ITEM 1. BUSINESS.
From time to time, in both written reports and oral statements, we make "forward-looking statements" within the meaning of Federal and state securities laws. Disclosures that use words such as we "believe," "anticipate," "expect," "may" or "plan" and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current expectations and are based upon data available to us at the time of the statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. Any such forward-looking statements, whether made in this report or elsewhere, should be considered in context with the various disclosures made by us about our business. These projections or forward-looking statements fall under the safe harbors of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended.
All metropolitan statistical area ("MSA") rank information used in this report is from the Fall 1998 Radio Market Survey Schedule & Population Rankings published by The Arbitron Company. According to the Radio Market Survey, the population estimates used were based upon 1990 U.S. Bureau Census estimates updated and projected to January, 1999 by Market Statistics, based on the data from Sales & Marketing Management's 1997 Survey of Buying Power. Information regarding the number of radio stations in the United States featuring religious talk and music formats, the number of stations featuring religious formats, the size of the listening audience for religious programming and the number of stations owned and/or operated in the top 25 radio markets by competitors of the company have been obtained from the 1999 Broadcasting & Cable Yearbook, The M Street Journal (November 18, 1998), Religion & Media Quarterly (July 1997) and the 1998 Directory of Religious Media.
GENERAL
Salem is the largest U.S. radio broadcasting company, measured by number of stations and audience coverage, providing programming targeted at audiences interested in religious and family issues. Our core business, developed over the last 25 years, is the ownership and operation of radio stations in large metropolitan markets. We own or operate 45 radio stations, including 33 stations which broadcast to 19 of the top 25 markets in terms of audience size. Our competitor with the next highest presence in the top 25 markets owns and/or operates 16 stations in 8 of such major markets. We also operate Salem Radio Network(R), a national radio network offering syndicated talk, news and music programming to over 1,100 affiliated radio stations.
Traditionally, we have programmed radio stations with our primary format, talk programming with religious and family themes. This format generally features nationally syndicated and local programs produced by organizations that purchase block program time on our stations. We also program some of our radio stations with news/talk and music formats that complement our primary format.
Our founders, our current CEO and chairman, are career radio broadcasters who have owned and operated radio stations with religious and family issues formats for the last 25 years. As Salem has grown, we have recruited managers with strong radio backgrounds and a commitment to our format. Our senior managers have an average of 25 years of industry experience and 9 years with Salem. Our management has a track record of successfully identifying, acquiring and operating new radio stations.
We continue to seek new ways to expand and integrate our distribution and content capabilities. We recently acquired magazine, Internet and software businesses that direct their content to persons with interests that are similar to those of our targeted radio audience. We will continue to opportunistically pursue acquisitions of new media and other businesses that serve our audience. We plan to use these businesses, together with our radio stations and network, to attract and retain a larger audience and customer base.
We were incorporated in California in 1986 in connection with a combination of most of the radio station holdings of our principal shareholders, Edward G. Atsinger III and Stuart W. Epperson. Each of the principal shareholders owned 50% of our outstanding common stock. New Inspiration Broadcasting Company, Inc., the licensee of KKLA-FM, Los Angeles, and Golden Gate Broadcasting Company, Inc., the licensee of KFAX-AM, San Francisco, were owned by the principal shareholders and Mr. Epperson's wife, Nancy A. Epperson. New Inspiration and Golden Gate were both "S corporations," as that term is defined in the Internal Revenue Code of 1986, as amended. In August 1997, we, New Inspiration and Golden Gate effected a reorganization pursuant to which New Inspiration and Golden Gate became our wholly owned subsidiaries. The S corporation status of New Inspiration and Golden Gate was terminated in the reorganization. As a result of the reorganization our outstanding common stock is owned by Mr. Atsinger (50%), Mr. Epperson (36.8%) and Mrs. Epperson (13.2%). See "Securities Ownership of Certain Beneficial Owners and Management."
DEVELOPMENT OF THE BUSINESS
In 1998, we completed the purchase of the following radio stations:
- ------------------------- (1) "MSA" means metropolitan statistical area.
(2) Combined purchase price for KTEK-AM and KYCR-AM acquisitions.
RADIO STATIONS
We own and operate 45 radio stations in 27 markets. The following table sets forth information about each of Salem's stations in order of market size:
- ------------------------- (1) Actual city of license may differ from metropolitan market served. (2) "MSA" means metropolitan statistical area. (3) This market includes the Nassau-Suffolk, NY Metro market which independently has a MSA rank of 17. (4) The company operates the station, which is licensed to a corporation owned by the principal shareholders of the company, under the terms of a local marketing agreement. The principal shareholders and the company are parties to an Option to Purchase Agreement whereunder the company has been granted an option to purchase KKOL-AM from the principal shareholders at any time on or before December 31, 1999. (5) The station is simulcast with WAVA-FM, Washington, D.C. (6) The station is simulcast with KKLA-FM, Los Angeles. (7) The station is simulcast with WHK-AM, Cleveland.
Program Revenue. For the year ended December 31, 1998, we derived 35.5% and 14.7% of our gross revenue, or $30.3 million and $12.6 million, respectively, from the sale of nationally syndicated and local block program time. We derive nationally syndicated program revenue from a programming customer base consisting primarily of geographically diverse, well-established non-profit religious and educational organizations that purchase time on stations in a large number of markets in the United States. Nationally syndicated program producers typically purchase 13, 26 or 52 minute blocks on a Monday through Friday basis and may offer supplemental programming for weekend release. We obtain local program revenue from community organizations and churches that typically purchase time primarily for weekend release and from local speakers who purchase daily releases. We have been successful in assisting quality local programs to expand into national syndication.
Advertising Revenue. For the year ended December 31, 1998, we derived 30.6% of our gross revenue, or $26.1 million from the sale of local spot advertising and 5.2% of our gross revenue, or $4.5 million from the sale of national spot advertising.
Operations. Each of the radio markets in which we have a presence has a general manager who is responsible for day-to-day operations, local spot advertising sales and, where applicable, local program sales for all of our stations in the market. We pay our general managers a base salary plus a percentage of the respective station's net operating income. For each station we also have a staff of full and part-time engineering, programming and sales personnel. We pay our sales staff on a commission basis.
We have decentralized our operations in response to the rapid growth we have experienced in recent years. Our operations vice presidents, some of whom are also station general managers, oversee several markets on a regional basis. Our operations vice presidents are experienced radio broadcasters with expertise in sales, programming and production. We will continue to rely on this strategy of decentralization and encourage operations vice presidents to apply innovative techniques to the operations they oversee which, if successful, can be implemented in our other stations.
Our corporate headquarters personnel oversee the placement and rate negotiation for all nationally syndicated programs. Centralized oversight of this component of company revenue is necessary because our key program customers purchase time in many of our markets. Corporate headquarters personnel also are responsible for centralized reporting and financial functions, benefits administration, engineering oversight and other support functions designed to provide resources to local management.
Satellite Radio. In August 1998 we expanded our reach by entering into an exclusive agreement with XM Satellite Radio, Inc. to develop, produce, supply and market religious and family issues audio programming which will be distributed by a subscriber-based satellite digital audio radio service. XM Satellite Radio, Inc. is one of two FCC licensees for this service (which is expected to commence in the year 2000) and it will have the capability of providing up to 100 channels of audio programming. We have agreed to provide religious and family issues talk programming on one channel and youth and adult religious music programming on two additional channels.
We believe that the listening audiences for our radio stations, which provide the financial support for program producers purchasing time on these stations, are responsive to affinity advertisers that promote products targeted to audiences interested in religious and family issues and are receptive to direct response appeals such as those offered through infomercials. All of our stations have affinity advertising customers in their respective markets. Local church groups and many community organizations such as rescue missions and family crisis support services can often effectively reach their natural constituencies by advertising on religious format stations. Significant advertising is also purchased by local and nationally affiliated religious bookstores, publishers specializing in inspirational and religious literature and other businesses that desire to specifically target audiences interested in religious and family issues. We also generate spot advertising revenue from general market retailers, including automobile dealers and grocery store chains, in many of our stations' markets.
SALEM RADIO NETWORK(R)
In 1993, we established Salem Radio Network(R) in connection with our acquisition of certain assets of the former CBN Radio Network. Establishment of Salem Radio Network(R) was a part of our overall business strategy to develop a national network of affiliated radio stations anchored by our owned and operated radio stations in major markets. Salem Radio Network(R) which is headquartered in Dallas, develops, produces and syndicates a broad range of programming specifically targeted to religious and family issues talk and music stations as well as general market news/talk stations. Currently, we have rights to six full-time satellite channels and all Salem Radio Network(R) product is delivered to affiliates via satellite.
As of January 31, 1999, Salem Radio Network(R) had approximately 1,100 affiliate stations, including our owned and operated stations, that broadcast one or more of the offered programming options. These programming options feature talk shows, news and music. Network operations also include commission revenue of Salem Radio Representatives from unaffiliated customers and an allocation of operating expenses estimated to relate to such commissions. Salem Radio Representatives, a wholly owned subsidiary of Salem, sells all national commercial advertising placed on Salem Radio Network's commercial affiliate radio stations. Salem Radio Network's gross revenue for the year ended December 31, 1998 was $6.1 million. Salem Radio Network(R) incurred a net operating loss of $392,000 for the year ended December 31, 1998.
Salem Radio Representatives. The company established Salem Radio Representatives in 1992 as a sales representation company specializing in placing national advertising on religious format radio stations. Salem Radio Network(R) has an exclusive relationship with Salem Radio Representatives, for the sale of available Salem Radio Network(R) spot advertising. Salem Radio Representatives receives a commission on all Salem Radio Network(R) sales. Salem Radio Representatives also contracts with individual radio stations to sell air time to national advertisers desiring to include selected company stations in national buys covering multiple markets.
NEW MEDIA
Internet. In January 1999, we purchased the assets of OnePlace, LLC for $6.2 million. OnePlace, based in Greensboro, North Carolina, provides Internet e-commerce, consumer profiling and other information technologies to the Christian products industry. In addition, OnePlace(TM) publishes a variety of content and software, including church management software and GuardiaNet(TM), an Internet based web screening software.
Magazines. In January 1999, we purchased CCM Communications, Inc. for $1.9 million. CCM, based in Nashville, Tennessee, has published magazines since 1978 which follow the contemporary Christian music industry. CCM's flagship publication, CCM Magazine, is a monthly music magazine offering interviews with artists, issue-oriented features, album reviews and concert schedules. Through CCM's recent acquisition of the Christian Research Report, the leading trade publication providing rating information to contemporary Christian music formatted radio stations, and its continued publication of CCM Update, the leading trade publication providing rating information to contemporary Christian music producers and retailers, we are uniquely positioned to track contemporary Christian music audience trends.
