Outdoor Channel Holdings 10-Q 2007
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the transition period from to
Commission file number: 000-17287
Outdoor Channel Holdings, Inc.
(Exact name of Registrant as specified in its charter)
43445 Business Park Drive, Suite 103
Temecula, California 92590
(Address and zip code of principal executive offices)
(Issuers 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. x Yes o No
Indicate by 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. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:
OUTDOOR CHANNEL HOLDINGS, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
For The Period Ended March 31, 2007
Table of Contents
* * *
OUTDOOR CHANNEL HOLDINGS, INC. AND SUBSIDIARIES
(In thousands, except per share data)
See Notes to Unaudited Condensed Consolidated Financial Statements.
OUTDOOR CHANNEL HOLDINGS, INC. AND SUBSIDIARIES
(In thousands, except per share data)
See Notes to Unaudited Condensed Consolidated Financial Statements.
OUTDOOR CHANNEL HOLDINGS, INC. AND SUBSIDIARIES
For the Three Months Ended March 31, 2007
See notes to unaudited condensed consolidated financial statements.
OUTDOOR CHANNEL HOLDINGS, INC. AND SUBSIDIARIES
See Notes to Unaudited Condensed Consolidated Financial Statements.
OUTDOOR CHANNEL HOLDINGS, INC. AND SUBSIDIARIES
(In thousands, except per share data)
NOTE 1ORGANIZATION AND BUSINESS
Description of Operations
Outdoor Channel Holdings, Inc. or Outdoor Channel Holdings, is incorporated under the laws of the State of Delaware. Collectively, with its subsidiaries, the terms we, us, our and the Company refer to Outdoor Channel Holdings, Inc. as a consolidated entity, except where noted or where the context makes clear the reference is only to Outdoor Channel Holdings, Inc. or one of our subsidiaries. Outdoor Channel Holdings, Inc. wholly owns GPAA, Inc. which in turn wholly owns The Outdoor Channel, Inc. (TOC) and also is the sole member of GPAA, LLC. Outdoor Channel Holdings is also the sole member of 43455 BPD, LLC the entity that owns the building that houses our broadcast facility. TOC operates Outdoor Channel, which is a national television network devoted to traditional outdoor activities, such as hunting, fishing and shooting sports, as well as off-road motor sports and other related lifestyle programming. In addition, TOC also operates Outdoor Channel 2 HD, which also is a national television network featuring programming produced utilizing high definition technology.
Our revenues include advertising fees from advertisements aired on Outdoor Channel, including fees paid by outside producers to purchase advertising time in connection with the airing of their programs on Outdoor Channel, and from advertisements in Gold Prospectors & Treasure Hunters in the Great Outdoors magazine; subscriber fees paid by cable and satellite service providers that air Outdoor Channel; membership fees from members in both LDMA-AU, Inc. (Lost Dutchmans) and Gold Prospectors Association of America, LLC (GPAA); and other income including income from sales of products and services related to gold prospecting, gold expositions, expeditions and outings.
NOTE 2UNAUDITED INTERIM FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial position of the Company as of March 31, 2007 and its results of operations and cash flows for the three months ended March 31, 2007 and 2006. Information included in the consolidated balance sheet as of December 31, 2006 has been derived from, and certain terms used herein are defined in, the audited financial statements of the Company as of December 31, 2006 (the Audited Financial Statements) included in the Companys Annual Report on Form 10-K (the 10-K) for the year ended December 31, 2006 that was previously filed with the Securities and Exchange Commission (the SEC). Pursuant to the rules and regulations of the SEC, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from these financial statements unless significant changes have taken place since the end of the most recent fiscal year. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the Audited Financial Statements and the other information also included in the 10-K.
Certain amounts in the 2006 unaudited condensed consolidated financial statements have been reclassified to conform to the 2007 presentation. The results of the Companys operations for the three months ended March 31, 2007 are not necessarily indicative of the results of operations for the full year ending December 31, 2007.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities as of the dates of the condensed consolidated balance sheets and reported amounts of revenues and expenses for the periods presented. Accordingly, actual results could materially differ from those estimates.
NOTE 3STOCK INCENTIVE PLANS
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R). We have elected to use the modified prospective transition method. This method requires compensation cost to be recognized in the financial statements over the service period for the fair value of all awards (including awards to employees) granted after the date of adoption as well as for existing awards for which the requisite service had not been rendered as of the date of adoption and requires that prior periods not be restated. Our stock incentive plans provide for the granting of qualified and nonqualified options, restricted stock and stock appreciation rights (SARs) to our officers, directors and employees. Outstanding options are generally exercisable from 90 days to four years after the date of the grant and expire no more than ten years after the grant. We satisfy the exercise of options and awards of restricted stock by issuing previously unissued common shares. Currently we have not awarded any SARs. Prior to September 30, 2006 we had not awarded any performance units but did so in the fourth quarter of 2006. Prior to the adoption of SFAS 123R, we used the intrinsic value method to account for stock options granted to employees and made no charges against earnings with
respect to those options at the date of grant since our employee options had exercise prices that were equal to the market price, however, as explained in the 10-K, we did recognize a charge in the third quarter of 2004 when we issued fully-vested options to purchase shares in Outdoor Channel Holdings in exchange for fully-vested options held by employees of TOC on September 8, 2004. SFAS 123R requires that we elect an approved method to calculate the historical pool of windfall tax benefits upon adoption of SFAS 123R within one year of its adoption. We have elected the method outlined in SFAS 123R, sometimes referred to as the long haul method, for this calculation.
We have not capitalized any share-based compensation to any of our assets. We expense awards at the earliest of its vesting schedule or pro rata on a straight line basis over the requisite service period. The following table summarizes share-based compensation expense for the three months ended March 31, 2007 and 2006:
During the quarter ended March 31, 2007 one employee transitioned to a service provider, therefore on a go forward basis the Company will follow the guidance in Emerging Issue Task Force Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjuction with Selling, Goods or Services Issue No. 96-18 (EITF 96-18) related to accounting for these options. No other options were issued during this period. As of March 31, 2007, the fair value of these stock options was estimated to be $0.47 per share. During the three months ended March 31, 2007, the impact on stock-based compensation expense related to a change in our estimated forfeiture rate related to thse options was to decrease expense by $131. This change in estimate did not materially impact loss per common share. We granted 60 employee stock options in the three months ended March 31, 2006 which had a weighted average fair value estimated to be $6.78 per share. The estimated values were derived by using the Black-Scholes option pricing model with the following respective assumptions:
Expected volatilities are based on historical volatility of our stock. We have adopted the guidance of the SECs Staff Accounting Bulletin No. 107 that notes if share options have plain vanilla characteristics, a simplified method of estimating the expected life of the option may be employed temporarily. The simplified method utilizes the average of the vested term and the original contract term. We have experienced certain events that indicate that our long-term historical experience is no longer valid. As such we adopted the simplified method. Our short-term historical experience with exercise and post-vesting employment termination behavior supports this method for determining the options expected life. When sufficient historical experience has been obtained, we will use such experience for future estimations of the expected life. The expected life represents the period of time that options granted are expected to be outstanding. The risk-free rate is based on the U.S. Treasury rate with a maturity date corresponding to the options expected life.
NOTE 4LOSS PER COMMON SHARE
We have presented basic and diluted loss per common share in the accompanying condensed consolidated statements of operations in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during each period. The calculation of diluted loss per common share is similar to that of basic loss per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares of the Company were issued during the period if any such issuances would have had a dilutive effect.
For the three months ended March 31, 2007 and 2006, the computation of diluted loss per common share does not take into account any of our outstanding stock options and restricted stock because the effect of their assumed exercise would be anti-dilutive. The number of shares potentially issuable by the Company at March 31, 2007 and 2006 upon the exercise of stock options and upon the vesting of restricted stock that were not included in the computation of net loss per common share because they were anti-dilutive totaled 3,991 and 3,558, respectively.
NOTE 5EQUITY TRANSACTIONS
Issuances of Common Stock by the Company
For the three months ended March 31, 2007 and 2006, we received cash from the exercise of options as follows:
During the three months ended March 31, 2007, we issued employees 34 shares of restricted stock while 14 shares of restricted stock have been canceled due to employee turnover. During the third quarter of 2006, we issued 56 shares to service providers. The rights to 6 shares issued to service providers vest annually over a five-year period. The rights to 50 shares vest upon specific performance related to subscriber growth.
Under SFAS 123R, the fair value of restricted stock and options, adjusted for a forfeiture assumption, at the respective dates of grant (which represents deferred compensation not required to be recorded initially in the condensed consolidated balance sheet) will be amortized to share-based compensation expense as the rights to the restricted stock and options vest with an equivalent amount added to additional paid-in capital. Changes to forfeiture assumptions are based on actual experience and are recorded in accordance with the rules related to accounting for changes in estimates. For the service providers, however, the future charge will be recognized in accordance with EITF 96-18 and will be retroactively adjusted to reflect the fair market value at the end of each reporting period until the restricted stock or options vest at which point the related charge will be adjusted for the final time. Previously we had estimated that all 50 of the performance related restricted shares would vest by the end of 2007. We revise this estimate at the end of each reporting period and as of March 31, 2007 we believe that 35 shares will vest by the end of 2007. We do not expect any of these shares will potentially vest beyond 2007. Based on the closing price on December 29, 2006, (the last trading day of 2006) this change in estimated number of shares reduced stock-based compensation expense in the three months ended March 31, 2007 by $197. Based on the closing market price on March 30, 2007 (the last trading day of the quarter) of $10.22 per share, the fair value of these 56 shares of restricted stock was $572. The reduction of stock-based compensation expense in the three months ended March 31, 2006 that resulted because of a lower period end stock price for these shares was $106. The combined effect of the two changes in estimate on loss per common share was to decrease the loss by $0.01. Assuming the closing market price as of March 31, 2007 does not change over the remaining vesting period, we would have $136 of expense yet to be recognized.
