UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission File No. 1-14164

 

SUN-TIMES MEDIA GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code

(312) 321-2299

 

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 and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

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

 

Large Accelerated Filer   þ   Accelerated Filer  o   Non-accelerated Filer  o

 

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

 

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

 

 

TABLE OF CONTENTS

 

INDEX

 

SUN-TIMES MEDIA GROUP, INC.

 

FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 as amended and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. These statements relate to future events or the Company’s future financial performance with respect to its financial condition, results of operations, business plans and strategies, operating efficiencies, competitive positions, growth opportunities, plans and objectives of management, capital expenditures, growth and other matters. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, levels of activity, performance or achievements of the Company or the newspaper industry to be materially different from those expressed or implied by any forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential,” “seek,” or “continue” or the negative of those terms or other comparable terminology. These statements are only predictions and such expectations may prove to be incorrect. Some of the things that could cause the Company’s actual results to differ substantially from its current expectations are:

 

 

The Company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise except as required by federal securities laws. The Company does not, nor does any other person, assume responsibility for the accuracy and completeness of those statements. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under the caption “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

 

The Company operates in a continually changing business environment, and new risks emerge from time to time. Management cannot predict such new risks, nor can it assess either the impact, if any, of such risks on the Company’s businesses or the extent to which any risk or combination of risks may cause actual results to differ materially from those projected in any forward-looking statements. In light of these risks, uncertainties and assumptions, it should be kept in mind that future events or conditions described in any forward-looking statement made in this Quarterly Report on Form 10-Q might not occur.

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Six Months Ended June 30, 2007 and 2006

 

 

See accompanying notes to condensed consolidated financial statements.

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the Three and Six Months Ended June 30, 2007 and 2006

 

 

See accompanying notes to condensed consolidated financial statements.

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2007 and December 31, 2006

 

 

See accompanying notes to condensed consolidated financial statements.

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)
For the Six Months Ended June 30, 2007

 

 

See accompanying notes to condensed consolidated financial statements.

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2007 and 2006

 

 

See accompanying notes to condensed consolidated financial statements.

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

 

The accompanying condensed consolidated financial statements of Sun-Times Media Group, Inc. (formerly “Hollinger International, Inc.”) and subsidiaries (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Certain information and note disclosures normally included in comprehensive annual financial statements presented in accordance with GAAP have been condensed or omitted pursuant to Securities and Exchange Commission rules and regulations.

 

Management believes that the accompanying condensed consolidated financial statements contain all adjustments (which include normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the Company’s consolidated financial condition, results of operations, stockholders’ equity, other comprehensive income and cash flows for the periods presented. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s 2006 Form 10-K (the “2006 10-K”).

 

The preparation of the Company’s condensed consolidated financial statements requires it 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 matters that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. These areas include bad debts, goodwill, intangible assets, income taxes, pensions and other post-retirement benefits, contingencies and litigation. The Company bases its estimates on historical experience, observance of trends in particular matters, information available from outside sources and various other assumptions that are believed to be reasonable under the circumstances. Information from these sources form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Actual amounts may differ from these estimates under different assumptions or conditions.

 

 

The Company operates principally in the business of publishing, printing and distributing newspapers and magazines. The Company’s publications include the Chicago Sun-Times, Post Tribune, Daily Southtown and other city and suburban newspapers in the Chicago metropolitan area. The Company’s business is organized and managed within a single operating segment.

 

At June 30, 2007, Hollinger Inc., a Canadian corporation, held, directly or indirectly, approximately 19.7% of the combined equity and approximately 70.0% of the combined voting power of the outstanding common stock of the Company.

 

The condensed consolidated financial statements include the accounts of the Company and its majority owned subsidiaries.

 

All significant intercompany balances and transactions have been eliminated in consolidation.

 

Certain amounts in the 2006 financial statements have been reclassified to conform with the current year presentation.

 

 

Gain from Disposal of Business Segment

 

In connection with the preparation of its consolidated financial statements for the year ended December 31, 2006, the Company determined that there was an error related to the gain from disposal of business segment

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

recorded in the first quarter of 2006. The error related to certain tax liabilities in respect of the sold operations that should have been considered in determining the gain.

 

The gain from disposal of business segment for the six months ended June 30, 2006 has been restated as follows (in thousands):

 

 

The amount of incremental gain also represents the effects on earnings from discontinued operations, and net loss for the six months ended June 30, 2006.

 

The effect on specific amounts presented in the Condensed Consolidated Statement of Operations (after effect of discontinued operations) for the six months ended June 30, 2006 is as follows:

 

 

Error in Adoption of SFAS No. 158

 

Upon adoption of Statement of Financial Accounting Standards (“SFAS”) No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”) in 2006, the Company recognized a comprehensive loss of $29.3 million (net of income taxes) to record the unfunded portion of its defined benefit and other postretirement benefit plan liabilities. This adjustment was disclosed in the footnotes to the financial statements. However, SFAS No. 158 requires that this adjustment not affect comprehensive income, but rather be reflected as an adjustment directly to stockholders’ equity.

 

As a result of this error, the reported comprehensive loss of $93.9 million was overstated by $29.3 million. The reported net loss, the loss from continuing operations, the cumulative pension adjustment and total stockholders’ deficit were not affected by this misstatement. The Company will correct this misstatement with the filing of its Form 10-K for the year ended December 31, 2007.

 

 

In January 2006, the Company announced a reorganization of its operations aimed at accelerating and enhancing its strategic growth and improving its operating results. The plan included a targeted 10% reduction in full-time staffing levels. Certain of the costs directly associated with the reorganization included voluntary and involuntary termination benefits. These costs have been recognized in accordance with SFAS No. 88 (as amended) “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” related to incremental voluntary termination severance benefits and SFAS No. 112 “Employers’ Accounting for Postemployment Benefits” for the involuntary, or base, portion of termination benefits under the Company’s established termination plan and practices. See Note 7.

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

The reorganization accrual is included in “Accounts payable and accrued expenses” in the Condensed Consolidated Balance Sheet at June 30, 2007. The following summarizes the termination benefits recorded and reconciles such charges to the accrual at June 30, 2007 (in thousands):

 

 

 

Basic earnings (loss) per share is calculated by dividing net earnings (loss) by the weighted average number of common stock equivalents outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net earnings (loss) after assumed conversion of dilutive securities by the sum of the weighted average number of common shares outstanding plus all additional common shares that would have been outstanding if potentially dilutive common shares had been issued. In certain periods, diluted earnings (loss) per share is the same as basic net earnings (loss) per share because dilutive securities are not used in the calculation if to do so would have been anti-dilutive or if potentially dilutive securities are not dilutive based on the Company’s stock price during the period. The number of potentially dilutive securities comprised of shares issuable in respect of stock options and deferred stock units at June 30, 2007 and 2006, was 0.8 million and 1.5 million, respectively.

 

The following tables reconcile the numerator and denominator for the calculation of basic and diluted earnings (loss) per share from continuing operations for the three and six month periods ended June 30, 2007 and 2006:

 

 

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

 

 

 

On February 6, 2006, the Company completed the sale of substantially all of its remaining Canadian operating assets, consisting of, among other things, approximately 87% of the outstanding equity units of Hollinger L.P. and all of the shares of Hollinger Canadian Newspapers GP Inc., Eco Log Environmental Risk Information Services Ltd. and KCN Capital News Company, for an aggregate sale price of $106.0 million, of which $17.5 million was placed in escrow ($19.9 million including interest and currency translation adjustments as of June 30, 2007). A majority of the escrow may be held up to seven years, and will be released to either the Company, Glacier Ventures International Corp. (the purchaser) or CanWest Global Communications Corp. (“CanWest”) upon a final award, judgment or settlement being made in respect of certain pending arbitration proceedings involving the Company, its related entities and CanWest. In addition, the Company received $4.3 million in the second quarter of 2006, and received an additional $2.8 million in July 2006, related to working capital and other adjustments. The Company recognized a gain on sale of $18.6 million, net of taxes of $35.7 million, which is included in “Gain from disposal of business segment” in the Condensed Consolidated Statements of Operations for the six month period ended June 30, 2006. For the one month ended January 31, 2006, revenue for the disposal group was $5.6 million and income before taxes and minority interest was $0.2 million.

