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EMMS > SEC Filings for EMMS > Form 10-K on 8-May-2014All Recent SEC Filings

Show all filings for EMMIS COMMUNICATIONS CORP

Form 10-K for EMMIS COMMUNICATIONS CORP


8-May-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
GENERAL
The following discussion pertains to Emmis Communications Corporation ("ECC") and its subsidiaries (collectively, "Emmis" or the "Company").
We own and operate radio and publishing properties located in the United States. Our revenues are mostly affected by the advertising rates our entities charge, as advertising sales represent approximately 70% of our consolidated revenues. These rates are in large part based on our entities' ability to attract audiences/subscribers in demographic groups targeted by their advertisers. The Nielsen Company generally measures radio station ratings weekly for markets measured by the Portable People Meter™ and four times a year for markets measured by diaries. Because audience ratings in a station's local market are critical to the station's financial success, our strategy is to use market research, advertising and promotion to attract and retain audiences in each station's chosen demographic target group.
Our revenues vary throughout the year. As is typical in the broadcasting industry, our revenues and operating income are usually lowest in our fourth fiscal quarter.
In addition to the sale of advertising time for cash, stations typically exchange advertising time for goods or services, which can be used by the station in its business operations. These barter transactions are recorded at the estimated fair value of the product or service received. We generally confine the use of such trade transactions to promotional items or services for which we would otherwise have paid cash. In addition, it is our general policy not to preempt advertising spots paid for in cash with advertising spots paid for in trade.
The following table summarizes the sources of our revenues for the past three years. The category "Non Traditional" principally consists of ticket sales and sponsorships of events our stations and magazines conduct in their local markets. The category "Other" includes, among other items, network revenues and barter.


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                                            Year ended February 28 (29),
                      2012      % of Total       2013      % of Total       2014      % of Total
Net revenues:
Local              $ 114,006        56.4 %    $ 103,089        52.6 %    $ 108,010        52.7 %
National              34,122        16.9 %       31,253        15.9 %       31,995        15.6 %
Political                702         0.3 %        2,242         1.1 %          604         0.3 %
Publication Sales      6,128         3.0 %        6,141         3.1 %        6,312         3.1 %
Non Traditional       19,177         9.5 %       19,653        10.0 %       20,762        10.1 %
Interactive            8,242         4.1 %        8,969         4.6 %       11,429         5.6 %
LMA Fees                 310         0.2 %        8,609         4.4 %       10,331         5.0 %
Other                 19,531         9.6 %       16,128         8.3 %       15,703         7.6 %
Total net revenues $ 202,218                  $ 196,084                  $ 205,146

A significant portion of our expenses varies in connection with changes in revenue. These variable expenses primarily relate to costs in our sales department, such as salaries, commissions and bad debt. Our costs that do not vary as much in relation to revenue are mostly in our programming and general and administrative departments, such as talent costs, syndicated programming fees, utilities, office expenses and salaries. Lastly, our costs that are highly discretionary are costs in our marketing and promotions department, which we primarily incur to maintain and/or increase our audience and market share.
KNOWN TRENDS AND UNCERTAINTIES
Although advertising revenues have stabilized following the 2008 economic recession, radio revenue growth remains challenged. Management believes this is principally the result of two factors: (1) new media, such as various media distributed via the Internet, telecommunication companies and cable interconnects, as well as social networks, which have gained advertising share against radio and other traditional media and created a proliferation of advertising inventory and (2) the fragmentation of the radio audience and time spent listening caused by satellite radio, internet radio, and digital audio sales has led some investors and advertisers to conclude that the effectiveness of radio advertising has diminished.

