10-Q 1 c87644e10vq.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 JUNE 30, 2004 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 August 16, 2004: 100 shares. ================================================================================ TABLE OF CONTENTS

2 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS LIBERTY GROUP OPERATING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

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

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

See accompanying notes to unaudited interim consolidated financial statements. 5 LIBERTY GROUP OPERATING, INC. NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS) (1) THE COMPANY AND BASIS OF PRESENTATION Liberty Group Operating, Inc. ("Operating Company," LGO" or "Registrant") is a Delaware corporation formed on January 27, 1998 for the purpose of acquiring a portion of the daily and weekly newspapers owned by American Publishing Company or its subsidiaries ("APC"), a wholly owned subsidiary of Hollinger International Inc. ("Hollinger"). 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 its 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. As of June 30, 2004, the Company owns and operates 289 publications located in 15 states that reach approximately 2.3 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 and Northeast United States and in the Chicago suburban market, which limits its exposure to economic conditions in any single market or region. The Company's portfolio of publications is comprised of 64 paid daily newspapers and 120 paid non-daily newspapers. In addition, the Company publishes 105 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. 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 unaudited interim consolidated financial statements as of June 30, 2004 and for the three and six months ended June 30, 2004 and June 30, 2003 should be read in conjunction with the audited consolidated financial statements of the Company included in LGO's Annual Report on Form 10-K for the year ended December 31, 2003 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 2004 presentation. 6 (3) LEE EXCHANGE On February 3, 2004, the Company acquired the daily newspapers in Corning, New York and Freeport, Illinois from Lee Enterprises, Inc. in exchange for the Company's daily newspapers in Elko, Nevada and Burley, Idaho, as well as its weeklies in Haily, Idaho and Jerome, Idaho (the "Lee Exchange"). In conjunction with the Lee Exchange, the Company received cash proceeds of $1,994 (net of amount due to Lee). The Company used an independent third-party valuation firm to determine the fair value of the newspaper businesses acquired in the Lee Exchange, which collectively resulted in a pre-tax gain of $7,661, or a gain of $4,591, net of the tax effect of $3,070. The Company has accounted for the acquired newspaper businesses using the purchase accounting method. Accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based on their respective fair values. An independent third-party valuation firm determined the fair values and estimated remaining useful lives for the advertiser and customer relationships and masthead intangible assets. Advertiser and customer relationships are being amortized over remaining useful lives of 30 and 20 years, respectively. Mastheads have not been amortized because their useful life was determined to be indefinite. The operating results of the acquired newspaper businesses from the Lee Exchange have been included in the unaudited interim consolidated financial statements since the exchange date. The operating results of the newspaper businesses disposed of in the Lee Exchange have been accounted for as a discontinued operation and, accordingly, such amounts have been reclassified to reflect the disposition as a discontinued operation for all periods presented. Income from discontinued operations for the six months ended June 30, 2004 includes operating income of $2 and a gain on the exchange of $4,591, net of tax. A computation of the gain on the exchange is as follow: Fair value of newspaper businesses acquired ................................. $ 24,579 Cash consideration received from Lee, less amount due to Lee ................ 1,994 -------- 26,573 Net book value of newspaper businesses disposed ............................. (18,174) Other liabilities ........................................................... (270) Legal and professional fees ................................................. (468) -------- Gain on exchange before taxes ............................................... 7,661 Income tax expense .......................................................... 3,070 -------- Gain on exchange, net of tax .......................................... $ 4,591 ======== The purchase price allocation for the newspaper businesses acquired is as follows: Fair value of newspaper businesses acquired ................................. $ 24,579 ======== Current assets .............................................................. $ 869 Property, plant, and equipment .............................................. 3,300 Advertiser customer relationships ........................................... 7,947 Subscriber customer relationships ........................................... 2,588 Mastheads ................................................................... 3,004 Current liabilities ......................................................... (920) -------- Remainder (goodwill) .................................................. $ 7,791 ========

