UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
 Washington, D.C.
20549
 
 
 FORM 10-Q
 
 þQUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d)
 OF
THE SECURITIES EXCHANGE ACT OF 1934
 
 For
the quarterly period ended:  December 6, 2009
 
 oTRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d)
 OF
THE SECURITIES EXCHANGE ACT OF 1934
 
 For
the transition period from ____________ to _____________
 
 Commission
file number 333-134701
 
 NETWORK
COMMUNICATIONS, INC.
 
 Formed under the laws of the State of
Georgia
 I.R.S. Employer Identification
Number 58-1404355
 
 2305
Newpoint Parkway, Lawrenceville, GA  30043
 Telephone Number:
(770) 962-7220
  ____________________________________
 
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
 Yes þ          No o
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405
of this chapter) during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
 
 Yes o          No o
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definitions of “large accelerated filer, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
 Large
accelerated filer o             Accelerated
filer  o                  Non-accelerated
filer  þSmaller reporting company  o
 
 Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
 Yes o          No þ
 Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
 Class
              Outstanding at December 6,
      2009Common
      Stock, $0.001 par value per share
              100
      shares
  Table of Contents
  
 TABLE OF
CONTENTS
 PART I:
      FINANCIAL INFORMATIONItem 1.
              CondensedConsolidated Financial Statements
      (Unaudited)
              PageCondensed Consolidated Balance Sheets as of December 6,
      2009 and March 29, 2009
              2Condensed Consolidated Statements of Operations for the
      three periods ended December 6, 2009 and December 7,
    2008
              3Condensed Consolidated Statements of Operations for
      the nine periods ended December 6, 2009 and December 7,
      2008
              4Condensed Consolidated Statement of Stockholders’
      Equity as of December 6, 2009
              5Condensed Consolidated Statements of Cash Flows for the
      nine periods ended December 6, 2009 and December 7,
    2008
              6Notes to Condensed Consolidated Financial
      Statements
              7Item 2.
              Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
              16Item 3.
              Quantitative and Qualitative Disclosures about Market
      Risk
              31Item
      4.
              Controls and Procedures
              31PART II:
      OTHER INFORMATIONItem 1.
              Legal Proceedings
              32Item
      1A.
              Risk Factors
              32Item
      2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              32Item
      3.
              Defaults upon Senior Securities
              32Item
      4.
              Submission of Matters to a Vote of Security
      Holders
              32Item
      5.
              Other Information
              32Item
      6.
              Exhibits
              32SignaturesEX10.29:
              AMENDMENT TO EMPLOYMENT AGREEMENTEX10.30:
              AMENDMENT TO EMPLOYMENT AGREEMENTEX-31.1:
              CERTIFICATION OF CEOEX-31.2:
              CERTIFICATION OF CFOEX-32.1:
              CERTIFICATION OF CEOEX-32.2:
              CERTIFICATION OF CFO
  
  1
 Table of Contents
  PART I –FINANCIAL INFORMATION
 
 Item 1.   Condensed Consolidated Financial
Statements
  NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED BALANCE SHEETS
  December
      6, 2009
              
              
              March
      29, 2009ASSETS
              
              (Unaudited)Current
      assetsCash
      and cash equivalents
              
              $
              3,043,294
              
              
              $
              2,584,740Accounts
      receivable, net of allowance for doubtful accounts of $3,832,883 and
      $3,948,260, respectively
              
              
              15,480,963
              
              
              
              12,063,799Inventories
              
              
              1,962,676
              
              
              
              2,849,917Prepaid
      expenses and deferred charges
              
              
              1,693,154
              
              
              
              3,332,139Deferred
      tax assets
              
              
              1,490,021
              
              
              
              1,595,511Income
      tax receivable
              
              
              4,220,232
              
              
              
              3,292,455Other
      current assets
              
              
              84,705
              
              
              
              59,487Total
      current assets
              
              
              27,975,045
              
              
              
              25,778,048Property,
      equipment and computer software, net
              
              
              22,155,270
              
              
              
              23,658,481Goodwill
              
              
              188,826,674
              
              
              
              188,531,513Deferred
      financing costs, net
              
              
              4,915,329
              
              
              
              5,959,080Intangible
      assets, net
              
              
              118,196,473
              
              
              
              128,512,560Other
      assets
              
              
              360,966
              
              
              
              417,378Total
      noncurrent assets
              
              
              334,454,712
              
              
              
              347,079,012Total
      assets
              
              $
              362,429,757
              
              
              $
              372,857,060LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesAccounts
      payable
              
              $
              7,672,418
              
              
              $
              6,459,301Accrued
      compensation and related taxes
              
              
              1,767,301
              
              
              
              1,503,679Customer
      deposits
              
              
              918,670
              
              
              
              964,022Unearned
      revenue
              
              
              1,116,307
              
              
              
              1,332,484Accrued
      interest
              
              
              523,461
              
              
              
              6,682,405Other
      current liabilities
              
              
              86,190
              
              
              
              383,004Current
      maturities of long-term debt
              
              
              6,766,359
              
              
              
              2,350,941Current
      maturities of capital lease obligations
              
              
              267,100
              
              
              
              342,192Total
      current liabilities
              
              
              19,117,806
              
              
              
              20,018,028Long-term
      debt, less current maturities
              
              
              285,761,389
              
              
              
              282,693,343Capital
      lease obligations, less current maturities
              
              
              171,508
              
              
              
              322,269Deferred
      tax liabilities
              
              
              25,265,751
              
              
              
              27,294,034Other
      long-term liabilities
              
              
              3,137
              
              
              
              —Total
      liabilities
              
              
              330,319,591
              
              
              
              330,327,674Commitments
      and contingencies (Note 9)Stockholders’
      EquityCommon
      stock, $0.001 par value; 100 shares authorized, issued and
      outstanding
              
              
              —
              
              
              
              —Additional
      paid-in capital (including warrants of $533,583 at December 6, 2009 and
      March 29, 2009)
              
              
              194,579,776
              
              
              
              194,579,776Accumulated
      deficit
              
              
              (162,438,936
              )
              
              
              (151,931,512
              )Accumulated
      other comprehensive loss, net of tax
              
              
              (30,674
              )
              
              
              (118,878
              )Total
      stockholders’ equity
              
              
              32,110,166
              
              
              
              42,529,386Total
      liabilities and stockholders’ equity
              
              $
              362,429,757
              
              
              $
              372,857,060
 
  See
      the accompanying notes to condensed consolidated financial
      statements.
 2
 Table of Contents
  NETWORK COMMUNICATIONS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
  
  
  Three
      Periods EndedDecember
      6, 2009
              
              
              December
      7, 2008Sales
              
              $
              33,738,158
              
              
              $
              43,476,382Cost
      of sales (exclusive of production depreciation and software amortization
      expense shown separately below)
              
              
              22,683,382
              
              
              
              30,270,543Production
      depreciation and software amortization
              
              
              1,455,058
              
              
              
              1,198,280Gross
      profit
              
              
              9,599,718
              
              
              
              12,007,559Selling,
      general and administrative expenses (exclusive of nonproduction
      depreciation and software amortization expense shown separately
      below)
              
              
              5,094,381
              
              
              
              4,704,072Nonproduction
      depreciation and software amortization
              
              
              511,236
              
              
              
              421,017Amortization
      of intangibles
              
              
              3,479,078
              
              
              
              3,984,276Impairment
      loss
              
              
              —
              
              
              
              85,352,000Operating
      income (loss)
              
              
              515,023
              
              
              
              (82,453,806
              )Other
      income (expense)Interest
      and dividend income
              
              
              1,437
              
              
              
              59,592Interest
      expense
              
              
              (6,457,645
              )
              
              
              (6,811,533
              )Other
      income
              
              
              2,452
              
              
              
              22,890Total
      other expense
              
              
              (6,453,756
              )
              
              
              (6,729,051
              )Loss
      before benefit from income taxes
              
              
              (5,938,733
              )
              
              
              (89,182,857
              )Income
      tax benefit
              
              
              (2,094,806
              )
              
              
              (8,413,650
              )Net
      loss
              
              $
              (3,843,927
              )
              
              $
              (80,769,207
              )
 
  See
      the accompanying notes to condensed consolidated financial
      statements.
 3
 Table of Contents
  NETWORK COMMUNICATIONS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
  
  
  Nine
      Periods EndedDecember
      6, 2009
              
              
              December
      7, 2008Sales
              
              $
              105,159,067
              
              
              $
              138,672,873Cost
      of sales (exclusive of production depreciation and software amortization
      expense shown separately below)
              
              
              71,072,621
              
              
              
              94,478,853Production
      depreciation and software amortization
              
              
              4,052,938
              
              
              
              3,572,914Gross
      profit
              
              
              30,033,508
              
              
              
              40,621,106Selling,
      general and administrative expenses (exclusive of nonproduction
      depreciation and software amortization expense shown separately
      below)
              
              
              14,550,430
              
              
              
              15,206,813Nonproduction
      depreciation and software amortization
              
              
              1,424,005
              
              
              
              1,255,348Amortization
      of intangibles
              
              
              10,538,189
              
              
              
              12,011,616Impairment
      loss
              
              
              —
              
              
              
              85,352,000Operating
      income (loss)
              
              
              3,520,884
              
              
              
              (73,204,671
              )Other
      income (expense)Interest
      and dividend income
              
              
              13,454
              
              
              
              147,602Interest
      expense
              
              
              (19,731,641
              )
              
              
              (20,180,802
              )Other
      income
              
              
              21,959
              
              
              
              87,707Total
      other expense
              
              
              (19,696,228
              )
              
              
              (19,945,493
              )Loss
      before benefit from income taxes
              
              
              (16,175,344
              )
              
              
              (93,150,164
              )Income
      tax benefit
              
              
              (5,667,920
              )
              
              
              (9,697,886
              )Net
      loss
              
              $
              (10,507,424
              )
              
              $
              (83,452,278
              )
 
 
 
  See
      the accompanying notes to condensed consolidated financial
      statements.
 4
 Table of Contents
  NETWORK COMMUNICATIONS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
  
 
 
 
 Common Stock
                  Shares                                  
       Amount
              
              
              Additional
                  Paid-In
                  Capital
              
              
              Accumulated
                  Deficit
              
              
              Accumulated
                Other
                Comprehensive
                (Loss)
      Income, net of tax
              
              
              TotalBalance
      at March 29, 2009
              
              
              100
              
              
              $
              —
              
              
              $
              194,579,776
              
              
              $
              (151,931,512
              )
              
              $
              (118,878
              )
              
              $
              42,529,386Comprehensive
      loss:Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (10,507,424
              )
              
              
              —
              
              
              
              (10,507,424
              )Foreign
      currency translation adjustments, net of tax
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              88,204
              
              
              
              88,204Comprehensive
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (10,419,220
              )Balance
      at December 6, 2009
              
              
              100
              
              
              $
              —
              
              
              $
              194,579,776
              
              
              $
              (162,438,936
              )
              
              $
              (30,674
              )
              
              $
              32,110,166
 
  See
      the accompanying notes to condensed consolidated financial
      statements.
 5
 Table of Contents
  NETWORK COMMUNICATIONS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 Nine
      Periods EndedDecember
      6, 2009
              
              
              December
      7, 2008Cash
      flows from operating activitiesNet
      loss
              
              $
              (10,507,424
              )
              
              $
              (83,452,278
              )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Deferred
      income taxes
              
              
              (1,922,793
              )
              
              
              (10,839,587
              )Depreciation
      and amortization
              
              
              17,464,939
              
              
              
              18,100,632Impairment
      loss
              
              
              —
              
              
              
              85,352,000Other
      non-cash adjustments
              
              
              3,398,282
              
              
              
              3,024,538Changes
      in operating assets and liabilities, net of acquired
      businesses
              
              
              (7,388,755
              )
              
              
              (8,062,843
              )Net
      cash provided by operating activities
              
              
              1,044,249
              
              
              
              4,122,462Cash
      flows from investing activitiesPurchase
      of property, equipment and computer software
              
              
              (3,932,107
              )
              
              
              (4,257,648
              )Payments
      for businesses acquired, net of cash
              
              
              (63,220
              )
              
              
              (1,336,499
              )Net
      cash used in investing activities
              
              
              (3,995,327
              )
              
              
              (5,594,147
              )Cash
      flows from financing activitiesProceeds
      from revolving facility
              
              
              12,000,000
              
              
              
              4,000,000Payments
      on revolving facility
              
              
              (6,000,000
              )
              
              
              —Payments
      on term loan facility
              
              
              (2,159,351
              )
              
              
              (5,535,200
              )Payments
      on capital leases
              
              
              (270,280
              )
              
              
              (324,561
              )Payments
      of debt issuance costs
              
              
              (160,737
              )
              
              
              —Net
      cash provided by (used in) financing activities
              
              
              3,409,632
              
              
              
              (1,859,761
              )Net
      increase (decrease) in cash
              
              
              458,554
              
              
              
              (3,331,446
              )Cash
      at beginning of fiscal year
              
              
              2,584,740
              
              
              
              6,715,837Cash
      at end of period
              
              $
              3,043,294
              
              
              $
              3,384,391Supplemental
      disclosurePayments
      for businesses acquired:Fair
      value of assets acquired
              
              $
              —
              
              
              $
              —Less
      liabilities assumed
              
              
              —
              
              
              
              —Total
      purchase price
              
              
              —
              
              
              
              —Deferred
      purchase price
              
              
              63,220
              
              
              
              1,336,499Cash
      paid for acquired businesses
              
              $
              63,220
              
              
              $
              1,336,499Noncash
      investing and financing activitiesAssets
      acquired through capital lease
              
              $
              44,426
              
              
              $
              101,189
 
 
 
