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Situational Analysis Report

from the

Interim Board of Directors

Nazarene Publishing House

to the

92nd General Board

Church of the Nazarene

Nazarene

21 February 2015

© Nazarene Publishing House. All rights reserved.

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Situational Analysis Report

from the

Interim NPH Board of Directors

Nazarene Publishing House

to the

92nd General Board

Church of the Nazarene

21 February 2015

I. NAZARENE PUBLISHING HOUSE (NPH) CRISES

In 1922, when Nazarene Publishing House found itself in dire financial

condition, three churchmen, John T. Benson, F. M. Messenger, and E. G.

Anderson, were appointed by the Board of General Superintendents (BGS)

to take charge of NPH. Soon afterwards, General Superintendent

R. T. Williams asked Mervel S. Lunn, an NPH accountant, to assume the

duties of general manager.

The miraculous recovery, which NPH experienced by God’s grace, was a

combination of swift action by the general superintendents, overwhelming

support from the church, and a willingness on the part of Mr. Lunn to assume

operating responsibility for NPH. Mr. Lunn did so because in those early

days, the fast-growing denomination needed the holiness materials that only

NPH could provide through books, curriculum, and music.

Less than a decade later, during the economic depression of the late 1920s

and 1930s, NPH stepped in and became the financial backstop for the

church by supporting missionaries and the ministerial relief fund. Putting the

church first over NPH’s own needs for expansion, Mr. Lunn made it possible

to keep the general interests of the Church of the Nazarene funded until the

overall economy improved.

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In this sense, it is important for NPH to be seen as historically integral to the

church, its Wesleyan-Arminian theology, and its mission to make Christlike

disciples in the nations.

Through WordAction Publishing, Beacon Hill Press of Kansas City, Lillenas

Publishing Company, The House, Barefoot Ministries, and other resources,

NPH has, since 1912, served a higher calling—helping the church

communicate the transforming gospel of Jesus Christ and spreading

Scriptural holiness to men, women, youth, and children in all walks of life.

Once again, the time has come to renew the long-standing partnership

between the church and NPH.

II. NEW GOVERNANCE FOR NPH

In our short time working together, the Interim NPH Board has developed

mutual respect for the experience, time, and service each member has been

committing to NPH and the Church of the Nazarene.

The board wishes to express its deep gratitude to Interim CEO Mark Brown,

the NPH management team, and the dedicated employees who are working

to guide NPH in this demanding transition. It is appropriate, as well, to

express our thanks to the NPH employees who labored faithfully over the

years and recently concluded their time of service.

The interim board also acknowledges the challenges in attempting to

summarize and briefly report the NPH situation. The interim board has

attempted in this report to present verified information and sequences of

actions discovered in the information, research reports, and records

available to us, to our NPH legal counsel, and to our auditors.

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III. PURPOSE OF THE REPORT

In response to the 14 October 2014 action of the Board of General

Superintendents, regarding the work of the interim board of directors, this

report has been prepared for presentation at the 92nd session of the General

Board of the Church of the Nazarene.

The purpose of this report has not been to judge or assign blame or praise

for the actions that have occurred in relationship to NPH. Rather, our goal

has been to present a record of the actions and conditions which led NPH to

its present reality. We have approached this task with humility, as it presents

an opportunity for the church to learn from its recent actions and to provide a

foundation for the possibility of recreating itself and one of its resourcing

ministries.

Questions have arisen as to the future of NPH and whether it can fulfill its

mission to provide Wesleyan-holiness literature and other resources for the

benefit of the church. While the assignment to create the future for NPH was

not given to this board, we hope to provide a foundation for envisioning the

future.

The presentations in this report are based on the best information available

to us after reviewing the relevant documentation with NPH management,

employees, advisors, and others deemed appropriate. In addition, particular

attention was given to the information and analyses provided in the reports

compiled by the BGS-appointed task force; NPH corporate attorneys,

Lathrop & Gage; and the General Board’s financial auditors, Grant Thornton.

Our conclusions and recommendations represent our best judgment in

reliance on such information available to us as of 15 February 2015.

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IV. BACKGROUND OF THE NPH AND PREMIER TRANSACTION

A. Election of a New NPH President

1. In a sincere attempt to turn around the publishing ministry of the

denomination, the Board of General Superintendents and the Board

of Directors of NPH sought a leader who would bring different

business experience and expertise outside of traditional

denominational publishing.

2. Several candidates were considered in the search and nomination

process and Gerald W. Smith was eventually nominated for election

as NPH president, on the condition that he would divest himself of

his business, Premier Studios, Inc. and that neither NPH nor the

General Board would purchase Premier. (Motion from Nominating Committee)

3. In response to our survey, some former NPH Board members

indicated that it was their understanding that the BGS wanted Gerald

W. Smith to be the new NPH president and that Premier Studios

become a part of NPH. Although we realize that this position may

not have been the position of the entire Board of General

Superintendents, this was the stated understanding of some of the

members of the NPH Board.

4. Gerald W. Smith was nominated and duly elected by the General

Board as president of NPH in September 2012.

5. Upon the election of Gerald W. Smith, leadership expected that his

background and experience would help reverse the decline

experienced by NPH in the preceding decade.

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B. Context of Premier Gift in 2012

The following is a chronology and summary of what was learned

according to the information available to the Interim NPH Board.

1. NPH had been experiencing a financial decline over the past

decade, thus creating legitimate concern that dramatic action was

necessary in order to turn NPH around. During the decade, net

revenue dropped from $23.8 million in 2003 to $14.9 million at

yearend in 2012.

This financial condition is one reason church leadership and the

NPH Board began articulating that NPH’s business model was

“broken” and needed major changes in order for NPH to survive.

2. When informed on 1 September 2012 that the Nominating

Committee had voted to forward one name, Gerald W. Smith, to the

General Board for election as president, the NPH Board chair, John

C. Bowling, also made the two aforementioned stipulations clear to

Gerald W. Smith: first, that the motion would require divestiture of

Premier; second, that neither NPH nor the General Board would buy

Premier.

3. On 4 September 2012, Gerald W. Smith responded by email to the

NPH Board chair accepting the nomination.

4. On 6 September 2012, the NPH Board chair informed the previous

BGS and current General Secretary that the best scenario, in terms

of operations and long-term financial benefit, would be for Premier to

be owned by NPH:

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This would give the church a full-fledged

communications team. It would provide a revenue

stream for NPH. It would save NPH and/or the church

from having to purchase or lease expensive equipment

to establish an in-house team from scratch or contract

those services out.

Then NPH Board chair, John C. Bowling, went on to say:

If Mr. Smith sells Premier to someone else he gets the

proceeds from the sale, but the experience and

intellectual property of the Premier team and Premier's

related entities (the magazine they publish, etc.) would

be lost to the church.

5. In the conversation with the NPH Board chair, Gerald W. Smith

valued Premier at $4.2 million and indicated that it was a profitable

company with business contracts in place for work to be provided in

the future.

Gerald W. Smith indicated he was willing to donate Premier to NPH,

but he wanted to be reimbursed for the equipment and other

investments he had made in the company. He estimated that would

be about $1.8 million.

6. The negotiation was summarized by the NPH Board chair:

a. Gerald W. Smith would donate the company to NPH.

b. Premier would be owned and controlled by NPH.

c. At least initially, Premier would remain a separate corporate

entity (but owned by NPH).

d. These actions would satisfy the first condition of the nomination,

that Gerald W. Smith divests his interest in Premier.

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e. Over time, Premier would reimburse Gerald W. Smith for his

investment out of the annual profits of Premier, with the

remainder of the profits being retained by NPH as part of

Premier’s financials or transferred directly to NPH.

f. The key point here is that under this arrangement no NPH money

or general church money would be used to purchase Premier or

to reimburse Gerald W. Smith. His reimbursement would come

solely from the business generated by Premier. That would

satisfy the second provision of the nomination caveat.

C. A Gift Becomes an Acquisition

1. As a result of these negotiations, Gerald W. Smith agreed to gift

certain assets of Premier Studios, Inc. and, as noted above, the

anticipated profits of Premier Studios, Inc. would be used to

reimburse him of his reported $1.8 million investments in the

Premier business.

2. In preparation for the completion of the anticipated gift of Premier

Studios, Inc., Gerald W. Smith provided unaudited balance sheet

statements dated 30 November 2012. The balance sheet included

statements of assets and liabilities for fiscal year 2012 and was

provided to the BGS and the NPH Board.

3. On 6 December 2012, GMC counsel, Michael Thompson, advised

in an email that NPH could not receive the stock of Premier

Studios, Inc. as a Subchapter S corporation, but that Premier

Studios, Inc. could file a revocation of the Subchapter S election to

be effective 31 December 2012. Then the stock transfer of Premier

Studios, Inc. to NPH could occur.

