ITEM 1. BUSINESS.
1.(a) GENERAL
Heritage Media Corporation, (the "Company", "Heritage", or "HMC"), is the largest targeted marketing services company in the United States through its ownership of DIMAC Marketing Corporation ("DIMAC") and ACTMEDIA, Inc. ("ACTMEDIA"). DIMAC is the leading full service, vertically integrated direct marketing services company in the United States. ACTMEDIA-Registered Trademark- is the leading provider of in-store marketing products and services, primarily to consumer packaged goods manufacturers with products in supermarkets, drug stores, and mass merchandisers worldwide. Heritage currently operates six network affiliated television stations and twenty-three radio stations in eight major markets.
ACTMEDIA provides coverage in over 40,000 grocery, drug and mass merchandiser stores in the United States. ACTMEDIA operates in twenty-eight different countries with core operations in the United States, Canada, Australia and New Zealand, and equity interests in in-store marketing companies in Europe, Asia, South America, the Middle East and Africa. ACTMEDIA uses this global distribution network, coupled with its diverse product base, to provide its clients with integrated solutions that combine sight, sound and one-to-one selling to form effective targeted in-store marketing programs.
DIMAC creates and implements comprehensive, custom tailored marketing programs to enable clients nationwide to focus their marketing expenditures on a highly targeted potential customer base. DIMAC provides every component of a complete direct marketing program, including customized market research, strategic and creative planning, creation and management of relational databases, telemarketing, media buying, production services, fulfillment services and subsequent program analysis. DIMAC provides its services to clients in a wide range of industries, including financial services, retail, publishing and healthcare, with a strong expertise and focus on telecommunications related businesses.
Television remains an effective mass media. Heritage's Television Group contributes substantial cash flow from operations with a local sales and news emphasis that yields one of the industry's leading operating margins. The Radio Group has been very successful in acquiring under-performing stations and improving their operations. The Radio Group has focused on creating duopolies in its markets.
1.(b) BUSINESS SEGMENT INFORMATION
Heritage operates in two business segments - Marketing Services and Broadcasting. The business segment information required by this item is set forth in Note 13 of Notes to Consolidated Financial Statements of Heritage, included herein.
1.(c) DESCRIPTION OF THE BUSINESS
MARKETING SERVICES
IN-STORE MARKETING
Targeted media augments mass media advertising by reinforcing advertising and promotional messages to consumers where they congregate and, in the case of in-store marketing, where purchase decisions are made.
The advent of the targeted media industry was prompted by the realization that traditional mass media vehicles (television, radio and print advertisements) were becoming less effective due to changes in the profile of a typical shopper and his or her shopping patterns and to the proliferation of the types of media used to communicate to the shopping public. Changing shopping patterns have led to shorter supermarket visits, usually without shopping lists, and declining brand loyalty. Industry sources estimate that a significant percentage (ranging from 40% to 70%) of brand purchase decisions are made in the supermarket. Economic trends also support the continued growth of in-store marketing because this medium is inexpensive in comparison to other marketing alternatives such as television, radio and traditional print advertisements. In-store marketing is based upon the foundation that the store is the only place where the product, the manufacturer's message and the consumer with an intent to buy all converge. In-store marketing products and services thus allow advertisers to communicate with consumers at or near the point-of-purchase before, or as, purchasing decisions are made, and measure the results of their in-store marketing programs.
PRODUCTS AND SERVICES
ACTMEDIA offers advertisers a broad assortment of in-store advertising and promotional products which can be purchased separately or integrated to produce a cohesive in-store marketing presentation for a given product or brand. ACTMEDIA's products and services include print advertising products, such as advertisements on shopping carts, aisle directories and shelf talkers; promotional products, such as cooperative coupon and sampling programs; on-shelf electronic couponing; audio in-store advertising; customized in-store demonstrations; and merchandising. By linking sight, sound and one-to-one selling, ACTMEDIA provides its clients with an effective means to reach the consumer at the point-of-purchase and provides solutions to manufacturers' in- store challenges.
INSTANT COUPON MACHINE-Registered Trademark-. The INSTANT COUPON MACHINE ("ICM"), which was developed by ACTMEDIA, is an electronic coupon dispenser that is mounted on shelf channels under or near featured products. Through independent market research sponsored by the Company, the ICM has been shown to increase brand switching substantially and to encourage first-time purchases of featured products. Coupons featured in ACTMEDIA's ICM achieve an average redemption rate of 18%, versus reported redemption rates of less than 2% for coupons in free-standing inserts, approximately 4% for coupons sent to consumers in direct mailings and less than 1% for run of press coupons. The research also indicates that unit sales increase an average of 32% over four weeks for products using the ICM.
In addition to its high redemption rate, research shows that the ICM generates significant unplanned purchases; approximately 58% of purchases made with coupons from the ICM are unplanned. The Company believes that the ICM is also effective in reaching shoppers who do not normally use coupons; in market tests approximately 47% of consumers who redeemed a coupon from the ICM stated that they never use or only occasionally use a coupon.
The ICM holds 500 coupons and is marketed to advertisers on a category- exclusive basis at the shelf. The ICM is sold in four-week cycles. National rollout of the ICM commenced in February 1992. Currently the ICM is available in approximately 11,500 grocery stores, 10,200 drug stores and 2,600 mass merchandise stores.
ACTNOW-Registered Trademark-. The ACTNOW program provides cooperative in- store coupon and sampling programs for groups of advertisers, generally five times per year. Under these programs, ACTMEDIA's representatives distribute coupons, samples and premiums inside the entrance of approximately 10,600 stores nationwide. Up to 15 million co-op coupon booklets and up to 15 million solo coupons and samples are distributed directly to shopping customers per event. In addition, product awareness is reinforced through the placement of featured products on a free-standing ACTNOW display.
Market tests indicate that these events typically result in 40% of coupon redeemers being new brand users or switchers. Of the ACTNOW coupons redeemed, research by the Company indicates approximately 18% are generally redeemed in the first day of an event, which contrasts positively to free-standing insert coupon rates of redemption.
IMPACT-Registered Trademark-. IMPACT is the nation's leading in-store supermarket demonstration program, offering advertisers complete turnkey service for their in-store events. Customized events, such as tastings, premiums, samplings and demonstrations, are conducted in up to 24,000 stores nationwide. All demonstrations are monitored every day by full-time and part-time supervisors. IMPACT's regular part-time staff of demonstrators, who implement the programs, maintain a consistent professional appearance with matching aprons and materials. Special display units are utilized in the programs and programs are sold on a store-day basis. Events are generally conducted at the front of the store but can be located elsewhere. Category exclusivity is offered by store chains on event days.
CARTS. ACTMEDIA's 8" by 10", four-color advertisements, mounted in plastic frames on the inside and outside of shopping carts, offer advertisers continuous storewide category-exclusive advertising delivery of a print advertisement. Because the shopping cart ads circulate around the entire store with the shopper, these advertisements are an effective tool for advertisers to reinforce their messages. Shopping cart advertisements are available in approximately 8,100 supermarkets nationwide, offering coverage of approximately 105 Designated Marketing Areas ("DMA"). Shopping cart advertisements are sold in four-week cycles to a maximum of twelve advertisers per cycle and, according to a study by Simmons Research, reach store locations visited by more than 122 million shoppers per cycle. According to studies by Audits & Surveys, Inc. ("A&S") conducted from 1973 to 1995, the use of shopping cart advertisements increased average unit sales for the products advertised by approximately 11% in stores where they were utilized.
AISLEVISION-Registered Trademark-. AISLEVISION features 28" by 18" four- color advertisement posters inserted in stores' overhead aisle directory signs. The large size of AISLEVISION draws attention to the supermarket aisle in which the product is stocked and has the added benefit of being frequently used by shoppers during their shopping trips. ACTMEDIA's AISLEVISION is sold in approximately 5,300 stores nationwide, offering category-exclusive coverage of approximately 151 DMA's. AISLEVISION is sold in four-week cycles to a maximum of 18 advertisers per cycle. Studies conducted by A&S from 1985 to 1995 reported that the use of AISLEVISION increased average unit sales for the products advertised by approximately 8%. An enhancement, AISLEACTION, allows the manufacturer to include motion on the directory sign, enhancing shopper awareness of the sign. Also, AISLEDIRECT, allows the manufacturer to tie AisleVision with ICM and direct consumers to the INSTANT COUPON MACHINE.
SHELFTALK-Registered Trademark-/SHELFTAKE-ONE-Registered Trademark-. SHELFTALK features advertisements placed in plastic frames mounted on supermarket or drug store shelves near its featured product. SHELFTAKE-ONE includes rebate offers or recipe ideas which consumers may remove from the plastic frame at the site of the featured product. These four-color, 5-1/4" by 4" ads, placed perpendicular to the shelf and facing in both directions, are an effective means of bringing attention to a product at the shelf level and reinforcing advertising messages at the point-of-purchase. SHELFTALK and SHELFTAKE-ONE are sold in approximately 11,200 supermarkets, offering coverage of approximately 170 DMA's, and in approximately 8,800 drug and mass merchandiser stores, covering approximately 160 DMA's. SHELFTALK and SHELFTAKE- ONE are sold in four week cycles on a category-exclusive basis. Studies conducted by A&S over a ten year period reported that SHELFTALK resulted in an approximately 6% average unit sales gain for the products advertised in grocery stores and an approximately 12% average unit sales gain for the products advertised in drug stores. Studies conducted by A & S through 1995 reported that SHELFTAKE-ONE increased average unit sales by 7% for products advertised in grocery stores and by 5% for products in drug stores.
ACTRADIO-Registered Trademark-. ACTRADIO is the nation's largest advertiser-supported satellite delivered in-store radio network. ACTRADIO delivers its in-store audio advertising in conjunction with music entertainment services provided by the nation's leading business music providers. The ACTRADIO network comprises approximately 8,100 chain supermarkets, 8,100 chain drug stores, 2,300 mass merchandise stores and 800 Toys 'R' Us /Kids 'R' Us toy and children clothing stores. ACTRADIO delivers over 700 million advertising impressions over a four-week period reaching 56% of adults an average of 6.8 times according to recent Simmons data. This massive reach and frequency makes ACTRADIO an attractive alternative to traditional broadcast, published, or direct mail advertising. Advertisers can extend their message at the point of sale at a fraction of the CPM (cost per thousand) of traditional media. In addition to its advertising value, A&S studies from 1987 through 1995 show that ACTRADIO delivers an average sales gain of 8% with a brand sell ad, and up to 20% when a promotional tag or price tag is added. Research conducted in 1992 also indicated that 94% of all shoppers are attentive to the brand sell commercials, and that over half of all shoppers claim it has a positive effect in their purchase choices.
POWERFORCE-Registered Trademark-. In January 1995, the Company acquired POWERFORCE Services, a leading national provider of in-store merchandising services. POWERFORCE conducts merchandising and promotional activities such as shelf and store restockings, special retailer events, point of purchase installations, retail sales and other merchandising for packaged goods manufacturers. Sales merchandising is a rapidly-growing $420 million industry due to the growing trend of manufacturers to down-size their full-time sales forces and outsource in-store activities to third parties such as POWERFORCE. POWERFORCE has 9,000 part-time merchandisers available across all major U.S. markets.
POWERFORCE operates in the supermarket, drug, mass merchandise, toy, hardware and computer retail classes of trade. The "client-dedicated" services which represent the majority of the POWERFORCE business, provides clients with recruiting, general supervision, payroll and call reporting services. Such contracts are generally on a long term basis. POWERFORCE also provides fully managed customized programs which clients generally use to accomplish a specific task. Such tasks may include stickering products, setting up displays and conducting sampling and providing demonstration programs.
ACTPROMOTE-Registered Trademark-. In September 1995, ACTMEDIA introduced ACTPROMOTE, an electronic "paperless" couponing network which supports price discounts distributed at the checkout scanner with on-shelf advertising and in- store audio promotion. Continued testing of this network is scheduled for 1997.
IN-STORE NETWORK
ACTMEDIA's in-store network delivers its products and services in over 24,000 supermarkets and 13,700 drug and 2,600 mass merchandiser stores across the country, a network substantially larger than that of any other in-store marketing company. By contracting to purchase the Company's in-store advertising and promotional products, advertisers gain access to up to approximately 186 of the nation's 211 DMA's covering over 70% of the households in the United States.
ACTMEDIA currently has contracts with approximately 300 store chains. ACTMEDIA's store contracts generally grant it the exclusive right to provide its customers with those in-store advertising services which are contractually specified. The contracts are of various durations, generally extending from three to five years and provide for a revenue-sharing arrangement with the stores. ACTMEDIA's store contract renewals are staggered and many of its relationships have been maintained for almost two decades.
ACTMEDIA's advertising and promotional programs are executed through one of the nation's largest independent in-store distribution and service organizations, although certain chains require the Company to
utilize their own employees. ACTMEDIA believes the training, supervision and size of its field service staff (approximately 450 full-time managers and up to approximately 23,000 available part-time employees) provide it with a significant competitive advantage as its competitors generally do not have a comparable field service staff.
The Company is currently expanding its in-store products to additional classes of trade, such as mass merchandisers, convenience stores, club stores, and discount stores.
CUSTOMER BASE
ACTMEDIA's customer base includes approximately 250 companies and 700 brands. This customer base includes the 25 largest advertisers of consumer packaged goods. In 1996, the Company's largest customers included the following:
Campbells Soup Kraft Foods Nestle Foods Reckitt & Coleman General Mills Kelloggs Pillsbury Thomas J. Lipton Co. Heinz Corp. Kimberly-Clark Procter & Gamble Van Den Bergh Foods Johnson & Johnson RJR Nabisco Ralston Purina
ACTMEDIA's sales organization markets its services to consumer packaged goods brand managers, promotion managers and their advertising and promotion agencies. ACTMEDIA's sales force consists of approximately 45 representatives, who are compensated on a salary-plus-commission basis. Sales representatives stress the benefits of in-store marketing services, including: (i) the exclusivity afforded advertisers for a specific merchandise category, a feature generally unavailable in television, radio, magazine or newspaper advertising; (ii) increases in sales volume; (iii) the ability to reach customers at the point-of-purchase where industry sources estimate that a significant number (ranging from 40% to 70%) of all brand buying decisions are made; (iv) ACTMEDIA's ability to reach a significant number of consumers at costs per thousand that are significantly less than comparable television or print advertising; and (v) measurement of results.
