NOTE 2. IMPAIRMENT OF GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS

We account for goodwill and other indefinite-lived intangible assets in accordance with FASB ASC Topic 350 “Intangibles—Goodwill and Other.” We do not amortize goodwill or other indefinite-lived intangible assets, but rather test for impairment annually or more frequently if events or circumstances indicate that an asset may be impaired.

Approximately 71% of our total assets as of December 31, 2012, consist of indefinite-lived intangible assets, such as broadcast licenses, goodwill and mastheads, the value of which depends significantly upon the operating results of our businesses. In the case of our radio stations, we would not be able to operate the properties without the related FCC license for each property. Broadcast licenses are renewed with the FCC every eight years for a nominal cost that is expensed as incurred. We continually monitor our stations’ compliance with the various regulatory requirements. Historically, all of our broadcast licenses are renewed at the end of their respective periods, and we expect that all broadcast licenses will continue to be renewed in the future. Accordingly, we consider our broadcast licenses to be indefinite-lived intangible assets in accordance with FASB ASC Topic 350, “Intangibles – Goodwill and Other.” Broadcast licenses account for approximately 94% of our indefinite-lived intangible assets. Goodwill and magazine mastheads account for the remaining 6%. We do not amortize goodwill or other indefinite-lived intangible assets, but rather test for impairment at least annually or more frequently if events or circumstances indicate that an asset may be impaired.

We complete our annual impairment tests in the fourth quarter of each year. We believe that our estimate of the value of our broadcast licenses, mastheads, and goodwill is a critical accounting estimate as the value is significant in relation to our total assets, and our estimates incorporate variables and assumptions that are based on experiences and judgment about future operating performance of our markets and business segments. The fair value measurements for our indefinite-lived intangible assets use significant unobservable inputs that reflect our own assumptions about the estimates that market participants would use in measuring fair value including assumptions about risk. The unobservable inputs are defined in FASB ASC Topic 820 “Fair Value Measurements and Disclosures” as Level 3 inputs discussed in detail in Note 7 to our Consolidated Financial Statements.

Broadcast Licenses

The unit of accounting we use to test broadcast licenses is the cluster level, which we define as a group of radio stations operating in the same geographic market, sharing the same building and equipment and managed by a single general manager. The cluster level is the lowest level for which discrete financial information and cash flows are available and the level reviewed by management to analyze operating results.

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350).” Under ASU 2012-02, we have the option to assess whether it is more likely than not that an indefinite-lived intangible asset is impaired. If it is more likely than not that impairment exists, we are required to perform a quantitative analysis to estimate the fair value of the assets. The qualitative assessment requires significant judgment in considering events and circumstances that may affect the estimated fair value of our broadcast licenses and to weigh the events and circumstances by what we believe to be the strongest to weakest indicator of potential impairment. ASU 2012-02 is effective for annual and interim impairment tests for fiscal years beginning after September 15, 2012, with early adoption permitted. We adopted the provisions of ASU 2012-02 as of our 2012 annual testing period. During 2011 and prior years, we applied the start-up income approach to estimate the fair value of each of our broadcast licenses.

We reviewed the significant assumptions in our most recent fair value estimates that were completed during our annual testing period ending December 31, 2011. Our review included an assessment to determine if events and circumstances have occurred that could affect the significant inputs used in these fair value estimates. Our 2011 fair value calculations were prepared using the start-up income approach to estimate the fair value of the broadcast license. The start-up-income approach measures the expected future economic benefits that the broadcast licenses provide and discounts these future benefits using a discounted cash flow analysis. The discounted cash flow analysis assumes that the broadcast licenses hypothetical start-up stations and the values yielded by the discounted cash flow analysis represent the portion of the stations value attributable solely to the broadcast license. The discounted cash flow model incorporates variables such as projected revenues, operating profit margins, forecasted growth rates, estimated start-up costs, losses expected to be incurred in the early years, competition within the market, the effective tax rate, future terminal values and the risk-adjusted discount rate. The variables used reflect historical company growth trends, industry projections, and the anticipated performance of the business. The discounted cash flow projection period was determined to be ten years; which is typically the time radio station operators and investors expect to recover their investments as widely used by industry analysts in their forecasts.