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4. The NPH Board voted to approve the acquisition of Premier

Studios, Inc. on 20 December 2012 in accordance with the terms of

an Acquisition and Merger Agreement effective 31 December 2012.

5. On 20 December 2012, Premier Studios, LLC was created by

Gerald W. Smith and certain assets and liabilities of Premier

Studios, Inc. were transferred to this new entity. Assigned to

Premier Studios, LLC was a portion of the assets and all of the

debt of Premier Studios, Inc. (Grant Thornton report)

6. There is no discoverable information that the full NPH Board was

aware of the creation of Premier Studios, LLC at the time of its vote

to receive the gift of Premier Studios, Inc. on 20 December 2012 or

that the assets and liabilities of the intended gift had changed since

the 30 November 2012 balance sheet submission.

7. Furthermore, a task force appointed by the BGS to review the

transaction did not discover any independently audited financial

statements for Premier Studios, Inc. or Premier Studios, LLC that

were presented to the former NPH Board in the course of this

transaction.

8. NCN News reported the following on 11 January 2013:

The substantial assets of Premier Studios and

all future business profits will go entirely into the

mission of NPH. The Smiths received no

compensation for this gift.

9. NPH financial records indicate there were no profits generated by

Premier Studios, LLC in 2013 and 2014.

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10. NPH eventually paid off two Premier bank notes that were included

in the transaction of Premier Studios, LLC to NPH in the original

principal amount of $1,958,000 out of NPH operating or reserve

funds.

11. NPH also assumed Premier Studio’s five-year lease, including its

mandatory five-year renewal with Wolf Creek Development, LLC,

with its ten-year obligation of $4,390,800 plus the taxes, insurance,

and upkeep over the period of the lease. (Grant Thornton report)

Based on the review of the title records of the building subject to

the lease and the company filings with the Delaware and Kansas

Secretaries of State for Premier Studios, Precom, Inc., and Wolf

Creek Development, we believe that Wolf Creek Development is

owned by Precom, Inc. (formerly known as Premier Studios, Inc.,

which was the company initially the subject of the gift agreement),

and that Precom, Inc. is in turn owned by Gerald and Dianna

Smith. The lease agreement between Wolf Creek, LLC (landlord)

and Premier Studios, Inc. (tenant) was signed solely by Gerald W.

Smith on 2 July 2012 and was to commence on 3 September

2012.

12. According to Lathrop & Gage and Grant Thornton, there was no

discoverable detailed independent third-party valuation of the

Premier business that was being gifted in the transaction.

13. During the presidential nomination and search process and the

acquisition of Premier, there were no discoverable external

assessments of the current and future needs of NPH or the church

to establish a course for the future.

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14. There was a published statement on 14 March 2013 in NCN News

as to a “reinvention of the global NPH model,” but no discoverable

NPH turnaround plan was presented or implemented during 2013

or 2014 to achieve this model.

D. 2014 Timeline

1. At the General Board meeting in February 2014, Gerald W. Smith

announced he would not seek re-election as president of NPH.

2. In February 2014 the NPH Board retained the law firm of Spencer

Fane Britt & Browne LLP to advise it in connection with its dealings

with Gerald W. Smith and its responses to inquiries from the BGS

and General Board regarding the Premier Studios transaction. The

BGS continued to rely on the services of Lathrop & Gage LLP to

review the transaction and assist in its oversight role.

3. On 29 April 2014, the NPH Board and Gerald W. Smith agreed that

he would be placed on an indefinite paid leave of absence. During

this time, an effort was made to negotiate the sale of Premier

Studios, LLC back to Gerald W. Smith. This action would have

placed all parties in substantially the same position that existed prior

to NPH’s acquisition of Premier Studios, LLC. NPH and Gerald W.

Smith were unable to come to mutually agreeable terms.

4. The combined NPH and Premier businesses fell into chaos, and a

“financial crisis” was declared by the Board of General

Superintendents. The general superintendents intervened in the

summer of 2014, vacating the office of NPH president and asking

the NPH Board to resign.

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5. Jim Van Hook, appointed interim CEO of NPH effective 29 April

2014, informed the BGS in August 2014 that NPH cash reserves

would likely run out by the end of 2014. As a result of that

assessment, NPH issued a WARN Act (The Worker Adjustment and

Retraining Notification Act) notice to its employees informing them of

their planned termination, effective 1 December 2014. The action

was taken as a means of protecting funds in order to preserve the

capacity of NPH to provide severance to employees and to retain

funds sufficient to close NPH, if required (estimated to be

$1,000,000 needed for closure).

V. GOVERNANCE AND LEADERSHIP TRANSITION

A. Transition Working Group

At the request of the Board of General Superintendents, Mark Brown,

with the assistance of a working group composed of Marilyn McCool,

Russ Bredholt, Tom Greaves (NPH’s corporate attorney from Lathrop &

Gage), and other specialists and advisors oversaw activities of NPH

during this transition.

The working group met weekly to address the immediate needs of NPH

during the period where there was no functional board of directors from

18 September 2014 until the election of the Interim NPH Board on 15

October 2014. Regular updates were provided to Dr. David W.

Graves, general superintendent in jurisdiction over NPH, and Charles A.

Davis, Jr., president of the General Board. During this period, NPH took

the following actions:

1. Sale of NPH’s Interest in the Global Ministry Center Campus

NPH released all right, title, and interest it had in the Global Ministry

Center campus, Lenexa, Kansas, USA, for a sale price of

$1,008,000 (its original investment) pursuant to a Property Sale

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Proceeds Agreement between NPH and the church, thus removing

NPH ownership in the Global Ministry Center campus. An

independent appraisal supported the purchase price. This action

was taken to eliminate NPH’s ownership position in the GMC

property, should NPH pursue bankruptcy or closure and sale of

assets.

2. Purchase of Morrill & Janes Bank Notes

NPH purchased from Morrill & Janes Bank and Trust a Promissory

Note (M&J Note), dated 1 April 2014, by Premier Studios, LLC for a

purchase price of $1,209,328.73, which equaled the remaining

principal and interest on the purchase date, pursuant to a Note

Purchase Agreement dated 25 September 2014. This loan had been

reduced from its original balance of $1,458,000 which was received

in the gift of Premier Studios, LLC.

In addition to the Promissory Note, NPH paid off Premier’s Line of

Credit with M&J on 1 August 2014 in the amount of $419,006.98.

When NPH assumed the line of credit as part of the transaction, the

amount of the obligation was $439,000 on 1 January 2013.

For both loans, NPH was a guarantor, meaning that the full assets of

NPH were pledged to secure the M&J Notes entered into as part of

the Premier transaction. NPH and Premier Studios, LLC each

granted a security interest in substantially all of their personal

property to secure the M&J Note. The purchase of the larger M&J

Note on 25 September 2014 was necessary for Premier Studios to

sell its assets free and clear of such lien.

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3. Forbearance Agreement

NPH entered into a Forbearance Agreement dated 26 September

2014 pursuant to which NPH, in its capacity as the senior lender

holding the M&J Note, declared the note in default, but permitted

Premier Studios, LLC to sell its assets and agreed to release its lien

on any assets sold by Premier Studios; provided that any proceeds

of such sale would be applied to the note or to satisfy such other

obligation of Premier Studios as otherwise consented to by NPH.

4. Sale of Premier Studios Assets

NPH hired an auctioneer to sell substantially all of the equipment

and inventory of Premier Studios, LLC and permitted the sale of

such assets. The auction was held on 27 September 2014. The

auction netted approximately $78,305 in proceeds after expenses.

5. Vacating of Premier Studios Premises

On 30 September 2014 all remaining assets of Premier Studios, LLC

and any assets of NPH that were located at the offices of Premier

Studios (10000 Marshall Drive, Lenexa, Kansas 66215) were

removed. A cleaning crew was hired to clean such premises and

Premier Studios vacated the premises. Lathrop & Gage sent a

notice to Wolf Creek, LLC (the Landlord) to notify the Landlord that

Premier Studios had ceased its business operations and had

vacated the premises. On 7 October 2014, Lathrop & Gage

delivered all keys and access cards to the Landlord’s legal counsel.

6. WARN Act Notice

It was determined that NPH did not have sufficient projected cash

flow to continue operating in its current condition past the end of the

year, 2014. In consultation with legal counsel, it was determined

that a WARN Act notice needed to be sent to all the employees of

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NPH, informing them that NPH would cease publishing and other

operations as were then currently being conducted and that NPH

anticipated that all employees would be terminated as of 1

December 2014.

