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The McClatchy Company (NYSE:MNI)

Q3 2009 Earnings Call

October 15, 2009 12:00 pm ET

Executives

Elaine Lintecum - Treasurer

Gary B. Pruitt - Chairman of the Board, President, Chief Executive Officer

Patrick J. Talamantes - Chief Financial Officer, Vice President - Finance

Chris Hendricks - Vice President of Interactive Media

Analysts

Craig Huber - Barclays Capital

Matthew [Sundin] – No Company Listed

Analyst for Alexia Quadrani - J.P. Morgan

Barry Lucas - Gabelli Sons

Edward Atorino - Benchmark Capital

David Ching – No Company Listed

Jake Newman - Credit Sights

Randy [Barron] – No Company Listed

Anna Palmer – No Company Listed

Operator

Welcome everyone to the McClatchy third quarter 2009 earnings conference call. (Operator Instructions) Ms. Lintecum, you may now begin.

Elaine Lintecum

Thank you. Thank you all for joining us today for our third quarter conference call. The call is being webcast at mcclatchy.com and the webcast will be archived for future reference. Joining me today is Gary Pruitt, our Chairman and CEO; our Vice President of Operations, Bob Weil and Frank Whittaker; our Vice President of Interactive Media, Chris Hendricks and our Vice President and CFO, Pat Talamantes. We are all available for questions at the end of Gary’s remarks. We will be sticking to the one question per participant rule but I will be available after the call for follow-up questions and I can be reached at the following phone number, area code 916-321-1846.

Our earnings release and statistical report were issued this morning before the market opened. The release includes a summary of unaudited results and the full text of our release and statistical report are posted on our website for your convenience.

All non-GAAP amounts are reconciled to the most directly comparable GAAP measure in the release and in attached schedule, as well as in schedules posted on our website. As a reminder, this conference call will contain forward-looking statements that are subject to risks and uncertainties, including among others those described in the company’s 2008 annual report on Form 10-K filed with the SEC. Actual results may differ materially from those described during this call.

Now here’s Gary Pruitt, our CEO.

Gary Pruitt

Thanks, Elaine. Today we reported income from continuing operations of $23.6 million or $0.28 per share for our third quarter. Excluding certain unusual items detailed in our press release our adjusted earnings from continuing operations in the third quarter were $11 million or $0.13 per share, slightly more than the 2008 third quarter. It is important to note that the tax rate for adjusted earnings in the third quarter of 2009 was 61.8% which is likely much higher than any of you used in your models.

Total revenues in the third quarter of 2009 were down 23.1%. Advertising revenues were down 28.1% but circulation revenues were up 6.7%. Online advertising revenue grew 3.1% in the third quarter of 2009 and were 17.6% of total advertising revenues compared to 12.2% of total advertising revenues in the third quarter of 2008.

Despite our revenue challenges, we are showing financial progress in this recession. We reduced cash expenses in the third quarter by 29.4% excluding severance and other restructuring charges. The restructuring of our business has been necessary to align expenses with revenues and it is contributing to our ability to manage the company through this downturn by enabling us to grow cash flow. Yes, you heard that right. Operating cash flow was $94.4 million in the third quarter and that was up 1.3%. Still believe me; we know print revenue declines remain a challenge.

Here are our revenue results by category. Retail advertising was down 23.1% during the quarter. The declines in our newspaper advertising were partially offset by strong growth in digital retail advertising. Online retail was up 57.7%.

Classified advertising revenues declined 37.7%. Here is a look at how the major categories performed during the quarter. Employment advertising was down 59.7% in the third quarter. Print employment revenues were down 67.3% while online revenues were down 49.4% reflecting both the lack of hiring and the close tie between print and online up sells in this category.

Automotive advertising was down 34%. Our print advertising was down 45% and online auto advertising was down only 1.5%. Real estate advertising was down 42.9%. Print advertising was down 49.5% and online real estate advertising declined 5.3% in the third quarter.

Turning next to national advertising it declined 28% in the quarter. Print losses were partially offset by a 36.1% growth in online national advertising. While digital advertising is included in the results above, we wanted to discuss this important growing part of our business with you in more detail.

McClatchy continues its transition to a successful print and online company. Our digital audience continues to grow impressively. Average monthly unique visitors to our websites were up 14.7% in the third quarter following 28.3% growth in the first half of 2009. Online advertising revenues returned to growth in the third quarter up 3.1% compared to the third quarter of 2008. Excluding employment advertising, a category that has been impacted both online and in print by the nationwide decline in jobs, online advertising revenues were up 28.4% in the quarter and up 27.2% year-to-date. Our digital performance has been aided by our ownership space in Career Builder, Cars.com and Apartments.com, leading companies in the digital classified advertising arena.

