UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

 

 

FORM 10-K

 

 

Commission file number: 1-1969

Arbitron Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

142 West 57th Street

New York, New York 10019

(Address of principal executive offices) (Zip Code)

 

(212) 887-1300

(Registrant’s telephone number, including area code)

 

 

 

 

  Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ  No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes o  No þ

 

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, and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated file. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer þ          Accelerated Filer o          Non-Accelerated Filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No þ

 

The aggregate market value of the registrant’s common stock as of June 30, 2006, the last business day of the registrant’s most recently completed second fiscal quarter (based upon the closing sale price of Arbitron’s common stock as reported by the New York Stock Exchange on that date), held by nonaffiliates, was approximately $1,115,039,156.

 

Common stock, par value $0.50 per share, outstanding as of February 23, 2007: 29,740,333 shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III incorporates certain information by reference from the registrant’s definitive proxy statement for the 2007 annual meeting of stockholders, which proxy statement will be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2006.

 

TABLE OF CONTENTS

 

 

 

Arbitron owns or has the rights to various trademarks, trade names or service marks used in its radio audience measurement business and subsidiaries, including the following: the Arbitron name and logo, Arbitrends^sm, RetailDirect^®, RADAR^®, Tapscan^®, Tapscan WorldWide^®, LocalMotion^®, Maximi$er^®, Maximi$er^®Plus, Arbitron PD Advantage^®, SmartPlus^®, Arbitron Portable People Meter^tm, Marketing Resources Plus^®, MRP^sm, PrintPlus^tm, MapMAKER Direct^sm, Media Professional^®, Media Professional Plus^sm, Qualitap^sm, MediaMaster^sm, Prospector^sm, and Schedule-It^sm.

 

The trademarks Windows^®, Media Rating Council^® and Homescan^® referred to in this Annual Report on Form 10-K are the registered trademarks of others.

 

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The statements regarding Arbitron Inc. and its subsidiaries (“we,” “our,” “Arbitron” or the “Company”) in this document that are not historical in nature, particularly those that utilize terminology such as “may,” “will,” “should,” “likely,” “expects,” “anticipates,” “estimates,” “believes,” or “plans” or comparable terminology, are forward-looking statements based on current expectations about future events, which Arbitron has derived from information currently available to it. These forward-looking statements involve known and unknown risks and uncertainties that may cause our results to be materially different from results implied in such forward-looking statements. These risks and uncertainties include, in no particular order, whether we will be able to:

 

 

Additional important factors known to Arbitron that could cause actual results to differ materially from our forward-looking statements are identified and discussed from time to time in Arbitron’s filings with the Securities and Exchange Commission, including in particular the risk factors discussed under the caption “ITEM 1A. RISK FACTORS” in this Annual Report on Form 10-K.

 

The forward-looking statements contained in this document speak only as of the date hereof, and Arbitron undertakes no obligation to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Arbitron Inc., a Delaware corporation, was formerly known as Ceridian Corporation (“Ceridian”). Ceridian was formed in 1957; however, its predecessors began operating in 1912. Arbitron’s audience research business commenced in 1949. Arbitron’s principal executive offices are located at 142 West 57th Street, New York, New York 10019, and its telephone number is (212) 887-1300.

 

The terms “Arbitron” or the “Company” as used in this document refer to Arbitron Inc. and its subsidiaries.

 

Arbitron is an international media and marketing information services firm primarily serving radio, cable television, advertising agencies, advertisers, out-of-home media, online media and, through its Scarborough Research joint venture with The Nielsen Company, formerly known as VNU, Inc., broadcast television and print media. Arbitron currently provides four main services:

 

 

Arbitron provides radio audience measurement and related services in the United States to radio stations, advertising agencies and advertisers. Arbitron estimates the size and demographics of audiences of radio stations in local markets in the United States and reports these estimates and related data to its customers. This information is used for advertising transactions in the radio industry. Radio stations use Arbitron’s data to price and sell advertising time, and advertising agencies and advertisers use Arbitron’s data in purchasing advertising time.

 

Arbitron’s Radio All Dimension Audience Research (“RADAR”) service measures national radio audiences and the audience size and composition of network radio programs and commercials.

 

Arbitron provides software applications that give its customers access to Arbitron’s estimates resident in its proprietary database and enable the customers to more effectively analyze and understand that information for sales, management and programming purposes. Some Arbitron software applications also allow customers to access data proprietary to third parties, provided the customer has a separate license to use such third-party data.

 

In addition to its core radio ratings service, which provides primarily quantitative data such as how many people are listening, Arbitron also provides qualitative data on listeners, viewers and readers that contain detailed socioeconomic information and information regarding what the respondents buy, where they shop and what forms of media they use. Arbitron provides these qualitative measures of consumer demographics, retail behavior and media usage in local markets throughout the United States. Arbitron Cable provides qualitative audience information to the advertising sales organizations of local cable companies and national cable networks. Arbitron Out-of-Home provides these qualitative measurements to out-of-home media sales organizations.

 

Arbitron provides custom research services to companies that are seeking to demonstrate the value of their advertising.

 

The comScore Arbitron Online Radio Ratings, a service jointly developed by Arbitron and comScore Networks Inc., is a custom service that measures the national audience of online radio networks.

 

Through its CSW Research Limited (“Continental Research”) subsidiary, Arbitron provides media, advertising, financial, public-sector, telecommunications and Internet research services in the United Kingdom and elsewhere in Europe.

 

Arbitron has developed a Portable People Meter^tm system of audience measurement for commercialization in the United States and has entered into commercial agreements with a number of international media information services companies pursuant to which Arbitron has granted the companies a license to use its PPM^tm encoding technology in their audience measurement services in specific countries outside the United States.

 

Arbitron’s quantitative radio audience measurement services and related software have historically accounted for a substantial majority of its revenue. The radio audience measurement service and related software revenues represented approximately 86 percent of Arbitron’s total revenue in 2006 and 2005, and approximately 85 percent in 2004. Arbitron’s revenue from domestic sources and international sources was 96 percent and four percent, respectively, for the years ended December 31, 2006, 2005 and 2004. Additional information regarding revenues by service and by geographical area is provided in Note 19 in the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K.

 

Since 1965, Arbitron has delivered to the radio industry reliable and timely radio audience information collected from a representative sample of radio listeners. The presence of credible audience estimates in the radio industry has helped radio stations to price and sell advertising time, and advertising agencies and advertisers to purchase advertising time. The Arbitron ratings have also become a valuable tool for use in radio programming, distribution and scheduling decisions.

 

The consolidation of radio station ownership in the United States has led to a greater diversity of programming formats. As audiences have become more fragmented, advertisers have increasingly sought to tailor their advertising strategies to target specific demographic groups through specific media. The audience information needs of radio broadcasters, advertising agencies and advertisers have correspondingly become more complex. Increased competition and more complex information requirements have heightened the need of radio broadcasters for improved information management systems and more sophisticated means to analyze this information. In addition, there is a demand for high-quality radio audience information internationally from the increasing number of commercial, noncommercial and public broadcasters in other countries.

 

As the importance of reaching niche audiences with targeted marketing strategies increases, broadcasters, publishers, advertising agencies and advertisers increasingly require that information regarding exposure to advertising be provided on a more granular basis and that this information be coupled with more detailed information regarding lifestyles and purchasing behavior. The need to integrate purchase data information with advertising exposure information may create opportunities for innovative approaches to satisfy these information needs.

 

Arbitron provides cable television companies with qualitative information concerning consumer demographics and retail behavior of cable audiences and software applications.

 

Out-of-home media advertising companies have indicated a need for audience information to increase their revenues, particularly as this industry segment has expanded to introduce “place-based” media in new locations, such as malls, airports and cinemas. Audience information for advertisers in the out-of-home sector is minimal. In response to this need, Arbitron provides qualitative audience information, software programs and custom research studies that help show advertisers that out-of-home advertising is an effective way to reach the people who purchase advertisers’ products and services. Arbitron has been working with the out-of-home media industry to help them utilize consumer information services in selling their advertising.

 

Each of the services provided by Arbitron are discussed below:

 

Collection of Listener Data Through Diary Methodology.  Arbitron uses listener diaries to gather radio listening data from sample households in 299 U.S. local markets for which it currently provides radio ratings. Participants in Arbitron surveys are selected at random by telephone number. When participants (known as “diarykeepers”) agree to take part in a survey, they are mailed a small pocket-sized diary and asked to record their listening in the diary over the course of a seven-day period. Participants are asked to report in their diary the station(s) to which they are listening, when they are listening and where they are listening, such as home, car, work or other place. Although survey periods are 12 weeks long, no participant keeps a diary for more than seven days. Each diarykeeper receives a diary, instructions for filling it out and a small cash incentive. The incentive varies according to markets, and the range is generally $1.00 to $6.00 for each diarykeeper in the household and up to $10.00 in certain incentive programs for returned diaries. In addition to the diary incentives, follow-up letters and phone calls are used to maximize response rates. Diarykeepers mail the diaries to Arbitron’s operations center in Columbia, Maryland, where Arbitron conducts a series of quality control checks, enters the information into its database and produces periodic audience measurement estimates. Arbitron receives and processes more than 1.5 million diaries every year to produce its audience listening estimates. All markets are measured at least twice each year, and major markets are measured four times per year. Arbitron’s proprietary data regarding radio audience size and demographics are generally then provided to customers through multiyear license agreements.

 

Response Rates and Sample Proportionality.  One of the challenges in measuring radio listening is to ensure that the composition of survey respondents is representative of the market being measured. Arbitron strives to achieve representative samples. For example, if eight percent of the population of a given market is comprised of women aged 18 to 34, Arbitron targets that eight percent of the diarykeepers in the sample are women aged 18 to 34. Therefore, each diarykeeper’s listening should effectively represent not only the diarykeeper’s personal listening but also the listening of the demographic segment in the market overall. In striving to achieve representative samples, Arbitron provides enhanced incentives to certain demographic segments to encourage participation. In markets with high concentrations of Hispanic households, Arbitron also uses Spanish-language interviewers and materials to reach Spanish-speaking households.

 

It has become increasingly difficult and more costly to obtain consent from persons to participate in the surveys. Arbitron must achieve response rates sufficient to maintain confidence in its ratings, the support of the industry and accreditation by the Media Rating Council. Response rates are a quality measure of survey performance and an important factor impacting costs associated with data collection. Overall response rates have declined over the past several years. If response rates continue to decline further or if recruitment costs significantly increase, Arbitron’s radio audience measurement business could be adversely affected. Arbitron has committed extensive efforts and resources to address the decline of response rates.

 

Another measure often used by clients to assess quality in Arbitron’s surveys is proportionality, which refers to how well the distribution of the sample for any individual survey matches the distribution of the population in the market. In recent years, Arbitron’s ability to deliver good proportionality in its surveys among younger demographic groups has deteriorated, caused in part by the trend among some households to disconnect their landline phones, effectively removing these households from the Arbitron sample frame. Arbitron has conducted a number of research tests over the past two years addressing this issue, including calling cellular phones to place diaries. Arbitron expects to phase in cellular-phone-only households into the Arbitron sample frame beginning in 2008.

 

In March 2006, Arbitron announced a comprehensive set of initiatives to bolster response rates and improve sample proportionality among African-American, Hispanic, and young male respondents in Arbitron’s diary-based markets. These initiatives include providing for substantial increases in cash incentives and other survey treatments. Arbitron continues to research and test new measures to address these sample quality challenges.

 

Small Market Initiatives.  In May 2005, Arbitron announced a program designed to increase the stability of radio audience estimates in certain small markets by applying a quarterly rolling-sample approach to surveys covering 110 small markets. The goal of this program is to provide quality enhancements for Arbitron’s service in certain small markets and increase the reliability of reported data by reducing the fluctuations in audience estimates

from measurement period to measurement period. By combining the quarterly measurement of the related surveys, the sample size for analyzing audience demographics for these small markets will be increased without any increased cost to our customers. The first phase of this program was successfully implemented during the Fall 2005 survey, with all affected reports issued during the three months ended March 31, 2006. The result of these enhancements was 40-50% reduction in ratings share fluctuation. The second phase is scheduled to begin with the release of the Spring 2008 radio survey results. In the second phase, the surveys will be conducted by allocating the placement of diaries evenly over a 12 month period. Audience estimates will then be reported in four reports per year based on the most recent 12 months of sample.

 

Quality Improvement Initiatives.  Arbitron invests in quality improvements for its radio audience measurement service. Current quality improvement initiatives include the following:

 

 

In 2006, quality initiative improvements included the following:

 

 

Portable People Meter Ratings Service.  For several years, Arbitron has pursued a strategy of evolving its data collection business from diaries, which are mostly completed by hand and returned by mail from respondents, to portable electronic measurement devices, which passively provide measurement services without additional manual effort by the respondents beyond carrying or wearing the meter. This strategy has been pursued to improve quality by taking advantage of new technological capabilities and to address the vast increase in media delivery vehicles, both inside and outside of the home.

 

Arbitron has developed a PPM system capable of measuring radio, broadcast television, cable television, Internet broadcasts, satellite radio and television audiences, and retail store video and audio broadcasts. The PPM device is a small mobile phone-sized device that is worn or carried by a survey participant throughout the day. It automatically detects inaudible codes that radio, broadcast television, cable television, Internet and satellite radio and satellite television providers embed in the audio portion of their programming, using encoders provided by Arbitron. These proprietary codes identify the media to which a participant is exposed throughout the day without the person having to engage in manual recording activities. At the end of each day, the PPM device is placed into a base station that recharges the device and sends the collected codes to Arbitron for tabulation.

 

In addition to using the encoding and decoding capabilities of the PPM system, Arbitron is also exploring the use of audio matching as a means to measure listening to stations that are not encoded with the PPM system. Audio matching collects audio signatures for any broadcast a PPM respondent is exposed to, which are later matched to signatures collected by an in-market monitoring system.

 

There are several advantages of the PPM system. It is simple and easy for respondents to use. It requires no button pushing, no recall and no effort to identify and write down channels or radio stations tuned to by respondents. The PPM system is able to passively detect exposure to encoded media by identifying each source through unique identification codes. The PPM system will help support the media industry’s increased focus on accountability to advertisers for the investments made by advertisers. It will help to shorten the time period between when advertising runs and when audience delivery is reported, and will provide multimedia measurement from the same respondent. Since the PPM system panels have larger weekly and monthly samples, more stable trends are expected. In addition, the PPM technology is capable of measuring new digital platforms, time-shifted broadcasts and retail, sports and music venues. The PPM technology may potentially be used to measure out-of-home media, print, commercials and entertainment audio, such as movies and video games.