  See
      the accompanying notes to condensed consolidated financial
      statements.
 6
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  
  1.
              Organization
      and Basis of Presentation
  Network Communications, Inc. (“NCI’’),
and its wholly-owned subsidiaries, NCID, LLC and other entities and Network
Publications Canada, Inc. (“NCI-Canada’’) (collectively “the Company’’) has its
principal management, administrative and production facilities in Lawrenceville,
GA.  The Company is a publisher, producing The Real Estate Book
(“TREB”), which is distributed in over 375 markets, the District of
Columbia, Puerto Rico, Virgin Islands, and Canada.  It also produces
the Apartment Finder, New Home
Finder, Mature Living Choices, Unique Homes Magazine, Black’s Guide, Kansas City
Homes and Gardens, New
England Home, Home by Design, Homes and Lifestyles
magazines,regional home
improvement magazines, and other publications.  The Company also
provides its customers the opportunity to purchase related marketing services,
such as custom publishing and direct mail marketing.  Revenue is
primarily generated from advertising displayed in the Company’s print
publications and online versions of such publications.  The combined
online and print distribution provide a unique advantage in reaching real estate
and home design consumers.  Advertisers may also purchase enhanced
print or online listings for an additional fee.  Each market is
operated either by an Independent Distributor (“ID”) assigned a particular
market or by the Company.  NCI is a wholly-owned subsidiary of
Gallarus Media Holdings, Inc. (“GMH’’), and effective January 7, 2005, a
wholly-owned subsidiary of our ultimate parent, GMH Holding Company
(“GMHC’’).  On January 7, 2005, the majority of GMHC stock was
acquired by Citigroup Venture Capital Equity Partners, L.P. and its affiliated
funds (“CVC Fund”).  As a result of their stock acquisition of GMHC,
CVC Fund owns approximately 71% of GMHC’s outstanding capital
stock.  By virtue of their stock ownership, CVC Fund has significant
influence over our management and will be able to determine the outcome of all
matters required to be submitted to the stockholders for
approval.  CVC subsequently spun off from its former owner, Citigroup,
and the new entity was renamed Court Square Capital Partners (“Court
Square”).
  2.
              Summary
      of Significant Accounting Policies
  Basis
of Presentation
  The
accompanying financial statements represent the condensed consolidated
statements of the Company and its wholly-owned subsidiaries.  The
Company reports on a 52-53 week accounting year which ends on the last Sunday of
March of that year and includes 13 four-week periods.  Fiscal quarters
1, 2 and 3 each include 12 weeks; fiscal quarter 4 includes 16 or 17
weeks.  The accompanying condensed consolidated financial statements
include the financial statements of the Company for the three periods and nine
periods ended December 6, 2009 and the three periods and nine periods ended
December 7, 2008.  All significant intercompany balances and
transactions have been eliminated in consolidation.
  The
year-end condensed consolidated balance sheet data was derived from audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of
America.
  The
accompanying interim condensed consolidated financial statements for the three
periods and nine periods ended December 6, 2009 and the three periods and nine
periods ended December 7, 2008 are unaudited.  Certain information and
note disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America for financial information have been condensed or omitted pursuant to the
rules and regulations of Article 10 of SEC Regulation S-X.  In the
opinion of management, these condensed consolidated financial statements contain
all adjustments, consisting of normal recurring adjustments, necessary to state
fairly the financial position, results of operations and cash flows for the
periods indicated.  Operating results for the three periods and nine
periods ended December 6, 2009 are not necessarily indicative of results that
may be expected for any other future interim period or for the fiscal year
ending March 28, 2010.  You should read the unaudited condensed
consolidated financial statements in conjunction with the Company’s consolidated
financial statements and accompanying notes included in its Annual Report on
Form 10-K for the fiscal year ended March 29, 2009 filed with the SEC
on June 19, 2009.
   7
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  Fair
Value of Financial Instruments
 
 The fair
values of the Company’s financial assets and liabilities at December 6, 2009 and
March 29, 2009, equal the carrying values reported on the consolidated balance
sheets except for the new senior secured term loan facility entered into on July
20, 2007 (the “new term loan facility”), the10 3⁄4% senior notes (“senior
notes”) and the senior subordinated note. The fair values of the new term loan
facility and senior notes are based on quoted market values. The fair value of
the new term loan facility was $45.9 million and $42.4 million as compared to
the carrying values of $68.6 million and $70.7 million as of December 6, 2009
and March 29, 2009, respectively. The fair value of the senior notes was $70.2
million and $24.7 million as compared to the carrying amounts of
$175.0 million and $175.0 million as of December 6, 2009 and
March 29, 2009, respectively.  The senior subordinated note
does not trade in a market so the fair value is based on appropriate valuation
methodologies including option model and liquidation analyses.  The
fair value of the senior subordinated note was $6.0 million and $6.0 million as
compared to the carrying amounts of $44.3 million and $40.9 million as of
December 6, 2009 and March 29, 2009, respectively.
 
 Derivative
Instruments
 
 The
Company has adopted the authoritative guidance for derivative instruments and
hedging activities which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. This guidance requires the
recognition of all derivative instruments as either assets or liabilities in the
balance sheet measured at fair value. The changes in fair value of derivative
instruments are recognized as gains or losses in the period of change. The
guidance, which was effective for the Company in the fourth quarter of fiscal
year 2009, requires enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged items
are accounted for, and (c) how derivative instruments and related hedged items
affect an entity's financial position, financial performance, and cash
flows.
 
 Occasionally,
the Company enters into foreign currency forward contracts whereby the Company
agrees to sell on a certain date Canadian Dollars in exchange of US Dollars at a
pre-determined foreign exchange rate. The Company has not elected to use hedge
accounting to record these contracts. The Company executes the contract on or
prior to the expiry date and the related gain or loss is recorded in its
statement of operations under the selling, general and administrative expenses
during the period the contract is executed. The Company uses these contracts to
minimize the foreign currency fluctuation risk resulting from activities of its
subsidiary, NCI-Canada. At December 6, 2009, the Company had four forward
contracts outstanding consisting of CAD $0.20 million, CAD $0.30 million, CAD
$0.45 million and CAD $0.45 million expiring on December 31, 2009, March 1,
2010, June 1, 2010, and September 1, 2010, respectively. At March 29, 2009, the
Company had one forward contract outstanding of CAD $0.30 million expiring on
July 1, 2009.  In addition, the Company recorded a loss of US $0.08
million versus a gain of US $0.03 million related to foreign currency forward
contracts executed during the nine periods ending December 6, 2009 and December
7, 2008, respectively in its statements of operations for the periods indicated
under the selling, general and administrative expenses line.
 
 Subsequent
events
 
 In the
first quarter of fiscal year 2010, the Company adopted the provisions of the
authoritative guidance for subsequent events, which require entities to
disclose the date through which subsequent events have been evaluated, as well
as whether that date is the date the financial statements were issued or the
date the financial statements were available to be issued. Accordingly, the
Company evaluated, for potential recognition and disclosure, events that
occurred prior to the filing of the Company’s Quarterly Report on Form 10-Q for
the quarterly period ended December 6, 2009 through January 15, 2010, the date
the financial statements were issued.
  8
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  
 Recent
Accounting Pronouncements
 
 In April
2009, the Financial Accounting Standards Board (“FASB”) issued a staff position
which increases the frequency of the disclosures related to the fair value of
financial instruments required by public entities to a quarterly basis rather
than just annually. The quarterly disclosures are intended to provide financial
statement users with more timely information about the effects of current market
conditions on an entity’s financial instruments that are not otherwise reported
at fair value.  The staff position is effective for interim and annual
periods ending after June 15, 2009, with early adoption permitted in certain
circumstances for periods ending after March 15, 2009. The Company adopted the
staff position in the first quarter of fiscal year 2010 and the adoption had no
impact on its financial position, results of operations, or cash
flows.
 
 In April
2008, the FASB issued a staff position which amended the factors an entity
should consider in developing renewal or extension assumptions used in
determining the useful life of recognized intangible assets under the
authoritative guidance for goodwill and other intangible assets. The new
guidance applies prospectively to intangible assets that are acquired
individually or with a group of other assets in business combinations and asset
acquisitions and is effective for financial statements issued for fiscal years
and interim periods beginning after December 15, 2008.  The Company
adopted the staff position in the first quarter of fiscal year 2010 and the
adoption had no material impact on its financial position, results of
operations, or cash flows.
 
 In
December 2007, the FASB issued the authoritative guidance for
noncontrolling interests in consolidated financial statements.  The
guidance establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. It also
clarifies that a noncontrolling interest in a subsidiary is an ownership
interest in the consolidated entity that should be reported as equity in the
consolidated financial statements.  The guidance is effective for
fiscal years beginning on or after December 15, 2008 and as such, the
Company adopted this standard in the first quarter of fiscal year 2010 and the
adoption had no impact on its financial position, results of operations, or cash
flows.
 
 In
December 2007, the FASB issued the authoritative guidance for business
combinations which changed significantly the accounting for business
combinations in a number of areas including the treatment of contingent
consideration, contingencies, acquisition costs, IPR&D and restructuring
costs. In addition, under the guidance, changes in deferred tax asset valuation
allowances and acquired income tax uncertainties in a business combination after
the measurement period will impact income taxes.  The guidance is
effective for fiscal years beginning after December 15, 2008 and, as such,
the Company adopted this standard in the first quarter of fiscal year 2010. The
provisions are effective for the Company for business combinations on or after
March 30, 2009.
 
 In
September 2006, the FASB issued the authoritative guidance for fair value
measurements which defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements. The guidance emphasizes that fair
value is a market-based measurement, not an entity-specific measurement, and
states that a fair value measurement should be determined based on the
assumptions that market participants would use in pricing the asset or
liability.  The guidance applies under other accounting pronouncements
that require or permit fair value measurements.
 
 The
guidance, among other things, requires companies to maximize the use of
observable inputs and minimize the use of unobservable inputs when measuring
fair value, and specifies a hierarchy of valuation techniques based on whether
the inputs to those valuation techniques are observable or unobservable.
Observable inputs reflect market data obtained from independent sources, while
unobservable inputs reflect the company’s market assumptions. The effective date
is for fiscal years beginning after November 15, 2007.
  The fair
value measurement guidance establishes a three-tiered hierarchy to prioritize
inputs used to measure fair value. Those tiers are defined as
follows:
  -
              Level
      1 inputs are quoted prices (unadjusted) in active markets for identical
      assets or liabilities that the reporting entity has the ability to access
      at the measurement date.
  9
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
   -
              Level
      2 inputs are inputs, other than quoted prices included within Level 1,
      that are observable for the asset or liability, either directly or
      indirectly. If the asset or liability has a specified (contractual) term,
      a Level 2 input must be observable for substantially the full term of the
      asset or liability.
  -
              Level
      3 inputs are unobservable inputs for the asset or
    liability.
 
 The
highest priority in measuring assets and liabilities at fair value is placed on
the use of Level 1 inputs, while the lowest priority is placed on the use of
Level 3 inputs.
 
  This
guidance also expands the related disclosure requirements in an effort to
provide greater transparency around fair value measures.
 
 At March
31, 2008, the Company adopted the guidance, and the adoption had no material
impact on the Company’s financial position, results of operations, or cash
flows.
 
 In
February 2008, the FASB amended the guidance to delay its effective date to
fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years, for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually).  The Company
adopted the amendment in the first quarter of fiscal year 2010 and the adoption
had no material impact on its financial position, results of operations or cash
flows.
 
 3.
              Inventories
  At
December 6, 2009 and March 29, 2009, inventories consisted of the
following:
 
 December
      6, 2009
              
              
              March
      29, 2009Distribution
      products and marketing aids for resale
              
              $
              280,257
              
              
              $
              274,683Production,
      paper and ink
              
              
              1,249,859
              
              
              
              2,057,004Work-in-process
              
              
              432,560
              
              
              
              518,230Total
              
              $
              1,962,676
              
              
              $
              2,849,917
 
  4.
              Acquisitions
  Generally,
whenever an acquisition is completed, the Company pays a premium over the fair
value of the net tangible and identified intangible assets acquired to fulfill
the Company’s strategic initiatives and to ensure strategic fit with its current
publications.  The majority of the Company’s transactions are asset
based in which the Company acquires the publishing assets associated with the
products purchased that fit its predetermined criteria as an expansion of the
Company’s geographical footprint, addition to market share in certain areas or
complementary services to its existing customers.  The Company
evaluates each asset purchased on an individual basis for fit with its
organization based on the historical performance of the asset along with the
Company’s expectations for growth.  The strength of each criteria and
the expected return on investment are evaluated in developing the purchase
price.
  Allocation
of Purchase Price
  The
application of purchase accounting under the authoritative guidance for business
combinations requires that the total purchase price be allocated to the fair
value of assets acquired and liabilities assumed based on their fair values at
the acquisition date.  The allocation process requires an analysis of
acquired contracts, customer relationships, contractual commitments and legal
contingencies to identify and record the fair value of all assets acquired and
liabilities assumed.  In valuing acquired assets and assumed
liabilities, fair values are based on, but not limited to: future expected cash
flows; current replacement cost for similar capacity for certain fixed assets;
market rate assumptions for contractual obligations; settlement plans for
litigation and contingencies; and appropriate discount rates and growth
rates.  Goodwill represents the excess of the purchase price over the
fair value of the net assets of the acquired business.  Goodwill,
which is tax deductible, resulting from the acquisitions is assigned to the
Company’s one business segment.  The Company adopted the guidance in
the first quarter of fiscal year 2010 and will apply the provisions on
acquisitions completed in the future.
   10
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  On
September 30, 2009, the Company paid $0.06 million for earn-outs related to the
acquisition of the publishing assets of DGP Apartment Publications of Louisiana
completed on August 30, 2007.  The earn-out payment was charged to
goodwill and shown under supplemental disclosure in the consolidated statements
of cash flows for the nine periods ended December 6, 2009.  In
addition, the Company did not complete any acquisitions in the third quarter
ended December 6, 2009.
  On May 1,
2009, the Company acquired the publishing assets of The Real Estate Book in the
Mid-Atlantic region for which consideration did not involve cash.  The
total purchase price was $0.4 million of which $0.2 million was recorded to
goodwill.
  On July
29, 2008, the Company paid $1.3 million for earn-outs related to the New England Home acquisition
completed on March 28, 2007.  The earn-out payment was charged to
goodwill and shown under supplemental disclosure in the consolidated statements
of cash flows for the nine periods ended December 7, 2008.
  5.
              Goodwill
  The total
amounts of goodwill on the Company’s books at December 6, 2009 and March 29,
2009 were $188.8 million and $188.5 million,
respectively.
 