INTERNATIONAL OPERATIONS AND INVESTMENTS
ACTMEDIA's strategy includes the establishment of a significant business presence outside of the United States. The majority of the Company's advertisers are large, multinational companies for whom the use of in-store marketing products in overseas markets is expected to be a logical extension of their advertising and promotional budgets. ACTMEDIA's products and services are now available in twenty-eight different countries with plans for further expansion in 1997.
In November 1990, the Company acquired one of Canada's largest in-store marketing companies (now renamed ACTMEDIA Canada), which primarily operated an in-store cart advertising program. In August 1991, ACTMEDIA Canada acquired a Canadian company whose services include in-store demonstrations, merchandising and information collection. In October 1994, ACTMEDIA Canada acquired Strategium Media, Inc. whose Infonet Media, Ltd. ("Infonet") subsidiary is a leading supplier of shelf-based advertising, couponing and promotional programs. The combination of these three companies now offers program coverage in 4,300 supermarkets and has enabled ACTMEDIA to attain a significant market position in Canada comparable to ACTMEDIA's U.S. market position. In February 1994, ACTMEDIA acquired in-store marketing companies in Australia and New Zealand.
ACTMEDIA has commenced a program to license its name and train licensees in the methods of conducting in-store operations in countries where the in-store industry is just developing or is too small for a direct ACTMEDIA presence. ACTMEDIA has minority equity participation and licensing agreements in Asia
(20%), Greece (10%), Japan (10%), and Ireland (10%). ACTMEDIA also has licensing agreements in Israel, South Africa, France, Portugal, the United Kingdom, Turkey, Mauritius and Zimbabwe.
ACTMEDIA has entered a joint venture with Publimart (Vista Group), a Mexican marketing services company, to form ACTMEDIA LATINA, which will act as master licensee for all Latin American countries. ACTMEDIA has a 10% equity participation in ACTMEDIA LATINA. ACTMEDIA LATINA has equity interests ranging from 10-51% in in-store marketing firms in Brazil, Mexico and Columbia. It manages licenses in Puerto Rico, Venezuela, Costa Rica and Argentina.
International sales in 1996 were $38.3 million (approximately 11%) of the In-store Marketing revenues.
DEVELOPMENT
ACTMEDIA's dedicated Venture Group is aggressively pursuing new product development, alliances, joint ventures and acquisitions both in-store and within complementary industries. The introduction of ACTMEDIA's current product line into new classes of trade as well as development of new clients continue to represent key focus areas. ACTMEDIA has several projects in the electronic couponing area that represent growth opportunities. International licensing, joint ventures and acquisitions continue to be evaluated as ways to further expand ACTMEDIA's products worldwide.
COMPETITION
The advertising and promotion industries are characterized by intense competition. ACTMEDIA competes directly with other point-of-purchase advertisers and coupon/sampling/distribution/demonstration companies and indirectly with all other media in the supply of advertising and promotion services, including national, local and cable television, radio, magazines, outdoor advertising and newspapers. Also, certain store chains offer limited advertising and promotional products and services.
The Company believes that the principal competitive factors affecting its in-store marketing business are the ability to demonstrate the cost effectiveness of its services as well as the comprehensive scope, coverage and quality of the services provided. There are relatively few barriers to entry particularly at the local level for suppliers of many different types of marketing (including packaged goods manufacturers, advertising agencies, retailers or other companies). However, the development of a nationwide capacity would require enormous resources in addition to hiring sufficient field service personnel to distribute and service comparable advertising or promotional programs, and it would take substantial time, effort and investment to obtain the comprehensive store relationships, contracts and execution systems developed by ACTMEDIA over the years.
Although the Company believes that ACTMEDIA, with a market share of approximately 30-35%, is the largest provider of in-store marketing services, other companies (some of which are affiliated with larger companies) offer similar services. Such other companies include Catalina Marketing Corporation, News America In-store and PIA Merchandising. Moreover, the in-store marketing environment is characterized by rapid technological change, and future technological developments (if and when cost effective) may affect competition.
DIRECT MARKETING
DIRECT MARKETING INDUSTRY
Direct marketing is a sophisticated, information driven communications process that permits the seller to focus its marketing dollars on a target audience of buyers and to precisely measure both the response to its marketing program and the return on its marketing expenditures. These attributes have contributed to the growth of direct marketing into a $32 billion industry that commands an estimated 19% of all U.S. advertising expenditures. Direct marketing has become an increasingly important advertising medium and integral component of many companies' overall marketing programs. Direct marketing is used for a variety of purposes including prospecting for new customers, enhancing existing customer relationships and exploring the potential for new products and services. Whereas traditional forms of advertising aim at a broad audience and focus on creating general brand or product awareness, direct marketing permits advertisers to identify, target and reach a specifically defined audience and accurately measure the response to their marketing message. The ability to measure responses allows a direct marketing program to be continually refined to further enhance its effectiveness. This capability facilitates follow-up marketing campaigns and allows for accurate measurement of return on marketing investment.
DIMAC
DIMAC was founded in 1921 and has evolved into one of the largest full service, vertically integrated direct marketing services company in the United States. DIMAC creates and implements comprehensive, custom tailored marketing programs that enable clients nationwide to focus their marketing expenditures on a highly targeted potential customer base. As a full service, vertically integrated firm, DIMAC provides every component of a complete direct marketing program, including customized market research, strategic and creative planning, creation and management of relational databases, telemarketing, media buying, production services, fulfillment services and subsequent program analysis. Vertical integration provides a key attribute in attracting new business and expanding existing relationships. Clients come to DIMAC for all or part of the direct marketing process and typically gravitate into additional services. DIMAC, which is headquartered in St. Louis, has additional facilities to service its client base in New York, Philadelphia, Boston, Chicago, Palm Coast, Houston, San Francisco, and Los Angeles.
Throughout the past thirty years, DIMAC has successfully expanded the range of its marketing services and increased the size of its customer base to include major corporations such as AT&T, American Express, BLOCKBUSTER Entertainment, NationsBank, several Blue Cross/Blue Shield organizations, Chase/Chemical Bank, Bloomingdales, SAKS and a significant number of U.S. public television stations.
GROWTH OPPORTUNITIES
As a whole, the direct marketing industry is extremely fragmented, with over 3,600 providers of related services. On average, these companies generate annual revenues of less than $5 million each and typically provide only one of the services provided by DIMAC. The increasing sophistication of direct marketing, which is fueling the industry's growth, is a challenge to smaller companies, which often lack the resources to keep pace with clients' ever increasing expectations. This combination of circumstances has initiated a period of consolidation in the industry which provides tremendous potential for a well capitalized and vertically integrated
company like DIMAC. This industry consolidation is expected to continue, affording DIMAC the opportunity to further expand not only the services it offers its clients, but also the respective market segments its clients serve. DIMAC's full service capability, coupled with its coast-to-coast presence, provide it with a critical mass increasingly difficult for competitors to match. In fact, DIMAC's full service capability has evolved into its most important competitive advantage. For clients, it means one-stop shopping, a feature increasingly important to marketers as businesses demand accountability and higher returns on advertising dollars.
BUSINESS STRATEGY
DIMAC has implemented a four-part strategy which has set the pace for its rapid growth and profitability. This strategy focuses on:
i) the expansion of the existing customer base through targeted business development in selected industries; ii) cross selling of services to existing customers; iii) introduction of new products and services; and iv) continued growth through targeted acquisitions.
In pursuit of its acquisition strategy, DIMAC has successfully completed eleven acquisitions since May 1990. With these acquisitions, DIMAC has created a nationwide network, adding clients in new industries such as not-for-profit, health care and publishing, and adding new services such as television and video creative services, media buying and telemarketing.
In 1996, DIMAC completed three transactions. New York-based Wilcox & Associates, acquired in March 1996, is a direct response agency that specializes in bank merger communications. Through sophisticated database work and highly personalized creative development, Wilcox enables its clients--banks which acquire other banks--to communicate with their newly acquired customers, helping to retain and cross-sell new services to those customers. DIMAC achieves synergy with Wilcox by performing the majority of the data processing, printing and lettershop work associated with its mailings. In May 1996, DIMAC acquired MBS/Multimode, a Long Island-based database marketing firm that builds highly sophisticated databases used by its clients to strategize and to analyze millions of transaction records in order to better understand and capitalize on the buying patterns of their customers. Working with DIMAC, MBS/Multimode is able to expand its services to a more diverse client base. In September 1996, DIMAC became a joint venture partner with KCET-TV, the public TV station in Los Angeles, to form KCET/DIMAC Communications, L.L.C. The joint venture, based in L.A., is designed to serve the fundraising efforts of KCET-TV and other public TV stations, making use of a sophisticated telemarketing center and a viewer service known as VideoFinders. KCET/DIMAC works closely with DIMAC's Boston office, which is oriented almost exclusively toward serving the not-for-profit sector, and with all three of DIMAC's production facilities as well as with its MBS/Multimode database subsidiary.
CLIENT BASE
DIMAC primarily targets Fortune 500 companies with sophisticated direct marketing requirements. DIMAC's clients include, among others, AT&T, American Express, BLOCKBUSTER Entertainment, NationsBank, Smithsonian, a number of Blue Cross/Blue Shield organizations and approximately 55% of all U.S. public television stations. AT&T accounted for approximately 24% of DIMAC's total revenues for the year ended December 31, 1996. On a combined basis after giving pro forma effect to the MBS, Wilcox, and KCET Communications acquisitions, AT&T accounted for 23% of DIMAC's revenues for the year ended December 31, 1996. DIMAC's large client base includes major U.S. corporations as well as smaller companies in a broad range of industries, including financial services, health care, telecommunications, publishing, packaged goods,
not-for-profit television and retail. As a part of DIMAC's business strategy, DIMAC will continue to diversify its client base through new business development and selected acquisitions.
COMPETITION
Many of DIMAC's services are sold in highly competitive markets in the United States, including the markets for planning and developing direct marketing strategies, printing and distribution of direct mail advertising materials, and tracking and analyzing the effectiveness of direct marketing campaigns. Many formats, including television, radio and newspaper, compete for the advertising dollars of DIMAC's clients. DIMAC competes across the spectrum of these markets with a significant number of companies of varying sizes, including divisions and subsidiaries of larger corporations. Management believes that DIMAC possesses a competitive advantage over these other companies because of DIMAC's ability to provide vertically integrated direct marketing services to its clients, resulting in cross-selling opportunities for DIMAC and increased cost-efficiency for its clients. A majority of these competitors typically specialize in limited areas of the direct marketing process.
BROADCASTING
TELEVISION
The Television Group owns five network-affiliated television stations in mid-sized markets and operates one station under a Local Market Agreement ("LMA"). The following table sets forth selected information relating to the television stations owned by Heritage:
- -------------------- (1) Source: Nielsen Television Designated Market Area ("DMA") Market rankings September 1996. (2) "Sign on-Sign off" market shares as reported in the November 1996 Nielsen ratings. Ratings are often quoted on a "sign on-sign off" basis, representing the average percentage of television households viewing the station during normal program viewing periods (approximately 6:00 a.m. to 2:00 a.m. for Nielsen). As such, ratings are one common measure used by advertisers and others to compare a station's overall ranking in a market to its competitors. (3) Rankings based on relative "sign on-sign off" market shares in the November 1996 ratings of Nielsen. (4) Does not reflect any homes in southern Quebec (including most of Montreal) which received the WPTZ-TV signal off the air or by cable. WPTZ-TV's signal is accessible to approximately 3.4 million people in the province of Quebec including approximately 2.8 million people in the city of Montreal. (5) Operated as a satellite of WPTZ-TV, but maintains some local programming and sells advertising locally.
Heritage operates its television stations in accordance with a cost-benefit strategy that stresses primarily revenue and cash flow generation and secondarily audience share and ratings. The objective of this strategy is to deliver acceptable profit margins while maintaining a balance between the large programming investment usually required to maintain a number one ranking (with its resultant adverse effect on profit margins), and the unfavorable impact on revenues that results from lower audience ratings.
Components of the Company's operating strategy include management's emphasis on obtaining local advertising revenues by market segmentation, which provides a competitive advertising advantage, focusing on local news programming and tightly controlling operating expenses. By emphasizing advertising sales from local businesses, the Company's stations produce a higher percentage of local business (approximately 65% local and 35% national) than the national average.
The Company has shaped its sales efforts around two central beliefs: (1) that national advertising spots and a station's relations with its clients are based on ratings, while the sales of local spots depends to a greater extent on the station's local sales force and their relations with clients and (2) that the local advertising segment is the fastest growing advertising segment. As a result of these beliefs, Heritage's stations generally maintain a larger, more experienced sales force but a smaller general staff than its competitors.
WEAR-TV, the ABC affiliate in Pensacola, is the only network affiliated station in the Pensacola-Mobile market which is physically located in Florida and benefits from the market's growth which comes primarily from Florida. In November 1996, the station's newscast remained the market's number one rating. WEAR-TV operates from a newly constructed state-of-the-art broadcast facility and enters the third year of a new five-year agreement with ABC.
On March 4, 1996, Heritage entered into a LMA to operate WFGX-TV Channel 35 in the Ft. Walton Beach, Florida area. Heritage operates Channel 35 as a commercial television station with primary focus on local news service and popular entertainment programming. The addition of Channel 35 in Ft. Walton Beach combined with WEAR-TV, Heritage's ABC affiliate in Pensacola, allows the Company to increase its broadcasting capacity on the Florida side of the Mobile, AL/Pensacola, FL market. Under the agreement, Heritage has an option to purchase the station, along with its FCC license. On October 1, 1996 WFGX-TV became an affiliate of the Warner Brothers Network.
The Television Group's station in Plattsburgh/Burlington, WPTZ-TV, an NBC affiliate, also provides NBC programming to southern Quebec, including Montreal. Additionally, WPTZ-TV operates WNNE-TV, a satellite station serving portions of New Hampshire and Vermont, which allows advertisers to selectively air their messages over WPTZ-TV's entire market or segments of the market. WPTZ-TV and WNNE-TV are in the second year of a ten-year affiliation agreement with NBC.