The WARN Act notice was sent by NPH to its employees on

1 October 2014 in order to fulfill the USA legal requirement to notify

employees when a corporation is facing potential closure. (The Act

requires a 60-day notice.) This decision followed the termination of

35 employees, 20 from Premier Studios, LLC and 15 from NPH,

effective 1 August 2014.

All such actions were endorsed by the Board of General

Superintendents. The Interim NPH Board acknowledged the power

and authority of the Board of General Superintendents and NPH to

take such actions and that these actions were the valid acts of NPH.

B. Interim CEO and Interim NPH Board

In October 2014, Mark Brown was named interim CEO by the Board of

General Superintendents. An Interim NPH Board of Directors was

nominated by the BGS and elected by the remaining member of the

previous board, David Wilson, who then resigned his position as a

member of the NPH Board.

C. Priorities of the Interim NPH Board

1. Transition

Beginning in October 2014, the Interim NPH Board has met at least

weekly by teleconference with the interim CEO, Mark Brown, to

identify immediate actions necessary to transition NPH to the

1 December 2014 release of employees and to transition NPH

beyond that 1 December date. The goal has been to ensure that

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NPH could continue to resource its customers inside and beyond the

Church of the Nazarene.

2. Customers

Considerable NPH staff time has been invested with local church

customers and church partners explaining and clarifying the

immediate future of NPH. The release of public information,

interpreted by many as indicating the closure of NPH, created

confusion and loss of customers at retail and wholesale levels. The

stabilization of these customers has been a high priority; however,

some losses have occurred.

3. Employees

After our election on 15 October 2014, the Interim NPH Board

focused upon completing the NPH transition initiated by the WARN

Act notification on 1 October 2014. This action required the

termination of all employees on 1 December 2014. The attempt to

stabilize NPH required the hiring of 28 individuals from the released

employee pool to begin work on 2 December 2014 in order to fulfill

core functions of the operation, particularly in the supplying of

curriculum for churches.

4. Curriculum

The Interim NPH Board recognizes that the long-term viability of

curriculum must be addressed, since the current business model is

dependent upon curriculum sales. Sales continue to decline

around two percent annually.

5. 2013 Audit

Keller & Owens, NPH auditors, indicated the following in their 6

January 2015 Management Letter to NPH:

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We encountered no significant difficulties in

dealing with NPH management in performing our

audit. However, we did experience limited

cooperation from Premier’s accounting

personnel. In addition, the termination of Premier

operations, loss of key NPH accounting

personnel, and the downsizing of NPH

operations did create significant delays and audit

time in completing the audit.

Due to leadership and operational challenges at NPH, the 2013 audit was not

completed in a timely manner. When the interim board took responsibility,

completion of the 2013 audit became a high priority.

The 2013 audit was also delayed because there was no detailed, verifiable

valuation of the gift of Premier Studios, LLC. An appraisal company, Atec, had

been previously hired to provide a valuation of the business assets of Premier

Studios, LLC. The preliminary one-page letter valuation received from Atec was

without supporting documentation for the business assets of Premier Studios,

LLC. The preliminary one-page, unsigned letter was not sufficient for the

auditors to establish a reliable value of Premier Studios, LLC.

When the interim board assumed office, attempts were made to secure

additional financial details of the valuation, but Atec would not respond and

failed to supply any further data, even to requests from legal counsel.

As noted above, the tangible assets of Premier Studios, LLC were sold at

auction and netted approximately $78,305. Premier Studios, LLC is not engaged

in any further business activities.

The 2013 audit was completed 6 January 2015 and has received a "Qualified

Opinion" due to the inability of NPH to provide the detailed valuation of the

Premier Studios, LLC transaction.

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6. 2014 Audit

The 2014 audit has also presented challenges. The challenges stem from the

following:

a. The departure of NPH financial staff in the fall of 2014

b. The requirement of Grant Thornton (General Board auditors) to

include NPH in the church’s consolidated audit

c. The resulting change of NPH's fiscal year to coincide with the fiscal

year of the General Board

d. The lack of staff to conduct the required year-end inventory of NPH

e. The inability to generate monthly financial reports throughout 2014

due to the change undertaken by NPH to convert to Premier’s cost

accounting system

f. The delay in completing the 2013 audit as the basis for the 2014 audit

These delays have negatively impacted the General Treasurer's Office in

the preparation and finalization of the 2014 consolidated audit for the

General Board, a reality deeply regretted by the Interim NPH Board. While

progress is being made toward the NPH 2014 audit, unfortunately, it is not

complete for inclusion in this 2015 General Board Session.

7. 2014 Year-End Financial Position

The 2014 year closed with a cash balance of nearly $2.7 million as a

result of reduced overhead, greater than predicted year-end income, and

the sale of NPH’s ownership interest in the Global Ministry Center

campus. This balance will be essential in providing the capacity to

negotiate the uneven cash flow of income and expenses for the coming

year. Continued monitoring of the financial position and cash flow of NPH

will be a key focus of the board in 2015.

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D. Existing NPH Obligations

Certain business relationships approved in the past two years by previous NPH

leadership now constrain the ability of the Interim NPH Board and management

to transition toward a new business model. The board has focused on the

following contract relationships affecting NPH:

1. Dexter Fulfillment Services

On 1 January 2014, NPH entered into several contracts with Dexter

Fulfillment Services (Dexter) pursuant to which Dexter is exclusively

providing printing, order fulfillment, warehousing of product, and

shipping of orders for NPH to service the Church of the Nazarene

and its Wesleyan partners.

This significant financial obligation of approximately $4,500,000

annually, has a 10-year term and no unilateral exit clause for NPH.

The interim board intends to explore with Dexter potential options to

better customize this arrangement for the long-term security of both

parties.

2. Toler Services Contract

The previous NPH president signed a book and services contract

with Stan A. Toler, General Superintendent Emeritus, on 16 August

2013, to purchase book inventory from the Wesleyan Publishing

Company and from Stan Toler's private titles and to begin an

aggressive printing of Toler books by Beacon Hill Press.

The NPH contract with Stan Toler was for global training and

speaking engagements that were to be sponsored by GMC

ministries and departments. In these events, books and other

resources were to be produced and provided by NPH, thus creating

sales of Toler’s works.

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In order to support the services contract created by NPH, financial

support was solicited from and initially provided by various GMC

ministries. However, when the BGS learned that World Evangelism

Fund and undesignated giving was and would be used to pay in

advance for these contract services, the participation by GMC

ministries was terminated.

The Interim NPH Board completed a mutually agreeable termination

agreement of the Toler contract and a sale back to Stan A. Toler for

the rights in the titles acquired under such contract, all inventory

associated with such titles, and the web domain name. The

termination and sale terms put NPH in a much stronger cash

position than it would have faced under the terms of the contract.

3. Lillenas Publishing Company

The sale of Lillenas was originally targeted to occur before the end

of 2014. The NPH Board made an initial review of the available

financial information, including royalties of the owned titles within

Lillenas, and considered whether a viable revenue stream could be

maintained in the future.

In the process of review and in preparation for the sale of Lillenas,

Jim Van Hook indicated to the board that a previously signed

agreement with the Lorenz Company placed a restrictive clause

upon Lillenas, should a sale be initiated. This clause appears to

have had the effect of devaluing the potential sales price in the open

market and has delayed the capacity of the interim board to pursue

a sale. During January 2015 a separate non-compete clause was

identified in the Lorenz contract, inhibiting the ability to sell Lillenas.

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The interim board has directed Mark Brown to consult with a music

business attorney to assist NPH in resolving these matters. The

board is seeking to remove these restrictions so that appropriate

due diligence can be conducted and a fair market value established,

should a decision be made to sell Lillenas.

Additionally, the failure of previous Lillenas management to end a

contractual relationship with Clydesdale Publishing when the

contract renewal or termination date occurred in August 2014 has

created an additional $90,000 annual obligation for Lillenas in a

contract that continues until 29 August 2016. Without a viable music

company to promote the marketing and sale of Clydesdale products,

NPH has little prospect of generating revenue to offset the financial

obligation of the contract. The Interim NPH Board has directed

management to seek counsel from our attorney for possible

resolution of this arrangement and the negotiation of potential

product sale outlets. Those negotiations have been underway since

late January 2015.

4. Wolf Creek Development Lease

The acquisition by NPH of Premier Studios, LLC included a ten-year

lease agreement (five-year lease with a mandatory five-year

renewal) signed by Gerald W. Smith for the Premier space in

Lenexa, Kansas. NPH has notified the Landlord that it has vacated

the Lenexa property. To date, the Landlord has not notified NPH of

any further action related to the lease.