 December
      6, 2009
              
              
              March
      29, 2009Gross
      cost of goodwill, beginning of fiscal year
              
              $
              308,053,546
              
              
              $
              306,518,991Additions
              
              
              295,161
              
              
              
              1,534,555Total
      gross cost of goodwill, end of period
              
              
              308,348,707
              
              
              
              308,053,546Accumulated
      impairment losses
              
              
              (119,522,033
              )
              
              
              (119,522,033
              )Balance,
      end of period
              
              $
              188,826,674
              
              
              $
              188,531,513
 
 As a
result of continued declines in the Company’s consolidated operating income
during the first, second and third quarters of fiscal year 2009 in the Company’s
only reportable segment, the publishing segment, in addition to the fair market
value during that period of its outstanding debt, the Company determined that it
had a triggering event under the authoritative guidance for goodwill and
performed, as of December 7, 2008, an assessment of goodwill for impairment
on all of the Company’s reporting units using the discounted cash flow approach.
The discounted cash flow approach was the same approach used in fiscal year
2008. The discount rate was adjusted from 11.7% in the analysis performed in
fiscal year 2008 to 12.5% in the third quarter of fiscal year 2009 analysis.
These assumptions were based on the economic environment and credit market
conditions during the fiscal year 2009. The Company’s reporting units are the
Resale and New Sales unit, the Rental and Leasing unit and the Remodeling and
Home Improvement unit.
 
 Based on
the results of the Company’s assessment of goodwill for impairment, it was
determined that the carrying values of the Resale and New Sales unit and the
Remodeling and Home Improvement unit exceeded their estimated fair
value. As a result, the Company initiated step two of the analysis for the
Resale and New Sales and the Remodeling and Home Improvement units. Also, the
Company determined that the carrying value of the Rental and Leasing unit did
not exceed its estimated fair value. As a result, no further testing was
required and no impairment of goodwill was identified for the Rental and Leasing
unit. As of December 7, 2008, the carrying amounts of goodwill associated
with the Resale and New Sales unit, the Rental and Leasing unit and the
Remodeling and Home Improvement unit were $194.6 million,
$94.5 million and $18.7 million, respectively. The second step was not
completed in the third quarter of fiscal year 2009 and as a result, the Company
recorded an estimated noncash impairment charge based on a preliminary
assessment in the amount of $85.4 million in the Company’s statements of
operations for the three periods and nine periods ended December 7, 2008.
The amounts of the estimated recorded impairment charges for the Resale and New
Sales unit and the Remodeling and Home Improvement unit were $74.0 million
and $11.4 million, respectively. Step two was completed in the fourth
quarter of fiscal year 2009 and resulted in an additional $34.1 million recorded
in the fourth quarter of fiscal year 2009. The impairment loss related primarily
to the deteriorating global economic conditions and the downturn in the resale
and new home markets. A change in the economic conditions or other circumstances
influencing the estimate of future cash flows or fair value could result in
future impairment charges of goodwill or intangible assets with indefinite
lives.
   11
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  As of
December 7, 2008, the Company had one intangible asset with an indefinite
life. The Company determined that this asset which is a trademark was not
impaired as of December 7, 2008.
  The
Company does not believe that a triggering event has occurred during the nine
periods ended December 6, 2009.
 
 6.
              Comprehensive
      Loss
  Comprehensive
loss includes reported net loss, and foreign currency translation adjustments,
net of tax. The following table shows NCI’s comprehensive loss for the three
periods and nine periods ended December 6, 2009 and December 7,
2008:
 
 Three
      Periods Ended
              
              
              Nine
      Periods Ended(Dollars
      in thousands)
              
              December 6, 2009
              
              
              December 7, 2008
              
              
              December 6, 2009
              
              
              December 7, 2008Net
      loss
              
              $
              (3,844
              )
              
              $
              (80,769
              )
              
              $
              (10,507
              )
              
              $
              (83,452
              )Foreign
      currency translation adjustments, net of tax
              
              
              8
              
              
              
              (129
              )
              
              
              88
              
              
              
              (150
              )Comprehensive
      loss
              
              $
              (3,836
              )
              
              $
              (80,898
              )
              
              $
              (10,419
              )
              
              $
              (83,602
              )
 
 7.
              Income
      Taxes
  The
following table sets forth the income tax benefit and effective tax rate for the
three periods and nine periods ended December 6, 2009 and December 7,
2008:
 
 Three
      Periods Ended
              
              
              Nine
      Periods Ended(Dollars
      in thousands)
              
              December 6, 2009
              
              
              December 7, 2008
              
              
              December 6, 2009
              
              
              December 7, 2008Income
      tax benefit
              
              $
              (2,095
              )
              
              $
              (8,414
              )
              
              $
              (5,668
              )
              
              $
              (9,698
              )Effective
      tax rate
              
              
              35.3
              %
              
              
              9.4
              %
              
              
              35.0
              %
              
              
              10.4
              %
 
  Income
tax benefit consists of current and deferred income taxes.  The
difference in effective income tax rates is due primarily to the impact of
nondeductible expenses relative to the level of net loss before taxes between
the two periods partially offset by the noncash goodwill impairment charge,
which was recorded in the third quarter of fiscal year 2009 pursuant to the
Company’s performance of step one of the goodwill assessment for impairment as a
result of the continued declines in the Company’s consolidated operating income
during the first three quarters of fiscal year 2009.  Also, the
Company has nondeductible expenses related to meals and entertainment and
certain interest expenses related to its senior subordinated
debt.  The Company is subject to taxation in the United States of
America (for federal and state) and Canada.
  8.
              Long-term
      Debt
  At
December 6, 2009 and March 29, 2009, long-term debt consisted of the
following:
  December
      6, 2009
              
              
              March
      29, 200910
      3⁄4% Senior Notes, due December 1, 2013
              
              $
              175,000,000
              
              
              $
              175,000,000New
      Senior Term loan facility, due November 30, 2012
              
              
              68,558,172
              
              
              
              70,717,523New
      Revolving loan facility, due November 30, 2010
              
              
              6,000,000
              
              
              
              —Senior
      Subordinated Note, due June 30, 2013
              
              
              44,335,488
              
              
              
              40,937,992Total
      long-term debt
              
              
              293,893,660
              
              
              
              286,655,515Less:Unamortized
      discount on Senior Notes and SeniorSubordinated
      Note
              
              
              (1,365,912
              )
              
              
              (1,611,231
              )Current
      maturities
              
              
              (6,766,359
              )
              
              
              (2,350,941
              )Long-term
      debt, less current maturities
              
              $
              285,761,389
              
              
              $
              282,693,343
  12
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  For a
discussion of certain of our debt characteristics, see “Note 13. Long-term
Debt”of
the Notes to Consolidated Financial Statements section of the Company’s Annual
Report on Form 10-K for the fiscal year ended March 29, 2009. Other
than the items noted below, there have been no significant developments since
March 29, 2009.
 
 New
Senior Credit Facility
 
 On July
20, 2007, the Company entered into a new term loan facility for an aggregate
principal amount of $76.6 million (“the new term loan facility”) and a senior
secured revolving loan facility (the “new revolving loan facility”) for an
amount up to $35.0 million (the new term loan facility together with the new
revolving loan facility; the “new credit facility”). The proceeds of the new
credit facility were used to repay all amounts outstanding under the Company’s
prior credit facility (dated as of November 30, 2005) and fund acquisitions
during the Company’s third quarter of fiscal year 2008. In connection with the
new credit facility, the Company recorded $0.5 million of deferred charges
during the third quarter of fiscal year 2008 for transaction fees and other
related debt issuance costs.  Additionally, approximately $3.7 million
of debt issuance costs associated with the extinguishment of the existing term
loan facility were written off and charged to interest expense during the third
quarter of fiscal year 2008.
 
 On June
10, 2008, the Company amended the new revolving loan facility dated July 20,
2007.  The amendment adjusted the interest coverage ratios over the
term of the new revolving loan facility.
 
 On
December 4, 2008, the Company amended the new revolving loan facility dated July
20, 2007.  The amendment adjusted the amount payable to employees and
other individuals in connection with the repurchase of equity interests held by
such individuals or upon the termination of employment of an individual in
connection with the repurchase of stock appreciation rights or other similar
interests, adjusted the interest coverage ratio and the senior secured leverage
ratio and eliminated the Company’s ability to carry forward any unused permitted
investments in respect of unrestricted subsidiaries.
 
 On May 4,
2009, the Company amended the new revolving loan facility dated
July 20, 2007 (the “amended revolving loan facility”). The amendment
restated the applicable percentage as defined in the revolving credit agreement,
increased the commitment fee from 0.50% to 0.75%, decreased the revolving credit
commitment from $35.0 million to $15.0 million, decreased the
permitted annual capital expenditures from $10.0 million to $6.0 million, and
adjusted the interest coverage ratio and the senior secured coverage ratio on
the revolving facility. In connection with the amendment, the Company wrote off
$0.2 million for debt issuance costs associated with the prior revolving
facility dated July 20, 2007 and recorded $0.2 million for debt issuance costs
associated with the new amended facility in the first quarter of fiscal year
2010.
 
 Under the
new credit facility, the Company has the option to borrow funds at an interest
rate equal to the London Interbank Offered Rate (“LIBOR”) plus a margin or at
the lender’s base rate (which approximates the Prime rate) plus a margin.
Interest rates under the new term loan facility are base rate plus a margin of
1.00% or LIBOR plus a margin of 2.00%. Interest rates under the new revolving
loan facility are base rate plus a margin ranging from 2.50% to 1.75% or LIBOR
plus a margin ranging from 3.50% to 2.75%. The applicable margin payable on the
amended revolving loan facility is subject to adjustments based upon a
leverage-based pricing grid.  The new credit facility requires the
Company to meet maximum leverage ratios and minimum interest coverage ratios and
includes a maximum annual capital expenditures limitation.  In
addition, the new credit facility contains certain restrictive covenants which,
among other things, limit our ability to incur additional indebtedness, pay
dividends, incur liens, prepay subordinated debt, make loans and investments,
merge or consolidate, sell assets, change our business, amend the terms of our
subordinated debt and engage in certain other activities customarily restricted
in such agreements.  It also contains certain customary events of
defaults, subject to grace periods, as appropriate.
 The new
revolving facility contains a cross default provision to other indebtedness in
excess of $5.0 million whereby payment defaults on such other indebtedness
result in cross default under the new revolving facility.  Covenant
defaults under such other indebtedness do not result in a cross default under
the new revolving facility until expiration of any relevant grace periods as set
forth under such other indebtedness.
  13
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  The new
term loan facility contains a cross default provision to other indebtedness in
excess of $7.5 million whereby payment defaults or covenant defaults on such
other indebtedness are, subject to certain exceptions, cure periods and grace
periods as set forth in the new term loan facility agreement.
 
 The new
credit facility is collateralized by substantially all of the assets of NCI and
its subsidiaries. In addition, NCI’s subsidiaries are joint and several
guarantors of the obligations. The new credit facility loan agreements contain
certain restrictive provisions which include, but are not limited to, requiring
the Company to maintain certain financial ratios and limits upon the Company’s
ability to incur additional indebtedness, make certain acquisitions or
investments, sell assets or make other restricted payments, including dividends
(as defined in the new term loan credit facility agreement).
 
 The
Company’s new credit facility contains a subjective acceleration clause in which
certain events of default, as detailed in the new credit facility agreement,
will result in acceleration of the call date of the new credit facility.
Management reviews these events on a regular basis and believes that the Company
currently has not triggered any of these events.
 
 As of
December 6, 2009, under the most restrictive covenants as defined in the new
revolving loan facility, the Company was required to maintain a minimum interest
coverage ratio, as defined in the amended revolving loan facility agreement, of
1.10 to 1.00.  The maximum allowable senior secured debt leverage
ratio, as defined in the amended revolving loan agreement, is 3.00 to
1.00.  As of December 6, 2009, the Company was in compliance with all
of the financial covenants of its amended revolving loan facility
agreement.
 
 The
Company had $68.6 million outstanding under the new term loan facility with
no availability to borrow at December 6, 2009.  Also, as of the fiscal
quarter end, the Company had an outstanding balance of $6.0 million under the
amended revolving loan facility as a result of the withdrawal of that amount
during the current quarterly period, with $9.0 million available to borrow,
subject to the Company maintaining compliance with the facility
covenants.  The interest rate at December 6, 2009 for the amended
revolving loan facility was at a rate of base plus 2.50% and/or LIBOR plus
3.50%. The effective interest rate on the balances outstanding under the new
term loan facility was 2.83% at December 6, 2009.
 
 The final
repayment of any outstanding amounts under the amended revolving loan facility
is due November 30, 2010, and as such, the outstanding balance of the
revolving loan facility was included in the current maturities of long-term debt
at December 6, 2009.  The new term loan facility commenced
amortization in quarterly installments of $0.192 million beginning
December 31, 2007 through September 30, 2012. The final settlement of any
outstanding amounts under the new term loan facility is due November 30,
2012.
 
 Under the
new credit facility, the Company may obtain additional funding through
incremental loan commitments in an amount not to exceed $75.0 million
provided that the Company remains in compliance with its financial covenants on
a pro forma basis. As of December 6, 2009, there were no borrowings against the
incremental loan facility.
 
