TO THE PRIOR CLAIMS OF OTHERS AND ARE NOT SUBJECT TO THE RESTRICTIVE COVENANTS CONTAINED IN THE TERMS OF THE SENIOR SECURED NOTES. Substantially all of the shares, properties and assets of certain of International's subsidiaries, including Publishing and certain of its subsidiaries, have been pledged to the lenders under the Publishing's Senior Credit Facility. The Company's right to participate in the distribution of assets of any subsidiary or affiliated company upon its liquidation or reorganization will be subject to the prior claims of the creditors of such subsidiary or affiliated company, including trade creditors, except to the extent that the Company may itself be a creditor with recognized claims against such subsidiary or affiliated company. Further, the Company and its restricted subsidiaries have agreed to certain restrictive covenants under the terms of the Senior Secured Notes. Because International and its subsidiaries will not be restricted subsidiaries for purposes of the indenture governing the Senior Secured Notes, such covenants will not apply to them. Therefore any cash flow generated by International and its subsidiaries and the proceeds from any sale of such subsidiaries will not be subject to the restrictive covenants contained in the indenture. International and its subsidiaries generate substantially all of the Company's total consolidated revenues and comprise substantially all of total consolidated assets. 9 ALL OF THE SHARES OF THE COMPANY ARE EXCHANGEABLE, REDEEMABLE OR RETRACTABLE. IF HOLDERS OF THE COMPANY'S SHARES ELECT TO EXCHANGE, REDEEM OR RETRACT THOSE SHARES, AS THE CASE MAY BE, THIS COULD HAVE A MATERIAL IMPACT ON THE FINANCIAL CONDITION OF THE COMPANY AND THE COMPANY MAY NOT BE ABLE TO SATISFY SUCH EXCHANGES, REDEMPTIONS OR RETRACTIONS. As a result of steps taken during 1997 and 1998, all of the shares of the Company are exchangeable, redeemable or retractable. The retractable common shares and Series II preference shares are retractable for shares of International's Class A common stock (or equivalent value if the Company exercises its option to redeem for cash) and the series III preference shares are retractable for cash. This enables the Company to qualify as a "mutual fund corporation" for purposes of the Income Tax Act (Canada). In the event that holders of the Company's shares elect to exchange, redeem or retract their shares for shares of International's Class A common stock, this would have a material impact on the financial condition of the Company and the Company may not be able to satisfy such exchanges, redemptions or retractions. The Company's issued capital stock consists of Series II preference shares, Series III preference shares and retractable common shares, each of which is retractable at the option of the holder. There is uncertainty regarding the Company's ability to meet future retractions of preference shares and retractable common shares. Under corporate law, the Company is not required to make any payment to redeem any shares in certain circumstances, including if the Company's liquidity would be unduly impaired as a consequence. If, when shares are submitted by holders for retraction or when the Series III preference shares mature on April 30, 2004, there are reasonable grounds for believing that, after making the payment in respect of those shares, the Company's liquidity would be unduly impaired, the retractions and redemptions will not be completed. In such event, shareholders would not become creditors of the Company but would remain as shareholders until such time as the retraction is able to be completed under applicable law. The Company's uncertain ability to make payments on future retractions and redemptions of shares is due to the fact that liquidity of its assets is limited at present, given that substantially all of its shares of International common stock were provided as security for the Senior Secured Notes. During the period April 1, 2003 to May 16, 2003 holders of 3,651,784 Series III preference shares, holders of 504,989 Series II preference shares, and holders of 22,500 retractable common shares submitted retraction notices to the Company. As of May 20, 2003, the Company completed or announced that it was able to complete the retraction of 504,989 Series II preference shares for 232,293 shares of International Class A common stock, 876,050 Series III preference shares for approximately $7.7 million in cash and 22,500 retractable common shares for cash of $124,000. This completed all retraction notices received up to and including April 30, 2003. On May 20, 2003, after careful deliberation, the Company concluded that it was not able to complete the retractions of shares submitted after April 30, 2003 without unduly impairing its liquidity. Since April 30, 2003 and up to and including June 19, 2003, the Company has received retraction notices from holders of 2,939,543 Series III preference shares of which 1,281,239 retraction notices were subsequently withdrawn, leaving retraction notices from holders of 1,658,354 Series III preference shares for aggregate retraction proceeds of approximately $15.8 million which are unable to be completed at the current time. In addition, during the same time period, retraction notices were received from the holders of 357,958 Series II preference shares for aggregate retraction proceeds of 164,660 shares of International Class A common stock or cash of approximately $2.5 million, which are unable to be completed at the current time. Giving effect to the retractions completed as of June 19, 2003, there continues to be outstanding 3,775,990 Series II preference shares (exchangeable for 1,736,955 shares of Class A common stock of International), 9,271,175 Series III preference shares and 32,917,186 retractable common shares. The Company's Series III preference shares have a fixed redemption date on April 30, 2004 for a cash payment of $10.00 per share plus any accrued and unpaid dividends to that date. The total cost to redeem all of the issued and outstanding Series III preference shares would be $92.7 million.. The Company will periodically review its liquidity position to determine if and when further retractions can be completed. The Company will not complete retractions or redemptions if to do so would unduly impair its liquidity. Retractions of Series II preference shares and Series III preference shares will be processed on a combined basis in order determined by their retraction date (with equal ranking of the series) in advance of any retractable common shares that are submitted for retraction. Following the satisfaction of all pending retracted Series II preference shares and Series III preference shares, retractions of the retractable common shares will be processed in order 10 determined by their retraction date. Accordingly, retractions of retractable common shares cannot be completed as long as there are pending and unsatisfied retractions of Series II preference shares and Series III preference shares. IF THE SHARES OF INTERNATIONAL'S CLASS B COMMON STOCK ARE SUBJECT TO ANY FORECLOSURE, REALIZATION OR OTHER SIMILAR ACTION, SUCH STOCK MAY BE AUTOMATICALLY CONVERTED INTO SHARES OF CLASS A COMMON STOCK OF INTERNATIONAL AND, AS A RESULT, LOSE THEIR MULTIPLE VOTING RIGHTS. Under International's certificate of incorporation, each share of International's Class B common stock is entitled to certain multiple voting rights per share. However, in the event that shares of Class B common stock pledged as collateral security for indebtedness become subject to any foreclosure, realization or other similar action by a third party pledgee, unless such shares are transferred to a third party purchaser who purchases or obtains the shares of Class B common stock in a "Permitted Transaction", they will be automatically converted into fully paid and non-assessable shares of International's Class A common stock on a share-for-share basis. A Permitted Transaction, as defined in International's certificate of incorporation, is a transaction with respect to shares of Class B common stock between a third party and the Company, its subsidiaries or affiliates, in which, or as part of which, the third party makes a bona fide tender offer, in compliance with the applicable securities and other laws, to purchase all of the outstanding shares of Class A common stock from the holders for an amount in cash or other consideration equal to the amount per share to be received by the record holder of shares of Class B common stock, and such tender offer is successfully consummated. Accordingly, it is unlikely that upon a foreclosure or realization on the pledged shares of Class B common stock by the collateral agent acting on behalf of holders of the Senior Secured Notes, the collateral agent would be able to exercise the same degree of control over International based upon its ownership of such stock as Lord Black, the controlling shareholder of the Company and International, currently does. RESTRICTIVE COVENANTS IN THE SENIOR SECURED NOTES ISSUED BY THE COMPANY COULD ADVERSELY AFFECT BUSINESS BY LIMITING THE COMPANY'S OPERATING AND STRATEGIC FLEXIBILITY. The indenture governing the Senior Secured Notes contains restrictive covenants, subject to certain exceptions, that limit the Company's ability to: - incur more debt or guarantee indebtedness; - pay dividends on its capital stock or redeem, repurchase or retire its capital stock or subordinated indebtedness, or make distributions or investments; - enter into transactions with affiliates; - create liens; - merge, consolidate or sell assets; and - sell or issue capital stock. As a result of these covenants, the Company's ability to respond to changing business and economic conditions may be significantly restricted and the Company may be prevented from engaging in transactions that might otherwise be beneficial. Any breach of these covenants could cause a default. RISKS RELATED TO INTERNATIONAL'S BUSINESS AND THE INDUSTRY Since the Company's asset value is derived from its investment in International, the Company is subject to the following risks that affect International and its business. RESTRICTIVE COVENANTS IN THE PUBLISHING NOTES AND PUBLISHING'S SENIOR CREDIT FACILITY COULD ADVERSELY AFFECT INTERNATIONAL'S BUSINESS BY LIMITING INTERNATIONAL'S OPERATING AND STRATEGIC FLEXIBILITY. The Senior Credit Facility and the indenture governing the Publishing Notes contain restrictive covenants, subject to certain exceptions, that limit Publishing's and its restricted subsidiaries' ability to: 11 - incur more debt or guarantee indebtedness; - pay dividends on their capital stock or redeem, repurchase or retire their capital stock or subordinated indebtedness, or make distributions or investments; - enter into transactions with affiliates; - create liens; - merge, consolidate or sell assets; - sell or issue capital stock; and - pay dividends or other amounts to Publishing from restricted subsidiaries. As a result of these covenants, International's ability to respond to changing business and economic conditions may be significantly restricted and International may be prevented from engaging in transactions that might otherwise be beneficial. Any breach of these covenants could cause a default under the Senior Credit Facility or Publishing Notes. INTERNATIONAL TOGETHER WITH ITS SUBSIDIARIES HAS A SIGNIFICANT DEGREE OF LEVERAGE AND SUBSTANTIAL DEBT SERVICE OBLIGATIONS AND ARE SUBJECT TO DEBT COVENANTS THAT COULD LIMIT THEIR ABILITY TO MAKE DEBT REDUCTIONS AND DISTRIBUTIONS. The instruments governing the terms of the principal indebtedness of International, Publishing and its principal United States and foreign subsidiaries, contain various covenants, events of default and other provisions that could limit International's financial flexibility, including the payment of dividends with respect to outstanding common stock and the pursuit of a growth strategy. Amongst the various covenants are several financial covenants requiring certain of International's subsidiaries to maintain stipulated leverage, fixed charge and interest coverage ratios. Failure to maintain the stipulated ratios could lead to increased interest costs, acceleration of certain time periods in the underlying documents, a prohibition of certain activities and restriction on the payment of dividends to the Company. International's Senior Credit Facility is denominated in US dollars and bears interest at floating rates referenced to several short term alternatives. In December 2002, International entered into cross currency (U.S. dollars to pounds sterling) floating to fixed swaps in respect of all borrowings under the Senior Credit Facility. The swap agreements, which mature December 2008 in respect of Term Loan A and December 2009 in respect of Term Loan B, have been entered into for US$265.0 million, being the full amount of borrowings under each of the term loans, at a weighted average rate of 8.47%. A UK subsidiary of International's is the borrower of amounts outstanding under the Senior Credit Facility. In 2003 Publishing entered into fixed to floating swap agreements to reduce International's effective rate of borrowing under US$250.0 million of Publishing's Senior Notes. A total of US$300.0 million of 9% Senior Notes is outstanding. The effective rate for the first six months is a blended rate of 5.98%. The swaps mature December 15, 2010, the same date on which the underlying notes mature. International relies on distributions from subsidiaries to meet its financial obligations. International is an international holding company and its assets consist solely of investments in its subsidiaries and affiliated companies. As a result, International ability to meet its future financial obligations is dependent upon the availability of cash flows from its domestic and foreign subsidiaries through dividends, intercompany advances, management fees and other payments. Similarly, International's ability to pay dividends on its common stock may be limited as a result of International's dependence upon the distribution of earnings of its subsidiaries and affiliated companies. International's subsidiaries and affiliated companies are under no obligation to pay dividends and, in the case of Publishing and its principal domestic and foreign subsidiaries, are subject to statutory restrictions and restrictions in debt agreements that limit their ability to pay dividends. Substantially all of the shares of International's non-Canadian subsidiaries have been pledged to lenders of International. International's right to participate in the distribution of assets of any subsidiary or affiliated company upon its liquidation or reorganization will be subject to the prior claims of the creditors of such subsidiary or affiliated company, including trade creditors, except to the extent that International may be a creditor with recognized claims against such subsidiary or affiliated company. INTERNATIONAL'S REVENUES ARE CYCLICAL AND DEPENDENT UPON GENERAL ECONOMIC CONDITIONS IN ITS NEWSPAPERS' TARGET MARKETS. Advertising and circulation are International's two primary sources of revenue. International's advertising revenues and, to a lesser extent, circulation revenues, are cyclical and dependent upon general economic conditions in its newspapers' target markets. Historically, increases in advertising revenues have corresponded with economic recoveries while decreases, as well as changes in the mix of advertising, have corresponded with general economic downturns and regional and local economic recessions. In 2001, due to the general downturn in the economy, advertising revenue for the Chicago Group on a same store 52-week basis was lower by US$20.0 million or 6.7% compared with 2000, and advertising revenue for the U.K. Newspaper Group was lower by L27.2 million or 10.6% (in local currency terms). Advertising revenue stabilized somewhat for the Chicago Group in the year ended December 31, 2002, as it was up marginally by 0.8% over the prior year. However, advertising revenue for the U.K. Newspaper Group continued to reflect difficult economic conditions, as it was lower by L17.7 million or 7.7% in 12 2002 compared to the prior year and for the three months ended March 31, 2003, in level currency, was 6.5% lower than the first quarter of 2002. In addition, International's dependency on advertising sales, which generally have a short lead-time, means that International has only a limited ability to accurately predict future results. INTERNATIONAL'S FOREIGN OPERATIONS AND ASSETS SUBJECT IT TO CURRENCY EXCHANGE RATE FLUCTUATIONS; ADVERSE MOVEMENTS IN EXCHANGE RATES MAY NEGATIVELY IMPACT INTERNATIONAL'S NET EARNINGS. Operations outside of the United States, principally in the U.K. Newspaper Group, accounted for approximately 56.1% of International's operating revenues and approximately 53.3% of International's operating income (excluding expenses incurred by the Investment and Corporate Group) for the year ended December 31, 2002. Generally, International does not hedge against foreign currency exchange rate risks except through borrowings in those currencies. As a result, International may experience economic loss and a negative impact on earnings with respect to its investments and on earnings of its foreign subsidiaries, solely as a result of currency exchange rate fluctuations (principally any weakening of the pound sterling against the U.S. dollar). In 2001, International and the Partnership sold participation interests ("Participations") in $756.8 million principal amount of debentures of a subsidiary of CanWest Global Communications Corp. ("CanWest") to a special purpose trust ("Participation Trust") at an exchange rate of US$0.6482 to each Canadian dollar which translates into US$ 490.5 million. Units of the Participation Trust, denominated in U.S. dollars, were in turn issued and sold by the Participation Trust to third parties. In respect of the underlying CanWest debentures, based on the original Canadian dollar principal amount, International will be required to deliver to the Participation Trust, US$490.5 million at the then current exchange rate, plus interest received. On September 30, 2002, International unwound certain foreign currency contracts and as a consequence its foreign exchange exposure on CanWest debentures is no longer hedged. At December 31, 2002, the accrued liability to the Participation Trust was US$575.9 million and the corresponding CanWest debentures had a principal amount receivable of $888.2 million. A US$0.05 change in the U.S. dollar to Canadian dollar exchange rate applied to the $888.2 million principal amount of CanWest debentures at December 31, 2002 would result in a US$44.4 million loss or gain to International. On May 11, 2003, CanWest redeemed $265 million of the debentures of which U.S.$159.8 million has been delivered to the Participation Trust and the balance of US$27.6 million has been received by International and the Partnership, a portion of which must be retained until November 4, 2010. This will reduce the International's obligation to the Trust and hence its exposure to changes in the U.S. dollar to Canadian dollar exchange rate. NEWSPRINT REPRESENTS INTERNATIONAL'S SINGLE LARGEST RAW MATERIAL EXPENSE AND INCREASES IN THE PRICE OF NEWSPRINT COULD DECREASE ITS NET EARNINGS. Newsprint represents International's single largest raw material expense and is its most significant operating cost, other than employee costs. In 2002, newsprint costs represented approximately 15.0% of International's revenues. Newsprint costs vary widely from time to time and trends in pricing can vary between geographic regions. During the first half of 2001, newsprint prices in North America were at their highest price per tonne since 1994 and 1995. However, the recessionary climate in 2001 caused a significant decline in industry consumption and this, coupled with an abundant supply of competitively priced newsprint, resulted in a downward trend in prices during the second half of 2001. This downward trend continued into 2002; however, there are indications that prices may moderately increase in the near term from their current levels. In the United Kingdom, International's newsprint prices payable in 2002, which are subject to longer-term contracts, were less than the average prices paid in 2001. If newsprint prices increase in the future and International cannot pass these costs on to its customers, such increases may have a material adverse effect on its results of operations. Although International has implemented measures in an attempt to offset a rise in newsprint prices, such as reducing page width where practical and managing its return policy, price increases have in the past had a material adverse effect on International and may do so again in the future. 13 COMPETITION IN THE NEWSPAPER INDUSTRY ORIGINATES FROM MANY SOURCES. THE ADVENT OF NEW TECHNOLOGIES AND INDUSTRY PRACTICES, SUCH AS THE PROVISION OF NEWSPAPER CONTENT ON FREE INTERNET SITES, MAY DECREASE INTERNATIONAL'S SALES OR FORCE INTERNATIONAL TO MAKE OTHER CHANGES THAT HARM ITS OPERATING PERFORMANCE. Revenues in the newspaper industry are dependent primarily upon advertising revenues and paid circulation. Competition for advertising and circulation revenue comes from local and regional newspapers, radio, broadcast and cable television, direct mail, and other communications and advertising media that operate in International's markets. The extent and nature of such competition is, in large part, determined by the location and demographics of the markets and the number of media alternatives in those markets. Some of International's competitors are larger and have greater financial resources than International. In the past, newspapers which compete in some of International's markets have chosen to reduce their cover prices and/or decrease the price of bulk sales in efforts to increase their circulation at the expense of International's newspapers. Price competition has been particularly intense in the United Kingdom and Chicago, Illinois in recent years. These actions have in the past forced International to similarly reduce its cover prices and/or decrease the price of bulk sales, which has had a negative effect on its sales revenues and overall financial performance. International may experience price competition from competing newspapers and other media sources in the future that force International to make similar reductions, which would again decrease its operating results and circulation revenues. In addition, the use of alternative means of delivery, such as free Internet sites, for news and other content has increased significantly in the past few years. In the event that significant numbers of International's customers choose to receive content using these alternative delivery sources rather than International's newspapers, International may be forced to decrease the prices it charges for its newspapers or make other changes in the way it operates, or International may face a long-term decline in circulation, any or all of which may harm International's financial and operating performance. INTERNATIONAL'S PUBLICATIONS HAVE EXPERIENCED DECLINES IN CIRCULATION IN THE PAST AND MAY DO SO IN THE FUTURE. The Chicago Sun-Times and The Daily Telegraph have experienced small declines in circulation. According to figures published by the Audit Bureau of Circulations, circulation of the Chicago Sun-Times experienced a compounded annual growth rate (CAGR) of minus 1.0% since it was acquired in 1994, through 2002, while circulation of The Daily Telegraph experienced a CAGR of minus 1.3% from September 1996 through 2002. International believes that the principal factors contributing to the declines in circulation include the competitive factors described above and the use of alternative means of information delivery such as the Internet. From 2000 through 2002, average daily circulation (Monday to Friday) of the Chicago Sun-Times has stabilized and shown a slight increase. However, there is a risk that circulation of International's newspapers will decline in the future. A significant decline in circulation could have a material adverse effect on International's business and financial performance. IF INTERNATIONAL FAILS TO IMPLEMENT ITS BUSINESS STRATEGY, ITS BUSINESS WILL BE ADVERSELY AFFECTED. International's future financial performance and success are dependent in large part upon its ability to successfully implement its business strategy. There is a risk that International will not be able to successfully implement its business strategy or be able to improve its operating results. In particular, there is a risk that International will not be able to increase circulation of its publications, obtain new sources of advertising revenues, generate additional revenues by building on the brand names of its publications or raise the cover prices of its publications without causing a decline in circulation. Furthermore, any growth through acquisitions and investments will be dependent upon identifying suitable acquisition or investment candidates and successfully consummating such transactions and integrating the acquired operations at reasonable costs. International may not be able to successfully integrate any acquired businesses and may not be able to achieve anticipated revenue and cost benefits. Such acquisitions and investments may require additional funding which may be provided in the form of additional debt, equity financing or a combination thereof. There is a risk that any such additional financing will not be available to International on acceptable terms or at all or that International or Publishing will not be permitted under the terms of its Senior Credit Facility or the terms of the indenture governing Publishing's Senior Notes to obtain such additional financing. Implementation of International's business strategy could be affected by a number of factors beyond its control, such as increased competition, general economic conditions, legal developments or increased operating costs and expenses. In particular, there has been a recent trend of increased consolidation among major retailers, some as a 14 result of bankruptcies of certain retailers. This trend may adversely affect International's results of operations by reducing the number of advertisers using its products and increasing the purchasing power of the consolidating retailers, thereby leading to increased margin pressure on its advertising revenues. Any failure by International to successfully implement its business strategy may adversely affect its ability to service its indebtedness including the ability to make principal and interest payments on its Senior Notes and Senior Credit Facility. This may also adversely affect International's ability to pay fees to RMI under the Services Agreements and pay dividends on its common stock. This could adversely affect the Company's ability to service its indebtedness, including the Company's ability to make interest payments on its Senior Secured Notes. International may, in addition, decide to alter or discontinue certain aspects of its business strategy at any time. THE COMPANY'S AND INTERNATIONAL'S PERFORMANCE COULD BE ADVERSELY AFFECTED IF IT AND INTERNATIONAL LOSE KEY PERSONNEL. The Company believes that its and International's success is largely dependent on the abilities and experience of Lord Black, the Chief Executive Officer, F. David Radler, the Chief Operating Officer, Daniel W. Colson, The Telegraph's Chief Executive Officer, and the senior management team. The loss of the services of Lord Black, F. David Radler, Daniel W. Colson or one or more of the senior executives could adversely affect the Company's and International's ability to effectively manage the respective overall operations or successfully execute current or future business strategies. In addition, the Company believes that its and International's success will depend upon its and International's ongoing ability to attract and retain qualified management and other employees. INTERNATIONAL MAY EXPERIENCE LABOR DISPUTES, WHICH COULD SLOW DOWN OR HALT PRODUCTION OR DISTRIBUTION OF ITS NEWSPAPERS OR OTHER PUBLICATIONS. Approximately 23% of International's employees are represented by labor unions and those employees are mostly covered by collective bargaining or similar agreements which are regularly renewable. A work stoppage or strike may occur prior to the expiration of the current labor agreements or during negotiations of new labor agreements or extensions of existing labor agreements. Work stoppages or other labor-related developments could slow down or halt production or distribution of the newspapers, which would adversely affect International's results of operations. INTERNATIONAL HAS A SUBSTANTIAL POTENTIAL TAX LIABILITY AS A RESULT OF GAINS ON THE SALE OF CERTAIN OF ITS NON-U.S. OPERATIONS. The Company has reflected in current liabilities on its consolidated balance sheet certain income taxes payable, a substantial portion of which has been provided on gains on the sale of a portion of International's non-U.S. operations. The potential taxes would be an obligation of International's subsidiaries in the Canadian Newspaper Group. While International has implemented initiatives that it believes will defer and/or reduce these taxes owed by subsidiaries in respect of these gains, the benefits of these strategies have not been reflected in our accounts. There is a risk that the initiatives International has implemented will not be successful in deferring and/or reducing these taxes. RISKS RELATED TO CONTROL BY A SINGLE SHAREHOLDER LORD BLACK IS THE COMPANY'S CONTROLLING SHAREHOLDER AND THERE MAY BE A CONFLICT BETWEEN HIS INTERESTS AND INTERESTS OF OTHER SHAREHOLDERS. Lord Black currently controls a majority of the voting power of the Company and indirectly the voting power of International, and other shareholders of the Company will be unable to affect the outcome of stockholder voting as long as Lord Black retains his controlling interest. Ravelston, the Company's controlling stockholder, is controlled by Lord Black, Chairman of the Board and Chief Executive Officer of the Company and International, through his direct and indirect ownership of Ravelston, a corporation owned by Lord Black and Messrs. F. David Radler, Daniel Colson, J.A. Boultbee, Peter Atkinson, Peter White, Charles Cowan and the estate of Mr. Dixon Chant (all of whom are current or former officers and/or directors of International and the Company). As of June 19, 2003, Lord Black controlled a 78.2% voting interest in the Company. As a result of this controlling interest, Lord Black will be able to determine the outcome of all matters that require shareholder approval, including the election of directors, amendment of the Company's articles and approval of significant corporate transactions. Lord Black will also have a significant influence over decisions affecting the capital structure, including the incurrence of additional indebtedness and the declaration of dividends. 15 We understand that neither Ravelston nor Lord Black presently intends to reduce its voting control over the Company such that a third party would be able to exercise effective control over it. ENTITIES AFFILIATED WITH LORD BLACK AND OTHER OFFICERS AND DIRECTORS OF INTERNATIONAL AND THE COMPANY ENGAGE IN SIGNIFICANT TRANSACTIONS WITH INTERNATIONAL AND THE COMPANY, WHICH TRANSACTIONS MAY NOT NECESSARILY BE CONSUMMATED ON AN ARMS-LENGTH BASIS. Various entities which are affiliated with Lord Black and other officers and directors of the Company and International engage in significant transactions with International and the Company, which transactions may not necessarily be consummated on an arms-length basis and involve a risk that those transactions may not be as favourable to the Company as those that could be negotiated with non-affiliated third parties. It is the policy of International and the Company that the independent directors of each company review and approve related party transactions in respect of the applicable company. Ravelston, the controlling shareholder of RMI, controls International through its ownership interest in the Company. Pursuant to two agreements between RMI and International and HCPH Co., RMI provides advisory, consultative, procurement and administrative services to International and HCPH Co. including strategic advice, planning, and financial services (including advice and assistance with respect to acquisitions, divestitures and joint ventures), other consulting services and assistance in operational matters. Certain subsidiaries of International also have separate services agreements directly with certain Ravelston executives, as well as Black-Amiel Management Inc. and Moffat Management Inc., both affiliates of Ravelston. All of the services agreements were negotiated in the context of a parent-subsidiary relationship and, therefore, were not the result of arms-length negotiations between independent parties. There is a risk that the terms of the services agreements may not be as favorable to International as the terms that might be reached through negotiations with non-affiliated third parties. The terms have been negotiated with and approved by the independent members of International's board of directors. CERTAIN OF THE COMPANY'S OFFICERS ARE EMPLOYED BY RAVELSTON OR RMI AS WELL AS HOLD SENIOR MANAGEMENT POSITIONS WITH THE COMPANY AND INTERNATIONAL, WHICH COULD RESULT IN CONFLICTS OF INTEREST OR COULD LIMIT THE TIME THOSE OFFICERS DEVOTE TO MANAGEMENT OF THE COMPANY. Lord Black, the Company's Chairman and Chief Executive Officer, Mr. Radler, the Company's Deputy Chairman and Chief Operating Officer, Mr. Colson, Vice-Chairman, Mr. Atkinson, Executive Vice-President, Mr. Boultbee, Executive Vice-President and Mr. Creasey, Chief Financial Officer, each hold senior management positions with Ravelston or RMI, as the case may be, as well as the Company and International. Some of these officers may spend a portion of their professional time and effort on behalf of companies other than the Company. In certain instances, their efforts for Ravelston will relate to activities which are unrelated to the interests of the Company. The Company has not established any minimum time requirements for these officers. ITEM 4. INFORMATION ON THE COMPANY A. HISTORY AND DEVELOPMENT OF THE COMPANY. Hollinger Inc. is the continuing company, under the laws of Canada, resulting from the 1985 amalgamation of Argcen Holdings Inc., Hollinger Argus Limited (incorporated June 28, 1910) and Labmin Resources Limited. The Company's corporate offices are located at 10 Toronto Street, Toronto, Ontario, M5C 2B7, (416) 363-8721. The Company is effectively controlled by Lord Black, Chairman of the Board and Chief Executive Officer of the Company, through Ravelston, a privately-held investment company, which Lord Black controls and whose principal asset is its direct and indirect ownership of the Company's securities. B. BUSINESS OVERVIEW The Company, through our operating subsidiaries, has in the past acquired underperforming newspaper properties with a view to improving the operation and enhancing profitability and value. Generally, it was our intention to control the business and to realize profits from the continued ownership, operation and improvement of the business along with profits from the periodic disposal of all or part of our holding in an operation. Our emphasis has been on daily newspapers and usually those that are dominant in their respective markets. Our purchases generally have been of newspaper businesses that are underperforming either through weak operating management or as a result of an inability to access necessary capital. We also concentrated on acquisitions and disposals that increased the average size of our newspapers or that had significant potential synergies with our other newspapers. 16 In recent years, we have focused more on selling mature newspaper franchises with considerably less emphasis on acquisitions. Management's current intention is to concentrate on a few core assets to maximize their potential. The Company's principal asset is its approximately 30.3% equity (approximately 72.8% voting) interest in International, a publisher of English-language newspapers in the United States, the United Kingdom and Israel with a smaller publishing presence in Canada. In addition to the investment in International, the Company also has interests through wholly-owned subsidiaries in various other properties that do not, in the aggregate, contribute materially to our revenue or earnings. These properties include a 40% interest in a daily newspaper in the Cayman Islands and Canadian commercial real estate properties, including our head office at 10 Toronto Street, Toronto, Canada. International's 23 paid daily newspapers have a worldwide combined circulation of approximately two million. In addition, International owns or has an interest in over 250 other publications, including non-daily newspapers and magazines. Included among International's 144 paid newspapers are the following premier titles: - the Chicago Group's Chicago Sun-Times, which has the highest daily readership and second highest circulation of any newspaper in the Chicago metropolitan area and has the fifth highest daily readership of any metropolitan daily newspaper in the United States; - the U.K. Newspaper Group's The Daily Telegraph, which is the leading daily broadsheet newspaper in the U.K. with a 36% share of circulation in its domestic market and approximately 300,000 greater circulation than that of its nearest competitor; and - the Community Group's Jerusalem Post, which is the most widely read English-language daily newspaper published in the Middle East and is highly regarded regionally and internationally. International's operations consist principally of the Chicago Group, the U.K. Newspaper Group, the Canadian Newspaper Group and the Community Group, as well as minority investments in various Internet and media-related companies and an investment in debentures of a subsidiary of CanWest held by the Partnership. CHICAGO GROUP The Chicago Group consists of more than 100 newspapers in the greater Chicago metropolitan area. The group's primary newspaper is the Chicago Sun-Times, which was founded in 1948 and is Chicago's most widely read newspaper. The Chicago Sun-Times is published in a tabloid format, has a daily circulation of approximately 480,000 and continues to have the leading daily readership in the 16 county Chicago metropolitan area, attracting 1.7 million readers daily. International pursues a clustering strategy in the greater Chicago metropolitan market, covering all of Chicago's major suburbs as well as its surrounding high growth counties. This strategy enables International to rationalize duplicative back office functions and printing facilities as well as offer joint selling programs to advertisers. In December 2000, International acquired Fox Valley Publications Inc. which publishes four daily newspapers, one paid non-daily and twelve free distribution publications in the Chicago suburbs for total cash consideration of $166.7 million (US$111.0 million). U.K. NEWSPAPER GROUP The U.K. Newspaper Group's operations include The Daily Telegraph, The Sunday Telegraph, The Weekly Telegraph, telegraph.co.uk, and The Spectator and Apollo magazines. The Daily Telegraph was launched in 1855 and is based in London, the dominant financial center in Europe. It is the largest circulation broadsheet daily newspaper in the U.K. as well as in all of Europe with an average daily circulation of approximately 980,000. The Daily Telegraph's Saturday edition has the highest average daily circulation (approximately 1.2 million) among broadsheet daily newspapers in the U.K. The Sunday Telegraph is the second highest circulation broadsheet Sunday newspaper in the U.K. with an average circulation of approximately 778,000. The Daily Telegraph's market leadership and national reach have allowed it to maintain the leading share of advertising among broadsheet daily newspapers in the U.K. over the last decade. In addition, International has leveraged The Daily Telegraph's strong reader loyalty, trusted brand name and proprietary customer database to generate incremental revenue from the sale of ancillary products and services to its readers. CANADIAN NEWSPAPER GROUP At December 31, 2002, International's Canadian Newspaper Group primarily consisted of HCPH Co. and an 17 87% interest in the Partnership. During 2001 HCPH Co. (formerly Hollinger Canadian Publishing Holdings Inc.) became the successor to the operations of XSTM. As of April 30, 2003, HCPH Co. and the Partnership owned ten daily and twenty-three non-daily newspaper properties and the Business Information Group (formerly Southam Magazine and Information Group) which publishes Canadian business magazines and tabloids for the automotive, trucking, construction, natural resources, manufacturing and other industries. In January 2001, the Partnership completed the sale of UniMedia Company to Gesca Limited, a subsidiary of Power Corporation of Canada. The publications sold represented the French language newspapers of the Partnership including three paid circulation dailies and 15 weeklies published in Quebec and Ontario. A pre-tax gain of approximately $75.1 million was recognized on this sale. In two separate transactions in July and November 2001, International and the Partnership completed the sale of most of the remaining Canadian newspapers to Osprey Media Group Inc. ("Osprey") for total cash proceeds of approximately $255.0 million plus closing adjustments primarily for working capital. Included in these sales were community newspapers in Ontario such as The Kingston Whig-Standard, The Sault Star, the Peterborough Examiner, the Chatham Daily News and The Observer (Sarnia). The former Chief Executive Officer of the Partnership is a minority shareholder of Osprey. In connection with the two sales of Canadian newspaper properties to Osprey in 2001, to satisfy a closing condition, the Company, International, Lord Black of Crossharbour PC(C), OC, KCSG and three senior executives entered into non-competition agreements with Osprey pursuant to which each agreed not to compete directly or indirectly in Canada with the Canadian businesses sold to Osprey for a five-year period, subject to certain limited exceptions, for aggregate consideration of $7.9 million. Such consideration was paid to Lord Black and the three senior executives and was approved by International's independent directors. In August 2001, International entered into an agreement to sell to CanWest its remaining 50% interest in the National Post. In accordance with the agreement, the Company's representatives resigned from their executive positions at the National Post effective September 1, 2001. Accordingly, from September 1, 2001, the Company had no influence over the operations of the National Post and the Company ceased to consolidate or record on an equity basis its share of earnings or losses. The results of operations of the National Post are included in the consolidated results to August 31, 2001. On November 16, 2000, International and its affiliates, XSTM and the Partnership, completed the sale of most of their Canadian newspapers and related assets to CanWest for total sale proceeds, at fair value, of approximately $2.8 billion. Included in the sale was a 50% interest in National Post, all of the metropolitan newspapers, including the Ottawa Citizen, The Gazette (Montreal), the Calgary Herald, the Edmonton Journal, The Vancouver Sun and The Province (Vancouver), a large number of community newspapers, including The Windsor Star, the Regina Leader Post, the Star Phoenix and the Times-Colonist (Victoria) and operating Canadian Internet properties, including canada.com. In connection with the sale to CanWest, Ravelston entered into a management services agreement with CanWest and National Post pursuant to which it agreed to continue to provide management services to the Canadian businesses sold to CanWest in consideration for an annual fee of $6 million. In addition, CanWest will be obligated to pay Ravelston a termination fee of $45 million, in the event that CanWest chooses to terminate the management services agreement, or $22.5 million, in the event that Ravelston chooses to terminate the agreement. Also, as required by CanWest as a condition to the transaction, the Company, International, Ravelston, Lord Black and Messrs. Boultbee, Radler and Atkinson, entered into non-competition agreements with CanWest pursuant to which each agreed not to compete directly or indirectly in Canada with the Canadian businesses sold to CanWest for a five-year period, subject to certain limited exceptions, for aggregate consideration of $80 million paid by CanWest in addition to the purchase price referred to above. Of that consideration, $38 million was paid to Ravelston and $42 million was paid to Lord Black and the three senior executives. International's independent directors approved the terms of these payments. In November 2000, XSTM converted its convertible promissory note in the Partnership in the amount of $225.8 million into 22,575,324 units of the Partnership, thereby increasing its interest in the Partnership to 87%. In November 2000, following the completion of the transaction with CanWest, the Partnership made a special cash distribution to its unitholders. The amount of the distribution was $3.10 per unit payable on December 1, 2000. In March 2001, following the completion of the transaction with Gesca Limited, the Partnership made a second special cash distribution to its unitholders. The amount of the distribution was $0.70 per unit payable on March 30, 18 2001. In August 2001, the Partnership made a third special cash distribution to its unitholders. The amount of the distribution was $1.18 per unit payable on August 20, 2001. In December 2001, the Partnership made a fourth special cash distribution to its unitholders. The amount of the distribution was $1.45 per unit payable on December 28, 2001. No special cash distributions were made by the Partnership to unitholders during 2002. COMMUNITY GROUP The Community Group consists of The Jerusalem Post, the most widely read English-language daily newspaper published in the Middle East with a daily and weekend readership of 223,000. The paid circulation of all The Jerusalem Post products, including English and French-language international weekly editions, is over 110,000. During 2001, the Company sold its last remaining United States community newspaper. For accounting and management purposes, the Community Group continues to include the Company's wholly-owned subsidiary Jerusalem Post which publishes The Jerusalem Post. In addition, International transferred two Community Group publications to Horizon Publications Inc. in exchange for net working capital. Horizon Publications Inc. is managed by former Community Group executives and controlled by certain members of International's board of directors. The terms of these transactions were approved by the independent directors of International. During 2000, International sold most of its remaining U.S. community newspaper properties, including 11 paid dailies, three paid non-dailies and 31 free distribution publications for total proceeds of approximately US$215,000,000 ($325,166,000). Pre-tax gains totalling $75,114,000 were recognized on these sales. Included in these dispositions, International sold four U.S. community newspapers for an aggregate consideration of US$38.0 million ($56.5 million) to Bradford Publishing Company, a company formed by a former U.S. Community Group executive and in which some of International's directors are shareholders. The terms of this transaction were approved by the independent directors of International. In connection with the sales of United States newspaper properties in 2000, to satisfy a closing condition, International, Lord Black and three senior executives entered into non-competition agreements with the purchasers, pursuant to which each agreed not to compete directly or indirectly in the United States with the United States businesses sold to the purchasers for a fixed period, subject to certain limited exceptions, for aggregate consideration of US$15.6 million ($23.4 million), a portion of which was paid in 2001 and a portion of which was paid in 2000. All such amounts were paid to Lord Black and the three senior executives. The independent directors of International have approved the terms of these payments. DISPOSITIONS OF INVESTMENTS In November 2001, International sold 27,405,000 non-voting shares in CanWest (including 405,000 shares issued on conversion of 2,700,000 multiple voting preferred shares), received as part of the proceeds on the 2000 CanWest sale as previously described, for total proceeds of approximately $271.3 million. The sale resulted in a pre-tax loss of $157.5 million. In August and December 2001, International and the Partnership sold Participations in $540.0 million and $216.8 million principal amounts, respectively, of debentures issued by a subsidiary of CanWest to the Participation Trust. Units of the Participation Trust were sold by the Participation Trust to arm's length third parties. These transactions resulted in net proceeds to International of $621.8 million and have been accounted for as sales of CanWest debentures. The net loss on these transactions amounted to $97.4 million. International has not retained an interest in the Participation Trust nor does it have any ongoing involvement in the Participation Trust. The Participation Trust and its investors have no recourse to International's other assets in the event that CanWest defaults on its debentures. Under the terms of the Participation Trust, the interest, principal and redemption payments received by International in respect of the underlying CanWest debentures will be paid to the Participation Trust in U.S. dollars on the basis of a fixed exchange rate. In addition, in accordance with the terms of the participation agreement, International cannot transfer to an unaffiliated third party the equivalent of US$50.0 million ($79.0 million at December 31, 2002) principal amount of CanWest debentures or proceeds received from those debentures. On February 17, 2000, Interactive Investor International, in which International owned 51.7 million shares or a 47% equity interest, completed its initial public offering issuing 52 million shares and raising L78 million ($181 19 million). The offering reduced International's equity ownership to 33% and resulted in a dilution gain of $25.8 million for accounting purposes. Subsequently, International sold five million shares of its holding, reducing its equity interest to 28.5% and resulting in a pre-tax gain in 2000 of $2.4 million. The balance of the investment was sold in 2001 resulting in an additional pre-tax gain in 2001 of $14.7 million. C. NEWSPAPER INDUSTRY OVERVIEW Newspaper publishing is one of the oldest and largest segments of the media industry and the only remaining mass medium that has not become fragmented. Newspapers are generally viewed as the best medium for retail advertising, which emphasizes the price of goods, in contrast to television, which is generally used for image-oriented advertising. According to the Newspaper Association of America ("NAA"), daily newspaper readers include 60% of college graduates and 64% of households with income greater than US$75,000. Due to their significant readership and household penetration, newspapers continue to be the most cost effective means for advertisers to reach this highly sought after demographic group. Additionally, management believes newspaper advertising is more cost effective than television and radio advertising. Most newspapers rely on advertising (70-80% of total revenue) and circulation (20-30% of total revenue) for their revenues; by contrast, television and radio rely almost entirely on advertising revenue. Newspaper advertising is sold in several ways: full-run (printed on a newspaper page and included in all editions, known as "run of press"), zoned part-run (printed on a page and included in editions slated for a specific local geographic area), or as preprints or inserts (advertising that is printed separately and inserted in a newspaper). Department stores traditionally have been a major source of display advertising, filling pages with pictures of their merchandise. Classified advertising is also a significant component of revenue for newspapers, usually accounting for about one-third of total advertising sales. The circulation and demographic information verified by the Audit Bureau of Circulations is the basis for the ad rates that newspapers charge to advertisers. U.S. NEWSPAPER INDUSTRY In 2001, daily newspaper advertising expenditures in the U.S. were approximately US$44.3 billion, representing a compounded annual growth rate ("CAGR") of 3.9% since 1991. In addition total morning daily and Sunday circulation has increased nationally from 29.4 million and 54.7 million in 1980 to 46.8 million and 59.1 million in 2001, respectively. While there are a few newspapers that have national circulation, most U.S. newspapers operate in regional markets with limited local competition. Display and classified advertising are sold to both local and national advertisers. Newspapers account for 30% of total U.S. advertising spending. Because newspapers reach 56% of U.S. adults daily, advertisers utilize newspapers to reach the broadest possible number of potential customers for their products and services. Over the last several years, newspapers have used a clustering strategy consisting of owning and managing papers with geographic proximity in order to achieve both revenue and cost benefits. Newspaper clusters are able to offer advertisers broader, bundled purchasing compared to the narrower reach of a single newspaper. Clusters can also facilitate cost efficiencies by consolidating printing facilities, distribution channels, sharing editorial resources and other types of centralized cost savings. U.K. NEWSPAPER INDUSTRY British national newspapers more closely resemble North American magazines in that they have broad distribution and readership across the country and derive a much larger portion of their advertising revenue from national advertisers, unlike North American newspapers which, because of their relatively small geographic distribution areas, derive a substantial portion of their advertising from local advertisers. National newspapers in the U.K. reach 70% of the adult population, the second highest reach of all U.K. media behind only television. The U.K. newspaper market is segmented and, within each segment, highly competitive. The U.K. newspaper market consists of 10 national daily and 11 national Sunday newspapers, 1,593 regional and local newspapers, 3,174 consumer magazines, and 5,713 business magazines. There are nine national U.K. newspaper owners and three newspaper segments, the quality, mid-market and popular segments. The market segment in which The Daily Telegraph competes is generally known as the quality daily newspaper segment, consisting of all the broadsheets. The Daily Telegraph and its competitors in this market segment appeal to the middle and upper end of the demographic scale. In 2001, newspapers received a 30% share of the total advertising spending in the U.K., which is 20 the largest percentage of any medium. In addition, national newspaper advertising spending has increased in nine of the last 10 years and has grown at a CAGR of 6.3% since 1991. D. BUSINESS STRATEGY The Company's revenue, on a consolidated basis, is dependent upon the financial performance of the underlying assets, principally the assets of International. Through our influence of International's strategic direction and management, we intend to pursue the following strategies: Pursue Revenue Growth by Leveraging International's Significant Market Position. International will continue to leverage its significant position in daily readership in the attractive Chicago and U.K. markets in order to drive revenue growth. For the Chicago Group, International will continue to build revenues by taking advantage of the extensive cluster of its combined Chicago Group publications, which allows International to offer local advertisers geographically and demographically targeted advertising solutions and national advertisers an efficient one-stop vehicle to reach the entire Chicago market. For the U.K. Newspaper Group, International will continue to focus on retaining The Daily Telegraph's national circulation dominance and increasing circulation of The Sunday Telegraph, introduce new sections to the newspaper in order to help advertisers target specific reader demographics, and periodically implement cover price increases. In addition, International believes that The Daily Telegraph's successful prepaid subscription program will continue to enhance revenue opportunities. Continue to Maximize Operating Efficiency of Underlying Assets. International has extensive expertise in introducing and maintaining operating efficiencies, producing superior newspapers and increasing revenues. Historically, these efficiencies have resulted from centralized newsprint purchasing, clustering and consolidating duplicative functions and facilities at its acquired newspaper publications, and investing in technology and production equipment. For example, in April 2001, International completed the installation of a U.S.$115 million, state-of-the-art printing facility in Chicago which has lowered its production costs, enhanced product quality, and increased the availability of color printing which generates higher advertising yields. In response to the recent economic downturn, International has reduced total compensation and other operating costs (other than newsprint) during fiscal year 2002 as compared to the corresponding period in 2001, which has positioned International to significantly benefit as the advertising market recovers. International will continue to aggressively manage its cost structure in the future in order to optimize cash flow. Publish Relevant and Trusted High Quality Newspapers. International is committed to maintaining the high quality of its newspaper product and editorial integrity so as to ensure continued reader loyalty, which is the foundation of its newspaper franchises. The Chicago Sun-Times has been recognized for its editorial quality with several Pulitzer Prize-winning writers and awards for excellence from Illinois' major press organizations. The Daily Telegraph and The Sunday Telegraph are known for their quality content and superior product and have in recent times been voted "National Newspaper of the Year", Britain's most coveted industry award. In addition, International is focused on maintaining its relevance in the United States in its urban and suburban markets by continuing to provide leading local news coverage, while providing in-depth national and international news coverage in the U.K. market. International believes that this is a key strategy in maintaining and building upon the entrenched readership base of its leading newspaper properties. Prudent Asset Management. In addition to pursuing revenue growth from its existing publications and maximizing operating efficiencies, International may from time to time pursue selective, complementary newspaper acquisitions and non-core divestitures. Management has a successful track record of identifying value-enhancing acquisitions and underperforming newspaper properties, integrating and optimizing these acquisitions, and opportunistically divesting assets for optimal value to achieve debt reduction. Since International's formation in 1986, the existing senior management team has built, primarily through acquisitions, and managed up to 400 newspapers and related publications. After acquiring control of The Daily Telegraph in 1986, International significantly modernized the Telegraph's printing plants, negotiated a two-thirds reduction in work force, and revitalized its titles. In 1994, it acquired the Chicago Sun-Times and has since doubled its operating profits. More recently, International divested its U.S. community newspaper operations and the majority of its Canadian newspaper assets, which were monetized at attractive cash flow multiples. This strategy has positioned International to emerge from the current downturn with reduced leverage, efficient and focused operations, and solid operating platforms for growth. In implementing these strategies there are certain risks that could cause actual results to differ from our expectations, including the impact of strategies of our competitors, the ability to compete in specific markets for products and services, the impact of industry consolidation among key suppliers or customers, the ability to continue to obtain improved efficiencies and lower overall production costs, increased newsprint costs, the ability to avoid significant increases in labor costs or a significant deterioration in labor relations and the impact of electronic commerce and the increased use of alternative non-print media such as the Internet. 21 E. BUSINESS OF THE COMPANY The Company's most important property in terms of revenue and earnings is International. Of International's reported total operating revenue in 2002, approximately 44% was attributable to the Chicago Group, 48% to the U.K. Newspaper Group, 7% to the Canadian Newspaper Group and 1% to the Community Group. In 2001, the Chicago Group, the U.K. Newspaper Group, the Canadian Newspaper Group and the Community Group accounted for 39%, 42%, 17% and 2%, respectively, of International's reported total operating revenues. The Company also has interests through wholly-owned subsidiaries in various other assets that do not, in the aggregate, contribute materially to the Company's revenue or earnings. These assets include a 40% interest in a daily newspaper in the Cayman Islands and Canadian commercial real estate properties. CHICAGO GROUP SOURCES OF REVENUE. The following table sets forth the sources of revenue and the percentage such sources represent of total revenues for the Chicago Group during the past three years.