The Company and the radio industry have begun several initiatives to address these issues. The radio industry is working aggressively to increase the number of smartphones that contain an enabled FM tuner. Most smartphones currently sold in the United States contain an FM tuner. However, most wireless carriers in the United States do not permit the FM tuner to receive the free over-the-air local radio stations it was designed to receive. Furthermore, in many countries outside the United States, enabled FM tuners are made available to smartphone consumers; consequently, radio listening increases. Activating FM as a feature on smartphones sold in the United States has the potential to increase radio listening and improve perception of the radio industry while offering network providers the benefits of a proven emergency notification system, reduced network congestion from audio streaming services, and a host of new revenue generating applications. Emmis is at the leading edge of this initiative and has developed TagStation®, a cloud-based software platform that allows a broadcaster to manage album art, meta data and enhanced advertising on its various broadcasts, and NextRadio®, a hybrid radio smartphone application, as an industry solution to make the user experience of listening to free over-the-air radio broadcasts on their enabled smartphones a rich experience. In August 2013, Sprint began enabling FM tuners and pre-loading the NextRadio® application on certain models of smartphones. The radio industry continues to work with other leading United States network providers, device manufacturers, regulators and legislators to cause FM tuners to be enabled in all smartphones.
The Company has also aggressively worked to harness the power of broadband and mobile media distribution in the development of emerging business opportunities by becoming one of the fifteen largest streaming audio providers in the United States, developing highly interactive websites with content that engages our listeners, using SMS texting and deploying mobile applications, harnessing the power of digital video on our websites and YouTube channels, and delivering real-time traffic to navigation devices.
Along with the rest of the radio industry, the majority of our stations have deployed HD Radio®. HD Radio® offers listeners advantages over standard analog broadcasts, including improved sound quality and additional digital channels. In addition to offering secondary channels, the HD Radio® spectrum allows broadcasters to transmit other forms of data. We are participating in a joint venture with other broadcasters to provide the bandwidth that a third party uses to transmit location-based data to hand-held and in-car navigation devices. The number of radio receivers incorporating HD Radio has increased in the past year, particularly in new automobiles. It is unclear what impact HD Radio® will have on the markets in which we operate.


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The results of our radio operations are heavily dependent on the results of our stations in the New York and Los Angeles markets. These markets account for approximately 50% of our radio net revenues. During the year ended February 28, 2014, KPWR-FM in Los Angeles experienced revenue growth that was better than its overall market, but revenue growth at WQHT-FM in New York lagged its overall market growth. Our results in New York and Los Angeles are often more volatile than our larger competitors due to our lack of scale in these markets. Our dependence on the performance of one station in each of these markets limits our ability to adapt as the competitive environment shifts. Furthermore, some of our competitors that operate larger station clusters in New York and Los Angeles are able to leverage their market share to extract a greater percentage of available advertising revenue through packaging a variety of advertising inventory at discounted unit rates and may be able to realize operating efficiencies by programming multiple stations in these markets. On March 1, 2014, we significantly increased our scale in New York when we began programming WBLS-FM and WLIB-AM pursuant to a Local Marketing and Programming Agreement. We expect to consummate our acquisition of these assets during fiscal 2015.
As part of our business strategy, we continually evaluate potential acquisitions of radio stations, publishing properties and other businesses that we believe hold promise for long-term appreciation in value and leverage our strengths. However, Emmis Operating Company's 2012 Credit Agreement substantially limits our ability to make acquisitions. To consummate the announced acquisition of WBLS-FM and WLIB-AM in New York, we will refinance the 2012 Credit Agreement. We also regularly review our portfolio of assets and may opportunistically dispose of assets when we believe it is appropriate to do so. See Note 8 to our consolidated financial statements for a discussion of various dispositions.

CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that encompass significant judgments and uncertainties, and potentially derive materially different results under different assumptions and conditions. We believe that our critical accounting policies are those described below. Revenue Recognition
Broadcasting revenue is recognized as advertisements are aired. Publication revenue is recognized in the month of delivery of the publication. Both broadcasting revenue and publication revenue recognition is subject to meeting certain conditions such as persuasive evidence that an arrangement exists and collection is reasonably assured. These criteria are generally met at the time the advertisement is aired for broadcasting revenue and upon delivery of the publication for publication revenue. Advertising revenues presented in the financial statements are reflected on a net basis, after the deduction of advertising agency fees, usually at a rate of 15% of gross revenues. FCC Licenses and Goodwill
We have made acquisitions in the past for which a significant amount of the purchase price was allocated to FCC licenses and goodwill assets. As of February 28, 2014, we have recorded approximately $163.2 million in goodwill and FCC licenses, which represents approximately 62% of our total assets. In the case of our radio stations, we would not be able to operate the properties without the related FCC license for each property. FCC licenses are renewed every eight years; consequently, we continually monitor our stations' compliance with the various regulatory requirements. Historically, all of our FCC licenses have been renewed at the end of their respective periods, and we expect that all FCC licenses will continue to be renewed in the future. We consider our FCC licenses to be indefinite-lived intangibles.
We do not amortize goodwill or other indefinite-lived intangible assets, but rather test for impairment at least annually or more frequently if events or circumstances indicate that an asset may be impaired. When evaluating our radio broadcasting licenses for impairment, the testing is performed at the unit of accounting level as determined by Accounting Standards Codification ("ASC") Topic 350-30-35. In our case, radio stations in a geographic market cluster are considered a single unit of accounting, provided that they are not being operated under a Local Marketing Agreement by another broadcaster. We complete our annual impairment tests on December 1 of each year and perform additional interim impairment testing whenever triggering events suggest such testing is warranted.
Valuation of Indefinite-lived Broadcasting Licenses Fair value of our FCC licenses is estimated to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To determine the fair value of our FCC licenses, the Company uses an income valuation method when it performs its impairment tests. Under this method, the Company projects cash flows that would be generated by each of its units of accounting assuming the unit of accounting was commencing operations in its respective market at the beginning of the valuation period. This cash flow stream is discounted to arrive at a value for the FCC license. The Company assumes the competitive situation that exists in each market remains unchanged, with the exception that its unit of accounting commenced operations at the beginning of the valuation period. In doing so, the Company extracts the value of going concern and any other assets acquired, and strictly values the FCC license.


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Major assumptions involved in this analysis include market revenue, market revenue growth rates, unit of accounting audience share, unit of accounting revenue share and discount rate. Each of these assumptions may change in the future based upon changes in general economic conditions, audience behavior, consummated transactions, and numerous other variables that may be beyond our control. The projections incorporated into our license valuations take current economic conditions into consideration.
Assumptions incorporated into the annual impairment testing as of December 1, 2013 were similar to those used in our December 1, 2012 annual impairment testing. Below are some of the key assumptions used in our annual and interim impairment assessments. The methodology used to value our FCC licenses has not changed in the three-year period ended February 28, 2014.

                              December 1, 2011   December 1, 2012  December 1, 2013
Discount Rate                   11.9% - 12.2%     11.9% - 12.3%     12.0% - 12.4%
Long-term Revenue Growth Rate    2.5% - 3.3%       2.3% - 3.3%       2.3% - 3.1%
Mature Market Share             3.2% - 29.4%       3.2% - 29.4%      3.5% - 30.2%
Operating Profit Margin         26.0% - 37.2%     25.1% - 38.3%     25.0% - 39.1%

In connection with the April 2012 LMA of 98.7FM in New York previously discussed, the Company separated its two New York stations into separate units of accounting. The Company performed an interim impairment test of those licenses during the quarter ended May 31, 2012, and recorded an interim impairment charge of $11.0 million. No further impairment of our FCC licenses was recorded as a result of our December 1, 2012 or December 1, 2013 annual tests.
Valuation of Goodwill
ASC Topic 350 requires the Company to test goodwill for impairment at least annually using a two-step process. The first step is a screen for potential impairment, while the second step measures the amount of impairment. The Company conducts the two-step impairment test on December 1 of each fiscal year, unless indications of impairment exist during an interim period. When assessing its goodwill for impairment, the Company uses an enterprise valuation approach to determine the fair value of each of the Company's reporting units (radio stations grouped by market and magazines on an individual basis). Management determines enterprise value for each of its reporting units by multiplying the two-year average station operating income generated by each reporting unit (current year based on actual results and the next year based on budgeted results) by an estimated market multiple. The Company uses a blended station operating income trading multiple of publicly traded radio operators as a benchmark for the multiple it applies to its radio reporting units. There are no publicly traded publishing companies that are focused predominantly on city and regional magazines as is our publishing segment. Therefore, the market multiple used as a benchmark for our publishing reporting units is based on recently completed transactions within the city and regional magazine industry or analyst reports that include valuations of magazine divisions within publicly traded media conglomerates. For the annual assessment performed as of December 1, 2013, the Company applied a market multiple of 7.0 times and 5.0 to 7.0 times the reporting unit's operating performance for our radio and publishing reporting units, respectively. Management believes this methodology for valuing radio and publishing properties is a common approach and believes that the multiples used in the valuation are reasonable given our peer comparisons and market transactions. To corroborate the step-one reporting unit fair values determined using the market approach described above, management also uses an income approach, which is a discounted cash flow method to determine the fair value of the reporting unit.
This enterprise valuation is compared to the carrying value of the reporting unit for the first step of the goodwill impairment test. If the reporting unit exhibits impairment, the Company proceeds to the second step of the goodwill impairment test. For its step-two testing, the enterprise value is allocated among the tangible assets, indefinite-lived intangible assets (FCC licenses valued using a direct-method valuation approach) and unrecognized intangible assets, such as customer lists, with the residual amount representing the implied fair value of the goodwill. To the extent the carrying amount of the goodwill exceeds the implied fair value of the goodwill, the difference is recorded as an impairment charge in the statement of operations. The methodology used to value our goodwill has not changed in the three-year period ended February 28, 2014.
During our December 1, 2012 annual goodwill impairment test, the Company wrote off $0.4 million of goodwill associated with our Indianapolis Monthly publication. Declining operating performance of Indianapolis Monthly resulted in a step-one indication of impairment for Indianapolis Monthly on both the market and income approaches. Upon completing the step-two analysis, the Company determined that the full carrying amount of Indianapolis Monthly goodwill of $0.4 million was impaired. No further impairment of our goodwill was recorded as a result of our December 1, 2013 annual test. Sensitivity Analysis
Based on the results of our December 1, 2013 annual impairment assessment, the fair value of our broadcasting licenses was approximately $281.5 million which was in excess of the $150.6 million carrying value by $130.9 million, or 87%. The fair values exceeded the carrying values of all of our units of accounting. Should our estimates or assumptions worsen, or


