10-Q 1 c81050e10vq.txt QUARTERLY REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 COMMISSION FILE NUMBER: 333-46959 LIBERTY GROUP OPERATING, INC. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 36-4197636 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 3000 DUNDEE ROAD, SUITE 203 60062 NORTHBROOK, ILLINOIS (Zip Code) (Address of Principal Executive Offices) Registrant's Telephone Number, Including Area Code: (847) 272-2244 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The number of shares outstanding of the Company's common stock, par value $0.01 per share, as of November 14, 2003: 100 shares. ================================================================================ TABLE OF CONTENTS

2 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited interim consolidated financial statements. 3 LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS)

See accompanying notes to unaudited interim consolidated financial statements. 4 LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to unaudited interim consolidated financial statements. 5 LIBERTY GROUP OPERATING, INC. NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE DATA) (1) THE COMPANY AND BASIS OF PRESENTATION Liberty Group Operating, Inc. ("LGO", "Operating Company" or "Registrant") and its subsidiaries are a leading U.S. publisher of local newspapers and related publications that are the dominant source of local news and print advertising in their markets. The Company (as defined below) owns and operates 302 publications located in 17 states that reach approximately 2.37 million people on a weekly basis. The majority of the Company's paid daily newspapers have been published for more than 100 years and are typically the only paid daily newspapers of general circulation in their respective non-metropolitan markets. The Company's newspapers generally face limited competition as a result of operating in markets that are distantly located from large metropolitan areas and that can typically support only one primary newspaper, with the exception of the Company's publications in the Chicago suburban market. The Company has strategically clustered its publications in geographically diverse, non-metropolitan markets in the Midwest, Northeast and Western United States and in the Chicago suburban market, which limits its exposure to economic conditions in any single market or region. No single display advertiser accounted for greater than 1% of the Company's total revenues during the three and nine months ended September 30, 2003 and 2002. The Company's portfolio of publications is comprised of 65 paid daily newspapers and 127 paid non-daily newspapers. In addition, the Company publishes 110 free circulation and "total market coverage," or TMC, publications with limited or no news or editorial content that it distributes free of charge and that generally provide 100% penetration in their areas of distribution. The Company believes that its publications are generally the most cost-effective method for its advertisers to reach substantially all of the households in their markets. Unlike large metropolitan newspapers, the Company derives a majority of its revenues from local display advertising rather than classified and national advertising, which are generally more sensitive to economic conditions. LGO is a Delaware corporation formed on January 27, 1998 for purposes of acquiring a portion of the daily and weekly newspapers owned by American Publishing Company or its subsidiaries, a wholly owned subsidiary of Hollinger International Inc. LGO is a wholly-owned subsidiary of Liberty Group Publishing, Inc. ("Parent" or "LGP"). The unaudited interim consolidated financial statements include the accounts of Operating Company and Operating Company's consolidated subsidiaries (the "Company"). The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These unaudited interim consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the results of the interim periods presented. The accompanying interim consolidated financial statements as of September 30, 2003 and for the three months and nine months ended September 30, 2003 and September 30, 2002 should be read in conjunction with the audited consolidated financial statements of the Company included in LGO's Form 10-K for the year ended December 31, 2002, filed with the Securities and Exchange Commission. The Company's results for the interim periods are not necessarily indicative of the results to be expected for the full year. (2) RECLASSIFICATIONS Certain amounts in the prior year's unaudited interim consolidated financial statements have been reclassified to conform to the 2003 presentation, which include the transfer of inserting expense and certain postage and delivery costs from selling, general and administrative to operating costs. The Company has restated its 2002 interim period consolidated financial information to reflect a revision to its depreciation and amortization expense that resulted from a mathematical error. Previously, the Company had reported depreciation and amortization expense of $4,469 and $13,342, respectively, for the three and nine months ended September 30, 2002. These amounts should have been $4,265 and $12,730, respectively, for the three and nine months ended September 30, 2002. The Company previously reported income tax benefit of $495 and $770, respectively, for the three and nine months ended September 30, 2002. In connection with the change in depreciation and amortization expense discussed above, the Company's income tax benefit for the three and nine months ended September 30, 2002 has been revised to $264 and $216, respectively. 