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------- 2000 2001 2002 ---------------------------------------------------------------------- (US$ IN THOUSANDS) Advertising.............. $305,027 76% $338,521 76% $341,261 77% Circulation.............. 80,261 20 92,716 21 89,427 20 Job Printing and Other... 16,129 4 11,647 3 11,089 3 ---------------------------------------------------------------------- Total.................... $401,417 100% $442,884 100% $441,777 100% ======================================================================
The Chicago Group consists of more than 100 titles in the greater Chicago metropolitan area including the Chicago Sun-Times, the Post Tribune in northwest Indiana and Chicago's Daily Southtown. International's other newspaper properties in the greater Chicago metropolitan area include: - Pioneer Newspapers Inc., which currently publishes 56 weekly newspapers in Chicago's north and northwest suburbs; - Midwest Suburban Publishing Inc., which in addition to the Daily Southtown, publishes 23 biweekly newspapers, 13 weekly newspapers and four free distribution papers primarily in Chicago's south and southwest suburbs; and - Fox Valley Publications Inc., which is doing business as Chicago Suburban Newspapers, publishes four daily newspapers, The Herald News, The Beacon News, The Courier News and The News Sun, 12 free distribution newspapers and six free total market coverage products ("TMC") in the fast growing counties surrounding Chicago and Cook County. ADVERTISING. Substantially all advertising revenues are derived from local and national retailers and classified advertisers. Advertising rates and rate structures vary among the publications and are based, among other things, on circulation, penetration and type of advertising (whether classified, national or retail). In 2002, retail advertising accounted for the largest share of advertising revenues (47%), followed by classified (39%) and national (14%). The Chicago Sun-Times offers a variety of advertising alternatives, including full-run advertisements, geographically zoned issues, special interest pull-out sections and advertising supplements in addition to regular sections of the newspaper targeted to different readers, such as arts, food, real estate, TV listings, weekend, travel and special sections. The Chicago area suburban newspapers also offer similar alternatives to the Chicago Sun-Times platform for their daily and weekly publications. The Chicago Group operates the Reach Chicago Newspaper Network, an advertising vehicle that can reach the combined readership base of all the Chicago Group publications and allows International to offer local advertisers geographically and demographically targeted advertising solutions and national advertisers an efficient one-stop vehicle to reach the entire Chicago market. CIRCULATION. Circulation revenues are derived from single copy newspaper sales made through retailers and vending racks and home delivery newspaper sales to subscribers. In 2002, approximately 69% of the copies of the Chicago Sun-Times sold and 61% of the circulation revenues were single copy sales. Approximately 80% of 2002 circulation revenues of the Chicago area suburban newspapers were derived from subscription sales. The average paid daily and Sunday circulation of the Chicago Sun-Times is approximately 481,000 and 383,000, respectively. 22 The Chicago Sun-Times has had consecutive increases over the past two years in paid daily circulation. The daily and Sunday paid circulation of the Daily Southtown is approximately 48,000 and 53,000, respectively. The daily and Sunday paid circulation of the Post-Tribune is approximately 65,000 and 70,000, respectively. The aggregate daily and Sunday paid circulation of the Chicago Suburban Newspapers is approximately 100,000 and 114,000, respectively. The aggregate circulation for the free TMC products is approximately 296,000 and the circulation of the free distribution newspapers and bi-weekly paid circulation of the Chicago Suburban Newspapers is approximately 227,000 and 21,000, respectively. OTHER PUBLICATIONS AND BUSINESS ENTERPRISES. The Chicago Group continues to strengthen its online dominance. Suntimes.com and the related Group websites have approximately 1.4 million unique users with some 25 million page impressions per month. The www.classifiedschicago.com regional classified-advertising website, which was created through a partnership with Paddock Publications, pools classified advertisements from all Chicago Group publications, as well as Paddock Publications' metropolitan daily to create a valuable new venue for advertisers, readers and on-line users. Additionally, www.DriveChicago.com continues to be a leader in automotive websites. During 2000, the Chicago Group joined Paddock Publications and the Chicago Automobile Trade Association to create this website that pools the automotive classified advertising of three of the Chicago metropolitan area's biggest dailies with the automotive inventories of many of Chicago's metropolitan new car dealerships. SALES AND MARKETING. Each newspaper or operating subsidiary in the Chicago Group has had its own marketing department which works closely with both advertising and circulation sales and marketing teams to introduce new readers to the Group's newspapers through various initiatives. The Chicago Sun-Times marketing department uses strategic partnerships, such as major event productions and sporting venues, for on-site promotion and to generate subscription sales. The Chicago Sun-Times has also formed a marketing and media partnership with local TV and radio outlets for targeted audience exposure. Similarly at Fox Valley Publications and Midwest Suburban Publishing, marketing professionals work closely with circulation sales professionals to determine circulation promotional activities, including special offers, sampling programs, in-store kiosks, sporting event promotions, dealer promotions and community event participation. In-house printing capabilities allow the Fox Valley marketing department to offer direct mail as an enhancement to customers' run of press advertising programs. Midwest Suburban Publishing, like the other newspapers, generally targets readers by zip code. Midwest Suburban Publishing owns its existing customer list of 120,000 names along with the Penny Saver address list containing 435,000 household names. The Post-Tribune marketing department focuses on attracting readers in the top 20 zip codes that major advertisers have identified as being the most attractive. DISTRIBUTION. The Chicago Group has gained benefits from International's clustering strategy. In recent years, International has succeeded in combining distribution networks within the Chicago Group where circulation overlaps. The Chicago Sun-Times is distributed through both an employee and contractor network depending upon the geographic location. The Chicago Sun-Times takes advantage of a joint distribution program with its sister publication, Fox Valley Publications, in which Fox Valley Publications distributes the Chicago Sun-Times in areas outside of Cook County. The Chicago Sun-Times has approximately 8,000 street newspaper boxes and more than 8,500 newsstands and over the counter outlets from which single copy newspapers are sold, as well as approximately 250 street "hawkers" selling the newspapers in high-traffic urban areas. Of the total circulation, approximately 69% is sold through single copy outlets, and 31% through home delivery subscriptions. Midwest Suburban Publishing's Daily Southtown is distributed primarily by Chicago Sun-Times independent contractors. Additionally, in certain western suburbs, the Daily Southtown also has a joint distribution program with Fox Valley Publications. The Daily Southtown and its sister publication, The Star, are also distributed in approximately 1,600 outlets and newspaper boxes in Chicago's southern suburbs and Chicago's south side and downtown areas. Midwest's Penny Saver is distributed through the post office and through independent contractors. Approximately 83% of Fox Valley Publication's circulation is from home delivery subscriptions. While 85% of the Post-Tribune's circulation is by home delivery, it also distributes newspapers to 635 retail outlets and approximately 420 single copy newspaper boxes. Pioneer has a solid home delivery base that represents 94% of its circulation. Pioneer is also distributed to more than 350 newspaper boxes and is in more than 1,200 newsstand locations. PRINTING. The Chicago Sun-Times' Ashland Avenue printing facility became fully operational in April 2001 and gives the Chicago Group printing presses that have the quality and speed necessary to effectively compete with the other regional newspaper publishers. Fox Valley Publications' 100,000 sq. ft. plant, which was completed in 1992, houses a state-of-the-art printing facility in Plainfield, Illinois, which prints all of its products. Midwest Suburban Publishing prints all of its publications at its South Harlem Avenue facility in Chicago. Pioneer prints the 23 main body of its weekly newspapers at its Northfield production facility. In order to provide advertisers with more color capacity, certain of Pioneer's sections are printed at the Chicago Sun-Times Ashland Avenue facility. The Post-Tribune has one press facility in Gary, Indiana. COMPETITION. Each of the Chicago area newspapers competes in varying degrees with radio, broadcast and cable television, direct marketing and other communications and advertising media as well as with other newspapers having local, regional or national circulation. The Chicago metropolitan region comprises Cook County and six surrounding counties and is served by eight local daily newspapers of which International owns six. The Chicago Sun-Times competes in the Chicago region with the Chicago Tribune, a large established metropolitan daily and Sunday newspaper, which is the fifth largest metropolitan daily newspaper in the United States based on circulation. In addition, the Chicago Sun-Times and other Chicago Group newspapers face competition from other newspapers published in adjacent or nearby locations and circulated in the Chicago metropolitan area market. RAW MATERIALS. The basic raw material for newspapers is newsprint. In 2002 approximately 132,000 tons were consumed. Newsprint costs equaled approximately 14.3% of the Chicago Group's revenues. Average newsprint prices for the Chicago Group decreased about 21% in 2002 from 2001. The Chicago Group is not dependent upon any single newsprint supplier. The Chicago Group's access to Canadian, United States and offshore newsprint producers ensures an adequate supply of newsprint. The Chicago Group, like other newspaper publishers in North America, has not entered into any long-term fixed price newsprint supply contracts. The Chicago Group believes that its sources of supply for newsprint are adequate for its anticipated needs. U.K. NEWSPAPER GROUP SOURCES OF REVENUE. The following table sets forth the sources of revenue and their percentage of total revenues for The Telegraph during the past three years.
------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------ 2000 2001 2002 ------------------------------------------------------------------------ (IN THOUSANDS OF BRITISH POUNDS STERLING) Advertising............ L255,945 69% L228,715 68% L211,045 66% Circulation............ 95,690 26 94,502 28 93,640 29 Other.................. 19,020 5 14,252 4 16,261 5 ------------------------------------------------------------------------ Total.................. L370,655 100% L337,469 100% L320,946 100% ========================================================================
(1) Financial data is in accordance with U.K. generally accepted accounting principles. The U.K. Newspaper Group's operations include The Daily Telegraph, The Sunday Telegraph, The Weekly Telegraph, telegraph.co.uk, and The Spectator and Apollo magazines. ADVERTISING. Advertising is the largest source of revenue at The Telegraph. The Telegraph's display advertising strengths are in the financial, automobile and travel sections. The level of classified advertisements, especially recruitment advertisements, fluctuates with the economy. The Telegraph's strategy with respect to classified advertising is to improve volume and yield in four sectors: recruitment, property, travel and automobiles. Classified advertising revenue represents 27% of total advertising revenue. Recruitment advertising is the largest classified advertising category, representing about 36% of all classified advertising in terms of revenue in 2002. CIRCULATION. The target audience of The Telegraph's newspapers is generally conservative, middle and upper income readers, with a continuing emphasis on gaining new younger readers. The editorial strengths of The Telegraph's newspapers are national, international, financial news and features and comprehensive sports coverage. In May 1996, The Telegraph introduced the first national advance purchase subscription program in the United Kingdom. The program has proven successful in driving circulation increases although there has been some inevitable cannibalization of single copy sales. By the end of 1996, the plan had about 100,000 weekday and 200,000 Sunday average sales and the average prepaid subscription was for a period of about 40 weeks. In order to gain broad acceptance of this revolutionary plan, the subscriptions were offered at a significant discount. The 24 amount of that discount was reduced throughout 1997 and continued to be reduced thereafter. The program currently has approximately 315,000 subscribers. OTHER PUBLICATIONS AND BUSINESS ENTERPRISES. The Telegraph is involved in several other publications and business enterprises, including The Spectator, Apollo, The Weekly Telegraph and telegraph.co.uk (formerly Electronic Telegraph). Telegraph.co.uk has over 3.2 million unique users with some 30 million page impressions per month. The Telegraph uses its brand in developing ancillary revenue streams such as reader offers including travel promotions, financial services, household products and books. During 1999, The Telegraph, in conjunction with The Boots Company plc, the United Kingdom's leading beauty and health retailer, launched a new web site focusing on the women's on-line market, www.handbag.com. The site deals with, among other things, health, beauty and the arts. SALES AND MARKETING. The Telegraph's marketing department helps introduce new readers to our newspapers through strategic marketing initiatives. The Telegraph has research groups that seek the views of readers. This provides useful information to better target editorial, promotional and commercial activities. The Telegraph's marketing and prospect database, which contains information about the newspaper readership, purchasing, and lifestyles of readers, is used to selectively target customers. In addition, the direct marketing department is responsible for the development of a customer contact strategy, circulation initiatives such as subscription programs, discount vouchers supporting the launch of new sections and supplements, and various support promotions. DISTRIBUTION. Since 1988, The Telegraph's newspapers have been distributed to wholesalers by truck under a contract with a subsidiary of TNT Express (U.K.) Limited ("TNT"). The Telegraph's arrangements with wholesalers contain performance provisions to ensure minimum standards of copy availability while controlling the number of unsold copies. On May 25, 2001, a new contract with TNT was entered into by each of the major publishers at West Ferry Printers, a joint venture owned equally by The Telegraph and another British newspaper publisher. That contract is for a minimum term of five years and six months and commenced on May 27, 2001. Wholesalers distribute newspapers to retail news outlets. The number of retail news outlets throughout the United Kingdom has increased as a result of a 1994 ruling by the British Department of Trade and Industry that prohibits wholesalers from limiting the number of outlets in a particular area. More outlets do not necessarily mean more sales and The Telegraph's circulation department has continued to develop its control of wastage while taking steps to ensure that copies remain in those outlets with high single copy sales. In addition to single copy sales, many retail news outlets offer home delivery services. In 2002 home deliveries accounted for 40% of sales of both The Daily Telegraph and The Sunday Telegraph. Historically, wholesalers and retailers have been paid commissions based on a percentage of the cover price. Prior to June 1994 when competitive pressures caused The Telegraph to reduce its cover price, wholesaler and retailer commissions amounted to approximately 34% of the then cover price. Notwithstanding the reduction of the cover price, the commissions paid were not reduced. In line with other national newspapers, The Telegraph has moved away from a commission paid on a percentage of cover price to a fixed amount per copy. PRINTING. The majority of copies of The Daily Telegraph and The Sunday Telegraph are printed by The Telegraph's two 50% owned joint venture printing companies, West Ferry Printers and Trafford Park Printers. The Telegraph has a very close involvement in the management of the joint venture companies and regards them as being important to The Telegraph's day-to-day operations. The magazine sections of the Saturday edition of The Daily Telegraph and of The Sunday Telegraph are printed under contract by external magazine printers. The Telegraph also prints the majority of its overseas copies under contracts with external printers in Northern Ireland, Spain and Belgium. Management of each joint venture printing company continually seeks to improve production performance. Major capital expenditures require the approval of the boards of directors of the joint venture partners. There is high utilization of the plants at West Ferry and Trafford Park Printers, with little spare capacity. At Trafford Park Printers, revenue earned from contract printing for third parties has a marginal effect on The Telegraph's printing costs. West Ferry Printers also undertakes some contract printing for third parties, which results in increased profitability. 25 West Ferry Printers has 18 presses, six of which are configured for The Telegraph's newspapers, eight are used for the newspapers published by The Telegraph's joint venture partner, Express Newspapers, and the remaining four are used by contract printing customers. Trafford Park Printers has six presses, two of which are used primarily for The Telegraph's newspapers. COMPETITION. In common with other national newspapers in the United Kingdom, The Telegraph's newspapers compete for advertising revenue with other forms of media, particularly television, magazine, direct mail, posters and radio. In addition, total gross advertising expenditures, including financial, display and recruitment classified advertising, are affected by economic conditions in the United Kingdom. The Telegraph's primary competition in the United Kingdom is The Times, however The Daily Telegraph has 42% greater circulation than The Times. There have been no strikes or general work stoppages involving employees of The Telegraph or the joint venture printing companies in the past five years. Management of The Telegraph believes that its relationships with its employees and the relationships of the joint venture printing companies with their employees are generally good. RAW MATERIALS. Newsprint represents the single largest raw material expense of The Telegraph's newspapers and, next to employee costs, is the most significant operating cost. Approximately 157,000 metric tons are consumed annually. In 2002, the total cost was approximately 17% of the U.K. Newspaper Group's revenues. Prices were fixed throughout 2002 at levels some 9.9% below the average price paid during 2001. Inventory held at each printing location is sufficient for three to four days production and in addition, suppliers' stock held in the United Kingdom normally represents a further four to five weeks consumption. Recently negotiated contracts for 2003 are at prices 7.1% below those for 2002. On October 17, 2001, Paper Purchase and Management Limited was established as a joint venture between The Telegraph and Guardian Media Group plc. The main purpose of the joint venture is to control the specifications and sourcing, as well as monitoring the usage, of newsprint throughout the printing plants operated by one or both of the joint venture partners and at other locations where the joint venture partners' publications are printed on a contract basis. Further, by combining the purchasing power of the joint venturers, The Telegraph is able to negotiate better prices. The Telegraph purchases newsprint from a number of different suppliers located primarily in Canada, the United Kingdom, Scandinavia and continental Europe. With many sources of newsprint accessible to it, The Telegraph is neither reliant on any single supplier nor is availability of newsprint a concern. CANADIAN NEWSPAPER GROUP SOURCES OF REVENUE. The following table sets forth the sources of revenue and the revenue mix of the total Canadian Newspaper Group, during the past three years, including revenue of operations sold up to the date of sale. Operations sold in the past three years include: the Canadian metropolitan newspapers and a large number of community papers to CanWest in 2000; the sale of the French language newspapers to Gesca in 2001; the sale of Ontario community newspapers to Osprey in 2001; and the sale of International's remaining 50% interest in the National Post to CanWest in 2001.
--------------------------------------------------------------- YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 2000 2001 2002 --------------------------------------------------------------- (IN THOUSANDS OF CANADIAN DOLLARS) Newspapers: Advertising............. $1,158,678 73% $171,032 56% $ 47,215 43% Circulation............. 287,513 18 53,030 17 6,611 6 Job printing and other.. 70,809 5 35,249 12 11,883 11 Business Communications.... 62,193 4 45,763 15 43,412 40 --------------------------------------------------------------- Total...................... $1,579,193 100% $305,074 100% $109,121 100% ===============================================================
At December 31, 2002 International's Canadian Newspaper Group primarily consisted of HCPH Co. and an 87% interest in the Partnership. During 2001, HCPH Co. became the successor to the operations of XSTM. 26 HCPH Co. and the Partnership own ten daily and twenty-three non-daily newspaper properties and the Business Information Group (formerly Southam Magazine and Information Group) which publishes Canadian business magazines and tabloids for the transportation, construction, natural resources, manufacturing and other industries. ADVERTISING. Newspaper advertising revenue in 2002 totaled $47.2 million. Advertisements are carried either within the body of the newspapers, and referred to as run-of-press ("ROP") advertising, or as inserts. ROP, which represented 91% of total advertising revenue in 2002 is categorized as either retail, classified or national. The three categories represented 72%, 12% and 16%, respectively, of ROP advertising revenue in 2002. CIRCULATION. Virtually all newspaper circulation revenue in 2002 was from subscription sales. COMPETITION. The majority of revenue is from advertising. Advertising lineage in the newspapers is affected by a variety of factors including competition from print, electronic and other media as well as general economic performance and the level of consumer confidence. Specific advertising segments such as real estate, automotive and help wanted will be significantly affected by local factors. RAW MATERIALS. The basic raw material for newspapers is newsprint. Newsprint consumption in 2002 was approximately 10,900 tons. The newspapers within the Canadian Newspaper Group have access to adequate supplies to meet anticipated production needs. They are not dependent upon any single newsprint supplier. The Canadian Newspaper Group, like other newspaper publishers in North America, has not entered into any long-term fixed price newsprint supply contracts. REGULATORY MATTERS. The publication, distribution and sale of newspapers and magazines in Canada is regarded as a "cultural business" under the Investment Canada Act and consequently, any acquisition of control of the Canadian Newspaper Group by a non-Canadian investor would be subject to the prior review and approval by the Minister of Industry of Canada. Because no such acquisition of control of the Company or International has occurred, the current ownership is acceptable. OWNERSHIP. During 2001, HCPH Co. became the successor to the operations of XSTM. International indirectly owns a combined 100% interest in HCPH Co. and indirectly owns an 87.0% interest in the Partnership. Under the Income Tax Act (Canada), there are limits on non-Canadian ownership of Canadian newspapers. At present, we do not meet those limits and, if this continues beyond a specified cure period, there could be adverse effects on advertising revenue. We intend to take the necessary steps to ensure that we are in compliance before the cure period expires. COMMUNITY GROUP SOURCES OF REVENUE. The following table sets forth the sources of revenue and the percentage that such sources represented of total revenues for the Community Group during the past three years.
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, -------------------------------------------------------------------- 2000 2001 2002 -------------------------------------------------------------------- (US$ IN THOUSANDS) Advertising................ $38,294 57% $ 5,806 30% $ 3,937 30% Circulation................ 19,168 28 7,751 41 6,082 46 Job Printing and Other..... 9,874 15 5,558 29 3,212 24 -------------------------------------------------------------------- Total...................... $67,336 100% $19,115 100% $ 13,231 100% ====================================================================
Approximately 46.0% of the Jerusalem Post's revenues of $13.2 million in 2002 were derived from circulation, with 24.2% from job printing and other and 29.8% from advertising. The Jerusalem Post in the past derived a relatively high percentage of its revenues from job printing as a result of a long-term contract to print and bind copies of the Golden Pages, Israel's equivalent of a Yellow Pages telephone directory. During 2002, Golden Pages effectively cancelled this agreement and has ceased placing printing orders. An action was commenced by the Jerusalem Post in 2003 seeking damages for the alleged breach. Newsprint costs relating to publication of the 27 Jerusalem Post equalled approximately 11.3% of the Jerusalem Post's revenues in 2002. Newsprint used in producing the Golden Pages was provided by the owners of that publication. REGULATORY MATTERS. Newspapers in Israel are required by law to obtain a license from the country's interior minister, who is authorized to restrain publication of certain information if, among other things, it may endanger public safety. To date, the Jerusalem Post has not experienced any difficulties in maintaining its license to publish or been subject to any efforts to restrain publication. In addition, all written media publications in Israel are reviewed by Israel's military censor prior to publication in order to prevent the publication of information that could threaten national security. Such censorship is considered part of the ordinary course of business in the Israeli media and has not adversely affected the Jerusalem Post's business in any significant way. F. ORGANIZATIONAL STRUCTURE The following simplified chart shows the basic corporate structure of the Company at June 19, 2003. [ORGANIZATIONAL STRUCTURE CHART] NOTES: (a) Represents equity interest (72.8% voting interest) G. PROPERTY, PLANTS AND EQUIPMENT The Company believes that its and International's properties and equipment are in generally good condition, well-maintained and adequate for current operations. The Chicago Sun-Times conducts its editorial, pre-press, marketing, sales and administrative activities in a 535,000 square foot, seven-story building in downtown Chicago, which is owned by International. International has completed the full conversion of its Chicago Sun-Times production operations to a new 320,000 square foot state-of-the-art printing facility, at a total construction cost of approximately US$115 million. It is intended that new facilities will be identified to house the 28 Chicago Sun-Times non-production activities and the downtown Chicago building will be redeveloped. Agreement has been reached for a joint development of the downtown Chicago building under which, if it proceeds, the Chicago Group will receive the first US$75 million of consideration and will share in future profits. There can be no assurance that this joint development will proceed. Pioneer utilizes and owns a building in north suburban Chicago for editorial, pre-press, sales and administrative activities. Pioneer leases several outlying satellite offices for its editorial and sales staff in surrounding suburbs. Production currently occurs at a 65,000 square foot leased building in a neighboring suburb. Midwest Suburban Publishing utilizes one building for editorial, pre-press, marketing, sales and administrative activities. Production activities occur at a separate facility. Both facilities are located in Chicago's south suburbs. The Post-Tribune editorial, prepress, marketing, sales and administrative activities are housed in the newly completed facility in Merrillville, Indiana while production activities continue at its facility in Gary, Indiana. The headquarters for Fox Valley Publications Inc is a 172,000 square foot owned facility, built in 1992 and located in Plainfield, Illinois. Fox Valley Publications produces its newspapers at this facility which also houses marketing functions, pre-press as well as certain sales and administrative activities. The editorial and sales activities are housed at five owned facilities located in surrounding suburbs. The Telegraph occupies five floors of a tower at Canary Wharf in London's Docklands under a 25-year operating lease expiring in 2017. Printing of The Telegraph's newspaper titles is done principally at fifty percent owned joint venture printing plants in London's Docklands and in Trafford Park, Manchester. The Jerusalem Post is produced and distributed in Israel from a three-story building in Jerusalem owned by Jerusalem Post. Jerusalem Post also leases a sales office in Tel Aviv and a sales and distribution office in New York. The Canadian Newspaper Group's newspapers and magazines are published at numerous facilities throughout Canada. ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS A. OPERATING RESULTS OVERVIEW - HOLLINGER INC. The Company is an international holding company and its assets consist primarily of investments in subsidiaries and affiliated companies, principally the investment in International. As at May 30, 2003, the Company directly and indirectly owns 11,256,538 shares of Class A common stock and 14,990,000 shares of Class B common stock of International, which represent 30.3% of the equity and 72.7% of the voting interests. International's Class A common stock is listed on the New York Stock Exchange. All of the Company's operating subsidiaries are owned through International. Significant liabilities of the holding company currently include Senior Secured Notes due 2011 and Series II and Series III preference shares, which are retractable by the holder. NB Inc., a wholly owned subsidiary of the Company, has subordinated debt due to International. On a non-consolidated basis, the Company's income consists mainly of dividends from subsidiaries, principally International, and its operating costs include public company costs (mainly legal and professional fees, directors' fees and transfer agent fees), interest on its Senior Secured Notes and dividends on Series II and Series III preference shares. On a non-consolidated basis, the Company has experienced a shortfall between the dividends and fees received from its subsidiaries and its obligations to pay its operating costs, including interest and dividends on its preference shares and such shortfalls are expected to continue in the future. Accordingly, the Company is dependent upon the continuing financial support of RMI, a wholly owned subsidiary of Ravelston, the Company's ultimate parent company, to fund such shortfalls and, therefore, pay its liabilities as they fall due. On March 10, 2003, concurrent with the issue of Senior Secured Notes, RMI entered into a support agreement with the Company, under which RMI has agreed to make annual support payments in cash to the Company by way of capital contributions (without the issuance of additional shares of the Company) or subordinated debt. The annual support payments will generally be equal to the greater of (a) the Company's negative net cash flow for the relevant period (which does not extend to outlays for retractions or redemptions), determined on a non-consolidated basis, and (b) U.S.$14.0 million per year. 29 Pursuant to this arrangement, RMI has made payments to the Company in respect of the period from March 10 to March 31, 2003 in the amount of US$1.1 million. RMI currently derives all of its income and operating cash flow from the fees paid pursuant to Services Agreements with International and its subsidiaries. RMI's ability to provide the required financial support under the support agreement with the Company is dependent on RMI continuing to receive sufficient fees pursuant to those Services Agreements. The Services Agreements may be terminated by either party by giving 180 days notice. The fees in respect of the Services Agreements are negotiated annually with and approved by the audit committee of International. The fees to be paid to RMI for the year ending December 31, 2003 amount to approximately US$22.0 million to US$24.0 million and were approved in February 2003. The fees in respect of the periods after December 31, 2003 have not yet been negotiated or approved. As described more fully below in"Hollinger International Inc. -- Recent Developments", a shareholder of International has requested that the Board investigate and, if determined to be advisable, take corrective action in respect of certain matters, including the payment of fees by International pursuant to management services agreements with RMI. Although the Board of International has established a special committee of the Board of Directors to conduct an independent review and investigation of the matters, the timing and outcome of the process and the impact on the Company and RMI is uncertain at this time. Under the terms of the Senior Secured Notes, if in any quarterly period after April 1, 2003, the Company fails to receive in cash a minimum aggregate amount of at least US$4.7 million from a) payments made by RMI pursuant to the support agreement and b) dividends paid by International on its shares held by the Company and NBI, the Company would be in default under its Senior Secured Notes and they could become due and payable immediately. Based on the Company's current investment in International and the current quarterly dividend paid by International of US$0.05 per share: (i) the minimum support payment required to be made by RMI to avoid a default under the terms of the Senior Secured Notes is approximately US$14.0 million annually and (ii) the Company estimates the support payment required by RMI to fund its negative net cash flow will approximate US$20.0 million for the twelve months ending June 30, 2004. This amount assumes payment by the Company of preference share dividends of approximately US$5.0 million which have yet to be considered by the Board of Directors and which depend on the Company having the ability under corporate law to pay such dividends. The Company's ongoing liquidity on a non-consolidated basis continues to depend to a large degree on support payments from RMI which in turn depends on fees received pursuant to its services agreements with International. If the Company does not receive support payments of at least US$15.0 million for the twelve months ending June 30, 2004, based on the above assumptions, then it will be required to dispose of assets of seek financing in order to meet its non-consolidated obligations as they fall due. The Company is contemplating a variety of initiatives to address the potential matters referred to above, however at this time there can be no certainty that such initiatives will be completed. On May 22, 2003, International and the Company announced that they had reached an agreement in principle whereby the Company would sell some of its holding of International's Class A shares to Southeastern Asset Management Inc. ("Southeastern"), and would seek certain phased changes in voting rights of International's Class B shares over five years. There were also, prior and subsequent to May 22, 2003, tentative agreements on the optimal scale of management fees, Southeastern nominations to International's Board of Directors, and on certain other matters, including possible consideration to the Company for varying the super-voting rights that attach to International's Class B shares. These discussions have evolved substantially but in a manner generally consistent with what was announced May 22, 2003. As a result of publicity accorded these discussions and International's affairs generally, other entities have initiated conversations on matters related to the subjects of the Southeastern discussions. All of these conversations are in progress, but it is impossible at this time to foretell whether they will reach an executable agreement, or what the nature of such an agreement might be. In addition, the Company's issued capital stock consists of Series II preference shares, Series III preference shares and retractable common shares, each of which is retractable at the option of the holder. There is uncertainty regarding the Company's ability to meet its future financial obligations arising from the retraction of preference shares and retractable common shares. These matters are more fully discussed under "Liquidity and Capital Resources - Financial Condition and Cash Flows". OVERVIEW - HOLLINGER INTERNATIONAL INC. International's business is concentrated in the publication of newspapers in the United States, the United Kingdom, Canada and Israel. Revenues are derived principally from advertising, paid circulation and, to a lesser extent, job printing. Of International's reported total operating revenue in 2002, approximately 44% was attributable to the Chicago Group, 48% to the U.K. Newspaper Group, 7% to the Canadian Newspaper Group and 1% to the Community Group. The Chicago Group consists of the Chicago Sun-Times and other daily and weekly newspapers in the greater Chicago metropolitan area. The U.K. Newspaper Group consists of the operations of The Daily Telegraph, The Sunday Telegraph, The Weekly Telegraph, telegraph.co.uk, and The Spectator and Apollo magazines, its subsidiaries and joint ventures. The Canadian Newspaper Group consists of the operations of HCPH Co., an 87% investment in the Partnership and until August 31, 2001, a 50% interest in National Post publications. The Community Group consists of the Jerusalem Post publications. During 2000, International sold most of its remaining U.S. community newspapers properties and completed the sale of most of International's Canadian newspapers and related assets to CanWest. During 2001, International sold most of the remaining Canadian newspaper properties, the 50% interest in the National Post and the last remaining United States community newspaper. In addition, International sold its approximate 15.6% equity interest in CanWest and participation interests in most of the debentures issued by a subsidiary of CanWest both of which were received in 2000 as part of the proceeds on the sale of Canadian newspaper properties to CanWest. Recent Developments -- Hollinger International Inc. On May 19, 2003, a shareholder of International filed a Schedule 13D with the SEC and, amongst other things, served a demand letter on the Board of International requesting that the Board investigate and, if determined to be advisable, take corrective action in respect of payments made to senior executives of International and to RCL in respect of non-competition agreements as previously disclosed in International's and the Company's financial statements. On June 11, 2003, the same shareholder filed an Amendment to the Schedule 13D with the SEC reiterating the earlier demands as well as requesting that the Board investigate and, if determined to be advisable, take corrective action in respect of (i) an asset sale by International to an entity affiliated with certain officers and directors of International, and (ii) the payment of fees by International pursuant to various affiliated management services agreements including fees paid to RMI. On June 17, 2003, in response to these requests, the Board established a special committee to conduct an independent review and investigation of those concerns. The special committee's review and investigation are continuing. The timing and outcome of this process is uncertain. The potential impact of the demand letters and special committee process on the financial statements of International and the Company and on RCL and RMI can not now be precisely calculated but the costs of the process are estimated at between US$6.0 million and US$8.0 million of increased expenses in the current year. Increased expenses related to higher director and officer insurance premiums, legal costs and other costs incurred in connection with the special committee's review and investigation will be reflected in the third and subsequent quarters. BUSINESS OF THE COMPANY The Company, through operating subsidiaries, has in the past acquired underperforming newspaper properties with a view to improving the operation and enhancing profitability and value. Generally, it was the Company's intention to control the business and to realize profits from the continued ownership, operation and improvement of the business along with profits from the periodic disposal of all or part of the Company's holding in an operation. The Company's emphasis has been on daily newspapers and usually those that are dominant in their respective markets. The Company's purchases generally have been of newspaper businesses that are underperforming either through weak operating management or as a result of an inability to access necessary capital. The Company also concentrated on acquisitions and disposals that increased the average size of the Company's newspapers or that had significant potential synergies with its other newspapers. In recent years, the Company has focused more on selling 30 mature newspaper franchises with considerably less emphasis on acquisitions. Management's current intention is to concentrate on a few core assets to maximize their potential. OUTLOOK FOR INTERNATIONAL The industry wide advertising market remains sluggish particularly in the United Kingdom. Although a turnaround is expected in advertising revenues for the industry, the timing of such turnaround is uncertain and it is too soon to have confidence in any recent encouraging news on that front. At the UK Newspaper Group advertising revenue in local currency for the three months ended March 31, 2003 was 6.5% lower than in 2002 and management does not anticipate any significant improvement in the United Kingdom advertising market in the near term. Mitigating the impact on operating income of that decline in advertising revenue are the impact of a September 2002 cover price increase at the Telegraph and the full year impact of aggressive cost reduction measures. In addition, the retirement of Senior Notes, Senior Subordinated Notes and Total Return Equity Swaps will result in lower interest costs at International in 2003. All of the Company's significant operations are owned through the investment in International. International has recently issued guidance in respect of its operating income for the year ending December 31, 2003. International's operating income is expected to be affected by non-recurring items, particularly the costs associated with the review now being conducted by the special committee of the Board of Directors of International and undertaken in response to the concerns of a shareholder of International. A thorough and independent inquiry into the matters raised leading up to the announcement of the formation of the special committee on June 17, 2003, will produce higher legal costs and insurance premiums than could have been foreseen when International's original forecast was made. The present impact on 2003 of these costs is in the range of US$6.0 million to US$8.0 million. The new forecast also reflects continued softness in the U.K. newspaper advertising market, which has persisted longer than was generally expected. Please refer to the form 10-Q filed by International with the SEC on August 18, 2003. THE COMPANY'S SIGNIFICANT TRANSACTIONS In June 2000, the Company and International exercised their option to pay cash on the mandatory exchange of the Hollinger Canadian Publishing Holdings Inc. Special shares. Each Special share was exchanged for cash of US$8.88 resulting in a payment to Special shareholders of US$95.0 million. The Company was responsible for US$36.8 million of this amount. On June 1, 2001, International converted all of its Series C preferred stock, which was held by the Company, at the conversion ratio of 8.503 shares of International's Class A common stock per share of Series C preferred stock into 7,052,464 shares of International's Class A common stock. The 7,052,464 shares of Class A common stock of International were subsequently purchased for cancellation by International on September 5, 2001 for a total of $143.8 million (U.S. $92.2 million). The purchase price per share was 98% of the closing price of a share of Class A common stock and was approved by International's independent directors. The proceeds were used to reduce the Company's bank indebtedness by $142.0 million. On September 27, 2001, International redeemed 40,920 shares of its Series E redeemable convertible preferred stock held by the Company at their stated redemption price of $146.63 per share for a total of $6.0 million. In December 2001, the Company sold 2,000,000 shares of International's Class A common stock to third parties for total cash proceeds of $31.4 million, the proceeds of which were used to reduce the Company's bank indebtedness. During January 2002, the Company sold a further 2,000,000 shares of International's Class A common stock to third parties for total cash proceeds of $38.6 million, the proceeds of which were used to reduce the Company's bank indebtedness. On March 10, 2003, the Company issued U.S. $120.0 million aggregate principal amount of 11 7/8% Senior Secured Notes due 2011. The total net proceeds were used to refinance existing indebtedness, to repay amounts due to Ravelston and to make certain advances to Ravelston. The Senior Secured Notes are fully and unconditionally guaranteed by RMI. The Company and RMI entered into a support agreement, under which RMI has agreed to make annual support payments in cash to the Company on a periodic basis by way of contributions to the capital of the Company (without receiving any shares of the Company) or subordinated debt. The amount of the annual support payments will be equal to the greater of (a) the non-consolidated negative net cash flow of the Company (which does not extend to outlays for retractions or redemptions) and (b) U.S. $14.0 million per year (subject to certain adjustments as permitted under the Indenture governing the Company's Senior Secured Notes), in either case, as 31 reduced by any permanent repayment of debt owing by Ravelston to the Company. Initially, the support amount to be contributed by RMI will be satisfied through the permanent repayment by Ravelston of its approximate $16.4 million of advances from the Company, which resulted from the use of proceeds of the Company's issue of Senior Secured Notes. Thereafter, all support amount contributions by RMI will be made through contributions to the capital of the Company, without receiving any additional shares of the Company, except that, to the extent that the minimum payment exceeds the negative net cash flow of the Company, the amounts will be contributed through an interest-bearing, unsecured, subordinated loan to the Company. The support agreement terminates upon the repayment of the Senior Secured Notes, which mature in 2011. All aspects of the offering of the Senior Secured Notes and the amendment to certain indebtedness due to International described below were approved by a Special Committee of the Board of Directors of the Company, comprised entirely of independent directors. On March 10, 2003, prior to the closing of the above offering, NB Inc. sold its shares of Class A common stock and Series E redeemable convertible preferred stock of International to RMI. Such shares were in turn sold back to NB Inc. from RMI at the same price, with a resulting increase in the tax basis of the shares of International and a taxable gain to RMI. As the exchange of the International shares with RMI represents a transfer between companies under common control, NB Inc. will record, in 2003, contributed surplus of approximately $2.3 million, being the tax benefit associated with the increase in the tax value of the shares of International. Contemporaneously with the closing of the issue of Senior Secured Notes, International: (a) repurchased for cancellation, from NB Inc., 2,000,000 shares of Class A common stock of International at U.S. $8.25 per share for total proceeds of U.S. $16.5 million; and (b) redeemed, from NB Inc., pursuant to a redemption request, all of the 93,206 outstanding shares of Series E redeemable convertible preferred stock of International at the fixed redemption price of $146.63 per share totalling U.S. $9.3 million. Proceeds from the repurchase and redemption were offset against debt due from NB Inc. to International, resulting in net outstanding debt due to International of approximately U.S. $20.4 million. The remaining debt bears interest at 14.25% (or 16.5% in the event that the interest is paid in kind), is subordinated to the Company's Senior Secured Notes (so long as the Senior Secured Notes are outstanding), and is guaranteed by Ravelston and secured by certain assets of Ravelston. All aspects of the transaction relating to the changes in the debt arrangements with NB Inc. and the subordination of this remaining debt have been reviewed by the audit committee of the Board of Directors of International, comprised entirely of independent directors. Effective April 30, 2003, US$15.7 million principal amount of subordinated debt owing to Hollinger International by NB Inc. was transferred by Hollinger International to HCPH Co., a subsidiary of Hollinger International, and subsequently transferred to RMI by HCPH Co. in satisfaction of a loan due from HCPH Co. to RMI (note 23d)). International and the Company previously reported that the committee of independent directors of International had agreed to the US$15.7 million offset to the remaining US$20.4 million of debt against amounts owed by International to RMI, and further stated that the offset was effected April 30, 2003. Although management of International and the Company believed final approval had been given to the offset by the committee of independent directors of International, the committee has advised that final approval of any offset remains subject to appropriate due diligence and receipt of a further independent fairness opinion. The due diligence process has not yet been concluded and accordingly, the offset has not been completed as at August 25, 2003. The debt owing by NB Inc. to Hollinger International of US$20.4 million bears interest at the rate of 14.25% if interest is paid in cash and 16.50% if it is paid in kind. The debts is subordinated to the Senior Secured Notes for so long as the Senior Secured Notes are outstanding, and is guaranteed by RCL and the Company. Hollinger International entered into a subordination agreement with the Company and NB Inc. pursuant to which Hollinger International has subordinated all payments of principal, interest and fees on the debt owed to it by NB Inc. to the payment in full of principal, interest and fees on the Senior Secured Notes, provided that payments with respect to principal and interest can be made to International to the extent permitted in the indenture governing the Senior Secured Notes. 32 HOLLINGER INTERNATIONAL INC.'S SIGNIFICANT TRANSACTIONS SIGNIFICANT TRANSACTIONS IN 2000 On November 16, 2000, International and its affiliates, XSTM and the Partnership ("Hollinger Group") completed the sale of most of International's Canadian newspapers and related assets to CanWest. Included in the sale were the following assets of the Hollinger Group: - a 50% interest in National Post (International continued as managing partner); - the metropolitan and a large number of community newspapers in Canada (including the Ottawa Citizen, The Vancouver Sun, The Province(Vancouver), the Calgary Herald, the Edmonton Journal, The Gazette (Montreal), The Windsor Star, the Regina Leader Post, the Star Phoenix and the Times- Colonist (Victoria); and - the operating Canadian Internet properties, including canada.com. The sale resulted in the Hollinger Group receiving approximately $1.7 billion (U.S.$1.1 billion) cash, approximately $425 million (U.S.$277 million) in voting and non-voting shares of CanWest at fair value (representing an approximate 15.6% equity interest and 5.7% voting interest) and subordinated non- convertible debentures of a holding company in the CanWest group at fair value of approximately $697 million (U.S.$456 million). The aggregate sale price of these properties at fair value was approximately $2.8 billion (U.S.$1.8 billion), plus closing adjustments for working capital at August 31, 2000 and cash flow and interest for the period September 1 to November 16, 2000 which, in total, approximated an additional U.S.$40.7 million at December 31, 2000. U.S.$972 million of the cash proceeds from this sale were used to pay down International's bank credit facility. During 2000, International sold most of its remaining U.S. community newspaper properties including 11 paid dailies, three paid non-dailies and 31 free distribution publications for total proceeds of approximately U.S.$215.0 million. Pre-tax gains totaling U.S.$91.2 million were recognized by International on these sales. In December 2000, International acquired four paid daily newspapers, one paid non-daily and 12 free distribution publications in the Chicago suburbs, for total consideration of U.S.$111.0 million. In November 2000, XSTM converted a promissory note from the Partnership in the principal amount of $225.8 million (U.S.$147.9 million) into 22,575,324 limited partnership units of the Partnership, thereby increasing its interest in the Partnership to 87.0%. On February 17, 2000, Interactive Investor International, in which International owned 51.7 million shares or a 47.0% equity interest, completed its initial public offering ("IPO"), issuing 52 million shares and raising $181.0 million. The IPO reduced International's equity ownership interest to 33% and resulted in a dilution gain of $25.8 million. Subsequently International sold five million shares of its holding, reducing its equity interest to 28.5% resulting in a pretax gain of $2.4 million in 2000. The balance of the investment was sold in 2001 resulting in an additional pre-tax gain in 2001 of $14.7 million. SIGNIFICANT TRANSACTIONS IN 2001 In January 2001, the Partnership completed the sale of UniMedia Company to Gesca Limited, a subsidiary of Power Corporation of Canada. The publications sold represented the French language newspapers of the Partnership, including three paid circulation dailies and 15 weeklies published in Quebec and Ontario. A pre-tax gain of approximately $75.1 million was recognized on this sale. In two separate transactions in July and November 2001, International and the Partnership completed the sale of most of International's remaining Canadian newspapers to Osprey Media Group Inc. ("Osprey") for total sale proceeds of approximately $255.0 million plus closing adjustments primarily for working capital. Included in these sales were community newspapers in Ontario, such as The Kingston Whig-Standard, The Sault Star, the Peterborough Examiner, the Chatham Daily News and The Observer (Sarnia). Pre-tax gains of approximately $1.5 million were recognized on these sales. The former Chief Executive Officer of the Partnership is a minority shareholder of Osprey. 33 In August 2001, International entered into an agreement to sell to CanWest its remaining 50% interest in the National Post. In accordance with the agreement, its representatives resigned from their executive positions at the National Post effective September 1, 2001. Accordingly, from September 1, 2001, International had no influence over the operations of the National Post and International no longer consolidates or records, on an equity basis, its share of earnings or losses. The results of operations of the National Post are included in the consolidated results to August 31, 2001. A pre-tax loss of approximately $120.7 million was recognized on the sale. In August and December 2001, International sold participation interests ("Participations") in $540.0 million (U.S. $350.0 million) and $216.8 million (U.S.$140.5 million), respectively, principal amounts of debentures issued by a subsidiary of CanWest to a special purpose trust ("Participation Trust"). Units of the Participation Trust were sold by the Participation Trust to arm's-length third parties. These transactions resulted in net proceeds of $621.8 million (U.S.$401.2 million) and have been accounted for as sales of International's CanWest debentures. The pre-tax loss on these transactions, including realized holding losses on the underlying debentures, amounted to $97.4 million and has been recognized in unusual items. On November 28, 2001, International sold 27,405,000 non-voting shares in CanWest (including 405,000 shares issued on conversion of 2,700,000 multiple voting preferred shares) for total cash proceeds of approximately $271.3 million. The sale resulted in a realized pre-tax loss of $157.5 million, which is included in unusual items. SIGNIFICANT TRANSACTIONS IN 2002 On December 23, 2002, a wholly owned subsidiary of International, Publishing and certain of Publishing's subsidiaries entered into an amended and restated U.S. $310.0 million Senior Credit Facility with a group of financial institutions arranged by Wachovia Bank N.A. (the "Senior Credit Facility"). The Senior Credit Facility consists of (a) a U.S. $45.0 million revolving credit facility, which matures on September 30, 2008 (the "Revolving Credit Facility"), (b) a U.S. $45.0 million Term Loan A, which matures on September 30, 2008 ("Term Loan A") and (c) a U.S. $220.0 million Term Loan B, which matures on September 30, 2009 ("Term Loan B"). Publishing (a wholly owned direct subsidiary) and Telegraph Group (a wholly owned indirect subsidiary) are the borrowers under the Revolving Credit Facility and First DT Holdings Ltd. ("FDTH", a wholly owned indirect subsidiary in the United Kingdom) is the borrower under Term Loan A and Term Loan B. The Revolving Credit Facility and Term Loans bear interest at either the Base Rate (U.S.) or LIBOR, plus an applicable margin. Cross-currency floating to fixed rate swaps from US$ LIBOR to Sterling fixed rate have been purchased in respect of all amounts advanced under the Senior Credit Facility. No amounts have currently been drawn under the Revolving Credit Facility. Publishing's borrowings under the Senior Credit Facility are guaranteed by Publishing's material U.S. subsidiaries, while FDTH's and Telegraph Group's borrowings under the Senior Credit Facility are guaranteed by Publishing and its material U.S. and U.K. subsidiaries. International is also a guarantor of the Senior Credit Facility. Publishing's borrowings under the Senior Credit Facility are secured by substantially all of the assets of Publishing and its material U.S. subsidiaries, a pledge of all of the capital stock of Publishing and its material U.S. subsidiaries and a pledge of 65% of the capital stock of certain foreign subsidiaries. FDTH's and Telegraph Group's borrowings under the Senior Credit Facility are secured by substantially all of the assets of Publishing and its material U.S. and U.K. subsidiaries and a pledge of all of the capital stock of Publishing and its material U.S. and U.K. subsidiaries. International's assets in Canada have not been pledged as security under the Senior Credit Facility. The Senior Credit Facility loan documentation requires Publishing to comply with certain covenants which include, without limitation and subject to certain exceptions, restrictions on additional indebtedness; liens; certain types of payments (including without limitation, capital stock dividends and redemptions, payments on existing indebtedness and intercompany indebtedness), and on incurring or guaranteeing debt of an affiliate, making certain investments and paying management fees; mergers, consolidations, sales and acquisitions; transactions with affiliates; conduct of business, except as permitted; sale and leaseback transactions; changing fiscal year; changes to holding company status; creating or allowing restrictions on taking action under the Senior Credit Facility loan documentation; and entering into operating leases, subject to certain baskets and exceptions. The Senior Credit Facility loan documentation also contains customary events of default. 