Software Publishing. In January 1999, we agreed to purchase the assets of NavPress Software, based in Austin, Texas, for $550,000. NavPress is a developer and supplier of electronic Bible and Christian reference books and Bible study software applications, including its best known products WORDsearch and LESSONmaker. Included within the company's product lines are Bible translations, commentaries, dictionaries, maps and illustrations, and classic Christian works.
COMPETITION
Radio. The radio broadcasting industry, including the religious and family issues format segment of this industry, is a highly competitive business. The financial success of each of our radio stations that features talk programming is dependent, to a significant degree, upon its ability to generate revenue from the sale of block program time to national and local religious and educational organizations. We compete for this program revenue with a number of different commercial and noncommercial radio station licensees. While no group owner in the United States specializing in the religious format approaches Salem in size of potential listening audience and presence in major markets, religious format stations exist and enjoy varying degrees of prominence and success in all markets. We own and operate 33 radio stations, which broadcast to 19 of the top 25 radio markets in terms of audience size. Our competitor with the next highest presence in the top 25 markets owns and/or operates only 16 stations in 8 of such major markets.
We also compete for revenue in the spot advertising market with other commercial religious format and general format radio station licensees. We compete in the spot advertising market with other media as well, including broadcast television, cable television, newspapers, magazines, direct mail and billboard advertising.
Competition may also come from new media technologies and services that are being developed or introduced. These include delivery of audio programming by cable television and satellite systems, digital audio radio services, the Internet, personal communications services and the proposed authorization by the FCC of a new service of low powered, limited coverage FM radio stations. Digital audio broadcasting may deliver multiformat digital radio services by satellite to national and regional audiences. The quality of programming delivered by digital audio broadcasting would be equivalent to compact disc.
The delivery of live and stored audio programming through the Internet has also created new competition. In addition, the anticipated commencement of satellite delivered digital audio radio services, which are intended to deliver multiple audio programming formats to local and national audiences, may create additional competition. We have attempted to address these existing and potential competitive threats through our recent Internet acquisition and through our exclusive arrangement to provide religious and family issues talk and music formats on one of the two FCC licensees of satellite digital audio radio services.
Network. Salem Radio Network(R) competes with other commercial radio networks that offer news and talk programming to religious and general format stations and two noncommercial networks that offer religious music formats. Salem Radio Network(R) also competes with other radio networks for the services of talk show personalities.
New Media. Our magazines compete for readers and advertisers with other publications that follow the religious music industry and publications that address issues of interest to church leadership. Our Internet business competes with other companies that deliver on-line audio programming and with web sites that offer content and e-commerce capabilities targeted to persons interested in religious and family issues.
EMPLOYEES
At March 1, 1999, Salem employed 569 full-time and 235 part-time employees. None of Salem's employees are covered by collective bargaining agreements, and we consider our relations with our employees to be good.
ITEM 2.
ITEM 2. PROPERTIES.
The types of properties required to support our radio stations include offices, studios and tower and antenna sites. A station's studios are generally housed with its office in a downtown or business district. We generally select our tower and antenna sites to provide maximum market coverage. Salem Radio Network(R) operations are supported by offices and studios from which its programming originates or is relayed from a remote point of origination. The operations of our new media businesses are supported by office facilities.
Our stations' studios and offices, Salem Radio Network's operations, the operations of our new media businesses and our corporate headquarters are located in leased facilities. Salem Radio Network(R) leases satellite transponders used for delivery of its programming. We either own or lease our radio station tower and antenna sites. We do not anticipate difficulties in renewing those leases that expire within the next several years or in obtaining other lease arrangements, if necessary.
We lease certain property from the principal shareholders or trusts and partnerships created for the benefit of the principal shareholders and their families. See "Certain Relationships and Related Transactions -- Leases from Principal Shareholders." All such leases have cost of living adjustments. Based upon our management's assessment and analysis of local market conditions for comparable properties, we believe such leases do not have terms that vary materially from those that would have been available from unaffiliated parties.
No one property is material to our overall operations. We believe that our properties are in good condition and suitable for our operations; however, we continually evaluate opportunities to upgrade our properties. We own substantially all of our equipment, consisting principally of transmitting antennae, transmitters, studio equipment and general office equipment.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in various routine legal proceedings, incident to the ordinary course of our business. We believe that the outcome of all pending legal proceedings in the aggregate will not have a material adverse effect on our consolidated financial condition or our results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On March 10, 1999, the security holders of the company gave their unanimous written consent to re-elect as directors of the company, the following five individuals: Edward G. Atsinger III, Stuart W. Epperson, Eric H. Halvorson, Richard A. Riddle, Roland S. Hinz.
No other matters have been submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the period covered by this report.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
(a) There is no established public trading market for the company's common stock.
(b) HOLDERS. As of March 31, 1999, there are three holders of the company's common stock.
(c) DIVIDENDS. No cash dividends were declared for any class of common equity in the last two fiscal years. See "Management's Discussion and Analysis of Financial Condition and Operating Results" for description of limitations on the company's ability to declare dividends.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION.
The selected consolidated financial information should be read in conjunction with the company's consolidated financial statements.
- --------------- (1) The extraordinary loss in 1995 and 1997 relates to the write-off of loan and related fees related to the repayment of long-term debt. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 4 of the Notes to Consolidated Financial Statements.
(2) The company's consolidated financial data for the periods presented include the results of operations, assets and liabilities of New Inspiration and Golden Gate, which were both S corporations under common ownership and control with the company prior to the reorganization. The S corporation status of New Inspiration and Golden Gate was terminated in the reorganization. Federal and state income taxes (except for a 1.5% state franchise tax) are not provided for New Inspiration and Golden Gate in the consolidated statements of operations of the company for the periods presented because the tax attributes of S corporations are passed through to their shareholders. Prior to the reorganization, New Inspiration and Golden Gate reimbursed the S corporation shareholders for their individual income tax liabilities on the earnings of the S corporations. These tax reimbursements to S corporation shareholders are reflected as an operating expense in the company's consolidated financial statements.
In August 1997, the company, New Inspiration and Golden Gate effected the reorganization pursuant to which the S corporations became wholly owned by the company. To give effect to the reorganization, including the termination of the S corporation status of New Inspiration and Golden Gate, pro forma net income excludes the tax reimbursements to S corporation shareholders (because such amounts would not have been paid had New Inspiration and Golden Gate been subject to income taxes) and includes a pro forma tax provision at an estimated combined federal and state income tax rate of approximately 40% (to reflect an estimated income tax provision (benefit) of the company) as if the reorganization had occurred at the beginning of each period presented in the company's consolidated financial data. See "Business--General."
The following table reflects the pro forma adjustments to historical net income:
- --------------- (3) "Broadcast cash flow" consists of net operating income before tax reimbursements to S corporation shareholders, depreciation and amortization and corporate expenses. "EBITDA" consists of net operating income before tax reimbursements to S corporation shareholders and depreciation and amortization. Although broadcast cash flow and EBITDA are not measures of performance calculated in accordance with GAAP, management believes that they are useful to an investor in evaluating the company because they are measures widely used in the broadcast industry to evaluate a radio company's operating performance. However, broadcast cash flow and EBITDA should not be considered in isolation or as substitutes for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with GAAP as a measure of liquidity or profitability. Moreover, broadcast cash flow and EBITDA are not measures of performance calculated in accordance with GAAP, these measures are not necessarily comparable to similarly titled measures employed by other companies. (4) Broadcast cash flow margin is broadcast cash flow as a percentage of net revenue. (5) For purposes of computing the ratio of earnings to fixed charges, "earnings" consist of income from operations before income taxes plus fixed charges, and "fixed charges" consist of interest expense plus an allocation of a portion of rent expense representing interest. For the years ended December 31, 1995, 1997 and 1998, the company's earnings were inadequate to cover fixed charges; the coverage deficiency for the years ended December 31, 1995, 1997 and 1998 was $313,000, $1.0 million and $1.9 million, respectively.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes included elsewhere in this report. Our consolidated financial statements are not directly comparable from period to period due to our acquisition activity.
The principal sources of our revenue are:
- the sale of block program time, both to national and local program producers,
- the sale of broadcast time on our radio stations for advertising, both to national and local advertisers, and
- the sale of broadcast time for advertising on Salem Radio Network(R).
The following table shows gross revenue and the percentage of gross revenue for each revenue source.
- --------------- (1) Prior to 1997, classification of revenue (i.e., national program, national advertising, local program or local advertising) from infomercials was determined at the discretion of local station general managers. In 1997, we began including revenue from infomercials in a separate category in order to establish uniformity of classification of revenue.
Our revenue is affected primarily by the program rates our radio stations charge and by the advertising rates our radio stations and Salem Radio Network(R) charge. Correspondingly, the rates for block program time are based upon our stations' ability to attract audiences that will support the program producers through contributions and purchases of their products. Advertising rates are based upon the demand for on-air inventory, which in turn is based on our stations' and Salem Radio Network's ability to produce results for its advertisers. Each of our stations and Salem Radio Network(R) have a general pre-determined level of on-air inventory that they make available for block programs and advertising, which may vary at different times of the day. In recent years we have begun to place greater emphasis on the development of local spot sales in all of our
markets. We encourage general managers and sales managers to create more spot inventory for sale. Additional spot inventory can be created in a variety of ways, such as removing programming which generates marginal audience response and adjusting the start time of programs to add inventory in more desirable dayparts. Our quarterly revenue varies throughout the year, as is typical in the radio broadcasting industry. Quarterly revenue from the sale of block program time does not tend to vary, however, since program rates are generally set annually.
Our cash flow is affected by the transition period experienced by stations we have acquired that previously operated with formats other than the religious and family issues formats. During the transition period when we develop the station's program customer and listener base, such stations typically do not generate significant cash flow from operations.
In the broadcasting industry, radio stations often utilize trade or barter agreements to exchange advertising time for goods or services (such as other media advertising, travel or lodging), in lieu of cash. In order to preserve most of its on-air inventory for cash advertising, we generally enter into trade agreements only if the goods or services bartered to us will be used in our business. We have minimized our use of trade agreements and have generally sold over 90% of our advertising time for cash. In addition, it is our general policy not to preempt advertising spots paid for in cash with advertising spots paid for in trade.
