| BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | 2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2015, should be read in conjunction with the consolidated financial statements contained in the Company's Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the "SEC") on March 5, 2015 (the "2014 Annual Report"). The Company's accounting policies are more fully described in the 2014 Annual Report. The preparation of the Company's unaudited condensed consolidated financial statements requires the Company to make judgments in selecting the appropriate assumptions for calculating financial estimates, which inherently contain some degree of uncertainty. The Company bases its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the reported amounts of revenues and expenses that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following discussion addresses the Company's most critical accounting policies, which require management's most difficult, subjective and complex judgments.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been recorded. Operating results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.
The condensed consolidated balance sheet as of December 31, 2014 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for the complete financial statements.
As fully described in 2014 Annual Report on Form 10-K, an amendment to the Russian law "On Mass Media" adopted in October 2014 will reduce the permitted level of foreign ownership in Russian mass media companies, including television broadcasters, from 50% direct ownership to 20% beneficial ownership or control, whether direct or indirect, starting from January 1, 2016. No amendments to or waivers from the Mass Media Law have been approved to date and therefore all mass media, including CTC Media's Russian broadcasting businesses, will be required to comply with these ownership and control limitations by January 1, 2016 (subject to a one-year grace period for offshore intermediate holding structures ultimately owned and controlled by Russian individuals or companies). The adoption of the Mass Media Law creates significant uncertainty for CTC Media and its stockholders.
The Company's Board of Directors, through its Special Committee of independent directors, and management team are continuing to work with external legal, financial and tax advisors to evaluate and implement an appropriate response that achieves compliance with the new law while safeguarding the interest of all of the Company's stockholders.
In the context of these legal developments in Russia, on July 6, 2015, the Company announced the receipt of a formal, non-binding offer from UTH Russia, a privately held Russian commercial television broadcasting group, for the purchase of a 75% interest in the group's Russian and Kazakhstan business operations. On September 24, 2015, the Company entered into a Framework Agreement with UTV-Management LLC, an affiliate of UTH Russia (together, "UTH"). Pursuant to the agreement, UTH would acquire a 75% interest in CTC Media's operating businesses for approximately $200.5 million in cash. The Agreement was approved by all members of the Board of Directors of the Company (except for those members originally designated by Telcrest Investments Ltd. who recused themselves pursuant to the Company's Economic Sanctions Compliance Policy), taking into consideration the recommendation of the Special Committee of independent directors that was established to undertake a review of the proposed transaction with UTH and the Company's strategic alternatives. In addition, in order to ensure that the ownership structure of the operating business fully meets the 80% ownership requirement of the Mass Media Law by the stated deadlines, the Company has agreed to approve the issuance to UTH of an additional participation interest in "CTC Investments" and, as the result UTH would hold a 80% interest in CTC Media's business following the closing of the transaction.
The transaction is subject to customary closing conditions, including regulatory approvals and the approval of the Company's stockholders by a simple majority of the outstanding shares of the Company's common stock at a special meeting. The shares of the Company's common stock held by Telcrest, the holder of approximately 25% of the shares of the Company's common stock, are currently blocked pursuant to U.S. economic sanctions and as such Telcrest would not be permitted to vote at the special meeting.
As of September 30, 2015 and the date of these financial statements and until the proposed transaction is approved by stockholders, the Company continues to manage and operate its businesses in Russia and Kazakhstan as continuing operations applying the going concern assumption. While there may be changes in management's assumptions in the near term, the Company believes that the accompanying financial statements fairly reflect the performance of the Company based on current information that is available. Should facts and circumstances change—in particular, if a transaction involving the sale of a material portion of the Company's Russian businesses is approved by the Company's stockholders, the Company will be required to report certain, if not all, of its principal operations as discontinued operations in the period in which such transaction is approved by both Board of Directors and stockholders.
Principles of Consolidation
Wholly owned subsidiaries and majority owned ventures where the Company has operating and financial control, as well as variable interest entities where the Company has been deemed the primary beneficiary with power and ability to control, are consolidated. Those ventures where the Company exercises significant influence, but does not exercise operating and financial control, are accounted for under the equity method. The Company uses the purchase method of accounting for all business combinations. Results of subsidiaries acquired and accounted for under the purchase method are included in operations from the date of acquisition. Non-controlling interests represent a non- controlling shareholder's proportionate share of the equity in certain of the Company's consolidated entities. Intercompany accounts and transactions are eliminated upon consolidation. Disposals are reflected at the time risks and rewards of ownership have been transferred.
