Sun-Times Media Group Q3 2007 Earnings Call Transcript

Sun-Times Media Group (SVN)

Q3 2007 Earnings Call

November 8, 2007, 4:30 pm ET

Executives

James McDonough – Vice President and General Counsel

Cyrus Freidheim - President and Chief Executive Officer

William Barker - Chief Financial Officer

Rick Surkamer - Chief Operating Officer

Analysts

Bonnie Wachtel - Wachtel & Company

Eugene Fox - Cardinal Capital Management

Jarrod Cornell - K Capital

William Dobbs - Merrill Lynch

Jennifer Wallace - Summit Capital

Presentation

Operator

Welcome to the Sun-Times Media Group third quarter earnings call. (Operator Instructions) I'll now turn the presentation over to Mr. Jim McDonough, General Counsel.

James McDonough

Thank you. Certain statements made in this presentation are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words believe, anticipate, expect, estimate, project, will be, will continue, will likely result, or similar words and phrases.

Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. The risks and uncertainties are detailed from time to time in reports filed by the Sun-Times Media Group with the Securities and Exchange Commission, including in its forms 10-K and 10-Q.

Numerous factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the company's business, or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

In addition, certain of this information in this presentation includes non-GAAP financial measures. A reconciliation of those measures to the most directly comparable GAAP financial measures is provided on our website. Go to www.thesuntimesgroup.com, click Investor Relations, and select webcasts to view the reconciliation.

I would now like to introduce Cyrus Freidheim, President and CEO of the company.

Cyrus Freidheim

Good afternoon and welcome to the Sun-Times Media group third quarter conference call.

The third quarter brought many challenges to the company. The newspaper advertising market in Chicago continued to be very tough. As a result, we have laid on more aggressive actions which I will review with you briefly today. Bill Barker, our CFO, will review the financials and the third quarter results in more detail.

We are simply not where we wanted to be in the third quarter. When we put our turn-around plan together in February, we set four objectives for 2007. Stabilize print advertising and circulation, get a new top team in place, attack on costs and increased reliability, and aggressive expansion of new media.

We are pleased with the progress on three of the four, but the most critical objective, to stabilize print and advertising circulation, has not been achieved as yet. The market for print advertising in the Chicago DMA has declined between 6% and 10% in each of the last six quarters.

The Sun-Times News Group underperformed our competition by 5% to 10% points until the second quarter of this year, when the gap was narrowed to 2 percentage points in the third quarter, where we outperformed our competitors, narrowly, for the first time in a very long time. This gives us the confidence that we do have the products and capability to be competitive, and that the actions we have been taking are working. But our revenues continue to decline, further eroding our operating earnings.

Our problem clearly is that the market for print advertising continues to decline at unprecedented levels. In absolute terms, our ad revenue in Q3 was down almost $5 million versus last year, and that combined with our decline in circulation revenue accounted for all of the decline in the Sun-Times News Group EBITDA, which is now close to break even.

Bill Barker will report that in more detail.

We have made good progress on the other three objectives we set out for 2007. There has been some impact on the bottom line this year, but most will occur in 2008 and beyond, which we knew in advance.

We committed to have a talented, new team in place quickly, and we have. We've had one change, our Chief Operating Officer of the Sun-Times News Group, John Cruickshank, resigned in September to become the news God of Canada at CBC. We were able to replace him internally with Rick Surkamer, who joined us in February. Rick is an exceptionally well-qualified executive who has substantial newspaper experience with the Tribune, and general management experience with four private equity and venture capital firms. Rick is fully engaged. We believe the team is as good as any in our industry.

We committed to invest aggressively in our websites and mobile media channels, and we are. The area of most dramatic industry decline is print classified advertising, which year-to-date has dropped by 18% in the Chicago DMA, comparable to national trends. In addition to weak underlying markets in real estate and autos, classified is shifting to the Internet. In response, we are developing robust offerings for classified on our websites. We are positioning ourselves to benefit from the shift of classified to the Internet, as classified to Internet revenue grows rapidly from its relatively low base to eventually compensate for the print losses. We have a strong position with classified advertisers and intend to maintain that position through this shift in channels.