6 (3) DISCONTINUED OPERATIONS The Company disposed of the assets of six related publications (acquired in 1999) in one transaction on January 7, 2002 for $26,510 (the "Disposition"). The net book value of the assets was $19,393, resulting in a pre-tax gain of $7,117, or a gain of $4,342, net of the tax effect of $2,775. As a result of the sale, the disposition of the property has been accounted for as a discontinued operation. Discontinued operations for the nine months ended September 30, 2002 consisted solely of the gain on sale of these publications. (4) SENIOR DISCOUNT DEBENTURES TO AFFILIATES On July 25, 2003, the Operating Company and Parent entered into an amendment to its Amended Credit Facility. The amendment permits Parent to issue debt in lieu of paying cash on the interest due on the 11 5/8% Senior Discount Debentures (the "Senior Discount Debentures") due February 1, 2009, and to issue debt in lieu of paying cash interest due on the additional debt that was issued in lieu of paying cash interest on the Senior Discount Debentures. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Liberty Group Operating, Inc. ("LGO", "Operating Company" or "Registrant") is a Delaware corporation formed on January 27, 1998 for purposes of acquiring a portion of the daily and weekly newspapers owned by American Publishing Company or its subsidiaries, a wholly owned subsidiary of Hollinger International Inc. LGO is a wholly owned subsidiary of Liberty Group Publishing, Inc. ("Parent" or "LGP"). The unaudited interim consolidated financial statements include the accounts of Operating Company and Operating Company's consolidated subsidiaries (the "Company"). The Company is a leading U.S. publisher of local newspapers and related publications that are the dominant source of local news and print advertising in their markets. The Company owns and operates 302 publications located in 17 states that reach approximately 2.37 million people on a weekly basis. The majority of the Company's paid daily newspapers have been published for more than 100 years and are typically the only paid daily newspapers of general circulation in their respective non-metropolitan markets. The Company generates revenues from advertising, circulation and job printing. Advertising revenue is recognized upon publication of the advertisements. Circulation revenue, which is billed to customers at the beginning of the subscription period, is recognized on a straight-line basis over the term of the related subscription. The revenue for job printing is recognized upon delivery. The Company's operating costs consist primarily of newsprint, labor and delivery costs. The Company's selling, general and administrative expenses consist primarily of labor costs. RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 Total Revenues. Total revenues for the quarter ended September 30, 2003 decreased by $1.3 million, or 2.7%, to $47.2 million from $48.5 million for the quarter ended September 30, 2002. The decrease in total revenues was comprised of a $0.8 million, or 2.2%, decrease in advertising revenues, a $0.2 million, or 2.7%, decrease in circulation revenue, and a $0.3 million, or 8.9%, decrease in job printing and other revenue. In the Company's community newspaper markets, advertising revenues decreased by $0.5 million, primarily due to lower local display and classified advertising; which were partially offset by increases in preprint and national advertising. Outside of the community newspaper markets, the Company's advertising revenues declined by $0.3 million, primarily due to lower classified and display revenue in the Chicago suburban market of $0.2 million and a reduction in non-newspaper related revenues of $0.1 million. The decrease in circulation revenue resulted primarily from a reduction in subscriber levels in certain community markets. The decrease in job printing and other revenue was primarily due to lower commercial volume in the Chicago suburban market. Total revenues for the nine months ended September 30, 2003 decreased by $3.5 million, or 2.4%, to $140.2 million from $143.7 million for the nine months ended September 30, 2002. The decrease in total revenues was comprised of a $2.6 million, or 2.4%, decrease in advertising revenues, a $0.5 million, or 1.8%, decrease in circulation revenue, and a $0.4 million, or 4.1%, decrease in job printing and other revenue. In the Company's community newspaper markets, advertising revenues decreased by $0.4 million, primarily due to lower local display and classified advertising; which were partially offset by increases in preprint and national advertising. Outside of the community newspaper markets, the Company's advertising revenues declined by $2.2 million primarily due to lower classified and display revenue in the Chicago suburban market of $1.5 million and a reduction in non-newspaper related revenues of $0.7 million. The decrease in circulation revenue resulted primarily from a reduction in subscriber levels in certain community newspaper markets. The decrease in job printing and other revenue was primarily due to lower commercial volume in the Chicago suburban market. 