REPORT OF INDEPENDENT AUDITORS



Board of Directors and Stockholders
Gray Communications Systems, Inc.

     We have  audited  the  accompanying  consolidated  balance  sheets  of Gray
Communications  Systems,  Inc., as of December 31, 1997 and 1996 and the related
consolidated  statements of operations,  stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1997.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion,  the financial statements referred to above present fairly,
in  all  material  respects,   the  consolidated   financial  position  of  Gray
Communications   Systems,   Inc.,  at  December  31,  1997  and  1996,  and  the
consolidated  results of its operations and its cash flows for each of the three
years in the period ended  December  31,  1997,  in  conformity  with  generally
accepted accounting principles.



                                             Ernst & Young LLP


Atlanta, Georgia
January 27, 1998 except for the Pending Acquisition of
Note C, as to which the date is February 13, 1998


                                       F-1
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                 December 31,
                                                                             1997             1996
<S>                                                                    <C>              <C>
Assets
Current assets:
     Cash and cash equivalents                                         $   2,367,300    $   1,051,044
     Trade accounts receivable, less allowance for doubtful accounts
         of $1,253,000 and  $1,450,000, respectively                      19,527,316       17,373,839
     Recoverable income taxes                                              2,132,284        1,747,687
     Inventories                                                             846,891          624,118
     Current portion of program broadcast rights                           2,850,023        2,362,742
     Other current assets                                                    968,180          379,793
                                                                       -------------    -------------
Total current assets                                                      28,691,994       23,539,223

Property and equipment (Notes C and D):
     Land                                                                    889,696          785,682
     Buildings and improvements                                           11,951,700       11,253,559
     Equipment                                                            52,899,547       41,954,501
                                                                       -------------    -------------
                                                                          65,740,943       53,993,742
     Allowance for depreciation                                          (23,635,256)     (18,209,891)
                                                                       -------------    -------------
                                                                          42,105,687       35,783,851

Other assets:
     Deferred loan costs (Note D)                                          8,521,356        9,141,262
     Goodwill and other intangibles (Note C)                             263,425,447      228,692,018
     Other                                                                 2,306,143        1,507,488
                                                                       -------------    -------------
                                                                         274,252,946      239,340,768
                                                                       -------------    -------------
                                                                       $ 345,050,627    $ 298,663,842
                                                                       =============    =============
</TABLE>


See accompanying notes.


                                       F-2
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
                     CONSOLIDATED BALANCE SHEETS (Continued)

<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                               1997             1996
<S>                                                                      <C>              <C>
Liabilities and stockholders' equity Current liabilities:
   Trade accounts payable (includes $850,000 and $1,000,000 payable to
Bull Run Corporation, respectively)                                      $   3,321,903    $   6,043,062
   Employee compensation and benefits                                        3,239,694        7,152,786
   Accrued expenses                                                          2,265,725        1,059,769
   Accrued interest                                                          4,533,366        4,858,775
   Current portion of program broadcast obligations                          2,876,060        2,362,144
   Deferred revenue                                                          1,966,166        1,764,509
   Current portion of long-term debt                                           400,000          140,000
                                                                         -------------    -------------
Total current liabilities                                                   18,602,914       23,381,045

Long-term debt (Notes C and D)                                             226,676,377      173,228,049

Other long-term liabilities:
   Program broadcast obligations, less current portion                         617,107          545,889
   Supplemental employee benefits (Note E)                                   1,161,218        1,357,275
   Deferred income taxes (Note H)                                            1,203,847              -0-
   Deferred interest swap                                                          -0-          191,055
   Other acquisition related liabilities (Notes C and D)                     4,494,016        4,735,013
                                                                         -------------    -------------
                                                                             7,476,188        6,829,232
Commitments and contingencies (Notes C, D and J)

Stockholders' equity (Notes C, D and F)
  Serial Preferred Stock, no par value; authorized 20,000,000 shares;       20,600,000       20,000,000
      issued 2,060 and 2,000, respectively ($20,600,000
      and $20,000,000 aggregate liquidation value, respectively)
   Class A Common Stock, no par value; authorized 15,000,000                10,358,031        7,994,235
      shares; issued 5,307,716 and 5,155,331 shares, respectively
   Class B Common Stock, no par value; authorized 15,000,000                66,397,804       66,065,762
      shares; issued 3,515,364 and 3,500,000 shares, respectively
   Retained earnings                                                         6,603,191       10,543,940
                                                                         -------------    -------------
                                                                           103,959,026      104,603,937
   Treasury Stock at cost, Class A Common, 781,921 and 663,180              (9,011,369)      (6,638,284)
      shares, respectively
   Treasury Stock at cost, Class B Common, 166,790 and 172,300              (2,652,509)      (2,740,137)
      shares, respectively                                               -------------    -------------
                                                                            92,295,148       95,225,516
                                                                         -------------    -------------
                                                                         $ 345,050,627    $ 298,663,842
                                                                         =============    =============
</TABLE>


See accompanying notes.


                                       F-3
<PAGE>


                        GRAY COMMUNCIATIONS SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                                                Year Ended December 31,
                                                                                     1997                1996                1995
<S>                                                                            <C>                 <C>                 <C>
Operating revenues:
     Broadcasting (less agency commissions)                                    $  72,300,105       $  54,981,317       $  36,750,035
     Publishing                                                                   24,536,348          22,845,274          21,866,220
     Paging                                                                        6,711,426           1,478,608                 -0-
                                                                               -------------       -------------       -------------
                                                                                 103,547,879          79,305,199          58,616,255
Expenses:
     Broadcasting                                                                 41,966,493          32,438,405          23,201,990
     Publishing                                                                   19,753,387          17,949,064          20,016,137
     Paging                                                                        4,051,359           1,077,667                 -0-
     Corporate and administrative                                                  2,528,461           3,218,610           2,258,261
     Depreciation                                                                  7,800,217           4,077,696           2,633,360
     Amortization of intangible assets                                             6,718,302           3,584,845           1,325,526
     Non-cash compensation paid in common stock
         (Note E)                                                                        -0-             880,000           2,321,250
                                                                               -------------       -------------       -------------
                                                                                  82,818,219          63,226,287          51,756,524
                                                                               -------------       -------------       -------------
                                                                                  20,729,660          16,078,912           6,859,731
Miscellaneous income and (expense), net (Note B)                                     (30,851)          5,704,582             143,612
                                                                               -------------       -------------       -------------
                                                                                  20,698,809          21,783,494           7,003,343
Interest expense                                                                  21,861,267          11,689,053           5,438,374
                                                                               -------------       -------------       -------------
                                      INCOME (LOSS) BEFORE INCOME TAXES
                                               AND EXTRAORDINARY CHARGE           (1,162,458)         10,094,441           1,564,969
Federal and state income taxes (Note H)                                              240,000           4,416,000             634,000
                                                                               -------------       -------------       -------------
                                                   INCOME (LOSS) BEFORE
                                                   EXTRAORDINARY CHARGE          (1,402,458)          5,678,441             930,969
Extraordinary charge on extinguishment of debt, net of
     applicable income tax benefit of $2,157,000 (Note D)                                -0-           3,158,960                 -0-
                                                                               -------------       -------------       -------------
                                                      NET INCOME (LOSS)           (1,402,458)          2,519,481             930,969
Preferred dividends (Note F)                                                       1,409,690             376,849                 -0-
                                                                               -------------       -------------       -------------
                                         NET INCOME (LOSS) AVAILABLE TO
                                                    COMMON STOCKHOLDERS        $  (2,812,148)      $   2,142,632       $     930,969
                                                                               =============       =============       =============

Average outstanding common shares-basic                                            7,901,697           5,398,436           4,354,183
Average outstanding common shares-diluted                                          7,901,697           5,625,548           4,481,317

Basic earnings per common share:
     Income (loss) before extraordinary charge available to
        common stockholders                                                    $       (0.36)      $        0.98       $        0.21
     Extraordinary charge                                                                -0-               (0.58)                -0-
                                                                               -------------       -------------       -------------
                                         NET INCOME (LOSS) AVAILABLE TO
                                                    COMMON STOCKHOLDERS        $       (0.36)      $        0.40       $        0.21
                                                                               =============       =============       =============

Diluted earnings per common share:
     Income (loss) before extraordinary charge available to
        common stockholders                                                    $       (0.36)      $        0.94       $        0.21
     Extraordinary charge                                                                -0-               (0.56)                -0-
                                                                               -------------       -------------       -------------
                                         NET INCOME (LOSS) AVAILABLE TO
                                                    COMMON STOCKHOLDERS        $       (0.36)      $        0.38       $        0.21
                                                                               =============       =============       =============
</TABLE>

See accompanying notes.


                                      F-4
<PAGE>

                        GRAY COMMUNICATIONS SYSTEMS, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                         Class A                 Class B                  Restricted
                                          Preferred Stock              Common Stock            Common Stock                 Stock
                                        Shares       Amount       Shares          Amount       Shares       Amount        Deferrals
<S>                                     <C>      <C>              <C>         <C>           <C>         <C>              <C>
Balance at December 31, 1994              -0-    $       -0-      4,841,785   $ 3,393,747         -0-   $       -0-      $      -0-

Net Income                                -0-            -0-            -0-           -0-         -0-           -0-             -0-
Class A Common Stock Cash Dividends
     ($0.08) per share                    -0-            -0-            -0-           -0-         -0-           -0-             -0-
Issuance of Class A Common Stock
     (Notes C, E, F, G and I):
     401(k) Plan                          -0-            -0-         18,354       298,725         -0-           -0-             -0-
     Directors' Stock Plan                -0-            -0-         23,500       238,919         -0-           -0-             -0-
     Non-qualified Stock Plan             -0-            -0-          5,000        48,335         -0-           -0-             -0-
     Gwinnett Acquisition                 -0-            -0-         44,117       500,000         -0-           -0-             -0-
     Restricted Stock Plan                -0-            -0-        150,000     2,081,250         -0-           -0-      (2,081,250)
Amortization of Restricted Stock
     Plan deferrals                       -0-            -0-            -0-           -0-         -0-           -0-       2,081,250
     Income tax benefits relating to
     stock  plans                         -0-            -0-            -0-       235,000         -0-           -0-             -0-

Balance at December 31, 1995              -0-            -0-      5,082,756     6,795,976         -0-           -0-             -0-
Net Income                                -0-            -0-            -0-           -0-         -0-           -0-             -0-
Common Stock Cash Dividends:
     Class A ($0.08 per share)            -0-            -0-            -0-           -0-         -0-           -0-             -0-
     Class B ($0.02 per share)            -0-            -0-            -0-           -0-         -0-           -0-             -0-
Purchase of Class B Common Stock
     (Note F)                             -0-            -0-            -0-           -0-         -0-           -0-             -0-
Issuance of Class A Common Stock
     (Notes F, G and I):
     401(k) Plan                          -0-            -0-         13,225       262,426         -0-           -0-             -0-
     Directors' Stock Plan                -0-            -0-         22,500       228,749         -0-           -0-             -0-
     Non-qualified Stock Plan             -0-            -0-         36,850       358,417         -0-           -0-             -0-
Preferred Stock Dividends                 -0-            -0-            -0-           -0-         -0-           -0-             -0-
Issuance of Class A Common Stock
     Warrants (Notes C and F)             -0-            -0-            -0-     2,600,000         -0-           -0-             -0-
Issuance of Series A Preferred
     Stock in exchange for
     Subordinated Note
     (Notes C and F)                    1,000     10,000,000            -0-    (2,383,333)        -0-           -0-             -0-
Issuance of Series B Preferred
     Stock (Notes C and F)              1,000     10,000,000            -0-           -0-         -0-           -0-             -0-