The primary operating expenses incurred in the ownership and operation of our radio stations include employee salaries and commissions, and facility expenses (e.g., rent and utilities). In addition to these expenses our network incurs programming costs and lease expenses for satellite communication facilities. We also incur and will continue to incur significant depreciation, amortization and interest expense as a result of completed and future acquisitions of stations, and due to existing borrowings and future borrowings, including outstanding senior subordinated notes and borrowings under our Credit Agreement.
The performance of a radio group, such as us, is customarily measured by the ability of its stations to generate Broadcast Cash Flow and EBITDA. Broadcast Cash Flow is defined as net operating income before tax reimbursements to S corporation shareholders, depreciation and amortization and corporate expenses. EBITDA is defined as net operating income before tax reimbursements to S corporation shareholders and depreciation and amortization. Although Broadcast Cash Flow and EBITDA are not measures of performance calculated in accordance with generally accepted accounting principles, and should be viewed as a supplement to and not a substitute for our results of operations presented on the basis of generally accepted accounting principles, we believe that Broadcast Cash Flow and EBITDA are useful because they are generally recognized by the radio broadcasting industry as a measure of performance and are used by analysts who report on the performance of broadcast companies.
Our consolidated statements of operations have included an operating expense called "tax reimbursements to S corporation shareholders." These amounts represent the income tax liability of our shareholders created by the income of New Inspiration and Golden Gate, which prior to the Reorganization were each S corporations. We consider the nature of this operating expense to be essentially equivalent to an income tax provision and have excluded this expense from the calculation of Broadcast Cash Flow and EBITDA for periods prior to August 13, 1997. Commencing August 13, 1997, pretax income of New Inspiration and Golden Gate is included in our consolidated income tax return and in our computation of the income tax provision included in our consolidated statement of operations.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net Revenue. Net revenue increased approximately $10.0 million or 14.7% to $77.9 million in 1998 from $67.9 million in 1997. The inclusion of revenue from the acquisitions of radio stations and revenue generated from local marketing agreements entered into during 1998 and 1997 provided approximately $2.2 million of the increase. For stations owned and operated over the comparable period in 1998 and 1997, net revenue improved approximately $7.8 million or 11.6% to $75.2 million in 1998 from $67.4 million in 1997 due primarily to an increase in revenue at the stations we acquired in 1996 that previously operated with formats other than religious and family issues formats, program rate increases and to a lesser extent to increases in on-air inventory and improved selling efforts at both the national and local level. Revenue from advertising as a percentage of our gross revenue increased from 33.1% in 1997 to 35.8% in 1998. Revenue from block program time as a percentage of our gross revenue decreased from 52.5% in 1997 to 50.2% in 1998. This change in our revenue mix is primarily due to our efforts to develop more local spot sales in all of our markets.
Station Operating Expenses. Station operating expenses increased approximately $2.9 million or 7.3% to $42.5 million in 1998 from $39.6 million in 1997. Approximately $1.2 million of such increase was due to the inclusion of expenses from the acquisitions of radio stations and expenses incurred for local marketing agreements entered into during 1998 and 1997. For stations owned and/or operated over the comparable periods in 1998 and 1997, station operating expenses increased approximately $1.7 million or 4.3% to $41.0 million in 1998 from $39.3 million in 1997 primarily due to selling and production expenses incurred to produce the increased revenue in the periods, as described above. This increase was offset in part by a one-time credit of $453,000 that we recorded in 1998. The credit related to music licensing fees and represented the proceeds of a settlement between us and the two largest performance rights organizations.
Broadcast Cash Flow. Broadcast Cash Flow increased approximately $7.1 million or 25.1% to $35.4 million in 1998 from $28.3 million in 1997. As a percentage of net revenue, Broadcast Cash Flow increased to 45.4% in 1998 from 41.7% in 1997. The increase is primarily attributable to the one-time credit for music licensing fees and the improved performance of stations and networks acquired in 1996 and 1997 that previously operated with formats other than religious and family issues formats. These acquired and reformatted stations typically produce lower margins during the early phase of the transition period from a non-religious format to a religious and family issues format. Broadcast Cash Flow margins improve as we implement scheduled program rate increases and increase spot advertising revenue on our stations.
Corporate Expenses. Corporate expenses increased approximately $1.2 million or 19.4% to $7.4 million in 1998 from $6.2 million in 1997, primarily due to bonuses totaling $538,000 paid to our president and to our chairman of the board in 1998, and additional personnel and overhead costs associated with station acquisitions in 1998.
EBITDA. EBITDA increased approximately $5.9 million or 26.7% to $28.0 million in 1998 from $22.1 million in 1997. As a percentage of net revenue, EBITDA increased to 35.9% in 1998 from 32.5% in 1997. The increase is primarily attributable to the one-time credit for music licensing fees and the improved performance of stations and networks acquired in 1996 and 1997 that previously operated with formats other than religious and family issues formats.
Tax Reimbursements to S Corporation Shareholders. There were no tax reimbursements to S corporation shareholders for 1998 because of the reorganization of the predecessor to the company which took place in August 1997, compared to $1.8 million in tax reimbursements to S corporation shareholders for 1997. New Inspiration and Golden Gate became wholly-owned subsidiaries of the predecessor to the company in August 1997 pursuant to a reorganization. The S corporation status of New Inspiration and Golden Gate was terminated in the reorganization.
Depreciation and Amortization. Depreciation and amortization expense increased approximately $1.3 million or 10.2% to $14.1 million in 1998 from $12.8 million in 1997, primarily due to radio station and network acquisitions consummated during 1998 and 1997.
Other Income (Expense). Interest income was essentially unchanged for the year ended December 31, 1998 compared to 1997. Gain (loss) on disposal of assets decreased $4.1 million from $4.3 million in 1997 to $.2 million in 1998. The gain in 1997 was primarily due to the sale of WPZE-AM, Boston. Interest expense increased approximately $3.2 million or 25.2% to $15.9 million in 1998 from $12.7 million in 1997, primarily due to interest expense associated with additional borrowings to fund acquisitions consummated during 1998 and 1997. Other expense was essentially unchanged for the year ended December 31, 1998 compared to 1997.
Provision (Benefit) for Income Taxes. Provision (benefit) for income taxes as a percentage of income (loss) before income taxes and extraordinary item (i.e., effective tax rate) was (17.8)% for 1998 and 9.8% for 1997. The effective tax rate in 1998 differs from the federal statutory income tax rate of 34.0% because of the effect of state income taxes and certain expenses that are not deductible for tax purposes. The effective tax rate in 1997 differs from the federal statutory income tax rate of 34.0% because of the effect of state income taxes, the establishment of a deferred tax liability and provision of approximately $609,000 resulting from the reorganization, offset by the inclusion of income from New Inspiration and Golden Gate, which were S corporations (and therefore, not subject to federal income taxes) prior to the reorganization in August 1997.
Net Loss. We recognized a net loss of approximately $1.6 million in 1998, compared to a net loss of approximately $2.4 million in 1997. Included in the net loss for 1997 is a $1.2 million extraordinary loss for the write off of deferred financing costs and termination fees related to the repayment of our prior credit agreement which we repaid in full upon issuance of the old notes on September 25, 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net Revenue. Net revenue increased approximately $8.9 million or 15.1% to $67.9 million in 1997 from $59.0 million in 1996. The inclusion of revenue from the acquisitions of radio stations and revenue generated from local marketing agreements entered into during 1997 and 1996 provided approximately $6.4 million of the increase. For stations owned and operated over the comparable period in 1997 and 1996, net revenue improved approximately $2.5 million or 4.4% to $58.7 million in 1997 from $56.2 million in 1996 due primarily to program rate increases and to a lesser extent to increases in on-air inventory and improved selling efforts at both the national and local level. Revenue from advertising as a percentage of our gross revenue was essentially unchanged from 1996 to 1997. Revenue from block program time as a percentage of our gross revenue decreased from 57.5% in 1996 to 52.5% in 1997. Revenue from informercials was 5.1% of gross revenue in 1997. Prior to 1997, classification of revenue (i.e., national program, national advertising, local program or local advertising) from infomercials was determined at the
discretion of local station general managers. This change in our revenue mix is primarily due to our efforts to develop more local spot sales in all of our markets, and to the separate reporting of revenue from infomercials beginning in 1997.
Station Operating Expenses. Station operating expenses increased approximately $6.1 million or 18.2% to $39.6 million in 1997 from $33.5 million in 1996. Approximately $5.2 million of such increase was due to the inclusion of expenses from the acquisitions of radio stations and expenses incurred for local marketing agreements entered into during 1997 and 1996. For stations owned and/or operated over the comparable periods in 1997 and 1996, station operating expenses increased approximately $0.9 million or 3% to $30.9 million in 1997 from $30.0 million in 1996 primarily due to selling and production expenses incurred to produce the increased revenue in the periods, as described above.
Broadcast Cash Flow. Broadcast Cash Flow increased approximately $2.8 million or 11.0% to $28.3 million in 1997 from $25.5 million in 1996. As a percentage of net revenue, Broadcast Cash Flow decreased to 41.7% in 1997 from 43.2% in 1996. The decrease is primarily attributable to lower margins achieved during the transition period of the stations and networks acquired in 1996 and 1997 that previously operated with formats other than religious and family issues formats.
Corporate Expenses. Corporate expenses increased approximately $1.5 million or 31.9% to $6.2 million in 1997 from $4.7 million in 1996, primarily due to additional personnel and overhead costs associated with station acquisitions in 1997 (approximately $896,000 of the increase), bonuses paid to corporate officers in 1997 (approximately $155,000 of the increase), the write-off of costs incurred for potential station acquisitions which were abandoned (approximately $172,000 of the increase), and expenses incurred for officers' life insurance (approximately $277,000 of the increase), in 1997.
EBITDA. EBITDA increased approximately $1.3 million or 6.3% to $22.1 million in 1997 from $20.8 million in 1996. As a percentage of net revenue, EBITDA decreased to 32.5% in 1997 from 35.3% in 1996. The decrease is primarily attributable to lower margins achieved during the transition period of the stations and networks acquired in 1996 and 1997 that previously operated with formats other than religious and family issues formats, and to increased corporate expenses in 1997 as compared to 1996.
Tax Reimbursements to S Corporation Shareholders. Tax reimbursements to S corporation shareholders decreased approximately $0.2 million or 10.0% to $1.8 million in 1997 from $2.0 million in 1996, primarily due to decreased taxable income of the S corporations as a result of the termination of the S corporation status of New Inspiration and Golden Gate in August 1997.