The triple-net lease included a monthly rent escalating from $34,196

to $40,868 per month over the ten-year term. The ten-year rent

obligation would have totaled $4,390,800 in rent payments, plus

taxes, insurance, and maintenance related to the premises. This

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lease was paid by NPH until 30 September 2014 when the Landlord

was notified that no further payments would be made.

E. Future Issues

1. Property Interest

NPH management has received expressions of interest in

purchasing the current NPH facilities on Troost in Kansas City,

Missouri, USA. The interim board initially discussed this issue and

will evaluate this possibility in greater detail should an actual offer be

made on the facilities and property. The board is aware of the

potential future costs and liabilities of maintaining large facilities with

minimal operations such as exist in the Troost properties.

2. Creating a Sustainable Business Model

The transition from termination of all employees on 1 December

2014 has begun; however, the future is not yet designed. Efforts to

understand and match the mission-essential resource needs of the

church with a viable NPH model must yet be accomplished.

Unless theologically sound Wesleyan-holiness resources (books,

curriculum, etc.) are viewed as essential to the mission of the

denomination and worthy of being purchased, there is not a reason

for NPH to exist as a business within the church.

3. Capacity of GMC and NPH to Operate as a Unit

The recent NPH situation illustrates the need for the

interdependency of all the GMC ministries toward a clear and

missional purpose. The necessity of achieving a common mission

demands a new mindset and perspective for the church. Clear,

articulated, and unified ministry and operational activities must be

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developed to support the highest priorities of the church’s efforts

to achieve the mission of the church.

Independent and separate actions by GMC ministries comprising

the church should not continue. Direct attention and leadership

must be given by the Board of General Superintendents and the

GMC ministry directors to synchronize the full efforts of the church

and its resources. Further, action must be taken to unify ministry

culture toward the fulfillment of the mission.

The interim NPH Board believes this effort must begin soon and

must be marked by measurable outcomes. Without such an effort,

a viable future of NPH is unlikely. Our concerns extend to the

denomination itself.

VI. SITUATIONAL ANALYSIS

A. NPH and its Transaction

At the point of accepting our governing assignment, the Interim NPH

Board was charged with examining the circumstances surrounding NPH

and presenting a report to the General Board.

The interim board has the benefit of updated financial information from

2013 and the benefit of being independent from the decisions and

transactions that have affected NPH.

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B. How did NPH get to the place it is today?

The board sought to answer several questions, among which are these:

1. What prompted the BGS, in consultation with the previous NPH

board, to decide on 28 July 2014 to declare vacant the office of NPH

president by removing Gerald W. Smith from that position effective

31 July 2014? (NCN News 1 August 2014)

2. What circumstances forced the BGS on 29 September 2014 to

declare NPH in “financial crisis,” and to request the resignation of the

NPH Board, which had been elected by the General Board of the

Church of the Nazarene? (NCN News 29 September 2014)

3. Why on 1 October 2014 did Nazarene Publishing House issue a

WARN Act notice (a Federal law in the United States) to its

employees indicating possible layoffs effective 1 December 2014?

The short answer to these questions is that by the end of 2014 NPH

would run out of cash. The financial context is reflected below:

1. After the 2008 stock market crash, NPH reserves dropped from

$11.9 million to $8.9 million.

2. In the four years from 2009 to 2013, reserves dropped an additional

$2.1 million, from $8.9 to $6.8, with $1.6 million of this decline being

a required payment to the NPH pension fund due to the market

downturn and NPH’s loss of assets.

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3. In the 21-month period from 1 January 2013 through 30 September

2014 while NPH and Premier Studios, LLC were a combined

business, reserves fell $5.1 million, from $6.8 million down to just

$1.7 million.

4. Additionally, a decade of decline in sales and net revenues also had

a cumulating negative effect on the financial position of NPH.

C. Factors Shaping NPH

Understanding the context of Nazarene Publishing House requires a

more holistic examination of factors shaping the present and future of

NPH:

1. A Church in Transition

The Church of the Nazarene is in organizational transition. We are

meeting as a General Board to address what is largely a USA

business matter, because the General Board, even though most

members are non-USA, plays a role in the search, nomination, and

election of the NPH president.

The Manual has not kept up with the realities of a church whose

membership is configured far differently than when NPH was

brought into existence in 1912. The Manual governs NPH as if it

were the global resourcing entity rather than recognizing the

significant resourcing contributions within Global Mission.

2. Market Disruptions

There are a number of factors that have converged over the past 30

years to radically change the publishing interests of the North

American church. They include:

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a. Decreased Sunday School attendance—even off-setting growth

in small groups (Nazarene Research Services)

b. A decline in the number of English-speaking churches and

attendees—a net loss of 693 churches since 1990 and a net loss

of 29,429 people in average worship attendance (Nazarene Research

Services)

c. The shift from choirs, duets, quartets, and solos to praise teams

with no printed music (This was a major loss for Lillenas

Publishing.)

d. Less denominational loyalty and diminished concern for a

holiness emphasis in resources, which is NPH’s only real reason

for publishing

e. Fewer commentaries and resources purchased from a single

source

Even with these trends, at least through 2013, Nazarene

congregations of all sizes continued purchasing from Nazarene

Publishing House. In fact, 73 percent of churches used at least

some curriculum for children, 63 percent for youth, and 79 percent

for adults (Nazarene Research Services). However, the way in which

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resources are now purchased has resulted in significant reductions

in total NPH sales volume.

3. The Future of Publishing

Googling “future of publishing business” produces 57 million

responses. Searching “future of denominational publishing” turns up

33 million results. Great interest exists in knowing more about the

future of the publishing industry.

A major characteristic of the Internet is an “information-sharing”

culture where material that was once purchased is now free.

However, “free” is not a sustainable business model unless it is

underwritten by other sources.

Where is publishing going next? The truth is, no one knows the

answer to this question. In all likelihood, the future of publishing will

be an integration of print and digital, and the most successful

publishers will be those who are able to structure their businesses in

a way that enables them to take full advantage of both. (Source: John

B. Thompson, author and professor of Sociology, University of Cambridge)

4. Intervention Without Adequate Assessment

The well-intentioned action to address the challenges confronting

NPH could have been better served by the use of professionally

guided internal (NPH) and external (church) needs assessments.

When the interim board searched for formal written assessments,

none could be found. The only documents found were a job profile

and an NPH survey. We could not find any analysis or study of the

needs of the Church of the Nazarene in the 21st century.

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Additionally, no analyses or strategies for the mission-centered use

of Wesleyan-holiness resources for the 21st century church were

identified or provided by church leadership as input to the process.

We believe that a thorough assessment would have shown the

following:

a. NPH was strongly tied to the state of the U.S. church, whose

membership and worship attendance are in decline.

b. While technology is only going to increase in importance to the

publishing industry, content is still the primary reason customers

purchase products and services, even as e-distribution channels

and digital resources expand.

c. NPH should have been focusing its attention on improving

product development, customer service, and revisioning its future

in this time of leadership transition.

d. NPH had more than sufficient debt-free space on Troost Avenue

in Kansas City. Obligating NPH to a long-term lease in Lenexa,

Kansas, created a significant financial burden.

e. With no debt and nearly $7 million in reserves at the end of 2012,

NPH needed to maintain liquidity for a turnaround, rather than

taking on additional debt and lease obligations with the

acquisition of Premier Studios, LLC.

f. NPH needed printing and fulfillment flexibility rather than the

long-term obligations now required by the contract with Dexter,

which offers NPH no unilateral exit clause.

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5. Decisions Without Full Due Diligence

The goal of due diligence is to assure that sufficient inquiry and

information have been acquired to make an informed decision. A

due diligence period also permits a buyer to determine if there are

any barriers or risks associated with a transaction. Accordingly, a

material transaction is usually conditional upon completion of the

due diligence stage.

Due diligence covers everything from review of material contracts to

investigation of liens and other encumbrances and involves a review

and understanding of the customer and supplier contracts, works in

progress, status of receivables, employee relations, banking

relations, and many other factors that impact the value of the

business and its future prospects.

The financial and legal due diligence stage should have provided

NPH with a complete understanding of the corporate entity it was

acquiring, with a full listing of its assets and liabilities—tangible and

intangible—so that the transaction could be finalized with full and

transparent detail.

In the responses provided by the former NPH Board members

(Appendix A) regarding their understanding of the transaction they

approved on 20 December 2012, there is a broad range of

understanding about what the transaction included for NPH from

Premier. The transaction would have been aided significantly if the

due diligence process had provided written, detailed documentation

regarding what specifically was included in the transaction so that all

decision makers in NPH and the church would have had a common

data set for the transaction decision regarding Premier Studios.

