ITEM 1. BUSINESS
Market data and other statistical information included in this Business section are based on industry publications, government publications and reports by market research firms or other published independent sources, including the United States Census Bureau, Arbitron and Nielsen surveys and Television Bureau Advertising (TVB).
Overview
We are one of the largest owners and operators of Spanish-language radio and television stations in the United States based on revenues and number of stations. We own 21 radio stations (fourteen FM and seven AM) and four television stations in Los Angeles, Houston, Dallas-Fort Worth and San Diego, the first, fourth, sixth and fourteenth largest Hispanic markets in the United States, respectively, based on Hispanic television households. We operate radio and television stations in markets that comprise approximately 28% of the U.S. Hispanic population.
Our Los Angeles cluster consists of five Spanish-language radio stations, one AM radio station with time-brokered programming and a television station. Our Houston cluster consists of seven Spanish-language radio stations, two AM radio stations with time-brokered programming and a television station. Our Dallas-Fort Worth cluster consists of five Spanish-language radio stations, one FM radio station with time-brokered programming and one television station. We also own a television station serving San Diego, California. In addition, we operate a television production facility, Empire Burbank Studios, in Burbank, California that we use to produce nine hours of television programming each day. There are also television production facilities in Houston and Dallas-Fort Worth that allow us to produce programming for those markets as well.
We seek to own and operate radio and television stations in the nation’s largest and most densely populated Hispanic markets. Our strategy is to increase revenue and cash flow in our markets by reformatting acquired stations with programming that is focused on the demographic composition of the market, providing creative advertising solutions for clients, executing targeted marketing campaigns to develop a local audience and implementing strict cost controls. We had a substantial debt balance of $413.8 million at December 31, 2006.
Operating Strategy
The principal components of our operating strategy are set forth below:
Develop popular stations by targeting the local community
As not all Hispanics have the same cultural and ethnic backgrounds, we seek to create radio and television programming specifically tailored to the preferences of each individual Hispanic market to create a highly recognizable local station identity. We believe that we are particularly adept at programming to the tastes and preferences of the Hispanics of Mexican heritage, which comprise 81%, 78%, 84% and 86% of the Hispanic populations in Los Angeles, Houston, Dallas-Fort Worth and San Diego, respectively, according to a 2005 survey by the U.S. Census Bureau. We believe our ability to produce locally targeted programming gives us an advantage over most other Spanish-language broadcasters that develop and distribute their programming on a national or regional basis and, as a result, we have generally been able to achieve and maintain strong station ratings in our markets.
Cross-promote our radio and television stations
We utilize a portion of our commercial inventory time at both our radio and television stations to run advertisements promoting our other stations and programming, which helps us capitalize on the strong ratings and targeted audience of our stations with no incremental cash outlay. In addition, we utilize our radio and television personalities to create complementary programs that attract our radio listeners to our television programs and our television viewers to our radio stations. For example, in Los Angeles and Houston, we produce music variety television shows hosted by our radio station disc jockeys that feature music industry news, interviews and videos of songs played
on our popular radio stations in those markets. We have also successfully launched a television program that exploits the popularity of our number one radio personality, Don Cheto. Don Cheto’s television program is shown on all of our stations.
Capitalize on our complementary radio and television stations to capture a greater share of advertising revenue
We create cross-selling opportunities by offering our advertisers customized marketing programs that allows them to cross-advertise on radio and television, as well as to cross-merchandise through product integration in our programming. This allows us to effectively compete for a significant portion of an advertiser’s Hispanic budget since advertisers have historically spent over 80% of their Hispanic advertising budgets on radio and television. We believe that we are able to capture a larger share of advertising revenues in our markets because of our ability to cross-sell and cross-promote our radio and television stations. We also take advantage of the advertiser relationships by allowing our account executives to sell across platforms and across markets.
Offer cost-effective advertising and value-added services to our advertisers
We believe that we differentiate ourselves from other Spanish-language broadcasters by offering advertisers the greatest value for their advertising dollar. By supporting advertisers’ media campaigns with creative promotions and offering our studio facilities to provide value-added services, such as free production of television commercials, we are able to cross-sell our broadcasting properties and attract new customers currently not advertising on radio or television. As a result, we have been able to significantly increase our advertiser base.
Provide product integration that allows us to differentiate ourselves from our competition
Because we produce over 53 hours of internal programming for our television stations each week, we are able to integrate the products of our advertisers into our television shows. The ability to provide product integration to our television advertisers in our television programming is a significant competitive advantage given the growing popularity of imbedding advertisers’ products and services in television shows and the inability of many of our competitors, who do not internally produce their own programs, to provide such services.
Develop a diverse local advertiser base
Consistent with our locally targeted programming strategy, our sales strategy is focused on establishing direct relationships with the local advertising community. Local advertising accounted for approximately 79.3% of our gross advertising revenue in 2006. We believe that local advertisers are more responsive to Hispanic advertising opportunities in our markets. Other advantages of our locally focused sales strategy include:
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our cash flows have been generally less vulnerable to ratings fluctuations as a result of our strong relationships with our advertisers;
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our cash flows have been relatively more recession resistant because local advertising has historically been less cyclical than national advertising; and
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our large and diverse client base has resulted in no single advertiser accounting for more than 1.5% of our net revenues in 2006.
Utilize cost-effective television programming to drive cash flow growth
Currently we produce over 53 hours of programming each week. Our television programming consists primarily of internally produced programming from 12:00 PM to 10:00 PM which creates a compelling programming line-up for our television stations. Our in-house television production facilities provide us with an efficient cost structure to create programming, such as our popular talk show José Luis Sin Censura, our reality-based program Desafio del Rancho, our musical variety shows Estudio 2, El Show de Don Cheto, La Raza TV, Que Buena TV, our game show A Que No Puedes, our news programs Alarma TV and Noticias STN, and our procedural dramas Secretos. We realize programming synergies between our radio and television assets by leveraging our dominant market presence in Spanish radio by creating music-based variety programs like Estudio 2. Estudio 2 is the number two
Hispanic television program in prime time in the Los Angeles market in the adult aged 18 to 34 and 18 to 49 demographics. Furthermore, we supplement our internally produced programming with purchased programs, primarily Spanish-language movies, which we obtain from numerous producers in Latin America. If we acquire additional television stations, we will be able to further leverage our programming library across a broader base of stations, thereby potentially increasing our profitability.
Capitalize on our valuable programming library
We recently have increased our production of television programming which should allow us to assemble a valuable programming library that can be exploited at limited additional cost through use on our other stations, syndication, DVDs, and other formats.
Acquisition Strategy
Our acquisition strategy focuses on identifying and acquiring selected assets of radio and television stations in the largest, most densely populated and fastest growing U.S. Hispanic markets to build market-leading Hispanic radio and television clusters. While our previous acquisitions have been concentrated in California and Texas, we may acquire assets of radio and television stations in U.S. markets that we have yet to enter. Although these stations often do not target the local Hispanic market at the time of acquisition, we believe they can be successfully reformatted to capture this audience. In analyzing our acquisition opportunities, we consider the following criteria for a station:
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the size and density of the Hispanic population and general economic conditions in the market;
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our ability to expand coverage in an existing cluster or develop a new cluster in a market where we believe we can acquire a meaningful share of the Hispanic audience, particularly where we can own both radio and television stations in a market as a result of such acquisition;
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our ability to acquire underdeveloped properties that offer the potential for significant improvement in revenues and cash flow through the application of our operating, administrative and programming expertise; and
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the power and quality of the station’s broadcasting signal.
We have built a long-term track record of acquiring and developing underperforming radio and television stations that has enabled us to achieve significant increases in our net revenue over the past decade. Since our inception in 1987, we have acquired and programmed 17 radio stations and 4 television stations. By reformatting these 21 stations with our own original Spanish language programming, implementing strict cost controls and providing creative advertising campaigns to our clients, we believe we have successfully developed and grown our stations in each of our markets. We believe that our record of successfully executing our acquisition strategy in new Hispanic markets will position us to continue creating top-ranked Hispanic station clusters in other Hispanic markets.
Hispanic Market Opportunity
We believe the Hispanic community represents an attractive market for future growth. In 2005, the U.S. Hispanic population was the largest minority group in the United States. The U.S. Hispanic population grew 3.3% from July 2004 to July 2005, accounting for about one-half of all U.S. population growth during that period, as reported by the U.S. Census Bureau. By 2010, the U.S. Hispanic population is expected to reach approximately 47.8 million people, or 16% of the total U.S. population. According to a Census Bureau survey released in February 2007, one out of every two Hispanics live in either California or Texas, the two states in which we operate.
In addition, advertisers have begun to direct more advertising dollars towards U.S. Hispanics and, consequently, Hispanic radio and television advertising revenues are expected to reach $5.5 billion by 2010, with projected growth of 32% from 2002 to 2010 according to “Economics of Hispanic Television in the United States” by Kagan Research. Spanish-language advertising rates have been rising faster in recent years when compared to the general media, yet these rates are still lower than those for English-language media. As advertisers continue to recognize the buying power of the U.S. Hispanic population, especially in areas where the concentration of Hispanics is very high and where a growing percentage of the retail purchases are made by Hispanic customers, we expect the gap in
advertising rates between Spanish-language and English-language media to narrow. As U.S. Hispanic consumer spending continues to grow relative to overall consumer spending, industry analysts expect that advertising expenditures targeted to Hispanics will increase significantly, eventually closing the gap between the current level of advertising targeted to Hispanic station audiences and the current level of advertising targeted to general market station audiences.
We believe we are well positioned to capitalize on the growing Hispanic advertising market given the concentration of the Hispanic population in certain markets in the United States, our attractive position in three of the six largest Hispanic markets in the United States based on Hispanic television households, Los Angeles, Houston and Dallas-Fort Worth, and our record of successfully executing our acquisition strategy in new Hispanic markets.
Our Markets
The following table sets forth certain demographic information about the markets in which our radio and television stations operate.
Source: American Community Survey Profile 2005 by the U.S. Census Bureau
(1) Represents the Los Angeles combined statistical area.
(2) Represents the Houston combined statistical area.
(3) Represents the Dallas-Fort Worth combined statistical area.
(4) Represents the San Diego combined statistical area.
(5) Represents growth from 1990 to 2005.
Our Radio and Television Stations
The following tables set forth certain information about our radio and television stations and their broadcast markets.
Radio Stations
(1) Our radio stations are in some instances licensed to communities other than the named principal community for the market.
(2) Represents rank among U.S. designated market areas by television households. Designated market areas are geographic markets as defined by A.C. Nielsen Company based on historical television viewing patterns and are updated annually.
(3) Represents rank among U.S. Hispanic markets by Hispanic television households. A ranking of 1, for example, means that Los Angeles has the most Hispanic television households in the United States.
(4) Represents the average share of listeners, ages 12 and older, listening to our radio stations during a specified period of time from the four most recent Arbitron surveys (Winter 2006, Spring 2006, Summer 2006 and Fall 2006), except for the Dallas stations which represents the average share of listeners ages 12 and older listening during the Winter 2007 phase 1 trend. We converted KNOR-FM to a Spanish-language format in July 2006 and purchased selected assets of the other Dallas radio stations in November 2006. A 3.5 station audience share means that 3.5% of all radio listeners in the station’s market listen to that station.
(5) KBUA-FM and KEBN-FM (formerly KMXN-FM) currently simulcast the signal of KBUE-FM in the San Fernando Valley and Orange County, respectively. We have upgraded the signals of KBUA-FM and KEBN-FM from 3kW to 6kW, thereby improving our coverage of the Los Angeles market and enabling us to use the stations for purposes other than to simulcast with KBUE-FM, if we so choose.
(6) Four of our stations, KVNR-AM, KSEV-AM, KJOJ-AM and KZMP-FM are operated by third parties under time brokerage agreements. We receive a monthly fee from the third parties for the air time and the third parties receive revenues from their sale of advertising spots.
(7) KJOJ-FM simulcasts the signal of KTJM-FM.
(8) KIOX-FM simulcasts the signal of KQQK-FM. An application for approval of a construction permit to increase KIOX-FM’s antenna height and improve its signal has been granted by the FCC. We have entered into an agreement to construct a new tower site that should improve the signal of KQQK-FM.
(9) KXGJ-FM simulcasts the signal of KEYH-AM. An application for approval of a construction permit to increase KXGJ-FM’s antenna height and improve its signal along with that of its simulcast partner, KEYH-AM has been granted by the FCC.
(10) KNOR-FM broadcasted an English-language hip hop music format until July 17, 2006, when we moved to our newly constructed tower site and began broadcasting the Regional Mexican format.
(11) We are currently constructing a new tower of approximately 2,000 feet to improve the signals of KQQK-FM and KTJM-FM stations. An application for approval of a construction permit for the construction has been granted by the FCC. KQQK-FM has moved to the new tower and we expect KTJM-FM to move to the tower within the next six months.
Television Stations
Source: Nielsen Media Research-NSI, January, 2007
(1) Represents rank among U.S. designated market areas by television households. Designated market areas are geographic markets as defined by A.C. Nielsen Company based on historical television viewing patterns and are updated annually.
(2) Represents rank among U.S. Hispanic markets by Hispanic TV households. A ranking of 1, for example, means that Los Angeles has the most Hispanic television households in the United States.
Programming
Radio. Our Spanish-language radio stations are targeted to the Spanish-speaking portion of the Hispanic population that is dominant in the local markets in which we operate. We tailor the format of each of our radio stations to reach a specific target demographic in order to maximize our overall listener base without causing direct format competition among our stations. We determine the optimal format for each of our stations based upon local market research. To create brand awareness and loyalty in the local community, we seek to enhance our market positions by sending on-air talent to participate in local promotional activities, such as concerts and live special events or promotions at client locations and other street level activities. These types of events also provide attractive promotional and advertising opportunities for our clients. We also promote our radio stations in our television programming airing in these markets.
The following provides a brief description of our Spanish-language radio station formats:
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KBUE-FM/KBUA-FM/KEBN-FM (Que Buena) plays contemporary, up-tempo, regional Mexican music that includes Norteña, Banda, Corrido and Ranchera music. The target audience for these stations is adult listeners aged 18 to 34.
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KHJ-AM (La Ranchera) plays traditional Ranchera, also known as Mariachi music. The target audience for this station is adult listeners aged 25 to 54.
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KWIZ-FM (Sonido) plays a mix of hit music from various musical genres. The target audience for this station is adult listeners aged 18 to 49.
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KTJM-FM/KJOJ-FM (La Raza) plays contemporary, up-tempo, regional Mexican music, similar to the music played on Que Buena, which includes Norteña, Banda, Corrido and Ranchera music. The target audience for these stations is adult listeners aged 18 to 34 and the station adjusts its music to the tastes of Houston Hispanics.
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KQQK-FM/KIOX-FM (XO) plays contemporary, up-tempo, Spanish pop music. The target audience for these stations is adult listeners aged 18 to 34.
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KQUE-AM (Radio Ranchito) plays traditional Ranchera music. The target audience for this station is adult listeners aged 25 to 54.
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KEYH-AM/KXGJ-FM (Concierto) plays Norteña music from the norther portion of Mexico. The target audience for these stations is adult listeners aged 18 to 49.
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KNOR-FM plays contemporary, up-tempo, regional Mexican music, similar to the music played on Que Buena, which includes Norteña, Banda, Corrido and Ranchera music. The target audience for this station is adult listeners 18 to 34.
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KTCY-FM plays contemporary, up-tempo, Spanish pop music. The target audience for this station is adult listeners 18 to 49.
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KZZA-FM plays Reggaeton and hip hop music. The target audience for this station is bi-lingual Hispanic adult listeners 18 to 34.
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KZMP-AM plays traditional Ranchera, also known as Mariachi music. The target audience for this station is adult listeners 25 to 54.
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KBOC-FM plays Norteña music which originates from northern Mexico. The target audience for this station is adult listeners 18 to 49.
Four of our radio stations are operated by third parties under time brokered agreements. Our time brokered stations are a source of stable cash flow given that they are typically operated under long-term contracts with annual price escalators, and we do not incur any of the programming costs associated with these stations. Currently, KVNR-AM in the Los Angeles market broadcasts Vietnamese-language programming. According to the 2000 U.S. Census, Los Angeles is the largest Vietnamese market in the United States. KSEV-AM in Houston broadcasts an English-language talk format that is operated by a local broker. KJOJ-AM in the Houston market broadcasts an Indian-language format that is operated by a local broadcaster. KZMP-FM in Dallas-Fort Worth broadcasts Indian and Pakistani-language programming.
Television. Our programming content consists primarily of internally produced programs such as single topic talk shows, comedy, local news, procedural dramas and musical variety shows, as well as purchased programs including Spanish-language movies. We own or have the rights to a library of more than 4,500 hours of Spanish-language movies, children’s shows and other programming content available for broadcast on our television stations. Currently we produce over 53 hours of programming each week.
We seek to maximize our television group’s profitability by broadcasting internally produced Spanish-language programming, marketing commercial time to advertisers and selling infomercial advertising.
