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Martha Stewart Living Omnimedia, Inc. (NYSE:MSO)

Q2 2007 Earnings Call

August 1, 2007 10:00 am ET

Executives

Howard Hochhauser - Chief Financial Officer

Susan Lyne - President and Chief Executive Officer

Wenda H. Millard - President, Media

Analysts

Lisa Monaco - Morgan Stanley

Richard R. Tullo - Sidoti & Company

David Kestenbaum - Morgan Joseph

Michael Meltz - Bear Stearns

Michael Kupinski - Noble Financial

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

Good morning and welcome to the Martha Stewart Living Omnimedia second quarter 2007 earnings conference call and webcast. (Operator Instructions) At this time, it is my pleasure to introduce Howard Hochhauser, Chief Financial Officer of Martha Stewart Living Omnimedia. Sir, you may begin when ready.

Howard Hochhauser

Thank you very much and good morning, everyone. Welcome to our conference call to review second quarter 2007 results. Susan Lyne, our President and Chief Executive Officer, will bring you up to speed on our strategic developments and then I will talk about our recent performance and our outlook for the third quarter and the full year, and finally, Wenda Harris Millard will discuss briefly the opportunities she sees as MSO. Our prepared remarks will take about 30 minutes and then we will open it up for your questions.

Before turning the call over to Susan, let me remind you that our discussions will contain forward-looking statements which are made pursuant to the Private Securities Litigation Reform Act of 1995 as amended. These statements are not guarantees of future performance and involve certain risks and uncertainties which are difficult to predict. Actual future results and trends may differ materially from what is forecast in forward-looking statements due to a variety of factors.

Now let me turn things over to Susan.

Susan Lyne

Thank you, Howard and good morning to all of you joining us on our Q2 earnings call. I want to start with a reality check. At the midpoint of 2007, an important year for our company, we are tracking ahead of plan. We are increasingly certain that we will return to profitability and deliver meaningful cash flow this year.

I have good news to share with you today. The results in terms of revenue and EBITDA are strong, exceeding the guidance we gave last quarter. Yes, the year-over-year comps have been impacted by one-time items, a one-time current year severance charge and a one-time prior year gain. Excluding those items, our business is improving and came in ahead of consensus.

Three quick reasons why we are feeling so positive; first, advertising is on fire, up 23% for the quarter in publishing. Ad revenue and pages are both up with revenue growth continuing to exceed page growth. Second half is looking very strong. Just yesterday, I was asked to sign off on additional edit pages for the October issue of Living to accommodate advertiser demand.

Two, we are more confident than ever that we will close the K-Mart gap. Why? Because our new merchandising programs -- I’m talking about KB Homes, crafts, Costco and most importantly Macy’s -- are all progressing well. If you haven’t been to Macy’s Harold Square recently, it is worth a visit. The collection is all set up, the product and the presentation are fantastic. Honestly, I think it will knock your socks off. We’ve got a great partner in Macy’s and they are investing in our mutual success, in-store and out.

Come September, you won’t be able to turn on your TV, leaf through a magazine or open your mail without seeing the Martha Stewart Collection.

And three, we are fully focused on our Internet opportunities. Since our last call, we’ve reassessed our investment priorities. We are reallocating dollars from publishing and moving them online. This decision will result in improved near- and long-term EBITDA results and deliver superior risk-adjusted returns going forward. And we’ve got just the right person overseeing this effort, Wenda Millard. I spent six months wooing her to take this new position at our company, President of Media, because I knew she could and would make a meaningful difference here.

I am sure many of you know Wenda as chief sales officer at Yahoo! for the last six-and-a-half years. She is widely credited with leading traditional advertisers to the digital space and establishing Yahoo! as a best-in-class marketing destination. What you may not know is that she had a distinguished career in magazine publishing before she went digital, and having served on our Board of Directors for three years, she truly understands our assets and under-leveraged resources.

So consolidating media under Wenda will allow us to compete more aggressively for ad dollars and to deliver more integrated content to our customers, both key goals for us.

Many of you have called to meet with Wenda, so I’ve asked her to join us today for the Q&A. I should tell you that her appointment was as well-received inside the company as out. You cannot be around her for long without becoming a believer.

