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GRAHAM HOLDINGS CO - 10-Q - Management's Discussion and Analysis of Results of Operations and Financial Condition.

May 7, 2014

This analysis should be read in conjunction with the condensed consolidated financial statements and the notes thereto. Results of Operations The Company reported income from continuing operations attributable to common shares of $131.0 million ($17.65 per share) for the first quarter of 2014, compared to $21.7 million ($2.92 per share) for the first quarter of 2013. Net income attributable to common shares was $132.1 million ($17.79 per share) for the first quarter ended March 31, 2014, compared to $4.7 million ($0.64 per share) for the first quarter of last year. Net income includes $1.1 million ($0.14 per share) in income and $17.0 million ($2.28 per share) in losses from discontinued operations for the first quarter of 2014 and 2013, respectively. (Refer to "Discontinued Operations" discussion below.) On April 11, 2014, the Company and Berkshire Hathaway Inc. announced that they have signed an agreement for Berkshire to acquire a wholly-owned subsidiary of the Company that includes, among other things, WPLG, the Company's Miami-based television station. The transaction is expected to close in the second or third quarter of 2014. As a result, income from continuing operations excludes WPLG, which has been reclassified to discontinued operations, net of tax, for all periods presented. 19 -------------------------------------------------------------------------------- Items included in the Company's income from continuing operations for the first quarter of 2014 are listed below: $4.5 million in early retirement program expense at the corporate office



(after-tax impact of $2.9 million, or $0.39 per share);

$127.7 million gain on the sale of the corporate headquarters building

(after-tax impact of $81.8 million, or $11.13 per share); and

$5.0 million in non-operating unrealized foreign currency gains (after-tax

impact of $3.2 million, or $0.44 per share).

Items included in the Company's income from continuing operations for the first quarter of 2013 are listed below: $9.4 million in severance and restructuring charges at the education division



(after-tax impact of $6.1 million, or $0.85 per share); and

$4.6 million in non-operating unrealized foreign currency losses (after-tax

impact of $3.0 million, or $0.41 per share).

Revenue for the first quarter of 2014 was $840.6 million, up 2% from $820.6 million in the first quarter of 2013. The Company reported operating income of $79.5 million in the first quarter of 2014, compared to $47.1 million in the first quarter of 2013. Revenues increased at the television broadcasting and cable divisions, while revenues at the education division were flat. Operating results improved in the first quarter at the television broadcasting, cable and education divisions. Division Results Education Education division revenue totaled $526.2 million for the first quarter of 2014, essentially flat compared with revenue of $527.8 million for the first quarter of 2013. Kaplan reported first quarter 2014 operating income of $2.5 million, compared to an operating loss of $4.1 million in the first quarter of 2013. Operating results for the first quarter of 2013 include restructuring costs of $9.4 million. A summary of Kaplan's operating results for the first quarter of 2014 compared to 2013 is as follows: Three Months Ended March 31 (in thousands) 2014 2013 % Change Revenue Higher education $ 253,779$ 271,860 (7 ) Test preparation 67,804 68,943 (2 ) Kaplan international 202,867 184,813 10 Kaplan corporate 2,014 2,604 (23 ) Intersegment elimination (290 ) (405 ) - $ 526,174$ 527,815 0 Operating Income (Loss) Higher education $ 13,144$ 5,101 - Test preparation (6,628 ) (4,345 ) (53 ) Kaplan international 10,882 6,397 70 Kaplan corporate (12,632 ) (8,822 ) (43 )