Production Facilities
We own Empire Burbank Studios, a fully equipped television production complex next to our corporate offices in Burbank, California. We also own studios and production facilities in Houston and Dallas, enabling us to produce local programming in these markets. The studios provide us with all of the physical facilities needed to produce our own Spanish-language television programming without the variable expense of renting these services from an outside vendor. We believe this enables us to produce our programming at a very low cost relative to our competitors. Owning our own production facilities also enables us to control the content of the programs we produce on air. We currently produce the following Spanish-language programs at our Burbank facilities:
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Noticias 62 En Vivo: two local newscasts airing on KRCA-TV, Channel 62, in Los Angeles that airs every weekday from 12:00 PM to 12:30 PM and from 9:00 PM to 10:00 PM. Our 9:00 PM newscast is anchored by Emmy Award winner, Jesús Javier;
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Los Angeles En Vivo: a local Los Angeles live entertainment variety show hosted by Rene Navarro and Elva Saray that airs on KRCA-TV every weekday from 12:30 PM to 1:00 PM;
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Que Buena TV: a music-oriented variety show centered around the music played by our Que Buena radio format in Los Angeles that airs on KRCA-TV every weekday from 3:00 PM to 4:00 PM;
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El Show de Don Cheto: a musical variety and game show featuring our number one radio personality and entertainer, Don Cheto. Airing on KRCA-TV and KSDX-TV weekdays from 4:00 PM to 5:00 PM and 5:00 PM to 6:00 PM, respectively. The show also airs in Houston and Dallas on KZJL-TV and KMPX-TV, respectively, weekdays from 3:00 PM to 4:00 PM and Saturdays from 9:00 PM to 10:00 PM;
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José Luis Sin Censura: a fast-paced single topic talk show hosted by well-known Spanish television personality José Luis Gonzáles that airs on KRCA-TV every weekday from 10:00 AM to 11:00 AM and 6:00 PM to 7:00 PM, on KSDX-TV every weekday from 7:00 PM to 8:00 PM, and on KZJL-TV and KMPX-TV every weekday from 5:00 PM to 6:00 PM. The show also airs on Saturdays from 9:00 PM to 10:00 PM;
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Estudio 2: a talent musical variety show that features a live performance by a hit musical artist, a talent search and the performance of a famous Mexican comedian. The show airs on KRCA-TV every weekday from 7:00 PM to 8:00 PM, on KSDX-TV from 8:00 PM to 9:00 PM, KZJL-TV and KMPX-TV 6:00 PM to 7:00 PM. The show also airs on Saturdays from 8:00 PM to 9:00 PM; and
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Secretos: a half-hour procedural drama program that airs on KRCA-TV every weekday from 8:00 PM to 8:30 PM, on KSDX-TV every weekday from 9:00 PM to 9:30 PM, and on KZJL-TV and KMPX-TV every weekday from 7:00 PM to 7:30 PM. The show also airs on Saturdays from 5:00 PM to 6:00 PM.
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Alarma TV: a fast paced news program featuring life style stories around the world. This shows airs every weekday in Los Angeles from 8:30 PM and in Texas from 7:30 PM to 8:00 PM.
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Teatro de la Risa: a half hour stand-up comedy show featuring popular comedians from Mexico, which airs Saturdays from 7:00 PM to 7:30 PM.
We are also in the process of producing Desafio del Rancho, a one hour show shot on location at a ranch where six contestants face various physical challenges with one contestant emerging as the winner at the end of the hour, and A Que No Puedes, a game show.
We currently produce the following Spanish-language program at our Houston facilities:
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La Raza TV: a music-oriented variety show centered around the music played by our La Raza radio format in Houston. The show airs on KZJL-TV and KMPX-TV every weekday from 2:00 PM to 3:00 PM.
Throughout the year, we also program musical specials based on some of our bigger premier events from different markets. Premios de la Radio is a live, televised special of our musical awards show at the Gibson Amphitheater in Los Angeles. The awards show features some of the top artists in the Hispanic music industry performing and presenting awards. Another popular special features our Cinco de Mayo and Fiestas Patrias concerts from Houston. These are daytime music festivals that have drawn crowds in excess of 60,000 and feature eight to ten bands.
Sales and Advertising
Most of our net revenues are generated from the sale of local, regional and national advertising for broadcast on our radio and television stations. For the year ended December 31, 2006, approximately 80% of our gross advertising revenues were generated from the sale of local advertising and approximately 20% of our gross advertising revenues were generated from the sale of regional and national advertising. Local sales are made by our sales staffs located in Los Angeles and Orange County, California and Houston and Dallas, Texas. Prior to April 2005, national sales were made by our national sales representative, Spanish Media Rep Team, Inc., or SMRT, an affiliate of our indirect parent’s two principal stockholders, in exchange for a commission from us that was based on a percentage of our net revenues from the national advertising sold. We merged SMRT into one of our wholly owned subsidiaries in April 2005 and as a result, our national sales are now made by our sales staff in Los Angeles, Miami, New York and Dallas.
We believe that advertisers can reach the Hispanic community more cost effectively through radio and television broadcasting than through printed advertisements. Advertising rates charged by radio and television stations are based primarily on:
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A station’s audience share within the demographic groups targeted by the advertisers;
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The number of radio and television stations in the market competing for the same demographic groups; and
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The supply and demand for radio and television advertising time.
A radio or television station’s listenership or viewership is reflected in ratings surveys that estimate the number of listeners or viewers tuned to the station. Each station’s ratings are used by its advertisers to consider advertising with the radio or television station and are used by us to, among other things, chart audience growth, set advertising rates and adjust programming.
Competition
Radio and television broadcasting are highly competitive businesses. The financial success of each of our radio and television stations depends in large part on our ability to increase our market share of the available advertising revenue, the economic health of the market and our audience ratings. In addition, our advertising revenue depends upon the desire of advertisers to reach our audience demographic.
Our Spanish-language radio stations compete against other Spanish-language radio stations in their markets for audiences and advertising revenue. In Los Angeles, our radio stations compete primarily against Univision Radio (formerly Hispanic Broadcasting Corporation), Spanish Broadcasting Systems, Inc. and Entravision Communications Corporation, three of the largest Hispanic group radio station operators in the United States. In Houston, our radio stations compete primarily against Univision Radio.
Our television stations primarily compete against Univision Communications, Inc. and Telemundo Communications Group, Inc. for audiences and advertising revenue in the Los Angeles, San Diego, Houston, and Dallas-Fort Worth markets.
When Univision Communications, Inc. and Hispanic Broadcasting Corporation, two of our competitors, merged with each other in September 2003, the combination resulted in a company with resources substantially greater than ours and became our first competitor to operate both radio and television stations in the Los Angeles, Houston, and Dallas-Fort Worth markets.
Employees
As of December 31, 2006, LBI had approximately 647 employees, of which approximately 445 were full-time employees. Of the full-time employees, approximately 245 were in television, approximately 179 were in radio and approximately 21 were in corporate. None of our employees are represented by labor unions, and we have not entered into any collective bargaining agreements. We believe that we maintain good relations with our employees.
REGULATION OF TELEVISION AND RADIO BROADCASTING
General
The Federal Communications Commission (“FCC”) regulates television and radio broadcast stations pursuant to the Communications Act of 1934, as amended (“Communications Act” or “Communications Act of 1934”). Among other things, the FCC:
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determines the particular frequencies, locations and operating power of stations;
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issues, renews, revokes and modifies station licenses;
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regulates equipment used by stations; and
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adopts and implements regulations and policies that directly or indirectly affect the ownership, changes in ownership, control, operation and employment practices of stations.
A licensee’s failure to observe the requirements of the Communications Act or FCC rules and policies may result in the imposition of various sanctions, including admonishment, fines, the grant of renewal terms of less than eight years, the grant of a license with conditions or, in the case of particularly egregious violations, the denial of a license renewal application, the revocation of an FCC license or the denial of FCC consent to acquire additional broadcast properties.
Congress and the FCC have had under consideration or reconsideration, and may in the future consider and adopt, new laws, regulations and policies regarding a wide variety of matters that could, directly or indirectly, affect the operation, ownership and profitability of our television and radio stations, result in the loss of audience share and advertising revenue for our television and radio broadcast stations or affect our ability to acquire additional television and radio broadcast stations or finance such acquisitions. These matters may include:
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changes to the license authorization and renewal process;
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proposals to impose spectrum use or other fees on FCC licensees;
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changes to the FCC’s equal employment opportunity regulations and other matters relating to involvement of minorities and women in the broadcasting industry;
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proposals to change rules relating to political broadcasting including proposals to grant free air time to candidates;
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changes regarding enforcement of the FCC’s rules on broadcasting indecent or obscene material, including increases in fines and changes in procedures for revocation of licenses;
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proposals to require broadcasters to air certain types and quantities of “local” programming;
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proposals to ban the broadcast of “violent” material;
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new, expanded obligations regarding children’s television programming on digital television channels;
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proposals to adopt new public interest obligations on television broadcasters during and after the transition to digital television;
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proposals to restrict or prohibit the advertising of beer, wine and other alcoholic beverages;
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changes in broadcast multiple ownership, foreign ownership, cross-ownership and ownership attribution policies; and
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proposals to alter provisions of the tax laws affecting broadcast operations and acquisitions.
We cannot predict what changes, if any, might be adopted, nor can we predict what other matters might be considered in the future, nor can we judge in advance what impact, if any, the implementation of any particular proposal or change might have on our business.
FCC Licenses
Television and radio stations operate pursuant to licenses that are granted by the FCC for a term of eight years, subject to renewal upon application to the FCC. During the periods when renewal applications are pending, petitions to deny license renewal applications may be filed by interested parties, including members of the public. The FCC may hold hearings on renewal applications if it is unable to determine that renewal of a license would serve the public interest, convenience and necessity, or if a petition to deny raises a “substantial and material question of fact” as to whether the grant of the renewal applications would be inconsistent with the public interest,
convenience and necessity. However, the FCC is prohibited from considering competing applications for a renewal applicant’s frequency, and is required to grant the renewal application if it finds:
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that the station has served the public interest, convenience and necessity;
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that there have been no serious violations by the licensee of the Communications Act or the rules and regulations of the FCC; and
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that there have been no other violations by the licensee of the Communications Act or the rules and regulations of the FCC that, when taken together, would constitute a pattern of abuse.
If as a result of an evidentiary hearing, the FCC determines that the licensee has failed to meet the requirements for renewal and that no mitigating factors justify the imposition of a lesser sanction, the FCC may deny a license renewal application. Historically, FCC licenses have generally been renewed. We have no reason to believe that our licenses will not be renewed in the ordinary course, although there can be no assurance to that effect. The non-renewal of one or more of our stations’ licenses could have a material adverse effect on our business.
The FCC licenses some television stations as low power television stations. Low power television stations generally operate at lower power and cover a smaller geographic area than full-service television stations, are not entitled to carriage by cable television and direct broadcast satellite operators and must accept interference from, and eliminate interference to, full-service television stations. Our station KSDX in San Diego is a low power television station.
Transfer and Assignment of Licenses
The Communications Act requires prior consent of the FCC for the assignment of a broadcast license or the transfer of control of a corporation or other entity holding a license. In determining whether to approve an assignment of a television or radio broadcast license or a transfer of control of a broadcast licensee, the FCC considers a number of factors pertaining to the licensee including compliance with various rules limiting common ownership of media properties, the “character” of the licensee and those persons holding “attributable” interests therein, the Communications Act’s limitations on foreign ownership and compliance with the FCC rules and regulations.
To obtain the FCC’s prior consent to assign or transfer a broadcast license, appropriate applications must be filed with the FCC. If the application to assign or transfer the license involves a substantial change in ownership or control of the licensee, for example, the transfer or acquisition of more than 50% of the voting equity, the application must be placed on public notice for a period of 30 days during which petitions to deny the application may be filed by interested parties, including members of the public. If an assignment application does not involve new parties, or if a transfer of control application does not involve a “substantial” change in ownership or control, it is a pro forma application, which is not subject to the public notice and 30-day petition to deny procedure. The regular and pro forma applications are nevertheless subject to informal objections that may be filed any time until the FCC acts on the application. If the FCC grants an assignment or transfer application, interested parties have 30 days from public notice of the grant to seek reconsideration of that grant. The FCC has an additional ten days to set aside such grant on its own motion. When ruling on an assignment or transfer application, the FCC is prohibited from considering whether the public interest might be served by an assignment or transfer to any party other than the assignee or transferee specified in the application.
Foreign Ownership Rules
Under the Communications Act, a broadcast license may not be granted to or held by persons who are not U.S. citizens, by any corporation that has more than 20% of its capital stock owned or voted by non-U.S. citizens or entities or their representatives, by foreign governments or their representatives or by non-U.S. corporations. Furthermore, the Communications Act provides that no FCC broadcast license may be granted to or held by any corporation directly or indirectly controlled by any other corporation of which more than 25% of its capital stock is owned of record or voted by non-U.S. citizens or entities or their representatives, foreign governments or their representatives or by non-U.S. corporations, if the FCC finds the public interest will be served by the refusal or
revocation of such license. These restrictions apply similarly to partnerships, limited liability companies and other business organizations. Thus, the licenses for our stations could be revoked if more than 25% of our outstanding capital stock is issued to or for the benefit of non-U.S. citizens in excess of these limitations.
Multiple Ownership and Cross-Ownership Rules
The FCC generally applies its other broadcast ownership limits, as described below, to “attributable” interests held by an individual, corporation or other association or entity. In the case of a corporation holding broadcast licenses, the interests of officers, directors and those who, directly or indirectly, have the right to vote 5% or more of the stock of a licensee corporation are generally deemed attributable interests, as are positions as an officer or director of a corporate parent of a broadcast licensee.
Stock interests held by insurance companies, mutual funds, bank trust departments and certain other passive investors that hold stock for investment purposes only become attributable with the ownership of 20% or more of the voting stock of the corporation holding broadcast licenses.
A time brokerage agreement with another television or radio station in the same market creates an attributable interest in the brokered television or radio station as well for purposes of the FCC’s local television or radio station ownership rules, if the agreement affects more than 15% of the brokered television or radio station’s weekly broadcast hours.
Debt instruments, non-voting stock, options and warrants for voting stock that have not yet been exercised, insulated limited partnership interests where the limited partner is not “materially involved” in the media-related activities of the partnership and minority voting stock interests in corporations where there is a single holder of more than 50% of the outstanding voting stock whose vote is sufficient to affirmatively direct the affairs of the corporation generally do not subject their holders to attribution.
However, the FCC now applies a rule, known as the equity-debt-plus rule, that causes certain creditors or investors to be attributable owners of a station, regardless of whether there is a single majority shareholder or other applicable exception to the FCC’s attribution rules. Under this rule, a major programming supplier (any programming supplier that provides more than 15% of the station’s weekly programming hours) or a same-market media entity will be an attributable owner of a station if the supplier or same-market media entity holds debt or equity, or both, in the station that is greater than 33% of the value of the station’s total debt plus equity. For purposes of the equity-debt-plus rule, equity includes all stock, whether voting or nonvoting, and, equity held by insulated limited partners in limited partnerships. Debt includes all liabilities, whether long-term or short-term. If a party were to purchase stock which, in combination with other of our debt or equity interests, amounts to more than 33% of the value of one or more of our station’s total debt plus equity and such party were a major programming supplier or held an attributable interest in a same-market media entity, such interest could result in a violation of one of the ownership rules. As a result of such violation, we may be unable to obtain from the FCC one or more authorizations needed to conduct our broadcast business and may be unable to obtain FCC consents for certain future acquisitions unless either we or the investor were to remedy the violation.
The FCC’s ownership rules affect the number, type, and location of broadcast and newspaper properties that we might acquire in the future. The ownership rules now in effect limit the aggregate audience reach of television stations that may be under common ownership, operation and control, or in which a single person or entity may hold office or have more than a specified interest or percentage of voting power, to 39% of the total national audience. FCC rules also place certain limits on common ownership, operation, and control of, or cognizable or “attributable” interests or voting power in:
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television stations serving the same area (the so-called television “duopoly” rule);
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radio stations serving the same area;
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television stations and radio stations serving the same area (the radio/television cross ownership rule); and
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television and/or radio stations and daily newspapers serving the same area (the newspaper/broadcast cross-ownership ban).
The FCC completed a comprehensive review of its ownership rules in 2003, significantly relaxing restrictions on the common ownership of television stations, radio stations and daily newspapers within the same local market. Many of the new rules may never take effect due to legal challenges. Specifically, on June 24, 2004, a three-judge panel of the United States Court of Appeals for the Third Circuit released a split-decision rejecting many of the new rules governing media ownership adopted by the FCC in 2003. While affirming the FCC in certain respects, the Third Circuit found fault with the FCC’s proposed new limits on media combinations, remanded them to the agency for further proceedings, and stayed the effectiveness of the new rules. Several parties filed petitions for Supreme Court review of the Third Circuit’s decision, but the Supreme Court declined to review the decision. As a result, with the exception of certain new regulations governing local radio ownership, the restrictions in place prior to the FCC’s 2003 decision continue to govern media transactions, pending completion of the agency proceedings on remand and further judicial review. The ultimate landscape of the FCC’s ownership regulations may not be finalized for some time.
The discussion below reviews the rules currently in effect, the changes contemplated in the FCC’s 2003 decision, and the Third Circuit’s response to the revised ownership regulations that the FCC adopted. These ongoing proceedings, as well as Congressional action, could dramatically change the rules or affect our ability to acquire additional radio and televisions stations.
Local Television Ownership Rule
Under the local television ownership rule currently in effect, an owner may operate two television stations assigned to the same market (defined as the Designated Market Area (DMA) created by the Nielsen media research firm based on historical television viewing patterns) so long as either:
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the television stations do not have overlapping broadcast signals; or
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there will remain after the transaction eight independently owned, full power noncommercial or commercial operating television stations in the market and one of the two commonly-owned stations is not ranked in the top four based upon audience share.
The FCC will consider waiving these ownership restrictions in certain cases involving failing or failed stations or stations which are not yet built.
Should they become effective, the FCC’s new local television ownership rules will allow an entity to own two television stations in any market with at least five television stations. However, no single entity may own more than one television station ranked among the top four in a local market based on audience ratings.
The FCC’s new rules would also allow, in certain circumstances, common ownership of three television stations in a single market. In the largest markets - those with 18 or more television stations - a company would be permitted to own three TV stations, although this portion of the rule also would be subject to the “top four” limitation described above.
The FCC’s new local television ownership rules also include a provision for waiver of the “top four” standard in certain circumstances. In markets with 11 or fewer television stations, the FCC would allow parties to seek waivers of the “top four” restriction and evaluate on a case-by-case basis whether joint ownership would serve the public interest.
The Third Circuit upheld the FCC’s decision to retain a prohibition of common ownership of more than one top four-ranked station in a given market. The Court remanded for further consideration, however, the other numerical limits applicable to same-market TV combinations.
Local Radio Ownership
The Communications Act and the FCC’s rules impose specific limits on the number of commercial radio stations an entity can own in a single market. The local radio ownership rules are as follows:
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in a radio market with 45 or more commercial radio stations, a party may own, operate or control up to eight commercial radio stations, not more than five of which are in the same service (AM or FM).
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in a radio market with between 30 and 44 (inclusive) commercial radio stations, a party may own, operate or control up to seven commercial radio stations, not more than four of which are in the same service (AM or FM).
