Estimated fair value of financial instruments
Current assets and current liabilities’ carrying values are representative of their fair values due to the relatively short period to maturity. The fair value of long-term debt approximates the carrying value because the interest charges under the terms of the long-term debt are based on the 3-month Canadian banker’s acceptance rates. The fair values of Canadian Content Development commitments approximated their carrying values as they were recorded at the net present values of their future cash flows, using discount rates ranging from 8.0% to 14.3%.
The following table outlines the hierarchy of inputs used in the calculation of fair value for each financial instrument:
The Company uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation techniques:
Level 1: quoted (unadjusted) prices in active markets for identical assets and liabilities
Level 2: other techniques for which all inputs that have a significant effect on the recorded value are observable, either directly or indirectly
Level 3: techniques which use inputs that have a significant effect on the recorded fair value that are not based on observable market data
Financial risk management
The following sections discuss the Company’s risk management objectives and procedures as they relate to market risk, credit risk, liquidity risk and capital risk.
Credit risk
Credit exposure on financial instruments arises from the possibility that a counterparty to an instrument in which the Company is entitled to receive payment fails to perform. The maximum credit exposure approximated $26,900,000 as at December 31, 2010, which included accounts receivable and the equity total return swap receivable.
The Company is subject to normal credit risk with respect to its receivables. A large customer base and geographic dispersion minimize the concentration of credit risk. Credit exposure is managed through credit approval and monitoring procedures. The Company does not require collateral or other security from clients for trade receivables; however the Company does perform credit checks on customers prior to extending credit. Based on the results of credit checks, the Company may require upfront deposits or full payments on account prior to providing service. The Company reviews its receivables for possible indicators of impairment on a regular basis and as such, it maintains a provision for potential credit losses which totaled $1,347,000 as at December 31, 2010. The Company is of the opinion that the provision for potential losses adequately reflects the credit risk associated with its receivables. Approximately 85% of trade receivables are outstanding for less than 90 days. Amounts would be written off directly against accounts receivable and against the allowance only if and when it was clear the amount would not be collected due to customer insolvency. Historically, the significance and incidence of amounts written off directly against receivables have been low. In 2010, $832,000 was written off which is less than 4% of the year end receivables’ balance and less than 1% of revenue. The Company believes its provision for potential credit losses is adequate.
With regard to the Company’s derivative instruments, the counterparty risk is managed by only dealing with Canadian Chartered Banks having high credit ratings.
Market risk
Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices, which includes quoted share prices in active markets, interest rates and the Company’s quoted share price as it relates to the stock appreciation rights plan.
(a) Managing risk associated with fluctuations in quoted share prices of marketable securities
The fair value of the Company’s marketable securities is affected by changes in the quoted share prices in active markets. Such prices can fluctuate and are affected by numerous factors beyond the Company’s control. In order to minimize the risk associated with changes in the share price of any one particular investment, the Company diversifies its portfolio by investing in various stocks in varying industries. It also conducts regular financial reviews of publicly available information related to its investments to determine if any identified risks are within tolerable risk levels. As at December 31, 2010, a 10% change in the share prices of each marketable security would result in a $440,000 after-tax change in net income.
Other income from the Company’s marketable securities at December 31, 2010 was $735,000. The Company disposed of certain of the investments it held in its portfolio which triggered losses aggregating $349,000 for the year (2009 – $5,343,000). Unrealized gains on the remaining investments held at December 31, 2010 were $1,084,000 (2009 – 1,754,000).
(b) Interest rate risk management
To hedge its exposure to fluctuating interest rates on its long-term debt, the Company has entered into interest rate swap agreements with Canadian Chartered Banks. The swap agreements involve the exchange of the three-month bankers’ acceptance floating interest rate for a fixed interest rate. The difference between the fixed and floating rates is settled quarterly with the bank and recorded as an increase or decrease to interest expense. The Company elected to apply hedge accounting and as such formally assesses effectiveness of the swaps at inception and on a regular basis and has concluded that the swaps are effective in offsetting changes in interest rates.
For 2010 interest rate fluctuations would have very little impact on the Company’s results as the total amount of the long term debt was hedged with very little fluctuation above the hedged amount. Therefore any change in the floating interest rate would have little or no impact on the Company’s results. Interest rate fluctuations would have an impact on the Company’s OCI. A 0.5% change in the floating interest rates would have impacted OCI due to changes in fair value of the interest rate swaps by approximately $370,000, net of tax.
In 2008, the Company entered into two interest rate swap agreements; one has a notional value of $15,000,000 and expires in June 2013, and the other has a notional amount of $45,000,000 and expires in May 2013. Three former interest rate swap agreements were terminated prior to expiry and the fair value of those agreements ($349,000 payable) was blended into the interest rate of the new $45,000,000 swap agreement. This fair value payable is being transferred from OCI to net income (as interest expense) over the remaining term of the original three swap agreements which expired between 2009 and 2011. The before-tax amount related to the $349,000 fair value payable transferred to net income from OCI for the year was $67,000 (2009 – $104,000).
Interest expense transferred to OCI from net income was $15,000 for the year (2009 – transfer of $757,000 to net income). As at December 31, 2009, the Company de-designated $10,000,000 of the $15,000,000 swap; therefore, hedge accounting no longer applies on the de-designated portion. Hedge accounting continues to apply for a notional amount of $50 million. Of the amount of interest expense transferred to net income from OCI, $36,000 related to the de-designated portion. During 2010, $5,000,000 of the $15,000,000 swap was formally terminated.
The Company has measured its own credit risk in relation to its interest rate swaps and as a result has recognized a $70,000 loss (2009 – $95,000 gain) in OCI.
The aggregate fair value payable of the swap agreements was $3,030,000 (2009 – $3,849,000).
(c) Share price volatility risk management
In July 2006, the Company entered into a cash-settled equity total return swap agreement to manage its exposure to fluctuations in its stock-based compensation costs related to the SAR plan. Compensation costs associated with the SAR Plan fluctuate as a result of changes in the market price of the Company’s Class A shares. The Corporation entered into this swap for a total of 1,275,000 notional Class A shares with a hedged price of $5.85. The swap expires in July 2011.
The swap includes an interest and dividend component. Interest is accrued and payable by the Company on quarterly settlement dates. Any dividends paid on the Class A shares are reimbursed to the Company on the quarterly settlement dates.
The Company elected to apply hedge accounting and in order to qualify for hedge accounting, there must be reasonable assurance that the instrument is and will continue to be an effective hedge. At the inception of the hedge and on an ongoing basis, the Company formally assesses and documents whether the hedging relationship is effective in offsetting changes in cash flows of the hedged item. Gains or losses realized on the quarterly settlement dates are recognized in net income in the same period as the SAR Plan compensation expense. Unrealized gains and losses, to the extent that the hedge is effective, are deferred and included in OCI until such time as the hedged item affects net income. If at any time, the hedge is deemed to be ineffective or the hedge is terminated or de-designated, gains or losses, including those previously recognized in OCI, will be recorded in net income immediately.
As at December 31, 2010, the Company de-designated 724,250 of the 1,275,000 notional Class A shares; therefore, hedge accounting no longer applies on the de-designated portion. Of the before-tax gains transferred from OCI to net income, $415,000 related to the de-designated portion.
The estimated fair value of the equity total return swap receivable based on the Class A shares’ market price at December 31, 2010 was $1,339,000 (2009 – $1,466,000).
Liquidity risk Liquidity risk is the risk that the Company is not able to meet its financial obligations as they become due or can do so only at excessive cost. The Company’s growth is financed through a combination of the cash flows from operations and borrowings under the existing credit facility. One of management’s primary goals is to maintain an optimal level of liquidity through the active management of the assets and liabilities as well as the cash flows. Other than for operations, the Company’s cash requirements are mostly for interest payments, repayment of debt, capital expenditures, Canadian Content Development payments, dividends and other contractual obligations that are disclosed below.
The Company was in full compliance with its bank covenants throughout the year and at year end and continues to have access to the available funds under the existing credit facilities. The Company’s revolving credit facility expires in June 2012. It is management’s intention to renew this revolving credit facility prior to its maturity and as a result there is no fixed repayment schedule.
The Company’s liabilities have contractual maturities which are summarized below:
Capital risk
The Company defines its capital as shareholders’ equity. The Company’s objective when managing capital is to pursue its strategy of growth through acquisitions and through organic operations so that it can continue to provide adequate returns for shareholders. The Company manages the capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of the underlying assets. In order to maintain or adjust the capital structure, the Company may adjust the amount of dividends paid to shareholders, issue new shares or repurchase shares. The Directors and Senior Management of the Company are of the opinion that from time to time the purchase of its shares at the prevailing market price would be a worthwhile investment and in the best interests of the Company and its shareholders. Material transactions and those considered to be outside the ordinary course of business, such as acquisitions and other major investments or disposals, are reviewed and approved by the Board of Directors.
To comply with Federal Government directions, the Broadcasting Act and regulations governing radio stations (the “Regulations”), the Company has imposed restrictions respecting the issuance, transfer and, if applicable, voting of the Company's shares. Restrictions include limitations over foreign ownership of the issued and outstanding voting shares. Pursuant to such restrictions, the Company can prohibit the issuance of shares or refuse to register the transfer of shares or, if applicable, prohibit the voting of shares in circumstances that would or could adversely affect the ability of the Company, pursuant to the provisions of the Regulations, to obtain, maintain, renew or amend any licence required to carry on any business of the Company, including a licence to carry on a broadcasting undertaking, or to comply with such provisions or with those of any such licence.
The Company is subject to covenants on its credit facility. The Company’s bank covenants include certain maximum or minimum ratios such as total debt to EBITDA ratio, interest coverage and fixed charge coverage ratio. Other covenants include seeking prior approval for acquisitions or disposals in excess of a quantitative threshold. The Company was in compliance with the covenants throughout the year and at year end.
Financial projections are updated and reviewed regularly to reasonably ensure that financial debt covenants will not be breached in future periods. The Company monitors the covenants and foreign ownership status of the issued and outstanding voting shares and presents this information to the Board of Directors quarterly. The Company was in compliance with all the above as at December 31, 2010.