SPANISH BROADCASTING SYSTEM INC - Quarter Report: 2006 September (Form 10-Q)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

Commission file number 33-82114

 

 

Spanish Broadcasting System, Inc.

(Exact name of registrant as specified in its charter)

 

 

2601 South Bayshore Drive, PH II

Coconut Grove, Florida 33133

(Address of principal executive offices) (Zip Code)

 

(305) 441-6901

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year,

if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filer: o      Accelerated filer: þ     Non-accelerated filer: o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: as of November 7, 2006, 40,277,805 shares of Class A common stock, par value $0.0001 per share, 24,503,500 shares of Class B common stock, par value $0.0001 per share and 380,000 shares of Series C convertible preferred stock, $0.01 par value per share, which are convertible into 7,600,000 shares of Class A common stock, were outstanding.

 

 

SPANISH BROADCASTING SYSTEM, INC.
INDEX

 

Special Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains both historical and forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are not based on historical facts, but rather reflect our current expectations concerning future results and events. These forward-looking statements generally can be identified by the use of statements that include phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “plan,” “project,” “foresee,” “likely,” “will” or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are, or may be, forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be different from any future results, performance and anticipated achievements expressed or implied by these statements. We do not intend to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company’s historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in this report, in Part II, “Item 1A. Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2005, and those described from time to time in our future reports filed with the Securities and Exchange Commission.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

The unaudited condensed consolidated financial statements include the accounts of Spanish Broadcasting System, Inc. and its subsidiaries (the “Company”, “we”, “us”, “our” or “SBS”). All intercompany balances and transactions have been eliminated in consolidation. The accompanying unaudited condensed consolidated financial statements as of September 30, 2006 and December 31, 2005 and for the three- and nine-month periods ended September 30, 2006 and 2005 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all information and notes required by generally accepted accounting principles for complete financial statements. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These unaudited condensed consolidated financial statements should be read in conjunction with our consolidated financial statements as of, and for, the fiscal year ended December 31, 2005, included in our fiscal year end 2005 Annual Report on Form 10-K.

 

In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, which are all of a normal and recurring nature, necessary for a fair presentation of the results of the interim periods. The results of operations for the three- and nine-month periods ended September 30, 2006 are not necessarily indicative of the results for a full year.

 

 

On January 31, 2006, we completed the sale of the assets of our radio stations KZAB-FM and KZBA-FM, serving the Los Angeles, California market, for a cash purchase price of $120.0 million (the “LA Asset Sale”), to Styles Media Group, LLC, a Florida limited liability company (“Styles Media Group”), pursuant to that certain asset purchase agreement, dated as of August 17, 2004, by and among Styles Media Group, Spanish Broadcasting System SouthWest, Inc., one of our subsidiaries, and us.

 

In connection with the closing of the LA Asset Sale, Styles Media Group paid a cash purchase price of $120.0 million, consisting of $65.0 million paid at closing and $55.0 million previously paid to us as non-refundable deposits. As a result of the LA Asset Sale, we recognized a pre-tax gain on the sale of assets, net of disposal costs, of approximately $50.8 million during the nine-months ended September 30, 2006.

 

Previously, on August 17, 2004, Spanish Broadcasting System SouthWest, Inc., also entered into a time brokerage agreement with Styles Media Group pursuant to which Styles Media Group was permitted to begin broadcasting its programming on radio stations KZAB-FM and KZBA-FM beginning on September 20, 2004. On January 31, 2006, the time brokerage agreement was terminated upon the completion of the sale.

 

We determined that, since we were not eliminating all significant revenues and expenses generated in this market, the LA Asset Sale did not meet the criteria to classify the stations’ operations as discontinued operations. KZAB-FM and KZBA-FM generated net revenues of $0.6 million and generated station operating income of $0.4 million for the three-month period ended September 30, 2005. KZAB-FM and KZBA-FM generated net revenues of $0.2 million and $1.7 million and generated station operating income of $0.1 million and $1.3 million for the nine-month periods ended September 30, 2006 and 2005, respectively. These stations’ net revenue and station operating income were mainly generated from the monthly fees received related to the time brokerage agreement.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

On December 23, 2004, in connection with the closing of the merger agreement, dated October 5, 2004, with Infinity Media Corporation (“Infinity”), Infinity Broadcasting Corporation of San Francisco (“Infinity SF”) and SBS Bay Area, LLC, a wholly-owned subsidiary of SBS (“SBS Bay Area”), we issued to Infinity (i) an aggregate of 380,000 shares of Series C convertible preferred stock, $0.002 par value per share (the “Series C preferred stock”), each of which is convertible at the option of the holder into twenty fully paid and non- assessable shares of our Class A common stock; and (ii) a warrant to purchase an additional 190,000 shares of Series C preferred stock, exercisable at any time from December 23, 2004 until December 23, 2008, at an exercise price of $300.00 per share (the “Warrant”).