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should negative events or circumstances occur in the units that have limited fair value cushion, additional license impairments may be needed.

                                                     Radio Broadcasting Licenses
                                                As of
                                December 1, 2013       December 1, 2013       Percentage by which fair
Unit of Accounting               Carrying Value           Fair Value        value exceeds carrying value
WQHT-FM (New York)                      2,596                   61,981                       2,287.6 %
98.7FM (New York)                      60,525                   61,981                           2.4 %
Austin Cluster                         39,254                   40,683                           3.6 %
St. Louis Cluster                      27,692                   30,874                          11.5 %
Indianapolis Cluster                   17,654                   22,812                          29.2 %
KPWR-FM (Los Angeles)                   2,018                   62,305                       2,987.5 %
Terre Haute Cluster                       819                      830                           1.3 %
Total                                 150,558                  281,466                          86.9 %

If we were to assume a 100 basis points change in any of our three key assumptions (a reduction in the long-term revenue growth rate, a reduction in local commercial share or an increase in the discount rate) used to determine the fair value of our broadcasting licenses on December 1, 2013, the resulting impairment charge would have been $27.7 million, $19.0 million and $11.9 million, respectively. Also, if we were to assume a market multiple decrease of one or a 10% decrease in the two-year average station operating income, two of the key assumptions used to determine the fair value of our goodwill on December 1, 2013, the resulting estimates of enterprise valuations would still exceed the carrying values of the enterprises. As such, step two of the goodwill impairment testing would not be required, thus no goodwill impairment would be recognized if these two key assumptions were lowered. Deferred Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequence of events that have been recognized in the Company's financial statements or income tax returns. Income taxes are recognized during the year in which the underlying transactions are reflected in the consolidated statements of operations. Deferred taxes are provided for temporary differences between amounts of assets and liabilities as recorded for financial reporting purposes and amounts recorded for income tax purposes. After determining the total amount of deferred tax assets, the Company determines whether it is more likely than not that some portion of the deferred tax assets will not be realized. If the Company determines that a deferred tax asset is not likely to be realized, a valuation allowance will be established against that asset to record it at its expected realizable value. Insurance Claims and Loss Reserves
The Company is self-insured for most healthcare claims, subject to stop-loss limits. Claims incurred but not reported are recorded based on historical experience and industry trends, and accruals are adjusted when warranted by changes in facts and circumstances. The Company had $0.5 million and $0.6 million accrued for employee healthcare claims as of February 28, 2013 and 2014, respectively. The Company also maintains large deductible programs (ranging from $100 thousand to $250 thousand per occurrence) for workers' compensation, employment liability, automotive liability and media liability claims.
ACQUISITIONS, DISPOSITIONS AND INVESTMENTS The transactions described below impact the comparability of operating results for the three years ended February 28, 2014. Sale of Slovakia radio operations
On February 25, 2013, Emmis completed the sale of its Slovakian radio network to Bauer Ausland 1 GMBH for $21.2 million in cash. Emmis believed the sale of its international radio properties would better enable the Company to focus its efforts on its domestic radio stations. The sale of our Bulgarian radio network on January 3, 2013 created a one-time tax benefit that we could use if we sold the Slovakian network on or before February 28, 2013. In connection with the sale, Emmis recorded a gain on sale of assets of approximately $14.8 million, which is included in income from discontinued operations in the accompanying consolidated statements of operations. Emmis paid approximately $1.7 million to settle working capital adjustments and other transaction related costs during the first quarter of fiscal 2014.