 In
addition to providing fixed principal payment schedules for the new credit
facility, the loan agreement also includes an Excess Cash Flow Repayment
Provision that requires repayment of principal based on the Company’s leverage
ratio, EBITDA, working capital, debt service and tax payments. The excess cash
flow amount is calculated and paid annually with the repayment of principal
allocated on a pro rata basis to the new term and revolving loan
facilities.  The Company is also required to pay an annual commitment
fee equal to 0.75% of the unused portion of the revolving credit
facility.
 
 On June
29, 2009, the Company made a payment of approximately $1.6 million under the
Excess Cash Flow Repayment Provision of the new term loan facility based on the
fiscal year ended March 29, 2009 financial results.  Accordingly, the
payment was included in the current maturities of long-term debt at March 29,
2009.
   14
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  9.
              Commitments
      and Contingencies
  Operating
Leases
  The
Company is obligated under noncancellable operating leases and leases for office
space which expire at various dates through 2015.  Certain of the
leases require additional payments for real estate taxes, water and common
maintenance costs.
  Employment
Agreements
  Two
senior executives of the Company have employment agreements which terminate in
December 2014.  Pursuant to the agreements, the executives are
entitled to annual base salaries and annual bonuses based on the Company’s
EBITDA for each year.  These agreements also provide for severance
payments equal to two years’ base salary and benefits upon termination of
employment by the Company without cause.
  Other
 
 The
Company is involved in various claims and lawsuits which arise in the normal
course of its business. Management does not believe that any of these actions
will have a material adverse effect on the Company's financial position, results
of operations, or cash flows.
 
 10.
              Related
      Party Transactions
  In
December 2004, the Company entered into a 10-year advisory agreement with CVC
Management LLC (“CVC”), an affiliate of CVC Fund, now known as Court Square
Capital Partners (“Court Square”), whereby the Company pays an annual advisory
fee to Court Square.  The advisory fee is equal to the greater of
$0.21 million or 0.016% of the prior fiscal year consolidated
revenue.  On July 31, 2006, Court Square Advisor, LLC, was assigned
the right to receive the fees payable by the Company pursuant to the advisory
agreement between CVC Management LLC, and NCI.  Under this agreement,
the Company made no payments during the nine periods ended December 6, 2009 and
paid $0.05 million in the nine periods ended December 7,
2008.  The Company accrued $0.36 million and $0.21 million
for management fees as of December 6, 2009 and March 29, 2009,
respectively.  Court Square Advisor suspended collection of all
advisory fees effective September 2008.  The Company continues to
accrue the advisory fees.
  In
addition, during the quarterly period ended December 6, 2009, the Company made a
payment of $0.1 million to Court Square, to reimburse them for payments made to
a third party consulting firm on behalf of the Company for a one-time sourcing
project.
  The
Company has retained TMG Public Relations (“TMG”) to perform public relations
and marketing services on its behalf on a project-by-project
basis.  TMG is owned by the spouse of Daniel McCarthy, NCI’s Chairman
and Chief Executive Officer.  The Company made payments to TMG of
$0.20 million and $0.15 million during the nine periods ended December
6, 2009 and December 7, 2008, respectively.  The Company
accrued $0.03 million and $0.02 million for services rendered as of
December 6, 2009 and March 29, 2009,
respectively.  The Company expects to continue to use the services of
TMG during the remainder of fiscal year 2010.
  Effective
July 31, 2007, the Company entered into an agreement with L&S Graphics,
which is a digital printing company owned by Brandon Lee, one of the Company’s
employees who performed the role of the general manager of By Design. The
Company agreed to utilize L&S Graphics for all digitally printed materials
related to the “By Design” products. L&S Graphics was later renamed “Digital
Lizard”.  Brandon Lee was hired on a two-year employment contract with
an expiration date of July 31, 2009.  As a result, effective that
date, Brandon Lee is no longer an employee of the Company and Digital Lizard
ceased to be a related party and L&S Graphics related party financial
information for the current fiscal year is only presented for the six periods
ended September 13, 2009.  Under this agreement, the Company made
payments of $0.68 million during the six periods ended
September 13, 2009 and $1.4 million during the nine periods ended
December 7, 2008 and accrued for $0.04 million as of
March 29, 2009.  Transactions with L&S Graphics
subsequent to the second quarter of fiscal year 2010 are no longer considered
related party transactions and are not disclosed in this
report.
  Effective
July 31, 2007, the Company entered into an office lease agreement with
MB&K, LLC which is owned by Brandon Lee, one of the Company’s employees who
performed the role of the general manager of By Design.  Brandon Lee
was hired on a two-year employment contract with an expiration date of July 31,
2009.  As a result, effective that date, Brandon Lee is no longer an
employee of the Company and MB&K, LLC ceased to be a related party and
MB&K LLC related party financial information for the current fiscal year is
only presented for the six periods ended September 13, 2009.  Under
this agreement, the Company made payments of $0.07 million during the six
periods ended September 13, 2009 and $0.09 million during the nine periods ended
December 7, 2008, and recorded no accruals as of March 29, 2009, as the Company
had met all its financial obligations under this
agreement.  Transactions with MB&K, LLC subsequent to the second
quarter of fiscal year 2010 are no longer considered related party transactions
and are not disclosed in this report.
 
  15
 Table of Contents
 NETWORK COMMUNICATIONS, INC. AND SUBSIDIARIES
 PART I
–FINANCIAL INFORMATION
 
 Item
2.   Management’s Discussion and Analysis of Financial Condition
and Results of Operations
  Cautionary
Statement Regarding Forward-Looking Information
  The
following Management’s Discussion and Analysis of our Financial Condition and
Results of Operations should be read in conjunction with the condensed
consolidated financial statements and notes thereto included as part of this
Quarterly Report on Form 10-Q. This report contains forward-looking statements
that are based upon current expectations. We sometimes identify forward-looking
statements with such words as “may”, “will”, “expect”, “anticipate”, “estimate”,
“seek”, “intend”, “believe” or similar words concerning future events. The
forward-looking statements contained herein, include, without limitation,
statements concerning future revenue sources and concentration, gross profit
margins, selling, general and administrative expenses, capital resources,
additional financings or borrowings and the effects of general industry and
economic conditions; and are subject to risks and uncertainties including, but
not limited to, those discussed below and elsewhere in this Quarterly Report on
Form 10-Q that could cause actual results to differ materially from the results
contemplated by these forward-looking statements. We also urge you to carefully
review the risk factors set forth in other documents we file from time to time
with the SEC.
  Overview
of Operations
  We are a
Georgia corporation that was formed in 1980.  The following discussion
and analysis is based upon our unaudited interim condensed consolidated
financial statements and our review of our business and
operations.  Furthermore, we believe the discussion and analysis of
our financial condition, results of operations, and cash flows as set forth
below are not indicative nor should they be relied upon as an indicator of our
future performance.  The following discussion includes a comparison of
our results of operations for the three periods ended December 6, 2009 to the
three periods ended December 7, 2008 and the nine periods ended December 6, 2009
to the nine periods ended December 7, 2008.
  We have
13 four-week reporting periods in each fiscal year.  Our fiscal year
refers to the 52-53 week accounting year ended on the last Sunday of March of
that year.  The first, second and third quarters each contain 3
periods, or 12 weeks each, and the fourth quarter contains 4 periods, or 16
weeks.  In the 53-week accounting year, the fourth quarter contains 17
weeks.
  We are
one of the largest and most diversified publishers of information for the local
real estate market in North America.  Through our extensive
proprietary network of online and print distribution points, we provide critical
local information to consumers involved in buying, leasing and renovating a
home.  Our reader base selects our print and online publications
almost exclusively for the extensive advertisements, and, as a result, we are
able to provide high quality leads at an effective cost to our advertisers,
which are comprised of real estate agents, property management companies, new
home builders and home renovation product and service providers.  In
fiscal year 2009, we believe that we generated over ten million leads for our
advertisers.  We operate in over 550 targeted markets which may
overlap geographically across the U.S. and Canada.  The predominant
content in our publications is advertisements, and our two largest publications
are 100% advertisement based.  In the resale and new sales home
market, our flagship brand, The Real Estate Book
(“TREB”), is the largest real estate advertising publication in North
America.  In the rental and leasing market, we provide residential and
commercial leasing listings, primarily through Apartment Finder and Black’s Guide.  In
the home design and home improvement market, we are the largest publisher of
local and regional design magazines for the luxury market, including Kansas City Homes &
Gardens, Atlanta Homes
& Lifestyles, Colorado Homes & Lifestyles,
Mountain Living and New
England Home.
   16
 Table of Contents
  We
distribute our printed publications through an extensive rack distribution
network, comprised of  high traffic locations in areas frequented by
our target consumers.  In addition, we maintain more than 30,000
uniquely shaped proprietary sidewalk distribution boxes.  For those
products targeting affluent consumers and businesses, we utilize sophisticated
database management and customer acquisition tools in order to develop highly
targeted direct mail distribution.  We also distribute all of our
content — including our database of more than 1.8 million homes and apartments —
online to our advertisers.  We maintain a proprietary online network
which has over two million unique visitors each month.  In addition,
we distribute our content to over twenty online distribution partners, including
Trulia and BobVila.com with a monthly reach of over 47 million online
users.  We believe our combined online and print distribution network,
which is provided to advertisers at one all-inclusive cost, drives exceptional
results for our advertisers.
  We have
two marketing channels through which we generate revenue, the Independent
Distributor (“ID”) channel and the Direct channel.  In our ID channel,
the independent distributor is responsible for selling the advertising,
collecting listings from agents/brokers and distributing publications in a
specific geographic market.  In our Direct channel, we sell the
advertising, collect the listings from the agents/brokers and create, print and
distribute the publications.
  As of
December 6, 2009, we had 803 employees, 387 of which were located at our
corporate headquarters and production facility in Lawrenceville, Georgia, a
suburb of Atlanta.
  We
believe the key drivers of financial performance are:
  ·
              advertising
      volume;
  ·
              expansion
      into other local real estate
markets;
  ·
              strong
      brand recognition; and
  ·
              per
      unit cost to produce our
publications.
  Business
Trends
 
 Real
estate market conditions continue to change. Our management team focuses on
several key indicators – annual sales volume of existing homes and the months of
supply of unsold homes; the market tightness index compiled by the National
Multi Housing Council; the Remodeling Market Index compiled by the National
Association of Home Builders; interest rates and consumer
confidence.
 
 ·
              Sales volume of existing homes
      and months of supply of unsold homes – Indicators for the resale
      home market continued to show a positive trend line in the September 2009
      to November 2009 timeframe.  Existing home sales experienced
      monthly sequential gains in September, October and November
      2009.  The annualized rate of sales in November 2009 was 6.5
      million units which was up 44% from November 2008.  The median
      home price in November 2009 was $172,600, a decrease of 4.3% from the
      prior year.  The November home price was also down from the
      August 2009 median home price of $177,300.  Home sales continued
      to skew toward the lower priced segment of the market, assisted by a surge
      of first-time home buyers taking advantage of the government sponsored tax
      credit prior to its original November 30 deadline.  First-time
      buyers accounted for more than 50% of November home
      transactions.  Distressed properties, defined as either short
      sales or foreclosed sales, remained a factor as they made up 33% of sales
      in November.  The total inventory of unsold existing homes in
      November 2009 stood at 3.6 million units or 6.5 months of inventory based
      on the current sales pace.  This compares favorably to November
      2008 when the number of unsold homes was 4.2 million or 11.0 months of
      inventory.  New home sales showed weakness during the September
      to November timeframe.  November new home sales were 355,000, a
      decline of 11.3% and 13.2% compared to October 2009 and November 2008,
      respectively.  Total inventory of new homes in November was
      235,000, which represented a 7.9 month supply at the current sales
      pace.
  17
 Table of Contents
  
 ·
              The Market Tightness Index– The National Multi Housing Council’s (“NMHC”) market tightness
      index in October 2009 was 31, an improvement compared to the August 2009
      reading of 20.  A reading below 50 indicates that markets are
      experiencing lower occupancy rates and lower rental rates.  The
      national vacancy rates in the third quarter of 2009 for investment-grade
      apartments was 7.9%, a slight improvement to the 8.1% rating in the second
      quarter of 2009 but still up from 6.2% in the prior year.  Same
      store rents for professionally managed apartments declined by 4.6%,
      surpassing last quarter’s record decline of 3.4%.  Multifamily
      construction continued to fall with permits and starts down compared to
      prior year by 65.6% and 67.0%, respectively.  The permits and
      starts statistics in the third quarter were the lowest on
      record.  Apartment transaction volume in the 2009 third quarter
      of $3.6 billion was up 12.1% from the second quarter but still down 64.2%
      compared to the third quarter of 2008.  The average price for
      properties sold in the third quarter of 2009 was $78,709 per unit, down
      9.7% from the second quarter of 2009 and 30.5% from the prior
      year.  Multifamily housing trends have historically been
      correlated to the employment market and job growth.  The
      increase in vacancy rates and the drop in rents are being driven by the
      high rate of unemployment.
 