 

The Company has reflected its remaining Canadian newspaper operations sold on February 6, 2006 as discontinued operations in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” Remaining administrative activities and assets and liabilities, largely related to pension, post-employment and post-retirement plans, are presented in continuing operations.

 

In the second quarter of 2006, the Company recorded an adjustment of $0.5 million, net of taxes of $0.3 million, to the gain on sale of The Daily Telegraph, The Sunday Telegraph, The Weekly Telegraph, telegraph.co.uk, and The Spectator and Apollo magazines (collectively, the “Telegraph Group”) largely related to additional tax losses surrendered to the purchaser.

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

 

Items Included in “Other Operating Costs”

 

Included in “Other operating costs” are the following amounts that the Company believes may make meaningful comparison of results between periods difficult based on their nature, magnitude and infrequency.

 

 

Items Included in “Corporate Expenses”

 

Included in “Corporate expenses” are the following amounts that the Company believes may make meaningful comparison of results between periods difficult based on their nature, magnitude and infrequency.

 

 

 

 

 

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

 

The Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”) on January 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s financial position or results of operations. As part of its adoption, the Company performed an item by item evaluation and considered the state of its ongoing audits by, and discussions with, various taxing authorities. Although the Company has made significant progress in resolving or settling certain tax issues as described below, the remaining items under the caption “Other tax liabilities” in the accompanying Condensed Consolidated Balance Sheet at June 30, 2007 have not sufficiently advanced to the degree or with the level of finality that would cause the Company to adjust its accruals for income tax liabilities under the “more likely than not” criteria pursuant to FIN 48.

 

FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. It is the Company’s continuing practice to recognize interest and/or penalties related to income tax matters in income tax expense. Accrued interest and penalties at June 30, 2007 and January 1, 2007 were $134.7 million and $310.8 million, respectively and are included in “Income taxes payable and other tax liabilities” and “Other tax liabilities” aggregating $451.9 million and $976.4 million at June 30, 2007 and January 1, 2007, respectively.

 

The Company’s U.S. tax returns for 1998 and subsequent years remain subject to examination by tax authorities. In our foreign tax jurisdictions, certain issues remain subject to examination by tax authorities, including tax returns for 2001 and subsequent years.

 

On April 26, 2007, the Company entered into a written agreement with the Canada Revenue Agency (“CRA”) settling certain tax issues largely related to the disposition of certain Canadian operations in 2000. As a result, the Company expects to pay aggregate Canadian federal and provincial taxes and interest of $36.1 million, in respect of these issues. Interest continues to accrue until such time as payment is made. Certain other tax issues remain open with respect to Canada. In the second quarter of 2007 the Company recorded a tax benefit of $586.7 million related to this settlement and deposited $18.9 million (Cdn.$20.0 million) with the CRA.

 

Income taxes were a benefit of $612.4 million and $29.9 million for the three months ended June 30, 2007 and 2006, respectively. Income taxes were a benefit of $592.2 million and $23.0 million for the six months ended June 30, 2007 and 2006, respectively. The Company’s income tax expense varies substantially from the U.S. Federal statutory rate primarily due to provisions or reductions related to contingent liabilities including interest the Company may be required to pay in various tax jurisdictions. Provisions for interest amounted to $12.2 million and $16.6 million for the three months ended June 30, 2007 and 2006, respectively, and $32.2 million and $31.4 million for the six months ended June 30, 2007 and 2006, respectively. In addition, the Company recorded a tax benefit of $4.1 million for the three and six months ended June 30, 2007 and $43.0 million for the three and six months ended June 30, 2006 resulting from the reversals of certain contingent tax liabilities which were no longer deemed necessary as the relevant statue of limitations period had lapsed.

 

The Company has recorded accruals to cover certain unresolved tax issues (both U.S. and foreign). Such contingent liabilities relate to additional taxes and interest the Company may be required to pay in various tax jurisdictions. During the course of examinations by various taxing authorities, adjustments or proposed adjustments may be asserted. The Company evaluates such items on a case by case basis and adjusts the accrual for contingent liabilities as deemed necessary.

 

A substantial portion of the accruals to cover contingent liabilities for income taxes at June 30, 2007 relate to the Company’s operations in the United States. 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 condensed consolidated financial statements.

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

 

The Company is involved in a series of disputes, investigations and legal proceedings relating to transactions between the Company and certain former executive officers and directors of the Company and their affiliates.

 

The potential impact of these disputes, investigations and legal proceedings on the Company’s financial condition and results of operations cannot currently be estimated. Costs incurred as a result of the investigation by a committee of independent directors (the “Special Committee”) of the Board of Directors and related litigation and criminal proceedings involving Conrad M. Black (“Black”) and others are reflected in “Indemnification, investigation and litigation costs, net of recoveries” in the Condensed Consolidated Statements of Operations.

 

On March 18, 2007 the Company announced settlements, negotiated and approved by the Special Committee, with former President and Chief Operating Officer, F. David Radler (“Radler”), (including his wholly-owned company, North American Newspapers Ltd. f/k/a F.D. Radler Ltd.) and the publishing companies Horizon Publishing Company (“Horizon”) and Bradford Publishing Company (“Bradford”). The Company received $63.4 million in cash to settle the following: (i) claims by the Company against Radler, Horizon and Bradford, (ii) potential additional claims against Radler related to the Special Committee’s recent findings regarding incorrectly dated stock options and (iii) amounts due from Horizon and Bradford. The Company has recorded $47.7 million of the settlement, as a recovery, within “Indemnification, investigation and litigation costs, net of recoveries” and $7.2 million in “Interest and dividend income” in the Condensed Consolidated Statement of Operations for the six months ended June 30, 2007. The remaining $8.5 million represents the collection of certain notes receivable.

 

Indemnification, investigation and litigation costs, net of recoveries primarily consist of legal and other professional fees and amounts recovered through actions of the Special Committee as summarized in the following table.

 

 

 

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

 

 

 

 

 

 

 

Defined Benefit Plans

 

For the six months ended June 30, 2007, an aggregate of $2.3 million of contributions have been made to the domestic and foreign defined benefit plans, all in cash. The Company contributed $3.3 million to fund its defined benefit pension plans in 2006 and expects to contribute $7.5 million in 2007.

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

Defined Contribution Plans

 

For the six months ended June 30, 2007, $2.2 million of contributions have been made to the Company’s domestic defined contribution benefit plans, all in cash, with no further contributions expected in 2007. The Company contributed $2.6 million to its domestic defined contribution plans in 2006.

 

Post-Retirement Plans

 

For the six months ended June 30, 2007, $1.1 million of contributions have been made to the Company’s post-retirement plans, all in cash. The Company contributed $2.0 million to fund its post-retirement plans in 2006 and expects to contribute $2.0 million in 2007.

 

 

The Company becomes involved from time to time in various claims and lawsuits incidental to the ordinary course of business, including such matters as libel, defamation and privacy actions. In addition, the Company is involved from time to time in various governmental and administrative proceedings with respect to employee terminations and other labor matters, environmental compliance, tax and other matters. Management believes that the outcome of any such pending claims or proceedings incidental to the ordinary course of business will not have a material adverse effect on the Company taken as a whole.