WCHS-TV, an ABC affiliate, is the only network affiliate based in the capital city of Charleston, WV, within the Charleston and Huntington market. WCHS-TV recently expanded its locally produced news programming to three hours each weekday. WCHS-TV also extended its affiliation agreement with ABC for five years.
Three of the Company's stations, WEAR-TV, WPTZ-TV and WCHS-TV, which represent 82% of the net revenues from Heritage's television operations in 1996, have developed specific market segmentation strategies based on their status as the sole network affiliate in one geographic area of a hyphenated market. This geographic advantage enables these stations to build strong local identities and leading positions in local news programming in their portions of these hyphenated markets.
The 1991 acquisition of KOKH-TV has been very successful. The improved channel position, signal strength, elimination of a commercial station in the Oklahoma City market, and the emergence of the Fox network have contributed to the significant revenue increase since the acquisition. KOKH-TV signed a new five-year affiliation agreement with Fox during 1995. Heritage increased its investment in the station in 1996 by establishing a local news department and upgrading the broadcast signal. The news operation began broadcasting in the second quarter and the signal was upgraded in the third quarter of 1996.
In July 1995 the Company made a $1.1 million escrow deposit for the construction permit for Channel 44 in Burlington, VT. The Company has received certain regulatory approvals for the construction of Channel 44 which, similar to Heritage's NBC affiliate serving the Plattsburgh, NY/Burlington, VT market, will provide television programming to Montreal upon becoming operational through a LMA. The Company has an option to purchase the station.
Heritage completed the sale of its smallest television station, KEVN-TV, located in Rapid City, SD on February 8, 1996.
RADIO
The Radio Group currently operates 23 radio stations, including three under a LMA pending acquisition, and has recently announced two additional transactions involving trades of existing stations in like-kind exchanges. The Radio Group will own and operate 24 stations (7 AM, 17 FM) in seven of the top 50 largest markets by population after all pending transactions have been completed. These holdings include at least three stations (and two FM stations) in every market. The following table sets forth certain information regarding the Company's Radio Group:
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(1) Metropolitan areas as defined and ranked by Arbitron, Fall 1996. (2) FM station ranking among radio stations in market with same programming format, based on share of target audience. (3) FM station ranking among all radio stations in market, based on share of target audience. (4) Purchase pending -- operated by Company under a Local Marketing Agreement.
The Radio Group's operating strategy since its inception has been to identify, acquire, and repair under-performing radio stations through the strategic implementation of management improvements, technical upgrades, programming and promotional enhancements, and expense reallocations and controls. As regulatory changes have occurred in the past several years that relaxed station ownership limits (see "Federal Regulation of Broadcasting"), the Radio Group has endeavored to acquire additional stations in its existing markets and establish a multiple-station presence in new markets. The Radio Group also seeks diversification in terms of geography and programming formats. The Company's stations are programmed in a variety of research-directed formats, and strive to be the highest-rated stations in their formats in each market. Presently, the Company's stations are top-rated (or unique) in their formats in every market, and three of its stations rank either first or second among all stations in their market in their target audience.
The Federal Communications Commission ("FCC") has authority to regulate the number of radio stations one entity can own in a single market area and in total. In late 1992, the FCC changed its rules to permit the ownership of up to two AM stations and two FM stations (such combinations being commonly known as
"duopolies") in most markets. In 1996, Congress enacted legislation that allows ownership of up to four FM stations in most of the markets in which the Radio Group operates. During the period of 1992-1995, the Company acquired FM duopolies in five markets. Since the beginning of 1996, (including announced transactions that have not closed) the Radio Group has established at least a duopoly presence in all of its markets, with ownership of 3 FM's and one AM in Rochester, New York, and the maximum of 4 FM's and one AM in Kansas City.
The Company entered into four transactions in 1996 and announced two transactions to date in 1997, three of which have closed. In February 1996, the Company acquired two FM radio stations in the Knoxville, Tennessee, market, and in March 1996, agreed to exchange its AM/FM stations in Seattle, Washington, for an AM/FM/FM duopoly combination in New Orleans, Louisiana, plus cash paid to the Company. The stations involved in the latter transactions are being operated by the respective acquiring companies under LMA's. In September 1996, the Company began operating its third FM station serving Rochester, New York, under an LMA, and closed this purchase in January 1997. Also in September 1996, the Company agreed to acquire an AM/FM combination in the Kansas City -- its first AM and third FM in this market. This purchase closed in January 1997. Reported results for 1996 include the Seattle stations through March 17th, the New Orleans stations beginning March 18th, and the Rochester FM from September 2nd.
In January 1997, the Company entered into a like-kind exchange agreement in which the Knoxville stations acquired in 1996 will be traded for a fourth FM station in the Kansas City market. In February 1997, the Company agreed to an exchange of its stand-alone FM in Cincinnati for an AM/FM/FM duopoly combination in the Norfolk, Virginia, market, plus payment of cash to the Company.
The Company's acquisition and operating strategies have resulted in operating income increases from break-even in 1987, its first full year, to approximately $13 million in 1996. The Radio Group has reported thirty-six consecutive quarters of year-to-year growth in operating cash flow.
COMPETITION
The financial success of the Company's television and radio stations is dependent on audience ratings and revenues from advertisers within each station's geographic market. The Company's television and radio stations compete for revenues with other media companies in their respective markets, as well as with other advertising media, such as newspapers, magazines, outdoor advertising, local cable systems, direct mail and alternative media. Some competitors are part of larger companies with substantially greater financial resources than Heritage.
Competition in the broadcasting industry occurs primarily in individual markets. Generally, a television broadcasting station in one market does not compete with stations in other market areas. Heritage's television stations are located in highly competitive markets. While the pattern of competition in the radio broadcasting industry is basically the same, it is not uncommon for radio stations outside of the market area to place a signal of sufficient strength within that area to gain a share of the audience.
In addition to the element of management experience, factors that are material to competitive position include authorized power, assigned frequency, network affiliation, audience characteristics and local program acceptance, as well as strength of local competition. The broadcasting industry is continuously faced with technological change and innovation, the possible rise in popularity of competing entertainment and communications media, changes in labor conditions and governmental restrictions or actions of federal regulatory bodies, including the FCC and the Federal Trade Commission ("FTC"), any of which could possibly have a material adverse effect on Heritage's financial position and results of operations.
In recent years, broadcast television stations have faced increasing competition from the other sources of television service, primarily cable television, and the ratings have reflected a decline in the viewing audience. These other sources can increase competition for a broadcasting station by bringing into its market distant broadcasting signals not otherwise available to the station's audience and also serving as a distribution system for non- broadcast programming. Programming is now being distributed to cable television systems by both terrestrial microwave systems and satellite. Other sources of competition include home entertainment systems (including television game devices, video cassette recorder and playback systems and video discs), multi- point distribution systems, multichannel multi-point distribution systems, video programming services available through the Internet, satellite master antenna television systems and other video delivery systems. Heritage's television stations also face competition from direct broadcast satellite services which transmit programming directly to homes equipped with special receiving antennas or to cable television systems for transmission to their subscribers. The likely entry of telephone companies into the cable television business could increase the competition the Company's television stations face from other distributors of audio and video programming.
The broadcasting industry is continuously faced with technological change and innovations, which could possibly have a material effect on the Company's broadcast operations and results. Commercial television broadcasting may face future competition from interactive video and data services that may provide two-way interaction with commercial video programming, along with information and data services that may be delivered by commercial television stations, cable television, direct broadcast satellites, multi-point distribution systems, multichannel multi-point distribution systems, or other future video delivery systems. Commercial radio broadcasting may face further competition from satellite delivered digital audio radio services.
FEDERAL REGULATION OF BROADCASTING
Television and radio broadcasting are subject to the jurisdiction of the FCC, which acts under authority granted by the Communications Act of 1934, as amended (the "Communications Act"). The Communications Act prohibits radio or television broadcasting except in accordance with a license issued by the FCC. The Communications Act also empowers the FCC, among other things, to issue, renew, modify or revoke broadcasting licenses, to determine the location of stations, to regulate the equipment used by stations, to adopt such regulations as may be necessary to carry out the provisions of the Communications Act and to impose penalties for violation of such regulations. The Telecommunications Act of 1996 (the "Telecommunications Act"), which amends major provisions of the Communications Act, was enacted on February 8, 1996. The FCC has commenced, but not yet completed, implementation of the provisions of the Telecommunications Act. The following is a brief summary of certain provisions of the Communications Act and specific FCC regulations and policies.
RENEWAL. Historically, broadcasting licenses have been issued for a maximum term of up to five years in the case of television stations and up to seven years in the case of radio stations, and are renewable upon application. The FCC is implementing the provision in the Telecommunications Act which provides for license terms of up to eight years for both television and radio stations. The FCC will apply this provision of the Telecommunications Act to renewals for radio station licenses expiring on or after October 1, 1995 and television station licenses expiring on or after October 1, 1996. In determining whether to renew a broadcast license, the FCC has authority to evaluate the licensee's compliance with the provisions of the Communications Act and the FCC's rules and policies. The FCC licenses for each of Heritage's radio and television stations expire at different times between February 1, 1998 and February 1, 2005.
The Communications Act authorizes the filing of petitions to deny any license renewal applications during certain periods of time following the filing of renewal applications. Petitions to deny can be used by interested parties, including members of the public, to raise issues concerning a renewal applicant's
qualifications. If a substantial and material question of fact concerning a renewal application is raised by the interested party, the FCC will hold an evidentiary hearing on the application. In the vast majority of cases, broadcast licenses are renewed by the FCC even where there are petitions to deny filed against broadcast license renewal applications. Under the Telecommunications Act, a competing application for authority to operate a station and replace the incumbent licensee may not be filed against a renewal applicant and considered by the FCC in deciding whether to grant a renewal application. The statute modified the license renewal process to provide for the grant of a renewal application upon a finding by the FCC that the licensee (1) has served the public interest, convenience, and necessity; (2) has committed no serious violations of the Communications Act or the FCC's rules; and (3) has committed no other violations of the Communications Act or the FCC's rules which would constitute a pattern of abuse. If the FCC cannot make such a finding, it may deny a renewal application, and only then may the FCC accept other applications to operate the station of the former licensee.
ACQUISITIONS OR SALES. The Communications Act prohibits the assignment of a license or the transfer of control of a licensee without the prior approval of the FCC. Applications to the FCC for such assignments or transfers are subject to petitions to deny by interested parties and are granted by the FCC only upon a finding that such action will serve the public interest, convenience and necessity. In determining whether to grant such applications, the FCC has authority to evaluate the same types of matters that it considers in evaluating a broadcast license renewal application. In the vast majority of cases where petitions to deny are filed against assignment or transfer applications, the applications are granted and the petitions are denied.
OWNERSHIP RESTRICTIONS. Under the Communications Act, broadcast licenses may not be held by or transferred or assigned to an alien or a foreign entity. Non-citizens, however, may own up to 20% of the capital stock of a licensee and up to 25% of the capital stock of a United States corporation that, in turn, owns a controlling interest in a licensee. In addition, the Communications Act provides that no broadcast license may be held by any corporation directly or indirectly controlled by any other corporation of which more than one-fourth of the capital stock of record is owned or voted by aliens, if the FCC finds the public interest will be served by the refusal to grant such license. Under the Telecommunications Act, aliens may serve as officers and directors of a broadcast licensee and any corporation controlling, directly or indirectly, such licensee.
The Telecommunications Act directs the FCC to eliminate or modify certain rules regarding the multiple ownership of broadcast stations and other media on a national and local level. Pursuant to this directive, the FCC has eliminated the limit on the number of television stations that an individual or entity may own or control nationally, provided that the audience reach of all television stations owned does exceed 35% of all U.S. households. The FCC also has initiated a rulemaking proceeding, in accordance with the Telecommunications Act, to determine whether to retain, eliminate, or modify its limitations on the number of television stations (currently one in most instances) that an individual or entity may own within the same geographic market.
The Telecommunications Act eliminates the limit on the number of radio broadcast stations that an individual or entity may own or control nationally. The statute also relaxes the FCC's local radio multiple ownership rules governing the common ownership of radio broadcast stations in the same geographic market. The statute permits the common ownership of up to 8 commercial radio stations, not more than 5 of which are in the same service (i.e., AM or FM), in markets with 45 or more commercial radio stations. In markets with 30 to 44 commercial radio stations, an individual or entity may own up to 7 commercial radio stations, not more than 4 of which are in the same service. In markets with 15 to 29 commercial radio stations, an individual or entity may own up to 6 commercial radio stations, not more than 4 of which are in the same service. In markets with 14 or fewer commercial radio stations, an individual or entity may own up to 5 commercial radio stations, not more than 3 of which are in the same service, provided that the commonly owned stations represent no more than 50% of the stations in the market.
The Telecommunications Act does not eliminate the FCC's rules restricting the common ownership of a radio station and a television station in the same geographic market ("one-to-a-market rule") and the common ownership of a daily newspaper and a broadcast station located in the same geographic market. The statute, however, does relax the FCC's one-to-a-market rule by authorizing the FCC to extend its waiver policy to stations located in the 50 largest television markets. The statute also allows the common ownership of a cable television system and a television station located in the same geographic market. Finally, the statute directs the FCC to review all of its ownership rules to determine whether they continue to serve the public interest. These requirements do not require any changes in the Company's present television and radio operations.
In applying the FCC's multiple and cross ownership rules, the licensee will also have attributed to it any media interests of officers, directors and shareholders who own 5% or more of the licensee's voting stock, except that certain institutional investors who exert no control or influence over a licensee may own up to 10% of such outstanding voting stock before attribution results. These FCC rules do not require any changes in Heritage's present television and radio operations.
Irrespective of the FCC rules, the Justice Department and the Federal Trade Commission ("Antitrust Agencies") have the authority to determine that a particular transaction presents antitrust concerns. The Antitrust Agencies have recently increased their scrutiny of the television and radio industries, and have indicated their intention to review matters related to the concentration of ownership within markets (including local marketing agreements ("LMAs") even when the ownership or LMA in question is permitted under the regulations of the FCC. There can be no assurance that future policy and rulemaking activities of the Antitrust Agencies will not impact the Company's operations.