 ·
              The Remodeling Market
      Index (“RMI”) - The RMI rose
      to 39.8 in the third quarter of 2009 from a 38.1 reading in the second
      quarter of 2009.  This signaled the third straight quarter of
      improvement in the index, however the index needs to register a reading of
      over 50 to signal that the majority of remodelers view market conditions
      as improving.  Overall market conditions remain weak, however
      remodelers did report that conditions in their markets are
      stabilizing.  Mortgage interest rates during the third quarter
      of 2009 remained at favorable levels, however the main challenges as they
      relate to home remodeling business levels continue to be the availability
      of credit and the shrinking amount of home equity resulting from lower
      home prices.
  Fair
Value of Financial Instruments
 
 The fair
values of our financial assets and liabilities at December 6, 2009 and March 29,
2009, equal the carrying values reported on the consolidated balance sheets
except for the new senior secured term loan facility entered into on July 20,
2007 (the “new term loan facility”), the10 3⁄4% senior notes (“senior notes”)
and the senior subordinated note. The fair values of the new term loan facility
and senior notes are based on quoted market values. The fair value of the new
term loan facility was $45.9 million and $42.4 million as compared to the
carrying values of $68.6 million and $70.7 million as of December 6, 2009 and
March 29, 2009, respectively. The fair value of the senior notes was $70.2
million and $24.7 million as compared to the carrying amounts of
$175.0 million and $175.0 million as of December 6, 2009 and
March 29, 2009, respectively.  The senior subordinated note
does not trade in a market so the fair value is based on appropriate valuation
methodologies including option model and liquidation analyses.  The
fair value of the senior subordinated note was $6.0 million and $6.0 million as
compared to the carrying amounts of $44.3 million and $40.9 million as of
December 6, 2009 and March 29, 2009, respectively.
  Revenue
  Our
principal revenue earning activity is related to the sale of online and print
advertising by both ID as well as direct sales to customers through
Company-managed distribution territories.  Independent Distributors
are contracted to manage certain distribution territories on behalf of
NCI.  We maintain ownership of all magazines and distribution
territories.  Prepaid subscriptions are recorded as unearned revenue
when received and recognized as revenue over the term of the
subscription.
  Costs
  Operating
expenses include cost of sales; depreciation and amortization; and selling,
general and administrative expenses (“SG&A”).  Cost of sales
include all costs associated with our Georgia production facility, our
outsourced printing, which are the costs we pay to third party printers to print
books not printed in our Georgia production facility, our field sales
operations, field distribution operations, online operations and bad debt
expense.  SG&A expenses include all corporate departments,
corporate headquarters, and the management of the publications.
   18
 Table of Contents
  Our
operating expense base consists of almost 75% fixed costs.  These
expenses relate to our production facility in Georgia, our national distribution
network and our sales management infrastructure.  The remaining 25% of
operating expenses are variable and relate to paper, ink, sales commissions,
performance-based bonuses, bad debt expense and third party production
expenses.  Costs related to our workforce are the largest single
expense item, accounting for almost 38% of our total operating expense
base.  The second largest expense item, which accounts for
approximately 18% of our total operating expense base, is the cost associated
with producing our publications.
  Depreciation
and Amortization
  Depreciation
costs of computer, equipment and software relate primarily to the depreciation
of our computer hardware and software developed for internal use or purchased,
as well as property, plant and equipment.  The depreciation and
amortization of equipment and software associated with production is shown
separately from our cost of sales in our statements of
operations.  The amounts of depreciation and amortization expense
related to production equipment and software for the nine periods ended December
6, 2009 and December 7, 2008 were $4.1 million and $3.6 million,
respectively.  Depreciation and amortization expense related to
nonproduction equipment and software is shown separately from the selling,
general and administrative expenses in our statements of
operations.  The amounts of depreciation and amortization expense
related to nonproduction equipment and software for the nine periods ended
December 6, 2009 and December 7, 2008 were $1.4 million and $1.3 million,
respectively.  Depreciation for computer, equipment and software as
well as property, plant and equipment is calculated on a straight-line basis
over the expected useful life of the related asset class.  Leasehold
improvements and leased assets are amortized over the shorter of their estimated
useful lives or lease terms.
  Amortization
costs relate to the amortization of intangible assets.  Our two
largest intangible assets are our independent distributor agreements and
trademarks/trade names.  The valuation and lives of our larger
intangible assets (trademarks, trade names, independent distributors and
advertiser lists) were determined by identifying the remaining useful life of
the components of each asset combined with a reasonable attrition rate and a
reasonable expectation for increase in revenue by each
component.  Certain markets experience a lower attrition
rate.  This has contributed to intangible assets with lives in excess
of 15 years.  The related amortization is calculated on a
straight-line basis over the expected useful life of the intangible
asset.
  Interest
Income and Interest Expense
  Interest
income consists primarily of interest income earned on our cash balances and
interest earned on notes receivable.  Interest expense consists
primarily of interest on outstanding indebtedness, interest on capital leases,
amortization of deferred financing costs and amortization of debt
discounts.
  Income
Taxes
  The
following table sets forth the income tax benefit and effective tax rate for the
three periods and nine periods ended December 6, 2009 and December 7,
2008:
 
 Three
      Periods Ended
              
              
              Nine
      Periods Ended(Dollars
      in thousands)
              
              December 6, 2009
              
              
              December 7, 2008
              
              
              December 6, 2009
              
              
              December 7, 2008Income
      tax benefit
              
              $
              (2,095
              )
              
              $
              (8,414
              )
              
              $
              (5,668
              )
              
              $
              (9,698
              )Effective
      tax rate
              
              
              35.3
              %
              
              
              9.4
              %
              
              
              35.0
              %
              
              
              10.4
              %
 
 Income
tax benefit consists of current and deferred income taxes.  The
difference in effective income tax rates is due primarily to the impact of
nondeductible expenses relative to the level of net loss before taxes between
the two periods partially offset by the noncash goodwill impairment charge which
was recorded in the third quarter of fiscal year 2009 pursuant to the
performance of step one of the goodwill assessment for impairment as a result of
the continued declines in our consolidated operating income during the first
three quarters of fiscal year 2009. Also we have nondeductible expenses related
to meals and entertainment and certain interest expenses related to our senior
subordinated debt.  We are subject to taxation in the United States of
America (for federal and state) and Canada.
   19
 Table of Contents
  Results
of Operations
  The
following table sets forth a summary of our operations and percentages of total
consolidated revenue and operating income for the three periods and nine periods
ended December 6, 2009 and December 7, 2008.  Our three revenue areas
are:  (i) resale and new sales; (ii) rental and leasing; and (iii)
remodeling and home improvement.  The resale and new sales area
includes The Real Estate
Book (“TREB”),
New Home Finder, Unique Homes,andHome by
Design.  Our rental and leasing area includes Apartment Finder, Mature Living Choices, and
Black’s
Guide.  Our remodeling and home improvement area includes all
of our home and design and home improvement publications.
 
 Three
      Periods Ended
              
              
              Nine
      Periods EndedDecember
      6, 2009
              
              
              December
      7, 2008
              
              
              December
      6, 2009
              
              
              December
      7, 2008(Dollars in
      thousands)
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %
              
              
              Amount
              
              
              %Resale
      and new sales
              
              $
              11,680
              
              
              
              34.6
              %
              
              $
              18,474
              
              
              
              42.5
              %
              
              $
              36,134
              
              
              
              34.4
              %
              
              $
              60,862
              
              
              
              43.9
              %Rental
      and leasing
              
              
              19,070
              
              
              
              56.5
              %
              
              
              19,528
              
              
              
              44.9
              %
              
              
              57,506
              
              
              
              54.7
              %
              
              
              58,478
              
              
              
              42.2
              %Remodeling
      and home improvement
              
              
              2,988
              
              
              
              8.9
              %
              
              
              5,474
              
              
              
              12.6
              %
              
              
              11,519
              
              
              
              10.9
              %
              
              
              19,333
              
              
              
              13.9
              %Total
      revenue
              
              
              33,738
              
              
              
              100.0
              %
              
              
              43,476
              
              
              
              100.0
              %
              
              
              105,159
              
              
              
              100.0
              %
              
              
              138,673
              
              
              
              100.0
              %Costs
      and expenses:Cost
      of sales (including production depreciation and software
      amortization)
              
              
              24,138
              
              
              
              71.6
              %
              
              
              31,469
              
              
              
              72.4
              %
              
              
              75,126
              
              
              
              71.4
              %
              
              
              98,052
              
              
              
              70.7
              %Selling,
      general and administrative (including nonproduction depreciation and
      software amortization)
              
              
              5,606
              
              
              
              16.6
              %
              
              
              5,125
              
              
              
              11.8
              %
              
              
              15,974
              
              
              
              15.2
              %
              
              
              16,462
              
              
              
              11.9
              %Amortization
      of intangibles
              
              
              3,479
              
              
              
              10.3
              %
              
              
              3,984
              
              
              
              9.2
              %
              
              
              10,538
              
              
              
              10.0
              %
              
              
              12,012
              
              
              
              8.7
              %Impairment
      loss
              
              
              —
              
              
              
              —
              %
              
              
              85,352
              
              
              
              196.3
              %
              
              
              —
              
              
              
              —
              %
              
              
              85,352
              
              
              
              61.5
              %Income
      (loss) from operations
              
              $
              515
              
              
              
              1.5
              %
              
              $
              (82,454
              )
              
              
              (189.7
              )%
              
              $
              3,521
              
              
              
              3.4
              %
              
              $
              (73,205
              )
              
              
              (52.8
              )%
 
 
 Three
Periods Ended December 6, 2009 Compared to Three Periods Ended December 7,
2008
  Revenue.  For the
three periods ended December 6, 2009, total consolidated revenue was $33.7
million compared to $43.5 million for the three periods ended December 7,
2008.  This was a decrease of $9.8 million or 22.5%.  Our
resale and new sales area declined by $6.8 million or 36.8% from $18.5 million
in the three periods ended December 7, 2008 to $11.7 million in
the three periods ended December 6, 2009. Our rental and leasing showed a
year-over-year revenue decline of $0.4 million or 2.1% from $19.5 million in the
three periods ended December 7, 2008 to $19.1 million in the
three periods ended December 6, 2009.  Our remodeling and home improvement
area decreased by $2.5 million or 45.5% from $5.5 million in the three
periods ended December 7, 2008 to $3.0 million in the three
periods ended December 6, 2009.  The revenue declines in the resale
and new sales area and the remodeling and home improvement areas were due to the
weak economic conditions in the real estate market. The revenue decline in the
rental and leasing area was mainly attributable to the decline in the ad page
volume for Black’s
Guide and Mature Living
Choices as a result of the slowdowns in the commercial real estate and
new home markets, respectively.
 