 

As discussed in Note 10, the Company is also subject to numerous disputes, investigations and legal proceedings with former executive officers and certain current and former directors. For a detailed discussion of these legal proceedings, see “Item 3 — Legal Proceedings” of the Company’s 2006 10-K.

 

Primarily in connection with the Company’s insurance programs, letters of credit are required to support certain projected workers’ compensation obligations and reimbursement of claims paid by a third party claims administrator. At June 30, 2007 letters of credit in the amount of $11.1 million were fully collateralized by restricted cash.

 

 

(a) On July 31, 2007 the Company announced that it had entered into an agreement to settle securities class action suits pending against it and a number of its former directors and officers in the United States and Canada, and an agreement to settle litigation over its directors and officers insurance coverage. These agreements are subject to court approval in the United States and Canada.

 

If approved, the securities class action settlement will resolve the claims asserted against the Company, a number of its former directors and officers, certain affiliated companies, and the Company’s auditor, KPMG LLP, in a consolidated class action in the United States District Court for the Northern District of Illinois entitled In re Hollinger International Inc. Securities Litigation, No. 04C-0834, and in similar actions that have been initiated in Saskatchewan, Ontario, and Quebec, Canada. Those actions assert, among other things, that from 1999 to 2003 the defendants breached U.S. federal, state, and/or Canadian law by allegedly making misleading disclosures and omissions regarding certain “non-competition” payments and the payment of allegedly excessive management fees. The Company’s settlement of the securities class action lawsuits will be funded entirely by $30.0 million in proceeds from the Company’s insurance policies. The settlement includes no admission of liability by the Company or any of the settling defendants and the Company continues to deny any such liability or damages.

 

In addition, the Company’s insurers will deposit $24.5 million in insurance proceeds into an escrow account to fund defense costs the Company incurred in the securities class action and other litigation or other claimed loss. The insurance carriers will then be released from any other claims for the July 1, 2002 to July 1, 2003 policy period. The Company and other parties will then seek a judicial determination regarding how to allocate the $24.5 million in

 

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

(Unaudited) — (Continued)

insurance proceeds among the insureds who assert claims to the proceeds. The Company and Hollinger Inc. have had negotiations concerning how any such proceeds awarded to them should be allocated between the two companies. If they cannot reach an agreement on that issue, they have agreed to resolve it through binding arbitration.

 

(b) On August 1, 2007 the Company announced that it received notice from Hollinger Inc., the Company’s controlling stockholder, that certain corporate actions with respect to the Company, have been taken by written consent adopted by Hollinger Inc. and its affiliate, 4322525 Canada Inc., who collectively hold a majority in voting interest in the Company. These corporate actions include (i) amending the Company’s By-Laws to increase the size of the Company’s Board of Directors from eight members to eleven members and to provide that vacancies occurring in the Board of Directors may be filled by stockholders having a majority in voting interest; (ii) removing John F. Bard, John M. O’Brien and Raymond Troubh as directors of the Company; and (iii) electing William E. Aziz, Brent D. Baird, Albrecht Bellstedt, Peter Dey, Edward C. Hannah and G. Wesley Voorheis as directors of the Company.

 

The Company also learned that Hollinger Inc. has applied for Court-supervised reorganization under the Companies’ Creditors Arrangement Act (Canada) and under applicable U.S. bankruptcy law. As a significant unsecured creditor of Hollinger Inc., the Company is considering its options in connection with this action. See Note 7.

 

As a result of this change in control, approximately 165,000 outstanding DSU’s that were not yet vested became vested and the Company is required to offer to repurchase the remaining $6.0 million of the Company’s 9% Senior Notes, due 2010, at 101% of face value, plus accrued and unpaid interest. The Company has classified these notes as “Current installments of long-term debt” on the accompanying Condensed Consolidated Balance Sheet at June 30, 2007.

 

(c) On August 6, 2007, the Company notified the New York Stock Exchange (the “NYSE”) that, because of the removal of John F. Bard and John O’Brien from the Board of Directors, the Company was no longer in compliance with Section 303A.07 of the NYSE Listed Company Manual, which section requires that a listed company have an audit committee comprised of at least three members. In addition, the Company’s Nominating and Governance Committee, which still consists of two continuing directors of the Board, determined on August 1, 2007 that none of the directors appointed by Hollinger Inc. are “independent” because of the method by which they were appointed and, in any event, three of the appointees are officers of, or counsel to, Hollinger Inc. However, further determination may be made on this matter, as and when appropriate. As a result of this determination, the Company also may not be in compliance with Section 303A.01 of the NYSE Listed Company Manual if a majority of its directors are not determined to be independent. The Company is evaluating its full range of options with respect to the actions taken by Hollinger Inc.

 

(d) On August 8, 2007, the Company entered into a contract with Chicago Tribune Company for home delivery and suburban single-copy delivery of the Chicago Sun-Times and most of its suburban publications. The Company will continue to distribute single-copy sales of the Chicago Sun-Times within the city of Chicago and will also continue to operate the circulation sales, billing and customer service functions.

 

The Company expects to commence the transfer of distribution responsibilities to Chicago Tribune Company beginning on or about September 3, 2007. The Company expects fewer than 60 full and part-time positions to be eliminated as a result of this arrangement and does not expect related separation costs to be material.

SUN-TIMES MEDIA GROUP, INC. AND SUBSIDIARIES

 

OVERVIEW

 

The advertising revenue of the Sun-Times Media Group, Inc. (the “Company”) experiences seasonality with the first quarter typically being the lowest. The Company’s revenue is primarily derived from the sale of advertising within the Company’s publications. Advertising revenue accounted for 77% of the Company’s consolidated revenue for the six months ended June 30, 2007. Advertising revenue is comprised of three primary sub-groups: retail, national and classified. Advertising revenue is subject to changes in the economy on both a national and local level and in individual business sectors. Advertising revenue is recognized upon publication of the advertisement.

 

21% of the Company’s consolidated revenue for the six months ended June 30, 2007 was generated by circulation of the Company’s publications. This includes sales of publications to individuals on a single copy or subscription basis and to sales outlets, which then re-sell the publications. The Company recognizes circulation revenue from subscriptions on a straight-line basis over the subscription term and single-copy sales at the time of distribution. The Company also generates revenue from job printing and other activities which are recognized upon delivery.

 

Significant expenses for the Company are editorial, production and distribution costs and newsprint and ink. Editorial, production and distribution compensation expense, which includes benefits, was 29% of the Company’s total operating revenue for the six months ended June 30, 2007. Compensation costs are recognized as employment services are rendered. Newsprint and ink costs represented 15% of the Company’s total operating revenue for the six months ended June 30, 2007. Newsprint prices are subject to fluctuation as newsprint is a commodity. Newsprint costs are recognized upon consumption. Collectively, these costs directly related to producing and distributing the product are presented as cost of sales in the Company’s Condensed Consolidated Statement of Operations. Corporate expenses representing all costs incurred for U.S. and Canadian administrative activities at the Corporate level including audit, tax, legal and professional fees, directors and officers insurance premiums, stock-based compensation, corporate wages and benefits and other public company costs, represented 35% of total operating revenue for the period ended June 30, 2007.

 

RECENT BUSINESS DEVELOPMENTS

 

Significant Developments in 2007

 

On April 26, 2007, the Company entered into a written agreement with the Canada Revenue Agency (“CRA”) settling certain tax issues resulting from the disposition of certain Canadian operations in 2000. As a result, the Company expects to pay aggregate Canadian federal and provincial taxes and interest of $36.1 million in respect of these issues. The Company recorded an income tax benefit and a reduction of its “Other tax liabilities” of $586.7 million in the second quarter of 2007 related to this settlement. See Note 9 to the condensed consolidated financial statements.