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in a radio market with between 15 and 29 (inclusive) commercial radio stations, a party may own, operate or control up to six commercial radio stations, not more than four of which are in the same service (AM or FM).
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in a radio market with 14 or fewer commercial radio stations, a party may own, operate or control up to five commercial radio stations, not more than three of which are in the same service (AM or FM), except that a party may not own, operate, or control more than 50% of the radio stations in such market.
In contrast to the other local media ownership rules, the FCC did not attempt to significantly relax its radio rules in 2003. The agency decided to retain these numerical caps, which were set by Congress in the Telecommunications Act of 1996 (“1996 Act”). The FCC did adjust certain aspects of the radio rules, however, by adopting a new definition of a “radio market,” deciding to take noncommercial radio stations into account in its determination of market size and limiting the transferability of existing radio clusters that would not comply with the new regulations. The Third Circuit upheld these changes and, upon FCC request, in September 2004 lifted its stay as applied to these rules. However, the Court of Appeals remanded the agency’s decision to retain the numerical caps, and that aspect of the FCC’s decision remains under review.
As a result, the rule that changes the way in which a radio “market” is defined is now in effect. This rule defines local radio markets using a geographic market approach assigned by Arbitron rather than a signal contour method. The new local radio ownership rule also includes both commercial and noncommercial stations in counting the number of stations in a given radio market. Because of the change in market definition, our Houston radio cluster does not comply with the new rules, but the “grandfathering” provisions of the FCC’s new rules permit us to retain it. We may not, however, be able to sell the entire cluster to a single party in the future. In addition, the radio market definition under the new rules could limit the number of additional radio stations that we can acquire.
Cross-Ownership Restrictions
The cross-ownership rules currently in effect generally prohibit common ownership of a newspaper and a broadcast property in the same market. The cross-ownership rules do permit a television station owner to own one radio station in the same market as its television station. In addition, a television station owner is permitted to own additional radio stations, not to exceed the local ownership limits for the market, as follows:
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in markets where 20 media voices will remain, an owner may own an additional five radio stations, or, if the owner only has one television station, an additional six radio stations; and
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in markets where ten media voices will remain, an owner may own an additional three radio stations.
A “media voice” includes each independently-owned and operated full-power television and radio station and each daily newspaper that has a circulation exceeding 5% of the households in the market, plus one voice for all cable television systems operating in the market.
The FCC’s new ownership rules would replace the existing newspaper/broadcast cross-ownership restriction as well as the radio/television cross-ownership limits with new “cross-media limits.”
Smaller Markets. In markets with three or fewer television stations in the DMA, the FCC’s new rules would prohibit cross-ownership among television stations, radio stations and daily newspapers.
Mid-Sized Markets. In markets with between four and eight television stations in the DMA, media combinations would be limited to one of the three following:
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A daily newspaper or newspapers, one television station, and up to half of the radio stations permissible under the local radio ownership limits;
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A daily newspaper or newspapers and as many radio stations as permissible under the local radio ownership limits (but no television stations); or
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Two television stations (if permissible under the local television ownership rule) and as many radio stations as permissible under the local radio ownership limits (but no daily newspapers).
Large Markets. In markets with nine or more television stations in the DMA, there would be no limits on television, newspaper and radio cross-ownership. Local television and radio ownership limits still exist in such markets.
Although the Third Circuit determined that the FCC’s decision to eliminate its outright ban on newspaper/broadcast cross-ownership was justified, the Court also found that the new cross-media limits were based on irrational assumptions and inconsistencies. The cross-media limits, consequently, were remanded to the FCC for further consideration.
National TV Ownership Limit
In its 2003 decision, the FCC raised the national TV ownership cap - the percentage of U.S. households that a single owner can reach through common owned television stations - from 35% to 45% of the national audience. In that same decision, the FCC decided to retain the 50% “discount” that it currently grants to ultra-high frequency (“UHF”) stations, finding that the discount continues to be necessary to promote competition. This rule change sparred considerable controversy in Congress, eventually leading lawmakers to include a new limitation in an appropriations bill. On January 22, 2004, President Bush signed into law the Consolidated Appropriations Act of 2004. Section 6229 of that legislation set the national television ownership cap at 39%. The Third Circuit subsequently ruled that challenges before it to the national television ownership cap and UHF discount were moot.
The FCC has initiated proceedings to address the issues raised by the Third Circuit in June 2006. Any new rules the FCC adopts would be subject to further judicial review.
Our ability to acquire additional television and radio stations, our acquisition strategy and our business may be significantly affected by the new multiple ownership and cross-ownership rules, ongoing FCC or Congressional review or amendment to the new rules, as well as litigation challenging and possible court action upon the new rules.
Because of these multiple and cross-ownership rules, if a shareholder, officer or director of LBI Holdings I or one of its subsidiaries holds an “attributable” interest in one or more of our stations, that shareholder, officer or director may violate the FCC’s rules if that person or entity also holds or acquires an attributable interest in other television or radio stations or daily newspapers, depending on their number and location. If an attributable shareholder, officer or director of LBI Holdings I or one of its subsidiaries violates any of these ownership rules, we may be unable to obtain from the FCC one or more authorizations needed to conduct our broadcast business, and may be unable to obtain FCC consents for certain future acquisitions.
Programming and Operation
The Communications Act requires broadcasters to serve the “public interest.” Since 1981, the FCC has gradually relaxed or eliminated many of the more formalized procedures it developed to promote the broadcast of certain types of programming responsive to the needs of a broadcast station’s community of license. Nevertheless, a broadcast licensee continues to be required to present programming in response to community problems, needs and interests and to maintain certain records demonstrating its responsiveness. The FCC will consider complaints from
the public about a broadcast station’s programming when it evaluates the licensee’s renewal application, but complaints also may be filed and considered at any time. Stations also must follow various FCC rules that regulate, among other things, political broadcasting, children’s programming, the broadcast of obscene or indecent programming, sponsorship identification, the broadcast of contests and lotteries, certain types of advertising such as for out-of-state lotteries and gambling casinos, and technical operation.
The FCC requires that licensees must not discriminate in hiring practices. In light of a 2001 court ruling that vacated FCC requirements that licensees follow certain specific practices with respect to minority hiring, the FCC has adopted employment-related rules that require licensees to engage in certain recruiting and “outreach” efforts, among other things, and to make several new filings to the FCC. In late 2004, the FCC began monitoring broadcasters’ compliance with equal employment requirements through random audits and targeted investigations.
The FCC rules also prohibit a broadcast licensee from simulcasting more than 25% of its programming on another radio station in the same broadcast service (that is, AM/AM or FM/FM). The simulcasting restriction applies if the licensee owns both radio broadcast stations or owns one and programs the other through a local marketing agreement, provided that the contours of the radio stations overlap in a certain manner.
Cable and Satellite Transmission of Local Television Signals
The FCC has adopted various regulations to implement provisions of the Cable Television Consumer Protection and Competition Act of 1992, as amended by the 1996 Act, governing the relationship between broadcasters and cable operators. Among other matters, these regulations require cable systems to devote a specified portion of their channel capacity to the carriage of the signals of local television stations and permit TV stations to elect between “must carry rights” or a right to restrict or prevent cable systems from carrying the station’s signal without the station’s permission (“retransmission consent”). The Communications Act and FCC regulations also contain measures to facilitate competition among cable systems, telephone companies and other systems in the distribution of TV signals, video programming and other services. We have elected “must carry” status for each of our stations on certain cable systems in our designated market areas. These elections and agreements will entitle our stations to carriage on those systems until December 31, 2008.
In November 1999, Congress enacted the Satellite Home Viewer Improvement Act of 1999 (“SHVIA” or “1999 Satellite Act”), which established a copyright licensing system for limited distribution of television programming to direct broadcast satellite viewers and directed the FCC to initiate rulemaking proceedings to implement the new system. SHVIA also extended the current system of satellite distribution of distant network signals to unserved households - those that do not receive a Grade B signal from a local network affiliate.
As part of the rulemakings required under SHVIA, the FCC established a market-specific requirement for mandatory carriage of local television stations. Similar to the obligations applicable to cable systems, the rules require satellite operators to carry all local broadcast signals in those markets in which they choose to provide any local signal, beginning January 1, 2002. Stations in affected markets were required to select either must carry or retransmission consent rights by October 1, 2005. This election is effective from January 1, 2006 to December 31, 2008. Further, under SHVIA, those broadcasters selecting retransmission consent (as opposed to must carry rights) originally were required to meet certain “good faith” requirements in negotiating for carriage rights until 2006.
With SHVIA originally set to expire on December 31, 2004, Congress passed the Satellite Home Viewer Extension and Reauthorization Act of 2004 (“SHVERA”), which extends the compulsory copyright license for carriage of distant signals through December 31, 2009 and addresses a variety of other issues related to the carriage of broadcast television signals on direct broadcast satellite systems. Specifically, SHVERA requires satellite carriers to phase out the carriage of distant signals in markets where they carry local broadcast signals. The new statute also permits satellite carriers to deliver the distant signal of a network station to consumers in unserved digital households (also referred to as “digital white areas”), but only if the local station affiliated with that network misses the FCC’s deadlines for increasing its digital signal power (also discussed below). In addition, the law extends to direct broadcast satellite operators the obligation to negotiate in good faith with respect to retransmission consent arrangements. Previously, only broadcasters were subject to the good faith requirement, which was scheduled to expire on December 31, 2005 but will now expire on December 31, 2009. In February 2005, the FCC adopted rules relating to station eligibility for satellite carriage and subscriber eligibility for receiving signals, and
which stations are entitled to “significantly viewed” status. In March 2005, the FCC adopted rules for carriage elections, unified retransmission consent negotiation, and a requirement that satellite carriers notify local broadcasters concerning carriage of significantly viewed signals.
We have taken advantage of this law to secure carriage of our full-service television stations in the Los Angeles, Houston, and Dallas-Fort Worth markets through 2008.
Time Brokerage Agreements
We have entered into time brokerage agreements under which we are given the right to broker time on stations owned by third parties, or agree that other parties may broker time on our stations. Historically, we have only purchased time on stations owned by third parties prior to purchasing selected assets of that station. By using time brokerage agreements, we can provide programming and other services to a station we expect to acquire before we receive all applicable FCC and other governmental approvals. As indicated, we have, from time to time, entered into time brokerage agreements giving third parties the right to broker time on stations owned by us.
FCC rules and policies generally permit time brokerage agreements if the station licensee retains ultimate responsibility for and control of the applicable station. As a part of that requirement, the licensee of a time-brokered station is required to maintain certain personnel at the time-brokered station. We may not be able to air all of our scheduled programming on a station with which we have time brokerage agreements and we may not receive the anticipated revenue from the sale of advertising for that programming. Likewise, we may not receive the payments from the time brokers to whom we have sold time on our stations.
Stations may enter into cooperative arrangements known as joint sales agreements. Under the typical joint sales agreement, a station licensee obtains, for a fee, the right to sell substantially all of the commercial advertising on a separately owned and licensed station in the same market. It also involves the provision by the selling party of certain sales, accounting and services to the station whose advertising is being sold. Unlike a time brokerage agreement, the typical joint sales agreement does not involve programming. The Third Circuit, however, upheld the FCC’s 2003 decision to make radio joint sales agreements attributable for multiple ownership purposes, and the new rule took effect in September 2004. The FCC has also initiated a rulemaking proceeding to consider whether television joint sales agreements should be attributable for purposes of its media ownership rules.
As part of its increased scrutiny of television and radio station acquisitions, the Department of Justice has stated publicly that it believes that time brokerage agreements and joint sales agreements could violate the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, if such agreements take effect prior to the expiration of the waiting period under that act. Furthermore, the Department of Justice has noted that joint sales agreements may raise antitrust concerns under Section 1 of the Sherman Antitrust Act and has challenged them in certain locations. The Department of Justice also has stated publicly that it has established certain revenue and audience share concentration benchmarks with respect to television and radio station acquisitions, above which a transaction may receive additional antitrust scrutiny.
Digital Television Services
The FCC has adopted rules for implementing digital television service in the U.S. Implementation of digital television will improve the technical quality of television signals and provide broadcasters the flexibility to offer new services, including, but not limited to, high-definition television and data broadcasting.
The FCC has established service rules and adopted a table of allotments for digital television. Under the table, certain eligible broadcasters with a full-service television station are allocated a separate channel for digital television operation. When the transition to digital television is complete, stations will be required to operate as single digital channel and to surrender any other channel on which they previously operated. Federal legislation specifies February 17, 2009 as the end of the transition, when broadcasters must cease analog operation.
The FCC adopted timetables that required stations to select their post-transition digital channels, as well as deadlines for certain stations to increase their digital facilities to operate at full authorized power. Equipment and other costs are associated with these requirements.
We have elected the currently-allotted digital channels for KZJL-TV and KMPX-TV as their permanent post-transition digital channels. In the case of KRCA-TV, we will need to change the frequency on which our digital station operates. We have completed construction of digital facilities for KZJL-TV and KMPX-TV at full authorized power. In the case of KRCA, we have completed construction of digital facilities that serve at least 80 percent of the population served by the analog station, as the FCC permits. We will continue to operate those facilities until the end of the transition, when we will be required to complete construction of full power digital facilities on the new channel chosen for post-transition operation.
Equipment and other costs associated with the transition to digital television, including the necessity of temporary dual-mode operations, the relocation of stations from one channel to another, and the buildout of full-power digital facilities, will impose some near-term financial costs on television stations providing the services. The potential also exists for new sources of revenue to be derived from digital television. We cannot predict the overall effect the transition to digital television might have on our business.
Indecency
Provisions of federal law regulate the broadcast of obscene, indecent or profane material. The FCC is actively enforcing these rules. Legislation that substantially increased the monetary penalties for violations of these regulations - from $32,500 to $325,000 per incident - was recently enacted into law.
Public Interest Programming
Broadcasters are required to air programming addressing the needs and interests of their communities of license, and to place “issues/programs lists” in their public inspection files to provide their communities with information on the level of “public interest” programming they air. In October 2000, the FCC commenced a proceeding seeking comment on whether it should adopt a standardized form for reporting information on a station’s public interest programming and whether it should require television broadcasters to post the new form - as well as all other documents in their public inspection files - either on station websites or the websites of state broadcasters’ associations. Moreover, in August 2003 the FCC introduced a “Localism in Broadcasting” initiative that, among other things, has resulted in the creation of an FCC Localism Task Force, localism hearings at various locations throughout the country, and the July 2004 initiation of a proceeding to consider whether additional FCC rules and procedures are necessary to promote localism in broadcasting.
Equal Employment Opportunity
The FCC’s equal employment opportunity rules generally require broadcasters to engage in broad and inclusive recruitment efforts to fill job vacancies, keep a considerable amount of recruitment data and report much of this data to the FCC and to the public via stations’ public files and websites. The FCC is still considering whether to apply these rules to part-time employment positions. Broadcasters are also obligated not to engage in employment discrimination based on race, color, religion, national origin or sex.
Digital Radio Services
The FCC has adopted spectrum allocation and service rules for satellite digital audio radio service. Satellite digital audio radio service systems can provide regional or nationwide distribution of radio programming with fidelity comparable to compact discs. Two companies-Sirius Satellite Radio Inc. and XM Radio-have launched satellite digital audio radio service systems, are currently providing nationwide service, and have announced plans to merge. The FCC is currently considering what rules to impose on both licensees’ operation of terrestrial repeaters that support their satellite services. The FCC also has approved a technical standard for the provision of “in band, on channel” terrestrial digital radio broadcasting by existing radio broadcasters (except for nighttime broadcasting by AM stations, which is undergoing further testing), and has allowed radio broadcasters to convert to a hybrid mode of digital/analog operation on their existing frequencies. We and other broadcasters have intensified efforts to
roll out terrestrial digital radio service. The FCC has commenced rulemaking to address formal standards and related licensing and service rule changes for terrestrial digital audio broadcasting. We cannot predict the impact of either satellite or terrestrial digital audio radio service on our business.
Radio Frequency Radiation
The FCC has adopted rules limiting human exposure to levels of radio frequency radiation. These rules require applicants for renewal of broadcast licenses or modification of existing licenses to inform the FCC whether the applicant’s broadcast facility would expose people or employees to excessive radio frequency radiation. We believe that all of our stations are in compliance with the FCC’s current rules regarding radio frequency radiation exposure.
Low-Power Radio Broadcast Service
In January 2000, the FCC created two new classes of noncommercial low power FM radio stations (“LPFM”). One class (LP100) is authorized to operate with a maximum power of 100 watts and a service radius of about 3.5 miles. The other class (LP10) is authorized to operate with a maximum power of 10 watts and a service radius of about 1 to 2 miles. In establishing the new LPFM service, the FCC said that its goal is to create a class of radio stations designed “to serve very localized communities or underrepresented groups within communities.” The FCC has accepted applications for LPFM stations and has granted some of these applications. In December 2000, Congress passed the Radio Broadcasting Preservation Act of 2000. This legislation requires the FCC to maintain interference protection requirements between LPFM stations and full-power radio stations on third-adjacent channels. It also requires the FCC to conduct field tests to determine the impact of eliminating such requirements. The FCC has commissioned a preliminary report on such impact and on the basis of that report, has recommended to Congress that such requirements be eliminated. We cannot predict the number of LPFM stations that eventually will be authorized to operate or the impact of such stations on our business.
Other Regulations Affecting Broadcast Stations
The FCC has adopted rules on children’s television programming pursuant to the Children’s Television Act of 1990 and rules requiring closed captioning of television programming. The FCC has also taken steps to implement digital television broadcasting in the U.S. Furthermore, the 1996 Act contains a number of provisions related to television violence. We cannot predict the effect of the FCC’s present rules or future actions on our television broadcasting operations.
Finally, Congress and the FCC from time to time consider, and may in the future adopt, new laws, regulations and policies regarding a wide variety of other matters that could affect, directly or indirectly, the operation and ownership of our broadcast properties. In addition to the changes and proposed changes noted above, such matters have included, for example, spectrum use fees, political advertising rates, and potential restrictions on the advertising of certain products such as beer and wine. Other matters that could affect our broadcast properties include technological innovations and developments generally affecting competition in the mass communications industry, such as direct broadcast satellite service, the continued establishment of wireless cable systems and low power television stations, “streaming” of audio and video programming via the Internet, digital television and radio technologies, the establishment of a low power FM radio service, and telephone company participation in the provision of video programming service.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
We may suffer a decrease in advertising revenues due to competitive forces.