  20
 Table of Contents
  TREB posted revenue of $8.0
million in the third quarter of fiscal year 2010 compared to $11.9 million
during the same period in fiscal year 2009 which was a decrease of $3.9 million,
or 32.8%.  The TREB ID sales channel had
revenue of $5.5 million in the third quarter of fiscal year 2010 compared to
$8.3 million during the same period of fiscal year 2009, a decrease of $2.8
million or 33.7%.  The decline was related to continued softness in
the real estate market and some market consolidations.  The TREB Direct sales channel had
a revenue decrease of $1.1 million or 30.6% from $3.6 million in the third
quarter of fiscal year 2009 to $2.5 million during the same period of fiscal
year 2010.  Unique
Homes had revenue of $0.9 million in the third quarter of fiscal year
2010 compared to $1.4 million in the same period of fiscal year 2009, a decrease
of $0.5 million or 35.7%  The decrease correlates with the decline in
the turnover of luxury home sales.
  Apartment Finder revenue for
the three periods ended December 6, 2009 was $18.5 million flat compared to the
three periods ended December 7, 2008.  Despite the challenges in the
multi-family industry, we have been able to maintain our customer counts of our
Apartment Finder
brand.  Black’s
Guide revenue decreased by $0.4 million or 57.1% from $0.7 million in the
third quarter of fiscal year 2009 to $0.3 million during the same period of
fiscal year 2010 due to the contraction in the commercial real estate
market.
  Our
remodeling and home improvement area produced revenue of $3.0 million in the
three periods ended December 6, 2009 compared to $5.5 million during the three
periods ended December 7, 2008, a decrease of $2.5 million or
45.5%.  The decrease was the result of advertisers reducing their
marketing expenditures in response to the continued weak conditions in the job
market, falling home prices and reduced availability of consumer
credit.  Our publications in this area include: Kansas City Homes & Gardens, At
Home in Arkansas, New England Home, Relocating in St. Louis,regional
Home Improvement magazines, and the Homes & Lifestyles
magazines.
  Cost of
sales.  Cost of sales for the three periods ended December 6,
2009 was $22.7 million, a decrease of $7.6 million, or 25.1%, from $30.3 million
during the three periods ended December 7, 2008.  The expense of labor
and related expenses, which is our largest cost component, was $10.2 million in
the three periods ended December 6, 2009 compared to $12.8 million during the
three periods ended December 7, 2008, a decrease of $2.6 million, or
20.3%.  The decrease reflects a reduction in
headcount.  Total commission and bonus expense decreased by $0.5
million or 20.0% from $2.5 million in the third quarter of fiscal year 2009 to
$2.0 million during the same period of fiscal year 2010 due to our revenue
decline.  Paper expense decreased by $1.3 million or 34.2%, from $3.8
million in the three periods ended December 7, 2008 to $2.5 million in the three
periods ended December 6, 2009.  The decrease was related to lower ad
page volume and more favorable paper prices.  Our outsource production
expense for the current quarter was $1.2 million, a decrease of $0.7 million or
36.8% from the third quarter of fiscal year 2009 expense of $1.9
million.  The decrease in outsource production expense was
attributable to bringing outsourced books back in-house and the decrease in our
revenue.  Distribution expense decreased in the current fiscal quarter
by approximately $0.8 million or 33.3% compared to the same period in the prior
year primarily due to reduced spend with third party distribution companies and
re-negotiated rates on our retail distribution contracts.  The expense
of our E-business and online operations decreased by $0.5 million or 35.7% from
$1.4 million in the third quarter of fiscal year 2009 to $0.9 million in the
current quarter.  We were able to achieve savings by restructuring our
operations while continuing to invest in online distribution.
 Production depreciation and software
amortization expense.  Production depreciation and software
amortization expense in the three periods ended December 6, 2009 and December 7,
2008 was $1.5 million and $1.2 million, respectively, which was an increase of
$0.3 million or 25.0%.  The increase was the result of equipment and
software purchased during the prior four fiscal quarters partially offset by
software assets being fully depreciated during the same period.
  Gross Profit.Our gross
profit decreased by $2.4 million or 20.0% from $12.0 million in the third
quarter of fiscal year 2009 to $9.6 million in the third quarter of fiscal year
2010. The decrease was mainly related to the decline in revenues of $9.8 million
in the current quarter compared to the same period of the prior year partially
offset by a decrease in the cost of sales of $7.6 million in addition to the
increase of production depreciation and software amortization expense of $0.3
million. The gross profit percentage for the current quarter was 28.5% compared
to 27.6% in the same period of the prior year. The increase was mainly
attributable to the continued monitoring programs of our costs and
expenses.
   21
 Table of Contents
  Selling, general and administrative
expenses (“SG&A”).  SG&A expenses for the three periods
ended December 6, 2009 were $5.1 million, which was an increase of $0.4 million
or 8.5% compared to $4.7 million in the three periods ended December 7,
2008.  Labor and related expenses in the three periods ended December
6, 2009 were $2.4 million, an increase of $0.1 million, or 4.3%, from $2.3
million during the same period in fiscal year 2009.
  Nonproduction depreciation and
software amortization expense.Nonproduction depreciation and
software amortization expense increased by $0.1 million or 25.0% from $0.4
million in the third quarter of fiscal year 2009 to $0.5 million in the same
period of fiscal year 2010.  The increase was the result of equipment
and software purchased during the prior four fiscal quarters partially offset by
software assets being fully depreciated during the same period.
  Amortization of
intangibles.  Amortization expense was $3.5 million in the
three periods ended December 6, 2009, compared to $4.0 million for the three
periods ended December 7, 2008, a decrease of $0.5 million or
12.5%.  The decrease was related to intangible assets being fully
depreciated during the prior four fiscal quarters.
  Impairment loss. As of
December 7, 2008, we performed an assessment of goodwill for impairment under
the authoritative guidance for goodwill. We completed step one of the analysis
which resulted in a potential impairment of goodwill for the Resale and New
Sales unit and the Remodeling and Home Improvement unit. Therefore, we recorded
a noncash estimated impairment loss in the amount of $85.4 million in the three
periods ended December 7, 2008. Step two was completed in the fourth quarter of
fiscal year 2009 and resulted in an additional $34.1 million recorded in the
fourth quarter of fiscal year 2009.
  Net interest
expense.  Net interest expense for the three periods ended
December 6, 2009 was $6.5 million compared to the net interest expense of $6.8
million during the three periods ended December 7, 2008.  The decrease
of $0.3 million or 4.4% was related to lower interest rates on our new senior
term loan facility in addition to a lower senior term loan balance partially
offset by the write off of deferred financing fees in connection with the
amendment of May 4, 2009 of the new revolving loan agreement, and a higher
balance on our senior subordinated note.
  Net loss.  Due to
the factors described above, we reported a net loss of $3.8 million during the
three periods ended December 6, 2009, compared to a net loss of $80.8 million
during the three periods ended December 7, 2008. The significant change in our
operating results for the quarter of the prior fiscal year compared to the
current quarter was related to the noncash estimated impairment loss of
$85.4 million that was recorded in the third quarter of fiscal year 2009,
pursuant to our conducting step one of the analysis of goodwill for impairment
as of December 7, 2008.
  Nine
Periods Ended December 6, 2009 Compared to Nine Periods Ended December 7,
2008
  Revenue.  For the
nine periods ended December 6, 2009, total consolidated revenue was
$105.2 million compared to $138.7 million for the nine periods ended
December 7, 2008.  This was a decrease of $33.5 million or
24.2%. Our resale and new sales area declined by $24.8 million or 40.7%
from $60.9 million in the nine periods ended December 7, 2008 to $36.1
million in the nine periods ended December 6, 2009. Our rental
and leasing area showed a year-over-year revenue decrease of $1.0 million or
1.7% from $58.5 million in the nine periods ended December 7, 2008 to
$57.5 million in the nine periods ended December 6, 2009.
 Our remodeling and home improvement area decreased by $7.8 million or
40.4% from $19.3 million in the nine periods ended
December 7, 2008 to $11.5 million in the nine periods ended December
6, 2009.  The revenue declines in the resale and new sales area and
the remodeling and home improvement areas were due to the weak economic
conditions in the real estate market. The decline in revenue in the rental and
leasing area was mainly attributable to the decline in the ad page volume for
Black’s Guide and Mature Living Choices as a
result of the slowdowns in the commercial real estate and new home markets,
respectively.
   22
 Table of Contents
  TREB posted revenue of $26.1
million in the nine periods ended December 6, 2009 compared to $42.4 million
during the nine periods ended December 7, 2008 which was a decrease of $16.3
million or 38.4%.  The decline was attributable to the slowdown in the
real estate market.  The TREB ID sales channel had
revenue of $17.9 million in the nine periods ended December 6, 2009 compared to
$29.2 million during the nine periods ended December 7, 2008, a decrease of
$11.3 million or 38.7%.  The decline was related to continued softness
in the real estate market and some market consolidations.  The TREB Direct sales channel had
a revenue decrease of $5.1 million or 38.6% from $13.2 million in the nine
periods ended December 7, 2008 to $8.1 million during the nine periods ended
December 6, 2009.  Unique Homes had revenue of
$3.0 million in the nine periods ended December 6, 2009 compared to $4.2 million
in the nine periods ended December 7, 2008, a decrease of $1.2 million or
28.6%.  The decrease correlates with the decline in the turnover of
luxury home sales.
  Apartment Finder revenue for
the nine periods ended December 6, 2009 was $55.6 million compared to $55.1
million during the nine periods ended December 7, 2008, an increase of $0.5
million or 0.9%.  Despite the challenges in the multifamily industry,
we have been able to maintain our customer counts of our Apartment Finder
brand.  Black’s
Guide revenue decreased by $1.0 million or 45.5% from $2.2 million in the
nine periods ended December 7, 2008 to $1.2 million during the nine periods
ended December 6, 2009 due to the contraction in the commercial real estate
market.
  Our
remodeling and home improvement area produced revenue of $11.5 million in the
nine periods ended December 6, 2009 compared to $19.3 million during the nine
periods ended December 7, 2008, a decrease of $7.8 million or
40.4%.  The decrease was the result of advertisers reducing their
marketing expenditures in response to the continued weak conditions in the job
market, falling home prices and reduced availability of consumer
credit.  Our publications in this area include: Kansas City Homes & Gardens, At
Home in Arkansas, New England Home, Relocating in St. Louis,regional
Home Improvement magazines, and the Homes & Lifestyles
magazines.
  Cost of
sales.  Cost of sales for the nine periods ended December 6,
2009 was $71.1 million, a decrease of $23.4 million, or 24.8%, from $94.5
million during the nine periods ended December 7, 2008.  The expense
of labor and related expenses, which is our largest cost component, was $31.2
million in the nine periods ended December 6, 2009 compared to $40.4 million
during the nine periods ended December 7, 2008, a decrease of $9.2 million, or
22.8%.  The decrease reflects a reduction in
headcount.  Total commission and bonus expense decreased by $1.9
million or 23.8% from $8.0 million in the nine periods ended December 7, 2008 to
$6.1 million during the nine periods ended December 6, 2009 due to our revenue
decline.  Paper expense decreased by $3.6 million or 29.8%, from $12.1
million in the nine periods ended December 7, 2008 to $8.5 million in the nine
periods ended December 6, 2009.  The decrease was related to lower ad
page volumes and more favorable paper prices.  Our outsource
production expense for the nine periods ended December 6, 2009 was $3.9 million,
a decrease of $1.9 million or 32.8% from the nine periods ended December 7, 2008
expense of $5.8 million as a result of bringing outsourced books back in-house
and lower page volume.  Distribution expense decreased in the nine
periods ended December 6, 2009 by approximately $2.6 million or 32.9% compared
to the same period in the prior year as we reduced our spend with third party
distribution companies and re-negotiated rates on our retail distribution
contracts.  The expense of our E-business and online operations
decreased by $1.9 million or 39.6% from $4.8 million in the nine periods ended
December 7, 2008 to $2.9 million in the nine periods ended December 6,
2009.  We achieved savings by restructuring operations while
increasing our online distribution investment.
 Production depreciation and software
amortization expense.  Production depreciation and software
amortization expense in the nine periods ended December 6, 2009 was $4.1
million.  This was an increase of $0.5 million, or 13.9%, compared to
$3.6 million for the nine periods ended December 7, 2008.  The
increase was the result of equipment and software purchased during the prior
four fiscal quarters partially offset by software assets being fully depreciated
during the same period.
  Gross Profit.Our gross
profit decreased by $10.6 million or 26.1% from $40.6 million in the nine
periods ended December 7, 2008 to $30.0 million in the nine periods ended
December 6, 2009.  The decrease was mainly related to the decline in
revenues of $33.5 million in the nine periods ended December 6, 2009 compared to
the same period of the prior year partially offset by a decrease in the cost of
sales of $23.4 million in addition to the increase of production depreciation
and software amortization expense of $0.5 million. The gross profit percentage
for the nine periods ended December 6, 2009 was 28.6% compared to 29.3% in the
same period of the prior year. The decrease was mainly attributable to lower
revenues and the fact that some of our cost of sales expenses are
fixed.
   23
 Table of Contents
  Selling, general and
administrative expenses.  SG&A expenses for the nine
periods ended December 6, 2009 were $14.6 million compared to $15.2 million for
the nine periods ended December 7, 2008, which was a decrease of $0.6 million or
3.9%.  Labor and related expenses in the nine periods ended December
6, 2009 was $7.4 million, a decrease of $0.3 million, or 3.9%, from $7.7 million
during the same period in fiscal year 2009.  The decrease reflects a
reduction in headcount.
  Nonproduction depreciation and
software amortization expense.Nonproduction depreciation and
software amortization expense increased by $0.1 million or 7.7% from $1.3
million in the nine periods ended December 7, 2008 to $1.4 million in the nine
periods ended December 6, 2009.  The increase was the result of
equipment and software purchased during the prior four fiscal quarters partially
offset by software assets being fully depreciated during the same
period.
  Amortization of
intangibles.  Amortization expense was $10.5 million in the
nine periods ended December 6, 2009, compared to $12.0 million for the nine
periods ended December 7, 2008, a decrease of $1.5 million or
12.5%.  The decrease in amortization expense was related to intangible
assets being fully depreciated during the prior four fiscal
quarters.
  Impairment loss. As of
December 7, 2008, we performed an assessment of goodwill for impairment under
the authoritative guidance for goodwill. We completed step one of the analysis
which resulted in a potential impairment of goodwill for the Resale and New
Sales unit and the Remodeling and Home Improvement unit. Therefore, we recorded
a noncash estimated impairment loss in the amount of $85.4 million in the third
quarter ended December 7, 2008. Step two was completed in the fourth quarter of
fiscal year 2009 and resulted in an additional $34.1 million recorded in the
fourth quarter of fiscal year 2009.
  Net interest
expense.  Net interest expense for the nine periods ended
December 6, 2009 was $19.7 million,  compared to $20.0 million in the
nine periods ended December 7, 2008.  The decrease of $0.3 million or
1.5% reflected a lower debt balance and lower interest rates on our new senior
term loan facility partially offset by the write off of deferred financing costs
in connection with the amendment of May 4, 2009 of the new revolving agreement
and a higher balance on our senior subordinated note.
  Net loss.  Due to
the factors set forth above, we reported a net loss of $10.5 million during the
nine periods ended December 6, 2009, compared to a net loss of $83.5 million
during the nine periods ended December 7, 2008.  The significant
change in our operating results for the nine periods ended December 7, 2008
compared to the same period in the current fiscal year was related to the
noncash estimated impairment loss of $85.4 million that was recorded in the
third quarter of fiscal year 2009, pursuant to our conducting step one of the
analysis of goodwill for impairment as of December 7, 2008.
  Liquidity
and Capital Resources
  Historically,
our primary source of liquidity has been cash flow from
operations.  We also have the ability to incur indebtedness under our
new revolving loan facility. At December 6, 2009, our cash on hand was $3.0
million compared to $2.6 million and $3.4 million at March 29, 2009 and December
7, 2008, respectively.
  The
following table summarizes our net increase (decrease) in cash and cash
equivalents as of December 6, 2009 and December 7, 2008:
  Nine
      Periods EndedDecember
      6, 2009
              
              
              December
      7, 2008(Dollars
      in thousands)Net
      cash provided by operating activities
              
              $
              1,044
              
              
              $
              4,122Net
      cash used in investing activities
              
              
              (3,995
              )
              
              
              (5,594
              )Net
      cash provided by (used in) financing activities
              
              
              3,410
              
              
              
              (1,860
              )Net
      increase (decrease) in cash
              
              
              459
              
              
              
              (3,332
              )Cash
      at beginning of fiscal year
              
              
              2,585
              
              
              
              6,716Cash
      at end of period
              
              $
              3,044
              
              
              $
              3,384
 
   24
 Table of Contents
  Our net
cash provided by operating activities in the nine periods ended December 6, 2009
was $1.0 million compared to $4.1 million in the nine periods ended December 7,
2008, a decrease of $3.1 million. The decrease was due to the decline in our
operating income.
  During
the nine periods ended December 6, 2009, net cash used in investing activities
was $4.0 million, mainly spent on the purchase of property, equipment and
software.  During the nine periods ended December 7, 2008, net cash
used in investing activities was $5.6 million consisting of $4.3 million for the
purchase of property, equipment and software, and $1.3 million for earn-out
payments related to acquisitions completed in fiscal year 2008.
  For the
nine periods ended December 6, 2009, the net cash provided by financing
activities was $3.4 million versus a use of $1.9 million for the nine periods
ended December 7, 2008.  The cash provided in the nine periods ended
December 6, 2009 was a result of the $6.0 million drawn on our new revolving
loan facility in the third quarter of fiscal year 2010 partially offset by a
payment of $1.6 million related to the excess cash flow payment made on our new
term loan facility in the second quarter of fiscal year 2010, scheduled
installments on our new term loan facility and payments for capital leases and
debt issuance costs.  The cash used in the nine periods ended December
7, 2008 was mainly related to the excess cash flow payment of $5.0 million made
on our new term loan facility in the second quarter of fiscal year 2009,
partially offset by $4.0 million drawn on the new revolving loan facility in
addition to the scheduled installments on our new term loan facility and
payments for capital leases.
  Senior
Notes and Credit Agreement
  We intend
to fund ongoing operations through cash generated by operations and borrowings
under our revolving loan facility.  On November 30, 2005, we
refinanced our capital structure. The objective of the refinancing was to
provide us with a long-term capital structure that was consistent with our
strategy and to preserve acquisition flexibility. The refinancing was completed
through an offering of $175.0 million of Senior Notes and a senior secured
credit facility.
 