Amortization of intangible assets (2,288 ) (2,518 ) 9 Intersegment elimination

44 131 - $ 2,522$ (4,056 ) - Kaplan Higher Education (KHE) includes Kaplan's domestic postsecondary education businesses, made up of fixed-facility colleges and online postsecondary and career programs. KHE also includes the domestic professional training and other continuing education businesses. In 2012, KHE began implementing plans to close or merge 13 ground campuses, consolidate other facilities and reduce its workforce. In connection with these and other plans, KHE incurred $9.1 million in restructuring costs in the first quarter of 2013, including accelerated depreciation ($3.6 million), severance ($0.9 million), lease obligation losses ($3.7 million) and other items ($0.9 million). At the end of 2013, the KHE campus closures or mergers had been largely completed, though two campuses remain to be closed in the first half of 2014. In April 2014, KHE announced plans to close two additional ground campuses that will be completed by the end of 2015. 20 -------------------------------------------------------------------------------- In the first quarter of 2014, KHE revenue declined 7% due largely to declines in average enrollments that reflect weaker market demand over the past year, lower average tuition and the impact of closed campuses. KHE operating income increased in the first quarter of 2014 due largely to expense reductions associated with lower enrollments and recent restructuring efforts, as well as significant restructuring costs recorded in the first quarter of 2013. New student enrollments at KHE increased 7% in the first quarter of 2014 due to growth at Kaplan University, offset by the impact of closed campuses. Total students at March 31, 2014, were down 2% compared to March 31, 2013, but increased 9% compared to December 31, 2013. Excluding campuses closed or planned for closure, total students at March 31, 2014, were down 1% compared to March 31, 2013, but up 10% compared to December 31, 2013. A summary of student enrollments is as follows: Excluding Campuses Closing As of As of March 31, December 31, March 31, March 31, December 31, March 31, 2014 2013 2013 2014 2013 2013 Kaplan University 47,109 42,816 45,788 47,109 42,816 45,788 Other Campuses 18,842 17,417 21,408 18,309 16,868 20,002 65,951 60,233 67,196 65,418 59,684 65,790



Kaplan University and Other Campuses' enrollments at March 31, 2014 and 2013, by degree and certificate programs, are as follows:

As of March 31 2014 2013 Certificate 21.6 % 22.6 % Associate's 30.6 % 30.1 % Bachelor's 32.3 % 33.5 % Master's 15.5 % 13.8 % 100.0 % 100.0 % Kaplan Test Preparation (KTP) includes Kaplan's standardized test preparation programs. KTP revenue declined 2% for the first quarter of 2014. Enrollment increased 2% for the first quarter of 2014 due to growth in health and bar review programs, offset by declines in graduate programs. KTP operating results declined in the first three months of 2014 due largely to decreased revenues. Kaplan International includes English-language programs and postsecondary education and professional training businesses largely outside the United States. Kaplan International revenue increased 10% in the first quarter of 2014 due to enrollment growth in the pathways programs, English-language and Singapore higher education programs. Kaplan International operating income improved in the first quarter of 2014 due to improved earnings in the pathways and English-language programs. Kaplan corporate represents unallocated expenses of Kaplan, Inc.'s corporate office, other minor businesses and certain shared activities. Kaplan continues to evaluate its cost structure and may develop additional restructuring plans in 2014. Cable Cable division revenue increased 2% in the first quarter of 2014 to $203.9 million, from $200.1 million for the first quarter of 2013. The revenue increase for the first three months of 2014 is due to growth of the division's Internet and commercial sales revenues, recent rate increases for many subscribers and a reduction in promotional discounts. The increase was partially offset by a 2% decline in total customers and a 4% decline in total PSUs, as the cable division continues to increase its focus on high-value customers and decrease its focus on marginal customers. Cable division operating income grew 12% in the first quarter of 2014 to $41.2 million, from $36.6 million in the first quarter of 2013. The division's operating income improved in the first three months of 2014 due to increased revenues and tight cost controls that resulted in a small reduction in overall operating costs. At March 31, 2014, total customers were down 2% and Primary Service Units (PSUs) were down 4% due to a decline in video subscribers. PSUs include about 6,100 subscribers who receive free basic cable service, primarily local governments, schools and other organizations as required by various franchise agreements. A summary of 21 --------------------------------------------------------------------------------



PSUs and total customers is as follows:

As of March 31 2014 2013 Video 524,563 588,180 High-speed data 484,168 463,726 Telephony 174,876 185,717