The success of our radio and television stations is primarily dependent upon their share of overall advertising revenues within their markets, especially in Los Angeles and Houston. Our stations compete for audiences and advertising revenue directly with other Spanish-language radio and television stations, and many of the owners of those competing stations have greater resources than we do. When two of our largest competitors merged with each other in 2003, the resulting company, with resources greater than ours, became our first competitor to operate both radio and television stations in Los Angeles, Houston and Dallas, markets in which we derive substantially all of our revenues. As the Hispanic population grows in the United States, more stations may begin competing with us by converting to a format similar to that of our stations.
In addition, our stations have experienced increased competition for audiences and advertising revenue with other media, including cable television and to a lesser extent, satellite television, newspapers, magazines, the Internet, portable digital music players and outdoor advertising. Our radio stations also compete with satellite-based radio services. Our failure to offer advertisers effective, high quality media outlets could cause them to allocate more of their advertising budgets to our competitors, which could cause a decrease in our net revenues.
The loss of key personnel could disrupt our business and result in a loss of advertising revenues.
Our success depends in large part on the continued efforts, abilities and expertise of our officers and key employees and our ability to hire and retain qualified personnel. The loss of any member of our management team, particularly either of our founders, Jose and Lenard Liberman, could disrupt our operations and hinder or prevent implementation of our business plan, which could have a material and adverse effect on our business, financial condition and results of operations. As the result of the resignation of William Keenan, we are currently searching for a chief financial officer. We can provide no assurance that we will be able to find a qualified candidate or that any new chief financial officer will be able to implement our business strategy.
Our growth depends on successfully executing our acquisition strategy.
As we have done in the past, we intend to continue to supplement our internal growth by acquiring media properties that complement or augment our existing markets. We may be unable to identify or complete acquisitions for many reasons, including:
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competition among buyers;
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the need for regulatory approvals, including FCC and antitrust approvals;
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revisions to the FCC’s restrictions on cross-ownership and on the number of stations or the market share that a particular company may own or control, locally or nationally;
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the high valuations of media properties; and
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the need to raise additional financing, which may be limited by the terms of our debt instruments, including LBI Media’s senior credit facilities and the indentures governing LBI Media’s senior subordinated notes and our senior discount notes.
If we are unable to successfully execute our acquisition strategy, our growth may be impaired.
In addition, future acquisitions by us could also result in the following consequences:
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issuances of equity securities;
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incurrence of debt and contingent liabilities;
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impairment of goodwill and other intangibles; and
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other acquisition-related expenses.
Furthermore, after we have completed an acquisition, our management must be able to assume significantly greater responsibilities, which may cause them to divert their attention from our existing operations. We believe that these challenges are more pronounced when we enter new markets rather than expand further in existing markets.
If we cannot successfully develop and integrate our recent and future acquisitions, our financial results could be adversely affected.
To develop and integrate our recent and future acquisitions, we may need to:
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reformat stations with Spanish-language programming and build advertiser, listener and/or viewer support;
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integrate and improve operations and systems and the management of a station or group of stations;
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retain or recruit key personnel to manage acquired assets;
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realize sales efficiencies and cost reduction benefits from acquired assets; and
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operate successfully in markets in which we may have little or no prior experience.
In addition, there is a risk that the stations we have acquired or may acquire in the future may not enhance our financial performance or yield other anticipated benefits. If we are unable to completely integrate into our business the operations of the properties that we have recently acquired or that we may acquire in the future, our costs could increase. Also, in the event that the operations of a new station do not meet our expectations, we may restructure or write-off the value of some portion of the assets of the new station.
If we are unable to convert acquired stations successfully to a Spanish-language format, anticipated revenues from these acquisitions may not be realized.
Our acquisition strategy has often involved acquiring non-Spanish language stations and converting them to a Spanish-language format. We intend to continue this strategy with some of our future acquisitions. This conversion process may require a heavy initial investment of both financial and management resources. We may incur losses for a period of time after a format change due to the time required to build up ratings and station loyalty. These format conversions may be unsuccessful in any given market, and we may incur substantial costs and losses in implementing this strategy.
Cancellations or reductions of advertising could adversely affect our results of operations.
We do not generally obtain long-term commitments from our advertisers. As a result, our advertisers may cancel, reduce or postpone orders without penalty. Cancellations, reductions or delays in purchases of advertising could adversely affect our results of operations, especially if we are unable to replace these purchases. Our expense levels are based, in part, on expected future net revenues and are relatively fixed once set. Therefore, unforeseen decreases in advertising sales could have a material adverse impact on our results of operations.
Our debt service obligations will require a significant amount of cash and could adversely affect our ability to operate our company successfully and achieve growth through acquisitions.
We currently have a substantial amount of debt. At December 31, 2006, we had total indebtedness of approximately $413.8 million, representing approximately 86% of our total capitalization.
Based on interest rates as of December 31, 2006 and assuming no additional borrowings or principal payments on LBI Media’s senior revolving credit facility until its maturity on March 31, 2012 or on our other indebtedness, as of December 31, 2006, we would need approximately $173.5 million over the next five years to meet our principal and interest payments under our debt agreements, of which approximately $30.2 million would be due over the next year.
Because we are highly leveraged, we will need to dedicate a substantial portion of our cash flow from operations to pay principal and interest on our debt, which may reduce our ability to fund working capital and to expand our business through capital expenditures, acquisitions and other means. As a result, we may not be able to expand our business or increase our net revenues.
In addition, if we are not able to pay our debts as they become due, we will be required to pursue one or more alternative strategies, such as, refinancing or restructuring our indebtedness, selling additional debt or equity securities or selling assets. We may not be able to refinance our debt or issue additional debt or equity securities on favorable terms, if at all, and if we must sell our assets, it may negatively affect our ability to generate net revenues.
The restrictive covenants in our debt instruments may affect our ability to operate our business successfully.
The indentures governing LBI Media’s senior subordinated notes and our senior discount notes and the terms of LBI Media’s senior credit facilities contain various provisions that limit our ability to, among other things:
•
incur or guarantee additional debt and issue preferred stock;
•
receive dividends or distributions from our subsidiaries;
•
make investments and other restricted payments;
•
issue or sell capital stock of restricted subsidiaries;
•
grant liens;
•
transfer or sell assets;
•
engage in different lines of business;
•
consolidate, merge or transfer all or substantially all of our assets; and
•
enter into transactions with affiliates.
These covenants may affect our ability to operate and finance our business as we deem appropriate. In addition, we are dependent on our subsidiaries for cash, and the covenants in our debt instruments restrict the ability of our subsidiaries to make cash distributions which could affect our ability to meet our cash obligations, including obligations under our indebtedness. If we are unable to meet our obligations as they become due or to comply with various financial covenants contained in the instruments governing our current or future indebtedness, this could constitute an event of default under the instruments governing our indebtedness.
The loss of our status as a qualified subchapter S subsidiary may result in us having less cash available for our operations.
LBI Holdings I has elected to be treated as an S corporation, and all of its subsidiaries, including us, have elected to be treated as qualified subchapter S subsidiaries for federal income tax purposes. As a result, our profits and losses are taxed directly to our stockholders. Should LBI Holdings I engage in any transaction that results in its inability to qualify as an S corporation, none of its subsidiaries, including us, will qualify as subchapter S subsidiaries for federal income tax purposes. Thus, our taxable income will be subject to tax at regular corporate rates and will not flow through to our stockholders for reporting on their own tax returns, and certain of our deductions may no longer be available. We will likely have less cash available to us as a result of losing our S corporation status. In addition, the loss of our S corporation status could be applied retroactively, resulting in us and our subsidiaries owing taxes for past periods.
If we are unable to maintain our FCC license for any station, we would have to cease operations at that station.
The success of our television and radio operations depends on acquiring and maintaining broadcast licenses issued by the FCC, which are typically issued for a maximum term of eight years and are subject to renewal. The license renewal applications for our radio stations have been granted by the FCC, and the licenses have been extended through 2013. The license renewal applications for our television stations are pending before the FCC. Any renewal applications submitted by us may not be approved, and the FCC may impose conditions or qualifications that could restrict our television and radio operations. In addition, third parties may challenge our renewal applications.
If we violate the Communications Act of 1934, or the rules and regulations of the FCC, the FCC may issue cease-and-desist orders or admonishments, impose fines, renew a license for less than eight years or revoke our licenses. The FCC recently has begun aggressive enforcement of its rules on broadcasting indecent or obscene material, and has stated that, in addition to increased fines, the FCC may initiate license revocation procedures against licensees that broadcast material the FCC considers to be indecent. The FCC has the right to revoke a license before the end of its term for acts committed by the licensee or its officers, directors or stockholders. If the FCC were to issue an order denying a license renewal application or revoking a license, we would be required to cease operating the radio or television station covered by the license, which could have a material adverse effect on our financial condition and results of operations. In addition, Congress, from time to time, considers legislation that addresses the FCC’s enforcement of its rules concerning the broadcast of obscene, indecent, or profane material. Potential changes to enhance the FCC’s authority in this area include the ability to impose additional monetary penalties, consider violations to be “serious” offenses in the context of license renewal applications, and, under certain circumstances, designate a license for hearing to determine whether such license should be revoked. In the event that such legislation is enacted into law, we could face increased costs in the form of fines and a greater risk that we could lose one or more of our broadcasting licenses.
Our failure to maintain our FCC broadcast licenses could cause a default under LBI Media’s senior credit facilities and cause an acceleration of our indebtedness.
LBI Media’s senior credit facilities require us to maintain all of our material FCC licenses. If the FCC were to revoke any of our material licenses, our lenders could declare all amounts outstanding under the senior credit facilities to be immediately due and payable, which would cause a cross-default under the indentures governing LBI Media’s senior subordinated notes and our senior discount notes. If our indebtedness is accelerated, we may not have sufficient funds to pay the amounts owed.
Our broadcast licenses could be revoked if more than 25% of our outstanding capital stock is owned of record or voted by non-U.S. citizens, foreign governments or non-U.S. corporations.
Under the Communications Act of 1934, a broadcast license may not be granted to or held by any corporation that has more than 20% of its capital stock owned or voted by non-U.S. citizens or their representatives, by foreign governments or their representatives or by non-U.S. corporations. Furthermore, the Communications Act provides that no FCC broadcast license may be granted to or held by any corporation directly or indirectly controlled by any other corporation of which more than 25% of its capital stock is owned of record or voted by non-U.S. citizens or entities or their representatives, by foreign governments or their representatives or by non-U.S. corporations, if the FCC finds the public interest will be served by the refusal or revocation of such license. Because of these restrictions, the licenses for our television and radio stations could be revoked if more than 25% of our outstanding capital stock is issued to or for the benefit of non-U.S. citizens in excess of these limitations.
If we fail to maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud, which could have a significant impact on our business and reputation.
Beginning with the year ending December 31, 2007, we will be required to evaluate internal controls over financial reporting in order to allow management to report on, and, beginning with the year ending December 31, 2008, our independent auditors to attest to, our internal controls over financial reporting, as required by Section 404
of the Sarbanes-Oxley Act of 2002 and rules and regulations of the SEC thereunder, which we refer to as Section 404. Section 404 will require us to, among other things, annually review and disclose the effectiveness of our internal controls over financial reporting, and evaluate and disclose changes in our internal controls over financial reporting quarterly. In the course of our evaluation, we may identify areas of our internal controls requiring improvement and may need to design enhanced processes and controls to address these and any other issues that might be identified through this review. As a result, we expect to incur additional expenses and we expect that this process will divert some of management’s time. We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations and may not be able to ensure that the process is effective or that the internal controls will be effective in a timely manner. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, our independent auditors may not be able to certify as to the effectiveness of our internal controls over financial reporting and we may be subject to sanctions or investigation by regulatory authorities, such as the Securities Exchange Commission. As a result, there could be an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control system and the hiring of additional personnel. Any such action could adversely affect our results.
Risks Related to the Television and Radio Industries
Our television and radio stations could be adversely affected by changes in the advertising market or a recession in the U.S. economy or in the economies of the regions in which we operate.
Revenue generated by our television and radio stations depends primarily upon the sale of advertising and is, therefore, subject to various factors that influence the advertising market for the broadcasting industry as a whole, including:
•
changes in the financial condition of advertisers, which may reduce their advertising budgets; and
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changes in the tax laws applicable to advertisers.
We also believe that advertising is largely a discretionary business expense. Advertising expenditures generally tend to decline during an economic recession or downturn. In addition, shifts in populations and demographics could adversely affect advertising expenditures. Consequently, our television and radio station revenues are likely to be adversely affected by shifts in Hispanic populations and demographics, a recession or downturn in the economies of Southern California, Houston or Dallas or other events or circumstances that adversely affect advertising activity. Foreign hostilities and terrorist attacks may affect our revenues and results of operations in the future.
Changes in the rules and regulations of the FCC could result in increased competition for our broadcast stations that could lead to increased competition in our markets.
Recent and prospective actions by the FCC could cause us to face increased competition in the future. The recent or prospective changes include:
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relaxation of restrictions on the participation by regional telephone operating companies in cable television and other direct-to-home audio and video technologies;
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establishment of a Class A television service for low-power stations that makes those stations primary stations and gives them protection against full-service stations;
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licensing of low-power FM radio stations designed to serve small localized areas and niche audiences;
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competition from direct broadcast satellite television providing the programming of traditional over-the-air stations, including local and out-of-market network stations;
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competition from satellite radio companies providing continuous, nationwide digital radio services; and
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revision of restrictions on cross-ownership (that is, ownership of both television and radio stations in combination with newspapers in the same market) and caps on the number of stations or market share that a particular company may own or control, locally or nationally.
The required conversion to digital television may impose significant costs that might not be balanced by consumer demand.
The FCC adopted rules for implementing a digital television service in the U.S. Under these rules, stations are required to build out and begin broadcasting a digital television signal. Federal legislation specifies February 17, 2009 as the date by which stations will be required to operate as a single digital channel and to surrender any other channel on which they previously operated. Our final costs to convert our television stations to full-service digital television have been significant, and there may not be sufficient consumer demand for digital television services to recover our investment in digital television facilities.
Because we rely on “must carry” rights for cable systems to carry our full power television stations, any change in current laws or regulations that eliminate or limit our ability to require cable systems to carry our full power television stations could result in the loss of coverage in those markets, which could result in a decrease in our market ratings and a potential loss of advertising revenues.
Pursuant to the Cable Television Consumer Protection and Competition Act of 1992, or the 1992 Cable Act, we currently may demand carriage of our full power television stations on a specific channel on cable systems within our local markets. Our television stations in Los Angeles, Houston and Dallas-Fort Worth rely on these “must carry” rights to gain access to the local cable systems. If the current laws or regulations were changed or new laws were adopted that eliminate or limit our ability to require cable systems to carry our full power television stations in Los Angeles, Houston and Dallas-Fort Worth, this could result in the loss of market coverage of our television stations, which would decrease our market ratings in those cities and potentially result in a decrease in our net advertising revenues or an increase in our operating expenses to maintain the same coverage.
Direct broadcast satellite companies may not continue to carry our local television stations, which could result in a decrease in our market ratings and a potential loss of advertising revenues.
Similar to the 1992 Cable Act, the 1999 Satellite Act requires direct broadcast satellite companies that elect to transmit local television stations to offer all other qualified local television stations in that market. This is known as the “carry one/carry all” rule. We have qualified our television stations in Los Angeles, Houston and Dallas-Fort Worth under this rule, and these stations are currently being broadcast on the satellite systems electing to carry local television stations in those markets. Because we rely on the carry one/carry all rule in these markets, if the satellite providers in Los Angeles, Houston or Dallas-Fort Worth elect to discontinue transmitting local television stations or if the current laws or regulations were changed or new laws were adopted, this could result in the loss of market coverage of our television stations, which would decrease our market ratings in those cities and potentially result in a decrease in our net advertising revenues or an increase in our operating expenses to maintain the same coverage.
We may have difficulty obtaining regulatory approval for acquisitions in our existing markets and, potentially, new markets.
We have acquired in the past, and may continue to acquire in the future, additional television and radio stations. Revisions to the FCC’s restrictions on the number of stations or market share that a particular company may own or control, locally or nationally, and to its restrictions on cross-ownership (that is, ownership of both television and radio stations in the same market) may limit our ability to acquire additional broadcast properties. The agencies responsible for enforcing the federal antitrust laws, the Federal Trade Commission, or FTC, and the Department of Justice, may investigate certain acquisitions. These agencies have, in certain cases, examined proposed acquisitions or combinations of broadcasters, and in certain cases, required divestiture of one or more stations to complete a transaction.
Any decision by the Department of Justice or FTC to challenge a proposed acquisition could affect our ability to consummate an acquisition or to consummate it on the proposed terms. The FTC or Department of Justice could seek to bar us from acquiring additional television or radio stations in any market where our existing stations already have a significant market share.
We must respond to the rapid changes in technology, services and standards which characterize our industry in order to remain competitive.
The television and radio broadcasting industry is subject to technological change, evolving industry standards and the emergence of new media technologies. Several new media technologies are being employed or developed, including the following:
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audio programming by cable television systems, direct broadcast satellite systems, Internet content providers and Internet-based audio radio services;
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satellite digital audio radio service with numerous channels and sound quality equivalent to that of compact discs;
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In-Band On-Channel ™ digital radio, which provides multi-channel, multi-format digital radio services in the same bandwidth currently occupied by traditional AM and FM radio services;
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low-power FM radio, with additional FM radio broadcast outlets that are designed to serve local interests;
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streaming video programming delivered via the Internet;
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video-on-demand programming offered by cable television companies; and
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digital video recorders with hard-drive storage capacity that offer time-shifting of programming and the capability of deleting advertisements when playing back the recorded programs.
We may not have the resources to acquire new technologies or to introduce new services that could compete with other new technologies. We may encounter increased competition arising from new technologies. If we are unable to keep pace with and adapt our television and radio stations to these developments, our competitive position could be harmed, which could result in a decrease in our market ratings and a potential decrease in net advertising revenues.