 The
Senior Notes will mature in December 2013.  Interest is payable
semi-annually.  The notes will be redeemable in the circumstances and
at the redemption prices described in the Senior Notes indenture.  The
indenture governing the notes also contains numerous covenants including, among
other things, restrictions on our ability to: incur or guarantee additional
indebtedness or issue disqualified or preferred stock; pay dividends or make
other equity distributions; repurchase or redeem capital stock; make investments
or other restricted payments; sell assets or consolidate or merge with or into
other companies; incur liens; enter into sale/leaseback transactions; create
limitations on the ability of our restricted subsidiaries to make dividends or
distributions to us; and engage in transactions with affiliates.
 
 New senior credit facility.On July 20, 2007, we entered into a senior secured term loan facility
(the “new term loan facility”) for an aggregate principal amount of $76.6
million and a senior secured revolving loan facility (the “new revolving loan
facility”) for an amount up to $35.0 million (the new term loan facility
together with the new revolving loan facility, the “new credit facility”). The
proceeds of the new credit facility were used to repay all amounts outstanding
under the existing credit facility (dated as of November 30, 2005) and fund
acquisitions completed during the third quarter of fiscal year
2008.  In connection with the new credit facility, the Company
recorded $0.5 million of deferred charges during the third quarter of fiscal
year 2008 for transaction fees and other related debt issuance
costs.  Additionally, approximately $3.7 million of debt issuance
costs associated with the extinguishment of the existing term loan facility were
written off and charged to interest expense during the third quarter of fiscal
year 2008.
 
 On June
10, 2008, we entered into an amendment of the new revolving loan
facility.  The amendment adjusted the interest coverage ratios over
the term of the new revolving loan facility.
 
  25
 Table of Contents
  On
December 4, 2008, we amended the new revolving loan facility dated July 20,
2007.  The amendment reduced the amount payable to employees and other
individuals in connection with the repurchase of equity interests held by such
individuals or upon the termination of employment of an individual in connection
with the repurchase of stock appreciation rights or other similar interests,
adjusted the interest coverage ratio and the senior secured leverage ratio and
eliminated our ability to carry forward any unused permitted investments in
respect of unrestricted subsidiaries.
 
 On May 4,
2009, we amended the new revolving loan facility dated July 20, 2007 (“the
amended revolving loan facility”). The amendment restated the applicable
percentage as defined in the revolving credit agreement, increased the
commitment fee from 0.50% to 0.75%, decreased the revolving credit commitment
from $35.0 million to $15.0 million, decreased the permitted annual capital
expenditures from $10.0 million to $6.0 million, and adjusted the interest
coverage ratio and the senior secured coverage ratio on the revolving facility.
In connection with the amendment, we wrote off $0.2 million for debt issuance
costs associated with the prior revolving facility dated July 20, 2007 and
recorded $0.2 million for debt issuance costs associated with the new amended
facility in the first quarter for fiscal year 2010.
 
 Our new
term loan facility matures in November 2012.  Additionally, we have
the ability to obtain up to $75.0 million under our incremental term loan
subject to compliance with our affirmative and negative
covenants.  Borrowings are also available under our amended revolving
loan facility maturing in November 2010.
  Borrowings
under our new credit facility bear interest, at our option, at either adjusted
LIBOR plus an applicable margin or the alternate base rate plus an applicable
margin.  The applicable margin with respect to borrowings under our
amended revolving loan facility is subject to adjustments based upon a
leverage-based pricing grid.  Our amended revolving credit facility
requires us to meet maximum leverage ratios and minimum interest coverage ratios
and includes a maximum annual capital expenditures limitation.  In
addition, the amended revolving credit facility contains certain restrictive
covenants which, among other things, limit our ability to incur additional
indebtedness, pay dividends, incur liens, prepay subordinated debt, make loans
and investments, merge or consolidate, sell assets, change our business, amend
the terms of our subordinated debt and engage in certain other activities
customarily restricted in such agreements.  It also contains certain
customary events of defaults, subject to grace periods, as
appropriate.  As of December 6, 2009, we were in compliance with all
debt covenant requirements. In addition to providing fixed principal payment
schedules for the new credit facility, the loan agreement also includes an
Excess Cash Flow Repayment provision that requires repayment of principal based
on the Company’s leverage ratio, EBITDA, working capital, debt service and tax
payments. The Excess Cash Flow amount is calculated and paid annually with the
repayment of principal allocated on a pro rata basis to the term and revolving
loans. Based on the Company’s financial results for the fiscal year ended March
29, 2009, we made a payment of $1.6 million on June 29, 2009 under the Excess
Cash Flow Repayment Provision of the new credit facility. Accordingly, the
liability was included in the current maturities on long-term debt as of March
29, 2009. We are also required to pay an annual commitment fee equal to 0.75% of
the unused portion of the new revolving loan facility.
  Our
ability to make scheduled payments of principal, or to pay the interest or
additional interest, if any, on, or to refinance our indebtedness, or to fund
planned capital expenditures will depend on our future performance, which, to a
certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond our
control.  Based upon the current level of operations, we believe that
cash flow from operations and available cash, together with borrowings available
under our new credit facility, will be adequate to meet our future liquidity
needs through November 29, 2010.  In addition, based on our current
forecast assumptions, we expect to be able to satisfy our debt covenants through
November 29, 2010.  Our assumptions with respect to future costs may
not be correct, and funds available to us from the sources discussed above may
not be sufficient to enable us to service our indebtedness, including the senior
notes, or cover any shortfall in funding for any unanticipated
expenses.  We may not be able to renew or refinance our new revolving
loan facility before it matures on November 30, 2010.  In addition, to
the extent we make future acquisitions, we may require new sources of funding
including additional debt, equity financing or some combination
thereof.  We may not be able to secure additional sources of funding
on favorable terms.
   26
 Table of Contents
  
 Critical
Accounting Policies and Estimates
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reflected in the condensed consolidated
financial statements and accompanying notes.  We base our estimates on
historical experience, where applicable and other assumptions that we believe
are reasonable under the circumstances. Actual results may differ from those
estimates under different assumptions or conditions.
 Principles
of Consolidation and Fiscal Year End
  We and
our consolidated entities report on a 52-53 week accounting year.  The
condensed consolidated financial statements included elsewhere in this report
include our consolidated financial statements for the three periods and nine
periods ended December 6, 2009 and December 7, 2008, respectively and the fiscal
year ended March 29, 2009.  All significant intercompany balances and
transactions have been eliminated in consolidation.
  Revenue
Recognition and Unearned Revenue
  Our
principal revenue earning activity of the Company is related to the sale of
online and print advertising.  Revenue recognition for print and
online products are consistently applied within Company-managed (Direct) and
ID-managed distribution territories as described below.  These revenue
arrangements are typically sold as a bundled product to customers and include a
print ad in a publication as well as online advertisement.  We bill
the customer a single negotiated price for both elements.  In
accordance with the authoritative guidance for accounting for revenue
arrangements with multiple deliverables, the Company separates its
deliverables into units of accounting and allocates consideration to each unit
based on relative fair values.  The Company recognizes revenue for
each unit of accounting in accordance with SEC Staff Accounting Bulletin Number
104, “Revenue
Recognition”.
  Print
  Print
revenues are derived from sale of advertising pages in our
publications.  We sell a bundled product to our customers that
includes a print advertisement as well as a standard online
advertisement.  The customer can also purchase premium placement
advertising pages such as front cover and back cover.  Revenue for
print advertisement sales, including the premium placement advertising pages, is
recognized when the publications are delivered and available for consumer
access.
  Online
  Online
revenues are derived from the sale of advertising on our various
websites.  We sell a bundled product to our customers that includes a
print advertisement in our publications as well as a standard online
advertisement.  The customer is permitted to purchase premium online
advertisements whereby it can include additional data items such as floor plans,
multiple photos and neighborhood information, and also secure premium placement
in search results.  In addition, we have started selling an online
only product to our customers.  Revenue for online sales, including
the premium online advertisements, is recognized ratably over the period the
online advertisements are maintained on the website.
  Unearned
revenue
  We have
historically billed our customers a few days before shipment. At both interim
and fiscal year end, we reverse the revenue and the pre-billings completed to
properly account for the timing differences and properly recognize revenue in
the proper period. Prepaid orders are recorded in unearned revenue if
pre-billed. Prepaid subscriptions are recorded as unearned revenue when received
and recognized as revenue over the term of the subscription.
 
 Trade
      Accounts Receivable
 Accounts
receivable consist primarily of amounts due from advertisers in our operated
markets and independent distributors.
  27
 Table of Contents
  We grant
credit without collateral to many of our customers. Substantially all trade
accounts receivable are comprised of accounts related to advertising displayed
in our various real estate publications. Management believes credit risk with
respect to those receivables is limited due to the large number of customers and
their dispersion across geographic areas, as well as the distribution of those
receivables among our various publication products.
 We use
the allowance method of reserving for accounts receivable estimated to be
uncollectible. The allowance is calculated by applying a risk factor to each
aging category.
 Customer
      Deposits
 We
receive cash deposits from customers for certain publications prior to printing
and/or upload of online advertising.  These deposits are recorded as a
liability and reflected accordingly in the condensed consolidated financial
statements.
 
 Goodwill
 As a
result of continued declines in our consolidated operating income during the
first, second and third quarters of fiscal year 2009 in our only reportable
segment, the publishing segment, in addition to the fair market value during
that period of our outstanding debt, we determined that we had a triggering
event under the authoritative guidance for goodwill and performed, as of
December 7, 2008, an assessment of goodwill for impairment on all of the
our reporting units using the discounted cash flow approach. The discounted cash
flow approach was the same approach used in fiscal year 2008. The discount rate
was adjusted from 11.7% in the analysis performed in fiscal year 2008 to 12.5%
in the third quarter of fiscal year 2009 analysis. These assumptions were based
on the economic environment and credit market conditions during the fiscal year
2009. Our reporting units are the Resale and New Sales unit, the Rental and
Leasing unit and the Remodeling and Home Improvement unit.
 
 Based on
the results of our assessment of goodwill for impairment, we determined that the
carrying values of the Resale and New Sales unit and the Remodeling and Home
Improvement unit exceeded their estimated fair value. As a result, we
initiated step two of the analysis for the Resale and New Sales and the
Remodeling and Home Improvement units. Also, we determined that the carrying
value of the Rental and Leasing unit did not exceed its estimated fair value. As
a result, no further testing was required and no impairment of goodwill was
identified for the Rental and Leasing unit. As of December 7, 2008, the
carrying amounts of goodwill associated with the Resale and New Sales unit, the
Rental and Leasing unit and the Remodeling and Home Improvement unit were
$194.6 million, $94.5 million and $18.7 million, respectively.
The second step was not completed in the third quarter of fiscal year 2009 and
as a result, we recorded an estimated noncash impairment charge based on a
preliminary assessment in the amount of $85.4 million in our statements of
operations for the three periods and nine periods ended December 7, 2008.
The amounts of the estimated recorded impairment charges for the Resale and New
Sales unit and the Remodeling and Home Improvement unit were $74.0 million
and $11.4 million, respectively. Step two was completed in the fourth
quarter of fiscal year 2009 and resulted in an additional $34.1 million recorded
in the fourth quarter of fiscal year 2009. The impairment loss related primarily
to the deteriorating global economic conditions and the downturn in the resale
and new home markets. A change in the economic conditions or other circumstances
influencing the estimate of future cash flows or fair value could result in
future impairment charges of goodwill or intangible assets with indefinite
lives.
  As of
December 7, 2008, we had one intangible asset with an indefinite life. We
determined that this asset which is a trademark was not impaired as of
December 7, 2008.
  In
addition, we did not recognize any impairment loss during the nine periods ended
December 6, 2009.
  28
 Table of Contents
  
 Impairment
      of Long-Lived Assets
 We assess
the recoverability of long-lived assets in accordance with the authoritative
guidance for accounting for the impairment or disposal of long-lived assets,
whenever adverse events or changes in circumstances indicate that impairment may
have occurred. If the future, undiscounted cash flows expected to result from
the use of the related assets are less than the carrying value of such assets,
an impairment has been incurred and a loss is recognized to reduce the carrying
value of the long-lived assets to fair value, which is determined by discounting
estimated future cash flows.  We did not recognize any impairment loss
related to long-lived assets in any of the periods presented in this
report.
 Intangible
      Assets
 Intangible
assets consist of the values assigned to consumer databases, independent
distributor agreements, advertising lists, subscriber lists, trade names,
trademarks, and other intangible assets. Amortization of intangible assets is
provided utilizing the straight-line method over the estimated useful
lives.  We have one intangible asset, which is a trademark, that has
an indefinite life.
 Recent
Accounting Pronouncements
  In May
2009, The Financial Accounting Standards Board (“FASB”) issued the authoritative
guidance for subsequent events.  This guidance
establishes general standards of accounting for and disclosures of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued.  It requires the disclosure of the date through
which an entity has evaluated subsequent events and whether that evaluation date
is the date of issuance or the date the financial statements were available to
be issued. This guidance is effective for interim and annual periods ending
after June 15, 2009 and as such, we adopted this standard in the first quarter
of fiscal year 2010 and the adoption had no impact on our financial position,
results of operations or cash flows.
 