(4) WRITE-OFF OF DEFERRED FINANCING COSTS As of March 31, 2003, the Company had incurred $161 in legal and bank fees associated with a proposed amendment to its Amended Credit Facility. On March 31, 2003, the Company wrote off these costs because the Company postponed amending its Amended Credit Facility. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXECUTIVE SUMMARY The Company's mission is to be the leading local news source in the communities it serves, to provide the most effective means for local advertisers to reach their potential customers and to create shareholder value. In order to achieve its long-term objectives, the Company focuses on generating reader and employee loyalty, expanding local advertising bases and improving margins through regional clustering and strict cost control measures. The Company primarily 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. The Company's long-term strategy is pursued with a portfolio of properties that serve its customers in print and online. As of June 30,.2004, properties outside the metropolitan areas, also referred to as the community markets, represented 87% of the Company's 289 publications, while the group of publications in the western suburbs of Chicago, also referred to as the Chicago suburban market, accounted for 13% of its publications. On February 3, 2004, the Company acquired daily newspapers in Corning, New York and Freeport, Illinois (and received cash consideration) from Lee Enterprises, Inc. in exchange for daily newspapers in Elko, Nevada and Burley, Idaho and weekly newspapers in Hailey, Idaho and Jerome, Idaho (the "Lee Exchange"). In conjunction with the exchange, the Company received cash proceeds of $2.0 million (net of amount due to Lee). The Company used an independent third-party valuation firm to determine the fair value of the newspaper businesses acquired in the Lee Exchange, which collectively resulted in a pre-tax gain of $7.7 million, or a gain of $4.6 million, net of the tax effect of $3.1 million. The operating results of the acquired newspaper businesses from the Lee Exchange have been included in the unaudited interim consolidated financial statements since the exchange date. The operating results of the newspaper businesses disposed of in the Lee Exchange have been accounted for as a discontinued operation and, accordingly, such amounts have been reclassified to reflect the disposition as a discontinued operation for all periods presented. See Note 3 to the unaudited interim consolidated financial statements included herein. RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain revenue and expense items (expressed as a percentage of total revenues):