34 On December 23, 2002, Publishing also issued U.S.$300.0 million aggregate principal amount of 9% senior unsecured notes due 2010 (the "9% Senior Notes") at par to certain qualified institutional buyers ("QIBs") pursuant to Rule 144A under the Securities Act of 1933, as amended. The proceeds from the sale of the 9% Senior Notes, together with drawdowns under the Senior Credit Facility and available cash balances, were used to redeem approximately U.S. $239.9 million of Publishing's Senior Subordinated Notes due 2006 and approximately U.S. $265.0 million of Publishing's Senior Subordinated Notes due 2007, plus applicable premium and accrued interest to the date of redemption, and to make a distribution of U.S. $100.0 million to International. International used the distribution (a) to repay all amounts borrowed by International on October 3, 2002 under its loan agreement with Trilon International Inc., (b) to retire the equity forward purchase agreements between International and certain Canadian chartered banks (the "Total Return Equity Swap") made as of October 1, 1998, as amended, and (c) for other general corporate purposes. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, investments, intangible assets, income taxes, restructuring, pensions and other post-retirement benefits, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required. We hold minority interests in both publicly traded and privately held companies. Some of the publicly traded companies have highly volatile share prices. We record an investment impairment charge when we believe an investment, whether or nor publicly traded, has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investments may not be reflected in an investment's current carrying value, thereby requiring an impairment charge in the future. We have significant goodwill recorded in our accounts. Certain of our newspapers operate in highly competitive markets. We are required to determine annually whether or not there has been any impairment in the value of these assets. Changes in long-term readership patterns and advertising expenditures may affect the value and necessitate an impairment charge. Certain indicators of potential impairment that could impact the Company's reporting units include, but are not limited to, the following: (a) a significant long-term adverse change in the business climate that is expected to cause a substantial decline in advertising spending, (b) a permanent significant decline in a reporting units' newspaper readership, (c) a significant adverse long-term negative change in the demographics of a reporting units' newspaper readership and (d) a significant technological change that results in a substantially more cost-effective method of advertising than newspapers. The Company sponsors several defined benefit pension and post-retirement benefit plans for domestic and foreign employees. These defined benefit plans include pension and post-retirement benefit obligations, which are calculated based on actuarial valuations. In determining these obligations and related expenses, key assumptions are made concerning expected rates of return on plan assets and discount rates. In making these assumptions, the Company evaluated, among other things, input from actuaries, expected long-term market returns and current high-quality bond rates. The Company will continue to evaluate the expected long-term rates of return on plan assets and discount rates at least annually and make adjustments as necessary, which could change the pension and post-retirement obligations and expenses in the future. Unrecognized actuarial gains and losses in respect of pension and post-retirement benefit plans are recognized by the Company over a period ranging from 8 to 17 years, which represents the weighted average remaining service life of the employee groups. Unrecognized actuarial gains and losses arise from several factors, including 35 experience, assumption changes in the obligations and from the difference between expected returns and actual returns on assets. At the end of 2002, the Company had unrecognized net actuarial losses of $233.4 million. These unrecognized amounts could result in an increase to pension expense in future years depending on several factors, including whether such losses exceed the corridor in accordance with CICA Section 3461, "Employee Future Benefits". The estimated accumulated benefit obligations for the defined benefit plans exceeded the fair value of the plan assets at December 31, 2002 and 2001, as a result of the negative impact that declines in global capital markets and interest rates had on the assets and obligations of the Company's pension plans. During 2002, the Company made contributions of $20.2 million to the defined benefit plans. Global capital market and interest rate fluctuations could impact funding requirements for such plans. If the actual operations of the plans differ from the assumptions, and the deficiency between the plans' assets and obligations continues, additional Company contributions may be required. If the Company is required to make significant contributions to fund the defined benefit plans, reported results could be adversely affected, and the Company's cash flow available for other uses may be reduced. The Company recognizes a pension valuation allowance for any excess of the prepaid benefit cost over the expected future benefit. Increases or decreases in global capital markets and interest rate fluctuations could increase or decrease any excess of the prepaid benefit cost over the expected future benefit resulting in an increase or decrease to the pension valuation allowance. Changes in the pension valuation allowance are recognized in earnings immediately. Included in current liabilities are income taxes that have been provided on gains on sales of assets computed on tax bases that result in higher gains for tax purposes than for accounting purposes. Strategies have been and may be implemented that may also defer and/or reduce these taxes, but the effects of these strategies have not been reflected in the accounts. CHANGES IN ACCOUNTING POLICIES ACCOUNTING FOR INCOME TAXES During 1999, the CICA mandated a change to the method of accounting for income taxes that made Canadian GAAP more consistent with US GAAP. The change was required to be adopted retroactively effective January 1, 2000 and the Company chose to do so without restating prior years' financial statements. The change required the Company to provide income taxes on the excess of book value of intangible assets, other than goodwill, over the tax value of those assets (book/tax differences). Over the years, the Company has recorded significant amounts as circulation assets when businesses were purchased, which has not resulted in amortizable tax cost. The adjustment made effective January 1, 2000 increased future income tax liabilities by $516.1 million and reduced minority interest by $225.1 million with the net amount being recorded as an increase in deficit in the amount of $291.0 million. The recording of these amounts is not an indication that taxes will actually be paid, not does it reflect the timing of any such payments. EARNINGS PER SHARE Effective January 1, 2001, the Company adopted, retroactively with restatement, the recommendations of CICA Section 3500 with respect to earnings per share. Under the revised standard, the treasury stock method is used instead of the imputed earnings approach for determining the dilutive effect of options, issued warrants or other similar instruments. The change in the method of calculation of earnings per share did not impact the previously reported basic earnings per share for 2000. Diluted earnings per share for 2000 were increased from $4.48 per share to $5.05 per share. BUSINESS COMBINATIONS AND GOODWILL AND OTHER INTANGIBLES In August 2001, the CICA issued Handbook Section 1581, "Business Combinations" ("Section 1581") and Handbook Section 3062, "Goodwill and Other Intangible Assets" ("Section 3062"). Section 1581 specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported separately from goodwill. Section 3062 requires that goodwill and intangible assets with indefinite useful lives no longer be 36 amortized, but instead be tested for impairment at least annually by comparing the carrying value to the respective fair value in accordance with the provisions of Section 3062. Section 3062 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment by assessing the recoverability of the carrying value. The Company adopted the provisions of Section 1581 as of July 1, 2001 and Section 3062 as of January 1, 2002. Upon adoption of Section 3062, the Company was required to evaluate its existing intangible assets and goodwill that were acquired in purchase business combinations, and effective January 1, 2002, has reclassified certain amounts previously ascribed to circulation to non-competition agreements and subscriber and advertiser relationships, with the balance to goodwill. In connection with Section 3062's transitional goodwill impairment evaluation, Section 3062 requires the Company to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. To accomplish this, the Company identified its reporting units and determined the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and identifiable intangible assets, to those reporting units as of January 1, 2002. The Company had until June 30, 2002 to determine the fair value of each reporting unit and compare it to the carrying amount of the reporting unit. To the extent the carrying amount of a reporting unit exceeded the fair value of the reporting unit, an indication existed that the reporting unit goodwill may be impaired and the Company was required to perform the second step of the transitional impairment test. The second step was required to be completed no later than December 31, 2002. In the second step, the Company compared the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill, both of which would be measured as of January 1, 2002. The implied fair value of goodwill was determined by allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation, in accordance with Section 1581. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. At January 1, 2002, the Company had unamortized goodwill in the amount of $905.6 million, which is no longer being amortized. This amount is before any reduction for the transitional impairment noted below. This change in accounting policy cannot be applied retroactively and the amounts presented for prior periods have not been restated for this change. The Company completed its transitional impairment testing for goodwill under Section 3062 and recorded an impairment charge of $32.0 million in respect of the goodwill for the Jerusalem Post operation. That loss, net of related minority interest, amounted to $12.1 million and has been recorded as a charge to the opening deficit as at January 1, 2002. STOCK-BASED COMPENSATION AND OTHER STOCK-BASED PAYMENTS The Company and certain of its subsidiaries have employee stock-based compensation plans. Until December 31, 2001, compensation expense was not recognized on the grant or modification of options under these plans. Effective January 1, 2002, the Company adopted Handbook Section 3870, "Stock-based Compensation and Other Stock-based Payments" ("Section 3870"). Under Section 3870, the Company is required to account for, on a prospective basis, all stock-based payments made by the Company to non-employees, including employees of RCL and employee awards that are direct awards of stock, call for settlement in cash or other assets, or are stock appreciation rights that call for settlement by the issuance of equity instruments, granted on or after January 1, 2002, using the fair value-based method. For all other stock-based payments, the Company has elected to use the settlement method of accounting whereby cash received on the exercise of stock options is recorded as capital stock. Under the fair value-based method, stock options granted to employees of RCL by the Company and its subsidiaries are measured at the fair value of the consideration received, or the fair value of the equity instruments issued, or liabilities incurred, whichever is more reliably measurable. Such fair value determined is recorded as a dividend-in-kind with no resulting impact on the Company's net earnings. Section 3870 will be applied prospectively to all stock-based payments to non-employees granted on or after January 1, 2002. The Company has not granted any stock options since the adoption of Section 3870. During 2002, the only options granted by International which are impacted by the adoption of 3870 are options granted to employees of RCL. The fair value of such options must be recorded as a dividend by International, with no impact to the Company's results. 37 Consequently, there is no impact of adoption of this standard on the Company's financial statements for the year ended December 31, 2002. RECENT CANADIAN ACCOUNTING PRONOUNCEMENTS FOREIGN CURRENCY AND HEDGING In November 2001, the CICA issued Accounting Guideline 13, "Hedging Relationships" ("AcG 13"). AcG 13 establishes new criteria for hedge accounting and will apply to all hedging relationships in effect on or after July 1, 2003. Effective January 1, 2004, the Company will reassess all hedging relationships to determine whether the criteria are met or not and will apply the new guidance on a prospective basis. To qualify for hedge accounting, the hedging relationship must be appropriately documented at the inception of the hedge and there must be reasonable assurance, both at the inception and throughout the term of the hedge, that the hedging relationship will be effective. The Company is in the process of formally documenting all hedging relationships and has not yet determined whether any of its current hedging relationships will not meet the new hedging criteria. IMPAIRMENT OF LONG-LIVED ASSETS In December 2002, the CICA issued Handbook Section 3063, "Impairment of Long-Lived Assets" and revised Section 3475, "Disposal of Long-Lived Assets and Discontinued Operations." These sections supersede the write-down and disposal provisions of Section 3061, "Property, Plant and Equipment" and Section 3475, "Discontinued Operations." The new standards are consistent with U.S. generally accepted accounting principles. Section 3063 establishes standards for recognizing, measuring and disclosing impairment of long-lived assets held for use. An impairment is recognized when the carrying amount of an asset to be held and used exceeds the projected future net cash flows expected from its use and disposal, and is measured as the amount by which the carrying amount of the asset exceeds its fair value. Section 3475 provides specific criteria for and requires separate classification for assets held for sale and for these assets to be measured at the lower of their carrying amounts and fair value, less costs to sell. Section 3475 also broadens the definition of discontinued operations to include all distinguishable components of an entity that will be eliminated from operations. Section 3063 is effective for the Company's 2004 fiscal year; however, early application is permitted. Revised Section 3475 is applicable to disposal activities committed to by the Company after May 1, 2003; however, early application is permitted. The Company expects that the adoption of these standards will have no material impact on its financial position, results of operations or cash flow at this time. DISCLOSURE OF GUARANTEES In February 2003, the CICA issued Accounting Guideline 14, "Disclosure of Guarantees" ("AcG 14"). AcG 14 requires certain disclosures to be made by a guarantor in its interim and annual financial statements for periods beginning after January 1, 2003. The Company has determined the impact these new disclosures and included such information in note 27h) to its audited consolidated financial statements included elsewhere in this Annual Report. RECENT US ACCOUNTING PRONOUNCEMENTS DEBT EXTINGUISHMENTS In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). The Statement addresses, among other things, the income statement treatment of gains and losses related to debt extinguishments, requiring that such expenses no longer be treated as extraordinary items, unless the items meet the definition of extraordinary per APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Upon adoption, any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented, that does not meet the criteria in APB Opinion No. 30 for classification as an extraordinary item, is required to be reclassified. The Company has adopted this Statement effective January 1, 2002 for US GAAP purposes and retroactively classified net losses on repayment of debt previously classified as extraordinary items. COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES 38 In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("FAS 146"). FAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities, and is effective for exit or disposal activities initiated after December 31, 2002. FAS 146 nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3") Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring). The principal difference between FAS 146 and EITF 94-3 relates to the recognition of a liability for a cost associated with an exit or disposal activity. FAS 146 requires that the cost associated with an exit or disposal activity be recognized when the liability is incurred, whereas under EITF 94-3 the liability was recognized at the date of an entity's commitment to an exit plan. The Company is currently assessing the impact of FAS 146 on its financial position and results of operations. GUARANTEES In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), which requires certain disclosures to be made by a guarantor in its interim and annual financial statements for periods ending after December 15, 2002 about its obligations under guarantees. FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees entered into or modified after December 31, 2002. FIN 45 requires the guarantor to recognize a liability for the non-contingent component of certain guarantees; that is, it requires the recognition of a liability for the obligation to stand ready to perform in the event that specified triggering events or conditions occur. The initial measurement of this liability is the fair value of the guarantee at inception. The Company included the disclosure of its guarantees in note 27h) of its audited consolidated financial statements included elsewhere in this Annual Report. VARIABLE INTEREST ENTITIES In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("VIE's") ("FIN 46") which requires that companies that control another entity through interests other than voting interest should consolidate the controlled entity. In the absence of clear control through a voting equity interest, a company's exposure (variable interests) to the economic risk and the potential rewards from a VIE's assets and activities are the best evidence of a controlling financial interest. VIE's created after January 31, 2003 must be consolidated immediately. VIE's existing prior to February 1, 2003 must be consolidated by the Company commencing with its third quarter 2003 financial statements. The Company has not yet determined whether it has any VIE's which will require consolidation. LIABILITIES AND EQUITY On May 15, 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The Statement requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company will adopt the provisions of the Statement on July 1, 2003. To date, the Company has not entered into any financial instruments within the scope of the Statement. The Company is currently assessing the impact of the new standard. DERIVATIVES AND HEDGING ACTIVITIES In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities". SFAS 149 amends and clarifies accounting for SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". In particular, it clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative as discussed in SFAS No. 133; clarifies when a derivative contains a financing component; amends the definition of an underlying to conform it to the language used in the FASB Interpretation No. 45; and amends certain other existing pronouncements. 39 SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company will adopt the provisions of SFAS No. 149 for U.S. GAAP purposes in the quarter ending June 30, 2003 and is currently assessing the impact, if any, that the adoption of SFAS No. 149 will have on its results of operations and financial position. CANADIAN AND UNITED STATES ACCOUNTING POLICY DIFFERENCES We prepare our consolidated financial statements in accordance with Canadian GAAP. GAAP in the United States (US GAAP) differs in certain respects from Canadian GAAP. The areas of material differences and their impact on our consolidated financial statements are described in note 26 to the audited consolidated financial statements, included elsewhere in this Annual Report. Our statement of operations prepared under Canadian GAAP does not present operating income as is required under US GAAP. The following are the significant differences between Canadian and US GAAP which would impact any assessment of our US GAAP operating income: i) Prior to January 1, 2002, the Company capitalized certain operating costs incurred to improve the long-term readership of our publications ("betterments") and amortized such costs on a straight-line basis over their useful lives. Capitalization of such operating costs is not permitted under US GAAP, which would result in higher operating costs, partially offset by lower amortization expense under US GAAP. ii) The Company presented as unusual items certain operating expenses, which are of an infrequent nature, including start up costs associated with new printing facilities as well as certain pension, benefit and redundancy costs. Such costs are presented as operating expenses under US GAAP. iii) The Company proportionately consolidated the operating results of our joint ventures under Canadian GAAP. Under US GAAP joint ventures are required to be accounted for using the equity method. While this GAAP difference does not affect our consolidated net earnings, it does increase operating revenues and operating expenses from those that would be reported under US GAAP. iv) The Company reported investment and interest income as revenue under Canadian GAAP, whereas such income is required to be reported as non-operating income under US GAAP. v) On January 1, 2000, upon adoption of a new income tax standard under Canadian GAAP, the Company elected not to restate our prior year's results. As a result, under Canadian GAAP the Company reported a charge to deficit. Under US GAAP this has been reflected as additional goodwill upon recognition of deferred income tax liabilities on business acquisitions. Accordingly, the Company had higher goodwill amortization (for periods prior to January 1, 2002) under US GAAP. There are also a number of additional differences between Canadian and US GAAP which would impact the Company's non-operating income, including the following: i) The Company is required under Canadian GAAP to treat the dividends paid on our Series II and Series III redeemable preference shares as interest expense. Under US GAAP, such dividends are charged to retained earnings which would result in lower interest expense under US GAAP. ii) The Company is not required to mark-to-market International's forward purchase contracts under Canadian GAAP. The unrealized losses on these contracts are required to be expensed under US GAAP. In December 2002, these contracts were settled and the losses realized. iii) Dilution gains reported under Canadian GAAP are lower than those which would be reported under US GAAP principally as a result of the capitalization of betterments under Canadian GAAP. iv) Gains on sales of businesses reported under Canadian GAAP are higher than those which would be reported under US GAAP principally as a result of additional goodwill recorded under US GAAP in connection with income taxes on business acquisitions noted under item (v) above. 40 v) Canadian GAAP requires recognition of a pension valuation allowance for any excess of the benefit expense over the expected future benefit. Changes in the pension valuation allowance are recognized in earnings under Canadian GAAP immediately. US GAAP does not permit the recognition of pension valuation allowances. vi) Under U.S. GAAP, the transitional provisions of new accounting standards for goodwill require the write-down resulting from the impairment test, upon adoption on January 1, 2002, to be reflected in the consolidated statement of earnings as a cumulative effect of a change in accounting principle. However, Canadian GAAP requires the same loss to be recorded as a charge to the opening deficit as at January 1, 2002. vii) Under Canadian GAAP, the Company was required to treat the transfer in 1997 of the Canadian newspapers to International as a disposition at fair value. This resulted in the recognition of a gain to the extent there is a minority interest in International. U.S. GAAP requires that the transfer of the Canadian newspapers to a subsidiary company be accounted for at historical values using "as-if" pooling of interests accounting. As a result, the revenues and expenses for the periods prior to January 1, 1997 would be restated to give effect to the transfer of the Canadian newspapers to International and the gross gain of $114,000,000, prior to deducting expenses, on the sale of the properties and the increase in intangible assets of an equivalent amount would not have been recorded for U.S. GAAP purposes. However, such gain would be recognized for U.S. GAAP purposes as the underlying Canadian newspaper operations were sold to third parties, or there was a further dilution in the Company's interest in International. In addition to the above items, under U.S. GAAP, the retractable common shares do not qualify as permanent equity due to the retractable features, being effective at the option of the holder. As a result, retractable common shares are classified outside shareholders' deficiency under U.S. GAAP. CONSOLIDATED FINANCIAL INFORMATION RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO 2001 NET LOSS. The net loss in the year ended December 31, 2002 amounted to $88.6 million or a loss of $2.76 per retractable common share compared to a net loss of $131.9 million or a loss of $3.91 per retractable common share in 2001. The results of both periods are impacted by a large number of unusual items which are discussed below. SALES REVENUE. Sales revenue in 2002 was $1,628.2 million compared with $1,822.1 million in 2001, a decrease of $193.9 million. The reduction in sales revenue is primarily due to the sale of most of the remaining Canadian newspaper properties in July and November 2001 and the sale of the remaining 50% interest in the National Post in August 2001. Declines in U.K. advertising revenue in local currency were partly offset by the strengthening of the pound sterling. Sales revenue, in local currency, for the Chicago Group was flat year over year. COST OF SALES AND EXPENSES. Cost of sales and expenses in 2002 were $1,453.9 million compared with $1,730.1 million in 2001, a decrease of $276.2 million. The decrease in cost of sales and expenses resulted primarily from the disposition of Canadian newspaper properties in 2001 as well as lower newsprint costs, lower compensation costs and general cost reductions at the Chicago Group and the U.K. Newspaper Group, primarily as a result of cost containment strategies. Lower cost of sales and expenses at the U.K. Newspaper Group, in local currency, were partially offset by the effect of the strengthening of the pound sterling. DEPRECIATION AND AMORTIZATION. Depreciation and amortization in 2002 amounted to $88.2 million compared with $144.7 million in 2001, a reduction of $56.5 million. The reduction results from both the disposition of Canadian properties in 2001 and the adoption on January 1, 2002 of CICA Handbook Section 3062, which resulted in goodwill not being amortized subsequent to January 1, 2002. In the year ended December 31, 2001, amortization of goodwill and intangible assets, including amortization of goodwill and intangible assets in respect of properties sold during 2001 which were not being amortized in 2002, approximated $53.3 million. INVESTMENT AND OTHER INCOME. Investment and other income in 2002 amounted to $29.7 million compared with $97.3 million in 2001, a decrease of $67.6 million. Investment and other income in 2001 included interest on debentures issued by a subsidiary of CanWest and a dividend on CanWest shares. In September 2001, CanWest temporarily suspended its semi-annual dividend. In the latter part of 2001, all of the CanWest shares were sold and Participations were sold to the Hollinger Participation Trust in respect of nearly all of the CanWest debentures, 41 resulting in significantly lower interest and dividend income in 2002. Most of the proceeds from the disposal of the CanWest investments were retained as short-term investments at low rates of interest until the end of the first quarter of 2002 when a portion of International's long-term debt was retired. INTEREST EXPENSE. Interest expense for 2002 was $121.7 million compared with $177.9 million in 2001, a reduction of $56.2 million. The reduction mainly results from lower average debt levels in 2002 compared with 2001. The Company reduced its revolving bank credit facility in 2001 by $173.4 million and by $38.5 million in January 2002 and International reduced its long-term debt beginning in March 2002 by U.S. $290.0 million. In addition, since both the Company's Series II and Series III preference shares are financial liabilities, dividends on such shares are included in interest expense. Dividends paid on the Series II preference shares were lower in 2002 than in 2001, as a result of Series II preference share retractions and International reducing its dividend on shares of Class A common stock, on which the Series II preference share dividends are based. NET LOSS IN EQUITY-ACCOUNTED COMPANIES. Net loss in equity-accounted companies amounted to $1.2 million in 2002 compared with $18.6 million in 2001. Net loss in equity-accounted companies in 2001 primarily represented an equity-accounted loss in Interactive Investor International, which was sold during the third quarter of 2001. NET FOREIGN CURRENCY LOSSES. Net foreign currency losses increased from a loss of $7.5 million in 2001 to a loss of $19.7 million in 2002. Net foreign currency losses in 2002 includes a $10.4 million net loss on amounts sold to the Hollinger Participation Trust and a $5.7 million loss on a cross currency swap. UNUSUAL ITEMS. Unusual items in 2002 amounted to a loss of $62.6 million compared with a loss of $295.4 million in 2001. Unusual items in 2002 included the loss on retirement of Publishing's Senior Notes in the amount of $56.3 million, a $63.6 million write-off of investments, and a $43.3 million loss on the termination of the Total Return Equity Swap, partly reduced by a $20.1 million gain on the dilution of the Company's investment in International, a net $44.5 million foreign exchange gain on the reduction of net investments in foreign subsidiaries and a $34.4 million reduction of the pension valuation allowance. Unusual items in 2001 included a $240.1 million loss on sales of investments, a $23.0 million loss on sale of publishing interests, a $79.9 million loss on write-off of investments and a $29.6 million realized loss on the Total Return Equity Swap, partly offset by a $59.4 million gain on the sale of and dilution of the Company's investment in International and a $58.7 million reduction of the pension valuation allowance. INCOME TAXES. In 2002, income tax expense was $124.0 million computed on a loss before income taxes and minority interest of $89.5 million primarily as a result of non-deductible expenses including the settlement of the Total Return Equity Swap and an increase in the tax valuation allowance of $74.0 million. In 2001, the income tax recovery was $89.5 million on a loss before income taxes and minority interest of $454.9 million in part due to the impact of losses at the National Post for which a tax benefit was not recorded. MINORITY INTEREST. Minority interest in the year ended December 31, 2002 was a recovery of $124.9 million compared to a recovery of $233.5 million in 2001. Minority interest primarily represents the minority share of the net loss of International and the net earnings of the Partnership. In 2001, minority interest also included the minority's 50% share of the National Post net loss to August 31, which totaled $28.7 million. RESULTS OF OPERATIONS BY SEGMENT FOR THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO 2001 CHICAGO GROUP Sales revenue in 2002 was $693.7 million compared with $686.3 million in 2001, an increase of $7.4 million or 1.1%. The increase results entirely from the slightly stronger United States dollar compared to the Canadian dollar on average in 2002 compared with 2001. In U.S. dollars, sales revenue was U.S. $441.8 million in 2002, a slight decrease compared with U.S. $442.9 million in 2001. Advertising revenue in 2002 was U.S. $341.3 million compared with U.S.$338.5 million in 2001, an increase of U.S. $2.8 million or 0.8%. Circulation revenue in 2002 was U.S. $89.4 million compared with U.S. $92.7 million in 2001, a decrease of U.S. $3.3 million or 3.6%. The decrease was primarily the result of price discounting. Cost of sales and expenses in 2002 were $591.6 million compared with $623.0 million in 2001, a decrease of $31.4 million or 5.0%. In U.S. dollars, cost of sales and expenses were U.S. $376.7 million in 2002 compared with U.S. $402.1 million in 2001, a decrease of U.S. $25.4 million or 6.3%. Cost savings were achieved across the board 42 with reductions in compensation costs, in newsprint costs and in other operating costs. Reductions in compensation and other costs are the result of cost management initiatives undertaken during the course of 2002 and 2001; however, the reduction in newsprint cost was primarily the result of newsprint price decreases. The average newsprint cost per tonne was approximately 21% lower in 2002 than in 2001. Depreciation and amortization in 2002 was $42.4 million compared with $53.5 million in 2001, a reduction of $11.1 million. The reduction is largely the result of the adoption, effective January 1, 2002 of Section 3062, which resulted in goodwill and intangible assets with indefinite useful lives no longer being amortized. Amortization of approximately $15.3 million in 2001 related to such assets. Operating income in 2002 totaled $59.7 million compared with $9.8 million in 2001, an increase of $49.9 million. This increase is the result of lower newsprint, compensation and other operating costs in 2002 compared with 2001 and lower amortization expense resulting from the adoption of new accounting standards for goodwill and intangible assets. U.K. NEWSPAPER GROUP In 2002, sales revenue for the U.K. Newspaper Group was $804.6 million compared with $801.1 million in 2001, an increase of $3.5 million or 0.4%. In pounds sterling, sales revenue was (pound)341.5 million in 2002 compared with (pound)358.9 million in 2001, a decrease of (pound)17.4 million or 4.8%. In 2002 compared to 2001, the pound sterling on average strengthened compared with the Canadian dollar. Advertising revenue at the Telegraph in 2002 was (pound)211.0 million compared with (pound)228.7 million in 2001, a decrease of (pound)17.7 million or 7.7%. Advertising revenues were lower in the recruitment and financial areas. Circulation revenue in 2002 was (pound)93.6 million at the Telegraph compared with (pound)94.5 million in 2001. Lower revenue from both a change in the mix of sales between single copy and subscribers and lower overall average circulation in 2002 compared with 2001 was partly offset by increased revenue resulting from single copy cover price increases of 5 pence in each of September 2001 and 2002 in respect of The Daily Telegraph. Total cost of sales and expenses in the year ended December 31, 2002 were $693.9 million compared with $703.3 million in 2001, a decrease of $9.4 million or 1.3%. In local currency, cost of sales and expenses in 2002 approximated (pound)294.3 million compared with (pound)314.9 million in 2001, a decrease of (pound)20.6 million or 6.5%. The majority of the decrease is due to a reduction in newsprint and compensation costs. The decrease in newsprint costs results from a reduction in consumption due to lower pagination as a result of lower advertising revenue, and a reduction in the average price per tonne of newsprint of 9.9%. Lower compensation costs in 2002 result primarily from reduced staff levels, mainly in editorial, which occurred at the end of 2001, as well as a general salary level freeze in 2002. Depreciation and amortization in 2002 was $35.9 million compared with $63.9 million in 2001, a reduction of $28.0 million. The reduction is primarily the result of the adoption, effective January 1, 2002, of new accounting standards, which resulted in goodwill and other intangible assets with indefinite useful lives not being amortized in 2002. Amortization expense of approximately $25.9 million in 2001 related to such assets. Operating income in 2002 totaled $74.8 million compared with $33.9 million in 2001, an increase of $40.9 million. The increase in operating income, in local currency, is the result of lower newsprint and compensation costs and reduced amortization expense resulting from the adoption of new accounting standards, reduced by lower advertising revenue. In addition, the strength of the pound sterling on average in 2002 compared with the Canadian dollar, further improved operating income in Canadian dollars. CANADIAN NEWSPAPER GROUP Sales revenue at the Canadian Newspaper Group in 2002 was $109.1 million compared with $305.1 million in 2001, a decrease of $196.0 million. The operating loss was $5.3 million in 2002 compared with an operating loss of $50.4 million in 2001, a decrease of $45.1 million. The results for 2001 included the results of the National Post and other Canadian newspaper properties, all of which were sold during 2001. The newspapers that were sold accounted for the majority of the decrease in year-over-year sales revenue and the net reduction in year-over-year operating loss. The 2001 operating loss included a $57.3 million operating loss for the National Post for the period January 1 to August 31, when the National Post was sold. Sales revenue for operations owned throughout 2001 and 2002 was $108.8 million in 2002 and $114.1 million in 2001, a decrease of $5.3 million or 4.6%. The decrease primarily resulted from lower sales revenue at the Business Information Group. 43 COMMUNITY GROUP In 2002, sales revenue was $20.8 million and the operating loss was $8.2 million compared with sales revenue of $29.6 million and an operating loss of $5.3 million in 2001. The results for 2001 include the last remaining U.S. Community Group newspaper which had operating revenue of U.S. $0.8 million and an operating loss of U.S. $0.2 million in 2001. Sales revenue at the Jerusalem Post in 2002 was U.S.$13.2 million compared with U.S. $19.1 million in 2001, a decrease of U.S. $5.9 million. Advertising revenue declined U.S. $1.9 million, circulation revenue declined U.S. $1.7 million and printing revenue declined U.S.$2.3 million, each due to the poor economic climate in Israel. In addition in the past, Jerusalem Post derived a relatively high percentage of its revenues from printing as a result of a long-term contract to print and bind copies of the Golden Pages, Israel's equivalent of a Yellow Pages telephone directory. During 2002, Golden Pages effectively cancelled this agreement and has ceased placing printing orders. An action was commenced by the Jerusalem Post in 2003 seeking damages for the alleged breach of contract. In addition, amortization expense in the amount of $0.9 million at the Jerusalem Post in 2001 was not incurred in 2002 as a result of new accounting standards for goodwill. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2001 COMPARED TO 2000 NET EARNINGS (LOSS). The Company had a net loss of $131.9 million in 2001 or a loss of $3.91 per retractable common share compared with net earnings of $189.4 million in 2000 or $5.11 per retractable common share. The results of both years included a large number of unusual items. In 2001, the net loss from unusual items after income taxes and minority interest amounted to $74.0 million compared with net income from unusual items after income taxes and minority interest, in 2000 of $219.5 million. Excluding the net effect of unusual items, the net loss in 2001 was $57.9 million compared with a net loss of $30.1 million in 2000. SALES REVENUE. Sales revenue in 2001 was $1,822.1 million compared with $3,158.3 million in 2000, a decrease of $1,336.2 million. The overall decrease in sales revenue was primarily due to the sale of Canadian Newspaper Group properties in both 2000 and 2001 and the 2000 sale of Community Group newspaper properties. In addition, lower sales revenue at the U.K. Newspaper Group and the Chicago Group on a same store basis contributed to the decrease. However, the acquisition of Fox Valley Publications Inc. (formerly Copley Group) in December 2000 increased total Chicago Group sales revenue. COST OF SALES AND EXPENSE. Total cost of sales and expenses in 2001 were $1,730.1 million compared with $2,586.2 million in 2000, a decrease of $856.1 million. The decrease in costs primarily results from the sales of Canadian Newspaper Group properties in both 2000 and 2001 and the sale of Community Group newspaper properties in 2000. In addition newsprint expense in respect of properties owned throughout both 2000 and 2001 was lower mainly as a result of lower consumption at the U.K. Newspaper Group and the Chicago Group. Cost of sales and expenses are net of betterments capitalized. On completion of a detailed impairment analysis of the cumulative betterments capitalized, principally in respect of the U.K. Newspaper Group, a write-down of $37.8 million was taken in the fourth quarter of 2001 and included in cost of sales and expenses. This partly offsets the decreases noted above. DEPRECIATION AND AMORTIZATION. Depreciation and amortization in 2001 totaled $144.7 million compared with $219.9 million in 2000, a decrease of $75.2 million. Lower depreciation and amortization resulting from the sale of properties in both the Community Group and Canadian Newspaper Group was in part offset by increased depreciation at the Chicago Group related to the new printing facility and increased depreciation and amortization resulting from the Fox Valley Publications Inc. acquisition in December 2000. INVESTMENT AND OTHER INCOME. Investment and other income in 2001 totaled $97.3 million compared with $28.1 million in 2000, an increase of $69.2 million. Investment and other income in 2001 included interest on the CanWest debentures until the sale of participation interests in August and December, interest on the remaining CanWest debentures, dividends on CanWest shares and bank interest on the significant cash balance primarily accumulated from the proceeds of the sale in 2001 of Canadian newspaper properties and the sale of CanWest shares and participation interests in CanWest debentures. In 2000, interest and dividend income on CanWest investments was received only for the period November 17 to December 31. INTEREST ON LONG-TERM DEBT. Interest on long-term debt amounted to $122.7 million in 2001 compared with $220.0 million in 2000, a decrease of $97.3 million. This decrease primarily results from the significantly lower debt 44 levels during 2001 compared with 2000. In November 2000, International repaid U.S.$972.0 million of its senior credit facility with the proceeds from the sale of properties to CanWest. UNUSUAL ITEMS. Unusual items in 2001 amounted to a loss of $295.4 million compared with a gain of $700.9 million in 2000. Unusual items in 2001 included a loss on sale of investments of $240.1 million, being primarily the loss on sale of participations in CanWest debentures and a loss on sale of CanWest shares, a net loss of $23.0 million on sale of publishing interests including the loss on sale of National Post, partly offset by gains on sales of Canadian properties, a $79.9 million write-off of investments, a $29.6 million realized loss on International's Total Return Equity Swap, a pension and post retirement plan liability adjustment of $16.8 million primarily in respect of retired former Southam employees, redundancy, rationalization and other costs of $16.9 million and $7.2 million of duplicated costs resulting from operating two plants during the start-up of a new plant in Chicago. These unusual losses were reduced by a $59.4 million gain on the effective sale of International shares and a $58.7 million accounting gain resulting from a decrease in the required pension valuation allowance in respect of Canadian Newspaper Group pension plans due to a decline in the value of plan assets. Unusual items in 2000 included $697.9 million of gains on sales of publishing interests, being primarily the sale of Canadian properties to CanWest and the sale of most of the remaining United States Community Group newspaper properties, a $47.9 million gain on sale of investments, a $28.5 million gain on the effective sales of International shares and a $25.8 million gain on the dilution of the investment in Interactive Investor International. These gains were reduced by a loss on the write-off of investments of $31.4 million, redundancy, rationalization and other costs of $41.5 million, the write-off of financing fees of $16.1 million and $10.1 million of duplicated costs resulting from operating two plants during the start-up of the new plant in Chicago. INCOME TAXES. In 2001, the effective tax rate was lower than the effective tax rate in 2000 due to the impact of significantly higher losses of the National Post, for which a tax benefit is not being recorded. MINORITY INTEREST. Minority interest in 2001 was a recovery of $233.5 million compared with an expense of $331.1 million in 2000. Minority interest primarily represents the minority share of the results of International, and the net earnings of the Partnership and in 2001, the minority's share of the National Post losses. In 2001, International reported a significant net loss including unusual losses whereas in 2000 International reported net earnings including unusual gains. Minority interest reflects the minority's share of these results. RESULTS OF OPERATIONS BY SEGMENT FOR THE YEAR ENDED DECEMBER 31, 2001 COMPARED TO 2000 CHICAGO GROUP Sales revenue in 2001 was $686.3 million compared with $596.8 million in 2000, an increase of $89.5 million. In United States dollars, sales revenue was US$442.9 million in 2001 compared with US$401.4 million, an increase of US$41.5 million. Advertising revenue was US$338.5 million in 2001 compared with US$305.0 million in 2000, an increase of US$33.5 million. Circulation revenue was US$92.7 million in 2001 compared with US$80.3 million in 2000, an increase of US$12.4 million. Printing and other revenue was US$11.7 million in 2001 compared with US$16.1 million in 2000, a decrease of US$4.4 million. Chicago Group results are based on standard accounting periods, which for 2000 resulted in a 53-week year for the reported results of the Chicago Group only. The effect of the 53rd week in 2000 was to add US$6.0 million to sales revenue and US$6.2 million to operating costs and expenses. On December 15, 2000, the acquisition of Chicago Suburban Newspapers from Copley Group was completed and operating results of this group have been included since that time. Revenues for operations owned in both years, excluding Chicago Suburban Newspapers ("same store") and based on a 52-week year in 2000, were US$363.6 million for 2001, compared with US$392.0 million in 2000. Advertising revenue in 2001, on a same store 52-week basis, was US$20.0 million or 6.7% lower than in 2000. Circulation revenue on a same store 52-week basis, in 2001, was US$2.7 million or 3.5% lower than in 2000. Chicago Sun-Times average daily circulation in 2001 was higher than in 2000; however, circulation revenue for 2001 was lower than in 2000 as a result of price discounting to build and maintain market share in response to competitive activity. Printing and other revenue, on a same store 52-week basis was US$10.1 million in 2001 compared with US$15.8 million in 2000, a decrease of US$5.7 million. Cost of sales and expenses in 2001 were $623.0 million compared with $504.1 million in 2000, an increase of $118.9 million. In US dollars, costs of sales and expenses were US$402.1 million in 2001 compared with US$339.0 45 million in 2000, an increase of US$63.1 million. Newsprint expense in 2001 was US$76.4 million compared with US$69.2 million in 2000, an increase of US$7.2 million. Compensation costs were US$178.7 million in 2001 compared with US$150.9 million in 2000, an increase of US$27.8 million. Other operating costs were US$147.0 million in 2001 compared with US$118.9 million in 2000, an increase of US$28.1 million. On a same store 52-week basis, cost of sales and expenses were US$328.5 million compared with US$329.9 million in 2000, a decrease of US$1.4 million or 0.4%. Same store newsprint expense in 2001 was US$67.5 million, compared to US$67.6 million in 2000. Average newsprint prices in 2001 were approximately 11% higher than in 2000. In 2001, newsprint consumption was significantly less than in 2000 as a result of lower page counts due to reduced advertising revenue, a reduction in commercial printing, and general cost controls. On a same store 52-week basis, compensation and other costs decreased US$1.3 million or 0.5% year over year. The lower compensation costs result from staff reductions across the Chicago Group offset in part by increased medical costs and workers compensation costs. Other operating costs are lower as a result of reduced commercial printing production costs, and general cost reductions across all areas. On a same store basis depreciation and amortization increased US$6.3 million mainly as a result of higher depreciation charges related to the new Chicago printing facility. Operating income in 2001 totaled $9.8 million compared with $55.4 million in 2000, a decrease of $45.6 million. On a same store 52-week basis in United States dollars, operating income was US$16.9 million in 2001 compared with US$37.0 million in 2000, a decrease of US$20.1 million. The decrease results primarily from lower sales revenue, increased depreciation and amortization offset in part by lower compensation and other operating costs. The acquisition of Chicago Suburban Newspapers in 2000 added US$79.3 million to sales revenue and operating income of US$2.4 million in 2001. U.K. NEWSPAPER GROUP In 2001, sales revenue for the U.K. Newspaper Group was $801.1 million compared with $882.2 million in 2000, a decrease of $81.1 million or 9.2%. In 2001 compared to 2000, the pound sterling on average weakened compared with the Canadian dollar. In pounds sterling, sales revenue was (pound)358.9 million in 2001 compared with (pound)392.3 million in 2000, a decrease of (pound)33.4 million or 8.5%. The decrease in revenue was almost entirely the result of lower advertising revenue. Advertising revenue in 2001 was (pound)228.7 million compared with (pound)255.9 million in 2000, a decrease of (pound)27.2 million or 10.6%. Circulation revenue in 2001 was (pound)94.5 million compared with (pound)95.7 million in 2000. On September 5, 2001, the price of The Daily Telegraph on Monday to Friday increased from 45 pence to 50 pence and on September 8, 2001, the price of The Daily Telegraph on Saturday increased from 75 pence to 85 pence. The price increases improved circulation revenue in the last quarter of 2001. Cost of sales and expenses in 2001 were $703.3 million compared with $684.9 million in 2000, an increase of $18.4 million or 2.7%. In local currency, cost of sales and expenses in 2001 approximated (pound)314.9 million compared with (pound)305.9 million in 2000, an increase of (pound)9.0 million or 2.9%. Newsprint expense in local currency was (pound)64.7 million in 2001 compared with (pound)60.6 million in 2000, an increase of (pound)4.1 million or 6.8%. This increase results from the significant increase in newsprint prices in 2001 compared to 2000, offset in part by 4% lower consumption in 2001 compared to 2000. In addition, cost of sales and expenses are net of betterments capitalized. On completion of a detailed impairment analysis during 2001 of the cumulative betterments capitalized, a write down was taken in the fourth quarter of 2001, resulting in a net reduction in betterments capitalized year over year of (pound)9.8 million. The increased cost of sales and expenses in 2001 compared with 2000 resulted from increased newsprint costs and the net reductions in betterments capitalized reduced in part by lower other operating costs. Depreciation and amortization in 2001 was $63.9 million compared with $58.1 million in 2000, an increase of $5.8 million. Operating income in 2001 totaled $33.9 million compared with $139.1 million in 2000, a decrease of $105.2 million. The decrease in operating income, is primarily the result of lower advertising revenue, increased newsprint costs, the net reduction in betterments capitalized and increased depreciation and amortization offset in part by lower other operating costs. CANADIAN NEWSPAPER GROUP Sales revenue in the Canadian Newspaper Group was $305.1 million in 2001 compared with $1,579.2 million in 2000 and in 2001 there was an operating loss of $50.4 million compared with operating income of $174.1 million in 2000. The significant decrease in both sales revenue and operating income was largely a result of the sale of 46 newspaper assets in November 2000 to CanWest, the sale of UniMedia Company completed in January 2001, the July and November 2001 sales of operations to Osprey and the August 31, 2001 sale of the National Post. Included in the $50.4 million operating loss for the year ended December 31, 2001, are overhead costs of approximately $3.8 million that are not expected to be incurred in 2002. Also included is a $2.6 million expense in respect of employee benefit costs of retired former Southam employees. COMMUNITY GROUP Sales revenue and operating income were $29.6 million and a loss of $5.3 million in 2001, compared to $100.1 million and operating income of $6.7 million in 2000. The significant decrease in both sales revenue and operating income results almost entirely from the sale of Community Group properties that occurred primarily during 2000. During the third quarter of 2001, the last remaining U.S. Community Group property was sold. At December 31, 2001, the Jerusalem Post was the only Community Group property still owned by the Company. B. LIQUIDITY AND CAPITAL RESOURCES FINANCIAL CONDITION AND CASH FLOWS The Company is an international holding company and its assets consist primarily of investments in its subsidiaries and affiliated companies. As a result, the Company's ability to meet its future financial obligations, on a non-consolidated basis, is dependent upon the availability of cash flows principally from International through dividends and other payments. International and the Company's other subsidiaries and affiliated companies are under no obligation to pay dividends. International's ability to pay dividends on its common stock may be limited as a result of its dependence on the receipt of dividends and other receipts primarily from Publishing. Publishing and its principal United States and foreign subsidiaries are subject to statutory restrictions and restrictions in debt agreements that limit their ability to pay dividends. Substantially all of the assets of Publishing and its material U.S. and U.K. subsidiaries have been pledged to the group's lenders. The Company's right to participate in the distribution of assets of any subsidiary or affiliated company upon its liquidation or reorganization will be subject to the prior claims of the creditors of such subsidiary or affiliated company, including trade creditors, except to the extent that the Company may itself be a creditor with recognized claims against such subsidiary or affiliated company. On a non-consolidated basis, the Company has experienced a shortfall between the dividends and fees received from its subsidiaries and its obligations to pay its operating costs, including interest and dividends on its preference shares, and such shortfalls are expected to continue in the future. Accordingly, the Company is dependent upon the continuing financial support of RMI to fund such shortfalls and, therefore, pay its liabilities as they fall due. RMI is a wholly owned subsidiary of Ravelston, the Company's ultimate parent company. On March 10, 2003, concurrent with the issue of U.S. $120.0 million Senior Secured Notes due 2011, RMI entered into a support agreement with the Company. Under the agreement, RMI has agreed to make annual support payments in cash to the Company on a periodic basis by way of contributions to the capital of the Company (without the issuance of additional shares of the Company) or subordinated debt. The annual support payments will be equal to the greater of (a) the Company's negative net cash flow (as defined) for the relevant period (which does not extend to outlays for retractions or redemptions), determined on a non-consolidated basis, and (b) U.S.$14.0 million per year (less any payments of management services fees by International directly to the Company or NB Inc. and any excess in the net dividend amount that the Company and NB Inc. receive from International over U.S.$4.65 million per year), in either case as reduced by any permanent repayment of debt owing by Ravelston to the Company. Pursuant to this arrangement, RMI has made payments to the Company in respect of the period from March 10 to March 31, 2003 in the amount of U.S.$1.1 million. RMI currently derives all of its income and operating cash flow from the fees paid pursuant to Services Agreements with International and its subsidiaries. RMI's ability to provide the required financial support under the support agreement with the Company is dependent on RMI continuing to receive sufficient fees pursuant to those Services Agreements. The Services Agreements may be terminated by either party by giving 180 days notice. The fees in respect of the Services Agreements are negotiated annually with and approved by the audit committee of International. The fees to be paid to RMI for the year ending December 31, 2003 amount to approximately U.S.$22.0 million to U.S.$24.0 million and were approved in February 2003. The fees in respect of the periods after December 31, 2003 have not yet been negotiated or approved. As described more fully above in "Hollinger International Inc. -- Recent Developments", a shareholder of International has requested that the Board investigate and, if determined to be advisable, take corrective action in respect of certain matters, including the payment of fees by International pursuant to management services agreements with RMI. Although the Board of International has established a special committee of the Board of Directors to conduct an independent review and investigation of the matters, the timing and outcome of the process and the impact on the Company and RMI is uncertain at this time. Under the terms of the Senior Secured Notes, if in any quarterly period after April 1, 2003, the Company fails to receive in cash a minimum aggregate amount of at least US$4.7 million from a) payments made by RMI pursuant to the support agreement and b) dividends paid by International on its shares held by the Company and NBI, the Company would be in default under its Senior Secured Notes and they could become due and payable immediately. Based on the Company's current investment in International and the current quarterly dividend paid by International of US$0.05 per share: (i) the minimum support payment required to be made by RMI to avoid a default under the terms of the Senior Secured Notes is approximately US$14.0 million annually and (ii) the Company estimates the support payment required by RMI to fund its negative net cash flow will approximate US$20.0 million for the twelve months ending June 30, 2004. This amount assumes payment by the Company of preference share dividends of approximately US$5.0 million which have yet to be considered by the Board of Directors and which depend on the Company having the ability under corporate law to pay such dividends. The Company's ongoing liquidity on a non-consolidated basis continues to depend to a large degree on support payments from RMI which in turn depends on fees received pursuant to its services agreements with International. If the Company does not receive support payments of at least US$15.0 million for the twelve months ending June 30, 2004, based on the above assumptions, then it will be required to dispose of assets of seek financing in order to meet its non-consolidated obligations as they fall due. The Company is contemplating a variety of initiatives to address the potential matters referred to above, however at this time there can be no certainty that such initiatives will be completed. 