Salem Media Group, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

IMPAIRMENT OF GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS

IMPAIRMENT OF GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS

12 Months Ended

Dec. 31, 2016

Goodwill and Intangible Assets Disclosure [Abstract]

IMPAIRMENT OF GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS

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 “IntangiblesGoodwill and Other that requires that we test for impairment at least annually or when events or circumstances indicates that they may be impaired. We do not amortize broadcast licenses, but rather test for impairment annually or more frequently if events or circumstances indicate that the value may be impaired. We perform our annual impairment testing during the fourth quarter of each year, which coincides with our budget and planning process for the upcoming year.

Broadcast Licenses

We perform a qualitative assessment for each of our broadcast market clusters annually. We review the significant assumptions and key estimates applicable to our prior year estimated fair value calculations to assess if events and circumstances have occurred that could affect these assumptions and key estimates. We also review internal benchmarks and the economic performance for each market cluster to assess if it is more likely than not that impairment exists.

The first step of our qualitative assessment is to calculate excess fair value, or the amount by which our prior year estimated fair value exceeds the current year carrying value. We believe based on our analysis and review, including the financial performance of each market, that a 25% excess fair value margin is a conservative and reasonable benchmark for our qualitative analysis. Markets with an excess fair value of 25% or more, which have had no significant changes in the prior year assumptions and key estimates, are not likely to be impaired.

Of the eleven markets for which an independent third party fair value appraisal was obtained in the prior year, three markets were subject to testing in the current year. The table below presents the percentage within a range by which our prior year start-up income estimated fair value exceeds the current year carrying value of our broadcasting licenses:

	Geographic Market Clusters as of December 31, 2016
	Percentage Range By Which 2015 Estimated Fair Value Exceeds 2016 Carrying Value
	≤ 25%		>26%-50%		>50% to 75%		> than 75%
Number of accounting units	3		4		1		3
Broadcast license carrying value (in thousands)	$	108,374	$	49,738	$	27,878	$	15,650

We performed a quantitative analysis for 22 of our market clusters for which we did not obtain an independent third party fair value appraisal during our prior year annual testing period and 1 newly acquired market for which the fair value had been previously estimated as of the acquisition date during the prior year.

The second step of our qualitative assessment consists of a review of the financial operating results for each market cluster. Radio stations are often sold on the basis of a multiple of projected cash flow, or Station Operating Income (“SOI”) defined as net broadcast revenue less broadcast operating expenses. See Item 6 Selected Financial Data within this annual report for information on SOI, a non-GAAP measure. Numerous trade organizations and analysts review these radio station sales to track SOI multiples applicable to each transaction. Based on published reports and analysis of market transactions, we believe industry benchmarks to be in the six to seven times cash flow range. We elected an SOI benchmark of four as a conservative indicator of fair value. Using an SOI multiple to estimate fair value, we did not identify additional markets for further testing.

The table below shows the percentage within a range by which our estimated fair value exceeded the carrying value of our broadcasting licenses for these twenty three market clusters:

	Geographic Market Clusters as of December 31, 2016
	Tested due to length of time from prior valuation Percentage Range by Which Prior Valuation Exceeds 2016 Carrying Value
	≤ 25%		>26%-50%		>50% to 100%		> than 100%
Number of accounting units	13		4		2		4
Broadcast license carrying value (in thousands)	$	166,107	$	10,635	$	9,904	$	6,771

We engaged Noble Financial, an independent third-party appraisal and valuation firm, to assist us in estimating the fair value of broadcast licenses in 25 of our market clusters. The estimated fair value of each market cluster was determined using the Greenfield Method, a form of the income approach. The premise of the Greenfield Method is that the value of an FCC license is equivalent to a hypothetical start-up in which the only asset owned by the station as of the valuation date is the FCC license. This approach eliminates factors that are unique to the operation of the station, including its format and historical financial performance. The method then assumes the entity has to purchase, build, or rent all of the other assets needed to operate a comparable station to the one in which the FCC license is being utilized as of the valuation date. Cash flows are estimated and netted against all start-up costs, expenses and investments necessary to achieve a normalized and mature state of operations, thus reflecting only the cash flows directly attributable to the FCC License. A multi-year discounted cash flow approach is then used to determine the net present value of these cash flows to derive an indication of fair value. For cash flows beyond the projection period, a terminal value is calculated using the Gordon constant growth model and long-term industry growth rate assumptions based on long-term industry growth and Gross Domestic Product (“GDP”) inflation rates.