There are a few more things I want to highlight before Howard takes you through the numbers and our guidance. In our publishing segment, revenue increased $6.6 million to $27.8 million, and EBITDA doubled on an adjusted basis to $4.1 million, due to ad revenue gains and the first revenues from a new long-term book contract. Ad revenue growth continues to outpace page growth but pages are up too, 12% at Living and 22% at Everyday Food. The March, June, August and September issues of Living are the largest issues for those months since 2002, our benchmark year.

We said last quarter that our books business was ramping up and on the heels of our 2006 bestsellers, we’ve signed a $9 million contract with Clarkson Potter for 10 books over the next five years. The first two will be in bookstores this fall -- volumes 1 and 2 of the Martha Stewart Living Cookbook. The company has a long and successful track record with Clarkson Potter. I actually went back and checked on how many titles we’ve published with them since Martha’s landmark Entertaining book in 1982, and it is 57.

We have a powerhouse publishing business and we are committed to growing it but we also know that new times demand new thinking and more innovative publishing models. Our newest publication, Blueprint, is a case in point. The magazine targets young women, 25 to 39, a demo of heavy Internet users.

By pulling back on direct mail and creating a more integrated, high quality online and newsstand product, we will reduce our ’08 investment by an estimated $5 million. This will allow us to deliver stronger year-over-year results in publishing and capture the high incremental margin from continued segment wide ad growth. We expect to redirect at least half of that savings to Internet in second-half ’07 and first-half ’08 to grow traffic and accelerate development of our website.

We made enormous progress on the site this year. Our new platform seamlessly integrates video, photography and print content. The next release in October will enable users to interact with and customize our content. But we are in the early stages of what we believe will be a very big business for us and we need to invest to accelerate success.

In conclusion, we are very confident with where we stand at the halfway mark for 2007. Advertising revenue is growing, with our publishing segment showing particular vigor. We are successfully executing on our strategies to close the K-Mart gap and with Wenda at the helm of our media properties, we are reallocating some of our investments in publishing to Internet. This will allow us to seize the digital opportunities and continue our drive to become a leading lifestyle destination on the web.

I am going to turn the call back over to Howard to walk you through a more detailed financial review and our guidance and then Wenda and I will be back for the Q&A.

Howard Hochhauser

Thank you, Susan. Today I’ll cover three topics: first, a review of the second quarter; second, a look at the business by segment; and finally, updated guidance.

Beginning with the quarter review, our positive second quarter results built on the strong start we posted in the first quarter. Total revenue in the quarter rose 8% to $73.4 million and our adjusted EBITDA loss of $800,000 came in slightly ahead of our guidance. Both quarters have what we view as one-time items. In this quarter, we recorded $1.4 million of non-recurring cash employee separation costs, while in the prior year quarter we had a $3.2 million gain due to a reduction in newsstand related fees.

On a pro forma basis, adjusted EBITDA would have been $600,000 in the current period compared with break-even in the prior year period. Comparing the publishing segment on a pro forma basis, revenue grew 16%, or $6.6 million, while adjusted EBITDA increased $4.1 million, a great example of the high incremental margins associated with our publishing business.

If you exclude the revenue and investment associated with Blueprint, our EBITDA margin would have been 21%, within shooting distance of our long-term margin goal of 25%.

We finished the quarter with $81.9 million in cash, cash equivalents and short-term investments.

As Susan discussed, we will continue to adjust our tactics and reallocate investment dollars to areas that provide for the highest returns on a risk-adjusted basis. Blueprint is a great case in point of such a tactical adjustment. As we look to 2008, Blueprint will move to a circulation model that is more in line with our model for Martha Stewart Weddings in that we will not be focused on traditional direct mail. Instead we will focus on organic subs and newsstands sales, as well as increasing our web focus. In doing so, we will reduce our 2008 Blueprint investment by $5 million while still building an important long-term brand in both print and online.

Finally, we were pleased last week to announce 10 book deal with Clarkson Potter, which provides us with a solid earnings stream in publishing for the next five years. In addition to having high earnings visibility, the deal comes with very attractive margins that will help us reach our goal of raising publishing margins to 25%.