We continue to report great success in retail online advertising fueled in part by our partnerships with Yahoo! and other technology companies. As we continue our successful migration to a multimedia company we are less vulnerable to print declines and in secular shift of advertising to digital media. Digital advertising represented 17.6% of total advertising in the third quarter up from 16.5% in the second quarter of 2009 and up from 12.2% in the third quarter of 2008.

This is among the highest percentage in the newspaper industry and importantly our digital business has a higher profit margin than our print business because it is not burdened with printing and distribution costs. We have implemented increases in circulation prices at most papers resulting in a 6.7% increase in circulation revenues in the quarter. Our strategy is to expand our total audience both in print and online. While circulation has declined these declines reflect in part our efforts to reduce unprofitable circulation that is less desirable to advertisers. Despite lower circulation volumes we believe we continue to extend our total reach in our markets with the combined, unduplicated audience of our websites and newspapers.

As I mentioned, total cash expenses in the third quarter were down 29.4% excluding the impact of severance and other restructuring charges. Compensation costs were down 29.6% excluding severance. Newsprint and supplement costs declined 46.1% reflecting lower prices and usage. Prices were down more than 25% and usage continues to decline. All other expenses decreased 20.1%.

Interest costs were $34.5 million in the quarter slightly higher than the third quarter of 2008. Interest on debt declined by $2.2 million reflecting lower debt levels and interest rates but interest on tax reserves increased in the quarter.

Our effective interest rate on bank borrowings is about 4.3%. The effective interest rate on our bonds is 6.4% and our all-in effective interest rate on outstanding debt is 5.4%.

Capital expenditures in the quarter were $3.0 million and were $11.4 million for the first nine months. We expect to hold capital expenditures below $20 million this year. Looking forward, the advertising declines we experienced show some signs of slowing but the ad revenue environment remains weak overall. As a result, we expect print advertising revenues to continue to decline in the fourth quarter. So far in October we are seeing advertising revenue trends that are somewhat similar to the third quarter.

We still have a lot of hard work ahead of us. As long as we are experiencing revenue declines we must maintain a tight rein on expenses. We expect to hold costs down in the mid 20% range in the fourth quarter. We completed the quarter with debt of $1.99 billion, down about $134 million from the end of 2008. Based on a trailing 12 months of cash flow, our leverage ratio as defined under our credit agreement improved for the second consecutive quarter to 5.7 times at the end of the third quarter and our interest coverage ratio was 2.8 times.

Both of these ratios are well within the covenant requirements under our credit agreement of a leverage ratio of less than 7 times and an interest coverage ratio of greater than 2 times. At the end of the quarter we had approximately $172 million available under our bank credit line.

We have faced these uncertain times with the resolve and confidence of a company that has successfully adapted to many economic downturns and media competitors over our 152 year history. We will continue to serve our communities with high quality journalism and we will continue to aggregate audiences and serve the needs of our local media and national advertisers both online and in print.

Now I will be happy to take your questions about our third quarter results.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Craig Huber - Barclays Capital.

Craig Huber - Barclays Capital

A multi-part question. I asked this last quarter as well. Could you speak if you would about the advertising rate declines you saw in the quarter for your newspapers? Last quarter when I asked the question you inferred it was greater than 5%, the ad rate decline.

Gary Pruitt

That is accurate. I know that some companies may have pegged it there but by our analysis it is greater than that. It is a little more difficult to get at these days with so many revenue contracts and contracts that cover various products; print, online, non-subscriber products, etc. so it is hard to peg it but we do see it as higher than that 5% decline.

Craig Huber - Barclays Capital

Do you mean perhaps closer to 10%, a tighter range maybe?

Gary Pruitt

It is difficult give a tighter range than that but yes I would say it is closer to 10% than 5%.

Operator

The next question comes from the line of Matthew [Sundin] – No Company Listed.

Matthew [Sundin] – No Company Listed

Price increases on print editions, obviously you are doing it and everyone is doing it. It makes sense. Do you think there is a plateau? What signs and signals are you looking for from customers in terms of renewal rates? Secondly, are you getting pushed back and what happens when you are getting pushed back on rates? Are you letting customers who are good drop away? Are they getting extensions of existing rates that they say they are going to cancel otherwise? Do you have a sense there?

Gary Pruitt

Sure. It is a complex question. We have increased the circulation rates at virtually every newspaper. We did that in part to offset the advertising decline and reflective of higher costs in distribution. We think it was the right move to make. Circulation has become a larger piece of our revenue pie. We have also seen volume declines not just because of price increases but because of eliminating unprofitable, usually far flung circulation from our markets and that circulation isn’t terribly valuable to advertisers as well. It is very expensive to distribute out there. We have also eliminated third-party copies where the ultimate reader of the paper isn’t the person who has paid for it such as hotel copies, etc. We have reduced the number of those third-party copies. Again, not as valuable to advertisers nor to readers.