Depreciation and Amortization. Depreciation and amortization expense increased approximately $4.4 million or 52.4% to $12.8 million in 1997 from $8.4 million in 1996, primarily due to radio station and network acquisitions consummated during 1997 and 1996.
Other Income (Expense). Interest income decreased $293,000 to $230,000 in 1997 from $523,000 in 1996, primarily due to interest income earned in 1996 on a $14.0 million deposit from the sale of KDBX-FM, Portland. Gain (loss) on disposal of assets decreased $11.8 million from $16.1 million in 1996 to $4.3 million in 1997. The gain in 1997 was primarily due to the sale of WPZE-AM, Boston. The gain in 1996 was primarily due to the sale of KDBX-FM, Portland and KDFX-AM, Dallas. Interest expense increased approximately $5.3 million or 71.6% to $12.7 million in 1997 from $7.4 million in 1996, primarily due to interest expense associated with additional borrowings to fund acquisitions
consummated during 1997 and 1996. Other expense was essentially unchanged for the year ended December 31, 1997 compared to 1996.
Provision (Benefit) for Income Taxes. Income tax provision (benefit) as a percentage of income (loss) before income taxes and extraordinary item (i.e., effective tax rate) was 9.8% for 1997 and 34.3% for 1996. The effective tax rate in 1997 differs from the federal statutory income tax rate of 34.0% because of the effect of state income taxes, the establishment of a deferred tax liability and provision of approximately $609,000 resulting from the reorganization offset by the inclusion of income from New Inspiration and Golden Gate, which were S corporations (and, therefore, not subject to federal income taxes) prior to the reorganization in August 1997. The effective tax rate in 1996 differs from the federal statutory income tax rate of 34.0% because of the effect of state income taxes, the effect of gains realized on the sale of radio stations in 1997, offset by the inclusion of income from New Inspiration and Golden Gate, which were S corporations (and, therefore, not subject to federal income taxes) prior to the reorganization in August 1997.
Net Income (Loss). We recognized a net (loss) of approximately $2.4 million in 1997, compared to net income of $12.8 million in 1996. Included in the net loss for 1997 is a $1.2 million extraordinary loss for the write off of deferred financing costs and termination fees related to the repayment of our prior credit agreement which we repaid in full upon issuance of the old notes on September 25, 1997.
LIQUIDITY AND CAPITAL RESOURCES
In the past, we principally financed acquisitions of radio stations through borrowings, including borrowings under credit agreements with banks, and, to a lesser extent, from cash flow from operations and selected asset dispositions. In September 1997, we issued and privately placed $150 million principal amount of 9 1/2% Senior Subordinated Notes due 2007. In March 1998, we consummated an offer for all outstanding notes, which were subject to certain restrictions on transfer, in exchange for notes registered pursuant to the Securities Act of 1933, as amended and thus not subject to such transfer restrictions. Pursuant to the exchange offer, the $150 million in principal amount of new notes were issued and a like amount of the old notes were canceled. Reference in this report to the notes includes both the new notes and the old notes. In September 1997, we used the net proceeds from the sale of the notes to repay substantially all of our outstanding indebtedness under a line of credit agreement, at which time such facility was canceled and we entered into the current credit agreement.
We anticipate funding future acquisitions from operating cash flow and borrowings, including borrowings under the credit agreement. At December 31, 1998, $24.0 million was outstanding under our credit agreement. The maximum amount that we may borrow under our credit agreement is limited by our debt to cash flow ratio, adjusted for recent radio station acquisitions as defined in the credit agreement (the "Adjusted Debt to Cash Flow Ratio"). At December 31, 1998, the maximum Adjusted Debt to Cash Flow Ratio allowed under the credit agreement was 6.75 to 1. Our ability to borrow for the purpose of acquiring a radio station is further limited by the credit agreement in that we may not borrow for an acquisition if the Adjusted Debt to Cash Flow Ratio is greater than 6.00 to 1. At December 31, 1998, the Adjusted Debt to Cash Flow Ratio was 5.99 to 1, resulting in total borrowing availability (i.e., in addition to amounts already outstanding) of approximately $22.6 million, $483,000 of which can currently be used for radio station acquisitions. In addition to debt service requirements under the credit agreement, we are required to pay $14.3 million per annum in interest on the Notes.
We fund expenditures for operations, administrative expenses and debt service from operating cash flow.
We believe that cash flow from operations and borrowings under the credit agreement should be sufficient to permit us to meet our financial obligations and to fund our operations for at least the next twelve months.
The credit agreement contains certain additional restrictive covenants customary for credit facilities of the size, type and purpose contemplated which, among other things, and with certain exceptions, limits our ability to enter into affiliate transactions, pay dividends, consolidate, merge or effect certain asset sales, make certain investments or loans and change the nature of our business. The credit agreement also requires us to satisfy certain financial covenants, which covenants will require the maintenance of specified financial ratios and compliance with certain financial tests, including ratios for maximum leverage as described above (not greater than 6.75 to 1 at December 31, 1998), minimum interest coverage (not less than 1.25 to 1 at December 31, 1998), minimum debt service coverage (a static ratio of not less than 1.1 to 1) and minimum fixed charge coverage (a static ratio of not less than 1.1 to 1).
We also have revolving credit facilities with Messrs. Atsinger and Epperson, totaling $5 million. At December 31, 1998, $1.8 million was outstanding under the agreement with Mr. Atsinger. Amounts borrowed under these facilities are payable upon demand and bear interest at a floating rate that is at all times at least 1% lower than the rate for base rate borrowings under our credit agreement. We will borrow under our credit agreement when Mr. Atsinger demands repayment.
In January 1999, we purchased the assets of OnePlace, LLC, for $6.2 million, and all the outstanding shares of stock of CCM Communications, Inc., for $1.9 million. OnePlace is engaged in the business of applying Internet e-commerce, consumer profiling and other information technologies in the Christian products industry. CCM Communications publishes magazines which follow the contemporary Christian music industry. The purchases were financed primarily by an additional borrowing. We amended our credit agreement to allow for such a borrowing, increasing the maximum permitted leverage ratio to not greater than 7.00 to 1 through June 29, 1999. After the borrowing for these acquisitions the Adjusted Debt to Cash Flow Ratio was 6.22 to 1, resulting in total borrowing availability of approximately $23.3 million, none of which can currently be used for radio station acquisitions.
In January 1999, we also agreed to purchase the assets of NavPress Software, Inc., for $550,000. NavPress Software develops and supplies electronic Bible and Christian reference books and Bible study software applications.
Net cash provided by operations increased to $11.0 million for the year ended December 31, 1998, compared to $7.3 million in 1997 due primarily to increased net operating income in 1998. Net cash provided by operations decreased to $7.3 million for the year ended December 31, 1997, compared to $10.5 million in 1996 due primarily to decreased net operating income in 1997.
Net cash used in investing activities increased to $31.8 million for the year ended December 31, 1998, compared to $26.3 million for 1997 primarily due primarily to radio station acquisitions (four stations purchased for $33.7 million in 1998 compared to eight stations purchased for $19.4 million in 1997). Net cash used in investing activities increased to $26.3 million for the year ended December 31, 1997, compared to $18.9 million for 1996 primarily due to the proceeds of the sales of KDBX-FM, Portland and KDFX-AM, Dallas offsetting the cash used in investing activities in 1996.
Net cash provided by financing activities was $21.0 million for the year ended December 31, 1998, and $18.7 million for 1997, and $9.4 million for 1996, primarily due to increased long-term debt borrowings in 1997 and 1998.
YEAR 2000 COMPUTER SYSTEM COMPLIANCE
The term "year 2000 issue" (the year 2000 referred to as "Y2K") is a general term used to describe the various problems that may result from the improper processing of dates and date-sensitive calculations by computers and other machinery as the year 2000 is approached and reached. These problems generally arise from the fact that most of the world's computer hardware and software have historically used only two digits (instead of four) to identify the year in a date, often meaning that the computer will fail to distinguish dates in the "2000's" from dates in the "1900's." These problems may also arise from other sources as well, such as the use of special codes and conventions in software that make use of the date field. In early 1998 we began implementing the assessment phase of our plan to address the Y2K issue in each broadcast area and have substantially completed a Y2K assessment phase of our computer, broadcast and environmental systems, redundant power systems and other critical systems including: (i) digital audio systems, (ii) traffic scheduling and billing systems, (iii) accounting and financial reporting systems, and (iv) local area networking infrastructure. As part of the assessment phase, we initiated formal communication with all of our key business partners to identify their exposure to the Y2K issue. This assessment will target potential external risks related to the Y2K issue and is still in progress, but is expected to be completed by the end of the second quarter of 1999. Key business partners include local and national programmers and advertisers, suppliers of communication services, financial institutions and suppliers of utilities. Amounts related to the assessment phase are primarily internal costs, are expensed as incurred, and have not been material to date and are not expected to be material through completion of the phase. The remediation phase is the next step in our plan to address the Y2K issue. Activities during this phase are in progress and include, if necessary, the actual repair, replacement, or upgrade of our systems based on the findings of the assessment phase. Systems which are Y2K ready include local area networks, digital audio systems, and traffic scheduling and billing systems. We have implemented a new accounting and financial reporting system which is Y2K ready. Costs related to this new system (approximately $200,000) will be included in capital expenditures. The final plan phase, the testing phase, will include the actual testing of the enhanced and upgraded systems. This process will include internal and external user review confirmation, as well as unit testing and integration testing with other system interfaces. The testing schedule is being developed and will begin during the second quarter of 1999 and is expected to be completed by the end of the third quarter. Based on test results and assessment of outside risks, contingency plans will be developed as determined necessary. We would expect to complete such plans in the fourth quarter of 1999. We anticipate minimal business disruption from both external and internal factors. However, possible risks include, but are not limited to, loss of power and communication links which are not subject to our control. We believe that our Y2K compliance issues from all phases of our plan will be resolved on a timely basis and that any related costs will not have a material impact on our operations, cash flows, or financial condition of future periods.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Derivative Instruments. We do not invest, and during the year ended December 31, 1998 did not invest, in market risk sensitive instruments.