Before I update you on specific guidance for the year, I’d like to talk a bit about free cash flow. MSLO has returned to growth over the past few years and in 2007 we forecast a return to positive adjusted EBITDA and net income. Given our business model and our capital structure, this is particularly good news. First, we have the good fortune of operating a low capital intensive business where our CapEx should have a run-rate of roughly $6 million. Second, we have high incremental margins, and finally we have approximately $92 million in net operating losses.

Overall, our adjusted EBITDA to free cash flow conversion is remarkably high and so as we return to positive adjusted EBITDA in ’07, we also return to positive free cash flow in a meaningful way.

Now let me talk about 2007 full year guidance. On a consolidated basis, we are maintaining the expected revenue in the range of $330 million to $340 million; operating income in the range of $9.5 million to $12.5 million; and adjusted EBITDA in the range of $34 million to $37 million. CapEx should approximate $6 million and we do not expect any material tax charges for the year.

Finally, let me give you third quarter 2007 guidance on both a consolidated and segment basis. On a consolidated basis, we are expecting revenue in the range of $68 million to $70.5 million, operating loss in the range of $7.5 million to $8.5 million, and adjusted EBITDA loss in the range of $2.5 million to $3.5 million.

On a segment basis, our guidance for the third quarter is as follows: for publishing, third quarter revenue is expected to be in the range of $45 million to $46 million, while adjusted EBITDA is expected to be approximately $5 million. In the third quarter, we anticipate ad page growth of 24% year over year for Living and 14% for Everyday Food. We continue to expect revenue growth to outpace page growth.

Merchandising revenues for the third quarter are expected to approximate $10 million to $10.5 million, while adjusted EBITDA is expected to be $4 million to $4.5 million. We expect Internet revenues of roughly $4 million for the quarter and adjusted EBITDA is expected to be a loss of $2 million.

Broadcasting revenue is expected to be $9 million to $10 million, and adjusted EBITDA should be in the range of a loss of $0.5 million to break even.

Corporate expenses will approximate $10 million.

In closing, we have returned to growth, armed with a strong balance sheet and are actively evaluating how best to deploy our capital. We expect to put our balance sheet to work in new ways in the future and look forward to becoming more aggressive on this front as we head into 2008.

Now let me hand the call over to Wenda for brief remarks.

Wenda H. Millard

Thank you, Howard. Let me first say how delighted I am to have an opportunity to bring my full media background to bear at a company I know well and a company I truly admire and importantly, where I see exciting opportunities for growth.

I am in truth a media junkie. I have spent over 30 years in the business, the first 20 in magazines and the last 11 in digital -- most recently, as Susan mentioned, as chief sales officer of Yahoo! and before that, as a founder of DoubleClick.

Even though I was an early evangelist for the Internet, I have always been a firm believer in positioning digital media as part of the mix of media the consumers enjoy, and as a part of the marketing mix. No single medium provides the complete answer. It is always about the mix and marketers today have a huge appetite for cross-platform, integrated advertising programs that add true value to their marketing objectives. I can think of no other media company that is so well-positioned to deliver on that.

MSLO brands have a unique relationship with their very passionate consumers who engage with them in an enviable way. Living alone has nearly 12 million readers. Fully engaging them on our site is in and of itself a huge opportunity, as is allowing marketers to leverage the intense engagement that our consumers have with all our media properties.

I am thrilled to be bringing a strong digital sensibility to MSLO. We have great assets in-house. All of our magazines, our TV and radio shows, and the relationships with our merchandising partners and we have a great team here with deep knowledge and deep talent. In other words, our digital franchise has enormous potential. I’m looking forward to extending it and accelerating that revenue driving marketing component and to sharing our results with you in the future.

Howard Hochhauser

This concludes the formal part of the presentation. I would now like to turn the call back to the conference call operator for Q&A. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Lisa Monaco of Morgan Stanley. Please go ahead.

Lisa Monaco - Morgan Stanley

Good morning. Wenda, I was wondering if you could just elaborate a little bit more on how and why you think that the Internet business at MSO can be a profitable business? The company I think has struggled over the last several years in making that business profitable so what specifically will be the revenue streams and how do you optimize the costs there? When do you think that business could be profitable? And then I have a follow-up. Thanks.

Wenda H. Millard

Any business that hopes to be profitable online first and foremost has to have a product that is engaging to a consumer and if you think about the multiple product here, whether it is the television show, the radio show and our gorgeous magazines, we have a running start.