Issuance of Class B Common Stock,
     net of expenses (Notes C and
     F)                                   -0-            -0-            -0-           -0-   3,500,000    66,065,762             -0-
Income tax benefits relating to
     stock plans                          -0-            -0-            -0-       132,000         -0-         -0-              -0-
                                        -----    -----------      ---------   -----------   ---------   -----------      ----------
Balance at December 31, 1996            2,000    $20,000,000      5,155,331   $ 7,994,235   3,500,000   $66,065,762      $     -0-
</TABLE>

<TABLE>
<CAPTION>
                                               Class A                        Class B
                                             Treasury Stock                Treasury Stock            Retained
                                          Shares          Amount        Shares         Amount        Earnings           Total
<S>                                     <C>          <C>                <C>        <C>             <C>           <C>
Balance at December 31, 1994            (663,180)    $(6,638,284)           -0-    $       -0-     $ 8,245,626        5,001,089

Net Income                                   -0-             -0-            -0-            -0-         930,969          930,969
Class A Common Stock Cash Dividends
     ($0.08) per share                       -0-             -0-            -0-            -0-        (348,689)        (348,689)
Issuance of Class A Common Stock
     (Notes C, E, F, G and I):
     401(k) Plan                             -0-             -0-            -0-            -0-             -0-          298,725
     Directors' Stock Plan                   -0-             -0-            -0-            -0-             -0-          238,919
     Non-qualified Stock Plan                -0-             -0-            -0-            -0-             -0-           48,335
     Gwinnett Acquisition                    -0-             -0-            -0-            -0-             -0-          500,000
     Restricted Stock Plan                   -0-             -0-            -0-            -0-             -0-              -0-
Amortization of Restricted Stock
      Plan deferrals                         -0-             -0-            -0-            -0-             -0-        2,081,250
Income tax benefits relating to
      stock plans                            -0-             -0-            -0-            -0-             -0-          235,000


Balance at December 31, 1995            (663,180)     (6,638,284)           -0-            -0-       8,827,906        8,985,598
Net Income                                   -0-             -0-            -0-            -0-       2,519,481        2,519,481
Common Stock Cash Dividends:
     Class A ($0.08 per share)               -0-             -0-            -0-            -0-        (357,598)        (357,598)
     Class B ($0.02 per share)               -0-             -0-            -0-            -0-         (69,000)         (69,000)
Purchase of Class B Common Stock
     (Note F)                                -0-             -0-       (172,300)    (2,740,137)            -0-       (2,740,137)
Issuance of Class A Common Stock
     (Notes F, G and I):
     401(k) Plan                             -0-             -0-            -0-            -0-             -0-          262,426
     Directors' Stock Plan                   -0-             -0-            -0-            -0-             -0-          228,749
     Non-qualified Stock Plan                -0-             -0-            -0-            -0-             -0-          358,417
Preferred Stock Dividends                    -0-             -0-            -0-            -0-        (376,849)        (376,849)
Issuance of Class A Common Stock
     Warrants (Notes C and F)                -0-             -0-            -0-            -0-             -0-        2,600,000
Issuance of Series A Preferred
     Stock in exchange for
     Subordinated Note
     (Notes C and F)                         -0-             -0-            -0-            -0-             -0-        7,616,667
Issuance of Series B Preferred
     Stock (Notes C and F)                   -0-             -0-            -0-            -0-             -0-       10,000,000
Issuance of Class B Common Stock,
     net of expenses (Notes C and
     F)                                      -0-             -0-            -0-            -0-             -0-       66,065,762
Income tax benefits relating to
     stock  plans                            -0-             -0-            -0-            -0-             -0-          132,000
                                        --------     -----------       --------    -----------     -----------   --------------
Balance at December 31, 1996            (663,180)    $(6,638,284)      (172,300)   $(2,740,137)    $10,543,940   $   95,225,516
</TABLE>



See accompanying notes.


                                       F-5


<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (continued)
<TABLE>
<CAPTION>
                                                                         Class A                 Class B                  Restricted
                                          Preferred Stock              Common Stock            Common Stock                 Stock
                                        Shares       Amount       Shares          Amount      Shares        Amount        Deferrals
<S>                                     <C>      <C>              <C>         <C>           <C>         <C>              <C>
Balance at December 31, 1996            2,000    $20,000,000      5,155,331   $ 7,994,235   3,500,000   $66,065,762      $    -0-
Net Loss                                  -0-            -0-            -0-           -0-         -0-           -0-           -0-
Common Stock Cash Dividends
     ($0.08) per share                    -0-            -0-            -0-           -0-         -0-           -0-           -0-
Preferred Stock Dividends                 -0-            -0-            -0-           -0-         -0-           -0-           -0-
Issuance of Class A Common Stock
     (Notes F and G):
     Directors' Stock Plan                -0-            -0-            501         9,645         -0-           -0-           -0-
     Non-qualified Stock Plan             -0-            -0-         29,850       317,151         -0-           -0-           -0-
     Stock Award Restricted
     Stock Plan                           -0-            -0-        122,034     1,200,000         -0-           -0-           -0-
Issuance of Class B Common Stock
     (Notes F and I):
     401(k) Plan                          -0-            -0-            -0-           -0-      15,364       282,384           -0-
Issuance of Series B Preferred
     Stock (Note F)                        60        600,000            -0-           -0-         -0-           -0-           -0-
Issuance of Treasury Stock
     (Notes F, G, and I):
     401(k) Plan                          -0-            -0-            -0-           -0-         -0-        49,658           -0-
     Non-qualified Stock Plan             -0-            -0-            -0-           -0-         -0-           -0-           -0-
Purchase of Class A Common Stock
     (Note F):                            -0-            -0-            -0-           -0-         -0-           -0-           -0-
Income tax benefits relating to
     stock plans                          -0-            -0-            -0-       837,000         -0-           -0-           -0-
                                        -----    -----------      ---------   -----------   ---------   -----------      -------
Balance at December 31, 1997            2,060    $20,600,000      5,307,716   $10,358,031   3,515,364   $66,397,804      $    -0-
                                        =====    ===========      =========   ===========   =========   ===========      =======
<CAPTION>
                                                Class A                           Class B
                                             Treasury Stock                   Treasury Stock            Retained
                                          Shares        Amount             Shares        Amount         Earnings         Total
<S>                                     <C>          <C>                <C>          <C>             <C>              <C>
Balance at December 31, 1996            (663,180)   (6,638,284)         $(172,300)   $(2,740,137)    $ 10,543,940     $ 95,225,516
Net Loss                                     -0-           -0-                -0-            -0-       (1,402,458)      (1,402,458
Common Stock Cash Dividends
     ($0.08) per share                       -0-           -0-                -0-            -0-         (628,045)        (628,045
Preferred Stock Dividends                    -0-           -0-                -0-            -0-       (1,409,690)      (1,409,690
Issuance of Class A Common Stock
     (Notes F and G):
     Directors' Stock Plan                   -0-           -0-                -0-            -0-              -0-            9,645
     Non-qualified Stock Plan                -0-           -0-                -0-            -0-              -0-          317,151
     Stock Award Restricted
     Stock Plan                              -0-           -0-                -0-            -0-              -0-        1,200,000
Issuance of Class B Common Stock
     (Notes F and I):
     401(k) Plan                             -0-           -0-                -0-            -0-              -0-          282,384
Issuance of Series B Preferred
     Stock (Note F)                          -0-           -0-                -0-            -0-              -0-          600,000
Issuance of Treasury Stock
     (Notes F, G, and I):
     401(k) Plan                             -0-           -0-              5,510         87,628              -0-          137,286
     Non-qualified Stock Plan             54,159     1,082,390                -0-            -0-         (500,556)         581,834
Purchase of Class A Common Stock
     (Note F):                          (172,900)   (3,455,475)               -0-            -0-              -0-       (3,455,475
Income tax benefits relating to
     stock plans                             -0-         -0-                  -0-            -0-              -0-          837,000
                                        --------   -----------           ---------   -----------       ----------      -----------
Balance at December 31, 1997            (781,921)  $(9,011,369)          $(166,790)  $(2,652,509)      $6,603,191      $92,295,148
                                        ========   ===========           =========   ===========       ==========      ===========
</TABLE>

See accompanying notes.


                                       F-6
<PAGE>


                        GRAY COMMUNCIATIONS SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                               Year Ended December 31,
                                                                                       1997             1996             1995
<S>                                                                              <C>              <C>              <C>
Operating activities
     Net income (loss)                                                           $  (1,402,458)   $   2,519,481    $     930,969
     Items which did not use (provide) cash:
        Depreciation                                                                 7,800,217        4,077,696        2,633,360
        Amortization of intangible assets                                            6,718,302        3,584,845        1,325,526
        Amortization of deferred loan costs                                          1,083,303          270,813              -0-
        Amortization of program broadcast rights                                     3,501,330        2,742,712        1,647,035
        Amortization  of original  issue  discount  on 8%  subordinated note               -0-          216,667              -0-
        Write-off of loan acquisition  costs from early  extinguishment of debt            -0-        1,818,840              -0-
        Gain on disposition of television station                                          -0-       (5,671,323)             -0-
        Payments for program broadcast rights                                       (3,629,350)      (2,877,128)      (1,776,796)
        Compensation paid in Common Stock                                                  -0-          880,000        2,321,250
        Supplemental employee benefits                                                (196,057)        (855,410)        (370,694)
        Common Stock contributed to 401(K) Plan                                        419,670          262,426          298,725
        Deferred income taxes                                                        1,283,000          (44,000)         863,000
        Loss on asset sales                                                            108,998          201,792            1,652
       Changes in operating assets and liabilities:
           Trade accounts receivable                                                  (369,675)      (1,575,723)        (852,965)
           Recoverable income taxes                                                   (384,597)        (400,680)      (1,347,007)
           Inventories                                                                (101,077)         254,952         (181,034)
           Other current assets                                                       (569,745)         (21,248)         (11,208)
           Trade accounts payable                                                   (2,825,099)       2,256,795        1,441,745
           Employee compensation and benefits                                       (2,848,092)       2,882,379        1,011,667
           Accrued expenses                                                          1,279,164       (2,936,155)        (414,087)
           Accrued interest                                                           (325,409)       3,794,284           78,536
           Deferred revenue                                                            201,657          710,286              -0-
                                                                                 -------------    -------------    -------------
Net cash provided by operating activities                                            9,744,082       12,092,301        7,599,674

Investing activities
     Acquisitions of newspaper businesses                                                  -0-              -0-       (2,084,621)
     Acquisition of television businesses                                          (45,644,942)    (210,944,547)             -0-
     Disposition of television business                                                    -0-        9,480,699              -0-
     Purchases of property and equipment                                           (10,371,734)      (3,395,635)      (3,279,721)
     Proceeds from asset sales                                                          24,885          174,401            2,475
     Deferred acquisition costs                                                        (89,056)             -0-       (3,330,481)
     Payments on purchase liabilities                                                 (764,658)        (243,985)        (111,548)
     Other                                                                            (652,907)        (139,029)        (125,356)
                                                                                 -------------    -------------    -------------
Net cash used in investing activities                                              (57,498,412)    (205,068,096)      (8,929,252)