Descriptions of Outdoor Channel Holdings stock option plans are included in Note 11 of the Companys Annual Report on Form 10-K for the year ended December 31, 2006. A summary of the status of the options granted under Outdoor Channel Holdings stock option plans and outside of those plans as of March 31, 2007 and 2006 and the changes in options outstanding during the three months then ended is presented in the table that follows:
Certain additional information regarding our stock options follows:
A summary of the status of Outdoor Channel Holdings nonvested restricted shares as of March 31, 2007 and 2006 and the changes in restricted shares outstanding during the years then ended is presented in the table that follows:
Expense to be Recognized
Expense associated with our stock based compensation plans yet to be recognized as compensation expense over the employees remaining requisite service periods as of March 31, 2007 and 2006 are as follows:
NOTE 6RELATED PARTY TRANSACTIONS
We lease our administrative facilities from Musk Ox Properties, LP, which in turn is owned by Messrs. Perry T. Massie and Thomas H. Massie, principal stockholders, directors and officers of Outdoor Channel Holdings. The lease agreement has a five-year term, expiring on December 31, 2010, with 2 five-year renewal options at our discretion. Monthly rent payments under this lease agreement were $29 with a 3% per year escalator clause. Rent expense paid to Musk Ox Properties, LP totaled approximately $90 and $87 in the three months ended March 31, 2007 and 2006, respectively. On April 24, 2007, in conjunction with the sale of the Membership Division (see Note 10-Subsequent Events), which resulted in our occupying less space, we have amended the lease with Musk Ox Properties, LP. The monthly rent is reduced to $17 per month through the end of 2007 with a 3% per year escalator thereafter.
NOTE 7INVESTMENT IN AVAILABLE-FOR-SALE SECURITIES
Our short term investments in marketable debt and equity securities are classified as available-for-sale and are recorded at fair value at the end of each period. Gross realized gains and losses on sales of these securities during the three months ended March 31, 2007 and 2006 and all amounts related to such investments prior to the three months ended March 31, 2007 and the year ended December 31, 2006 were not material. Included in investments in available-for-sale securities at March 31, 2007 and December 31, 2006 are investments in auction rate securities with short-term interest rates that generally can be reset every 28 days. The auction rate securities have long-term maturity dates and provide us with enhanced yields. However, we believe we have the ability to quickly liquidate them at their original cost, although there is no guaranty and, accordingly, they are carried at cost, which approximates fair value, and classified as current assets. We had unrealized net holding gains on marketable equity securities at March 31, 2007 and December 31, 2006 of $47 and $48, respectively, that are in accumulated other comprehensive income.
The investment in available-for-sale securities is as follows:
We consider the yields we recognize from auction rate securities and from cash held in our money market accounts to be interest income. Yields we recognize from our investments in equity securities we consider to be dividend income. Both are recorded in other income for the three months ended March 31, 2007 and 2006 as follows:
NOTE 8INCOME TAX PROVISION
The income tax benefit reflected in the accompanying unaudited condensed consolidated statement of operations for the three months ended March 31, 2007 and 2006 is different than that computed based on the applicable statutory Federal income tax rate of 34%. That portion of the current year SFAS 123R compensation expense relating to qualified incentive stock options, or ISOs, is recognized for financial statement purposes but is generally not deductible for tax purposes and thus is treated as a permanent difference between the two. For the three months ended March 31, 2007 and 2006, we recognized a charge of $54 and $151, respectively, related to ISOs under SFAS 123R compensation expense.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty of Income Taxes an interpretation of FAS No. 109, (FIN 48) which addresses the uncertainty of income taxes recognized in accordance with Statement of Financial Accounting Standards No. 109 Accounting for Income Taxes. 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. FIN 48 is effective for fiscal years that begin after December 15, 2006. We have adopted FIN 48 as of January 1, 2007, as required. We file income tax returns in the United States and various state and local tax jurisdictions. We have net operating loss and credit carryforwards that will be subject to examination beyond the year in which they are ultimately utilized. We believe any future potential adjustments of these carryforwards will be immaterial to our financial statements. Our policy is to record interest and penalties on uncertain tax positions as income tax expense. As of March 31, 2007, we believe that there are no significant uncertain tax positions, and no amounts have been recorded for interest and penalties. We do not anticipate any events that would require us to record a liability related to any uncertain income tax position in 2007 as prescribed by FIN 48.
NOTE 9SEGMENT INFORMATION
Pursuant to the Provisions of Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS 131), we report segment information in the same format as reviewed by our Chief Operating Decision Maker (the CODM). We segregate our business activities into TOC and the Membership Division. TOC is a separate business activity that broadcasts television programming on Outdoor Channel and Outdoor Channel 2 HD 24 hours a day, seven days a week. TOC generates revenue from advertising fees (which include fees paid by outside producers to purchase advertising time in connection with the airing of their programs on Outdoor Channel) and subscriber fees. Lost Dutchmans and GPAA membership sales and related activities are reported in the Membership Division. The Membership Division also includes magazine sales, advertisements within the magazine, the sale of products and services related to gold prospecting, gold expositions, expeditions and outings. Intersegment sales, which are excluded in the presentation below, amounted to $120 and $149 in each of the three months ended March 31, 2007 and 2006, respectively.
In April 2007, we began to actively pursue the sale of our Membership Division (see Note 10Subsequent Events). We have disclosed the Membership Division as part of continuing operations in accordance with the provisions of SFAS 144.
Information with respect to these reportable segments as of and for the three months ended March 31, 2007 and 2006 is as follows:
*We capture corporate overhead that is applicable to both segments, but not directly related to operations in a separate business unit, as Corporate. The expenses allocated to Corporate consisted primarily of: professional fees including public relations, accounting and legal fees, taxes associated with being incorporated in Delaware, board fees, and other corporate fees not associated directly with either TOC or the Membership Division. Corporate assets consist primarily of cash not held in our operating accounts, available-for-sale securities, deferred tax assets, net and income tax refund receivable.
NOTE 10SUBSEQUENT EVENTS
In December 2006, our Board of Directors authorized a special committee of the board to consider various alternatives regarding the strategic plans of the Membership Division. On April 20, 2007, after considering and analyzing various alternatives including the continued operation, the possible sale or the liquidation of such division, the special committee concluded that the operations of the Membership Division is no longer strategic to the core business of The Outdoor Channel, Inc. and approved the sale of such division to Mr. Thomas H. Massie, a principal stockholder, director and officer of Outdoor Channel Holdings. On April 24, 2007, we consummated the sale of the businesses, for cash, for a purchase price of $3,589 which is the combined carrying value of the businesses. Included in the carrying value was approximately $2,025 of cash and $389 of net intercompany receivable which was paid by the parent to the Membership Division in April 2007.
The balance as of March 31, 2007 of major classes of assets and liabilities of the Membership Division, including $389 of intercompany receivables, are as follows:
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Safe Harbor Statement
The information contained in this report may include forward-looking statements. Our actual results could differ materially from those discussed in any forward-looking statements. The statements contained in this report that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), including statements, without limitation, regarding our expectations, beliefs, intentions or strategies regarding the future. We intend that such forward-looking statements be subject to the safe-harbor provisions contained in those sections. Such forward-looking statements relate to, among other things: (1) expected revenue and earnings growth and changes in mix; (2) anticipated expenses including advertising, programming, personnel and others; (3) Nielsen Media Research, which we refer to as Nielsen, estimates regarding total households and cable and satellite homes subscribing to and viewers (ratings) of The Outdoor Channel; and (4) other matters. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
These statements involve significant risks and uncertainties and are qualified by important factors that could cause our actual results to differ materially from those reflected by the forward-looking statements. Such factors include but are not limited to risks and uncertainties which are included in Part II, Item 1A Risk Factors below and other risks and uncertainties discussed elsewhere in this report. In assessing forward-looking statements contained herein, readers are urged to read carefully all cautionary statements contained in this Form 10-Q and in our other filings with the Securities and Exchange Commission. For these forward-looking statements, we claim the protection of the safe harbor for forward-looking statements in Section 27A of the Securities Act and Section 21E of the Exchange Act.
Through our indirect wholly owned subsidiary, The Outdoor Channel, Inc. or TOC, we own and operate Outdoor Channel which is a national television network devoted primarily to traditional outdoor activities, such as hunting, fishing and shooting sports, as well as off-road motor sports and other outdoor related lifestyle programming. TOC revenues include (1) advertising fees from advertisements aired on Outdoor Channel and fees paid by third-party programmers to purchase advertising time in connection with the airing of their programs on Outdoor Channel; and (2) subscriber fees paid by cable and satellite service providers that air Outdoor Channel. Outdoor Channel Holdings also wholly owns 43455 BPD, LLC that owns the building housing our broadcast facility.
We also own and operate businesses we refer to as the Membership Division. These businesses include: LDMA-AU, Inc., which we refer to as Lost Dutchmans, and Gold Prospectors Association of America, LLC, which we refer to as GPAA. Lost Dutchmans is a national gold prospecting campground club with properties in Arizona, California, Colorado, Georgia, Michigan, North Carolina, Oregon and South Carolina. Among other services offered, GPAA is the publisher of the Gold Prospector & Treasure Hunters in the Great Outdoors magazine. In addition, we are the owner of a 2,300 acre property near Nome, Alaska used to provide outings for a fee to the members of Lost Dutchmans and GPAA. Membership fees are earned from members in both Lost Dutchmans and GPAA and other income including magazine sales, products and services related to gold prospecting, gold expositions, expeditions and outings.