Cautionary Statement Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. You can identify these statements by the use of words like “may,” “will,” “could,” “continue,” “expect” and variations of these words or comparable words. Actual results could differ substantially from the results that the forward-looking statements suggest for various reasons. The risks and uncertainties include but are not limited to:
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our dependence on advertising revenues;
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general economic conditions in the United States;
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our ability to reduce costs without adversely impacting revenues;
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changes in rules and regulations of the FCC;
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our ability to attract, motivate and retain salespeople and other key personnel;
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our ability to successfully convert acquired radio and television stations to a Spanish-language format;
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our ability to maintain FCC licenses for our radio and television stations;
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successful integration of acquired radio and television stations;
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potential disruption from natural hazards;
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our ability to protect our intellectual property rights;
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strong competition in the radio and television broadcasting industries;
•
sufficient cash to meet our debt service obligations; and
•
our ability to obtain regulatory approval for future acquisitions.
The foregoing factors are not exhaustive, and new factors may emerge or changes to the foregoing factors may occur that could impact our business. The forward-looking statements in this Annual Report, as well as subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf, are hereby expressly qualified in their entirety by the cautionary statements in this report, including the risk factors noted elsewhere in this Annual Report or other documents that we file from time to time with the Securities and Exchange Commission, particularly Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. We are not obligated to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
The types of properties required to support our radio and television stations include offices, studios and transmitter and antenna sites. Through our wholly owned subsidiary, we own studio and office space at 1845 West Empire Avenue, Burbank, California 91504. This property is subject to a mortgage in favor of Jefferson Pilot Financial, with whom one of our indirect subsidiaries has entered into a loan agreement. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Empire Burbank Studios’ Mortgage Note.” We also own studio and office space at 1813 Victory Place, Burbank, California 91504. In addition, we own offices, studio and production facilities in Houston and Dallas, Texas for our operations there. We own a number of our transmitter and antenna sites and lease or license the remainder from third parties. We generally select our tower and antenna sites to provide maximum market coverage. In general, we do not anticipate difficulties in renewing these site leases. No single facility is material to us, and we believe our facilities are generally in good condition and suitable for our operations.
ITE M 3. LEGAL PROCEEDINGS
Nine former employees of our subsidiary, Liberman Broadcasting of California LLC (successor in interest to Liberman Broadcasting, Inc.), a California limited liability company and our wholly owned subsidiary, filed suit in Los Angeles Superior Court, alleging claims on their own behalf and also on behalf of a purported class of former and current Liberman Broadcasting of California employees. The complaint alleges, among other things, wage and hour violations relating to overtime pay, and wrongful termination and unfair competition under California Business and Professions Code. Plaintiffs seek, among other relief, unspecified general, treble and punitive damages, as well as profit disgorgement, restitution and attorneys’ fees. Liberman Broadcasting of California has filed its answer to the complaint, generally denying plaintiffs’ claims and allegations. The plaintiffs have begun conducting discovery and have filed a motion for class certification. Liberman Broadcasting of California intends to oppose the motion for certification and vigorously defend itself in the lawsuit. It is too early to assess whether Liberman Broadcasting of California will ultimately be liable for any damages.
From time to time, we are involved in litigation incidental to the conduct of our business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders during the last quarter of our fiscal year ended December 31, 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Holders
There is currently no established public trading market for the common stock of LBI Media Holdings, Inc. LBI Media Holdings, Inc. is a wholly owned subsidiary of LBI Holdings I, Inc. Jose Liberman, trustee of the Liberman Trust dated 11/07/02, and Lenard Liberman together own all of the outstanding stock of LBI Holdings I, Inc. (67.6495 shares and 132.3505 shares, respectively).
Dividends
LBI Media Holdings paid dividends to its parent of $1.5 million and $3,500 for the years ended December 31, 2006 and 2005, respectively. LBI Media Holdings also paid distributions to the stockholders of its parent of $332,000 for the year ended December 31, 2006. LBI Media’s senior credit facilities, the indentures governing its senior subordinated notes and LBI Media Holdings’ senior discount notes impose restrictions on the payment of cash dividends or payments on account of or on redemption, retirement or purchase of its common stock or other distributions. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
Securities Authorized for Issuance under Equity Compensation Plans
Not applicable.
Performance Graph
Not applicable.
Recent Sales of Unregistered Securities
LBI Media did not sell any securities during the year ended December 31, 2006.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
LBI Media Holdings has not reacquired any of its equity securities for the three years ended December 31, 2006, other than in connection with internal restructurings in which no proceeds were received.
I TEM 6. SELECTED FINANCIAL DATA
The following selected financial data is derived from our audited consolidated financial statements. The financial data set forth below should be read in conjunction with, and is qualified in its entirety by, the corresponding audited consolidated financial statements, related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this annual report.
(1) On February 12, 2004, Liberman Broadcasting, Inc., a Delaware corporation, filed a registration statement on Form S-1 with the Securities and Exchange Commission for a proposed initial public offering of its Class A Common Stock. The offering was withdrawn and, as a result, approximately $0.3 million and $1.5 million of costs initially deferred in connection with the registration process were written-off in the years ended December 31, 2005 and 2004, respectively. The offering costs were expensed by us, because we advanced the funds used by Liberman Broadcasting, Inc. to pay the offering costs and a portion of the net proceeds from the offering were to be used to repay borrowings under our senior revolving credit facility.
(2) We define Adjusted EBITDA as net income (loss) plus cumulative effect of accounting change, income tax expense, gain (loss) on sale of property and equipment, net interest expense, interest rate swap expense, impairment of broadcast license, and depreciation and amortization. Management considers this measure an important indicator of our liquidity relating to our operations because it eliminates the effects of noncash items. This measure should be considered in addition to, but not as a substitute for or superior to, other measures of liquidity and financial performance prepared in accordance with U.S. generally accepted accounting principles, such as cash flows from operating activities, operating income and net income (loss). In addition, our definition of Adjusted EBITDA may differ from those of many companies reporting similarly named measures.
In determining our Adjusted EBITDA in past years, we treated deferred compensation expense as a noncash item, because we had the option and the intention to pay such amounts in the common stock of our indirect parent after our indirect parent’s initial public offering. Our first payment became due in 2006, and we have additional payments due in 2007.We have determined that we can no longer meet the conditions necessary to pay the deferred compensation in stock. Accordingly, we settled our deferred compensation amounts in cash in 2006 and expect to pay the 2007 payments in cash. We have presented prior years’ Adjusted EBITDA to conform to this current treatment. As a result, Adjusted EBITDA for prior years may appear as a different amount from what we have reported in prior years.
We discuss Adjusted EBITDA and the limitations of this financial measure in more detail under “Item 7. Management’s Discussion and Analysis of Finance Condition and Results of Operations-Non-GAAP Financial Measure.”
The table set forth below reconciles net cash provided by operating activities, calculated and presented in accordance with U.S. generally accepted accounting principles, to Adjusted EBITDA.
(3) Represents cash paid for interest. Does not include accrued but unpaid interest expense.
(4) Total debt does not include the 9% subordinated notes issued by LBI Holdings I, our parent. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We own and operate radio and television stations in Los Angeles, California, Houston, Texas and Dallas, Texas and a television station in San Diego, California. Our radio stations consist of four FM and two AM stations serving Los Angeles, California and its surrounding area, five FM and four AM stations serving Houston, Texas and its surrounding areas, and five FM stations and one AM station serving Dallas-Fort Worth, Texas and its surrounding areas. Our four television stations consist of three full-power stations serving Los Angeles, California, Houston, Texas and Dallas-Fort Worth, Texas and a low-power station serving San Diego, California. In addition, we operate a television production facility, Empire Burbank Studios, in Burbank, California that we use to produce our core programming for all of our television stations, and we have television production facilities in Houston and Dallas-Fort Worth that allow us to produce programming in those markets as well.
We operate in two reportable segments, radio and television. We generate revenue from sales of local, regional and national advertising time on our radio and television stations and the sale of time to brokered or infomercial customers on our radio and television stations. Advertising rates are, in large part, based on each station’s ability to attract audiences in demographic groups targeted by advertisers. Our stations compete for audiences and advertising revenue directly with other Spanish-language radio and television stations, and we generally do not obtain long-term commitments from our advertisers. As a result, our management team focuses on creating a diverse advertiser base, producing cost-effective, locally focused programming, providing creative advertising solutions for clients, executing targeted marketing campaigns to develop a local audience and implementing strict cost controls. We recognize revenues when the commercials are broadcast or the brokered time is made available to the customer. We incur commissions from agencies on local, regional and national advertising, and our net revenue reflects deductions from gross revenue for commissions to these agencies.
Our primary expenses are employee compensation, including commissions paid to our local and national sales staff, promotion, selling, programming and engineering expenses, general and administrative expenses and interest expense. Our programming expenses for television consist of costs related to the production of original programming content, production of local newscasts and, to a lesser extent, the acquisition of programming content from other sources. Because we are highly leveraged, we will need to dedicate a substantial portion of our cash flow from operations to pay interest on our debt. We may need to pursue one or more alternative strategies in the future to meet our debt obligations, such as refinancing or restructuring our indebtedness, selling equity securities or selling assets.
We are organized as a California corporation and are a “qualified S subsidiary” under federal and California state tax laws. As such, we are deemed for tax purposes to be part of our parent, an “S corporation,” and our taxable income is reported by the shareholders of LBI Holdings I, Inc. on their respective federal and state income tax returns.
On November 2, 2006, two of our wholly owned subsidiaries, Liberman Broadcasting of Dallas, Inc. (predecessor in interest to Liberman Broadcasting of Dallas LLC) and Liberman Broadcasting of Dallas License Corp. (predecessor in interest to Liberman Broadcasting of Dallas License LLC), purchased the selected assets of five radio stations owned and operated by Entravision Communications Corporation, or Entravision, and certain subsidiaries of Entravision pursuant to an asset purchase agreement dated as of August 2, 2006, as amended on November 2, 2006. Also in the fourth quarter of 2006, Liberman Broadcasting of Dallas purchased a building in Dallas, Texas to accommodate its growth in stations owned in the Dallas-Fort Worth market. The total purchase price of the selected radio station assets was approximately $92.5 million and was paid for in cash primarily through borrowings under our senior revolving credit facility. The assets that were acquired include, among other things, (i) licenses and permits authorized by the Federal Communications Commission for or in connection with the operation of each of the radio stations, (ii) tower and transmitter facilities, and (iii) broadcast and other studio equipment used to operate the following five stations: KTCY-FM (101.7 FM, licensed to Azle, TX), KZZA-FM (106.7 FM, licensed to Muenster, TX), KZMP-FM (104.9 FM, licensed to Pilot Point, TX), KZMP-AM (1540 AM, licensed to University Park, TX), and KBOC-FM (98.3 FM, licensed to Bridgeport, TX). The programming of KZMP-FM is provided by, and we anticipate it will continue to be provided by, a third-party broker.
In April 2005, we acquired our national sales representative, Spanish Media Rep Team, or SMRT, for an aggregate purchase price of approximately $5.1 million. SMRT merged with and into Liberman Broadcasting, Inc. (predecessor in interest to Liberman Broadcasting of California LLC), a California corporation and our wholly owned subsidiary. Liberman Broadcasting paid approximately $3.3 million in cash and issued notes totaling $1.8 million to the shareholders of SMRT. The notes bore interest at the rate of 3.35% and were due and repaid in April 2006. The shareholders of SMRT were the same beneficial shareholders of our indirect parent, LBI Holdings I, Inc.
In July 2004, we completed our acquisition of the selected assets of radio station KNOR-FM, licensed to Krum, Texas, for an aggregate purchase price of approximately $16.1 million (including acquisition costs), and have changed the format, customer base, revenue stream and employee base of this station.
In January 2004, we completed our acquisition of the selected assets of KMPX-TV, licensed to Decatur, Texas, for an aggregate purchase price of approximately $37.6 million (including acquisition costs) and have significantly changed the format, customer base, revenue stream and employee base of this station.
We generally experience lower operating margins for several months following the acquisition of radio and television stations. This is primarily due to the time it takes to fully implement our format changes, build our advertiser base and gain viewer or listener support.
From time to time, we engage in discussions with third parties concerning our possible acquisition of additional radio or television stations or related assets. Any such discussions may or may not lead to our acquisition of additional broadcasting assets.
Results of Operations
Separate financial data for each of our operating segments is provided below. We evaluate the performance of our operating segments based on the following:
(1) We define Adjusted EBITDA as net income (loss) plus cumulative effect of accounting change, income tax expense, (loss) gain on sale of property and equipment, net interest expense, interest rate swap expense, impairment of broadcast license, and depreciation and amortization. See footnote (2) under Item 6.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is currently confined to our cash and cash equivalents, changes in interest rates related to borrowings under LBI Media’s senior credit facilities and changes in the fair value of LBI Media’s senior subordinated notes, our senior discount notes and LBI Holdings I’s subordinated notes. Because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have any significant impact on the realized value of our investments.
In July 2006, LBI Media entered into a five-year interest rate swap agreement relating to its floating rate borrowings commencing in November 2006 ($80 million for the first three years and $60 million for the subsequent two years). Because this interest rate swap does not meet the requirements for hedge accounting, changes in its fair value are recorded periodically to earnings which, for the year ended December 31, 2006, increased interest expense by $1.8 million. We are not exposed to the impact of foreign currency or commodity price fluctuations.
We are exposed to changes in interest rates on the portion of LBI Media’s variable rate senior credit facilities that is not hedged with the interest rate swap. A hypothetical 10% increase in the interest rates applicable
to the year ended December 31, 2006 would have increased interest expense by approximately $0.8 million. Conversely, a hypothetical 10% decrease in the interest rates applicable to the year ended December 31, 2006 would have decreased interest expense by approximately $0.8 million. At December 31, 2006, we believe that the carrying value of amounts payable under LBI Media’s senior credit facilities that are not hedged by our interest rate swap approximates the fair value based upon current yields for debt issues of similar quality and terms. In addition, changes in the fair value of LBI Media’s interest rate swap are recorded into current earnings as an increase or decrease in interest expense.
The fair value of our fixed rate long-term debt is sensitive to changes in interest rates. Based upon a hypothetical 10% increase in the interest rate, assuming all other conditions affecting market risk remain constant, the market value of our fixed rate debt would have decreased by approximately $0.8 million at December 31, 2006. Conversely, a hypothetical 10% decrease in the interest rate, assuming all other conditions affecting market risk remain constant, would have resulted in an increase in market value of approximately $0.8 million at December 31, 2006. Management does not foresee nor expect any significant change in our exposure to interest rate fluctuations or in how such exposure is managed in the future.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and related financial information, as listed under Item 15, appear in a separate section of this annual report beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in and/or disagreements with accountants on accounting and financial disclosure during the year ended December 31, 2006.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. We maintain disclosure controls and procedures that are designed to ensure that: (i) information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms; and (ii) such information is accumulated and communicated to our management, including our President and Executive Vice President and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 15d-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our President and Executive Vice President and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of December 31, 2006. Based on the foregoing, our President and Executive Vice President and Chief Financial Officer concluded that, as of the end of the annual period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Controls
Based on our evaluation carried out in accordance with SEC Rule 15d-15(b) under the supervision and with the participation of our management, including our President and Executive Vice President and Chief Financial Officer, concluded that there were no changes during the fourth fiscal quarter of 2006 in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following sets forth information about our current directors, executive officers and key non-executive employees:
* All ages are as of December 31, 2006
Jose Liberman co-founded our company in 1987 together with his son, Lenard, and has served as our President and as a member on our board of directors since our formation. Mr. Liberman started his career in radio broadcasting in 1957 with the purchase of XERZ in Mexico and the establishment of a radio advertising representative firm in Mexico. In 1976, Mr. Liberman acquired KLVE-FM, the first Los Angeles FM station to utilize a Hispanic format. In 1979, he purchased KTNQ-AM and combined it with KLVE to create the first Hispanic AM/FM combination in Los Angeles. Mr. Liberman is the father of our Executive Vice President, Chief Financial Officer, Secretary and Director, Lenard Liberman.
Lenard Liberman has served as our Executive Vice President, Chief Financial Officer and Secretary and has been a member of our board of directors since our formation in 1987. Mr. Liberman has served as our Chief Financial Officer since January 2007 and previously served as our Chief Financial Officer from April 1999 to April 2000, April 2002 to April 2003 and April 2005 to May 2006. Mr. Liberman manages all day-to-day operations including acquisitions and financings. He received his juris doctorate degree and masters of business administration degree from Stanford University in 1987. Mr. Liberman is the son of our President and Director, Jose Liberman.
Winter Horton has served as our Corporate Vice President since 2001. Mr. Horton joined us in 1997 as Vice President of Programming for KRCA. In 2001, as Corporate Vice President, Mr. Horton launched our four radio stations and one television station in Houston. He was also responsible for the launch of our Dallas stations, including KMPX, KNOR, KTCY, KZMP-AM, KZZA and KBOC. He is currently responsible for all of our Texas radio and television operations. Mr. Horton also oversees our production facilities in Burbank, Houston and Dallas.
Eduardo Leon has served as our Vice President of Programming since 1998. He is responsible for all programming aspects of our radio stations. Prior to joining us, Mr. Leon was the program director from 1996 to 1998 at radio station WLEY-FM in Chicago, which is owned by Spanish Broadcasting Systems, Inc. In 1992, he founded Radio Ideas, a Spanish-language radio consulting company.
Board Composition
Our board of directors is currently composed of two directors, Jose and Lenard Liberman. Our directors are elected annually by the shareholders.
Board Committees
We do not currently have any board committees. Accordingly, we do not have an audit committee, a compensation committed or a nominating committee. As we do not have an audit committee, we do not have an audit committee financial expert.
Compliance with Section 16(a) of the Exchange Act.
We do not have a class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended.
Code of Ethics
We are not required to have a code of ethics because we do not have a class of equity securities listed on a national securities exchange.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
Overview of Compensation Philosophy and Program
Our two executive officers are Jose Liberman and Lenard Liberman, who are also our sole directors and the sole beneficial shareholders of our parent, LBI Holdings I, Inc. As a result, Messrs. Jose and Lenard Liberman establish their own compensation and the compensation of any of our other executive officers. During 2006, William Keenan served as our chief financial officer until he resigned in January 2007. We are currently searching for a new chief financial officer. Jose Liberman, Lenard Liberman and William Keenan were our named executive officers for the year ended December 31, 2006.