Financing activities Proceeds from borrowings:
         Short-term debt                                                                   -0-              -0-        1,200,000
         Long-term debt                                                             75,350,000      238,478,310        2,950,000
     Repayments of  borrowings:
         Short-term debt                                                                   -0-              -0-       (1,200,000)
         Long-term debt                                                            (22,678,127)    (109,434,577)      (1,792,516)
     Deferred loan costs                                                              (463,397)      (9,410,078)             -0-
     Dividends paid                                                                 (1,428,045)        (426,598)        (348,689)
     Class A Common Stock transactions                                               1,163,796          719,166          522,254
     Proceeds  from  equity  offering  B Class B Common  Stock,  net of
         expenses                                                                          -0-       66,065,762              -0-
     Proceeds from offering of Series B Preferred Stock                                    -0-       10,000,000              -0-
     Proceeds from settlement of interest rate swap agreement                              -0-          215,000              -0-
     Proceeds from sale of treasury shares                                             581,834              -0-              -0-
     Purchase of Class A Common Stock                                               (3,455,475)             -0-              -0-
     Purchase of Class B Common Stock                                                      -0-       (2,740,137)             -0-
                                                                                 -------------    -------------    -------------
Net Cash provided by financing activities                                           49,070,586      193,466,848        1,331,049
                                                                                 -------------    -------------    -------------
Increase in cash and cash equivalents                                                1,316,256          491,053            1,471
Cash and cash equivalents at beginning of year                                       1,051,044          559,991          558,520
                                                                                 -------------    -------------    -------------
Cash and cash equivalents at end of year                                         $   2,367,300    $   1,051,044    $     559,991
                                                                                 =============    =============    =============
</TABLE>


See accompanying notes.


                                      F-7
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.   Summary of Significant Accounting Policies

     Description of Business

     The Company's  operations,  which are located in eight southeastern states,
include  eight  television  stations,  three daily  newspapers,  two area weekly
advertising only publications and paging operations.

     Principles of Consolidation

     The consolidated  financial  statements include the accounts of the Company
and its  subsidiaries.  All significant  intercompany  accounts and transactions
have been eliminated.

     Revenue Recognition

     The Company recognizes revenues as services are performed.

     Use of Estimates

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that affect the amounts  reported in the financial  statements  and
accompanying notes. Actual results could differ from those estimates.

     Cash and Cash Equivalents

     Cash and cash  equivalents  include cash on deposit  with a bank.  Deposits
with the bank are generally insured in limited amounts.

     Inventories

     Inventories, principally newsprint and supplies, are stated at the lower of
cost or market.  The Company  uses the  last-in,  first-out  ("LIFO")  method of
determining  costs  for  substantially  all of  its  inventories.  Current  cost
exceeded the LIFO value of inventories by  approximately  $15,000 and $13,000 at
December 31, 1997, and 1996, respectively.

     Program Broadcast Rights

     Rights to programs available for broadcast under program license agreements
are initially recorded at the beginning of the license period for the amounts of
total  license  fees  payable  under the license  agreements  and are charged to
operating  expense  on the  basis of  total  programs  available  for use on the
straight-line  method.  The portion of the  unamortized  balance  expected to be
charged to operating  expense in the succeeding  year is classified as a current
asset, with the remainder  classified as a non-current  asset. The liability for
the license fees payable under the program  license  agreements is classified as
current or  long-term,  in  accordance  with the  payment  terms of the  various
license agreements.


                                      F-8
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

A.   Summary of Significant Accounting Policies (Continued)

     Property and Equipment

     Property  and  equipment  are  carried at cost.  Depreciation  is  computed
principally by the straight-line  method for financial reporting purposes and by
accelerated  methods  for  income  tax  purposes.  Buildings,  improvements  and
equipment are depreciated over estimated useful lives of approximately 35 years,
10 years and 5 years, respectively.

     Intangible Assets

     Intangible   assets  are  stated  at  cost  and  are  amortized  using  the
straight-line method. Goodwill is amortized over 40 years. Loan acquisition fees
are  amortized  over  the  life  of  the  applicable  indebtedness.  Non-compete
agreements  are amortized over the life of the specific  agreement.  Accumulated
amortization of intangible assets resulting from business acquisitions was $11.5
million and $4.9 million as of December 31, 1997, and 1996, respectively.

     If facts  and  circumstances  indicate  that  the  goodwill,  property  and
equipment or other assets may be impaired,  an evaluation  of  continuing  value
would  be  performed.  If  an  evaluation  is  required,  the  estimated  future
undiscounted  cash flows associated with these assets would be compared to their
carrying  amount to determine if a write down to fair market value or discounted
cash flow value is required.

     Income Taxes

     Deferred income taxes are provided on the differences between the financial
statement  and income tax basis of assets and  liabilities.  The Company and its
subsidiaries file a consolidated  federal income tax return.  Consolidated state
income tax returns are filed when appropriate and separate state tax returns are
filed  when  consolidation  is  not  available.  Local  tax  returns  are  filed
separately.

     Capital Stock

     On August 17, 1995, the Board of Directors declared a 50% stock dividend on
the Company's  Class A Common Stock payable  October 2, 1995 to  stockholders of
record  on  September  8,  1995,  to effect a three  for two  stock  split.  All
applicable  share and per share data have been  adjusted  to give  effect to the
stock split.

     Earnings Per Common Share

     In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share ("Statement 128").  Statement 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share.  Unlike primary earnings per share, basic earnings per share excludes any
dilutive  effects of  options,  warrants  and  convertible  securities.  Diluted
earnings  per share is very similar to the  previously  reported  fully  diluted
earnings per share.  All  earnings  per share  amounts for all periods have been
presented,  and  where  appropriate,   restated  to  conform  to  Statement  128
requirements.


                                      F-9
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     A. Summary of Significant Accounting Policies (Continued)

     Stock Based Compensation

     The Company has elected to follow  Accounting  Principles Board Opinion No.
25,   "Accounting  for  Stock  Issued  to  Employees"  ("APB  25")  and  related
interpretations  in  accounting  for its  stock  options.  Under  APB 25, if the
exercise  price of the stock  options  granted by the Company  equals the market
price of the underlying stock on the date of the grant, no compensation  expense
is recognized.

     Concentration of Credit Risk

     The  Company  provides  print  advertising  and  advertising  air  time  to
national,  regional and local  advertisers  within the geographic areas in which
the  Company  operates.  Credit  is  extended  based  on an  evaluation  of  the
customer's financial  condition,  and generally advance payment is not required.
Credit losses are provided for in the financial statements and consistently have
been within management's expectations.

     Fair Value of Financial Instruments

     The Company has adopted FASB Statement No. 107, Disclosure about Fair Value
of Financial Instruments, which requires disclosure of fair value, to the extent
practical,  of certain of the Company's  financial  instruments.  The fair value
amounts do not necessarily represent the amount that could be realized in a sale
or settlement.  The Company's financial instruments are comprised principally of
long-term debt and preferred stock.

     The estimated  fair value of long-term  debt at December 31, 1997, and 1996
exceeded book value by $13.2 million and $9.6  million,  respectively.  The fair
value of the Preferred  Stock at December 31, 1997,  and 1996  approximates  its
carrying  value at that date.  The Company  does not  anticipate  settlement  of
long-term debt or preferred stock at other than book value.

     The fair value of other financial instruments  classified as current assets
or  liabilities  approximates  their  carrying  values  due  to  the  short-term
maturities of these instruments.

     Reclassifications

     Certain amounts in the accompanying  consolidated financial statements have
been reclassified to conform to the 1997 format.

B.   Business Disposition

     The  Company  sold  the  assets  of  KTVE  Inc.  (the  "KTVE  Sale"),   its
NBC-affiliated  television station, in Monroe,  Louisiana-El Dorado, Arkansas on
August 20, 1996.  The sales price  included $9.5 million in cash plus the amount
of the accounts receivable on the date of closing to the extent collected by the
buyer,  to be paid to the Company  within 150 days  following  the closing  date
(approximately $829,000). The Company recognized a pre-tax gain of approximately
$5.7  million  and  estimated  income  taxes of  approximately  $2.8  million in
connection with the sale.


                                      F-10
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

C.   Business Acquisitions

     The  Company's  acquisitions  have been  accounted  for under the  purchase
method of accounting.  Under the purchase  method of accounting,  the results of
operations  of  the  acquired   businesses  are  included  in  the  accompanying
consolidated  financial statements as of their respective acquisition dates. The
assets  and  liabilities  of  acquired  businesses  are  included  based  on  an
allocation of the purchase price.

     Pending Acquisition

     On February 13, 1998, the Company signed a definitive purchase agreement to
acquire all of the outstanding  capital stock of Busse Broadcasting  Corporation
("Busse").  The purchase price is approximately $112.0 million plus Busse's cash
and cash  equivalents  less Busse's  indebtedness  including its 11 5/8 % Senior
Secured Notes due 2000.  Busse owns and operates three VHF television  stations:
KOLN-TV,    the    CBS-affiliate    operating    on    Channel    10   in    the
Lincoln-Hastings-Kearney,  Nebraska television market, and its satellite station
KGIN-TV,  the  CBS-affiliate  operating  on  Channel 11  serving  Grand  Island,
Nebraska; and WEAU-TV, the NBC-affiliate operating on Channel 13 serving the Eau
Claire-La  Crosse,  Wisconsin  market.  The  purchase of Busse is subject to FCC
approval.  The acquisition is expected to close on or before  September 1, 1998.
In connection with the proposed purchase of Busse, the Company will pay Bull Run
Corporation ("Bull Run"), a principal stockholder of the Company, a finder's fee
equal to 1% of the purchase price for services performed,  none of which was due
and included in accounts payable at December 31, 1997.

     1997 Acquisitions

     On August 1, 1997,  the Company  purchased the assets of WITN-TV  ("WITN").
The purchase  price of  approximately  $41.7 million  consisted of $40.7 million
cash,  $600,000 in acquisition  related  costs,  and  approximately  $400,000 in
liabilities  which  were  assumed  by the  Company.  Based  on  the  preliminary
allocation of the purchase price, the excess of the purchase price over the fair
value of net tangible  assets  acquired was  approximately  $37.4  million.  The
Company funded the costs of this acquisition  through its senior credit facility
(the  "Senior  Credit  Facility").  WITN  operates  on  Channel  7  and  is  the
NBC-affiliate in the  Greenville-Washington-New  Bern, North Carolina market. In
connection  with the  purchase of the assets of WITN ("WITN  Acquisition"),  the
Company will pay Bull Run a fee equal to 1% of the  purchase  price for services
performed,  of which  $400,000  was due and  included  in  accounts  payable  at
December 31, 1997.