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VII. THE OUTCOMES

In August 2013, eight months after the NPH/Premier transaction, the BGS

authorized a legal and financial review by a task force. That task force

comprised of Charles A. Davis, Jr.; John C. Bowling (NPH Board chair, later

replaced by David McKellips, a member of the NPH Board); and Eugénio A.

Duarte, BGS chair, was appointed to work with the NPH Board; President

Gerald W. Smith; Lathrop & Gage; and the General Board’s auditor, Grant

Thornton.

The assignment for the task force was to determine the timeline of actions

and fiduciary facts from Gerald W. Smith’s election in September 2012

through December 2012 when the transaction for the acquisition of Premier

Studios, Inc. was made and approved by its board of directors.

The task force report, submitted to the BGS in November 2013, can be

summarized as follows:

A. Premier Studios, LLC came with significant financial obligations (bank

loans, lease, employees) and no positive cash flow to cover the

expenses, even though it was represented to the NPH Board and the

BGS that such funds were sufficient to do so. (Grant Thornton Report)

B. At the time of transfer, there was a negative cash flow from Premier’s

operations. Grant Thornton’s report indicates a negative year-end cash

balance for 2011 and 2012, and financial statements for NPH indicate a

loss for the year 2013.

C. During the task force review, it was substantiated that Premier had no

long-term contracts to generate future revenue following the termination

of its General Board web-hosting and annual maintenance contract in

2012. (Grant Thornton Report)

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D. The previous NPH Board approved an agreement to acquire Premier

Studios, Inc. However, certain assets of Premier Studios, Inc. were

assigned to Premier Studios, LLC, and NPH became the sole member

of Premier Studios, LLC. Gerald and Dianna Smith continued to own

Premier Studios, Inc. and changed its name to Precom, Inc.

Incomplete financial schedules (bank loans, Wolf Creek lease) were

attached to the acquisition agreement. As of 20 December 2012, the

complete schedules were either not available for inspection by the

previous NPH Board or the schedules did not exist. The schedules in

the agreement were not completed until almost a year later, in 2013. It

is not clear if any NPH Board member ever saw the M&J Bank Notes or

the lease agreement with Wolf Creek, LLC prior to the 20 December

2012 vote.

E. The assertion that Premier was covering its own operating costs and

was a profitable business is not what was discovered by the task force

in the financial statements reviewed. Immediately upon the transfer of

Premier Studios, LLC, NPH was required to direct some internal and

contracted business functions to Premier. These functions were then

billed back to NPH and, in some cases, for substantially more than NPH

had historically been paying.

F. From the time Premier Studios, LLC was acquired in December 2012

until its liquidation in September 2014, NPH made cash contributions of

more than $3 million to fund Premier’s operations. This amount includes

payment of the lease, taxes, insurance, building maintenance, and

payroll costs. The funds used by Premier to pay its operating expenses

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came mostly from NPH operating income, reserves, and accounts

payable. Upon the closure of Premier, it was in debt to NPH for

approximately $3 million.

G. Premier Studio, LLC’s tangible assets were eventually sold at auction in

September 2014 for a net return of $78,305.

H. The intangible and leasehold improvements in the transaction, never

professionally valued to the satisfaction of the auditors, were not

available to help NPH satisfy the cash requirements for the liabilities it

incurred.

VIII. WHAT THE INTERIM NPH BOARD HAS LEARNED

We may never have perfect answers to all of these questions, but in our

effort to better understand what happened and to enable us to chart a more

constructive path forward, we have drawn some broad conclusions.

A. The Need for Full Due Diligence

The interim board believes that had full legal and financial due diligence

been conducted and had the results of such due diligence been shared

with all appropriate parties in leadership, the decision would not have

been made to acquire Premier under the terms and conditions of the

transaction as they occurred.

In the final analysis, Premier Studios, LLC was an expensive acquisition

that consumed valuable resources and energies in a financially fragile

time in the history of NPH, and it did not represent what many believed

NPH was receiving in the transaction.

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B. Failure of Process

The NPH Board, the BGS, and the Executive Committee of the General

Board did not have adequate data to fully evaluate the business

condition of Premier Studios, LLC. Nor did it have the ability to value

the assets and liabilities of Premier or to identify potential conflicts of

interest associated with the transaction. Thus, the transaction that

occurred was different than what was described in the Gift Agreement

and the Agreement of Merger documents.

Obviously, in evaluating this transaction, we are limited to the

information available to us. Our review indicates that in preparing for a

business transaction of this nature, specialized outside counsel would

have provided much-needed decision-making information to everyone

involved. We also realize that this was a unique transaction for the

church, which has little experience in such complex business matters.

The church would have benefited from external expertise and

independent analyses.

Additionally, the engagement of independent auditors and attorneys to

properly structure the acquisition would have provided a clear and

known set of documents for advance consideration by the NPH Board,

the BGS, and the Executive Committee of the General Board. We

could not find any documentation of this type of work prior to the

decision. As a result, unanticipated outcomes occurred.

C. Potential Conflicts of Interest

Because of failures in the governance and decision processes, potential

conflicts of interest at the governance and leadership levels of NPH and

the church, were not fully considered from the search process through

the past two years of NPH operation, which, we believe, affected the

current condition of NPH.

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However, our report did find that despite concerns regarding potential

investment and business relationships, all former NPH Board members

affirmed in their responses to questions posed, that they had no

investments in or business partnerships with Wolf Creek Development

or any business managed or directed by Gerald W. or Dianna Smith.

Additionally, all board members indicated that they did not receive any

gift valued at more than $100 from the Smiths or Wolf Creek

Development. Members did disclose that at an annual meeting of the

NPH Board, NPH provided board members with an iPad mini for the

documents and information necessary to their work as a board.

Our report indicates that there was no business or investment conflict of

interest by former NPH Board members regarding investment or

business relationships with Gerald W. or Dianna Smith during the time

of their board service.

D. Challenges of Communication and Governance Structure

Some involved in the transaction have asserted that there was full

disclosure regarding the nature of the transaction and that actions

were taken to address potential conflicts of interest. While we cannot

evaluate what was believed to be known at various moments of the

transaction and decision making, the complex governance structure

for NPH and the church contributed to the situation.

Additionally, unclear lines of communication within and beyond the

governance structures led to the development of an adversarial

relationship among the NPH Board, the BGS, and the Executive

Committee of the General Board. Restricted communications and the

hiring of separate legal counsel, by the NPH Board, further contributed

to the adversarial relationships with the BGS and the General Board.

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This unhealthy context of relationships and communication, magnified

by the weak and diffused governance structure of the church and NPH,

contributed to costly delays, damaged relationships, and weakened

trust in leadership across the church. These were and are harmful to

NPH, the church, and leadership.

E. Summary of Current NPH Governance Responsibilities

The Interim NPH Board believes that this governance confusion

regarding relative authority and the lack of checks and balances within

this structure are contributing factors to the problems of NPH. We

recommend that consideration be given to reforming the governance

structure of NPH and the denomination in relationship to NPH in order

to provide greater clarity of authority, responsibility, and accountability.

Below is our understanding of the relative authorities and the current

status of NPH governance and management.

1. NPH Purpose

The Articles of Association of Nazarene Publishing House provide

that the purpose and scope of NPH is to take and hold property for

the use and benefit of the church and that the entire business of

NPH must be conducted in harmony with the Manual of the

church— the guiding principle that the NPH Board and leadership

team must observe in managing the business and affairs of NPH.

2. NPH President

The Bylaws of NPH grant the president the authority to manage the

business of NPH under the supervision of the NPH Board. The

president’s election, however, is not by the NPH Board, but through

a search and nomination process involving the NPH Board and the

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General Board. The election of the NPH president is currently the

responsibility of the General Board. (Manual par. 335.19 and 338.5)

The Manual provides that the nominating committee shall be

composed of six general superintendents, three members of the

NPH Board (who are not ex-officio) and three members of the

General Board Executive Committee. (Manual 338.5)

The president may be removed by the Board of General

Superintendents. (Manual 317.5)

3. NPH Board

The NPH Bylaws provide that its board shall be composed of nine

members: the president of NPH, the general secretary of the

denomination, one General Board member elected by the General

Board Executive Committee, and six members-at-large nominated

by the BGS and elected by the General Board.

Additionally, the rotating general superintendent in jurisdiction over

NPH is included in the composition of the NPH Board in a

counseling and advisory capacity, but not as a voting member.

There is no mechanism provided for removing board members

between general assemblies, although board members may resign.

Vacancies are filled by the remaining members of the NPH Board

after nominations are received from the BGS.