7 Operating Costs. Operating costs for the quarter ended September 30, 2003 decreased by $0.3 million, or 1.4%, to $22.5 million from $22.8 million for the quarter ended September 30, 2002. The decrease in operating costs was primarily due to reductions in labor of $0.1 million, and external services of $0.1 million.. Operating costs for the nine months ended September 30, 2003 decreased by $0.5 million, or 0.8%, to $66.7 million from $67.2 million for the nine months ended September 30, 2002. The decrease in operating costs was primarily due to reductions in labor of $0.1 million, external services of $0.2 million and newsprint costs of $0.2 million. Selling, General and Administrative. Selling, general and administrative expenses for the quarter ended September 30, 2003 increased by $0.4 million, or 2.9%, to $13.9 million from $13.5 million for the quarter ended September 30, 2002. The increase in selling, general and administrative expenses was primarily due to higher insurance costs of $0.2 million. Selling, general and administrative expenses for the nine months ended September 30, 2003 increased by $0.1 million, or 0.1%, to $39.9 million from $39.8 million for the nine months ended September 30, 2002. The increase in selling, general, and administrative expenses was primarily due to higher insurance costs of $0.2 million and increases in promotion expense of $0.1 million, partially offset by lower compensation of $0.1 million due to a reduction in performance based incentive compensation. Depreciation and Amortization. Depreciation and amortization expense for the quarter ended September 30, 2003 decreased by $0.8 million to $3.5 million from $4.3 million for the quarter ended September 30, 2002. During the quarter ended September 30, 2003, the Company recorded $2.3 million in amortization of intangible assets, compared with $3.2 million for the quarter ended September 30, 2002. The decrease in amortization is primarily due to a decrease in non-compete intangible amortization of $0.8 million resulting from certain non-compete assets that are now fully amortized. Depreciation and amortization expense for the nine months ended September 30, 2003 decreased by $2.1 million to $10.6 million from $12.7 million for the nine months ended September 30, 2002. For the nine months ended September 30, 2003, the Company recorded $7.0 million in amortization of intangible assets, compared with $8.8 million for the nine months ended September 30, 2002. The decrease in amortization is primarily due to a decrease in non-compete intangible amortization of $1.8 million resulting from certain non-compete assets that are now fully amortized. Income from Continuing Operations. Income from continuing operations for the quarter ended September 30, 2003 decreased by $0.4 million, or 5.4%, to $7.2 million from $7.6 million for the quarter ended September 30, 2002. The decrease in income from continuing operations during the quarter ended September 30, 2003 was primarily due to higher selling, general and administrative expense of $0.4 million and lower revenues of $1.3 million, partially offset by lower depreciation and amortization expense of $0.8 million, lower loss on sale of assets of $0.2 million and lower operating costs of $0.3 million. Income from continuing operations for the nine months ended September 30, 2003 decreased by $0.7 million, or 2.8%, to $22.9 million from $23.6 million for the nine months ended September 30, 2002. The decrease was primarily due to lower revenues of $3.4 million, partially offset by lower depreciation and amortization expense of $2.1 million and lower operating costs of $0.6 million. EBITDA. EBITDA (which is defined as earnings before interest, taxes, depreciation and amortization) for the quarter ended September 30, 2003 decreased by $0.9 million, or 8.3%, to $10.7 million from $11.6 million for the quarter ended September 30, 2002. The decrease was primarily due to lower revenues of $1.3 million and higher selling, general and administrative costs of $0.4 million, partially offset by lower operating costs of $0.3 million, lower losses on sales of assets of $0.2 million, and the inclusion in 2002 of a $0.2 million impairment of other assets. EBITDA for the nine months ended September 30, 2003 decreased by $7.7 million, or 19.6%, to $31.3 million from $39.0 million for the nine months ended September 30, 2002. The decrease was primarily due to lower revenues of $3.4 million and a write-off of deferred financing costs of $0.2 million, partially offset by lower operating costs of $0.6 million. The decrease in EBITDA was further attributable to the inclusion in 2002 of an after-tax gain of $4.3 million on the Disposition (defined below), partially offset by the inclusion in 2002 of both cumulative effect of change in accounting principle related to goodwill and masthead impairment losses of $1.4 million and the impairment of other assets of $0.2 million. EBITDA is not a measurement of financial performance under accounting principles generally accepted in the United States of America, or GAAP, and should not be considered in isolation or as an alternative to income from operations, net income (loss), cash flows from operating activities or any other measure of performance or liquidity derived in accordance with GAAP. EBITDA is presented because the Company believes