Specifically, in the third quarter we have added a new, comprehensive residential real estate website, searchchicago.com/homes, which allows people in the Chicago area to search thousands of homes over more than 10 counties in Northeastern Illinois and Northwest Indiana. We already have one major sponsor signed up. A launch of searchchicago.com/homes completes the trio Search Chicago offerings this year in jobs, auto, and homes. These sites give advertisers and consumers an excellent complement to classified advertising in print.

We added a dozen hyper-local interactive websites this quarter in Chicago's North Shore suburbs, called neighborhoodcircle.com, for a total of 15 around the region. These sites are becoming neighborhood social circles and chat rooms, and advertising sales are building on these sites, and we're very pleased with how they're doing so far. One of our sites won first place from the Illinois Press Association this summer, an indication that we are on track.

This fall, we launched a prep sports site that reaches all 300-plus high schools in the region with scores, pictures, and stories in all sports. In the third quarter, we launched a 24/7 news and information on suntimes.com, and have integrated our new media editorial staffs into newsrooms across the company. Our entire editorial staff is embracing the digital world.

This quarter we have also integrated our Internet sales staff into the advertising department and launched an aggressive training program for all account executives in new media advertising. We are on plan to introduce a major new service or site every month this year. Our unique visits per month have increased by 11% this year, and our page views and time-per-visit stats have jumped substantially. Our Internet advertising revenues have grown 49% over last year. We are pleased with our progress, and are acutely aware of the Internet's importance to our future.

Cost reduction and reliability improvement programs laid out in our original plan are all on target. As we had indicated, these savings were used to fund investments in IT and new media. This summer, the management team recognized that our plan was not producing the results we needed. Despite significant improvement in our competitive position across our businesses, the weak market in print advertising was preventing us from stabilizing ad revenue. We had made dramatic changes in the way we went to market and invested substantially in additional sales representatives. As I indicated, we outperformed our market in the third quarter, but ad sales continued to decline.

Consequently, we have made a course correction. We have not diminished our effort to increase advertising sales, but we cannot depend on increases in revenue for our turnaround and profitability. We are accelerating our shift to the Internet, we are restructuring our newsrooms to digital-first, and are establishing one of our operating units as a pilot for the news and information company of the future. We are tripling the percentage of advertising account executives that are focused on new media sales.

We have launched a major program to reduce costs in addition to these, and we will resize our operation to our expected revenue in 2008. We will give you more detail about our plans as they materialize, but let me tell you some of the actions we have taken to date.

First, in the distribution area. We had three major problems with our distribution system. Delivery reliability across the company was unacceptable. Costs were well above industry standards, and the zoning of the Chicago Sun-Times was uncompetitive for advertisers. After months of intense discussions, negotiations, and planning, we reached an agreement with the Chicago Tribune company in August for the Tribune to take over most of our newspaper distribution. That transition is complete, and we expect to see financial benefits and improved customer service from this arrangement in the fourth quarter. The transition was not easy, but we got it done. Service levels suffered temporarily, but are approaching target levels now. As we told you before, we expect annual savings of at least $5 million.

In October, we outsourced all of our customer service call centers to Winnipeg, Canada. We will have a moderate reduction in costs, but far more important, we will achieve significant improvements in customer service, which will have a major impact on customer retention--our churn was well above industry standards--and on new subscriptions. In both of these outsourcing actions we will avoid millions of dollars of investment to bring distribution and customer service to competitive levels.

We have reduced the dimensions of several of our papers and special sections, and tightened the ratios of news and advertising to reduce the cost of newsprint. Savings year-to-date on newsprint, including favorable price movement, has been $4 million or 23%.