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Sale of Bulgarian radio operations
On January 3, 2013, Emmis completed the sale of its Bulgarian radio network to Reflex Media EEOD for $1.7 million in cash. Emmis believed the sale of its international radio properties would better enable the Company to focus its efforts on its domestic radio stations. In connection with the sale, Emmis recorded a loss on sale of assets of approximately $1.3 million, which is included in income from discontinued operations in the accompanying consolidated statements of operations. The loss on disposal primarily resulted from the reclassification of accumulated currency translation adjustments. Sale of Emmis Interactive Inc.
On October 31, 2012, Emmis completed the sale of Emmis Interactive Inc., a subsidiary of Emmis that provided a content management system, data analytic tools and related services, to Marketron Broadcast Solutions, LLC ("Marketron") for no net proceeds. The sale of Emmis Interactive Inc. allowed Emmis to mitigate expected future operating losses and focus its efforts on its domestic radio operations and other promising technology initiatives. Marketron had assumed operating control of Emmis Interactive, Inc., on October 4, 2012. In connection with the sale, Emmis recorded a loss on sale of assets of approximately $0.7 million, which is primarily related to severance for former employees and is included in income from discontinued operations in the accompanying consolidated statements of operations. Sale of Sampler Publications
On October 1, 2012, Emmis completed the sale of Country Sampler magazine, Smart Retailer magazine, and related publications (altogether the "Sampler Publications") and certain real estate used in their operations to subsidiaries of DRG Holdings, LLC. Emmis believed the sale of the Sampler Publications, which were niche crafting publications, would enable it to more clearly focus on its core city and regional publications. Emmis received gross proceeds from the sale of $8.7 million, incurred approximately $0.2 million in transaction expenses and tax obligations, and used the remaining $8.5 million to repay term loans under the Company's 2006 Credit Agreement. In connection with the sale, Emmis recorded a gain on sale of assets of approximately $0.7 million, which is included in income from discontinued operations in the accompanying consolidated statements of operations
Sale of KXOS-FM
On August 23, 2012, Emmis completed the sale of KXOS-FM in Los Angeles for $85.5 million in cash. In connection with the sale, Emmis recorded a gain on sale of assets of approximately $32.8 million, which is included in income from discontinued operations in the accompanying consolidated statements of operations. KXOS-FM had previously been operating pursuant to a local programming and marketing agreement, which is discussed in more detail in Note 1 to the accompanying consolidated financial statements. Sale of controlling interest in WRXP-FM, WKQX-FM AND WLUP-FM On September 1, 2011, the Company completed the sale of a controlling interest in Merlin Media, LLC ("Merlin Media"), which owned the following radio stations:
(i) WKQX-FM, 101.1 MHz, Channel 266, Chicago, IL (FIN 19525), (ii) WRXP-FM, 101.9 MHz, Channel 270, New York, NY (FIN 67846) and (iii) WLUP-FM, 97.9 MHz, Channel 250, Chicago, IL (FIN 73233) (collectively the "Merlin Stations"). The Company received gross cash sale proceeds of $130 million in the transaction, and incurred approximately $8.6 million of expenses, principally consisting of severance, state and local taxes, and professional and other fees and expenses. The Company used the net cash proceeds to repay approximately 38% of the term loans then outstanding under its 2006 Credit Agreement. Emmis also paid a $2.0 million exit fee to Canyon related to the repayment of Extended Term Loans on September 1, 2011.
On September 1, 2011, subsidiaries of Emmis entered into the 2nd Amended & Restated Limited Liability Company Agreement (the "LLC Agreement") of Merlin . . .

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