4. Role of the General Board and Board of General Superintendents

The General Board and the BGS have limited expressed authority

over the business affairs of NPH, other than as provided above with

respect to the search, nomination, and election of the NPH president

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and the NPH Board of Directors at the beginning of a new

quadrennium.

In the event that the NPH Board and president are not fulfilling their

responsibilities to the satisfaction of the General Board or the Board

of General Superintendents, there currently are very few structural

checks and balances that permit the General Board or the BGS to

take action.

IX. RECOMMENDATIONS

The assessment of the Interim NPH Board leads us to recommend the

following:

A. Due diligence and formal assessment are necessary for any

significant operational or missional changes within the church or its

core entities.

A formal assessment of the needs of the church and its responsible

entities (in this case NPH), should be conducted prior to the search,

nomination, and election of a new leader. The analysis of the needs,

combined with the professional capacities, experiences, and

requirements for future effectiveness should be standard operation in

leadership selection. Full and independent financial and legal due

diligence should be required in any business arrangement or acquisition

involving the church. New policies such as these should be adopted

and included in the governing documents for the church and its entities.

B. Understanding and fulfilling core mission is essential for the

church, NPH, and the related ministries and entities of the GMC.

Premier Studios, LLC, as a for-profit business, was not essential to the

mission of the church or NPH as this transaction was structured. While

37

innovation in the church through business units should not be ruled out

as a future option, consideration must begin with an evaluation of the

core values and essential mission of the church in relationship to that

potential business operation.

Since NPH is a wholly-owned subsidiary of The Church of the

Nazarene, Inc., we believe a more clearly defined missional purpose

and the identification of potential assets and liabilities with this

transaction would have assisted NPH and the church in decision

making.

C. The church must link Wesleyan-holiness resources to its mission.

If NPH is to exist for the church, the church must decide, articulate, and

desire to use Wesleyan-holiness resources as a core strategy of

achieving its mission.

D. Theological clarity and coherence should be a priority.

The BGS, NPH, USA/Canada Region, district superintendents, pastors,

and Sunday School and Discipleship Ministries International (SDMI)

should partner in creating a future for communicating and teaching

Nazarene theology, Core Values, and mission through local churches.

E. The Manual should be updated regarding NPH.

The Manual should be updated at the 2017 General Assembly in regard

to NPH and its governance structure and accountability. Paragraphs

regarding NPH should be removed from the Manual and placed in a

single, unified governance document providing clear responsibility and

accountability.

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F. Governance, responsibility, and accountability for NPH and the

church must be clarified.

Current governance documents for the church and NPH are written for

effective and successful times. Little guidance or authority is specified

or assigned for needed action in times of crises or failure, and this

exposes the church to legal, financial, and personal jeopardy. Conflicts

of interest must be identified, communicated, enforced, and considered

before any decision of a complex nature is made.

X. NPH AND THE CHURCH’S PUBLISHING MINISTRY—WHAT’S NEXT?

The decision about the future of NPH must include whether this resource

should be operated as a business or a ministry.

Looking toward the future, we recommend the following:

A. A comprehensive needs assessment for mission-essential resources

should be conducted by church leadership, NPH, districts, and

ministries of the Church of the Nazarene, particularly in the

USA/Canada Region which is served by NPH. This assessment should

be the basis for planning and designing a possible NPH future with the

ministries of the church in its local, district, and regional operation.

B. The current, onerous NPH contract obligations should be renegotiated

or terminated in a timely manner to provide financial and operational

flexibility for NPH to develop a sustainable future.

C. The product line of NPH should be aligned to mission-essential

resources for the church with a clear and sustainable business plan.

39

D. The GMC and NPH must see each other as united in the same ministry

and mission effort. An alignment of decision making and operational

culture, planning, missional direction, service, and support for the larger

mission of the Church of the Nazarene must be achieved.

E. NPH facilities and land should be evaluated in a comprehensive context

of future needs, purpose, finances, and mission. Any proposed

transaction should include a full legal, financial, and independent due

diligence process for informing decision makers.

F. Prior to the 2017 General Assembly and the possibility of Manual

changes, new and precise operating procedures for governance,

accountability, and responsibility for NPH should be put in place and, if

necessary, resolutions drafted for Manual revisions.

G. The church and all of its ministries and subsidiaries must be collectively

focused on the mission of the church in a linked, coordinated, and

effective manner if the Church of the Nazarene is to fulfill its mission.

H. NPH needs sustainable leadership and governance for a business

future or the development of a publishing ministry integral to the

church’s mission.

XI. CLOSING REMARKS

We are here today to acknowledge the difficult corporate and personal

struggles of these past two years for NPH and the church. Our report has

attempted to provide an understanding of events and actions that led to the

dramatic changes in the viability of NPH. We also recognize that the

struggles NPH has experienced are complicated by more than a decade of

declining sales and declining denominational loyalty.

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We acknowledge that many have given their professional lives in service to

Christ and the church through NPH. They guided the ministry of NPH over

decades. For each of these individuals we are grateful and thankful for their

work and influence. We grieve for those who have lost much in these difficult

times.

While the past has brought us to today, the future is what we must address.

The church must answer with its actions whether Wesleyan-holiness

resources are necessary to our mission of preaching, teaching, evangelizing,

and discipling those in our churches and communities. NPH is necessary

only if it has a vital and unequivocal role in and for the church. The church

does not need a business just to have a business; it needs a resource

partner to equip it to fulfill its mission.

The recent recession has taught us to look for the opportunities and

possibilities of a new way to approach the future. So out of our chaos, crisis,

and struggle, what is it that God wants to do in and through the church and

NPH for His honor and glory? We know it must be different than what it has

been. The church is changing. NPH is changing. What is it that we must do

together as God’s people through the church and NPH?

We have struggled and anguished long enough. Now, it is time to turn the

page to a new chapter for the church and the future of NPH—one that fulfills

God’s purpose for our church and for His people. Toward that purpose, this

report is prayerfully given to you.

Respectfully submitted,

Bob Brower, Ph.D., Chair

Monte L. Chitwood, Vice-Chair

Keith A. Pardue, Secretary

David W. Graves, BGS Chair, Ex Officio

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Appendix A

The Interim NPH Board sent by email the following letter and set of questions inviting former NPH Board members (excluding the NPH president) who served from July 2012 until September 2014 to respond. Below are the introductory letter and the collected responses of those NPH Board members that responded. Each collected response listed below is an unedited direct quote.

February 4, 2015

To the Members of the 2013 & 2014 NPH Board of Directors:

We are writing to you as the Interim NPH Board of Directors to request your assistance in completing our report to the General Board. The Executive Committee of the General Board requested that we review all available information regarding the actions that led to the necessity of NPH invoking the WARN Act on December 1, 2014, thus we are requesting input from each former NPH Board member who served during the transition from Hardy Weathers to Gerald W. Smith to Jim Van Hook.

The scope of our report is to include the history of NPH's sales decline over the past several years, the context of NPH that guided the presidential search, the transaction of Premier Studios and its impact upon NPH, the recent business activity of NPH, and the factors that led to NPH's current state.

The Executive Committee of the General Board has provided guidance for our work. We have attached 11 questions we are requesting a response for. The last three are specific questions the Executive Committee has requested we include, in order to address rumors that have surrounded the NPH context over the past couple of years. We would be grateful for your participation in providing your perspective and answers. Please feel free to include any information related to this entire matter you deem appropriate for the Interim NPH Board to consider.

The NPH Report will not identify any individual with any response provided to these questions. The responses will be grouped by question and will be attached as an addendum to our report. It is our goal, by asking these questions, to understand as much as possible, the facts of the transaction, so that we will be in a better position to respond to questions that have been raised, and to move forward with the future of NPH.

Thank you in advance for your consideration.

On behalf of the Interim Board, thank you,

Monte Chitwood, Keith Pardue, and Bob Brower

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Response request from the NPH Board

The Interim NPH Board has been asked to gather input from previous members of the NPH Board as part of our work in reporting to the General Board. It

would be appreciated if you are able to supply responses to the items below. Thank you.

1. On December 20, 2012 what did you understand NPH would

receive in the gift of Premier Studios, Inc.?

• Everything connected with Premier, including the outside business and equipment

• It was my understanding that NPH was being given the Premier Studios

“business,” including the capital equipment and other assets in place at

the time and would receive any existing business contracts and that

NPH would incorporate Premier as a business unit within the company

and that NPH would hire the staff to ensure continuity and expertise.

• It was my understanding that NPH was given an irrevocable gift of

Premier Studios, thereby meeting the requirement of divestiture. Gerald

and Diana were offering their business and it would become a

subsidiary of NPH, expecting nothing in return (other than a tax write

off).