 

On March 18, 2007 the Company announced settlements, negotiated and approved by a special committee of independent directors (the “Special Committee”), with former President and Chief Operating Officer, F. David Radler (“Radler”), (including his wholly-owned company, North American Newspapers Ltd. f/k/a F.D. Radler Ltd.) and the publishing companies Horizon Publishing Company (“Horizon”) and Bradford Publishing Company (“Bradford”). The Company received $63.4 million in cash to settle the following: (i) claims by the Company against Radler, Horizon and Bradford, (ii) potential additional claims against Radler related to the Special Committee’s recent findings regarding incorrectly dated stock options and (iii) amounts due from Horizon and Bradford. The Company has recorded $47.7 million of the settlement, as a recovery, within “Indemnification, investigation and litigation costs, net of recoveries” and $7.2 million in “Interest and dividend income” in the Condensed Consolidated Statement of Operations for the six months ended June 30, 2007. The remaining $8.5 million represents the collection of certain notes receivable.

 

Based on information accumulated by a third party from data submitted by Chicago area newspaper organizations, newspaper print advertising declined 8% for the six months ended June 30, 2007 for the greater

Chicago market versus the comparable period in 2006. Advertising revenue for the Company declined 12% for the six months ended June 30, 2007, compared to the same period in 2006.

 

Critical Accounting Policies and Estimates

 

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”) on January 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s financial position or results of operations. As part of its adoption, the Company performed an item by item evaluation and considered the state of its ongoing audits by, and discussions with, various taxing authorities. See Note 9 to the condensed consolidated financial statements.

 

FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. It is the Company’s continuing practice to recognize interest and/or penalties related to income tax matters in income tax expense.

 

For a discussion of the Company’s critical accounting policies and estimates, refer to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (the “2006 10-K”).

 

CONSOLIDATED RESULTS OF OPERATIONS

 

General

 

During February 2006, the Company sold its remaining Canadian newspaper assets (the “Canadian Newspaper Operations”). In this quarterly report, the Canadian Newspaper Operations are reported as discontinued operations. All amounts in this “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations” relate to continuing operations, unless otherwise noted. See Note 6 to the condensed consolidated financial statements.

 

Income (Loss) from Continuing Operations

 

Income from continuing operations in the second quarter of 2007 amounted to $528.0 million, or $6.57 per basic share, compared to $20.1 million in the second quarter of 2006, or $0.23 per basic share. The improvement in income from continuing operations of $507.9 million was largely due to an income tax benefit aggregating $612.4 million reflecting the settlement of certain tax issues with the CRA, which resulted in an income tax benefit of $586.7 million. Also contributing to the improvement were lower cost of sales of $3.8 million. These amounts were partially offset by lower revenue in the second quarter 2007 of $13.1 million, an increase in indemnification, investigation and litigation costs of $19.3 million, an increase in corporate expenses of $36.5 million (largely resulting from $33.7 million in bad debt expense) and increased total other income (expense) of $7.6 million. In addition, income tax benefit excluding the settlement mentioned above, decreased by $4.2 million.

 

Income from continuing operations for the six months ended June 30, 2007 amounted to $523.2 million, or $6.51 per basic share, compared to a loss of $6.5 million, or a $0.07 loss per basic share, for the six months ended June 30, 2006. The improvement from results of continuing operations of $529.7 million was largely due to an income tax benefit aggregating $592.2 million reflecting the settlement of certain tax issues with the CRA mentioned above of $586.7 million and the settlement with Radler, of which $47.7 million was recorded as a reduction of indemnification, investigation and litigation costs, net, and $7.2 million was recorded as interest income. Also contributing to the improvement were lower cost of sales of $8.0 million and a decrease in other operating costs of $7.6 million. These amounts were partially offset by lower revenue for the six months ended June 30, 2007 of $24.2 million, an increase in indemnification, investigation and litigation costs of $31.4 million, (excluding the recovery mentioned above), an increase in corporate expenses of $42.6 million (largely resulting from $33.7 million in bad debt expense), a reduction in income tax benefits, excluding the CRA settlement, of $17.5 million and increased other income (expense), net of $7.5 million.

Operating Revenue and Operating Loss — Overview

 

Operating revenue and operating loss in the second quarter of 2007 were $94.3 million and $80.6 million, respectively, compared with operating revenue of $107.4 million and an operating loss of $13.7 million in the second quarter of 2006. The decrease in operating revenue of $13.1 million compared to the second quarter of 2006 is largely a reflection of a decrease in advertising revenue of $10.4 million and circulation revenue of $1.6 million. The $66.9 million increase in operating loss in 2007 is primarily due to lower revenue of $13.1 million and higher indemnification, investigation and litigation costs, net, of $19.3 million. In addition, sales and marketing costs increased by $1.9 million and corporate expenses increased by $36.5 million (reflecting the previously mentioned bad debt expense). These items were partially offset by lower cost of sales of $3.8 million.

 

For the six months ended June 30, 2007, operating revenue and operating loss were $185.6 million and $75.0 million, respectively, compared with operating revenue of $209.8 million and an operating loss of $38.0 million for the six months ended June 30, 2006. The decrease in operating revenue of $24.2 million compared to the same period in 2006 is largely a reflection of a decrease in advertising revenue of $19.3 million and circulation revenue of $3.1 million. The $37.0 million increase in operating loss in 2007 is primarily due to lower revenue of $24.2 million, higher indemnification, investigation and litigation costs of $31.4 million, excluding a recovery of $47.7 million, higher corporate expenses of $42.6 million (reflecting the previously mentioned bad debt expense) and higher sales and marketing costs of $1.9 million. These amounts were partially offset by the recovery of $47.7 million under the Radler settlement, lower other operating costs of $7.6 million and lower cost of sales of $8.0 million

 

Operating Revenue

 

Total operating revenue

 

Total operating revenue was $94.3 million in the second quarter of 2007 compared to $107.4 million for the same period in 2006, a decrease of $13.1 million, or 12%.

 

For the six months ended June 30, 2007, total operating revenue was $185.6 million compared to $209.8 million for the same period in 2006, a decrease of $24.2 million, or 12%.

 

Advertising revenue

 

Advertising revenue was $73.2 million in the second quarter 2007 compared with $83.6 million in the second quarter of 2006, a decrease of $10.4 million, or 12%. The decrease was largely a result of lower retail advertising revenue of $3.1 million, lower classified advertising of $5.4 million and lower national advertising revenue of $3.0 million, partially offset by increased internet advertising revenue of $1.1 million.

 

For the six months ended June 30, 2007, advertising revenue was $143.2 million, compared to $162.5 million for the same period in 2006, a decrease of $19.3 million, or 12%. Retail advertising revenue decreased $5.8 million, classified advertising revenue decreased $11.0 million and national advertising revenue decreased $4.7 million for the six months ended June 30, 2007, respectively, compared to the same period in 2006. Internet revenue increased $2.2 million to $5.7 million for the six months ended June 30, 2007 compared to $3.5 million for the same period in 2006.

 

Circulation revenue

 

Circulation revenue was $19.3 million in the second quarter of 2007 compared with $20.9 million in the second quarter of 2006, a decrease of $1.6 million. The decline in circulation revenue was attributable to declines in volume, primarily in the daily single copy category.

 

For the six months ended June 30, 2007, circulation revenue was $38.8 million compared to $41.9 million for the same period in 2006, a decrease of $3.1 million. The decline in circulation revenue was attributable to declines in volume, primarily in the daily single copy category.