 

After conducting its first market trial of the PPM system in Manchester, England, in 1999, Arbitron conducted a market trial in Wilmington, Delaware, in 2000 and 2001. In late 2001 through 2003, Arbitron conducted a market trial for the television and radio markets in Philadelphia, Pennsylvania.

 

In late 2004, Arbitron began recruiting consumers to participate in a market demonstration utilizing PPM technology to be conducted in Houston, Texas. More than 100 media outlets were encoded (including radio, broadcast television and cable television) as well as top retailers, including Kroger, Best Buy^tm and Gallery Furniture. In September 2005, Arbitron released the first data from this demonstration. Arbitron achieved a number of sample quality performance targets, including recruitment of a representative panel, particularly across ethnic and language usage segments. Arbitron continues to work on improving the performance of recruitment and the daily cooperation rates of young males, African-Americans and Hispanics.

 

In July 2005, the results of a PPM economic impact study were released by the Radio Advertising Bureau (“RAB”). This study, led by the RAB and funded by Arbitron, reported on the potential impact to the radio industry of electronic measurement and a move from diaries to the PPM service for radio audience measurement. The results of the study indicated that advertising expenditures associated with the radio industry would likely increase with a fully deployed PPM electronic ratings system and decrease with a continuation of the existing diary system of radio audience measurement.

 

In May 2000, Arbitron entered into an agreement with Nielsen Media Research, Inc. (“NMR”), a subsidiary of The Nielsen Company and a provider of U.S. television and cable audience measurement services, under which Arbitron granted NMR an option to join Arbitron in the potential commercial deployment of PPM audience measurement in the United States, for both the television and radio industries, and under which the costs of such commercialization would be shared with NMR. On March 1, 2006, Arbitron announced that NMR did not exercise its option and the option was terminated.

 

Arbitron currently is concentrating its efforts on previously announced plans to create a PPM ratings service for radio. Through its custom research services, Arbitron is exploring applications of PPM data, including nonratings programming, marketing and out-of-home services for broadcast television and cable television. Arbitron is also exploring providing services for companies that sell advertising on in-store (retail) media. On March 14, 2006, Arbitron announced that it would begin the rollout of the PPM ratings service as its radio ratings service in the top 50 markets in the United States. Under the Company’s current rollout schedule, which it updated in November 2006, PPM ratings service is expected to be introduced into the top 10 radio markets by the fall of 2008 and into all of the top 50 radio markets two to three years thereafter.

 

On May 18, 2006, Arbitron announced that CBS Radio, which is one of the largest major-market operators in the United States and in 2006 represented approximately nine percent of Arbitron’s revenue, had entered into a seven-year agreement for PPM radio ratings when the new audience ratings technology is deployed in the CBS Radio markets encompassing in Arbitron’s previously announced PPM service rollout plan. In addition to CBS Radio, more than 10 other radio broadcasters have recently signed long-term contracts to use the PPM service if

Arbitron deploys the PPM service for commercial use. These broadcasters, and the market(s) for which they signed, accounted for more than 40 percent of the total radio advertising dollars in the top 12 U.S. markets in 2005 (the latest annual figures available).

 

To date, Arbitron has signed contracts with a number of national and regional advertising agencies to use the PPM service, if Arbitron deploys the PPM service for commercial use. These agencies accounted for more than 90 percent of the national advertising dollars spent on radio advertising in 2005 (the latest annual figures available).

 

Although additional milestones remain and there is the possibility that the pace of commercialization of the PPM ratings service could be slowed, Arbitron believes that the PPM ratings service represents a significant enhancement to and a viable replacement for its diary-based ratings service in major radio markets, and is an essential component of the Company’s future growth. If the pace of the commercialization of the PPM ratings service is slowed, revenue increases that Arbitron expects related to the service will also be delayed.

 

Commercialization of the PPM ratings service will require a substantial financial investment. The Company believes it has sufficient cash and short-term investments as well as access to the 2006 Credit Facility to fund such requirements. The Company currently estimates that the aggregate capital expenditure associated with PPM ratings service commercialization for audience ratings measurement will be approximately $25.0 million over the first two to three years of commercialization. Arbitron also anticipates that, over the same period, its results of operations will be materially negatively impacted as a result of the rollout of this PPM ratings service. Ultimately, however, the Company believes that, while commercialization of PPM ratings service will have a near-term negative impact on the Company’s results of operations, its operating margins can be restored through the completion of the PPM transition process in the top 50 radio markets, although there can be no assurance that this will be the case.

 

The amount of capital required for deployment of the PPM ratings service and the impact of the rollout on the Company’s results of operations will be greatly affected by the speed with which the radio industry requests the PPM ratings service and the timing of the rollout. If the radio industry is slow to accept the PPM ratings service, as opposed to the use of diaries or some other competing alternative, then it will take longer to roll out the commercialization of the PPM ratings service, and the costs associated with that deployment will be delayed. On the other hand, if the radio industry asks for electronic measurement sooner rather than later and if Arbitron is able to accommodate such request, Arbitron’s capital needs will accelerate, and the near-term negative impact on the Company’s results of operations will be more significant.

 

In June 2005, Clear Channel Communications, Inc. (“Clear Channel”), which is the largest owner of radio stations in the United States and represented approximately 19 percent of Arbitron’s revenue in 2006, announced that it was issuing a Request for Proposals to create a “state-of-the-art” radio ratings system to replace the current diary measurement system to which it subscribes. This process is ongoing. Clear Channel has organized a cross-industry evaluation committee to review the proposals and this committee is expected to report on its findings in early 2007.

 

On February 9, 2007, The Media Audit/Ipsos announced that they will receive funding from a number of broadcasters to test their competing electronic ratings system in the Houston market. See “Legal Proceedings” in Item 3 of this Form 10-K for a description of Arbitron’s patent infringement lawsuit against The Media Audit/Ipsos.

 

Portable People Meter Service — 2007 Developments.  Philadelphia became the first radio market to be electronically measured in January 2007. After two months of pre-currency measurement, the March PPM-based ratings will become the currency for radio advertising transactions in Philadelphia. On January 29, 2007, Arbitron announced that the Media Rating Council (“MRC”) had accredited the PPM radio ratings data in Houston. Houston had been Arbitron’s radio and television demonstration market for the Portable People Meter since mid-2005. Arbitron previously committed to achieving accreditation prior to commercialization in that market. Arbitron is committed to pursuing MRC accreditation of the PPM methodology as it is deployed in all PPM markets.

 

Portable People Meter Service — International.  Arbitron has entered into commercial agreements with a number of international media information services companies pursuant to which Arbitron has granted the companies a license to use its PPM encoding technology in their audience measurement services in specific countries outside the United States. Use of the PPM service continues to increase internationally. It is currently

being used in seven countries. On March 24, 2006, Arbitron announced that TNS Inc. (“TNS”), a PPM service licensee, signed a five-year contract with the Kazakhstan television Joint Industry Committee to provide trading currency television audience measurement using Arbitron’s PPM system. TNS and the Steadman Group also announced plans to provide industry audience measurement for radio, television and print to Kenya.

 

On May 18, 2006, Arbitron announced that RAJAR (Radio Joint Audience Research Limited), the industry radio ratings consortium for the United Kingdom, in combination with BARB (Broadcaster’s Audience Research Board), the joint industry committee responsible for television audience measurement in the United Kingdom, selected Arbitron’s PPM system for an electronic radio and television audience measurement demonstration panel in London, a market of more than six million persons. This two-year panel will operate in parallel to the current ratings systems in the United Kingdom and the data will be analyzed separately.

 

In December 2006, TNS Gallup was awarded contracts to measure television audiences in Denmark and Norway using the PPM encoding technology.

 

These international licenses are not currently a material part of Arbitron’s business.

 

National Marketing Panel Service (“Project Apollo”).  On February 1, 2007, Arbitron announced the formation of a jointly owned limited liability company with NMR, named Project Apollo LLC (the “LLC”). The LLC was formed to complete the development and testing of the Project Apollo marketing research service and the expansion of the pilot panel to a full national service, if the test results meet expectations and generate marketplace support. Following this development and testing and prior to the expansion of the pilot panel to a full national service, either Arbitron or NMR may exercise an option to terminate the LLC. The objective of this service is to provide multimedia exposure data combined with sales data from a single source to produce a measure of advertising effectiveness for advertisers, agencies and broadcasters in order to correlate advertising with shopping behavior and sales. Since April 2005, Arbitron and The Nielsen Company have shared costs and capital expenditures associated with the development and deployment of a pilot panel to demonstrate the national market research service. In January 2006, Arbitron announced that a pilot panel of more than 5,000 households and 11,000 people had been installed as part of the demonstration process. The following seven advertisers, which in the aggregate spent more than $6.8 billion on advertising on U.S.-measured media in 2005 (the latest annual figures available), are collaborating with the LLC: Kraft, Pepsi, Pfizer, Procter & Gamble, SC Johnson, Unilever and Wal-Mart. These companies have each signed an agreement to receive Project Apollo pilot panel data.

 

AC Nielsen (US) Inc., an affiliate of NMR, has entered into an agreement with the LLC to permit the LLC to use its Homescan Panel and certain other data and recruit panelists, tabulate data, and provide related services. Arbitron has entered into an agreement with the LLC under which Arbitron will license PPM data and equipment to the LLC and provide other data collection and transmission services.

 

This innovative service would consist of a panel of participants, each of whom would receive incentives to carry Arbitron’s PPM device, which would collect the participants’ exposure to multiple media sources. Data on consumer preferences and purchases with respect to a wide range of services and products would also be collected from panelists, electronically and through surveys, with the expectation of using households from The Nielsen Company’s ACNielsen Homescan consumer panel, which currently tracks packaged-goods purchases. Data would be collected in aggregate form to provide an understanding of participants’ media interactions and their resulting shopping and purchasing behavior. The ultimate objective would be to provide advertisers with an enhanced ability to determine the return on investment for their marketing efforts.

 

The World Federation of Advertisers, a worldwide network of 55 National Advertiser Associations located on five continents and including over 40 of the world’s top 100 advertisers, has officially endorsed the development of Project Apollo in the United States. The national marketing research service is a new service, however, for which market acceptance is not yet known. This service would require substantial additional expenditures if it ultimately proves to be a viable commercial service. During the year ended December 31, 2006, the Company incurred approximately $8.9 million of net expenditures relating to the national marketing panel pilot. If a decision is made to commercialize this service, substantial additional expenditures would be incurred during the next few years.

 

Since the pilot program for the national marketing service is in progress and customer response is preliminary, it is not yet possible to provide a meaningful assessment of future costs associated with a potential

commercialization of this service. However, the same general cost pattern would apply as with the PPM ratings service, which is that substantial costs would have to be incurred in advance of revenues. This would result in a materially negative impact on results of operations in the first three to four years of commercialization.

 

Radio Market Report and Other Data Services.  Arbitron’s listening estimates are provided in a number of different reports that are published and licensed to its customers. The cornerstone of Arbitron’s radio audience measurement services is the Radio Market Report, which is available in all local markets for which Arbitron currently provides radio ratings. The Radio Market Report provides audience estimates for those stations in a market that meet Arbitron’s Minimum Reporting Standards. The estimates cover a wide variety of demographics and dayparts, which are the time periods for which audience estimates are reported. Each Radio Market Report contains estimates to help radio stations, advertising agencies and advertisers understand who is listening to the radio, which stations they are listening to, and the time and location of the listening.

 

Arbitron licenses its respondent-level database through Maximi$er and Maximi$er Plus, which are services for radio stations, and Media Professional and Media Professional Plus, which are services for advertising agencies and advertisers. Arbitron’s respondent-level database allows radio stations, advertising agencies and advertisers to customize survey areas, dayparts, demographics and time periods to support targeted marketing strategies. The Maximi$er service includes a Windows-based application to access a market’s entire radio diary database on a client’s personal computer. Radio stations use the Maximi$er service to produce information about their station and programming not available in Arbitron’s published Radio Market Reports. The Maximi$er Plus service allows radio stations to access Arbitron’s National Regional Database (“NRD”) to analyze ratings information for customer-defined groupings of stations in multiple markets and counties. The Media Professional service is designed to help advertising agencies and advertisers plan and buy radio advertising time quickly, accurately and easily. These services integrate radio planning and buying into one comprehensive research and media-buying tool. It allows advertising agencies and advertisers to uncover key areas critical to the buying process, including determining the most effective media target, understanding market trends and identifying potential new business. The Media Professional Plus service allows advertising agencies and advertisers to access Arbitron’s NRD to create custom geographies and trade areas using radio Metro, television DMA and/or county information. Media Professional Plus also provides the data on a specific trading area’s cost per point needed to help advertising agencies and advertisers place more efficient media buys.

 

In addition to the licensing above, Arbitron is offering third-party software providers and customers a license to use proprietary software that will enable enhanced access to Arbitron’s respondent level data.

 

In May 2005, Arbitron announced a program designed to increase the stability of radio audience estimates in certain small markets by applying a quarterly rolling-sample approach to surveys covering 110 small markets. The goal of this program is to provide quality enhancements for our service in certain small markets and increase the reliability of reported data by reducing the fluctuations in audience estimates from measurement period to measurement period. By combining the quarterly measurement of the related surveys, the sample size for analyzing audience demographics for these small markets will be increased without any increased cost to our customers. The first phase of this program was successfully implemented during the Fall 2005 survey, with all affected reports issued during the three months ended March 31, 2006. The result of these enhancements was a 40 to 50 percent reduction in ratings share variation. The second phase is scheduled to begin with the release of the Spring 2008 radio survey results. In the second phase, the surveys will be conducted by allocating the placement of diaries evenly over a 12-month period. Audience estimates will then be reported in four reports per year, up from the current two reports per year, with each report based on the most recent 12 months of sample.

 

In addition to the Radio Market Report, Arbitron provides a range of ancillary services that includes Radio County Coverage Reports, Hispanic Radio Data and Black Radio Data.