REGULATORY CHANGES. Legislation enacted by Congress called the Cable Television Consumer Protection and Competition Act of 1992 (the "Act") imposes certain regulatory requirements on the operation of cable television systems. The Act provides television stations with the right to control the use of their signals on cable television systems. Each television station was required to elect by October 1, 1996, for the period from January 1, 1997 through December 31, 1999, whether it wanted to avail itself of must-carry rights or, alternatively, to assert retransmission rights. If a television station elected to exercise its authority to grant retransmission consent, cable systems were required to obtain consent of that television station for the use of its signal and could be required to pay the television station for such use. The Company, prior to the October 1, 1996 deadline, elected must-carry for all its stations except the Fox affiliate, which successfully negotiated cable retransmission consents in association with the Fox Television Network. These elections remain in effect until October 1, 1999 when the stations again elect. The Act further requires mandatory cable carriage of all qualified local television stations not exercising their retransmission rights. Several challenges to the constitutionality of these requirements have been filed in Federal court. On December 13, 1995, a special three-judge panel of the U.S. District Court for the District of Columbia upheld the constitutionality of the provision in the Cable Television Consumer Protection and Competition Act of 1992 requiring mandatory cable carriage of all qualified local television stations not exercising their retransmission rights. An appeal of the District Court's decision is pending before the Supreme Court. In the meantime, the FCC's must- carry regulations implementing the Cable Act remain in effect. The Company cannot predict the outcome of such challenges. If the Supreme Court finds the must-carry rules to be unconstitutional, some cable systems may delete carriage of signals of some of the Company's stations and it is likely that either Congress or the FCC will attempt to enact new must-carry requirements intended to withstand constitutional scrutiny.
The Telecommunications Act lifts the prohibition on the provision of cable television services by telephone companies in their telephone areas subject to regulatory safeguards and permits telephone companies to own cable systems under certain circumstances. It is not possible to predict the impact, on the Company's television stations, of any future relaxation or elimination by the FCC of this restriction. The elimination or
further relaxation of the restriction, however, could increase the competition the Company's television stations face from other distributors of video programming.
The Telecommunications Act also authorizes the FCC to issue additional licenses for advanced television ("ATV") services only to each full-power commercial television station and certain applicants for new television stations ("Existing Broadcasters"). The Telecommunications Act directs the FCC to adopt rules to permit Existing Broadcasters to use their ATV channels for various purposes, including foreign language, niche, or other specialized programming. The FCC has issued for public comment a proposed ATV Table of Allotments intended to provide an ATV channel for each existing television station in a manner that attempts to replicate each station's existing coverage area while taking into account interference to existing television stations and between ATV stations. On December 26, 1996, the FCC adopted a standard for the transmission of digital television in the United States, which is consistent with a consensus agreement voluntarily developed by a broad cross-section of parties, including the broadcasting, equipment manufacturing and computer industries. The statute authorizes the FCC to collect fees from Existing Broadcasters who use their ATV channels to provide services for which payment is received. Prior to the enactment of the Telecommunications Act, members of Congress sought assurance from the FCC that it would not implement any plan to award spectrum for ATV service until legislation is enacted to address spectrum issues such as whether broadcasters should be required to pay for ATV licenses. In response, the FCC stated that it would not award licenses or construction permits for ATV service until legislation is enacted to address ATV spectrum issues. Such legislation, if adopted, may require Existing Broadcasters to pay for ATV licenses. Heritage cannot predict what action Congress will take with respect to the ATV spectrum or the effect of any action on the business of Heritage.
Legislation has been introduced from time to time which would amend the Communications Act in various respects and the FCC from time to time considers new regulations or amendments to its existing regulations. In addition, a number of proposals for regulatory changes are pending before the FCC. Such matters include proposals pending before the FCC to relax the rules governing the common ownership of television stations locally and nationally, to impose spectrum use or other fees on FCC licenses, to modify rules relating to political advertising, to relax the rule governing the common ownership of a television and radio station in the same market, to authorize a new type of wireless cable system, and to authorize advanced (high definition) television systems. Certain of these changes have the potential to increase operating costs and/or increase the number of competing broadcast stations. Heritage cannot predict whether such changes will be adopted or, if adopted, the effect that any such changes would have on the business of Heritage.
EMPLOYEES
Heritage and its subsidiaries employ approximately 4,400 full-time and up to 23,000 available part-time employees. Of this total, ACTMEDIA employs approximately 800 full-time and up to approximately 23,000 available part-time personnel, including POWERFORCE Services. Substantially all of ACTMEDIA's part- time personnel are field service staff. None of the In-store Marketing Group's employees are represented by a collective bargaining unit. DIMAC employs approximately 2,700 employees of which 100 employees in St. Louis are members of the Graphic Communications International Union (G.C.I.U.) Local 505. The G.C.I.U. contract runs through November 30, 1999. Heritage's broadcast subsidiaries currently employ approximately 900 employees of which 40 employees are represented by unions. The Company believes that it has a good relationship with its employees and unions.
ITEM 2.

ITEM 2. PROPERTIES.
Heritage's headquarters are located in Dallas, Texas. The lease agreement for the 13,350 square feet of office space in Dallas expires April 30, 2000. ACTMEDIA leases office facilities with an aggregate of approximately 76,000 square feet in Norwalk, Connecticut and 8,100 square feet in Des Plaines, Illinois with leases expiring in 2000 and 1998, respectively, and 46 field offices with an aggregate of approximately 111,000 square feet pursuant to leases with terms of three years or less. POWERFORCE leases office facilities in Chicago totaling 15,619 square feet under an agreement that expires June 30, 1998.
DIMAC leases a 276,000 square foot facility in St. Louis, Missouri with an expiration date in September 2015. DIMAC has 11 remote locations, including its subsidiaries, with an aggregate of approximately 484,000 square feet pursuant to leases with terms expiring from 1997 to 2002. Palm Coast owns its 120,000 square foot facility with a 30,000 square feet addition under construction with expected completion in the third quarter of 1997. DIMAC has a 245,000 square foot facility under construction in Central Islip, New York that will consolidate DIMAC eastern region and MBS Multimode; the expected completion is in the third quarter of 1997.
The types of properties required to support each of Heritage's broadcast stations include offices, studios, transmitter sites and antenna sites. A station's studios are generally housed with its offices in downtown or business districts. Heritage's television stations own approximately 74 total acres in 5 locations upon which buildings with approximately 60,000 square feet of office and studio space are located. The television stations own and lease approximately 93 acres, upon which the tower or transmitters are located. Heritage's radio stations own three AM transmitter sites totaling 58 acres and two facilities totaling 15,510 square feet. The radio stations lease approximately 47,000 square feet in six locations upon which office and studio space is located. The radio stations also lease tower space at 15 locations totaling 50 acres.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS.
Heritage is subject to litigation in the ordinary course of business. It is not subject to any such legal proceedings which management believes are likely to result in any material losses being incurred.
ITEM 4.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Shares of the Company's Common Stock are listed on the New York Stock Exchange ("NYSE") under the symbol "HTG" since July 1996. Prior to this time the Company's Common Stock was traded on the American Stock Exchange since September 1988. No other class of Heritage's common equity is currently publicly traded. The following table sets forth the high and low closing prices of the Common Stock for each quarterly period within the two most recent fiscal years:
HIGH LOW ---- --- First Quarter. . . . . . $18 1/2 $12 3/4 Second Quarter . . . . . 20 5/8 17 3/8 Third Quarter. . . . . . 21 1/8 18 1/8 Fourth Quarter . . . . . 19 1/2 10 1/2
First Quarter. . . . . . $13 5/8 $11 7/8 Second Quarter . . . . . 14 3/4 12 3/4 Third Quarter. . . . . . 16 1/8 13 1/2 Fourth Quarter . . . . . 15 12 1/2
On July 25, 1996, the Company declared a two-for-one stock split effected as a stock dividend payable to all holders of record on August 5, 1996 with the payment date of August 12, 1996. All per share information has been adjusted to reflect the stock dividend on a retroactive basis.
On March 3, 1997 the last reported sale price of the Company's Common Stock was $11.625 per share. At March 3, 1997 there were approximately 550 record holders of Common Stock.
Heritage has never paid cash dividends on shares of any class of its common stock. Heritage presently intends to retain its funds to support the growth of its business, to repay indebtedness or for other general corporate purposes and therefore does not anticipate paying cash dividends on shares of any class of its common stock in the foreseeable future. Additionally, the various financing agreements to which either Heritage or one or more of its subsidiaries is a party may effectively prohibit or sharply impact Heritage's ability to pay dividends. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capitalization and Liquidity".
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA. (In thousands, except per share data)
Set forth below is selected consolidated financial data with respect to the Company for the years ended December 31, 1996, 1995, 1994, 1993, and 1992 which were derived from the audited consolidated financial statements of the Company. This information should be read in conjunction with the audited Consolidated Financial Statements of the Company and its subsidiaries and the related notes thereto included elsewhere in this Report. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
- ------------------- (1) Information reflects acquisition and investment transactions described under Note 2 of Notes to Consolidated Financial Statements. See Item 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Some statements contained in this document are forward looking and actual results may differ materially. Statements not based on historical facts involve risks and uncertainties, including, but not limited to, the effect of economic conditions, capacity and supply constraints or difficulties, actual purchases under agreements by certain of the Company's largest clients, and the ability of the Company to maintain favorable client relationships and competitive factors.
GENERAL
In February 1994, ACTMEDIA completed the acquisition of in-store marketing companies located in Australia and New Zealand. In March 1994, Heritage completed the acquisition of KRJY-FM in the St. Louis market. In October 1994, the Company completed the sale of the assets of KDLT-TV located in Sioux Falls, South Dakota. In October 1994, ACTMEDIA Canada, Inc. acquired Infonet.
In January 1995, ACTMEDIA completed the acquisition of POWERFORCE Services located in Chicago. In June 1995, Heritage purchased KXYQ-FM in Portland, Oregon and changed the call letters to KKRH-FM. In March 1995, the Company agreed to acquire radio station KKCJ-FM in Kansas City, changed the call letters to KCIY- FM, and began programming and marketing the station under a LMA, the acquisition was completed in July 1995. In December 1995, ACTMEDIA wrote off its Netherlands in-store investment Media Meervoud.
In February 1996, Heritage completed its merger with DIMAC Marketing Corporation. In February 1996, DIMAC acquired Wilcox & Associates, Inc. ("Wilcox"), a New York City based direct response advertising agency. Also in February 1996, the Company completed the acquisition of radio stations WMYU-FM and WWST-FM serving Knoxville, Tennessee. In March 1996, the Company agreed to exchange its Seattle, Washington radio stations KCIN-FM and KRPM-AM for EZ Communications, Inc. radio stations WRNO-FM, WEZB-FM and WBYU-AM serving New Orleans, Louisiana. The Company included the financial results of the New Orleans stations from March 18, 1996 under the terms of a LMA. In March 1996, the Company entered into a LMA with Television Fit for Life, Inc. to operate Channel 35, WFGX-TV in Fort Walton Beach, Florida. The Company began operating WFGX-TV in July 1996 as a commercial television station. In April 1996, DIMAC acquired MBS/Multimode, Inc. ("MBS"), a database marketing firm based in Huntington Station, New York. In August 1996, the Company agreed to acquire an additional Rochester, New York, radio station, WHRR-FM. The Company began operating the station under a LMA on September 1, 1996 and changed the call letters to WQRV-FM. The acquisition was completed in January 1997. In September 1996, DIMAC formed a marketing services joint venture with Community Television of Southern California (CTSC) a public television station. DIMAC retains majority ownership of the joint venture. Also in September 1996, the Company agreed to purchase two additional radio stations in Kansas City, Missouri, KXTR-FM and KCAZ-AM. Included in this transaction is a small monthly business magazine which was sold in February 1997. No revenue or operating income was reported in the 1996 consolidated financial statements. The purchase was completed in January 1997. In February 1996, the Company completed the sale of its smallest television station, KEVN-TV, located in Rapid City, South Dakota.
Due to the numerous acquisitions, dispositions, and financing activities, the results of operations from year to year are not comparable. See Note 2 of Notes to Consolidated Financial Statements for additional information concerning the Company's acquisitions, dispositions, and related transactions.
RESULTS OF OPERATIONS: 1996 COMPARED TO 1995
Consolidated net revenues of $620.8 million increased 42% over the 1995 revenues of $435.8 million. Operating income of $94.9 million in 1996 exceeded the comparable 1995 period by 30%. Pretax income of $46.4 million in 1996, before extraordinary item, exceeded the $35.7 million in 1995 by 30%. Earnings per share, before extraordinary item, was $.60 in 1996 versus $.75 per share in 1995. The improved operating results reflect the inclusion of DIMAC Marketing Corporation, effective February 1, 1996, and increased operating income from the Marketing Services and Broadcasting segments. Consolidated net revenues and operating income increased 5% and 4%, respectively, in 1996 versus the 1995 period on a proforma basis including all acquisitions and dispositions. The 1996 period included a $6 million gain on the sale of the South Dakota television station, a $1.1 million loss on the write-off of obsolete fixed assets, and a $2.9 million extraordinary loss on the extinguishment of debt.
MARKETING SERVICES. The Marketing Services segment contributed $521.2 million of revenues in 1996, an increase of 51%, compared to $346.4 million in 1995. The inclusion of DIMAC results added $173.9 million in revenues as ACTMEDIA's revenues were level to 1995. Marketing Services revenues in 1996 increased 4% versus comparable 1995 including DIMAC in both periods. ACTMEDIA's growth of Instant Coupon Machine and advertising revenues were offset by lower promotion and merchandising revenues. DIMAC generated proforma revenue improvement of 11% over prior year.
Operating income for the Marketing Services segment of $70.1 million in 1996 significantly increased versus $50.5 million in 1995. The inclusion of DIMAC's results in 1996 added $14.4 million and ACTMEDIA generated $5.2 million of operating income growth. Marketing Services operating income in 1996 was level with comparable 1995 including DIMAC in both periods. ACTMEDIA's 10% improvement of operating income was offset by DIMAC's lower operating income due to $6.7 million of increased amortization of intangibles associated with the merger.