The Company is the primary beneficiary of the Channel 31 Group, a variable interest entity consisting of a 20% participation interest in Teleradiokompaniya 31st Kanal LLP ("Channel 31"), and a 70% and 60% interest in Prim LLP and Advertising and Marketing LLP, respectively, which provide programming content and the advertising sales function to Channel 31 (together, the "Channel 31 Group"). These interests provide the Company with a right to 60% of the economic interest of the Channel 31 Group. The Company consolidates the Channel 31 Group. As of September 30, 2015, the Channel 31 Group had assets (excluding intercompany assets) totaling $14,078 and liabilities (excluding intercompany liabilities) totaling $2,441. These assets and liabilities primarily relate to broadcasting licenses, trade payables for programming rights, loans and related deferred tax assets and liabilities. The Company finances the Channel 31 Group's operations in the ordinary course of business. Channel 31 Group's net income attributable to CTC Media, Inc. stockholders excluding intercompany expenses totaled $115 and $67 for the three and nine months ended September 30, 2015, respectively.
Seasonality
The Company experiences seasonal fluctuations in overall television viewership and advertising revenues. Overall television viewership is lower during the summer months and highest in the first and fourth quarters. Seasonal fluctuations in consumer patterns also affect television advertising expenditures. In 2014, approximately 30% of the Company's total advertising revenues in ruble terms were generated in the fourth quarter.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates in the financial statements include, among others, the estimate of fair values in business combinations, estimates of the fair value of the Company's common stock in determining stock-based compensation, the amortization method and periods for programming rights, useful lives of tangible and intangible assets, impairment of goodwill, valuation of intangible assets and long-lived assets, estimates of contingencies, estimates of income taxes in relation to the Company's interpretation of current tax laws, in particular, in the determination of foreign tax credits, determination of valuation allowances for deferred tax assets, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. While the Company believes it has made, and continues to make, reasonable judgments in determining its tax filing positions in each jurisdiction in which it is subject to tax, views may differ as to the determination of its tax obligations. These judgments may ultimately be subjected to examination by the tax authorities and further revisions may be required in the Company's estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making changes in estimates from time to time, and evaluates the estimates on an ongoing basis. Actual results may differ from those estimates under different assumptions or conditions.
Revenue Recognition
Revenue is recognized when there is persuasive evidence of an arrangement, services have been rendered, the price is fixed or determinable and collectability is reasonably assured. An allowance for doubtful accounts is maintained for estimated losses resulting from the customers' inability to make payments. The Company recognizes advertising revenues at the moment when the advertising is broadcast and net of value-added taxes ("VAT").
The Company's own sales house serves as the exclusive advertising sales agent for substantially all national and regional advertising sales, with the exception of advertising sales to local clients of a number of the Company's owned-and-operated regional stations. The Company recognizes its Russian advertising revenues, excluding regional advertising revenues from local clients, based on the gross amounts billed to the advertisers and their agencies under direct sales arrangements.
The Company's cooperation model with Video International provides for the licensing of specialized advertising software by Video International to the Company's sales house, together with the provision by Video International of related software maintenance and analytical support and consulting services. Compensation expenses payable to Video International for the use of advertising software, related maintenance and analytical support and consulting services are included in selling, general and administrative expenses in the Company's consolidated statement of income.
In addition, a number of the Company's owned-and-operated regional stations and Channel 31 have agency agreements with local subsidiaries of Video International with respect to advertising sales to local clients, which is recognized net of agency commissions.
Sublicensing revenues primarily represent revenues the Company earns from sublicensing its rights to programming and from the licensing of internally- produced programming. Sublicensing revenue is recognized at such time as there is persuasive evidence that a sale or arrangement with a customer exists, the underlying programming is complete and has been transferred to the customer, the licensing period has commenced and the customer can begin use, the arrangement fee is fixed or determinable, and collection of the arrangement fee is reasonably assured. Given the recent uncertainties in Ukraine, in 2014, the Company commenced the use of the installment method for sublicensing arrangements with Ukrainian counterparties.