I have to admit that I did not read all 36 pages of the agreement

carefully, so I did not realize at the time that the company did not own

any real property. I mistakenly assumed that the company included the

building that housed Premier Studios, but at our next meeting it was

clearly outlined that the building was leased from a trust owned by

Gerald and Diana.

• I fear that my answers will not be exact because of the length of time

that has elapsed. But as I recall, I understood that NPH would receive

the business, clients, and equipment but not the building. Upon reading

the contract, I noted that the building was not included and so I wrote

Dr. Bowling to ask about it. His response was something like, (not his

exact words but my interpretation at the time), “we needed to receive

the gift of the business before the end of the year and we would work

out the building details later.”

• I understood we were getting the gift of the Premier Studios, Inc. all of its assets and liabilities.

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On December 20, 2012, I understood NPH would be receiving all business

aspects of Premier Studios: current and potential client relationships,

contracts, and revenue streams; management and employee knowledge and

expertise plus attendant compensation and benefit obligations; operational

systems and methods; tangible and intangible assets (equipment, cash,

software and software licenses, etc.); plus the business’s debts and lease

obligations.

• My recollection is the NPH would receive Premier Studios so that Gerald W. Smith could divest himself of this. I was under the impression that NPH would receive open accounts, business contracts, etc. which came with Premier.

2. On December 20, 2012 what did you understand the

"substantial assets" of Premier Studios Inc. would bring to NPH?

• The staff, outside business, and equipment

• It was my understanding that NPH would acquire both the fixed

equipment (production equipment, sound studio, etc.) and also acquire

the business expertise of its leadership and staff.

• I understood that the biggest assets were the creativity and new model of doing business that Gerald and his team would bring to NPH. NPH had been losing money rapidly and we needed a new model desperately. I also saw the reports sent to the board indicating that Premier had averaged $305,623 in net income in the previous three years and had $1.3 million in assets and $1.4 million in fixed assets.

• I thought NPH would be receiving the equipment such as the recording studio equipment.

• I was very unclear as to exactly what Premier Studios had to offer but was reassured that it was substantial.

• On December 20, 2012, and thereafter I felt the most important aspects of the Premier acquisition were its business and digital communications strategies and expertise, its creative and production capabilities, and its client-focused organization and decision models. These had been relied upon by the denomination for many years and were in contrast to the aspects of NPH operations that had led to serious revenue declines

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and financial losses for many years. NPH was failing rapidly and needed an entirely new approach in order to survive.

• I knew the Premier gift also included both tangible and intangible assets

as well as a profit stream (albeit a modest stream compared to the

magnitude of NPH’s continuing losses).

• My understanding is that Gerald and Premier were bringing a new

business model. In addition, I thought there would be various equipment

items, intellectual property, etc. I wasn’t on the board very long when I

was made aware of the significant losses NPH was absorbing. There

was a sense of urgency to turn things around.

3. On December 20, 2012 did you understand the purpose of and

reason for the creation of Premier Studios LLC, after the gift

agreement was signed?

• No. It was not until much later in the process that I became aware of the creation of the LLC.

• I understood that prior to the gifting there were other, smaller, business

units operating under the Premier Studio umbrella, that were not

technically part of the Premier business (for example, I think Gerald

bought and sold guitars and ran that through the company – things like

that). This new entity would be necessary as a place to house those

assets, etc.

• I honestly don’t remember the exact date I understood that a new LLC was created for the elements of Gerald’s company that were being gifted to NPH. When it was explained to me, it seems like it was because there were some entities in the old company that were not a part of his communication business, like interest in a golf course. I don’t remember if any of that had come to the board by Dec. 20, 2012.

• No and I still don’t.

• No

• I was not aware that an LLC had been formed. The only documents I saw referred to Premier Studios, Inc. Why would Premier Studios, Inc. become an LLC? The issue was never addressed with me at any level.

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• Prior to December 20, 2012, I had read the acquisition agreement and other documents provided to all NPH board members and knew the denomination’s attorneys had worked diligently and urgently to compose the agreement, which included the legal procedures and structures for Gerald and Dianna Smith to gift the Premier business to NPH. That gifting met the Nominating Committee’s “full divestiture” requirement – agreed to by Gerald W. Smith as a condition of his election. The acquisition agreement noted the possibility that Gerald W. Smith could choose to convert Premier to a different corporate structure (from its existing Subchapter S status) prior to gifting the business to NPH. I had full confidence in the expertise of the denomination’s professional staff and outside legal counsel to vet such matters as final execution of the transaction was completed following NPH board approval.

• I do not think I understood the purpose and reason for the LLC on

December 20, 2012. I don’t recall when I learned of this step.

4. On December 20, 2012 did you understand the purpose of

including the $500,000 line of credit debt and the $1,458,000

promissory note debt of Premier Studio in the gift to NPH? Were

those debts discussed by the NPH Board while you were

physically present or on a conference call, as part of the gift

transaction, on or before December 20, 2012?

• In the contract, reference was made to a line of credit, but no specific amount was mentioned. I did not understand the purpose of including the promissory note in the agreement. I do not recall these amounts being discussed by the NPH board.

• I was aware of the line of credit, but was not aware of the promissory

note. I specifically asked Gerald if there was a debt encumbering

Premier and was told that there was not. When I later learned of the

promissory note, I determined that it was a legitimate “cost of doing

business” item and was essentially offset by the assets being given.

Prior to the gift, Premier was managing that debt out of Premier

operations and making a profit – my assessment was that Premier

would continue to manage the debt out of its operating margin and thus,

this DID NOT represent added unsupported debt for NPH, not covered

by the additional revenue to be generated by Premier.

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If a person is given a $50 debt and at the same time given a $100 bill –

how does one view the debt? It was my understanding that the assets

of Premier were more than the debt incurred.

• I think I understood by Dec. 20 the purpose of a business having a line of credit, and even understood that business mergers bring both assets and debt, but I do not remember us discussing the debt or promissory note at a meeting of the Board. Although it was in the documents, in retrospect, I think it would have been wise to highlight the debt to make sure the board was clear on both the assets and liabilities of this merger. Since I thought the company owned property (my mistake), I probably assumed any debt was for land or equipment.

• Not to my knowledge or recollection.

• I raised the issue with the chairman in a late afternoon phone call on the 20th of why NPH would accept the liabilities of Premier. I told him that accepting the liabilities seemed to be a very unusual business practice.

• On December 20, 2012, I believe I had seen the statement of assets

and liabilities for Premier that detailed both debts. It’s possible,

however, that I had not. I did understand that all of Premier’s debt was

being serviced by its ongoing operations. I also believed – correctly, it

turned out – that the assets in the Premier gift exceeded its debt and

other liabilities.

At this point I do not recall if the debt was discussed by the board as

described in the question. However, I clearly recall subsequent

meetings in which both the debts and assets of Premier at the time of

gifting were discussed in detail with the board by Gerald W. Smith.

• I do not recall understanding this. I do not remember if the debts were discussed.

5. On December 20, 2012 did you understand the terms (length of

time) and monthly costs of the Lease agreement to be with Wolf

Creek Development prior to closing? When was it known by you

that the lease was for 10 years?

• No. We were told it was a month by month agreement to allow a

determination to be made as to the best location for the business. To

the best of my memory, I became aware of the 10 year agreement in the

summer of 2013.

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• At that time, I understood the lease to be short-term, essentially month-

to-month, which would be extended for perhaps a year or two, during

which time NPH would determine its long-range plan regarding location.

The rationale for continuing the lease was that the Board and

management were already substantially downsizing the staff at Troost

and were in negotiations to sell the printing and distribution operation.

If/when printing and distribution went away, the viability of maintaining

the Troost location would be called into question. So, rather than

breaking the lease and moving everything to Troost (at a substantial

cost), it was my thought that we continue the lease until the future

needs of NPH could be determined.

I personally talked with the BGS and the NPH Board to make them

aware that there was a lease and that Gerald’s trust owned the building.

I was not aware of a ten year agreement and do not know who

authorized or signed off on the long-term commitment.

• I did not understand that the business was being leased until the next NPH Board meeting in 2013. As I remember, I asked at that 2013 meeting if we were bound by the lease if we decided we wanted to move the whole operation to Troost. I believe I was told that we could get out of the lease if we determined it was in our best interests. Part of the agenda at that meeting was to show us the unique capabilities of that building and its value to our business operation of NPH. The board seemed optimistic and supportive at the time.

• I was not told of the monthly costs of the lease agreement nor the length of time until approximately 1 year. To say that I was shocked would be an understatement.