BROADCASTING. The Broadcasting segment generated $99.6 million of revenues in 1996, an 11% increase compared to 1995. The Television Group, excluding the South Dakota station sold in 1996, grew revenues by 9% to $46.3 million primarily due to a 6% growth of local revenues and $3.1 million of additional political revenues. National spot revenues decreased 4% in 1996 versus 1995. The Pensacola, FL television station grew revenues by 20% in 1996 versus 1995. The Radio Group contributed $53.3 million of revenues, a 9% increase over 1995, on a same station basis, due primarily to an 11% growth of local revenues and a 10% increase in national revenues.
Operating income of $29.7 million in 1996 increased by 21% versus 1995 including the radio acquisitions and excluding the television station sold in 1996. The improvement reflects a 6% increase from the Television Group, despite a $1.6 million increase in the Oklahoma station news operation expenses, and a 47% increase from the Radio Group primarily from the improvement of the Portland and Kansas City duopolies, the Cincinnati station and positive contributions from the New Orleans and Knoxville acquisitions.
CORPORATE EXPENSES. Corporate expenses of $5 million in 1996 increased from $3.9 million in 1995, but remained less than 1% of consolidated net revenues.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization of $45.2 million in 1996 increased by 48% compared to $30.6 million in 1995. This increase resulted primarily from the inclusion of DIMAC, which added $12.8 million, a $.8 million increase in Radio Group amortization associated with acquisitions, and $.7 million additional ACTMEDIA depreciation associated with higher capital expenditures.
INTEREST EXPENSE. Interest expense increased from $34.7 million in 1995 to $52.9 million in the 1996 period due to both higher interest rates and higher debt levels associated with the DIMAC acquisition.
OTHER EXPENSE. Other expense in 1996 included the $6 million gain on the sale of the South Dakota television station and a $1.1 million loss on the write-off of obsolete In-store Marketing fixed assets.
INCOME TAXES. Income tax expense for 1995 relates primarily to Federal income tax of $6.3 million and state and foreign income taxes of $2.8 million. Income tax expense for 1996 is comprised of Federal income tax of $19.6 million and state, local and foreign taxes of $4.8 million. Income tax expense in 1995 was reduced by the utilization of the Company's remaining net operating loss carryforwards.
EXTRAORDINARY ITEM. Heritage Media Services, Inc. ("HMSI"), a wholly-owned subsidiary, repurchased the Company's outstanding 11% Senior Subordinated Notes with a cumulative face amount totaling $25.5 million prior to scheduled maturity and recognized an extraordinary loss of $1.3 million, net of taxes, during 1996. Also in 1996, HMSI repurchased outstanding 11% Senior Notes with a face amount totaling $27.2 million prior to scheduled maturity and recognized a year-to-date extraordinary loss of $ 1.6 million, net of taxes, which included the write-off of $ .4 million of debt issuance costs.
NET INCOME. The Company improved its pretax income, before extraordinary item, from $35.7 million in 1995 to $46.4 million in 1996 primarily as a result of an additional $21.9 million of operating income and $4.9 million of net nonrecurring other income, reduced by increased interest expense. Net income of $19.1 million in 1996 decreased versus $26.6 million in 1995 due to the significant increase in Federal income tax expense (discussed above) and the $2.9 million extraordinary loss on the extinguishment of debt (see Note 4 of Notes to Consolidated Financial Statements).
BALANCE SHEET: 1996 COMPARED TO 1995
The balance sheet changes from December 31, 1995 to December 31, 1996 were primarily due to the DIMAC, Wilcox, MBS and radio station acquisitions and respective financings. See Note 2 to the Consolidated Financial Statements for purchase price allocation and Note 4 for long-term debt discussion.
RESULTS OF OPERATIONS: 1995 COMPARED TO 1994
Consolidated net revenues of $435.8 million in 1995 represented a 37% increase over the 1994 revenues of $317.6 million. Operating income of $73.0 million in 1995 exceeded the comparable 1994 period by 26%. The earnings per share was $.75 versus $.08 in 1994. The improvement in the Company's operating results for the 1995 period primarily reflects revenue growth from all of the In-store Marketing Group's products, the addition of POWERFORCE Services and increased Broadcasting advertising revenues. The earnings per share improvement in 1995 versus 1994 was due principally to $15.2 million of additional operating income reduced by higher interest expense and income taxes. The 1995 period included an $.8 million write-down of television program rights, a $3.6 million write-off of the Netherlands investment, and an $.8 million gain on sale of assets. The 1994 period included a $4.9 million non-cash expense for stock appreciation rights. The 1994 period also included the $.57 per share impact of settlement rights accretion and dividends. All comparisons, unless otherwise noted, are for the year ended December 31, 1995 versus the comparable 1994 period.
MARKETING SERVICES In-store Marketing contributed $346.4 million of revenues in 1995, an increase of 51%, compared to $230.1 million in 1994. All of the group's product revenues increased versus 1994. Advertising and promotion revenues each improved by 20%. ICM revenues grew 14%. International revenues increased by 49% to $34.7 million in 1995 due primarily to the merger of Infonet into and the growth of the Canadian operation. POWERFORCE Services added $68.8 million of revenues in its first year with ACTMEDIA. The demonstration and sales merchandising businesses experienced increased competition which has adversely affected pricing.
The Netherlands investment, Media Meervoud, continued to incur losses in 1995. ACTMEDIA management's evaluation of the business concluded that the operation would not be funded beyond December 31, 1995. ACTMEDIA completed the sale in February 1996 and wrote-off its $3.6 million investment as of December 31, 1995.
In-store Marketing operating income of $50.5 million increased by 36% from $37.2 million in the 1994 period due primarily to the increased 1995 revenues and an improvement in the group's operating margin, excluding the POWERFORCE acquisition. The operating margin was 14% in 1995 versus 16% in 1994. Excluding the operating results of POWERFORCE, which operates with a higher level of variable expenses, In-store Marketing's operating margin increased to 18% in 1995.
BROADCASTING. The Television Group generated $45.6 million of revenues in 1995, a 2% decline compared to $46.7 million in 1994. Revenues improved 2% compared to 1994 on a same station basis. The Television Bureau of Advertising Times Sales Survey reported that industry-wide gross local revenues increased by 5% and national revenues were up 1% compared to 1994. The Television Group's local revenues increased 2% and national revenues improved 12% compared to the 1994 period on a same station basis. Network compensation increased $.9 million in 1995 versus 1994. The 1995 period included $.5 million political revenues versus $3.3 million in 1994. All of the Television Group's stations, except Charleston, WV, generated improved revenues and operating income in 1995 compared to 1994.
Operating income of $17.0 million increased by 13% compared to 1994 on a same station basis, excluding the 1995 $.8 million write-down of program rights, primarily as a result of higher revenues and reduced expenses. The operating margin improved from 35% in 1994 to 37% in 1995.
Net revenues of the Radio Group increased by 7% from $40.8 million in 1994 to $43.8 million in 1995. The Radio Advertising Bureau reported that total revenues grew by 7% (local up 8%, national up 3%) in the industry in the comparable period. Revenues for the stations owned for all of both periods increased 4% primarily as a result of improved station ratings. The radio stations acquired in 1995 contributed $1.6 million of the revenue increase. The 1994 period included $.5 million of political revenues. The significant contributors to the growth were the St. Louis and Rochester duopolies and the Kansas City station. The Cincinnati station's revenues declined significantly due to the previously discussed format competition. However, the station achieved the number four rank in the market in the fourth quarter after the format change to smooth jazz.
Operating income grew from $8.7 million in 1994 to $9.4 million in 1995 primarily as a result of the improved revenues by the stations owned for all or both periods as a $1.2 million operating loss was incurred by the stations acquired in 1995. The operating margin improved from 21% in 1994 to 25% in 1995 on a same station basis.
CORPORATE EXPENSES. Corporate expenses in 1995 of $3.9 million increased 4% compared to $3.7 million in 1994.
OTHER OPERATING EXPENSES. The 1995 period included a $.8 million writedown of television program rights as a result of management's assessment of their realizable value (based upon projected future utilization of the programs). The 1994 period included a $4.9 million non-cash expense for stock appreciation rights (see Note 9 of Notes to Consolidated Financial Statements).
DEPRECIATION AND AMORTIZATION. Depreciation and amortization of $30.6 million in 1995 increased by 12% compared to $27.3 million in 1994 due primarily to additional In-store Marketing depreciation associated with a higher fixed asset base and additional amortization attributed to acquisitions.
INTEREST EXPENSE. Interest expense increased from $30.4 million in 1994 to $34.7 million in 1995 due to higher interest rates and higher debt levels.
OTHER EXPENSES. The 1995 results of operations included the non-cash $3.6 million write-off of MMV. Included in the 1994 results was a $1.4 million non- cash charge to reflect the loss on the sale of television station KDLT-TV.
INCOME TAXES. Income tax expense for 1994 relates primarily to state income taxes. Income tax expense for 1995 is comprised of Federal income tax of $6.4 million and state, local and foreign taxes of $2.7 million. Income tax expense in 1995 was reduced by the recognition of the Company's remaining net operating loss carryforwards of approximately $25 million. In addition, the utilization of approximately $13 million of restricted net operating carryforwards in 1995 was credited to goodwill as such carryforwards were not recognized as deferred tax assets upon acquisition of the related entities in prior periods.
NET INCOME. Primarily as a result of an additional $15.2 million of operating income, reduced by $4.3 million additional interest and $6.4 million incremental taxes, the Company improved its net income from $22.2 million in 1994 to $26.6 million in 1995. Net income applicable to common stock reflects settlement rights accretion of $19.5 million and preferred dividends of $.1 million in 1994.
CASH FLOW INFORMATION
Cash flows provided by operating activities totaling $61.8 million in 1996 increased by $8 million versus 1995 due primarily to higher non-cash items and lower working capital requirements. In 1996 the $61.8 million of cash provided by operating activities, $176.2 million from financing activities, and $13.8 million of asset sale proceeds, were utilized primarily for acquisitions, net ($220.9 million) and capital expenditures ($31.3 million).
Cash flows provided by operating activities totaled approximately $53.8 million in 1995 increased by $4 million versus 1994. These funds were principally utilized for net capital expenditures ($15.1 million), acquisitions ($19 million), and reduction of long-term debt ($12.5 million).
LIQUIDITY AND CAPITAL RESOURCES
The Company expects the major operating requirements for cash in 1997 to include $12 million to complete contractually committed acquisitions, approximately $8 million for earnout payments related to the DIMAC acquisition, approximately $29 million for leases and other contractual obligations, and approximately $38 million for capital expenditures. Capital expenditures are expected to increase in 1997 to higher levels due to the construction and expansion of DIMAC facilities on Long Island, NY ($11 million) and Palm Coast, FL ($2 million) and the construction of the television station in Burlington, VT ($2 million). Heritage also has long-term debt maturities totaling $69.8 million during 1997.
The Company expects to fund its anticipated cash requirements with internally generated funds and from various external sources, which may include the Company's existing credit agreements and additional financings. Heritage maintains significant borrowing capacity to take advantage of growth and investment opportunities. At December 31, 1996 the Company had committed bank lines of credit totaling $285.7 million and available liquidity totaling $57.8 million for general corporate purposes.
During 1996, HMSI purchased the Company's outstanding 11% Senior Subordinated Notes with cumulative face amount totaling $25.5 million prior to maturity. Also during 1996, HMSI repurchased outstanding 11% Senior Notes with a face amount totaling $27.2 million. HMSI entered into a $50 million bank credit facility to refinance a portion of the 11% Senior Secured Notes. At December 31, 1996 $29.6 million of the facility was outstanding and $20.4 million of additional borrowings were available.
The Company was in compliance with all debt covenants and had satisfied all financial ratios and tests as of December 31, 1996 under its Credit Agreements and the Company expects to remain in compliance and satisfy all such financial ratios and tests during 1997. The Company manages its debt levels based on: the ratio of debt to EBITDA, which has been reduced from 5.89 in 1992 to 4.28 in 1996; and the ratio of EBITDA to interest, net which has increased from 1.45x to 2.65x in 1996. However, the Company is still highly leveraged and is expected to have a high level of debt for the foreseeable future. See Note 4 of Notes to consolidated Financial Statements for further discussion and details.
On January 14, 1997, the Company entered into a $50 million bank credit facility (the "1997 HMC Credit Facility") for general corporate purposes. The 1997 HMC Credit Facility consists of a $50 million revolving credit facility which matures January 12, 1998. The credit agreement includes a number of financial and other convenants, and loans under this agreement are unsecured. As of February 21, 1997, there were no outstanding borrowings under this facility.
The HMSI 11% Senior Notes are redeemable in whole or in part, at HMSI's option at any time on or after June 15, 1997. The 11% HMC Senior Subordinated Notes are redeemable, in whole or in part, at the Company's option at any time on or after October 1, 1997. The Company expects to redeem such notes in 1997, replace the existing bank credit facilities and provide additional liquidity through the use of new replacement indebtedness.
Heritage will continue to expand and explore value-creating investments and acquisitions. The Company will review all expenditures to maximize financial returns and maintain financial flexibility while continuing its long-term goal to de-leverage its capital structure.
SHAREHOLDERS EQUITY
In conjunction with efforts to enhance common shareholder value, on October 14, 1996, the Board of Directors authorized the purchase of up to 5,000,000 shares of the Company's Common Stock, from time to time, through open market and private purchases at prices then prevailing. The Company has purchased, in 1996 and 1997 to date, 891,000 shares at a total cost of $9,945,855 and an average price of $11.16 per share.
RECENTLY ISSUED ACCOUNTING PRINCIPLES
In June 1996, the Financial Accounting Standards Board issued SFAS No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES. SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and is to be applied prospectively. This Statement provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Management of the Company does not expect that adoption of SFAS No. 125 will have a material impact on the Company's financial position, results of operations, or liquidity.
FOREIGN EXCHANGE
The Company has foreign operations, primarily in Canada, and Australia/New Zealand. Exchange rate fluctuations between the currencies of these countries and the U.S. Dollar result in the translation and reporting of carrying amounts of foreign investments which vary from year-to-year in the Company's consolidated financial statements. Based on the current scope of its foreign operations, the Company believes that any such fluctuations would not have a material adverse effect on the Company's consolidated financial condition or results of operations as reported in U.S. Dollars.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements and financial statement schedules of Heritage Media Corporation and Subsidiaries as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 are included on pages through herein.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
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ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Certain information in response to this item is incorporated by reference to the disclosure contained under the heading "Directors and Executive Officers" in the Proxy Statement.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION.