 

RADAR.  The RADAR service provides a measurement of national radio audiences and the audience size of network radio programs and commercials. The audience measurements are provided for a wide variety of demographics and dayparts for total radio listening and for 56 separate radio networks.

 

Network audience estimates are created by merging the radio listening of selected survey respondents with the actual times that network programs and commercials are aired on each affiliated station. RADAR estimates are

delivered through Arbitron’s PC 2010 software application, which includes a suite of products for sophisticated analysis of network audiences. This service is provided to radio networks, advertising agencies and network radio advertisers.

 

Since 2003, the RADAR survey sample has continually increased from 50,000 Arbitron diaries to an anticipated survey sample of 125,000 Arbitron diaries by March 2007.

 

In addition to its reports, Arbitron licenses software applications that provide access to Arbitron audience estimates resident in its proprietary database. These applications enable customers to more effectively analyze and understand that information for sales, management and programming purposes. These services also help customers to further refine sales strategies and compete more effectively for advertising dollars. Some Arbitron software applications also allow customers to access data proprietary to third parties, provided the customer has a separate license to use such third-party data.

 

Arbitron’s Tapscan family of software solutions is used by many radio stations, advertising agencies and advertisers. The Tapscan software is one of the advertising industry’s leading radio analysis applications. It can help create illustrative charts and graphs that make complex information more useful to potential advertisers. Other features include prebuy research, including frequency-based tables, cost-per-point analysis, hour-by-hour and trending, use of respondent-level data, automatic scheduling and goal tracking, instant access to station format and contact information. Another Tapscan service, Qualitap, is also made available to television and cable outlets in the United States under a licensing arrangement with Marketron International, Inc.

 

The MapMAKER Direct service analyzes where the radio audience lives, and works to provide detailed maps and reports. Program directors can use this service to better understand their listeners and better target their promotional efforts. Arbitron’s PD Advantage service offers radio station program directors the ability to create a variety of reports that help analyze the market, the audience and the competition.

 

Arbitron’s SmartPlus service, formerly known as Marketing Resources Plus, provides media buying software systems, including the SmartPlus software, to local and regional advertising agencies for broadcast and print media.

 

Arbitron’s Integrated Radio Systems service, also referred to as IRS, provides software systems that help radio stations manage their advertising sales process and automate the daily tasks in a sales department. The Integrated Radio Systems applications combine a customer relationship management system with scheduling and research applications and with inventory/pricing management tools.

 

In its radio ratings service, Arbitron provides primarily quantitative data, such as how many people are listening. Arbitron also provides qualitative data, such as consumer and media usage information, to radio stations, cable companies, television stations, out-of-home media, magazine and newspaper publishers, advertising agencies and advertisers. The qualitative data on listeners, viewers and readers provide more detailed socioeconomic information and information on what respondents buy, where they shop and what forms of media they use. Arbitron provides these measurements of consumer demographics, retail behavior and media usage in 276 local markets throughout the United States.

 

Arbitron provides qualitative services tailored to fit a customer’s specific market size and marketing requirements:

 

 

Each service profiles a market, the consumers and the media choices in terms of key characteristics. These services cover the major retail and media usage categories. Arbitron provides training and support services that help its customers understand and use the local market consumer information that Arbitron provides.

 

Scarborough Report.  The MRC-accredited Scarborough service is provided through a joint venture between Arbitron and SRDS, Inc., a subsidiary of The Nielsen Company. Although Arbitron’s interest in the Scarborough Research joint venture is 49.5 percent, partnership voting rights and earnings are divided equally between Arbitron and SRDS, Inc. The Scarborough service provides detailed information about media usage, retail and shopping habits, demographics and lifestyles in 80 large United States markets, utilizing a sample of consumers in the relevant markets. Scarborough data feature more than 1,700 media, retail and lifestyle characteristics, which can help radio stations, television stations, cable companies, advertising agencies and advertisers, newspaper and magazine publishers and out-of-home media companies provide an in-depth profile of their consumers. Examples of Scarborough categories include retail shopping (e.g., major stores shopped or purchases during the past 30 days), auto purchases (e.g., plan to buy new auto or truck), leisure activities (e.g., attended sporting event) and personal activities (e.g., golfing). Media information includes broadcast and cable television viewing, radio listenership, newspaper readership by section, magazine readership and yellow pages usage. This information is provided twice each year to newspapers and magazines, radio and television broadcasters, cable companies, out-of-home media, advertising agencies and advertisers in the form of the Scarborough Report. Arbitron is the exclusive marketer of the Scarborough Report to radio broadcasters, cable companies and out-of-home media. Arbitron also markets the Scarborough Report to advertising agencies and advertisers on a shared basis with Scarborough Research. Scarborough Research markets the Scarborough Report to newspapers, magazines and online service providers. NMR markets the Scarborough Report to television broadcasters.

 

Scarborough Mid-Tier Local Market Consumer Study.  The Scarborough Mid-Tier Local Market Consumer Study is also provided through the Scarborough joint venture between Arbitron and SRDS, Inc. This service provides information about media usage, retail and shopping habits, demographics and lifestyles in three mid-sized markets in 2007, utilizing a survey sample of adult consumers age 18 and above in the relevant markets. This survey information is collected through a single consumer questionnaire. The survey period is a point-in-time measurement that lasts six to eight weeks. Arbitron is the exclusive marketer of the Scarborough Mid-Tier Local Market Consumer Study to radio broadcasters, cable companies, and out-of-home media. Arbitron also markets the Scarborough Mid-Tier Local Market Consumer Study to advertising agencies and advertisers on a shared basis with Scarborough Research. Scarborough Research markets the Scarborough Mid-Tier Local Market Consumer Study to newspapers, magazines and online service providers. NMR markets the Scarborough Mid-Tier Local Market Consumer Study to television broadcasters.

 

RetailDirect Service.  Arbitron’s RetailDirect service is a locally oriented, purchase data and media usage research service provided in 20 midsized United States markets. This service, which utilizes diaries and telephone surveys, provides a profile of the audience in terms of local media, retail and consumer preferences so that local radio and television broadcasters, out-of-home media and cable companies have information to help them develop targeted sales and programming strategies. Retail categories include automotive, audio-video, furniture and appliances, soft drinks and beer, fast food, department stores, grocery stores, banks and hospitals. Media usage categories include local radio, broadcast television, cable networks, out-of-home media, newspapers, yellow pages and advertising circulars.

 

Qualitative Diary Service/LocalMotion Service.  Arbitron’s Qualitative Diary Service collects consumer and media usage information from Arbitron radio diarykeepers in 176 smaller United States markets. The same people who report their radio listenership in the market also answer more than 28 demographic, product and service questions. Consumer behavior information is collected for key local market retail categories, such as automotive sales, grocery, fast food, furniture and bedding stores, beer, soft drinks and banking. The Qualitative Diary Service also collects information about other media, such as television news viewership, cable television viewership, out-of-home media exposure and newspaper readership. This qualitative service provided for cable television companies is known as LocalMotion.

 

Arbitron provides its local market consumer information services to media other than radio, including cable television. Feedback from Arbitron’s cable customers suggests that the cable industry is in need of improved local measurement systems because current quantitative measurement methods, such as diaries and television meter-based measurement systems, have not provided adequate depth of demographic information on cable network audiences. Without solid measures of demographic audiences at the local market level, cable may not be achieving its full potential of local and national advertising revenues. In response to this need, Arbitron Cable provides cable companies with qualitative audience information and software programs concerning consumer demographics and retail behavior of cable audiences.

 

Arbitron provides its local market consumer information services to out-of-home media companies. This industry has expanded to introduce “place-based” media in new locations, such as malls, airports and cinemas. Arbitron is working with the out-of-home media industry to help them utilize consumer information services in selling its advertising. Arbitron seeks to use the expertise and resources from its many years of audience measurement to assist out-of-home media companies and their advertisers to identify and reach their audiences.

 

Arbitron is in the process of expanding its custom research efforts to serve companies who are seeking to demonstrate the value of their advertising propositions. For example, Arbitron has provided custom research services for subscribers including satellite radio, multicultural broadcasters with Chinese-language programming, sports play-by-play broadcasters, digital out-of-home and place-based media companies and cable multiple system operators.

 

The comScore Arbitron Online Radio Ratings, a service jointly developed by Arbitron and comScore Networks Inc., is a custom service that measures the national audience of online radio networks.

 

Through its custom research services, Arbitron is exploring applications of PPM data, including nonratings programming, marketing and out-of-home services for broadcast television and cable television. Arbitron is also exploring providing services for mobile media and companies that sell advertising on in-store (retail) media.

 

CSW Research Limited (“Continental Research”)

 

Through its Continental Research subsidiary, Arbitron provides media, advertising, business-to-business, public sector, telecommunications and Internet research services in the United Kingdom and elsewhere in Europe.

 

Media.  Continental Research’s media clients cover the full spectrum of traditional and new media, with particular strength in the digital television and radio markets. Its media services include measuring audiences, evaluating existing services and building forecasting models.

 

Advertising.  Continental Research evaluates every stage of the advertising process: from strategy development, creative development, precampaign testing, pre- and post-advertising and tracking and on-air coincidental studies, to analysis of those responding to the campaign and consumers who purchased the advertised products.

 

Business-to-Business.  Continental Research’s experience in business-to-business research ranges from new product development to market measurement to advertising tracking. Continental Research has produced its Business Omnibus study every month since 1993, which covers the whole United Kingdom business market. When conducting financial research and other business and consumer studies, Continental Research uses The Million Plus Panel, which comprises a pool of approximately 3.7 million United Kingdom residents and contains up to 3,000 demographic, lifestyle and purchasing details for each resident.

 

Public Sector.  Continental Research’s public sector services provide surveys for central and local governments and individual government departments and regulatory bodies. Continental Research designs cost-effective,

targeted studies that provide government departments with information regarding their initiatives to become more customer-focused.

 

Telecommunications and Internet.  Continental Research’s telecommunications and Internet projects have ranged from local area markets to multinational markets and have examined pricing, promotion, billing, product differentiation, advertising effectiveness, distribution systems, customer satisfaction, market estimation and new product development research.

 

Mexico

 

During 2006, the Arbitron syndicated radio audience measurement service provided audience estimates covering a wide variety of demographics and dayparts for the three largest radio markets in Mexico: Mexico City, Guadalajara and Monterrey. This service also provided qualitative information concerning consumer and media usage in Mexico. In February 2007, Arbitron announced that it would discontinue its service in Mexico after the delivery of the Fall 2006 survey in February 2007.

 

Arbitron’s objectives are to grow its radio audience measurement business and to expand its information services to a broader range of media types, including broadcast television, cable, out-of-home media, satellite radio and television, Internet broadcasts and mobile media. Key elements of Arbitron’s strategy to pursue these objectives include:

 

 

Arbitron’s customers are primarily radio stations, radio networks, cable companies, advertising agencies and corporate advertisers. As of December 31, 2006, Arbitron provided its radio audience measurement and related services to approximately 4,600 radio stations and 2,100 advertising agencies and advertisers nationwide under

contracts that generally vary in length from one to seven years. Clear Channel Communications, Inc. and CBS Radio, represented approximately 19 percent and nine percent, respectively, of Arbitron’s revenue in 2006. The consolidation of United States radio broadcasters in the 1990s has led to the increased concentration of Arbitron’s customer base. Although this consolidation could put pressure on the pricing of Arbitron’s radio ratings service, it has also contributed to an increase in the number of stations subscribing to the ratings service, as stations have become Arbitron customers upon their acquisition by larger broadcasting groups. It has also been Arbitron’s experience that stations that are part of larger broadcasting groups are somewhat more likely to purchase Arbitron’s analytical software applications and other services in addition to the Radio Market Report. Furthermore, Arbitron believes that it is well positioned to provide new products and services to meet the emerging needs of broadcasting groups.

 

As of December 31, 2006, Arbitron provided its qualitative measurement and related services to 79 cable systems and 91 out-of-home media customers.

 

Arbitron markets its products and services in the United States through a direct sales force that consisted of 72 sales account managers and 43 training service consultants, as of December 31, 2006.

 

Arbitron has entered into a number of agreements with third parties to assist in marketing and selling its products and services in the United States. For example, Marketron International, Inc. distributes, on an exclusive basis, Arbitron’s Qualitap software to television and cable outlets in the United States.

 

Arbitron supports its sales and marketing efforts through the following:

 

 

Internationally, Arbitron markets services through approximately 18 research executives operating through Continental Research’s office in the United Kingdom.

 

Arbitron has also continued its international sales and marketing efforts in other areas, such as Mexico, Europe and the Asia/Pacific regions.

 

Arbitron believes that the principal competitive factors in its markets are the credibility and reliability of the audience research, the ability to provide quality analytical services for use with the audience information and the end-user experience with services and price.

 

Arbitron is a leader in the radio audience measurement business. Arbitron competes in the radio audience measurement business in some small markets with Eastlan Resources, a privately held research company. In Mexico, Arbitron competes in the radio audience measurement business with INRA International Research Mexico. Arbitron is also aware of at least five companies, Liechti AG / Telecontrol AG, GfK Eurisko, The Media Audit (a division of International Demographics, Inc.), Ipsos SA and AGB Nielsen Media Research, that are developing technologies that could compete with Arbitron’s PPM service.

 

Arbitron competes with a large number of other providers of applications software, qualitative data and proprietary qualitative studies used by broadcasters, cable companies, advertising agencies, advertisers, and out-of-home media companies. These competitors include STRATA Marketing Inc., Telmar Information Services Corp., Marketron Inc., Interactive Media Systems, Wicks Broadcast Solutions, LLC and Donovan Data Systems in the area of applications software, and The Media Audit (a division of International Demographics, Inc.), Mediamark Research Inc. (a subsidiary of GfK AG) and Simmons Market Research Bureau (a subsidiary of Experian Marketing Solutions) in the area of qualitative data.

 

Arbitron’s Continental Research subsidiary operates in a highly competitive custom research market in the United Kingdom.

 

In June 2005, Clear Channel announced that it was issuing a Request for Proposals to create a state-of-the-art radio ratings system to replace the current diary measurement system to which it subscribes. This process is ongoing. Clear Channel has organized a cross-industry evaluation committee to review the proposals and this committee is expected to report on its findings in early 2007.