We attempt to design a total compensation package for our named executive officers that fairly compensates them in relation to peers within the Spanish language broadcast industry. We believe that the most effective executive compensation program for our named executive officers is one that is designed to motivate them to achieve our business objectives, while also assisting us in attracting, motivating and retaining executives critical to our long term success.
We use various elements of compensation to reward performance. Our named executive officers are provided with a basic level of compensation for assuming and performing their responsibilities. We also provide the ability to obtain cash bonus awards as an incentive to provide a timely award for attainment of certain corporate or individual performances in a particular period. We consider long term and equity incentives on a case by case basis. Under an employment agreement with Mr. Keenan, had LBI Holdings I, Inc. completed an offering of its class A common stock, we would have granted stock options to Mr. Keenan in order to provide a long-term incentive.
Role of Executive Officers in Compensation Decisions
Our board of directors has the responsibility for establishing, implementing and monitoring adherence with our compensation philosophy. Accordingly, the board of directors makes all compensation decisions. As stated above, Jose Liberman and Lenard Liberman are our only directors. Because Jose Liberman and Lenard Liberman are also named executive officers, each of them participated in the decisions concerning their own compensation for the year ended December 31, 2006.
Setting Executive Compensation
We do not formally benchmark our compensation against any peer group. However, we informally consider competitive market practices with respect to the salaries and total compensation of our named executive officers. We review the market practices by reviewing annual reports on Form 10-K or similar information of other companies in the Hispanic radio and television industry that are located in our general geographic market areas. However, while we review such market information, it is only one factor we consider in establishing compensation, and we have not made use of any formula incorporating such data.
In determining whether to increase or decrease compensation to our named executive officers, we generally take into account any changes, of which we are aware, in the market pay levels, the performance of the named executive officer, any increases or decreases in responsibilities and roles of the named executive officer, and the business needs for the named executive officer.
Neither we nor the board of directors has hired a compensation consultant, and neither we nor the board of directors has made a decision to do so.
Elements of our Compensation Program
For the year ended December 31, 2006, our total compensation package for our named executive officers consisted of the following components:
•
base salary;
•
bonus;
•
for Mr. Keenan, stock options to be granted only if and when a public offering of LBI Holdings I’s Class A common stock is consummated;
•
perquisites and other personal benefits; and
•
retirement benefits.
Each element of compensation is considered separately and we do not generally take into account amounts realized from prior compensation in establishing other elements of compensation. Our goal is to provide a total compensation package that we believe our named executive officers and our stockholders will view as fair and equitable. This determination of compensation for each named executive officer is not a mechanical process, and our board of directors has used its judgment and experience to determine the appropriate mix of compensation for each individual.
For Jose Liberman and Lenard Liberman, the compensation package focuses on annual compensation because the Libermans hold all of the common stock of our indirect parent, thus providing them with powerful long term performance incentives. For other executive officers, we have considered long-term incentive compensation as part of a total compensation package. The form and amount of such compensation, if any, would be determined on a case-by-case basis.
Base Salary - We provide named executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. Subject to any employment agreement, base salary for named executive officers are reviewed on an annual basis and at the time of a change in responsibilities. Increases in salary, if any, are based on a subjective evaluation of such factors as the level responsibility, individual performance for the prior year, relevant market data, and each named executive officers’ experience and expertise.
We do not have employment agreements with Jose Liberman or Lenard Liberman, our President and Executive Vice President and Secretary at December 31, 2006, respectively. Base salary for both Jose Liberman and Lenard Liberman was $500,000 for the year ended December 31, 2006.
As of December 31, 2006, William S. Keenan, our Chief Financial Officer, was the only named executive officer working pursuant to an employment agreement. The employment agreement was entered into as of April 18, 2006 and provided for a base salary of $250,000 per year. The board of directors had not increased Mr. Keenan’s salary before his resignation in January 2007, because Mr. Keenan had not yet worked with us for one year.
Bonus - Bonus compensation to our named executive officers has been entirely discretionary. Jose Liberman and Lenard Liberman did not receive a bonus for the year ended December 31, 2006. Historically, Jose and Lenard Liberman have not received bonuses.
Our employment agreement with Mr. Keenan provided for the possible payment of cash bonuses of up to $60,000 in a twelve month period if Mr. Keenan remained with us through May 3, 2007 and the performance of all material obligations under the employment agreement had been satisfied. As described below under “Employment, Change in Control and Termination Arrangements”, Mr. Keenan resigned prior to May 3, 2007 and therefore we paid him no bonus.
Long-Term Incentive Compensation - As of December 31, 2006, we had not granted any options in our common stock or the common stock of our indirect parent, LBI Holdings I. Pursuant to the employment agreement with Mr. Keenan, Mr. Keenan would have received a stock option grant to purchase shares of LBI Holdings I’s class A common stock had an initial public offering for LBI Holdings I’s class A common stock been consummated. Mr. Keenan resigned on January 26, 2007, terminating the right to receive this stock option grant.
Perquisites and Other Benefits - We provide named executive officers with perquisites and other personal benefits that we believe are reasonable. We do not view perquisites as a significant element of our comprehensive compensation structure, but we do believe they can be useful in attracting, motivating and retaining executive talent.
The named executive officers are provided with personal travel, use of company automobiles, and financial planning and tax assistance. In addition, we provide the same or comparable health and welfare benefits to our named executive officers as are available for all other full-time employees. We believe that the perquisites and other personal benefits that we offer are typical employee benefits for high-level executives working in our industry and in our geographic area. We believe that these benefits enhance employee morale and performance, and are not excessively costly to the company. We provide these benefits in our discretion. Our perquisite and personal benefit programs may change over time as the board of directors determines is appropriate.
Attributed costs of the personal benefits described above for the named executive officers for the fiscal year ended December 31, 2006, are included in the column “All Other Compensation” of the “Summary Compensation Table” below.
Retirement Benefits - Our named executive officers are permitted to contribute to a 401(k) plan up to the maximum amount allowed under the Internal Revenue Code. We do not provide a matching contributions The 401(k) plan is available to all full-time employees. Our named executive officers do not participate in any deferred benefit retirement plans such as a pension plan. We do not have any deferred compensation program for any named executive officer.
Employment, Change in Control and Termination Arrangements
Employment Agreements - We do not have employment agreements with Jose Liberman or Lenard Liberman, our President and Executive Vice President and Secretary, respectively.
Mr. Keenan entered into an employment agreement with us on April 18, 2006, pursuant to which he received an annual base salary of $250,000 and the ability to receive annual bonuses of up to $60,000. See “Elements of Our Compensation Program - Bonus” and “Employment, Change in Control and Termination Arrangements - Potential Payment Upon Termination”. The employment agreement terminated upon Mr. Keenan’s resignation in January 2007.
Change in Control - None of our named executive officers are entitled to any payment or accelerated benefit in connection with a change in control of the Company.
Potential Payment Upon Termination - Other than the employment agreement we had with Mr. Keenan, we are not obligated to make any severance or other payment upon termination to our named executive officers.
Mr. Keenan’s employment agreement would have required us to pay an amount equal to six months’ salary, in addition to amounts due as salary and bonuses earned at the time of such termination, if we had terminated Mr. Keenan’s employment without “Cause” during the term of his agreement. In connection with Mr. Keenan’s resignation in January 2007, we entered into a severance and mutual release agreement with him. Pursuant to the terms of that agreement, we agreed to pay Mr. Keenan, in addition to base salary through the resignation date, a lump-sum payment of $62,499, subject to statutory and authorized deductions, which represented three-months base salary under his employment agreement. We will also pay for continued medical insurance benefits on behalf of Mr. Keenan and his dependents through April 30, 2007 and will offer continued medical insurance benefits at his cost for up to eighteen months thereafter.
Internal Revenue Code Section 162(m)
We do not have any common equity securities required to be registered under the Securities Exchange Act of 1934. Therefore, the limitation on tax deductibility of executive compensation under Section 162(m) of the Internal Revenue Code does not apply to us.
Compensation Committee Report
As we do not have a compensation committee, our board of directors reviews and determines the compensation of our executive officers. The board of directors has reviewed and discussed with management the information under the Compensation Discussion and Analysis above. Based on such review and discussion, the board of directors has approved the inclusion of the Compensation Discussion and Analysis in this report.
The Board of Directors:
Jose Liberman
Lenard Liberman
Executive Compensation
The following table describes the compensation we paid to our named executive officers during the fiscal years ended December 31, 2006. We have not issued any equity-based awards to our named executive officers or directors:
Summary Executive Compensation Table for 2006
(1) All other compensation includes payments by us for Mr. Liberman’s personal income taxes and tax preparation, personal expenses and leasing of personal vehicles.
(2) All other compensation includes payments by us for Mr. Liberman’s personal income taxes and tax preparation and planning of $33,632, personal expenses of $27,187 and leasing of personal vehicles of $21,958. Mr. Liberman was Chief Financial Officer until May 2006 and has been our Chief Financial Officer since January 2007.
(3) William S. Keenan joined us as Chief Financial Officer in May 2006 and resigned in January 2007. All other compensation does not include the lump sum payment of $62,400 (subject to statutory and authorized deductions) or the cost of continued medical benefits provided to Mr. Keenan and his dependents as these amounts were determined upon Mr. Keenan’s resignation in January 2007.
Potential Payments Upon Termination of Change of Control
As described above under “Compensation Discussion and Analysis-Employment, Change in Control and Termination Arrangements”, Mr. Keenan’s employment agreement would have required us to pay an amount equal to six months’ salary, in addition to amounts due as salary and bonuses earned, if we had terminated Mr. Keenan’s employment without “Cause” during the term of his agreement. Had such a termination occurred, the amount of the continued salary would have been $125,000. In connection with Mr. Keenan’s resignation in January 2007, we entered into a severance and mutual release agreement with him. Pursuant to the terms of that agreement, we agreed to pay Mr. Keenan, in addition to base salary through the resignation date, a lump-sum payment of $62,499, subject to statutory and authorized deductions, which represented three-months base salary under his employment agreement. We will also pay for continued medical insurance benefits on behalf of Mr. Keenan and his dependents through April 30, 2007 and will offer continued medical insurance benefits at his cost for up to eighteen months thereafter.
Director Compensation
Our directors do not currently receive any cash compensation for services on our board of directors.
Compensation Committee Interlocks and Insider Participation
We do not have a compensation committee. Our board of directors is responsible for determining the compensation of our executive officers. Jose Liberman and Lenard Liberman, our President and Executive Vice President, Chief Financial Officer and Secretary, respectively, were our only two directors for 2006 and determined the compensation of all executive officers for 2006. Otherwise, no executive officer of our company serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
We are a wholly owned subsidiary of our parent, LBI Holdings I, Inc. Jose Liberman, trustee of the Liberman Trust dated 11/07/02, and Lenard Liberman together own all of the outstanding stock of LBI Holdings I, Inc. (67.6495 shares and 132.3505 shares, respectively). Jose and Lenard Liberman each are executive officers and work at our offices at 1845 West Empire Avenue, Burbank, California 91504.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
We are not required to have, and do not have, an audit committee. Accordingly, our board of directors reviews and approves all related person transactions. Our board of directors has not adopted written procedures for review of, or standards for approval of, these transactions, but instead review such transactions on a case-by-case basis.
Stockholder Loans
As of December 31, 2006, we had outstanding loans, including accrued interest, aggregating $249,622 and $2,471,141 to Jose and Lenard Liberman, respectively. The loans were for the personal use of Jose and Lenard Liberman. For Jose Liberman, we made loans of $146,590 and $75,000 on December 20, 2001 and July 29, 2002, respectively. During the year ended December 31, 2006, the largest aggregate amount of principal outstanding of these loans was $221,590. Mr. Liberman did not pay any principal or interest to the Company for the year ended December 31, 2006.
For Lenard Liberman, we made loans of $243,095, $32,000 and $1,916,563 on December 20, 2001, June 14, 2002 and July 9, 2002, respectively. During the year ended December 31, 2006, the largest aggregate amount of principal outstanding of these loans was $2,191,658. Mr. Liberman did not pay any principal or interest to the Company for the year ended December 31, 2006.
Each of these loans bears interest at the alternative federal short-term rate published by the Internal Revenue Service for the month in which the advance was made, which rate was 2.48%, 2.91% and 2.84% for December 2001, June 2002 and July 2002, respectively. Each loan matures on the seventh anniversary of the date on which the loan was made. Under the Sarbanes-Oxley Act of 2002, we may not make any additional personal loans to Jose or Lenard Liberman and the maturity dates of the existing loans may not be extended.
Spanish Media Rep Team
Prior to April 2005, Jose and Lenard Liberman owned and operated our national sales representative, Spanish Media Rep Team, Inc., or SMRT. SMRT received a 15% commission from us for any commercial time it sells to national advertisers on our radio and television stations. We believe we paid commissions to SMRT on an arm’s length basis because the rate was based upon the commission rates we paid to former third party national sales representative firms.
On April 27, 2005, we acquired our national sales representative, Spanish Media Rep Team, or SMRT, for an aggregate purchase price of approximately $5.1 million. SMRT merged with and into Liberman Broadcasting, Inc. (predecessor in interest to Liberman Broadcasting of California LLC), a California corporation and our wholly owned subsidiary. Liberman Broadcasting of California paid approximately $3.3 million in cash and issued notes totaling $1.8 million to the stockholders of SMRT. The notes bore interest at the rate of 3.35% and were due and repaid on April 28, 2006. The shareholders of SMRT were the same beneficial stockholders of our indirect parent, LBI Holdings I, Inc.
L.D.L. Enterprises, Inc.
Lenard Liberman is the sole shareholder of L.D.L. Enterprises, Inc., a mail order business. From time to time, we allow L.D.L. Enterprises to use, free of charge, unsold advertising time on our radio and television stations.
Director Independence
Our board of directors consists solely of two members, Jose Liberman and Lenard Liberman. Messrs. Liberman indirectly own all of the shares our company. As a result, our directors are not deemed to be independent directors under the applicable Securities and Exchange Commission regulations. Because our common stock is not listed on a national securities exchange, we are not required to maintain a board consisting of a majority of independent directors or to maintain an audit committee, nominating committee or compensation committee consisting solely of independent directors.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees related to services performed by Ernst & Young LLP in 2006 and 2005 are as follows:
We do not have an audit committee. Our board of directors approves all services performed by Ernst & Young LLP. Fees for audit services include fees associated with the annual audit, the reviews of our quarterly reports on Form 10-Q, the issuance of comfort letters, the issuance of consents, and assistance with and review of documents filed with the SEC. Tax fees include tax compliance, tax advice and tax planning services.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
1. Financial Statements
The following financial statements of LBI Media and report of independent auditors are included in Item 8 of this annual report and submitted in a separate section beginning on page:
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets.
Consolidated Statements of Operations
Consolidated Statements of Stockholder’s Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Financial Statements Schedules
All required schedules are omitted because they are not applicable or the required information is shown in the financial statements or the accompanying notes.
3. Exhibits
The exhibits filed as part of this annual report are listed in Item 15(b).
(b) Exhibits.
The following exhibits are filed as a part of this report:
* Filed herewith.

Management contract or compensatory plan or arrangement.
(1) Incorporated by reference to LBI Media’s Registration Statement on Form S-4, filed with the Securities and Exchange Commission on October 4, 2002, as amended (File No. 333-100330).
(2) Incorporated by reference to LBI Media Holdings’ Registration Statement on Form S-4, filed with the Securities and Exchange Commission October 30, 2003, as amended (File No. 333-110122).
(3) Incorporated by reference to LBI Media Holdings’ Current Report on Form 8-K filed with the Securities and Exchange Commission on April 29, 2005 (File No. 333-110122).
(4) Incorporated by reference to LBI Media Holdings’ Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 15, 2006 (File No. 333-110122).
(5) Incorporated by reference to LBI Media Holdings’ Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 14, 2006 (File No. 333-110122).
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 on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Burbank, State of California, on March 29, 2007.
LBI MEDIA HOLDINGS, INC.
/s/ Lenard D. Liberman
Lenard D. Liberman
Executive Vice President, Chief Financial Officer and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
LBI Media Holdings, Inc.
We have audited the accompanying consolidated balance sheets of LBI Media Holdings, Inc. (a wholly owned subsidiary of LBI Holdings I, Inc.) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholder’s equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and 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 LBI Media Holdings, Inc. at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
March 29, 2007
Los Angeles, California
LBI MEDIA HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
LBI MEDIA HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
LBI MEDIA HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
LBI MEDIA HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
1. Summary of Significant Accounting Policies
Description of Business and Basis of Presentation
LBI Media Holdings, Inc. (“LBI Media Holdings”) was incorporated in Delaware on June 23, 2003 and is a qualified subchapter S subsidiary of LBI Holdings I, Inc. (the “Parent”). Should LBI Holdings I engage in any transaction that results in its inability to qualify as a subchapter S corporation, none of its subsidiaries, including LBI Media Holdings, will qualify as subchapter S subsidiaries for federal income tax purposes. Pursuant to an Assignment and Exchange Agreement dated September 29, 2003 between the Parent and LBI Media Holdings, the Parent assigned to LBI Media Holdings all of its right, title and interest in 100 shares of common stock of LBI Media, Inc. (“LBI Media”) (constituting all of the outstanding shares of LBI Media) in exchange for 100 shares of common stock of LBI Media Holdings. Thus, upon consummation of the exchange, LBI Media Holdings became a wholly owned subsidiary of the parent, and LBI Media became a wholly owned subsidiary of LBI Media Holdings.
LBI Media Holdings is not engaged in any business operations and has not acquired any assets or incurred any liabilities, other than the acquisition of stock of LBI Media, the issuance of senior discount notes (see Note 4) and the operations of its subsidiaries. Accordingly, its only material source of cash is dividends and distributions from its subsidiaries, which are subject to restriction by LBI Media’s senior credit facilities and the indenture governing the senior subordinated notes issued by LBI Media (see Note 4). Parent-only condensed financial information of LBI Media Holdings on a stand-alone basis has been presented in Note 9.