 

Under the terms of the certificate of designation governing the Series C preferred stock, the holder of Series C preferred stock has the right to convert each share of Series C preferred stock into twenty fully paid and non-assessable shares of our Class A common stock. The shares of Series C preferred stock issued at the closing of the merger are convertible into 7,600,000 shares of our Class A common stock, subject to adjustment, and the Series C preferred stock issuable upon exercise of the Warrant is convertible into an additional 3,800,000 shares of our Class A common stock, subject to adjustment. To date, none of these warrants have been exercised.

 

In connection with the closing of the merger transaction, we also entered into a registration rights agreement with Infinity, pursuant to which, following a period of one year (or earlier if we take certain actions), Infinity may instruct us to file up to three registration statements, on a best efforts basis, with the Securities and Exchange Commission (SEC) providing for the registration for resale of the Class A common stock issuable upon conversion of the Series C preferred stock.

 

We are required to pay holders of Series C preferred stock dividends on parity with our Class A common stock and Class B common stock, and each other class or series of our capital stock, if created, after December 23, 2004.

 

 

The rights of the holders of shares of Class A common stock and Class B common stock are identical, except for voting rights and conversion provisions. The Class A common stock is entitled to one vote per share and the Class B common stock is entitled to ten votes per share. Holders of each class of common stock are entitled to receive dividends and, upon liquidation or dissolution, are entitled to receive all assets available for distribution to stockholders. The holders of each class have no preemptive or other subscription rights and there are no redemption or sinking fund provisions with respect to such shares. Each class of common stock is subordinate to our 103/4% Series B cumulative exchangeable redeemable preferred stock, par value $0.01 per share and liquidation preference of $1,000 per share (the “Series B preferred stock”) and on parity with the Series C preferred stock with respect to dividend rights and rights upon liquidation, winding up and dissolution of SBS.

 

 

In connection with the merger agreement with Infinity, as discussed in Note 3(a), we have a warrant outstanding to ultimately purchase an aggregate of 3,800,000 shares of our Class A common stock, which expires on December 23, 2008. In addition, all 700,000 warrants issued with the purchase of radio station KXOL-FM, serving our Los Angeles market, expired unexercised during the nine-months period ended September 30, 2006.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Background of the 2006 Omnibus Equity Compensation Plan

 

On July 16 2006, we adopted an omnibus equity compensation plan (the “Omnibus Plan”) in which grants can be made to participants in any of the following forms: (i) incentive stock options, (ii) nonqualified stock options, (iii) stock appreciation rights (“SARs”), (iv) stock units, (v) stock awards, (vi) dividend equivalents, and (vii) other stock-based awards. The Omnibus Plan authorizes up to 3,500,000 shares of our Class A common stock for issuance, subject to adjustment in certain circumstances. The Omnibus Plan provides that the maximum aggregate number of shares of Class A common stock that may be made with respect to grants, other than dividend equivalents, to any individual during any calendar year is 1,000,000 shares, subject to adjustments. In addition, the maximum aggregate number of shares of Class A common stock with respect to grants of stock units, stock awards and other stock-based awards that may be made to any individual during a calendar year is also 1,000,000 shares, subject to adjustments. As of September 30, 2006, we have not issued any grants under the Omnibus Plan.

 

Background of the 1999 Stock Option Plans

 

In September 1999, we adopted an employee incentive stock option plan (the “1999 ISO Plan”) and a non-employee director stock option plan (the “1999 NQ Plan”). Options granted under the 1999 ISO Plan will vest according to terms to be determined by the compensation committee of our board of directors, and will have a contractual life of up to 10 years from the date of grant. Options granted under the 1999 NQ Plan will vest 20% upon grant and 20% each year for the first four years from grant. All options granted under the 1999 ISO Plan and the 1999 NQ Plan vest immediately upon a change in control of SBS, as defined therein. A total of 3,000,000 shares and 300,000 shares of Class A common stock have been reserved for issuance under the 1999 ISO Plan and the 1999 NQ Plan, respectively. Additionally, on November 2, 1999, we granted a stock option to purchase 250,000 shares of Class A common stock to a former director. These options vested immediately, and expire 10 years from the date of grant.