8 THREE AND SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE AND SIX MONTHS ENDED JUNE 30, 2003 Total Revenues. Total revenue for the quarter ended June 30, 2004 increased by $4.2 million, or 8.8%, to $51.8 million from $47.6 million for the quarter ended June 30, 2003. The increase in total revenue was comprised of a $1.9 million, or 5.1%, increase in advertising revenue, a $0.8 million, or 10.4%, increase in circulation revenue, and a $1.5 million, or 52.0%, increase in job printing and other revenue. The increase in advertising revenue was primarily due to same property increases in the Company's community and Chicago suburban markets of $0.3 million and $0.1 million, respectively, revenue from the newspaper businesses acquired in the Lee Exchange of $1.6 million, partially offset by a decrease in non-newspaper revenues of $0.2 million. The increase in circulation revenue was primarily due to the Lee Exchange of $0.9 million and higher circulation revenue in the Chicago suburban market of $0.1 million, partially offset by lower circulation revenues in the Company's community markets of $0.2 million. The increase in job printing and other revenue was primarily due to an increase in commercial printing in the Chicago suburban market due to the acquisition of a print facility in December 2003. Total revenue for the six months ended June 30, 2004 increased by $7.6 million, or 8.4%, to $97.5 million from $89.9 million for the six months ended June 30, 2003. The increase in total revenue was comprised of a $3.5 million, or 5.1%, increase in advertising revenue, a $1.3 million, or 8.0%, increase in circulation revenue, and a $2.8 million, or 48.8%, increase in job printing and other revenue. The increase in advertising revenue was primarily due to same property increases in the Company's community and Chicago suburban markets of $1.3 million and $0.2 million, respectively, and revenue from the newspaper businesses acquired in the Lee Exchange of $2.6 million, partially offset by a decrease in non-newspaper revenue of $0.5 million. The increase in circulation revenue was primarily due to the Lee Exchange of $1.5 million and higher circulation revenue in the Chicago suburban market of $0.1 million, partially offset by lower circulation revenues in the Company's community markets of $0.3 million. The increase in job printing and other revenue was primarily due to an increase in commercial printing in the Chicago suburban market due to the acquisition of a print facility in December 2003. Operating Costs. Operating costs for the quarter ended June 30, 2004 increased by $2.6 million, or 12.0%, to $24.4 million from $21.8 million for the quarter ended June, 30, 2003. The increase in operating costs was primarily due to operating costs from the newspaper businesses acquired in the Lee Exchange and the print facility acquired in December 2003 of $2.5 million and higher newsprint costs of $0.2 million. Operating costs for the six months ended June 30, 2004 increased by $4.9 million, or 11.5%, to $47.4 million from $42.5 million for the six months ended June 30, 2003. The increase in operating costs was primarily due to operating costs from the newspaper businesses acquired in the Lee Exchange and the print facility acquired in December 2003 of $4.4 million and higher newsprint costs of $0.4 million. Selling, General and Administrative. Selling, general and administrative expense for the quarter ended June 30, 2004 was $13.1 million, the same as the quarter ended June, 30, 2003. For the quarter, selling, general and administrative expenses increased by $0.6 million as a result of the newspaper businesses acquired in the Lee Exchange and the print facility acquired in December 2003, which was offset by lower communication costs of $0.1 million and reductions in labor costs of $0.5 million, resulting primarily from lower headcount and insurance costs. Selling, general and administrative expenses for the six months ended June 30, 2004 increased by $0.7 million, or 2.9%, to $25.8 million from $25.1 million for the six months ended June 30, 2003. The increase in selling, general and administrative expenses of $1.0 million was due primarily to selling, general and administrative costs from the newspaper businesses acquired in the Lee Exchange and the print facility acquired in December 2003, partially offset by a reduction in labor costs of $0.2 million, resulting primarily from lower insurance costs. Depreciation and Amortization. Depreciation and amortization expense for the quarter ended June 30, 2004 decreased by $0.1 million, or 2.6%, to $3.3 million from $3.4 million for the quarter ended June, 30, 2003. During the quarter ended June 30, 2004, the Company recorded $2.2 million in amortization of intangible assets, compared with $2.3 million for the quarter ended June 30, 2003. The decrease in amortization is primarily due to a decrease in non-compete intangible amortization resulting from certain non-compete assets that are now fully amortized partially offset by depreciation and amortization from the Lee Exchange and the print facility acquired in December. Depreciation and amortization expense for the six months ended June 30, 2004 decreased by $0.3 million, or 4.2%, to $6.6 million from $6.9 million for the six months ended June 30, 2003. During the six months ended June 30, 2004, the Company recorded $4.3 million in amortization of intangible assets, compared with $4.7 million for the six months ended June 30, 2003. The decrease in amortization is primarily due to a decrease in non-compete intangible amortization resulting from certain non-compete assets that are now fully amortized partially offset by depreciation and amortization from the Lee Exchange and the print facility acquired in December. 9 EBITDA. The Company recorded net income of $2.1 million for the quarter ended June 30, 2004, compared to net income of $2.3 million for the quarter ended June 30, 2003. EBITDA (which is defined as earnings before interest, taxes, depreciation and amortization) for the quarter ended June 30, 2004 increased by $1.1 million, or 8.0%, to $14.2 million from $13.2 million for the quarter ended June 30, 2003. The increase was primarily due to higher revenues of $4.2 million, partially offset by higher operating costs of $2.6 million and higher selling, general and administrative costs of $0.1 million. In addition, the quarter ended June 30, 2003 included income from discontinued operations before taxes, depreciation and amortization of $0.4 million from the disposed publications in the Lee Exchange. The Company recorded net income of $7.3 million for the six months ended June 30, 2004, compared to net income of $2.3 million for the six months ended June 30, 2003. EBITDA for the six months ended June 30, 2004 increased by $9.2 million, or 40.6%, to $32.0 million from $22.7 million for the six months ended June 30, 2003. The increase was primarily due to higher revenues of $7.6 million, partially offset by higher operating costs of $4.9 million and higher selling, general and administrative costs of $0.7 million. In addition, the six months ended June 30, 2004 included a gain of $7.7 million, before taxes, from the exchange of publications in the Lee Exchange, partially offset by the income from discontinued operations before taxes, depreciation and amortization of $0.6 million for the six months ended June 30, 2003. The six months ended June 30, 2003 also included a write-off of deferred financing costs 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, 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. The Company believes that net income 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 six months ended June 30, 2004 and 2003 (in thousands):