47 Initially, the support amount to be contributed by RMI will be satisfied through the permanent repayment by Ravelston of its approximate $16.4 million of advances from the Company, which resulted from the use of proceeds of the Company's issue of its Senior Secured Notes. Thereafter, all support amount contributions by RMI will be made through contributions to the capital of the Company, without receiving any additional shares of the Company, except that, to the extent that the minimum payment exceeds the negative net cash flow of the Company, the amounts will be contributed through an interest-bearing, unsecured, subordinated loan to the Company. The support agreement terminates upon the repayment of the Senior Secured Notes which mature in 2011. The Senior Secured Notes are secured by a first priority lien on 10,108,302 shares of International's Class A common stock and 14,990,000 shares of International's Class B common stock owned by the Company and NB Inc. Therefore, at June 19, 2003, the Company and NB Inc., in total, hold only 1,148,236 shares of International Class A common stock which are unencumbered, the current market value of which approximates US$15.3 million. The Company has the right to redeem up to 35% of the Senior Secured Notes with money raised from a public offering, which would, in turn, result in a portion of the pledged shares of International Class A common stock being released from this lien. The Company has no plans at this time to conduct a public offering. On March 10, 2003, the Company repaid the amount due to Ravelston, made an advance to Ravelston and repaid all borrowings under its revolving credit facility and operating line of credit with the proceeds of its issuance of Senior Secured Notes. Currently, the Company does not have a line of credit. The Trust Indenture governing the Senior Secured Notes places certain limitations on the Company's ability to incur additional indebtedness and the ability to retract the Series II and III preference shares and the retractable common shares. In addition, on March 10, 2003, Ravelston and RMI entered into a contribution agreement with the Company. The contribution agreement is not pledged to the trustee for the Notes, and holders of the Notes are not entitled to any rights thereunder. The contribution agreement sets out the manner in which RMI will make support payments to the Company as described above. Ravelston has guaranteed RMI's obligations under the contribution agreement and its obligation to make support payments to the Company under the support agreement. Ravelston's guarantee will not enure to the benefit of, or be enforceable by, the trustee for the Notes or holders of the Notes. The Company has pledged the benefit of this guarantee as security for its obligations under the indebtedness of NB Inc. due to International. The contribution agreement will terminate upon the repayment in full of the Notes, the termination of the support agreement or if the Company ceases to be a public company. On May 22, 2003, International and the Company announced that they had reached an agreement in principle whereby the Company would sell some of its holding of International's Class A shares to Southeastern Asset Management Inc. ("Southeastern"), and would seek certain phased changes in voting rights of International's Class B shares over five years. There were also, prior and subsequent to May 22, 2003, tentative agreements on the optimal scale of management fees, Southeastern nominations to International's Board of Directors, and on certain other matters, including possible consideration to the Company for varying the super-voting rights that attach to International's Class B shares. These discussions have evolved substantially but in a manner generally consistent with what was announced May 22, 2003. As a result of publicity accorded these discussions and International's affairs generally, other entities have initiated conversations on matters related to the subjects of the Southeastern discussions. All of these conversations are in progress, but it is impossible at this time to foretell whether they will reach an executable agreement, or what the nature of such an agreement might be. RETRACTABLE SHARES. The Company's issued capital stock consists of Series II preference shares, Series III preference shares and retractable common shares, each of which is retractable at the option of the holder. There is continuing uncertainty regarding the Company's future ability to complete retractions and redemptions of preference shares and retractable common shares. Dividends on the preference shares are not payable until declared by the Board of Directors which will take into account when dividends are considered from time to time, among other things, the support payments to be made to it by RMI. Under corporate law, the Company cannot redeem shares (either on a retraction or on the April 30, 2004 redemption date in the case of the Series III Preference Shares) or declare or pay dividends in certain circumstances, including if there are reasonable grounds for believing that the Company is, or would after the payment be, unable to pay its liabilities as they become due. In such circumstances, shareholders do not become creditors of the Company and, in the case of shares submitted for retraction or in the case of the Series III Preference Shares to be redeemed on April 30, 2004, holders thereof remain as shareholders until such time as the retraction or redemption is able to be completed under applicable law. The Company's uncertain ability to make payments on future retractions and redemptions of shares or dividends on shares is due to the fact that liquidity of its assets is limited at present, given that substantially all of its shares of International common stock were provided as security for the Senior Secured Notes. During the six months ended June 30, 2003, the Company was able to complete the retraction of 504,989 Series II preference shares for 232,293 shares of International Class A common stock, 300,000 Series II preference shares for cash consideration of $1,585,000 being the cash equivalent value of 0.46 of a share of Class A common stock of International for which each Series II preference share was exchangeable, at the time of retraction, 876,050 Series III preference shares for approximately $7.7 million in cash and 22,500 retractable common shares for cash of $124,000. This completed all retraction notices received up to and including April 30, 2003. 48 After careful deliberation, the Company concluded at the current time that it was not able to complete the retractions of shares submitted after April 30, 2003 without unduly impairing its liquidity. Since April 30, 2003 and up to and including August 5, 2003, the Company has received retraction notices from holders of 3,680,193 Series III preference shares of which 1,387,139 retraction notices were subsequently withdrawn, leaving retraction notices from holders of 2,293,054 Series III preference shares for aggregate retraction proceeds of approximately $21.8 million which are unable to be completed at the current time. In addition, during the same time period, retraction notices were received from the holders of 401,712 Series II preference shares for aggregate retraction proceeds of 184,787 shares of International Class A common stock or cash of approximately $2.9 million, which are unable to be completed at the current time. Also, during the same period, retraction notices were received from holders of 318 retractable common shares for aggregate retraction proceeds of $1000, which are unable to be completed at the current time. Giving effect to the retractions completed as of September 4, 2003, there continues to be outstanding 3,775,990 Series II preference shares (exchangeable for 1,736,955 shares of Class A common stock of International), 9,271,175 Series III preference shares and 33,891,404 retractable common shares. The Company's Series III preference shares have a fixed redemption date on April 30, 2004 for a cash payment of $10.00 per share plus any accrued and unpaid dividends to that date. The total cost to redeem all of the issued and outstanding Series III preference shares would be $92.7 million. The Company made an offer to exchange all of its Series III preference shares for newly issuable Series IV preference shares having comparable terms, except for a higher dividend rate (8% compared to 7% for the Series III preference shares) and a longer term to mandatory redemption (April 30, 2008 compared to April 30, 2004). Holders will have the right at any time to retract Series IV preference shares for a retraction price payable in cash which, during the first four years will be calculated using 95% of prices for Government of Canada Bonds having a comparable yield and term, and during the fifth year will be $9.50 per share (plus unpaid dividends in each case). On June 9, 2003, the Company announced that it was permitting the exchange offer to expire because holders of at least 5,000,000 of the Series III preference shares had not accepted the offer. The Company will periodically review its liquidity position to determine if and when further retractions can be completed. The Company will not complete retractions or redemptions if to do so would unduly impair its liquidity. Retractions of Series II preference shares and Series III preference shares will be processed on a combined basis in order determined by their retraction date (with equal ranking of the series) in advance of any retractable common shares that are submitted for retraction. Following the satisfaction of all pending retracted Series II preference shares and Series III preference shares, retractions of the retractable common shares will be processed in order determined by their retraction date. Accordingly, retractions of retractable common shares cannot be completed as long as there are pending and unsatisfied retractions of Series II preference shares and Series III preference shares. RETRACTION PRICE OF RETRACTABLE COMMON SHARES OF HOLLINGER INC. The retractable common shares of the Company have terms equivalent to common shares, except that they are retractable at any time by the holder for their retraction price in exchange for shares of the Company's holding of International Class A common stock of equivalent value. The Company has the right to settle the retraction price by cash payment. The retraction price determined each quarter (or, in certain specific cases more frequently) by the Company's Retraction Price Committee, is between 90% and 100% of the Company's current value, being the aggregate fair market value of all of its assets less the aggregate of (i) the maximum amount payable at such date by the Company on its liquidation, dissolution or winding-up in respect of outstanding preference shares other than the retractable common shares, and (ii) its liabilities, including any tax liabilities that would arise on a sale of all or substantially all of its assets, which, in the opinion of the Board, would not be refundable at such date, divided by the number of retractable common shares outstanding on such date. Currently the Company and its wholly owned subsidiaries, which excludes International, have assets which consist principally of the investment in International together with other miscellaneous investments. The Company as at June 19, 2003 directly and indirectly owned 11,256,538 shares of Class A common stock and 14,990,000 49 shares of Class B common stock of International with a then market value of approximately U.S.$294.2 million. The Company's significant liabilities include U.S.$120.0 million 11 7/8% Senior Secured Notes due 2011, Series II preference shares, which are exchangeable into 1,736,955 shares of International Class A common stock with a current value of approximately U.S.$19.5 million and Series III preference shares which are redeemable on April 30, 2004 for an aggregate of $92.7 million. The retraction price of the retractable common shares during 2002 and early 2003 was as follows:
Per Retractable Common Share January 10, 2002 $ 7.50 April 11, 2002 $ 9.50 July 9, 2002 $ 7.50 October 3, 2002 $ 5.50 January 7, 2003 $ 5.50 April 2, 2003 $ 1.75
The decline in the retraction price of the retractable common shares from $5.50 per share on January 7, 2003 to $1.75 per share on April 2, 2003 primarily results from the lower market price of shares of International Class A common stock and a strengthening of the Canadian dollar relative to the U.S. dollar. Since at the current time the Company is unable to complete retractions in respect of retraction notices received for Series III preference shares, the Company would be unable to complete any retraction notices received in the future in respect of retractable common shares until all preference share retraction notices, received by the Company and not withdrawn, are completed. At June 19, 2003 there are 33,891,404 retractable common shares issued and outstanding, of which 26,516,886 are held by Ravelston and its affiliates. WORKING CAPITAL Working capital consists of current assets less current liabilities. At June 30, 2003, working capital excluding the current portion of long-term debt obligations was a deficiency of $384.1 million compared to working capital, excluding the current portion of long-term debt obligations and the related funds held in escrow at December 31, 2002, which was a deficiency of $604.4 million. The decrease in the working capital deficiency is due to the refinancing of the Company's bank indebtedness and the repayment of the amount due to Ravelston with the proceeds of the issue of Senior Secured Notes. Current assets, excluding funds held in escrow, were $628.3 million at June 30, 2003 compared to $618.1 million at December 31, 2002. Current liabilities, excluding debt obligations, but including short-term bank indebtedness and retractable preference shares, were $1,012.4 million at June 30, 2003, compared with $1,222.5 million at December 31, 2002. Current liabilities, at June 30, 2003, include $118.1 million in respect of retractable preference shares. These retractable preference shares are included in current liabilities since they are retractable at any time at the option of the holder. Also included in current liabilities is approximately $500.9 million of income taxes that has primarily been provided on gains on sales of assets computed on tax bases that result in higher gains for tax purposes than for accounting purposes. Strategies have been and may be implemented that may also defer and/or reduce these taxes but the effects of these strategies have not been reflected in the accounts. While the timing of the payment of such income taxes, if any, is uncertain, the Company does not expect any significant amounts to be paid in 2003. At December 31, 2002, working capital, excluding the current portion of long-term debt obligations and the related funds held in escrow, was a deficiency of $604.4 million compared to working capital of $133.6 million at December 31, 2001. Current assets excluding funds held in escrow were $618.1 million at December 31, 2002 compared with $1,223.8 million at December 31, 2001. Current liabilities, excluding debt obligations, but including short-term bank indebtedness, were $1,222.5 million at December 31, 2002, compared with $1,090.2 million at December 31, 2001. Current liabilities at December 31, 2002 include $147.3 million in respect of retractable preference shares and the related deferred unrealized gain. Also included in current liabilities at December 31, 2002 are approximately $436.7 million of income taxes that have been provided on gains on sales of assets computed on tax bases that result in higher gains for tax purposes than for accounting purposes. Strategies have been and may be implemented that may also defer and/or reduce these taxes but the effects of these strategies have not been reflected in the accounts. While the timing of the payment of such income taxes, if any, is uncertain, the Company does not expect any significant amounts to be paid in 2003. The reduction in working capital in 2002, excluding the current portion of long-term debt obligations and related funds held in escrow, is primarily the result of the retractable preference shares being included in current liabilities and the reduction in cash and cash equivalents as a result of the pay-down of long-term debt since December 31, 2001, offset by the reduction in bank indebtedness. During the year ended December 31, 2002, approximately U.S.$370.8 million of cash and cash equivalents, which included both principal repayments and related premiums, was used to retire a portion of Publishing's long-term debt. During January 2002, the Company's revolving bank credit facility was reduced to $81.9 million from $120.4 million at December 31, 2001, using proceeds from the sale of 2,000,000 shares of International's Class A common stock. During 2001, the Company reduced its bank indebtedness by $142.0 million with proceeds from the sale of 50 7.1 million shares of International's Class A common stock to International for cancellation and from the December 2001 sale to third parties of 2,000,000 shares of International's Class A common stock. At December 31, 2002, the Company had fully borrowed on its bank operating line that provided for up to $10.0 million of borrowings and its revolving bank credit facility that provided for up to $80.8 million in borrowings. The Company's revolving bank credit facility was secured by International shares owned by the Company and bore interest at the prime rate plus 2.5% or the bankers' acceptance ("BA") rate plus 3.5%. Under the terms of the revolving bank credit facility, the Company and its wholly owned subsidiaries were subject to restrictions on the incurrence of additional debt. The revolving bank credit facility was amended and restated on August 30, 2002 and was to mature on December 2, 2002. A mandatory repayment of the revolving bank credit facility in the amount of $50.0 million was required by December 2, 2002 and if such payment was made, the lenders could have consented to an extension of the maturity date to December 2, 2003 in respect of the principal outstanding. On December 2, 2002, the lenders extended the $50.0 million principal repayment date to December 9, 2002. This repayment was not made, and on December 9, 2002, the bank credit facility was amended to require a principal repayment of $44.0 million on February 28, 2003 with the balance maturing on December 2, 2003. As a result of the impending closing of the Company's Senior Secured Note issue, the lenders further extended the due date for the repayment of $44.0 million to March 14, 2003. On March 10, 2003, the revolving bank credit facility in the amount of $80.8 million and the bank operating line of $10.0 million were repaid with part of the proceeds of the Company's issue of Senior Secured Notes. On October 3, 2002, International entered into a term lending facility and borrowed U.S.$50.0 million ($79.6 million). As a result of International's borrowing under this term lending facility, the Company was in default of a covenant under its revolving bank credit facility which, while in default, resulted in borrowings being due on demand. The Company's banks waived the default and on December 23, 2002 International repaid the full amount borrowed under the term lending facility. LONG-TERM DEBT Long-term debt, including the current portion, was $1,789.3 million at December 31, 2002 compared with $1,351.6 million at December 31, 2001. On March 10, 2003, the Company issued U.S. $120.0 million aggregate principal amount of 11 7/8% Senior Secured Notes due 2011. The total net proceeds were used to repay the Company's revolving bank credit facility and bank operating line, repay amounts due to Ravelston and to make an advance to Ravelston. The Senior Secured Notes are fully and unconditionally guaranteed by RMI and are secured by a first priority lien on 10,108,302 shares of International's Class A Common stock and 14,990,000 shares of Class B common stock owned by the Company NB Inc. On December 23, 2002, certain of International's subsidiaries entered into an amended and restated U.S. $310.0 million Senior Credit Facility with a group of financial institutions arranged by Wachovia Bank, N.A. (the "Senior Credit Facility"). The Senior Credit Facility consists of (a) a U.S. $45.0 million revolving credit facility, which matures on September 30, 2008 (the "Revolving Credit Facility"), (b) a U.S. $45.0 million Term Loan A, which matures on September 30, 2008 ("Term Loan A") and (c) a U.S. $220.0 million Term Loan B, which matures on September 30, 2009 ("Term Loan B"). Publishing (a wholly owned direct subsidiary) and Telegraph Group Limited ("Telegraph Group", a wholly owned indirect United Kingdom subsidiary) are the borrowers under the Revolving Credit Facility and First DT Holdings Ltd. ("FDTH", a wholly owned indirect U.K. subsidiary) is the borrower under Term Loan A and Term Loan B. The Revolving Credit Facility and Term Loans bear interest at either the Base Rate (U.S.) or U.S. $ LIBOR, plus an applicable margin. Cross-currency floating to fixed rate swaps from U.S.$ LIBOR to Sterling fixed rate have been purchased in respect of all amounts advanced under the Senior Credit Facility. No amounts have currently been drawn under the Revolving Credit Facility Publishing's borrowings under the Senior Credit Facility are guaranteed by Publishing's material U.S. subsidiaries, while FDTH's and Telegraph Group's borrowings under the Senior Credit Facility are guaranteed by Publishing and its material U.S. and U.K. subsidiaries. International is also a guarantor of the Senior Credit Facility. Publishing's borrowings under the Senior Credit Facility are secured by substantially all of the assets of Publishing and its material U.S. subsidiaries, a pledge of all of the capital stock of Publishing and its material U.S. subsidiaries and a pledge of 65% of the capital stock of certain foreign subsidiaries. FDTH's and Telegraph Group's borrowings 51 under the Senior Credit Facility are secured by substantially all of the assets of Publishing and its material U.S. and U.K. subsidiaries and a pledge of all of the capital stock of Publishing and its material U.S. and U.K. subsidiaries. International's assets in Canada have not been pledged as security under the Senior Credit Facility. The Senior Credit Facility loan documentation requires Publishing to comply with certain covenants which include, without limitation and subject to certain exceptions, restrictions on additional indebtedness; liens; certain types of payments (including without limitation, capital stock dividends and redemptions, payments on existing indebtedness and intercompany indebtedness), and on incurring or guaranteeing debt of an affiliate, making certain investments and paying management fees; mergers, consolidations, sales and acquisitions; transactions with affiliates; conduct of business, except as permitted; sale and leaseback transactions; changing fiscal year; changes to holding company status; creating or allowing restrictions on taking action under the Senior Credit Facility loan documentation; and entering into operating leases, subject to certain baskets and exceptions. The Senior Credit Facility loan documentation also contains customary events of default. On December 23, 2002, Publishing issued U.S. $300.0 million aggregate principal amount of 9% senior unsecured notes due 2010 (the "9% Senior Notes") at par to certain qualified institutional buyers ("QIBs") pursuant to Rule 144A under the Securities Act of 1933, as amended. The aggregate commissions were U.S. $8.3 million. The proceeds from the sale of the 9% Senior Notes, together with drawdowns under the Senior Credit Facility and available cash balances, were used to redeem approximately U.S. $239.9 million of Publishing's Senior Subordinated Notes due 2006 and approximately U.S. $265.0 million of Publishing's Senior Subordinated Notes due 2007, plus applicable premium and accrued interest to the date of redemption, and to make a distribution of U.S. $100.0 million to International. International used the distribution (a) to repay all amounts borrowed by International on October 3, 2002 under its loan agreement with Trilon International Inc., (b) to retire the equity forward purchase agreements between International and certain Canadian chartered banks (the "Total Return Equity Swap") made as of October 1, 1998, as amended, and (c) for other general corporate purposes. The trust indenture in respect of the 9% Senior Notes contains customary covenants and events of default, which are comparable to those under the Senior Credit Facility. On February 14, 2002, Publishing commenced a cash tender offer for any and all of its outstanding 8.625% Senior Notes due 2005. In March 2002, Senior Notes in the aggregate principal amount of U.S. $248.9 million had been validly tendered pursuant to the offer and these Senior Notes were paid out in full. In addition, in 2002, Publishing purchased for retirement an additional U.S.$41.1 million in aggregate principal amount of the Senior Notes and Senior Subordinated Notes. The total principal amount of Publishing's Senior Notes and Senior Subordinated Notes retired during 2002 was U.S. $290.0 million. The premiums paid to retire the debt totaled U.S. $27.1 million, which, together with a write-off of U.S. $8.3 million of related deferred financing costs, have been presented as an unusual item. AMOUNT DUE TO INTERNATIONAL FROM NB INC. The amount due to International from NB Inc. at December 31, 2002, including accrued interest, totaled U.S.$45.8 million. On March 10, 2003 International repurchased for cancellation, from NB Inc., 2,000,000 shares of Class A common stock of International at U.S.$8.25 per share for total proceeds of U.S.$16.5 million and redeemed from NB Inc., pursuant to a redemption request, all of the 93,206 outstanding shares of Series E Redeemable Convertible Preferred Stock of International at the fixed redemption price of $146.63 per share. Proceeds from the repurchase and redemption were offset against the debt due to International from NB Inc., resulting in net outstanding debt due to International of approximately U.S.$20.4 million as of March 10, 2003. The remaining debt of U.S.$20.4 million was subordinated in right of payment to the 11 7/8% Senior Secured Notes due 2011 and the interest rate amended to 14.25% if paid in cash and 16.5% if paid in kind. The debt due to International originated on July 11, 2000 and represented amounts loaned by International to NBI in connection with the cash purchase by the Company of Hollinger Canadian Publishing Holdings Inc. special shares. Following the receipt of an independent fairness opinion and a review by a committee of the Board of Directors of International, composed entirely of independent directors, of all aspects of the transaction relating to the changes in the debt arrangements with the Company and the subordination of this remaining debt, the committee approved the new debt arrangements. International and the Company previously reported that the committee of independent directors of International referred to had agreed to a partial offset to the remaining US$20.4 million of debt against amounts owed by International to RMI, and further stated that the offset was effected April 30, 2003. Although management of International and the Company believed final approval had been given to the offset by the committee of independent directors of International, the committee has advised that final approval of any offset remains subject to appropriate due diligence and receipt of a further independent fairness opinion. The due diligence process has not yet been concluded and accordingly, the accompanying interim consolidated financial statements do not reflect the completion of the offset. 52 International is indebted to RMI as a consequence of the sale of NP Holdings Company ("NP Holdings") and its related tax losses to RMI on July 3, 2002. Prior to the sale, NP Holdings had no significant assets or liabilities except for its tax losses and an obligation to CanWest for $22.5 million. To structure NP Holdings such that it had no material net assets or liabilities except for its tax losses upon its sale to RMI, immediately prior to the sale International contributed $22.5 million as equity to NP Holdings and then borrowed that amount from NP Holdings by way of promissory note. As that note was offset by the CanWest obligation, NP Holdings had no net material assets or liabilities apart from its tax losses upon sale. Notwithstanding these transactions, International may have continuing direct exposure to CanWest in respect of the $22.5 million obligation. As a result of an understanding that the partial offset had been completed on April 30, 2003, NBI did not pay interest on the full principal amount of the debt due to International and Ravelston did not make a payment of US$600,000 due on June 30, 2003 into a cash collateral account securing the debt. International is in discussions with NBI and Ravelston regarding these matters. CASH FLOWS Cash flows provided by operating activities were $149.4 million in 2002, and cash flows used for operating activities were $334.9 million in 2001. Improved operating results and lower cash interest costs and cash taxes resulted in improved year-over-year cash flows provided by operating activities. The cash flows used in operating activities in 2001 primarily resulted from the sales of Canadian Newspaper Group properties and Community Group properties, lower operating results at the Company's remaining operations and the non-cash interest income received on the CanWest debentures. Cash flows used in financing activities were $751.4 million in 2002 and $239.5 million in 2001. In 2002, International repaid U.S. $290.0 million of long-term debt primarily from available cash balances and repaid U.S. $100.0 million to terminate the Total Return Equity Swaps. The cash flows used in financing activities in 2001 included the repurchase of shares of International's Class A common stock and the redemption of retractable common and preferred shares totalling $72.4 million. Cash flows used in investing activities were $18.8 million in 2002 compared to cash flows provided by investing activities of $1,132.5 million in 2001. The cash flows used in investing activities in 2002 resulted primarily from purchases of fixed assets and investments partially offset by proceeds from the sale of 2,000,000 shares of International's Class A common stock in January 2002 and proceeds on the sale of fixed assets. The cash flows provided by investing activities in 2001 resulted principally from the sales of Canadian newspaper operations and sale of investments offset in part by additions to investments and fixed assets. CAPITAL RESOURCES AND NEEDS Additions to capital assets amounted to $64.0 million, $91.0 million and $113.0 million in 2002, 2001 and 2000, respectively. These additions are principally in respect of International's operations. The following is a summary of the major capital expenditures during these periods:
2002 2001 2000 Million $ Million $ Million $ --------- --------- --------- Chicago Sun-Times plant................................... $ 3 $ 6 $ 38 Montreal presses.......................................... - - 26 National Post............................................. - - 4 Printing joint venture-- new presshall and mailroom....... - 20 - Airplane.................................................. - 18 - Jerusalem Post press...................................... 5 - - Fox Valley - printing facility............................ 6 - - Other capital additions and routine capital expenditures.. 50 47 45 --------- --------- --------- $ 64 $ 91 $ 113 ========= ========= =========
CAPITAL EXPENDITURES AND ACQUISITION FINANCING. In the past three years, the Chicago Group, the Community Group, the U.K. Newspaper Group and the Canadian Newspaper Group have funded their capital expenditures and acquisition and investment activities out of cash provided by their respective operating activities and in 2000 through borrowings. In 2003 International expects to invest approximately U.S.$20 million in capital expenditures primarily through available cash flow. Capital expenditures at the Chicago Group amounted to $24.3 million, $19.3 and $38.2 million in 2002, 2001 and 2000, respectively. International began construction of a new printing facility in Chicago during 1998, which became partially operational in 2000 and fully operational in 2001. The capital expenditures in 2001 and 2000 are primarily related to the construction of this facility. 53 Capital expenditures at the Community Group amounted to $7.9 million, $0.5 million and $4.9 million in 2002, 2001 and 2000, respectively. The capital expenditures in 2002 were primarily for the acquisition of a new press by the Jerusalem Post. Capital expenditures at the U.K. Newspaper Group were $27.7 million, $48.8 million and $24.1 million in 2002, 2001 and 2000, respectively. Capital expenditures at the Canadian Newspaper Group were $3.6 million, $4.4 million and $42.8 million in 2002, 2001 and 2000, respectively. Capital expenditures at the Corporate Group were $0.1 million, $18.4 million and $2.6 million in 2002, 2001 and 2000, respectively. Expenditures in 2001 were primarily in respect of a new airplane to replace an older airplane that was sold in early 2002. DERIVATIVE INSTRUMENTS The Company or its subsidiaries may enter into various swap, option and forward contracts from time to time when management believes conditions warrant. Management does intend, however, that such contracts will be limited to those that relate to the actual exposure to commodity prices, interest rates and foreign currency risks. If, in management's view, the conditions that made such arrangements worthwhile no longer exist, the contracts may be closed. On December 27, 2002, FDTH, entered into two cross-currency floating to fixed rate swap transactions to hedge principal and interest payments on U.S. dollar borrowings by FDTH under the December 23, 2002 Senior Credit Facility. The contracts have a total foreign currency obligation notional value of U.S. $265.0 million, fixed at a rate of U.S. $1.5922 to (pound)1, convert the interest rate on such borrowings from floating rate to a fixed blended interest rate of 8.47%, and expire as to U.S. $45.0 million on December 29, 2008 and as to U.S. $220.0 million on December 29, 2009. The swaps were purchased to take advantage of low rates on this type of instrument and to provide certainty on interest charges to the operations of the U.K. Newspaper Group in a time of soft advertising sales. On January 22, 2003 and February 6, 2003, Publishing entered into interest rate swaps to convert U.S. $150.0 million and U.S. $100.0 million, respectively, of the total U.S.$300.0 million Senior Notes issued in December 2002, from fixed to floating rates for the period to December 15, 2010, subject to early termination notice, with the objective of reducing the cost of borrowing. Interest for the first six months has been set at 5.98% and floats, for subsequent periods, at the six-month LIBOR rate plus a blended spread of 4.61%. A further discussion of the Company's derivative instruments can be found in note 24 to the Company's audited consolidated financial statements included elsewhere in this Annual Report. OFF-BALANCE SHEET ARRANGEMENTS HOLLINGER PARTICIPATION TRUST. As part of its November 16, 2000 purchase and sale agreement with CanWest, International was prohibited from selling the CanWest debentures received in partial consideration prior to May 15, 2003. In order to monetize this investment, International entered into a participation agreement in August 2001 pursuant to which it sold participation interests in $540.0 million (U.S. $350.0 million) principal amount of CanWest debentures to the Participation Trust administered by an arm's-length trustee. That sale of participation interests was supplemented by a further sale of participation interests in $216.8 million (U.S. $140.5 million) principal amount of CanWest debentures in December 2001. International remains the record and beneficial owner of the participated CanWest debentures and is required to make payments to the Participation Trust with respect to those debentures if and to the extent it receives payment in cash or kind on the debentures from CanWest. Coincident with the Participation Trust's purchase of the participation interests, the Participation Trust sold senior notes to arm's-length third parties to finance the purchase of the participation interests. These transactions resulted in net cash proceeds to International of $621.8 million and for accounting purposes have been accounted for as sales of CanWest debentures. The net loss on the transactions amounted to $97.4 million and is included in unusual items in 2001. At any time up to November 5, 2005, CanWest may elect to pay interest on the debentures by way of additional CanWest debentures or through the issuance of non-voting common shares of CanWest. Further, at any time after 54 May 15, 2003, the holders of the Participation Trust senior notes may, under the terms of the Participation Trust request that the Participation Trust require International to complete an outright transfer to the Participation Trust of the CanWest debentures. The unrealized foreign exchange losses recognized at December 31, 2002 and 2001 are classified as deferred credits in the consolidated balance sheet. On May 11, 2003, CanWest redeemed $265 million of the debentures of which U.S.$159.8 million has been delivered to the Participation Trust and the balance of US$27.6 million has been received by International and the Partnership, a portion of which must be retained until November 4, 2010. This will reduce the Company's obligation to the Participation Trust and hence its exposure to changes in the U.S. dollar to Canadian dollar exchange rate. COMMERCIAL COMMITMENTS AND CONTRACTUAL OBLIGATIONS. The Telegraph Group has guaranteed the printing joint venture partners' share of leasing obligations to third parties, which amounted to $1.0 million (L0.4 million) at December 31, 2002. These obligations are also guaranteed jointly and severally by each joint venture partner. In connection with International's insurance program, letters of credit are required to support certain projected workers' compensation obligations. At December 31, 2002, letters of credit in the amount of $4.4 million were outstanding. In special circumstances, International's newspaper operations may engage freelance reporters to cover stories in locales that carry a high risk of personal injury or death. Subsequent to December 31, 2002, the Telegraph has engaged a number of journalists and photographers to report from the Middle East. As a term of their engagement, The Telegraph has agreed to provide a death benefit which, in the aggregate for all freelancers engaged, amounts to $13.1 million (L5.1 million). This exposure is uninsured. Precautions have been taken to avoid a concentration of the freelancers in any one location. In connection with certain of its cost and equity method investments, International is committed to fund approximately $1.9 million (U.S.$1.2 million) to those investees in 2003. Set out below is a summary of the amounts due and committed under contractual cash obligations, other than in respect of the retractable common shares at December 31, 2002:
Due Due Due in between between 1 year 1 and 4 and Due over Total or less 3 years 5 years 5 years ------------- ---------- ---------- ----------- ---------- (Dollars in thousands) Existing Senior and Senior Subordinated Notes(1)..... $ 1,279,781 $ 797,751 $ 8,030 $ - $ 474,000 Other long-term debt................................. 443,954 4,886 40,014 45,212 353,842 Capital lease obligations............................ 65,586 12,157 17,165 11,909 24,355 Series II preference shares(2)....................... 33,827 33,827 - - - Series III preference shares(3)...................... 101,472 101,472 - - - Operating leases..................................... 257,251 27,095 45,590 35,125 149,441 ----------- ---------- ---------- ----------- ----------- Total contractual cash obligations................... $ 2,181,871 $ 977,188 $ 110,799 $ 92,246 $ 1,001,638 =========== ========== ========== =========== ==========
(1) During 2002, Publishing purchased for retirement approximately $406.8 million (U.S.$254.9 million) of the existing Senior Notes due 2005. The balance of those notes outstanding, approximately $8.0 million (U.S.$5.1 million) will mature in 2005. Included in the total of notes outstanding is $797.8 million (U.S.$504.9 million) of Senior Subordinated Notes with maturities in 2006 and 2007. At December 31, 2002, the borrowings under the Senior Credit Facility and the 9% Senior Notes due 2010 were held in escrow pending and for the purpose of redemption of the Senior Subordinated Notes. Consequently, outstanding balances for the Senior Subordinated Notes, irrespective of their maturity date, have been reflected as due in one year or less. Refer to "long-term debt" for a discussion of the new $489.8 million (U.S.$310 million) Senior Credit Facility maturing in 2008 and 2009. (2) The Company has Series II preference shares that are exchangeable at the holder's option for 0.46 of a share of International's Class A common stock for each Series II preference share. The Company has the option 55 to make a cash payment of equivalent value on redemption of any of the Series II preference shares. As at December 31, 2002, the market value of the shares of International's Class A common stock that they are exchangeable into totals $33.8 million. While it is uncertain as to when, if ever, the preference shares will be retracted, because the retraction can occur at any time at the option of the holder, the outstanding balance has been reflected as due in one year or less. (3) The Company has Series III preference shares which provide for a mandatory redemption on the fifth anniversary of issue (April 30, 2004) for $10.00 cash per share (plus unpaid dividends) and an annual cumulative dividend, payable quarterly, of $0.70 per share per annum (or 7%) during their five-year term. The Company had the right at its option to redeem all or any part of the Series III preference shares at any time after three years (April 30, 2002) for $10.00 cash per share (plus unpaid dividends). Holders have the right at any time to retract Series III preference shares for a retraction price payable in cash which, until April 30, 2003, fluctuated by reference to two benchmark Government of Canada bonds having a comparable yield and term to the shares, and during the year ending April 30, 2004, will be $9.50 per share (plus unpaid dividends in each case). While it is uncertain as to when, if ever, the preference shares will be retracted, because the retraction can occur at any time at the option of the holder, the outstanding balance has been reflected as due in one year or less. In addition to amounts committed under contractual cash obligations, the Company and International have also assumed a number of contingent obligations by way of guarantees and indemnities in relation to the conduct of their business. The more significant guarantees and indemnities include those for lease obligations of a 50% owned joint venture producing many of International's U.K. publications; in support of representations and warranties on the disposition of operations; against changes in laws affecting returns to certain lenders; and against fluctuations in foreign currency exchange rates in respect of the Participation Trust. For more information on our contingent obligations, refer to note 27 h) - the Company's audited consolidated financial statements, included elsewhere in this Annual Report. 56 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS A. MAJOR SHAREHOLDERS To the knowledge of the directors and officers of the Company, there is no beneficial owner or person who exercises control or direction over more than 5% of the outstanding retractable common shares of the Company except as follows. Ravelston exercises control or direction over a total of 26,516,886 retractable common shares or 78.2% of the outstanding retractable common shares of the Company. Lord Black indirectly controls Ravelston and therefore beneficially owns or exercises control or direction over 78.2% of the outstanding retractable common shares of the Company. The address of Ravelston is 10 Toronto Street, Toronto, Ontario, M5C 2B7. 57 B. RELATED PARTY TRANSACTIONS International and its subsidiaries have entered into Services Agreements with Ravelston, whereby Ravelston acts as manager of International and its subsidiaries and carries out head office and executive responsibilities. These Services Agreements were assigned on July 5, 2002 to RMI, a wholly-owned subsidiary of Ravelston. Ravelston and RMI billed International and its subsidiaries $37.3 million in 2002 pursuant to these agreements ($44.9 million in 2001 and $49.9 million in 2000). In addition, certain executives of Ravelston and Moffat Management and Black-Amiel Management, affiliates of Ravelston and RMI, have separate Services Agreements with certain subsidiaries of International. During 2002, amounts paid directly by subsidiaries of International pursuant to such agreements were $3.0 million ($2.6 million in 2001 and $5.4 million in 2000). The fees under Ravelston's and RMI's services agreement and the fees paid directly to executives and affiliates of Ravelston, have been negotiated and approved by International's independent directors. In addition to the amounts referred to in the preceding paragraph, during 2001 and 2000 there were further remuneration paid directly by subsidiaries of International to certain Ravelston executives of $2.6 million and $6.3 million, respectively (2002-nil). Similarly, Ravelston carries out head office and executive responsibilities for the Company and its subsidiaries, other than International and its subsidiaries. In 2002 and 2001, no amounts were charged by Ravelston for such services. In 2000, the Company received $10.7 million, net, from Ravelston pursuant to a services agreement which was terminated on December 31, 2000. In 2002, expenses are net of $2.4 million received from Ravelston and RMI as a reimbursement of certain head office expenses incurred on behalf of Ravelston and RMI ($2.0 million in 2001). Such expenses were not incurred on behalf of Ravelston in 2000. During 2001 and 2000, in connection with the sales of properties, the Company, Ravelston, International, Lord Black and three senior executives entered into non-competition agreements with the purchasers in return for cash consideration paid. 58 During the three months ended March 31, 2003, International made a venture capital investment of US$2.5 million in a company in which a director of International has a minority interest. On March 10, 2003, prior to the issue of Senior Secured Notes, NB Inc. sold its shares of Class A common stock and Series E redeemable preferred stock of International to RMI. Such shares were in turn sold back to NB Inc. from RMI at the same price with a resulting increase in the tax basis of the shares of International and a taxable gain to RMI. All of the Services Agreements were negotiated in the context of a parent-subsidiary relationship and, therefore, were not the result of arm's length negotiations between independent parties. The terms of the Services Agreements may therefore not be as favorable to International and its subsidiaries as the terms that might be reached through negotiations with non-affiliated third parties. ASSET SALES On July 3, 2002, NP Holdings Company ("NP Holdings"), a subsidiary of International, was sold to RMI for cash consideration of $5,750,000. The net assets of NP Holdings primarily included Canadian tax losses. The tax losses, only a portion of which were previously recognized for accounting purposes, were effectively sold at their carrying value. Due to the inability of NP Holdings to utilize its own tax losses prior to their expiry, as a result of its disposing of its interest in the National Post, it sold these losses to a company which would be able to utilize the losses. The only other potential purchaser for these losses, CanWest, declined the opportunity to acquire the losses. The terms of the sale of the tax losses to RMI were negotiated with and approved by the independent directors of International. In two separate transactions in July and November, 2001, International and the Partnership completed the sale of most of their remaining Canadian newspapers to Osprey for total sale proceeds of approximately $255 million plus closing adjustments primarily for working capital. The former Chief Executive Officer of the Partnership is a minority shareholder and Chief Executive Officer of Osprey. International's independent directors approved the terms of these transactions. In connection with the above two sales of Canadian newspaper properties to Osprey and to satisfy a closing condition, International, the Company, and Lord Black and three senior executives entered into non-competition agreements with Osprey pursuant to which each agreed not to compete directly or indirectly in Canada with the Canadian businesses sold to Osprey for a five-year period, subject to certain limited exceptions, for aggregate consideration of $7.9 million. Such consideration was paid to Lord Black and the three senior executives and was approved by International's independent directors. On November 16, 2000, International, together with its affiliates, Southam and the Partnership, completed the sale of most of their Canadian newspapers and related assets to CanWest. The aggregate sale price of these properties at fair value was approximately $2.8 billion, plus closing adjustments for working capital at August 31, 2000 and cash flow and interest for the period September 1 to November 16, 2000 which in total at December 31, 2000 approximated an additional $40.7 million. In connection with the sale to CanWest, Ravelston entered into a management services agreement with CanWest and National Post pursuant to which it agreed to continue to provide management services to the Canadian businesses sold to CanWest in consideration for an annual fee of $6 million payable by CanWest. CanWest will be obligated to pay Ravelston a termination fee of $45 million in the event that CanWest chooses to terminate the management services agreement or $22.5 million in the event that Ravelston chooses to terminate the agreement. Further, CanWest required as a condition to the transaction that International, Ravelston, the Company, Lord Black and three senior executives enter into non-competition agreements with CanWest pursuant to which each agreed not to compete directly or indirectly in Canada with the Canadian business sold to CanWest for a five-year period, subject to certain limited exceptions, for aggregate consideration of $80 million paid by CanWest in addition to the purchase price referred to above of which $38 million was paid to Ravelston and $42 million was paid to Lord Black and the three senior executives. International's independent directors approved the terms of these payments. During 2001, International transferred two publications to Horizon Publications Inc. in exchange for net working capital. Horizon Publications Inc. is managed by former Community Group executives and controlled by 59 certain members of the Board of Directors of International. The terms of theses transactions were approved by the independent directors of International. During 2000, International sold most of its remaining U.S. community newspaper properties, for total proceeds of approximately US$215 million. In connection with those sales, to satisfy a closing condition, International, Lord Black and three senior executives entered into non-competition agreements with the purchasers to which each agreed not to compete directly or indirectly in the United States with the United States businesses sold to purchasers for a fixed period, subject to certain limited exceptions, for aggregate consideration paid in 2001 of US$0.6 million. These amounts were in addition to the aggregate consideration paid in respect of these non-competition agreements in 2000 of US$15 million. International's independent directors approved the terms of these payments. Included in these dispositions during 2000 International sold four U.S. community newspapers for an aggregate consideration of US $38.0 million ($56.5 million) to Bradford Publishing Company, a company formed by a former U.S. Community Group executive and in which some of International's directors are shareholders. The terms of this transaction were approved by the independent directors of International. International issued to a subsidiary of the Company in connection with the 1995 Reorganization in which International acquired the Company's interest in The Telegraph and Southam, 739,500 shares of Series A preferred stock. The Series A preferred stock was subsequently exchanged for Series D preferred stock. During 1998, 408,551 shares of Series D preferred stock were converted into 2,795,165 shares of Class A common stock. In February 1999, 196,823 shares of Series D preferred stock were redeemed for cash of US$19.4 million. In May 1999, the remaining 134,126 shares of Series D preferred stock were converted into 134,126 shares of Series E preferred stock. In September 2001, 40,920 shares of Series E preferred stock were redeemed for cash of US$3.8 million. The shares of Series E preferred stock were redeemable in whole or in part, at any time and from time to time, subject to restrictions in International's credit facilities, by International or by a holder of such shares. As described above, the remaining Series E preferred stock was redeemed on March 10, 2003. Pursuant to a January 1997 transaction wherein International acquired Canadian publishing assets from the Company, International issued 829,409 shares of Series C preferred stock. The stated value of each share was $108.51. On June 1, 2001, International converted all the Series C preferred stock at the conversion ratio of 8.503 shares of Class A common stock per share of Series C preferred stock into 7,052,464 shares of Class A common stock. On September 5, 2001, International purchased for cancellation, from the Company, the 7,052,464 shares of Class A common stock for a total cost of US$92.2 million or US$13.07 per share which represented 98% of the September 5, 2001 closing price. International has reviewed its procedures for ensuring that transactions with affiliates of Publishing (other than its subsidiaries) comply with the covenants under its debt instruments existing prior to the December 2002 refinancing, including the indentures governing outstanding debt securities. Based on this review, International has determined that in one related-party transaction, although International satisfied the requirement to obtain the approval of the independent directors of International's Board of Directors that the transaction was being undertaken on an arm's length basis, International did not obtain a fairness opinion although the transaction exceeded the relevant threshold for delivering such an opinion by US$23 million. In light of the various intercompany transactions and arrangements within the Hollinger group and the related party transactions that have occurred from time to time in the past and may occur in the future, International intends to strengthen its controls for monitoring compliance with those covenants under the 9% Senior Notes and other debt instruments by which International, Publishing and our other subsidiaries are bound that are applicable to such transactions and arrangements. Lord Black controls Ravelston and, through Ravelston and its subsidiaries, together with his associates, he exercises control or direction over 78.2% of our outstanding retractable common shares. RIGHTS OF FIRST REFUSAL Ravelston has rights of first refusal in respect of any retractable common shares of the Company that may be issued on exercise of options held to acquire retractable common shares should the holders decide to exercise their options and dispose of the retractable common shares. PRINCIPAL AGREEMENTS WITH INTERNATIONAL 60 Services Agreements. Two Services Agreements govern the provision of certain advisory, consultative, procurement and administrative services to International and its subsidiaries by RMI. Services provided include, among other things, strategic advice and planning and financial services (including advice and assistance with respect to acquisitions) and assistance in operational matters. The Services Agreements will be in effect until terminated by either party under certain specified circumstances. The Services Agreements may be terminated by either party giving 180 days notice. Payments by International and its subsidiaries made pursuant to the Services Agreements are subject to the review and approval of the Audit Committee of the Board of Directors of International. Business Opportunities Agreement. The Business Opportunities Agreement provides that International will be the Company's principal vehicle for engaging in and effecting acquisitions in newspaper businesses and in related media businesses in the United States, Israel and, through The Telegraph, the European Community, Australia and New Zealand (the "Telegraph Territory"). The Company has reserved to itself the ability to pursue newspaper and all media acquisition opportunities outside the United States, Israel and the Telegraph Territory, and media acquisition opportunities unrelated to the newspaper business in the United States, Israel and the Telegraph Territory. The Business Opportunities Agreement does not restrict newspaper companies in which the Company has a minority investment from acquiring newspaper or media businesses in the United States, Israel or the Telegraph Territory, nor does it restrict subsidiaries of the Company from acquiring up to 20% interests in publicly held newspaper businesses in the United States. The Business Opportunities Agreement will be in effect for so long as the Company holds at least 50% of the voting power of International, subject to termination by either party under specified circumstances. The Company assigned its rights and obligations under the Business Opportunities Agreement to a wholly-owned subsidiary on September 22, 1997 with the consent of International. Co-operation Agreement. In connection with the listing of The Telegraph's shares on the London Stock Exchange in July 1992, the Company and The Telegraph entered into the Co-operation Agreement which sets forth the basis upon which the Company and The Telegraph will divide their respective newspaper and other media interests world-wide. Under this agreement, The Telegraph and the Company have agreed not to engage in, or hold a significant interest in an enterprise engaging in, the newspaper, magazine, radio or television business where the other has existing operations, except in specified circumstances. For purposes of this agreement, The Telegraph's areas of operation are the United Kingdom, the rest of the European Union, Australia and New Zealand; the Company's areas of operation are the United States, Canada, the Caribbean and Israel. International, which assumed the Company's position under the Co-operation Agreement in 1995, has agreed not to violate the Co-operation Agreement. RELATED PARTY INDEBTEDNESS The Company and its subsidiaries have amounts due to related parties of $103.3 million and $72.8 million as at December 31, 2002 and 2001 respectively. Included in these amounts are unsecured demand loans and advances, including accrued interest owing to Ravelston of $75.8 million and $59.1 million as at December 31, 2002 and 2001, respectively, which were borrowed to partially fund the Company's operating costs, including interest and preference share dividend obligations. The loans bear interest at the bankers' acceptance rate plus 3.75% per annum or 6.68% at December 31, 2002. In addition, International owes $5.0 million and $13.7 million at December 31, 2002 and 2001, respectively, to Ravelston or RMI in connection with fees payable pursuant to the Services Agreements as noted below. The amounts due to related parties at December 31, 2002 also include $22.5 million owing to RMI in connection with the assumption by RMI, as a result of its purchase of NP Holdings (as noted below), of a liability of $22.5 million owing to CanWest. As at December 31, 2002, this amount is due on demand, is unsecured and is stated to bear interest at an annual rate of the bankers' acceptance rate plus 4%. On July 11, 2000, International loaned US$36.8 million to a subsidiary of the Company in connection with the cash purchase by the Company of HCPH Co. Special shares. The loan is payable on demand and to December 31, 2001, interest was payable at the rate of 13% per annum at which time, with the approval of the independent directors, it was changed to LIBOR plus 3% per annum. This loan, together with accrued interest, totaled US$45.8 million at December 31, 2002. On March 10, 2003, prior to the closing of the offering of 117/8% Senior Secured Notes, International repurchased for cancellation, from NB Inc., 2,000,000 shares of Class A common stock at US$8.25 per share for total proceeds of $24.2 million (US $16.5 million) and redeemed, from NB Inc., pursuant to a redemption request, all of the 93,206 outstanding shares of Series E redeemable convertible preferred stock of International at the fixed redemption price of $146.63 per share for total proceeds of $13.6 million (US$9.3 million). The proceeds from the repurchase and redemption were used to repay US$25.4 million of the loan resulting in the net outstanding debt due to International of approximately $29.9 million (US$20.4 million) as of March 10, 2003. The remaining 61 debt bears interest at 14.25% or, if paid in additional notes, 16.5% and is subordinated to the Company's Senior Secured Notes (so long as the Senior Secured Notes are outstanding), guaranteed by Ravelston and secured by certain assets of Ravelston. Following a review by a special committee of the Board of Directors of International, comprised entirely of independent directors, of all aspects of the transaction relating to the changes in the debt arrangements with NB Inc. and the subordination of this remaining debt, the special committee approved the new debt arrangements, including the subordination. Effective April 30, 2003, US$15.7 million principal amount of subordinated debt owing to Hollinger International by NB Inc. was transferred by Hollinger International to HCPH Co., a subsidiary of Hollinger International, and subsequently transferred to RMI by HCPH Co. in satisfaction of a loan due from HCPH Co. to RMI (note 23d). International and the Company previously reported that the committee of independent directors of International had agreed to the US$15.7 million offset to the remaining US$20.4 million of debt against amounts owed by International to RMI, and further stated that the offset was effected April 30, 2003. Although management of International and the Company believed final approval had been given to the offset by the committee of independent directors of International, the committee has advised that final approval of any offset remains subject to appropriate due diligence and receipt of a further independent fairness opinion. The due diligence process has not yet been concluded and accordingly, the offset has not been completed as at August 25, 2003. The debt owing by NB Inc. to Hollinger International of US$20.4 million bears interest at the rate of 14.25% if interest is paid in cash and 16.50% if it is paid in kind. The debts is subordinated to the Senior Secured Notes for so long as the Senior Secured Notes are outstanding, and is guaranteed by RCL and the Company. Hollinger International entered into a subordination agreement with the Company and NB Inc. pursuant to which Hollinger International has subordinated all payments of principal, interest and fees on the debt owed to it by NB Inc. to the payment in full of principal, interest and fees on the Senior Secured Notes, provided that payments with respect to principal and interest can be made to International to the extent permitted in the indenture governing the Senior Secured Notes. In response to the 1998 issuer bid, all options held by executives were exercised. As at December 31, 2002, included in accounts receivable is $5.8 million (2001-$5.8 million) due from Lord Black and F. David Radler, which bear interest at the prime rate plus 1/2%. The receivables are fully secured by a pledge of the shares held by the executives. In 1999, companies controlled by Lord Black and F. David Radler invested in the Partnership. As at December 31, 2002, included in accounts receivable is $0.4 million (2001-$0.4 million) due from these companies, which bears interest at the prime rate plus 1/2%. The receivables are partially secured by a pledge of the units held in the Partnership. Included in Other Assets at December 31, 2002 is $6.5 million (US$4.1 million) owing to International from Bradford Publishing Company ("Bradford"), a company in which certain of the Company's and International's directors are significant shareholders. Such amount represents the present value of the remaining amounts owing under a non-interest bearing note receivable granted to International in connection with a non-competition agreement entered into on the sale of certain operations to Bradford during 2000. The amount receivable is unsecured, due over the period to 2010 and is subordinated to Bradford's lenders. Included in Other Assets at December 31, 2002 is $7.7 million (US$4.9 million) owed by Horizon Publications Inc. ("Horizon"), a company controlled by certain members of the Board of Directors of International and the Company. Such amount represents the unpaid purchase price payable to International in connection with the sale of certain operations to Horizon during 1999. The loan receivable is unsecured, bears interest at the lower of LIBOR plus 2% and 8% per annum and is due in 2007. During 2002, the Company paid to Horizon a management fee in the amount of $0.3 million in connection with certain administrative services provided by Horizon. The fee was approved by International's independent directors. ITEM 18. FINANCIAL STATEMENTS See our consolidated financial statements and the notes thereto beginning on page F-1 of this Form 20-F/A, which we incorporate herein by reference. 62 ITEM 18. FINANCIAL STATEMENTS INDEX TO FINANCIAL STATEMENTS HOLLINGER INC. Audited Consolidated Financial Statements Report of KPMG LLP, Independent Auditors.................. F-2 Consolidated Balance Sheets as of December 31, 2001 and 2002................................................... F-4 Consolidated Statements of Earnings (Losses) for the Year Ended December 31, 2000, 2001 and 2002................. F-5 Consolidated Statements of Deficit for the Years Ended December 31, 2000, 2001 and 2002....................... F-6 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 2001 and 2002....................... F-7 Notes to Consolidated Financial Statements................ F-8