     On April 24, 1997, the Company  acquired all of the issued and  outstanding
common  stock of GulfLink  Communications,  Inc.  ("GulfLink")  of Baton  Rouge,
Louisiana.  The GulfLink operations include nine transportable  satellite uplink
trucks.  The purchase  price of  approximately  $5.2  million  consisted of $4.1
million cash,  $127,000 in acquisition  related costs,  and  approximately  $1.0
million  in  liabilities  which  were  assumed  by  the  Company.  Based  on the
preliminary  allocation of the purchase price,  the excess of the purchase price
over the fair value of net  tangible  assets  acquired  was  approximately  $3.6
million.  The Company  funded the costs of this  acquisition  through its Senior
Credit Facility. In connection with the purchase of the common stock of GulfLink
Communications,  Inc. (the "GulfLink Acquisition"),  the Company paid Bull Run a
fee equal to $58,000 for services performed.

     Unaudited pro forma  operating  data for the year ended  December 31, 1997,
and 1996 is  presented  below  and  assumes  that the WITN  Acquisition  and the
GulfLink Acquisition occurred on January 1, 1996.


                                      F-11
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Business Acquisitions (continued)

     1997 Acquisitions (continued)

     This  unaudited pro forma  operating data does not purport to represent the
Company's actual results of operations had the WITN Acquisition and the GulfLink
Acquisition  occurred on January 1, 1996,  and should not serve as a forecast of
the  Company's  operating  results  for  any  future  periods.   The  pro  forma
adjustments are based solely upon certain  assumptions that management  believes
are  reasonable  under  the  circumstances  at this  time.  Unaudited  pro forma
operating  data for the  year  ended  December  31,  1997,  are as  follows  (in
thousands, except per common share data):

<TABLE>
<CAPTION>
                                                                  WITN        GulfLink     Pro forma     Adjusted
                                                    Gray       Acquisition  Acquisition   Adjustments    Pro Forma
                                                                            (Unaudited)
<S>                                                 <C>            <C>           <C>             <C>      <C>
Revenues, net                                       $ 103,548      $ 4,551       $ 1,000         $ -0-    $ 109,099
                                                    =========      =======       =======         =====    =========
Net income (loss) available to common
    stockholders                                    $ (2,812)        $ 146          $ 74     $ (1,177)    $ (3,769)
                                                    ========         =====          ====     ========     ========
Income (loss) per share available to
    common stockholders:
    Basic                                            $ (0.36)                                              $ (0.48)
                                                     =======                                               =======
    Diluted                                          $ (0.36)                                              $ (0.48)
                                                     =======                                               =======
</TABLE>

Unaudited pro forma  operating data for the year ended December 31, 1996, are as
follows (in thousands, except per common share data):

<TABLE>
<CAPTION>
                                           WITN       GulfLink      KTVE         First        Pro forma    Adjusted
                              Gray     Acquisition  Acquisition     Sale        American     Adjustments   Pro Forma
                                                                              Acquisition
                                                                 (Unaudited)
<S>                          <C>            <C>          <C>       <C>           <C>             <C>       <C>
Revenues, net                $ 79,305       $ 8,431      $ 2,937   $ (2,968)     $ 21,203        $ -0-     $108,908
                             ========       =======      =======   ========      ========        =====     ========
Net income (loss)
   available to common
stockholders                  $ 2,143       $ 2,566        $ 197   $ (3,173)    $ (1,773)    $ (2,357)    $ (2,397)
                              =======       =======        =====   ========     =========    ========     ========
Income (loss) per
   share available to
   common stockholders:
         Basic                 $ 0.40                                                                      $ (0.30)
                               ======                                                                      =======
         Diluted               $ 0.38                                                                      $ (0.30)
                               ======                                                                      =======
</TABLE>

     The pro forma results  presented  above include  adjustments to reflect (i)
the incurrence of interest  expense to fund the GulfLink  Acquisition,  the WITN
Acquisition,   and  the  First   American   Acquisition   (as  defined  in  1996
Acquisitions),  (ii) depreciation and amortization of assets acquired, (iii) the
reduction  of  employee   compensation   related  to   severance   and  vacation
compensation for 1996, (iv) the elimination of the corporate expense  allocation
net  of  additional   accounting  and  administrative   expenses  for  the  WITN
Acquisition and the First American  Acquisition,  (v) increased  pension expense
for the First American  Acquisition,  and (vi) the income tax effect of such pro
forma  adjustments.  Average  outstanding  shares  used to  calculate  pro forma
earnings per share data for 1996  include the  3,500,000  Class B Common  shares
issued in connection with the First American Acquisition.


                                      F-12
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

C.   Business Acquisitions (continued)

     1996 Acquisitions

     On September 30, 1996, the Company  purchased  from First  American  Media,
Inc. substantially all of the assets used in the operation of two CBS-affiliated
television stations, WCTV-TV ("WCTV") serving Tallahassee,  Florida-Thomasville,
Georgia and WKXT-TV  ("WKXT") in Knoxville,  Tennessee,  as well as those assets
used in the operations of a satellite  uplink and production  services  business
and a  communications  and paging business (the "First  American  Acquisition").
Subsequent to the First American  Acquisition,  the Company  rebranded WKXT with
the call  letters  WVLT  ("WVLT") as a component  of its strategy to promote the
station's  upgraded news product.  The purchase  price of  approximately  $183.9
million  consisted of $175.5 million cash,  $1.8 million in acquisition  related
costs,  and the assumption of  approximately  $6.6 million of  liabilities.  The
excess of the purchase price over the fair value of net tangible assets acquired
was approximately $160.2 million. The Company's Board of Directors has agreed to
pay Bull Run, a fee equal to approximately  $1.7 million for services  performed
in connection with this acquisition.  At December 31, 1997, $450,000 of this fee
remains payable and is included in accounts payable.

     The First American  Acquisition  and the early  retirement of the Company's
existing bank credit facility and other senior indebtedness (see Notes D and F),
were funded as follows: net proceeds of $66.1 million from the sale of 3,500,000
shares of the  Company's  Class B Common Stock;  net proceeds of $155.2  million
from the sale of $160.0 million principal amount of the Company's 10 5/8% Senior
Subordinated Notes due 2006; $16.9 million of borrowings under the Senior Credit
Facility;  and $10.0  million net proceeds  from the sale of 1,000 shares of the
Company's  Series B Preferred Stock with warrants to purchase  500,000 shares of
the  Company's  Class A Common  Stock at $24 per  share.  The shares of Series B
Preferred Stock were issued to Bull Run and to J. Mack Robinson, Chairman of the
Board of Bull Run and President and Chief Executive Officer of the Company,  and
certain of his  affiliates.  The Company  obtained an opinion from an investment
banker as to the  fairness  of the terms of the sale of such  Series B Preferred
Stock with warrants.

     In   connection   with  the  First   American   Acquisition,   the  Federal
Communications  Commission  (the  "FCC")  ordered  the  Company to apply for FCC
approval to divest  itself of WALB-TV  ("WALB")  in Albany,  Georgia and WJHG-TV
("WJHG") in Panama  City,  Florida by March 31, 1997 to comply with  regulations
governing  common  ownership of  television  stations with  overlapping  service
areas. The FCC is currently  reexamining  these  regulations,  and if it revises
them in accordance  with the interim policy it has adopted,  divestiture of WJHG
would not be required.  Accordingly,  the Company  requested and in July of 1997
received  an  extension  of  the  divestiture   deadline  with  regard  to  WJHG
conditioned  upon  the  outcome  of the  rulemaking  proceedings.  It can not be
determined  when the FCC will complete its  rulemaking on this subject.  Also in
July of 1997, the Company obtained FCC approval to transfer control of WALB to a
trust with a view towards the trustee  effecting (i) a swap of WALB's assets for
assets  of  one or  more  television  stations  of  comparable  value  and  with
comparable broadcast cash flow in a transaction  qualifying for deferred capital
gains treatment under the "like-kind  exchange" provision of Section 1031 of the
Internal  Revenue Code of 1986,  or (ii) a sale of such assets.  Under the trust
arrangement,  the  Company  relinquished  operating  control of the station to a
trustee  while  retaining the economic  risks and benefits of ownership.  If the
trustee  is  required  to  effect  a sale of WALB,  the  Company  would  incur a
significant  gain and related tax liability,  the payment of which could have an
adverse  effect on the Company's  ability to acquire  comparable  assets without
incurring  additional  indebtedness.  The FCC  allowed  up to six months for the
trustee to file an application  seeking the agency's approval of a swap or sale.
This six month period expired in January 1998 without a swap or


                                      F-13
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

C.   Business Acquisitions (continued)

     1996 Acquisitions (continued)

sale being executed. The trustee has filed an application requesting a six month
extension to effect a swap or sale.  The FCC has not yet ruled on this extension
application.

     Condensed  unaudited  balance  sheets of WALB and WJHG are as  follows  (in
thousands):

<TABLE>
<CAPTION>
                                                                  WALB                            WJHG
                                                                              December 31,
                                                          1997            1996            1997            1996
                                                                              (Unaudited)
<S>                                                         <C>             <C>             <C>             <C>
Current assets                                              $ 2,379         $ 2,058         $ 1,053         $ 1,079
Property and equipment                                        1,473           1,579             848             981
Other assets                                                    471             100             346              55
                                                            -------         -------         -------         -------
     Total assets                                           $ 4,323         $ 3,737         $ 2,247         $ 2,115
                                                            =======         =======         =======         =======

Current liabilities                                         $   994         $ 1,189         $   350         $   497
Other liabilities                                               215             242             127             -0-
Stockholder's equity                                          3,114           2,306           1,770           1,618
                                                            -------         -------         -------         -------
     Total liabilities and stockholder's equity             $ 4,323         $ 3,737         $ 2,247         $ 2,115
                                                            =======         =======         =======         =======
</TABLE>

     Condensed  unaudited  income  statement  data  for the  three  years  ended
December 31, 1997, for WALB and WJHG are as follows (in thousands):

<TABLE>
<CAPTION>
                                                  WALB                                      WJHG
                                         Year ended December 31,                   Year ended December 31,
                                    1997          1996          1995          1997           1996          1995
                                                                    (Unaudited)
<S>                                  <C>           <C>            <C>           <C>           <C>           <C>
Broadcasting revenues                $ 10,090      $ 10,611       $ 9,445       $ 4,896       $ 5,217       $ 3,843
Expenses                                4,770         5,070         4,650         3,757         4,131         3,573
                                     --------      --------       -------       -------       -------       -------
Operating income                        5,320         5,541         4,795         1,139         1,086           270
Other income (expense)                      3             7            17           (5)             6            60
                                     --------      --------       -------       -------       -------       -------
Income before income taxes           $  5,323      $  5,548       $ 4,812       $ 1,134       $ 1,092       $   330
                                     ========      ========       =======       =======       =======       =======

Net income                           $  3,295      $  3,465       $ 2,984       $   737       $   685       $   205
                                     ========      ========       =======       =======       =======       =======
</TABLE>

     On January 4, 1996, the Company  purchased  substantially all of the assets
of WRDW-TV, a CBS television  affiliate serving the Augusta,  Georgia television
market (the "Augusta  Acquisition").  The purchase price of approximately  $37.2
million which included assumed  liabilities of approximately  $1.3 million,  was
financed primarily through long-term  borrowings.  The assets acquired consisted
of office equipment and broadcasting  operations located in North Augusta, South
Carolina.  The excess of the purchase  price over the fair value of net tangible
assets acquired was approximately  $32.5 million. In connection with the Augusta
Acquisition, the Company's Board of Directors approved the payment of a $360,000
fee to Bull Run.