The key estimates and assumptions used in the start-up income valuation for all of our broadcast licenses were as follows:

We reviewed each of the key estimates and assumptions and determined that there have been no significant changes that would need to be applied to a hypothetical start-up station in order to estimate the fair value. Projected revenues, operating profit margins, forecasted growth rates, estimated start-up costs, losses expected to be incurred in the early years, competition within the market, the effective tax rate, future terminal values and the risk-adjusted discount rate are consistent with those applied in the 2011 testing period. We also reviewed internal benchmarks and economic performance for each of our markets to conclude that we could reasonably rely upon the 2011 fair value estimates and assumptions as a starting point to our qualitative analysis.

We calculated the amount by which the 2011 estimated fair values exceeded our carrying amounts to calculate the excess of fair value. We concluded that markets with broadcast licenses with a 25% or more excess of the estimated fair value over the carrying value were not likely to be impaired. We believe based on our analysis and review, including the financial performance of each market, that a 25% excess fair value margin is conservative and reasonable in the qualitative analysis.

The tables below present the percentage within a range by which the estimated fair value exceeded the carrying value of our broadcasting licenses for each of our clusters:

We considered the 12 markets with an excess fair value that was less than 25% of the carrying values to be more likely than not impaired. For these markets, we engaged Bond & Pecaro, an independent third-party appraisal and valuation firm to perform a quantitative appraisal of our broadcast licenses. Bond & Pecaro utilized the start-up income approach to value broadcast licenses. The key estimates and assumptions used in the Bond & Pecaro start-up income valuation for these selected markets were as follows:

The table below presents the results of our quantitative analysis for the annual testing period ending December 31, 2012:

Based on our review and analysis we determined that no impairment charges were necessary to the carrying value of our broadcast licenses as of the annual testing periods ending December 31, 2012. Based on prior tests, we determined that no impairments of our broadcast licenses were necessary for years ending December 31, 2011 or 2010, respectively.

Mastheads

Mastheads consist of the graphic elements that identify our publications to readers and advertisers. These include customized typeset page headers, section headers, and column graphics as well as other name and identity stylized elements within the body of each publication. We test the value of mastheads as a single combined publishing entity as our print magazines operate from one shared facility under one general manager with operating results and cash flows reported on a combined basis for all publications.

Based on actual operating results as of our year end testing period that did not meet or exceed our expectations, we performed a quantitative review of mastheads as of our annual testing period ending December 31, 2012. We had also performed an interim valuation of mastheads as of June 30, 2012 in which our excess fair value was estimated to be only 1.7%. We engaged Bond & Pecaro, an independent third-party appraisal firm, to perform an income-based approach to determine the estimated fair value of our mastheads. The income approach is based upon an estimated royalty stream that measures a cost savings to the business because it does not have to pay a royalty to use the owned trade name and content. The analysis assumes that the assets are employed by a typical market participant in their highest and best use. Under the income approach, we utilize a discounted cash flow method to calculate the estimated fair value of our mastheads, the key estimates and assumptions to which are as follows:

We recognized an impairment charge of $0.1 million associated with the value of mastheads in our publishing segment as of the annual testing period ending December 31, 2012. This impairment was driven by a reduction in projected net revenues resulting from ongoing operating results that have not met expectations. The impairment was indicative of trends in the publishing industry as a whole and is not unique to our company or operations.

Goodwill - Broadcast

During 2012, we adopted ASU 2011-08, “Testing Goodwill for Impairment.” As a result, beginning in 2012, the first step of the impairment tests for goodwill is a thorough assessment of qualitative factors to determine if events or circumstances indicate that it is not more likely than not that the fair value of these assets is less than their carrying amounts. If the qualitative test indicates it is not more likely than not that the fair value of these assets is less than their carrying amounts, a quantitative assessment is not required. The unit of accounting used to test broadcast licenses is the cluster level, which we define as a group of radio stations operating in the same geographic market, sharing the same building and equipment and managed by a single general manager. Nine of our 31 market clusters and our networks have goodwill associated with them as of our annual testing period ending December 31, 2012.