(1) Depreciation and amortization expense for the three months ended June 30, 2003 includes $122 related to the newspaper businesses disposed of as part of the Lee Exchange. Depreciation and amortization expense for the six months ended June 30, 2004 and 2003 includes $45 and $263, respectively, related to the newspaper businesses disposed of as part of the Lee Exchange. (2) Income tax expense for the six months ended June 30, 2004 consists of $3,070 of income tax expense related to the gain recorded on the Lee Exchange and $3,694 of income tax expense related to the income from continuing operations. Income tax expense for the three months ended June 30, 2003 consists of $1,406 related to continuing operations and $145 related to discontinued operations. Income tax expense for the six months ended June 30, 2003 consists of $1,511 related to continuing operations and $145 related to discontinued operations. Interest Expense. Interest expense for the quarter ended June 30, 2004 decreased by $0.2 million, or 3.0%, to $5.6 million from $5.8 million for the quarter ended June 30, 2003. Interest expense for the six months ended June 30, 2004 decreased by $0.4 million, or 3.3%, to $11.3 million from $11.7 million for the six months ended June 30, 2003. 10 Write-off of Deferred Financing Costs. As of March 31, 2003, the Company 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, the Company wrote off these costs because the Company postponed amending its Amended Credit Facility. Income Tax Expense. Income tax expense for the quarter ended June 30, 2004 increased by $1.8 million, or 126.7%, to $3.2 million from $1.4 million for the quarter ended June 30, 2003. Income tax expense for the six months ended June 30, 2004 was $3.7 million compared to $1.5 million for the six months ended June 30, 2003. The increase of $2.2 million for the six months ended June 30, 2004 was primarily due to an increase in deferred federal income tax expense recognized by the Company for the three months ended June 30, 2004 Income from Discontinued Operations. Income from discontinued operations, net of tax, for the quarter ended June 30, 2004 decreased by $0.2 million, or 100%, from $0.2 million for the quarter ended June 30, 2003. Income from discontinued operations was $4.6 million for the six months ended June 30, 2004 compared to $0.2 million for the six months ended June 30, 2003. The Lee Exchange on February 3, 2004 resulted in a pre-tax gain of $7.7 million and an after-tax gain of $4.6 million. 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. The Company assesses impairment of goodwill and mastheads by using multiples of recent and projected revenues and EBITDA (earnings before interest, taxes, depreciation, and amortization) for individual or strategic regional clusters of 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. If the fair value is less than the carrying value, then the Company will consider whether a temporary or permanent impairment has occurred based on the specific facts and circumstances associated with the individual or strategic regional cluster of properties. The multiples of revenue 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. The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Company assesses the recoverability of its long-lived assets, including property, plant and equipment and definite lived intangible assets, whenever events or changes in business circumstances indicate the carrying amount of the assets, or related group of assets, may not be fully recoverable. Factors leading to impairment include significant under performance relative to expected historical or projected future operating losses, significant changes in the manner of use of the acquired assets or the strategy for the Company's overall business, and significant negative industry or economic trends. The assessment of recoverability is based on management's estimate. If undiscounted future operating cash flows do not exceed the net book value of the long-lived assets, then a permanent impairment has occurred. The Company would record the difference between the net book value of the long-lived asset and the fair value of such asset as a charge against income in the consolidated statements of operations if such a difference arose. LIQUIDITY AND CAPITAL RESOURCES The Company's primary cash requirements are for working capital, borrowing obligations and capital expenditures. The Company has no material commitments for capital expenditures. The Company intends to continue to pursue its strategy of opportunistically acquiring community newspapers in contiguous markets and new markets. The Company's principal sources of funds have historically been, and will be, cash provided by operating activities and borrowings under its revolving credit facility. The indentures relating to the Notes and the Amended Credit Facility 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. 11 Management believes that the Company has adequate capital resources and liquidity to meet its working capital needs, borrowing obligations, all required capital expenditures and pursue its business strategy for at least the next 12 months. With the revolving credit facility maturing in March 2005, the Company is currently considering various opportunities to refinance or extend the revolving credit facility, to amend the Amended Credit Facility or to enter into a new credit facility. Cash flows from operating activities. Net cash provided by operating activities for the six months ended June 30, 2004 was $11.3 million compared with net cash provided by operating activities of $9.5 million for the six months ended June 30, 2003. The increase is primarily due to an increase in income from continuing operations before depreciation and amortization of $2.0 million, partially offset by an increase in working capital requirements for the six months ended June 30, 2004. Cash flows from investing activities. Net cash provided by investing activities was $0.5 million for the six months ended June 30, 2004 compared to net cash used in investing activities of $0.7 million for the six months ended June 30, 2003. The increase in cash flows was primarily due to an increase of $1.9 million in cash proceeds from the exchange of publications and sales of other assets, partially offset by an increase in capital expenditures of $0.7 million. The $2.2 million of cash proceeds from the exchange of publications and sales of other assets for the six months ended June 30, 2004 are proceeds from the Lee Exchange. The Company's capital expenditures consisted of the purchase of machinery, equipment, furniture and fixtures relating to its publishing operations and amounted to 1.7% of revenues. Cash flows from financing activities. Net cash used in financing activities was $11.5 million for the six months ended June 30, 2004 compared to net cash used in financing activities of $7.2 million for the six months ended June 30, 2003. The Company's financing activities for the six months ended June 30, 2004 reflects increased dividend payments to Parent and repayments of the Term Loan B and the revolving credit facility 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. The weighted average interest rate for the Amended Credit Facility for the three and six months ended June 30, 2004 was 4.7%. 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 March 2005 maturity date. As of June 30, 2004, the Term Loan B requires principal payments of $0.3 million in 2004, $25.0 million in 2005, $32.8 million in 2006 and $8.2 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 six months ended June 30, 2004 was $5.6 and $11.3 million, respectively, including amortization of deferred financing costs of $0.3 million and $0.6 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, 12 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 June 30, 2004, approximately $67.9 million was outstanding under the Amended Credit Facility (without giving effect to $2.2 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 LGP entered into an amendment to the Amended Credit Facility. The amendment permits LGP to issue debt in lieu of paying cash for the interest due on debt instruments issued by LGP. SUMMARY DISCLOSURE ABOUT CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following table reflects a summary of the Company's contractual obligations as of June 30, 2004 (in thousands):