     Funds for the Augusta  Acquisition  were obtained from the  modification of
the  Company's  existing  bank debt on January  4, 1996 (the  "Bank  Loan") to a
variable rate reducing revolving credit facility (the


                                      F-14
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

C.   Business Acquisitions (continued)

     1996 Acquisitions (continued)

"Old Credit  Facility") and the sale to Bull Run of an 8% subordinated  note due
January 3, 2005 in the  principal  amount of $10.0  million (the "8% Note").  In
connection  with the sale of the 8% Note,  the Company  also issued  warrants to
Bull Run to purchase 487,500 shares of Class A Common Stock at $17.88 per share,
337,500 shares of which were vested at December 31, 1997. The remainder vests in
four equal annual installments of 37,500 shares through 2001. Approximately $2.6
million of the $10.0  million of proceeds  from the 8% Note was allocated to the
warrants and increased Class A Common Stock.  The Old Credit  Facility  provided
for a  credit  line up to  $54.2  million.  This  transaction  also  required  a
modification  of the interest rate of the Company's $25.0 million senior secured
note with an institutional investor (the "Senior Note") from 10.08% to 10.7%.

     As part of the financing  arrangements for the First American  Acquisition,
the Old Credit  Facility and the Senior Note were retired and the Company issued
to Bull Run, in  exchange  for the 8% Note,  1,000  shares of Series A Preferred
Stock. The warrants issued with the 8% Note were retired and the warrants issued
with the Series A Preferred Stock will vest in accordance with the same schedule
described above provided the Series A Preferred Stock remains  outstanding.  The
Company  recorded an  extraordinary  charge of $5.3 million  ($3.2 million after
taxes or $0.58 per basic  common  share and $0.56 per diluted  common  share for
1996) in connection  with the early  retirement of the $25.0 million Senior Note
and the write-off of loan  acquisition  costs from the early  extinguishment  of
debt.

     Unaudited pro forma  operating  data for the year ended  December 31, 1996,
and 1995 is presented below and assumes that the Augusta Acquisition,  the First
American Acquisition, and the KTVE Sale occurred on January 1, 1995.

     This  unaudited pro forma  operating data does not purport to represent the
Company's  actual results of operations had the Augusta  Acquisition,  the First
American Acquisition,  and the KTVE Sale occurred on January 1, 1995, and should
not serve as a  forecast  of the  Company's  operating  results  for any  future
periods.  The pro forma  adjustments  are based solely upon certain  assumptions
that management  believes are reasonable  under the  circumstances at this time.
Unaudited pro forma  operating data for the year ended December 31, 1996, are as
follows (in thousands, except per common share data):

<TABLE>
<CAPTION>
                                                                           First
                                                               KTVE       American     Pro forma       Adjusted
                                                 Gray          Sale     Acquisition   Adjustments      Pro Forma
                                                                          (Unaudited)
<S>                                               <C>         <C>           <C>           <C>             <C>
Revenues, net                                    $ 79,305     $ (2,968)     $ 21,203         $ -0-        $ 97,540
                                                 ========     ========      ========         =====        ========
Net income (loss) before extraordinary
    charge available to common
    stockholders                                  $ 5,301     $ (3,173)     $ (1,773)     $ (1,743)       $ (1,388)
                                                  =======     ========      ========      ========        ========
Income (loss) per share available to
    common stockholders before
    extraordinary charge:
          Basic                                    $ 0.98                                                  $ (0.17)
                                                   ======                                                  =======
          Diluted                                  $ 0.94                                                  $ (0.17)
                                                   ======                                                  =======
</TABLE>



                                      F-15
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

C.   Business Acquisitions (continued)

     1996 Acquisitions (continued)

     Unaudited pro forma  operating  data for the year ended  December 31, 1995,
are as follows (in thousands, except per common share data):

<TABLE>
<CAPTION>
                                                 Augusta        KTVE         First      Pro forma      Adjusted
                                     Gray      Acquisition      Sale       American    Adjustments    Pro Forma
                                                                          Acquisition
                                                                    (Unaudited)
<S>                                   <C>          <C>         <C>           <C>         <C>            <C>
Revenues, net                        $ 58,616      $ 8,660     $ (4,188)     $ 27,321        $ 228      $ 90,637
                                     ========      =======     ========      ========        ======     ========
Net income (loss) available
    to common stockholders            $   931      $ 2,242       $ (278)      $ 6,348    $ (15,316)     $ (6,073)
                                      =======      =======       ======       =======    =========      ========
Income (loss) per share
    available to common
    stockholders:
         Basic                      $    0.21                                                            $ (0.77)
                                    =========                                                            =======
         Diluted                    $    0.21                                                            $ (0.77)
                                    =========                                                            =======
</TABLE>

     The pro forma results  presented  above include  adjustments to reflect (i)
the incurrence of interest  expense to fund the First American  Acquisition  and
the WRDW  Acquisition,  (ii)  depreciation  and amortization of assets acquired,
(iii) the reduction of employee  compensation  related to severance and vacation
compensation for 1996, (iv) the elimination of the corporate expense  allocation
net of additional accounting and administrative  expenses for the First American
Acquisition,  (v) increased pension expense for the First American  Acquisition,
and  (vi)  the  income  tax  effect  of  such  pro  forma  adjustments.  Average
outstanding  shares used to calculate pro forma earnings per share data for 1996
and 1995 include the 3,500,000  Class B Common shares issued in connection  with
the First American Acquisition.

1995 Acquisitions

     On January 6, 1995, the Company  purchased  substantially all of the assets
of the Gwinnett  Post-Tribune  and assumed  certain  liabilities ( the "Gwinnett
Acquisition").   The  assets   consisted  of  office  equipment  and  publishing
operations  located  in  Lawrenceville,  Georgia.  The  purchase  price  of $3.7
million,  including assumed liabilities of approximately  $370,000,  was paid by
approximately  $1.2 million in cash (financed through  long-term  borrowings and
cash from  operations),  the issuance of 44,117 shares of the Company's  Class A
Common Stock  (having fair value of $500,000),  and $1.5 million  payable to the
sellers  pursuant to  non-compete  agreements.  The excess of the purchase price
over the fair value of net  tangible  assets  acquired  was  approximately  $3.4
million.  In connection  with the Gwinnett  Acquisition  the Company's  Board of
Directors approved the payment of a $75,000 fee to Bull Run.


                                      F-16
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

D.   Long-term Debt

     Long-term debt consists of the following (in thousands):

                                                              December 31,
                                                           1997           1996
10 5/8 % Senior Subordinated Notes due 2006            $ 160,000      $ 160,000
Senior Credit Facility                                    65,630         12,680
Other                                                      1,446            688
                                                       ---------      ---------
                                                         227,076        173,368
Less current portion                                        (400)          (140)
                                                       ---------      ---------
                                                       $ 226,676      $ 173,228
                                                       =========      =========

     On September 20, 1996, the Company sold $160.0 million  principal amount of
the  Company's  10 5/8%  Senior  Subordinated  Notes (the  "Senior  Subordinated
Notes") due 2006. The net proceeds of $155.2  million from this offering,  along
with the net  proceeds  from (i) the KTVE  Sale,  (ii) the  issuance  of Class B
Common Stock, (iii) the issuance of Series B Preferred Stock and (iv) borrowings
under the Senior  Credit  Facility,  were used in financing  the First  American
Acquisition  as well as the  early  retirement  of the  Senior  Note and the Old
Credit  Facility.   Interest  on  the  Senior   Subordinated  Notes  is  payable
semi-annually on April 1 and October 1, commencing April 1, 1997.

     The Senior  Subordinated  Notes are jointly and severally  guaranteed  (the
"Subsidiary  Guarantees") by all of the Company's  subsidiaries (the "Subsidiary
Guarantors").  The obligations of the Subsidiary Guarantors under the Subsidiary
Guarantees is subordinated, to the same extent as the obligations of the Company
in respect of the Senior Subordinated Notes, to the prior payment in full of all
existing and future senior debt of the Subsidiary Guarantors (which will include
any guarantee issued by such Subsidiary Guarantors of any senior debt).

     The Company is a holding  company  with no material  independent  assets or
operations, other than its investment in its subsidiaries. The aggregate assets,
liabilities,  earnings and equity of the Subsidiary Guarantors are substantially
equivalent to the assets,  liabilities,  earnings and equity of the Company on a
consolidated  basis.  The  Subsidiary  Guarantors  are,  directly or indirectly,
wholly-owned  subsidiaries of the Company and the Subsidiary  Guarantees will be
full,  unconditional and joint and several. All of the current and future direct
and  indirect  subsidiaries  of the  Company  will be  guarantors  of the Notes.
Accordingly,  separate financial statements and other disclosures of each of the
Subsidiary  Guarantors are not presented because  management has determined that
they are not material to investors.

The Company has a $125.0 million Senior Credit  Facility,  as amended,  which is
comprised  of a term  loan  (the  "Term  Commitment")  of  $71.5  million  and a
revolving  credit  facility (the "Revolving  Commitment") of $53.5 million.  The
agreement  pursuant  to which the Senior  Credit  Facility  was issued  contains
certain  restrictive  provisions,  which,  among  other  things,  limit  capital
expenditures  and  additional  indebtedness  and require  minimum levels of cash
flows.  The  Senior   Subordinated  Notes  also  contained  similar  restrictive
provisions.  Additionally,  the  effective  interest  rate of the Senior  Credit
Facility  can be  changed  based  upon  the  Company's  maintenance  of  certain
operating  ratios as defined by the Senior  Credit  Facility,  not to exceed the
lender's prime rate plus 0.5% or LIBOR plus 2.25%.  The effective  interest rate
on the Senior Credit  Facility at December 31, 1997, and 1996 was 7.9% and 8.4%,
respectively.


                                      F-17
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

D.   Long-term Debt (continued)

     The amounts  available  under the Revolving  Commitment  will be reduced by
$7,356,000 in 1998; $8,025,000 in years 1999, 2000, 2001 and 2002; $9,363,000 in
2003; and $4,681,000 in 2004.

     The amount  borrowed  by the  Company on  December  31, 1999 under the Term
Commitment  will be  converted  to a four  and  one-half  year  term  loan.  The
principal  of the term loan shall be repaid in  nineteen  consecutive  quarterly
installments  commencing on December 31, 1999.  Each of the first five quarterly
installments are equal to 2.50% of the principal balance outstanding at December
31, 1999. Each of the next thirteen quarterly installments are equal to 3.75% of
the principal balance outstanding at December 31, 1999. The nineteenth and final
installment due June 30, 2004 will be equal to the remaining balance outstanding
and any outstanding interest due on June 30, 2004.

     The  Company is  charged a  commitment  fee on the excess of the  aggregate
average  daily  undisbursed  amount  of the  Revolving  Commitment  and the Term
Commitment over the amount outstanding. At December 31, 1997, the commitment fee
was 0.375% per annum. At December 31, 1997, the Company has approximately  $65.6
million  outstanding  on the Senior Credit  Facility.  At December 31, 1997, the
Company's  interest rate for the Senior Credit  Facility,  was based on a spread
over LIBOR of 1.75% or Prime.