Market Risk. Our market risk exposure with respect to financial instruments is to changes in the "prime rate" in the United States. We may borrow up to $75 million under a revolving credit facility. At December 31, 1998, we had borrowed $24 million. Amounts outstanding under the revolving credit facility bear interest at a base rate, at Salem's option, of the bank's prime rate or LIBOR. For purposes of determining the interest rate in 1998 the prime rate spread ranged from 0% to 1.75%, and the LIBOR spread ranged from 1% to 3%. At December 31, 1998, the interest rate on amounts outstanding under the revolving credit facility was 8.25%. In January 1999, the revolving credit facility was amended to change certain required loan ratio terms and to amend the interest rate spreads. As of January 1, 1999, the interest rate spread ranges from 0% to 2.25%, and the LIBOR spread ranges from 1% to 3.5%. At December 31, 1998, a hypothetical 100 basis point increase in the prime rate would result in additional interest expense of $240,000 on an annualized basis.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required by this item are set forth at the end of this Annual Report on Form 10-K beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The executive officers, directors and key employees of Salem Communications Corporation and its subsidiaries and their ages and positions with the company are as follows:
All directors hold office until the next annual meeting of shareholders following their election, or until their successors are elected and qualified. Officers are elected annually by the board of directors and serve at the discretion of the board.
Mr. Atsinger has been President, Chief Executive Officer and a director of Salem since its inception. He has been engaged in the ownership and operation of radio stations since 1969 and is a member of the board of directors of the National Religious Broadcasters.
Mr. Epperson has been Chairman of Salem since its inception. Mr. Epperson has been engaged in the ownership and operation of radio stations since 1961. In addition, he is a member of the board of directors of the National Religious Broadcasters. Mr. Epperson is married to Nancy A. Epperson who is Mr. Atsinger's sister.
Mr. Halvorson has been Chief Operating Officer of Salem since 1995, Executive Vice President of the company since 1991 and a director of the company since 1988. From 1991 to the present, Mr. Halvorson has also served as the General Counsel of the company. Mr. Halvorson was the managing partner of the law firm of Godfrey & Kahn, S.C.-Green Bay from 1988 until 1991. From 1985 to 1988, he was Vice President and General Counsel of the company. From 1976 until 1985, he was an associate and then a partner of Godfrey & Kahn, S.C.-Milwaukee. Mr. Halvorson was a Certified Public Accountant with Arthur Andersen & Co. from 1971 to 1973.
Mr. Anderson has been President of Salem Radio Network(R) since 1994. From 1993 to 1994, Mr. Anderson was the Vice President-General Manager of the Network. Mr. Anderson was employed by Multimedia, Inc. from 1980 to 1993. After serving as program director and general manager at Multimedia stations in Greenville, Shreveport and Milwaukee, he was named Vice President, Operations, of the Multimedia radio division in 1987 and was subsequently appointed as Executive Vice President and group head of Multimedia's radio division.
Mr. Gastaldo has been Chief Financial Officer of Salem since 1993, and a Vice President of the company since 1992. From 1992 to 1993, Mr. Gastaldo was Vice President-Administration of the company, and from 1989 to 1991 he was Manager-Internal Audit of the company. He was a Certified Public Accountant with Ernst & Young from 1978 to 1989.
Mr. Gaines has been Vice President-Operations of Salem since 1994. Prior to that time, he served as General Manager of KKLA-FM from 1992 to 1994 and General Manager of WYLL-FM from 1990 to 1992. Mr. Gaines has been involved in the management of radio stations since 1964. He served as Executive Vice President of Commonwealth Communications from 1988 to 1990, Vice President of Penn Communications from 1985 to 1988, Executive Vice President of Broadstreet Communications from 1974 to 1985 and Vice President and General Manager of Metromedia from 1964 to 1974.
Mr. Armstrong has been Vice President-Operations of Salem since 1996 and General Manager of KKLA-FM/AM since 1994. He has also supervised operations of KLTX-AM since January 1997 and of KIEV-AM since August 1998. Mr. Armstrong has 28 years of radio broadcast experience and has been general manager of stations in Santa Ana and Orange, California.
Mr. Davis has been Vice President-Operations of Salem since 1996 and General Manager of WMCA-AM since 1989. He has also been the General Manager of WWDJ-AM since 1994. He has previously served as Vice President and Executive Director of Christian Fund for the Disabled as well as President of Practice Resources, Inc., Davis Eaton Corporation and Vintage Specialty Advertising company.
Mr. Sasso has been Vice President-Operations of Salem since 1996 and General Manager of the company's Colorado Springs stations from 1994 to present. He also served as General Manager of the company's Denver stations from 1995 to 1996. Mr. Sasso is the former owner of eight radio stations in Florida, Mississippi and Louisiana which were sold in 1989. From 1969 to 1979 he served in various radio management capacities for King Broadcasting and The American Broadcasting Companies.
Mr. Ruleman has been Vice President - Operations of Salem since January, 1999 and General Manager of WAVA-AM/FM since 1992. He was General Manager of KPRZ-AM from 1986 to 1992. From 1973 to 1986, Mr. Ruleman served as Vice President of Palomar Broadcasting Corporation, a group owner of radio stations in Southern California.
Mr. Young has been Chief Executive Officer of OnePlace, Ltd. since January, 1999, Chief Executive Officer and a stockholder of its predecessor corporation, OnePlace, LLC since August, 1998. From 1997 to 1998 Mr. Young served as Chief Executive Officer of Landmark Community Interests, an Internet-based technology company controlled by Landmark Communications, Inc. He served as President of networkMCI Digital Imaging, the web site development and electronic commerce implementation division of MCI Telecommunications, from 1995 to 1997. Prior to 1995 Mr. Young founded and developed
several technology companies including Image Technology, Inc., and Advanced MediaGraphics Center, both of which companies were sold to MCI Telecommunications.
Mr. Styll founded Praise Productions, the predecessor of CCM Communications, Inc., in 1978 and has served as the President of CCM Communications, Inc. since its incorporation in 1979. He served as President of the Gospel Music Association from 1991 to 1994 and as President of the Christian Music Trade Association from 1996 to 1998. Mr. Styll is a member of the National Academy of Recording Arts and Sciences.
Mr. Riddle has been a director of Salem since September, 1997. Mr. Riddle is an independent businessman specializing in providing financial assistance and consulting to manufacturing companies. Since 1991 he has been the President of Richray Industries, a holding company for various manufacturing companies. He was President and majority stockholder of I. L. Walker company from 1988 to 1997 when the company was sold. He also was Chief Operating Officer and majority stockholder of Richter Manufacturing from 1970 to 1987.
Mr. Hinz has been a Director of Salem since September, 1997. Mr. Hinz has been the owner and President of Hi-Torque Publishing company, a publisher of magazines covering the motorcycling and biking industries, since 1981. He is active in a number of non-profit organizations and serves as Chairman of the Fund Development Committee of English Language Institute China. Mr. Hinz also serves on the boards of directors of Gordon Conwell Theological Seminary, Association for Community Education, Inc., Truth for Life, and Lake Avenue Congregational Church.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth all compensation paid by the company for 1998, 1997 and 1996 to the company's Chief Executive Officer and the four highest paid executive officers of the company.
SUMMARY COMPENSATION TABLE
- ------------------------- (1) Distributions of net income from New Inspiration and Golden Gate (in an amount equal to the amount above that necessary to meet individual tax liabilities, discussed in footnote 2 to this table, that had previously been taxed, but not distributed, to the S corporation shareholders. See the company's Consolidated Statements of Shareholders' Equity included elsewhere in this report.
(2) Tax reimbursement payments made to satisfy individual federal and state income tax liabilities generated by New Inspiration and Golden Gate as a result of their S corporation status. See the company's Consolidated Statements of Shareholders' Equity included elsewhere in this report.
(3) Represents employer matching contributions to individuals' 401(k) accounts.
(4) Includes cancellation of $25,000 indebtedness owed to the company by Mr. Halvorson plus accrued interest of $7,420 and a distribution to Mr. Halvorson of $30,155, an amount equal to the tax liability incurred by Mr. Halvorson as a result of cancellation of this debt.
COMPENSATION OF DIRECTORS
Officers of Salem who also serve as directors do not receive compensation for their services as directors other than the compensation they receive as officers of Salem. Directors of Salem who are not also officers or employees of Salem were paid a one-time fee of $7,500 in 1998 and receive $2,500 per quarter for their services as directors of Salem. Directors of Salem are entitled to reimbursement of their reasonable out-of-pocket expenses in connection with their travel to and attendance at board meetings.
EMPLOYMENT AGREEMENTS
Edward G. Atsinger III entered into an employment agreement with Salem effective as of August 1, 1997, pursuant to which he will serve as President and Chief Executive Officer of the company for an annual salary of $400,000 and an annual bonus determined at the discretion of the board of directors, for an initial period of three years. The employment agreement with Mr. Atsinger provides Salem with a right of first refusal on corporate opportunities, which includes acquisitions of radio stations in any market in which Salem is interested, and includes a noncompete provision for a period of two years from the cessation of Mr. Atsinger's employment with the company and a nondisclosure provision which is effective for the term of the employment agreement and indefinitely thereafter. In addition to the requirements of his employment agreement, since the inception of the company Mr. Atsinger has been obligated under applicable state law to first present corporate opportunities to Salem before pursuing any such opportunity himself. Under the terms of his employment agreement, Mr. Atsinger is also entitled to participate in any benefit plans provided by Salem to its employees. If Mr. Atsinger is terminated without cause by Salem, he is entitled to severance payments equal to his salary for the greater of six months and the remainder of the term of his agreement. In addition, subject to certain exceptions, if Salem declines to renew Mr. Atsinger's agreement after the initial period, he is entitled to severance payments equal to his salary for three months.
Stuart W. Epperson entered into an employment agreement with Salem effective as of August 1, 1997, pursuant to which he will serve as Chairman of the company for an annual salary of $400,000 and an annual bonus determined at the discretion of the board of directors, for an initial period of three years. The employment agreement with Mr. Epperson provides Salem with a right of first refusal on corporate opportunities, which might include acquisitions of radio stations in any market in which Salem is interested, and includes a noncompete provision for a period of two years from the cessation of Mr. Epperson's employment with the company and a nondisclosure provision which is effective for the term of the employment agreement and indefinitely thereafter. In addition to the requirements of his employment agreement, since the inception of Salem Mr. Epperson has been obligated under applicable state law to first present corporate opportunities to Salem before pursuing any such opportunity himself. Under the terms of his employment agreement, Mr. Epperson is also entitled to participate in any benefit plans provided by Salem to its employees. If Mr. Epperson is terminated without cause by Salem, he is entitled to severance payments equal to his salary for the greater of six months and the remainder of the term of his agreement. In addition, subject to certain exceptions, if Salem declines to renew Mr. Epperson's agreement after the initial period, he is entitled to severance payments equal to his salary for three months.