I think from a profitability standpoint, being an advertising driven business, you have to be intimately familiar with what it is that marketers want and above all us, Marketers today want an engaged consumer.

I think one of the reasons that I am so excited about this opportunity for this company, I don’t know another media company that can boast the level of engagement across so many properties that this company has, so I have to be very optimistic about the opportunity that we have to offer marketers.

Lisa Monaco - Morgan Stanley

But does that mean that the primary revenue base online will be advertising base, is it e-commerce, or --

Wenda H. Millard

It will be advertising based. I think that if you look at the digital space and how many companies have tried to get the consumer to pay for content, I think that is over, with the exception of the wallstreetjournal.com, and then again, that may be over too. I would say that from a commerce standpoint, as you know we do have wonderful relationships in the flowers business and in the photography business, so there’s an opportunity certainly for e-commerce but I think that our focus and the lion’s share of our revenue will come from marketers.

Lisa Monaco - Morgan Stanley

And Howard or Susan, just on retail, if you can just flush out why you have increased confidence that you will be able to offset the loss from the K-Mart contract. And then Howard specifically, how should we think about the margins for that segment this year with the investment spending and then next year and perhaps ’09? Thanks.

Susan Lyne

I’ll take the first one. You know, Robin Marino has done a superb job. She laid out a roadmap for how we were going to do this. It included diversifying our product lines and our channels. She focused on businesses that could really be meaningful contributors for us, and that meant broad, higher end home goods, food, homes and crafts, and she partnered with the best. We had a very clear timeline. Robin and the entire merchandising team have come through. We are on track, on schedule and we have a pretty good sense of what those programs are going to deliver to us next year and that has given us increasing confidence.

Howard Hochhauser

Let me talk to you about the long-term merchandising margins and get to the cost structure business. You know this year, the cost structure is roughly $25 million, $26 million so we are at where we think we need to be in terms of a run-rate business. This year the margin will be 70%. It has pretty consistently been at that 70% range. The beauty of the licensing business, it is higher margin and not just high EBITDA margin but high free cash flow. There is really no CapEx associated with the business. If you look into the future, it is going to be roughly consistent with that 70% number.

Lisa Monaco - Morgan Stanley

Okay, and then just one last follow-up; is there any way to give us more color on what you are expecting in terms of contribution next year from Macy’s, Costco, and crafts? Thanks.

Howard Hochhauser

You know, we don’t want to get into the position of sizing these opportunities ahead of actually launching them. I’ll just say that now seeing the product we are more confident than ever. And just to talk about crafts for a minute, you may have read online the EK Success is in the process of buying Wilton, which is another large crafting company, and Dimensions, which is yet another large crafting company.

We had a subordinate interest in EK, so we are going to participate in this new entity in two fashions. One, we’ll likely put some cash into this venture as a co-invest alongside with GTCR; and then secondly, we’ll likely restructure our subordinated interest on to more favorable terms. You may recall that the return, the hurdle on the old deal was 20% so we are targeting something much lower, close to 8%.

So crafts will have a licensing deal. We will also participate in some of the value created on the wholesale side.

And then, getting back to Macy’s, K-Mart, Costco, we’re not in a position to size that just yet.

Lisa Monaco - Morgan Stanley

Thanks.

Operator

Thank you. Our next question is coming from Richard Tullo of Sidoti & Company. Please go ahead.

Richard R. Tullo - Sidoti & Company

Good morning, guys. First question -- you said that you were going to decrease the investment in Blueprint by $5 million in ’08, is that correct?

Howard Hochhauser

Yes.

Richard R. Tullo - Sidoti & Company

And are you going to deploy that whole $5 million towards the Internet or is there going to be a cost savings involved?

Susan Lyne

No, we said we would probably deploy about half of that to the Internet and that will be for a combination of things.

Let me just pull back to Blueprint for a second because what I want to make clear here is that this is a new model for Blueprint. It is not just a reduction of expense. We really believe that Blueprint can be a model for us going forward too. I think everybody recognizes that that old model of enormous expense on direct mail where you are throwing a lot of pieces out there and getting a very low return is just broken. It is a bad model.