Total Primary Service Units (PSUs) 1,183,607 1,237,623 Total Customers

714,010 732,010 Television Broadcasting Revenue at the television broadcasting division increased 24% to $85.7 million in the first quarter of 2014, from $68.9 million in the same period of 2013; operating income for the first quarter of 2014 was up 52% to $44.4 million, from $29.1 million in the same period of 2013. The increase in revenue and operating income is due to a $3.1 million increase in political advertising revenue, $9.5 million in incremental winter Olympics-related advertising revenue at the Company's NBC affiliates and $4.7 million in increased retransmission revenues. As discussed above, the television broadcasting operating results exclude WPLG, the Company's Miami-based television station, which has been reclassified to discontinued operations for all periods presented. Other Businesses Other businesses includes the operating results of The Slate Group and Foreign Policy Group, which publish online and print magazines and websites; SocialCode, a marketing solutions provider helping companies with marketing on social-media platforms; Celtic Healthcare, a provider of home health and hospice services; Forney, a global supplier of products and systems that control and monitor combustion processes in electric utility and industrial applications, acquired by the Company in August 2013; and Trove, a digital team focused on emerging technologies and new product development. In April 2014, Celtic Healthcare acquired the assets of VNA-TIP Healthcare of Bridgeton, MO. This acquisition will expand Celtic's home health and hospice service areas from Pennsylvania and Maryland to the Missouri and Illinois region. Corporate Office Corporate office includes the expenses of the Company's corporate office, the pension credit for the Company's traditional defined benefit plan and certain obligations related to prior business dispositions. In the first quarter of 2014, the corporate office implemented a Separation Incentive Program that resulted in early retirement program expense of $4.5 million, which will be funded from the assets of the Company pension plan. Excluding early retirement program expense, the total pension credit for the Company's traditional defined benefit plan was $22.4 million and $9.2 million in the first quarter of 2014 and 2013, respectively. Equity in Earnings (Losses) of Affiliates The Company holds a 16.5% interest in Classified Ventures, LLC and interests in several other affiliates. The Company's equity in earnings of affiliates, net, was $4.1 million for the first quarter of 2014, compared to $3.4 million for the first quarter of 2013. On April 1, 2014, the Company received a gross cash distribution of approximately $95 million from Classified Ventures' sale of apartments.com. In connection with this sale, the Company will record a pre-tax gain of approximately $92 million in the second quarter of 2014. Other Non-Operating Income (Expense) The Company recorded total other non-operating income, net, of $133.3 million for the first quarter of 2014, compared to expense of $4.1 million for the first quarter of 2013. The first quarter 2014 non-operating income, net, included a pre-tax $127.7 million gain on the sale of the headquarters building, $5.0 million in unrealized foreign currency gains and other items. The first quarter 2013 non-operating expense, net, included $4.6 million in unrealized foreign currency losses and other items. Net Interest Expense The Company incurred net interest expense of $8.2 million for the first quarter of 2014, compared to $8.5 million for the first quarter of 2013. At March 31, 2014, the Company had $452.5 million in borrowings outstanding at an average interest rate of 7.0%. 22 -------------------------------------------------------------------------------- Provision for Income Taxes The effective tax rate for income from continuing operations for the first quarter of 2014 was 37.1%, compared to 41.5% for the first quarter of 2013. The higher effective tax rate in 2013 results mostly from losses in Australia for which no tax benefit is recorded. Discontinued Operations On April 11, 2014, the Company and Berkshire Hathaway Inc. announced that they have signed an agreement for Berkshire to acquire a wholly-owned subsidiary of the Company that includes WPLG, the Company's Miami-based television station, a number of Berkshire shares currently held by the Company and cash in exchange for approximately 1.6 million shares of Graham Holdings Class B common stock currently owned by Berkshire. The transaction is expected to close in the second or third quarter of 2014. As a result, income from continuing operations excludes WPLG, which has been reclassified to discontinued operations, net of tax, for all periods presented. The specific number of shares of each company and the amount of cash will be determined on the closing date based on certain factors, including the market prices of the shares of both companies at that time. The transaction is subject to FCC approval and other customary conditions. In addition, there are certain termination rights relating to minimum trading prices of the stock of each company immediately prior to closing and to a minimum value of the television station for purposes of the transaction on the closing date. Earnings (Loss) Per Share The calculation of diluted earnings per share for the first quarter of 2014 was based on 7,352,230 weighted average shares outstanding, compared to 7,266,284 for the first quarter of 2013. At March 31, 2014, there were 7,401,499 shares outstanding and the Company had remaining authorization from the Board of Directors to purchase up to 159,219 shares of Class B common stock. Kaplan Higher Education (KHE) Regulatory Matters The Department of Education (ED) convened a negotiated rulemaking committee in September 2013 to consider a new gainful employment rule that is expected to go into effect in July 2015. On March 25, 2014, the ED released a final draft regulation. The new proposed regulation requires that each educational program meet certain debt-to-earnings ratios and programmatic level loan cohort default rate metric. Programs that fail one of these proposed metrics multiple years in a row would become ineligible for Title IV aid. The proposed rule also includes revised requirements for program approval, public disclosure on certain outcomes (graduation, placement, repayment rates, and other consumer information) and a "certification" requirement that each program is included in the school's accreditation grant and has programmatic level accreditation if required for licensure in the occupation. A new final regulation published on or before November 1, 2014, generally would have an