 In April
2009, the FASB issued a staff position which increases the frequency of the
disclosures related to the fair value of financial instruments required by
public entities to a quarterly basis rather than just annually. The quarterly
disclosures are intended to provide financial statement users with more timely
information about the effects of current market conditions on an entity’s
financial instruments that are not otherwise reported at fair value. The staff
position is effective for interim and annual periods ending after June 15, 2009,
with early adoption permitted in certain circumstances for periods ending after
March 15, 2009. We adopted the staff position in the first quarter of fiscal
year 2010 and the adoption had no impact on our financial position, results of
operations, or cash flows.
 
 In April
2008, the FASB issued a staff position which amended the factors an entity
should consider in developing renewal or extension assumptions used in
determining the useful life of recognized intangible assets under the
authoritative guidance for goodwill and other intangible assets.  The
new guidance applies prospectively to intangible assets that are acquired
individually or with a group of other assets in business combinations and asset
acquisitions and is effective for financial statements issued for fiscal years
and interim periods beginning after December 15, 2008.  We adopted the
staff position in the first quarter of fiscal year 2010 and the adoption had no
material impact on our financial position, results of operations, or
cashflows.
 
 In
March 2008, the FASB issued the authoritative guidance for the disclosures
about derivative Instruments and hedging activities, which amends the disclosure
requirements for derivative instruments and hedging activities.  The
guidance provides an enhanced understanding about how and why derivative
instruments are used, how they are accounted for and their effect on an entity’s
financial position, performance and cash flows. The guidance, which is effective
for the first interim period beginning after November 15, 2008, requires
additional disclosure in future filings.  We adopted this standard in
the fourth quarter of fiscal year 2009 and the adoption did not have any
material impact on our financial position, results of operations, or cash
flows.
 
  29
 Table of Contents
  In
December 2007, the FASB issued the authoritative guidance for the
noncontrolling interests in consolidated financial statements.  The
guidance establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. It also
clarifies that a noncontrolling interest in a subsidiary is an ownership
interest in the consolidated entity that should be reported as equity in the
consolidated financial statements. The guidance is effective for fiscal years
beginning on or after December 15, 2008 and as such, we adopted this
standard in the first quarter of fiscal year 2010 and the adoption had no impact
on our financial position, results of operations, or cash flows.
 
 In
December 2007, the FASB issued the authoritative guidance for business
combinations which changed significantly the accounting for business
combinations in a number of areas including the treatment of contingent
consideration, contingencies, acquisition costs, IPR&D and restructuring
costs. In addition, under the guidance, changes in deferred tax asset valuation
allowances and acquired income tax uncertainties in a business combination after
the measurement period will impact income taxes. The guidance is effective for
fiscal years beginning after December 15, 2008 and, as such, we adopted
this standard in the first quarter of fiscal year 2010.  The
provisions are effective for us for business combinations on or after March 30,
2009.
 
 In
September 2006, the FASB issued the authoritative guidance for fair value
measurements which defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements.  The guidance emphasizes
that fair value is a market-based measurement, not an entity-specific
measurement, and states that a fair value measurement should be determined based
on the assumptions that market participants would use in pricing the asset or
liability.  The guidance applies under other accounting pronouncements
that require or permit fair value measurements.
 
 The fair
value measurement guidance, among other things, requires companies to maximize
the use of observable inputs and minimize the use of unobservable inputs when
measuring fair value, and specifies a hierarchy of valuation techniques based on
whether the inputs to those valuation techniques are observable or unobservable.
Observable inputs reflect market data obtained from independent sources, while
unobservable inputs reflect the company’s market assumptions. The effective date
is for fiscal years beginning after November 15, 2007.
  The
guidance establishes a three-tiered hierarchy to prioritize inputs used to
measure fair value. Those tiers are defined as follows:
  -
              Level
      1 inputs are quoted prices (unadjusted) in active markets for identical
      assets or liabilities that the reporting entity has the ability to access
      at the measurement date.
  -
              Level
      2 inputs are inputs, other than quoted prices included within Level 1,
      that are observable for the asset or liability, either directly or
      indirectly. If the asset or liability has a specified (contractual) term,
      a Level 2 input must be observable for substantially the full term of the
      asset or liability.
  -
              Level
      3 inputs are unobservable inputs for the asset or
    liability.
 
 The
highest priority in measuring assets and liabilities at fair value is placed on
the use of Level 1 inputs, while the lowest priority is placed on the use of
Level 3 inputs.
 
  This
guidance also expands the related disclosure requirements in an effort to
provide greater transparency around fair value measures.
 
 At March
31, 2008, we adopted the guidance and the adoption had no material impact on our
financial position, results of operations or cash flows.
 
 In
February 2008, the FASB amended the guidance to delay its effective date to
fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years, for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually).  We adopted the
amendment in the first quarter of fiscal year 2010 and the adoption had no
material impact on our financial position, results of operations or cash
flows.
  30
 Table of Contents
  Off-Balance
Sheet Arrangements
  At
December 6, 2009, we did not have any relationships with unconsolidated entities
or financial partnerships, such as entities often referred to as structured
finance or special purpose entities, which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes.
  Contractual
Obligations
  For a
discussion of our contractual obligations, see the “Management’s Discussion and
Analysis of Financial Condition and Results of Operations – Liquidity and
Capital Resources – Contractual Obligations” section in our Annual Report on
Form 10-K for the fiscal year ended March 29, 2009.  There have been
no material developments with respect to contractual obligations since March 29,
2009.
  Item 3.  Quantitative and Qualitative Disclosures
About Market Risk
  For a
discussion of certain of the market risks to which we are exposed, see the
“Quantitative and Qualitative Disclosures About Market Risk”section
in our Annual Report on Form 10-K for the fiscal year ended March 29,
2009.  There have been no material changes with respect to
quantitative and qualitative disclosures about market risk since March 29,
2009.
 
 Item 4.  Controls and Procedures
 
 Evaluation
of Disclosure Controls and Procedures
  As of the
end of the period covered by this Quarterly Report on Form 10-Q, our management
performed an evaluation, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934).  Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer have
identified the material weaknesses in internal control over financial reporting
discussed below and as a result, have concluded that, as of the end of the
quarterly period covered by this report, our disclosure controls and procedures
were not effective as of December 6, 2009.
  Based on
the evaluation performed by management under the supervision and with the
participation of our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act), our
management identified the following material weaknesses in our internal control
over financial reporting as of the quarterly period ended December 6,
2009:
 
 1.
              
              Deficiencies
      in our IT environment due to untimely removal of network access for
      terminated employees.2.
              
              Deficiencies
      in maintaining adequate controls over certain key spreadsheets used in our
      financial reporting process including review of these
      spreadsheets.
 Since the
discovery of the material weaknesses in internal controls described above,
management is strengthening the Company’s internal controls over financial
reporting and is taking various actions to improve our internal controls
including, but not limited to the following:
 
 1.
              
              Remediation
      efforts were made to ensure notification of IT upon the departure of
      employees for purposes of terminating their network access. The Company is
      currently reviewing the access eligibility of the current users of its
      network. Testing of these remediation efforts is
  pending.2.
              
              Remediation
      efforts were made to ensure adequate controls over key spreadsheets by
      implementing review and password protection on the spreadsheets and
      formulas and maintaining historic data in a read-only access as well as a
      formal review process. Testing of these remediation efforts is
      pending.
 
 Changes
in Internal Control Over Financial Reporting
 
 Other
than the items noted above, there has been no change in our internal control
over financial reporting that occurred during the quarterly period ended
December 6, 2009 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
 
   31
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 PART II
–OTHER INFORMATION
  Item 1.
              Legal
      Proceedings
 From time to time, we are involved in legal proceedings arising in the
ordinary course of our business. We are not currently a party to any litigation
that management believes, if determined adversely to us, would have a material
adverse effect on our financial condition, results of operations, or cash
flows.
 
 Item 1A.
              Risk
      Factors
 For a
discussion of risk factors, see “Item 1A. – Risk Factors” in our Annual Report
on Form 10-K for the fiscal year ended March 29, 2009.  There have
been no material changes from the risk factors previously disclosed in our
Annual Report on Form 10-K for the fiscal year ended March 29,
2009.
 
 Item 2.
              Unregistered Sales of Equity Securities and Use of
  Proceeds
 None.
 Item 3.
              Defaults
      upon Senior Securities
 None.
 Item 4.
              Submission
      of Matters to a Vote of Security
Holders
 None.
 Item 5.
              Other
      Information
 
 On
January 11, 2010, the Company amended and restated the employment agreement of
December 23, 2004 with Mr. Daniel McCarthy, the Chairman of the Board of
Directors and Chief Executive Officer of the Company and its subsidiaries. The
term of employment will be five years commencing on December 23, 2009 or less in
case of resignation, death, disability or termination by the Company with or
without cause.  The employment agreement includes a provision that
prevents Mr. McCarthy, during the employment period and for a period of two
years thereafter from directly or indirectly owning, managing or engaging in any
business, or acting as an investor in or lender to any business including on his
own behalf or on behalf of another person which constitutes or is competitive
with the Company during the employment period, or as of the end of the
employment period if the employment period has then ended.  Mr.
McCarthy’s employment agreement provides for base salary of $480,000 per annum
(or as otherwise agreed between Mr. McCarthy and the Company) in addition to an
annual increase subject to the Board’s approval of such increase. However, Mr.
McCarthy has agreed with the Company that his compensation for services shall
remain at his previous compensation level of $434,100 while a pay freeze remains
in effect at the Company.  Mr. McCarthy shall also
receive family health, dental, life, long-term disability, directors
and officers liability insurance and such other benefits offered to senior
executives of the Company from time to time.  In addition, Mr. McCarthy may
receive a performance bonus if certain financial performance criteria are
met subject to the Board’s approval. In case of termination by the Company
without cause, Mr. McCarthy is entitled to receive severance payments in an
aggregate amount equal to two years’ salary based on the salary in effect
at the time the employment period is terminated, as well as two years of
benefits continuation if then available under the Company's benefits plans or
COBRA continuation coverage for a period equal to the period such COBRA
continuation coverage is available up to two years.
 
 On
January 11, 2010, the Company amended and restated the employment agreement of
January 7, 2005 with Mr. Gerard Parker, the Chief Financial Officer of the
Company and its subsidiaries. The term of employment will be five years
commencing on December 23, 2009 or less in case of resignation, death,
disability or termination by the Company with or without cause.  The
employment agreement includes a provision that prevents Mr. Parker, during the
Employment Period and for a period of two years thereafter from directly or
indirectly owning, managing or engaging in any business, or acting as an
investor in or lender to any business including on his own behalf or on behalf
of another person which constitutes or is competitive with the Company during
the employment period, or as of the end of the employment period if the
employment period has then ended.  Mr. Parker’s employment agreement
provides for base salary of $325,000 (or as otherwise agreed between Mr. Parker
and the Company) in addition to an annual increase subject to the Board’s
approval of such increase. However, Mr. Parker has agreed with the Company that
his compensation for services shall remain at his current compensation level of
$289,406 while a pay freeze remains in effect at the Company.  Mr.
Parker shall also receive family health, dental, life, long-term
disability, directors and officers liability insurance and such
other benefits offered to senior executives of the Company from time to
time.  In addition, Mr. Parker may receive a performance bonus if
certain financial performance criteria are met subject to the Board’s approval.
In case of termination by the Company without cause, Mr. Parker is entitled to
receive severance payments in an aggregate amount equal to two years’ salary
based on the salary in effect at the time the employment period is terminated,
as well as two years of benefits continuation if then available under the
Company's benefits plans or to COBRA continuation coverage for a period
equal to the period such COBRA continuation coverage is available up to two
years.
 
 Item 6.
              Exhibit
 Exhibits
are filed or furnished with this report as set forth in the Exhibits Index
hereof.
 
 
  32
 Table of Contents
     
   SIGNATURES
   Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
  Network
      Communications, Inc.Date:  January
      15, 2010
              
              By:
              /s/  Daniel R.
      McCarthy
                Chairman
      and Chief Executive Officer
                (Principal
      Executive Officer)Date:
      January 15, 2010
              
              By:
              /s/  Gerard P.
      Parker
                Senior
      Vice President and Chief Financial Officer
                (Principal
      Financial and Accounting Officer)
 
  
  33
 Table of Contents
 NETWORK
COMMUNICATIONS, INC. AND SUBSIDIARIES
 PART II
–OTHER INFORMATION
  Exhibit Index
 
 Number
              
              Title10
              .29
              
              Amendment
      to Employment Agreement of Daniel McCarthy.10
              .30
              
              Amendment
      to Employment Agreement of Gerard Parker.31
              .1
              
              Certification
      of the Chairman and Chief Executive Officer pursuant to Section 302
      of the Sarbanes-Oxley Act of 2002.31
              .2
              
              Certification
      of the Senior Vice President and Chief Financial Officer pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.32
              .1*
              
              Certification
      of Chairman and Chief Executive Officer pursuant to Title 18 of the United
      States Code Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32
              .2*
              
              Certification
      of Senior Vice President and Chief Financial Officer pursuant to Title 18
      of the United States Code Section 1350, as adopted pursuant to Section 906
      of the Sarbanes-Oxley Act of 2002.
 
 *
              This
      exhibit is hereby furnished to the SEC as an accompanying document and is
      not to be deemed “filed” for purposes of Section 18 of the Securities
      Exchange Act of 1934 or otherwise subject to the liabilities of that
      Section, nor shall it be deemed incorporated by reference into any filing
      under the Securities Act of 1933 or the Securities Exchange Act of
      1934.