So we have done a lot of thinking about how and where we can acquire subscribers and dedicated customers for the long-term. We think Blueprint is the perfect opportunity for us to really demonstrate this. We’ve already gotten traction on their blog sites. There is a really nice chatter going on right now about Blueprint if you look at the entire blog universe.

We know there is a bigger opportunity for us to tap that customer if we can talk to her every day and we can be the first place she turns. So this is a win-win for us. We can really save a significant amount of money on direct mail and on some of the old model costs and redirect it to something that will both help our publishing group in that it will build Blueprint in a more interesting way but will also help us build that Internet business.

Richard R. Tullo - Sidoti & Company

One follow-up; how many issues will be published for Blueprint in 2008?

Susan Lyne

Six.

Richard R. Tullo - Sidoti & Company

Six. Okay. Thank you. And in relation to the paint deal with Lowe’s, how is that trending as compared to the old deal with Sherman Williams? Is that a significant pick-up in royalties?

Susan Lyne

I can’t tell you exactly what those numbers are because we have yet to get our full first quarter numbers back from them, but I will point you to their last earnings call where they said the two bright spots in their same-store sales were, one of them was in the paint area and they pointed to the introduction of the Martha Stewart paint colors. So that’s as much as I can give you on that.

We do think Lowe’s is the right place for us to be selling paint and that we are going to grow it significantly over time. We also like them as a partner so we are hoping we can expand that program.

Richard R. Tullo - Sidoti & Company

A couple more questions in regard to -- sorry to monopolize -- in regard to merchandise; how many KB Homes were sold during the quarter, and how does that compare to your expectations?

Howard Hochhauser

Rich, we don’t break out homes quarterly. The fact that the housing market is soft, so I am sure you saw the article in the Journal, our houses are selling well relative to the market but overall, we’ll sell a few hundred homes this year, without getting into quarterly specifics.

Susan Lyne

I think that there is a couple of things we should note here. One is that our homes have been really well-received by consumers. We are selling about double the number of homes that other new developments are in every area we’ve gone into. So as we open more of these developments, and I believe we’ll have 12 of them open by the end of the year, they become a kind of annuity for us going forward. Obviously the housing market is depressed and it will take maybe even another year for that new home inventory to really roll down. But we genuinely believe this is a smart business for us. KB Home is very, very interested in opening as many Martha communities as they can for the simple reason that they sell better than anything else.

It is a challenged market but we are doing very well in it.

Richard R. Tullo - Sidoti & Company

When do you think we’ll start, these homes will start to move the needle in terms of revenue? Is that going to be early 2008?

Howard Hochhauser

We’re booking revenue this year. Next year, to call on the housing market, that is going to continue to grow. But like all of our licensing deals, it is high margin so as it grows, we have this fixed cost base. It is going to -- yes, improve our profitability next year.

Susan Lyne

And I will just add to that that again, as we add more of these communities, next year we will start off the year with at least 12 communities. This year I believe we started off with four or five. So just by virtue of that, you are going to see a big jump in our revenues, whether or not the housing market starts to improve. So this is a -- it will be a meaningful contributor next year, not on the scale obviously of a Macy’s or a Costco, but it will certainly move the needle to a certain extent in our merchandising group.

Richard R. Tullo - Sidoti & Company

Thank you.

Operator

Thank you. Our next question is coming from David Kestenbaum of Morgan Joseph. Please go ahead.

David Kestenbaum - Morgan Joseph

Thanks a lot. Could you just talk about the Macy’s rollout schedule, how that is proceeding? How many stores are you in currently and do you think you will be in all 800 by Christmas time?

Susan Lyne

We will be in all stores by September 10th. In fact, we are in many stores, whether it is fully set up now or it is partially set up now, we are already in I believe the majority of stores.

You can go to Harold Square and see the entire assortment set up now. There are another I’d say half-dozen stores around this area that we’ve actually visited that are either partially set up or fully set up. So this is all in advance of our September 10th launch when we will be pushing out a huge marketing campaign. We are also already available now on macys.com -- almost the full assortment, not everything but they keep adding things day by day as they get them into inventory.

But we will be fully in stores by September.

David Kestenbaum - Morgan Joseph

Is Macy’s paying for that marketing campaign?