Although as a result we have seen steeper declines than usual in circulation. We are aware of that so we plan to be less aggressive going forward in pricing than we have been in the recent past. The pricing increases, we hope to decrease discounting of our papers and in cutting expenses decreased our marketing of our papers, all contributing to lower volumes. We are focused on a total audience and our online audience continues to grow robustly and our reach within our markets is impressive. Those markets where we have measures, usually our larger markets, we are reaching about 70% of adults either in print or online. So we are focused on that number. You can expect some price increases going forward but not as numerous as we have seen in the past. It has also had one other positive effect I guess and that is I guess what is churn. More of a core subscriber base that is loyal readers of the print product, that are loyal readers of the print product.

Operator

The next question comes from the line of Analyst for Alexia Quadrani - J.P. Morgan.

Analyst for Alexia Quadrani - J.P. Morgan

Can you talk about paper pricing trends going forward and your inventory? Any more on hand than usual given we may be hitting a bottom in pricing? In general on the cost side as you go into next year and circle these impressive cuts can you continue finding areas to cut and maintain these rates without compromising your product?

Gary Pruitt

On the newsprint question I will turn it over to Pat and then I will address the cost question for 2010. Pat?

Patrick Talamantes

Thanks. Demand is obviously very weak and production is still very low compared to industry capacity. The industry has attempted to close down some mills but it really hasn’t affected that capacity picture very much. Publisher inventory including ours are very high. We expect prices will bounce around where they are now and perhaps only move modestly higher over the next few months. They will remain down on a year-over-year basis through the first half of next year in our view. These pricing trends and continued usage declines will continue to help our cost reduction efforts for the foreseeable future.

Gary Pruitt

As far as expense cuts go we have had numerous rounds of expense cuts. They have been extremely painful. We had hoped to avoid them. We couldn’t. They were necessitated by the revenue decline and aligning our expenses to the new revenue reality. We are committed to doing what it takes. We are committed to doing no more than it takes also. We had various actions in reducing expenses throughout 2009. So we have the benefit of those effects rolling over in various months in 2010. So even without taking further actions expenses would be down in 2010. We will have to see how revenues move forward in 2010. We are in the process of budgeting right now and looking at what expense levels need to be for those revenue levels but we would expect expenses to be down again even based on the steps we have taken to date.

Operator

The next question comes from the line of Barry Lucas - Gabelli Sons.

Barry Lucas - Gabelli Sons

You completed an exchange offer just about 120 days ago and in the interim high yield markets have improved so the deal done by Gannett at more attractive prices and Sinclair is coming to market. With the bank debt going current in less than 9 months Pat how are you thinking about the balance sheet and how do you address that issue?

Patrick Talamantes

As you are probably aware we are as focused on this issue as we have been on the operating side. We are watching the markets very closely and as you noted our bonds are trading up quite dramatically from where we were at the exchange offer period. We are exploring all avenues to refinance the 2011 maturities that you mentioned. Fortunately we continue to be very comfortable with our ability to remain in covenant compliance and also we have no cash amortization payments or maturities until that June 2011 time frame. We do anticipate, as many of you do, an eventual recovery in ad spending and improved financial results which together with the improving credit market picture particularly for media companies, as you noted Gannett and Sinclair, we expect will lead to refinancing opportunities to the extent that we find options that we can implement we will keep you posted.

At this point we are not in a position to speculate about what we might or might not do. The one thing that investors should keep in mind is the fact that leverage has been very well behaved, ticking down this year. But then also keep in mind that the leverage ratio through the bank debt and the guaranteed debt is only slightly more than half of that. So that creates a great opportunity to look at in terms of refinancing.

Operator

The next question comes from the line of Edward Atorino - Benchmark Capital.

Edward Atorino - Benchmark Capital

If you look at the run rate on comp it is about $130 million. Is that a good number for the fourth quarter or will it be down from that? Second, on depreciation and amortization is the $32 million a quarter a run rate going forward?

Gary Pruitt

I missed the second part of your question.

Edward Atorino - Benchmark Capital

The depreciation and amortization going to be $32 million or is that going to come down a little bit next year?

Gary Pruitt

As far as the comp goes the run rate in the fourth quarter is going to be similar. Expenses may be a little higher than the third quarter. Seasonal. The seasonal effect may drive some of that. We don’t see a substantial change except the seasonality of that.