In December 2006, our Board of Directors authorized a special committee of the board to consider various alternatives regarding the strategic plans of the Membership Division. On April 20, 2007, after considering and analyzing various alternatives including the continued operation, the possible sale or the liquidation of such division, the special committee concluded that the operations of the Membership Division is no longer strategic to the core business of The Outdoor Channel, Inc. and approved the sale of such division to Mr. Thomas H. Massie, a principal stockholder, director and officer of Outdoor Channel Holdings. On April 24, 2007, we consummated the sale of the businesses, for cash, for a purchase price of $3,589,000 which is the combined carrying value of the businesses. Included in the carrying value was approximately $2,025,000 of cash and $389,000 of net intercompany receivable which was paid by the parent to the Membership Division in April 2007. In this report, we have disclosed the Membership Division as part of continuing operations in accordance with the provisions of SFAS 144, and we will be reporting the sale of the Membership Division as discontinued operations in subsequent filings.
In September 2006, the FASB issued SFAS No. 157 (SFAS 157), Fair Value Measurements which establishes a consistent framework for measuring fair value and expands disclosures on fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We have not determined the impact, if any, the adoption of SFAS 157 will have on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We have not determined the impact, if any, the adoption of SFAS 159 will have on our consolidated financial statements.
The FASB had issued certain other accounting pronouncements as of March 31, 2007 that will become effective in subsequent periods; however, our management does not believe that any of those pronouncements would have significantly affected our financial accounting measurements or disclosures had they been in effect during the three months ended March 31, 2007.
Comparison of Operating Results for the Three Months Ended March 31, 2007 and March 31, 2006
The following table discloses certain financial information for the periods presented, expressed in terms of dollars, dollar change, percentage change and as a percent of total revenue (all dollar amounts are in thousands):
Our revenues include revenues from (1) advertising fees; and (2) subscriber fees. Advertising revenue is generated from the sale of advertising time on Outdoor Channel including advertisements shown during a program (also known as short-form advertising) and infomercials in which the advertisement is the program itself (also known as long-form advertising). Advertising revenue is also generated from fees paid by third party programmers that purchase advertising time in connection with the airing of their programs on Outdoor Channel.
Membership income is generated by our activities other than the operation of Outdoor Channel and includes membership sales, magazine sales, merchandise sales, and from the sale of advertising space in publications such as the Gold Prospectors & Treasure Hunters in the Great Outdoors magazine and sponsored outings and expeditions in connection with GPAA and Lost Dutchmans. On April 24, 2007, we consummated the sale of these businesses, for cash, for a purchase price of $3,589,000 which is the combined carrying value of the businesses (see Note 10Subsequent Events). In this report, we have disclosed the Membership Division as continuing operations in accordance with the provisions of SFAS 144, and we will be reporting the sale of the Membership Division as discontinued operations in subsequent filings.
Results of Operations
Total revenues for the three months ended March 31, 2007 were $11,926,000, an increase of $637,000, or 5.6%, compared to revenues of $11,289,000 for the three months ended March 31, 2006. The net increases were the result of changes in several items comprising revenue as discussed below.
Advertising revenue for the three months ended March 31, 2007 was $6,048,000, an increase of $363,000 or 6.4% compared to $5,685,000 for the three months ended March 31, 2006. For March 2007, Nielsen estimated that Outdoor Channel had 30.0 million viewers compared to 26.2 million for the same period a year ago. The increase in advertising revenue for the three months ended March 31, 2007 principally reflects higher prices paid for advertising time with some incremental advertising inventory retained by us to sell. These factors contributing to the increase were offset somewhat by less revenue generated from third party programming as a slightly higher percentage of our inventory was retained for our in-house sales. We expect demand for our advertising inventory will continue to be strong reflecting our position within our programming genre and niche.
Nielsen revises its estimate of the number of subscribers to our channel each month, and for May 2007 Nielsen decreased its estimate to 29.4 million subscribers. Nielsen is the leading provider of television audience measurement and advertising information services worldwide, and its estimates and methodology are generally accepted and used in the advertising industry. Although we realize Nielsens estimate is typically greater than the number of subscribers on which a network is paid by the service providers, we are currently experiencing a greater difference in these two different numbers of subscribers than we would expect. We anticipate this difference to decrease as we grow our total subscriber base. There can be no assurances that Nielsen will continue to report growth of its estimate of our subscribers and in fact at some point Nielsen might even report additional declines in our subscriber estimate. If that were to happen, we could suffer a reduction in advertising revenue.
Subscriber fees for the three months ended March 31, 2007 were $4,749,000, an increase of $366,000 or 8.4% compared to $4,383,000 for the three months ended March 31, 2006. The increase in subscriber fees for the period was primarily due to an increased number of paying subscribers both from new affiliates and from existing distributors as well as contractual subscriber fee rate increases with existing service providers carrying Outdoor Channel.
We plan to accelerate our subscriber growth utilizing various means including deployment of rate relief for new and existing subscribers and payment of subscriber acquisition or launch support fees among other tactics. Such launch support fees are capitalized and amortized over the period that the pay television distributor is required to carry the newly acquired TOC subscriber. To the extent revenue is associated with the incremental subscribers, the amortization is charged to offset the related revenue. Any excess of launch support amortization over the related subscriber fee revenue is charged to expense. As a result of a combination of these tactics, we anticipate subscriber fee revenue; net will decrease over the short-term future as we deploy this strategy.
Membership income for the three months ended March 31, 2007 was $1,129,000, a decrease of $92,000 or 7.5% compared to $1,221,000 for the three months ended March 31, 2006. The decline was principally due to the timing of the receipt of payments related to memberships. Receipt of payments impacts our revenue recognition related to memberships purchased with time payments.
Cost of Services
Our cost of services consists primarily of the cost of providing our broadcast signal and programming to the distributors for transmission to the consumer and costs associated with the production and delivery of our magazine and cost of merchandise sold. Cost of services includes (1) programming costs; (2) satellite transmission fees; (3) production and operations costs; and (4) other direct costs. Total cost of services for the three months ended March 31, 2007 was $3,751,000, an increase of $156,000 or 4.3%, compared to $3,595,000 for the three months ended March 31, 2006. As a percentage of revenues, total cost of services was 31.4% and 31.9% in the three months ended March 31, 2007 and 2006, respectively. Our level of cost of services reflects the similar levels of service being provided during the comparative quarters. The improved rate reflects the impact of price increases noted above.
Programming expenses for the three months ended March 31, 2007 were $1,474,000, a decrease of $70,000 or 4.5% compared to $1,544,000 for the three months ended March 31, 2006. The decrease is principally a result of replacing one show title mid-quarter with another lower cost title reflecting a temporary change in programming strategy.
Our policy is to charge costs of specific show production to programming expense over the expected airing period beginning when the program first airs. The cost of programming is generally first recorded as prepaid programming costs and is then charged to programming expense based on the anticipated airing schedule. The anticipated airing schedule has typically been over 2 or 4 quarters that generally does not extend over more than 2 years. As the anticipated airing schedule changes, the timing and amount of the charge to expense is prospectively adjusted accordingly. At the time we determine a program is
unlikely to air or re-air, we charge programming expense with the remaining associated cost recorded in prepaid programming. We do not make any further expense or asset adjustments if in subsequent periods demand brings episodes to air that had previously been fully expensed. Programming expenses are expected to stabilize over the near term. Further, we are considering a new programming strategy which will include more airings per show including a greater number of repeat episodes within the quarter and potentially more quarters extending over more years. As this plan is developed we will reconsider the appropriate timing of the charge to expense of our programming costs.
Satellite transmission fees for the three months ended March 31, 2007 were $596,000, a decrease of $42,000, or 6.6%, compared to $638,000 for the three months ended March 31, 2006. We do not expect significant fluctuations in satellite transmission fees other than marginal adjustments.
Production and operations costs for the three months ended March 31, 2007 were $1,473,000, an increase of $268,000, or 22.2%, compared to $1,205,000 for the three months ended March 31, 2006. The increase in costs principally relates to increased spending related to an annual programming event and costs related to the support of our new broadcast facility have contributed to the increased production and operation costs.
Other direct costs for the three months ended March 31, 2007 and 2006 were $208,000. These costs are other support costs that will vary marginally quarter to quarter and we expect will grow at a slower rate of growth than our revenue.
Other expenses consist of the cost of (1) advertising; (2) selling, general and administrative expenses; and (3) depreciation and amortization.
Total other expenses for the three months ended March 31, 2007 were $8,976,000, an increase of $597,000 or 7.1%, compared to $8,379,000 for the three months ended March 31, 2006. As a percentage of revenues, total expenses were 75.3% and 74.2% in the three months ended March 31, 2007 and 2006, respectively. The increase in other expenses was due to several factors including $1,003,000 from the recognized expense related to performance units granted to our new CEO in the fourth quarter of 2006, additional depreciation expense resulting from our broadcast facility which was placed into service effective April 1, 2006, increased accounting fees incurred in the first quarter of 2007 related to a heavier financial reporting effort than normal and increased professional fees related to consultants hired to help us execute our business plan as well as helping us assess our Membership Division segment. Offsetting some of the aggregate increase is less spending on advertising costs as more fully described below.