F-1 AUDITORS' REPORT To the Board of Directors of Hollinger Inc. We have audited the consolidated balance sheets of Hollinger Inc. as at December 31, 2001 and 2002 and the consolidated statements of earnings (losses), deficit and cash flows for each of the years in the three-year period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and United States generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2001 and 2002 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2002 in accordance with Canadian generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Toronto, Canada April 1, 2003, except as to note 29, which is as of June 19, 2003 other than /s/ KPMG LLP note 29 e), which is as of August 25, 2003 Chartered Accountants F-2 COMMENTS BY AUDITORS FOR U.S. READERS ON CANADA -- U.S. REPORTING DIFFERENCES In the United States, reporting standards for auditors require the addition of an explanatory paragraph (following the opinion paragraph) when there is a change in accounting principles that has a material effect on the comparability of the Company's financial statements, such as the changes described in note 2, or when there is a retroactive adjustment such as those described in note 26v), to the consolidated financial statements as at December 31, 2001 and 2002 and for each of the years in the three-year period ended December 31, 2002. Our report to the shareholders dated April 1, 2003 is expressed in accordance with Canadian reporting standards, which do not require a reference to such changes in accounting principles in the auditors' report when the change is properly accounted for and adequately disclosed in the financial statements. Toronto, Canada /s/ KPMG LLP April 1, 2003 Chartered Accountants F-3 HOLLINGER INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31 ----------------------- 2001 2002 ---------- ---------- (IN THOUSANDS OF CANADIAN DOLLARS) ASSETS CURRENT ASSETS Cash and cash equivalents (note 3).......................... $ 806,347 $ 188,852 Escrow deposits (note 10a))................................. -- 859,128 Accounts receivable......................................... 336,438 355,031 Amounts due from related parties (note 23d))................ 26,874 23,640 Prepaid expenses............................................ 17,604 28,499 Inventory................................................... 36,506 22,058 ---------- ---------- 1,223,769 1,477,208 INVESTMENTS (note 5)........................................ 259,435 210,145 CAPITAL ASSETS (note 6)..................................... 666,501 660,501 GOODWILL (note 7)........................................... 174,324 913,327 OTHER INTANGIBLE ASSETS (note 7)............................ 1,177,544 185,143 DEFERRED FINANCING COSTS AND OTHER ASSETS (note 8).......... 154,543 193,537 ---------- ---------- $3,656,116 $3,639,861 ========== ========== LIABILITIES CURRENT LIABILITIES Bank indebtedness (note 9).................................. $ 129,475 $ 90,810 Accounts payable and accrued expenses....................... 358,444 337,086 Amounts due to related parties (note 23d)).................. 72,793 103,295 Income taxes payable........................................ 463,853 476,387 Deferred revenue............................................ 65,627 67,612 Retractable preference shares (note 11)..................... -- 135,299 Deferred unrealized gain on retractable preference shares (note 11a))............................................... -- 11,983 Senior Subordinated Notes due 2006 and 2007 (note 10a))..... -- 797,751 Current portion of long-term debt (note 10)................. 10,020 16,800 ---------- ---------- 1,100,212 2,037,023 LONG-TERM DEBT (note 10).................................... 1,341,606 974,770 RETRACTABLE PREFERENCE SHARES (note 11)..................... 147,472 -- DEFERRED UNREALIZED GAIN ON RETRACTABLE PREFERENCE SHARES (note 11a))............................................... 7,670 -- FUTURE INCOME TAXES (note 18)............................... 486,937 375,479 OTHER LIABILITIES AND DEFERRED CREDITS (note 12)............ 109,761 130,648 ---------- ---------- 3,193,658 3,517,920 ---------- ---------- MINORITY INTEREST........................................... 725,928 473,272 ---------- ---------- SHAREHOLDERS' DEFICIENCY Capital stock (note 13)..................................... 271,774 273,759 Deficit..................................................... (485,313) (605,145) ---------- ---------- (213,539) (331,386) Equity adjustment from foreign currency translation (note 14)....................................................... (49,931) (19,945) ---------- ---------- (263,470) (351,331) ---------- ---------- $3,656,116 $3,639,861 ========== ========== Commitments (note 15) Contingencies (note 16) Subsequent events (notes 1, 9, 10a), 16d) and 29)
F-4 HOLLINGER INC. CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
YEAR ENDED DECEMBER 31 ---------------------------------------- 2000 2001 2002 ---------- ---------- ---------- (IN THOUSANDS OF CANADIAN DOLLARS EXCEPT PER SHARE AMOUNTS) REVENUE Sales.............................................. $3,158,280 $1,822,060 $1,628,198 Investment and other income........................ 28,146 97,282 29,729 ---------- ---------- ---------- 3,186,426 1,919,342 1,657,927 ---------- ---------- ---------- EXPENSES Cost of sales and expenses......................... 2,586,183 1,730,108 1,453,894 Depreciation and amortization...................... 219,932 144,716 88,193 Interest on long-term debt......................... 219,970 122,701 92,625 Other interest..................................... 54,361 55,225 29,122 ---------- ---------- ---------- 3,080,446 2,052,750 1,663,834 ---------- ---------- ---------- NET LOSS IN EQUITY-ACCOUNTED COMPANIES............... (14,115) (18,571) (1,233) ---------- ---------- ---------- NET FOREIGN CURRENCY LOSSES.......................... (12,288) (7,470) (19,741) ---------- ---------- ---------- EARNINGS (LOSS) BEFORE THE UNDERNOTED................ 79,577 (159,449) (26,881) Unusual items (note 17)............................ 700,945 (295,434) (62,630) Income tax (expense) recovery (note 18)............ (260,091) 89,477 (124,025) Minority interest.................................. (331,058) 233,508 124,896 ---------- ---------- ---------- NET EARNINGS (LOSS).................................. $ 189,373 $ (131,898) $ (88,640) ========== ========== ========== EARNINGS (LOSS) PER RETRACTABLE COMMON SHARE (note 19) Basic.............................................. $ 5.11 $ (3.91) $ (2.76) ========== ========== ========== Diluted............................................ $ 5.05 $ (4.17) $ (2.79) ========== ========== ==========
F-5 HOLLINGER INC. CONSOLIDATED STATEMENTS OF DEFICIT
YEAR ENDED DECEMBER 31 ------------------------------------ 2000 2001 2002 ---------- ---------- ---------- (IN THOUSANDS OF CANADIAN DOLLARS) DEFICIT AT BEGINNING OF YEAR As previously reported.................................. $(180,732) $(310,988) $(485,313) Adjustment of prior years' deficit (note 2)............. (291,004) -- -- --------- --------- --------- As restated............................................. (471,736) (310,988) (485,313) Net earnings (loss)....................................... 189,373 (131,898) (88,640) --------- --------- --------- (282,363) (442,886) (573,953) Adjustment to deficit related to transitional impairment charge, net of minority interest (note 1)............... -- -- (12,071) Dividends -- retractable common shares.................... (22,177) (20,216) (19,220) Gain (premium) on retraction of retractable common shares (notes 13b), 13d) and 13e))............................. (6,448) (22,211) 141 Share issue costs......................................... -- -- (42) --------- --------- --------- DEFICIT AT END OF YEAR.................................... $(310,988) $(485,313) $(605,145) ========= ========= =========
F-6 HOLLINGER INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 ----------------------------------- 2000 2001 2002 ----------- --------- --------- (IN THOUSANDS OF CANADIAN DOLLARS) CASH PROVIDED BY (USED FOR): OPERATING ACTIVITIES CASH FLOWS PROVIDED BY (USED FOR) OPERATIONS BEFORE THE UNDERNOTED (note 20a)).................................... $ 153,579 $(120,211) $ 59,628 Change in non-cash operating working capital (note 20b)).... (82,456) (144,429) 41,328 Other costs................................................. (42,188) (70,234) 48,474 ----------- --------- --------- 28,935 (334,874) 149,430 ----------- --------- --------- FINANCING ACTIVITIES Redemption and cancellation of capital stock................ (700) (273) (1,064) Redemption and cancellation of retractable preference shares.................................................... (5,133) (317) (277) Premium on retirement of senior notes....................... -- -- (56,287) Capital stock of subsidiaries purchased for cancellation by subsidiaries.............................................. -- (71,767) (157,056) Issue of partnership units and common shares of subsidiaries.............................................. 8,166 10,637 6,667 Decrease in long-term debt and deferred liabilities......... (1,280,475) -- -- Redemption of HCPH Special shares........................... (140,429) -- -- Repayment of long-term debt................................. -- (176,383) (582,920) Proceeds from long-term debt................................ -- 152,778 514,343 Proceeds from issuance of notes............................. -- -- 474,000 Payment of debt issue costs................................. -- (7,230) (24,666) Escrow deposits and restricted cash......................... -- -- (859,128) Dividends................................................... (22,177) (20,216) (16,031) Dividends and distributions paid by subsidiaries to minority interest.................................................. (127,390) (126,478) (48,721) Other....................................................... -- (204) (249) ----------- --------- --------- (1,568,138) (239,453) (751,389) ----------- --------- --------- INVESTING ACTIVITIES Proceeds on disposal of fixed assets........................ 18,813 157 17,024 Purchase of fixed assets.................................... (112,661) (91,406) (63,603) Proceeds on sale of investment in subsidiary................ -- 31,417 38,637 Proceeds on disposal of investments......................... 87,465 919,567 7,188 Additions to investments.................................... (92,735) (99,040) (17,636) Additions to circulation.................................... (37,667) (3,920) -- Decrease (increase) in other assets......................... 779 (1,132) (450) Investment in newspaper operations.......................... (175,376) -- -- Proceeds on disposal of newspaper and magazine operations... 2,016,885 376,865 -- ----------- --------- --------- 1,705,503 1,132,508 (18,840) ----------- --------- --------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS............................................... (6,825) 14,250 3,304 ----------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 159,475 572,431 (617,495) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 74,441 233,916 806,347 ----------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 233,916 $ 806,347 $ 188,852 =========== ========= ========= CASH FLOW PROVIDED BY (USED FOR) OPERATIONS PER RETRACTABLE COMMON SHARE (note 19) SUPPLEMENTAL DISCLOSURE OF FINANCING AND INVESTING ACTIVITIES Interest paid............................................. $ 244,592 $ 153,972 $ 108,159 Income taxes paid......................................... $ 69,710 $ 122,087 $ 14,095
F-7 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 1. SIGNIFICANT ACCOUNTING POLICIES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES These consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") in Canada, which vary in certain significant respects from United States GAAP. A description of significant differences, as applicable to the Company is included in note 26. BASIS OF PREPARATION These consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles using a basis of presentation which assumes that the Company will continue in operation for the foreseeable future and be able to realize its assets and discharge its liabilities and commitments in the normal course of business. The Company is an international holding company and its assets consist primarily of investments in its subsidiaries and affiliated companies. As a result, the Company's ability to meet its future financial obligations, on a non-consolidated basis, is dependent upon the availability of cash flows from its Canadian and foreign subsidiaries through dividends, management fees and other payments. On a non-consolidated basis during 2002, the Company experienced a shortfall between the dividends and fees received from its subsidiaries and its obligations to pay its operating costs, including interest and dividends on its preference shares and such shortfalls were expected to continue in the future. Accordingly, the Company is dependent upon the continuing financial support of Ravelston Management Inc. ("RMI") to fund such shortfalls and, therefore, pay its liabilities as they fall due. RMI is a wholly owned subsidiary of The Ravelston Corporation Limited ("Ravelston"), the Company's ultimate parent company. On March 10, 2003, the date of issue of US $120,000,000 aggregate principal amount of Senior Secured Notes due 2011, RMI entered into a Support Agreement with the Company. Under the agreement, RMI has agreed to make annual support payments in cash to the Company on a periodic basis by way of contributions to the capital of the Company (without receiving any shares of the Company) or subordinated debt. The amount of the annual support payments will be equal to the greater of (a) the non-consolidated negative net cash flow of the Company (which does not extend to outlays for retractions or redemptions) and (b) US$14.0 million per year (less any future payments of services agreements fees directly to the Company or to any of the Company's wholly owned restricted subsidiaries, as they are defined in the indenture governing the Company's Senior Secured Notes due 2011, and any excess in the net dividend amount received by the Company and 504468 N.B. Inc. ("NB Inc.") on the shares of Hollinger International Inc. ("Hollinger International") that the Company and NB Inc. own that is over US$4.65 million per year), in either case, reduced by any permanent repayment of debt owing by Ravelston to the Company. Initially, the support amount to be contributed by RMI is expected to be satisfied through the permanent repayment by Ravelston of its approximate $16.4 million of advances from the Company resulting from the use of proceeds of the Company's offering of Senior Secured Notes. Thereafter, all support amount contributions by RMI will be made through contributions to the capital of the Company without receiving any additional shares of the Company, except that, to the extent that the support payment exceeds the negative net cash flow of the Company, the amounts will be contributed through an interest-bearing, unsecured, subordinated loan to the Company. The support agreement terminates upon the repayment of the Senior Secured Notes, which mature in 2011. RMI currently derives all of its income and operating cash flow from the fees paid pursuant to services agreements with Hollinger International and its subsidiaries. RMI's ability to provide the required financial support under the Support Agreement with the Company is dependent on RMI continuing to receive sufficient fees pursuant to those services agreements. The services agreements may be terminated by either party by giving 180 days notice. The fees in respect of the services agreements are negotiated annually with and approved by the audit committee of Hollinger International. The fees to be paid to RMI for the year ending F-8 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) December 31, 2003 amount to approximately US$22.0 million to US$24.0 million and were approved in February 2003. The fees in respect of the periods after December 31, 2003 have not yet been negotiated or approved. If, in any quarterly period after April 1, 2003, the Company fails to receive in cash a minimum aggregate amount of at least US$4.7 million from a) payments made by RMI pursuant to the Support Agreement and b) dividends paid by Hollinger International on its shares held by the Company, net of dividends paid by the Company on its Series 11 preference shares, the Company would be in default under its Senior Secured Notes. Based on the Company's current investment in Hollinger International and the current quarterly dividend paid by Hollinger International of US$0.05 per share, the minimum support payment required to be made by RMI to avoid such a default is approximately US$3.5 million per quarter or US$14.0 million annually. This default could cause the Senior Secured Notes to become due and payable immediately. The Company's issued capital stock consists of Series II preference shares, Series III preference shares and retractable common shares each of which is retractable at the option of the holder. On retraction, the Series II preference shares are exchangeable into a fixed number of shares of the Company's Class A common stock of Hollinger International or at the Company's option, cash of equivalent value. The Series III preference shares are currently retractable at the option of the holder for a retraction price payable in cash, which fluctuates by reference to two benchmark Government of Canada bonds having a comparable yield and term to the shares and, after May 1, 2003, for a cash payment of $9.50 per share. The retractable common shares are retractable at any time at the option of the holder at their retraction price (which is fixed from time to time) in exchange for the Company's shares of Hollinger International Class A common stock of equivalent value or, at the Company's option, cash. There is uncertainty regarding the Company's ability to meet future retractions of preference shares and retractable common shares. Under corporate law, the Company is not required to make any payment to redeem any shares in certain circumstances, including if the Company is, or after the payment, the Company would be, unable to pay its liabilities as they come due. If at the time of future retractions, the Company does not have sufficient cash or sufficient available Hollinger International shares of Class A common stock to both fund such retractions and continue to pay its liabilities as they come due, shareholders would not become creditors of the Company but would remain as shareholders until such time as the retraction is able to be completed under applicable law. On May 20, 2003, the Company concluded it was not able to complete retractions of shares submitted after April 30, 2003, without unduly impairing its liquidity (note 29f)). The Company's uncertain ability to make payments on future retractions and redemptions of shares is due to the fact that liquidity of its assets is limited at present given that substantially all of its shares of Hollinger International common stock were provided as security for the Senior Secured Notes. GENERAL BUSINESS Hollinger Inc. publishes, prints and distributes newspapers and magazines in Canada, the United Kingdom, the United States of America, and Israel through subsidiaries and associates. In addition, Hollinger Inc. has developed related websites on the Internet. The consolidated financial statements include the accounts of Hollinger Inc., its subsidiaries, other controlled entities and its pro rata share of assets, liabilities, F-9 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) revenue and expenses of joint ventures (collectively, the "Company"). The Company's significant subsidiaries and controlled entities are set out below:
PERCENTAGE OWNED AS AT DECEMBER 31, ----------------------------------- 2000 2001 2002 ------- ------- ------- Hollinger International Inc. ("Hollinger International").... 47.5%(3) 36.0%(3) 31.8%(3) Hollinger International Publishing Inc. ("Publishing")...... 100.0%(1) 100.0%(1) 100.0%(1) The Sun-Times Company....................................... 100.0%(1) 100.0%(1) 100.0%(1) Jerusalem Post Publications Limited ("Jerusalem Post")...... 100.0%(1) 100.0%(1) 100.0%(1) Hollinger Canadian Publishing Holdings Co. ("HCPH Co.")(2).................................................. 100.0%(1) 100.0%(1) 100.0%(1) The National Post Company ("National Post") (note 5c))...... 50.0%(1) -- -- Telegraph Group Limited ("Telegraph")....................... 100.0%(1) 100.0%(1) 100.0%(1) Hollinger Canadian Newspapers, Limited Partnership ("Hollinger L.P.")........................................ 87.0%(1) 87.0%(1) 87.0%(1)
--------------- (1) Percent owned by Hollinger International. (2) During 2001 HCPH Co. (formerly Hollinger Canadian Publishing Holdings Inc. ("HCPH")) became the successor to the operations of XSTM Holdings (2000) Inc. (formerly Southam Inc. ("Southam")). (3) Represents the Company's equity interest in Hollinger International. The Company's voting percentage at December 31, 2002 is 72.8% (2001 -- 71.8% and 2000 -- 73.3%). FOREIGN CURRENCY TRANSLATION Monetary items denominated in foreign currency are translated to Canadian dollars at exchange rates in effect at the balance sheet date and non-monetary items are translated at exchange rates in effect when the assets were acquired or obligations incurred. Revenues and expenses are translated at exchange rates in effect at the time of the transactions. Foreign exchange gains and losses are included in income. The financial statements of foreign subsidiaries, all of which are self-sustaining, are translated using the current rate method, whereby all assets and liabilities are translated at year-end exchange rates, with items in the consolidated statements of earnings translated at the weighted average exchange rates for the year. Exchange gains or losses arising from the translation of balance sheet items are deferred and disclosed separately within shareholders' equity. These exchange gains or losses are not included in earnings unless they are actually realized through a reduction of the Company's net investment in the foreign subsidiary. Exchange gains or losses on the translation of exchangeable preference shares are deferred as they have been designated as a hedge of the Company's investment in shares of Hollinger International Class A common stock for which they are exchangeable. Effective January 1, 2002, the Company adopted, on a retroactive basis, The Canadian Institute of Chartered Accountants ("CICA") amended Handbook Section 1650, "Foreign Currency Translations" ("Section 1650"), which eliminates the deferral and amortization of foreign currency translation gains and losses on long-term monetary items denominated in foreign currencies, with a fixed or ascertainable life. There was no impact to the Company upon adoption of this standard as at January 1, 2002 or any period presented. CASH EQUIVALENTS Cash equivalents consist of certain highly liquid investments with original maturities of three months or less. F-10 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) INVENTORY Inventory, principally printing material, is valued at the lower of cost and net realizable value. Cost is determined using the first-in, first-out (FIFO) method. CAPITAL ASSETS Capital assets are stated at cost. Cost represents the cost of acquisition or construction, including the direct costs of financing until the asset is ready for use. Leases which transfer substantially all of the benefits and risks of ownership to the Company or its subsidiaries are recorded as assets, together with the obligations, based on the present value of future rental payments, excluding executory costs. Capital assets, including assets under capital leases, are depreciated over their estimated useful lives as follows: Buildings straight line over 25 to 40 years Machinery and equipment straight line over 4 to 20 years or 7% to 12% on the diminishing-balance basis Leasehold interests straight line over the term of the lease ranging from 5 to 40 years
GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill represents the excess of acquisition costs over estimated fair value of net assets, including definite lived intangibles, acquired in business combinations. Until December 31, 2001, goodwill amortization was calculated using the straight-line method over the respective estimated useful lives to a maximum of 40 years. Prior to January 1, 2002, circulation represented the long-term readership of paid newspapers and the Company allocated a portion of the purchase price discrepancy in each business acquired to the cost of circulation. In addition, the Company capitalized costs incurred to increase the long-term readership. Circulation was amortized on a straight-line basis over periods ranging from 10 to 40 years. Effective January 1, 2002, the Company adopted the CICA Handbook Section 3062, "Goodwill and Other Intangible Assets" ("Section 3062") and certain transitional provisions of CICA Handbook Section 1581, "Business Combinations" ("Section 1581"). The new standards require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. The standards also specify criteria that intangible assets must meet to be recognized and reported apart from goodwill. In addition, Section 3062 requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment by assessing the recoverability of the carrying value. As of the date of adoption of Section 3062 and certain transitional provisions of Section 1581, the Company has discontinued amortization of all existing goodwill, evaluated existing intangible assets and has reclassified from circulation amounts in respect of non-competition agreements and subscriber and advertiser relationships, which meet the new criteria for recognition of intangible assets apart from goodwill. The balance of circulation has been reclassified to goodwill effective January 1, 2002. In connection with the Section 3062 transitional impairment evaluation, the Company was required to assess whether goodwill was impaired as of January 1, 2002. The fair values of the Company's reporting units were determined primarily using a multiple of maintainable normalized cash earnings. As a result of this F-11 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) transitional impairment test, and based on the methodology adopted, the Company has determined that the carrying amount of the Jerusalem Post was in excess of the estimated fair value at January 1, 2002. Accordingly, the value of goodwill attributable to the Jerusalem Post of $32.0 million has been written down in its entirety. Such loss, net of related minority interest amounted to $12.1 million and has been recorded as a charge to the opening deficit as at January 1, 2002. The Company has determined that the fair value of all other reporting units is in excess of the respective carrying amounts, both on adoption and at year end for purposes of the annual impairment test. In addition to the transitional goodwill impairment test as of January 1, 2002, the Company is required to test goodwill for impairment on an annual basis for each of its reporting units. The Company is also required to evaluate goodwill for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Certain indicators of potential impairment that could impact the Company's reporting units include, but are not limited to, the following: (a) a significant long-term adverse change in the business climate that is expected to cause a substantial decline in advertising spending, (b) a permanent significant decline in a reporting unit's newspaper readership, (c) a significant adverse long-term negative change in the demographics of a reporting unit's newspaper readership and (d) a significant technological change that results in a substantially more cost-effective method of advertising than newspapers. Effective January 1, 2002, the Company had unamortized goodwill in the amount of $873.7 million, which is no longer being amortized. This amount reflects the transitional impairment loss of $32.0 million relating to the Jerusalem Post. This change in accounting policy cannot be applied retroactively and the amounts presented for prior periods have not been restated for this change. If this change in accounting policy were applied to the reported consolidated statement of earnings for the years ended December 31, 2000 and 2001, the impact of the change, in respect of goodwill and intangible assets not being amortized, would be as follows:
2000 2001 -------- --------- Net earnings (loss) -- as reported.......................... $189,373 $(131,898) Add goodwill and intangible asset amortization, net of income taxes and minority interest........................ 31,384 16,978 -------- --------- Adjusted net earnings (loss)................................ $220,757 $(114,920) ======== ========= Basic earnings (loss) per share -- as reported.............. $ 5.11 $ (3.91) ======== ========= Basic adjusted earnings (loss) per share.................... $ 5.97 $ (3.41) ======== ========= Diluted earnings (loss) per share -- as reported............ $ 5.05 $ (4.17) ======== ========= Diluted adjusted earnings (loss) per share.................. $ 5.90 $ (3.64) ======== =========
Adjusted net earnings (loss), noted above, reflects only the reduction in amortization expense of intangibles now classified as goodwill and does not give effect to the impact that this change in accounting policy would have had on the gains and losses resulting from the disposal of operations during 2000 and 2001, nor the expensing of the costs previously capitalized to increase long-term readership in 2000 and 2001. INVESTMENTS Investments are accounted for at cost, except for investments in which the Company exercises significant influence which are accounted for by the equity method. Investments are written down when declines in value are considered to be other than temporary. Dividend and interest income are recognized when earned. F-12 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Prior to the adoption of new accounting standards for goodwill on January 1, 2002, as described above, the excess of acquisition costs over the Company's share of the fair value of net assets at the acquisition date of an equity method investment was amortized on a straight-line basis over its estimated useful life. Effective January 1, 2002, such equity method goodwill is no longer amortized. The Company recognizes a loss when there is other than a temporary decline in the fair value of the investment below its carrying value. DEFERRED FINANCING COSTS Deferred financing costs consist of certain costs incurred in connection with debt financings. Such costs are amortized on a straight-line basis over the term of the related debt. DERIVATIVES The Company uses derivative financial instruments to manage risks generally associated with interest rate and foreign currency exchange rate market volatility. The Company does not hold or issue derivative financial instruments for trading purposes. None of the derivatives has been designated as a hedge. All derivatives are recorded at their fair value with changes in fair value reflected in the consolidated statements of earnings, other than Hollinger International's forward share purchase contracts (described in note 24b)). STOCK-BASED COMPENSATION AND OTHER STOCK-BASED PAYMENTS The Company and certain of its subsidiaries have employee stock-based compensation plans. Until December 31, 2001, compensation expense was not recognized on the grant or modification of options under these plans. Effective January 1, 2002, the Company adopted the new CICA Handbook Section 3870, "Stock-based Compensation and Other Stock-based Payments" ("Section 3870"). Under Section 3870, the Company is required to adopt, on a prospective basis, the fair value-based method to account for all stock-based payments made by the Company to non-employees, including employees of Ravelston, the parent company, and employee awards that are direct awards of stock, call for settlement in cash or other assets, or are stock appreciation rights that call for settlement by the issuance of equity instruments, granted on or after January 1, 2002. For all other stock-based payments, the Company has elected to use the settlement method of accounting, whereby cash received on the exercise of stock options is recorded as capital stock. Under the fair value-based method, stock options granted to employees of Ravelston by the Company and its subsidiaries are measured at the fair value of the consideration received, or the fair value of the equity instruments issued, or liabilities incurred, whichever is more reliably measurable. Such fair value determined is recorded as a dividend-in-kind in the Company's financial statements with no impact on the Company's net earnings. Section 3870 has been applied prospectively to all stock-based payments to non-employees granted on or after January 1, 2002. EMPLOYEE BENEFIT PLANS The Company accrues its obligations under employee benefit plans and the related costs, net of plan assets. The following policies are applied in accounting for employee benefit plans: - The cost of pensions and other retirement benefits earned by employees is actuarially determined using the projected benefit method pro-rated on service and management's best estimate of expected plan investment performance, salary escalation, retirement ages of employees and expected health care costs. - For the purpose of calculating the expected return on plan assets, those assets are valued at fair value. F-13 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) - Past service costs from plan amendments are amortized on a straight-line basis over the average remaining service period of employees active at the date of amendment. - The excess of the net actuarial gain (loss) over 10% of the greater of the benefit obligation and the fair value of plan assets is amortized over the average remaining service period of active employees. The average remaining service period of the active employees covered by the plans ranges from 8 to 17 years. INCOME TAXES Future income tax assets and liabilities are recognized for the future income tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded against any future income tax asset if it is more likely than not that the asset will not be realized. Income tax expense is the sum of the Company's provision for current income taxes and the difference between opening and ending balances of future income tax assets and liabilities. The effect on future tax assets and liabilities for change in tax rates is recognized in income in the period that includes the enactment date. REVENUE RECOGNITION The Company's principal sources of revenue comprise advertising, circulation and job printing. As a general principle, revenue is recognized when the following criteria are met: (a) persuasive evidence of an arrangement exists, (b) delivery has occurred and services have been rendered, (c) the price to the buyer is fixed or determinable, and (d) collectibility is reasonably assured or is probable. Advertising revenue, being amounts charged for space purchased in the Company's newspapers, is recognized upon publication of the advertisements. Circulation revenue from subscribers, billed to customers at the beginning of a subscription period, is recognized on a straight-line basis over the term of the related subscription. Deferred revenue represents subscription receipts that have not been earned. Circulation revenue from single copy sales is recognized at the time of distribution. In both cases, circulation revenue is recorded net of fees or commissions paid to distributors and retailers and less an allowance for returned copies. Job printing revenue, being charges for printing services provided to third parties, is recognized upon delivery. LOSS PER SHARE Basic loss per share is computed by dividing the net loss by the weighted average shares outstanding during the year. Diluted loss per share is computed similar to the basic loss per share except that the weighted average shares outstanding is increased to include additional shares from the assumed exercise of stock options of Hollinger Inc., if dilutive and the net loss is increased to reflect the impact of additional shares of Hollinger International being issued from the exercise of its stock options and Series E preferred shares, if dilutive. The number of additional shares is calculated by assuming that outstanding stock options were exercised and that the proceeds from such exercises were used by Hollinger International to acquire shares of common stock of Hollinger International at the average market price during the year. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to bad debts, investments, intangible assets, income taxes, restructuring, pensions and other post- F-14 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) retirement benefits, contingencies and litigation. The Company relies on historical experience and on various other assumptions that are believed to be reasonable under the circumstances in making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required. The Company holds minority interests in both publicly traded and not publicly traded Internet-related companies. Some of the publicly traded companies have highly volatile share prices. The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of underlying investments may not be reflected in an investment's current carrying value, thereby possibly requiring an impairment charge in the future. The Company has significant goodwill recorded in its accounts. Certain of its newspapers operate in highly competitive markets. The Company is required to determine annually whether or not there has been any impairment in the value of these assets. Changes in long-term readership patterns and advertising expenditures may affect the value and necessitate an impairment charge. Certain indicators of potential impairment that could impact the Company's reporting units include, but are not limited to, the following: a) a significant long-term adverse change in the business climate that is expected to cause a substantial decline in advertising spending, b) a permanent significant decline in a reporting unit's newspaper readership, c) a significant adverse long-term negative change in the demographics of a reporting unit's newspaper readership, and d) a significant technological change that results in a substantially more cost-effective method of advertising than newspapers. The Company sponsors several defined benefit pension and post-retirement benefit plans for domestic and foreign employees. These defined benefit plans include pension and post-retirement benefit obligations, which are calculated based on actuarial valuations. In determining these obligations and related expenses, key assumptions are made concerning expected rates of return on plan assets and discount rates. In making these assumptions, the Company evaluated, among other things, input from actuaries, expected long-term market returns and current high-quality bond rates. The Company will continue to evaluate the expected long-term rates of return on plan assets and discount rates at least annually and make adjustments as necessary, which could change the pension and post-retirement obligations and expenses in the future. Unrecognized actuarial gains and losses in respect of pension and post-retirement benefit plans are recognized by the Company over a period ranging from 8 to 17 years, which represents the weighted average remaining service life of the employee groups. Unrecognized actuarial gains and losses arise from several factors, including experience, assumption changes in the obligations and from the difference between expected returns and actual returns on assets. At the end of 2002, the Company had unrecognized net actuarial losses of $233.4 million. These unrecognized amounts could result in an increase to pension expense in future years depending on several factors, including whether such losses exceed the corridor in accordance with CICA Section 3461, "Employee Future Benefits". The Company recognized a pension valuation allowance for any excess of the prepaid benefit cost over the expected future benefit. Increases or decreases in global capital markets and interest rate fluctuations could increase or decrease any excess of the prepaid benefit cost over the expected future benefit resulting in F-15 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) an increase or decrease to the pension valuation allowance. Changes in the pension valuation allowance are recognized in earnings immediately. 2. CHANGE IN ACCOUNTING POLICIES a) Earnings per share Effective January 1, 2001, the Company adopted, retroactively with restatement, the recommendations of the CICA Section 3500 with respect to earnings per share. Under the revised standard, the treasury stock method is used instead of the imputed earnings approach for determining the dilutive effect of options, issued warrants or other similar instruments. The change in the method of calculation of earnings per share did not impact the previously reported basic earnings per share for 2000. Diluted earnings per share for 2000 were increased from $4.49 per share to $5.05 per share. b) Income taxes Effective January 1, 2000, the CICA changed the accounting standard relating to the accounting for income taxes. The new standard adopted the liability method of accounting for future income taxes. Prior to January 1, 2000, income tax expense was determined using the deferral method. The Company adopted the new income tax accounting standard retroactively on January 1, 2000, and did not restate the financial statements of any prior periods. As a result, the Company has recorded an increase to deficit of $291,004,000, an increase to the future tax liability of $516,113,000 and a decrease to minority interest of $225,109,000 as at January 1, 2000. c) Goodwill and other intangible assets Effective January 1, 2002, the Company adopted CICA Handbook Section 3062, "Goodwill and Other Intangible Assets" ("Section 3062") and certain transitional provisions of CICA Handbook Section 1581, "Business Combinations" ("Section 1581"). The new standards must be adopted prospectively and require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. The standards also specify criteria that intangible assets must meet to be recognized and reported apart from goodwill. The impact of this change in accounting policy is discussed under "Goodwill and Other Intangible Assets" in note 1. 3. RESTRICTED CASH Cash and cash equivalents at December 31, 2001 included US$7,500,000 ($11,944,000) of restricted cash deposited with an escrow agent under the terms of one of Hollinger International's forward share purchase contracts (note 24b)), which were terminated in 2002. In addition, US$5,000,000 ($7,963,000) of cash was pledged as security at December 31, 2001 for Hollinger International's US$5,000,000 Restated Credit Facility (note 10f)) under which no amounts were permitted to be borrowed at December 31, 2001. At December 31, 2002, restricted cash includes US$2,000,000 ($3,160,000) deposited in connection with outstanding letters of credit. 4. ACQUISITIONS AND DISPOSITIONS a) In January 2002, the Company sold 2,000,000 shares of Hollinger International Class A common stock to third parties for total cash proceeds of $38.6 million. This transaction, together with the retraction of Series II preference shares of the Company for shares of Hollinger International F-16 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Class A common stock (note 11a)), resulted in a pre-tax gain on the effective sales of the Hollinger International shares of $20.1 million (note 17). b) In January 2001, Hollinger L.P. completed the sale of UniMedia Company to Gesca Limited, a subsidiary of Power Corporation of Canada, for cash consideration. The publications sold represented the French language newspapers of Hollinger L.P., including three paid circulation dailies and 15 weeklies published in Quebec and Ontario. A pre-tax gain of approximately $75.1 million was recognized on this sale (note 17). c) In two separate transactions in July and November 2001, the Company and Hollinger L.P. completed the sale of most of its remaining Canadian newspapers to Osprey Media Group Inc. ("Osprey") for total cash proceeds of approximately $255.0 million plus closing adjustments primarily for working capital. Included in these sales were community newspapers in Ontario such as The Kingston Whig-Standard, The Sault Star, the Peterborough Examiner, the Chatham Daily News and The Observer (Sarnia). Pre-tax gains of approximately $1.5 million were recognized on these sales (note 17). The former Chief Executive Officer of Hollinger L.P. is a minority shareholder of Osprey. Hollinger International's independent directors have approved the terms of these transactions. In connection with the two sales of Canadian newspaper properties to Osprey in 2001, to satisfy a closing condition, the Company, Hollinger International, Lord Black of Crossharbour, PC(C), OC, KCSG and three senior executives entered into non-competition agreements with Osprey pursuant to which each agreed not to compete directly or indirectly in Canada with the Canadian businesses sold to Osprey for a five-year period, subject to certain limited exceptions, for aggregate consideration of $7.9 million. Such consideration was paid to Lord Black and the three senior executives and has been approved by Hollinger International's independent directors. d) In August 2001, the Company entered into an agreement to sell to CanWest Global Communications Corp. ("CanWest") its 50% interest in the National Post. In accordance with the agreement, the Company's representatives resigned from their executive positions at the National Post effective September 1, 2001. Accordingly, from September 1, 2001, the Company had no influence over the operations of the National Post and the Company no longer consolidated or recorded on an equity basis its share of earnings or losses. The results of operations of the National Post are included in the consolidated results to August 31, 2001. A pre-tax loss of approximately $120.7 million was recognized on the sale and is included in unusual items (note 17). e) During 2001, Hollinger International converted all of its Series C Preferred Stock which was held by the Company, at the conversion ratio of 8.503 shares of Hollinger International Class A common stock per share of Series C Preferred Stock into 7,052,464 shares of Hollinger International Class A common stock. The 7,052,464 shares of Class A common stock of Hollinger International were subsequently purchased for cancellation by Hollinger International for a total of US$92.2 million ($143.8 million). The purchase price per share was 98% of the closing price of the shares of Hollinger International Class A common stock and was approved by Hollinger International's independent directors. The Company used the proceeds to reduce its bank indebtedness by $142.0 million (note 9). On September 27, 2001, Hollinger International redeemed 40,920 shares of its Series E preferred stock held by the Company at their stated redemption price of $146.63 per share for a total cash payment of $6.0 million. F-17 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) In December 2001, the Company sold 2,000,000 shares of Hollinger International Class A common stock to third parties for total cash proceeds of $31.4 million and reduced its bank indebtedness by the same amount (note 9). The above transactions, together with the retraction of retractable common shares of the Company in exchange for shares of Hollinger International Class A common stock (note 13d)) and the retraction of Series II preference shares of the Company for shares of Class A common stock of Hollinger International (note 11a)), resulted in a total pre-tax gain on the effective sales of the Hollinger International shares of $59.4 million (note 17). f) During 2001, Hollinger International transferred two publications to Horizon Publications Inc. in exchange for net working capital. Horizon Publications Inc. is managed by former Community Group executives and controlled by certain members of the Board of Directors of Hollinger International. The terms of these transactions were approved by the independent directors of Hollinger International. g) On November 16, 2000, Hollinger International and its affiliates, Southam and Hollinger L.P. ("Hollinger Group") completed the sale of most of its Canadian newspapers and related assets to CanWest. Included in the sale were the following assets of the Hollinger Group: - a 50% interest in National Post, with Hollinger International continuing as managing partner; - the metropolitan and a large number of community newspapers in Canada (including the Ottawa Citizen, The Vancouver Sun, The Province (Vancouver), the Calgary Herald, the Edmonton Journal, The Gazette (Montreal), The Windsor Star, the Regina Leader Post, the Star Phoenix and the Times-Colonist (Victoria); and - the operating Canadian Internet properties, including canada.com. The sale resulted in the Hollinger Group receiving approximately $1.7 billion cash, approximately $425 million in voting and non-voting shares of CanWest at fair value, and subordinated non-convertible debentures of a holding company in the CanWest group with a fair value of approximately $697 million. The aggregate sale price of these properties at fair value was approximately $2.8 billion, plus closing adjustments for working capital at August 31, 2000 and cash flow and interest for the period September 1 to November 16, 2000 which in total was estimated as an additional $63 million at December 31, 2000. The cash proceeds were used to pay down outstanding debt on Hollinger International's Bank Credit Facility (note 10). The sale resulted in a pre-tax gain of approximately $566.0 million in 2000 which was included in unusual items (note 17). In 2001, certain of the closing adjustments were finalized, resulting in an additional pre-tax gain in 2001 of approximately $29.1 million which is included in unusual items (note 17). At December 31, 2002, approximately $60.7 million (2001 -- $57.3 million) in respect of closing adjustments remained due to the Company and is included in accounts receivable. Certain closing adjustments have not yet been finalized. Amounts due bear interest at a rate of approximately 9%. The amount outstanding is subject to negotiation between CanWest and the Company. Adjustments to the balance due, if any, resulting from further negotiations will be recorded as an unusual item. In connection with the sale to CanWest, The Ravelston Corporation Limited ("Ravelston"), a holding company controlled by Lord Black, entered into a management services agreement with CanWest and National Post pursuant to which it agreed to continue to provide management services to the Canadian businesses sold to CanWest in consideration for an annual fee of $6 million payable by CanWest. In addition, CanWest will be obligated to pay Ravelston a termination fee of $45 million, in the event that CanWest chooses to terminate the management services agreement or F-18 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) $22.5 million, in the event that Ravelston chooses to terminate the agreement (which cannot occur before December 31, 2002). Also, as required by CanWest as a condition to the transaction, the Company, Ravelston, Hollinger International, Lord Black and three senior executives entered into non-competition agreements with CanWest pursuant to which each agreed not to compete directly or indirectly in Canada with the Canadian businesses sold to CanWest for a five-year period, subject to certain limited exceptions, for aggregate consideration of $80 million paid by CanWest in addition to the purchase price referred to above, of which $38 million was paid to Ravelston and $42 million was paid to Lord Black and the three senior executives. The independent directors of Hollinger International have approved the terms of these payments. h) On November 1, 2000, Southam converted the convertible promissory note in Hollinger L.P. in the principal amount of $225,753,000 into 22,575,324 limited partnership units of Hollinger L.P., thereby increasing Hollinger International's interest in Hollinger L.P. to 87.0%. i) During 2000, Hollinger International sold most of its remaining U.S. community newspaper properties, including 11 paid dailies, three paid non-dailies and 31 free distribution publications for total proceeds of approximately US$215,000,000 ($325,166,000). Pre-tax gains totalling $75,114,000 were recognized on these sales and were included in unusual items in 2000 (note 17). In connection with the sales of United States newspaper properties in 2000, to satisfy a closing condition, Hollinger International, Lord Black and three senior executives entered into non-competition agreements with the purchasers pursuant to which each agreed not to compete directly or indirectly in the United States with the United States businesses sold to the purchasers for a fixed period, subject to certain limited exceptions, for aggregate consideration paid in 2001 of US$600,000 ($917,000). These amounts were in addition to the aggregate consideration paid in respect of these non-competition agreements in 2000 of US$15.0 million ($22.5 million). All such amounts were paid to Lord Black and the three senior executives. The independent directors of Hollinger International have approved the terms of these payments. j) Included in the dispositions during 2000 described in note 4i), Hollinger International sold four U.S. community newspapers for an aggregate consideration of US$38.0 million ($56.5 million) to Bradford Publishing Company, a Company formed by a former U.S. Community Group executive and in which some of Hollinger International's directors are shareholders. The terms of this transaction were approved by the independent directors of Hollinger International. k) On February 17, 2000, Interactive Investor International, in which Hollinger International owned 51.7 million shares or a 47% equity interest, completed its initial public offering ("IPO") issuing 52 million shares and raising L78,000,000 ($181,000,000). The IPO reduced Hollinger International's equity ownership to 33% and resulted in a dilution gain of $25,775,000 for accounting purposes. Subsequently, Hollinger International sold five million shares of its holding, reducing its equity interest to 28.5% and resulting in a pre-tax gain in 2000 of $2,400,000. Both the dilution gain and gain on sale were included in unusual items in 2000 (note 17). The balance of the investment was sold in 2001 resulting in an additional pre-tax gain in 2001 of $14.7 million (note 17). l) In December 2000, Hollinger International acquired four paid daily newspapers, one paid non-daily and 12 free distribution publications in the Chicago suburbs for total cash consideration of US$111,000,000 ($166,744,000). Of the aggregate purchase price, $78,781,000 was ascribed to circulation and $48,244,000 to goodwill. All of the Company's acquisitions have been accounted for using the purchase method with the results of operations included in these consolidated financial statements from the dates of acquisition. F-19 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The details of the acquisitions including those detailed above are as follows:
2000 2001 2002 -------- ---- ---- Assets acquired, at fair value Current assets............................................ $ 19,444 $-- $-- Fixed assets.............................................. 51,724 -- -- Circulation............................................... 78,781 -- -- Goodwill and other assets................................. 57,418 -- -- -------- -- -- 207,367 -- -- -------- -- -- Less liabilities assumed Current liabilities....................................... 16,269 -- -- Long-term liabilities..................................... 15,722 -- -- -------- -- -- 31,991 -- -- -------- -- -- Net cost of investments..................................... $175,376 $-- $-- ======== == ==
5. INVESTMENTS
2001 2002 -------- -------- ASSOCIATED COMPANIES, AT EQUITY The Company Cayman Free Press Ltd. -- 40% interest................. $ 11,245 $ 11,314 Telegraph Trafford Park Printers Limited ("Trafford Park"), West Ferry Printers Limited ("West Ferry"), Paper Purchase Management Limited ("PPM") and handbag.com Limited (handbag) joint ventures -- 50% interests............ 29,110 27,763 Internet-related investments.............................. 8,205 8,012 Other..................................................... 1,490 1,886 -------- -------- 50,050 48,975 -------- -------- MARKETABLE INVESTMENTS, AT COST CanWest debentures a)..................................... 72,259 85,664 Internet-related investments.............................. 6,680 5,812 -------- -------- 78,939 91,476 -------- -------- OTHER NON-MARKETABLE INVESTMENTS, AT COST Internet and telephony-related investments................ 78,272 36,282 Other..................................................... 52,174 33,412 -------- -------- 130,446 69,694 -------- -------- $259,435 $210,145 ======== ========
a) The CanWest debentures were issued by a wholly owned subsidiary of CanWest and are guaranteed by CanWest. The debentures were received on November 16, 2000 as partial consideration for the operations sold to CanWest. Interest on the CanWest debentures is calculated, compounded and payable semi-annually in arrears at a rate of 12.125% per annum. At any time prior to November 5, 2005, CanWest may elect to pay interest on the debentures by way of non-voting shares of CanWest, debentures in substantially the same form as the CanWest debentures, or cash. Subsequent to November 5, 2005, interest is to be paid in cash. The debentures are due November 15, 2010, but F-20 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) are redeemable at any time prior to May 15, 2003 for cash at CanWest's option at 100% of the principal amount. CanWest debentures at December 31, 2002 had a principal face amount of $93.0 million (2001 -- $77.2 million), including $15.8 million of additional debentures received in 2002 (2001 -- $67.1 million) in payment of the interest due on existing debentures held by the Company, a portion of which related to 2001. These debentures have been recorded at their fair value at the time they are received. As part of Hollinger International's November 16, 2000 purchase and sale agreement with CanWest, Hollinger International was prohibited from selling CanWest debentures prior to May 15, 2003. In order to monetize the debentures, Hollinger International entered into a participation agreement in August 2001 pursuant to which it sold participation interests in $540.0 million (US$350.0 million) principal amount of CanWest debentures to a special purpose trust (the "Participation Trust") administered by an arm's-length trustee. That sale of participation interests was supplemented by a further sale of $216.8 million (US$140.5 million) in December 2001 for a total of $756.8 million (US$490.5 million). Both sales were conducted at a fixed rate of exchange of US$0.6482 for each $1. Hollinger International remains the record owner of the participated CanWest debentures and is required to make payments to the Participation Trust with respect to those debentures if and to the extent it receives payment in cash or in kind on the debentures from CanWest. These payments are not reflected in the Company's accounts. Coincident with the Participation Trust's purchase of the participation interests, the Participation Trust sold senior notes to arm's-length third parties to finance the purchase of the participation interests. These transactions resulted in net proceeds to Hollinger International of $621.8 million and for accounting purposes have been accounted for as sales of CanWest debentures. The net loss on the 2001 transactions, including realized holding losses on the debentures, amounted to $97.4 million and has been included in unusual items (note 17). Hollinger International believes that the participation arrangement does not constitute a prohibited sale of debentures as legal title was not transferred. CanWest has advised Hollinger International that it accepts that position. Hollinger International has not retained an interest in the Participation Trust nor does it have any beneficial interest in the assets of the Participation Trust. The Participation Trust and its investors have no recourse to Hollinger International's other assets in the event that CanWest defaults on its debentures. Under the terms of the Participation Trust, the interest payments received by Hollinger International in respect of the underlying CanWest debentures will be paid to the Participation Trust. However, after May 15, 2003, Hollinger International may be required to deliver to the Participation Trust CanWest debentures with a face value equivalent to US$490.5 million based on then current rates of exchange. The CanWest debentures are denominated in Canadian dollars and, consequently, there is a currency exposure on the debentures subject to the delivery provision. A substantial portion of that exposure was previously hedged; however, the hedge instrument (a forward foreign exchange contract) was terminated in contemplation of and in conjunction with Publishing's placement of Senior Notes (note 10a)) and amendment of Publishing's Senior Credit Facilities (note 10b)). During 2001 and 2002, the net loss before tax, realized on the mark to market of both the obligation to the Participation Trust and the related hedge contract was $0.7 million and $10.4 million, respectively, and has been included in net foreign currency losses in the consolidated statement of earnings. In 2002, the loss before tax is net of cash received on the termination of the hedge of $9.9 million. F-21 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Pursuant to the terms of the Participation Trust, the Company is unable to sell to an unaffiliated third party until at least November 4, 2010 the equivalent of US$50.0 million ($79.0 million at December 31, 2002) principal amount of CanWest debentures. b) CanWest shares at December 31, 2000 consisted of 2,700,000 multiple voting preferred shares and 27,000,000 non-voting shares. The non-voting shares were publicly traded and the multiple voting shares were not publicly traded but were convertible into non-voting shares at the rate of 0.15 non-voting share for each voting preferred share or a total additional 405,000 non-voting shares. The non-voting shares and voting preferred shares represented an approximate 15.6% equity interest and 5.7% voting interest in CanWest. On November 28, 2001, Hollinger International sold the 2,700,000 multiple voting preferred shares and 27,000,000 non-voting shares in CanWest for total cash proceeds of approximately $271.3 million. The sale resulted in a realized pre-tax loss of $157.5 million which is included in unusual items (note 17). 6. CAPITAL ASSETS
2001 2002 ---------- ---------- COST Land...................................................... $ 54,878 $ 52,050 Buildings and leasehold interests......................... 326,449 340,886 Machinery and equipment................................... 803,345 848,576 ---------- ---------- 1,184,672 1,241,512 ---------- ---------- ACCUMULATED DEPRECIATION AND AMORTIZATION Buildings and leasehold interests......................... 58,680 66,373 Machinery and equipment................................... 459,491 514,638 ---------- ---------- 518,171 581,011 ---------- ---------- NET BOOK VALUE.............................................. $ 666,501 $ 660,501 ========== ========== OWNED ASSETS Cost...................................................... $ 898,007 $ 887,484 Accumulated depreciation and amortization................. 330,240 352,956 ---------- ---------- Net book value............................................ $ 567,767 $ 534,528 ========== ========== LEASED ASSETS Cost...................................................... $ 286,665 $ 354,028 Accumulated depreciation and amortization................. 187,931 228,055 ---------- ---------- Net book value............................................ $ 98,734 $ 125,973 ========== ==========
Depreciation and amortization of capital assets totalled $116,760,000, $78,450,000 and $74,352,000 in 2000, 2001 and 2002, respectively. Hollinger International capitalized interest in 2000, 2001 and 2002 amounting to $4,653,000, $129,000 and nil, respectively, related to the construction and equipping of production facilities for its newspapers in Chicago. 7. GOODWILL AND OTHER INTANGIBLE ASSETS As described in note 1 to the consolidated financial statements, the Company adopted Section 3062 and certain transitional provisions of Section 1581 effective January 1, 2002. F-22 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The changes in the carrying amount of goodwill by reportable segment for the year ended December 31, 2002 are as follows:
U.K. CANADIAN CHICAGO COMMUNITY NEWSPAPER NEWSPAPER CONSOLIDATED GROUP GROUP GROUP GROUP TOTAL -------- --------- --------- ---------- ------------ Balance as at January 1, 2002........................ $234,320 $31,975 $569,013 $70,333 $905,641 Transitional impairment loss -- Jerusalem Post (note 1).......................... -- (31,975) -- -- (31,975) -------- ------- -------- ------- -------- Revised balance as at January 1, 2002..................... 234,320 -- 569,013 70,333 873,666 Adjustment of excess acquisition reserves........ (19,477) -- -- -- (19,477) Repurchase of shares of Hollinger International Class A common stock by Hollinger International (note 24b))................. 3,344 -- 8,240 -- 11,584 Foreign exchange and other.... (1,534) -- 48,809 279 47,554 -------- ------- -------- ------- -------- Balance as at December 31, 2002........................ $216,653 $ -- $626,062 $70,612 $913,327 ======== ======= ======== ======= ========
Upon adoption of Section 3062, intangible assets totalling $978,569,000, which were previously ascribed to circulation, net of $247,252,000 of deferred taxes, were reclassified to goodwill. Intangible assets with a total net book value at January 1, 2002 of $198,975,000 previously ascribed to circulation, consisting of non-competition agreements of $12,195,000 net of accumulated amortization of $8,360,000 and subscriber and advertiser relationships of $186,780,000 net of accumulated amortization of $35,261,000 were recognized as identifiable intangible assets apart from goodwill upon adoption of Section 3062. The Company's amortizable other intangible assets consist of non-competition agreements with former owners of acquired newspapers which are amortized using the straight-line method over the term of the respective non-competition agreements which range from three to five years, and subscribers and advertiser relationships which are amortized using the straight-line method over 30 years. The components of other amortizable intangible assets at December 31, 2002 are as follows:
GROSS CARRYING ACCUMULATED NET BOOK AMOUNT AMORTIZATION VALUE -------- ------------ -------- Amortizable other intangible assets: Non-competition agreements........................ $ 22,120 $15,049 $ 7,071 Subscriber and advertiser relationships........... 220,485 42,413 178,072 -------- ------- -------- $242,605 $57,462 $185,143 ======== ======= ========
Amortization of non-competition agreements for the year ended December 31, 2002 was $6,689,000. Amortization of advertiser and subscriber relationships for the year ended December 31, 2002 was $7,152,000. Future amortization of amortizable intangible assets is as follows: 2003 -- $13,895,000, 2004 -- $7,483,000, 2005 -- $7,235,000, 2006 -- $7,195,300, and 2007 -- $7,195,000. Amortization of goodwill and other intangible assets in total for the year ended December 31, 2001 was $66,266,000 (2000 -- $103,172,000). F-23 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 8. DEFERRED FINANCING COSTS AND OTHER ASSETS
2001 2002 -------- -------- Deferred pension asset (note 22)............................ $ 83,459 $123,230 Deferred finance costs, net of amortization of $38,494,000 (2001 -- $36,512,000)..................................... 52,484 52,759 Deferred foreign exchange loss on exchangeable shares....... 1,446 1,234 Other assets................................................ 17,154 16,314 -------- -------- $154,543 $193,537 ======== ========
Amortization of deferred finance costs, included in other interest expense, totalled $18,504,000, $18,648,000 and $11,347,000 in 2000, 2001 and 2002, respectively. 9. BANK INDEBTEDNESS
2001 2002 -------- ------- The Company................................................. $129,475 $90,810 ======== =======
At December 31, 2002, the Company has a bank operating line which provides for up to $10.0 million of borrowings and a revolving bank credit facility which provides for up to $80.8 million of borrowings. The Company's revolving bank credit facility is secured by shares of Hollinger International Class A and Class B common stock owned by the Company and bears interest at the prime rate plus 2.5% or the banker's acceptance ('BA') rate plus 3.5%. Under the terms of the revolving bank credit facility, the Company and its subsidiaries are subject to restrictions on the incurrence of additional debt. The revolving bank credit facility was amended and restated on August 30, 2002 and was to mature on December 2, 2002. A mandatory repayment of the revolving bank credit facility in the amount of $50.0 million was required by December 2, 2002 and if such payment was made, the lenders could have consented to an extension of the maturity date to December 2, 2003 in respect of the principal outstanding. On December 2, 2002, the lenders extended the $50.0 million principal repayment date to December 9, 2002. This repayment was not made and on December 9, 2002, the bank credit facility was amended to require a principal payment of $44.0 million on February 28, 2003 with the balance maturing on December 2, 2003. As a result of the impending closing of the Company's Senior Secured Note issue, the lenders further extended the due date for the repayment of the $44.0 million to March 14, 2003. On March 10, 2003, the revolving bank credit facility in the amount of $80.8 million and the bank operating line of $10.0 million were repaid with part of the proceeds of the Company's issue of Senior Secured Notes (note 29a)). On October 3, 2002, Hollinger International entered into a term lending facility and borrowed US$50.0 million ($79.6 million). As a result of Hollinger International's borrowing under this term facility, the Company was in default of a covenant under its revolving bank credit facility which, while in default, resulted in the Company's borrowings being due on demand. The banks waived the default and on December 23, 2002, Hollinger International repaid the full amount borrowed under its term lending facility (note 10d)). During 2001, the Company reduced its bank indebtedness by $142,000,000 with proceeds from the sale, to Hollinger International for cancellation, of 7,052,464 million of its shares of Class A common stock (note 4e)). In December 2001, the Company sold 2,000,000 shares of Hollinger International Class A common stock to third parties for total cash proceeds of $31,400,000 (note 4e)) and reduced bank indebtedness by the same amount. During January 2002, the Company sold a further 2,000,000 shares of F-24 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Class A common stock of Hollinger International and reduced bank indebtedness by an additional $38,600,000 (note 4a)). 10. LONG-TERM DEBT
2001 2002 ---------- ---------- Hollinger International Senior Notes due 2010 (US$300,000,000).................... $ -- $ 474,000 Senior Credit Facility (US$265,000,000)................... -- 418,698 Senior Notes due 2005 (US$5,082,000) (2001 -- US$260,000,000)........................................ 414,050 8,030 Senior Subordinated Notes due 2006 (US$239,900,000) (2001 -- US$250,000,000)..................................... 398,125 379,051 Senior Subordinated Notes due 2007 (US$265,000,000) (2001 -- US$290,000,000)..................................... 461,825 418,700 Other..................................................... 16,933 5,103 Other....................................................... 15,346 20,152 Obligations under capital leases Printing joint ventures................................... 37,914 60,096 Other..................................................... 7,433 5,491 ---------- ---------- 1,351,626 1,789,321 Less: Current portion included in current liabilities........... 10,020 16,800 Senior Subordinated Notes (note 10a))..................... -- 797,751 ---------- ---------- $1,341,606 $ 974,770 ========== ==========
a) On December 23, 2002, Publishing issued US$300,000,000 of 9% Senior Notes due 2010 guaranteed by Hollinger International. Net proceeds of the issue of US$291,700,000 plus cash on hand and borrowings under Publishing's Senior Credit Facility (note 10b)) were used in December 2002 to retire Hollinger International's equity forward share purchase contracts (Total Return Equity Swaps (note 24b)) and to repay amounts borrowed under its term facility maturing December 31, 2003 (note 10d)) and in January 2003 to retire, in their entirety, Publishing's outstanding Senior Subordinated Notes due 2006 and 2007 with the balance available for general corporate purposes. The Senior Notes bear interest at 9% payable semi-annually and mature on December 15, 2010. The Senior Notes are redeemable at the option of Publishing anytime after December 15, 2006 at 104.5% of the principal amount, after December 15, 2007 at 102.25% of the principal amount and after December 15, 2008 at 100% of the principal amount. On December 23, 2002, Publishing gave notice of redemption to both the holders of the Senior Subordinated Notes due 2006 with a principal remaining outstanding of US$239.9 million and to the holders of the Senior Subordinated Notes due 2007 with a principal remaining outstanding of US$265.0 million. Such notes were retired in January 2003 with a payment of $859.1 million (US$543.8 million), including early redemption premiums and accrued interest. At December 31, 2002, the notes remained outstanding and have been disclosed as a current liability. The proceeds from the December 2002 issue of Publishing's Senior Notes and borrowings under the Senior Credit Facility used to fund the redemption were held in escrow at December 31, 2002 and have been disclosed as escrow deposits in current assets. F-25 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Unamortized deferred financing costs in the amount of $28.0 million and the $31.1 million premium related to the retirement of the Senior Subordinated Notes will be charged to earnings in 2003 on extinguishment of the notes. The Indentures relating to the 9% Senior Notes contain financial covenants and negative covenants that limit Publishing's ability to, among other things, incur indebtedness, pay dividends or make other distributions on its capital stock, enter into transactions with related companies, and sell assets, including stock of a restricted subsidiary. The Indentures provide that upon a change of control (as defined in the Indentures), each noteholder has the right to require Publishing to purchase all or any portion of such noteholder's notes at a cash purchase price equal to 101% of the principal amount of such notes, plus accrued and unpaid interest. The Senior Credit Facility (note 10b)) restricts Publishing's ability to repurchase these notes even when Publishing may be required to do so under the terms of the Indenture relating to the 9% Senior Notes in connection with a change of control. On January 22, 2003 and February 6, 2003, Publishing entered into interest rate swaps to convert US$150.0 million and US$100.0 million, respectively, of the 9% Senior Notes issued in December 2002 to floating rates for the period to December 15, 2010, subject to early termination notice. The Trust Indenture in respect of the 9% Senior Notes contains customary covenants and events of default, which are comparable to those under the Senior Credit Facility. b) On December 23, 2002, Publishing and certain of its subsidiaries entered into a senior credit facility with an aggregate commitment of US$310,000,000 (the "Senior Credit Facility"). The Senior Credit Facility consists of i) US$45,000,000 revolving credit facility which matures on September 30, 2008 (the "Revolving Credit Facility"), ii) a US$45,000,000 Term Loan A which matures on September 30, 2008 ("Term Loan A") and iii) a US$220,000,000 Term Loan B which matures on September 30, 2009 ('Term Loan B'). Publishing and Telegraph are the borrowers under the Revolving Credit Facility and First DT Holdings Ltd. ("FDTH"), a wholly owned indirect U.K. subsidiary) is the borrower under Term Loan A and Term Loan B. The Revolving Credit Facility and Term Loans bear interest at either the Base Rate (U.S.) or U.S. LIBOR, plus an applicable margin. Interest is payable quarterly. At December 31, 2002, FDTH had a total US$265,000,000 of borrowings outstanding under Term Loan A and Term Loan B. On December 27, 2002, a United Kingdom subsidiary of the Company entered into two cross-currency rate swap transactions to hedge principal and interest payments on U.S. dollar borrowings under the December 23, 2002 Senior Credit Facility. The contracts have a total foreign currency obligation notional value of US$265.0 million, fixed at a rate of US$1.5922 to L1, convert the interest rate on such borrowing from floating to fixed, and expire as to US$45.0 million on December 29, 2008 and as to US$220.0 million on December 29, 2009. Publishing's borrowings under the Senior Credit Facility are guaranteed by Publishing's material U.S. subsidiaries, while FDTH's and Telegraph's borrowings under the Senior Credit Facility are guaranteed by Publishing and its material U.S. and U.K. subsidiaries. Hollinger International is also a guarantor of the Senior Credit Facility. Publishing's borrowings under the Senior Credit Facility are secured by substantially all of the assets of Publishing and its material U.S. subsidiaries, a pledge of all of the capital stock of Publishing and its material U.S. subsidiaries and a pledge of 65% of the capital stock of certain foreign subsidiaries. FDTH's and Telegraph's borrowings under the Senior Credit Facility are secured by substantially all of the assets of Publishing and its material U.S. and U.K. subsidiaries and a pledge of all of the capital stock of Publishing and its material U.S. and F-26 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) U.K. subsidiaries. Hollinger International's assets in Canada have not been pledged as security under the Senior Credit Facility. The Senior Credit Facility agreement requires Publishing to comply with certain covenants which include, without limitation and subject to certain exceptions, restrictions on additional indebtedness; liens, certain types of payments (including without limitation, capital stock dividends and redemptions, payments on existing indebtedness and intercompany indebtedness), and on incurring or guaranteeing debt of an affiliate, making certain investments and paying management fees; mergers, consolidations, sales and acquisitions; transactions with affiliates; conduct of business except as permitted; sale and leaseback transactions; changing fiscal year; changes to holding company status; creating or allowing restrictions on taking action under the Senior Credit Facility loan documentation; and entering into operating leases, subject to certain basket calculations and exceptions. The Senior Credit Facility loan agreement also contains customary events of default. As of December 31, 2002, Hollinger International's aggregate annual rental payments under operating leases exceeded the amounts permitted under the covenants to the Senior Credit Facility. Hollinger International has been advised by the Administrative Agent of the Senior Credit Facility that the lenders have agreed to amend the Senior Credit Facility effective March 28, 2003, to increase the amount permitted under the operating lease covenant and have agreed to a waiver of any default or event of default in connection therewith. Based on the amended covenant, Hollinger International would have been in compliance as of December 31, 2002. c) On February 14, 2002, Publishing commenced a cash tender offer for any and all of its outstanding 8.625% Senior Notes due 2005. The tender offer was made upon the terms and conditions set forth in the Offer to Purchase and Consent Solicitation Statement dated February 14, 2002. Under the terms of the offer, Hollinger International offered to purchase the outstanding notes at a price to be determined three business days prior to the expiration date of the tender offer by reference to a fixed spread of 87.5 basis points over the yield to maturity of the 7.50% U.S. Treasury Notes due February 15, 2005, plus accrued and unpaid interest up to, but not including the day of payment for the notes. The purchase price totalled US$1,101.34 for each US$1,000 principal amount of notes. Included in the purchase price was a consent payment equal to US$40 per US$1,000 principal amount of the notes, payable to those holders who validly consented to the proposed amendments to the indenture governing the notes. In connection with the tender offer, Publishing solicited consents from the holders of the notes to amend the Indenture governing the notes by eliminating most of the restrictive provisions. On March 15, 2002, $397.2 million (US$248.9 million) in the aggregate principal amount had been validly tendered pursuant to the offer and on March 18, 2002, these noteholders were paid out in full. In addition, during the year, Publishing purchased for retirement an additional $9.6 million (US$6.0 million) in aggregate principal amount of the 8.625% Senior Notes due 2005. During 2002, Publishing purchased for retirement $16.1 million (US$10.1 million) in aggregate principal amount of the 9.25% Senior Subordinated Notes due 2006 and $39.9 million (US$25.0 million) in the aggregate principal amount of its 9.25% Senior Subordinated Notes due 2007. The total principal amount of the above Publishing Senior and Senior Subordinated Notes retired during 2002 was $462.8 million (US$290.0 million). The premiums paid to retire the debt totalled $43.0 million which, together with a write-off of $13.3 million of related deferred financing costs, have been presented as an unusual item (note 17). F-27 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) As at December 31, 2001, Hollinger International did not meet a financial test set out in the Trust Indentures for Publishing's Senior Notes due 2005 and Senior Subordinated Notes. As a result, Publishing and its subsidiaries were unable to incur additional indebtedness, make restricted investments, make advances, pay dividends or make other distributions on their capital stock. d) In October 2002, Hollinger International borrowed on an unsecured basis $79,600,000 (US$50,000,000) at 10.5% under a term facility maturing December 31, 2003. Proceeds from Publishing's aforementioned Senior Credit Facility and the issue of 9% Senior Notes were used, in part, to repay these borrowings in December 2002. e) Amounts borrowed under a former short-term credit facility of $191,100,000 (US$120,000,000) entered into by Hollinger International in 2001 were repaid during that year. f) In June 2000, Publishing, HCPH, Telegraph, Southam, HIF Corp., a wholly owned subsidiary of Publishing, and a group of financial institutions increased the term loan component of the Fourth Amended and Restated Credit Facility ("Restated Credit Facility") by US$100,000,000 to US$975,000,000. On November 16, 2000, using the proceeds from the CanWest transaction (note 4(g)) US$972,000,000 of borrowings were repaid and the Restated Credit Facility was reduced to US$5,000,000. The Restated Credit Facility was secured by the collateralization of US$5,000,000 of Hollinger International's positive cash balance (note 3). At December 31, 2001, no amounts were owing under the Restated Credit Facility. During 2002, the Restated Credit Facility was terminated. g) Principal amounts payable on long-term debt, excluding obligations under capital leases, for each of the five years subsequent to December 31, 2002 are as follows: 2003 (including the extinguishment of Senior Subordinated Notes).................................................... $802,637 2004........................................................ $ 20,268 2005........................................................ $ 27,776 2006........................................................ $ 22,109 2007........................................................ $ 23,103 Subsequent.................................................. $827,841
h) Minimum lease commitments, together with the present value of obligations under capital leases, are as follows: 2003........................................................ $ 15,044 2004........................................................ 12,245 2005........................................................ 9,454 2006........................................................ 9,084 2007........................................................ 6,379 Subsequent.................................................. 28,913 -------- Total future minimum lease payments......................... 81,119 Less imputed interest and executory costs................... (15,532) -------- Present value of minimum lease payments discounted at an average rate of 6.9%...................................... 65,587 Less current portion included in current liabilities........ (11,914) -------- $ 53,673 ========
F-28 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 11. RETRACTABLE PREFERENCE SHARES
2001 2002 -------- -------- 4,580,979 Series II preference shares (2001 -- 5,366,979)... $ 46,000 $ 33,827 10,147,225 Series III preference shares 2001 -- 10,147,225)............................................... 101,472 101,472 -------- -------- $147,472 $135,299 ======== ========
HCPH SPECIAL SERIES II SERIES III SHARES TOTAL --------- ---------- -------- --------- Balance, January 1, 2000.................. $129,168 $104,622 $ 51,421 $ 285,211 Redeemed/retracted........................ (69,502) (3,150) (54,482) (127,134) Accretion................................. -- -- 3,061 3,061 Unrealized loss........................... 28,815 -- -- 28,815 -------- -------- -------- --------- Balance, January 1, 2001.................. 88,481 101,472 -- 189,953 Redeemed/retracted........................ (27,135) -- -- (27,135) Unrealized gain........................... (15,346) -- -- (15,346) -------- -------- -------- --------- Balance, December 31, 2001................ 46,000 101,472 -- 147,472 Redeemed/retracted........................ (7,860) -- -- (7,860) Unrealized gain........................... (4,313) -- -- (4,313) -------- -------- -------- --------- Balance, December 31, 2002................ $ 33,827 $101,472 $ -- $ 135,299 ======== ======== ======== =========
a) The Series II preference shares are exchangeable non-voting preference shares issued at $10.00 per share. On May 12, 1999, the Series II preference shares became redeemable at the holder's option for 0.46 of a share of Class A common stock of Hollinger International for each Series II preference share. The Company has the option to make a cash payment of equivalent value on the redemption of any of the Series II preference shares. Each Series II preference share entitles the holder to a dividend equal to the amount of any dividend on 0.46 of a share of Class A common stock of Hollinger International (less any U.S. withholding tax thereon payable by the Company or any subsidiary). In 2002, these retractable preference shares are included in current liabilities since they are retractable at any time at the option of the holder. During 2002, 750,000 Series II preference shares were retracted in exchange for 345,000 shares of Hollinger International Class A common stock which, together with the Hollinger International share sale described in note 4a), resulted in a gain on effective sale of Hollinger International shares of $20,103,000 (note 17). In addition, 36,000 Series II preference shares were retracted for the cash equivalent value of 0.46 of a Class A common share of Hollinger International at the time of retraction, which totalled $277,000. During 2001, 2,685,465 Series II preference shares were retracted in exchange for 1,235,312 of shares of Hollinger International Class A common stock which, together with the retraction of retractable common shares in exchange for shares of Hollinger International Class A common stock (note 13d)) and Hollinger International share redemptions and sales described in note 4e), resulted in a gain on effective sale of Hollinger International shares of $59,449,000 (note 17). In addition, 28,038 Series II preference shares were retracted for the cash equivalent value of 0.46 of a share of Class A common stock of Hollinger International at the time of retraction, which totalled $317,000. During 2000, a total of 6,710,817 Series II preference shares were retracted in exchange for 3,086,971 shares of Hollinger International Class A common stock which, together with the F-29 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) retraction of retractable common shares in exchange for shares of Hollinger International common stock (note 13e)), resulted in a gain on effective sale of Hollinger International shares of $28,450,000 (note 17). In addition, 239,435 Series II preference shares were retracted for the cash equivalent value of 0.46 of a share of Class A common stock of Hollinger International at the time of retraction, which totalled $2,385,000. The Series II preference shares represent a financial liability and are recorded in the accounts at their fair value, being the market value of the shares of Class A common stock of Hollinger International for which they are exchangeable. At December 31, 2002, the market value of the shares of Class A common stock of Hollinger International into which the 4,580,979 Series II preference shares were exchangeable was $33,827,000 or $11,983,000 less than the issue price. At December 31, 2001, the market value of the shares of Class A common stock of Hollinger International into which the 5,366,979 Series II preference shares are exchangeable was $46,000,000 or $7,670,000 less than issue price. As at December 31, 2002, the cumulative deferred unrealized gains of $11,983,000 have been deferred as the Series II preference shares are hedged by the Company's investment in shares of Hollinger International Class A common stock, which it intends to deliver in future Series II preference share retractions, if any. Delivery of shares of Hollinger International Class A common stock on such retractions would result in a dilution gain to the Company which would be included in unusual items. b) The Series III preference shares provide for a mandatory redemption on the fifth anniversary of issue being April 30, 2004 for $10.00 cash per share (plus unpaid dividends) and an annual cumulative dividend, payable quarterly, of $0.70 per share per annum (or 7%) during the five-year term. The Company has the right at its option to redeem all or any part of the Series III preference shares at any time after April 30, 2002, for $10.00 cash per share (plus unpaid dividends). Holders have the right at any time to retract Series III preference shares for a retraction price payable in cash which, until April 30, 2003, fluctuates by reference to two benchmark Government of Canada bonds having a comparable yield and term to the Series III preference shares, and during the year ending April 30, 2004, the retraction price will be $9.50 per share (plus unpaid dividends in each case). During 2000, 315,000 Series III preference shares were retracted for cash of $2,748,000. The resulting gain of $402,000 was included in unusual items (note 17). c) Certain of the HCPH Special shares, issued in 1997, represented a financial liability of the Company which was hedged by the Company's investment in shares of Class A common stock of Hollinger International. In June 2000, the Company exercised its option to pay cash on the mandatory exchange of these Special shares in the amount of US$36.8 million. The previously deferred foreign exchange loss arising from translating the U.S. dollar obligation was written off to unusual items (note 17). In addition, in connection with the acquisition of Southam shares in 1997, HCPH issued 6,552,425 Special shares valued at $10.00 per share at the time of issue. In accordance with the terms of these shares, Hollinger International was required to deliver cash or common shares of Hollinger International upon the exchange of the Special shares and accordingly, they did not represent a financial liability of the Company and were presented as minority interest. These shares were exchangeable at the option of the holder at any time prior to June 26, 2000, into newly issued Class A subordinate voting shares of Hollinger International. On June 12, 2000, Hollinger International exercised its option to pay cash on the mandatory exchange of the HCPH Special shares. Pursuant to the terms of the indenture governing the Special shares, each Special share was F-30 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) exchanged for cash of US$8.88 resulting in a payment to Special shareholders by Hollinger International of US$58.2 million. 12. OTHER LIABILITIES AND DEFERRED CREDITS
2001 2002 -------- -------- Deferred gains.............................................. $ 3,189 $ 2,536 Pension obligations (note 22)............................... 8,182 12,863 Accrued post-retirement cost (note 22)...................... 62,092 60,506 Other benefit obligations................................... 35,607 18,824 Liability for amounts due to Participation Trust (notes 5a) and 24d))................................................. 691 21,444 Liability for cross currency swap (note 24d))............... -- 14,475 -------- -------- $109,761 $130,648 ======== ========
Deferred gains represent a lease inducement, which is being recognized in income over the term of the lease, and a portion of the gain arising on the Telegraph's transfer of certain equipment to the Trafford Park joint venture, which is being recognized in income as the assets are depreciated and/or sold by the joint venture. 13. CAPITAL STOCK
2001 2002 -------- -------- AUTHORIZED Unlimited number of retractable common shares and an unlimited number of preference shares ISSUED AND FULLY PAID PREFERENCE SHARES 4,580,979 Series II (2001 -- 5,366,979) (note 11)......... $ -- $ -- 10,147,225 Series III (2001 -- 10,147,225) (note 11)...... -- -- RETRACTABLE COMMON SHARES 32,352,047 (2001 -- 32,068,937)........................... 271,774 273,759 -------- -------- $271,774 $273,759 ======== ========
a) The retractable common shares have terms equivalent to common shares, except that they are retractable at any time by the holder for their retraction price, which is fixed from time to time, in exchange for the Company's shares of Hollinger International Class A common stock of equivalent value or, at the Company's option, cash. The retraction price each quarter (or, in certain specific cases more frequently) is between 90% and 100% of the Company's current value, as determined by the Retraction Price Committee in accordance with the share conditions. b) During 2002, 141,000 and 1,148 retractable common shares were retracted for cash of $7.50 per share and $5.50 per share, respectively. The total retractions in 2002 of 142,148 retractable common shares resulted in a gain on retraction of $141,000, which has been included in the consolidated statements of deficit. c) In December 2002, the Company paid a stock dividend of 10 cents per retractable common share, resulting in 425,258 retractable common shares being issued for $3,189,000 with a corresponding amount booked to dividends paid. F-31 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) d) During 2001, 20,015 retractable common shares were retracted for cash amounts ranging between $8.00 and $14.50 per share for total cash consideration of $273,000. In addition, a further 1,809,500 and 2,476,035 retractable common shares were retracted for $14.50 and $13.00 per share, respectively, and were settled with the delivery of an aggregate of 2,570,002 shares of Hollinger International Class A common stock. This, together with the retraction of Series II preference shares for Hollinger International Class A common stock (note 11a)) and the Hollinger International share redemptions and sales described in note 4e), resulted in a gain on effective sale of the Hollinger International shares of $59,449,000 (note 17). The total retractions in 2001 of 4,305,550 retractable common shares resulted in a premium on retraction of $22,211,000, which has been charged to deficit. e) During 2000, 13,210 and 33,918 retractable common shares were retracted for cash of $10.00 per share and $16.75 per share, respectively. In addition, a further 51,100 and 723,700 retractable common shares were retracted for $11.50 and $16.75, respectively, and were settled with the delivery of 554,927 shares of Hollinger International Class A common stock. This, together with the retraction of Series II preference shares for Hollinger International shares (note 11a)), resulted in a gain on effective sale of the Hollinger International shares of $28,450,000 (note 17). The total retractions in 2000 of 821,928 retractable common shares resulted in premium on retraction of $6,448,000 which has been charged to deficit. f) The Company and certain of its subsidiaries have stock option plans for their employees. i) Details of the Hollinger Inc. stock option plan are as follows: The Company has one Executive Share Option Plan ("Plan"), under which the Company may grant options to certain key executives of the Company, its subsidiary or affiliated companies or its parent company, for up to 5,560,000 retractable common shares. These options give the holder the right to purchase, subject to the executives' entitlement to exercise, one retractable common share of the Company for each option held. The options are exercisable to the extent of 25% thereof at the end of each of the first through fourth years following granting, on a cumulative basis. Options expire six years after the date of grant. Unexercised options expire one month following the date of termination of the executives' employment, except in the case of retirement at normal retirement age, death or certain offers made to all or substantially all of the holders of retractable common shares of the Company, in which events, all unexercised options become exercisable in full. Stock option activity with respect to the Company's stock options is as follows
NUMBER OF EXERCISE SHARES PRICE ------- -------- Options outstanding as at December 31, 1999, 2000 and 2001.................................................... 928,000 $13.72 Options expired in 2002................................... (15,000) 13.72 ------- ------ Options outstanding as at December 31, 2002............... 913,000 $13.72 ======= ====== Options exercisable at December 31, 2000.................. 464,000 $13.72 ======= ====== Options exercisable at December 31, 2001.................. 696,000 $13.72 ======= ====== Options exercisable at December 31, 2002.................. 913,000 $13.72 ======= ======
Options outstanding at December 31, 2000, 2001 and 2002 had a remaining contractual life of four, three and two years, respectively. F-32 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) ii) Details of Hollinger International's stock option plan are as follows: Hollinger International's Incentive Plan is administered by its independent committee ("Committee") of its Board of Directors. The Committee has the authority to determine the employees to whom awards will be made, the amount and type of awards, and the other terms and conditions of the awards. In 1999, the Company adopted the 1999 Stock Incentive Plan ("1999 Stock Plan") which superseded its previous two plans. The 1999 Stock Plan authorizes the grant of incentive stock options and nonqualified stock options. The exercise price for stock options must be at least equal to 100% of the fair market value of the shares of Hollinger International Class A common stock on the date of grant of such option. Under Section 3870, stock options granted to employees of Ravelston, the parent company of the Company, must be measured at fair value and recorded as a dividend-in-kind by Hollinger International. On February 5, 2002, Hollinger International granted 1,309,000 stock options to employees of Ravelston with an exercise price of US$11.13 per share. The aggregate fair value of these options was $9,594,000 (US$6,111,000) and this has been recorded by Hollinger International as an in-kind dividend (with no impact on the accounts of the Company) during the year. On April 2, 2001, Hollinger International granted 1,402,500 stock options to employees of Ravelston with an exercise price of US$14.37 per share. The aggregate fair value of these options was $12,090,000 (US$7,800,000) and was recorded by Hollinger International as an in-kind dividend in 2001. For all other series of stock options, no compensation cost has been recognized by Hollinger International. Stock option activity with respect to Hollinger International's stock options is as follows:
NUMBER WEIGHTED OF AVERAGE SHARES EXERCISE PRICE ---------- -------------- (IN US$) Options outstanding at December 31, 1999............ 5,149,500 $11.88 Options granted..................................... 2,559,250 10.57 Options exercised................................... (471,063) 11.67 Options cancelled................................... (536,374) 12.11 ---------- ------ Options outstanding at December 31, 2000............ 6,701,313 11.38 Options granted..................................... 2,418,000 14.40 Options exercised................................... (624,162) 11.01 Options cancelled................................... (82,750) 12.33 ---------- ------ Options outstanding at December 31, 2001............ 8,412,401 12.26 Options granted..................................... 2,227,000 11.14 Options exercised................................... (75,375) 10.81 Options cancelled................................... (168,688) 12.64 ---------- ------ Options outstanding at December 31, 2002............ 10,395,338 $12.03 ========== ====== Options exercisable at December 31, 2000............ 1,989,548 $11.51 ========== ====== Options exercisable at December 31, 2001............ 3,032,682 $11.48 ========== ====== Options exercisable at December 31, 2002............ 4,739,994 $11.85 ========== ======
F-33 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) iii) Had the Company determined compensation expense based on the fair value method at the grant date for stock options granted to employees, consistent with the method prescribed under Section 3870, the Company's net earnings (loss) for the year and the earnings (loss) per share would have been reported as the pro forma amounts indicated below. This compensation expense takes into account all options granted by the Company and Hollinger International, including those granted prior to January 1, 2002. The fair value of the options is amortized over the vesting period.
2000 2001 2002 -------- --------- -------- Net earnings (loss), as reported............ $189,373 $(131,898) $(88,640) Stock-based compensation expense -- Hollinger Inc............................. (478) (239) (72) Stock-based compensation expense -- Hollinger International Inc............... (4,712) (4,711) (3,985) -------- --------- -------- Pro forma net earnings (loss)............... $184,183 $(136,848) $(92,697) ======== ========= ======== Net earnings (loss) per share: As reported............................... $ 5.11 $ (3.91) $ (2.76) Effect of stock-based compensation expense................................ (0.14) (0.15) (0.13) -------- --------- -------- Pro forma basic net earnings (loss) per share..................................... $ 4.97 $ (4.06) $ (2.89) ======== ========= ======== Diluted net earnings (loss) per share, as reported.................................. $ 5.05 $ (4.17) $ (2.79) Pro forma diluted net earnings (loss) per share..................................... $ 4.91 $ (4.32) $ (2.92) ======== ========= ========
The fair value of each Hollinger International stock option granted during 2000, 2001 and 2002 was estimated on the date of grant for pro forma disclosure purposes using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in fiscal 2000, 2001 and 2002, respectively: dividend yield of 3.4%, 4.6% and 3.6%, expected volatility of 43.3%, 55.2% and 68.3%, risk-free interest rates of 5.1%, 5.0% and 4.5% and expected lives of 10 years. Weighted average fair value of options granted by Hollinger International during 2000, 2001 and 2002 was $6.12 (US$4.12), $8.79 (US$5.67) and $8.87 (US$5.65), respectively. 14. EQUITY ADJUSTMENT FROM FOREIGN CURRENCY TRANSLATION As described in note 1 under "Foreign currency translation", this amount results principally from the accounting treatment for self-sustaining foreign subsidiaries. The change in the amount from December 31, 2001 to December 31, 2002 primarily reflects the weakening of the Canadian dollar against the British pound partly offset by the strengthening of the Canadian dollar against the U.S. dollar and the recognition in unusual items (note 17) of a realized foreign exchange gain arising on the reduction of net investments in foreign subsidiaries. The amount at December 31, 2002 is unrealized and bears no relationship to the underlying value of the Company's investment in foreign subsidiaries. F-34 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 15. COMMITMENTS a) Future minimum lease payments subsequent to December 31, 2002 under operating leases are as follows: 2003........................................................ $ 27,095 2004........................................................ $ 23,976 2005........................................................ $ 21,614 2006........................................................ $ 18,229 2007........................................................ $ 16,896 2008 and subsequent......................................... $149,441
b) In connection with certain of its cost and equity investments (note 5), Hollinger International and its subsidiaries are committed to fund approximately $1.9 million to those investees in 2003. 16. CONTINGENCIES a) The Telegraph has guaranteed to third parties, the joint venture partners' share of operating lease obligations of both the West Ferry and Trafford Park joint ventures, which amounted to $948,000 (L372,000) at December 31, 2002. These obligations are also guaranteed jointly and severally by each joint venture partner. b) In connection with the Company's insurance program, letters of credit are required to support certain projected workers' compensation obligations. At December 31, 2002, letters of credit in the amount of $4,384,500 were outstanding. c) A number of libel and legal actions against the Company and its subsidiaries are outstanding. The Company believes there are valid defences to these proceedings or sufficient insurance to protect it from material loss. d) In special circumstances, the Company's newspaper operations may engage freelance reporters to cover stories in locales that carry a high risk of personal injury or death. Subsequent to December 31, 2002, the Telegraph has engaged a number of journalists and photographers to report from the Middle East. As a term of their engagement, the Telegraph has agreed to provide a death benefit which, in the aggregate for all freelancers engaged, amounts to $13,100,000 (L5,153,000). This exposure is uninsured. Precautions have been taken to avoid a concentration of the journalists and photographers in any one location. The uninsured exposure was reduced to $3,820,000 (L2,600,000) as of March 31, 2003. F-35 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 17. UNUSUAL ITEMS
2000 2001 2002 -------- --------- -------- Net gain on dilution of investments......................... $ 25,775 $ -- $ -- Gain (loss) on sale of investments.......................... 47,921 (240,060) -- Gain on sales of interest in Hollinger International (notes 4a), 4e), 11a) and 13d)).................................. 28,450 59,449 20,103 Net gain (loss) on sales of Publishing interests............ 697,871 (22,963) -- Loss on retirement of Senior Notes (note 10c)).............. -- -- (56,287) New Chicago plant pre-operating costs....................... (10,097) (7,237) (661) Write-off of financing fees................................. (16,088) -- -- Write-off of investments.................................... (31,381) (79,943) (63,609) Decrease in pension valuation allowance (note 22)........... -- 58,704 34,402 Realized loss on Total Return Equity Swap (note 24b))....... -- (29,646) (43,313) Pension and post-retirement plan liability adjustment....... -- (16,823) -- Net foreign exchange gain on reduction of net investment in foreign subsidiaries...................................... -- -- 44,548 Other income (expense), net................................. (41,506) (16,915) 2,187 -------- --------- -------- $700,945 $(295,434) $(62,630) ======== ========= ========
The income tax expense related to unusual items amounted to $229,812,000 in 2000, and an income tax recovery of $76,849,000 and $8,043,000 in 2001 and 2002, respectively. The minority interest expense in unusual items after income taxes amounted to $251,628,000 in 2000, and a minority interest recovery of $144,634,000 and $48,570,000 in 2001 and 2002, respectively, resulting in net earnings (loss) from unusual items after income taxes and minority interest of $219,505,000, ($73,951,000) and ($6,017,000) in 2000, 2001 and 2002, respectively. 18. INCOME TAXES Income tax expense (recovery) attributable to income from continuing operations consists of:
2000 2001 2002 -------- --------- -------- Current............................................. $617,694 $ 56,304 $ (2,615) Future.............................................. (357,603) (145,781) 126,640 -------- --------- -------- $260,091 $ (89,477) $124,025 ======== ========= ========
F-36 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The income tax expense (recovery) in the consolidated statements of earnings varies from the amount that would be computed by applying the basic federal and provincial income tax rates to loss before income taxes and minority interest as shown in the following table:
2000 2001 2002 -------- --------- -------- Earnings (loss) before income taxes and minority interest.......................................... $780,522 $(454,883) $(89,511) ======== ========= ======== Basic income tax rate............................... 43.95% 41.75% 41.00% ======== ========= ======== Computed income tax expense (recovery).............. $343,039 $(189,914) $(36,700) Decrease (increase) in income tax expenses (recovery) resulting from: Different tax rate on earnings of subsidiaries................................. (83,949) 22,075 17,834 Tax gain in excess of book gain................ (244,030) 24,293 949 Potential tax benefit of current year's losses not recorded................................. 29,255 -- -- Large Corporations Tax......................... 15,531 940 1,079 Loss on Total Return Equity Swap............... -- 12,377 17,758 Change in valuation allowance.................. -- 42,841 74,043 Minority interest in earnings of Hollinger L.P.......................................... (26,669) (2,001) (1,214) Permanent differences.......................... 226,914 (88) 50,276 -------- --------- -------- Income tax expense (recovery)....................... $260,091 $ (89,477) $124,025 ======== ========= ======== Effective tax rate.................................. 33.32% 19.67% 138.56% ======== ========= ========
The Company's Canadian subsidiaries have operating losses carried forward for tax purposes of approximately $76,892,000, the tax benefit of which has not been reflected in the accounts. These losses expire as follows: 2004........................................................ $ 5 2005........................................................ 586 2006........................................................ 7,452 2007........................................................ 3,365 2008........................................................ 40,112 2009........................................................ 25,372 ------- $76,892 =======
The Company has recorded a valuation allowance of $74,043,000 in the current year related to net operating loss carryforwards and other deferred tax assets in the Canadian group. The valuation allowance in the prior year related entirely to net operating losses of N.P. Holdings Company, a subsidiary of the Company. As described in note 23c), this subsidiary was sold to an affiliate during the year. The tax losses were sold at their carrying value. F-37 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The tax effects of temporary differences that give rise to significant portions of the future tax assets and future tax liabilities are presented below:
2001 2002 --------- --------- Future tax assets: Net operating loss carryforwards.......................... $ 127,753 $ 37,283 Compensation and accrued pension.......................... 7,459 6,952 Investments............................................... 20,717 51,676 Post-retirement benefit obligations....................... 28,044 28,050 Other..................................................... 86,046 30,933 --------- --------- Gross future tax assets..................................... 270,019 154,894 Less valuation allowance.................................... (28,539) (74,043) --------- --------- Net future tax assets....................................... 241,480 80,851 --------- --------- Future tax liabilities: Property, plant and equipment, principally due to differences in depreciation............................ 94,037 107,671 Intangible assets, principally due to differences in basis and amortization....................................... 469,564 189,365 Pension assets............................................ 7,746 47,266 Long-term advances under joint venture printing contract............................................... 20,801 20,290 Deferred gain on exchange of assets....................... 56,009 40,342 Other..................................................... 80,260 51,396 --------- --------- Gross future tax liabilities................................ 728,417 456,330 --------- --------- Future income tax liabilities............................... $(486,937) $(375,479) ========= =========
19. LOSS AND CASH FLOWS PER RETRACTABLE COMMON SHARE The following tables reconcile the numerator and denominator for the calculation of basic and diluted loss per share for the years ended December 31, 2000, 2001 and 2002:
YEAR ENDED DECEMBER 31, 2000 --------------------------------------- INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Basic EPS Net earnings available to common shareholders.... $189,373 37,041 $5.11 Effect of dilutive securities Stock options of subsidiary.................... (2,161) -- (0.06) -------- ------ ----- Diluted EPS Net earnings available to common shareholders.... $187,212 37,041 $5.05 ======== ====== =====
F-38 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED)
YEAR ENDED DECEMBER 31, 2001 --------------------------------------- INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Basic EPS Net loss available to common shareholders........ $(131,898) 33,740 $(3.91) Effect of dilutive securities Stock options of subsidiary.................... (8,651) -- (0.26) --------- ------ ------ Diluted EPS Net loss available to common shareholders........ $(140,549) 33,740 $(4.17) ========= ====== ======
YEAR ENDED DECEMBER 31, 2002 --------------------------------------- INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Basic EPS Net loss available to common shareholders........ $(88,640) 32,064 $(2.76) Effect of dilutive securities Stock options of subsidiary.................... (885) -- (0.03) -------- ------ ------ Diluted EPS Net loss available to common shareholders........ $(89,525) 32,064 $(2.79) ======== ====== ======
For 2000, 2001 and 2002, the effect of potentially dilutive options of the Company were excluded from the computation of diluted loss per share as their effect is anti-dilutive.