Payments received in advance for advertising and other revenue are recorded as deferred revenue until earned.
Programming Rights
Programming rights are stated at the lower of their unamortized cost or net realizable value. The Company reports an asset and liability for the rights acquired and obligations incurred at the commencement of the licensing period when the cost of the programming is known or reasonably determinable, the program material has been accepted and the programming is available for airing.
Purchased program rights are classified as current or non-current assets based on anticipated usage and the licensing period. Internally produced programming and purchased programming with unlimited rights are classified as non-current.
The Company amortizes programming based on expected revenue generation patterns, based on the proportion that current estimated revenues bear to the estimated remaining total lifetime revenues. If the initial airing of content allowed by a license is expected to provide more value than subsequent airings, the Company applies an accelerated method of amortization. These accelerated methods of amortization depend on the estimated number of runs the content is expected to receive, and are determined based on a study of historical results for similar programming. For content that is expected to be aired only once, the entire cost is recognized as an expense on the first run. To the extent that the revenues the Company expects to earn from broadcasting a program are lower than the book value, the programming rights are written down to their net realizable value by way of recording an additional amortization charge. Such write-downs establish a new cost basis for programming rights.
Amortizable Long-Lived Assets
Amortizable assets are stated at cost less accumulated amortization. Definite- lived intangible assets primarily represent broadcast licenses and cable network connections that are amortized on a straight-line basis through the end of their estimated period of future economic benefit ranging from 2018 to 2022.
The estimated useful lives of broadcasting licenses is subject to the availability of further information about the transition to digital broadcasting which could require the Company to revise its amortization expense on a prospective basis. Amortizable assets, including property and equipment and definite-lived intangibles, are reviewed periodically to determine whether an event or change in circumstances indicates that the carrying amount of the asset may not be recoverable. For long-lived assets to be held and used, the Company bases its evaluation on such impairment indicators as the nature of the assets, the future economic benefit of the assets and any historical or future profitability measurements, as well as other external market conditions or factors that may be present. If such impairment indicators are present or other factors exist that indicate that the carrying amount of the asset may not be recoverable, the Company determines whether impairment has occurred through the use of an undiscounted cash flows analysis of assets at the lowest level for which identifiable cash flows exist. If the carrying value of the asset or group of assets exceeds the undiscounted cash flows, impairment is deemed to have occurred, and the Company recognizes an impairment loss for the difference between the carrying amount and the estimated fair value of the asset. The fair value of the asset is estimated using a discounted cash flow analysis or other valuation techniques.
Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not forced liquidations or distress sales) between market participants on the measurement date.
The fair value hierarchy contains three levels as follows:
Level 1—Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.
Level 2—Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets in non-active markets; (3) inputs other than quoted prices that are observable for the asset or liability; and (4) inputs that are derived principally from or corroborated by other observable market data.
Level 3—Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management's estimates of market participant assumptions.
There were no transfers between categories during the periods presented.
The carrying amounts of the Company's financial instruments, which include cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximate their fair value as of December 31, 2014 and September 30, 2015, respectively.
Goodwill and Long-Lived Intangible Assets Impairment Tests
The Company assesses the carrying value of its goodwill on an annual basis, or more frequently if events or changes in circumstances indicate that such carrying value may not be recoverable. Other than its annual review, factors the Company considers important which could trigger an impairment review include under-performance of reporting units or changes in projected results, changes in the manner of utilization of the asset, a severe and sustained decline in the price of the Company's shares and negative market conditions or economic trends. For a discussion of the methodology and major assumptions employed in the Company's impairment testing, refer to the Company's Annual Report on Form 10-K filed with the SEC on March 5, 2015.
Impairment reviews as of December 31, 2014
In the annual impairment review performed as of December 31, 2014, the Company recorded non-cash impairment losses totaling $29.4 million related to Peretz goodwill. The decline in fair value of Peretz goodwill was due to revised estimates of future cash flows during the fourth quarter of 2014, primarily reflecting the revised expectations of the total TV advertising market, following reduced advertising demand and increased uncertainty in the medium-term, including uncertainties regarding the ultimate outcome of the Ukraine crisis and its impact on the Russian economy. The Company concluded that the estimated fair value of the CTC reporting unit was significantly in excess of its carrying amount as of December 31, 2014. Due to the revision of estimates of future cash flows in the impairment review as of December 31, 2014, the excess of fair value over the carrying amount of the Domashny reporting unit decreased to 15%.