it is an indicative measure of the Company's operating performance and its ability to meet its debt service requirements and is used by investors and analysts to evaluate companies in its industry as a supplement to GAAP measures. Not all companies calculate EBITDA using the same methods; therefore, the EBITDA figures set forth herein may not be comparable to EBITDA reported by other companies. A substantial portion of the Company's EBITDA must be dedicated to the payment of interest on its outstanding indebtedness and to service other commitments, thereby reducing the funds available to the Company for other purposes. Accordingly, EBITDA does not represent an amount of funds that is available for management's discretionary use. 8 The Company believes that net loss is the financial measure calculated and presented in accordance with GAAP that is most directly comparable to EBITDA. The following table reconciles net income to EBITDA for the three and nine months ended September 30, 2003 and 2002:

Interest Expense. Interest expense for the quarter ended September 30, 2003 decreased by $0.4 million to $5.8 million from $6.2 million for the quarter ended September 30, 2002. The decrease in interest expense was due primarily to lower interest rates and less outstanding indebtedness during the quarter ended September 30, 2003 as compared to the quarter ended September 30, 2003. Interest expense for the nine months ended September 30, 2003 decreased by $1.6 million to $17.4 million from $19.0 million for the nine months ended September 30, 2002. The decrease in interest expense was due primarily to lower interest rates and less outstanding indebtedness during the nine months ended September 30, 2003 as compared to the nine months ended September 30, 2002. Write-off of Deferred Financing Costs. As of March 31, 2003, LGO incurred $0.2 million in legal and bank fees associated with a proposed amendment to its Amended Credit Facility (as defined below). On March 31, 2003, LGO wrote off these costs because LGO decided to postpone amending its Amended Credit Facility. Income Tax Expense (Benefit). Income tax expense for the quarter ended September 30, 2003 was $0.6 million compared to income tax benefit of ($0.3) million for the quarter ended September 30, 2002. The increase of $0.9 million for the quarter ended September 30, 2003 was primarily due to higher deferred federal income tax expense recognized by the Company for the quarter ended September 30, 2003. Income tax expense for the nine months ended September 30, 2003 was $2.3 million compared to an income tax benefit of ($0.2) million for the nine months ended September 30, 2002. The increase of $2.5 million for the nine months ended September 30, 2003 was primarily due to an increase in deferred federal income tax expense recognized by the Company for the nine months ended September 30, 2003. Income from Discontinued Operations. The Company disposed of the assets of six related publications (acquired in 1999) in one transaction on January 7, 2002 for $26.5 million (the "Disposition"). The net book value of the assets was $19.4 million, resulting in a pre-tax gain of $7.1 million, or a gain of $4.3 million, net of the tax effect of $2.8 million. As a result of the sale, the disposition of the property has been accounted for as a discontinued operation. Discontinued operations for the nine months ended September 30, 2002, consisted solely of the gain on sale of the publications. Cumulative Effect of Change in Accounting Principle. Pursuant to the adoption of SFAS No. 142, the Company performed an initial impairment test of its properties in the first quarter of 2002. As a result of this test, the Company determined that the fair values of five properties were less than the net book value of the Company's goodwill and mastheads for such properties on January 1, 2002. As a result, an after-tax goodwill and masthead impairment loss of $1.4 million, or $2.4 million pre-tax, was recorded in the quarter ended March 31, 2002. The Company performed an impairment test at the end of 2002, which indicated that no additional impairment needed to be recorded. The Company will perform its annual impairment test for 2003 in the fourth quarter. Net Income. The Company reported net income of $0.8 million for the quarter ended September 30, 2003, compared to net income of $1.4 million for the quarter ended September 30, 2002. The $0.6 million decrease in net income was primarily attributable to lower income from continuing operations of $0.4 million and higher income tax expense of $0.9 million, partially offset by lower interest expense of $0.5 million and the inclusion in 2002 of an impairment expense of $0.2 million. The Company recorded net income of $3.0 million for the nine months ended September 30, 2003, compared to net income of $7.4 million for the nine months ended September 30, 2002. The decrease in net income was primarily attributable to an increase in income tax expense of $2.5 million, a decrease in income from continuing operations of $0.7 million, a write-off of deferred financing costs of $0.2 million and the inclusion in 2002 of the after-tax gain of $4.3 million on the Disposition, partially offset by the inclusion in 2002 of the cumulative effect of change in accounting principle related to goodwill and masthead impairment losses in the amount of $1.4 million, lower interest expense of $1.6 million and the inclusion in 2002 of an impairment expense of $0.2 million. 