 

Impact of the Adoption of SFAS No. 123(R) “Share-Based Payment”

 

We adopted SFAS No. 123(R) using the modified prospective transition method beginning January 1, 2006. Accordingly, during the nine-month period ended September 30, 2006, we recorded stock-based compensation expense for awards granted prior to, but not yet vested, as of January 1, 2006, as if the fair value method required for pro forma disclosure under SFAS No. 123 “Accounting for Stock-Based Compensation,” were in effect for expense recognition purposes, adjusted for estimated forfeitures. For stock-based awards granted after January 1, 2006, we have recognized compensation expense based on the estimated grant date fair value method using the Black-Scholes option pricing model. For these awards, we have recognized compensation expense using a straight-line amortization method (prorated). As SFAS No. 123(R)requires that stock-based compensation expense be based on awards that are ultimately expected to vest, stock-based compensation for the three- and nine-month periods ended September 30, 2006 have been reduced for estimated forfeitures. When estimating forfeitures, we consider voluntary termination behaviors as well as

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

trends of actual option forfeitures. The impact on our results of operations of recording stock-based compensation for the three- and nine-month periods ended September 30, 2006 was as follows (in thousands):

 

 

As of September 30, 2006, there was $2.5 million of total unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under all of our plans. The cost is expected to be recognized over a weighted-average period of approximately two years.

 

SFAS No. 123(R) requires cash flows resulting from excess tax benefits to be classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for exercised options in excess of the deferred tax asset attributable to stock compensation costs for such options. We did not receive any cash payments from option exercises for the three-and nine-month periods ended September 30, 2006. In addition, we did not recognize a tax benefit on our stock-based compensation expense due to our valuation allowance on substantially all of our deferred tax assets.

 

Valuation Assumptions

 

We calculated the fair value of each option award on the date of grant using the Black-Scholes option pricing model. The per share weighted-average fair value of stock options granted to employees during the three- and nine-month periods ended September 30, 2005 was $7.42 and $5.82, respectively. There have been no stock options granted for the three- and nine-month periods ended September 30, 2006. The following weighted average assumptions were used for each respective period:

 

 

Our computation of expected volatility for the three- and nine-month periods ended September 30, 2006 was based on a combination of historical and market-based implied volatility from traded options on our stock. Prior to 2006, our computation of expected volatility was based on historical volatility. Our computation of expected life in 2006, was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The range provided above results from the behavior patterns of separate groups of employees that have similar historical experience. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-Based Payment Award Activity

 

A summary of the status of our stock options, as of December 31, 2005 and September 30, 2006, and changes during the nine-months ended September 30, 2006, is presented below (in thousands, except per share data):

 

 

The following table summarizes information about stock options outstanding and exercisable at September 30, 2006 (in thousands, except per share data):

 

 

Pro forma Information for Periods Prior to the Adoption of SFAS 123(R)

 

Prior to the adoption of SFAS No. 123(R), we provided the disclosures required under SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosures.” Employee stock-based compensation expense recognized under SFAS No. 123(R) was not reflected in our results of operations for the three- and nine-month periods ended September 30, 2005 for employee stock option awards as all options were granted with an exercise price equal to the market value of the underlying common stock on the date of grant.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The pro forma information for the three- and nine-month periods ended September 30, 2005 was as follows (in thousands, except per share amounts):

 

 

 

Due to the recent commencement of our new television operation “MEGA TV”, we are now reporting two operating segments, radio and television.

 

Radio broadcasting.  We own and operate 20 radio stations located in some of the nation’s top Hispanic markets: Los Angeles, New York, Miami, Chicago, San Francisco and Puerto Rico.

 

Television broadcasting.  We own and operate two television stations, which operate as one television operation, branded “MEGA TV”, serving the South Florida market.

 

Separate financial data for each of our operating segments is provided below. We evaluate the performance of our operating segments, from a financial perspective, based on the following (in thousands):

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

From time to time we are involved in litigation incidental to the conduct of our business, such as contractual matters and employee-related matters. In the opinion of management, such litigation is not likely to have a material adverse effect on our business, operating results or financial position.