 

On February 9, 2007, The Media Audit/Ipsos announced that they will receive funding from a number of broadcasters to test their competing electronic ratings system in the Houston market. See “Legal Proceedings” in Item 3 of this Form 10-K for a description of Arbitron’s patent infringement lawsuit against The Media Audit/Ipsos.

 

Arbitron’s intellectual property is, in the aggregate, of material importance to its business. Arbitron relies on a combination of patents, copyrights, trademarks, service marks and trade secret laws, license agreements and other contractual restrictions to establish and protect its proprietary rights in its products and services. As of December 31, 2006, in the United States, Arbitron had been granted 24 patents and had 39 patent applications pending. Internationally, Arbitron had been granted 106 patents and had 135 patent applications pending as of December 31, 2006. Arbitron’s patents primarily relate to its data collection and processing systems and software and its PPM service. Several patents relating to the PPM service, which expire at various times beginning in 2012, when viewed together are of material importance to the Company’s business.

 

Arbitron’s audience listening estimates are original works of authorship and are copyrightable under the federal copyright laws in the United States. The Radio Market Report is published either quarterly or semiannually, depending on the Arbitron market surveyed, while the Radio County Coverage Report is published annually. Arbitron seeks copyright registration for each Radio Market Report and for each Radio County Coverage Report published in the United States. Arbitron also seeks copyright protection for its proprietary software and for databases comprising the Radio Market Report and other services containing its audience estimates and respondent-level data. Prior to the publication of the Arbitron reports and release of the software containing the respondent-level data, Arbitron registers its databases under the United States federal copyright laws. Arbitron’s proprietary data regarding audience size and demographics are provided to customers generally through multiyear license agreements.

 

A number of Arbitron’s services are marketed under United States federally registered trademarks that are helpful in creating recognition in the marketplace. Some of Arbitron’s registered trademarks and service marks

include: the Arbitron name and logo, Maximi$er, RetailDirect and RADAR. The Arbitron name and logo is of material importance to the Company’s business. Arbitron has a trademark application pending for Arbitron PPM. Arbitron also has a number of common-law trademarks, including Media Professional, Qualitap, MediaMaster and Prospector. Arbitron has registered its name as a trademark in the United Kingdom, Mexico, the European Union, Australia, Singapore, Chile, and Japan and is exploring the registration of its marks in other foreign countries.

 

The laws of some countries might not protect Arbitron’s intellectual property rights to the same extent as the laws of the United States. Effective patent, copyright, trademark and trade secret protection may not be available in every country in which Arbitron markets or licenses its products and services.

 

Arbitron believes its success depends primarily on the innovative skills, technical competence, customer service and marketing abilities of its personnel. Arbitron enters into confidentiality and assignment-of-inventions agreements with substantially all of its employees and enters into nondisclosure agreements with its suppliers and customers to limit access to and disclosure of its proprietary information.

 

Arbitron must protect against the unauthorized use or misappropriation of its audience estimates, databases and technology by third parties. There can be no assurance that the copyright laws and other statutory and contractual arrangements Arbitron currently depends upon will provide it sufficient protection to prevent the use or misappropriation of its audience estimates, databases and technology in the future. The failure to protect Arbitron’s proprietary information, intellectual property rights and, in particular, its audience estimates and databases could severely harm Arbitron’s business.

 

In addition, claims by third parties that Arbitron’s current or future products or services infringe upon their intellectual property rights may harm Arbitron’s business. Intellectual property litigation is complex and expensive, and the outcome of this litigation is difficult to predict. Arbitron has been involved in litigation relating to the enforcement of its copyrights covering its radio listening estimates and patents covering its proprietary technology. Although Arbitron has generally been successful in these cases, there can be no assurance that the copyright laws and other statutory and contractual arrangements Arbitron currently depends upon will provide it sufficient protection to prevent the use or misappropriation of its audience estimates, databases and technology in the future. Litigation, regardless of outcome, may result in substantial expense to Arbitron and significant diversion of its management and technical personnel. Any adverse determination in any litigation may subject Arbitron to significant liabilities to third parties, require Arbitron to license disputed rights from other parties, if licenses to these rights could be obtained, or require Arbitron to cease using the technology.

 

Arbitron’s research and development activities have related primarily to the development of new products and customer software and other technical expenses, including maintenance of legacy operations and reporting systems. Arbitron expects that it will continue research and development activities on an ongoing basis, particularly in light of the rapid technological changes affecting its business. The majority of the investment effort and spending will be dedicated to improving the quality and efficiency of Arbitron’s data collection and processing systems, developing new software applications that will assist Arbitron’s customers in realizing the full potential of Arbitron’s audience measurement services, developing Arbitron’s PPM technology and developing a single-source service that will be able to measure audience and other information from a number of different forms of media. Research and development expenses during fiscal years 2006, 2005 and 2004 totaled $44.2 million, $38.6 million and $33.3 million, respectively.

 

Arbitron’s PPM equipment has been certified to meet Federal Communications Commission requirements relating to emissions standards and standards for modem connectivity. Additionally, all PPM equipment has been certified to meet the safety standards of Underwriters Laboratories Inc. (commonly referred to as UL), as well as Canadian and European safety standards.

 

Arbitron’s media research activities are regulated by the United States Federal Trade Commission in accordance with a Decision and Order issued in 1962 to CEIR, Inc., a predecessor company. This order originally

arose in connection with the television ratings business, and Arbitron believes that today it applies to Arbitron’s media measurement services. The order requires full disclosure of the methodologies used by Arbitron and prohibits Arbitron from making representations in selling or offering to sell an audience measurement service without proper qualifications and limitations regarding probability sample, sampling error and accuracy or reliability of data. It prohibits Arbitron from making statements that any steps or precautions are taken to ensure the proper maintenance of diaries unless such steps or precautions are in fact taken. It also prohibits Arbitron from making overly broad statements regarding the media behavior a survey reflects. The order further prohibits Arbitron from representing the data as anything other than estimates and from making a statement that the data are accurate to any precise mathematical value. The order requires that Arbitron make affirmative representations in its reports regarding nonresponse by survey participants and the effect of this nonresponse on the data, the hearsay nature of a survey participant’s response, the fact that projections have been made, and the limitations and deficiencies of the techniques or procedures used. Arbitron believes that it has conducted and continues to conduct its radio audience measurement services in compliance with the order.

 

Arbitron’s Radio Market Report Service is accredited by and subject to the review of the MRC. The MRC is an industry organization created to ensure high ethical and operational standards in audience measurement research. Arbitron’s Radio Market Report Service has been accredited by the MRC since 1968. On January 29, 2007, Arbitron announced that the MRC had accredited the PPM radio ratings data in Houston. Additional Arbitron services that are accredited by the MRC are RADAR, Maximi$er and Media Professional software, the Custom Survey Area Report (“CSAR”) and the Radio County Coverage services. To merit continued accreditation of its services, Arbitron must: (1) adhere to the MRC’s Minimum Standards for Media Rating Research; (2) supply full information to the MRC regarding details of its operations; (3) conduct its media measurement services substantially in accordance with representations to its subscribers and the MRC; and (4) submit to, and pay the cost of, thorough annual audits of accredited Arbitron services by certified public accounting firms engaged by the MRC.

 

Federal and state regulations restrict telemarketing to individuals who request to be included on a do-not-call list. Currently, these regulations do not apply to survey research, but there can be no assurance that these regulations will not be made applicable to survey research in the future. In addition, federal regulations prohibit calls made by autodialers to wireless lines without consent from the subscriber. Because consumers are able to transfer a wireless number to a landline carrier or a landline number to a wireless carrier, it can be difficult for Arbitron to efficiently identify wireless numbers in advance of placing an autodialed call.

 

As of December 31, 2006, Arbitron employed 1,007 people on a full-time basis and 513 people on a part-time basis in the United States and 38 people on a full-time basis and 350 people on a part-time basis internationally. None of Arbitron’s employees are covered by a collective bargaining agreement. Arbitron believes its employee relations are good.

 

Arbitron recognizes revenue for services over the terms of license agreements as services are delivered, and expenses are recognized as incurred. Arbitron gathers radio-listening data in approximately 299 United States local markets. All markets are measured at least twice per year (April-May-June for the “Spring survey” and October-November-December for the “Fall survey”). In addition, all major markets are measured two additional times per year (January-February-March for the “Winter survey” and July-August-September for the “Summer survey”). Arbitron’s revenue is generally higher in the first and third quarters as a result of the delivery of the Fall survey and Spring survey, respectively, to all markets, compared to revenue in the second and fourth quarters, when delivery of the Winter survey and Summer survey, respectively, is only made to major markets. Arbitron’s expenses are generally higher in the second and fourth quarters as the Spring survey and Fall survey are being conducted.

 

Arbitron’s Web site address is www.arbitron.com, and interested persons may obtain, free of charge, copies of filings (including Arbitron’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on

Form 8-K, and any amendments to those reports) that Arbitron has made with the Securities and Exchange Commission through a hyperlink at this site to a third-party Securities and Exchange Commission filings Web site (as soon as reasonably practicable after such filings are filed with, or furnished to, the Securities and Exchange Commission). Also available on Arbitron’s Web site are its Corporate Governance Policies and Guidelines, Code of Ethics for the Chief Executive Officer and Financial Managers, Code of Ethics and Conduct, the Audit Committee Charter, the Nominating Committee Charter, the Corporate Governance Committee Charter and the Compensation and Human Resources Committee Charter. Copies of these documents are also available in print, free of charge, to any stockholder who requests a copy by contacting Arbitron’s treasury manager.

 

On June 16, 2006, the Company submitted the annual certification of its chief executive officer regarding the Company’s compliance with the New York Stock Exchange’s (the “NYSE”) corporate governance listing standards, pursuant to Section 303A.12 of the NYSE Listed Company Manual. The Company delivered an interim written affirmation to the NYSE on February 16, 2007 following a change in the memberships of both the Company’s Audit and Corporate Governance Committees. See the Company’s Current Report on Form 8-K filed with the SEC on February 21, 2007 for a description of the interim written affirmation.

 

Risk Factors Relating to Arbitron’s Businesses and the Industry in Which Arbitron Operates

 

Arbitron’s business, financial position and operating results are dependent on the performance of its radio audience measurement business.

 

Arbitron’s quantitative radio audience measurement service and related software sales represented approximately 86 percent of Arbitron’s total revenue for 2006. Arbitron expects that sales of its radio audience measurement service and related software will continue to represent a substantial portion of Arbitron’s revenue for the foreseeable future. Any factors adversely affecting the pricing of, demand for, or market acceptance of Arbitron’s radio audience measurement service and related software, such as competition, technological change, or further consolidation in the radio industry, could adversely affect Arbitron’s business, financial position and operating results.

 

Technological change may render Arbitron’s products and services obsolete. If Arbitron is unable to successfully adapt to changing technologies and customer demands, either through the development and marketing of new products and services, or through enhancements to its existing products and services, its business, financial position and results of operations would be adversely affected.

 

Arbitron expects that the market for its products and services will be characterized by changing technology, evolving industry standards, frequent new product and service announcements and enhancements and changing customer demands. The introduction of new products and services embodying new technologies and the emergence of new industry standards could render existing products and services obsolete and/or challenge current accepted levels of precision of data measurement. In addition, advertising-supported media may be challenged by new technologies that could have an effect on the advertising industry, Arbitron’s customers and Arbitron’s products and services. Arbitron’s continued success will depend on its ability to adapt to changing technologies and to improve the performance, features, and reliability of its products and services in response to changing customer and industry demands. Arbitron may experience difficulties that could delay or prevent the successful design, development, testing, introduction, or marketing of its products and services. Arbitron’s new products and services, such as its PPM service, or enhancements to its existing products and services, may not adequately meet the requirements of its current and prospective customers or achieve any degree of significant market acceptance. Arbitron’s inability to successfully adapt to changing technologies and customer demands, either through the development and marketing of new products and services, or through enhancements to its existing products and services, would adversely affect its business, financial position and results of operations.

 

Consolidation in the radio broadcasting industry has led to Arbitron’s increasing dependence on key customers. The loss of a key customer would significantly reduce Arbitron’s revenue and operating results.

 

The consolidation in the radio broadcasting industry has led to Arbitron’s increasing dependence on a limited number of key customers. The loss of a key customer would significantly reduce Arbitron’s revenue and operating

results. In 2006, Clear Channel and CBS Radio represented approximately 19 percent and nine percent, respectively, of Arbitron’s revenue.

 

Arbitron cannot give any assurances that it could replace the revenue that would be lost if a key customer failed to renew all or part of its agreements with Arbitron. The loss of a key customer would materially impact Arbitron’s business, financial position and operating results.

 

Consolidation in the radio broadcasting industry may put pressure on the pricing of Arbitron’s radio audience measurement service and related software sales, thereby leading to decreased earnings growth.

 

Consolidation in the radio broadcasting industry could put pressure on the pricing of Arbitron’s radio audience measurement service and related software sales, from which Arbitron derives a substantial portion of its total revenue. Arbitron prices its radio audience measurement service and related software applications on a per radio station, per service or per product basis, negotiating licenses and pricing with the owner of each radio station or group of radio stations. Consolidation in the radio broadcasting industry could have the effect that the greater the number of radio stations owned and the greater the number of services and applications purchased by a radio station owner, the more likely the owner is to seek price concessions from Arbitron. If Arbitron makes price concessions, it could adversely affect its business, financial position and operating results.

 

Arbitron’s agreements with its customers are not exclusive and contain no renewal obligations. The failure of Arbitron’s customers to renew all or part of their contracts could have an adverse effect on Arbitron’s business, financial position and operating results.

 

Arbitron’s customers are not prohibited from entering into agreements with any other competing service provider, and once the term of the agreement (usually one to seven years) expires, there is no automatic renewal feature in the contract. Because the Arbitron Radio Market Report is delivered on a quarterly or semiannual basis, it is common for Arbitron’s customer contracts to expire before renewal negotiations are concluded. Therefore, there may be significant uncertainty as to whether a particular customer will renew all or part of its contract and, if so, the particular terms of such renewal. If a customer owning stations in a significant number of markets does not renew its contracts, this would have an adverse effect on Arbitron’s business, financial position and operating results.

 

Long-term agreements with Arbitron’s customers limit its ability to increase the prices Arbitron charges for its services if Arbitron’s costs increase.