We have restructured schedules on our printing presses to enable in-house printing of two publications which were previously outsourced, a $1 million-plus saving. We have taken a number of actions on our products to improve profitability through reducing costs and increasing revenue.

A few examples, we dropped Fluff, a section devoted to celebrities and fashion that drew no advertising. We combined and refocused several free shoppers and returned them to reasonable profitability.

We just announced that we are merging two suburban newspapers, the Daily Southtown and twice-weekly Star. We will be serving their overlapping markets with the Daily Southtown Star in-zone inserts for some markets. We expect to save $3 million plus annually. This summer we launched two new sections for autos and movies, which have resulted in significant increases in auto and entertainment advertising. Auto advertising in fact grew in the third quarter in a market of double-digit declines. A new food section has just been launched with the counsel of several major food advertisers.

We are taking you through these actions because we want you to understand that we fully recognize the impact of the tough market, and we are taking every measure we can to improve profitability. Our goal is to resize the company to the realities of the market and return the Sun-Times News Group to competitive profitability. We will keep you informed as we roll out additional actions.

In my year with the management of the Sun-Times Media Group, no period has been quiet, and we have had no normal periods. The third quarter stands tall as a period of major events and surprises. Let me go through a few. In July, the criminal trial concluded and four former senior officers of the company were found guilty. They will be sentenced later this month. Another former officer who pled guilty will be sentenced in December, and their defense costs our Company $5.5 million in the third quarter, and $46 million for the first nine months of this year. We will file for a recovery when appeals are completed.

On August 1st, our shareholder, Hollinger Inc, announced that it exercised the super-voting rights of its B shares and took majority control of our Board of Directors. On the same day, it filed for bankruptcy. Negotiations between Inc., our company, and Hollinger Inc.'s bondholders are ongoing.

Our Company's objectives in these negotiations are first to convert the super-voting right B shares into A shares and return control of our Board to our shareholders; to settle the litigation between our company and Hollinger Inc.; to recover as much of the outstanding debt from Hollinger Inc. as possible; and to release our Company from any further litigation or indemnification expenses resulting from Hollinger Inc. actions. A mediator has been appointed by the Canadian Court to assist in the negotiation. We continue to be hopeful that the situation will be resolved before year-end, though we can give no guarantees.

Also in August, $48 million of the company's money invested in short-term asset-backed paper was not redeemed. We had $150 million of our cash in Canada invested in asset-backed commercial paper market. $102 million was redeemed on time. A committee is working out the restructuring of the various trusts involved into longer-term debt instruments matching the underlying assets. We have made it known to both the investor committee and our advisor, CIBC, that we need our cash now. We have taken provision of 10%, $4.8 million, to recognize the likely markdown of the assets. We do expect to get our money back.

We reached an agreement to settle securities class action lawsuits against the company, and the former directors and officers in the United States and Canada, for $30 million, which is covered by our DNO insurance. We also agreed to settle litigation over the remainder of our director and officer's insurance coverage for $24.5 million, which will be split between Sun-Times Media Group, Hollinger Inc., and a number of other claimants. Those agreements are subject to court approval in both countries, and we expect a final settlement sometime next year.

We have determined that the Sun-Times Media Group cannot include the benefit of tax deductions of past losses when computing deferred taxes for its balance sheet. Nor can it assume a future tax deduction for accrued interest on contingent tax liabilities. The trigger for this accounting agreement is cumulative losses in recent years, and three consecutive years of losses which we will have by the end of this year. The result of this accounting change will be a significant adjustment to two balance sheet accounts, deferred tax liabilities, and other tax liabilities, and a charge to earnings through the tax line of $166 million. These are all outlined in the press release.

I would like to emphasize three important factors for investors. First, they are non-cash charges and do not impact our cash position, and have no impact on our recovery of $40 million in NOLs this year. Second, we still have the ability to realize these tax benefits in the future. We simply cannot recognize these benefits at this time. And, third, these charges do not imply anything about our future profitability.