YEAR ENDED DECEMBER 31 ---------------------- 2000 2001 2002 ----- ------ ----- Cash flows provided by (used for) operations per retractable common share Basic..................................................... $4.15 $(3.56) $1.86 Diluted................................................... $4.09 $(3.82) $1.83
Cash flows provided by (used for) operations per retractable common share is based on the cash flows provided by (used for) operations as computed in note 20. Diluted cash flows provided by (used for) operations utilize the effect of dilutive securities on income, as disclosed in note 19. Cash flows provided by (used for) operations per retractable common share calculations utilize the weighted average number of retractable common shares outstanding during the year of 37,040,670, 33,740,182 and 32,064,151, in 2000, 2001 and 2002, respectively. F-39 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 20. CASH FLOWS a) Cash flows provided by (used for) operations is before any increase or decrease in non-cash operating working capital and other costs. These items are included in the consolidated statements of cash flows. Cash flows provided by (used for) operations is determined as follows:
2000 2001 2002 -------- --------- -------- Net earnings (loss)................................. $189,373 $(131,898) $(88,640) Unusual items (note 17)............................. (700,945) 295,434 62,630 Current income taxes related to unusual items....... 459,831 (15,155) 149 Items not involving cash: Depreciation and amortization..................... 219,932 144,716 88,193 Amortization of deferred financing costs.......... 18,504 18,648 11,347 Future income taxes............................... (357,603) (145,781) 126,640 Minority interest................................. 307,079 (249,439) (131,187) Net earnings in equity-accounted companies, net of dividends received............................. 14,115 36,789 1,233 Non-cash interest income on CanWest debentures.... 11,463 (67,517) (9,239) Miscellaneous..................................... (8,170) (6,008) (1,498) -------- --------- -------- $153,579 $(120,211) $ 59,628 ======== ========= ========
b) The change in non-cash operating working capital is determined as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 2000 2001 2002 --------- -------- -------- Changes in current assets and current liabilities, net of acquisitions and dispositions: Accounts receivable............................... $ (77,880) $ 23,666 $ 1,061 Inventory......................................... (11,152) (3,886) 14,704 Prepaid expenses.................................. 903 (2,594) (4,337) Amounts due to related parties.................... (5,897) -- 14,775 Accounts payable and accrued expenses............. (38,678) 55,373 (26,223) Income taxes payable.............................. 53,466 (77,980) 31,821 Deferred revenue.................................. (933) (11,726) (1,307) Bank indebtedness................................. 10,340 (150,813) 1,094 Other............................................. (12,625) 23,531 9,740 --------- -------- -------- $ (82,456) $(144,429) $ 41,328 ========= ======== ========
21. SEGMENTED INFORMATION The Company operates principally in the business of publishing, printing and distribution of newspapers and magazines and holds investments principally in companies which operate in the same business as the Company. Other investments held by the Company either do not represent a business segment or are not sufficiently significant to warrant classification as a separate segment and are included within Corporate and Other. HCPH Co., Hollinger L.P. and, until August 31, 2001, National Post make up the Canadian Newspaper Group. The U.S. Community Group includes the results of the Jerusalem Post and the last remaining U.S. Community paper until it was sold in August 2001. The following is a summary of the reportable segments of the Company. F-40 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED)
UNITED STATES -------------------- U.K. CANADIAN YEAR ENDED CHICAGO COMMUNITY NEWSPAPER NEWSPAPER CORPORATE CONSOLIDATED DECEMBER 31, 2000 GROUP GROUP GROUP GROUP AND OTHER TOTAL ----------------- -------- --------- --------- ---------- --------- ------------ Sales revenue............. $596,759 $100,104 $882,196 $1,579,200 $ 21 $3,158,280 Cost of sales and expenses................ 504,079 85,702 684,900 1,294,975 16,527 2,586,183 -------- -------- -------- ---------- -------- ---------- Sales revenue less cost of sales and expenses...... 92,680 14,402 197,296 284,225 (16,506) 572,097 Depreciation and amortization............ 37,328 7,653 58,148 110,112 6,691 219,932 -------- -------- -------- ---------- -------- ---------- Operating income (loss)... $ 55,352 $ 6,749 $139,148 $ 174,113 $(23,197) $ 352,165 ======== ======== ======== ========== ======== ========== Expenditures on capital assets.................. $ 38,177 $ 5,038 $ 24,039 $ 42,812 $ 2,595 $ 112,661 ======== ======== ======== ========== ======== ==========
UNITED STATES -------------------- U.K. CANADIAN YEAR ENDED CHICAGO COMMUNITY NEWSPAPER NEWSPAPER CORPORATE CONSOLIDATED DECEMBER 31, 2001 GROUP GROUP GROUP GROUP AND OTHER TOTAL ----------------- -------- --------- ---------- --------- --------- ------------ Sales revenue............. $686,266 $29,619 $ 801,053 $305,073 $ 49 $1,822,060 Cost of sales and expenses................ 622,974 31,950 703,296 337,383 34,505 1,730,108 -------- ------- ---------- -------- -------- ---------- Sales revenue less cost of sales and expenses...... 63,292 (2,331) 97,757 (32,310) (34,456) 91,952 Depreciation and amortization............ 53,537 2,962 63,855 18,134 6,228 144,716 -------- ------- ---------- -------- -------- ---------- Operating income (loss)... $ 9,755 $(5,293) $ 33,902 $(50,444) $(40,684) $ (52,764) ======== ======= ========== ======== ======== ========== Total assets.............. $973,279 $85,291 $1,257,805 $691,568 $648,173 $3,656,116 ======== ======= ========== ======== ======== ========== Expenditures on capital assets.................. $ 19,343 $ 463 $ 48,788 $ 4,405 $ 18,407 $ 91,406 ======== ======= ========== ======== ======== ==========
UNITED STATES -------------------- U.K. CANADIAN YEAR ENDED CHICAGO COMMUNITY NEWSPAPER NEWSPAPER CORPORATE CONSOLIDATED DECEMBER 31, 2002 GROUP GROUP GROUP GROUP AND OTHER TOTAL ----------------- -------- --------- ---------- --------- ---------- ------------ Sales revenue............ $693,690 $20,781 $ 804,584 $109,121 $ 22 $1,628,198 Cost of sales and expenses............... 591,628 25,259 693,895 112,723 30,389 1,453,894 -------- ------- ---------- -------- ---------- ---------- Sales revenue less cost of sales and expenses............... 102,062 (4,478) 110,689 (3,602) (30,367) 174,304 Depreciation and amortization........... 42,378 3,682 35,939 1,713 4,481 88,193 -------- ------- ---------- -------- ---------- ---------- Operating income (loss)................. $ 59,684 $(8,160) $ 74,750 $ (5,315) $ (34,848) $ 86,111 ======== ======= ========== ======== ========== ========== Total assets............. $895,917 $59,173 $1,120,023 $411,891 $1,152,857 $3,639,861 ======== ======= ========== ======== ========== ========== Expenditures on capital assets................. $ 24,344 $ 7,888 $ 27,680 $ 3,575 $ 116 $ 63,603 ======== ======= ========== ======== ========== ==========
Corporate and Other includes results of miscellaneous operations. 22. EMPLOYEE BENEFIT PLANS DEFINED CONTRIBUTION PENSION PLANS Hollinger International sponsors six defined contribution plans, three of which have provisions for Hollinger International matching contributions. For the years ended December 31, 2000, 2001 and 2002, F-41 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Hollinger International contributed $2,372,000, $2,402,000 and $3,330,000, respectively. Hollinger International sponsors 11 defined contribution plans in Canada and contributed $3,069,000, $261,500 and $241,000 to the plans in 2000, 2001 and 2002, respectively. The Telegraph sponsors a defined contribution plan for the majority of its employees, as well as a defined contribution plan to provide pension benefits for senior executives. For 2000, 2001 and 2002, contributions to the defined contribution plan are included as part of the service cost of the defined benefit plan. For the years ended December 31, 2000, 2001 and 2002, the Telegraph contributed $874,000, $803,000 and $835,000, respectively, to the Telegraph Executive Pension Scheme. The Telegraph plan's assets consist principally of U.K. and overseas equities, unit trusts and bonds. DEFINED BENEFIT PENSION PLANS The Company's subsidiaries have ten foreign and seven domestic single-employer defined benefit plans and contribute to various union-sponsored, collectively bargained multi-employer pension plans. The Company's subsidiaries' contributions to these plans for the years ended December 31, 2000, 2001 and 2002 were:
2000 2001 2002 ------- ------- ------- Single-employer plans................................... $20,010 $15,737 $20,166 ======= ======= ======= Multi-employer plans.................................... $ 9,324 $ 1,938 $ -- ======= ======= =======
The Telegraph has a defined benefit plan that was closed to new participants on July 1, 1991 and provides only benefits accrued up to that date. The liabilities of the plan have been actuarially valued as at December 31, 2002. At that date, the market value of the plan assets was $191,742,000, representing 91% of the estimated cost of purchasing the plan's benefits from an insurance company. The actuary assumed a discount rate of 5.6%. Increases to pension payments are discretionary and are awarded by the trustees, with the Telegraph's consent, from surpluses arising in the fund from time to time. Contributions to the plan were $9,900,000 $10,034,000 and $10,616,000 in 2000, 2001 and 2002, respectively. West Ferry and Trafford Park have defined benefit plans, the West Ferry Printers Pension Scheme and the Trafford Park Printers Pension Scheme, respectively, of which 50%, being the Telegraph's share in the joint venture, of the pension costs and obligations are included in the Company's financial statements. Pursuant to the West Ferry joint venture agreement, the Telegraph has a commitment to fund 50% of the obligation under West Ferry's defined benefit plan. SINGLE-EMPLOYER PENSION PLANS The benefits under the subsidiary companies' single-employer pension plans are based primarily on years of service and compensation levels. These companies fund the annual provisions which are deductible for income tax purposes. The plans' assets consist principally of marketable equity securities and corporate and government debt securities. F-42 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The components of the net period cost (benefit) for the years ended December 31, 2000, 2001 and 2002 are as follows:
2000 2001 2002 -------- -------- -------- Service cost......................................... $ 22,076 $ 15,308 $ 15,930 Interest cost........................................ 64,590 49,433 49,541 Expected return on plan assets....................... (90,011) (56,133) (52,422) Amortization of prior service costs.................. 900 583 782 Settlement and curtailment........................... 6,487 2,272 -- Amortization of net (gain) loss...................... (304) 1,516 6,200 Change in valuation allowance against prepaid benefit cost............................................... 97,258 (59,106) (34,729) -------- -------- -------- Net period cost (benefit)............................ $100,996 $(46,127) $(14,698) ======== ======== ========
The table below sets forth the reconciliation of the benefit obligation as of December 31, 2001 and 2002:
2001 2002 --------- -------- Benefit obligation at the beginning of the year............. $ 864,839 $780,138 Adjustments to opening balance.............................. 7,243 -- Service cost................................................ 15,308 15,930 Interest cost............................................... 49,433 49,541 Participant contributions................................... 9,027 7,539 Divestitures................................................ (122,131) -- Plan amendments............................................. 28 9,629 Settlement gain............................................. (12,973) -- Exchange rate differences................................... 17,860 33,314 Changes in assumptions...................................... -- (1,000) Actuarial loss (gain)....................................... 17,402 (21,064) Benefits paid............................................... (65,898) (69,670) --------- -------- Benefit obligation at the end of the year................... $ 780,138 $804,357 ========= ========
The 2001 settlement gain was related to the sale of Canadian newspapers. The 2000 curtailment and settlement gains were related to the sale of Canadian and Community Group newspapers. The table below sets forth the change in plan assets for the years ended December 31, 2001 and 2002:
2001 2002 --------- -------- Fair value of plan assets at the beginning of the year...... $ 971,208 $757,751 Adjustment to opening balance............................... -- 4,897 Actual return on plan assets................................ (37,943) (67,865) Exchange rate differences................................... 16,969 27,529 Employer contributions...................................... 15,737 20,166 Participant contributions................................... 9,027 7,539 Settlement gain............................................. (15,245) -- Divestitures................................................ (136,104) -- Benefits paid............................................... (65,898) (69,670) --------- -------- Fair value of plan assets at the end of the year............ $ 757,751 $680,347 ========= ========
F-43 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The following table provides the amounts recognized in the consolidated balance sheet as of December 31, 2001 and 2002:
2001 2002 -------- --------- Plan deficit................................................ $(22,387) $(124,010) Unrecognized net actuarial loss............................. 133,110 233,369 Unrecognized prior service cost............................. 3,699 3,039 Unrecognized net transition obligation...................... (331) 2,054 -------- --------- Prepaid benefit cost........................................ 114,091 114,452 Valuation allowance......................................... (38,814) (4,085) -------- --------- Prepaid benefit cost, net of valuation allowance............ $ 75,277 $ 110,367 ======== =========
The above prepaid benefit cost is classified in the consolidated balance sheet as follows:
2001 2002 ------- -------- Deferred pension asset (note 8)............................. $83,459 $123,230 Pension obligations (note 12)............................... (8,182) (12,863) ------- -------- Prepaid benefit cost, net of valuation allowance............ $75,277 $110,367 ======= ========
The ranges of assumptions on the Company's foreign plans were as follows:
2000 2001 2002 ----------- ----------- ------------ Discount rate.............................. 6.0% - 8.0% 6.0% - 8.0% 5.6% - 6.75% Expected return on plan assets............. 6.0% - 9.0% 6.0% - 9.0% 5.6% - 8.25% Compensation increase...................... 3.0% - 3.5% 2.5% - 3.5% 2.5% - 3.30% ----------- ----------- ------------
The ranges of assumptions used for the Company's domestic plans were as follows:
2000 2001 2002 ----------- ----------- ------------ Discount rate.............................. 7.0% 6.5% 7.00% Long-term rate of return on plan assets.... 7.0% - 9.0% 7.0% - 9.0% 6.5% - 7.00% Compensation increase...................... 3.5% - 4.0% 4.0% - 4.5% 4.0% - 4.50% ----------- ----------- ------------
VALUATION ALLOWANCE As a result of the 2000 sale of Canadian newspapers to CanWest, the expected future benefits to be derived from the plan surplus at that time were significantly reduced and a valuation allowance of $97.9 million was provided for. Due to the reduction in the plan surplus in 2001 and 2002 as a result of a decline in the market value of the assets in the plan, the valuation allowance required against the pension asset has been reduced by $58.7 million and $34.4 million, respectively. This change in the valuation allowance, in respect of the HCPH Co. pension plans, has been recognized in income in 2001 and 2002 as an unusual item (note 17). Approval by the various provincial pension regulatory bodies has not yet been granted for the transfer of pension assets related to the operations previously sold. To the extent pension surpluses are required to be transferred for the CanWest properties, the Company is entitled to a cash payment from CanWest for a portion of that amount. The Company anticipates that these transfers will be made in 2003. F-44 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) MULTI-EMPLOYER PENSION PLANS Certain U.S. employees were covered by union-sponsored multi-employer pension plans, all of which are defined benefit plans. Contributions were determined in accordance with the provisions of negotiated labour contracts and are generally based on the number of man-hours worked. Pension expense for these plans was $1,828,000, nil and nil for the years ended December 31, 2000, 2001 and 2002, respectively. The newspaper properties participating in these multi-employer plans were sold in 2000. The passage of the Multi-employer Pension Plan Amendments Act of 1980 (the "Act") may, under certain circumstances, cause Hollinger International to become subject to liabilities in excess of the amounts provided for in the collective bargaining agreements. Generally, liabilities are contingent upon withdrawal or partial withdrawal from the plans. Hollinger International has not undertaken to withdraw or partially withdraw from any of the plans as of December 31, 2002. Under the Act, withdrawal liabilities would be based upon Hollinger International's proportional share of each plan's unfunded vested benefits. As of the date of the latest actuarial valuations, Hollinger International's share of the unfunded vested liabilities of each plan was zero. POST-RETIREMENT BENEFITS The Company's subsidiaries sponsor two post-retirement plans that provide post-retirement benefits to certain employees in Canada. The components of net period post-retirement cost (benefit) for the years ended December 31, 2000, 2001 and 2002 are as follows:
2000 2001 2002 -------- ------- ------ Service cost............................................ $ 1,021 $ 186 $ 133 Interest cost........................................... 4,044 2,966 2,801 Amortization of gains................................... (199) (3,700) (500) Settlement/curtailment.................................. (18,250) (2,671) -- -------- ------- ------ Net period post-retirement cost (benefit)............... $(13,384) $(3,219) $2,434 ======== ======= ======
The table below sets forth the reconciliation of the accumulated post-retirement benefit obligation as of December 31, 2001 and 2002:
2001 2002 ------- ------- Accumulated post-retirement benefit obligation at the beginning of the year..................................... $65,766 $65,160 Adjustment to opening balance............................... 9,580 4,461 Service cost................................................ 186 133 Interest cost............................................... 2,966 2,801 Actuarial gains............................................. (2,192) (1,152) Benefits paid............................................... (2,860) (3,103) Divestitures................................................ (8,286) -- ------- ------- Accumulated post-retirement benefit obligation at the end of the year.................................................. $65,160 $68,300 ======= =======
The fair value of plan assets was $1,200,000 and $5,449,000 at December 31, 2001 and 2002, respectively. F-45 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The table below sets forth the plan's funded status reconciled to the amounts recognized in the Company's financial statements:
2001 2002 -------- -------- Unfunded status............................................. $(63,960) $(62,851) Unrecognized net loss....................................... 1,868 2,345 -------- -------- Accrued post-retirement liability (note 12)................. $(62,092) $(60,506) ======== ========
The weighted average discount rate used in determining the accumulated post-retirement benefit obligation was 6.75%, 6.5% and 6.25% for 2000, 2001 and 2002, respectively. All benefits under the plans are paid for by contributions to the plans. For measuring the expected post-retirement benefit obligation of former Southam employees, an 8% annual rate of increase in the per capita claims was assumed for 2002, 9% for 2001, and 10% for 2000. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. If the health care cost trend rate was increased 1%, the accumulated post-retirement benefit obligation as of December 31, 2001 and 2002 would have increased $3,390,000 and $2,846,000, respectively, and the effect of this change on the aggregate of service and interest cost for 2001 and 2002 would have been an increase of $220,000 and $260,000, respectively. If the health care cost trend rate was decreased 1%, the accumulated post-retirement benefit obligation as of December 31, 2001 and 2002 would have decreased by $2,098,000 and $2,556,000, respectively, and the effect of this change on the aggregate of service and interest cost for 2001 and 2002 would have been a decrease of $160,000 and $233,000, respectively. 23. RELATED PARTY TRANSACTIONS a) Lord Black controls Ravelston and, through Ravelston and its subsidiaries, together with his associates, he exercises control or direction over 78.2% (2000 -- 68.6%; 2001 -- 77.8%) of the outstanding retractable common shares of the Company. Ravelston has rights of first refusal in respect of any retractable common shares of the Company that may be issued on exercise of options held to acquire retractable common shares should the holders decide to exercise their options and dispose of the retractable common shares. Hollinger International and its subsidiaries have entered into a services agreement with Ravelston, whereby Ravelston acts as manager of the Company and carries out head office and executive responsibilities. The services agreement was assigned on July 5, 2002 to RMI, a wholly owned subsidiary of Ravelston. Ravelston and RMI billed to Hollinger International and its subsidiaries fees totalling $49,943,000, $44,853,000 and $37,272,000 for 2000, 2001 and 2002, respectively, pursuant to this agreement. Similarly, Ravelston carries out head office and executive responsibilities for the Company and its subsidiaries, other than Hollinger International and its subsidiaries. In 2001 and 2002, no amounts were charged by Ravelston for such services. In 2000, the Company received $10.7 million, net, from Ravelston pursuant to a services agreement which was terminated on December 31, 2000. Expenses of the Company are net of $2.0 million and $2.4 million in 2001 and 2002, respectively, received from Ravelston and RMI as a reimbursement of certain head office expenses incurred on behalf of Ravelston and RMI. Such expenses were not incurred on behalf of Ravelston in 2000. Certain executives of Ravelston and Moffat Management and Black-Amiel Management, affiliates of Ravelston and RMI, have separate services agreements with certain subsidiaries of Hollinger International. Amounts paid directly by subsidiaries of Hollinger International pursuant to such F-46 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) agreements were $5,436,000, $2,629,000 and $2,976,000 for 2000, 2001 and 2002, respectively. The fees under Ravelston's and RMI's services agreement and the fees paid directly to executives and affiliates of Ravelston, in aggregate, are negotiated with and approved by Hollinger International's independent committee. In addition to all of the amounts referred to above, during 2000 and 2001, there was further remuneration paid directly by subsidiaries of Hollinger International to certain Ravelston executives of $6,293,000 and $2,592,000, respectively (2002 -- nil). b) On July 11, 2000, Hollinger International loaned US $36,817,000 to a subsidiary of the Company in connection with the cash purchase by the Company of HCPH Co. Special shares. The loan is payable on demand and to December 31, 2001 interest was payable at the rate of 13% per annum. Effective January 1, 2002, the interest rate was adjusted to LIBOR plus 3% per annum. This loan, together with accrued interest, totalled US $45,848,000 at December 31, 2002. On March 10, 2003, a portion of this loan has been settled and the terms of the loan have been amended as described in note 29c). c) On July 3, 2002, N.P. Holdings Company ("NP Holdings"), a subsidiary of Hollinger International, was sold for cash consideration of $5.75 million to RMI. The net assets of NP Holdings primarily included Canadian tax losses. The tax losses, only a portion of which was previously recognized for accounting purposes, were effectively sold at their carrying value. Due to the inability of NP Holdings to utilize its own tax losses prior to their expiry, as a result of its disposing of its interest in the National Post, it sold these losses to a company which would be able to utilize the losses. The only other potential purchaser for these losses, CanWest, declined the opportunity to acquire the losses. The terms of the sale of the tax losses to RMI were approved by the independent directors of Hollinger International. d) The Company and its subsidiaries have unsecured demand loans and advances, including accrued interest owing to Ravelston totalling $59.1 million and $75.8 million at December 31, 2001 and 2002, respectively. At December 31, 2000, the Company and its subsidiaries have unsecured demand loans and advances receivable of $1.0 million. The Company has borrowed the majority of these funds from Ravelston to partially fund its operating costs, including interest and preference share dividend obligations. The loans bear interest at the bankers' acceptance rate plus 3.75% per annum or 6.68% as at December 31, 2002. Hollinger International owes $11.6 million, $13.7 million and $5.0 million at December 31, 2000, 2001 and 2002, respectively, to Ravelston or RMI in connection with fees payable pursuant to the services agreement. As at December 31, 2002, HCPH Co. also owes RMI $22.5 million in connection with the assumption by RMI, as a result of its purchase of NP Holdings (note 23c)), of a liability of $22.5 million owing to CanWest. This amount is due on demand, is unsecured and is stated to bear interest at an annual rate of the bankers' acceptance rate plus 4%. e) In response to the 1998 issuer bid, all options held by executives were exercised. As at December 31, 2000, 2001 and 2002, included in accounts receivable is $5,866,000, $5,843,000 and $5,892,000, respectively, due from executives, which bears interest at the prime rate plus 1/2%. The receivables are fully secured by a pledge of the shares held by the executives. f) In 1999, executive-controlled companies invested in Hollinger L.P. As at December 31, 2000, 2001 and 2002, included in accounts receivable is $681,000, $436,000 and $373,000 due from these companies, which bears interest at the prime rate plus 1/2%. The receivables are partially secured by a pledge of the units held in Hollinger L.P. F-47 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) g) During 2000 and 2001, in connection with the sales of properties described in note 4c), 4g) and 4i), the Company, Ravelston, Hollinger International, Lord Black and three senior executives entered into non-competition agreements with the purchasers in return for cash consideration paid. h) As described in note 4c), 4f) and 4j), during 2001, the Company sold newspaper properties to certain related parties. i) As described in note 4e), during 2001, Hollinger International redeemed certain of its shares held by the Company and converted preference shares held by the Company into shares of Hollinger International Class A common stock. The shares of Class A common stock were subsequently purchased by Hollinger International from the Company for cancellation. j) Included in Other Assets at December 31, 2002 is $6,525,000 (US$4,130,000), owing to Hollinger International from Bradford Publishing Company ('Bradford'), a company in which certain of the Company's and Hollinger International's directors are significant shareholders. Such amount represents the present value of the remaining amounts owing under a non-interest bearing note receivable granted to Hollinger International in connection with a non-competition agreement entered into on the sale of certain operations to Bradford during 2000. The note receivable is unsecured, due over the period to 2010 and is subordinated to Bradford's lenders. k) Included in Other Assets at December 31, 2002 is $7,677,000 (US$4,859,000) owed by Horizon Publications Inc. ("Horizon"), a company controlled by certain members of the Board of Directors of Hollinger International and the Company. Such amount represents the unpaid purchase price payable to Hollinger International in connection with the sale of certain operations to Horizon during 1999. The loan receivable is unsecured, bears interest at the lower of LIBOR plus 2% and 8% per annum and is due in 2007. l) During 2002, the Company paid to Horizon a management fee in the amount of $256,000 in connection with certain administrative services provided by Horizon. Such fee was approved by Hollinger International's independent directors. m) Additional related party transactions occurring subsequent to year end are described in note 29. 24. FINANCIAL INSTRUMENTS a) Risk management activities i) Credit risk The Company does not have a significant exposure to any individual customer or counterparty. The Company is exposed to credit risk in the event of non-performance by counterparties in connection with its foreign currency contracts and interest rate swap agreements. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but mitigates this risk by dealing only with financially sound counterparties and, accordingly, does not anticipate loss due to non-performance. ii) Interest rate and currency risk The Company and its subsidiaries have entered into interest rate swaps, forward foreign exchange contracts and cross-currency rate swaps, as described in detail in notes 24c) and 24d) below. F-48 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) iii) Market risk During 1999, the Company's Series II exchangeable preference shares became exchangeable for a fixed number of shares of Hollinger International Class A common stock. As a result, such shares are valued at an amount equivalent to the market price of the underlying shares of Hollinger International Class A common stock for which they are exchangeable. While the carrying value of these exchangeable shares will fluctuate with the market price of the shares of Hollinger International Class A common stock, this market risk is mitigated by the Company's holding of such Hollinger International shares. b) Forward share purchase contracts At December 31, 2000, Hollinger International had arrangements with four banks pursuant to which the banks had purchased 14,109,905 shares of Hollinger International's Class A common stock at an average price of US$14.17. Hollinger International had the option, quarterly, up to and including September 30, 2000, to buy the shares from the banks at the same cost or to have the banks resell those shares in the open market. These arrangements were extended from time to time for periods ultimately ending between February 28, 2003 and June 30, 2003. In the event the banks resold the shares, any gain or loss realized by the banks would be for Hollinger International's account. Under the arrangements, until Hollinger International purchased the shares or the banks resold the shares, dividends paid on shares belonged to Hollinger International and Hollinger International paid interest to the banks, based on their purchase price at the rate of LIBOR plus a spread. In August 2001, Hollinger International purchased for cancellation from one of the banks 3,602,305 shares of Class A common stock for US$50,000,000 or US$13.88 per share. The market value of these shares on the date of purchase was US$47,000,000 or US$13.05 per share. In November 2001, one of the banks sold in the open market 3,556,513 shares of Hollinger International Class A common stock for US$34,200,000 or an average price of US$9.62 per share. This resulted in a loss to the bank of US$15,800,000, which, in accordance with the arrangement, was paid in cash by Hollinger International. At December 31, 2001, Hollinger International had two forward equity swap arrangements remaining with banks for a total of US$100,000,000. Of that total, US$10,000,000 was prepaid during the course of 2002 from available cash on hand. In October 2002, a further US$50,000,000 was prepaid using the proceeds from borrowings in that month referred to in note 10d). In December 2002, the forward equity swap arrangements were terminated when Hollinger International purchased for cancellation from the banks approximately 7.0 million shares of Class A common stock of Hollinger International for a total cost of US$100,000,000 (including the US$60,000,000 prepaid during 2002). The additional US$40,000,000 payment was paid from a portion of the proceeds received in December 2002 from Publishing's Senior Credit Facility and 9% Senior Notes (note 10). This resulted in a realized loss of $43,313,000, on the 2002 termination of the contracts, which has been included in unusual items (note 17). During 2001, a realized loss of $29,646,000 on contracts terminated in 2001 was included in unusual items (note 17). The Total Return Equity Swaps were originally entered into as a structure for the repurchase of Hollinger International's shares over an extended time frame based on a price fixed at the outset of the arrangement. Hollinger International does not presently intend to enter into further similar arrangements. F-49 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) c) Fair values of financial instruments The Company has entered into various types of financial instruments in the normal course of business. Fair value estimates are made at a specific point in time, based on assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates reflecting the country of origin and varying degrees of perceived risk. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, may not accurately represent future realizable values. The carrying value and estimated fair value of the Company's financial instruments at December 31, 2001 and 2002 are as follows:
2001 2002 ----------------------- ----------------------- CARRYING CARRYING VALUE FAIR VALUE VALUE FAIR VALUE ---------- ---------- ---------- ---------- Marketable securities (note 5)... $ 78,939 $ 65,871 $ 91,476 $ 90,032 Long-term debt (note 10)......... 1,351,626 1,288,199 1,789,321 1,651,150 Retractable preference shares (note 11)...................... 147,472 147,472 135,299 135,299 Liability for interest rate swaps.......................... 1,567 1,567 -- -- Foreign currency obligation (note 12)............................ 25,442 25,442 21,444 21,444 Forward foreign exchange contract -- asset (note 12)............. 24,751 24,751 -- -- Forward share purchase contracts -- liability (note 24b))....... -- 29,735 -- -- Cross-currency swap -- liability (note 12)...................... -- -- 14,475 14,475
The carrying values of cash and cash equivalents, escrow deposits, accounts receivable, bank indebtedness, accounts payable and accrued expenses and amounts due to related parties approximate their fair values, due to the relatively short periods to maturity of the instruments. The fair value of marketable securities is based on the closing market value of such securities at the year end. Fair values for long-term debt have been determined based on the future contractual cash payments at the respective operation's current borrowing rate. The fair value of the long-term debt related to the Senior Subordinated Notes at December 31, 2002 is the value at which they were retired in January 2003. Fair value of the retractable preference shares is based on the market value of the shares of Hollinger International Class A common stock or the cash proceeds for which they are retractable or redeemable. The fair value of the cross-currency swaps, interest rate swaps, forward share purchase contracts, and forward foreign exchange contracts is the estimated amount that the Company would pay or receive to terminate the agreements. Interest rate swaps were considered a hedge until the hedged debt was repaid in 2000. Subsequent to the debt repayment, the estimated cost to terminate the swap has been included in income. Such swaps were terminated in 2002. The foreign currency obligation and forward foreign exchange contract are in connection with the sale of participations in the CanWest debentures, which is described in note 5. The cross-currency swap is in connection with the Service Credit Facility, as described in note 10b). The carrying values of all other financial instruments at December 31, 2002 and 2001 approximate their estimated fair values. F-50 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) d) Derivative instruments The Company may enter into various swaps, options and forward contracts from time to time when management believes conditions warrant. Such contracts are limited to those that relate to the Company's actual exposure to commodity prices, interest rates and foreign currency risks. If, in management's view, the conditions that made such arrangements worthwhile no longer exist, the contracts may be closed. At the end of 2001, there were no material contracts or arrangements of these types, other than the forward exchange contract related to the Participation Trust as described in note 5. The contract was terminated as at September 30, 2002. The contract was marked to market and the related gains and losses included in foreign exchange losses during the year. The cumulative loss on the Company's obligation under the Participation Trust as at December 31, 2002 is $21,444,000 (2001 -- $691,000) and is included in the consolidated balance sheet in other liabilities and deferred credits (note 12). As described in note 10b), the Company entered into two cross-currency rate swaps to offset principal and interest payments on U.S. dollar borrowings by a U.K. subsidiary under Publishing's December 2002 Senior Credit Facility. The fair value of the contracts as of December 31, 2002 of $14,475,000 million is included in the consolidated balance sheet in other liabilities and deferred credits (note 12). 25. RECENT ACCOUNTING PRONOUNCEMENTS a) Foreign currency and hedging In November 2001, the CICA issued Accounting Guideline 13, "Hedging Relationships" ("AcG 13"). AcG 13 establishes new criteria for hedge accounting and will apply to all hedging relationships in effect on or after July 1, 2003. On January 1, 2004, the Company will reassess all hedging relationships to determine whether the criteria are met or not and will apply the new guidance on a prospective basis. To qualify for hedge accounting, the hedging relationship must be appropriately documented at the inception of the hedge and there must be reasonable assurance, both at the inception and throughout the term of the hedge, that the hedging relationship will be effective. The Company is in the process of formally documenting all hedging relationships and has not yet determined whether any of their current hedging relationships will not meet the new hedging criteria. b) Impairment of long-lived assets In December 2002, the CICA issued Handbook Section 3063, "Impairment of Long-Lived Assets" and revised Section 3475, "Disposal of Long-Lived Assets and Discontinued Operations". These sections supersede the write-down and disposal provision of Section 3061, "Property, Plant and Equipment", and Section 3475, "Discontinued Operations". The new standards are consistent with U.S. GAAP. Section 3063 establishes standards for recognizing, measuring and disclosing impairment of long-lived assets held for use. An impairment is recognized when the carrying amount of an asset to be held and used exceeds the projected future net cash flows expected from its use and disposal and is measured as the amount by which the carrying amount of the asset exceeds its fair value. Section 3475 provides specific criteria for and requires separate classification for assets held for sale and for these assets to be measured at the lower of their carrying amounts and fair value, less costs to sell. Section 3475 also broadens the definition of discontinued operations to include all distinguishable components of an entity that will be eliminated from operations. Section 3063 is effective for the Company's 2004 fiscal year; however, early application is permitted. Revised Section 3475 is applicable to disposal activities committed to by the Company after May 1, 2003; F-51 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) however, early application is permitted. The Company expects that the adoption of these standards will have no material impact on its financial position, results of operations or cash flow at this time. c) Disclosure of guarantees In February 2003, the CICA issued Accounting Guideline 14, "Disclosure of Guarantees" ("AcG 14"). AcG 14 requires certain disclosures to be made by a guarantor in its interim and annual financial statements for periods beginning after January 1, 2003. AcG 14 is generally consistent with the disclosure requirements for guarantees in the U.S. (Financial Accounting Standards Board ("FASB") Interpretation No. 45) but, unlike the FASB's guidance, does not encompass recognition and measurement requirements. The Company has evaluated the impact of adoption of AcG 14 and the disclosures are included in note 27h). 26. SCHEDULE OF RECONCILIATION TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) The following represents additional information to the consolidated financial statements of the Company that were prepared in accordance with Canadian GAAP. Set out below are the material adjustments (net of deferred income taxes, minority interest and foreign exchange rate adjustments where applicable) to net earnings (loss) for the years ended December 31, 2000, 2001 and 2002 and to shareholders' deficiency at December 31, 2001 and 2002 in order to conform to accounting principles generally accepted in the United States ("U.S. GAAP").
YEAR ENDED DECEMBER 31, ------------------------------------------ 2000 2001 (RESTATED-(V)) (RESTATED-(V)) 2002 -------------- -------------- -------- NET EARNINGS (LOSS) Net earnings (loss) for the year based on Canadian GAAP................................................. $ 189,373 $(131,898) $(88,640) Capitalization of betterments, net of related amortization(a)...................................... (4,633) 5,230 -- Gain on sale of shares, gain on subsidiary's issue of shares or sale of assets(c)(v)....................... 13,868 30,920 4,505 Foreign exchange(d).................................... 6,406 10,086 (7,293) Cost of acquisitions, net of amortization(e)........... 42 42 42 Compensation to employees(f)........................... (1,127) 918 -- Net earnings (loss) in equity accounted companies(g)... (7,882) 7,882 -- Adjustment to tax provision(h)(v)...................... (162,764) (41,893) -- Business combinations(i)(v)............................ 29,932 56,932 -- Financial instruments(j)............................... 2,421 9,294 8,185 Total return equity swap(k)(v)......................... (9,112) (15,316) 17,789 Valuation allowance against prepaid pension asset(l)(v).......................................... 29,757 (14,244) (6,277) --------- --------- -------- Net earnings (loss) for the year based on U.S. GAAP, before accounting change, as restated(v)............. 86,281 (82,047) (71,689) Cumulative effect of accounting change for goodwill(q).......................................... -- -- (12,071) --------- --------- -------- Net earnings (loss) for the year based on U.S. GAAP, as restated(v).......................................... $ 86,281 $ (82,047) $(83,760) ========= ========= ========
F-52 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED)
DECEMBER 31, --------------------------- 2001 2002 --------------- -------------- (RESTATED-26V)) (RESTATED-26V)) SHAREHOLDERS' DEFICIENCY Shareholders' deficiency based on Canadian GAAP............. $(263,470) $(351,331) Capitalization of betterments, net of related amortization(a)........................................... (182,807) (195,166) Amortization of intangible assets(b)........................ (24,175) (24,175) Gain on sale of shares, gain on subsidiary's issue of shares or sale of assets(c)(v)................................... 117,854 122,359 Foreign exchange(d)......................................... (1,569) (1,404) Cost of acquisitions, net of amortization(e)................ (1,890) (1,848) Compensation to employees(f)................................ (2,764) (2,764) Net loss in equity accounted companies(g)................... (1,389) (1,389) Income taxes(h)(v).......................................... 63,699 63,699 Business combinations(i)(v)................................. 4,603 4,603 Financial instruments(j).................................... 18,707 23,019 Total return equity swap(k)(v).............................. (17,789) -- Valuation allowance against prepaid pension asset(l)(v)..... 8,513 2,236 Capital stock(m)............................................ (271,774) (273,759) Investments(n).............................................. (3,755) (839) Minimum pension liability adjustment(o)..................... (11,552) (25,612) --------- --------- Shareholders' deficiency based on U.S. GAAP, as restated(v)............................................... $(569,558) $(662,371) ========= =========
YEAR ENDED DECEMBER 31, 2002 -------------- U.S. GAAP shareholders' deficiency, beginning of year........................ $(569,558) U.S. GAAP net loss for the year.............................................. (83,760) Dividends -- retractable common shares....................................... (19,220) Dividends -- Series II and Series III preference shares(j)................... (8,185) Premium on retraction of retractable common shares........................... 141 Net increase in deferred marked to market adjustment in respect of the Series II preference shares(j).................................... 4,312 Movement in deferred foreign exchange loss on Series II and Series III preference shares presented outside of shareholders' deficiency for Canadian GAAP purposes(j)............................................ 172 Share issue costs............................................................ (42) Other comprehensive income items: Change in equity adjustment from foreign currency translation(d)............. 24,914 Net unrealized loss on investments held for sale(c).......................... 2,915 Net minimum pension liability adjustment(o).................................. (14,060) --------- U.S. GAAP shareholders' deficiency, end of year.............................. $(662,371) =========
BALANCE SHEET DIFFERENCES: The following material balance sheet differences exist between Canadian and U.S. GAAP. 1) Other intangible assets:
DECEMBER 31, --------------------- 2001 2002 ---------- -------- Canadian GAAP............................................... $1,177,544 $185,143 Adjustment for capitalization of betterments, net of related amortization(a)........................................... (394,246) -- Adjustment for amortization(b).............................. (24,175) -- Adjustment for cost of acquisitions(e)...................... (1,876) -- Adjustment for business combinations(i)(v).................. 4,603 -- ---------- -------- U.S. GAAP................................................... $ 761,850 $185,143 ========== ========
F-53 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 2) Goodwill:
DECEMBER 31, ------------------- 2001 2002 -------- -------- Canadian GAAP............................................... $174,324 $913,327 Adjustment for capitalization of betterments, net of related amortization(a)........................................... -- (424,589) Adjustment for amortization(b).............................. -- (24,175) Adjustment for cost of acquisitions(e)...................... -- (1,809) Adjustment for income taxes(h)(v)........................... 63,699 63,699 Adjustment for business combinations(i)(v).................. -- 4,603 -------- -------- U.S. GAAP................................................... $238,023 $531,056 ======== ========
3) Minority interest:
DECEMBER 31, --------------------- 2001 2002 --------- --------- Canadian GAAP............................................... $ 725,928 $ 473,272 Adjustment for minority interest(v)......................... (252,886) (235,969) --------- --------- U.S. GAAP................................................... $ 473,042 $ 237,303 ========= =========
4) Future income tax liabilities:
DECEMBER 31, --------------------- 2001 2002 --------- --------- Canadian GAAP............................................... $ 486,937 $ 375,479 Adjustment for income taxes................................. (107,399) (122,637) --------- --------- U.S. GAAP................................................... $ 379,538 $ 252,842 ========= =========
5) Deferred pension asset:
DECEMBER 31, ------------------- 2001 2002 -------- -------- Canadian GAAP............................................... $ 83,459 $123,230 Adjustment for change in valuation allowance against prepaid asset(l)(v)............................................... 38,487 3,758 -------- -------- U.S. GAAP................................................... $121,946 $126,988 ======== ========
6) Total return equity swap liability:
DECEMBER 31, ------------------- 2001 2002 -------- -------- Canadian GAAP............................................... $ -- $ -- Adjustment for unrealized losses(k)(v) 55,912 -- -------- -------- U.S. GAAP................................................... $ 55,912 $ -- ======== ========
7) Capital stock:
DECEMBER 31, ------------------- 2001 2002 -------- -------- Canadian GAAP............................................... $271,774 $273,759 Adjustment to reclassify retractable common shares(m)....... (271,774) (273,759) -------- -------- U.S. GAAP................................................... $ -- $ -- ======== ========
F-54 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) SUMMARY OF ACCOUNTING POLICY DIFFERENCES: The areas of material difference between Canadian and U.S. GAAP and their impact on the consolidated financial statements of the Company are set out below: a) Capitalization of betterments Effective January 1, 1990, the Company capitalized as circulation the costs incurred to increase the long-term readership of its publications ("betterments"). U.S. GAAP does not permit capitalization of these costs. As a result of new Canadian accounting standards, effective January 1, 2002, the Company no longer capitalizes these costs under Canadian GAAP. b) Amortization of intangible assets Prior to the adoption on January 1, 2002 of new U.S. and Canadian accounting standards for goodwill described below, U.S. GAAP required the amortization of all intangible assets acquired on a straight-line basis over a period not exceeding 40 years. Under Canadian GAAP, prior to December 31, 1990, there was no requirement to amortize intangible assets, such as circulation, that were considered to have an indefinite life. Effective January 1, 1991, Canadian GAAP required that all intangible assets be amortized. As a result, commencing January 1, 1990 under Canadian GAAP, the Company amortized the cost of circulation on a straight-line basis over periods ranging from 10 to 40 years. Effective January 1, 2002, the Company adopted new Canadian accounting standards for Goodwill and Other Intangible Assets and certain transitional provisions for Business Combinations. These new Canadian standards are substantially consistent with the new U.S. accounting standards SFAS 141 and SFAS 142, except that under U.S. GAAP, any transitional impairment charge is recognized in earnings as a cumulative effect of a change in accounting principle. The new standards require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. The standards also specify criteria that intangible assets must meet to be recognized and reported apart from goodwill. In addition, the standard requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and that such assets are reviewed for impairment by assessing the recoverability of the carrying value. Effective January 1, 2002, the Company has discontinued amortization of all existing goodwill, evaluated existing intangible assets and has made the necessary reclassifications in order to conform with the new criteria for recognition of intangible assets apart from goodwill. Amounts previously ascribed to circulation, including costs capitalized to increase long-term readership and certain other intangible assets have now been reclassified to goodwill, net of the related deferred income taxes, effective January 1, 2002. This change in accounting policy cannot be applied retroactively and the amounts presented for prior periods have not been restated for this change. If this change in accounting policy were applied to the reported net earnings (loss) under U.S. GAAP for the years ended December 31, 2000 and F-55 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 2001, the impact of the change, in respect of the U.S. GAAP goodwill and intangible assets with indefinite useful lives not being amortized, would be as follows:
DECEMBER 31, ------------------------- 2000 2001 ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE) U.S. GAAP net earnings (loss), as reported.................. $ 86,281 $(82,047) Add U.S. GAAP amortization, net of income tax and minority interest.................................................. 38,668 17,548 -------- -------- Adjusted U.S. GAAP net earnings (loss)...................... $124,949 $(64,499) ======== ======== U.S. GAAP basic net earnings (loss) per share, as reported.................................................. $ 1.52 $ (2.33) Adjusted U.S. GAAP basic net earnings (loss) per share...... $ 2.56 $ (1.81) U.S. GAAP diluted net earnings (loss) per share, as reported.................................................. $ 1.42 $ (2.62) Adjusted U.S. GAAP diluted net earnings (loss) per share.... $ 2.46 $ (2.10)
Adjusted net earnings (loss), noted above, reflects only the reduction in amortization expense in respect of intangibles now classified as goodwill and does not give effect to the impact that this change in accounting policy would have had on the gains and losses resulting from the disposal of operations during 2001 and 2000. c) Gain on sale of shares, gain on subsidiary's issue of shares or sale of assets As a result of the adjustments in a) and b) above, and for periods subsequent to January 1, 2002, as a result of adjustments (h) and (i), the carrying value of the investments in Hollinger L.P., Southam and Hollinger International are lower under U.S. GAAP, resulting in the gain on sale of properties by Hollinger International, Southam and Hollinger L.P., gains on the sale by the Company of shares of Hollinger International, and gains on dilution of investments in Hollinger International and Hollinger L.P., being higher under U.S. GAAP. d) Foreign exchange Under Canadian GAAP, a portion of the equity adjustment from foreign currency translation, included in shareholders' deficiency, is required to be transferred to income whenever there is a reduction in the net investment in a foreign entity or repayment of foreign currency denominated long-term intercompany loans. U.S. GAAP requires the transfer of a portion of this account to income only when the reduction in net investment is due to a sale or complete or substantially complete liquidation. While there may be differences in the timing of the recognition of such foreign exchange gains and losses under Canadian and U.S. GAAP, this difference in accounting has no effect on total shareholders' deficiency. e) Cost of acquisitions Under Canadian GAAP, the Company previously had a policy of including certain internal acquisition costs as part of the purchase price of businesses acquired. U.S. GAAP does not permit capitalization of these costs. f) Compensation to employees The Company and Hollinger International have various stock option and stock purchase plans for executives. Under Canadian GAAP, compensation is not recognized on the grant or modification of any employee option. In accordance with U.S. GAAP, options granted to employees of the parent company are measured using the fair value based method and treated as a dividend in kind with no resulting impact on either net earnings (loss) or shareholders' deficiency. For all other employee F-56 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) options, the compensation element is measured under U.S. GAAP using the intrinsic value based method of accounting and is apportioned over the period of service to which the compensation is related. As a result of a previous reduction in the exercise price of Hollinger International's options, compensation expense was recorded under U.S. GAAP in 2000 and a reversal of compensation was recorded under U.S. GAAP in 2001. g) Equity accounted companies Under U.S. GAAP the compensation element of executive stock options related to equity accounted companies is measured and apportioned over the period of service to which the compensation is related. Under Canadian GAAP, compensation is not recognized for stock options. In addition, betterments, net of related amortization, related to equity accounted companies were capitalized under Canadian GAAP until January 1, 2002. This is not permitted under U.S. GAAP. As a result of the above adjustments, the carrying value of equity accounted investments is lower under U.S. GAAP, resulting in the gain on the disposition of these investments in 2001 being higher under U.S. GAAP. The adjustments for 2000 and 2001 are in respect of the Company's investment in Interactive Investor International. h) Income taxes Effective January 1, 2000, the Company adopted, on a retroactive basis, new Canadian accounting standards for income taxes, which now require income taxes to be accounted for using the asset and liability method, consistent with U.S. GAAP. Previously, under Canadian GAAP, the deferral method of providing for income taxes was used. Under Canadian accounting standards for income taxes, the Company is not required to restate its comparative figures for prior years and the cumulative effect of this change in accounting policy of $291,004,000 (net of related minority interest) has been charged directly to retained earnings as at January 1, 2000. Of this adjustment, $276,215,000 was attributable to future income tax liabilities established in respect of amounts ascribed to circulation on business acquisitions which are largely not deductible for income tax purposes. Under U.S. GAAP, the establishment of such future tax liabilities on business acquisitions would have resulted in additional goodwill being recorded for an equivalent amount. Under U.S. GAAP, the deferred tax recovery recorded in respect of circulation amortization is fully offset by the related goodwill amortization, with no net impact on U.S. GAAP net earnings. Effective January 1, 2002, on the adoption of the new Canadian and U.S. accounting standards for Goodwill and Business combinations (note b)), amounts ascribed to circulation have been reclassified to goodwill, which is no longer being amortized. The new Canadian accounting standard for income taxes adopted January 1, 2000 does not require the restatement of prior years' business acquisitions and permits the adjustment, otherwise made to goodwill under U.S. GAAP, to be made directly to retained earnings (net of related minority interest). As a result of not restating comparative figures, the $276,215,000 net deferred tax impact of circulation recorded on January 1, 2000 as a charge against retained earnings under Canadian GAAP would have been recorded as goodwill under U.S. GAAP. This difference, in turn, resulted in higher goodwill amortization or write-off charges under U.S. GAAP in the amount of $162,764,000 and $41,893,000 for the years ended December 31, 2000 and 2001, respectively. Accordingly, while there may not be any new material differences between Canadian and U.S. GAAP with respect to income taxes for periods subsequent to January 1, 2000, there will continue to be a difference between Canadian and U.S. GAAP in respect of the remaining F-57 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) $63.7 million of deferred taxes which will eliminate subsequent to January 1, 2002 only when the underlying operation is sold or the Company's interest in the underlying operations is diluted. U.S. GAAP income tax expense would have differed from the amounts computed by applying the basic federal and provincial income tax rates to U.S. GAAP earnings (loss) before income taxes, minority interest and cumulative effect of change in accounting principle as shown in the following table:
2000 2001 2002 -------- --------- --------- Earnings (loss) before income taxes, minority interest and cumulative effect of change in accounting principle............................. $896,205 $(417,688) $(140,394) ======== ========= ========= Basic income tax rate.............................. 43.95% 41.75% 41.00% ======== ========= ========= Computed income tax expense (recovery)............. $393,882 $(174,385) $ (57,562) Change in income tax expense (recovery) resulting from: Different tax rate on earnings of subsidiaries..... (89,178) 19,565 15,144 Tax gain in excess of book gain.................... (82,350) 52,158 949 Potential tax benefit of current year's losses not recorded......................................... 29,255 -- -- Large Corporations Tax............................. 15,531 940 1,079 Loss on total return equity swap................... 8,013 27,134 (4,844) Change in valuation allowance...................... -- 42,841 74,043 Minority interest earnings in Hollinger L.P........ (26,669) (2,001) (1,214) Permanent differences.............................. 208,778 (35,810) 56,983 -------- --------- --------- Income tax expense (recovery)...................... $457,262 $ (69,558) $ 84,578 ======== ========= ========= Effective tax rate................................. 51.02% 16.65% 60.24% ======== ========= =========
Canadian and foreign components of earnings (loss) before income taxes, minority interest and cumulative effect of change in accounting principle are presented below:
2000 2001 2002 -------- --------- --------- Canadian........................................... $886,301 $(255,352) $ 10,020 Foreign............................................ 9,904 (162,336) (150,414) -------- --------- --------- $896,205 $(417,688) $(140,394) ======== ========= =========
F-58 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Income tax expense (recovery) for the periods shown below consists of:
CURRENT DEFERRED TOTAL -------- --------- --------- Year ended December 31, 2000: Canadian......................................... $529,497 $(167,453) $ 362,044 Foreign.......................................... 88,198 7,020 95,218 -------- --------- --------- $617,695 $(160,433) $ 457,262 ======== ========= ========= Year ended December 31, 2001: Canadian......................................... $ 7,153 $(147,773) $(140,620) Foreign.......................................... 49,151 21,911 71,062 -------- --------- --------- $ 56,304 $(125,862) $ (69,558) ======== ========= ========= Year ended December 31, 2002: Canadian......................................... $ (5,503) $ 92,301 $ 86,798 Foreign.......................................... 2,888 (5,108) (2,220) -------- --------- --------- $ (2,615) $ 87,193 $ 84,578 ======== ========= =========