 

On December 5, 2003, Amigo Broadcasting, L.P. (“Amigo”) filed an original petition and application for temporary injunction in the District Court of Travis County, Texas (the “Court”), against us, Raul Bernal (“Bernal”) and Joaquin Garza (“Garza”), two of our former employees. Amigo filed a first and second amended petition and application for temporary injunction on June 25, 2004 and February 18, 2005, respectively. The second amended petition alleged that we (1) misappropriated Amigo’s proprietary interests by broadcasting the characters and concepts portrayed by the Bernal and Garza radio show (the “Property”),

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(2) wrongfully converted the Property to our own use and benefit, (3) induced Bernal and Garza to breach their employment agreements with Amigo, (4) used and continued to use Amigo’s confidential information and property with the intention of diverting profits from Amigo and of inducing Amigo’s potential customers to do business with us and our syndicators, (5) invaded Amigo’s privacy by misappropriating the names and likenesses of Bernal and Garza, and (6) committed violations of the Lanham Act by diluting and infringing on Amigo’s trademarks. Based on these claims, Amigo seeks damages in excess of $3.0 million.

 

On December 5, 2003, the Court issued a temporary injunction against all of the defendants and scheduled a hearing before the Court on December 17, 2003. The temporary injunction dissolved by its terms on December 1, 2004. On December 17, 2003, the parties entered into a settlement agreement, whereby the Court entered an Order on Consent of the settling parties, permitting Bernal and Garza’s radio show to be broadcast on our radio stations. In addition, we agreed that we would not broadcast the Bernal and Garza radio show in certain prohibited markets and that we would not distribute certain promotional materials that were developed by Amigo. On January 5, 2004, we answered the remaining claims asserted by Amigo for damages. On March 18, 2005, the case was removed to the United States District Court for the Western District of Texas (the “District Court”) and a trial date was scheduled for May 2006. On January 17, 2006, we filed a motion for summary judgment with the District Court. On March 2, 2006, the parties conducted mediation but were unable to reach a settlement. The case was thereafter tried before a jury the week of May 1, 2006. At the close of plaintiff’s evidence, defendants presented a motion for judgment as a matter of law and the motion was granted on all counts. The District Court entered judgment for the defendants, Garza, Bernal and us. On June 2, 2006, Plaintiff filed a notice of appeal to the Fifth Circuit Court of Appeals. The time for filing of their brief expires on December 12, 2006 and to date the brief has not been filed, so we are unable to identify the specific basis for the appeal. Based on the existing circumstances, we believe that it is unlikely that the appeal will result in a material adverse outcome to us.

 

 

On February 17, 2006, we repaid and terminated our second lien credit facility, dated as of June 10, 2005, among us, Merrill Lynch Pierce Fenner & Smith, Incorporated, Wachovia Bank, National Association, Lehman Commercial Paper Inc., and certain other lenders (the “Second Lien Credit Facility”). We used approximately $101.0 million of the net cash proceeds from the LA Asset Sale to pay the full amount owed under the Second Lien Credit Facility. Accordingly, we have no further obligations remaining under the Second Lien Credit Facility. As a result of the prepayment of the Second Lien Credit Facility, we recognized a loss on early extinguishment of debt related to the prepayment premium and the write-off of unamortized deferred financing costs of approximately $3.0 million during the nine-months ended September 30, 2006.

 

 

On March 1, 2006, our wholly-owned subsidiaries, Mega Media Holdings, Inc. (“Mega Media Holdings”) and WDLP Licensing, Inc. (“Mega-Sub,” and, together with Mega Media Holdings, “Mega Media”), completed the acquisition of certain assets, including licenses, permits and authorizations issued by the Federal Communications Commission (the “FCC”) used in or related to the operation of television stations WSBS-TV (Channel 22, formerly known as WDLP-TV), its derivative digital television station WSBS-DT (Channel 3, formerly known as WDLP-DT) in Key West, Florida and WSBS-CA (Channel 50, formerly known as WDLP- CA) in Miami, Florida, pursuant to that certain asset purchase agreement, dated as of July 12, 2005, as amended on September 19, 2005, October 19, 2005 and January 6, 2006, with WDLP Broadcasting Company, LLC, WDLP Licensed Subsidiary, LLC, Robin Broadcasting Company, LLC, and Robin Licensed Subsidiary, LLC (collectively, the “Sellers”). WSBS-TV-DT and WSBS-CA are operating as one television operation, branded as “MEGA TV”, serving the South Florida market. MEGA TV debuted on the air on March 1, 2006.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In connection with the closing, Mega Media paid an aggregate purchase price equal to $37.6 million, consisting of: (i) cash in the amount of $17.0 million; (ii) a thirty-four month, non-interest-bearing secured promissory note in the principal amount of $18.5 million (present valued at approximately $14.8 million at the closing), which we have guaranteed and is secured by the assets acquired in the transaction; (iii) deposits of $0.5 million and $1.0 million made on July 13, 2005 and January 6, 2006, respectively; and (iv) two extension payments of $0.3 million made on September 1, 2005 and January 6, 2006, respectively, in consideration for the extensions of the closing date.