On an upbeat note, for the first time in memory, the company and its largest guild, Chicago Sun-Times, reached agreement on a new 3-year contract prior to the contract deadline. The contract recognizes the company's situation, and provides the flexibility to operate competitively in the digital news and information world. Other guild contracts are close to settlement.

Now I'll turn it over to Bill Barker, our CFO, who will go through the financial results.

William Barker

Thanks, Cyrus. Good afternoon. I'll give a brief financial overview, then provide some details behind the TNL and balance sheet numbers that were highlighted in today's press release. More detail will be available in our Form 10-Q, which we will file tomorrow.

First, a few financial headlines for the quarter. Advertising revenue was $71.7 million, which was down 6% versus last year. For comparison purposes, ad revenue in the second quarter was down 12% versus the prior year. Circulation revenue was $18.9 million, which was down 7% versus last year, and in line with the 8% decline in the second quarter.

Total revenue was $92.5 million, down 7% versus last year, compared to a 12% decline in the second quarter. Total cost of sales was 5% lower than a last year, $58.9 million for the quarter, reflecting a $3.6 million improvement in our cost for newsprint and ink. The cost favorability resulted from a combination of favorable market prices--the cost of newsprint was down 15% versus last year--and lower newsprint consumption, down 11% versus last year. Sales and marketing expenses increased $1.3 million to $18 million for the quarter, reflecting an increased focus on local selling resources.

Other operating costs, which include finance, HR, IT, and new media support, increased $3.2 million to $16.1 million for the quarter. $1.4 million of the increase was related to one-time costs associated with the implementation of the Tribune distribution agreements. The remaining $1.8 million increase was related to planned increased investments in the IT and new media areas.

Corporate expenses for the quarter were $7.7 million, versus $14 million last year. Last year's number included $4.1 million of severance expense. The additional reductions versus last year are related to lower DNO insurance expenses and lower outside tax and legal fees.

Indemnification, investigation and litigation costs net of recoveries were $7 million, which was similar to last year's amount of $6.7 million, but down significantly from the second quarter amounts of $25.1 million, due to the completion of the trial of former Company executives early in the quarter.

Depreciation and amortization totaled $8 million in the quarter, down from $9.4 million a year ago, as we recognized less depreciation due to the closure of two of printing plants late last year and early this year. Thus our Q3 operating loss was $23.2 million, which includes $1.4 million of one-time costs related to the new distribution agreements, $7 million in indemnification net costs, $8 million of depreciation and amortization, and $7.7 million of corporate costs.

Other income and expense was a net expense of $13.2 million for quarter, which was comprised of two main components, the $4.8 million impairment adjustment that was recognized for Canadian asset-backed commercial paper that Cyrus mentioned, and $8.3 million of foreign exchange losses.

The foreign exchange losses are driven by the accounting treatment of some short-term inter-Company loans, and the fact that our Canadian subsidiary is holding cash denominated in U.S. dollars. As the U.S. dollar has weakened, that cash investment is reflected as a loss on the Canadian subsidiary's books. In reality, the company is no worse off from a U.S. cash perspective, and the offset to the reported foreign exchange loss is found in foreign currency translation adjustment on the balance sheet.

Now I'll give some additional background on our revenues, EBITDA, and some balance sheet items. On the revenue front, Q3 ad revenues for total Sun-Times News Group, or STNG, were down 6% versus last year, and this decline was consistent between the Chicago Sun-Times and the suburban newspapers.

Q3 circulation revenues for total STNG were down 7%, circulation revenues for the Sun-Times were down 8%, and circulation revenues for the suburban papers were down 6%. As we have mentioned previously, the Chicago Sun-Times accounts for just under half of our combined ad and circulation revenues.

In our last conference call, we outlined a measure called adjusted EBITDA, which excludes any corporate costs such as external audit fees or DNO insurance, and any costs or recoveries related to indemnification, investigation and litigation, and also excludes any one-time costs or gains. As Jim mentioned, the calculation of adjusted EBITDA can be found on our website.