     The Senior Subordinated Notes and the Senior Credit Facility are secured by
substantially all of the Company's existing and hereafter acquired assets.

     At December 31, 1997,  retained earnings of approximately  $1.4 million and
$1.0 million were  available  for  dividends to holders of preferred  and common
stock, respectively.

     Aggregate minimum principal maturities on long-term debt as of December 31,
1997, were as follows (in thousands):

               1998                             $     400
               1999                                 8,593
               2000                                10,300
               2001                                11,165
               2002                                11,058
               Thereafter                         185,560
                                                ---------
                                                $ 227,076

     The Company made interest  payments of  approximately  $21.3 million,  $7.6
million, and $5.4 million during 1997, 1996 and 1995, respectively.

     In  the  quarter  ended  September  30,  1996,  the  Company   recorded  an
extraordinary  charge of $5.3  million  ($3.2  million  after taxes or $0.58 per
basic common share or $0.56 per diluted  common  share) in  connection  with the
early  retirement  of the Senior  Note and the  write-off  of  unamortized  loan
acquisition costs of the Senior Note and the Old Credit Facility  resulting from
the early extinguishment of debt.


                                      F-18
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

E.   Supplemental Employee Benefits and Other Agreements

     The Company had an employment agreement with its former President, Ralph W.
Gabbard,  which provided for an award of 122,034 shares of the Company's Class A
Common Stock if his employment with the Company  continued until September 1999.
Mr.  Gabbard died  unexpectedly  in September  1996.  The Company  awarded these
shares to the estate of Mr.  Gabbard.  Approximately  $880,000  and  $240,000 of
expense was recorded in 1996 and 1995, respectively.

     In December 1995, the Company amended an existing  employment  agreement to
pay consulting fees to its former chief executive officer.  The Company recorded
approximately $596,000 of corporate and administrative  expenses during the year
ended December 31, 1995, in accordance with the terms of the amended  employment
agreement.  Additionally,  in December 1995 the Company issued 150,000 shares of
the  Company's  Class A Common Stock to this former chief  executive  officer in
accordance  with his  employment  agreement  which was amended to remove certain
restrictions,   including,  among  others,  a  time  requirement  for  continued
employment. Compensation expense of approximately $2.1 million was recognized in
1995 for the  150,000  shares of Class A Common  Stock  issued  pursuant to this
agreement.

     The Company  has entered  into  supplemental  retirement  benefit and other
agreements  with certain key employees.  These benefits are to be paid primarily
in equal monthly  amounts over the employees' life for a period not to exceed 15
years  after  retirement.   The  Company  charges  against   operations  amounts
sufficient  to fund the present  value of the  estimated  lifetime  supplemental
benefit over each employee's anticipated remaining period of employment.

     The following  summarizes activity relative to certain officers' agreements
and the supplemental employee benefits (in thousands):

                                                        December 31,
                                             1997           1996           1995
Beginning liability                       $ 3,158        $ 2,938        $ 2,518
                                          -------        -------        -------
Provision                                     161            918            976
Forfeitures                                   -0-            -0-           (169)
                                          -------        -------        -------
Net expense                                   161            918            807
Payments                                   (1,793)          (698)          (387)
                                          -------        -------        -------
Net change                                 (1,632)           220            420
                                          -------        -------        -------
Ending liability                            1,526          3,158          2,938
Less current portion                         (365)        (1,801)          (725)
                                          -------        -------        -------
                                          $ 1,161        $ 1,357        $ 2,213
                                          =======        =======        =======

F.   Stockholders' Equity and Earnings Per Share

     The Company amended its Articles of Incorporation to increase to 50,000,000
the number of shares of all classes of stock which the Company has the authority
to issue,  of which,  15,000,000  shares are  designated  Class A Common  Stock,
15,000,000 shares are designated Class B Common Stock, and 20,000,000 shares are
designated  "blank check"  preferred  stock for which the Board of Directors has
the authority to determine the rights, powers, limitations and restrictions. The
rights of the Company's  Class A and Class B Common Stock are identical,  except
that the  Class A Common  Stock  has 10 votes  per  share and the Class B Common
Stock has one vote per share. The Class A and Class B Common Stock


                                      F-19
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

F.   Stockholders' Equity and Earnings Per Share (Continued)

receive  cash  dividends on an equal per share basis.  In  September  1996,  the
Company  issued  1,000  shares  each of Series A and  Series B  Preferred  Stock
relating to the financing arrangements for the First American Acquisition.

     As part of the financing for the Augusta Acquisition,  funding was obtained
from the 8% Note, which included the issuance of detachable warrants to Bull Run
to purchase 487,500 shares of Class A Common Stock at $17.88 per share,  337,500
shares of which were vested at December 31, 1997.  The  remainder  vests in four
equal annual installments of 37,500 through 2001.  Approximately $2.6 million of
the $10.0 million of proceeds from the 8% Note was allocated to the warrants and
increased Class A Common Stock.  This allocation of the proceeds was based on an
estimate of the relative fair values of the 8% Note and the warrants on the date
of issuance.  The Company  amortized  the original  issue  discount on a ratable
basis in accordance with the original terms of the 8% Note through September 30,
1996. The Company  recognized  approximately  $217,000 in amortization costs for
the $2.6  million  original  issue  discount.  In  September  1996,  the Company
exchanged the 8% Note with Bull Run for 1,000 shares of  liquidation  preference
Series A Preferred  Stock yielding 8%. The warrants issued with the 8% Note were
retired and the warrants  issued with the Series A Preferred  Stock will vest in
accordance  with  the  same  schedule  described  above  provided  the  Series A
Preferred Stock remains outstanding.  The holder of the Series A Preferred Stock
will receive cash dividends at an annual rate of $800 per share. The liquidation
or redemption price of the Series A Preferred Stock is $10,000 per share.

     As part of the financing for the First  American  Acquisition,  the Company
also issued 1,000 shares of Series B Preferred Stock,  with warrants to purchase
an aggregate of 500,000  shares of Class A Common Stock at an exercise  price of
$24.00 per share.  Of these  warrants  300,000  vested upon  issuance,  with the
remaining warrants vesting in five equal annual  installments  commencing on the
first  anniversary  of the date of  issuance.  The shares of Series B  Preferred
Stock were issued to Bull Run and to J. Mack Robinson,  Chairman of the Board of
Bull Run and President and Chief Executive  Officer of the Company,  and certain
of his  affiliates.  The Company  obtained a written  opinion from an investment
banker as to the  fairness  of the terms of the sale of such  Series B Preferred
Stock with  warrants.  The holders of the Series B Preferred  Stock will receive
dividends at an annual rate of $600 per share,  except the Company at its option
may pay these  dividends in cash or in additional  shares.  The  liquidation  or
redemption  price of the  Series B  Preferred  Stock is $10,000  per  share.  In
September  1997,  the Company  issued 60 shares of Series B  Preferred  Stock as
payment of dividends to the holders of its then  outstanding  Series B Preferred
Stock.

     On  September  24,  1996,  the Company  completed a public  offering of 3.5
million  shares of its Class B Common  Stock at an offering  price of $20.50 per
share. The proceeds, net of expenses, from this public offering of approximately
$66.1 million were used in the financing of the First American Acquisition.

     The Company has a Stock  Purchase  Plan which allows  outside  directors to
purchase up to 7,500  shares of the  Company's  Common Stock  directly  from the
Company  before the end of January  following  each calendar  year. The purchase
price per share approximates the market price of the Common Stock at the time of
the grant.  During 1997, 1996 and 1995, certain directors purchased an aggregate
of 501, 22,500, and 23,500 shares of Class A Common Stock,  respectively,  under
this plan.


                                      F-20
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

F.   Stockholders' Equity and Earnings Per Share (Continued)

     The  Company's  Board of  Directors  authorized  the  purchase of up to two
million  shares of the  Company's  Class A or Class B Common  Stock to either be
retired or reissued in connection  with the Company's  benefit plans,  including
the Capital Accumulation Plan and the Incentive Plan. During 1997 and the fourth
quarter of 1996, the Company  purchased  172,900 Class A Common Stock shares and
172,300 Class B Common Stock shares, respectively, under this authorization. The
1997 and 1996 treasury shares were purchased at prevailing market prices with an
average effective price of $19.99 and $15.90 per share,  respectively,  and were
funded from the Company's operating cash flow.

     Statement of Financial  Accounting  Standards No. 128. "Earnings Per Share"
is effective for full-year 1997 and subsequent  periods.  Statement 128 modifies
the  method  for  calculations  of net  income  per share  applicable  to common
stockholders  and also requires a  reconciliation  between basic and diluted per
share amounts.

     The following  table  presents the effect of Statement  128 (in  thousands,
except per common share data):

<TABLE>
<CAPTION>
                                                                   1997                1996               1995

<S>                                                              <C>                 <C>                <C>
Net income (loss) available to common stockholders               $ (2,812)           $  2,143           $    931
                                                                 ========            ========           ========

Basic average common shares outstanding                             7,902               5,398              4,354
                                                                 ========            ========           ========
Basic net income (loss) per share available
       to common stockholders                                    $  (0.36)           $   0.40           $   0.21
                                                                 ========            ========           ========

Basic average common shares outstanding                             7,902               5,398              4,354
Stock compensation awards                                             -0-                 228                127
                                                                 --------            --------           --------
Diluted average common shares outstanding                           7,902               5,626              4,481
                                                                 ========            ========           ========
Diluted net income (loss) per share available
       to common stockholders                                    $  (0.36)           $   0.38           $   0.21
                                                                 ========            ========           ========
</TABLE>

G.   Long-term Incentive Plan and Stock Purchase Plan

     The Company has elected to follow  Accounting  Principles Board Opinion No.
25,   "Accounting   for  Stock  Issued  to  Employees"   (APB  25)  and  related
Interpretations  in  accounting  for its  employee  stock  options  because,  as
discussed below,  the alternative fair value accounting  provided for under SFAS
No. 123 "Accounting for Stock-Based Compensation" ("Statement 123") requires use
of option  valuation  models that were not developed for use in valuing employee
stock  options.  Under  APB 25,  because  the  exercise  price of the  Company's
employee stock options  equals the market price of the  underlying  stock on the
date of the grant, no compensation expense is recognized.

     The Company has a long-term  incentive  plan (the  "Incentive  Plan") under
which 200,000 shares of the Company's Class A Common Stock and 400,000 shares of
the Company's  Class B Common Stock are reserved for grants to key personnel for
(i) incentive  stock options,  (ii)  non-qualified  stock  options,  (iii) stock
appreciation  rights,  (iv)  restricted  stock and (v)  performance  awards,  as
defined by the Incentive  Plan.  Shares of Common Stock  underlying  outstanding
options or performance  awards are counted against the Incentive  Plan's maximum
shares while such options or awards are outstanding.


                                      F-21
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Long-term Incentive Plan and Stock Purchase Plan (continued)

Under the Incentive  Plan, the options  granted  typically vest after a two year
period and expire  three  years  after full  vesting.  Options  granted  through
December 31, 1997, have been granted at a price which  approximates  fair market
value on the date of the grant.

     The Company also has a Stock Purchase Plan which grants  outside  directors
up to 7,500 shares of the  Company's  Common  Stock.  Under this Stock  Purchase
Plan,  the options  granted vest at the beginning of the upcoming  calendar year
and expire at the end of January following that calendar year.