 

In addition, as part of the television station acquisition, we entered into an advertising agreement with the Sellers that provides them with up to $2.0 million per year, for each of the three years from the date of closing, of commercial advertising time on any of our radio stations. Accordingly, we recognized this liability to provide commercial advertising as part of consideration given for the acquisition and recorded a liability (unearned revenue) of approximately $5.3 million at the closing, which represented the present value of the commercial advertising due.

 

 

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination based on the technical merits of the position. The second step is the measurement of any tax positions that meet the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. An enterprise that presents a classified statement of financial position should classify a liability for unrecognized tax benefits as current to the extent that the enterprise anticipates making a payment within one year or within the operating cycle. FIN 48 is effective for fiscal years beginning after December 15, 2006 or fiscal year 2007 for us. We are currently evaluating the impact that FIN 48 may have on our consolidated financial statements.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS No. 157) which defines fair value, establishes a framework for measuring fair value in GAAP, and enhances disclosures about fair value measurements. SFAS No. 157 applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 or fiscal year 2008 for us. We are currently evaluating the impact that SFAS No. 157 may have on our consolidated financial statements.

 

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108), which requires registrants to consider the effect of all carry over and reversing effects of prior-year misstatements when quantifying errors in current-year financial statements. SAB 108 requires that the registrant quantify the current year misstatement using both the iron curtain approach and the rollover approach to determine whether current-year financial statements need to be adjusted. SAB 108 allows registrants to record the effects of adopting SAB 108 as a cumulative-effect adjustment to retained earnings. This adjustment must be reported as of the beginning of the first fiscal year ending after November 15, 2006 or fiscal year 2006 for us. We are currently evaluating the impact that SAB 108 may have on our consolidated financial statements.

 

SPANISH BROADCASTING SYSTEM, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Our income tax expense differs from the statutory federal tax rate of 35% and related statutory state tax rates, primarily as a result of the application of SFAS 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). Under SFAS No. 142, the reversal of our deferred tax liabilities related to our intangible assets could no longer be assured over our net operating loss carry forward period. Therefore, our effective book tax rate is impacted by establishing a valuation allowance on substantially all of our deferred tax assets.

 

 

Our total comprehensive income (loss) comprised of net income and unrealized gain on derivative instrument, for the three- and nine-months ended September 30, 2006 was as follows (in thousands):

 

 

 

On October 25, 2006 we entered into a definitive Purchase and Sale Agreement, dated August 24, 2006, as amended on September 25, 2006, as further amended on October 25, 2006 (the “Purchase Agreement”), on real property located in Miami, Florida. The real property consists of approximately 5.51 acres with approximately 62,000 square feet of office space (the “Property”). The Property is being acquired from 7007 Palmetto Investments, LLC (“Seller”), an unrelated third party, for $8,830,000, plus broker’s fees for a total of approximately $9,350,000, subject to adjustments at closing.

 

On August 24, 2006, upon execution of the Purchase Agreement, we made a $100,000 refundable deposit in escrow for the transaction. On October 25, 2006, pursuant to the terms of the Purchase Agreement, we made an additional deposit of $935,000 in escrow that together with the initial $100,000 deposit will be released to Seller at closing. The closing of the Property is expected to occur in the first quarter of 2007 and is subject to customary closing conditions. We expect to finance the purchase price through a combination of cash on hand and outside financing.