Susan Lyne

Yes, they are and they have been an extraordinary partner, I think, for a number of reasons. They know the Martha Stewart brand and this product assortment, which is fabulous, is a huge win for them. This is really differentiated product that only Macy’s will be able to offer people, so they are putting a lot behind it both in-store and also marketing -- a large television buy, national television buy, national magazines, a line of direct mail pieces -- some beautiful stuff they’ve done. I think everybody here, we’ve got 2,000 SKUs in store, so it’s a big, big program for them and they are investing in their success along with ours.

David Kestenbaum - Morgan Joseph

Could you talk about how the food testing is going with Costco? I think last call you alluded that you may be able to kick that off late ’07 but probably more like an ’08 story.

Susan Lyne

It is going extremely well. If you ask our food group, it has been a love fest. I think they are genuinely enjoying the intelligence of the Costco team in terms of understanding how to create an assortment and we will be doing one product for end of year and then start rolling out new products, new categories monthly starting in January.

David Kestenbaum - Morgan Joseph

How many products do you envision in ’08 going through Costco?

Susan Lyne

I think that the Costco model is a very different model, first of all. They look for high volume SKUs. They only have I believe 2,000 regular SKUs in store all the time and another thousand that kind of rotate through, so each of those SKUs does huge volume.

We are looking at this as a big item business, so it is probably going to be maybe 50. That is our expectation right now and it falls into prepared foods, ready-to-eat, reheat, and frozen. And they will be for the everyday shopper and for people who are looking to entertain.

Interestingly, we think there is both a B-to-B and a B-to-C business to be had here. Martha started as a caterer and entertaining guru and clearly there’s a big business at Costco there. But also, for anybody who wants to pick up something and make it feel homemade when they get it home to the table.

David Kestenbaum - Morgan Joseph

Thanks a lot.

Operator

Thank you. Our next question is coming from Michael Meltz of Bear Stearns. Please go ahead.

Michael Meltz - Bear Stearns

Great. I have a few questions here. Just for the quarter, can you tell us what K-Mart performance was? And then, within the publishing group, can you tell us what the circulation revenue performance was and what MSL advertising and circulation, how that performed?

Howard Hochhauser

K-Mart retail sales in the quarter were down about 21%. I’ll let Susan jump in after to put some color as to the why of the sales decline.

The Martha Stewart Living ad revenue in the quarter increased 22% actually in the period year over year, while circulation was essentially flat. We are going to report our ABC numbers, I think they come out this week or next week and Living is still -- the May issue of Martha Stewart Living I think was up 30% year on year and is among our highest May issues in several years on the newsstand.

So Living, you know what is going on in the circulation area. Living is going to report an increase in total circulation -- a modest increase, but still an increase.

Susan Lyne

Let me just put a little bit more color on the K-Mart story. We are relaunching our soft home at K-Mart this fall. It’s been a long time since our soft home has been completely refreshed. But in advance of that, K-Mart made it very clear they were going to be really selling off, dropping down inventory to nothing, to essentially sell off all of the old soft home stuff in advance of that September launch.

In general, one thing I would also stress is that we have no control over the inventory levels in their stores, whether it is for a new category or an old category, or the visual presentation. It is a somewhat different kind of partnership than the others we’ve launched this past year. And they have definitely gotten out of certain categories that were big for us in the past, whether it is some of the lawn and garden stuff, seeds, tools, watering accessories -- those were big categories for us and they are just gone. RTA furniture as well.

So we continue to do what I think is beautiful design work for them and yet we have no control over the breadth of their buy.

Michael Meltz - Bear Stearns

Okay, can you tell us -- Howard, that was comp sales? What were total sales?

Howard Hochhauser

It’s an extra point. So it goes from 21 to 22.

Michael Meltz - Bear Stearns

Okay, and that being said though, Susan at the outset you said you still think you can close the gap for next year. Can you just talk a little bit about how we should be -- as you switch to the earned royalty, how are you thinking about the K-Mart performance next year?

Susan Lyne

I think that we are -- look, in our own planning we do not plan for much more than the basic guarantee. I think we have to look at it that way. Again, we don’t have enough visibility into K-Mart’s plans to expect more than that. So we start from an assumption that we will be making essentially the guarantee from K-Mart next year.