 

Arbitron generally enters into long-term contracts with its customers, including contracts for delivery of its radio audience measurement services. The terms of these customer agreements usually range from one to seven years. Over the term of these agreements the costs of providing services may increase (or increase at faster rates than its historical experience) for reasons outside of Arbitron’s control. Although Arbitron’s customer contracts generally provide for annual price increases, there can be no assurance that these revenue increases will exceed the increased cost of providing the services.

 

If Arbitron’s PPM ratings service does not generate the revenues that it anticipates, or if Arbitron’s ability to earn such revenues is delayed, its financial results will suffer.

 

Arbitron believes that the PPM ratings service represents a viable replacement for its diary-based ratings service in larger markets, offering customers considerable incremental value, and, therefore, its commercialization is an essential component of Arbitron’s future growth, which Arbitron expects will result in increased revenues in the coming years. In November 2006, Arbitron updated its previously announced plan to progressively roll out the PPM ratings service to the top 50 radio markets by 2010.

 

Arbitron’s financial results during 2007 and beyond will depend in part on its success in commercializing its PPM ratings service, and other new initiatives and its ability to generate meaningful revenues from them. If Arbitron is significantly delayed in commercializing these services, expected revenue increases related to the PPM ratings service will be delayed and its financial results will be negatively affected. Factors that may effect the pace of the commercialization of Arbitron’s PPM ratings service, and as a result, its revenues or operating results include the following, some of which are beyond its control:

 

 

 

Arbitron expects to invest in the continued development and commercialization of its PPM ratings service and the National Marketing Panel Service, which may not be successfully developed or commercialized. The costs associated with commercialization of these services will adversely affect Arbitron’s operating results, over the commercialization period.

 

Arbitron expects to continue to invest in the development and commercial deployment of its PPM ratings service and National Marketing Panel Service.

 

The continuing anticipated commercialization of the PPM ratings service will require significant capital resources and a substantial financial investment over the next several years. Arbitron currently believes that the aggregate capital investment associated with PPM commercialization for audience ratings measurement could be approximately $25.0 million over the first two to three years of commercialization. Arbitron also anticipates that, over the same period, its results of operations will be materially negatively impacted as a result of the rollout of this PPM ratings service.

 

The amount of capital required for deployment of the PPM ratings service and the impact of the rollout on the Company’s results of operations will be greatly affected by the speed with which the radio industry requests PPM technology and the timing of the rollout. If the radio industry is slow to accept the PPM ratings service, as opposed to the use of diaries or some other competing alternative, then it will take longer to roll out the commercialization of the PPM ratings service, and the negative impact associated with the costs of deployment will be prolonged. On the other hand, if the radio industry asks for electronic measurement sooner rather than later, Arbitron’s capital needs will intensify, and the near term negative impact on the Company’s results of operations will be more significant.

 

Since the pilot program for the national marketing panel service is in progress and customer response is preliminary, it is not yet possible to provide a meaningful assessment of future costs associated with a potential commercialization of this service. However, the same general cost pattern would apply as with the PPM ratings service, which is that substantial costs would have to be incurred in advance of revenues. Arbitron believes this will result in a materially negative impact on results of operations in the first three to four years of commercialization.

 

The success of commercialization of the PPM ratings service and the National Marketing Panel Service is dependent on contract manufacturers who produce the PPM equipment according to Arbitron’s proprietary design as well as those who manufacture parts and develop certain software applications. The failure of Arbitron to obtain, in a timely manner, sufficient quantities of quality equipment and the necessary software applications to meet Arbitron’s needs could adversely affect the commercial deployment of the PPM ratings service and the National Marketing Panel Service and, therefore, could adversely affect Arbitron’s operating results.

 

Arbitron will need to purchase equipment used in the PPM ratings service and the National Marketing Panel Service and to obtain certain software reporting applications to use with the PPM service data. The software applications will need to be developed in a timely manner. The equipment must be produced by the manufacturer in a timely manner, in the quantities needed and with the quality necessary to function appropriately in the market. Certain specialized parts used in the PPM equipment may impact the manufacturing and the timing of the delivery of the equipment to Arbitron. In addition, if countries and states enact regulation limiting hazardous materials, Arbitron may be required to redesign some of its PPM components to meet these regulations. A redesign process may impact the manufacturing and timing of the delivery of the equipment to Arbitron. The failure of Arbitron to obtain, in a timely manner, sufficient quantities of quality equipment and the necessary software applications to

meet Arbitron’s needs could adversely affect the commercial deployment of the PPM ratings service or the National Marketing Panel Service and therefore could adversely affect Arbitron’s operating results.

 

Arbitron’s inability to complete the process of the Media Rating Council (“MRC”) audit of the PPM methodology, in a timely manner, could delay the commercialization of the PPM service, which could adversely affect Arbitron’s business.

 

Arbitron has committed to completing the MRC audit process and to the MRC sharing its audit findings with its PPM audit committee prior to commercializing its PPM service.

 

If the process of the MRC audit of the PPM methodology is not completed in a timely manner, commercialization of the PPM service would be delayed. Such a delay could adversely affect Arbitron’s business, financial position and operating results.

 

The success of Arbitron’s radio audience measurement business depends on diarykeepers who record their listening habits in diaries and return these diaries to Arbitron. The failure of Arbitron to recruit participants and to collect these diaries could adversely affect Arbitron’s business.

 

Arbitron uses listener diaries to gather radio listening data from sample households in the United States local markets for which it currently provides radio ratings. A representative sample of the population in each local market is randomly selected for each survey. This sample is recruited by telephone to keep a diary of their radio listening for one week. Participants are asked to designate in their diary the station(s) to which they are listening, when they are listening and where they are listening, such as home, car, work or other place. To encourage their participation in the survey, Arbitron gives diarykeepers a modest cash incentive. Arbitron receives and processes more than 1.5 million diaries every year to produce its audience listening estimates. It is increasingly difficult and more costly to obtain consent from the phone sample to participate in the surveys, especially among younger demographic groups. Arbitron must achieve response rates sufficient to maintain confidence in its ratings, the support of the industry and accreditation by the MRC. The failure of Arbitron to successfully recruit participants and to convince diarykeepers to record their listening habits and mail in their diaries could adversely impact Arbitron’s business, financial position and operating results.

 

It may become more difficult and more expensive for Arbitron to reach and recruit participants for its audience measurement services, which could adversely affect its business, financial position and operating results.

 

Arbitron’s participants participate in its surveys on a voluntary basis only, and there can be no assurance that they will continue to do so. Arbitron’s success will depend on its ability to reach and recruit participants and to achieve response rates sufficient to maintain its radio audience measurement services. As consumers adopt modes of telecommunication other than telephone landlines, such as mobile phones and cable or Internet calling, it is becoming increasingly more difficult for Arbitron to reach and recruit participants. Recruiting mobile phone-only households will lead to increased costs, which could adversely affect Arbitron’s business, financial position and operating results.

 

Arbitron’s ability to recruit participants for its surveys could be adversely affected by governmental regulations.

 

There is an increasing concern among the American public regarding privacy issues. Federal and state governmental regulations restrict telemarketing to individuals who request to be included on a do-not-call list. Currently, these regulations do not apply to survey research. If the laws are extended to include survey research, Arbitron’s ability to recruit participants for its surveys could be adversely affected. Arbitron is evaluating alternatives to its current methodology, including using panels for its surveys and recontacting previous consenters. In addition, federal regulations prohibit calls made by autodialers to wireless lines without consent from the party. Because consumers are able to transfer a wireless number to a landline carrier or a landline number to a wireless carrier, it can be difficult for Arbitron to identify wireless numbers in advance of placing an autodialed call. Arbitron is using the services of a third-party supplier that tracks wireless numbers to help identify wireless numbers in its telephone sample.

 

Arbitron has limited experience designing, recruiting and maintaining PPM panels.

 

The commercial viability of many of its new business initiatives is dependent on its ability to recruit and maintain compliant PPM panelists and ensure optimal panel composition to accommodate a broad variety of media research services. Arbitron has limited experience in operating such PPM panels and it may encounter unanticipated difficulties as it attempts to do so. Without historical benchmarks on key sample performance metrics, it will be challenging to maintain the appropriate balance of research quality, panel size and operation costs.

 

The license of proprietary software that will enable enhanced access to respondent-level data to third-party software providers and customers could adversely affect the market for some of Arbitron’s existing software products.

 

Arbitron is offering third-party software providers and customers a license to use proprietary software that will enable enhanced access to Arbitron’s respondent-level data. Previously, limited access to respondent level data was only available to customers who licensed certain software services from Arbitron. Once Arbitron begins licensing the software that will provide enhanced access, which Arbitron anticipates will commence in 2008, the sales of Arbitron’s existing software services may be adversely affected.

 

Arbitron’s success will depend on its ability to protect its intellectual property rights.

 

Arbitron believes that the success of its business will depend, in part, on:

 

 

Arbitron relies on a combination of contractual provisions, confidentiality procedures and patent, copyright, trademark, service mark and trade secret laws to protect the proprietary aspects of its technology, data and estimates. Several patents related to the PPM service, which expire at various times beginning in 2012, when viewed together, are of material importance to the Company. These legal measures afford only limited protection, and competitors may gain access to Arbitron’s intellectual property and proprietary information. Litigation may be necessary to enforce Arbitron’s intellectual property rights, to protect its trade secrets and to determine the validity and scope of Arbitron’s proprietary rights. Arbitron has been involved in litigation relating to the enforcement of its copyrights covering its radio listening estimates. Although Arbitron has generally been successful in these cases, there can be no assurance that the copyright laws and other statutory and contractual arrangements Arbitron currently depends upon will provide it sufficient protection to prevent the use or misappropriation of its audience estimates, databases and technology in the future. Litigation, regardless of outcome, could result in substantial expense and diversion of resources with no assurance of success and could adversely impact Arbitron’s business, financial position and operating results.

 

One of Arbitron’s strategies is to expand its international business, which involves unique risks and, if unsuccessful, could impede the growth of Arbitron’s business.

 

Arbitron continues to explore opportunities that would facilitate licensing its PPM technology into selected international markets in Europe and the Asia/Pacific regions.

 

We have limited experience in international operations, and may not be able to compete effectively in international markets or effectively manage our operations in various countries. If we do not generate enough revenue from international operations to offset the expense of these operations, our business could suffer. In addition, these operations have specific inherent risks, including, without limitation, the following:

 

 

 

Audience estimates are used as the basis for advertising transactions when they achieve credibility and trust in the eyes of the media marketplace. In some countries, there is little confidence in the historical measurement services due to the perception of tampering and fraud. In expanding its international scope, Arbitron could be at risk of potential tampering and fraud, or the perception thereof, by broadcasters or other third parties with Arbitron’s methodology.

 

In countries where there has not been a historical practice of using audience measurement information in the buying and selling of advertising time, it may be difficult for Arbitron to maintain subscribers as the market transitions to using Arbitron’s audience measurement service as the basis for conducting advertising transactions.

 

Arbitron is dependent on its proprietary software systems for current and future business requirements. Significant delays in the completion of these systems, cost overages and/or inadequate performance of the systems once completed could adversely affect Arbitron’s business, financial position and operating results.

 

Arbitron’s current systems do not have the capability to accommodate all additional product enhancements requested by Arbitron clients. Arbitron is engaged in a major effort to replace its internal processing software and its client software. Significant delays in the completion of these systems, cost overages and/or inadequate performance of the systems once completed could adversely affect Arbitron’s business, financial position and operating results.

 

Criticism of the Arbitron audience measurement service by various industry groups and market segments could adversely affect Arbitron’s business.

 

Due to the high-profile nature of Arbitron’s services in the media and marketing information service industry, Arbitron could become the target of criticism by various industry groups and market segments. Arbitron believes that criticism of its methodology or negative perception of the quality of its research could adversely affect its business.

 

Arbitron’s future growth and success will depend on its ability to successfully compete with companies that may have financial, marketing, distribution, technical and other advantages over Arbitron.

 

Arbitron competes with many companies, some of which are larger and have access to greater capital resources. Arbitron believes that its future growth and success will depend on its ability to successfully compete with other companies that provide similar services in the same markets, some of which may have marketing, technical and other advantages, and its ability to design, develop and commercialize new products and services that address the industry needs for more efficient methods of data collection and processing and broader media measurement techniques.

 

In June 2005, Clear Channel announced that is was issuing a Request for Proposals to create a state-of-the-art radio ratings system to replace the current diary measurement system to which it subscribes. This process is ongoing. Clear Channel has organized a cross-industry evaluation committee to review the proposals, and this committee is expected to report on its findings in early 2007.

 

On February 9, 2007, The Media Audit/Ipsos announced that they will receive funding from a number of broadcasters to test their competing electronic ratings system in the Houston market. See “Legal Proceedings” in Item 3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for a description of Arbitron’s patent infringement lawsuit against The Media Audit/Ipsos.

 

Arbitron cannot provide any assurance that it will be able to compete successfully, and the failure to do so could have a material adverse effect on Arbitron’s business, financial position and operating results.

 

The media research industry is exploring options to achieve greater influence over the providers of audience measurement.

 

The media research industry is exploring options to achieve greater influence over and accountability from the providers of audience measurement. Two of the options could include forming an industry research consortium or a joint industry committee. A research consortium could potentially conduct independent research and development on ratings and audience measurement systems and make recommendations to the provider of audience measurement research. A joint industry committee could potentially result in the establishment of a cooperative media ratings service or an industry committee that would award contracts for media research. If these efforts to establish a research consortium or a joint industry committee are directed at radio, Arbitron’s business, financial position and operating results could be adversely affected.

 

An economic downturn generally, and in the advertising and radio industries in particular, could adversely impact Arbitron’s revenue.

 

Arbitron’s clients derive most of their revenue from transactions involving the sale or purchase of advertising. During challenging economic times, advertisers may reduce advertising expenditures, impacting advertising agencies and media. A shift of advertising dollars from traditional media, such as radio, to nontraditional media, such as the Internet, could adversely impact the radio industry. As a result, advertising agencies and media may be less likely to purchase Arbitron’s media information services, which could adversely affect Arbitron’s business, financial position and operating results.

 

Advertisers are pursuing increased accountability from the media industry for their return on investments made in media. As a result, advertisers may shift advertising expenditures away from less accountable forms of media, such as radio, which could have an adverse effect on Arbitron’s business, financial position and operating results.

