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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2002, for Gray Television, Inc. (formerly Gray Communications Systems, Inc.). The Company operates in three segments: broadcasting (13 TV stations), publishing (4 daily newspapers), and paging. The reporting period includes significant corporate actions, including the adoption of new accounting standards (SFAS 142) and major capital transactions.

Key Financial Metrics

Note: The nine-month net loss is heavily impacted by a non-cash cumulative effect of accounting change ($30.6 million) and an extraordinary charge on debt extinguishment ($7.3 million).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 16% for the quarter and 8% for the nine-month period compared to 2001. Broadcasting revenues drove this growth, up 21% (quarter) and 10% (nine months), largely due to a cyclical increase in political advertising ($3.2 million in Q3 2002 vs. $85,000 in Q3 2001).
• Expense Reduction: Operating expenses decreased 12% for both periods. This was primarily due to a 54% reduction in depreciation and amortization expenses following the adoption of SFAS 142, which eliminated the amortization of goodwill and indefinite-lived intangible assets.
• Profitability: Operating income surged to $11.9 million in Q3 2002 from $2.2 million in Q3 2001. However, the nine-month period resulted in a net loss due to one-time charges.
• Debt Structure: The Company issued $100 million in senior subordinated notes in September 2002 to repay bank borrowings. Additionally, $168.6 million in restricted cash held for debt redemption at year-end 2001 was released, significantly improving liquidity.

Guidance, Outlook, and Risks

Acquisitions and Capital Resources

• GMAT Acquisition: On October 25, 2002, the Company completed the acquisition of Gray MidAmerica Television (GMAT) for approximately $513.4 million, funded by a $231.7 million common stock offering, $275 million in new debt, and cash on hand. This added 15 stations to the portfolio.
• KOLO-TV Acquisition: A definitive agreement was signed to acquire KOLO-TV (Reno, NV) for $41.5 million, pending closing.
• Debt Amendment: In connection with the GMAT acquisition, the Company amended its bank loan agreement, increasing committed credit to $450 million. An extraordinary charge of approximately $5.6 million is expected in Q4 2002 related to this amendment.

Guidance for Q4 2002

Management anticipates Q4 2002 results (including GMAT from Oct 25) as follows:

• Total Net Revenues: $70.0 million to $71.5 million.
• Media Cash Flow: $29.0 million to $30.0 million.
• Political Revenue: Estimated at $10.5 million for the quarter.

Risks and Contingencies

• IRS Audit: The IRS has asserted a tax deficiency of $12.1 million plus interest/penalties regarding a 1996 acquisition. The Company has filed a petition in Tax Court to contest this.
• Digital Conversion: The Company is incurring costs for digital television conversion, with approximately $8.1 million paid in 2002 and an additional $23.5 million anticipated through 2004.
• Accounting Changes: The Company will adopt SFAS 145 in Q1 2003, reclassifying $16.9 million of debt extinguishment costs from extraordinary items to continuing operations.

Investor Verification Checklist

• Debt Extinguishment Charges: Verify the impact of the expected $5.6 million extraordinary charge in Q4 2002 and the reclassification of prior charges under SFAS 145.
• GMAT Integration: Confirm the actual contribution of the newly acquired GMAT stations to Q4 revenue and cash flow against the $23 million revenue and $10.5 million cash flow estimates.
• IRS Litigation: Monitor the status of the $12.1 million tax deficiency dispute with the IRS.
• Political Revenue Volatility: Assess the sustainability of revenue growth given the heavy reliance on political advertising cycles in 2002.
• Liquidity Post-Acquisition: Review the updated debt covenants and available credit under the amended $450 million bank facility following the GMAT acquisition.