     Prior to 1996,  grants under the Incentive Plan and the Stock Purchase Plan
were made with the Company's  Class A Common Stock. In 1996, the Company amended
its  Incentive  Plan and Stock  Purchase Plan for grants to be made with Class B
Common Stock. Therefore,  all options granted subsequent to 1995, were made with
Class B Common Stock.

     Pro forma  information  regarding  net  income  and  earnings  per share is
required  by  Statement  123,  which  also  requires  that  the  information  be
determined  as if the Company  has  accounted  for its  employee  stock  options
granted subsequent to December 31, 1994 under the fair value method of Statement
123. The fair value for these options was estimated at the date of grant using a
Black-Scholes   option   pricing  model  with  the  following   weighted-average
assumptions for 1997, 1996 and 1995,  respectively:  risk-free interest rates of
5.82%, 5.43% and 6.06%;  dividend yields of 0.32%,  0.50% and 0.53%;  volatility
factors of the expected  market price of the  Company's  Class A Common Stock of
0.28, 0.33 and 0.26; and a weighted-average expected life of the options of 4.5,
2.0 and 2.7 years.

     The  Black-Scholes   option  valuation  model  was  developed  for  use  in
estimating the fair value of traded  options which have no vesting  restrictions
and which are fully transferable.  In addition,  option valuation models require
the input of highly  subjective  assumptions  including the expected stock price
volatility.  Because the Company's  employee stock options have  characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially  affect the fair value estimate,  in
management's  opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

     For  purposes of pro forma  disclosures,  the  estimated  fair value of the
options is amortized to expense over the options' vesting period.  The Company's
pro forma information follows (in thousands except per common share data):

                                                       1997        1996    1995
Pro forma income (loss) before extraordinary
   charge available to common stockholders          $ (3,174)   $ 5,190   $  792
Pro forma income (loss) before extraordinary
   charge per common share:
     Basic                                          $  (0.40)   $  0.96   $ 0.18
     Diluted                                        $  (0.40)   $  0.92   $ 0.18




                                      F-22
<PAGE>




                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Long-term Incentive Plan and Stock Purchase Plan (continued)

A summary of the Company's stock option  activity for Class A Common Stock,  and
related  information  for the years ended  December  31 follows  (in  thousands,
except weighted average data):

<TABLE>
<CAPTION>
                                                                 Year Ended December 31,
                                                  1997                     1996                    1995
                                                      Weighted                 Weighted                 Weighted
                                                       Average                  Average                 Average
                                                      Exercise                 Exercise                Exercise
                                           Options      Price      Options       Price      Options      Price
<S>                                           <C>      <C>             <C>      <C>            <C>      <C>
Stock options outstanding B
     beginning of year                        198      $13.11          263      $12.39         199      $ 9.80
     Options granted                          -0-                      -0-                     111       16.14
     Options exercised                        (85)      10.75          (52)       9.93         (29)      10.08
     Options forfeited                                    -0-           (6)      12.44         (18)      10.45
     Options expired                          (52)      19.25           (7)      10.17         -0-
                                              ---                      ---                     ---
Stock options outstanding
     B end of  year                            61      $11.15          198      $13.11         263      $12.39
                                              ===                      ===                     ===
Exercisable at end of year                     61      $11.15          164      $13.06          86      $ 9.84

Weighted-average fair value of
     options granted during the year                                                                    $ 3.37
</TABLE>

     Exercise prices for Class A Common Stock options outstanding as of December
31,  1997,   ranged  from  $9.67  to  $13.33  for  the   Incentive   Plan.   The
weighted-average  remaining contractual life of the Class A Common Stock options
outstanding for the Incentive Plan is 1.4 years.

     A summary of the Company's  stock option activity for Class B Common Stock,
and related  information  for the years ended December 31 follows (in thousands,
except weighted average data):

<TABLE>
<CAPTION>
                                                                              Year Ended December 31,
                                                                           1997                     1996
                                                                                Weighted                Weighted
                                                                                Average                  Average
                                                                               Exercise                 Exercise
                                                                    Options      Price      Options       Price
<S>                                                                     <C>     <C>            <C>        <C>
Stock options outstanding B beginning of year                            68     $15.88         -0-
     Options granted                                                    352      25.20          68        $15.88
                                                                        ---                    ---
Stock options outstanding B end of year                                 420     $23.70          68        $15.88
                                                                        ===                    ===

Exercisable at end of year                                               53     $15.88         -0-

Weighted-average fair value of options granted during the
     year                                                                       $ 8.10                    $ 3.22
</TABLE>

Exercise prices for Class B Common Stock options  outstanding as of December 31,
1997, ranged


                                      F-23
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Long-term Incentive Plan and Stock Purchase Plan (continued)

from $15.88 to $25.50 for the Incentive  Plan and $15.88 to $24.19 for the Stock
Purchase Plan. The  weighted-average  remaining  contractual life of the Class B
Common Stock options  outstanding for the Incentive Plan and Stock Purchase Plan
is 4.7 and 0.5 years, respectively.

H.   Income Taxes

     The Company uses the liability method in accounting for income taxes. Under
this  method,  deferred  tax  assets and  liabilities  are  determined  based on
differences  between financial reporting and tax bases of assets and liabilities
and are  measured  using the  enacted  tax rates and laws that will be in effect
when the differences are expected to reverse.

     Federal and state income tax expense (benefit) included in the consolidated
financial statements are summarized as follows (in thousands):

                                                  Year Ended December 31,
                                            1997           1996            1995
Current
     Federal                              $(1,620)       $ 1,462        $  (253)
     State and local                          577            841             24
Deferred                                    1,283            (44)           863
                                          -------        -------        -------
                                          $   240        $ 2,259        $   634
                                          =======        =======        =======

     The total  provision  for income  taxes for 1996  included a tax benefit of
$2.2 million which related to an extraordinary charge on extinguishment of debt.

     Significant components of the Company's deferred tax liabilities and assets
are as follows (in thousands):

                                                             1997         1996
Deferred tax liabilities:
     Net book value of property and equipment              $ 2,670      $ 1,165
     Goodwill                                                6,281        2,370
     Other                                                     120          120
                                                           -------      -------
            Total deferred tax liabilities                   9,071        3,655

Deferred tax assets:
     Liability under supplemental retirement plan              526        1,241
     Allowance for doubtful accounts                           499          619
     Difference in basis of assets held for sale               941          941
     Federal operating loss carryforwards                    4,412          -0-
     State and local operating loss carryforwards            1,952        1,164
     Other                                                     290          511
                                                           -------      -------
            Total deferred tax assets                        8,620        4,476
     Valuation allowance for deferred tax assets              (753)        (753)
                                                           -------      -------
            Net deferred tax assets                          7,867        3,723
                                                           -------      -------

Deferred tax assets (liabilities) net                      $(1,204)     $    68
                                                           =======      =======


                                      F-24
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

H.   Income Taxes (continued)

     A substantial  portion of the federal  operating  loss  carryforwards  will
expire in the year ended December 31, 2012.

     A reconciliation  of income tax expense at the statutory federal income tax
rate and income taxes as reflected in the consolidated  financial  statements is
as follows (in thousands):

                                                        Year Ended December 31,
                                                      1997       1996      1995
Statutory rate applied to income                    $  (395)   $ 1,625   $   532
State and local taxes, net of federal tax benefits      572         (7)       91
Permanent difference relating to sale of KTVE           -0-        602       -0-
Other items, net                                         63         39        11
                                                    -------    -------   -------
                                                    $   240    $ 2,259   $   634
                                                    =======    =======   =======

     The  Company  made  income tax  payments of  approximately  $275,000,  $3.6
million and $742,000 during 1997, 1996 and 1995,  respectively.  At December 31,
1997, the Company had current  recoverable  income taxes of  approximately  $2.1
million.

I.   Retirement Plans

     Pension Plan

     The Company has a retirement  plan  covering  substantially  all  full-time
employees.  Retirement benefits are based on years of service and the employees'
highest  average  compensation  for five  consecutive  years during the last ten
years of employment.  The Company's funding policy is to contribute annually the
minimum amounts deductible for federal income tax purposes.

     The net pension expense includes the following (in thousands):

<TABLE>
<CAPTION>
                                                            Year Ended December 31,
                                                          1997      1996      1995
<S>                                                      <C>       <C>       <C>
Service costs B benefits earned during the year          $ 429     $ 360     $ 221
Interest cost on projected benefit obligation              442       409       384
Actual return on plan assets                              (608)     (574)     (655)
Net amortization and deferral                              121       126       187
                                                         -----     -----     -----
Net pension expense                                      $ 384     $ 321     $ 137
                                                         =====     =====     =====
Assumptions:
     Discount rate                                         7.0%      7.0%      8.0%
     Expected long-term rate of return on assets           7.0%      7.0%      8.0%
     Estimated rate of increase in compensation levels     5.0%      5.0%      6.0%
</TABLE>


                                      F-25
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

I.   Retirement Plans (continued)

     Pension Plan (continued)

     The following  summarizes  the plan's funded status and related  assumption
(in thousands):

<TABLE>
<CAPTION>
                                                                               December 31,
                                                                             1997        1996
<S>                                                                        <C>         <C>
Actuarial present value of accumulated benefit obligation is as follows:
     Vested                                                                $ 5,962     $ 5,675
     Other                                                                     491         291
                                                                           -------     -------
                                                                           $ 6,453     $ 5,966
                                                                           =======     =======
Plan assets at fair value, primarily mutual funds and an unallocated
      insurance contract                                                   $ 6,919     $ 6,282
Projected benefit obligation                                                (7,053)     (6,483)
                                                                           -------     -------
Plan assets less than projected benefit obligation                            (134)       (201)
Unrecognized net (gain) loss                                                   (58)         72
Unrecognized net asset                                                        (246)       (300)
                                                                           -------     -------
Pension liability included in consolidated balance sheet                   $  (438)    $  (429)
                                                                           =======     =======
Assumptions:
     Discount rate                                                             7.0%        7.0%
     Estimated rate of increase in compensation levels                         5.0%        5.0%
</TABLE>

     Capital Accumulation Plan

     Effective  October 1, 1994,  the Company  adopted  the Gray  Communications
Systems,  Inc. Capital  Accumulation Plan (the "Capital  Accumulation Plan") for
the purpose of providing  additional  retirement  benefits for substantially all
employees. The Capital Accumulation Plan is intended to meet the requirements of
section 401(k) of the Internal Revenue Code.

     On November 14, 1996, the Company amended its Capital  Accumulation Plan to
allow an investment  option in the Company's Class B Common Stock. The amendment
also allows for the Company's  percentage  match to be made by a contribution of
the Company's Class B Common Stock, effective in 1997. On December 13, 1996, the
Company  reserved  200,000  shares  of the  Company's  Class B Common  Stock for
issuance under the Capital Accumulation Plan.

     Employee  contributions to the Capital  Accumulation Plan, not to exceed 6%
of the employees' gross pay, are matched by Company  contributions.  Until 1997,
the Company's percentage match was made by a contribution of the Company's Class
A Common  Stock.  The  Company's  percentage  match  amount is  declared  by the
Company's  Board of Directors  before the  beginning of each plan year. In 1997,
the Company's  percentage match has been made by a contribution of the Company's
Class B Common Stock. The Company's percentage match was 50% for the three years
ended  December  31,  1997.  The  Company  contributions  vest,  based upon each
employee's number of years of service, over a period not to exceed five years.