Eric H. Halvorson entered into an employment agreement with Salem effective as of November 1991, pursuant to which he serves as Executive Vice President of Salem at an annual salary starting at $175,000, with annual increases of $11,000 to $14,000, for a period of seven years. The agreement was subsequently amended in April 1996 to extend the term for one additional year and increase the base salary to $255,000, $270,000 and $285,000 for 1996, 1997 and 1998, respectively, and was again amended in July 1997 to extend the term through December 2003 at a base salary of $300,000 for each year after 1998. The employment agreement provides that Mr. Halvorson may participate in any benefit plans provided by Salem to its employees. If Mr. Halvorson is terminated without cause by Salem, he is entitled to severance payments equal to his salary for the remaining
term of his agreement. Mr. Halvorson also entered into a deferred compensation agreement with Salem effective as of November 1991, pursuant to which Mr. Halvorson will receive (i) 50% of the average of his three highest years of compensation, payable for a period of ten consecutive years, if he remains employed by Salem until age 60, or (ii) a discounted amount, based upon the compensation he would have received if he had remained employed until age 60, if his employment terminates for any reason after the term of the employment agreement or before he reaches age 60 by reason of death, disability or termination by Salem without cause.
Greg R. Anderson entered into an employment agreement with Salem Radio Network(R) effective as of October 1994, pursuant to which he serves as President of Salem Radio Network(R) for a period of three years at an annual salary of $120,000, $126,000 and $132,300 for each year during the term of the agreement, respectively. The agreement was subsequently amended in December 1995 to increase Mr. Anderson's base salary to $162,300 and was amended again in August 1997 to extend the term for three additional years. Mr. Anderson is also entitled to participate in any benefit plans provided by Salem Radio Network(R) to its employees and is entitled to receive 6 months severance payment upon termination by Salem at any time before the end of the term of the employment agreement.
401(K) PLAN
The company adopted a 401(k) savings plan in 1993 for the purpose of providing, at the option of the employee, retirement benefits to full-time employees of the company and its subsidiaries. Contributions to the 401(k) savings plan are made by the employee and, on a voluntary basis, by the company. The company currently matches 10% of the employee's contributions to the 401(k) savings plan which do not exceed 10% of the employee's annual compensation. The company made a contribution of $87,000 to the 401(k) savings plan during the year ended December 31, 1998.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information with respect to the beneficial ownership of all of Salem's common stock. In addition, the table below provides the total economic interest and voting power of all shareholders.
The address of the individuals listed below is 4880 Santa Rosa Road, Suite 300, Camarillo, California 93012.
- ------------------------- (1) Stuart W. Epperson and Nancy A. Epperson are husband and wife.
(2) Edward G. Atsinger III is the President, Chief Executive Officer and a director of the company.
(3) Stuart W. Epperson is the Chairman of the Board of the company.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
CERTAIN LOAN TRANSACTIONS
In December 1997, the company borrowed $2.0 million from Mr. Atsinger pursuant to a promissory note with a revolving principal amount of up to $2.5 million. The outstanding balance on the note as of December 31, 1998 was $1.8 million. The note is a demand note which bears interest at a floating rate that is currently 8%. During the term of the note, the interest rate will at all times be 1% lower than the rate for base rate borrowings under the company's revolving credit facility. The company will borrow under the revolving credit facility when Mr. Atsinger demands repayment. The note is outstanding as of the date hereof.
In January 1998, the company borrowed $1.5 million from Mr. Epperson pursuant to a promissory note with a revolving principal amount of up to $2.5 million. In May 1998, the company repaid $1.5 million and there was no outstanding balance on the note as of December 31, 1998. The note is a demand note which bears interest at floating rate that is currently 8%. During the term of the note, the interest rate will at all times be 1% lower than the rate for base rate borrowings under the company's revolving credit facility. The company will borrow under the revolving credit facility when Mr. Epperson demands repayment. The note is outstanding as of the date hereof.
In 1997, the company purchased split-dollar life insurance policies for its then-sole shareholders, Messrs. Atsinger and Epperson. Mr. Epperson selected a policy in the amount of $20 million while Mr. Atsinger selected a policy in the amount of $40 million, resulting in a premium difference of $94,000 between the two policies, which difference was paid to Mr. Epperson in cash in the form of an interest-free loan. The loan will be called upon payment by Mr. Atsinger of $94,000 to the company.
LEASES WITH PRINCIPAL SHAREHOLDERS
The company leases the studios and tower and antenna sites described in the table below from Messrs. Atsinger and Epperson or trusts and partnerships created for the benefit of Messrs. Atsinger and Epperson and their families. All such leases have cost of living adjustments. Based upon management's assessment and analysis of local market conditions for comparable properties, the company believes that such leases do not have terms that vary materially from those that would have been available from unaffiliated parties.
- --------------- (1) The expiration date reported for certain facilities represents the expiration date assuming exercise of lease term extensions at the company's option.
Rental expense paid by the company to Messrs. Atsinger and Epperson or trusts or partnerships created for the benefit of their families for 1998 amounted to approximately $1,050,000. Rental expense paid by the company to Mr. Atsinger or trusts created for the benefit of his family for 1998 amounted to approximately $60,000.
MANAGEMENT SERVICES CONTRACT
The company provides management services for Sonsinger, Inc. which is the licensee of KKOL-AM, Seattle. Messrs. Atsinger and Epperson are the owners of 100% of the outstanding shares of Sonsinger. Messrs. Atsinger and Epperson and the company are parties to an Option to Purchase Agreement whereunder the company has been granted an option to purchase KKOL-AM from Messrs. Atsinger and Epperson at any time on or before December 31, 1999 at a price equal to the lower of the cost of the station to Messrs. Atsinger and Epperson, $1.4 million, and its fair market value as determined by an independent appraisal. Pursuant to a local marketing agreement with Sonsinger, entered into June 13, 1997, the company programs KKOL-AM and sells all the airtime. The company retains all of the revenue and incurs all of the expenses related to the operation of KKOL-AM and incurred approximately $164,000 in local marketing fees under this agreement in 1998.
TOWER CONSTRUCTION CONTRACT
In October 1997, in order to reduce the indebtedness under the revolving credit facility, the company assigned its contract with a tower construction company to build a broadcast tower in Houston to Messrs. Atsinger and Epperson, subject to the principal shareholders obtaining financing. Messrs. Atsinger and Epperson reimbursed the company for its costs and expenses of $3.7 million on December 31, 1997. The antenna for the company's station in Houston, KKHT-FM,is located on the tower and the company pays rent at an annual rate of $150,000 to Messrs. Atsinger and Epperson.
RADIO STATIONS OWNED BY THE EPPERSONS
Mrs. Epperson has personally acquired four radio stations in the Norfolk-Virginia Beach-Newport News, Virginia market. Additionally, Mr. Epperson has personally acquired certain radio stations in the Greensboro-Winston-Salem, North Carolina market. These Virginia and North Carolina markets are not currently served by stations owned and operated by the company. Acquisitions in such markets are not part of the company's current business and acquisition strategies.
TRANSPORTATION SERVICES SUPPLIED BY PRINCIPAL
From time to time, Salem rents an airplane and a helicopter from Atsinger Aviation LLC, which is owned by Mr. Atsinger. As approved by the independent members of Salem's board of directors, Salem rents these aircraft on an hourly basis at below-market rates and uses them for general corporate needs. In 1998, the company paid $69,180 to Atsinger Aviation for airplane rental; no amounts were paid for helicopter rental in 1998.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements. ---------------------
The financial statements required to be filed hereunder are set forth at the end of this Report beginning on page.
2. Exhibits. ---------
- ----------------- + Incorporated by reference to the exhibit of the same number, unless otherwise noted, of Salem's Registration Statement on Form S-4 (No. 333-41733), as amended, as declared effective by the Securities and Exchange Commission on February 9, 1998.
++ Incorporated by reference to Salem's Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 4, 1998.
(b) Reports on Form 8-K. --------------------
On September 4, 1998, the company filed a Current Report on Form 8-K, reporting Item 2, in connection with the acquisition of the assets of radio station KIEV-AM, Glendale, California.
SIGNATURES
Pursuant to the requirements 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.
SALEM COMMUNICATIONS CORPORATION
March 31, 1999 By: /s/ Edward G. Atsinger III ------------------------------------- Edward G. Atsinger III President and Chief Executive Officer
March 31, 1999 By: /s/ Dirk Gastaldo ------------------------------------- Dirk Gastaldo Vice President and Chief Financial Officer
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.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders Salem Communications Corporation
We have audited the accompanying consolidated balance sheets of Salem Communications Corporation as of December 31, 1997 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and the schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Salem Communications Corporation at December 31, 1997 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Woodland Hills, California March 24, 1999
SALEM COMMUNICATIONS CORPORATION
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
See accompanying notes.
SALEM COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS)
See accompanying notes.
SALEM COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
See accompanying notes.
SALEM COMMUNICATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Reorganization
The accompanying consolidated financial statements of Salem Communications Corporation (Salem or the Company) include the Company and its wholly-owned subsidiaries. Prior to the reorganization described below (the Reorganization) the financial statements had been presented on a combined basis and included Salem, New Inspiration Broadcasting Company, Inc. (New Inspiration), Golden Gate Broadcasting Company, Inc. (Golden Gate) and Beltway Media Partners (Beltway), and all of these entities were under common control. New Inspiration and Golden Gate were S corporations for income tax purposes. Salem, New Inspiration and Golden Gate were the partners of Beltway. The combined financial statements were entitled Salem Broadcasting Entities. Pursuant to the Reorganization the financial statements have been renamed and the disclosure of common stock information has been retroactively restated for all periods presented as if the Reorganization had been completed as of the beginning of the earliest period presented. All significant intercompany balances and transactions have been eliminated.
The Company is a holding company with substantially no assets, operations or cash flows other than its investments in subsidiaries. All of the Company's subsidiaries are Guarantors of the 9 1/2% Senior Subordinated Notes due 2007 (the Notes) discussed in Note 4. The Guarantors (i) are wholly owned subsidiaries of the Company, (ii) comprise all the Company's direct and indirect subsidiaries and (iii) have fully and unconditionally guaranteed on a joint and several basis, the Notes. The Company has not presented separate financial statements and other disclosures concerning the Guarantors because management has determined that such information is not material to investors.