Certain information in response to this item is incorporated by reference to the disclosure contained under the heading "Directors and Executive Officers" in the Proxy Statement.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information in response to this item is incorporated by reference to the disclosure contained under the headings "Principal Stockholders" and "Directors and Executive Officers" in the Proxy Statement.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information in response to this item is incorporated by reference to the disclosure contained under the heading "Directors and Executive Officers" in the Proxy Statement.
PART IV
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ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
(1) Financial Statements:
Financial Statements to this form are listed in the "Index to Consolidated Financial Statements" at page.
(2) Schedules:
Financial statement schedules to this form are listed in the "Index to Consolidated Financial Statements" at page herein.
(3) Exhibits:
See "Exhibit Index" included herein.
Registrant agrees to furnish, upon the request of the Commission, a copy of all constituent instruments defining the rights of holders of long-term debt of Registrant and its consolidated subsidiaries.
(b) Reports on Form 8-K.
The Company filed a Report on Form 8-K dated December 11, 1995 (subsequently amended by Forms 8-K/A dated January 4, 1996 and January 17, 1996) with respect to the Company's agreement and plan of merger with DIMAC Corporation. Such report contains consolidated financial statements of DIMAC Corporation; combined financial statements of T.R. McClure and Company, Inc. and related companies; financial statements of Palm Coast Data, Ltd.; and pro forma condensed combined financial statements of the Company.
Pursuant to the requirement of Section 13 or 15(d) 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 on March 10, 1997.
HERITAGE MEDIA CORPORATION
By /s/ DAVID N. WALTHALL ------------------------------------ David N. Walthall President Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ JAMES M. HOAK, JR. Chairman of the Board and Director March 10, 1997 - ----------------------- James M. Hoak, Jr.
/s/ DAVID N. WALTHALL President, Chief Executive Officer March 10, 1997 - ----------------------- and Director (Principal Executive David N. Walthall Officer)
/s/ JAMES P. LEHR Senior Vice President - ----------------------- Chief Accounting & Administrative March 10, 1997 James P. Lehr Officer (Principal Accounting Officer)
/s/ JAMES S. COWNIE Director March 10, 1997 - ----------------------- James S. Cownie
/s/ JOSEPH M. GRANT Director March 10, 1997 - ----------------------- Joseph M. Grant
/s/ CLARK A. JOHNSON Director March 10, 1997 - ----------------------- Clark A. Johnson
/s/ ALAN R. KAHN Director March 10, 1997 - ----------------------- Alan R. Kahn
/s/ H. BERRY CASH Director March 10, 1997 - ----------------------- H. Berry Cash
HERITAGE MEDIA CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS "FORM 10-K"
DECEMBER 31, 1996 AND 1995
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGE ----
Consolidated Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
Financial Statement Schedules:
I. Condensed Financial Information of Registrant as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994
II. Valuation and Qualifying Accounts for the years ended December 31, 1996, 1995 and 1994
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Heritage Media Corporation:
We have audited the consolidated financial statements of Heritage Media Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Heritage Media Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
Dallas, Texas February 21, 1997
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS, EXCEPT SHARE INFORMATION)
See accompanying notes to consolidated financial statements.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(DOLLARS IN THOUSANDS)
See accompanying notes to consolidated financial statements.
HERITAGE MEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Heritage Media Corporation ("HMC" or "the Company") operates in two segments - Marketing Services and Broadcasting. The Company's Marketing Services segment includes ACTMEDIA, Inc.'s ("ACTMEDIA") in-store marketing operations in the United States, Canada, New Zealand, and Australia and DIMAC Marketing Corporation's ("DIMAC") direct marketing operations in the United States. The Broadcasting segment includes Television and Radio operations in the United States.
(a) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.
(b) GOODWILL AND OTHER INTANGIBLES
The cost of acquired companies is allocated first to identifiable assets and liabilities based on estimated fair market values. The excess of cost over identifiable assets and liabilities is recorded as goodwill. Costs allocated to identifiable intangible assets are amortized over the remaining estimated useful lives of the assets as determined by underlying contract terms or independent appraisals.
Goodwill and other intangibles at December 31, 1996 and 1995 are summarized as follows (thousands of dollars):
The Company continually reevaluates the propriety of the carrying amount of goodwill as well as the related amortization period to determine whether current events and circumstances warrant adjustments to the carrying values and/or revised estimates of useful lives. This evaluation is based on the Company's projection of the undiscounted operating income before depreciation, amortization and interest over the remaining lives of the amortization periods of related goodwill. The projections are based on the historical trend line of actual results since the commencement of operations and adjusted for expected changes in operating results. To the extent such projections indicate that the undiscounted operating income (as defined above) is not expected to be adequate to recover the carrying amounts of goodwill, such carrying amounts are written down by charges to expense in amounts equal to the excess of the carrying amount of goodwill over related undiscounted operating income. The assessment of the recoverability of goodwill will be impacted if estimated operating income is not achieved. At this time, the Company believes that no impairment of the goodwill and other intangibles has occurred and that no reduction of the estimated useful lives is warranted.
(c) INVENTORIES
Inventories are stated at the lower of average cost or market for in- store marketing and the lower of cost (first-in, first-out method) or market for direct marketing.
(d) PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation is provided by the straight-line method over the estimated useful lives of the assets. The useful lives and the amounts of the Company's property and equipment at December 31, 1996 and 1995 are as follows (thousands of dollars):
The Company recorded writedowns of obsolete in-store marketing equipment of $1,111,000 in 1996 in connection with the Company's in- store radio marketing delivery system.
(e) BROADCAST PROGRAM RIGHTS
Broadcast program rights are recorded as assets and liabilities at their gross amounts when the programs are available for telecasting. The assets are carried at the lower of cost or estimated net realizable value and are classified as current or noncurrent based upon the expected use of the programs in succeeding years. The contract liabilities are classified as current or noncurrent in accordance with contract payment terms. Costs are charged to operations by the straight-line method over the contract period.
(f) OTHER ASSETS
Debt issuance costs are amortized to interest expense using the interest method over the period of the related debt agreement.
(g) REVENUES
Revenues from in-store marketing are derived primarily from providing advertising, promotion and production services in retail stores and by selling advertising time to national advertisers on an in-store music entertainment network. Revenues from in-store marketing are recognized over the contract period of the related advertising program as the services are performed and revenues from advertisements on the in-store music network are recognized when the commercial is aired. Advance payments received from advertisers relating to contracted in- store marketing advertising programs are
recorded as deferred advertising revenues until they are earned. DIMAC performs services in accordance with individual client projects. Revenues are generally recognized as services are performed and DIMAC can reasonably determine the amount of revenue to be recognized.
Broadcasting revenues are derived primarily from local, regional and national advertising and network compensation. Advertising revenues are recognized upon the airing of commercials, while network revenues are recognized monthly as earned. Revenues are presented net of advertising agency and national sales representatives' commissions.
(h) BARTER TRANSACTIONS
The Company exchanges unsold advertising time for products and services. These transactions are reported at the estimated fair value of the product or service received. Barter revenues are recorded when the commercials are broadcast and barter expenses are recorded when merchandise or services are used. If merchandise or services are received prior to the broadcast of a commercial, a liability is recorded. Likewise, a receivable is recorded if a commercial is broadcast before the goods or services are received. Barter amounts are not significant to the Company's consolidated financial statements.
(i) EARNINGS PER SHARE
Earnings per common share is computed by dividing net income, adjusted for accretion and premium on retirement of the settlement rights and dividends on preferred stock for 1994, by the weighted average number of common shares outstanding during each year. The common stock equivalent effect of common stock purchase options, preferred stock and settlement rights have been excluded from the computation for 1995 and 1994 as their effect is either antidilutive or immaterial. Following is a reconciliation of net income to net income applicable to common stock for the year ended December 31, 1994 (thousands of dollars):
Net income $ 22,299 Accretion and premium on retirement of settlement rights (note 5) (19,503) Dividends on preferred stock (148) -------- Net income applicable to common stock $ 2,648 -------- --------
(j) INCOME TAXES
The Company provides for deferred taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for net operating loss carryforwards and the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(k) FOREIGN CURRENCY TRANSLATION
For foreign operations, the balance sheet accounts are translated at the current year-end exchange rate and income statement items are translated at the average exchange rate for the year. Resulting translation adjustments are presented as a separate component of stockholders' equity. Foreign transaction exchange gains and losses are recognized as income or expense; such amounts were not material in any of the years presented.
(l) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, on January 1, 1996. This Statement requires that long- lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount of fair value less costs to sell. Initial adoption of this Statement, as of January 1, 1996, did not have a material impact on the Company's financial position, results of operations, or liquidity.
(m) DERIVATIVE FINANCIAL INSTRUMENTS
The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Such financial instruments are used to manage well-defined interest rate risks related to interest on the Company's outstanding debt.
As interest rates change under interest rate swap agreements, the differential to be paid or received is recognized as an adjustment to interest expense. The Company is not exposed to credit risk as its interest rate swap agreements are with the participating banks under the Company's senior credit facility.
(n) DISCLOSURE OF CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
In the opinion of management, credit risk with respect to trade receivables is limited due to the large number of diversified customers and the geographic diversification of the Company's customer base. The Company performs ongoing credit evaluations of its customers and believes that adequate allowances for any uncollectible trade receivables are maintained. At December 31, 1996 and 1995, no receivable from any customer exceeded 5% of stockholders' equity and no customer accounted for more than 10% of net revenues in 1996, 1995 or 1994.
(o) RECLASSIFICATIONS
Certain reclassifications have been made in the prior years' consolidated financial statements to conform to the 1996 presentation.
(2) ACQUISITIONS AND DISPOSITIONS
(a) MARKETING SERVICES
In February 1996, the Company completed its acquisition of DIMAC Marketing Corporation, one of the leading full service, vertically integrated direct marketing services companies in the United States. The Company acquired DIMAC for cash in a transaction valued at approximately $260 million. Under the terms of the merger agreement, each of the approximately 6.5 million shares of DIMAC common stock were exchanged for merger consideration of $28 per share. The merger was accounted for by the Company as a purchase. Goodwill resulting from the acquisition of $220 million is being amortized on a straight- line basis over 40 years. The Company included the financial results of DIMAC beginning February 1, 1996.
On February 28, 1996, DIMAC acquired substantially all of the assets of Wilcox & Associates, Inc., a subchapter S corporation providing direct response advertising services to bank institutions, in a purchase transaction. The purchase price was $3.9 million plus assumption of certain specified liabilities of $1.6 million. Goodwill resulting from the acquisition of $3.0 million is being amortized on a straight-line basis over 40 years. The Company included the financial results of Wilcox & Associates beginning March 1, 1996.
On April 30, 1996, DIMAC acquired substantially all of the assets of MBS/Multimode, Inc., a database marketing firm based in Huntington Station, New York for $24.7 million, plus the assumption of certain specified liabilities. The acquisition was accounted for as a purchase. Goodwill resulting from the acquisition of $22.4 million is being amortized on a straight-line basis over 25 years. The Company included the financial results of MBS/Multilmode, Inc. beginning May 1, 1996.
(b) BROADCASTING
During the years ended December 31, 1996, 1995 and 1994, the Company acquired the following FM radio stations (thousands of dollars):
Station/Market Date Cost -------------- ---- ---- WEZW/Milwaukee, WI January 6, 1994 $6,021 KRJY/St. Louis, MO March 15, 1994 7,754 KXYQ/Portland, OR June 15, 1995 7,397 KKCJ/Kansas City, MO July 25, 1995 7,785 WMYU and WWST/Knoxville February 17, 1996 6,500
In February 1996, the Company completed the sale of KEVN-TV, Rapid City, South Dakota. As result of this sale, the Company recognized a gain of $6.0 million.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The acquisitions discussed above were accounted for as purchases and recognized in the consolidated financial statements as follows (thousands of dollars):
(c) PRO FORMA INFORMATION (UNAUDITED)
The following summary presents selected unaudited pro forma consolidated information for the Company assuming the marketing services and broadcasting acquisitions had occurred as of the beginning of 1996 and 1995, after giving effect to certain adjustments, including amortization of goodwill and other intangibles, increased interest expense on debt related to the acquisitions, and related income tax effects (thousands of dollars, except per share information):
Years ended December 31, ------------------------ 1996 1995 -------- ------- Net revenues $639,061 572,276
Net income 18,217 12,248
Net earnings per common share $ .50 .35
The pro forma amounts assume that the financing requirements of the acquisitions were met by actual debt issuances, assuming that all such financings were completed as of the beginning of 1996 and 1995. The pro forma amounts are not necessarily indicative of what the results would actually have been if the transactions had been consummated earlier and are not intended to be an indication of operating results expected to be achieved in the future.
(d) SUBSEQUENT EVENTS
On January 7, 1997, the Company completed the purchase of the assets of WHRR-FM serving Rochester, New York for $1.9 million. On January 24, 1997 the Company completed the purchase of the assets of KXTR-FM serving Kansas City, Missouri for $9.7 million.