The primary assumptions used in the Greenfield Method are:

(1)

gross operating revenue in the station’s designated market area,

(2)

normalized market share,

(3)

normalized profit margin,

(4)

duration of the “ramp-up” period to reach normalized operations, (which was assumed to be three years),

(5)

estimated start-up costs (based on market size),

(6)

ongoing replacement costs of fixed assets and working capital,

(7)

the calculations of yearly net free cash flows to invested capital; and

(8)

amortization of the intangible asset, the FCC license.

The assumptions used reflect those of a hypothetical market participant and not necessarily the actual or projected results of Salem. The key estimates and assumptions used in the start-up income valuation for our broadcast licenses were as follows:

Broadcast Licenses	December 31, 2014	December 31, 2015	December 31, 2016
Risk-adjusted discount rate	8.0%	8.0%	8.5%
Operating profit margin ranges	(13.9%) - 30.8%	(13.9%) - 30.8%	(13.9%) - 30.8%
Long-term market revenue growth rate ranges	1.5% - 2.5%	2.0%	1.9%

The risk-adjusted discount rate reflects the Weighted Average Cost of Capital (“WACC”) developed based on data from same or similar industry participants and publicly available market data as of the measurement date. The increase in the WACC for the 2016 testing period as compared to 2015 was largely attributable to increases in corporate borrowing interest rates during 2016 within the composite mix of industry participants considered in the analysis.

Based on our review and analysis, we determined that the carrying value of broadcast licenses in four of our market clusters were deemed to be impaired as of the annual testing period ending December 31, 2016. We recorded an impairment charge of $6.5 million to the value of broadcast licenses in Cleveland, Dallas-Ft Worth, Detroit and Portland. There were no impairment charges during the testing periods ending December 31, 2015 or 2014. The impairment charge was driven by an increase in the WACC during the year ended December 31, 2016 as compared to the prior year. We believe that these trends are indicative of trends in the industry as a whole and not unique to our company or operations.

The table below presents the results of our impairment testing under the income approach for the 2016 annual testing period. Markets with a negative excess fair value were impaired as of the balance sheet date with corresponding adjustments to the FCC license value recorded.

Market Cluster		Excess Fair Value 2016 Estimate
Atlanta, GA		6.6%
Cleveland, OH		(6.4%)
Columbus, OH		47.1%
Dallas, TX		(1.0%)
Denver, CO		765.2
Detroit, MI		(3.3%)
Honolulu, HI		146.40%
Houston, TX		1,103.4%
Little Rock		345.4%
Los Angeles, CA		390.7%
Louisville, KY		14.6%
Miami FL		29.1%
Nashville, TN		193.0%

New York, NY		466.5%
Omaha NE		22.5%
Philadelphia, PA		86.3%
Phoenix, AZ		83.4%
Pittsburgh, PA		348.4%
Portland, OR		(9.6%)
San Antonio, TX		257.2%
San Diego, CA		37.8%
San Francisco, CA		21.8%
Seattle, WA		309.6%
St Louis		261.2%
Washington, D.C.		107.2%

Mastheads

We regularly perform quantitative reviews of our mastheads due to the low margin by which our estimated fair values have exceeded our carrying value, and ongoing operating results that have not met or exceeded our expectations. We engaged Noble Financial, an independent third-party appraisal firm, to assist us in estimating the fair value of our mastheads using a Relief from Royalty method, a form of the income approach.

The Relief from Royalty method estimates the fair value of mastheads through use of a discounted cash flow model that incorporates a hypothetical “royalty rate” that a third-party owner would be willing to pay in lieu of owning the asset. The royalty rate is based on observed royalty rates for comparable assets as of the measurement date. We adjust the selected royalty rate to account for a percentage of the royalty fee that could be attributed to the use of other intangibles, such as goodwill, time in existence, trade secrets and industry expertise. The adjusted royalty rate represents the royalty fee remaining that could be attributed to the use of the masthead only.