9 CRITICAL ACCOUNTING POLICY DISCLOSURE The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As of January 1, 2002, the Company adopted SFAS No. 142. SFAS No. 142 requires an annual impairment test for goodwill and other intangible assets with indefinite lives. The Company assesses impairment of goodwill and mastheads by using multiples of recent and projected revenues and EBITDA for individual properties to determine the fair value of the properties and deducts the fair value of assets other than goodwill and mastheads to arrive at the fair value of goodwill and mastheads. This amount is then compared to the carrying value of goodwill and mastheads to determine if any impairment has occurred. The multiples of revenues and EBITDA used to determine fair value are based on the Company's experience in acquiring and selling properties and multiples reflected in the purchase prices of recent sales transactions of newspaper properties similar to those it owns. If there is a significant change in such multiples, or deterioration in revenue or EBITDA for any of the properties, additional impairment losses may have to be recorded. LIQUIDITY AND CAPITAL RESOURCES Cash flows from operating activities. Net cash provided by operating activities for the nine months ended September 30, 2003 decreased to $12.7 million compared with net cash provided by operating activities of $15.5 million for the nine months ended September 30, 2002. The decrease of $2.8 million in cash flows was primarily due to a decrease in income from continuing operations before depreciation and amortization of $2.7 million. Cash flows from investing activities. Net cash used in investing activities was $0.6 million for the nine months ended September 30, 2003 compared to net cash provided by investing activities of $25.3 million for the nine months ended September 30, 2002. The decrease of $25.9 million in cash flows was primarily due to the $26.5 million of proceeds from the Disposition in 2002, partially offset by proceeds from the sale of assets in 2003. The Company's capital expenditures consisted of the purchase of machinery, equipment, furniture and fixtures relating to its publishing operations. For the three months and nine months ended September 30, 2003 capital expenditures were $0.6 million and $1.6 million, or 1.1% and 1.3% of revenues, respectively. The Company has no material commitments for capital expenditures. The Company will continue to pursue its strategy of opportunistically acquiring community newspapers in contiguous markets and new markets. Cash flows from financing activities. Net cash used in financing activities was $9.5 million for the nine months ended September 30, 2003 compared to net cash used in financing activities of $37.6 million for the nine months ended September 30, 2002. The decrease of $28.1 million in cash flows used was primarily due to a repayment during the quarter ended March 31, 2002 of the Company's Amended Credit Facility resulting from the Disposition proceeds of $26.5 million. The Company's net cash used in financing activities for the nine months ended September 30, 2003 reflects payments under LGO's Amended and Restated Credit Agreement, dated as of April 18, 2000, as further amended, with a syndicate of financial institutions led by Citibank, N.A, with Citicorp USA, Inc. as administrative agent (the "Amended Credit Facility"). The Company is subject to certain covenants that limit its ability to pay cash dividends and make other restricted payments and does not expect to pay cash dividends in the foreseeable future. Amended Credit Facility. The Amended Credit Facility provides for a $100.0 million principal amount Term Loan B that matures in March 2007 and a revolving credit facility with a $135.0 million aggregate commitment amount available, including a $10.0 million sub-facility for letters of credit, that matures in March 2005. The Amended Credit Facility is secured by a first-priority security interest in substantially all of the tangible and intangible assets of LGO, LGP and LGP's other present and future direct and indirect subsidiaries. Additionally, the loans under the Amended Credit Facility are guaranteed, subject to specified limitations, by LGP and all of the future direct and indirect subsidiaries of LGO and LGP. The Company is required to permanently reduce the Term Loan B and/or revolving commitment amount with disposition proceeds in excess of $1.5 million if the proceeds are not reinvested in Permitted Acquisitions (as defined under the Amended Credit Facility) within 300 days of receipt of such proceeds. The Term Loan B and the revolving credit facility bear interest, at LGO's option, equal to the Alternate Base Rate for an ABR loan (as defined in the Amended Credit Facility) or the Adjusted LIBO Rate for a eurodollar loan (as defined in the Amended Credit Facility) plus an applicable margin. The applicable margin is based on: (1) whether the loan is an ABR loan or eurodollar loan; and (2) the ratio of (a) indebtedness of LGO and its subsidiaries that requires interest to be paid in cash to (b) pro forma EBITDA for the 12-month period then ended. LGO also pays an annual fee equal to the applicable eurodollar margin for the aggregate amount of outstanding letters of credit. Additionally, LGO