Michael Meltz - Bear Stearns

So just so we are clear, for modeling, we should be assuming you are at close to the $20 million level next year?

Howard Hochhauser

That’s right.

Susan Lyne

That’s correct.

Michael Meltz - Bear Stearns

Okay, and this assumes no new deals announced? This assumes everything that you’ve announced already?

Howard Hochhauser

This assumes everything we’ve announced. We frankly have some deals that we haven’t spoken about publicly because of competitive or consumer issues, but the everything that we’ve signed is what is underlying our assumptions.

And just to put some context, so we are assuming $20 million, which is the minimum, to make that statement, our retail sales this year will approximate $850 million, so there is still a pretty big delta.

Michael Meltz - Bear Stearns

Okay, I understand. And then Howard, I think to an earlier question you though margin would be flat next year -- I’m sorry, margin would stay at 70% next year. Is that -- did I hear that right?

Howard Hochhauser

That’s right. The 70% margin is our -- frankly, it is our near-term and long-term. We’re there and that’s what our target is. We are going to stay at 70%.

Michael Meltz - Bear Stearns

Okay, and last question for me; in terms of Blueprint, I understand what you are doing and I think it makes sense. It is the right thing to do but it is not quite clear. Besides Wenda joining, what has changed in the past three months with regard to how Blueprint is trending? Have direct mail -- have response rates not been that strong or --

Susan Lyne

No, quite the contrary, actually. Response rates have been stronger, more positive than we expected. As we said, we are raising the rate base, just raised it and we are raising it again come December. So that has no bearing on this. This really is about looking at our five-year plans and understanding that we are going to have to make some real choices about where we put investment dollars. And it is clear to us that we have a bigger near-term and long-term opportunity if we ramp Internet faster, so we are redirecting some dollars. All these choices are hard choices on some level but they are rational choices and I think they support our shareholders and they support our ability to grow.

Michael Meltz - Bear Stearns

Okay, last question for me -- where is the rate base and where is it going?

Howard Hochhauser

We increased it to 400,000, so this isn’t about changing rate base or changing frequency. We forecast the rate base will stay the same and the frequency will stay the same.

This is something we’ve been talking about internally for a while, going back to our December board meeting, actually. I think what has changed is now we have one person managing all the assets.

Wenda, I don’t know if you want to jump in and just talk about overseeing both, what your opportunities are.

Wenda H. Millard

I think just to talk a little bit about Blueprint and the thing that we didn’t acknowledge is that demographic, 25 to 39, that’s the sweet spot and many of them tend to be -- their core medium is digital and I think that there’s an expectation on the part of the consumer that they have a robust web experience with this property.

I think it is important to understand -- this is not a comment at all on print. It is almost a comment on the consumer. This is a comment on the audience more than anything else and I think what -- one thing, by the way; this is day number 13 for me, not three months, so I am thinking about a lot of things. But what I do see in centralizing, having one person oversee media is that that opportunity for unbiased thinking and I think that what the Blueprint decision represents.

I am in favor of all media and I am in favor more than anything about what is right for the consumer, because if it is right for the consumer it will be right for the marketer, so it is always a win-win.

Michael Meltz - Bear Stearns

Okay, great. Thank you for your time.

Operator

Thank you. Our next question is coming from Michael Kupinski of Noble Financial. Please go ahead.

Michael Kupinski - Noble Financial

Thank you. While the revenues look stronger than what I was looking, the Internet revenues were a little bit, even though very strong, were a little lighter than what I expected. I guess I was anticipating, given the relaunch of the website, that we would have seen a little bit stronger revenue growth there. Even with your guidance, while still very strong, it seems a little light to me. I was just wondering if in the relaunch that you noticed that there were issues that have popped up. If there were, are these short-term fixes or do you think that there would be something that you might have to invest in?

And if you can also just kind of benchmark for me what you think the overall Internet revenue growth might be in the, not only just coming quarters but just looking out maybe in the next year or two.

Susan Lyne

Let me talk a little bit about the quarter. I will first say that we were very clear last quarter and when we started this rebuild process that we knew we were going to have a reset right after our launch, that -- when you put a whole new platform out there, you have all the search engines having to re-index and there is a drop. So we anticipated that. I will say, however, that I am a little disappointed in the ad sales numbers and we are going to be looking a lot more closely at our SEO because I don’t think we have optimized well enough yet, and that’s one of the things we are really investing in for second-half.