On January 21, 1997, the Company announced plans to trade its Knoxville, Tennessee stations, WMYU-FM and WWST-FM for KQRC-FM serving Kansas City in a like-kind exchange. On February 18, 1997, the Company announced plans to exchange WVAE-FM, its station in Cincinnati, for WGH-FM, WVCL-FM, and WGH-AM serving Norfolk, Virginia plus $5 million cash. The Company will operate the Norfolk stations under a Local Management Agreement ("LMA"). Both transactions are subject to approval by the FCC.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(3) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1996 and 1995 are summarized as follows (thousands of dollars):
1996 1995 -------- ------ Accounts payable $ 35,968 17,329 Payroll and employee benefits 16,189 8,314 Taxes payable 15,429 1,386 Store commissions 11,676 8,906 Interest 7,426 2,423 Accrued promotion costs 3,064 3,757 License fees 346 511 Other 24,690 9,443 -------- ------ $114,788 52,069 -------- ------ -------- ------
(4) LONG-TERM DEBT
Long-term debt at December 31, 1996 and 1995 is summarized as follows (thousands of dollars):
1996 1995 -------- ------- Senior notes(a) $122,845 150,000 Credit agreements(b) 257,500 113,400 1992 Senior subordinated notes(c) 24,520 50,000 1996 Senior subordinated notes(d) 175,000 -- Canadian credit agreement(e) 13,317 15,674 Other(f) 6,987 10,791 -------- ------- 600,169 339,865 Less current installments 69,775 5,026 -------- ------- $530,394 334,839 -------- ------- -------- -------
(a) Heritage Media Services, Inc. ("HMSI") a wholly owned subsidiary, issued $150 million of 11% Senior Secured Notes (the "Senior Notes") due June 15, 2002. The Senior Notes are redeemable, in whole or in part, at HMSI's option at any time on or after June 15, 1997, at amounts decreasing from 105.5% to 100% of par on June 15, 1999. The Senior Notes rank on a parity with the obligations of HMSI under its credit agreement, are guaranteed by HMC and HMSI's domestic subsidiaries and are secured by a pledge of capital stock of HMSI and its domestic subsidiaries. During 1996, HMSI repurchased $27.2 million of the Senior Notes and recognized a $1.6 million extraordinary loss related to the extinguishment of debt.
(b) HMSI maintains a credit agreement (the "1992 Credit Agreement") with a group of banks providing for a $76.4 million term loan and a reducing revolving credit facility of up to $75 million. Quarterly principal payments under the 1992 Credit Agreement commence on March 31, 1997 and continue until June 1999, when the balance is due. At December 31, 1996, $76.4 million of the term facility and $70.5 million of the revolving credit facility were outstanding and $4.5 million of additional borrowings were available under this credit facility. HMSI pays an annual commitment fee equal to 0.5% of the unadvanced portion of the 1992 Credit Agreement. Loans under the 1992 Credit Agreement bear interest at rates based on the agent bank's base rate, a Eurodollar rate or a CD rate plus a margin depending on HMSI's ratio of consolidated total debt to
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
operating cash flow (as defined). At December 31, 1996, the interest rates were 6.5% - 8.5% under the Eurodollar and base rate options. The loans under the 1992 Credit Agreement are secured by the stock of substantially all subsidiaries of the Company.
On February 21, 1996, the Company, through DIMAC, entered into a $175 million bank credit facility (the "DIMAC Credit Agreement") with a group of banks to refinance the long-term obligations acquired through the DIMAC merger and to assist in funding the balance of the transaction. The DIMAC Credit Agreement is comprised of a $50 million term loan which begins to amortize September 30, 1997, continuing until June 30, 2003 and a $125 million reducing revolving credit facility. The revolving credit commitment will reduce quarterly beginning March 31, 1998. Loans under the DIMAC Credit Agreement bear interest at rates based on the agent bank's base rate or a Eurodollar rate plus a margin depending on DIMAC's total leverage ratio (as defined). At December 31, 1996, $50 million of the term loan and $31.0 million of the revolver were outstanding, all at the Eurodollar rate less than 6.7% at December 31, 1996, and $53.3 million of additional borrowings were available under this credit facility. The remaining $40.7 million of the credit facility was unavailable due to certain financial covenants. As DIMAC's trailing twelve month operating cash flow (as defined) increases, the available portion of the credit facility will gradually increase, eventually resulting in the availability of the full $175 million. Loans under the DIMAC Credit Agreement are guaranteed by the Company and DIMAC's subsidiaries and are secured by a pledge of the capital stock of DIMAC and its subsidiaries.
On May 31, 1996, the Company through HMSI, entered into a $50 million bank credit facility (the "1996 HMSI Credit Facility") to refinance a portion of its existing 11% Senior Secured Notes due June 15, 2002. The 1996 HMSI Credit Facility consists of a $50 million revolving credit facility which matures December 31, 1997. At December 31, 1996, $29.6 million of the facility was outstanding and $20.4 million of additional borrowings were available. Loans under the 1996 HMSI Credit Facility are guaranteed by the Company and HMSI's domestic subsidiaries and are secured by a pledge of the capital stock of HMSI and its domestic subsidiaries.
(c) The Company issued $50 million of 11% Senior Subordinated Notes ("the 1992 Senior Subordinated Notes") due October 1, 2002. The 1992 Senior Subordinated Notes are redeemable, in whole or in part, at the Company's option at any time on or after October 1, 1997, at amounts decreasing from 105.5% to 100% of par at October 1, 1999. The 1992 Senior Subordinated Notes rank on a parity with the 8.75% Senior Subordinated Notes discussed below and are subordinated to all other indebtedness of the Company and its subsidiaries. During 1996, HMSI repurchased $25.5 million of the Company's 1992 Senior Subordinated Notes and recognized a $1.3 million extraordinary loss related to the extinguishment of debt.
(d) On February 20, 1996 the Company issued $175 million of 8.75% Senior Subordinated Notes (the "1996 Senior Subordinated Notes") due February 15, 2006, to assist in funding the Company's merger with DIMAC. Interest on the 1996 Senior Subordinated Notes is payable semi- annually. The 1996 Senior Subordinated Notes rank on a parity with the 1992 Senior Subordinated Notes and are subordinated to all other indebtedness of the Company and its subsidiaries.
(e) The Company's Canadian subsidiary maintains a credit agreement with one Canadian bank providing for a Cdn $27 million (US $19 million) term loan and a Cdn $2 million (US $1.4 million) revolving credit facility. At December 31, 1996, approximately Cdn $3.3 million of additional borrowings were available under this credit agreement. Repayments under the term loan are made quarterly, commencing September 30, 1996, and continue through December 1999. Borrowings under this credit agreement bear interest at the lender's prime rate plus the applicable margin. At December 31, 1996, the interest rate was 9%.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Borrowings under this credit agreement are guaranteed by HMC and secured by the assets of Strategium Media, Inc.
(f) Other debt bears interest at varying rates ranging from 6% to 11% at December 31, 1996 and consists primarily of notes payable due in varying amounts through 2004.
The loan agreements described above require the Company and/or its subsidiaries to comply with various financial and other covenants, including the maintenance of certain operating and financial ratios, and they contain substantial limitations on, or prohibitions of, dividends, additional indebtedness, liens, capital expenditures, asset sales and certain other items.
In August 1995, the Company entered into several two-year interest rate swap agreements with a combined notional principal amount of $50 million to more proportionately balance the mix of floating and fixed rate debt. Of the total $50 million, $40 million matures on June 15, 1997 and the remaining $10 million matures on August 1, 1997. Under these arrangements, the Company will receive an average rate of 6.13% during the term of these agreements and will pay the respective six month LIBOR rate at each of the three reset periods (every six months). The six month LIBOR rate on the day these agreements were executed was 5.90%. The impact of the swap agreements on interest expense for the years ended December 31, 1996 and 1995 was not material.
The Company is currently highly leveraged, and it is expected to continue to have a high level of debt for the foreseeable future. As a result of its leverage and in order to repay existing indebtedness, the Company will be required to generate substantial operating cash flow. The ability of the Company to meet these requirements will depend on, among other things, prevailing economic conditions and financial, business and other factors, some of which are beyond the control of the Company. Further, being a holding company of operating companies through HMSI and DIMAC, the Company's ability to repay its indebtedness incurred at the parent company level will be limited by restrictions on the ability of HMSI under the 1992 Credit Agreement and Senior Note Indenture, and DIMAC under the DIMAC Credit Agreement, to declare and pay dividends to the Company. Under the 1992 Credit Agreement, which is the most restrictive of the loan agreements at December 31, 1996, the total amount of dividends that could be paid by HMSI to the Company was approximately $1,716,000. Under the DIMAC Credit Agreement, the total amount of dividends that could be paid by DIMAC to the Company was $10,000,000 at December 31, 1996. Such dividends are not permitted if, as a result of such payments, a default would occur under either of the agreements. As a result of the foregoing restrictions, consolidated net assets of HMSI totaling approximately $137,729,000 and consolidated net assets of DIMAC of $166,118,000, at December 31, 1996 are not available to the Company to pay dividends or repay debt.
Aggregate annual maturities of long-term debt for each of the years in the five year period ending December 31, 2001 are $69,775,000; $92,664,000; $53,164,000; $10,261,000; and $10,258,000, respectively.
(5) SETTLEMENT RIGHTS
In connection with the Actmedia acquisition in 1989, the Company issued approximately 7,553,000 settlement rights. These rights originally entitled the holders to receive cash or common stock having a value equal to approximately 18% of the fair market value of the business, properties and assets of ACTMEDIA as a going concern at specified future dates. The settlement rights were initially recorded at their estimated fair value at the date of issuance which approximated $7,553,000. During the year ended December 31, 1994, all remaining
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
outstanding settlement rights were retired by the Company for cash of $39,017,000, which resulted in the recognition of settlement rights accretion of $19,503,000, or $.56 per share.
(6) STOCKHOLDERS' EQUITY
At the Annual Meeting on May 16, 1996, the shareholders of the Company approved and authorized the following: a) a change of the state of incorporation of the Company from Iowa to Delaware, b) the elimination of the different classes of common stock, c) the authorization of 100,000,000 shares of common stock, $.01 par value, and d) the authorization of 10,000,000 shares of preferred stock, $.01 par value, 800,000 shares of which have been designated Series A Junior Participating Preferred Stock.
In August 1994, the Company adopted a rights plan which provided for the distribution of one right for each outstanding share of the Company's common stock. The rights, which were distributed on August 29, 1994, entitle the holder to buy 1/100 of a share of Series A Junior Participating Preferred Stock ("Series A preferred stock") for $70 per share. Each share of Series A preferred stock entitles the holder to, among other things, 100 votes on all matters submitted to a vote of the Company's shareholders. The rights are exercisable only if a person or group, other than the Company and certain related entities, acquires 15% or more of the Company's common stock or announces a tender offer, the consummation of which would result in ownership by such person or group of 15% or more of the Company's common stock. No value was assigned to the rights for accounting purposes.
On July 25, 1996, the Company declared a two-for-one stock split effected as a stock dividend payable to all holders of record on August 5, 1996 with the payment date of August 12, 1996. The consolidated financial statements, including all references to the number of shares of common stock and all per share information have been adjusted to reflect the stock dividend on a retroactive basis.
On October 14, 1996, the Board of Directors authorized the purchase of up to 5,000,000 shares of the Company's common stock, from time to time, through open market and private purchase at prices then prevailing.
(7) STOCK OPTIONS PLANS
The Company has two stock option plans pursuant to which the Company's Board of Directors may grant stock options to key employees, officers and directors. Under the 1987 Plan, the Company may grant options for up to three million shares of common stock. Under the 1996 Plan, adopted by the Board of Directors in January 1996, the Company may grant options for up to three million shares of common stock. Under both plans, the exercise price of each option may not be less than market value at the date of grant without approval of the Board of Directors, and the options are exercisable beginning two years from date of grant and expire ten years from date of grant. At December 31, 1996, there were 2,269,546 and 1,484,262 options outstanding under the 1987 Plan and the 1996 Plan, respectively.
The Company applies APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, in accounting for its plans and accordingly, no compensation cost has been recognized for its stock options in the consolidated financial statements. Had compensation cost for the Company's two stock based compensation plans been determined consistent with FASB statement No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Years ended December 31, ------------------------ 1996 1995 ---- ----
Net income As Reported $ 19,099 26,571 Pro forma 17,150 26,496
Earnings per share As Reported $ .52 .75 Pro forma .47 .75
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in both 1996 and 1995: dividend yield of 0 percent; expected volatility of 58 percent; risk free interest rates ranging from 5% to 8.8% over a ten-year period; and an expected life of 5 years.
A summary of the status of the Company's two stock option plans as of December 31, 1996, 1995 and 1994, and changes during the years ended on those dates is presented below:
The following table summarizes information about the stock options outstanding at December 31, 1996:
Options Outstanding Options Exercisable ------------------- ------------------- Weighted-Avg.
(8) EMPLOYEE BENEFIT PLANS
The Company has various 401(K) plans (the "Plan") whereby participants may contribute portions of their annual compensation to the Plan and certain contributions may be made at the discretion of the Company based on criteria set forth in the Plan agreement. Participants are generally 100% vested in Company contributions after five years of employment with the Company. Company expenses under the Plan were not material in 1996, 1995 or 1994.
Effective January 1, 1995, the Company established a nonqualified deferred contribution plan for full-time, highly compensated members of Company management whereby participants may defer up to 25% of their compensation (as defined) on a pre-tax basis. The Company may match participants' deferrals at its discretion and currently provides for a match of 100% of a participant's deferral up to 5% of eligible compensation. Amounts contributed to the plan earn interest at a rate determined by the Company annually (currently 6%). Participants are 100% vested in their contributions to the plan and the related earnings and vest in matching contributions of the Company and the related earnings if they are employed by the Company on the last day of each plan year. Company expenses under the plan, including matching contributions and interest, were not material in 1996 or 1995.
(9) OTHER COSTS
The Company had a Stock Appreciation Rights Plan (the "SAR Plan") under the terms of which certain ACTMEDIA employees could be granted a total of 250,000 stock appreciation units. Upon termination of the Plan in January 1995, unit holders received payments aggregating $6,522,000 which consisted of cash of $3,800,000 and 211,800 shares of the Company's common stock with a total value of $2,700,000. For the year ended December 31, 1994, compensation expense accrued under the SAR Plan was $4,922,000.