In August 1997, the Company, New Inspiration and Golden Gate effected the Reorganization pursuant to which New Inspiration and Golden Gate became wholly-owned subsidiaries of the Company, with Beltway remaining a partnership. The Company accounted for the Reorganization as a combination of entities under common control, which is a method similar to a pooling of interests. In October 1998, the Company, New Inspiration and Golden Gate contributed their partnership interests in Beltway to Salem Media of Virginia, Inc. (SMV), thereby dissolving Beltway. SMV is an indirectly wholly-owned subsidiary of the Company.
The S Corporation status of New Inspiration and Golden Gate was terminated in the Reorganization. Prior to the Reorganization, New Inspiration and Golden Gate distributed cash and promissory notes to their respective shareholders in the aggregate amount of $8.5 million. Of such amount, $1.8 million, equal to the estimated federal and state income tax liability of the S corporation shareholders on the earnings of New Inspiration and Golden Gate, was paid by New Inspiration and Golden Gate in cash. The balance, $6.7 million representing the balance of the net income of New Inspiration and Golden Gate that had previously been taxed, but not distributed to the shareholders, was paid in the form of promissory notes. In September 1997, the Company financed the repayment of these promissory notes by an additional borrowing.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Description of Business
Salem is a domestic U.S. radio broadcast company which focuses on talk and music programming targeted at audiences interested in religious and family issues. Salem operated 45 and 43 radio stations across the United States at December 31, 1998 and 1997, respectively. The Company also owns and operates Salem Radio Network (SRN), SRN News Network (SNN), Salem Music Network (SMN) and Salem Radio Representatives (SRR). SRN, SNN and SMN are radio networks which produce and distribute talk, news and music programming to Salem's radio stations and other independent radio station affiliates. SRR sells commercial air time to national advertisers for Salem's radio stations and networks, and for independent radio station affiliates.
The significant accounting policies of Salem are summarized below and conform with generally accepted accounting principles and reflect practices appropriate to the radio broadcasting industry.
Segments
The Company operates in one reportable segment.
Revenue Recognition
Revenue from radio programs and commercial advertising is recognized when broadcast. Salem's customers principally include not-for-profit charitable organizations and commercial advertisers.
Advertising by the radio stations exchanged for goods and services is recorded as the advertising is broadcast and is valued at the fair market value of goods or services received or to be received. The value of the goods and services received in such barter transactions is charged to expense when used. Barter revenue for the years ended December 31, 1996, 1997 and 1998, was approximately $1,498,000, $1,743,000 and $2,510,000, respectively. Barter expenses were approximately the same.
Cash Equivalents
Salem considers all highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents. The recorded amount for cash and cash equivalents approximates the fair market value.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost less accumulated depreciation. Depreciation is computed using the straight-line method over estimated useful lives as follows:
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The carrying value of property, plant and equipment is evaluated periodically in relation to the operating performance and anticipated future cash flows of the underlying radio stations and businesses for indicators of impairment. When indicators of impairment are present and the undiscounted cash flows estimated to be generated from these assets are less than the carrying value of these assets an adjustment to reduce the carrying value (if necessary) to the fair market value of the assets is recorded. No adjustments to the carrying amounts of property, plant and equipment have been made during the years ended December 31, 1996, 1997 and 1998.
Intangible Assets
Intangible assets acquired in conjunction with the acquisition of various radio stations are being amortized over the following estimated useful lives using the straight-line method:
The carrying value of intangibles is evaluated periodically in relation to the operating performance and anticipated future cash flows of the underlying radio stations and businesses for indicators of impairment. When indicators of impairment are present and the undiscounted cash flows estimated to be generated from these assets are less than the carrying amounts of these assets, an adjustment to reduce the carrying value (if necessary) to the fair market value of these assets is recorded. No adjustments to the carrying amounts of intangible assets have been made during the year ended December 31, 1996, 1997 and 1998.
Bond Issue Costs
Bond issue costs are being amortized over the term of the Notes as an adjustment to interest expense.
Tax Reimbursements to S Corporation Shareholders
"Tax reimbursements to S Corporation shareholders" represents additional salary payments made in the amount necessary to satisfy individual federal and state income tax liabilities of the S Corporation shareholders on the earnings of New Inspiration and Golden Gate prior to the Reorganization.
Income Taxes
The Company accounts for income taxes in accordance with the Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." SFAS No. 109 prescribes the liability method of
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
providing for deferred income taxes. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements.
Federal and state income taxes (except for 1.5% state franchise tax) have not been provided through August 12, 1997 for New Inspiration and Golden Gate because they were S Corporations and income tax attributes of S Corporations are passed through to their shareholders.
Concentrations of Business and Credit Risks
The majority of the Company's operations are conducted in several locations across the country. The Company's credit risk is spread across a large number of customers, none of which accounted for a significant volume of revenue or outstanding receivables. The Company does not normally require collateral on credit sales; however, credit histories are reviewed before extending substantial credit to any customer. The Company establishes an allowance for doubtful accounts based on customers' payment history and perceived credit risks. Bad debts have been within management's expectations.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications were made to the prior year financial statements to conform to the current year presentation.
2. ACQUISITIONS AND DISPOSITIONS OF ASSETS
Pro forma information to present operating results as if the acquisitions discussed below had occurred at the beginning of the year acquired is not presented because the Company, generally, changes the programming format of the radio stations such that the source and nature of revenue and operating expenses are significantly different than they were prior to the acquisition and, accordingly, historical and pro forma financial information is not considered meaningful by management. Pro forma and historical financial information of radio stations acquired where the format was not changed is not significant to the consolidated financial position or operating results of the Company.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During the year ended December 31, 1998, the Company purchased the assets (principally intangibles) of the following radio stations:
The purchase price has been allocated to the assets acquired as follows:
In 1998, the Company sold the assets (principally intangibles) of radio stations KTSL-FM (Spokane, WA) for $1.3 million and KAVC-FM (Lancaster, CA) for $1.6 million.
During the year ended December 31, 1997, the Company purchased the assets (principally intangibles) of the following radio stations:
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The purchase price has been allocated to the assets acquired as follows:
In November 1997, the Company sold the assets (principally intangibles) of radio station WPZE-AM (Boston, MA) for $5 million. Proceeds from the sale (included in other assets as a deposit at December 31, 1997) were initially being held by a qualified intermediary under a like-kind exchange agreement to preserve the Company's ability to effect a tax-deferred exchange. The Company did not effect a tax-deferred exchange and received the proceeds from the sale in 1998.
During the year ended December 31, 1996, the Company purchased the assets (principally intangibles) (and in the case of KBIQ-FM, all of the outstanding shares of common stock) of the following radio stations:
The purchase price has been allocated to the assets acquired as follows:
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In 1996, the Company sold the assets (principally intangibles) of radio stations WTJY-FM (Johnstown, Ohio), for $1.5 million, KLTE-FM (Kirksville, Missouri), for $550,000 and KDBX-FM (Banks, Oregon), for $14 million. In addition, KDFX-AM (Dallas, Texas), was exchanged as part of the purchase price of KWRD-FM. The Company received approximately $8 million of value of KDFX-AM towards the total purchase price of KWRD-FM of $40.1 million, resulting in a gain recognized of approximately $4.0 million.
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following at December 31:
4. LONG-TERM DEBT
Long-term debt consisted of the following at:
Since the note payable to banks and revolving line of credit carry floating interest rates, the carrying amount approximates their fair market value. The Notes were issued in September 1997 at par. At December 31, 1998, their fair market value was approximately $156.8 million.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Revolving Line of Credit with Banks
In September 1997, Salem entered into a new credit agreement with five banks (the Credit Agreement) to provide for borrowing capacity of up to $75 million under a revolving line of credit (reduced to $72.3 million as of December 31, 1998). The maximum amount that the Company may borrow under the Credit Agreement is limited by the Company's debt to cash flow ratio, adjusted for recent radio station acquisitions as defined in the Credit Agreement (the Adjusted Debt to Cash Flow Ratio). At December 31, 1998, the maximum Adjusted Debt to Cash Flow Ratio allowed under the Credit Agreement was 6.75 to 1.00. The Company's ability to borrow for the purpose of acquiring a radio station is further limited by the Credit Agreement in that the Company may not borrow for an acquisition if the Adjusted Debt to Cash Flow Ratio is greater than 6.00 to 1.00. At December 31, 1998, the Adjusted Debt to Cash Flow Ratio was 5.99 to 1.00, resulting in total borrowing availability (i.e., in addition to amounts already outstanding) of approximately $22.6 million, approximately $483,000 of which can currently be used for radio station acquisitions. The note evidencing the indebtedness bears interest at a fluctuating base rate plus a spread that was determined by Salem's Adjusted Debt to Cash Flow Ratio. At Salem's option, the base rate is either a bank's prime rate or LIBOR. For purposes of determining the interest rate the prime rate spread ranges from 0% to 1.75%, and the LIBOR spread ranges from 1% to 3%. At December 31, 1998, the interest rate on amounts outstanding under the Credit Agreement was 8.25%. Interest is payable quarterly. Commencing March 31, 1999, the commitment under the Credit Agreement reduces by $2.5 million quarterly through December 31, 2003, and by $6.25 million quarterly through June 30, 2004. The Credit Agreement expires August 31, 2004. The classification of the amounts due under the revolving line of credit in the accompanying balance sheet at December 31, 1998 is based on the terms of the Credit Agreement.
In January 1999, the Credit Agreement was amended to increase the maximum Adjusted Debt to Cash Flow Ratio to 7.00 to 1.00 through June 29, 1999. The interest rate spreads were also amended. The prime rate spread ranges from 0% to 2.25%, and the LIBOR spread ranges from 1% to 3.5%.
The Credit Agreement with the banks (a) provides for restrictions on additional borrowings and leases; (b) prohibits Salem, without prior approval from the banks, from paying dividends, liquidating, merging, consolidating or selling its assets or business, and (c) requires Salem to maintain certain financial ratios and other covenants. Salem has pledged all of its assets as collateral under the Credit Agreement. Additionally, all the Company's stock holdings in its subsidiaries are pledged as collateral.