pays a fee on the unused portion of the revolving credit facility. No principal payments are due on the revolving credit facility until the maturity date. As of September 30, 2003, the Term Loan B requires 10 principal payments of $0.7 million in 2004, $26.9 million in 2005, $35.3 million in 2006 and $8.8 million in 2007. The Amended Credit Facility contains financial covenants that require LGO and LGP to satisfy specified quarterly financial tests, including a maximum senior leverage ratio, a minimum cash interest coverage ratio and a maximum leverage ratio. The Amended Credit Facility also contains affirmative and negative covenants customarily found in loan agreements for similar transactions. The Company is highly leveraged and has indebtedness that is substantial in relation to its stockholder's equity, tangible equity and cash flow. Interest expense for the three and nine months ended September 30, 2003 was $5.8 million and $17.4 million, respectively, including amortization of deferred financing costs of $0.3 million and $0.9 million, respectively. The degree to which the Company is leveraged could have important consequences, including the following: (1) a substantial portion of the Company's cash flow from operations must be dedicated to the payment of interest on Operating Company's $180.0 million aggregate principal amount of 9 3/8% Senior Subordinated Notes (the "Notes") due February 1, 2008 and interest on other indebtedness, thereby reducing the funds available to the Company for other purposes; (2) indebtedness under the Amended Credit Facility is at variable rates of interest, which causes the Company to be vulnerable to increases in interest rates; (3) the Company is more leveraged than certain competitors in its industry, which might place the Company at a competitive disadvantage; (4) the Company's substantial degree of leverage could make it more vulnerable in the event of a downturn in general economic conditions or other adverse events in its business; and (5) the Company's ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be impaired. As of September 30, 2003, approximately $86.7 million was outstanding under the Amended Credit Facility (without giving effect to $1.5 million of outstanding letters of credit as of such date), and the aggregate principal amount of the Notes outstanding was $180.0 million. On July 25, 2003, the Operating Company and Parent entered into an amendment to the Amended Credit Facility. The amendment permits Parent to issue debt in lieu of paying cash for the interest due on the 11 5/8% Senior Discount Debentures (the "Senior Discount Debentures") due February 1, 2009, and to issue debt in lieu of paying cash interest due on the additional debt that was issued in lieu of paying cash interest on the Senior Discount Debentures. On July 30, 2003, Parent entered into an agreement, effective August 1, 2003, with Green Equity Investors II, L.P. ("GEI II") and Green Equity Investors III, L.P. ("GEI III"), whereby Parent may, at its option, issue 11 5/8% Senior Debentures (the "Senior Debentures") to GEI II and GEI III on each interest payment date of the Senior Discount Debentures, in lieu of paying cash interest on the Senior Discount Debentures that are owned by GEI II and GEI III, with an aggregate initial principal amount equal to the amount of cash interest otherwise payable on such interest payment date under the terms of the Senior Discount Debentures. In addition, Parent may, at its option, issue additional Senior Debentures to GEI II and GEI III on each interest payment date of the Senior Debentures, in lieu of paying cash interest on the Senior Debentures that are owned by GEI II and GEI III, with an aggregate initial principal amount equal to the amount of cash interest otherwise payable on such interest payment date under the terms of the Senior Debentures. This agreement may be terminated by GEI II and GEI III at any time upon delivery of written notice to Parent at least 30 days prior to the next interest payment date. On August 1, 2003, Parent elected to issue Senior Debentures in lieu of paying cash interest on the Senior Discount Debentures that were owned by GEI II and GEI III. In conjunction with its election, Parent issued Senior Debentures to GEI II and GEI III in the amount of $687,003 and $3,335,247, respectively, which will each accrue interest at an annual rate of 11 5/8% and become payable on February 1, 2009. Liquidity. The Company's principal sources of funds will be cash provided by operating activities and borrowings under its revolving credit facility. The indentures relating to the Notes, Senior Discount Debentures and the Amended Credit Facility and the terms of the Senior Debentures impose upon the Company certain financial and operating covenants, including, among others, requirements that the Company satisfy certain quarterly financial tests, including a maximum senior leverage ratio, a minimum cash interest coverage ratio and a maximum leverage ratio, limitations on capital expenditures and restrictions on the Company's ability to incur debt, pay dividends or take certain other corporate actions. Management believes that the Company has adequate capital resources and liquidity to meet its borrowing obligations, all required capital expenditures and pursue its business strategy for at least the next 12 months. On June 3, 2002, LGP filed a