• I had no idea as to the terms of the lease agreement. I didn’t realize it was a ten year lease until after I was no longer on the board. The board was assured it was within the range of standard business practices.

• Prior to and on December 20, 2012, I knew that Premier Studios did not own the Lenexa building (or other real property) and that the Lenexa facility was being leased for a substantial amount from an entity owned by Gerald and Diana Smith. That had been disclosed to me by Gerald

W. Smith personally and by the chair of the NPH board. It was also clearly spelled out in the acquisition agreement furnished to the board – which specified that the lease would stay in place after the transaction.

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With such disclosure, I did not consider continuation of that lease to be

a conflict of interest from a legal or policy standpoint – nor did the

denominations outside attorney when I inquired about that in a

subsequent meeting with the BGS.

However, even though I did not consider the continued lease to be a conflict of

interest due to its disclosure, I felt it would be interpreted that way by most people.

And regardless of how others might interpret it, I thought it was unwise to continue

that arrangement after Premier became part of NPH with Gerald W. Smith serving

as NPH president. Therefore, I had urged Gerald W. Smith to sell the Lenexa

building rather than have it become a continuing, serious point of contention –

which it clearly did.

I do not recall when I first knew the specific terms of the lease.

• If I remember correctly, my take was that the lease agreement was either short-term, or it would not be a long term commitment or liability. I do recall that there was some thought of having some flexibility and options available with both properties.

6. What did you understand to be the financial health of Premier

Studios Inc., at the time of gifting, and the operational assets

that Premier Studios Inc. would bring to NPH as a church

business?

• I knew Premier took a substantial financial hit when the GMC ended its web hosting/maintenance agreement in February 2012. I understood that they replaced our business and were doing fine.

• I had reviewed the financials of Premier and determined the company

was making a profit (although less than some previous years) – the

benefit to NPH was to bring into the company a profitable business unit,

which had the potential of becoming more profitable. Nothing else at

NPH was making a profit.

• I did not believe that Premier was a highly successful business when

NPH received it.

• Based on the financials that were sent to the board on December 19, 2012, my

assessment was that Premier Studios, Inc., was a going concern and needed to

take drastic action if it were going to remain in business. It did not make sense to

me that our leadership would agree to the deal.

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• Before the NPH board voted to accept the Premier gift I had seen the

previous three-year summary of financial results showing Premier’s

continued profitability in 2009, 2010, and 2011. The decline in

Premier’s profits during that time period did not worry me based on what I knew about several other organizations in similar businesses at

the time as well as some specific changes that had occurred in

Premier’s client assignments.

See my answers to previous questions for my response re: operational

assets.

• I saw the reports sent to the board indicating that Premier had averaged $305,623 in net income in the previous three years and had $1.3 million in assets and $1.4 million in fixed assets. I saw that the income was down the previous year, but it still showed a history of making profits at a time when everything at NPH was losing money. I was hopeful that Gerald and his team could join the dedicated team at NPH and together help turn our business around. If not, I knew the future of NPH was questionable.

• I thought that Premier was a profitable business. I do recall seeing reports that showed positive trends, a positive net income and significant assets.

7. What was the basis of analysis to determine the financial

viability of Premier Studios Inc. prior to receiving it as a gift to

NPH?

• I knew Premier took a substantial financial hit when the GMC ended its web hosting/maintenance agreement in February 2012. I understood that they replaced our business and were doing fine.

• As I recall, NPH was provided with the past three years’ financial statements and an audited financial report from Premier.

• I believe we were provided a financial statement by Gerald W. Smith.

But as I recall, the profit from the year before was minimal, perhaps $80,000?

• Looking over the financial reports. Trusting that if Gerald did not know how to run a business, he would not have made it past the Search and Nominating Committees, many of whom knew Gerald well. In retrospect, I wish we would have not more independent business minds help us to evaluate the viability of the business and ask questions. I

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also wish those who did have questions about Gerald’s business practices would have raised the issues with the Board at that time, before the merger took place.

• One of the board members in the September meeting said, “Obviously,

due diligence should be done by a third party to determine its value.” I assumed the executive committee performed that responsibility. No report was ever received.

• I believe we received some financial statements from Premier and perhaps an audited report. I was under the impression that Gerald knew how to run a successful, progressive and profitable business. One of my regrets in this whole process is that I did not ask enough questions. I did not seek clarification.

8. On December 20, 2012 were you aware that during a

discussion with Nazarene leadership prior to his taking office

on December 1, 2012 Gerald W. Smith requested that he

receive $1.8 million dollars from NPH in exchange for

divesting his ownership and investment in Premier Studios

Inc.?

• No. If it’s true, I’m shocked.

• I was aware that many scenarios were discussed as a way of meeting

the requirement that Gerald divest himself of Premier. This may have

been one of the scenarios considered. There was past precedent for

NPH buying or compensating an individual for a company and then

having that individual become an employee – that was the case with

Haldor Lillenas and Lillenas Publishing. One could give a business

and sell the assets at the same time.

• News to me…..

• No, I am just now learning of this conversation. On December 19,

2012, I received the e-mailed documents as a board member. The

next day I did not respond to the e-mail requesting my vote. Only after receiving the announcement from Dr. Duarte that the transaction had been approved did I call, John Bowling. I expressed my reservations but accepted the fact that the decision had already been announced.

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• No.

• No. I was not aware.

Responses requested from the Executive Committee of General Board:

9. Do you or your spouse have, or have you ever had, any funds invested in or partnered with Wolf Creek Development or any other business in which Gerald W. Smith is involved?

• All Board members who responded indicated “NO.”

10. Do you or your spouse have, or have you ever had, any funds invested in accounts that are/were under the management of Gerald W. Smith, Dianna Smith or Wolf Creek Development LLC?

• All Board members who responded indicated “NO.”

11. Have you or your spouse ever received a gift in the value of more than $100 from Gerald W. Smith, Dianna Smith, Wolf Creek Development LLC or any business entity in which Gerald W. Smith was involved?

No. I did receive a box of chocolates (as I recall) from Gerald W.

Smith as President of NPH – my understanding a similar gift went

to each NPH Board member – I have no idea of the value of that

gift.)

• No. I’ll note, however, that each director at the NPH board’s 2013 annual meeting received an iPad Mini. Since it was for accessing e-books and other digital products and services for which NPH was planning increased emphasis, I do not consider it to be a “gift.” “Gift” might apply more to the tokens of appreciation, of similar value but with no relation to NPH business, that were presented to NPH directors at meetings prior to Gerald W. Smith’s presidency.

• The remainder of the responses were “NO”

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Additional Comments provided by respondents:

• Respondent A:

1. I’m requesting that this also be included in the report to the General Board for thoughtful consideration. It concerns the three questions asking previous NPH board members if they – or if their spouses – have ever had investments with or have ever received gifts from Gerald W. Smith, Dianna Smith, or Wolf Creek, etc. The questions came completely out of the blue. It was the first I had heard of any such issue.

2. I could truthfully answer “no” to each question and did so. But the inclusion of the questions disturbs me for two reasons.

3. First, we were told the questions were specifically included by the

General Board Executive Committee in order to “address rumors” within a report to the entire General Board. Elevating the stature of “rumors” in that manner is troubling. Anonymous rumors should be ignored, especially within the body of believers. But apparently the “rumors” were serious enough, pervasive enough, or specific enough to be of serious concern. Surely they were not about the entire board. So it would have been a more scriptural approach – and it would have provided more definitive information – if someone on the Executive Committee had simply contacted the individual(s) whose integrity was in question instead of questioning the integrity of board members more broadly.

4. Second, each NPH director signed a Conflict of Interest statement annually. It required that we disclose any relationship or situation we felt would impair objectivity. The implication in asking the questions is that we did not answer truthfully.

Respondent B:

I want to add a few additional comments to the above questions.

1. I trusted in the collective wisdom of the search committee, the nominating committee, and eventually, the General Board. If I had to do it over again, I would have asked more questions, sought clarification, and done more research.

2. I did not meet Gerald W. Smith until after his nomination. I heard things and had conversations with people, but I did not know Gerald.

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3. For the most part, I am grateful that I was able to serve on the NPH Board for 4 or 5 years. It was quite disheartening to hear the financial reports every year get progressively worse.

I have a great deal of appreciation for the staff and employees of NPH.

They have served sacrificially and with distinction in difficult times. It is

so clear that they greatly love NPH.

It was an honor to serve with the folks on the board. They passionately

wanted to see NPH succeed in its mission. The desire of the board was

to see NPH reverse the serious downward trends and be financially

healthy. I could sense the intense love the board had for the Church of

the Nazarene and for NPH. I am deeply saddened that things did not

turn out as hoped. We failed…and that grieves me.