Operating Costs and Expenses

 

Total operating costs and expenses

 

Total operating costs and expenses in the second quarter of 2007 were $174.9 million, compared with $121.1 million in the second quarter of 2006, an increase of $53.8 million. This increase is largely reflective of higher indemnification, investigation and litigation costs of $19.3 million, higher corporate expenses of $36.5 million (reflecting the previously mentioned bad debt expense), and higher sales and marketing costs of $1.9 million. These increases were partially offset by lower cost of sales of $3.8 million.

 

For the six months ended June 30, 2007, total operating costs and expenses were $260.5 million, compared with $247.8 million for the comparable period in 2006, an increase of $12.7 million. This increase is largely reflective of higher corporate expenses of $42.6 million (reflecting the previously mentioned bad debt expense), partially offset by a decline in indemnification, investigation and litigation costs, net of $16.4 million, reflecting the $47.7 million recovery in 2007 described above, lower cost of sales of $8.0 million and lower other operating costs of $7.6 million.

 

Total cost of sales

 

Cost of sales, which includes newsprint and ink, as well as distribution, editorial and production costs was $59.5 million for the second quarter of 2007, compared with $63.3 million for the same period in 2006, a decrease of $3.8 million. Wages and benefits were $26.6 million in the second quarter of 2007 and $27.0 million in the second quarter of 2006, a decrease of $0.4 million. The slight decrease in wages and benefits reflects the impact of workforce reductions resulting from the 2006 reorganization activities offset by merit and union pay increases. See Note 4 to the condensed consolidated financial statements. Newsprint and ink expense was $13.2 million for the second quarter of 2007, compared with $16.8 million for the same period in 2006, a decrease of $3.6 million or 21%. Total newsprint consumption in the second quarter of 2007 decreased 13% compared with the same period in 2006, and the average cost per metric ton of newsprint in the second quarter of 2007 was 9% lower than the second quarter of 2006. Other cost of sales were generally flat at $19.7 million in the second quarter of 2007 compared to $19.5 million in the second quarter of 2006.

 

For the six months ended June 30, 2007, cost of sales was $118.7 million for the six months ended June 30, 2007, compared with $126.7 million for the same period in 2006, a decrease of $8.0 million. Wages and benefits were $53.3 million for the six months ended June 30, 2007 and $54.4 million for the six months ended June 30, 2006, a decrease of $1.1 million. The slight decrease in wages and benefits reflects the impact of workforce reductions resulting from the 2006 reorganization activities offset by merit and union pay increases. See Note 4 to the condensed consolidated financial statements. Newsprint and ink expense was $26.9 million for the second quarter of 2007, compared with $33.7 million for the same period in 2006, a decrease of $6.8 million, or 20%. Total newsprint consumption for the six months ended June 30, 2007 decreased 16% compared with the same period in 2006, and the average cost per metric ton of newsprint for the six months ended June 30, 2007 was 5% lower than the same period in 2006.

 

Total selling, general and administrative

 

Included in selling, general and administrative costs are sales and marketing expenses, other operating costs including administrative support functions, such as information technology, finance and human resources, and corporate expenses and indemnification, investigation and litigation costs, net.

 

Total selling, general and administrative costs were $107.8 million in the second quarter of 2007 compared with $49.7 million for the same period in 2006, an increase of $58.1 million. Indemnification, investigation and litigation costs, net increased $19.3 million largely due to the indemnification costs related to criminal proceedings against certain former officers. In addition, sales and marketing costs increased by $1.9 million and corporate expenses increased by $36.5 million (reflecting the previously mentioned bad debt expense).

 

For the six months ended June 30, 2007, total selling, general and administrative costs were $125.6 million compared with $105.1 million for the same period in 2006, an increase of $20.5 million. This increase was due to higher corporate expense of $42.6 million (reflecting the previously mentioned bad debt expense), which was

partially offset by lower indemnification, investigation and litigation costs, net of $16.4 million largely due to the $47.7 million recovery in 2007, somewhat offset by increased indemnification costs related to criminal proceedings against certain former officers and lower other operating costs of $7.6 million.

 

Sales and marketing

 

Sales and marketing costs were $18.1 million in the second quarter of 2007, compared with $16.2 million in the second quarter of 2006, an increase of $1.9 million, largely due to additional market research and marketing costs including those related to promoting a new look and slogan for the Chicago Sun-Times in radio and promotional billboards.

 

For the six months ended June 30, 2007, sales and marketing costs were $33.6 million compared with $31.7 million for the same period in 2006, an increase of $1.9 million, largely due to additional market research and marketing costs including those related to promoting a new look and slogan for the Chicago Sun-Times in radio and promotional billboards.

 

Other operating costs

 

Other operating costs consist largely of accounting and finance, information technology, human resources, property and facilities and other general and administrative costs supporting the newspaper operations.

 

Other operating costs were $14.5 million in the second quarter of 2007 and generally comparable to the $14.1 million for the same period in 2006.

 

For the six months ended June 30, 2007, other operating costs were $28.9 million compared with $36.5 million for the same period in 2006, a decrease of $7.6 million. This decrease is largely due to lower reorganization costs and severance expense of $9.7 million, largely resulting from the reorganization activities in 2006, the $0.9 million write-off of certain cancelled system development projects in 2006 and a $0.6 million reduction in a reserve for a contract dispute in 2007, partially offset by increased wages and benefits of $0.6 million, increased professional fees of $0.5 million, costs associated with the removal of a printing press for a closed facility of $0.4 million, increased telecommunication costs of $0.8 million and increased web related support and other costs of $1.0 million.

 

Corporate expenses

 

Corporate operating expenses in the second quarter of 2007 were $50.1 million compared with $13.6 million in the second quarter of 2006, an increase of $36.5 million. This increase is largely due to bad debt expense of $33.7 million related to a loan with an affiliate (see Note 7 to the condensed consolidated financial statements), an adjustment of $8.6 million in the second quarter of 2007 to decrease the estimated net proceeds to be received related to the sale of publishing interests in prior years and higher legal fees related to litigation and arbitration activities of $1.3 million, partially offset by lower compensation expenses of $2.4 million, a $2.0 million liability recorded in 2006 related to an estimated liability for unclaimed property, lower insurance costs, primarily directors and officers of $0.6 million, lower business taxes of $0.4 million and lower non-legal professional fees of $1.6 million. The decrease in compensation is largely due to lower pension expense related to legacy Canadian plans of $1.5 million and lower severance costs of $0.6 million.

 

For the six months ended June 30, 2007, corporate operating expenses were $65.6 million compared with $23.0 million for the six months ended June 30, 2006, an increase of $42.6 million. This increase is largely due to bad debt expense of $33.7 million related to a loan with an affiliate (see Note 7 to the condensed consolidated financial statements), adjustments of $13.6 million in 2007 to decrease the estimated net proceeds to be received related to the sale of publishing interests in prior years and higher legal fees of $2.9 million reflecting higher litigation and arbitration costs, partially offset by lower compensation expenses of $4.4 million, a $2.0 million liability recorded in 2006 related to an estimated liability for unclaimed property and lower insurance costs, primarily directors and officers of $0.8 million. The decrease in compensation is largely due to lower pension expense related to legacy Canadian plans of $2.4 million, lower severance costs of $1.2 million and lower stock-based compensation costs of $0.5 million.

Indemnification, investigation and litigation costs, net of recoveries

 

Indemnification, investigation and litigation costs, net of recoveries in the second quarter of 2007 were $25.1 million compared with $5.8 million in the second quarter of 2006, an increase of $19.3 million. Indemnification costs increased $20.8 million to $22.8 million in the second quarter of 2007 from $2.0 million in the second quarter of 2006 as the criminal proceedings against certain former officers began in March 2007. See Note 10 to the condensed consolidated financial statements.