     Company matching contributions aggregating $419,670,  $262,426 and $298,725
were charged to expense for 1997, 1996 and 1995, respectively,  for the issuance
of 20,874 Class B shares; 13,225 and 18,354 Class A shares, respectively.


                                      F-26
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

J.   Commitments and Contingencies

     The Company has various operating lease commitments for equipment, land and
office  space.  The  Company  has also  entered  into  commitments  for  various
television  film  exhibition  rights for which the license  periods have not yet
commenced.  Rent expense  resulting  from  operating  leases for the years ended
December 31, 1997,  1996 and 1995 were $1.4  million,  $501,000,  and  $267,000,
respectively.  Future minimum  payments under  operating  leases with initial or
remaining  noncancelable lease terms in excess of one year and obligations under
film  exhibition  rights for which the license period have not yet commenced are
as follows (in thousands):


                          Lease             Film             Total
           1998          $ 1,434          $ 1,083          $ 2,517
           1999            1,255            3,128            4,383
           2000              674            2,693            3,367
           2001              505            1,650            2,155
           2002              290              920            1,210
     Thereafter              732              -0-              732
                         -------          -------          -------
                         $ 4,890          $ 9,474          $14,364
                         =======          =======          =======

     The Company is subject to legal  proceedings  and claims which arise in the
normal  course of its  business.  In the  opinion of  management,  the amount of
ultimate  liability,  if any, with respect to these actions will not  materially
affect the Company's financial position.


                                      F-27
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

K.   Information on Business Segments

     The Company operates in three business segments:  broadcasting,  publishing
and paging.  The  broadcasting  segment  operates eight  television  stations at
December 31, 1997. The  publishing  segment  operates three daily  newspapers in
three different  markets,  and two area weekly  advertising only publications in
southwest  Georgia  and north  Florida.  The paging  operations  are  located in
Florida,  Georgia,  and Alabama.  The following tables present certain financial
information concerning the Company's three operating segments (in thousands):

<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                               1997         1996         1995
                                                       (In thousands)
<S>                                         <C>          <C>          <C>
Operating revenues:
     Broadcasting                           $  72,300    $  54,981    $  36,750
     Publishing                                24,536       22,845       21,866
     Paging                                     6,712        1,479          -0-
                                            ---------    ---------    ---------
                                            $ 103,548    $  79,305    $  58,616
                                            =========    =========    =========

Operating profit:
      Broadcasting                          $  17,509    $  14,106    $   7,822
      Publishing                                2,206        1,980         (962)
      Paging                                    1,015           (7)         -0-
                                            ---------    ---------    ---------
Total operating profit                         20,730       16,079        6,860
Miscellaneous income and (expense), net           (31)       5,704          144
Interest expense                              (21,861)     (11,689)      (5,439)
                                            ---------    ---------    ---------
Income (loss) before income taxes           $  (1,162)   $  10,094    $   1,565
                                            =========    =========    =========
</TABLE>

     Operating  profit  is total  operating  revenue  less  operating  expenses,
excluding  miscellaneous  income and expense (net) and  interest.  Corporate and
administrative  expenses are allocated to operating  profit based on net segment
revenues.


                                      F-28
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

K.   Information on Business Segments (continued)

                                                       Year Ended December 31,
                                                    1997        1996       1995
                                                           (In thousands)
Depreciation and amortization expense:
     Broadcasting                                 $11,024     $ 5,554    $ 2,723
     Publishing                                     1,973       1,730      1,190
     Paging                                         1,480         329        -0-
                                                  -------     -------    -------
                                                   14,477       7,613      3,913
     Corporate                                         42          50         46
                                                  -------     -------    -------
Total depreciation and amortization expense       $14,519     $ 7,663    $ 3,959
                                                  =======     =======    =======

Capital expenditures:
     Broadcasting                                 $ 5,000     $ 2,674    $ 2,285
     Publishing                                     4,235         692        973
     Paging                                           975         -0-        -0-
                                                  -------     -------    -------
                                                   10,210       3,366      3,258
     Corporate                                        162          30         22
                                                  -------     -------    -------
Total capital expenditures                        $10,372     $ 3,396    $ 3,280
                                                  =======     =======    =======

                                                             December 31,
                                                    1997        1996       1995
                                                           (In thousands)
 Identifiable assets:
      Broadcasting                               $287,254    $245,614   $ 54,022
      Publishing                                   19,818      16,301     18,170
      Paging                                       23,950      23,764        -0-
                                                 --------    --------   --------
                                                  331,022     285,679     72,192
      Corporate                                    14,029      12,985      6,048
                                                 --------    --------   --------
Total identifiable assets                        $345,051    $298,664   $ 78,240
                                                 ========    ========   ========


                                      F-29
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

L.   Selected Quarterly Financial Data (Unaudited)

<TABLE>
<CAPTION>
                                                                                               Fiscal Quarters
                                                                             First          Second           Third          Fourth
Year Ended December 31, 1997                                                     (In thousands, except for per share data)
<S>                                                                      <C>             <C>             <C>             <C>
Operating revenues                                                       $   22,761      $   25,499      $   25,984      $   29,304
Operating income                                                              4,337           6,124           4,271           5,998
Net income (loss)                                                              (461)            622          (1,162)           (401)
Net income (loss) available to common stockholders                             (811)            272          (1,513)           (760)
Basic income (loss) per share                                            $    (0.10)     $     0.03      $    (0.19)     $    (0.10)
Diluted income (loss) per share                                          $    (0.10)     $     0.03      $    (0.19)     $    (0.10)

<CAPTION>
                                                                                               Fiscal Quarters
                                                                             First          Second           Third          Fourth
Year Ended December 31, 1996                                         (In thousands, except for per share data)
<S>                                                                      <C>             <C>             <C>             <C>
Operating revenues                                                       $   17,027      $   18,487      $   16,699      $   27,092
Operating income                                                              2,678           4,633           2,381           6,387
Income before extraordinary charge                                              311           1,490           2,947             930
Extraordinary charge                                                            -0-             -0-           3,159             -0-
Net income (loss)                                                               311           1,490            (212)            930
Net income (loss) available to common stockholders                              311           1,490            (239)            580
Basic income (loss) per share
      Income before extraordinary charge available to                    $     0.07      $     0.33      $     0.62      $     0.07
          common stockholders
      Extraordinary charge                                                     0.00            0.00           (0.67)           0.00
                                                                         ----------      ----------      ----------      ----------
      Net income (loss) available to common stockholders                 $     0.07      $     0.33      $    (0.05)     $     0.07
                                                                         ==========      ==========      ==========      ==========
Diluted income (loss) per share
      Income before extraordinary charge available to                    $     0.07      $     0.32      $     0.58      $     0.07
          common stockholders
      Extraordinary charge                                                     0.00            0.00           (0.63)           0.00
                                                                         ----------      ----------      ----------      ----------
      Net income (loss) available to common stockholders                 $     0.07      $     0.32      $    (0.05)     $     0.07
                                                                         ==========      ==========      ==========      ==========
</TABLE>

     Because of the method used in calculating per share data, the quarterly per
share data will not  necessarily  add to the per share data as computed  for the
year.

     The third  quarter  of 1996  includes  the KTVE  Sale and an  extraordinary
charge.  As a result of the KTVE Sale, the Company  recognized a pre-tax gain of
approximately  $5.7 million and  estimated  income taxes of  approximately  $2.8
million  (See  Note  B).  The  Company  recorded  an  extraordinary   charge  on
extinguishment of debt of $5.3 million and an income tax benefit of $2.2 million
(See Note D).



                                      F-30
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS



     We  have   audited   the   consolidated   financial   statements   of  Gray
Communications  Systems,  Inc. as of December 31, 1997 and 1996,  and for each
of the three  years in the period  ended  December  31,  1997,  and have issued
our report  thereon  dated January 27, 1998 (except for the Pending  Acquisition
of Note C, as to which the date is February 13, 1998). Our audits also included
the financial statement schedule of Gray Communications Systems, Inc. listed in
Item 14(a).  This schedule is the  responsibility  of the Company's  management.
Our responsibility is to express an opinion based on our audits.

     In our opinion,  the financial  statement  schedule referred to above, when
considered  in  relation  to the basic  financial  statements  taken as a whole,
presents fairly in all material respects the information set forth therein.



                                             /s/ ERNST & YOUNG LLP

Atlanta, Georgia
January 27, 1998


                                      F-31
<PAGE>


                        GRAY COMMUNICATIONS SYSTEMS, INC.

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                                        Additions
                                                --------------------------
                                  Balance at       Charged to     Charged to                    Balance at
                                  Beginning        Costs and        Other                        End of
Description                       Of Period        Expenses       Accounts**    Deductions*     Period
-----------                       ----------       ----------     ----------    -----------    ----------
<S>                               <C>               <C>             <C>           <C>          <C>
Year ended December 31, 1997

Allowance for doubtful accounts   $1,450,000        $188,000        $31,000       $416,000     $1,253,000


Year ended December 31, 1996

Allowance for doubtful accounts     $450,000        $894,000       $583,000       $477,000     $1,450,000


Year ended December 31, 1995

Allowance for doubtful accounts     $694,000        $384,000        $33,000       $661,000       $450,000
</TABLE>

     *    "Deductions"   represent   write-offs   of  amounts   not   considered
          collectible
     **   Represents amounts recorded in certain  allocations of purchase prices
          for the Company's acquisitions


                                      F-32
<PAGE>


                          Independent Auditors' Report


The Board of Directors
Capital Sports Properties, Inc.:


We have audited the balance sheets of Capital Sports Properties, Inc. as of June
30, 1996 and December 31, 1995, and the related statements of earnings,  changes
in  stockholders'  equity and cash flows for the six-months  ended June 30, 1996
and the year ended  December 31, 1995, not separately  presented  herein.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects, the financial position of Capital Sports Properties, Inc.
as of June 30, 1996 and December 31, 1995, and the results of its operations and
its  cash  flows  for the  six-months  ended  June 30,  1996 and the year  ended
December 31, 1995, in conformity with generally accepted accounting principles.



                                             /s/ KPMG PEAT MARWICK LLP

Stamford, Connecticut
February 10, 1997


                                      F-33
<PAGE>


KPMG Peat Marwick LLP
1600 PNC Center
201 East Fifth Street
Cincinnati, OH 45202

Dayton, OH


                          Independent Auditors' Report

The Board of Directors
Host Communications, Inc.:


We have audited the consolidated balance sheets of Host Communications, Inc. and
subsidiaries as of June 30, 1996 and 1995, and the related consolidated
statements of earnings, stockholders' equity, and cash flows for the years then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects, the financial position of Host Communications,
Inc. and  subsidiaries at June 30, 1996 and 1995, and the results of their
operations and their cash flows for the years then ended in conformity with
generally  accepted accounting principles.

As discussed in notes 1 and 3 to the  consolidated  financial  statements,  the
Company changed  its  method of  accounting  for  license  fee  revenues  and
rights fee expenses.



                                             /s/ KPMG PEAT MARWICK LLP

October 11, 1996



                                      F-34