effective date of July 1, 2015, although the ultimate effective date is unknown at this time. The Company cannot predict the ultimate timing or substance of gainful employment regulations, nor can the Company fully predict the impact on Kaplan programs or institutions. Moreover, some of the data needed to compute program eligibility under the final draft regulation are not readily accessible; graduate incomes would be compiled by the Social Security Administration. In addition, the continuing eligibility of programs for Title IV funding may be affected by factors beyond Kaplan's control, such as changes in the actual or deemed income level of its graduates, changes in student borrowing levels, increases in interest rates, changes in the U.S. Federal poverty income level relevant for calculating one of the proposed metrics and other factors. As a result, the ultimate outcome of gainful employment regulation and its impact on Kaplan's operations is uncertain. The proposed regulation could cause Kaplan to eliminate or limit enrollments in certain educational programs at some or all of its schools, could result in the loss of student access to Title IV programs and could have a material adverse impact on KHE revenues, operating income and cash flows. Financial Condition: Capital Resources and Liquidity Acquisitions and Dispositions Acquisitions. In the first three months of 2014, the Company acquired one small business included in its education division; the purchase price allocation comprised goodwill on a preliminary basis. In the first three months of 2013, the Company acquired one small business included in other business; the purchase price allocation mostly comprised goodwill and other intangible assets. On April 1, 2014, Celtic Healthcare acquired VNA-TIP Healthcare, a provider of home health and hospice services in Missouri and Illinois. The operating results of VNA-TIP will be included in other businesses beginning in the second quarter of 2014. 23 -------------------------------------------------------------------------------- Dispositions. On April 11, 2014, the Company and Berkshire Hathaway Inc. announced that they have signed an agreement for Berkshire to acquire a wholly-owned subsidiary of the Company that includes WPLG, the Company's Miami-based television station, a number of Berkshire shares currently held by the Company and an amount of cash in exchange for approximately 1.6 million shares of Graham Holdings Class B common stock currently owned by Berkshire. The transaction is expected to close in the second or third quarter of 2014. The specific number of shares of each company and the amount of cash will be determined on the closing date based on certain factors, including the market prices of the shares of both companies at that time. The transaction is subject to FCC approval and other customary conditions. In addition, there are certain termination rights relating to minimum trading prices of the stock of each company immediately prior to closing and to a minimum value of the television station for purposes of the transaction on the closing date. On October 1, 2013, the Company completed the sale of most of its newspaper publishing businesses. The publishing businesses sold include The Washington Post, Express, The Gazette Newspapers, Southern Maryland Newspapers, Greater Washington Publishing, Fairfax County Times and El Tiempo Latino and related websites (Publishing Subsidiaries). In March 2013, the Company completed the sale of certain assets of The Herald, a daily and Sunday newspaper headquartered in Everett, WA. Capital Expenditures During the first three months of 2014, the Company's capital expenditures totaled $36.6 million. The Company estimates that its capital expenditures will be in the range of $225 million to $250 million in 2014. Liquidity The Company's borrowings increased by $1.8 million, to $452.5 million at March 31, 2014, as compared to borrowings of $450.8 million at December 31, 2013. At March 31, 2014, the Company had $642.8 million in cash and cash equivalents, compared to $569.7 million at December 31, 2013. Restricted cash at March 31, 2014, totaled $52.0 million, compared to $83.8 million at December 31, 2013. The Company had money market investments of $460.9 million and $431.8 million that are classified as cash, cash equivalents and restricted cash in the Company's condensed consolidated Balance Sheets as of March 31, 2014 and December 31, 2013, respectively. As of March 31, 2014, the Company held investments in commercial paper totaling $99.9 million with original maturities over 90 days. The Company did not have any investments in commercial paper at December 31, 2013. For the first quarter of 2014, these investments are presented in the Company's Condensed Consolidated Statements of Cash Flows as net cash used in investing activities. The Company's total debt outstanding of $452.5 million at March 31, 2014 included $398.0 million of 7.25% unsecured notes due February 1, 2019, $46.2 million of AUD 50 million borrowing and $8.3 million in other debt. On March 27, 2014, the Company completed the sale of its headquarters building for approximately $158.0 million. On April 1, 2014, the Company received a gross cash distribution of approximately $95 million from Classified Ventures' sale of apartments.com. On April 11, 2014, the Company and Berkshire Hathaway Inc. announced that they have signed an agreement for Berkshire to acquire a wholly-owned subsidiary of the Company that includes WPLG, the Company's Miami-based television station, a number of Berkshire shares currently held by the Company and cash in exchange for approximately 1.6 million shares of Graham Holdings Class B common stock currently owned by Berkshire. The transaction is expected to close in the second or third quarter of 2014. In June 2011, the Company entered into a credit agreement (the Credit Agreement) providing for a U.S. $450 million, AUD 50 million four year revolving credit facility (the Facility), with each of the lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent (JP Morgan), and J.P. Morgan Australia Limited, as Australian Sub-Agent. The Facility will expire on June 17, 2015, unless the Company and the banks agree to extend the term. In September 2013, Standard and Poor's affirmed the Company's "BBB" long-term corporate debt rating and changed the outlook from Negative to Stable. In addition, S&P upgraded the Company's short-term corporate debt rating from "A-3" to "A-2". On March 12, 2014, Moody's placed the Company's senior unsecured rating and its Prime-2 commercial paper rating on review for downgrade. The Company's current credit ratings are as follows: Standard Moody's & Poor's Long-term Baa1 BBB Short-term Prime-2 A-2 24