 

For the six months ended June 30, 2007, indemnification, investigation and litigation costs, net of recoveries was a net recovery of $2.5 million compared to an expense of $13.9 million in the second quarter of 2006, an improvement of $16.4 million. In 2007, the Company recorded a net recovery of $47.7 million resulting from a settlement with a former officer. Indemnification costs increased $32.0 million to $40.2 million for the six months ended June 30, 2007 from $8.2 million in same period in 2006 as the criminal proceedings against certain former officers began in March 2007. See Note 10 to the condensed consolidated financial statements.

 

Depreciation and amortization

 

Depreciation and amortization expense in the second quarter of 2007 was $7.6 million compared with $8.1 million in 2006, a decrease of $0.5 million. In the second quarter of 2006, the Company recorded additional depreciation expense of $0.3 million related to the Harlem Avenue printing plant which was closed in October 2006. Amortization expense includes $1.9 million in both the second quarter of 2007 and the second quarter of 2006 related to capitalized direct response advertising costs.

 

For the six months ended June 30, 2007, depreciation and amortization expense was $16.2 million compared with $16.0 million for the same period in 2006, an increase of $0.2 million. In the first six months of 2007, the Company recorded additional depreciation expense of $1.0 million related to the printing facility in Gary, Indiana closed in March 2007 and recorded an additional $0.6 million related to the Harlem Avenue printing plant in the first six months of 2006. Amortization expense includes $3.4 million for the first six months of 2007 and $3.5 million for the first six months of 2006 related to capitalized direct response advertising costs.

 

Operating loss

 

As a result of the items noted above, operating loss in the second quarter of 2007 was $80.6 million compared with a $13.7 million operating loss for the same period in 2006, an increase of $66.9 million. For the six months ended June 30, 2007, operating loss was $75.0 million compared with a $38.0 million operating loss for the same period in 2006, an increase of $37.0 million.

 

Interest and Dividend Income

 

Interest and dividend income in the three months ended June 30, 2007 amounted to $3.4 million compared to $4.5 million for the same period in 2006, a decrease of $1.1 million. For the six months ended June 30, 2007, interest and dividend income amounted to $13.7 million compared to $8.7 million in 2006, an increase of $5.0 million, largely due to the $7.2 million of interest received on the settlement with Radler.

 

Other Income (expense), net

 

Other income (expense), net in the second quarter of 2007 was an expense of $6.9 million compared to $0.4 million for the same period in 2006. The $6.5 million increase in expense was largely due to an increase in foreign exchange losses of $8.4 million, partially offset by an improvement of gain (loss) on sale of investments of $1.6 million. The increase in foreign exchange losses largely relates to the impact on U.S. denominated cash and cash equivalents in Canada and certain intercompany loans payable in Canadian dollars resulting from the weakening of the U.S. dollar during the quarter.

 

For the six months ended June 30, 2007 other income (expense), net was an expense of $7.4 million compared to income of $0.1 million for the same period in 2006. The $7.5 million increase in expense was largely due to a $9.5 million increase in foreign exchange losses, partially offset by an improvement of gain (loss) on sale of investments of $1.6 million. The increase in foreign exchange losses largely relates to the impact on

U.S. denominated cash and cash equivalents in Canada and the net impact of certain intercompany and affiliate loans resulting from the weakening of the U.S. dollar during the first six months of 2007.

 

Income Taxes

 

Income taxes were a benefit of $612.4 million in the second quarter of 2007 and a benefit of $29.9 million in the second quarter of 2006. The larger benefit primarily represents the impact of the settlement of certain tax issues with the CRA, which resulted in the reversal of certain tax liabilities of $586.7 million. Generally, the Company’s income tax expense varies substantially from the U.S. Federal statutory rate primarily due to provisions or reductions related to contingent liabilities including interest the Company may be required to pay in various tax jurisdictions. Provisions for additional interest on contingent liabilities that may be payable amounted to $12.2 million in the second quarter of 2007 and $16.6 million for the second quarter of 2006. See Note 9 to the condensed consolidated financial statements.

 

For the first six months of 2007, income taxes were a benefit of $592.2 million compared with a benefit of $23.0 million for the first six months of 2006. The larger benefit primarily represents the impact of the settlement with the CRA, which resulted in the reversal of certain tax liabilities of $586.7 million. Provisions for additional interest on contingent liabilities that may be payable amounted to $32.2 million in the first six months ended June 30, 2007 and $31.4 million for the same period in 2006. See Note 9 to the condensed consolidated financial statements.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash and Cash Equivalents

 

Cash and cash equivalents amounted to $212.1 million at June 30, 2007 as compared to $186.3 million at December 31, 2006, an increase of $25.8 million. This increase in cash was primarily the result of the settlement with Radler of $63.4 million (including interest and the collection of certain notes receivable) and the receipt of the settlement proceeds of $50.0 million from the settlement with directors and officers insurance carriers, partially offset by net cash outflows to support operations including the indemnification costs and tax payments of $23.9 million. See Note 10 to the condensed consolidated financial statements.

 

Sun-Times Media Group, Inc. is a 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 is dependent upon the availability of cash flows from its subsidiaries through dividends, intercompany advances and other payments. Similarly, the Company’s ability to pay any future dividends on its common stock may be limited as a result of its dependence upon the distribution of earnings of its subsidiaries and affiliated companies. The Company’s subsidiaries and affiliated companies are under no obligation to pay dividends and may be subject to or become subject to statutory restrictions and restrictions in debt agreements that limit their ability to pay dividends or repatriate funds to the United States. The Company’s right to participate in the distribution of assets of any subsidiary or affiliated company upon its liquidation or reorganization, if such an event were to occur, would 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.

Factors That Are Expected to Affect Liquidity in the Future

 

Potential Cash Outlays Related to Accruals for Income Tax Contingent Liabilities

 

The Company has the following income tax liabilities recorded in its Condensed Consolidated Balance Sheets:

 

 

The Company has recorded accruals to cover contingent liabilities related to additional taxes and interest it may be required to pay in various tax jurisdictions. Such accruals, included in “Other tax liabilities” listed above, reflect additional interest and penalties that may become payable in respect to the contingent liabilities.

 

Significant cash outflows are expected to occur in the future regarding the income tax contingent liabilities. Although the Company is attempting to resolve a significant portion of the contingent liabilities with the relevant taxing authorities, the timing and amounts of any cash payments the Company may be required to make remain uncertain. Efforts to resolve or settle certain of these tax issues, for amounts that are substantially less than the related accrual, were successful in 2007. Efforts to resolve or settle certain other tax issues are ongoing and a substantial portion of the Company’s cash and cash equivalent balances, as reflected on the Condensed Consolidated Balance Sheet at June 30, 2007 may be required to fund any such resolution or settlement. See Note 9 to the condensed consolidated financial statements.

 

Potential Cash Outflows Related to Operations

 

The Company’s cash flow is expected to continue to be cyclical, reflecting changes in economic conditions. The Company is dependent upon the Sun-Times News Group for operating cash flow. That cash flow in turn is dependent to a significant extent on the Sun-Times News Group’s ability to sell advertising in its Chicago area market. Advertising revenue for the Sun-Times News Group declined 12% during the first six months of 2007 as compared to the same period in 2006. Based on the Company’s assessment of market conditions in the Chicago area and the potential of these negative trends continuing, the Company has considered and may continue to consider a range of options to address the resulting significant shortfall in performance and cash flow and has suspended its dividend payments since the fourth quarter of 2006.