Pre-tax royalty income is based on a 10-year revenue forecast and assumed to carry on into perpetuity. Revenue beyond the projection period (terminal year) is based on estimated long-term industry growth rates. The analysis also incorporated the present value of the tax amortization benefit associated with the mastheads. The key estimates and assumptions are as follows:

Mastheads	December 31, 2014	December 31, 2015	December 31, 2016
Risk-adjusted discount rate	8.0%	8.0%	9.5%
Projected revenue growth ranges	(4.8%) 1.4%	2.1% 2.9%	(4.3%) 1.2%
Royalty rate	3.0%	3.0%	3.0%

The risk-adjusted discount rate reflects the WACC developed based on data from same or similar industry participants and publicly available market data as of the measurement date. The increase in the WACC for the 2016 testing period as compared to 2015 was largely attributable to increases in corporate borrowing interest rates during 2016 within the composite mix of industry participants considered in the analysis.

Based on our review and analysis as of the December 2016 annual testing period, we recorded an impairment charge of $0.5 million associated with the carrying value of mastheads. This impairment was driven by an increase in the WACC associated with the print magazine publishing business and declines in our forecasted revenue growth rates based on a continual erosion of operating results. The print magazine industry as a whole is impacted by the growth of digital-only publications, which are often free to readers or available at a significantly reduced cost to readers. We believe that the impairment is indicative of trends in the magazine publishing industry as a whole and is not unique to our company or publications.

Goodwill Broadcast Radio Stations

Nineteen of our broadcast markets had goodwill associated with them as of December 31, 2016. Based on our review, we tested eight of these market clusters for impairment of goodwill during the annual testing period ending December 31, 2016. We engaged Noble Financial, an independent third-party appraisal firm, to assist us in estimating the enterprise of value our market clusters for the purpose of testing goodwill for impairment.

The key estimates and assumptions used for our enterprise valuations are as follows:

	December 31, 2014	December 31, 2015	December 31, 2016
Enterprise Valuations	Broadcast Markets	Broadcast Markets	Broadcast Markets
Risk-adjusted discount rate	8.0%	8.0%	8.5%
Operating profit margin ranges	8.4% - 46.1%	49.7%	(18.5%) 43.3%
Long-term revenue market growth rate ranges	1.0% - 5.0%	2.0%	1.9%

Based on our review and analysis, we determined that no impairment charges were necessary to the carrying value of our broadcast market goodwill as of the annual testing period ending December 31, 2016, December 31, 2015, and December 31, 2014, respectively and that Step 2 was not necessary.

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

	Broadcast Market Clusters as of December 31, 2016
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%		>20% to 50%		> than 50%

Number of accounting units	3		3		6		7
Carrying value including goodwill (in thousands)		93,978	$	27,714	$	124,464	$	71,270

	Broadcast Market Clusters as of December 31, 2015
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%		>20% to 50%		> than 50%

Number of accounting units	3		3		2		11
Carrying value including goodwill (in thousands)	$	56,179	$	52,164	$	37,570	$	169,907

	Broadcast Market Clusters as of December 31, 2014
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%		>20% to 50%		> than 50%

Number of accounting units	5		---		2		7
Carrying value including goodwill (in thousands)	$	81,507	$	---	$	27,636	$	84,693

Goodwill Broadcast Networks

TCM, one of our five networks has goodwill associated with it as of our annual testing period ending December 31, 2016. We identified operating losses within TCM that indicated that the value of goodwill may be impaired. We engaged Noble Financial, an independent third-party appraisal firm, to assist us in estimating the enterprise of value our networks for the purpose of testing goodwill for impairment.

The key estimates and assumptions used for our enterprise valuations for each period tested are as follows:

	December 31, 2015	December 31, 2016
Enterprise Valuations	Broadcast Networks	Broadcast Networks
Risk-adjusted discount rate	9.0%	9.5%
Operating profit margin ranges	(74.1) (97.5%)	1.0% 24.4%
Long-term revenue market growth rates	2.0%	1.9%

Based on this review and analysis, we determined that the fair value of the reporting unit was more than the carrying value. No impairment charges were recorded and Step 2 was not necessary based on the results. We did not perform a sensitivity analysis for the current year certain key assumptions, as such changes in assumptions would have no impact on the carrying value of goodwill associated with our broadcast networks.