 

Upon closing, we will consolidate our radio and television operations in the building. The land acquired with the building will allow for expansion, if needed, for future operations. We are currently in negotiations for the release of the leased space currently occupied by the television operations located at 2601 South Bayshore Drive, Coconut Grove, Florida, where we rent executive offices in a building indirectly owned by Raúl Alarcón, Jr. (our Chairman of the Board, Chief Executive Officer and President) and for the release of the leased studios and offices of our Miami radio stations currently located in leased facilities, which are indirectly owned by Raúl Alarcón, Jr. and Pablo Raúl Alarcón, Sr. (our Chairman Emeritus and Director).

 

In accordance with the terms of the Purchase Agreement, we assigned the Purchase Agreement to a newly created wholly owned subsidiary, SBS Miami Broadcast Center, Inc. (“SBS Miami Broadcast Center”), pursuant to an Assignment and Assumption Agreement, dated October 25, 2006. Simultaneously with the entering into the Assignment and Assumption Agreement, SBS Miami Broadcast Center entered into a triple net lease agreement (the “Lease”) with Seller for the office space of approximately 62,000 square feet at a base rent of $5,166 per month, plus applicable taxes and insurance. The Lease commenced on October 25, 2006, with a rent commencement date of November 25, 2006, and terminates on the closing of the Property or the date of earlier termination if terminated pursuant to the terms of the Lease or the Purchase Agreement.

 

Overview

 

We are the largest publicly traded Hispanic-controlled media and entertainment company in the United States. We own and operate 20 radio stations in markets that reach approximately 49% of the U.S. Hispanic population, and two television stations, which are expected to reach approximately 1.5 million households in the South Florida market. Our radio stations are located in six of the top-ten Hispanic markets of Los Angeles, New York, Puerto Rico, Chicago, Miami and San Francisco. Los Angeles and New York have the largest and second largest Hispanic populations, and are also the largest and second largest radio markets in the United States in terms of advertising revenue, respectively. Our two television stations operate as one television operation, branded “MEGA TV”. We also occasionally produce live concerts and events throughout the United States and Puerto Rico. In addition, we operate LaMusica.com, a bilingual Spanish-English website providing content related to Latin music, entertainment, news and culture.

 

On March 1, 2006, we acquired television stations WSBS-TV (Channel 22, formerly known as WDLP-TV) and its derivative digital television station WSBS-DT (Channel 3, formerly known as WDLP-DT) in Key West, Florida and WSBS-CA (Channel 50, formerly known as WDLP-CA) in Miami, Florida, serving the South Florida market. On March 1, 2006, we also launched MEGA TV, our general interest Spanish-language television operation. We intend to design our television programming to meet a broad range of preferences of the U.S. Hispanic market, directed primarily at the 18-to-49 year old age bracket. We plan to develop approximately 60% of our programming and expect to commission other content from Spanish-language production partners. The channel currently features televised versions of our Miami top-rated radio shows, debate shows, dance and music contests, reality and entertainment shows, game shows and paid programming. We anticipate that television revenue will be generated primarily from the sale of local and national market advertising.

 

The success of each of our stations depends significantly upon its audience ratings and share of the overall advertising revenue within its market. The broadcasting industry is a highly competitive business, but some barriers to entry do exist. Each of our stations competes with both Spanish-language and English-language stations in its market, as well as with other advertising media, such as newspapers, cable television, the Internet, magazines, outdoor advertising, satellite radio, transit advertising and direct mail marketing. Factors which are material to our competitive position include management experience, our stations’ rank in their markets, signal strength and frequency, and audience demographics, including the nature of the Spanish-language market targeted by a particular station.

 

Our primary source of revenue is the sale of advertising time on our stations to local and national advertisers. Our revenue is affected primarily by the advertising rates that our stations are able to charge, as well as the overall demand for advertising time in each respective market. Seasonal net broadcasting revenue fluctuations are common in the broadcasting industry and are primarily due to fluctuations in advertising demand from local and national advertisers. Typically for the broadcasting industry, the first calendar quarter generally produces the lowest revenue. Our most significant operating expenses are compensation expenses, programming expenses, professional fees and advertising and promotional expenses. Our senior management strives to control these expenses, as well as other expenses, by working closely with local station management and others, including vendors.

 

Comparison Analysis of the Operating Results for the Three-Months Ended September 30, 2006 and 2005

 

Due to the recent commencement of our television operation, we are now reporting two operating segments, radio and television. The following summary table presents separate financial data for each of our operating segments for the three-month periods ended September 30, 2006 and 2005.