 

The Company does not currently have a credit facility in place. The recent decline in revenue and operating performance in the Sun-Times News Group may have a detrimental impact on the amount of debt and/or terms available to the Company in bank and bond markets. Moreover, exclusive of cash proceeds from settlements as described above, the operating performance of the Company continues to result in the use of cash to fund continuing operations, particularly in respect of indemnification and litigation costs.

 

The Company is currently involved in several legal actions as both plaintiff and defendant and is funding significant amounts under indemnification agreements to certain former officers and directors. The actions are in various stages and it is not yet possible to determine their ultimate outcome. At this time, the Company cannot estimate the impact these actions and the related legal fees and indemnification obligations may have on its future cash requirements. However, such requirements may be significant and may exceed amounts that may be recovered through insurance claims or otherwise.

 

Other

 

The Company expects that its liquid assets at June 30, 2007 are sufficient to support its operations and meet its obligations into 2008. However, the Company will continue reviewing and considering potential sources of additional liquidity, which may include the sale of certain assets.

Cash Flows

 

Cash flows provided by continuing operating activities were $17.6 million for the first six months of 2007, a $47.2 million improvement compared with $29.6 million used in continuing operating activities for the same period in 2006. The comparison of operating cash flows between years is affected by several key factors. The net income from continuing operations has increased by $529.7 million to $523.2 million in the six months ended June 30, 2007 from a net loss of $6.5 million for the same period in 2006. Net income in the first six months of 2007 included a $586.7 million benefit from the settlement of certain tax issues with the CRA, which is reflected in “Reduction of tax liability.” The $529.7 million improvement in net income from continuing operations also includes the $47.7 million settlement with, and $7.2 million of interest received from, Radler and was somewhat offset by $31.4 million in higher indemnification, investigation and litigation costs (before recoveries), bad debt expense of $33.7 million related to a loan due from an affiliate and a $13.6 million adjustment in estimated net proceeds to be received related to a sale of newspaper operations in prior years. In addition, the Company received $50.0 million related to a settlement with the Company’s insurance carriers in the first quarter of 2007.

 

Cash flows provided by investing activities for the six months ended June 30, 2007 were $6.1 million compared with cash flows provided by investing activities of $141.0 million for the same period in 2006. The decrease of $134.9 million in cash provided by investing activities is primarily the result of net proceeds received in 2006 of $79.9 million from the sale of the remaining Canadian Newspaper Operations, $52.1 million from net sales of short-term investments in 2006 and a decrease of $14.1 million from the disposal of investments and other assets, which was somewhat offset by the 2007 collection of $8.5 million of notes receivable pursuant to settlement with a former director and $2.1 million from the sale of property, plant and equipment in 2007.

 

Cash flows used in financing activities were $4.4 million for the six months ended June 30, 2007 and $75.3 million for the same period in 2006. The $70.9 million decrease in cash used in financing activities primarily reflects the repurchase of common stock which totaled $71.5 million in 2006.

 

Capital Expenditures

 

The Company does not have material commitments to acquire capital assets and expects its cash on hand and future cash flow provided by its operating subsidiaries to be sufficient to fund its recurring capital expenditures.

 

Dividends and Other Commitments

 

On December 13, 2006, the Company announced that its Board of Directors reviewed its dividend policy and voted to suspend the Company’s quarterly dividend of five cents ($0.05) per share.

 

Commercial Commitments and Contractual Obligations

 

Primarily in connection with the Company’s insurance programs, letters of credit are required to support certain projected workers’ compensation obligations and reimbursement of claims paid by a third party claims administrator. At June 30, 2007, letters of credit in the amount of $11.1 million were fully collateralized by restricted cash.

 

Set out below is a summary of the amounts due and committed under contractual cash obligations at June 30, 2007 (unless otherwise noted):

 

 

 

In addition to amounts committed under contractual cash obligations, the Company has also assumed certain contingent obligations by way of guarantees and indemnities in relation to the conduct of its business and disposition of businesses. The Company is also involved in various matters in litigation. For more information on the Company’s litigation and contingent obligations, see Notes 10 and 12 to the Company’s condensed consolidated financial statements.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). This Statement defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in U.S. generally accepted accounting principles (“GAAP”) and expands disclosure related to the use of fair value measures in financial statements. SFAS No. 157 does not expand the use of fair value measures in financial statements, but standardizes its definition and guidance in GAAP. The Standard emphasizes that fair value is a market-based measurement and not an entity-specific measurement based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price). SFAS No. 157 establishes a fair value hierarchy from observable market data as the highest level to fair value based on an entity’s own fair value assumptions as the lowest level. The Statement is to be effective for the Company’s financial statements issued after November 15, 2007; however, earlier application is encouraged. The Company is currently evaluating the timing of adoption but does not expect such adoption to have a material impact on its financial position and results of operations.

 

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

 

Newsprint.  Newsprint expense amounted to $25.7 million in the first six months of 2007 and $32.1 million during the same period in 2006. Management believes that newsprint prices may continue to show significant price variation in the future. Suppliers implemented a newsprint price increase of approximately $25 per metric ton in June 2006 and decreases of approximately $25 per metric ton in September and December 2006. The Company takes steps to ensure that it has sufficient supply of newsprint and has mitigated cost increases by adjusting pagination and page sizes and printing and distribution practices. Based on levels of usage during the six months ended June 30, 2007, a change in the price of newsprint of $50 per metric ton would have increased or decreased the income from continuing operations for the six months ended June 30, 2007 by $1.2 million. The average price per metric ton of newsprint was approximately $630 for the six months ended June 30, 2007 versus approximately $665 for the same period in 2006.

 

Labor Relations.  As of June 30, 2007, 39% of the Company’s employees are covered by collective bargaining agreements. Contracts covering 73% of union employees will expire or are being negotiated during

the next twelve months. There have been no strikes or work stoppages at any of the Company’s newspapers in the past 5 years.

 

Inflation.  During the past three years, inflation has not had a material effect on the Company’s newspaper businesses.

 

Interest Rates.  At June 30, 2007, the Company has no debt that is subject to interest calculated at floating rates and a change in interest rates would not have a material effect on the Company’s results of operations.

 

Foreign Exchange Rates.  A portion of the Company’s results are generated outside of the United States in currencies other than the United States dollar (primarily the Canadian dollar). As a result, the Company’s operations are subject to changes in foreign exchange rates and changes in the value of the United States dollar against other currencies would affect the Company’s net earnings. Based on earnings and ownership levels for the six months ended June 30, 2007, a $0.05 change in the Canadian dollar exchange rate of $0.8823 would affect the Company’s reported net income for the six months ended June 30, 2007 by $30.7 million, largely related to Canadian income taxes.

 

Reference should be made to “Risk Factors” in the Company’s 2006 10-K for a discussion on the potential impact changes in foreign exchange rates may have related to taxes that may be paid to foreign jurisdictions. As a result of the settlement with the CRA, the foreign exchange risk related to taxes has been substantially reduced.

 

(a) Disclosure Controls and Procedures.  The Company maintains a system of disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate to allow timely decisions regarding required disclosure. Disclosure controls include components of internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP.

 

As reported in the 2006 10-K, as of December 31, 2006, the Company’s management identified material weaknesses in its internal control over financial reporting relating to 1) an ineffective control environment that did not sufficiently promote effective internal control over financial reporting throughout the organization, 2) ineffectively designed information technology general controls over program development, program changes, computer operations, and access to programs and data, and 3) ineffective controls relating to the accounting for uncertain tax positions and foreign deferred income taxes. Largely as a result of material weaknesses in these areas, management concluded in its 2006 10-K that the Company’s disclosure controls and procedures were ineffective as of December 31, 2006.