Advertising expenses for the three months ended March 31, 2007 were $736,000, a decrease of $1,426,000 or 66.0% compared to $2,162,000 for the three months ended March 31, 2006. We reduced our spending on advertising in the first quarter related to our print media campaigns and our race program sponsorship. We believe that our advertising expenses will substantially increase over the short-term future as we continue to deploy tactics to increase our subscriber base and the number of viewers watching our programming.
Selling, general and administrative expenses for the three months ended March 31, 2007 were $7,467,000, an increase of $1,923,000 or 34.7% compared to $5,544,000 for the three months ended March 31, 2006. As a percentage of revenues, selling, general and administrative expenses were 62.6% and 49.1% in the three months ended March 31, 2007 and 2006, respectively. We granted our new CEO two traunches of performance units of 400,000 shares each which vest in 50,000 share increments based upon our stock price reaching stipulated levels. We have calculated their fair value using a lattice model. The first traunch has an estimated value of $4,634,000 and has an expected service period of 0.6 years. In the three months ended March 31, 2007, we recognized $745,000 related to this grant. The second grant of 400,000 performance units which also vest in 50,000 share increments based upon our stock price reaching stipulated levels was calculated to have a fair value of $4,474,000 and an expected service period of 1.1 years. In the three months ended March 31, 2007, we recognized $908,000 of compensation expense related to this grant. The remainder of the increase in selling, general and administrative fees related primarily to increased research fees to support our selling efforts, consulting fees pertaining to assistance in the execution of our strategic plan, accounting fees for heavier than normal financial reporting and for the audit of our evaluation of the effectiveness of our internal control over financial reporting in 2007 related to the 2006 fiscal year and to other operating costs.
We anticipate that selling, general and administrative costs will continue to increase over the foreseeable future. Such increases are expected to result from the amortization of subscriber acquisition fees, also referred to as launch support fees which might be in the form of advertising support, in excess of the related subscriber revenue as well as other marketing, advertising and promotion expenses as we continue to work to gain increased distribution of our channel, as well as from increases in other corporate expenses. We anticipate we will incur compensation costs in the amount of $6,612,000 in the year ending December 31, 2007 related to the performance units granted to our new CEO.
Depreciation and amortization for the three months ended March 31, 2007 were $773,000, an increase of $100,000 or 14.9% compared to $673,000 for the three months ended March 31, 2006. The increase in depreciation primarily relates to our broadcast facility which was placed into service April 1, 2006.
Loss from Operations
Loss from operations for the three months ended March 31, 2007 was $801,000, a change of $116,000 compared to $685,000 for the three months ended March 31, 2006. As discussed above, this larger loss was driven by the expense of performance units and was partially offset by growth of our revenue and less spending on advertising. As we continue to strive to grow our subscriber base which involves increased advertising expenditures, possible subscriber rate relief to our carriage partners and the ongoing and planned payment of launch or advertising support, we will continue to incur increased expenses such as broadband, marketing and advertising that are unlikely to be immediately offset by revenues. As a result, we anticipate our operating margins will be negatively impacted for the short-term future until scale is achieved to reverse the trend. There can be no assurance that these strategies will be successful.
Interest expense for the three months ended March 31, 2006 was $78,000. We did not incur interest in the three months ended March 31, 2007. This is attributable to having obtained two term loans in November 2005 with original aggregate principal amount of $4,950,000 with effective fixed interest rates of 6.59% and 6.35% which we repaid in October 2006. We do not expect to incur interest expense in the foreseeable future.
Other income for the three months ended March 31, 2007 was $703,000, an increase of $80,000 compared to $623,000 for the three months ended March 31, 2006. This improvement was primarily due to increased dividends and interest earned on our increased average balances of our investment in available-for-sale securities and cash and cash equivalent balances.
Loss Before Income Taxes
Loss before income taxes as a percentage of revenues was 0.8% for the three months ended March 31, 2007 compared to 1.3% for the three months ended March 31, 2006.
The TOC segments income before income taxes increased to $679,000 for the three months ended March 31, 2007 from $554,000 for the three months ended March 31, 2006. Expressed as a percentage of revenue, the TOC segments income before income taxes increased to 6.4% for the three months ended March 31, 2007, compared to 5.6% for the three months ended March 31, 2006. The increase was due mainly to positive revenue growth from the noted advertising price increases and subscriber growth offset by the recognition of performance unit compensation costs related to our new CEO. Additionally we decreased our spending in print advertising and discontinued our race program. We expect that the TOC segment income before income taxes will be challenged as we continue to recognize the performance unit charges, invest in new advertising programs and offer subscriber rate relief in order to stimulate subscriber growth.
The Membership Division segments income before income taxes decreased to $73,000 for the three months ended March 31, 2007 compared to $189,000 for the three months ended March 31, 2006. Expressed as a percentage of revenues, the Membership Division segments income before income taxes declined to 5.8% for the three months ended March 31, 2007 compared to 13.7% for the three months ended March 31, 2006. Revenue decreased $110,000 or 8% in the three months ended March 31, 2007 which was principally due to timing of receipt of payments related to memberships which has an impact on our revenue recognition.
Corporate incurred a loss before income taxes for the three months ended March 31, 2007 amounting to $850,000, a change of $33,000 compared to a loss of $883,000 for the three months ended March 31, 2006. The expenses allocated to Corporate include: professional fees such as public relations, accounting and legal fees, business insurance, board of directors fees and expenses and an allocation of corporate officers payroll and related expenses. We experienced growth in accounting related fees in the three months ended March 31, 2007 compared to the same period a year earlier due to heavier than normal financial reporting. Offsetting the growth in accounting fees was a decline in legal fees related to specific projects in 2006 that did not repeat in 2007.
Income Tax Provision (Benefit)
Income tax provision (benefit) for the three months ended March 31, 2007 was a benefit of $36,000, a change of $53,000 as compared to a provision of $17,000 for the three months ended March 31, 2006. We have projected a loss for the year ending December 31, 2007, principally as a result of stock-based compensation expense which includes approximately $6.6 million related to performance units issued to our CEO which will only vest if certain levels of our stock price are reached and
maintained for specified periods of time. As a result, we have projected the income tax rate for the year to be approximately 37% representing the combined effects of state and federal income taxes. As of March 31, 2006, we had estimated that we would realize a profit for the year ended December 31, 2006. As such, we recorded a provision for the three months ended March 31, 2006.
Net loss for the three months ended March 31, 2007 was $62,000, a change of $95,000 compared to $157,000 for the three months ended March 31, 2006. The smaller loss was due to the reasons stated above.
Liquidity and Capital Resources
We generated $6,580,000 of cash in our operating activities in the three months ended March 31, 2007, compared to $343,000 in the three months ended March 31, 2006 and had a cash and cash equivalent balance of $32,498,000 at March 31, 2007, an increase of $17,051,000 from the balance of $15,447,000 at December 31, 2006. We also had short-term investments classified as available-for-sale securities of $31,588,000 at March 31, 2007, a decrease of $10,556,000 from the balance of $42,144,000 at December 31, 2006. The investments at March 31, 2007 were comprised principally of auction rate securities aggregating to $30,695,000 with interest rates that generally reset every 28 days. The auction rate securities have long-term maturity dates and provide us with enhanced yields. Various equity securities, aggregating to $893,000, make up the remainder of the March 31, 2007 balance. We believe we have the ability to quickly liquidate the auction rate securities and commercial paper at their original cost although there is no guaranty we would be able to do so. Net working capital increased to $70,210,000 at March 31, 2007, compared to $67,346,000 at December 31, 2006.
The increase in cash flow from operating activities in the three months ended March 31, 2007 compared to the same period in 2006 was due to a number of factors including the receipt of federal and state income tax refunds resulting from our utilization of our net operating loss for both the 2005 income tax returns and, as appropriate, carryback opportunities, improvements in the timing of the collection of our accounts receivable, greater increases in non-cash costs and operating expenses as compared to the increase in costs and operating expenses as a whole, and our ability to recognize tax benefits from exercise of stock options in excess of recognized expense in 2006 but due to our 2007 outlook, we can not recognize a corresponding amount in 2007.
Net cash provided by investing activities was $10,192,000 in the three months ended March 31, 2007 compared to $323,000 for the three months ended March 31, 2006. The increase in cash provided by investing activities was related principally to the net difference of sales and purchases of short-term auction rate securities partially plus a decrease in capital expenditures. During the first quarter of 2006, there were capital expenditures related to the final build-out stage of our new broadcast facility.
Cash provided by financing activities was $279,000 in the three months ended March 31, 2007 compared to $652,000 for the three months ended March 31, 2006. The cash provided by financing activities in the three months ended March 31, 2007 was principally the proceeds from the exercise of stock options offset by the purchase of treasury stock as employees used stock to satisfy withholding taxes related to vesting of restricted shares. During the three months ended March 31, 2006, cash provided by financing activities was principally the result of realizing tax benefits from the exercise of stock options in excess of recognized expense plus the proceeds from the exercise of stock options. During the three months ended March 31, 2007, we could not recognize the tax benefits from the exercise of stock options in excess of recognized expense because we do not project that we will be able to realize this years benefit during this year. For the three months ended March 31, 2006, cash provided by financing activities was offset by principal payments on outstanding debt.
On November 2, 2005, we renewed our revolving line of credit agreement (the revolver) with U.S. Bank N.A. (the Bank), extending the maturity date to September 7, 2007 and increasing the total amount which can be drawn upon under the revolver from $5,000,000 to $8,000,000. The revolver provides that the interest rate shall be LIBOR plus 1.25%. The revolver is collateralized by substantially all of our assets. This credit facility contains customary financial and other covenants and restrictions, as amended on November 2, 2005, including a change of control provision and certain minimum profitability metrics (which, as amended, exclude the effects of non-cash stock based employee compensation expense) measured at each quarter end. As of March 31, 2007 and as of the date of this report, we did not have any amounts outstanding under this credit facility.