-------------------------------------------------------------------------------- During the first three months of 2014 and 2013, the Company had average borrowings outstanding of approximately $451.2 million and $516.7 million, respectively, at average annual interest rates of approximately 7.0%. During the first three months of 2014 and 2013, the Company incurred net interest expense of $8.2 million and $8.5 million, respectively. At March 31, 2014 and December 31, 2013, the Company had working capital of $849.4 million and $768.3 million, respectively. The Company maintains working capital levels consistent with its underlying business requirements and consistently generates cash from operations in excess of required interest or principal payments. The Company expects to fund its estimated capital needs primarily through existing cash balances and internally generated funds and to a lesser extent borrowings supported by our Credit Agreement. In management's opinion, the Company will have sufficient liquidity to meet its various cash needs throughout 2014. There were no significant changes to the Company's contractual obligations or other commercial commitments from those disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Forward-Looking Statements This report contains certain forward-looking statements that are based largely on the Company's current expectations. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results and achievements to differ materially from those expressed in the forward-looking statements. For more information about these forward-looking statements and related risks, please refer to the section titled "Forward-Looking Statements" in Part I of the Company's Annual Report on Form 10-K. Item 3. Quantitative and Qualitative Disclosures about Market Risk. The Company is exposed to market risk in the normal course of its business due primarily to its ownership of marketable equity securities, which are subject to equity price risk; to its borrowing and cash-management activities, which are subject to interest rate risk; and to its foreign business operations, which are subject to foreign exchange rate risk. The Company's market risk disclosures set forth in its 2013 Annual Report filed on Form 10-K have not otherwise changed significantly. Item 4. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures An evaluation was performed by the Company's management, with the participation of the Company's Chief Executive Officer (the Company's principal executive officer) and the Company's Senior Vice President-Finance (the Company's principal financial officer), of the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of March 31, 2014. Based on that evaluation, the Company's Chief Executive Officer and Senior Vice President-Finance have concluded that the Company's disclosure controls and procedures, as designed and implemented, are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms and is accumulated and communicated to management, including the Chief Executive Officer and Senior Vice President-Finance, in a manner that allows timely decisions regarding required disclosure. (b) Changes in Internal Control Over Financial Reporting There has been no change in the Company's internal control over financial reporting during the quarter ended March 31, 2014 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 25



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