OFF-BALANCE SHEET ARRANGEMENTS The Company does not engage in off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships with unconsolidated entities of other persons that may have a material current or future effect on its financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. RELATED PARTY TRANSACTIONS The Company paid $370,000 in management fees for each of the quarters ended June 30, 2004 and 2003 to Leonard Green & Partners, L.P. The Company paid $740,000 in management fees for each of the six month periods ended June 30, 2004 and 2003 to Leonard Green & Partners, L.P. The Company was obligated to pay other fees to Leonard Green & Partners, L.P. of $125,000 at June 30, 2004. DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS 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 13 Company's ability to attract and retain key employees. See "Risk Factors" beginning on page 20 of our Annual Report on Form 10-K for the year ended December 31, 2003 for a discussion of the above factors and other factors. 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. 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 June 30, 2004, Operating Company had borrowings outstanding of $1.5 million under the revolving credit facility (without giving effect to $2.2 million of outstanding letters of credit as of such date) and $66.4 million under the Term Loan B. The weighted average interest rate for the Amended Credit Facility for the three and six months ended June 30, 2004 was 4.7%. 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 June 30, 2004. For additional information regarding the Company's Amended Credit Facility, see "Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources." Newsprint is a commodity subject to supply and demand market conditions. See Item 1 "Business-Newsprint" in the LGO's Form 10-K for the year ended December 31, 2003 for further discussion. 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 June 30, 2004, 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 control 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 control over financial reporting. 14 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, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES. 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 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: August 16, 2004 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) 15

LIBERTY GROUP OPERATING INC 10-Q