As of March 31, 2007, we had sufficient cash on hand and expected cash flow from operations to meet our short-term cash flow requirements. Management believes that our existing cash resources including cash on-hand and anticipated cash flows from operations will be sufficient to fund our operations at current levels and anticipated capital requirements through at least June 1, 2008. To the extent that such amounts are insufficient to finance our working capital requirements or our desire to expand operations beyond current levels, we could seek additional financing. There can be no assurance that equity or debt financing will be available if needed or, if available, will be on terms favorable to us.
At March 31, 2007 and December 31, 2006, our investment portfolio included fixed-income securities of $30,695,000 and $41,250,000, respectively. These securities are subject to interest rate risk and will decline in value if interest rates increase. However, due to the short duration of our investment portfolio, an immediate 10% change in interest rates would have no material impact on our financial condition, operating results or cash flows. Declines in interest rates over time will, however, reduce our interest income while increases in interest rates over time may increase our interest expense.
We do not have a significant level of transactions denominated in currencies other than U.S. dollars and as a result we have very limited foreign currency exchange rate risk. The effect of an immediate 10% change in foreign exchange rates would have no material impact on our financial condition, operating results or cash flows.
As of March 31, 2007 and as of the date of this report, we did not have any outstanding borrowings. The rate of interest on our line-of-credit is variable, but we currently have no outstanding balance under this credit facility. Because of these reasons, an immediate 10% change in interest rates would have no material, immediate impact on our financial condition, operating results or cash flows.
Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and pursuant to the regulations of the Securities and Exchange Commission. Disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act, include controls and procedures designed to ensure the information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that our system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2007, the end of the period covered by this report. Based on this evaluation, we have concluded that as a result of a material weakness in our internal control over financial reporting discussed below, our disclosure controls and procedures were not effective as of March 31, 2007.
Managements report on internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and disposition of assets; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2006, based on the framework set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management reviewed the results of this evaluation with the Audit Committee of our Board of Directors, and based on this evaluation, management determined that as of December 31, 2006 a material weakness existed relating to inadequate financial department staffing and a lack of financial accounting expertise necessary to properly account for certain complex or non-routine transactions. This deficiency has not been fully remediated as of March 31, 2007, the date of this report.
Notwithstanding the existence of this material weakness, we believe that the consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented. Until this deficiency is remediated, management has concluded that there is more than a remote likelihood that a material misstatement to the annual or interim consolidated financial statements could occur and not be prevented or detected
by the Companys controls in a timely manner. Accordingly, management has determined that this control deficiency continues to constitute a material weakness. Because of this material weakness, we have concluded that we did not maintain effective internal control over financial reporting as of March 31, 2007 based on the criteria in Internal ControlIntegrated Framework.
Remediation plan for material weakness in internal control over financial reporting. The lack of staff resources and financial expertise arose as a result of several issues including time constraints imposed on the accounting staff as a result of our heavier than normal financial reporting requirements during the fourth quarter of 2006 carrying into the first quarter of 2007, employee turnover and our inability to timely fill accounting and financial-related positions. Our management, with the oversight of our Audit Committee, has devoted considerable effort to remediate the material weakness identified above. However, as of March 31, 2007, we had not fully remediated the material weakness in our internal control over financial reporting.
We are actively recruiting to fill additional open positions within the accounting department. In addition, we are implementing accounting software that will enhance our capabilities across many accounting disciplines, particularly as it relates to share-based compensation. We will more fully develop the technical expertise of our existing staff and fill open positions with qualified replacements. We have engaged additional outside consultants to bolster our U.S. GAAP expertise until and after we have been successful in bringing the expertise in-house. We believe that we have been even more active in using such trained personnel in the three months ended March 31, 2007 and believe this action has had a significantly positive impact on our internal controls over financial reporting.
Many of the remedial actions we have taken are very recent, and other remedial actions are yet to be implemented including the hiring of additional personnel. Because our remediation efforts include the hiring of additional personnel many of the controls in our current system of internal controls will still rely extensively on manual review and approval, and management will not be able to conclude that the material weakness has been eliminated until such additional personnel has been hired and the controls have been successfully operated and tested. We, along with our Audit Committee, will continue to monitor and evaluate the effectiveness of these remedial actions and make further changes as deemed appropriate.
Changes in internal control over financial reporting. Other than as noted above, during the quarter ended March 31, 2007, there was no change in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting subsequent to the date referred to above.
Our business and operations are subject to a number of risks and uncertainties, and the following list should not be considered to be a definitive list of all factors that may affect our business, financial condition and future operating results and should be read in conjunction with the risks and uncertainties, including risk factors, contained in our other filings with the Securities and Exchange Commission. Any forward-looking statements made by us are made with the intention of obtaining the benefits of the safe harbor provisions of the Securities Litigation Reform Act and a number of factors, including, but not limited to those discussed below, could cause our actual results and experiences to differ materially from the anticipated results or expectations expressed in any forward-looking statements.
We do not control the methodology used by Nielsen to estimate our subscriber base or television ratings, and changes, or inaccuracies, in such estimates could cause our advertising revenue to decrease.
Our ability to sell advertising is largely dependent on the size of our subscriber base and television ratings estimated by Nielsen. We do not control the methodology used by Nielsen for these estimates, and estimates regarding Outdoor Channels subscriber base made by Nielsen is theirs alone and does not represent opinions, forecasts or predictions of Outdoor Channel Holdings, Inc. or its management. Outdoor Channel Holdings, Inc. does not by its reference to Nielsen or distribution of the Nielsen Universe Estimate imply its endorsement of or concurrence with such information. In particular, we believe that we may be subject to a wider difference between the number of subscribers as estimated by Nielsen and the number of subscribers reported by our cable and satellite MSOs than is typically expected because we are not fully distributed and are sometimes carried on poorly penetrated tiers. In addition, if Nielsen modifies its methodology or changes the statistical sample it uses for these estimates, such as the demographic characteristics of the households, the size of our subscriber base and our ratings could be negatively affected resulting in a decrease in our advertising revenue.
Cable and satellite service providers could discontinue or refrain from carrying Outdoor Channel, or decide to not renew our distribution agreements, which could substantially reduce the number of viewers and harm our operating results.
The success of Outdoor Channel is dependent, in part, on our ability to enter into new carriage agreements and maintain existing agreements or arrangements with, and carriage by, satellite systems and multiple system operators, which we refer to as MSOs, affiliated regional or individual cable systems. Although we currently have arrangements or agreements with, and are being carried by, all the largest MSOs and satellite service providers, having such relationship or agreement with a MSO does not ensure that an MSOs affiliated regional or individual cable systems will carry or continue to carry Outdoor Channel or that the satellite service provider will carry our channel. Under our current contracts and arrangements, TOC typically offers satellite systems and cable MSOs, along with their cable affiliates, the right to broadcast Outdoor Channel to their subscribers, but such contracts or arrangements do not require that Outdoor Channel be offered to all subscribers of, or any tiers offered by, the service provider. Because certain carriage arrangements do not specify on which service levels Outdoor Channel is carried, such as analog versus basic digital, expanded digital or specialty tiers, and in which geographic markets Outdoor Channel will be offered, we have no assurance that Outdoor Channel will be carried and available to viewers of any particular MSO or to all satellite subscribers. In addition, if we are unable to fully comply with the terms of such agreements, the service providers could discontinue carrying Outdoor Channel. Lastly, we are currently not under any long-term contract with some of the service providers that are currently distributing our channel. Our distribution agreements with six of the major service providers, accounting for approximately 59% of our subscriber base as of August 2006, will have terminated as of May 1, 2007. If we are unable to renew these distribution agreements, we could lose a substantial number of subscribers. If cable and satellite service providers discontinue or refrain from carrying Outdoor Channel, or decide to not renew our distribution agreement with them, this could reduce the number of viewers and harm our operating results.
We may not be able to grow our subscriber base at a sufficient rate to offset planned increased costs, decreased revenue or at all, and as a result our revenues and profitability may not increase and could decrease.
A major component of our growth strategy is based on increasing the number of subscribers to our channels. Growing our subscriber base depends upon many factors, such as the success of our marketing efforts in driving consumer demand for our channels; overall growth in cable and satellite subscribers; the popularity of our programming; our ability to negotiate new carriage agreements, or amendments to, or renewals of, current carriage agreements, and maintain existing distribution; plus other factors that are beyond our control. There can be no assurance that we will be able to maintain or increase the subscriber base of our channels on cable and satellite systems or that our current carriage will not decrease as a result of a
number of factors or that we will be able to maintain our current subscriber fee rates. In particular, negotiations for new carriage agreements, or amendments to, or renewals of, current carriage agreements, are lengthy and complex, and we are not able to predict with any accuracy when such increases in our subscriber base may occur, if at all, of if we can maintain our current subscriber fee rates. If we are unable to grow our subscriber base, our subscriber and advertising revenues may not increase and could decrease. In addition, as we plan and prepare for such projected growth in our subscriber base, we plan to increase our expenses accordingly. If we are not able to increase our revenue to offset these increased expenses, and if our subscriber fee revenue decreases, our profitability could decrease.
If we offer favorable terms or incentives to service providers in order to grow our subscriber base, our operating results may be harmed or your percentage of the Company may be diluted.
Although we currently have plans to offer incentives to service providers in an attempt to increase the number of our subscribers, we may not be able to do so economically or at all. If we are unable to increase the number of our subscribers on a cost-effective basis, or if the benefits of doing so do not materialize, our business and operating results would be harmed. In particular, it may be necessary to reduce our subscriber fees in order to grow our subscriber base. In addition, if we make any upfront cash payments to service providers for an increase in our subscriber base, our cash flow could be adversely impacted, and we may incur negative cash flow for some time. In addition, if we were to make such upfront cash payments or provide other incentives to service providers, we expect to amortize such amounts ratably over the term of the agreements with the service providers. However, if a service provider terminates any such agreement prior to the expiration of the term of such agreement, then under current accounting rules we may incur a large expense in that quarter in which the agreement is terminated equal to the remaining un-amortized amounts and our operating results could accordingly be adversely affected. In addition, if we offer equity incentives, the terms and amounts of such equity may not be favorable to us or our stockholders.
If, in our attempt to increase our number of subscribers, we structure favorable terms or incentives with one service provider in a way that would require us to offer the same terms or incentives to all other service providers, our operating results may be harmed.
Many of our existing agreements with cable and satellite service providers contain most favored nation clauses. These clauses typically provide that if we enter into an agreement with another service provider on more favorable terms, these terms must be offered to the existing service provider, subject to some exceptions and conditions. Future agreements with service providers may also contain similar most favored nation clauses. If, in our attempt to increase our number of subscribers, we reduce our subscriber fees or structure launch support fees or other incentives to effectively offer more favorable terms to any service provider, these clauses may require us to offer similar incentives to other service providers or reduce the effective subscriber fee rates that we receive from other service providers, and this could negatively affect our operating results.
If our channels are placed in unpopular program packages by cable or satellite service providers, or if service fees are increased for our subscribers, the number of viewers of our channel may decline which could harm our business and operating results.
We do not control the channels with which our channel is packaged by cable or satellite service providers. The placement by a cable or satellite service provider of our channel in unpopular program packages could reduce or impair the growth of the number of our viewers and subscriber fees paid by service providers to us. In addition, we do not set the prices charged by cable and satellite service providers to their subscribers when our channel is packaged with other television channels. The prices for the channel packages in which our channel is bundled may be set too high to appeal to individuals who might otherwise be interested in our network. Further, if our channel is bundled by service providers with networks that do not appeal to our viewers or is moved to packages with fewer subscribers, we may lose viewers. These factors may reduce the number of viewers of our channel, which in turn would reduce our subscriber fees and advertising revenue.
Consolidation among cable and satellite operators may harm our business.
Cable and satellite operators continue to consolidate, making us increasingly dependent on fewer operators. If these operators fail to carry Outdoor Channel, use their increased distribution and bargaining power to negotiate less favorable terms of carriage or to obtain additional volume discounts, our business and operating results would suffer.
We may not be able to effectively manage our future growth, and our growth may not continue, which may substantially harm our business and prospects.
We have undergone rapid and significant growth in revenue and subscribers over the last several years. There are risks inherent in rapid growth and the pursuit of new strategic objectives, including among others: investment and development of appropriate infrastructure, such as facilities, information technology systems and other equipment to support a growing organization; hiring and training new management, sales and marketing, production, and other personnel and the diversion of managements attention and resources from critical areas and existing projects; and implementing systems and procedures to
successfully manage growth, such as monitoring operations, controlling costs, maintaining effective quality and service, and implementing and maintaining adequate internal controls. Although we have recently moved into our new Temecula, California broadcast facility, we expect that additional expenditures will be required as we continue to upgrade our facilities. We cannot assure you that we will be able to successfully manage our growth, that future growth will occur or that we will be successful in managing our business objectives. We can provide no assurance that our profitability or revenues will not be harmed by future changes in our business. Our operating results could be harmed if such growth does not occur, or is slower or less profitable than projected.
We may not be able to secure additional national advertising accounts, and as a result, our revenues and profitability may be negatively impacted.
Our ability to secure additional national advertising accounts, which generally pay higher advertising rates, depends upon the size of our audience, the popularity of our programming and the demographics of our viewers, as well as strategies taken by our competitors, strategies taken by advertisers and the relative bargaining power of advertisers. Competition for national advertising accounts and related advertising expenditures is intense. We face competition for such advertising expenditures from a variety of sources, including other cable network companies and other media. We cannot assure you that our sponsors will pay advertising rates for commercial air time at levels sufficient for us to make a profit or that we will be able to attract new advertising sponsors or increase advertising revenues. If we are unable to attract national advertising accounts in sufficient quantities, our revenues and profitability may be harmed.
We have found a material weakness in our internal controls over financial reporting and we cannot be certain in the future that we will be able to report that our controls are without material weakness or to complete our evaluation of those controls in a timely fashion.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404), and the rules and regulations promulgated by the SEC to implement Section 404, we are required to include in our Form 10K an annual report by our management regarding the effectiveness of our internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. As of December 31, 2006, our internal control over financial reporting was ineffective due to the presence of a material weakness, as more fully described in Item 9A of this Form 10-K. We are actively working to correct this material weakness, which will continue until we are able to hire additional staff in our accounting department and successfully operate and test our controls with such staff in place.
If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, we may discover material weaknesses that we would then be required to disclose. We may not be able to accurately or timely report on our financial results, and we might be subject to investigation by regulatory authorities. This could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which may have an adverse effect on our stock price.
In addition, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the preparation and presentation of financial statements. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Expenses relating to programming costs are generally increasing and a number of factors can cause cost overruns and delays, and our operating results may be adversely impacted if we are not able to successfully recover the costs of developing and acquiring new programming.
The average cost of programming has increased recently for the cable industry and such increases may continue. We plan to build our programming library through the acquisition of long-term broadcasting rights from third party producers, in-house production and outright acquisition of programming, and this may lead to increases in our programming costs. The development, production and editing of television programming requires a significant amount of capital and there are substantial financial risks inherent in developing and producing television programs. Actual programming and production costs may exceed their budgets. Factors such as labor disputes, death or disability of key spokespersons or program hosts, damage to film negatives, master tapes and recordings or adverse weather conditions may cause cost overruns and delay or prevent completion of a project. If we are not able to successfully recover the costs of developing or acquiring programming through increased revenues, whether the programming is produced by us or acquired from third-party producers, our business and operating results will be harmed.
Our operating results may be negatively impacted if our Outdoor Channel 2 HD network is not as successful as we anticipate.
In July 2005, we launched an all new, all native high definition network called Outdoor Channel 2 HD. There can be no assurance that Outdoor Channel 2 HD will not incur unexpected costs and expenses. Distribution of Outdoor Channel 2 HD will depend on successfully executing new or amended distribution agreements with cable and satellite service providers. There can be no assurance that such agreements can be made, and if they are made, that they will be on terms favorable to us or that they will not require us to grant periods of free service and/or marketing commitments to encourage carriage. The public may not adopt HD consumer television equipment in numbers sufficient to allow profits for an advertiser-supported service. Bandwidth constraints may keep Outdoor Channel 2 HD from achieving sufficient distribution from service providers to reach profitability. Competition for quality HD content may increase the costs of programming for Outdoor Channel 2 HD beyond our control or expectations. All of these factors, combined or separately, could increase costs or restrain revenue and adversely affect our operating results.
Our operating results may vary significantly, and historical comparisons of our operating results are not necessarily meaningful and should not be relied upon as an indicator of future performance.
Our operations are influenced by many factors. These factors may cause our financial results to vary significantly in the future and our operating results may not meet the expectations of securities analysts or investors. If this occurs, the price of our stock may decline. Factors that can cause our results to fluctuate include, but are not limited to:
· carriage decisions of cable and satellite service providers;
· demand for advertising, advertising rates and offerings of competing media;
· changes in the growth rate of cable and satellite subscribers;
· cable and satellite service providers capital and marketing expenditures and their impact on programming offerings and penetration;
· seasonal trends in viewer interests and activities;
· pricing, service, marketing and acquisition decisions that could reduce revenues and impair quarterly financial results;
· the mix of cable television and satellite-delivered programming products and services sold and the distribution channels for those products and services;
· our ability to react quickly to changing consumer trends;
· specific economic conditions in the cable television and related industries; and
· changing regulatory requirements.
Due to the foregoing and other factors, many of which are beyond our control, our revenue and operating results vary from period to period and are difficult to forecast. Our expense levels are based in significant part on our expectations of future revenue. Therefore, our failure to meet revenue expectations would seriously harm our business, operating results, financial condition and cash flows. Further, an unanticipated decline in revenue for a particular calendar quarter may disproportionately affect our profitability because our expenses would remain relatively fixed and would not decrease correspondingly.
Changes to financial accounting standards or our accounting estimates may affect our reported operating results.
We prepare our financial statements to conform to accounting principles generally accepted in the United States of America which are subject to interpretations by the Financial Accounting Standards Board, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. Accounting policies affecting many other aspects of our business, including rules relating to business combinations and employee stock option grants, have recently been revised or are under review. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. In addition, our preparation of financial statements in accordance with GAAP requires that we make estimates, judgments and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of revenue and expenses during the reporting period. A change in the facts and circumstances surrounding those estimates, including the interpretation of the terms and conditions of our contractual obligations, could result in a change to our estimates and could impact our operating results.
If we fail to develop and distribute popular programs, our viewership would likely decline, which could cause advertising and subscriber fee revenues to decrease.
Our operating results depend significantly upon the generation of advertising revenue. Our ability to generate advertising revenues is largely dependent on our Nielsen ratings, which estimates the number of viewers of Outdoor Channel, and this directly impacts the level of interest of advertisers and rates we are able to charge. If we fail to program popular shows that
maintain or increase our current number of viewers, our Nielsen ratings could decline, which in turn could cause our advertising revenue to decline and adversely impact our business and operating results. In addition, if we fail to program popular shows the number of subscribers to our channel may also decrease, resulting in a decrease in our subscriber fee and advertising revenue.
The market in which we operate is highly competitive, and we may not be able to compete effectively, particularly against competitors with greater financial resources, brand recognition, marketplace presence and relationships with service providers.
We compete for viewers with other pay cable television and broadcast networks, including Versus (formerly OLN), Spike TV, ESPN2 and others. If these or other competitors, many of which have substantially greater financial and operational resources than us, significantly expand their operations with respect to outdoor-related programming or their market penetration, our business could be harmed. In addition, certain technological advances, including the deployment of fiber optic cable, which are already substantially underway, are expected to allow cable systems to greatly expand their current channel capacity, which could dilute our market share and lead to increased competition for viewers from existing or new programming services.
We also compete with television network companies that generally have large subscriber bases and significant investments in, and access to, competitive programming sources. In some cases, we compete with cable and satellite service providers that have the financial and technological resources to create and distribute their own television networks, such as Versus, which is owned and operated by Comcast. In order to compete for subscribers, we may be required to reduce our subscriber fee rates or pay either launch fees or marketing support or both for carriage in certain circumstances in the future which may harm our operating results and margins. We may also issue our securities from time to time in connection with our attempts for broader distribution of The Outdoor Channel and the number of such securities could be significant. We compete for advertising sales with other pay television networks, broadcast networks, and local over-the-air television stations. We also compete for advertising sales with satellite and broadcast radio and the print media. We compete with other cable television networks for subscriber fees from, and affiliation agreements with, cable and satellite service providers. Actions by the Federal Communications Commission, which we refer to as the FCC, and the courts have removed certain of the impediments to entry by local telephone companies into the video programming distribution business, and other impediments could be eliminated or modified in the future. These local telephone companies may distribute programming that is competitive with the programming provided by us to cable operators.
Changes in corporate governance and securities disclosure and compliance practices have increased and may continue to increase our legal compliance and financial reporting costs.
The Sarbanes-Oxley Act of 2002 required us to change or supplement some of our corporate governance and securities disclosure and compliance practices. The Securities and Exchange Commission and NASDAQ have revised, and continue to revise, their regulations and listing standards. These developments have increased, and may continue to increase, our legal compliance and financial reporting costs.
The satellite infrastructure that we use may fail or be preempted by another signal, which could impair our ability to deliver programming to our cable and satellite service providers.
Our ability to deliver programming to service providers, and their subscribers, is dependent upon the satellite equipment and software that we use to work properly to distribute our programming. If this satellite system fails, or a signal with a higher priority replaces our signal, which is determined by our agreement with the owner of the satellite, we may not be able to deliver programming to our cable and satellite service provider customers and their subscribers within the time periods advertised. We have negotiated for back-up capability with our satellite provider on an in-orbit spare satellite, which provides us carriage on the back-up satellite in the event that catastrophic failure occurs on the primary satellite. Our contract provides that our main signal is subject to preemption and until the back-up satellite is in position, we could lose our signal for a period of time. A loss of our signal could harm our reputation and reduce our revenues and profits.
Natural disasters and other events beyond our control could interrupt our signal.
Our systems and operations may be vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures and similar events. They also could be subject to break-ins, sabotage and intentional acts of vandalism. Since our production facilities for Outdoor Channel are all located in Temecula, California, the results of such events could be particularly disruptive because we do not have readily available alternative facilities from which to conduct our business. Our business interruption insurance may not be sufficient to compensate us for losses that may occur. Despite any precautions we may take, the occurrence of a natural disaster or other unanticipated problems at our facilities could result in interruptions in our services. Interruptions in our service could harm our reputation and reduce our revenues and profits.
Seasonal increases or decreases in advertising revenue may negatively affect our business.
Seasonal trends are likely to affect our viewership, and consequently, could cause fluctuations in our advertising revenues. Our business reflects seasonal patterns of advertising expenditures, which is common in the broadcast industry. For this reason, fluctuations in our revenues and net income could occur from period to period depending upon the availability of advertising revenues. Due, in part, to these seasonality factors, the results of any one quarter are not necessarily indicative of results for future periods, and our cash flows may not correlate with revenue recognition.
We may be unable to access capital, or offer equity as an incentive for increased subscribers, on acceptable terms to fund our future growth and operations.
Our future capital and subscriber growth requirements will depend on numerous factors, including the success of our efforts to increase advertising revenues, the amount of resources devoted to increasing distribution of Outdoor Channel, and acquiring and producing programming for Outdoor Channel. As a result, we could be required to raise substantial additional capital through debt or equity financing or offer equity as an incentive for increased distribution. To the extent that we raise additional capital through the sale of equity or convertible debt securities, or offer equity incentives for subscriber growth, the issuance of such securities could result in dilution to existing stockholders. If we raise additional capital through the issuance of debt securities, the debt securities would have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictions on our operations. We cannot assure you that additional capital, if required, will be available on acceptable terms, or at all. If we are unable to obtain additional capital, or must offer equity incentives for subscriber growth, our current business strategies and plans and ability to fund future operations may be harmed.
We may not be able to attract and retain key personnel.
Our success depends to a significant degree upon the continued contributions of the principal members of our sales, marketing, production and management personnel, many of whom would be difficult to replace. Other than our CEO, Roger L. Werner, Jr., none of our employees are under contract and all of our employees are at-will. Any of our officers or key employees could leave at any time, and we do not have key person life insurance policies covering any of our employees. The competition for qualified personnel has been strong in our industry. This competition could make it more difficult to retain our key personnel and to recruit new highly qualified personnel. The loss of Perry T. Massie, our Chairman of the Board, Roger L. Werner, Jr., our CEO and President, Thomas H. Massie, our Executive Vice President, William A. Owen, our Chief Financial Officer, or Thomas E. Hornish, our COO and General Counsel, could adversely impact our business. To attract and retain qualified personnel, we may be required to grant large option or other stock-based incentive awards, which may be highly dilutive to existing stockholders. We may also be required to pay significant base salaries and cash bonuses to attract and retain these individuals, which payments could harm our operating results. If we are not able to attract and retain the necessary personnel we may not be able to implement our business plan.
New video recording technologies may reduce our advertising revenue.
A number of new personal video recorders, such as TiVo® in the United States, have emerged in recent years. These recorders often contain features allowing viewers to watch pre-recorded programs without watching advertising. The effect of these recorders on viewing patterns and exposure to advertising could harm our operations and results if our advertisers reduce the advertising rates they are willing to pay because they believe television advertisements are less effective with these technologies.
Cable and satellite television programming signals have been stolen or could be stolen in the future, which reduces our potential revenue from subscriber fees and advertising.
The delivery of subscription programming requires the use of conditional access technology to limit access to programming to only those who subscribe to programming and are authorized to view it. Conditional access systems use, among other things, encryption technology to protect the transmitted signal from unauthorized access. It is illegal to create, sell or otherwise distribute software or devices to circumvent conditional access technologies. However, theft of cable and satellite programming has been widely reported, and the access or smart cards used in cable and satellite service providers conditional access systems have been compromised and could be further compromised in the future. When conditional access systems are compromised, we do not receive the potential subscriber fee revenues from the cable and satellite service providers. Further, measures that could be taken by cable and satellite service providers to limit such theft are not under our control. Piracy of our copyrighted materials could reduce our revenue from subscriber fees and advertising and negatively affect our business and operating results.
Because we expect to become increasingly dependent upon our intellectual property rights, our inability to protect those rights could negatively impact our ability to compete.
Approximately 72% of programs we aired in 2006 (exclusive of infomercials) on Outdoor Channel were provided by third-party television and film producers. In order to build a library of programs and programming distribution rights, we must obtain all of the necessary rights, releases and consents from the parties involved in developing a project or from the owners of the rights in a completed program. There can be no assurance that we will be able to obtain the necessary rights on acceptable terms, or at all, or properly maintain and document such rights. In addition, protecting our intellectual property rights by pursuing those who infringe or dilute our rights can be costly and time consuming. If we are unable to protect our portfolio of trademarks, service marks, copyrighted material and characters, trade names and other intellectual property rights, our business and our ability to compete could be harmed.
We may face intellectual property infringement claims that could be time-consuming, costly to defend and result in our loss of significant rights.
Other parties may assert intellectual property infringement claims against us, and our products may infringe the intellectual property rights of third parties. From time to time, we receive letters alleging infringement of intellectual property rights of others. Intellectual property litigation can be expensive and time-consuming and could divert managements attention from our business. If there is a successful claim of infringement against us, we may be required to pay substantial damages to the party claiming infringement or enter into royalty or license agreements that may not be available on acceptable or desirable terms, if at all. Our failure to license the proprietary rights on a timely basis would harm our business.
Some of our existing stockholders can exert control over us and may not make decisions that are in the best interests of all stockholders.
Our current officers, directors and greater than 5% stockholders together currently control greater than 50% of our outstanding common stock. As a result, these stockholders, acting together, would be able to exert significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control of our company, even when a change may be in the best interests of stockholders. In addition, the interests of these stockholders may not always coincide with our interests as a company or the interests of other stockholders. Accordingly, these stockholders could cause us to enter into transactions or agreements that you would not approve.
The market price of our common stock has been and may continue to be subject to wide fluctuations.