Impairment reviews as of September 30, 2015
Overall, the market trading price of our common stock was down from $4.87 per share as of December 31, 2014 to $1.75 per share at September 30, 2015. In the nine months ended September 30, 2015, our capitalization dramatically decreased by 64%. As a result, as of September 30, 2015, our market capitalization amounted to $273,182, while our consolidated net book value (or shareholders' equity) amounted to $388,615. One of the most significant underlying reasons for the substantial decline in the market trading price of our common stock was likely the amendment to the Russian law "On Mass Media" and the perceived increase in the risk that we may not successfully achieve compliance with such requirements by the stated deadline.
Due to the significant decline in the market trading price of the Company's common stock and market capitalization during the nine months of 2015, the Company updated an interim analysis for impairment as of September 30, 2015. As described above (see— Fair value measurements ), in accordance with ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distress sale) between market participants at the measurement date under current market conditions. In determination of fair value of the Company's reporting units, the Company applied multiple valuation techniques by weighting indications of fair value resulting from the application of the going-concern-based present value technique and the market approach. All inputs used for fair value measurements were categorized within Level 3.
The most significant changes in assumptions used in the valuation of goodwill as of September 30, 2015 as compared to December 31, 2014 were as follows:
Cost of capital —The cost of capital reflects the return a hypothetical market participant would require for a long-term investment in an asset and can be viewed as a proxy for the risk of that asset. The Company calculates the cost of capital according to the Capital Asset Pricing Model using a number of assumptions, the most significant of which is a Country Risk Premium ("CRP"). The CRP reflects the excess risk to an investor of investing in markets other than the United States and generally fluctuates with expectations of changes in a country's macroeconomic environment. Additionally, changes in the financial markets, such as an increase in interest rates or an increase in the expected required return on equity by market participants within the industry, could increase the discount rate, thus decreasing the fair value of the assets. The cost of capital used by the Company in its analysis in 2014 ranged from 15.7% to 18.6% in 2014, and was 18.1% as of September 30, 2015.
Forecasted programming costs —The level of cash flow generated by each operation is ultimately governed by the extent to which the Company manages the relationship between revenues and costs. The Company forecasts the level of programming costs by reference to (a) the historical absolute and relative levels of costs the Company has incurred in generating revenue in each reporting unit and regional station, (b) the operating strategy of each business, (c) specific forecasted programming costs to be incurred and (d) expectations as to what these costs would be for an average market participant. The Company's estimates of forecasted programming costs are developed from a number of external sources, in combination with a process of on-going consultation with operational management. The forecasted programming costs for 2015 increased by approximately 11% compared with the estimates made at the time of the annual impairment review performed as of December 31, 2014.
As a result of the impairment review performed as of September 30, 2015, the Company concluded that the fair values of the CTC, Domashny and Peretz reporting units exceeded their carrying values. The excess of fair value over the carrying amount of the Peretz and Domashny reporting units amounted to 1% and 6%, respectively. The estimated fair values for CTC remained significantly in excess of their respective carrying amounts.
As of September 30, 2015, the carrying values of goodwill related to CTC, Domashny and Peretz totaled $25 million, $13 million and $4 million, respectively. In addition, as of September 30, 2015, the Company had significant balances of amortizable broadcasting licenses totaling $20 million, including CTC licenses—$3 million; Domashny licenses—$4 million, and Peretz licenses—$11 million.
In order to evaluate the sensitivity of the fair value calculations in our impairment analysis, we hypothetically applied 10 and 15 percentage points' decreases in the fair value of each reporting unit and broadcasting licenses.
Hypothetical impairment loss that could be recorded if fair value is lower by:
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Broadcasting licenses*
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Goodwill:
CTC goodwill
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Domashny goodwill
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Peretz goodwill
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Total
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*
pre-tax effect
The Company considers all current information in determining the need for or calculating the amount of any impairment charges; however, future changes in events or circumstances could result in decreases in the fair values of its intangible assets and goodwill.