LBI Media Holdings and its wholly owned subsidiaries (collectively referred to as the “Company”) own and operate radio and television stations located in California and Texas. In addition, the Company owns television production facilities that is used to produce programming for Company-owned television stations. Portions of this facility are also occasionally rented to independent third parties. The Company sells commercial airtime on its radio and television stations to local and national advertisers. In addition, the Company has entered into time brokerage agreements with third parties for four of its radio stations.
The Company’s KHJ-AM, KVNR-AM, KWIZ-FM, KBUE-FM, KBUA-FM and KEBN-FM radio stations service the Los Angeles, California market, its KQUE-AM, KJOJ-AM, KSEV-AM, KEYH-AM, KJOJ-FM, KTJM-FM, KQQK-FM, KIOX-FM and KXGJ-FM radio stations service the Houston, Texas market, and its KNOR-FM, KZMP-AM, KTCY-FM, KZZA-FM, KZMP-FM and KBOC-FM radio stations service the Dallas-Fort Worth, Texas market.
The Company’s television stations, KRCA, KZJL, KMPX and KSDX service the Los Angeles, California, Houston, Texas, Dallas-Fort Worth, Texas and San Diego, California markets, respectively.
The Company’s television studio facility in Burbank, California, Houston, Texas, and Dallas, Texas, are owned and operated by its wholly owned subsidiaries, Empire Burbank Studios, Inc. (Empire), Liberman Television of Houston, Inc. and Liberman Television of Dallas, Inc., respectively.
Principles of Consolidation
The consolidated financial statements include the accounts of LBI Media Holdings and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. The accounts of the Parent, including certain indebtedness (see Note 4), are not included in the accompanying consolidated financial statements.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less and investments in money market accounts to be cash equivalents.
Fair Value of Financial Instruments
The carrying value of the Company’s financial instruments included in current assets and current liabilities (such as cash and equivalents, accounts receivable, accounts payable and accrued expenses, and other similar items)
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
approximate fair value due to the short-term nature of such instruments. The estimated fair value of the LBI Media’s Senior Subordinated Notes (see Note 4), based on quoted market prices, was approximately $159.0 million (carrying value of $150.0 million) at both December 31, 2006 and 2005. The estimated fair value of the Company’s Senior Discount Notes (see Note 4) was approximately $58.8 million and $50.0 million at December 31, 2006 and 2005, respectively (carrying values of $56.5 million and $50.8 million, respectively). The Company’s other long-term debt has variable interest rates or rates that the Company believes approximate current market rates and, accordingly, the carrying value is a reasonable estimate of its fair value.
Short-Term Investments
The Company held investments in marketable equity securities which were classified by management as available for sale. Securities classified as available for sale were carried at fair value, which was based on quoted market prices. Unrealized holding gains and losses were excluded from net income (loss) and were recorded as accumulated other comprehensive income or loss. The Company used the specific identification method of determining the cost of securities sold.
Program Rights
Program rights are stated at the lower of unamortized cost or estimated net realizable value. Program rights, together with the related liabilities, are recorded when the license period begins and the program becomes available for broadcast. Program rights are amortized using the straight-line method over the license term. Program rights expected to be amortized in the succeeding year and program rights payable due within one year are classified as current assets and current liabilities, respectively.
Property and Equipment
Property and equipment are recorded at cost less accumulated depreciation, maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over estimated useful lives as follows:
The carrying value of property and equipment is evaluated periodically in relation to the operating performance and anticipated future cash flows of the underlying radio and television stations 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 to the fair market value of the assets is recorded, if necessary. The fair market value of the assets is determined by using current broadcasting industry equipment prices, solicited current market data from dealers of used broadcast equipment and used equipment price lists, catalogs and listings in trade magazines and publications. During 2005, the Company revised the useful life of one of its broadcast towers that was scheduled for replacement.
The Company determined that the asset was impaired and recorded an impairment write-down of approximately $865,000 in 2005. Such write-down is included in depreciation and amortization expense in the consolidated statements of operations. Excluding the 2005 impairment charge, depreciation expense approximated $6,940,000, $6,300,000 and $5,125,000 during the years ended December 31, 2006 and 2005 and 2004, respectively.
Interest cost is capitalized on individually significant projects during construction and approximated $515,000 in 2006. No interest cost was capitalized in 2005 and 2004.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Broadcast Licenses
The Company’s broadcast licenses are intangible assets with indefinite lives and are reviewed for impairment during the third quarter of each fiscal year, with additional evaluations performed if potential impairment indicators are noted. The Company believes its broadcast licenses have indefinite useful lives given that they are expected to indefinitely contribute to the future cash flows of the Company and that they may be continually renewed without substantial cost to the Company. In certain prior years, the licenses were considered to have finite lives and were subject to amortization. Accumulated amortization of broadcast licenses totaled approximately $17.7 million at both December 31, 2006 and 2005.
If indicators of impairment are identified and the undiscounted cash flows estimated to be generated from these assets are less than the carrying value, an adjustment to reduce the carrying value to the fair market value of the assets would be recorded. The Company completed its annual impairment review of its broadcast licenses in the third quarters of 2006 and 2005 and conducted additional reviews of the fair value of some of its broadcast licenses in the fourth quarter of 2005 and the second quarter of 2006. The fair value of the Company’s broadcast licenses is determined by assuming that entry into the particular market took place as of the valuation date and considering the signal coverage of the related station as well as the projected advertising revenues for the particular market(s) in which each station operates. The Company adjusted the projected total advertising revenues in those markets, which was partially due to greater competition for revenues from non-traditional media, and determined the fair value of each broadcast license primarily from projected total advertising revenues for a given market without taking into consideration the Company’s format or management capabilities. As a result, the downward adjustment in projected revenues resulted in a decrease in the fair value of certain of the Company’s broadcast licenses. The following table sets forth the noncash impairment write-downs recorded by the Company for the years 2006 and 2005:
Barter Transactions
Included in the consolidated statements of operations are nonmonetary transactions arising from the trading of advertising time for merchandise and services. Barter revenues and expenses are recorded at the fair market value of the goods or services received when the commercial is broadcast. The Company recognizes barter revenues when the commercial is broadcast. Barter expenses are recorded at the same time as barter revenue, which approximates the date the expenses were incurred. Barter revenue and expense, net, totaled $1.1 million, $1.0 million, and $0.7 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Deferred Financing Costs
Financing costs are amortized using the straight-line method over the terms of the related credit facilities. Amortization of such costs is included in interest expense in the consolidated statements of operations.
Revenue Recognition
Broadcasting revenues from local and national commercial advertising are recognized when the advertisements are broadcast. Revenues from renting airtime are recognized when such time is made available to the customer.
Income Taxes
The Company is a “qualified S subsidiary” for federal and California income tax purposes. As such, the Company is deemed to be part of its Parent, an “S Corporation,” for tax purposes, and the taxable income of the Company is required to be reported by the stockholders of the Parent on their respective federal and state income tax returns. California assesses a 1.5% tax on all “S Corporations” subject to certain minimum taxes. Texas does not recognize Subchapter S status and accordingly assesses a tax on individual legal entities in an amount equal to the
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
greater of either (i) 4.5% of earned surplus or (ii) 0.25% of taxable capital. At December 31, 2006 and 2005, the Company has a net deferred tax asset for which a full valuation allowance has been provided. The net deferred tax asset relates to the state tax impact of various temporary differences primarily related to depreciation, amortization and deferred compensation. The deferred tax liability at December 31, 2006 and 2005 is primarily the result of book and tax basis differences related to the Company’s indefinite-lived intangible assets. If the Parent were no longer a qualified S corporation, its subsidiaries would also no longer qualify as S corporations. If a change in tax status had occurred as of December 31, 2006, the Company would have recorded a one-time non-cash charge of approximately $44.5 million to adjust its deferred tax accounts.
The Company may be audited by the Internal Revenue service and various state tax authorities. Disputes may arise with these tax authorities involving issues of the timing and amount of deductions and allocations of income and expenses among various tax jurisdictions because of differing interpretations of tax laws and regulations. The Company periodically evaluates its exposures associated with tax filing positions and, while it believes its positions comply with applicable laws, may record liabilities based upon estimates of the ultimate outcome of these matters.
The Company’s book basis in its assets and liabilities exceeded its tax basis in such assets and liabilities by approximately $23.9 million and $21.2 million at December 31, 2006 and 2005, respectively.
Advertising Costs
Advertising costs are expensed as incurred. The consolidated statements of operations include advertising costs (included in promotional expenses) of approximately $0.5 million, $0.3 million and $0.1 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Use of Estimates
The preparation of financial statements in conformity with U.S. 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.
Concentration of Credit Risk
The Company sells broadcast time to a diverse customer base including advertising agencies and other direct customers. The Company performs credit evaluations of its customers and generally does not require collateral. The Company maintains allowances for potential losses and such losses have been within management’s expectations.
Comprehensive Income
For the years ended December 31, 2006, 2005 and 2004, comprehensive income amounted to $5.1 million, $1.5 million, and $8.1 million respectively. Accumulated other comprehensive income in the consolidated statements of stockholder’s equity is comprised of changes in unrealized gains/losses on investments in marketable securities.
Derivative Instruments
Since November 2006, the Company has utilized a derivative instrument to hedge its exposure to interest rate risks. The Company records derivative instruments on the balance sheet as either assets or liabilities that are measured at their fair value under the provisions of Statement of Financial Accounting Standards No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities”, as amended. SFAS 133 requires that changes in the fair value of derivative instruments be recognized currently in earnings unless specific hedge accounting criteria are met, in which case, changes in fair value are deferred to accumulated other comprehensive income and reclassified into earnings when the underlying transaction affects earnings. The interest rate swap effective at December 31, 2006 did not meet the requirements for hedge accounting treatment at its inception and, accordingly, changes in its fair value are included in current period earnings as interest rate swap income or expense in the consolidated statement of operations.
Offering Costs
In February 2004, Liberman Broadcasting, Inc., a Delaware corporation, filed a registration statement on Form S-1 (File No. 333-112773) with the Securities and Exchange Commission for the proposed initial public offering of its Class A Common Stock (the “Offering”).
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Because the Company advanced the funds used by Liberman Broadcasting, Inc., a Delaware Corporation (“Liberman Broadcasting”), to pay the offering costs and a portion of the Offering proceeds were to be used to repay borrowings under the LBI Media’s senior credit facilities, the offering costs have been charged to the Company. Such costs, which aggregated $0.3 million and $1.5 million during the years ended 2005 and 2004, respectively, are included in Offering costs in the consolidated statements of operations as the Offering had been postponed due to market conditions.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards No. 157-Fair Value Measurements (“SFAS 157”). Issued in September 2006, SFAS 157 is effective for fiscal years beginning after November 15, 2007. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements and therefore does not require new fair value measurements. The application of SFAS 157, however, may change the Company’s fair value methodology. The Company is currently evaluating what impact, if any, the adoption of SFAS 157 will have on the Company’s financial position, results of operations and cash flows.
Statement of Financial Accounting Standards No. 159-The Fair Value Option for Financial Assets and Financial Liabilities-including an amendment of FAS 115 (“SFAS 159”) Issued in February 2007, SFAS 159 is effective for fiscal years beginning after November 15, 2007. SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations in which they are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. The Company is currently evaluating what impact, if any, the adoption of SFAS 159 will have on the Company’s financial position, results of operations and cash flows.
FASB Interpretation No. 48-Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109) (“FIN 48”). Issued in July 2006, this interpretation clarifies the accounting for uncertainty in income taxes recognized in the financial statements by prescribing a recognition threshold and measurement attribute for the financial statements recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation became effective beginning on January 1, 2007. The Company is currently evaluating what impact, if any, the adoption of FIN 48 will have on the Company’s financial position, results of operations and cash flows.
SEC Staff Accounting Bulletin No. 108-Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). Issued in September 2006, SAB 108 became effective for fiscal years ending on or after November 15, 2006. SAB 108 describes the approach that should be used to quantify the materiality of a misstatement, requiring registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors, and provides guidance for correcting prior year errors. The adoption of SAB 108, during the year ended December 31, 2006, did not have a material impact on the Company’s financial position, results of operations or cash flows.
2. Acquisitions
On November 2, 2006, the Company completed its acquisition of the selected assets of five radio stations: KTCY-FM, licensed to Azle, TX, KZZA-FM, licensed to Muenster, TX, KZMP-FM, licensed to Pilot Point, TX, KZMP-AM, licensed to University Park, TX, and KBOC-FM, licensed to Bridgeport, TX, pursuant to an asset purchase agreement dated as of August 2, 2006, as amended. The aggregate purchase price was approximately $93.3 million, including acquisition costs of approximately $0.8 million. The Company has changed or intends to change the format and customer base of the acquired stations. The Company allocated the purchase price as follows:
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The intangible assets have useful lives of less than one year and are included in other current assets in the consolidated balance sheets. Amortization expense is computed on a straight-line basis and approximated $135,000 in 2006 and zero in 2005 and 2004.
As further described in Note 6, in April 2005, Liberman Broadcasting, Inc., a California corporation and a wholly-owned subsidiary of the Company (“LBI”) acquired its national sales representative, Spanish Media Rep Team, or SMRT, for an aggregate purchase price of approximately $5.1 million. SMRT merged with and into LBI. LBI paid approximately $3.3 million in cash and issued notes payable totaling $1.8 million to the stockholders of SMRT. The notes payable bore interest at the rate of 3.35% and were due and repaid proximate to closing. The stockholders of SMRT were the same beneficial stockholders of the Company’s parent, LBI Holdings I, Inc. The following sets forth the changes in assets and liabilities resulting from the SMRT acquisition in 2005:
In January 2004, the Company completed its acquisition of selected assets of KMPX-TV, licensed to Decatur, Texas. The aggregate purchase price was approximately $37.6 million, including acquisition costs of approximately $0.6 million. The Company changed the format, customer base and employee base of the acquired station and allocated the purchase price as follows:
In July 2004, the Company completed its acquisition of selected assets of radio station KNOR-FM, licensed to Krum, Texas. The aggregate purchase price was approximately $16.1 million, including acquisition costs of approximately $0.6 million. The Company changed the format, customer base and employee base of the acquired station and the initial purchase price allocation is as follows:
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Property and Equipment
Property and equipment consist of the following:
4. Long-Term Debt
Long-term debt consists of the following (excluding the debt of the Parent-see discussion below):
LBI Media’s 2006 Revolver and 2006 Term Loan
On May 8, 2006, LBI Media refinanced the 2004 Revolver (defined below) with a $110.0 million senior term loan credit facility (the “2006 Term Loan”) and a $150.0 million senior revolving credit facility (the “2006 Revolver”, and together with the 2006 Term Loan, the “2006 Senior Credit Facilities”). The 2006 Revolver includes a $5.0 million swing line subfacility and allows for letters of credit up to the lesser of $5.0 million and the available remaining revolving commitment amount. LBI Media has the option to request its lenders to increase the amount of the 2006 Senior Credit Facilities by an additional $50.0 million; however, the lenders are not obligated to do so. The increases under the 2006 Term Loan and the 2006 Revolver, taken together, cannot exceed $50.0 million in the aggregate. The 2006 Term Loan and 2006 Revolver mature on March 31, 2012.
LBI Media must pay 0.25% of the original principal amount of the 2006 Term Loan each quarter ($275,000 or $1.1 million annually) plus 0.25% of any additional principal amount incurred in the future under the 2006 Term Loan. There are no scheduled reductions of commitments under the 2006 Revolver.
Borrowings under the 2006 Senior Credit Facilities bear interest based on either, at the option of LBI Media, the base rate for base rate loans or the LIBOR rate for LIBOR loans, in each case plus the applicable margin
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
stipulated in the senior credit agreements. The base rate is the higher of (i) Credit Suisse’s prime rate and (ii) the Federal Funds Effective Rate (as published by the Federal Reserve Bank of New York) plus 0.50%. The applicable margin for loans under the 2006 Revolver, which is based on LBI Media’s total leverage ratio, will range from 0% to 1.00% per annum for base rate loans and from 1.00% to 2.00% per annum for LIBOR loans. The applicable margin for the 2006 Term Loan is 0.50% for base rate loans and 1.50% for LIBOR loans. The applicable margin for any future term loans will be agreed upon at the time those term loans are incurred. Interest on base rate loans is payable quarterly in arrears and interest on LIBOR loans is payable either monthly, bimonthly or quarterly depending on the interest period elected by LBI Media. All amounts that are not paid when due under either the 2006 Revolver or 2006 Term Loan will accrue interest at the rate otherwise applicable plus 2.00% until such amounts are paid in full. Borrowings under the 2006 Revolver and 2006 Term Loan bore interest at weighted average rates of 6.61% and 6.87%, including the applicable margin, respectively, at December 31, 2006.
Borrowings under the 2006 Senior Credit Facilities are secured by substantially all of the tangible and intangible assets of LBI Media and its wholly owned subsidiaries, including a first priority pledge of all capital stock of each of LBI Media’s subsidiaries. The 2006 Senior Credit Facilities also contain customary representations, affirmative and negative covenants and defaults for a senior credit facility, including restrictions on LBI Media’s ability to pay dividends. At December 31, 2006, LBI Media was in compliance with all such covenants.
LBI Media will pay quarterly commitment fees on the unused portion of the 2006 Revolver based on its utilization rate of the total borrowing capacity. Under certain circumstances, if LBI Media borrows less than 50% of the revolving credit commitment, it must pay a quarterly commitment fee of 0.50% times the unused portion. If LBI Media borrows 50% or more of the total revolving credit commitment, it must pay a quarterly commitment fee of 0.25% times the unused portion.
In connection with the issuance of the 2006 Senior Credit Facilities, the Company entered into an interest rate swap agreement with a notional principal amount of $80.0 million for three years and $60.0 million for the following two years. The Company will receive interest at a fixed rate of 5.56% and pay interest at the base rate for base rate loans or the LIBOR rate for LIBOR loans, in each case plus the applicable margin specified in the agreements governing the 2006 Senior Credit Facilities. As this swap agreement did not meet the requirements for hedge accounting at its inception, changes in its fair value are recorded into earnings each period, with an offsetting asset or liability reflecting the fair value of the interest rate swap, related to the difference between the fixed rate and the floating rate of interest on the swap, recorded in the consolidated balance sheets. Accordingly, during the year ended December 31, 2006, the Company recognized interest rate swap expense of $1.8 million in its consolidated statements of operations and, at December 31, 2006, the Company recorded a long-term liability of $1.8 million in its consolidated balance sheets.