i) Business combinations Under Canadian GAAP, the Company was required to treat the transfer in 1997 of the Canadian newspapers to Hollinger International as a disposition at fair value. This resulted in the recognition of a gain to the extent there is a minority interest in Hollinger International. U.S. GAAP requires that the transfer of the Canadian Newspapers to a subsidiary company be accounted for at historical values using "as-if" pooling of interest accounting. As a result, the revenues and expenses for the periods prior to January 1, 1997 would be restated to give effect to the transfer of the Canadian Newspapers to Hollinger International and the gross gain, prior to deducting expenses, of $114,000,000 on the sale of the properties and the increase in intangible assets of an equivalent amount would not have been recorded for U.S. GAAP purposes. However, such gain would be recognized for U.S. GAAP purposes as the underlying Canadian newspaper operations were sold to third parties, or there was a further dilution in the Company's interest in Hollinger International. In addition, because the consideration received by the Company in 1997 included shares of Hollinger International, the Company was required to treat this as an acquisition of an additional interest in Hollinger International, which resulted in $20,500,000 being ascribed to circulation and additional annual amortization expense of $932,000. Effective January 1, 2002, upon adoption of the new Canadian and U.S. accounting standards for Goodwill and Business Combinations (note 26b)), amounts ascribed to circulation have been reclassified to goodwill, which is no longer being amortized. Accordingly, there would be no difference between Canadian and U.S. GAAP with respect to this item for periods subsequent to January 1, 2002 unless the underlying operation is sold, or the Company's interest in the underlying operations is diluted. j) Financial instruments Canadian GAAP requires the value ascribed to certain subsidiary Special shares outstanding during 2000 to be increased over the life of the shares to the Company's optional cash settlement amount through a periodic charge to earnings. Under U.S. GAAP, the shares are recorded at their fair value on the date of issue and such a charge to increase their carrying amount is not required, until the shares were settled in 2000. F-59 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Under Canadian GAAP, the $11,054,000, $9,294,000, $8,185,000 of dividends on mandatory redeemable preferred stock in 2000, 2001 and 2002, respectively, must be recorded as interest expense. Under U.S. GAAP, such dividends are charged against shareholders' deficiency. Under U.S. GAAP, the mark to market and foreign exchange adjustments totalling a gain of $7,670,000 at December 31, 2001 and a gain of $11,983,000 at December 31, 2002 to the carrying value of the Series II preference shares, which reflect the value of the underlying Hollinger International shares for which they are exchangeable, must be recorded within shareholders' deficiency. Under Canadian GAAP, such adjustments are deferred and recorded on the balance sheet outside of shareholders' deficiency. k) Total return equity swap During 2000, U.S. GAAP clarified the accounting for certain derivative financial instruments indexed to, and potentially settled, in a company's own stock, that require a cash payment by the issuer upon the occurrence of future events outside the control of the issuer. This new U.S. GAAP guidance applies to new contracts entered into after September 30, 2000. Consequently, the extension of Hollinger International's forward share purchase contracts on October 1, 2000 resulted in such contracts being accounted for using the asset and liability method after that date. Under this method, the derivative forward contract was marked to market subsequent to October 1, 2000. The unrealized loss during the period, October 1 to December 31, 2000, net of minority interest, totalled $9,112,000 and was charged to earnings for U.S. purposes. During 2001, the mark to market losses for the contracts totalled $95,267,000 of which $59,920,000 of losses were realized when certain forward share purchase contracts were settled, resulting in a U.S. GAAP difference, net of related minority interest, of $15,316,000. In December 2002, the total return equity swaps were settled and the losses realized. For Canadian GAAP, no adjustment was required to reflect the mark to market adjustment for such forward purchase contracts and losses were recognized only when realized upon the settlement of the contract. l) Valuation allowance against prepaid pension asset Canadian GAAP requires recognition of a pension valuation allowance for any excess of the prepaid benefit expense over the expected future benefit. Changes in the pension valuation allowance are recognized in earnings under Canadian GAAP immediately. U.S. GAAP does not permit the recognition of pension valuation allowances. m) Capital stock U.S. GAAP requires that common shares which are retractable at the option of the holder be presented in the consolidated balance sheet outside of shareholders' deficiency. Canadian GAAP permits these retractable common shares to be shown as equity. n) Unrealized holding gains (losses) on investments available for sale Under Canadian GAAP, the Company accounts for all of its investments, which consist of corporate debt and equity securities, at historical cost. U.S. GAAP requires those investments in marketable securities which are available for sale, other than those investments accounted for on an equity basis, to be recorded at fair value. Unrealized holding gains and losses, net of the related tax and minority interest effect, on available for sale securities are excluded from earnings and are reported as a separate component of other comprehensive income and shareholders' equity until realized. Realized F-60 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) gains and losses from the sale of available-for-sale securities are determined on a specific identification basis. o) Minimum pension liability adjustment Under U.S. GAAP, the Company is required to record an additional minimum pension liability for certain of its defined benefit pension plans to reflect the excess of the accumulated benefit obligations over the fair value of the plan assets with a corresponding charge against other comprehensive income included in shareholders' deficiency (note 26u)). No such adjustment is required under Canadian GAAP. p) Interest in joint ventures Canadian GAAP requires the proportionate consolidation of interests in joint ventures. Proportionate consolidation is not permitted under U.S. GAAP and interests in joint ventures are accounted for on the equity basis. Although the adoption of proportionate consolidation has no impact on net earnings (loss) or shareholders' deficiency, it does increase assets, liabilities, revenues, expenses and cash flows from operations from those amounts otherwise reported under U.S. GAAP. q) Change in accounting principle Under U.S. GAAP, the transitional provisions of SFAS 142 require the write-down resulting from the impairment test upon adoption on January 1, 2002 to be reflected in the consolidated statement of earnings as a cumulative effect of a change in accounting principle. However, Canadian GAAP requires the same loss to be recorded as a charge to the opening deficit as at January 1, 2002. As described in note 1, goodwill attributable to Jerusalem Post was written down in its entirety upon adoption of SFAS 142. r) Unusual items Included in Unusual items on the consolidated statements of earnings under Canadian GAAP are certain items which under U.S. GAAP must be classified as either operating costs, non-operating income or non-operating expenses. In particular, the unusual items (note 17) would have been classified as follows: net gain on dilution of investments as non-operating expenses, gains and losses on sale of investments and publishing interests as non-operating income or expenses, net, gain on effective sale of interest in Hollinger International as non-operating income and partially non-operating expense, loss on retirement of Senior Notes as non-operating expenses, new Chicago plant pre-operating costs as operating costs, write-off of financing fees as non-operating expenses, write-off of investments as non-operating expenses, realized loss on total return equity swap as non-operating costs, pension and post-retirement plan liability adjustment as operating costs and redundancy, rationalization and other costs as operating costs. F-61 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) s) Net earnings (loss) per retractable common share
YEARS ENDED DECEMBER 31 ----------------------- 2000 2001 2002 ----- ------ ------ (DOLLARS PER SHARE) Basic net earnings (loss) per retractable common share: Earnings (loss) before cumulative effect of change in accounting principles.................................. $1.52 $(2.33) $(2.32) Net earnings (loss) for the year.......................... $1.52 $(2.33) $(2.70) Diluted earnings (loss) per retractable common share: Earnings (loss) before cumulative effect of change in accounting principles.................................. $1.42 $(2.62) $(2.35) Net earnings (loss) for the year.......................... $1.42 $(2.62) $(2.73)
Earnings (loss) per retractable common share amounts in accordance with U.S. GAAP are based on U.S. GAAP net earnings. The weighted average number of outstanding shares for purposes of calculating basic and diluted net earnings (loss) per share is the same under both Canadian and U.S. GAAP (note 19). Under U.S. GAAP, the change in the unrealized mark to market gain (loss) on the Series II preference shares of ($19,048,000), $12,759,000 and $5,431,000 as at December 31, 2000, 2001 and 2002 must be treated as an adjustment to dividends paid for purposes of calculating basic and diluted net earnings (loss) per share. Such adjustment is not required under Canadian GAAP. t) Statement of cash flows Canadian GAAP permits the disclosure of the amount of funds provided by operations before changes in non-cash operating working capital and certain other items to be included in the consolidated statements of cash flows as a subtotal. In addition, Canadian GAAP permits the disclosure of cash flows provided by operations per retractable common share. U.S. GAAP does not permit disclosure of these items. Canadian GAAP requires proportionate consolidation of interests in joint ventures, which is not permitted under U.S. GAAP. As a result, under U.S. GAAP, the total funds provided by operations (including the changes in non-cash working capital and other items) for the years ended December 31, 2000, 2001 and 2002 would have decreased by $25,280,000, $25,102,000 and $6,282,000, respectively. F-62 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) u) Comprehensive income (loss) Total comprehensive income (loss) in accordance with U.S. GAAP is as follows:
YEARS ENDED DECEMBER 31 ------------------------------ 2000 2001 2002 -------- -------- -------- Net earnings (loss) based on U.S. GAAP, as restated (v)..... $ 86,281 $(82,047) $(83,760) Other comprehensive net earnings (loss), net of tax, being: Unrealized gain (loss) on investments held for sale, net of related tax recovery of $20,390, $29,002 and $2,372 and minority interest of $38,990, $77,542 and $5,701 in 2000, 2001 and 2002, respectively...................... (35,244) (54,066) 2,256 Reclassification adjustment for realized loss reclassified out of accumulated comprehensive income, net of related tax recovery of nil, $47,102 and $832 and minority interest of nil, $118,041 and $1,384 in 2000, 2001 and 2002, respectively..................................... -- 83,005 659 -------- -------- -------- (35,244) 28,939 2,915 Change in the equity adjustment from foreign currency translation............................................... (64,559) 10,527 24,914 Minimum pension liability adjustment, net of a related tax recovery of nil, $11,726 and $24,897 and minority interest of $1,570, $13,055 and $29,504 in 2000, 2001 and 2002, respectively.............................................. (1,570) (9,982) (14,060) -------- -------- -------- Comprehensive loss based on U.S. GAAP....................... $(15,092) $(52,563) $(69,991) ======== ======== ========
v) Restatements Shareholder's deficiency and net earnings (loss) based on U.S. GAAP as at December 31, 2000 and 2001 and for the years ended December 31, 2000 and 2001 differ from the amounts previously reported as follows: i) In 2001, adjustments described in note 26k), were previously computed without giving effect to the full amount of the realized losses, which would have already been recognized in the net loss for Canadian GAAP purposes. The dilution gain adjustment recorded in 2001 (note 26c)) has also been effected as a consequence of this adjustment. This restatement reduced the previously reported U.S. GAAP net loss in fiscal 2001 by $20,098,000. ii) In 2000, the Company recorded a valuation allowance against the excess of the prepaid benefit expense for certain of its Canadian operations, over the expected future benefit. U.S. GAAP does not specifically address pension valuation allowances and the Company had believed that such valuation allowance was appropriate under U.S. GAAP. Recently U.S. regulators have interpreted there to be a difference between Canadian and U.S. GAAP in this area. In light of these recent developments, the Company retroactively adjusted for the changes in the valuation allowance and the related impact on the dilution gain, which resulted in an increase to reported U.S. GAAP net earnings for fiscal 2000 of $29,757,000 and an increase to reported U.S. GAAP net loss for fiscal 2001 of $5,670,000, each net of related income tax and minority interest. iii) In addition to giving effect to the matters noted above, certain basic and diluted earnings per share figures for 2000, and 2001 have been restated from amounts previously reported due to an error in the computation of the unrealized mark to market adjustment on the Series II preference shares (note 26s)) as well as a restatement of the dilutive effect of certain dilutive securities of International. F-63 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) iv) As described in note 26i), in 1997 the Company recorded for Canadian GAAP purposes, a gain on the sale of certain Canadian newspapers to Hollinger International. Under U.S. GAAP, no gain could be recognized in 1997. However, such gain should have been recognized as the underlying Canadian newspaper operations were sold to third parties, or there was a further dilution in the Company's interest in Hollinger International. In the years 1998 through 2001, the Company did not appropriately recognize such gains for U.S. GAAP purposes and has restated its U.S. GAAP results for these years to reflect such gains. In addition, as a result of this matter, the Company has also retroactively restated the adjustment to the income tax provision for U.S. GAAP purposes. As a result of these two items, the Company has retroactively decreased the previously reported U.S. GAAP shareholder's deficiency as at December 31, 1999 by a net $21.1 million and increased reported U.S. GAAP net earnings for fiscal 2000 by $21.1 million and increased reported U.S. GAAP net earnings for fiscal 2001 by $40.8 million. v) In 2001 and 2002, the Company originally presented its retractable common shares as part of shareholders' deficiency. Under U.S. GAAP the retractable common shares do not qualify as permanent equity due to the retractable features being effective at the option of the holder. As a result, the retractable common shares are required to be reclassified outside of shareholders' deficiency. In addition, under U.S. GAAP loans receivable from employees relating to share purchases were originally presented in the consolidated balance sheet as a deduction from capital stock. As a result of the presentation of retractable common shares outside of shareholders' deficiency for U.S. GAAP purposes, the loans receivable from employees relating to share purchases are no longer required to be deducted from capital stock. The Company has retroactively restated its U.S. GAAP shareholders' deficiency in respect of these changes in presentation, the net impact of which was to increase to the shareholders' deficiency in 2001 by $265,931 to $569,558. The net effect of all these restatements to basic and diluted net earnings (loss) for the years ended December 31, 2000 and 2001 is summarized below:
YEARS ENDED DECEMBER 31 ------------------- 2000 2001 -------- -------- (DOLLARS PER SHARE) U.S. GAAP basic earnings (loss) per retractable common share: As previously reported.................................... $(0.12) $(3.89) Restated.................................................. $ 1.52 $(2.33) U.S. GAAP diluted loss per retractable common share: As previously reported.................................... $(0.49) $(4.11) Restated.................................................. $ 1.42 $(2.62)
w) Recent pronouncements In June 2001, the FASB issued FAS 143, "Accounting for Asset Retirement Obligations" ("FAS 143"), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. If the obligation is settled to other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The Company is required to adopt the provisions of FAS 143 for the quarter ending March 31, 2003. To accomplish this, the Company must identify all legal obligations for asset retirement obligations, if any, and determine the fair value of these obligations on the date of adoption. The determination of fair value is complex and will require the Company to gather market information and develop cash flow models. Additionally, the Company will be required to develop processes to track and monitor these obligations. The Company has determined that the adoption of FAS 143 does not have a material impact on its financial statements. F-64 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) In April 2002, the FASB issued FAS 145 which rescinded FAS 4, "Reporting Gains and Losses from Extinguishment of Debt" ("FAS 145"). FAS 145 addresses, among other things, the income statement treatment of gains and losses related to debt extinguishments, requiring that such expenses no longer be treated as extraordinary items, unless the items meet the definition of extraordinary per APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". Upon adoption, any gain or loss on extinguishment of debt that was classified as an extraordinary item, in prior periods presented, that does not meet the criteria in Opinion 30 for classification as an extraordinary item, is required to be reclassified to non-operating expense. The Company retroactively adopted the new presentation requirements of FAS 145 effective January 1, 2002. The adoption of such accounting standard did not impact the Company's U.S. GAAP net earnings as information regarding extraordinary losses under U.S. GAAP on debt extinguishment was presented for disclosure purposes only. In July 2002, the FASB issued FAS 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("FAS 146"), which is effective for exit or disposal activities that are initiated after December 31, 2002. FAS 146 nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"), "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in Restructuring)". The principal difference between FAS 146 and EITF 94-3 related to the recognition of a liability for a cost associated with an exit or disposal activity. FAS 146 requires that a liability be recognized for exit or disposal costs only when the liability is incurred, whereas under EITF 94-3, the liability was recognized when a company commits to an exit plan, and that the liability be initially measured at fair value. The Company is currently assessing the impact of the new standards. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("VIE'S") ("FIN 46"), which requires the companies that control another entity through interests other than voting interest should consolidate the controlled entity. In the absence of clear control through a voting equity interest, a company's exposure (variable interests) to the economic risk and the potential rewards from a VIE's assets and activities are the best evidence of a controlling financial interest. VIE's created after January 31, 2003 must be consolidated immediately. VIE's existing prior to February 1, 2003 must be consolidated by the Company commencing with its third quarter 2003 financial statements. The Company has not yet determined whether it has any VIE's which will require consolidation. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure", an amendment of FASB Statement No. 123. This Statement amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. The Company plans to continue to use the intrinsic value method for U.S. GAAP purposes. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in note 27e). F-65 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) 27. ADDITIONAL DISCLOSURES REQUIRED UNDER U.S. GAAP a) Accounting policy Issuance of a Subsidiary's Stock The Company accounts for the issuance of a subsidiary's stock as a dilution gain or loss which is included in the statement of earnings. b) Marketable equity and debt securities All marketable equity and debt securities are classified as available for sale, recorded at fair value, and presented as non-current assets. Available for sale securities consist of the following:
GROSS AMORTIZED UNREALIZED FAIR COST LOSS VALUE --------- ----------- ------- December 31, 2001 Internet-related securities........................... $ 6,680 $ (4,873) $ 1,807 Can-West debentures................................... 72,259 (9,931) 62,328 ------- -------- ------- $78,939 $(14,804) $64,135 ======= ======== =======
GROSS AMORTIZED UNREALIZED FAIR COST GAIN (LOSS) VALUE --------- ----------- ------- December 31, 2002 Internet-related equity securities.................... $ 5,812 $ 940 $ 6,752 Can-West debentures................................... 85,664 (2,384) 83,280 ------- ------- ------- $91,476 $(1,444) $90,032 ======= ======= =======
During 2001, the Company disposed of certain available-for-sale securities resulting in gross realized losses of $139,586,000. In computing the realized losses, cost was determined based on average cost. c) Accounts receivable Accounts receivable consist of the following:
2001 2002 -------- -------- Customer trade receivables.................................. $255,336 $272,537 Other....................................................... 107,240 115,167 -------- -------- Gross accounts receivable................................... 362,576 387,704 Allowance for doubtful accounts............................. (26,138) (32,673) -------- -------- Accounts receivable......................................... $336,438 $355,031 ======== ========
F-66 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) d) Accounts payable and accrued expenses Accounts payable and accrued expenses consist of the following:
2001 2002 -------- -------- Trade payables.............................................. $175,418 $173,236 Accrued payroll and benefits................................ 32,205 40,297 Accrued interest............................................ 41,116 28,102 Other accrued expenses...................................... 109,705 95,451 -------- -------- $358,444 $337,086 ======== ========
e) Stock based compensation Under U.S. GAAP, FIN 44, "Accounting for Certain Transactions involving Stock Compensation" was effective July 1, 2000 and required repriced options to be treated as variable stock option awards. As a result, the Company has recorded, net of minority interest, $1,127,000 of compensation expense for 2000 and a reversal of compensation expense of $918,000 for 2001, in respect of certain repriced options of Hollinger International. For all other stock options granted by the Company and its subsidiaries, no compensation cost has been recognized. Had the Company determined compensation costs based on the fair value at the grant date of its stock options under Statement of Financial Accounting Standards No. 123 ("FAS 123") "Accounting for Stock-Based Compensation", the Company's U.S. GAAP net earnings (loss) and earnings (loss) per share would have been reduced to the pro forma amounts indicated in the following table:
2000 2001 2002 -------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE) Net earnings (loss) as restated (note 26v))........... $86,281 $(82,047) $(83,760) Add compensation expense, as reported................. 1,071 (763) -- Deduct pro forma compensation expense................. (5,190) (4,950) (4,057) ------- -------- -------- Pro forma U.S. GAAP net earnings (loss)............... $82,162 $(87,760) $(87,817) ======= ======== ======== U.S. GAAP basic net earnings (loss) per share as reported............................................ $ 1.52 $ (2.33) $ (2.70) U.S. GAAP diluted net earnings (loss) per share as reported............................................ $ 1.42 $ (2.62) $ (2.70) U.S. GAAP pro forma basic net earnings (loss) per share............................................... $ 1.41 $ (2.50) $ (2.82) U.S. GAAP pro forma diluted net earnings (loss) per share............................................... $ 1.30 $ (2.79) $ (2.82)
The Company has not granted any options since 1998. The weighted average fair value of stock options granted during 2000, 2001 and 2002 by Hollinger International was estimated to be US$4.12, US $5.67 and US$5.65, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: dividend yield 3.4%, 4.6% and 3.6%, expected volatility 43.3%, 55.2% and 68.3%, risk free interest rates of 5.1%, 5.0% and 4.5%, and expected lives of 10 years in each of those same years. f) Rent expense Rent expense was $28,440,000, $22,589,000, and $26,790,000 for 2000, 2001 and 2002, respectively. g) Derivatives For U.S. GAAP reporting purposes, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138 F-67 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) ("SFAS No. 133") on January 1, 2001. There was no impact on results of operations or financial position upon adoption. The Company may enter into various swap, option and forward contracts from time to time when management believes conditions warrant, as described in note 24d). Such derivative contracts have not been designated as effective hedges, and therefore the changes in their fair value are recorded in earnings under both Canadian and U.S. GAAP. On December 27, 2002, a United Kingdom subsidiary of the Company entered into two cross-currency rate swap transactions to hedge principal and interest payments on U.S. dollar borrowings under Publishing's December 2002 Senior Credit Facility. The contracts have a total foreign currency obligation notional value of U.S.$265 million, fixed at a rate U.S.$1.5922 to L1, convert the interest rate on such borrowing from floating to fixed, and expire as to of U.S.$45 million on December 29, 2008 and as to U.S.$220 million on December 29, 2009. On January 22, 2003 and February 6, 2003, Publishing entered into interest rate swaps to convert U.S.$150 million and U.S.$100 million, respectively, of the Publishing Notes issued in December 2002 to floating rates for the period to December 15, 2010, subject to early termination notice. Changes in the value of derivatives comprising the forward exchange contract described in note 5a) and cross-currency swaps described above amounted to a gain of $24.3 million and a loss of $28.5 million in 2001 and 2002, respectively. The fair values of all derivative contracts are disclosed in note 24c). h) Guarantees In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others", which establishes and clarifies requirements for disclosure of most guarantees and the recognition of an initial liability for the fair value of obligations a guarantor assumes under guarantees. The initial liability recognition and measurement provisions are effective in respect of guarantees entered into or modified after December 31, 2002. FIN 45 provides guidance regarding the identification of guarantees and requires a guarantor to disclose the significant details of guarantees that have been given regardless of whether it will have to make payments under the guarantees. Senior Secured Notes In connection with the issuance in 2003 of 11 7/8% Senior Secured Notes due 2011, the Company and certain of its subsidiaries have agreed to indemnify its lenders against any losses or damages resulting from inaccuracy of financial statements, environmental matters, taxes and compliance with Securities Act. The Company and its subsidiaries also indemnified the Noteholders against any related tax liabilities arising from payments made with respect to the Notes, except taxes on Noteholder's income. These indemnifications generally extend for the term of the Senior Secured Notes and do not provide for any limit on the maximum potential liability. The Company is unable to estimate the maximum potential liability for these types of indemnifications as the Notes indenture does not specify a maximum amount and the amounts are dependent upon future contingent events, the nature and likelihood of which cannot be determined at this time. No amount has been accrued in the interim consolidated financial statements with respect to these indemnifications and the Company is unable to estimate amounts due for withholding taxes, if any, at this time. Any such amounts will increase the future effective cost of borrowing. F-68 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) The Company has indemnified the lenders and their affiliates from and against all losses as a result of any obligations of any of the borrowers and guarantors under the Company's Senior Secured Notes. Property Leases A subsidiary of the Company has agreed to indemnify lessors of its operating leases against liabilities, damages, costs, claims and actions resulting from damaged property, violations of any lease covenants or any accident or injury occurring on the leased premises. The Company is unable to estimate the maximum exposure for these types of indemnifications as the operating leases do not specify a maximum amount and the amounts are dependent upon future contingent events, the nature and likelihood of which cannot be determined at this time. No amount has been accrued in the interim consolidated financial statements with respect to these indemnifications. Joint Ventures The Telegraph Group Limited ("Telegraph") has guaranteed the printing joint venture partners' share of equipment leasing obligations to third parties, which amounted to approximately $948,000 (L372,000) at December 31, 2002. These obligations are guaranteed jointly and severally by each joint venture partner. Land leased by the Telegraph under a Head Lease under which the property is held until July 2183 has been sublet to West Ferry Printers, one of the Telegraph's printing joint ventures. The sublease is for a term of 34 years from 1987. Although the sublease has been consented to by the landlord, it has not released Telegraph from its obligation under the lease and, accordingly, Telegraph is contingently liable for performance by West Ferry Printers. Annual rents under the lease are based on a percentage of immoveable assets, currently L600,000 per year. Pursuant to a joint venture agreement in the United Kingdom, the Telegraph has agreed to guarantee up to L0.5 million, if required, in connection with borrowing by the joint venture. To date, the joint venture has made no request for the supporting guarantee. Pursuant to the West Ferry joint venture agreement, the Telegraph has a commitment to fund 50% of the obligation under West Ferry's defined benefit plan. Dispositions In connection with certain dispositions of assets and/or businesses, the Company has provided customary representations and warranties whose terms range in duration and may not be explicitly defined. The Company has also retained certain liabilities for events occurring prior to sale, relating to tax, environmental, litigation and other matters. Generally, the Company has indemnified the purchasers in the event that a third party asserts a claim against the purchaser that relates to a liability retained by the Company. These types of indemnification guarantees typically extend for a number of years. The Company is unable to estimate the maximum potential liability for these indemnifications as the underlying agreements do not always specify a maximum amount and the amounts are dependent upon the outcome of future contingent events, the nature and likelihood of which cannot be determined at this time. Historically, the Company has not made any significant indemnification payments under such agreements and no amount has been accrued in the accompanying interim consolidated financial F-69 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) statements with respect to these indemnification guarantees. The Company continues to monitor the conditions that are subject to guarantees and indemnifications to identify whether it is probable that a loss has occurred, and would recognize any such losses under any guarantees or indemnifications when those losses are probable and estimable. Amended and Restated Credit Agreement The Company and its subsidiaries also indemnified the Borrower against any related tax liabilities arising from payments made with respect to the revolving bank credit facility, except taxes on Borrower's income. These indemnifications generally extended for the term of the revolving bank credit facility and did not provide for any limit on the maximum potential liability. The revolving bank credit facility was repaid in March 2003. Credit Facilities Under Hollinger International's Senior Credit Facility, Hollinger International has agreed to indemnify its lenders under that facility against certain costs or losses resulting from changes in laws and regulations which would increase the lenders' costs or reduce the rate of return otherwise available to them in respect of the loans to Hollinger International. Hollinger International has further agreed to indemnify certain lenders against existing loans to the extent that such loans impose an obligation for withholding tax or similar charge on interest, should such tax or charge not be recoverable by the lenders. These indemnifications generally extend for the term of the credit facilities and do not provide for any limit on the maximum potential liability. Hollinger International is unable to estimate the maximum potential liability for these types of indemnifications as the credit agreements do not specify a maximum amount and the amounts are dependent upon future contingent events, the nature and likelihood of which cannot be determined at this time. No amount has been accrued in the accompanying interim consolidated financial statements with respect to these indemnifications. International is unable to estimate amounts due for withholding taxes at this time. Any such amounts will increase the future effective cost of borrowing. Hollinger International has indemnified the lenders and their affiliates from and against all losses as a result of any obligations of any of the borrowers and guarantors under its Senior Credit Facility. Participation Trust In connection with the participation agreement, International has agreed to indemnify the Participation Trust and its trustee, in the event the participation agreement entitles the issuer to fail to make payments with respect to the debentures. Although the indemnity has not been capped, the Company estimates the liability is limited to the amount of participation interests sold, totalling US$490.5 million, plus accrued interest and any further debentures received as paid-in-kind interest. Other The Company licenses some of the content it publishes for use by third parties. In doing so, the Company warrants that it is entitled to license that content and indemnifies the licensee against claims against improper use. The number of quantum of such claims cannot be reasonably estimated. Historically, claims of this nature have not been significant. In special circumstances, the Company's newspaper operations may engage freelance reporters to cover stories in locales that carry a high risk of personal injury or death. Telegraph has engaged a number of journalists and photographers to report from the Middle East. As a term of engagement, F-70 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) Telegraph has agreed to provide a death benefit which, in the aggregate for all freelancers engaged, amounts to L2,600,000. This exposure is uninsured. Precautions have been taken to avoid a concentration of the freelancers in any one location. 28. COMPARATIVE FIGURES Certain comparative figures have been reclassified to conform with the financial statement presentation adopted in the current period. 29. SUBSEQUENT EVENTS a) On March 10, 2003, the Company issued US$120,000,000 aggregate principal amount of 11 7/8% Senior Secured Notes due 2011. These notes are secured by 10,108,302 shares of Hollinger International Class A common stock and all 14,990,000 shares of Hollinger International Class B common stock. The total net proceeds were used to repay existing bank indebtedness, to repay amounts due to Ravelston and make an advance to Ravelston. The Senior Secured Notes are fully and unconditionally guaranteed by RMI, a wholly owned subsidiary of Ravelston. The Company and RMI entered into a support agreement, under which RMI is required to make an annual support payment in cash to the Company on a periodic basis by way of contributions to the capital of the Company (without receiving any shares of the Company) or subordinated debt. The amount of the annual support payment will be equal to the greater of a) the non-consolidated negative net cash flow of the Company (which does not include outlays for retractions or redemptions) and b) US$14.0 million per year (less any future payments of services agreements fees NB Inc. and any excess in the net dividend amount received by the Company or any of the Company's wholly owned restricted subsidiaries, as they are defined in the indenture governing the Company's Senior Secured Notes due 2011, on the shares of Hollinger International that the Company and NB Inc. own that is over US$4.65 million per year), in either case, reduced by any permanent repayment of debt owing by Ravelston to the Company. Initially, the support amount to be contributed by RMI is expected to be satisfied through the permanent repayment by Ravelston of its approximate $16.4 million of advances from the Company, which resulted from the use of proceeds of the Company's offering of its Senior Secured Notes. Thereafter, all support amount contributions by RMI will be made through contributions to the capital of the Company, without receiving any additional shares of the Company, except that, to the extent that the minimum payment exceeds the negative net cash flow of the Company, the amounts will be contributed through an interest-bearing, unsecured, subordinated loan to the Company. The support agreement terminates upon the repayment of the Senior Secured Notes, which mature in 2011. All aspects of this transaction have been reviewed and approved by a special committee of the Board of Directors of the Company, comprised entirely of independent directors. b) On March 10, 2003, prior to the closing of the above offering, NB Inc. sold its shares of Class A common stock and Series E redeemable preferred stock of Hollinger International to RMI. Such shares were in turn sold back to NB Inc. from RMI at the same price with a resulting increase in the tax basis of the shares of Hollinger International and a taxable gain to RMI. As the exchange of the Hollinger International shares with RMI represents a transfer between companies under common control, NB Inc. will record in 2003, contributed surplus of approximately $1.4 million, being the tax benefit associated with the increase in the tax value of the shares of Hollinger International. c) On March 10, 2003, Hollinger International repurchased shares of its Class A common stock and redeemed shares of Series E preferred stock from the Company and has revised certain debt F-71 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) arrangements it had in place with the Company. These transactions were completed in conjunction with the Company closing a private placement of Senior Secured Notes (note 29a)). Contemporaneously with the closing of the issue of Senior Secured Notes, Hollinger International: i) repurchased for cancellation, from NB Inc., 2,000,000 shares of Class A common stock of Hollinger International at US$8.25 per share for total proceeds of $24.2 million (US$16.5 million); and ii) redeemed, from NB Inc., pursuant to a redemption request, all of the 93,206 outstanding shares of Series E redeemable convertible preferred stock of Hollinger International at the fixed redemption price of $146.63 per share being a total of $13.6 million (US$9.3 million). As a result, the Company's equity and voting interest in Hollinger International is 30.3% and 72.6%, respectively. The dilution gain arising on this effective sale will be recorded in 2003. Proceeds from the repurchase and redemption were offset against debt due to Hollinger International from NB Inc. (note 23b)), resulting in net outstanding debt due to Hollinger International of approximately $29.9 million (US$20.4 million) as of March 10, 2003. The remaining debt bears interest at 14.25% or, if paid in additional notes, 16.5% and is subordinated to the Company's Senior Secured Notes (so long as the Notes are outstanding), guaranteed by Ravelston and secured by certain assets of Ravelston. Following a review by a special committee of the Board of Directors of Hollinger International, comprised entirely of independent directors, of all aspects of the transaction relating to the changes in the debt arrangements with NB Inc. and the subordination of this remaining debt, the special committee approved the new debt arrangements, including the subordination. d) On April 21, 2003, the Company made an offer to exchange its Series III preference shares into Series IV preference shares on a share-for-share basis. The terms of the new Series IV preference shares will provide for a mandatory redemption on April 30, 2008 for $10.00 cash per share (plus unpaid dividends) and an annual cumulative dividend, payable quarterly, of $0.80 per share per annum (or 8%) during the five-year term. As with the Series III preference shares, i) the Company will have the right at its option to redeem all or part of the Series IV preference shares at any time after three years for $10.00 cash per share (plus unpaid dividends) and ii) holders will have the right at any time to retract the Series IV preference shares for a retraction price payable in cash which, during the first four years, will be calculated by reference to Government of Canada bonds having a comparable yield and term to the shares, and during the fifth year, the retraction price will be $9.50 per share (plus unpaid dividends in each case). The offer was conditional upon acceptance by holders of at least 50% of the outstanding Series III preference shares. The bid originally expired on May 27, 2003 and was extended until June 9, 2003. This condition was not met and, accordingly, the offer was terminated. e) Effective April 30, 2003, US$15.7 million principal amount of subordinated debt owing to Hollinger International by NB Inc. was transferred by Hollinger International to HCPH Co., a subsidiary of Hollinger International, and subsequently transferred to RMI by HCPH Co. in satisfaction of a loan due from HCPH Co. to RMI (note 23d)). International and the Company previously reported that the committee of independent directors of International had agreed to the US$15.7 million offset to the remaining US$20.4 million of debt against amounts owed by International to RMI, and further stated that the offset was effected April 30, 2003. Although management of International and the Company believed final approval had been given to the offset by the committee of independent directors of International, the committee has advised that final approval of any offset remains subject to appropriate due diligence and receipt of a further independent fairness opinion. The due diligence process has not yet been concluded and accordingly, the offset has not been completed as at August 25, 2003. The debt owing by NB Inc. to Hollinger International of U.S.$20.4 million bears interest at the rate of 14.25% if interest is paid in cash and 16.50% if it is paid in kind. The debt is subordinated to the Senior Secured Notes for so long as the Senior Secured Notes are F-72 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) outstanding, and is guaranteed by RCL and the Company. Hollinger International entered into a subordination agreement with the Company and NB Inc. pursuant to which Hollinger International has subordinated all payments of principal, interest and fees on the debt owed to it by NB Inc. to the payment in full of principal, interest and fees on the Senior Secured Notes, provided that payments with respect to principal and interest can be made to International to the extent permitted in the indenture governing the Senior Secured Notes. f) During the period April 1, 2003 to May 16, 2003, holders of 3,651,784 Series III preference shares, holders of 504,989 Series II preference shares and holders of 22,500 retractable common shares submitted retraction notices to the Company. As of May 20, 2003, the Company completed or announced that it was able to complete the retraction of 504,989 Series II preference shares for 232,293 shares of Hollinger International Class A common stock, 876,050 Series III preference shares for approximately $7.7 million in cash and 22,500 retractable common shares for cash of $124,000. This completed all retraction notices received up to and including April 30, 2003. On May 20, 2003, after careful deliberation, the Company concluded that it was not able to complete the retractions of shares submitted after April 30, 2003 without unduly impairing its liquidity. Since April 30, 2003 and up to and including June 19, 2003, the Company has received retraction notices from holders of 2,939,593 Series III preference shares, of which 1,281,239 retraction notices were subsequently withdrawn, leaving retraction notices from the holders of 1,658,354 Series III preference shares, for aggregate retraction proceeds of $15.8 million, which were unable to be completed at the current time. In addition, during the same time period, retraction notices were received from the holders of 357,958 Series II preference shares for aggregate retraction proceeds of 164,660 shares of Hollinger International Class A common stock or cash of $2.5 million, which were unable to be completed at the current time. The Company will periodically review its liquidity position to determine if and when further retractions can be completed. The Company will not complete the retractions or redemptions if to do so would unduly impair its liquidity. Retractions of Series II preferences shares and Series III preference shares will be processed on a combined basis in order determined by their retraction date (with equal ranking of the series) in advance of any retractable common shares that are submitted for retraction. Following the satisfaction of all pending retracted Series II preference shares and Series III preference shares, retractions of the retractable common shares will be processed in order determined by their retraction date. Accordingly, retractions of retractable common shares cannot be completed as long as there are pending and unsatisfied retractions of Series II preference shares and Series III preference shares. g) On May 11, 2003, 3815668 Canada Inc., a subsidiary of CanWest (the Issuer of the 12 1/8% Subordinated Debentures due 2010 received by the Company in partial consideration on sale of the Company's Canadian newspaper operations to CanWest in November 2000) redeemed $265.0 million principal amount of the 12 1/8% debentures, exclusive of interest accrued to the redemption date of $8.8 million. Of the total amount received, US$159.8 million has been delivered to the Participation Trust and the balance of US$27.6 million has been received by Hollinger International and Hollinger LP., a portion of which must be retained until November 4, 2010. h) On May 19, 2003, a shareholder of Hollinger International filed a Schedule 13D with the U.S. Securities and Exchange Commission (the "SEC") and amongst other things, served a demand letter on the Board of Directors of Hollinger International (the "Board") requesting that the Board investigate and, if determined to be advisable, take corrective action in respect of F-73 HOLLINGER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (TABULAR AMOUNTS ARE IN THOUSANDS OF CANADIAN DOLLARS EXCEPT WHERE NOTED) payments made to senior executives of Hollinger International in respect of non-competition agreements, that had been disclosed in the financial statements. On June 11, 2003, the same shareholder filed an Amendment to the Schedule 13D with the SEC reiterating the earlier demands as well as requesting that the Board investigate and, if determined to be advisable, take corrective action in respect of i) an asset sale by Hollinger International to an entity affiliated with certain officers and directors of Hollinger International, and (ii) the payment of fees by Hollinger International pursuant to various affiliated management services agreements. On June 17, 2003, in response to these requests, the Board established a special committee to conduct an independent review and investigation of those allegations. The potential impact of filing and the demand letters, on the financial statements of Hollinger International and the Company, is not known at the current time. i) On May 22, 2003, Hollinger International and the Company announced that they had reached an agreement in principle, regarding a proposed transaction with Southeastern Asset Management Inc. ("Southeastern"). Under the proposed transaction, Southeastern would purchase from the Company between five to ten million shares (as determined by the Company) of Hollinger International Class A common stock at a purchase price of US$11.60 per share. The terms of the shares of Class B common stock of Hollinger International, which currently have ten votes per share and represent approximately 67% of the voting power of Hollinger International, would be amended to allocate 35% of the voting power of Hollinger International to the shares of Class B common stock for a period of 3 1/2 years. The voting power of the shares of Class B common stock would then be reduced to two votes per share for 18 months thereafter, after which time, the shares of Class B common stock would be converted on a share-for-share basis into shares of Class A common stock. Going forward, Ravelston management would be employed and paid directly by Hollinger International. An aggregate annual compensation level of US$20 million has received the support of Southeastern which would have the right to nominate three directors to the Board of Hollinger International. Completion of the transaction is subject to various conditions, including approval of the Board of Directors of Hollinger International and the Company, approval by the shareholders of Hollinger International and the execution of definitive agreements. If the requisite approvals are obtained, it is contemplated that the transaction would close on or before September 30, 2003. Since the proposed transaction is in its preliminary stages and has not yet been finalized, the Company has not yet determined the potential impact on its financial statements. j) In 2003, Hollinger International made a venture capital investment of US$2.5 million in a corporation in which a director of Hollinger International has a minority interest. k) Commencing April 3, 2003, Hollinger International began purchasing its own shares through the public market and holding the shares acquired as treasury stock. During the period April 3, 2003 to May 5, 2003, Hollinger International acquired 1,000,000 shares of its Class A common stock at an average price of U.S.$8.79 per share for total cash consideration of U.S.$8.8 million. F-74 HOLLINGER INC. SCHEDULE 1 -- CONDENSED UNCONSOLIDATED FINANCIAL INFORMATION OF THE COMPANY CONDENSED NON-CONSOLIDATED BALANCE SHEETS
DECEMBER 31 --------------------- 2001 2002 --------- --------- (IN THOUSANDS OF CANADIAN DOLLARS) ASSETS CURRENT ASSETS Prepaid expenses and other assets........................... $ 978 $ 1,751 Due from subsidiaries....................................... 22,620 26,616 --------- --------- 23,598 28,367 Equity investments in subsidiaries and affiliates........... 130,460 115,612 Other assets................................................ 1,446 1,234 --------- --------- $ 155,504 $ 145,213 ========= ========= LIABILITIES CURRENT LIABILITIES Bank indebtedness........................................... $ 129,475 90,810 Accounts payable and accrued expenses....................... 3,003 2,278 Retractable preference shares............................... -- 135,299 Deferred unrealized gain on retractable preference shares... -- 11,983 Due to subsidiaries (note 5)................................ 107,174 210,085 Due to The Ravelston Corporation Limited.................... 23,500 46,089 --------- --------- 263,152 496,544 Retractable preference shares............................... 147,472 -- Deferred unrealized gain on retractable preference shares... 7,670 -- Future income taxes......................................... 680 -- --------- --------- 418,974 496,544 --------- --------- SHAREHOLDERS' DEFICIENCY Capital stock............................................... 271,774 273,759 Contributed surplus (note 2)................................ 51,797 51,797 Deficit (note 3)............................................ (537,110) (656,942) --------- --------- (213,539) (331,386) Equity adjustment from foreign currency translation......... (49,931) (19,945) --------- --------- (263,470) (351,331) --------- --------- $ 155,504 $ 145,213 ========= =========
See accompanying notes to condensed non-consolidated financial statements. F-75 HOLLINGER INC. SCHEDULE 1 -- CONDENSED UNCONSOLIDATED FINANCIAL INFORMATION OF THE COMPANY -- (CONTINUED) CONDENSED NON-CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
YEARS ENDED DECEMBER 31 ---------------------------------- 2000 2001 2002 --------- ---------- --------- (IN THOUSANDS OF CANADIAN DOLLARS) REVENUE Interest income............................................. $ 183 $ 388 $ 26 -------- --------- -------- EXPENSES General and administrative expenses......................... 1,900 2,591 3,259 Amortization of deferred finance costs...................... 1,177 1,963 2,560 Interest on exchangeable shares............................. 11,054 9,294 8,185 Interest on amounts due to The Ravelston Corporation Limited................................................... -- -- 2,045 Other interest.............................................. 14,386 11,626 5,614 -------- --------- -------- 28,517 25,474 21,663 -------- --------- -------- Net earnings (loss) in equity accounted companies........... 185,740 (165,899) (66,773) -------- --------- -------- Net foreign currency gains (losses)......................... 74 (16) 15 -------- --------- -------- Earnings (loss) before the undernoted....................... 157,480 (191,001) (88,395) Unusual gains (losses), net (note 4)........................ 32,969 54,670 (293) Income tax recovery (expense)............................... (1,076) 4,433 48 -------- --------- -------- Net earnings (loss)......................................... $189,373 $(131,898) $(88,640) ======== ========= ========
See accompanying notes to condensed non-consolidated financial statements. F-76 HOLLINGER INC. SCHEDULE 1 -- CONDENSED UNCONSOLIDATED FINANCIAL INFORMATION OF THE COMPANY -- (CONTINUED) CONDENSED NON-CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31 ---------------------------------- 2000 2001 2002 --------- ---------- --------- (IN THOUSANDS OF CANADIAN DOLLARS) CASH PROVIDED BY (USED FOR): OPERATING ACTIVITIES Net earnings (loss)......................................... $189,373 $(131,898) $(88,640) Unusual gains (losses), net................................. (32,969) (54,670) 293 Other income (costs)........................................ 1,444 (1,964) 212 -------- --------- -------- 157,848 (188,532) (88,135) Items not involving cash: Amortization of deferred finance costs...................... 1,177 1,963 2,560 Net (earnings) loss in equity accounted companies, net of amounts received.......................................... (96,193) 245,738 74,472 Change in non-cash operating working capital................ (343) 23,144 (1,499) Other....................................................... 1,677 -- -- Future income taxes......................................... -- (5,239) (680) -------- --------- -------- 64,166 77,074 (13,282) FINANCING ACTIVITIES Redemption and cancellation of capital stock................ (700) (273) (1,064) Redemption and cancellation of exchangeable shares.......... (5,133) (317) (277) Increase (decrease) in short-term borrowings................ 4,039 (32,525) (38,665) Increase in amount due to Ravelston......................... 2,267 21,233 22,589 Change in amounts due to subsidiaries....................... 12,728 (63,713) 49,203 Dividends paid on retractable common shares................. (22,177) (20,216) (16,031) Redemption of HCPH special shares........................... (54,482) -- -- Other....................................................... -- -- (2,473) -------- --------- -------- (63,458) (95,811) 13,282 INVESTING ACTIVITIES Proceeds on disposal of investments......................... -- 19,892 -- Additions to investments.................................... -- (1,155) -- Increase in other assets.................................... (708) -- -- -------- --------- -------- (708) 18,737 -- -------- --------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ -- $ -- $ -- ======== ========= ======== SUPPLEMENTAL DISCLOSURE Dividends received from subsidiaries...................... $ 89,547 $ 79,839 $ 7,699 ======== ========= ========
See accompanying notes to condensed non-consolidated financial statements. F-77 NOTES TO CONDENSED NON-CONSOLIDATED FINANCIAL STATEMENTS SCHEDULE 1 -- CONDENSED UNCONSOLIDATED FINANCIAL INFORMATION OF THE COMPANY YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002 1. BASIS OF PRESENTATION: The accompanying condensed non-consolidated financial statements include the accounts of Hollinger Inc. and, on an equity basis, its subsidiaries and affiliates. These financial statements should be read in conjunction with the consolidated financial statements of the Company. The Company is a holding company and its assets consist primarily of investments in its wholly owned subsidiaries, including Hollinger International and Publishing. As a result, the Company's ability to meet its future financial obligations, including the retraction and redemption of shares, is dependent upon the availability of cash flows from its United States and foreign subsidiaries through dividends, intercompany advances, management fees and other payments, as well as on the ongoing support of RMI. This is fully described in note 1 to the Company's consolidated financial statements. As further described in note 9 to the Company's consolidated financial statements, Publishing and its principal United States and foreign subsidiaries are subject to statutory restrictions and restrictions in debt agreements that limit their ability, among other things, to incur indebtedness, pay dividends or make other distributions on its capital stock, enter into transactions with related companies, and sell assets, including stock of a restricted subsidiary. As a result, substantially all of the net assets of the Company's subsidiaries are restricted. As further described in note 9 to the Company's consolidated financial statements, on December 23, 2002, Publishing issued senior unsecured notes and certain of Publishing's subsidiaries entered into a Senior Credit Facility. These debt agreements also restrict Publishing's ability and the ability of Publishing's restricted subsidiaries, to, among other things, incur additional debt, make advances, pay dividends or distributions on, redeem or repurchase capital stock, make investments, enter into transactions with affiliates, issue stock of restricted subsidiaries, engage in unrelated lines of business, create liens to secure debt; and transfer or sell assets or merge with or into other companies. 2. CONTRIBUTED SURPLUS: During 2000 and 2001, the Company sold certain of its investments in its wholly-owned subsidiaries to other wholly-owned subsidiaries, for cash, promissory notes and share consideration. The excess of or shortfall in the cash and promissory notes received over the historical carrying value of the Company's investment in the wholly-owned subsidiaries sold has been reflected as contributed surplus. 3. DEFICIT: As described in note 1 "Significant Accounting Policies -- Goodwill and Other Intangible Assets" to the Company's consolidated financial statements, on adoption of new accounting standards, Hollinger International has determined that the carrying amount of the Jerusalem Post was in excess of the estimated fair value at January 1, 2002. The impairment write down of goodwill, net of related minority interest has been charged to opening deficit as at January 1, 2002. 4. UNUSUAL GAINS (LOSSES), NET: In 2000 and 2001, unusual gains (losses), net are principally comprised of the dilution gain arising on the sale of shares of Hollinger International and gains resulting from the delivery of shares of Hollinger International on the exchange of Series II preference shares. 5. DUE TO SUBSIDIARIES: The amount due to subsidiaries includes $198,311,000 at December 31, 2002 ($96,195,000 at December 31, 2001) to 504468 N.B. Inc., which results from advances made to the Company from the F-78 SCHEDULE I HOLLINGER INC. NOTES TO CONDENSED NON-CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED SCHEDULE 1 -- CONDENSED UNCONSOLIDATED FINANCIAL INFORMATION OF THE COMPANY -- (CONTINUED) proceeds from sales of shares of Hollinger International Class A common stock and from dividends received by 504468 N.B. Inc. on its shares of Hollinger International common stock. 504468 N.B. Inc. will declare a dividend to settle the amount receivable from the Company and declare regular dividends in the future to settle future funds advanced to the Company. F-79 ITEM 19. EXHIBITS
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT 1.1a* Certificate of Amalgamation and Articles of Amalgamation amalgamating Argcen Holdings Inc., Hollinger Argus Limited and Labmin Resources Limited, dated September 17, 1985 1.1b* Amalgamation Agreement between Argcen Holdings Inc., Hollinger Argus Limited and Labmin Resources Limited, dated August 23, 1985 1.1c* Certificate of Amendment and Articles of Amendment, dated June 14, 1989 1.1d* Certificate of Amendment and Articles of Amendment, dated May 30, 1996 1.1e* Certificate of Amendment and Articles of Amendment, dated September 11, 1997 1.1f* Certificate of Amendment and Articles of Amendment, dated November 7, 1997 1.1g* Certificate of Amendment and Articles of Amendment, dated June 3, 1998 1.1h* Certificate of Amendment and Articles of Amendment, dated April 28, 1999 1.1I* Certificate of Amendment and Articles of Amendment, dated April 22, 2003 1.2a* By-Law Number A24, dated March 14, 1984 1.2b* By-Law Number A25, dated June 28, 1984 1.2c* By-Law Number A26, dated February 27, 2002 4.1* Trust Indenture, dated as of March 10, 2003, among Hollinger Inc., Ravelston Management Inc., 504468 N.B. Inc. and Wachovia Trust Company, National Association, Ravelston Corporation Limited and Sugra Limited 4.2* Registration Rights Agreement, dated as of March 5, 2003 among Hollinger Inc., Ravelston Management Inc., 504468 N.B. Inc., and Wachovia Securities, Inc. 4.3* Form of Note 4.4 Hollinger Inc. Non-Competition, Non-Solicitation and Confidentiality Agreement, dated as of November 15, 2000, between CanWest Global Communications Corporation, 3815668 Canada Inc. and Hollinger Inc. (Incorporated by reference to Exhibit 4.4 to Amendment No. 1 to the Registration Statement on Form F-4 dated September 17, 2003). 4.5 Contribution Agreement, dated as of March 10, 2003, between The Ravelston Corporation Limited, Ravelston Management Inc. and Hollinger Inc. (Incorporated by reference to Exhibit 4.5 to Amendment No. 1 to the Registration Statement on Form F-4 dated September 17, 2003). 4.6 Support Agreement, dated as of March 10, 2003, between Ravelston Management Inc. and Hollinger Inc. (Incorporated by reference to Exhibit 4.6 to Amendment No. 1 to the Registration Statement on Form F-4 dated September 17, 2003). 8.1* List of Subsidiaries - see Item 4f. - "Organizational Structure" 12.1 Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act 12.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act 13.1 Certification by the Chief Executive Officer of periodic financial report pursuant to 18 U.S.C. Section 1350, as mandated by Section 906 of the Sarbanes-Oxley Act 13.2 Certification by the Chief Financial Officer of periodic financial report pursuant to 18 U.S.C. Section 1350, as mandated by Section 906 of the Sarbanes-Oxley Act
* PREVIOUSLY FILED AS AN EXHIBIT TO, OR INCORPORATED BY REFERENCE AS INDICATED IN, OUR ANNUAL REPORT ON FORM 20-F FOR THE YEAR ENDED DECEMBER 31, 2002 FILED ON JUNE 27, 2003. 64 SIGNATURES The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and it has duly caused and authorized the undersigned to sign this amendment to the annual report on its behalf. HOLLINGER INC. (Registrant) By: /s/ Conrad M. Black -------------------------------------- Lord Black of Crossharbour, PC(C), OC, KCSG Chairman and Chief Executive Officer 65