Stock-based Compensation Expense
The Company estimates the fair value of equity awards at the date of grant using the Black-Scholes option pricing model. The Black-Scholes pricing model was originally developed for use in estimating the fair value of traded options, which have different characteristics than the Company's employee equity awards. The model is also sensitive to changes in subjective assumptions, which can materially affect the fair value estimate. These subjective assumptions include expected volatility, the expected life of the awards, future employee turnover rates, and future employee award exercise behavior. The Company determines the fair value of its common stock by using closing prices as quoted on the NASDAQ Global Select Market. Performance-based unvested share awards require management to make assumptions regarding the likelihood of achieving the set goals.
Once the Company has estimated the fair value of the equity instruments, it recognizes this estimated cost as stock-based compensation expense over the service period. Equity-based incentive awards that meet liability accounting criteria are remeasured at each reporting date at their fair value until settlement. The fair value of such unsettled equity-based incentive awards is recognized in liabilities.
Tax Provisions and Valuation Allowance for Deferred Tax Assets
Deferred income taxes result from temporary differences between the tax bases of assets and liabilities and the bases as reported in the consolidated financial statements, as well as the tax benefits of net operating loss carry-forwards which are expected to be realized. The Company records valuation allowances related to the tax effects of deductible temporary differences and loss carry- forwards when, in the opinion of management, it is more likely than not that the respective tax assets will not be realized. Changes in the Company's assessment of the probability of realization of deferred tax assets may affect the Company's effective income tax rate.
The Company records temporary differences related to investments in its Russian subsidiaries. These temporary differences consist primarily of undistributed earnings that the Company does not plan to permanently reinvest in operations outside the U.S. The Company estimates its tax positions based on its best judgment given the facts, circumstances, and information available at the reporting date. Change in facts and circumstances are recognized in the period in which the change occurs. As described in Note 8, as of September 30, 2015, the Company's income tax position was significantly affected by the one-off recognition of $40.2 million of deferred tax benefit resulting from the remeasurement of the Company's deferred tax liability in respect of unremitted earnings of its Russian subsidiaries. This remeasurement was triggered by a change in the Company's expectations for the US tax position due to expected sale transaction outlined in the Framework Agreement with UTH concluded in September 2015 (see Note 2).
The level of sophistication and expertise with respect to complex tax laws is continually evolving both on the part of tax professionals and the taxing authorities. The Company is a U.S. legal entity with substantially all of its operations outside the U.S., primarily in Russia. As a result, the Company's tax filing positions in the U.S. are substantially impacted by the Company's interpretation of tax law and how the Company applies it in determining U.S. taxes payable and deferred tax liabilities. While the Company believes it has made, and continues to make, reasonable judgments in determining its tax filing positions in each jurisdiction in which the Company is subject to tax, views may differ as to the determination of its tax obligations. These judgments may ultimately be subjected to examination by the tax authorities and further revisions may be required in the Company's estimates.
New and Recently Adopted Accounting Pronouncements
There have been no developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company's consolidated financial statements, from those disclosed in the Company's 2014 Annual Report on Form 10-K, except for the noted below.
In February 2015, the FASB issued Accounting Standards Update 2015-02, Consolidation (Topic 820): Amendments to the Consolidation Analysis ("ASU 2015-02"). ASU 2015-02 provides a revised consolidation model for all reporting entities to use in evaluating whether they should consolidate certain legal entities. The amendments, among other things, (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities, (2) eliminate the presumption that a general partner should consolidate a limited partnership and (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related-party relationships. These amendments are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the potential impact that these amendments will have on its consolidated financial statements.
In April 2015, the FASB issued Accounting Standards Update 2015-05, Intangibles—Goodwill and Other—Internal-Use Software ("ASU 2015-05"). ASU 2015-05 provides guidance to Subtopic 350-40, which will help entities to evaluate the accounting for fees paid by a customer in a cloud computing arrangement. Examples of cloud computing arrangements include software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements. These amendments are effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. The Company is currently assessing the potential impact that these amendments will have on its consolidated financial statements.
In May 2015, the FASB issued Accounting Standards Update 2015-08, Business Combination (Topic 805) ("ASU 2015-08"). ASU 2015-08 amends various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115. The adoption of this guidance is not expected to have a material effect on the Company's condensed consolidated balance sheet or results of operations.
In June 2015, the FASB issued Accounting Standards Update 2015-10, Technical Corrections and Improvements ("ASU 2015-10"). The amendments represent changes to clarify the Codificati |