Goodwill Digital Media

Five of our digital media businesses had goodwill associated with them as of our annual testing period ending December 31, 2016. We tested two of these entities for impairment based on an excess carrying value of less than 25%. The key estimates and assumptions used in the valuation of our digital media entities for each testing period are as follows:

Enterprise Valuation	December 31, 2014	December 31, 2015	December 31, 2016
Risk adjusted discount rate	8.0%	8.0% - 9.0%	8.5% - 9.5%
Operating profit margin ranges	(7.4%) - 34.9%	(8.9%) - 13.8%	(20.3%) - 8.2%
Long-term revenue market growth rate ranges	2.50%	2.0 - 3.0%	1.9% - 2.5%

The risk-adjusted discount rate reflects the WACC developed based on data from same or similar industry participants and publicly available market data as of the measurement date. The increase in the WACC for the 2016 testing period as compared to 2015 was largely attributable to increases in the risk free rate and corporate borrowing interest rates during 2016 as compared to the prior year.

We engaged Noble Financial, an independent third-party appraisal firm, to assist us in estimating the enterprise of value these digital media businesses for the purpose of testing goodwill for impairment. Based on our review and analysis, we determined that the carrying value of our wellness business exceeded its fair value and Step 2 was necessary. Under Step 2, the implied fair value of the reporting unit, including goodwill, was estimated to determine the amount of the impairment. We recorded an impairment charge of $32,000 to the carrying value of goodwill and an impairment charge of approximately $8,000 to amortizable intangible assets. These impairment charges resulted from reductions in revenue forecasts for this business unit due to actual operating results to date that have not met expectations.

The table below presents the percentage within a range by which the estimated fair value exceeded the carrying value of our accounting units, including goodwill.

	Digital Media Entities as of December 31, 2016
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%		>20% to 50%		> than 50%

Number of accounting units	2		1		1		1
Carrying value including goodwill (in thousands)	$	811	$	3,910	$	28,285	$	941

	Digital Media Entities as of December 31, 2015
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%		>20% to 50%		> than 50%

Number of accounting units	1		-				4
Carrying value including goodwill (in thousands)	$	4,488	$	-	$		$	29,126

	Digital Media Entities as of December 31, 2014
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%		>20% to 50%		> than 50%

Number of accounting units	1		1		1		1
Carrying value including goodwill (in thousands)	$	4,649	$	6,118	$	385	$	26,101

Goodwill Publishing

Two of our publishing entities had goodwill associated with them as of the annual testing period ending December 31, 2016. Based on actual operating results that did not meet our annual projections, we engaged Noble Financial, an independent third-party appraisal firm to assist us with estimating the enterprise value of one of these entities for the purpose of testing goodwill for impairment. 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:

Enterprise Valuation	December 31, 2014	December 31, 2014	December 31, 2016
Risk adjusted discount rate	8.0%	8.0%	8.5%
Operating margin ranges	2.4% - 5.9%	4.2% 6.2%	3.5% 5.7%
Long-term revenue market growth rates	1.5%	2.0%	1.9%

Based on our review and analysis of the enterprise estimated fair value, we determined that no impairment charges were necessary to the carrying value of goodwill associated with our publishing entities as of the annual testing period ending December 31, 2016 and that Step 2 was not necessary.

The table below presents the percentage within a range by which the estimated fair value exceeded the carrying value of our accounting units, including goodwill.

Publishing Accounting units as of December 31, 2016

Percentage Range By Which Estimated Fair Value Exceeds Carrying
Value Including Goodwill

< 10%

>10% to 20%

>20% to 50%

> than 50%

Number of accounting units

Carrying value including goodwill (in thousands)

1,360

	Publishing Accounting units as of December 31, 2015
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%	>20% to 50%	> than 50%

Number of accounting units		1				1
Carrying value including goodwill (in thousands)	$	854	$	$	$	2,453

	Publishing Accounting units as of December 31, 2014
	Percentage Range By Which Estimated Fair Value Exceeds Carrying Value Including Goodwill
	< 10%		>10% to 20%	>20% to 50%	> than 50%

Number of accounting units		2				1
Carrying value including goodwill (in thousands)	$	3,417	$	$	$	2,314

We believe that we have made reasonable estimates and assumptions to calculate the estimated fair value of our indefinite-lived intangible assets, however, these estimates and assumptions are highly judgmental in nature. Actual results can be materially different from estimates and assumptions. 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.