Form 10-Q
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-Q

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2003

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission file number 1-14595

 


 

FOX ENTERTAINMENT GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware   95-4066193

(State or Other Jurisdiction

of Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1211 Avenue of the Americas, New York, New York   10036
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s telephone number, including area code (212) 852-7111

 


 

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 Securities Exchange Act of 1934).    Yes  x    No  ¨

 

As of November 5, 2003, 352,436,375 shares of Class A Common Stock, par value $.01 per share, and 547,500,000 shares of Class B Common Stock, par value $.01 per share, were outstanding.

 



Table of Contents

FOX ENTERTAINMENT GROUP, INC.

 

FORM 10-Q

 

TABLE OF CONTENTS

 

               Page

Part I. Financial Information

    
     Item 1.    Financial Statements     
          Unaudited Consolidated Condensed Statements of Operations for the three months ended September 30, 2003 and 2002    3
          Consolidated Condensed Balance Sheets as of September 30, 2003 (unaudited) and June 30, 2003 (audited)    4
          Unaudited Consolidated Condensed Statements of Cash Flows for the three months ended September 30, 2003 and 2002    5
          Notes to the Unaudited Consolidated Condensed Financial Statements    6
     Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    14
     Item 3.    Quantitative and Qualitative Disclosures About Market Risk    24
     Item 4.    Controls and Procedures    24

Part II. Other Information

    
     Item 1.    Legal Proceedings    24
     Item 6.    Exhibits and Reports on Form 8-K    25
     Signature    25

 

2


Table of Contents

FOX ENTERTAINMENT GROUP, INC.

 

UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(in millions except per share amounts)

 

    

For the three months
ended

September 30,


 
     2003

    2002

 

Revenues

   $ 2,758     $ 2,344  

Expenses:

                

Operating

     1,786       1,586  

Selling, general and administrative

     319       322  

Depreciation and amortization

     42       47  
    


 


Operating income

     611       389  

Other income (expense):

                

Interest expense, net

     (8 )     (46 )

Equity earnings (losses) of affiliates

     7       2  

Minority interest in subsidiaries

     (2 )     (9 )

Other, net

     26       —    
    


 


Income before provision for income taxes

     634       336  

Provision for income tax expense on a stand-alone basis

     (233 )     (122 )
    


 


Net income

   $ 401     $ 214  
    


 


Basic and diluted earnings per share

   $ 0.45     $ 0.25  
    


 


Basic and diluted weighted average number of common equivalent shares outstanding

     900       850  
    


 


 

The accompanying notes are an integral part of these unaudited consolidated condensed financial statements.

 

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FOX ENTERTAINMENT GROUP, INC.

 

UNAUDITED CONSOLIDATED CONDENSED BALANCE SHEETS

(in millions except share and per share amounts)

 

     As of
September 30,
2003


   As of
June 30,
2003


     (unaudited)    (audited)

Assets:

             

Cash and cash equivalents

   $ 36    $ 72

Accounts receivable, net

     2,835      2,647

Filmed entertainment and television programming costs, net

     3,360      3,161

Investments in equity affiliates

     1,581      1,560

Property and equipment, net

     1,443      1,464

Intangible assets, net

     8,662      8,663

Goodwill, net

     4,816      4,813

Other assets and investments

     916      919
    

  

Total assets

   $ 23,649    $ 23,299
    

  

Liabilities and Shareholders’ Equity:

             

Liabilities:

             

Accounts payable and accrued liabilities

   $ 1,472    $ 1,665

Participations, residuals and royalties payable

     1,271      1,141

Television programming rights payable

     1,473      1,397

Deferred revenue

     455      449

Borrowings

     717      —  

Deferred income taxes

     2,152      2,053

Other liabilities

     815      797
    

  

       8,355      7,502

Due to affiliates of News Corporation

     562      704
    

  

Total liabilities

     8,917      8,206
    

  

Minority interest in subsidiaries

     28      790
    

  

Commitments and contingencies

             

Shareholders’ Equity:

             

Preferred stock, $.01 par value per share; 100,000,000 shares authorized; 0 shares issued and outstanding as of September 30 and June 30, 2003

     —        —  

Class A Common stock, $.01 par value per share; 1,000,000,000 authorized; 352,436,375 issued and outstanding as of September 30 and June 30, 2003

     4      4

Class B Common stock, $.01 par value per share; 650,000,000 authorized; 547,500,000 issued and outstanding as of September 30 and June 30, 2003

     6      6

Additional paid-in capital

     12,780      12,780

Retained earnings and accumulated other comprehensive income

     1,914      1,513
    

  

Total shareholders’ equity

     14,704      14,303
    

  

Total liabilities and shareholders’ equity

   $ 23,649    $ 23,299
    

  

 

The accompanying notes are an integral part of these unaudited consolidated condensed financial statements.

 

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FOX ENTERTAINMENT GROUP, INC.

 

UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(in millions)

 

    

For the three months

ended

September 30,


 
     2003

    2002

 

Operating activities:

                

Net income

   $ 401     $ 214  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation and amortization

     42       47  

Amortization of cable distribution investments

     31       31  

Equity (earnings) losses of affiliates and distributions

     (7 )     (1 )

Minority interest in subsidiaries

     2       6  

Deferred taxes

     58       54  

Change in operating assets and liabilities, net of acquisitions:

                

Accounts receivable and other assets

     (199 )     18  

Filmed entertainment and television programming costs, net

     (169 )     (260 )

Accounts payable and accrued liabilities

     (50 )     (51 )

Participations, residuals and royalties payable and other liabilities

     117       77  
    


 


Net cash provided by operating activities

     226       135  
    


 


Investing activities:

                

Acquisitions, net of cash acquired

     (5 )     (427 )

Investments in equity affiliates

     (19 )     (51 )

Other investments

     (26 )     (2 )

Purchases of property and equipment, net of acquisitions

     (22 )     (26 )

Disposals of property and equipment

     —         9  
    


 


Net cash used in investing activities

     (72 )     (497 )
    


 


Financing activities:

                

Borrowings

     118       —    

Repayment of borrowings

     (138 )     (947 )

Decrease in minority interest in subsidiaries

     (2 )     —    

Decrease in Preferred Interests

     (26 )     (76 )

(Repayments to) advances from affiliates of News Corporation, net

     (142 )     1,405  
    


 


Net cash (used in) provided by financing activities

     (190 )     382  
    


 


Net (decrease) increase in cash and cash equivalents

     (36 )     20  

Cash and cash equivalents, beginning of year

     72       56  
    


 


Cash and cash equivalents, end of period

   $ 36     $ 76  
    


 


 

The accompanying notes are an integral part of these unaudited consolidated condensed financial statements.

 

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FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 1 – Basis of Presentation

 

Fox Entertainment Group, Inc. (the “Company”) is principally engaged in the development, production and worldwide distribution of feature films and television programs, television broadcasting and cable network programming. The Company is a majority-owned subsidiary of The News Corporation Limited (“News Corporation”), which, as of September 30, 2003, held equity and voting interests in the Company of 80.6% and 97.0%, respectively.

 

The accompanying unaudited consolidated condensed financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been reflected in these unaudited consolidated condensed financial statements. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2004.

 

These interim unaudited consolidated condensed financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended June 30, 2003 as filed with the Securities and Exchange Commission.

 

The preparation of financial statements in conformity with GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated condensed financial statements and the reported amounts of revenues and expenses during the reporting period. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

 

Certain prior year amounts have been reclassified to conform to the fiscal 2004 presentation.

 

Effective for the third quarter of fiscal 2003, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123,” which requires quarterly disclosure about the method of accounting for stock-based employee compensation and the effect on reported results. The Company follows the disclosure-only provisions of SFAS No. 123 “Accounting for Stock-Based Compensation,” and in accordance with its provisions, applies Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees.”

 

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FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 1 – Basis of Presentation - continued

 

The following table reflects the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions for stock-based employee compensation. These pro forma effects may not be representative of future amounts since the estimated fair value of stock options on the date of grant is amortized to expense over the vesting period and additional options may be granted in future years.

 

    

For the three months

ended

September 30,


 
     2003

    2002

 
    

(in millions except

per share data)

 

Net income, as reported

   $ 401     $ 214  

Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects

     (13 )     (11 )
    


 


Pro forma net income

   $ 388     $ 203  
    


 


Basic and diluted earnings per share:

                

As reported

   $ 0.45     $ 0.25  

Pro forma

   $ 0.43     $ 0.24  

 

Note 2 – Comprehensive Income

 

Comprehensive income is as follows:

 

    

For the three months

ended

September 30,


 
     2003

   2002

 
     (in millions)  

Net income, as reported

   $ 401    $ 214  

Other comprehensive income:

               

Foreign currency translation adjustments

     —        (6 )
    

  


Total comprehensive income

   $ 401    $ 208  
    

  


 

Note 3 – Goodwill and Other Intangible Assets

 

The initial adoption of SFAS No. 142, “Goodwill and Other Intangible Assets”, effective July 1, 2002, required the Company to perform an impairment assessment of its goodwill and indefinite-lived intangible assets as of the date of adoption. This impairment assessment compared the fair value of these intangible assets to their carrying value. As a result of the tests performed, the Company determined that none of its goodwill and indefinite-lived intangible assets were impaired.

 

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FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 4 – Filmed Entertainment and Television Programming Costs, net

 

Filmed entertainment and television programming costs, net consisted of the following as of:

 

    September 30, 2003

  June 30, 2003

    (in millions)

Filmed entertainment costs:

           

Films:

           

Released

  $ 725   $ 733

Completed, not released

    33     31

In production

    626     603

In development or preproduction

    50     52
   

 

      1,434     1,419
   

 

Television productions:

           

Released

    397     481

In production

    201     77

In development or preproduction

    2     —  
   

 

      600     558
   

 

Total filmed entertainment costs, less accumulated amortization

    2,034     1,977

Television programming costs, less accumulated amortization

    1,326     1,184
   

 

Total filmed entertainment and television programming costs, net

  $ 3,360   $ 3,161
   

 

 

Note 5 – New Millennium II

 

In September 2003, the Company purchased substantially all of the outstanding equity of Tintagel Investors L.L.C. (“Tintagel”), the entity that held the Preferred Interest in New Millennium II (“NM2”), for $25.5 million plus accrued and unpaid Preferred Payments in the amount of approximately $106,000. As a result of the acquisition of this equity interest, the Company has consolidated the assets and liabilities of Tintagel for accounting purposes and all Preferred Interests and Preferred Payments in NM2 have been eliminated. The June 30, 2003 outstanding NM2 Preferred Interest of $762 million was included in Minority interest in subsidiaries on the consolidated balance sheet and Preferred Payments were included in Minority interest in subsidiaries in the statement of operations. Tintagel’s September 30, 2003 outstanding indebtedness of $717 million is included in Borrowings on the unaudited consolidated condensed balance sheet and the corresponding interest is included in Interest expense, net. Tintagel continues to be a separate legal entity from the Company with separate assets and liabilities.

 

Note 6 – Acquisitions

 

In August 2002, the Company acquired WPWR-TV in the Chicago designated market area (DMA) from Newsweb Corporation for $425 million. This transaction has been treated as a purchase in accordance with SFAS Nos. 141, “Business Combinations,” and 142, “Goodwill and Other Intangible Assets.”

 

In April 2003, News Corporation, General Motors Corporation (“GM”) and Hughes Electronics Corporation (“Hughes”) reached an agreement in which News Corporation would acquire 34% of Hughes (the “Hughes Transaction”). News Corporation will acquire GM’s approximate 19.9% interest in Hughes for approximately $3.8 billion (subject to upward adjustment), of which approximately $768 million (subject to upward adjustment) may be paid in News Corporation American Depositary Receipts representing preferred limited voting ordinary shares (“ADRs”). News Corporation will acquire through a merger an additional 14.1% of Hughes for approximately $2.7 billion that is payable, at News Corporation’s option, in cash, News Corporation ADRs, or a combination thereof. Simultaneously with the closing of this transaction, News Corporation will transfer its 34% ownership interest in Hughes to the Company in exchange for promissory notes representing $4.5 billion and approximately 74.2 million shares of the Company’s Class A Common Stock, thereby increasing News Corporation’s ownership interest in the Company from 80.6% to approximately 82%. News Corporation’s voting percentage will remain at 97%. The closing of the transaction is subject to a number of conditions, including regulatory approvals.

 

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FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 7 – Segment Information

 

The Company manages and reports its activities in four business segments:

 

  Filmed Entertainment, which principally consists of the production and acquisition of live-action and animated motion pictures for distribution and licensing in all formats in all entertainment media primarily in the United States, Canada and Europe, and the production of original television programming in the United States and Canada;

 

  Television Stations, which principally consists of the operation of broadcast television stations in the United States;

 

  Television Broadcast Network, which principally consists of the broadcasting of network programming in the United States; and

 

  Cable Network Programming, which principally consists of the production and licensing of programming distributed through cable television systems and direct broadcast satellite operators in the United States and professional sports team ownership in the United States.

 

The Company’s reportable operating segments have been determined in accordance with the Company’s internal management structure, which is organized based on operating activities. The Company evaluates performance based upon several factors, of which the primary financial measures are segment operating income and Operating Income Before Depreciation and Amortization.

 

    

For the three months

ended

September 30,


     2003

   2002

     (in millions)

Revenues:

             

Filmed Entertainment

   $ 1,250    $ 883

Television Stations

     518      514

Television Broadcast Network

     394      424

Cable Network Programming

     596      523
    

  

Total revenues

   $ 2,758    $ 2,344
    

  

 

Operating Income Before Depreciation and Amortization, defined as operating income (loss) plus depreciation and amortization and the amortization of cable distribution investments, eliminates the variable effect across all business segments of non-cash depreciation and amortization. Depreciation and amortization expense includes the depreciation of property and equipment, as well as amortization of finite-lived intangible assets. Amortization of cable distribution investments represents a reduction against revenues over the term of a carriage arrangement and as such it is excluded from Operating Income Before Depreciation and Amortization. Since Operating Income Before Depreciation and Amortization is a non-GAAP measure, it should be considered in addition to, not as a substitute for, operating income (loss), net income (loss), cash flow and other measures of financial performance reported in accordance with GAAP. Operating Income Before Depreciation and Amortization does not reflect cash available to fund requirements and the items excluded from Operating Income Before Depreciation and Amortization, such as depreciation and amortization, are significant components in assessing the Company’s financial performance.

 

Management believes that Operating Income Before Depreciation and Amortization is an appropriate measure for evaluating the operating performance of the Company’s business segments. Operating Income Before Depreciation and Amortization, which is the information reported to and used by the Company’s chief decision maker for the purpose of making decisions about the allocation of resources to segments and assessing their performance, provides management, investors and equity analysts a measure to analyze operating performance of each business segment and enterprise value against historical and competitors’ data, although historical results, including Operating Income Before Depreciation and Amortization, may not be indicative of future results (as operating performance is highly contingent on many factors including customer tastes and preferences).

 

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Table of Contents

FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 7 – Segment Information - continued

 

    

For the three months

ended

September 30,


 
     2003

    2002

 
     (in millions)  

Operating Income Before Depreciation and Amortization:

                

Filmed Entertainment

   $ 345     $ 118  

Television Stations

     237       224  

Television Broadcast Network

     (41 )     (3 )

Cable Network Programming

     143       128  
    


 


Total Operating Income Before Depreciation and Amortization

     684       467  

Amortization of cable distribution investments

     (31 )     (31 )

Depreciation and Amortization

     (42 )     (47 )
    


 


Total operating income

     611       389  
    


 


Interest expense, net

     (8 )     (46 )

Equity earnings (losses) of affiliates

     7       2  

Minority interest in subsidiaries

     (2 )     (9 )

Other, net

     26       —    
    


 


Income before provision for income taxes

   $ 634     $ 336  

Provision for income tax expense on a stand-alone basis

     (233 )     (122 )
    


 


Net income

   $ 401     $ 214  
    


 


 

    For the three months ended September 30, 2003

 
   

Operating

Income Before

Depreciation and

Amortization


   

Depreciation

and

amortization


   

Amortization

of cable

distribution

investments


   

Operating

income

(loss)


 
    (in millions)  

Filmed Entertainment

  $ 345     $ (12 )   $  —       $ 333  

Television Stations

    237       (16 )     —         221  

Television Broadcast Network

    (41 )     (4 )     —         (45 )

Cable Network Programming

    143       (10 )     (31 )     102  
   


 


 


 


Total

  $ 684     $ (42 )   $ (31 )   $ 611  
   


 


 


 


 

10


Table of Contents

FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 7– Segment Information - continued

 

     For the three months ended September 30, 2002

 
    

Operating

Income Before

Depreciation and
Amortization


   

Depreciation

and

amortization


   

Amortization

of cable

distribution

investments


   

Operating

income

(loss)


 
     (in millions)  

Filmed Entertainment

   $ 118     $ (13 )   $ —       $ 105  

Television Stations

     224       (15 )     —         209  

Television Broadcast Network

     (3 )     (5 )     —         (8 )

Cable Network Programming

     128       (14 )     (31 )     83  
    


 


 


 


Total

   $ 467     $ (47 )   $ (31 )   $ 389  
    


 


 


 


 

Intersegment revenues generated primarily by the Filmed Entertainment segment of approximately $152 million and $160 million for the three months ended September 30, 2003 and 2002, respectively, have been eliminated within the Filmed Entertainment segment. Intersegment operating profits generated primarily by the Filmed Entertainment segment of approximately $20 million and $16 million for the three months ended September 30, 2003 and 2002, respectively, have been eliminated on consolidation within the Filmed Entertainment segment.

 

Interest expense, net, Equity earnings (losses) of affiliates, Minority interest in subsidiaries, Other, net and Provision for income tax expense on a stand-alone basis are not allocated to segments, as they are not under the control of segment management.

 

    

As of

September 30, 2003


  

As of

June 30, 2003


     (in millions)

Total assets:

             

Filmed Entertainment

   $ 4,710    $ 4,503

Television Stations

     11,440      11,388

Television Broadcast Network

     1,028      978

Cable Network Programming

     4,890      4,870

Investments in equity affiliates

     1,581      1,560
    

  

Total assets

   $ 23,649    $ 23,299
    

  

Goodwill and Intangible assets, net:

             

Filmed Entertainment

   $ 445    $ 445

Television Stations

     10,049      10,050

Television Broadcast Network

     —        —  

Cable Network Programming

     2,984      2,981
    

  

Total goodwill and intangible assets, net

   $ 13,478    $ 13,476
    

  

 

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FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 8 – Guarantees

 

The Company, News Corporation and certain of News Corporation’s other subsidiaries are guarantors of various debt obligations of News Corporation and certain of its subsidiaries. The principal amount of indebtedness outstanding under such debt instruments as of September 30 and June 30, 2003 was approximately $10 billion. The debt instruments limit the ability of guarantors, including the Company, to subject their properties to liens, and certain of the debt instruments impose limitations on the ability of News Corporation and certain of its subsidiaries, including the Company, to incur indebtedness in certain circumstances. Such debt instruments mature at various times between 2004 and 2096, with a weighted average maturity of over 20 years.

 

In the case of any event of default under such debt obligations, the Company will be directly liable to the creditors or debtholders. News Corporation has agreed to indemnify the Company from and against any obligations it may incur by reason of its guarantees of such debt obligations. As of September 30, 2003, News Corporation was in compliance with all of its debt covenants and had satisfied all financial ratios and tests and expects to remain in compliance and satisfy all such ratios and tests.

 

As of June 30, 2003, the Company guaranteed sports rights agreements for SportsChannel Chicago Associates (“SportsChannel Chicago”), which aggregated approximately $1,007 million. On September 30, 2003, SportsChannel Chicago received notice that each of the Chicago Cubs, Bulls, Blackhawks and White Sox have exercised their right to terminate their rights agreement with SportsChannel Chicago effective September 30, 2004. Upon termination of the rights agreements, the remaining guarantee would be approximately $43 million through fiscal 2005.

 

Note 9 – Contingencies

 

Regional Sports Networks:

 

In January 2003, Fox Sports Net, Inc. (“Fox Sports Net”) exercised its right to put its 50% direct ownership interests in SportsChannel Chicago and SportsChannel Pacific Associates (collectively the “SportsChannels”) to Regional Programming Partners (“RPP”). In March 2003, RPP and Fox Sports Net agreed on a $150 million purchase price for the interest in the SportsChannels, payable in the form of three-year promissory notes of the subsidiaries of RPP, which own only the interests in the SportsChannels, the terms of which are under negotiation. The transaction is expected to close in the first half of fiscal 2004. Following the closing of this sale, the SportsChannels will be held 100% by RPP and indirectly 40% by Fox Sports Net and 60% by Rainbow Media Sports Holdings, Inc., and each will remain a Fox Sports Net affiliate.

 

Hughes:

 

In April 2003, a putative derivative and shareholder class action (Norman Levin v. K. Rupert Murdoch et al., 03 CV 2929) was filed in the United States District Court for the Southern District of New York against the Company’s board members and the Company (as nominal defendant), alleging among other things that in approving the Hughes Transaction (see Note 6), they breached their fiduciary duties to the Company’s public shareholders. On September 15, 2003, the plaintiff agreed to dismiss the action with prejudice as to himself and without prejudice to putative class members other than himself. On September 19, 2003, the Court entered the agreed upon order of dismissal.

 

In April 2003, six putative shareholder class actions were filed in state courts in Delaware (four actions) and California (two actions) against GM and certain of its board members, alleging that in approving the Hughes Transaction (see Note 6), the defendants breached their fiduciary duties to public holders of GM’s Class H shares. Hughes and its board members are defendants in certain of these actions and also are alleged to have breached fiduciary duties to the same shareholders. News Corporation was a defendant in two of the Delaware actions and was alleged to have aided and abetted the other defendants’ purported breaches of fiduciary duties. The Delaware actions were consolidated on May 6, 2003, and a consolidated complaint was filed on August 29, 2003. News Corporation was not named as a defendant in the consolidated complaint.

 

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FOX ENTERTAINMENT GROUP, INC.

 

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

Note 10 – Other, net

 

For the three months ended September 30, 2003, Other, net consisted of a gain related to the settlement of the Company’s insurance claim primarily for its broadcast tower at the World Trade Center in New York, New York.

 

Note 11 – Recent Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”. FIN 46 requires an enterprise to consolidate a variable interest entity if it is determined that the enterprise is a primary beneficiary of that entity, subject to the criteria set forth in FIN 46. Assets, liabilities, and non controlling interests of newly consolidated variable interest entities will be initially measured at fair value. After initial measurement, the consolidated variable interest entity will be accounted for under the guidance provided by Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 is effective immediately for variable interest entities created or entered into after January 31, 2003. For variable interest entities created or acquired before February 1, 2003, FIN 46 applies in the second quarter of fiscal 2004. The Company is currently in the process of evaluating the impact of adopting FIN 46 on its consolidated balance sheets and statements of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 amends SFAS No. 6, “Elements of Financial Statements,” to improve accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new statement requires that those instruments be classified as liabilities in statements of financial position. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 in July 2003 had no material impact on the consolidated condensed balance sheet and statement of operations of the Company. The FASB is addressing certain implementation issues associated with the application of SFAS No. 150. On October 29, 2003, the FASB decided to defer certain provisions of SFAS No. 150 related to noncontrolling interests in subsidiaries included in consolidated financial statements. The Company will monitor the actions of the FASB and assess the impact, if any, that these actions may have on its financial statements.

 

Note 12– Subsequent Events

 

On October 10, 2003, the Company announced that it had reached an agreement in principle to sell the Los Angeles Dodgers, together with Dodger Stadium and the team’s training facilities in Vero Beach, Florida and the Dominican Republic, to an investment group headed by Mr. Frank McCourt. This agreement is subject to Major League Baseball approval and customary closing conditions.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This document contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words “expect,” “estimate,” “anticipate,” “predict,” “believe” and similar expressions and variations thereof are intended to identify forward-looking statements. These statements appear in a number of places in this document and include statements regarding the intent, belief or current expectations of the Fox Entertainment Group, Inc. (the “Company”), its directors or its officers with respect to, among other things, trends affecting the Company’s financial condition or results of operations. The readers of this document are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Those risks and uncertainties are discussed under the heading “Risk Factors,” in the Company’s Registration Statement on Form S-3 (SEC file no. 333-85978) as declared effective by the Securities and Exchange Commission on May 3, 2002, as well as the information set forth below. The Company does not ordinarily make projections of its future operating results and undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Readers should carefully review other documents filed by the Company with the Securities and Exchange Commission. This section should be read in conjunction with the unaudited consolidated condensed financial statements of the Company and related notes set forth elsewhere herein.

 

The Company manages and reports its activities in four business segments:

 

  Filmed Entertainment, which principally consists of the production and acquisition of live-action and animated motion pictures for distribution and licensing in all formats in all entertainment media primarily in the United States, Canada and Europe, and the production of original television programming in the United States and Canada;

 

  Television Stations, which principally consists of the operation of broadcast television stations in the United States;

 

  Television Broadcast Network, which principally consists of the broadcasting of network programming in the United States; and

 

  Cable Network Programming, which principally consists of the production and licensing of programming distributed through cable television systems and direct broadcast satellite operators in the United States and professional sports team ownership in the United States.

 

Sources of Revenue

 

Filmed Entertainment. The Filmed Entertainment segment derives revenue from theatrical distribution, home video and DVD sales and distribution through pay-per-view, pay television services and broadcast television. The revenues and operating results of the Filmed Entertainment segment are significantly affected by the timing of the Company’s theatrical, home video and DVD releases, the number of its original and returning television series that are aired by television networks and the number of its television series on off-network syndication. Theatrical release dates are determined by several factors, including timing of vacation and holiday periods and competition in the marketplace. Each motion picture is a separate and distinct product, and its financial success depends upon many factors, including public acceptance.

 

Television Stations and Television Broadcast Network. The two reportable television segments derive their revenues principally from the sale of advertising time. Generally, advertising time is sold to national advertisers by the Fox Broadcasting Company (“FOX”) and to national “spot” and local advertisers by the Company’s group of 35 owned and operated full power television broadcast stations (“O&Os”) in their respective markets. The sale of advertising time is affected by viewer demographics, program ratings and general market conditions. Adverse changes in the general market conditions for advertising may affect revenues.

 

Cable Network Programming. The Cable Network Programming segment derives revenues from monthly affiliate fees received from cable television systems and direct broadcast satellite (“DBS”) operators based on the number of subscribers, net of the amortization of cable distribution investments, as well as from the sale of advertising time. Monthly affiliate fees are dependent on maintenance of carriage arrangements with cable television systems and DBS operators. The sale of advertising time is affected by viewer demographics, program ratings and general market conditions. Adverse changes in general market conditions for advertising may affect revenues.

 

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Components of Expenses

 

Filmed Entertainment. Operating costs incurred by the Filmed Entertainment segment include exploitation costs, primarily prints and advertising; the amortization of capitalized production, overhead and interest costs; and participations and talent residuals. Selling, general and administrative expenses include salaries, employee benefits, rent and other routine overhead.

 

Television Stations, Television Broadcast Network and Cable Network Programming. Operating expenses of the two reportable television segments and the Cable Network Programming segment include expenses related to acquiring programming and rights to programming. Operating expenses also typically include production and technical expenses related to operating the technical facilities of the broadcaster or cable network. Selling, general and administrative expenses include all promotional expenses related to improving the market visibility and awareness of the broadcaster or cable network and sales commissions paid to the in-house sales force involved in the sale of advertising as well as salaries, employee benefits, rent and other routine overhead.

 

Depreciation and Amortization Expense. Depreciation and amortization expense includes the depreciation of property and equipment, as well as amortization of finite-lived intangible assets.

 

Use of Operating Income Before Depreciation and Amortization. Operating Income Before Depreciation and Amortization, defined as operating income (loss) plus depreciation and amortization and the amortization of cable distribution investments, eliminates the variable effect across all business segments of non-cash depreciation and amortization. Depreciation and amortization expense includes the depreciation of property and equipment, as well as amortization of finite-lived intangible assets. Amortization of cable distribution investments represents a reduction against revenues over the term of a carriage arrangement and as such it is excluded from Operating Income Before Depreciation and Amortization. Since Operating Income Before Depreciation and Amortization is a non-GAAP measure, it should be considered in addition to, not as a substitute for, operating income (loss), net income (loss), cash flow and other measures of financial performance reported in accordance with generally accepted accounting principles (“GAAP”). Operating Income Before Depreciation and Amortization does not reflect cash available to fund requirements and the items excluded from Operating Income Before Depreciation and Amortization, such as depreciation and amortization, are significant components in assessing the Company’s financial performance.

 

Management believes that Operating Income Before Depreciation and Amortization is an appropriate measure for evaluating the operating performance of the Company’s business segments. Operating Income Before Depreciation and Amortization, which is the information reported to and used by the Company’s chief decision maker for the purpose of making decisions about the allocation of resources to segments and assessing their performance, provides management, investors and equity analysts a measure to analyze operating performance of each business segment and enterprise value against historical and competitors’ data, although historical results, including Operating Income Before Depreciation and Amortization, may not be indicative of future results (as operating performance is highly contingent on many factors including customer tastes and preferences).

 

The following comparative discussion of the results of operations of the Company includes, among other factors, an analysis of changes in business segment Operating Income Before Depreciation and Amortization.

 

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Results of Operations – Three months ended September 30, 2003 versus Three months ended September 30, 2002.

 

The following table sets forth the Company’s operating results, by segment, for the three months ended September 30, 2003 as compared to the three months ended September 30, 2002.

 

     For the three months ended September 30,

 
     2003

    2002

    Change

    % Change

 
     (in millions)  

Revenues (1):

                              

Filmed Entertainment

   $ 1,250     $ 883     $ 367     42 %

Television Stations

     518       514       4     1 %

Television Broadcast Network

     394       424       (30 )   (7 )%

Cable Network Programming

     596       523       73     14 %
    


 


 


 

Total revenues

   $ 2,758     $ 2,344     $ 414     18 %
    


 


 


 

Operating income (loss):

                              

Filmed Entertainment

   $ 333     $ 105     $ 228     217 %

Television Stations

     221       209       12     6 %

Television Broadcast Network

     (45 )     (8 )     (37 )   * *

Cable Network Programming

     102       83       19     23 %
    


 


 


 

Total operating income (loss)

     611       389       222     57 %
    


 


 


 

Interest expense, net

     (8 )     (46 )     38     83 %

Equity earnings (losses) of affiliates

     7       2       5     * *

Minority interest in subsidiaries

     (2 )     (9 )     7     78 %

Other, net

     26       —         26     * *
    


 


 


 

Income before provision for income taxes

     634       336       298     89 %

Provision for income tax expense on a stand-alone basis

     (233 )     (122 )     (111 )   (91 )%
    


 


 


 

Net income

   $ 401     $ 214     $ 187     87 %
    


 


 


 

Other data:

                              

Operating Income Before Depreciation and Amortization (2):

                              

Filmed Entertainment

   $ 345     $ 118     $ 227     192 %

Television Stations

     237       224       13     6 %

Television Broadcast Network

     (41 )     (3 )     (38 )   * *

Cable Network Programming

     143       128       15     12 %
    


 


 


 

Total Operating Income Before Depreciation and Amortization

   $ 684     $ 467     $ 217     46 %
    


 


 


 


** not meaningful

 

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FOOTNOTE:

 

  (1) The Company classifies the amortization of cable distribution investments against revenue in accordance with Emerging Issues Task Force No. 01-09, “Accounting for the Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products,” as detailed in the following table:

 

     For the three months
ended September 30,


 
     2003

    2002

 
     (in millions)  

Gross Revenues

   $ 2,789     $ 2,375  

Amortization of cable distribution investments

     (31 )     (31 )
    


 


Revenues

   $ 2,758     $ 2,344  
    


 


 

  (2) Operating Income Before Depreciation and Amortization, defined as operating income (loss) plus depreciation and amortization and the amortization of cable distribution investments, eliminates the variable effect across all business segments of non-cash depreciation and amortization. Depreciation and amortization expense includes depreciation of property and equipment, as well as the amortization of finite-lived intangible assets. Amortization of cable distribution investments represents a reduction against revenues over the term of a carriage arrangement and as such it is excluded from Operating Income Before Depreciation and Amortization. Since Operating Income Before Depreciation and Amortization is a non-GAAP measure, it should be considered in addition to, not as a substitute for, operating income (loss), net income (loss), cash flow and other measures of the financial performance prepared in accordance with GAAP and presented in the consolidated condensed financial statements included elsewhere in this filing. The following is a reconciliation of Operating income (loss) to Operating Income Before Depreciation and Amortization by segment:

 

    For the three months ended September 30, 2003

 
    Operating
Income Before
Depreciation and
Amortization


    Depreciation
and
amortization


    Amortization
of cable
distribution
investments


    Operating
income
(loss)


 
    (in millions)  

Filmed Entertainment

  $ 345     $ (12 )   $  —       $ 333  

Television Stations

    237       (16 )     —         221  

Television Broadcast Network

    (41 )     (4 )     —         (45 )

Cable Network Programming

    143       (10 )     (31 )     102  
   


 


 


 


Total

  $ 684     $ (42 )   $ (31 )   $ 611  
   


 


 


 


 

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     For the three months ended September 30, 2002

 
    

Operating

Income Before
Depreciation and
Amortization


    Depreciation
and
amortization


    Amortization
of cable
distribution
investments


    Operating
income
(loss)


 
     (in millions)  

Filmed Entertainment

   $ 118     $ (13 )   $ —       $ 105  

Television Stations

     224       (15 )     —         209  

Television Broadcast Network

     (3 )     (5 )     —         (8 )

Cable Network Programming

     128       (14 )     (31 )     83  
    


 


 


 


Total

   $ 467     $ (47 )   $ (31 )   $ 389  
    


 


 


 


 

Overview. For the quarter ended September 30, 2003, the Company’s revenues were $2,758 million, an increase of $414 million over the $2,344 million in revenue for the quarter ended September 30, 2002. This 18% increase was primarily due to revenue increases at the Filmed Entertainment and Cable Network Programming segments. Operating expenses increased approximately 13% for the first quarter of fiscal 2004 primarily due to increased home entertainment marketing and maufacturing costs at the Filmed Entertainment Segment. Selling, general and administrative expenses were consistent as compared to the quarter ended September 30, 2002. Depreciation and amortization expenses decreased $5 million from the first quarter of fiscal 2003. For the quarter ended September 30, 2003, Operating income and Operating Income Before Depreciation and Amortization increased $222 million to $611 million and $217 million to $684 million, respectively, from the corresponding period of the prior year. These increases were primarily due to the revenue increases noted above, partially offset by the increase in operating expenses for the first quarter of fiscal 2004.

 

Equity earnings of affiliates of $7 million increased $5 million from earnings of $2 million for the corresponding period of the prior year. This increase is primarily related to improved results at National Geographic Channel – Domestic.

 

Net income for the three months ended September 30, 2003 was $401 million ($0.45 per share), an improvement of $187 million from $214 million ($0.25 per share) for the corresponding period of the prior year. This improvement was primarily due to the operating improvements noted above, reduced interest expense and other, net of $26 million related to the settlement of the Company’s insurance claim primarily for its broadcast tower at the World Trade Center in New York, New York.

 

Filmed Entertainment. For the first quarter of fiscal 2004, revenues at the Filmed Entertainment segment increased from $883 million for the first quarter of fiscal 2003 to $1,250 million, or 42%. This increase was primarily due to increased worldwide home entertainment revenues, higher domestic syndication revenues, and higher worldwide pay television and international free television revenues, partially offset by decreases in worldwide theatrical revenues. Higher revenues for the worldwide home entertainment market reflect the strong worldwide performances of Daredevil and Phone Booth, increased revenues for The Simpsons and 24, and improved performance from various library titles on DVD, as compared to the corresponding period of the prior year which included Shallow Hal, High Crimes, and Behind Enemy Lines. Domestic syndication revenues increased due to higher revenues for M*A*S*H and the initial domestic syndication of Angel and Judging Amy, without comparative syndication releases in the corresponding period of the prior year. Worldwide pay television and international free television revenues increased due to a stronger film lineup and more feature films available. Theatrical revenue decreased primarily due to fewer theatrical releases as compared to the same period last fiscal year. The current period included the worldwide theatrical performance of League of Extraordinary Gentlemen and 28 Days Later. The corresponding period of the prior year’s results included the theatrical performance of Road to Perdition, Like Mike, One Hour Photo, Swimfan, Banger Sisters, and Minority Report. For the three months ending September 30, 2003, the Filmed Entertainment segment reported Operating income of $333 million as compared to $105 million in the corresponding period of the prior year. Operating Income Before Depreciation and Amortization increased from $118 million to $345 million from the corresponding period of the prior year. These increases were due to the revenue increases noted above and reduced marketing costs associated with fewer first quarter theatrical releases, partially offset by increased home entertainment marketing and manufacturing costs.

 

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Television Stations. For the three months ended September 30, 2003, the Television Stations segment’s revenues increased slightly to $518 million as compared to $514 million in the corresponding period of the prior year. Although advertising markets decreased primarily due to the absence of political spending as compared to the corresponding period of the prior year, the Company’s O&Os estimated market share increased 0.6 percentage points due to strong advertising sales for the Major League Baseball (“MLB”) regular season and the telecast of the MLB All-Star game, in addition to the telecast of the Emmy Awards®, which were not telecast on FOX in the prior year. These increases were partially offset by the non-renewal of the Boston Red Sox broadcasts in the local Boston market and the finale of American Idol, which was telecast on FOX in the corresponding period of the prior year. For the three months ended September 30, 2003, the Television Stations segment generated Operating income of $221 million, which was $12 million, or 6% higher than the corresponding period of the prior year. Operating Income Before Depreciation and Amortization increased $13 million to $237 million from $224 million in the corresponding period of the prior year. This increase was due to lower local program production costs as a result of non-renewal of the local Boston Red Sox broadcasts and the broadcast of pre-season National Football League (“NFL”) games in certain markets, and cost savings at the duopoly O&Os.

 

Television Broadcast Network. For the quarter ended September 30, 2003, the Television Broadcast Network’s revenues decreased $30 million to $394 million from $424 million in the corresponding period of the prior year. This 7% decrease was due to ratings decreases for prime time programming, primarily related to the corresponding period of the prior year’s highly successful American Idol, which was not telecast on FOX in the current period. These decreases were partially offset by revenues from the Emmy Awards®, which was telecast on FOX this year. Operating losses for the Television Broadcast Network segment increased $37 million to a loss of $45 million and Operating Income Before Depreciation and Amortization decreased $38 million to a loss of $41 million compared to the corresponding period of the preceding year. The increase in operating losses was driven by the revenue decrease noted above, as well as by increases in prime time programming costs for the Emmy Awards® and series cancellations.

 

Cable Network Programming. Total revenues for the Cable Network Programming segment increased by $73 million or approximately 14% from $523 million to $596 million for the quarter ended September 30, 2003. This increase reflects improved results across all of the Cable Network Programming channels. Fox News Channel’s (“Fox News”), FX Network’s (“FX”), SPEED Channel’s (“SPEED”) and the majority-owned regional sports networks’ (“RSNs”) revenues increased 25%, 4%, 29%, and 14%, respectively, from the corresponding period of the prior year.

 

At Fox News, advertising revenues increased 35% from the corresponding period of the prior year due to increased pricing. Affiliate revenues increased by 4%, attributed to an increase in subscribers versus the corresponding period of the prior year, partially offset by a 6% increase in amortization of cable distribution investments. As of September 30, 2003, Fox News reached approximately 84 million Nielsen households, a 4% increase over the corresponding period of the prior year.

 

At FX, affiliate revenues increased 9% from the corresponding period of the prior year, reflecting an increase in subscribers, partially offset by a 2% increase in amortization of cable distribution investments. As of September 30, 2003, FX reached approximately 82 million Nielsen households, a 4% increase over the prior year. This improvement was partially offset by a 2% decrease in advertising revenues resulting from current period charges for shortfalls in guaranteed viewers.

 

At SPEED, affiliate revenues increased by 27%, reflecting an increase in subscribers and average per subscriber rates versus the prior year, including a 3% decrease in amortization of cable distribution investments. Advertising revenues increased 22% from the corresponding period of the prior year due to improved pricing and increased audience. As of September 30, 2003, SPEED reached approximately 59 million Nielsen households, a 10% increase over the prior year.

 

At the RSNs, affiliate revenues increased 15% over the prior year primarily from an increase in direct to home (“DTH”) subscribers and higher average per cable subscriber rates. Advertising revenues increased 9% primarily due to higher pricing per game for MLB telecasts resulting from an improved sports advertising market.

 

The Cable Network Programming segment reported Operating income of $102 million, an increase of $19 million from the first quarter of fiscal 2003. Operating Income Before Depreciation and Amortization for the Cable Network Programming segment increased $15 million to $143 million from $128 million from the corresponding period of the prior year. These improvements were primarily driven by the revenue increases noted above. The revenues increases were partially offset by increased costs for breaking news and programming enhancements at Fox News, higher programming costs due to new original programming, Nip/Tuck, and series cancellation costs for Lucky and The Orlando Jones Show at FX, higher programming costs at SPEED and higher average rights fees for professional events at the RSNs.

 

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Interest expense, net. Interest expense decreased $38 million for the quarter ended September 30, 2003 from $46 million to $8 million due to reduced amounts Due to affiliates of News Corporation resulting from repayments.

 

Equity earnings (losses) of affiliates. Equity earnings of affiliates of $7 million increased $5 million from earnings of $2 million from the corresponding period of the prior year. This increase was primarily related to improved results at National Geographic Channel-Domestic.

 

Affiliate:


  

Ownership

Percentage


  For the three months
ended September 30,


 
     2003

    2002

    Change

 
         (in millions)  

National Geographic Channel - Domestic

  

66.70%

  $ (2 )   $ (7 )   $ 5  

National Geographic Channel - International

  

50%

    (1 )     (1 )     —    

National Sports Partners

   50%     (11 )     (5 )     (6 )

Regional Programming Partners

   40%     12       6       6  

Other

   Various     9       9       —    
        


 


 


Total equity earnings (losses) of affiliates

       $ 7     $ 2     $ 5  
        


 


 


 

The Company’s share of National Geographic Channel-Domestic’s loss was $2 million for the three months ended September 30, 2003, as compared to a loss of $7 million in the corresponding period of the prior year. Affiliate and advertising revenues increased due to a significant growth in distribution. As of September 30, 2003, National Geographic Channel-Domestic reached approximately 46 million Nielsen households, a 32% increase over the corresponding period of the prior year.

 

The Company’s share of Regional Programming Partners’ (“RPP”) income was $12 million for the three months ended September 30, 2003, as compared to income of $6 million in the corresponding period of the prior year. This improvement was primarily due to significant cost savings at the Metro Channels and lower programming costs at Madison Square Garden Network.

 

The Company’s share of National Sports Partners’ (“NSP”) loss was $11 million for the three months ended September 30, 2003, as compared to losses of $5 million in the corresponding period of the prior year primarily due to lower advertising revenues from the absence of The Last Word and other programs which were telecast in the corresponding period of the prior year, lower sublicense revenue from collegiate events and higher programming rights due to the timing of certain collegiate football games as compared to the corresponding period of the prior year.

 

Minority interest in subsidiaries. Minority interest in subsidiaries decreased $7 million to $2 million for the quarter ended September 30, 2003 due to the Company’s acquisition of substantially all of the outstanding equity of New Millennium II held by third parties. (See New Millennium II in Liquidity and Capital Resources below.)

 

Other, net. For the three months ended September 30, 2003, Other, net consisted of a gain related to the settlement of the Company’s insurance claim primarily for its broadcast tower at the World Trade Center in New York, New York.

 

Provision for income tax expense on a stand-alone basis. The effective tax rate for the first quarter of fiscal 2004 was 37% as compared to 36% for the corresponding period of the prior year. The effective tax rate is higher than the U.S. statutory rate due to certain foreign income being taxed at higher rates.

 

Liquidity and Capital Resources

 

The Company’s principal sources of cash flow are internally generated funds, various film financing alternatives and borrowings from The News Corporation Limited (“News Corporation”) and its subsidiaries. As of September 30, 2003, News Corporation had consolidated cash and cash equivalents of $4.9 billion, excluding the cash of the Company, and a revolving credit facility of $1.75 billion. We believe that cash flow from operations and the funds available from News Corporation will be adequate for the Company to conduct its operations. The Company’s internally generated funds are highly dependent upon the state of the advertising market and public acceptance of film and television products. Any significant decline in the advertising market or the performance of its films could adversely impact its cash flows from operations.

 

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The principal uses of cash flow that affect the Company’s liquidity position include the following: investments in the production and distribution of new feature films and television programs, the acquisition of and payments under programming rights for entertainment programming and sporting events, operational expenditures, interest and income tax payments.

 

Net cash flows provided by operating activities during the three months ended September 30, 2003 were $226 million as compared to $135 million for the corresponding period in fiscal 2003. For the quarter ended September 30, 2003, higher net income and lower inventory spending, due to a reduction in the number of new films in production, was partially offset by higher pension contributions of $25 million and higher accounts receivables. The increase in accounts receivable was due to the initial domestic syndication of Judging Amy and Angel and the cable syndication of M*A*S*H.

 

Net cash flows used in investing activities for the three months ended September 30, 2003 and 2002 were $72 million and $497 million, respectively. The current period included cash used for payments for cable distribution investments and funding of the investments in NSP and Regency Television. The corresponding period of the prior year included the cash used for the acquisition of WPWR, as well as funding of the investments in Regency Television, National Geographic Channels and NSP.

 

Net cash flows used in financing activities were $190 million during the three months ended September 30, 2003 as compared to net cash provided of $382 million in the corresponding period of the prior year. The change in financing activities is primarily due to repayments to affiliates of News Corporation. In the corresponding period of the prior year, the Company redeemed all of the outstanding 9 3/4% Senior Discount Notes due 2007 and all of the outstanding 8 7/8% Senior Notes due 2007 in the amount of $947 million.

 

Under a tax sharing agreement between the Company and News Corporation (“Tax Sharing Agreement”), the Company is included in the consolidated tax return of News Corporation. Amounts paid in accordance with the Tax Sharing Agreement, which are included in Due to affiliates of News Corporation, were $111 million and $35 million during the quarters ended September 30, 2003 and 2002, respectively.

 

New Millennium II

 

In September 2003, the Company purchased substantially all of the outstanding equity of Tintagel Investors L.L.C. (“Tintagel”), the entity that held the Preferred Interest in New Millennium II (“NM2”), for $25.5 million plus accrued and unpaid Preferred Payments in the amount of approximately $106,000. As a result of the acquisition of this equity interest, the Company has consolidated the assets and liabilities of Tintagel for accounting purposes and all Preferred Interests and Preferred Payments in NM2 have been eliminated. The June 30, 2003 outstanding NM2 Preferred Interest of $762 million was included in Minority interest in subsidiaries on the consolidated balance sheet and Preferred Payments were included in Minority interest in subsidiaries in the statement of operations. Tintagel’s September 30, 2003 outstanding indebtedness of $717 million is included in Borrowings on the unaudited consolidated condensed balance sheet and the corresponding interest is included in Interest expense, net. Tintagel continues to be a separate legal entity from the Company with separate assets and liabilities.

 

Guarantees

 

The Company, News Corporation and certain of News Corporation’s other subsidiaries are guarantors of various debt obligations of News Corporation and certain of its subsidiaries. The principal amount of indebtedness outstanding under such debt instruments as of September 30 and June 30, 2003 was approximately $10 billion. The debt instruments limit the ability of guarantors, including the Company, to subject their properties to liens, and certain of the debt instruments impose limitations on the ability of News Corporation and certain of its subsidiaries, including the Company, to incur indebtedness in certain circumstances. Such debt instruments mature at various times between 2004 and 2096, with a weighted average maturity of over 20 years.

 

In the case of any event of default under such debt obligations, the Company will be directly liable to the creditors or debtholders. News Corporation has agreed to indemnify the Company from and against any obligations it may incur by reason of its guarantees of such debt obligations. As of September 30, 2003, News Corporation was in compliance with all of its debt covenants and had satisfied all financial ratios and tests and expects to remain in compliance and satisfy all such ratios and tests.

 

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As of June 30, 2003, the Company guaranteed sports rights agreements for SportsChannel Chicago Associates (“SportsChannel Chicago”), which aggregated approximately $1,007 million. On September 30, 2003, SportsChannel Chicago received notice that each of the Chicago Cubs, Bulls, Blackhawks and White Sox have exercised their right to terminate their rights agreement with SportsChannel Chicago effective September 30, 2004. Upon termination of the rights agreements, the remaining guarantee would be approximately $43 million through fiscal 2005.

 

Ratings of News Corporation Public Debt

 

As of September 30, 2003, News Corporation’s debt ratings from Moody’s (Ba1 for subordinated notes and Baa3 for senior unsecured notes) and Standard & Poors (BBB-) for the debt guaranteed by the Company and others were within the investment grade scale.

 

Acquisitions

 

WPWR-TV

 

In August 2002, the Company acquired WPWR-TV in the Chicago designated market area (DMA) from Newsweb Corporation for $425 million. This transaction has been treated as a purchase in accordance with Statement of Financial Accounting Standards (“SFAS”) Nos. 141, “Business Combinations,” and 142, “Goodwill and Other Intangible Assets.”

 

Hughes Transaction

 

In April 2003, News Corporation, General Motors Corporation (“GM”) and Hughes Electronics Corporation (“Hughes”) reached an agreement in which News Corporation would acquire 34% of Hughes (the “Hughes Transaction”). News Corporation will acquire GM’s approximate 19.9% interest in Hughes for approximately $3.8 billion (subject to upward adjustment), of which approximately $768 million (subject to upward adjustment) may be paid in News Corporation American Depositary Receipts representing preferred limited voting ordinary shares (“ADRs”). News Corporation will acquire through a merger an additional 14.1% of Hughes for approximately $2.7 billion that is payable, at News Corporation’s option, in cash, News Corporation ADRs, or a combination thereof. Simultaneously with the closing of this transaction, News Corporation will transfer its 34% ownership interest in Hughes to the Company in exchange for promissory notes representing $4.5 billion and approximately 74.2 million shares of the Company’s Class A Common Stock, thereby increasing News Corporation’s ownership interest in the Company from 80.6% to approximately 82%. News Corporation’s voting percentage will remain at 97%. The closing of the transaction is subject to a number of conditions, including regulatory approvals.

 

Contingencies

 

Regional Sports Networks

 

In January 2003, Fox Sports Net, Inc. (“Fox Sports Net”) exercised its right to put its 50% direct ownership interests in SportsChannel Chicago and SportsChannel Pacific Associates (collectively the “SportsChannels”) to RPP. In March 2003, RPP and Fox Sports Net agreed on a $150 million purchase price for the interest in the SportsChannels, payable in the form of three-year promissory notes of the subsidiaries of RPP, which own only the interests in the SportsChannels, the terms of which are under negotiation. The transaction is expected to close in the first half of fiscal 2004. Following the closing of this sale, the SportsChannels will be held 100% by RPP and indirectly 40% by Fox Sports Net and 60% by Rainbow Media Sports Holdings, Inc., and each will remain a Fox Sports Net affiliate.

 

Hughes

 

In April 2003, a putative derivative and shareholder class action (Norman Levin v. K. Rupert Murdoch et al., 03 CV 2929) was filed in the United States District Court for the Southern District of New York against the Company’s board members and the Company (as nominal defendant), alleging among other things that in approving the Hughes Transaction, they breached their fiduciary duties to the Company’s public shareholders. On September 15, 2003, the plaintiff agreed to dismiss the action with prejudice as to himself and without prejudice to putative class members other than himself. On September 19, 2003, the Court entered the agreed upon order of dismissal.

 

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In April 2003, six putative shareholder class actions were filed in state courts in Delaware (four actions) and California (two actions) against GM and certain of its board members, alleging that in approving the Hughes Transaction, the defendants breached their fiduciary duties to public holders of GM’s Class H shares. Hughes and its board members are defendants in certain of these actions and also are alleged to have breached fiduciary duties to the same shareholders. News Corporation was a defendant in two of the Delaware actions and was alleged to have aided and abetted the other defendants’ purported breaches of fiduciary duties. The Delaware actions were consolidated on May 6, 2003, and a consolidated complaint was filed on August 29, 2003. News Corporation was not named as a defendant in the consolidated complaint.

 

Recent Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”. FIN 46 requires an enterprise to consolidate a variable interest entity if it is determined that the enterprise is a primary beneficiary of that entity, subject to the criteria set forth in FIN 46. Assets, liabilities, and non controlling interests of newly consolidated variable interest entities will be initially measured at fair value. After initial measurement, the consolidated variable interest entity will be accounted for under the guidance provided by Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 is effective immediately for variable interest entities created or entered into after January 31, 2003. For variable interest entities created or acquired before February 1, 2003, FIN 46 applies in the second quarter of fiscal 2004. The Company is currently in the process of evaluating the impact of adopting FIN 46 on its consolidated balance sheets and statements of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 amends SFAS No. 6, “Elements of Financial Statements,” to improve accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new statement requires that those instruments be classified as liabilities in statements of financial position. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 in July 2003 had no material impact on the consolidated condensed balance sheet and statement of operations of the Company. The FASB is addressing certain implementation issues associated with the application of SFAS No. 150. On October 29, 2003, the FASB decided to defer certain provisions of SFAS No. 150 related to noncontrolling interests in subsidiaries included in consolidated financial statements. The Company will monitor the actions of the FASB and assess the impact, if any, that these actions may have on its financial statements.

 

Subsequent Events

 

On October 10, 2003, the Company announced that it had reached an agreement in principle to sell the Los Angeles Dodgers, together with Dodger Stadium and the team’s training facilities in Vero Beach, Florida and the Dominican Republic, to an investment group headed by Mr. Frank McCourt. This agreement is subject to MLB approval and customary closing conditions.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

 

The Company is exposed to the impact of foreign currency fluctuations and utilizes derivative instruments in a limited manner to modify its exposure to foreign exchange rate movements. The Company’s policy is to enter into derivative and other financial instruments only to the extent considered necessary to meet its business objectives. The Company does not enter into these transactions for speculative purposes.

 

Foreign Exchange Rate Risk

 

The Company uses foreign exchange forward contracts and options to minimize its limited exposure to exchange rate movements. The foreign exchange contracts have principally been used to hedge the costs of producing films abroad and are principally denominated in the Czech Koruna, the South African Rand and the Euro. The Company designates forward contracts and options used to hedge future production costs as cash flow hedges.

 

At September 30, 2003, the notional amount of financial instruments with exposure to foreign currency risk was approximately $36 million and the net unrealized gain was approximately $1 million. The potential loss in fair value for such financial instruments from a 10% adverse change in quoted foreign currency exchange rates would be approximately $3.7 million. Consistent with the nature of the economic hedge provided by such foreign exchange contracts, such gains or losses largely would be offset by corresponding decreases or increases, respectively, in the U.S. Dollar value of future foreign currency obligations.

 

ITEM 4. CONTROLS AND PROCEDURES

 

The Company’s Chairman and Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report and, based on this evaluation, have concluded that the disclosure controls and procedures are effective.

 

There have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s first fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Part II.Other Information

 

ITEM 1. LEGAL PROCEEDINGS

 

In April 2003, a putative derivative and shareholder class action (Norman Levin v. K. Rupert Murdoch et al., 03 CV 2929) was filed in the United States District Court for the Southern District of New York against the Company’s board members and the Company (as nominal defendant), alleging among other things that in approving the Hughes Transaction, they breached their fiduciary duties to the Company’s public shareholders. On September 15, 2003, the plaintiff agreed to dismiss the action with prejudice as to himself and without prejudice to putative class members other than himself. On September 19, 2003, the Court entered the agreed upon order of dismissal.

 

In April 2003, six putative shareholder class actions were filed in state courts in Delaware (four actions) and California (two actions) against GM and certain of its board members, alleging that in approving the Hughes Transaction, the defendants breached their fiduciary duties to public holders of GM’s Class H shares. Hughes and its board members are defendants in certain of these actions and also are alleged to have breached fiduciary duties to the same shareholders. News Corporation was a defendant in two of the Delaware actions and was alleged to have aided and abetted the other defendants’ purported breaches of fiduciary duties. The Delaware actions were consolidated on May 6, 2003, and a consolidated complaint was filed on August 29, 2003. News Corporation was not named as a defendant in the consolidated complaint.

 

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

 

Not Applicable

 

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not Applicable

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Not Applicable

 

ITEM 5. OTHER INFORMATION

 

Not Applicable

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a) Exhibits

 

31.1 Certification of the Chairman and Chief Executive Officer pursuant to SEC Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

 

31.2 Certification of the Chief Financial Officer pursuant to SEC Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *

 

32.1 Certification of the Chairman of the Board and Chief Executive Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

 

32.2 Certification of the Senior Executive Vice President and Chief Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

* Filed herewith

 

(b) Reports on Form 8-K

 

The following current report on Form 8-K was filed by the Company during the Company’s first fiscal quarter:

 

  (i) Current Report on Form 8-K of the registrant filed August 13, 2003 relating to the earnings announcement by Fox Entertainment Group, Inc. of its financial results for the Fourth Quarter and Fiscal year ended June 30, 2003

 

SIGNATURE

 

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 6, 2003

 

FOX ENTERTAINMENT GROUP, INC.

       

By: /s/ David F. DeVoe


       

David F. DeVoe

       

Senior Executive Vice President and Chief Financial Officer

 

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