In September 1997, in connection with the issuance of the Notes and the Credit Agreement the Company repaid all amounts due under its previous revolving line of credit with the banks. The Company wrote off certain deferred financing costs and terminated all of its interest rate swap and cap agreements associated with the line of credit (see Note 5). The write-off and termination fees of $1,185,000, net of a $659,000 income tax benefit, was recorded as an extraordinary item in the accompanying statement of operations for the year ended December 31, 1997.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9 1/2% Senior Subordinated Notes due 2007
The Notes bear interest at 9 1/2% per annum, with interest payment dates on April 1 and October 1, commencing April 1, 1998. Principal is due on the maturity date, October 1, 2007. The Notes are redeemable at the option of the Company, in whole or in part, at any time on or after October 1, 2002, at the redemption prices specified in the indenture. The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior subordinated basis by the Guarantors (the Company's subsidiaries). The Notes are general unsecured obligations of the Company, subordinated in right of payment to all existing and future senior indebtedness, including the Company's obligations under the Credit Agreement. The indenture limits the incurrence of additional indebtedness by the Company, the payment of dividends, the use of proceeds of certain asset sales, and contains certain other restrictive covenants affecting the Company. In March 1998, the Company consummated an exchange offer for the original notes (Original Notes) which were issued in September 1997. The exchange offer commenced when the Company's registration statement under the Securities Act of 1933 was declared effective. The Notes are identical in all material respects to the Original Notes except that the Notes do not contain terms with respect to transfer restrictions. The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior subordinated basis by the Guarantors. The Notes are in general freely transferable without further registration under the Securities Act of 1933.
Other Debt
In August 1998, in connection with the Company's acquisition of KIEV-AM, the Company agreed to lease the real property on which the station's towers and transmitter are located for $10,000 per month. The Company also agreed to purchase the property for $3 million in February 2000. The Company recorded this transaction in a manner similar to a capital lease. The amount recorded as a long-term obligation at December 31, 1998, represents the present value of the future commitments under the lease and purchase contract, discounted at 8.5%.
At December 31, 1998 and 1997, the Company owed $1.8 million and $2 million, respectively, to one of its shareholders. Interest is payable monthly. The note is payable upon demand by the shareholder. The Company intends to refinance the borrowing if demanded by the shareholder with the proceeds from a borrowing under the Credit Agreement. Accordingly, the amount is reflected as long-term debt in the accompanying balance sheet at December 31, 1998, consistent with the terms of the Credit Agreement.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Maturities of Long-Term Debt
Principal repayment requirements under all long-term debt agreements outstanding at December 31, 1998, for each of the next five years and thereafter are as follows:
5. INTEREST RATE CAP AND SWAP AGREEMENTS
In 1996 and 1997 Salem had entered into interest rate swap and cap agreements to reduce the impact of changes in interest rates on its floating-rate long-term debt. In September 1997, in connection with the issuance of the Notes and the Credit Agreement the Company terminated all of its interest rate swap and cap agreements for aggregate fees of $417,000. The Company wrote off these costs (unamortized swap fee of $201,000 and the swap termination fee of $417,000) in September 1997. This write-off, net of income tax benefit, was included in the extraordinary loss in the accompanying statement of operations for the year ended December 31, 1997 (see Note 4).
6. INCOME TAXES
As discussed in Note 1, prior to the Reorganization, New Inspiration and Golden Gate were S Corporations for income tax purposes. Accordingly, any federal and state income tax liability on net income of the S Corporations has been the liability of shareholders of the S Corporations. The S Corporation status of New Inspiration and Golden Gate was terminated in the Reorganization, which was effective August 13, 1997, and the income of New Inspiration and Golden Gate will thereafter be subject to federal and state income taxes. The accompanying consolidated statements of operations include an unaudited pro forma income tax adjustment, using an estimated combined effective tax rate of approximately 40%, to reflect the estimated income tax expense of the Company as if New Inspiration and Golden Gate had been subject to federal and state income taxes for the periods presented. In connection with the Reorganization, which resulted in the termination of the S Corporation status of New Inspiration and Golden Gate, the Company recorded a deferred tax liability and provision of approximately $609,000 in December 1997.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The consolidated provision (benefit) for income taxes for Salem consisted of the following at December 31:
The consolidated deferred tax asset and liability consisted of the following at December 31:
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A reconciliation of the statutory federal income tax rate to the effective tax rate, as a percentage of income before income taxes, is as follows:
The S Corporations had book income (loss) before income taxes of $3,800,000 and $2,400,000 in 1996 and 1997, respectively. These amounts include the S Corporations' 85% ownership interest in Beltway.
At December 31, 1998, the Company has net operating loss carryforwards for federal income tax purposes of approximately $5,800,000 which expire in years 2010 through 2018 and for state income tax purposes of approximately $4,600,000 which expire in years 1999 through 2013. The Company has federal alternative minimum tax credit carryforwards of approximately $147,000. For financial reporting purposes, a valuation allowance of $95,000 has been provided in 1998 and 1997 to offset a portion of the deferred tax assets related to the state net operating loss carryforwards.
7. COMMITMENTS AND CONTINGENCIES
Salem leases various land, offices, studios and other equipment under operating leases that expire over the next 10 years. The majority of these leases are subject to escalation clauses and may be renewed for successive periods ranging from one to five years on terms similar to current agreements and except for specified increases in lease payments. Rental expense included in operating expense under all lease agreements was $3,800,000, $4,800,000 and $4,800,000 in 1996, 1997, and 1998 respectively.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1998, are as follows:
The Company is involved in certain legal actions and claims arising in the normal course of business. It is the opinion of management that such litigation and claims will be resolved without material effect on the Company's consolidated financial position, operations and cash flows.
The Company has a deferred compensation agreement with one of its officers, which provides for retirement payments to the officer for a period of ten consecutive years, if he remains employed by the Company until age 60. The retirement payments are based on a formula defined in the agreement. The estimated obligation under the deferred compensation agreement is being provided for over the service period. At December 31, 1997 and 1998, a liability of approximately $370,000 and $432,000 respectively, is included in other liabilities in the accompanying balance sheet for the amounts earned under this agreement.
8. RELATED PARTY TRANSACTIONS
In December 1997, the Company borrowed $2 million from a shareholder pursuant to a promissory note with a revolving principal amount of up to $2.5 million. The outstanding balance on the note as of December 31, 1998 and 1997 was $1.8 million and $2 million, respectively (see Note 4). The note is a demand note which bears interest at a floating rate (8 1/4% at December 31, 1998). During the term of the note, the interest rate will at all times be 1% lower than the rate for base rate borrowings under the Company's Credit Agreement. The Company will borrow under the Credit Agreement when the shareholder demands repayment.
In January 1998, the Company borrowed $1.5 million from another shareholder pursuant to another promissory note with a revolving principal amount of up to $2.5 million. The Company repaid all amounts outstanding in May 1998. There were no amounts outstanding at December 31, 1998 and 1997. The note is a demand note which bears interest at a floating rate. During the term of the note, the interest rate will at all times be 1% lower than the rate for base rate borrowings under the Company's Credit Agreement. The Company will borrow under the Credit Agreement when the shareholder demands repayment of any amounts outstanding.
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A shareholder's trust owns real estate on which certain assets of two radio stations are located. Salem, in the ordinary course of its business, entered into two separate lease agreements with this trust. Rental expense included in operating expense for 1996, 1997 and 1998 amounted to $57,000, $57,000 and $60,000, respectively.
Land and buildings occupied by various Salem radio stations are leased from the shareholders of Salem. Rental expense under these leases included in operating expense for 1996, 1997 and 1998 amounted to $800,000, $1,000,000 and $1,000,000, respectively.
In October 1997, the Company assigned its contract with a tower construction company to build a broadcast tower in Houston to the principal shareholders subject to the principal shareholders obtaining financing. The principal shareholders obtained such financing on December 31, 1997 and reimbursed the Company for its costs and expenses under the contract, which amounted to approximately $3.7 million.
At December 31, 1995, notes receivable from shareholders totaled approximately $3,400,000. The notes bore interest at the Applicable Federal Rate and were payable upon demand. In December 1996, New Inspiration and Golden Gate distributed $5.5 million to the shareholders, of which $4.8 million was used by the shareholders to repay the notes receivable and accrued interest.
In June 1997, the Company entered into a local marketing agreement (LMA) with a corporation, Sonsinger, Inc. (Sonsinger), owned by two of Salem's shareholders for radio station KKOL-AM. The shareholders and the Company are parties to an Option to Purchase Agreement whereunder the Company has been granted an option to purchase KKOL-AM from the shareholders at any time on or before December 31, 1999 at a price equal to the lower of the cost of the station to the shareholders, $1.4 million, and its fair market value as determined by an independent appraisal. Under the LMA, Salem programs KKOL-AM and sells all the airtime. Salem retains all of the revenue and incurs all of the expenses related to the operation of KKOL-AM and incurred approximately $64,000 and $164,000 in 1997 and 1998, respectively in LMA fees to Sonsinger.
From time to time, the Company rents an airplane and a helicopter from a company which is owned by one of the principal shareholders. As approved by the independent members of the Company's board of directors, the Company rents these aircraft on an hourly basis at below-market rates and uses them for general corporate needs. Total rental expense for these aircraft for 1996, 1997 and 1998 amounted to approximately $38,000, $60,000 and $69,000, respectively.
9. DEFINED CONTRIBUTION PLAN
In 1993, the Company established a 401(k) defined contribution plan (the Plan), which covers all eligible employees (as defined in the Plan). Participants are allowed to make nonforfeitable contributions up to 15% of their annual salary, but may not exceed the annual maximum contribution limitations established by the Internal Revenue Service. The Company currently matches 10% of the amounts contributed by each participant but does not match participants' contributions in excess of 10% of their compensation per pay period. Effective January 1, 1999 the Company matches 25% of the amounts contributed by each participant but does not match participants' contributions in excess of 6% of their
SALEM COMMUNICATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
compensation per pay period. The Company contributed and expensed $48,000, $80,000 and $87,000 to the Plan in 1996, 1997 and 1998 respectively.
10. SUBSEQUENT EVENTS
In January 1999, the Company purchased the assets of OnePlace, LLC (OnePlace), for $6.2 million, and all the outstanding shares of stock of CCM Communications, Inc. (CCM), for $1.9 million. OnePlace is engaged in the business of applying Internet e-commerce, consumer profiling and other information technologies in the Christian products industry. CCM publishes magazines which follow the contemporary Christian music industry. The purchases were financed primarily by an additional borrowing. The Company amended its Credit Agreement with the banks to allow for such a borrowing (see Note 4).
In January 1999, the Company also agreed to purchase the assets of NavPress Software, Inc. (NavPress), for $550,000. NavPress develops and supplies electronic Bible and Christian reference books and Bible study software applications.
SALEM COMMUNICATIONS CORPORATION
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
S-1
SALEM COMMUNICATIONS CORPORATION
INDEX TO EXHIBITS
E-1