Our stock has historically been and continues to be traded at relatively low volumes and therefore has been subject to price volatility. Various factors contribute to the volatility of our stock price, including, for example, low trading volume, quarterly variations in our financial results, increased competition and general economic and market conditions. While we cannot predict the individual effect that these factors may have on the market price of our common stock, these factors, either individually or in the aggregate, could result in significant volatility in our stock price during any given period of time. There can be no assurance that a more active trading market in our stock will develop. As a result, relatively small trades may have a significant impact on the price of our common stock. Moreover, companies that have experienced volatility in the market price of their stock often are subject to securities class action litigation. If we were the subject of such litigation, it could result in substantial costs and divert managements attention and resources.
Anti-takeover provisions in our certificate of incorporation, our bylaws and under Delaware law may enable our incumbent management to retain control of us and discourage or prevent a change of control that may be beneficial to our stockholders.
Provisions of Delaware law, our certificate of incorporation and bylaws could discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. These provisions also could limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. Furthermore, these provisions could prevent attempts by our stockholders to replace or remove our management. These provisions:
· allow the authorized number of directors to be changed only by resolution of our board of directors;
· establish a classified board of directors, providing that not all members of the board be elected at one time;
· require a 66 2/3% stockholder vote to remove a director, and only for cause;
· authorize our board of directors to issue without stockholder approval blank check preferred stock that, if issued, could operate as a poison pill to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our board of directors;
· require that stockholder actions must be effected at a duly called stockholder meeting and prohibit stockholder action by
· establish advance notice requirements for stockholder nominations to our board of directors or for stockholder proposals that can be acted on at stockholder meetings;
· except as provided by law, allow only our board of directors to call a special meeting of the stockholders; and
· require a 66 2/3% stockholder vote to amend our certificate of incorporation or bylaws.
In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may, unless certain criteria are met, prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a prescribed period of time.
Technologies in the cable and satellite television industry are constantly changing, and our failure to acquire or maintain state-of-the-art technology may harm our business and competitive advantage.
The technologies used in the cable and satellite television industry are rapidly evolving. Many technologies and technological standards are in development and have the potential to significantly transform the ways in which programming is created and transmitted. We cannot accurately predict the effects that implementing new technologies will have on our programming and broadcasting operations. We may be required to incur substantial capital expenditures to implement new technologies, or, if we fail to do so, may face significant new challenges due to technological advances adopted by competitors, which in turn could result in harming our business and operating results.
The cable and satellite television industry is subject to substantial governmental regulation for which compliance may increase our costs and expose us to penalties for failure to comply.
The cable television industry is subject to extensive legislation and regulation at the federal and local levels, and, in some instances, at the state level, and many aspects of such regulation are currently the subject of judicial proceedings and administrative or legislative proposals. Similarly, the satellite television industry is subject to federal regulation. Operating in a regulated industry increases our cost of doing business as a video programmer.
The Cable Television Consumer Protection and Competition Act of 1992, to which we refer as the 1992 Cable Act, includes provisions that preclude cable operators affiliated with video programmers from favoring their programmers over competitors. The 1992 Cable Act also effectively precludes such programmers from selling their programming exclusively to cable operators. These provisions potentially benefit independent programmers such as us by limiting the ability of cable operators affiliated with programmers from carrying only programming in which they have an ownership interest and from offering exclusive programming arrangements. However, the United States Court of Appeals for the District of Columbia Circuit vacated the FCC rule limiting the carriage of affiliated programmers by cable operators. Although the FCC issued further notices of proposed rulemaking in 2001 and 2005 addressing this issue, it has not adopted new rules. The exclusivity provision is scheduled to expire in October 2007, but the FCC has initiated a rulemaking proceeding to determine if a further extension is necessary to protect competition and diversity.
Regulatory carriage requirements also could reduce the channel capacity available to carry Outdoor Channel. The 1992 Cable Act granted television broadcasters a choice of must-carry rights or retransmission consent rights. The rules adopted by the FCC generally provide for mandatory carriage by cable systems of all local full-power commercial television broadcast signals selecting must-carry rights and, depending on a cable systems channel capacity, non-commercial television broadcast signals. Such statutorily mandated carriage of broadcast stations, coupled with the provisions of the Cable Communications Policy Act of 1984, which require cable television systems with 36 or more activated channels to reserve a percentage of such channels for commercial use by unaffiliated third parties and permit franchise authorities to require the cable operator to provide channel capacity, equipment and facilities for public, educational and government access channels, could reduce carriage of Outdoor Channel by limiting its carriage in cable systems with limited channel capacity. In 2001, the FCC adopted rules relating to the cable carriage of digital television signals. Among other things, the rules clarify that a digital-only television station can assert a right to analog or digital carriage on a cable system. The FCC initiated a further proceeding to determine whether television broadcasters may assert the rights to carriage of both analog and digital signals during the transition to digital television and to carriage of all digital signals. In 2005, the FCC decided that television broadcasters do not have such additional must-carry rights. Broadcasters formally have requested that the FCC reconsider this decision and are seeking legislative change to require such carriage. In June 2006, this matter was scheduled to be heard by the FCC at its open meeting, but was removed from the agenda without discussion. The imposition of such additional must-carry regulation, in conjunction with any limited cable system channel capacity, would increase the likelihood that cable operators may be forced to drop some cable programming services and could reduce carriage of Outdoor Channel.
The Telecommunications Act of 1996 required the FCC to establish rules and an implementation schedule to ensure that video programming is fully accessible to the hearing impaired through closed captioning. The rules adopted by the FCC require substantial closed captioning over a six to ten year phase-in period, which began in 2000, with only limited exemptions. As a result, we will continue to incur additional costs for closed captioning. Failure to meet these closed
captioning requirements could cause a service provider to discontinue carrying Outdoor Channel and result in regulatory action by the FCC.
If we distribute television programming through other types of media, we may be required to obtain federal, state and local licenses or other authorizations to offer such services. We may not be able to obtain licenses or authorizations in a timely manner, or at all, or conditions could be imposed upon licenses and authorizations that may not be favorable to us. In the future, increased regulation of rates could, among other things, put downward pressure on the rates charged by cable programming services, and affect the ability or willingness of cable system operators to retain or to add Outdoor Channel network on their cable systems.
In addition, government-mandated a la carte carriage or small tiers of channels by cable system operators could adversely impact our viewership levels if Outdoor Channel is sold a la carte or moved to such a tier. In response to a request from the Committee on Energy and Commerce of the House of Representatives, the FCCs Media Bureau conducted a study in 2004 regarding, among other things, government-mandated a la carte or mini-tier packaging of programming services in which each subscriber would purchase only those channels that he or she desired instead of the larger bundles of different channels as is typical today. The Media Bureaus report in 2004 observed that such packaging would increase the cost of programming to consumers and injure programmers. On February 9, 2006, the Media Bureau released a further report which stated that the 2004 report was flawed and which concluded that a-la-carte sales could be in the best interests of consumers. Although the FCC cannot mandate a-al-carte sales, its endorsement of the concept could encourage Congress to consider proposals to mandate a-ala-carte sales or otherwise seek to impose greater regulatory controls on how cable programming is sold. If, in response to any statue enacted by Congress, or any rate or other government regulation, cable system operators implement channel offerings that require subscribers to affirmatively choose to pay a separate fee to receive Outdoor Channel, either by itself or in combination with a limited number of other channels, the number of viewers for Outdoor Channel could be reduced.
The regulation of programming services, cable television systems and satellite licensees is subject to the political process and has been in constant flux over the past decade. Further material changes in the law and regulatory requirements are difficult to anticipate and our business may be harmed by future legislation, new regulation, deregulation or court decisions interpreting laws and regulations.
We must comply with many local, states, federal and environmental regulations, for which compliance may be costly and may expose us to substantial penalties.
Our recreational outdoor activity entities, GPAA and Lost Dutchmans, share the general risks of all outdoor recreational activities such as personal injury, environmental compliance and real estate and environmental regulation. In addition to the general cable television industry regulations, we are also subject to various local, state and federal regulations, including, without limitation, regulations promulgated by federal and state environmental, health and labor agencies. Our prospecting clubs are subject to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, development and other utilization of their properties. We cannot predict what impact current or future regulations may have on these businesses. In addition, failure to maintain required permits or licenses, or to comply with applicable regulations, could result in substantial fines or costs or revocation of our operating licenses, which would have a material adverse effect on our business and operating results.
If our goodwill becomes impaired, we will be required to take a non-cash charge which could have a significant effect on our reported net earnings.
A significant portion of our assets consists of goodwill. In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS 142, we test goodwill for impairment during the fourth quarter of each year, and on an interim date if factors or indicators become apparent that would require an interim test. A significant downward revision in the present value of estimated future cash flows for a reporting unit could result in an impairment of goodwill under SFAS 142 and a non-cash charge would be required. Such a charge could have a significant effect on our reported net earnings.
Future issuance by us of preferred shares could adversely affect the holders of existing shares, and therefore reduce the value of existing shares.
We are authorized to issue up to 25,000,000 shares of preferred stock. The issuance of any preferred stock could adversely affect the rights of the holders of shares of our common stock, and therefore reduce the value of such shares. No assurance can be given that we will not issue shares of preferred stock in the future.
We do not expect to pay dividends in the foreseeable future.
We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will also depend on our financial condition, operating results, capital requirements and other factors and will be at the discretion of our board of directors. Furthermore, at the time of any potential payment of a cash dividend we may subject to contractual restrictions on, or prohibitions against, the payment of dividends.
* Pursuant to Commission Release No. 33-8238, this certification will be treated as accompanying this Quarterly Report on Form 10-Q and not filed as part of such report for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of Section 18 of the Securities Exchange Act of 1934, as amended, and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the registrant specifically incorporates it by reference.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.