We have a lot of very interesting add-ons coming in the second-half of this year. We’re going to be doubling content on our site. We have some really nice new personalization features and things that will allow people to really customize our content for their use.

But that said, I think we have work to do in that SEO area and the good thing is we know what the issues are and we are on it. But it will take a little time to be able to ramp that. We don’t think we’re going to be ramping as quickly as we had anticipated, and I am just going to throw this over to Wenda because she’s got I think a lot more insight into this marketplace as a whole and into what is typical than I do. Obviously one of the key reasons I so wanted her to join our company was to have somebody who I could really partner with on all of this.

Wenda H. Millard

Well, you know, I’m used to higher numbers. I will admit that. But this is not that -- this doesn’t concern me particularly. I think that first of all, this is an ambitious undertaking in what is still, by most everyone’s measure, maybe second inning. We’ve been in this business, all of us, for just a dozen years and I think that every single day there are new opportunities, there are significant decisions to make, there are challenges. Technology always surprises you.

I don’t -- I’m not terribly concerned at all. I will tell you I’m terribly excited about what I have seen for the fall. I do think we do have some learnings on the SEO side but what I am really excited about is what we are doing on content and the promises that we are going to be able to keep with the user in terms of enhancing the site experience by adding a lot of opportunities for them to sort the information, share the information, store the information and certainly very, very important, to personalize the information.

I really look at this very, very optimistically going forward.

[Multiple Speakers]

Michael Kupinski - Noble Financial

I was just wondering if you could benchmark or give us a benchmark of what type of growth that you would look for to gauge your success on implementing the content issues and things like that that you plan to drive on the website. What should look for? What would you be satisfied with if you saw, over the next couple of years in terms of what type of growth and whether that would be benchmarked against just general advertising growth for the Internet, or just a specific number?

Wenda H. Millard

I can’t give you a specific number. It’s really early days. Remember, it’s day 13.

Susan Lyne

Ask her next quarter.

Michael Kupinski - Noble Financial

All right. I’ll try again then.

Operator

Thank you. Our final question is a follow-up coming from Richard Tullo of Sidoti & Company. Please go ahead.

Richard R. Tullo - Sidoti & Company

Yesterday you guys announced a deal on the DIY deal for some content on cable television. Could you please talk a little bit about that deal and perhaps provide some insight into any cross-selling opportunities created via the last up-front?

Howard Hochhauser

I’ll talk about the numbers and then hand it off to Susan to talk about the business side. It’s more than just cable, so it’s a two-year deal for 39 episodes and it’s a high margin library deal, so we are giving them existing episodes from the Martha Stewart Living Show. It is just under $1 million, with not a lot of edit required on our end. Let me take it off to Susan.

Susan Lyne

It is actually not episodes, it’s segments, all crafting segments from multiple shows so it will feel like new programming for people watching it. These are great pieces that actually I think will help our overall crafting business. Again, I just want to reiterate what Howard was saying -- we feel like our crafts line has given us a lot of learning and some very promising results, and it has encouraged us to really get behind this business in a bigger way. We are going to be expanding distribution later this year and then, much more significantly next year.

But this co-invest with GTCR on this rolled up crafts entity is a great opportunity for the company. We are getting ownership based on our brand value as part of it and the growth that will come from that, but all in we are going to be owning just north of 10% of a company with EBITDA of approximately $100 million to $125 million, and that is a big positive for us. It is going to allow us to, when you put our royalties and our investment revenue and revenue from this new TV show together, crafts becomes a really dynamic contributor to the company.

Richard R. Tullo - Sidoti & Company

Thank you.

Susan Lyne

One other thing I would just note on the DIY deal is that this a way for us to -- I’m sorry?

Richard R. Tullo - Sidoti & Company

Yes, thank you very much.

Operator

Thank you. At this time, I would like to turn the floor back over to you.

Howard Hochhauser

Thank you very much for attending today’s call. We look forward to talking to you in 90 days. You may disconnect.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

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Source: Martha Stewart Living Omnimedia Q2 2007 Earnings Call Transcript

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