 

Advertisers are pursuing increased accountability from the media industry for their return on investments made in media. Advertisers may shift advertising expenditures away from less accountable forms of media, such as radio, to more accountable forms of media, such as the Internet. As a result, advertising agencies and radio stations may be less likely to purchase Arbitron’s media information services, which could have an adverse effect on Arbitron’s business, financial position and operating results.

 

Arbitron enters into agreements with third parties to use certain data and services in connection with the provision of its current services. In addition, Arbitron may need to enter into agreements with third parties to assist with the marketing, technical, and financial aspects of expanding its services for other types of media. In the event Arbitron is unable to use such third-party data and services or if Arbitron is unable to enter into agreements with third parties, when necessary, Arbitron’s business and/or its potential growth could be adversely affected.

 

Arbitron relies on third parties to provide certain data and services for use in connection with the provision of its current services. In the event that such data and services are unavailable for Arbitron’s use or are not available on favorable terms, its business could be adversely affected.

 

Further, in order for Arbitron to build on its experience in the radio audience measurement industry and expand into measurement for other types of media, Arbitron may need to enter into agreements with third parties. These third parties could provide the marketing, technical, and financial aspects that Arbitron requires in order to be able to expand into other types of media. Arbitron’s inability to enter into these agreements with third parties at all or upon favorable terms, when necessary, could adversely affect Arbitron’s growth and business.

 

Long-term disruptions in the mail, telecommunication infrastructure and/or air service could adversely affect Arbitron’s business.

 

Arbitron’s business is dependent on the use of the mail, telecommunication infrastructure and air service. Long-term disruptions in one or more of these services, which could be caused by events such as natural disasters, the outbreak of war, the escalation of hostilities, and/or acts of terrorism (particularly involving cities in which Arbitron has offices, including Columbia, Maryland, which is in close proximity to Washington, DC, and government agencies) could adversely affect Arbitron’s business, financial position and operating results.

 

Risk Factors Relating to Arbitron’s Indebtedness

 

On December 20, 2006, Arbitron entered into a five-year, $150.0 million revolving credit facility that contains financial terms, covenants and operating restrictions that could restrict its financial flexibility and adversely impact its ability to conduct its business. These include:

 

 

These restrictions may restrict or prohibit its ability to raise additional debt capital when needed or could prevent Arbitron from investing in other growth initiatives. Arbitron’s ability to comply with these financial requirements and other restrictions may be affected by events beyond its control, and its inability to comply with them could result in a default under the terms of the agreement.

 

Although Arbitron currently has no borrowings under this credit facility, if a default occurs on future borrowings, either because Arbitron is unable to generate sufficient cash flow to service the debt or because Arbitron fails to comply with one or more of the restrictive covenants, the lenders could elect to declare all of the then outstanding borrowings, as well as accrued interest and fees, to be immediately due and payable. In addition, a default may result in the application of higher rates of interest on the amounts due, resulting in higher interest expense being incurred by Arbitron.

 

Risk Factors Relating to Owning Arbitron’s Common Stock

 

Changes in market conditions, or sales of Arbitron common stock, could adversely affect the market price of Arbitron’s common stock.

 

The market price of Arbitron’s common stock depends on various financial and market conditions, which may change from time to time and which are outside of its control.

 

Sales of a substantial number of shares of Arbitron’s common stock, or the perception that such sales could occur, also could adversely affect prevailing market prices for Arbitron’s common stock. In addition to the possibility that Arbitron may sell shares of its common stock in a public offering at any time, Arbitron also may issue shares of common stock in connection with grants of restricted stock or upon exercise of stock options that Arbitron grants to its directors, officers and employees. All of these shares will be available for sale in the public markets from time to time.

 

It may be difficult for a third party to acquire Arbitron, which could depress the stock price of Arbitron’s common stock.

 

Delaware corporate law and Arbitron’s Amended and Restated Certificate of Incorporation and Bylaws contain provisions that could have the effect of delaying, deferring or preventing a change in control of Arbitron or the removal of existing management or directors and, as a result, could prevent our stockholders from being paid a premium for their common stock over the then-prevailing market price. These provisions could also limit the price that investors might be willing to pay in the future for shares of Arbitron’s common stock. These include:

 

 

 

Arbitron’s Amended and Restated Certificate of Incorporation also contains the following provisions, which provisions could prevent transactions that are in the best interest of stockholders:

 

 

None.

 

Arbitron’s primary locations are in Columbia, Maryland, and its headquarters are located at 142 West 57th Street, New York, New York. Arbitron’s New York City office serves as its home base for sales and marketing, while its survey research, technology and data collection/production operations are located in its Columbia, Maryland, facility. In addition, Arbitron has five regional sales offices located in the metropolitan areas of Atlanta, Georgia; Washington, DC/Baltimore, Maryland; Chicago, Illinois; Dallas, Texas; and Los Angeles, California; and operations offices in Dallas, Texas; Houston, Texas; Cranford, New Jersey; Birmingham, Alabama; and Indianapolis, Indiana. Arbitron’s Continental Research subsidiary is located in London, England. Arbitron conducts all of its operations in leased facilities. Most of these leases contain renewal options and require payments for taxes, insurance and maintenance in addition to base rental payments. Arbitron believes that its facilities are sufficient for their intended purposes and are adequately maintained.

 

During 2005, the Pennsylvania Department of Revenue concluded a sales tax audit and notified the Company of an assessment of $3.6 million, including outstanding sales tax and accumulated interest since 2001. Since 2005, the assessment has increased due to additional interest to $3.8 million as of December 31, 2006. Currently, the Company is in the appeals process with the Commonwealth of Pennsylvania, and continues to contest the assessment in its entirety. Consistent with the findings of a previous Pennsylvania sales tax audit, the Company contends that it continues to provide nontaxable services to its Pennsylvania customers and intends to vigorously defend this position during the appeals process. Although the Company anticipates a successful outcome, it cannot guarantee that a favorable settlement will occur. Given the nature of this uncertainty, no loss has been recognized as of December 31, 2006.

 

On October 10, 2006 the Company filed a patent infringement lawsuit against International Demographics, Inc. (D/B/A The Media Audit), Ipsos Group S.A., Ipsos ASI, Inc., Ipsos America, Inc. aka Ipsos North America and Ipsos Media (collectively “the Ipsos entities”) in the United States District Court for the Eastern District of Texas. The complaint alleges that International Demographics and the Ipsos entities are infringing three patents owned by Arbitron, United States Patents No. 5,787,334, No. 5,574,962 and No. 5,483,276, each relating to electronic audience measurement technology. In its suit, Arbitron seeks a permanent injunction against International Demographics and the Ipsos entities, in addition to adequate compensatory damages as determined by the court.

 

Arbitron and its subsidiaries are involved from time to time in a number of judicial and administrative proceedings considered ordinary with respect to the nature of their current and past operations, including employment-related disputes, contract disputes, government proceedings, customer disputes and tort claims. In some proceedings, the claimant seeks damages as well as other relief, which, if granted, would require substantial expenditures on the part of Arbitron. Some of these matters raise difficult and complex factual and legal issues, and are subject to many uncertainties, including, but not limited to, the facts and circumstances of each particular action,

and the jurisdiction, forum and law under which each action is pending. Because of this complexity, final disposition of some of these proceedings may not occur for several years. As such, Arbitron is not always able to estimate the amount of its possible future liabilities. There can be no certainty that Arbitron will not ultimately incur charges in excess of present or future established accruals or insurance coverage. Although occasional adverse decisions (or settlements) may occur, it is the opinion of management that the final disposition of these proceedings will not, considering the merits of the claim, have a material adverse effect on Arbitron’s financial position or results of operations.

 

No matters were submitted to a vote of Arbitron’s stockholders during the fourth quarter of 2006.

 

Arbitron’s common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “ARB.” As of February 23, 2007, there were 29,740,333 shares outstanding and 6.642 stockholders of record of Arbitron common stock.

 

The following table sets forth the high and low sale prices of Arbitron common stock as reported on the NYSE Composite Tape and the dividends declared per share of its common stock for each quarterly period for the past two years ended December 31, 2006 and 2005.

 

 

 

The transfer agent and registrar for the Arbitron common stock is The Bank of New York.

 

On January 24, 2006, the Company announced that its Board of Directors authorized a program to repurchase up to $70.0 million of its outstanding common stock through either periodic open-market or private transactions at then-prevailing market prices through December 31, 2006. As of June 29, 2006, the Company completed the program by repurchasing 1,991,944 shares for an aggregate purchase price of $70.0 million.

 

On November 16, 2006, Arbitron announced that its Board of Directors authorized a program to repurchase up to $100.0 million of its outstanding common stock through either periodic open-market or private transactions at then-prevailing market prices over a period of two years through November 2008. As of February 16, 2007, no shares were repurchased under this program.

 

There were no stock purchases in the fourth quarter of 2006.

 

The selected financial data set forth below should be read together with the information under the heading “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Arbitron’s consolidated financial statements and related notes included in this Form 10-K.

 

The Company’s statements of income for the years ended December 31, 2006, 2005, and 2004 and balance sheet data as of December 31, 2006, and 2005 set forth below are derived from audited consolidated financial

statements included elsewhere in this Form 10-K. The statement of income data for the years ended December 31, 2003 and 2002, and balance sheet data as of December 31, 2004, 2003 and 2002 are derived from audited consolidated financial statements of Arbitron not included in this Form 10-K.

 

 

The Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payments (“SFAS No. 123R”) as of January 1, 2006. Share-based compensation expense for 2006 was $6.5 million. Share-based awards were previously accounted for under Accounting Principles Board (“APB”) opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). See notes 2 and 15 to the notes to the consolidated financial statements for further discussion and analysis.

 

The following discussion should be read in conjunction with Arbitron’s consolidated financial statements and the notes thereto that follow in this Form 10-K.

 

Arbitron is a leading international media and marketing information services firm primarily serving radio, cable television, advertising agencies, advertisers, out-of-home media, online media and, through its Scarborough Research joint venture with The Nielsen Company, broadcast television and print media.

 

Significant Customers.  Historically, the Company’s quantitative radio measurement services and related software have accounted for a substantial majority of its total revenues. Consolidation in the radio broadcasting industry has led to a concentration of ownership of radio stations and, consequently, Arbitron’s dependence on a limited number of key customers for such services and related software has increased. In 2006, Clear Channel and CBS Radio represented approximately 19 percent and nine percent, respectively, of Arbitron’s total revenue. The Company’s agreements with these customers are not exclusive and do not contain automatic renewal obligations. Arbitron currently has license agreements with Clear Channel to provide radio ratings and software services for Clear Channel’s radio stations and networks through Arbitron’s Fall 2008 survey. In May 2006, Arbitron announced that it had entered into a license agreement with CBS Radio to provide diary-based services and PPM radio ratings, when the new ratings technology is deployed, through Arbitron’s Winter 2014 survey.

 

Slow Growth in Diary Business.  Due to slow economic growth of the radio industry generally, as well as the high penetration of its current services in the radio station business, Arbitron expects that its future annual organic rate of revenue growth from its quantitative diary-based radio measurement services and related software will be slower than historical trends. The Company anticipates that in the near term organic revenue growth will only moderately exceed the level of contractual price escalators in its radio ratings contracts.

 

Electronic Measurement Initiatives.  Arbitron has announced its plan to progressively roll out its PPM ratings service to the top 50 radio markets by 2010. Philadelphia became the first radio market to be electronically measured in January 2007. Also in January 2007, the Company announced that the Media Rating Council (“MRC”) had accredited the PPM radio ratings data in Houston, which had been the Company’s PPM demonstration market since mid-2005. The Company also is actively exploring opportunities to leverage its PPM technologies for strategic applications in addition to its quantitative radio measurement services. In this regard, the Company has formed Project Apollo LLC, a jointly owned limited liability company with Nielsen Media Research, Inc. (“NMR”) to explore the feasibility of the commercialization of a national marketing service panel.

 

Commercialization of the PPM radio ratings service and exploration of other strategic applications of the PPM technology, including the national marketing panel service, will require a substantial financial investment. The Company believes that during the PPM roll out period its cost of revenue will increase and substantial capital expenditures will be incurred to build its fixed costs structure and support future large-scale PPM commercialization efforts. In addition, the Company expects that its expenses will increase as a result of continued deployment costs associated with the national marketing panel service and the strategic development of its electronic ratings business.

 

Ultimately, Arbitron believes that, while commercialization of the PPM ratings service and other strategic applications of the PPM technology will have a near-term negative impact on its results of operations, its operating margins can be restored through the completion of the PPM transition process in the top 50 radio markets, although there can be no assurance that this will be the case.

 

Arbitron must achieve response rates sufficient to maintain confidence in its ratings, the support of the industry and accreditation by the Media Rating Council. Overall response rates have declined over the past several years and it has become increasingly difficult and more costly for the Company to obtain consent from persons to participate in its surveys. Another measure often used by clients to assess quality in Arbitron’s surveys is proportionality, which refers to how well the distribution of the sample for any individual survey matches the distribution of the population in the market. In recent years, Arbitron’s ability to deliver good proportionality in its surveys among younger demographic groups has deteriorated, caused in part by the trend among some households to disconnect their landline phones, effectively removing these households from the Arbitron sample frame. Arbitron has committed extensive efforts and resources to address the decline of response rates and to maintain sample proportionality. In March 2006, Arbitron announced a comprehensive set of initiatives to bolster response rates and improve sample proportionality among African-American, Hispanic, and young male respondents in Arbitron’s diary-based markets. These initiatives include providing for substantial increases in cash incentives and other survey treatments.

Management believes that significant additional expenditures will be required in the future with respect to response rates and sample proportionality.

 

This Annual Report on Form 10-K and, in particular, this management’s discussion and analysis, contain or incorporate a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management’s beliefs and assumptions. Any statements contained herein (including without limitation statements to the effect that Arbitron or its management “believes,” “expects,” “anticipates,” “plans,” and similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included in this report. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those included in this Annual Report on Form 10-K in Item 1A — Risk Factors. We do not intend to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.