 

During 2007, and as discussed further below, the Company has taken actions to remediate the material weaknesses discussed above, and it is continuing to assess additional controls that may be required to remediate these weaknesses. The Company’s management, under the supervision of and with the participation of the CEO and CFO, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2007, pursuant to Exchange Act Rule 13a-15(e) and 15d-15(e). As part of its evaluation, management has evaluated whether the control deficiencies related to the reported material weaknesses in internal control over financial reporting continue to exist. As of June 30, 2007, the Company has not completed implementation and testing of the changes in controls and procedures that it believes are necessary to conclude that the material weaknesses have been remediated and therefore, the Company’s management has concluded that it cannot assert that the control deficiencies relating to the reported material weaknesses have been effectively remediated. As a result, the Company’s CEO and CFO have concluded that the Company’s disclosure controls and procedures were ineffective as of June 30, 2007.

Procedures were undertaken in order that management could conclude that reasonable assurance exists regarding the reliability of financial reporting and the preparation of the condensed consolidated financial statements contained in this filing. Accordingly, management believes that the condensed consolidated financial statements included in this Form 10-Q fairly present, in all material respects, the Company’s financial position, results of operations and cash flows for the periods presented.

 

(b) Changes in Internal Control Over Financial Reporting.  During 2007, management has taken the following actions that materially affect, or are reasonably likely to materially affect, the Company’s internal control over financial reporting and to remediate the material weaknesses described in the Company’s 2006 10-K.

 

During the six months ended June 30, 2007:

 

 

Other than as discussed above, there have not been any changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

The following is a discussion of developments in the legal proceedings the Company has reported in its 2006 10-K. For a detailed discussion of these legal proceedings see “Item 3 — Legal Proceedings” in the Company’s 2006 10-K.

 

Stockholder Class Actions; Delaware Insurance Coverage Action

 

As previously disclosed in the 2006 Form 10-K, in February and April 2004, certain stockholders of the Company initiated securities class action claims asserted against the Company, a number of its former directors and officers, certain affiliated companies, and the Company’s auditor, KPMG LLP, in a consolidated class action in the United States District Court for the Northern District of Illinois entitled In re Hollinger International Inc. Securities Litigation, No. 04C-0834, and in similar actions that have been initiated in Saskatchewan, Ontario, and Quebec, Canada. Those actions assert, among other things, that from 1999 to 2003 the defendants breached U.S. federal, state, and/or Canadian law by allegedly making misleading disclosures and omissions regarding certain “non-competition” payments and the payment of allegedly excessive management fees. On July 31, 2007, the Company entered into agreements to settle these suits and litigation over its directors and officers insurance coverage. The Company’s settlement of the securities class action lawsuits will be funded entirely by $30.0 million in proceeds from the Company’s insurance policies. The settlement includes no admission of liability by the Company or any of the settling defendants and the Company continues to deny any such liability or damages. In addition, the Company’s insurers will deposit $24.5 million in insurance proceeds into an escrow account to fund defense costs

the Company incurred in the securities class action and other litigation or other claimed loss. The insurance carriers will then be released from any other claims for the July 1, 2002 to July 1, 2003 policy period. The Company and other parties will then seek a judicial determination regarding how to allocate the $24.5 million in insurance proceeds among the insureds who assert claims to the proceeds. The Company and Hollinger Inc. have had negotiations concerning how any such proceeds awarded to them should be allocated between the two companies. If they cannot reach an agreement on that issue, they have agreed to resolve it through binding arbitration. The securities class action settlement is conditioned upon prior approval of the insurance settlement, and the insurance settlement agreement is conditioned upon subsequent approval of the class action settlement. The parties are in the process of seeking these approvals in the appropriate courts in the United States and Canada. Due to the contingent and conditional nature of the settlement and insurance proceeds, the Company’s financial statements do not reflect any amounts related to the agreements described above.

 

This settlement is also of the legal action entitled Sun-Times Media Group, Inc. v. Sun-Alliance Insurance Company of Canada, Civ. A. No. 06C-11-108 (RRC) (Del. Superior Ct.) that was previously disclosed in the 2006 Form 10-K.

 

Hollinger Inc. CCAA Proceedings

 

On August 1, 2007, Hollinger Inc. and two of its Canadian subsidiaries, 4322525 Canada, Inc. and Sugra Limited, filed Notices of Application in, and received an Initial Order (the “CCAA Order”) from the Ontario Superior Court of Justice (Commercial List) in Ontario, Canada, for protection under the Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36, as amended (the “CCAA”). Later that day, Hollinger Inc. and the same two affiliates filed cases (the “Chapter 15 Cases”) under Chapter 15 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) in connection with the proceedings pending in Canada and in furtherance of the enforcement in the United States of the CCAA Order. In its Chapter 15 Case, Hollinger Inc. filed a motion for a temporary restraining order and a preliminary injunction prohibiting, among other things, any party from taking any actions against Hollinger Inc. or its assets. On August 1, 2007, the Bankruptcy Court granted Hollinger’s motion for a temporary restraining order, which temporary restraining order will remain in effect until a hearing scheduled for August 10, 2007 before the Bankruptcy Court to enter a preliminary injunction. In initiating the Chapter 15 Case (and in addition to the request for a temporary restraining order and preliminary injunction), Hollinger Inc. seeks recognition from the Bankruptcy Court of the proceeding commenced in Canada under the CCAA, and relief available under Chapter 15, including further injunctive relief, upon such recognition.

 

Receivership and Companies’ Creditors Arrangement Act (Canada) Proceedings in Canada involving the Ravelston Entities

 

As previously reported in the 2006 Form 10-K, on April 20, 2005, The Ravelston Corporation Limited (“Ravelston”) and Ravelston Management, Inc. were placed in receivership. On January 22, 2007, Hollinger Inc. and Domgroup Ltd. (“Domgroup”) served in the Ontario Superior Court of Justice a motion for an order confirming the validity and enforceability of interests that Hollinger Inc. and Domgroup allege they have in Ravelston property and assets securing more than Cdn.$25.0 million in Ravelston debt. The Company brought a cross-motion to stay Hollinger Inc.’s and Domgroup’s motion or, alternatively, to establish a schedule for the resolution of the issue. On June 28, 2007, the Court dismissed the Company’s motion to stay the proceedings. The schedule for the proceeding will be the subject of a further decision of the Court.

 

Federal Indictment of Ravelston and Former Company Officials

 

As previously reported in the 2006 Form 10-K, a federal grand jury in Chicago has indicted Conrad M. Black (“Black”), Radler, J.A. Boultbee, Peter Y. Atkinson, Mark S. Kipnis, and Ravelston on federal fraud and other charges. Radler and Ravelston entered guilty pleas under the terms of their respective plea agreements. A jury trial was held, and on July 13, 2007, the jury returned verdicts of guilty on three fraud counts against all defendants and one obstruction of justice count against Black, and verdicts of not guilty on all other counts. Briefing on the government’s forfeiture charges is scheduled to be completed by September 14, 2007, and sentencing is scheduled for November 30, 2007.

 

None.

 

None.

 

The Company held its 2007 Annual Meeting of Stockholders on June 12, 2007 in Chicago IL. Of the 80,253,269 shares of common stock entitled to vote at the meeting, 53,114,394 shares of Class A Common Stock (1 vote per share) and 14,990,000 shares of Class B Common Stock (10 votes per share) were represented at the meeting in person or by proxy, constituting a quorum. The voting results were as follows:

 

1) The stockholders elected the following Directors to serve until the Company’s 2008 Annual Meeting of Stockholders and until their successors are duly elected and qualified. The votes were as follows:

 

 

2) The stockholders approved the amendment of the Company’s amended and restated 1999 Stock Incentive Plan. The votes were as follows: