Conference Call to Discuss U.S. Tax Court Ruling
September 28, 2005
Dennis FitzSimons, Chairman, President and CEO
Great, thank you. Good morning. This is Dennis FitzSimons and I’d like to thank you for joining us on such short notice. With me this morning are Don Grenesko, Tribune’s Chief Financial Officer and Crane Kenney, our General Counsel, also (Mark Mallory), our Controller is here.
We felt it was important that you hear from us as quickly as possible on yesterday’s tax court ruling. So this morning we’ll give you some background on the case, a summary of the ruling, our best estimate on the timing of the appeal process, the financial impact, the accounting treatment, and answer any questions you may have.
So first let me turn it to Crane Kenney for some legal background on the case.
Crane Kenney, Sr. Vice President/General Counsel and Corporate Secretary
Thanks Dennis. I'd like to provide some background on this to begin. The Matthew Bender transaction was completed by Times Mirror in 1998 and we inherited this tax dispute as part of our acquisition of Times Mirror in 2000. Matthew Bender was Times Mirror's legal textbook publisher that for business reasons Times Mirror decided to reorganize in combination with the Dutch company Reed Elsevier.
In December of last year we tried this case in tax court in Los Angeles . At the completion of the trial last December, the trial judge indicated a ruling would be reviewed by the other 18 members of the tax court in what is known as a tax court opinion. Yesterday's opinion appears to be a memorandum opinion indicating that it was not reviewed by the entire tax court and was therefore issued more quickly.
We're disappointed in the court's opinion and the legal analysis. And without going into all the details, I'd like to address the appeals process first and we can take questions if you have them.
We've reviewed the opinion with our outside advisors and we believe we have strong grounds for appeal. The appeal will be in the Seventh Circuit here in Illinois and the process will take approximately 18 months before a decision is rendered.
This is a process that has been followed by a number of other taxpayers with the tax court and many of them had success recently in returning these opinions.
I'll take questions later on the intricacies of the opinion if you'd like, but I'd like to turn it over to Don Grenesko now to talk about the financial impact.
Don Grenesko, Sr. Vice President/Finance and Administration
Hi, good morning everyone. Let me start by covering the accounting issues and according to generally accepted accounting principals, GAAP, these tax issues are still covered by purchase accounting related to the Times Mirror acquisition.
Accordingly, about $500 million will be added to our goodwill on our balance sheet. Now that’s equal to $600 million of capital gains taxes plus $80 million of interest charged by the IRS from the date of the transaction in 1998 until the time we acquired Times Mirror in June of 2000.
From that $680 million total, we net the $180 million reserve that we picked up from Times Mirror. So that’s the accounting issue - $500 million will be added to goodwill and that will not be amortized going forward.
In our third quarter income statement, we will take a one-time $125 million after-tax charge which is equal to the interest the IRS is assessing since the time of the acquisition of Times Mirror net of the remaining $70 million of the total $250 million reserve that is currently on our books. Now let me emphasize these are preliminary accounting estimates which we are still finalizing and they could change.
From a cash standpoint, we will have to pay around $1 billion for federal and state taxes and interest and we expect to make those payments shortly. In the coming months we will receive a deduction for the state taxes and interest we paid and that will reduce our net cash outlay to around $850 million.
Because we knew that we might lose this case in tax court, we did issue $780 million of five and ten year fixed rate bonds last month which we used to repay all of our commercial borrowings. So we plan to fund the $1 billion payment through our commercial paper program which is supported by the $1.2 billion in revolving credit agreements that we have.
Our debt currently stands a little below $2 billion excluding the PHONES, and we expect that to grow to around $2.9 billion at the end of this year. Now, that still leaves us with a comfortable debt to operating cash flow ratio this year of about 1.9 times.
Year to date our stock repurchases have been $365 million. We had expected to do about $500 million in share repurchases this year but we expect to scale back on that number in the fourth quarter.
With that, we’re now prepared to take your questions.
Questions and Answers
Craig Huber, Lehman Bros.
Q. On prior comments you've made on conference calls you guys had expressed optimism that you would hopefully win this tax case. Your actions however that you have not stepped up your major share buyback program with the stock in the mid-30s and so forth speaks to your conservatism in how you're running your balance sheet and so forth. How surprised are you now that this thing has come out that you actually lost it and really how optimistic are you you're going to win the appeal?
A. You know we reviewed all our comments really to just answer the question that you have asked, and I think we were always somewhat conservative.
We had been told by outside observers that the feeling was that our court case went very well in December, but we always indicated that you never know in litigation. And that, as Don mentioned, was the reason we issued the five and ten year notes back during the summer.
So, we were optimistic but in tax court it's not a favorable forum for taxpayers. So we were prepared for this, but hoping we might win. But as Crane mentioned, other taxpayers have been successful on appeal, but we would not predict anything at this point. Our attorneys will be aggressive in the appeal.
Q. Some people have theorized that you may sell off part of your large portfolio of investments to help fund if you did lose this tax case. Some people thought that maybe you'd sell your stake in the Food Network. Any chance you would try to monetize any of that stuff?
A. The issue there has always been tax efficiency. And at this point we would not make any short-term decision. As Don mentioned, our debt-to-cash flow levels are still good so we're not under pressure to do anything right now. We'll continue to make decisions that we feel are in the best interest long-term for our shareholders.
Lee Westerfield, Harris Nesbitt
Q. I wonder if you could help me understand a little bit better the nature of the tax court panel 18 membership, but only a few - not the full - issued in this memorandum. What does it signify? Is there any signal that we draw out of that about the tax court's process here and about what might occur on appeal?
A. I wouldn't want to try and speculate on what was happening in the tax court chambers as to why it appears to be reviewed only by Mary Ann Cohen, our judge, and not the full body of justices.
What she told us at the trial was that she would not be the only one reviewing her opinion leading all of us, including the service, to believe that it would be a full tax court opinion meaning each of the other judges on the tax court would take a look at it and have comments before it came out. That led many of us to conclude that the ruling would likely be in the fourth quarter or early next year.
The opinion as written is certainly brief and the brevity as well as the timing of it leads us to believe it was not reviewed by the full tax court, but I wouldn't want to speculate as to what that means or why that happened.
Q. But does that have any bearing on the appeal?
A. It doesn't and we're going to be appealing based on the full record of which the opinion is a part. We certainly believe the full record is helpful to us and a very brief opinion like this, you know, is just going to be one part of it.
Q. With regard to what you might get back from the state taxes, what's the timing on that, the difference between the estimated billion and the $850 million?
A. We make estimated tax payments in December, March and April, so we will be reducing our estimated tax payments in those three periods so we'll get a lot of it back in a couple of months, and then we should have the majority of the reduction by April of next year.
Q. In addition to Matthew Bender, the press release mentions a similar transaction and I haven't been familiar with that. What is the similar transaction completed with Times Mirror back in the day?
A. The reference in the press release to a similar transaction was the Mosby transaction. The Mosby textbook business was a medical textbook business that Times Mirror used the same structure to reorganize in 1998 as well.
The trial addressed only Matthew Bender, but because the structures were the same, we and the IRS agree that the Mosby transaction will be treated similarly so the numbers that Don referred to cover both transactions. We wanted to make sure that was clear on the press release.
Fred Searby, J.P. Morgan
Q. Can you just update us on what you think the ratings agencies' reaction will be and if there's any material expectation that your cost of debt will go up? And just what should we be modeling on the commercial paper, just where you are and what that rate should be? And then finally it sounds like you're slowing back share buyback. Would you expect, going into 2006, this is a temporary phenomenon? When would you expect to be back given where your share price is?
A. We're going through our planning process for 2006 right now so it's too early for us to make any judgments as to what we're going to do in terms of share repurchases for next year at this point.
Q. I guess that begs the question of why, given that you only have debt to EBITDA 1.8 times and that still sounds under-levered, would you, where your share price is now, slow down at all?
A. As we've indicated previously, it's our intention to work with the rating agencies to maintain our existing debt rating. So we want to have those discussions with the rating agencies in the next week or so and go over some preliminary plans we have with them, but we wanted to maintain those existing ratings that we have.
Our commercial paper right now, if we were to issue it today, we're a little bit under 4%. We're about 3.8% and we don't expect that there will be a significant increase in our borrowing costs because of this.
Douglas Arthur, Morgan Stanley
Q. Why are you so adamant about limiting the amount of stock repurchase even with this highly expected outcome here on the tax case? I mean, with the stock at these valuation levels, I would think that it would be prudent to step up the stock repurchase regardless of the impact on ratings.
A. We've got the flexibility to do that and we'll be looking at this, as Don said. We want to have these conversations with the rating agencies and then going forward as we get into our planning process for '06, which we're in the midst of right now, we will be making decisions on the levels of our share repurchases.
Jim Goss, Barrington Research
Q. Does the appeals process normally take the entire 18 months that you suggested or is that just a ballpark or an outside limit? Is the result going to be an all-or-none issue or is there ever some sort of compromise or would that have taken place in the first place? Then, I'd like you to clarify with what you just said about Mosby and Bender - are they both part of the same suit, then, and to the extent that you've always talked about Bender, is most of it mix-wise assigned to Bender rather than Mosby?
A. The 18 months is a ballpark. The process from here will be first determination of the amount of tax owed for both Bender and Mosby. And by far the largest tax liability resides in the Bender transaction, the one we just tried.
The structure used in Mosby was very, very similar and in fact, we agree with the service that the treatment of Matthew Bender in the tax court would also govern the treatment of Mosby as we determine the taxes.
So the process from here will be determining the amount of taxes owed. And I guess I'd just reiterate that as we use these numbers today, the billion, these are our best estimates.
That will take a period of time, we hope short, with the service to determine that. From there we will file our notice of appeal and move forward. Determining how long it will take the Seventh Circuit to render an opinion is really outside anyone's knowledge.
The briefing schedule will be set by the court. We'll go through that, we'll have oral arguments and then it will be up to the court to determine when they issue an opinion. So yeah, 18 months, you know, is a ballpark and I wouldn't want to be held to it.
On the second issue of compromise, the outcome from the Appellate court could be basically one of three. They could rule in our favor and reverse the tax court. They could affirm the tax court, or they could remand it back to the tax court for further consideration. They could, in fact, ask the tax court to further elaborate on its decision if they agree with us that the tax court did not fully articulate the reasoning for judgment.
It's not a situation where they would take dispute with the amount of tax owed or a portion more or less to one or the other.
Let me just be clear and make sure everybody understands that in the numbers that we've given you today, Mosby is included. So there would be no additional amount. This is an assumption that the same ruling applies to Mosby.
And similarly the appeal, and a hopeful success there, would apply to Mosby as well.
Debra Schwartz, CSFB
Q. Am I correct in assuming that this was not adjusted for in the purchase price of Times Mirror?
A. That is correct.
Q. Can you comment on what the returns are on the Times Mirror acquisition? Are you earning above your cost of capital on it?
A. We haven't done that in that calculation, but we'll have to go through that. Normally it takes five or six years for an acquisition to cover its cost of capital so, you know, we're still assessing that at this point.
Q. I was wondering also if you could elaborate on the specific points on which you plan to appeal this?
A. I think today we're all still adjusting to the opinion. I wouldn't want to show too many cards in terms of what the appeal will be. I think we do have strong grounds. We talked this morning already with all of our outside counsel on a number of points which we think are strong appeal points, but I don't think I want today to be explaining what those are.
Let me just make one comment that this tax issue was one that in the assessment of the Times Mirror transaction was fully considered. The initial suggestion by outside attorneys was this was a difficult case in tax court. We became more optimistic as the tax court proceeding went forward and again, based on comments by some outside observers.
But our best chance is on appeal. We would have preferred a different ruling from tax court, now we'll go forward with the appeal.
Peter Appert, Goldman Sachs
Q. Is there any opportunity here to go after the advisors on the original transaction, the accountants for the investment banks, to share in the liability?
A. We're not at the stage where we're talking about countersuits. I think given the shortness we've had the opinion itself, I think we're still digesting it and, you know, we really haven't addressed that yet.
Fred Searby, J.P. Morgan
Q. Can you give us some idea given how expensive lawyers are and what you're spending in extraordinary legal fees to continue to contest this case or what the run rate, if it's material?
A. It wouldn't be material. Actually the stage where we are now, the discovery is essentially over. On appeal you're in general just addressing the record as it's already been made. So by far, the largest expense is behind us and any expense going forward would not be material to the company.
Q. And what was that expense running at?
A. Well I think we spent, all in from the time of the acquisition of Times Mirror in 2000 through the trial, in the $3 million range.
Closing Remarks
Dennis FitzSimons
If there's just one comment we would make is that we do have financial flexibility going forward in that our debt levels are still reasonable at 1.9x debt-to- cash flow ratio. :: :: ::
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