(10) INCOME TAXES
Total income tax expense for the years ended December 31, 1996, 1995 and 1994 was allocated as follows (thousands of dollars):
1996 1995 1994 ---- ---- ----
Income from continuing operations $ 24,432 9,133 2,742 Extraordinary item (1,546) -- -- Utilization of tax benefits of acquired entities, credited to goodwill -- (4,495) -- Tax benefit of compensation expense from stock options in excess of amounts recognized for financial reporting purposes, credited to additional paid-in-capital (958) (348) -- --------- ----- ----- $ 21,928 4,290 2,742 --------- ----- ----- --------- ----- -----
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Income tax expense attributable to income from continuing operations for the years ended December 31, 1996 and 1995 consists of (thousands of dollars):
U.S. State and Federal Local Foreign Total ------- --------- ------- ------ Year Ended December 31, 1996: Current $15,190 3,745 138 19,073 Deferred 4,384 975 --- 5,359 ------- ----- --- ------ $19,574 4,720 138 24,432 ------- ----- --- ------ ------- ----- --- ------
U.S. State and Federal Local Foreign Total ------- --------- ------- ------ Year Ended December 31, 1995: Current $ 7,420 2,820 28 10,268 Deferred (987) (148) -- (1,135) ------- ----- --- ------ $ 6,433 2,672 28 9,133 ------- ----- --- ------ ------- ----- --- ------
Income tax expense attributable to income from continuing operations for the year ended December 31, 1994 of $2,742,000 consisted primarily of current state income taxes.
Income tax expense for the years ended December 31, 1996, 1995 and 1994 differed from the amounts computed by applying the U.S. federal income tax rate of 35 percent to pretax income from continuing operations as a result of the following (thousands of dollars):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below (thousands of dollars):
1996 1995 ------- -----
Deferred tax assets: Capital loss carryforwards $ 308 1,447 Alternative minimum tax credit carryforwards 4,026 1,462 Accounts receivable principally due to allowance 1,820 1,491 for doubtful accounts Other 8,692 1,297 ------- ----- Total deferred tax assets 14,846 5,697 ------- -----
Deferred tax liabilities: Property and equipment, primarily due to differences in depreciation 7,342 4,512 Other intangibles 9,530 -- Other 2,198 50 ------- ----- Total deferred tax liabilities 19,070 4,562 ------- ----- Net deferred tax assets/(liabilities) $(4,224) 1,135 ------- ----- ------- -----
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The valuation allowance related to deferred tax assets was reduced by $13,539,000 and $10,645,000 in the years ended December 31, 1995 and 1994, respectively.
In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon these considerations, deferred tax assets have been recognized to the extent that they are expected to be realized through reversals during the carryforward period of existing taxable temporary differences giving rise to deferred tax liabilities.
At December 31, 1996, the Company has pre-tax capital loss carryforwards for tax purposes of approximately $880,000 which are available to offset future capital gains through 1997. In addition, the Company has alternative minimum tax credit carryforwards of approximately $4,026,000 which are available to reduce future federal regular income taxes, if any, over an indefinite period.
(11) COMMITMENTS AND CONTINGENCIES
(a) LEASES AND CONTRACTS
The Company and its subsidiaries lease certain property, transportation and other equipment under noncancellable operating leases expiring at various dates through 2010. The Company also has long-term contractual obligations with two major broadcast ratings firms that provide monthly ratings services, and guaranteed store contracts. Minimum commitments under all noncancellable leases and contracts for the years ending December 31, 1997 through 2001 were approximately $29,279,000, $25,974,000, $20,422,000, $5,287,000 and $3,544,000, respectively.
The Company has certain contingent payment obligations related to acquisitions completed based on attainment of certain financial performance targets by the acquired entities. The total contingent consideration paid during 1996 was approximately $4,500,000. These contingent payment obligations extend for various periods through July 2000.
Lease, rental and contractual expense for the years ended December 31, 1996, 1995 and 1994 amounted to approximately $16,194,000, $10,840,000 and $8,139,000, respectively.
In addition, the Company and its subsidiaries have acquired property and other equipment through capital leases. Minimum payments of the capital leases for the years ending December 31, 1997 through 2001 and thereafter are approximately $4,077,000, $3,870,000, $2,755,000, $2,007,000, $1,824,000 and $29,708,000, respectively. The minimum capital lease payments include $24,255,000 of interest and $19,986,000 representing the present value of minimum capital lease payments. The current portion of $2,040,000 is included in accrued expenses with the remaining balance included in other long-term liabilities.
At December 31, 1996, the gross amount of property and equipment recorded under capital leases were building $14,250,000 and machinery/other equipment $5,730,000. Accumulated depreciation relating to these assets was $1,440,000 at December 31, 1996.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(b) BROADCAST PROGRAM RIGHTS
The Company has entered into contracts for broadcast program rights that expire at various dates during the next four years. Contracts totaling approximately $467,000 relate to programs which are not currently available for use and, therefore, are not reflected as assets or liabilities in the accompanying consolidated balance sheet at December 31, 1996. The aggregate minimum payments under contracts for programs currently available (those included on the consolidated balance sheet at December 31, 1996) and programs not currently available (those not included on the consolidated balance sheet at December 31, 1996) are approximately $2,176,000, $1,256,000, $481,000 and $167,000 for the years ending December 31, 1997 through 2000, respectively.
The Company entered into contracts for broadcast program rights of approximately $3,241,000, $2,200,000 and $2,129,000 during the years ended December 31, 1996, 1995 and 1994, respectively.
(c) LITIGATION
The Company is a party to lawsuits which are generally incidental to its business. Management of the Company does not believe the resolution of such matters will have a significant effect on its liquidity, financial position or results of operations.
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values (thousands of dollars) of the Company's financial instruments for which the estimated fair value of the instrument differs significantly from its carrying amounts at December 31, 1996 and 1995. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties (thousands of dollars):
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
Cash, accounts receivable and accounts payable: The carrying amount of these assets and liabilities approximates fair value because of the short maturity of these instruments.
Interest rate swaps: The fair value of the interest rate swaps is estimated by obtaining quotations from brokers. The fair value is an estimate of the amounts that the Company would receive (pay) at the reporting date if the contracts were transferred to other parties or canceled by the broker. Receivables (payables) under interest rate swaps were not material at December 31, 1996 and 1995.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Long-term debt: The fair values of the Company's Senior Notes, 1992 Senior Subordinated Notes, and 1996 Senior Subordinated Notes are based on market quotes obtained from dealers. As amounts outstanding under the Company's credit agreements bear interest at current market rates, their carrying amounts approximate fair value.
(13) SEGMENT INFORMATION
Information relating to the Company's business segments as of and for the years ended December 31, 1996, 1995 and 1994 is as follows (thousands of dollars):
1996 1995 (c) 1994 (c) -------- -------- -------- Net revenues: Marketing Services $521,236 346,392 230,111 Broadcasting 99,594 89,384 87,517 -------- -------- -------- Total $620,830 435,776 317,628 -------- -------- -------- -------- -------- -------- Operating income (loss): Marketing Services $ 70,104 50,530 37,163 (a) Broadcasting 29,660 26,384 (b) 24,418 Corporate (4,895) (3,901) (3,743) -------- -------- -------- Total $ 94,869 73,013 57,838 -------- -------- -------- -------- -------- -------- Selling, general and administrative expenses: Marketing Services $ 98,795 57,973 44,422 Broadcasting 30,604 26,707 28,522 Corporate 4,708 3,793 3,656 -------- -------- -------- Total $134,107 88,473 76,600 -------- -------- -------- -------- -------- -------- Depreciation, amortization and writedown of program rights: Marketing Services $ 31,050 17,700 15,428 Broadcasting 14,012 13,596 (b) 11,783 Corporate 187 107 87 -------- -------- -------- Total $ 45,249 31,403 27,298 -------- -------- -------- -------- -------- -------- Identifiable assets: Marketing Services $660,132 310,637 289,559 Broadcasting 223,486 223,332 215,566 Corporate 18,118 17,042 9,022 -------- -------- -------- Total $901,736 551,011 514,147 -------- -------- -------- -------- -------- --------
Capital expenditures: Marketing Services $ 23,167 10,746 9,538 Broadcasting 7,574 3,722 3,636 Corporate 561 620 97 -------- -------- -------- Total $ 31,302 15,088 13,271 -------- -------- -------- -------- -------- --------
(a) Includes nonrecurring expenses of $4,922,000 in 1994 relating to stock appreciation rights.
(b) Includes writedowns of program rights of $781,000 in 1995.
(c) Segment information for 1995 and 1994 has been restated to combine the prior year's television and radio segments as the broadcasting segment.
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(14) QUARTERLY FINANCIAL DATA (UNAUDITED)
Gross profit represents net revenues less cost of services.
Operating income is defined as net revenue less cost of services; selling, general and administrative expenses; depreciation and amortization; and other charges.
ACTMEDIA reports its operations on a 13-cycle basis whereby the results of operations of three, four-week periods are reported in each of the first three quarters of the fiscal year and four, four-week periods are reported in the fourth quarter of the fiscal year.
The total of net income per share for the four quarters within a given year will not necessarily equal net income per share for the year due to the different periods used to calculate weighted average shares outstanding.
HERITAGE MEDIA CORPORATION
FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS YEARS ENDED DECEMBER 31, 1996 AND 1995 (DOLLARS IN THOUSANDS)
ASSETS 1996 1995 ------ -------- ------- Current assets $ 6,077 6,277 Property and equipment, net of accumulated depreciation 2,110 2,154 Investment in and advances to subsidiaries, at equity 379,900 177,628 Other assets, net 2,018 4,183 -------- ------- $390,105 190,242 -------- ------- -------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $ 61,367 7,964 Deferred income taxes 2,720 4,016 Long-term debt, excluding current portion 190,131 57,862 -------- ------- Total liabilities 254,218 69,842
Stockholders' equity: Preferred stock -- -- Common stock 357 355 Additional paid-in capital 225,685 223,230 Accumulated deficit (82,544) (101,643) Accumulated foreign currency translation adjustments (748) (1,088) Treasury stock at cost (6,863) (454) -------- ------- Total stockholders' equity 135,887 120,400 -------- ------- $390,105 190,242 -------- ------- -------- -------
See accompanying notes to condensed financial information.
HERITAGE MEDIA CORPORATION
FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS)
See accompanying notes to condensed financial information.
HERITAGE MEDIA CORPORATION
FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS)
See accompanying notes to condensed financial information
SCHEDULE I, CONTINUED
HERITAGE MEDIA CORPORATION
NOTES TO CONDENSED FINANCIAL INFORMATION YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(1) GENERAL
The accompanying condensed financial information of Heritage Media Corporation ("Registrant" or the "Company") should be read in conjunction with the consolidated financial statements of the Registrant included in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996.
Heritage Media Corporation is primarily a holding company.
(2) ACQUISITION AND DISPOSITION
In February, 1996 the Company completed its acquisition of DIMAC Marketing Corporation ("DIMAC"), one of the leading full service, vertically integrated direct marketing services companies in the United States. The Company acquired DIMAC for cash in a transaction valued at approximately $260 million. Under the terms of the merger agreement, each of the approximately 6.5 million shares of DIMAC common stock were exchanged for merger consideration of $28 per share. The merger was accounted for by the Company as a purchase. The Company included the financial results of DIMAC beginning February 1, 1996.
This acquisition was recognized in the condensed financial statements as follows (thousands of dollars):
Working capital deficit $(14,941) Goodwill and other intangibles 247,217 Other non current assets 18,535 Long-term debt (65,397) Other long term liabilities (3,336) -------- Total cash paid $182,078 -------- --------
On March 31, 1996, HMC contributed the stock of KIHT-FM to Heritage Media Services, Inc. for $7.2 million. Accordingly, financial statements for periods prior to the contribution are restated to provide comparative information.
(3) OTHER
See note 6 to consolidated financial statements for a description of the common stock of the Company.
SCHEDULE II
HERITAGE MEDIA CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS)
HERITAGE MEDIA CORPORATION
INDEX TO EXHIBITS
EXHIBIT NUMBER -------
2(a) - Agreement and Plan of Merger, dated October 23, 1995, by and among the registrant, Arch Acquisition Corp. and DIMAC Corporation (1) 3(a) - Articles of Incorporation (2) 3(b) - Bylaws (3) 4(a) Indenture, dated as of June 15, 1992 of Heritage Media Services, Inc. ("HMSI") to Bankers Trust Company, as trustee (4) 4(b) - Form of Pledge Agreement among the registrant, certain subsidiaries of the registrant, Bankers Trust Company and Citibank N.A. (4) 4(c) - Indenture dated as of October 1, 1992 of the registrant to Bank of Montreal Trust Company, as trustee (5) 4(d) Indenture, dated as of February 15, 1996, of the registrant to The Bank of New York, as trustee (6) 4(e) - Registrant's Series A Junior Participating Preferred Plan (7) 4(f) - First Supplemental Indenture, dated as of February 15, 1996, of the registrant to The Bank of New York, as trustee (12) 10(a) - Form of Credit Agreement among DIMAC Corporation, Citibank, N.A., as Administrative Agent, and NationsBank of Texas, N.A., as Documentation Agent (12) 10(b) - Form of Credit Agreement among HMSI, the banks named therein, Citibank, N.A., as agent and NationsBank of Texas, N.A., as co- agent (4) 10(c) - Registrant's Amended and Restated Stock Option Plan (9) 10(d) - Registrant's Employee Stock Ownership Plan, as amended (10) 21 - Subsidiaries of the registrant (8) 23(a) - Consent of KPMG Peat Marwick LLP (8) 27 - Financial Data Schedules (8) 99 - Proxy statement for annual meeting to be held on May 15, 1997 (11)
- ------------------- (1) Filed as an Exhibit to the registrant's Registration Statement No. 33-64473 on Form S-4 and incorporated herein by reference. (2) Filed as an Exhibit to the registrant's Form 10-K for the year ended December 31, 1989 and incorporated herein by reference. (3) Filed as an Exhibit to the registrant's Form 10-K for the year ended December 31, 1990 and incorporated herein by reference. (4) Filed as an Exhibit to the registrant's Registration Statement No. 33-47953 on Form S-2 and incorporated herein by reference. (5) Filed as an Exhibit to the registrant's Registration Statement No. 33-52062 on Form S-2 and incorporated herein by reference. (6) Filed as an Exhibit to the registrant's Registration Statement No. 33-63963 on Form S-3 and incorporated herein by reference. (7) Filed as an Exhibit to the registrant's Form 8-K filed August 29, 1994 and incorporated herein by reference.
(8) Filed herewith. (9) Filed as an Exhibit to the registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. (10) Filed as an Exhibit to the registrant's Registration Statement No. 333-15511 on Form S-8 and incorporated herein by reference. (11) To be filed on or before April 30, 1997. (12) Filed as an exhibit to the registrant's Form 10-K for the year ended December 31, 1995.