registration statement with the Securities and Exchange Commission on Form S-2 with respect to an 11 initial public offering of Common Stock. As of March 31, 2003, LGP had incurred $2.2 million in legal and professional fees associated with its proposed initial public offering that had been capitalized as deferred offering costs. On March 31, 2003, LGP wrote off these costs because LGP decided to postpone its proposed initial public offering. Safe Harbor Provision. This Form 10-Q contains certain "forward-looking statements" (as defined in Section 21E of the Securities Exchange Act of 1934, as amended) that reflect the Company's expectations regarding its future growth, results of operations, performance and business prospects and opportunities. Words such as "anticipates," "believes," "plans," "expects," "intends," "estimates" and similar expressions have been used to identify these forward-looking statements, but are not the exclusive means of identifying these statements. These statements reflect the Company's current beliefs and expectations and are based on information currently available to the Company. Accordingly, these statements are subject to known and unknown risks, uncertainties and other factors that could cause the Company's actual growth, results of operations, performance and business prospects and opportunities to differ from those expressed in, or implied by, these statements. As a result, no assurance can be given that the Company's future growth, results of operations, performance and business prospects and opportunities covered by such forward-looking statements will be achieved. Such factors include, among others: (1) the Company's dependence on local economies and vulnerability to general economic conditions; (2) the Company's substantial indebtedness; (3) the Company's holding company structure; (4) the Company's ability to implement its acquisition strategy, (5) the Company's competitive business environment, which may reduce demand for advertising and (6) the Company's ability to attract and retain key employees. For purposes of this Form 10-Q, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. The Company is not obligated and has no intention to update or revise these forward-looking statements to reflect new events, information or circumstances. SUMMARY DISCLOSURE ABOUT CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following table reflects a summary of the Company's contractual cash obligations, excluding interest, as of September 30, 2003 (in thousands):

RELATED PARTY TRANSACTIONS The Company paid $370,000 in management fees for each of the quarters ended September 30, 2003 and 2002 to Leonard Green & Partners, L.P. The Company paid $1,110,000 in management fees for each of the nine months ended September 30, 2003 and 2002 to Leonard Green & Partners, L.P. As of September 30, 2003, the Company is also obligated to pay other fees to Leonard Green & Partners, L.P. of $125,000, which will be paid this year. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Operating Company has a $135.0 million revolving credit facility and a separate Term Loan B that mature in March 2005 and 2007, respectively. Borrowings under the revolving credit facility and the Term Loan B bear interest at an annual rate, at Operating Company's option, equal to the Alternate Base Rate (as defined in the Amended Credit Facility) or the Adjusted LIBO Rate (as defined in the Amended Credit Facility) plus a margin that varies based upon a ratio set forth in the Amended Credit Facility. As a result, Operating Company's interest expense will be affected by changes in the Alternate Base Rate or in the Adjusted LIBO Rate. At September 30, 2003, Operating Company had borrowings outstanding of $14.9 million under the revolving credit facility (without giving effect to $1.5 million of outstanding letters of credit as of such date) and $71.8 million under the Term Loan B. A hypothetical 100 basis point change in interest rates would impact quarterly interest expense by approximately $0.2 million based on the balance outstanding at September 30, 2003. 12 ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As of September 30, 2003, the end of the quarter covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in the Company's internal controls over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. PART II ITEM 1. LEGAL PROCEEDINGS. The Company is involved from time to time in legal proceedings relating to claims arising out of its operations in the ordinary course of business. The Company is not party to any legal proceedings that, in the opinion of the Company's management, are reasonably expected to have a material adverse effect on the Company's business, financial condition or cash flows. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None ITEM 5. OTHER INFORMATION. None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 31 Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K None 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: November 14, 2003 LIBERTY GROUP OPERATING, INC. /s/ KENNETH L. SEROTA --------------------- Kenneth L. Serota President, Chief Executive Officer and Chairman of the Board of Directors (principal executive officer) /s/ DANIEL D. LEWIS ------------------- Daniel D. Lewis Chief Financial Officer (principal financial and accounting officer) 14

LIBERTY GROUP OPERATING INC 10-Q