 

On January 24, 2006, Arbitron announced that its Board of Directors authorized a program to repurchase up to $70.0 million of its outstanding common stock through either periodic open-market or private transactions at then-prevailing market prices through December 31, 2006. As of June 29, 2006, the program was completed with 2.0 million shares repurchased for an aggregate purchase price of $70.0 million.

 

On November 16, 2006, Arbitron announced that its Board of Directors authorized a program to repurchase up to $100.0 million of its outstanding common stock through either periodic open-market or private transactions at then-prevailing market prices over a period of two years through November 2008. As of February 16, 2007, no shares were repurchased under this program.

 

Critical accounting policies and estimates are those that are both important to the presentation of Arbitron’s financial position and results of operations, and require management’s most difficult, complex or subjective judgments.

 

Arbitron capitalizes software development costs with respect to significant internal use software initiatives or enhancements in accordance with Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The costs are capitalized from the time that the preliminary project stage is completed and management considers it probable that the software will be used to perform the function intended, until the time the software is placed in service for its intended use. Once the software is placed in service, the capitalized costs are amortized over periods of three to five years. Management performs an assessment quarterly to determine if it is probable that all capitalized software will be used to perform its intended function. If an impairment exists, the software cost is written down to estimated fair value. During the year ended December 31, 2006, Arbitron recorded an impairment charge of $0.6 million for internally developed PPM software associated with the NMR election not to join Arbitron in the commercial deployment of the PPM system. As of December 31, 2006, and 2005, Arbitron’s capitalized software developed for internal use had carrying amounts of $19.3 million and $15.2 million, respectively, including $9.0 million and $6.7 million, respectively, of software related to the PPM system.

 

Arbitron uses the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year and for deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Management must make assumptions, judgments and estimates to determine the current provision for income taxes and also deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset. Assumptions, judgments, and estimates relative to the current provision for income taxes take into account current tax laws, interpretation of current tax laws and possible outcomes of current and future audits conducted by domestic and foreign tax authorities. Changes in tax law or interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in

the consolidated financial statements. Assumptions, judgments and estimates relative to the value of a deferred tax asset take into account forecasts of the amount and nature of future taxable income. Actual operating results and the underlying amount and nature of income in future years could render current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause actual income tax obligations to differ from estimates, thus impacting Arbitron’s financial position and results of operations.

 

Comparison of Year Ended December 31, 2006 to Year Ended December 31, 2005

 

The following table sets forth information with respect to the consolidated statements of income of Arbitron for the years ended December 31, 2006 and 2005.

 

Consolidated Statements of Income
(Dollars in thousands, except per share amounts)

 

 

 

The following table sets forth information with regard to share-based compensation expense recognized under SFAS No. 123R and APB No. 25 for the years ended December 31, 2006, and 2005, respectively:

 

 

Revenue.  Revenue increased 6.2% to $329.3 million for the year ended December 31, 2006, from $310.0 million for the same period in 2005, due primarily to increases in the ratings subscriber base, contract renewals, and price escalations in multiyear customer contracts for Arbitron’s quantitative data license revenue, a $2.9 million increase in Scarborough revenue resulting primarily from new business contracts, a $1.6 million increase in PPM International revenues, and a $1.1 million increase associated with the Project Apollo pilot panel for the national marketing research service which was initiated in 2006.

 

Cost of Revenue.  Cost of revenue increased by 17.4% to $129.7 million for the year ended December 31, 2006, from $110.5 million for the same period in 2005, and as a percentage of revenue to 39.4% in 2006 from 35.7% in 2005. The increase in cost of revenue was largely attributable to a $10.3 million increase in Arbitron’s quantitative, qualitative and software application services, which primarily includes a $3.5 million increase in data collection and processing costs, a $2.9 million increase in costs associated with response rate initiatives and proportionality, a $2.3 million increase in Scarborough royalties resulting from the higher revenues mentioned previously, and a $0.6 million increase for additional compensation expense related to Arbitron’s share-based awards. Cost of revenue increased by $6.7 million related to the Project Apollo pilot panel for the national marketing research service. Similar expenditures were classified as research and development in the amount of $3.1 million for the year ended December 31, 2005. A $1.8 million increase related to increased PPM international business also contributed to the overall increase in cost of revenue for the year ended December 31, 2006 as compared to the same period in 2005. Arbitron expects that its cost of revenue will increase in the future as a result of its efforts to commercialize the PPM ratings service and support the rollout of this service over the next two to three years.

 

Selling, General and Administrative.  Selling, general and administrative expenses increased 17.5% to $79.1 million for the year ended December 31, 2006, from $67.3 million for the same period in 2005, and increased as a percentage of revenue to 24.0% in 2006 from 21.7% in 2005. Approximately $6.9 million of the increase in selling, general and administrative expenses was due to an increase in Arbitron’s quantitative, qualitative and software application services, which includes a $1.9 million increase in expenses associated with the update of our

legacy financial and customer relationship management systems and increased sales and marketing costs of $2.3 million related to Arbitron’s ratings business, including the PPM service. The adoption of SFAS No. 123R, effective January 1, 2006, resulted in $5.2 million of additional compensation expense related to Arbitron’s share-based awards. Asset impairment charges related to internally developed software associated with the NMR election not to join Arbitron in the commercial deployment of the PPM system accounted for $0.6 million of the increase in selling, general, and administrative expenses.

 

Research and Development.  Research and development expenses increased 14.7% to $44.2 million during the year ended December 31, 2006, from $38.6 million for the same period in 2005, and increased as a percentage of revenue to 13.4% in 2006 from 12.4% in 2005. Increased research and development expenses of $5.7 million resulted from Arbitron’s continued development of the next generation of its client software, and applications and infrastructure to support the PPM service and the diary-based service ($5.5 million), and an increase in precommercialization panel expenses primarily in the Houston and Philadelphia markets ($2.9 million). These increases were partially offset by a $3.1 million decrease in research and development expenses associated with the Project Apollo pilot panel for a national marketing research service, which were classified as cost of revenue in 2006 as previously mentioned.

 

Operating Income.  Operating income decreased 18.5% to $76.3 million for the year ended December 31, 2006, from $93.6 million for the same period in 2005. Operating margin percentage decreased to 23.2% in 2006 from 30.2% in 2005. Operating margins for the year ended December 31, 2006, were negatively impacted due to higher costs related to planned expenses required to build Arbitron’s PPM panels for markets other than Houston and to operate the Houston panel, and expenses related to Arbitron’s share-based awards.

 

Equity in Net Income of Affiliate.  Equity in net income of affiliate (relating to Arbitron’s Scarborough joint venture) decreased 1.0% to $7.7 million for the year ended December 31, 2006, from $7.8 million for the same period in 2005. The slight decrease in operating income for the affiliate resulted primarily from quality improvement initiatives initiated in 2006. Arbitron expects the equity in net income of affiliate to decrease in the future as a result of forming the Project Apollo LLC; the purpose of which is to complete the development and testing of the Project Apollo marketing research service and the expansion of the pilot panel to a full national service if the test results meet expectations and generate marketplace support.

 

Interest Income.  Interest income was relatively flat for the year ended December 31, 2006 as compared to the same period in 2005, as lower average cash and short term investment balances were offset by higher interest rates.

 

Interest Expense.  Interest expense increased 52.5% to $6.1 million for the year ended December 31, 2006, from approximately $4.0 million for the same period in 2005, due to Arbitron’s prepayment of its senior-secured notes obligation on October 18, 2006. In accordance with the provisions of the note agreement, Arbitron was obligated to pay an additional make-whole interest amount of $2.6 million as a result of the prepayment. Arbitron accelerated the amortization of the $0.3 million outstanding balance of deferred financing costs associated with the debenture. Both of these amounts were expensed as interest in Arbitron’s financial statements during the fourth quarter of 2006.

 

Income Tax Expense.  The effective tax rate was reduced from 37.8%, which excludes the impact of a $4.7 million tax benefit recognized for the reversal of certain tax contingencies during the year ended December 31, 2005, to 37.5% for the year ended December 31, 2006, reflecting the impact of increased tax-exempt interest income.

 

Net Income.  Net income decreased 24.7% to $50.7 million for the year ended December 31, 2006, from $67.3 million for the same period in 2005, due primarily to planned expenses required to build Arbitron’s PPM panels for markets other than Houston and to operate the Houston panel, additional share-based compensation expense associated with the adoption of SFAS No. 123R, effective January 1, 2006, and the strategic development of Arbitron’s ratings business and Project Apollo.

EBIT and EBITDA.  Arbitron has presented EBIT and EBITDA, both non-GAAP financial measures, as supplemental information that management of Arbitron believes is useful to investors to evaluate Arbitron’s results because they exclude certain items that are not directly related to Arbitron’s core operating performance. EBIT is calculated by adding back net interest expense and income tax expense to net income. EBITDA is calculated by adding back net interest expense, income tax expense, and depreciation and amortization to net income. EBIT and EBITDA should not be considered substitutes either for net income, as indicators of Arbitron’s operating performance, or for cash flow, as measures of Arbitron’s liquidity. In addition, because EBIT and EBITDA may not be calculated identically by all companies, the presentation here may not be comparable to other similarly titled measures of other companies. EBIT decreased 17.2% to $84.0 million and EBITDA decreased 12.9% to $93.4 million for the year ended December 31, 2006 from $101.4 million and $107.3 million, respectively, in the same period in 2005.

Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004

 

The following table sets forth information with respect to the consolidated statements of income of Arbitron for the years ended December 31, 2005 and 2004.

 

Consolidated Statements of Income
(Dollars in thousands, except per share amounts)

 

 

 

 

Revenue.  Revenue increased 4.5% to $310.0 million in 2005 from $296.6 million in 2004. Approximately $13.7 million of the increase was due to increases in the ratings and qualitative subscriber base, analytical software applications and price escalations in multiyear customer contracts and contract renewals. In addition, the Smartplus, formerly known as Marketing Resources Plus, acquisition and Integrated Radio Systems, L.L.C. (“IRS”) acquisition accounted for $1.5 million and $0.4 million, respectively, of the increase in revenues. Smartplus was acquired on March 11, 2004 and therefore, the year ended December 31, 2005 had the benefit of the full twelve months of operations as compared to approximately ten months for the same period of 2004. IRS was acquired on September 20, 2005. These increases were partially offset by a $1.5 million net decrease in Scarborough revenue and a $1.0 million decrease in Continental Research revenue. The net decrease in Scarborough revenue for the year ended December 31, 2005 as compared to the same period in 2004 was significantly impacted by the accelerated delivery of 17 markets during the fourth quarter of 2004 rather than the first quarter of 2005.

 

Cost of Revenue.  Cost of revenue decreased slightly by 0.2% to $110.5 million in 2005 from $110.7 million in 2004, and decreased as a percentage of revenue to 35.7% in 2005 from 37.3% in 2004. The $0.2 million decrease was primarily attributed to decreases in Scarborough royalty costs of $1.2 million caused by the accelerated delivery of 17 Scarborough markets in 2004 and decreases in Continental Research costs of $0.7 million, partially offset by a $0.6 million increase in PPM ratings costs associated with the national marketing panel service, a $0.5 million increase in security costs, and a $0.8 million increase in custom research costs.

 

Selling, General and Administrative.  Selling, general and administrative expenses increased 9.1% to $67.3 million in 2005 from $61.7 million in 2004, and increased as a percentage of revenue to 21.7% in 2005 from 20.8% in 2004. The $5.6 million increase was due to increased expenses associated with Arbitron’s quantitative, qualitative and software application services of $3.2 million, increased PPM ratings expenses of $2.8 million, and increased expenses associated with the Smartplus and IRS acquisitions of $1.0 million. These increases were partially offset by a decrease in Internet service expenses of $1.1 million.

 

Research and Development.  Research and development expenses increased 15.8% to $38.6 million in 2005 from $33.3 million in 2004, and increased as a percentage of revenue to 12.4% in 2005 from 11.2% in 2004. Increased spending associated with Arbitron’s ratings and qualitative subscriber service of approximately $2.3 million, the Houston PPM market demonstration and other PPM ratings initiatives of approximately $1.6 million, and the deployment of Project Apollo’s pilot panel of approximately $1.4 million comprise the $5.3 million increase.

 

Operating Income.  Operating income increased 3.0% to $93.6 million in 2005 from $90.9 million in 2004. Operating margin decreased to 30.2% in 2005 from 30.7% in 2004.

 

Equity in Net Income of Affiliate.  Equity in net income of affiliate (relating to Arbitron’s Scarborough joint venture) increased 3.7% to $7.8 million in 2005 from $7.6 million in 2004. The increased earnings of Scarborough resulted mainly from increased revenues that were partially offset by the accelerated delivery of 17 markets during the fourth quarter of 2004 discussed previously.

 

Interest Income.  Interest income increased to $3.1 million in 2005 from $1.1 million in 2004. The increase was primarily attributable to higher average cash and short-term investment balances and interest rates for the year ended December 31, 2005 as compared to the same period in 2004.

 

Interest Expense.  Interest expense decreased to $4.0 million in 2005 from $7.9 million in 2004. The decrease is due to Arbitron’s extinguishment of its credit facility in September 2004. For the year ended December 31, 2004, the average balance outstanding under the credit facility was $28.5 million. The interest expense incurred for the year ended December 31, 2005 is associated with Arbitron’s 9.96% senior-secured-notes maturing on January 31, 2008.

 

Income Tax Expense.  Arbitron’s effective tax rate was 33.1% and 33.9% in 2005 and 2004, respectively. During 2005, certain liabilities for tax contingencies related to prior periods were reversed, due to the settlement and completion of certain income tax audits and returns and the expiration of audit statutes. Also, the valuation allowance on certain deferred tax assets was reduced to reflect the estimated future benefit of utilizing state net

operating loss carryforwards in certain states. The net benefit of these changes and other items was $4.7 million in 2005. For the year ended December 31, 2005, the effective tax rate, exclusive of these events, decreased to 37.8% primarily due to the benefit of increased tax-exempt interest income. During 2004, liabilities for certain tax contingencies were reversed and a valuation allowance on the deferred tax assets related to certain state net operating loss carryforwards was reduced. The net benefit of these changes and other items was $4.2 million in 2004. The effective tax rate, exclusive of these events, was 38.5% for the year ended December 31, 2004.

 

Net Income.  Net income increased 11.1% to $67.3 million in 2005 from $60.6 million in 2004. Lower interest expense accounted for $3.9 million of the $6.7 million increase.