Edward Atorino - Benchmark Capital

I am taking what you are saying in 2010 it is going to be down from whatever the quarterly rate is right now?

Gary Pruitt

Again as we roll over certain expense actions we took in 2009 then the expense reductions would be less. That is right if that is what you are saying. We will be looking at that and looking at the timing of those and adjusting as the revenue picture becomes clearer. Of course we are still budgeting as we go through this so it is hard to project anything definitive for 2010. As far as depreciation and amortization goes, Pat?

Patrick Talamantes

I think depreciation and amortization should be fine except just know that sometimes we have non-cash items, losses from closure of facilities or other items that sometimes trigger that number to be a little bit higher.

Gary Pruitt

Then over time of course as capital expenditures have been lower, depreciation will be lower but that is more of a longer-term effect.

Operator

The next question comes from the line of David Ching – No Company Listed.

David Ching – No Company Listed

What was the nature of the tax rate increase in the third quarter?

Patrick Talamantes

At the end of the second quarter we had based our tax rate on a loss excluding items and so the rate at the end of the quarter was a 35% statutory rate minus an amount for state taxes and FIN 48 reserves that don’t vary with income. Our new estimate for our tax rate is projected on income for the full year so our estimated tax rate is 35% plus state taxes and FIN 48 reserves. So it slipped between second quarter and third quarter because of a revised projection. That revised projection of 61.8% is high relative to rates you are used to because of our relatively low pre-tax income caused by the recession. That magnifies the percentages from state taxes and FIN 48 reserves.

David Ching – No Company Listed

So on a go forward basis is this a tax rate that can be used?

Patrick Talamantes

That is our forecast for the rest of the year as of today and in 2010 really that rate should change based on the extent of increase or decrease in your model for pre-tax income. So if in your model pre-tax income rises that number should lessen. If it declines it should rise. That is about as good as I can do without giving you a forecast from the company.

Operator

The next question comes from the line of Jake Newman - Credit Sights.

Jake Newman - Credit Sights

On the online part of the business, an increase of 28% in the non-jobs while there was I think a 14% increase in the quarter’s average unique visitors. I’m wondering what drove the increase outside of the increase in unique visitors. Was it more page views per visitor? Higher sell out rates or higher cost per thousand?

Gary Pruitt

The online revenue isn’t exactly tied on a quarterly basis like that to unique visitors. There are revenue contracts and each category has its own unique pricing characteristics so it is not necessarily precisely correlated with the growth percentage in unique visitors. So we saw declines in the classified categories, particularly in employment, but very strong growth in retail and national. So on our online some of those are sales that are with print. Some of our online revenue, in fact nearly half of our online revenue is online only, a completely separate revenue stream from the print side and in some categories online is bigger than our print. In the employment category just a little bit over 50% of our employment revenue is now online, bigger than print overall. Chris I don’t know if you had anything to add?

Chris Hendricks

I would say if you look at the book the question relating the traffic to revenue about 20% of the revenue in the quarter was CTM based or would be tied to the traffic.

Gary Pruitt

So 80% wouldn’t.

Chris Hendricks

That is correct.

Gary Pruitt

So obviously there is a long-term relationship but the short-term relationship isn’t as tight as perhaps your question implied.

Operator

The next question comes from the line of Randy [Barron] – No Company Listed.

Randy [Barron] – No Company Listed

To follow-up on the tax question, what is the cash tax in the quarter and then also is there a Miami land update for us?

Patrick Talamantes

Cash tax for the quarter was about $20 million. That was the amount that we actually paid during the quarter in taxes. Cash taxes tend to be higher in the second half of the year than they are in the first half of the year. That is why that number may seem large relative to where our provisions have been. In terms of the Miami land update, we are continuing to…

Gary Pruitt

Pat could have given this answer just as well. We are working with the buyer. The buyer remains committed to closing the deal and buying this land but it is too soon right now to say if this transaction is going to close by the end of the year which was our hope. We are hopeful it can do that but we are also realistic about the commercial real estate markets and the financial markets and we are going to continue to keep you posted but right now we are working with the buyer and they are committed to getting this deal closed.

Operator

The next question comes from the line of Anna Palmer – No Company Listed.

Anna Palmer – No Company Listed

Could you mention how much cash you had at the end of the quarter? I think you mentioned that you had 170 in the revolver.

Patrick Talamantes

Yes we had $4.2 million in cash at the end of the quarter and revolver capacity of $172 million.

Operator

There are no further questions at this time.

Gary Pruitt

Thank you for your time and attention here. We will continue to make progress and navigate through this difficult period. Thank you for your support.

Operator

This now concludes today’s conference call. You may now disconnect at this time.

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