LBI Media’s 2004 Revolver
In June 2004, LBI Media amended and restated its then existing senior revolving credit facility (as amended and restated, the “2004 Revolver”). The 2004 Revolver included an initial $175.0 million revolving loan and a $5.0 million swing line sub-facility. The borrowing capacity under the 2004 Revolver was subsequently increased to $220.0 million. There were no scheduled reductions of commitments under the 2004 Revolver.
Borrowings under the 2004 Revolver were secured by substantially all of the tangible and intangible assets of LBI Media, including a first priority pledge of all capital stock of each of LBI Media’s subsidiaries. The 2004 Revolver also contained customary representations, affirmative and negative covenants and defaults for a senior credit facility.
LBI Media paid quarterly commitment fees on the unused portion of the 2004 Revolver based on its utilization rate of the total borrowing capacity. Under certain circumstances, if LBI Media borrowed less than 50% of the revolving credit commitment, it had to pay a quarterly commitment fee of 0.500% times the unused portion. If LBI Media borrowed 50% or more of the total revolving credit commitment, it had to pay a quarterly commitment fee of 0.375% times the unused portion.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LBI Media’s Senior Subordinated Notes
In July 2002, LBI Media issued $150.0 million of Senior Subordinated Notes due 2012 (the “Senior Subordinated Notes”). The Senior Subordinated Notes bear interest at the rate of 10 1/8% per annum, and interest payments are to be made on a semi-annual basis each January 15 and July 15. LBI Media is a holding company that has no independent assets or operations other than its investment in its subsidiaries. All of LBI Media’s subsidiaries are wholly owned and provide full and unconditional joint and several guarantees of the Senior Subordinated Notes.
The indenture governing the Senior Subordinated Notes contains certain restrictive covenants that, among other things, limit LBI Media’s ability to borrow under the 2006 Revolver, and previously, the 2004 Revolver, and pay dividends. LBI Media could borrow up to $150.0 million under the 2006 Revolver (subject to certain reductions under certain circumstances) without having to meet the restrictions contained in the indenture, but any amount over $150.0 million (subject to certain reductions under certain circumstances) would be subject to LBI Media’s compliance with a specified leverage ratio (as defined in the indenture of the Senior Subordinated Notes). At December 31, 2006, LBI Media was in compliance with all such covenants.
Senior Discount Notes
In October 2003, the Company issued $68.4 million aggregate principal amount at maturity of Senior Discount Notes that mature in 2013 (the “Senior Discount Notes”). The notes were sold at 58.456% of principal amount at maturity, resulting in gross proceeds of approximately $40.0 million and net proceeds of approximately $38.8 million after certain transaction costs. Under the terms of the notes, cash interest will not accrue or be payable on the notes prior to October 15, 2008 and instead the value of the notes will be increased each period until it equals $68.4 million on October 15, 2008; such accretion (approximately $5.7 million, $5.2 million and $4.6 million for the years ended December 31, 2006, 2005 and 2004, respectively) is recorded as additional interest expense by the Company. Thereafter, cash interest on the notes will accrue at a rate of 11% per year payable semi-annually on each April 15 and October 15; provided, however, that the Company may make a cash interest election on any interest payment date prior to October 15, 2008. If the Company makes a cash interest election, the principal amount of the notes at maturity will be reduced to the accreted value of the notes as of the date of the cash interest election, and cash interest will begin to accrue at a rate of 11% per year from the date the Company makes such election. The Senior Discount Notes may be redeemed by the Company at any time on or after October 15, 2008 at redemption prices specified in the indenture governing the Senior Discount Notes, plus accrued and unpaid interest. The indenture governing the Senior Discount Notes contains certain restrictive covenants that, among other things, limit the Company’s ability to incur additional indebtedness and pay dividends. As of December 31, 2006, the Company was in compliance with all such covenants. The Senior Discount Notes are structurally subordinated to the 2006 Senior Credit Facilities and the Senior Subordinated Notes.
LBI Media’s 2004 Empire Notes
In July 2004, Empire Burbank Studios, Inc., a wholly owned indirect subsidiary of the Company, issued an installment note for approximately $2.6 million (the “2004 Empire Note”). The 2004 Empire Note bears interest at the rate of 5.52% per annum and is payable in monthly principal and interest payments of $21,411 through maturity in July 2019. The borrowings under the 2004 Empire Note are secured primarily by all of Empire’s real property.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2006, the Company’s long-term debt had scheduled repayments for each of the next five years as follows
The above table does not include interest payments and scheduled repayments relating to the debt of the Parent and does not include any deferred compensation amounts the Company may ultimately pay. Pursuant to SEC guidelines, such debt of the Parent is not reflected in the Company’s financial statements as (a) the Company will not assume the debt of the Parent, either presently or in a planned transaction in the future; (b) the proceeds from the offering of $150 million of Senior Subordinated Notes in 2002 and the Senior Discount Notes in 2003 were not used to retire all or a part of the debt the Parent; and (c) the Company does not guarantee or pledge its assets as collateral for the debt of the Parent. The Parent is a holding company that has no assets, operations or cash flows other than its investments in the Company. Accordingly, funding from the Company will be required for the Parent to repay its debt. The Parent’s debt, which is expressly subordinated in right of payment to the 2006 Senior Credit Facilities, Senior Subordinated Notes and Senior Discount Notes, is described below.
Parent Subordinated Notes
In March 2001, the Parent entered into an agreement whereby, in exchange for $30.0 million, it issued junior subordinated notes (the “Parent Subordinated Notes”) and warrants to the holders of the Parent Subordinated Notes to initially acquire 14.02 shares (approximately 6.55%) of the Parent’s common stock at an initial exercise price of $0.01 per share. In connection with the refinancing of the 2004 Revolver and the issuance of the Company’s Senior Discount Notes in October 2003 described above, the Parent amended the terms of the Parent Subordinated Notes and the related warrants. The following information gives effect to such amendments. The Parent Subordinated Notes initially bear interest at 9% per year and will bear interest at 13% per year beginning September 21, 2009. The Parent Subordinated Notes will mature on the earliest of (i) January 31, 2014, (ii) their acceleration following the occurrence and continuance of a material event of default (as defined in the agreement), (iii) a merger, sale or similar transaction involving the Parent or substantially all of the subsidiaries of the Parent, (iv) a sale or other disposition of a majority of the Parent’s issued and outstanding capital stock or other rights giving a third party a right to elect a majority of the Parent’s board of directors and (v) the date on which the warrants issued in connection with the Parent Subordinated Notes are repurchased pursuant to the call options applicable to such warrants. Interest is not payable until maturity.
The warrants will expire on the earlier of (i) the later of (a) July 31, 2015, and (b) the date which is six months from the payment in full of all outstanding principal and interest on the Parent Subordinated Notes or (ii) the closing of an underwritten public equity offering in which the Parent raises at least $25.0 million (subject to extension in certain circumstances).
A performance-based adjustment may increase or decrease the number of shares issued upon exercise of the warrants based on the Parent’s future consolidated broadcast cash flow (as defined). Upon the maturity date of the Parent Subordinated Notes, the payment in full of the Parent Subordinated Notes and the repurchase of the warrants, a change in control of the Parent or the exercise of the call or put options described below, the number of shares issuable upon the exercise of the warrants at the time of such event will be decreased by multiplying such number of shares by .9367, if the Parent achieves consolidated broadcast cash flow for the trailing 12 months in excess of 125% of its budgeted forecasts and in the case of the sale of the Parent, its total fair market value is greater than 13 times consolidated broadcast cash flow for the trailing 12 months. The number of shares issuable upon the exercise of the warrants will be increased by multiplying such number of shares by 1.0633, if the Parent achieves consolidated broadcast cash flow less than 75% of its budgeted plan for the trailing 12 months and in the case of the sale of the Parent, its total fair market value is less than 15 times consolidated broadcast cash flow for the trailing 12 months.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The warrants contain a put right and a call right as described below. If either of these rights is exercised, it could require a significant amount of cash from the Company to repurchase the warrants, since the Parent is a holding company that has no operations or assets, other than its investment in the Company, and is dependent on the Company for cash flow. However, the Company has no legal obligation to provide that funding.
Put Right: The warrant holders have a “put right,” which entitles them at any time on or after the maturity date of the Parent Subordinated Notes to require the Parent to repurchase the warrants, or if the warrants have been exercised, the stock issued pursuant to the warrants, at the fair market value of the stock/warrants (the fair market value is subject to certain adjustments).
Call Right: If the Parent proposes an acquisition with a valuation of at least $5.0 million in connection with which any proposed financing source reasonably requires in good faith, as a condition of financing and/or permitting the acquisition, an amendment to the maturity date of the notes and a majority of the holders of the Parent Subordinated Notes do not agree to such amendment, the Parent has the right to purchase the warrants (or related stock, if the warrants have been issued) at fair market value, in connection with its payment in full of the aggregate of principal and interest outstanding under the Parent Subordinated Notes.
Based on the relative fair values at the date of issuance, the Parent allocated $13.6 million to the Parent Subordinated Notes and $16.4 million to the warrants. These fair values were determined by using the income and market valuation approaches. The income approach analyzes future cash flows and discounts them to arrive at a current estimated fair value. The market approach uses recent sales and offering prices of similar properties to determine estimated fair value. The Parent Subordinated Notes will be accreted through January 31, 2014, up to their $30.0 million redemption value; such accretion (approximately $1.0 million, $0.9 million, and $0.9 million for the years ended December 31, 2006, 2005 and 2004, respectively) is recorded as additional interest expense by the Parent. In the financial statements of the Parent, the warrants are stated at fair value each reporting period ($25.5 million and $24.4 million at December 31, 2006 and 2005, respectively), with subsequent changes in fair value being recorded as interest expense.
5. Commitments and Contingencies
Leases
The Company leases the land, tower and/or studio space for certain stations under noncancelable operating leases that expire at various times through 2024, with some having renewal options, generally for one to five years. Rental expenses under these agreements totaled approximately $1.9 million, $1.6 million and $1.5 million during the years ended December 31, 2006, 2005 and 2004, respectively.
Future minimum lease payments by year and in the aggregate, under noncancelable operating leases, consist of the following at December 31, 2006:
Deferred Compensation
One of the Company’s subsidiaries and the Parent have entered into employment agreements with certain employees. Services required under the employment agreements are rendered to the Company, and payments of amounts earned under the agreements are made by the Company. Accordingly, the Company has reflected amounts
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
due under these employment agreements in its financial statements. In addition to annual compensation and other benefits, these agreements provide the employees with the ability to participate in the increase of the “net value” (as defined) of the Parent over certain base amounts (“Incentive Compensation”). There are two components of Incentive Compensation: (i) a component that vests in varying amounts over time; and (ii) a component that vests upon the attainment of certain performance measures. The time vesting component is accounted for over the vesting periods specified in the employment agreements. Performance based amounts are accounted for at the time it is considered probable that the performance measures will be attained. Any Incentive Compensation amounts due are required to be paid within thirty days after the date the “net value” of the Parent is determined. If the Parent is publicly traded, the Company may elect, at its option, to receive all or a portion of the deferred compensation awards in the form of common stock of the Parent.
The employment agreements contain provisions which allow for limited accelerated vesting in the event of a change in control of the Parent (as defined). Unless there is a change in control of the Parent (as defined), the “net value” (as defined) of the Parent was and will be determined as of December 31, 2005, December 31, 2006 or December 31, 2009 (depending upon the particular employment agreement).
As a part of the calculation of this Incentive Compensation, the Company used the income and market valuation approaches to determine the “net value” of the Parent. The income approach analyzes future cash flows and discounts them to arrive at a current estimated fair value. The market approach uses recent sales and offering prices of similar properties to determine estimated fair value. Each employee negotiated the base amounts at the time the employment agreement was entered into. The vested amounts are shown as deferred compensation in the consolidated balance sheets; the related expense (benefit) is shown as deferred compensation in the consolidated statements of operations; and related cash payments are shown as deferred compensation payments in the consolidated statement of cash flows.
Until the “net value” of the Parent has been determined by appraisal as of each valuation date, the Company evaluates and estimates the deferred compensation liability under these employment agreements. At December 31, 2006 and 2005, the Company has estimated that certain employees had vested in approximately $8.3 million and $9.0 million, respectively, of Incentive Compensation. During the fourth quarter of 2006, a payment of approximately $1.6 million was made to one employee, satisfying the Company’s obligations under the employment agreement with a December 31, 2005 “net value” determination date. The Company is scheduled to make payments under those employment agreements with December 31, 2006 “net value” determination dates during 2007, subject to “net value” appraisal results. Deferred compensation expense for the year ended December 31, 2006 was reduced by approximately $1.3 million because the amounts ultimately paid to the employee whose net value was determined as of December 31, 2005 were less than the amount accrued as of that date. Amounts charged (credited) to operating expenses related to these agreements, net of payments, were $0.9 million, $(2.4 million) and $2.9 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Litigation
In June 2005, nine former employees of the Company’s wholly owned subsidiary, Liberman Broadcasting, Inc., a California corporation (LBI), filed suit in Los Angeles Superior Court, alleging claims on their own behalf and also on behalf of a purported class of former and current LBI employees. The complaint alleges, among other things, wage and hour violations relating to overtime pay, and wrongful termination and unfair competition under California Business and Professions Code. Plaintiffs seek, among other relief, unspecified general, treble and punitive damages, as well as profit disgorgement, restitution and their attorneys’ fees. LBI has filed its answer to the complaint, generally denying plaintiffs’ claims and allegations. The plaintiffs have begun conducting discovery and have filed a motion for class certification. The Company intends to oppose that motion for certification and vigorously defend itself in the lawsuit. Because of the preliminary nature of this matter, the Company is unable to assess the likelihood of an unfavorable outcome to the matter or the amount of any monetary damages that may ultimately be awarded.
The Company is subject to pending litigation arising in the normal course of its business. While it is not possible to predict the results of such litigation, management does not believe the ultimate outcome of these matters will have a materially adverse effect on the Company’s financial position or results of operations.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Related Party Transactions
In April 2005, the Company’s national sales representative, Spanish Media Rep Team, Inc. (“SMRT”) merged with and into Liberman Broadcasting, Inc., a California corporation, and a wholly owned subsidiary of the Company (“LBI”). LBI paid $3.3 million in cash and issued notes payable totaling $1.8 million to the stockholders of the Parent in exchange for the common stock of SMRT (representing a total purchase price of $5.1 million). The notes payable bore interest at the rate of 3.35% and were due and repaid on April 28, 2006. As the merger constituted a transaction between entities under common control, it is required to be accounted for at historical cost. The prior periods were not restated to give effect to the consolidation of SMRT. SMRT had a net book deficit of approximately $0.7 million at the date of the merger. Such amount, plus the $5.1 million purchase price, was recorded as a distribution to the stockholders of the Parent in the accompanying financial statements.
The Company was charged approximately $0.5 million and $2.0 million from SMRT during the years ended December 31, 2005 and 2004. Such amounts, which the Company believes represented market rates, are included in selling expenses in the consolidated statements of operations.
The Company had approximately $2.7 million due from stockholders of the Parent and from affiliated companies at both December 31, 2006 and 2005. The Company loaned approximately $1.9 million to a stockholder of the Parent in July 2002. These loans bear interest at the applicable federal rate and mature through July 2009. Additionally, at the direction of the stockholders of the Parent, the Company made loans advances to certain religious and charitable organizations totaling approximately $0.3 million, including accrued interest, at December 31, 2005, which were included in amounts due from related parties in the consolidated balance sheets. The Company made additional loan advances in 2006 of approximately $0.1. The shareholders of the indirect parent of the Company determined that the Company would not collect on these loan advances. As a result, $0.4 million, was charged as a charitable contribution, and is included in 2006 selling, general and administrative expense in the consolidated statement of operations.
One of the Parent’s stockholders is the sole shareholder of L.D.L. Enterprises, Inc. (LDL), a mail order business. From time to time, the Company allows LDL to use, free of charge, unsold advertising time on its radio and television stations.
7. Defined Contribution Plan
In 1999, 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 of up to 60% of their annual salary, including commissions, up to the maximum IRS allowable amount. The Company is allowed to contribute a discretionary amount to the Plan. For the years ended December 31, 2006, 2005 and 2004, the Company made no discretionary contributions to the Plan.
8. Segment Data
SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” requires companies to provide certain information about their operating segments. The Company has two reportable segments-radio operations and television operations. Management uses operating income before depreciation, impairment of broadcast license and offering costs as its measure of profitability for purposes of assessing performance and allocating resources.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. LBI Media Holdings, Inc. (Parent Company Only)
The terms of LBI Media’s 2006 Senior Credit Facilities and the indenture governing LBI Media’s Senior Subordinated Notes restrict LBI Media’s ability to transfer net assets to the Company in the form of loans, advances, or cash dividends. The following parent-only condensed financial information presents balance sheets and related statements of operations and cash flows of the Company by accounting for the investments in the owned subsidiaries on the equity method of accounting. The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto.
LBI MEDIA HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Valuation and Qualifying Accounts and Reserves
The following is a summary of the valuation and qualifying accounts and reserves for the years ended December 31, 2006, 2005 and 2004:
EXHIBIT INDEX
EXHIBIT INDEX
* Filed herewith.

Management contract or compensatory plan or arrangement.
(1) Incorporated by reference to LBI Media’s Registration Statement on Form S-4, filed with the Securities and Exchange Commission on October 4, 2002, as amended (File No. 333-100330).
(2) Incorporated by reference to LBI Media Holdings’ Registration Statement on Form S-4, filed with the Securities and Exchange Commission October 30, 2003, as amended (File No. 333-110122).
(3) Incorporated by reference to LBI Media Holdings’ Current Report on Form 8-K filed with the Securities and Exchange Commission on April 29, 2005 (File No. 333-110122).
(4) Incorporated by reference to LBI Media Holdings’ Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 15, 2006 (File No. 333-110122).
(5) Incorporated by reference to LBI Media Holdings’ Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 14, 2006 (File No. 333-110122).