 

EBIT and EBITDA.  Arbitron has presented EBIT and EBITDA, both non-GAAP financial measures, as supplemental information that management of Arbitron believes is useful to investors to evaluate Arbitron’s results because they exclude certain items that are not directly related to Arbitron’s core operating performance. EBIT is calculated by adding back net interest expense and income tax expense to net income. EBITDA is calculated by adding back net interest expense, income tax expense, and depreciation and amortization to net income. EBIT and EBITDA should not be considered substitutes either for net income, as indicators of Arbitron’s operating performance, or for cash flow, as measures of Arbitron’s liquidity. In addition, because EBIT and EBITDA may not be calculated identically by all companies, the presentation here may not be comparable to other similarly titled measures of other companies. EBIT increased 3.0% to $101.4 million and EBITDA increased 3.0% to $107.3 million in 2005 from $98.4 million and $104.2 million, respectively, in 2004.

 

Working capital was ($4.6) million and $58.8 million as of December 31, 2006, and 2005, respectively. The $63.3 million decrease in working capital was primarily due to Arbitron using $50.0 million of available cash and short-term investments to prepay its senior-secured notes obligation on October 18, 2006. Excluding the deferred revenue liability, which does not require a significant additional cash outlay by Arbitron, working capital was $62.3 million and $121.2 million as of December 31, 2006 and 2005, respectively. Cash and cash equivalents were $33.6 million and $40.8 million as of December 31, 2006 and 2005, respectively. In addition, short-term investments and receivables from brokers, collectively, were $27.6 million and $82.6 million as of December 31, 2006 and 2005, respectively. Management expects that Arbitron’s cash position, along with these readily convertible assets, as of December 31, 2006, and cash flow generated from operations and its available revolving credit facility will be sufficient to support Arbitron’s operations for the foreseeable future.

 

Net cash provided by operating activities was $68.1 million and $77.4 million for the years ended December 31, 2006, and 2005, respectively. The $9.2 million decrease in net cash provided by operating activities was mainly attributable to a $16.7 million decrease in net income, and a $6.0 million decrease related to the excess tax benefit from stock option exercises for the year ended December 31, 2005. The decrease related to excess tax benefit from stock option exercises continue to be presented as an operating activity for 2005 in accordance with the modified prospective adoption of SFAS No. 123R on January 1, 2006. These decreases were partially offset by a $6.1 million increase in non-cash share-based compensation also due to the SFAS No. 123R adoption and a $2.5 million increase in deferred taxes. Increased operating expenses significantly decreased net income. These expenses included planned expenses required to build Arbitron’s PPM panels for markets other than Houston, operate the Houston panel and develop the national marketing research service through the Project Apollo pilot panel.

 

Net cash provided by operating activities was further impacted by a $5.0 million increase related to accrued expenses and other current liabilities substantially due to a $4.7 million reversal of certain tax contingencies and other items in 2005, partially offset by a $3.3 million decrease in cash flow for increased purchases of PPM international inventory in 2006.

 

Net cash provided by investing activities was $35.4 million for the year ended December 31, 2006, and net cash used in investing activities was $102.4 million for the year ended December 31, 2005. The $137.7 million increase in cash provided by investing activities was driven primarily by the full year impact of increased net sales of short-term investments of $137.5 million. Arbitron’s investment in available-for-sale variable rate demand notes issued by municipal government agencies and auction-rate securities began in the fourth quarter ended December 31,

2005. In addition, Arbitron acquired Integrated Radio Systems, L.L.C. on September 20, 2005 for $4.2 million. However, no acquisitions were made during the year ended December 31, 2006. These increases in cash flow from investing activities for the year ended December 31, 2006, as compared to the same period of 2005 were partially offset by increased capital spending of $3.9 million, which was largely related to PPM metering equipment purchases during 2006 for the PPM ratings service.

 

Net cash used in financing activities was $111.1 million and $20.8 million for the year ended December 31, 2006, and 2005, respectively. The $90.3 million fluctuation in financing activities was primarily attributable to the $50.0 million debt prepayment of Arbitron’s senior secured note on October 18, 2006 and a $30.0 million increase in repurchases of Arbitron’s outstanding common stock during the year ended December 31, 2006, as compared to the same period in 2005. The $9.0 million decrease in proceeds from stock option exercises was the result of significantly fewer options nearing expiration and lower average stock prices for the year ended December 31, 2006, as compared to the same period of 2005. Arbitron’s first quarterly dividend payment to Company stockholders was paid in April 2005. A $2.7 million increase in dividend payments resulted for the year ended December 31, 2006, as compared to the same period of 2005 because four quarterly dividend payments to Company stockholders were made during 2006, as compared to the three payments made during the same period of 2005.

 

These increases in net cash used in financing activities were partially offset by a $1.9 million increase in realized tax benefits related to share-based awards, which in accordance with SFAS No. 123R, is required to be presented prospectively in Arbitron’s cash flow statement as a financing activity rather than as an operating activity for periods subsequent to January 1, 2006, the adoption date for SFAS No. 123R.

 

On October 18, 2006, Arbitron prepaid its senior-secured notes obligation using $50.0 million of its available cash and short-term investments. Under the original terms of the note agreement, the notes carried a fixed interest rate of 9.96% and a maturity date of January 31, 2008. In accordance with the provisions of the note agreement, Arbitron was obligated to pay an additional make-whole interest amount of $2.6 million.

 

On December 20, 2006, Arbitron entered into an agreement with a consortium of lenders to provide up to $150.0 million of financing to Arbitron through a five-year, unsecured revolving credit facility (the “2006 Credit Facility”). The agreement permits Arbitron to increase the financing available under the 2006 Credit Facility up to $200.0 million provided that any number of lenders are willing to increase the size of their commitment. Interest on borrowings under the credit facility will be calculated based on a floating rate for a duration of up to six months as selected by Arbitron.

 

Arbitron’s 2006 Credit Facility contains financial terms, covenants and operating restrictions that potentially restrict financial flexibility. Under the terms of the 2006 Credit Facility, Arbitron is required to maintain certain leverage and coverage ratios and meet other financial conditions. The agreement contains certain financial covenants and limits, among other things, Arbitron’s ability to sell assets, incur additional indebtedness, and grant or incur liens on its assets. Under the terms of the 2006 Credit Facility, all of Arbitron’s material domestic subsidiaries, if any, guarantee the commitment. Currently, Arbitron does not have any material domestic subsidiaries as defined under the terms of the 2006 Credit Facility. Although the management of Arbitron does not believe that the terms of its 2006 Credit Facility limit the operation of its business in any material respect, the terms of the 2006 Credit Facility may restrict or prohibit Arbitron’s ability to raise additional debt capital when needed or could prevent Arbitron from investing in other growth initiatives. Arbitron has been in compliance with the terms of the 2006 Credit Facility since its inception.

 

Arbitron announced on February 28, 2005, that its Board of Directors (the “Board”) approved the payment of Arbitron’s first quarterly cash dividend. Since that time the Board has continued to approve the payment of quarterly dividends of $.10 per common share to the stockholders of record as of the close of business on the 15th of each quarter end month. For 2006, a quarterly dividend payment was made in the month subsequent to each quarter end.

 

On January 24, 2006, Arbitron announced that its Board of Directors authorized a program to repurchase up to $70.0 million of its outstanding common stock through either periodic open-market or private transactions at then-prevailing market prices through December 31, 2006. As of June 29, 2006, the program was completed with approximately 2.0 million shares repurchased for an aggregate purchase price of $70.0 million.

 

On November 16, 2006, Arbitron announced that its Board of Directors authorized a program to repurchase up to $100.0 million of its outstanding common stock through either periodic open-market or private transactions at then-prevailing market prices through November 2008. As of February 23, 2007, no shares were repurchased under this program.

 

Commercialization of the PPM ratings service will require a substantial financial investment. Arbitron believes it has sufficient cash and short-term investments as well as access to the 2006 Credit Facility to fund such requirements. Arbitron currently estimates that the aggregate capital expenditure associated with PPM ratings service commercialization for audience ratings measurement will be approximately $25.0 million over the first two to three years of commercialization. Arbitron also anticipates that, over the same period, its results of operations will be materially negatively impacted as a result of the rollout of this PPM ratings service. Ultimately, however, Arbitron believes that, while commercialization of PPM ratings service will have a near-term negative impact on Arbitron’s results of operations, its operating margins can be restored through the completion of the PPM transition process in the top 50 radio markets, although there can be no assurance that this will be the case.

 

The amount of capital required for deployment of the PPM ratings service and the impact of the rollout on Arbitron’s results of operations will be greatly affected by the speed with which the radio industry requests the PPM ratings service and the timing of the rollout. If the radio industry is slow to accept the PPM ratings service, as opposed to the use of diaries or some other competing alternative, then it will take longer to roll out the commercialization of the PPM ratings service, and the costs associated with that deployment will be delayed. On the other hand, if the radio industry asks for electronic measurement sooner rather than later, Arbitron’s capital needs will accelerate, and the near-term negative impact on Arbitron’s results of operations will be more significant.

 

The national marketing research service is a new service, however, for which market acceptance is not yet known. This service would require substantial additional expenditures if it ultimately proves to be a viable commercial service. During the year ended December 31, 2006, the Company incurred approximately $8.9 million of net expenditures relating to the national marketing pilot. If a decision is made to commercialize this service, substantial additional expenditures would be incurred during the next few years.

 

Since the pilot program for the national marketing service is in progress and customer response is preliminary, it is not yet possible to provide a meaningful assessment of future costs associated with a potential commercialization of this service. However, the same general cost pattern would apply as with the PPM ratings service, which is that substantial costs would have to be incurred in advance of revenues. This would result in a negative impact on results of operations in the first three to four years of commercialization, which impact likely would be material.

 

Arbitron expects to fund the pilot program for the national marketing service, and the expected commercialization of the PPM radio ratings service with its existing cash position and short-term investments, future cash from operations or through the most advantageous source of capital at the time, which may include borrowings under its current credit facility, sales of common and preferred stock and/or joint venture transactions. Arbitron believes that one or more of these sources of capital will be available to fund its PPM-related cash needs, but there can be no assurance that the external sources of capital will be available on favorable terms, if at all.

 

The following table summarizes Arbitron’s contractual cash obligations as of December 31, 2006 (in thousands):

 

 

 

Arbitron did not enter into any off-balance sheet arrangements during 2006 or 2005, nor did Arbitron have any off-balance sheet arrangements outstanding at December 31, 2006 or 2005.

 

Effective January 1, 2006, Arbitron adopted SFAS No. 123R, Share-Based Payments Revised. See Notes 2 and 15 in the Notes to Consolidated Financial Statements for the disclosures required by SFAS No. 123R.

 

In July 2006, the FASB issued FASB Interpretation (“FIN”) 48, Accounting for Uncertainty in Income Taxes (“FIN No. 48”), an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN No. 48 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006 and the cumulative effects, if any, of applying FIN No. 48 should be recorded as an adjustment to retained earnings. The management of Arbitron is currently evaluating the impact of adopting FIN No. 48 to Arbitron’s consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“SFAS No. 158”), which requires the recognition of the overfunded or underfunded status of a defined benefit plan as an asset or liability in the consolidated balance sheet and to recognize any changes in that funded status through comprehensive income. This Statement requires Arbitron to measure the funded status of a plan as of December 31, 2006 and to disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. Arbitron currently measures planned assets and benefit obligations as of September 30 each year. In accordance with the provisions of SFAS No. 158, the measurement date will be required to be as of the date of Arbitron’s fiscal year-end consolidated balance sheet effective for fiscal years ending after December 15, 2008. The impact to Arbitron’s consolidated balance sheet of adopting SFAS No. 158 as of December 31, 2006 consisted of a $1.5 million decrease in total assets, a $5.6 million increase in total liabilities, and a $7.1 million decrease in total equity. The net earnings and cash flows of the Company were not impacted by the adoption of SFAS No. 158. See Note 14 in the Notes to Consolidated Financial Statements for the additional disclosures required by SFAS No. 158.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The management of Arbitron is evaluating the impact of SFAS No. 157, effective January 1, 2008, but does not currently expect the adoption of SFAS No. 157 to have a material impact on Arbitron’s consolidated financial condition and results of operations.

 

Arbitron holds its cash and cash equivalents in highly liquid securities. Arbitron also holds short-term investments, which consist of investment grade, highly liquid securities classified as available-for-sale. A hypothetical interest rate change of 1% would have an impact of approximately $0.8 million on interest income over a twelve month period.

 

Arbitron currently has no exposure to interest rate risk with respect to debt securities due to the prepayment of Arbitron’s 9.96% senior-secured notes in October 2006, Arbitron’s only outstanding debt obligation at that time. In December 2006, Arbitron entered into an agreement with a consortium of lenders to provide up to $150.0 million of financing to Arbitron through a five-year, unsecured revolving credit facility. Interest on borrowings under the credit facility will be calculated based on a floating rate for a duration of up to six months. As of December 31, 2006 there were no outstanding borrowings under the new revolving credit facility. Arbitron does not use derivatives for speculative or trading purposes.

 

Because Arbitron currently has no outstanding floating rate debt, a hypothetical market interest rate change of 1% would have no effect on Arbitron’s results of operations.

 

Arbitron’s foreign operations are not significant at this time, and, therefore, Arbitron’s exposure to foreign currency risk is minimal.

 

The report of the independent registered public accounting firm and financial statements are set forth below (see Item 15(a) for list of financial statements and financial statement schedules):

ARBITRON INC.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

The Board of Directors and Stockholders

  Arbitron Inc.:

 

We have audited the accompanying consolidated balance sheets of Arbitron Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity (deficit), comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2006. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed under item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Arbitron Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 2, of the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, on January 1, 2006 and Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans on December 31, 2006.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Arbitron Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

 

 

Baltimore, Maryland

February 27, 2007

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

  Arbitron Inc.:

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Arbitron Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Arbitron Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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.

 

In our opinion, management’s assessment that Arbitron Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Arbitron Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Arbitron Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity (deficit), comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated February 27, 2007, expressed an unqualified opinion on those consolidated financial statements.

 

 

Baltimore, Maryland

February 27, 2007

 

ARBITRON INC.

 

Consolidated Balance Sheets

December 31, 2006 and 2005

(In thousands, except par value data)