The first step of our review included an assessment to determine if events and circumstances have occurred that could affect the significant inputs used in our fair value estimates. We estimated fair values using a market and income approach and compared the estimated fair value of each cluster to its carrying value including goodwill. Using a market approach, we applied a multiple of four to each clusters’ station operating income (“SOI”) to calculate the estimated fair value. Radio stations are often sold on the basis of a multiple of projected cash flow, or SOI. Numerous trade organizations and analysts track these radio transactions. Based on reports and analysis of these transactions, we believe industry benchmarks to be in the six to seven times cash flow range. Based our analysis, we determined that an SOI benchmark of four would be a conservative indicator of fair value. Under the income approach, we utilized a discounted cash flow method to calculate the estimated fair value of the accounting unit. The discounted cash flow method incorporates the cumulative present value of the net after-tax cash flows projected for each market assuming that it is a hypothetical start-up station. The key estimates and assumptions used in the start-up income valuation of our broadcast markets for each testing period are as follows:

If the carrying amount, including goodwill, exceeds the estimated fair value of the cluster, an indication exists that the amount of goodwill attributed to that cluster may be impaired. When we have indication of impairment, we perform a second step to determine the amount of any impairment. We engaged Bond & Pecaro, an independent third-party appraisal and valuation firm, to determine the enterprise value of three of our markets in a manner similar to a purchase price allocation. The enterprise valuation assumes that the subject assets are installed as part of an operating business rather than as a hypothetical start-up. The key estimates and assumptions used for our enterprise valuations are as follows:

Based on our review and analysis we determined that no broadcast goodwill impairment charges were necessary as of the annual testing periods ending December 31, 2012, 2011 and 2010. The estimated fair value of our networks exceeded the carrying value by 120.0%, 101.6%, and 98.6% for each of the annual testing periods ending December 31, 2012, 2011 and 2010, respectively.

The tables below present the percentage within a range by which the enterprise value exceeded the carrying value of each of our clusters, including goodwill:

Goodwill – Internet & Publishing

During 2012, we adopted ASU 2011-08, “Testing Goodwill for Impairment.” As a result, beginning in 2012, the first step of the impairment tests for goodwill is a thorough assessment of qualitative factors to determine if events or circumstances indicate that it is not more likely than not that the fair value of these assets is less than their carrying amounts. If the qualitative test indicates it is not more likely than not that the fair value of these assets is less than their carrying amounts, a quantitative assessment is not required. The units of accounting we use to test goodwill in our Internet business include Townhall.com and Salem Web Network. The operating results for Salem Web Network reflect the operating results and cash flows for all of our Internet sites exclusive of Townhall.com. We also separate our publishing business into two accounting units. The first publishing accounting unit is the magazine unit, which operates and produces all publications from a stand-alone facility, under one general manager, with operating results and cash flows of all publications reported on a combined basis. The second accounting unit is our book publishing division, Xulon Press, which also operates from a stand-alone facility, under one general manager who is responsible for the separately stated operating results and cash flows. Four of these accounting units have goodwill associated with them as our annual testing period.

We applied a market approach to estimate the fair value of each or our accounting units. Under the market approach, we applied a multiple of four to each accounting units’ operating income to estimate the fair value. We believe that a multiple of four is a conservative benchmark based on actual industry transactions. The first step of our review compared the estimated fair value of each accounting unit to its carrying value including goodwill. If the carrying amount, including goodwill, exceeded the estimated fair value of the unit, an indication exists that the amount of goodwill attributed to that unit may be impaired. When we have indication of impairment, we performed a second step to determine the amount of any impairment. We engaged Bond & Pecaro, an independent third-party appraisal and valuation firm, to determine the enterprise value of one of our accounting units in a manner similar to a purchase price allocation. The enterprise valuation assumes that the subject assets are installed as part of an operating business rather than as a hypothetical start-up. The key estimates and assumptions used for our enterprise valuations are as follows:

The key assumptions in our third-party enterprise valuation varied from the testing period ending December 31, 2011 to the testing period ending December 31, 2010 due to the accounting units for which the enterprise valuations were performed. Due to the nature of the business, publishing varies greatly from our print magazines to our online print-on demand digital book publisher and our Internet businesses. The key estimates for 2012 include the ranges applicable to both publishing and our Internet businesses.

Based on our review and analysis we determined that no impairment charges were necessary as of the annual testing periods ending December 31, 2012, 2011 and 2010. The table below presents the percentage within a range by which the enterprise value exceeded the carrying value of our accounting units, including goodwill.

We believe we have made reasonable estimates and assumptions to calculate the estimated fair value of our indefinite-lived intangible assets, however, these estimates and assumptions could be materially different from actual results. If actual market conditions are less favorable than those projected by the industry or by us, or if events occur or circumstances change that would reduce the estimated fair value of our indefinite-lived intangible assets below the amounts reflected on our balance sheet, we may recognize future impairment charges, the amount of which may be material.