When the $1.4 million of one-time costs related to Tribune distribution agreement are excluded, adjusted EBITDA for total STNG was $800,000 for the quarter, which equates to an adjusted EBITDA margin for total STNG of 1%.

To determine adjusted EBITDA by group, we allocate the costs of centralized and shared operating resources, such as accounting, IT, HR, and new media, on a percentage of sales basis. Using this methodology, the Chicago Sun-Times had a breakeven adjusted EBITDA margin for the quarter, compared to a 1% in the second quarter, while the rest of the businesses had an adjusted EBITDA margin of about 2%, compared to 3.5% in the second quarter.

We have not yet begun to realize the financial benefits of two major market enhancement projects we have recently announced: the Tribune distribution deal and the restructuring of our Southtown and Star newspapers. We expect to begin realizing the financial benefits from these efforts beginning in the fourth quarter and continuing into 2008.

Next, moving on to the balance sheet, as I previously mentioned we have reduced the value of our Canadian asset-backed commercial paper by 10% on our balance sheet, and we have reclassified the investment as a non-current asset. Previously, these assets have been included in the cash and cash equivalents line.

Given the current uncertain state of the market and the lack of a buy-sell pricing mechanism, it's very difficult to determine the precise value of our investments. We believe the 10% adjustment to be appropriate at this time, based on several factors, including the actions of other companies with Canadian asset-backed commercial paper exposure, our knowledge of the quality of the assets in the commercial paper conduits, and our internal estimates of potential discounts given likely interest rate and risk premium assumptions.

However, we want to be clear that the 10% adjustment is an estimate at this point, and we will revisit our valuation at year-end, when more information on the timing and likely outcome of the restructuring efforts should be available. The investor community leading the restructuring effort has targeted December 14th for an update on the restructuring process.

Our combined cash and short-term investments declined from $212 million at the end of the second quarter to $132 million at the end of the third quarter. This $80 million decline was driven by reclassifying our $48 million Canadian commercial paper investments, as well as our operating loss for the quarter, the timing of payments of invoices received for indemnification fees for the trial, and a payment made to the Canada Revenue Agency in the quarter. We have $34.4 million in escrow deposits and restricted cash on our balance sheet, which can be broken into two distinct pieces.

The first piece is $11 million of cash collateral, supporting letters of credit related primarily to our workers' comp insurance policies. I do not expect that amount will change significantly in the near future. The second piece is $21 million in escrow related to the arbitration regarding final proceeds from the sale of the company's Canadian operations in early 2006. We do not expect the arbitration proceedings to be completed this year, and must await a final judgment before determining how much, if any, of the escrow deposit we will recoup.

We have $40.4 million in recoverable income taxes, which is the refund associated with the application of our NOL carry-back. We have filed the paperwork for the refund, and expect to receive it before year-end. Other current assets of $11 million are mostly prepaids related to insurance and rent. The $49.8 million of investments includes a reclassified Canadian commercial paper. $17 million of other assets are primarily capitalized expenses relating to our telemarketing efforts, which are amortized with roughly two-thirds of the capitalized amount being amortized in the first year.

Moving on to the liability section, we have $6 million of current installments of long-term debt on our September 30th balance sheet, which was reclassified from long-term debt in the second quarter as a result of a change in control provision in our outstanding debt. The recent change in our Board of Directors triggered the provision, and we completed the required $6 million redemption of the debt in October.

Regarding tax liabilities, we had a significant change in our reported deferred income tax liabilities and other tax liabilities. The change reflects the impact of a valuation allowance we have recorded against net deferred tax assets aggregating $165.8 million. The valuation allowance was considered necessary based on the losses experienced in recent years. Under accounting guidelines, the cumulative reported loss represents significant evidence that a company should not recognize future tax benefits which depend on potential future generation of taxable income.

The valuation allowance relates to deferred tax assets with respect to net operating loss carry-forwards, and the tax benefit attributable to future deduction of interest and state income tax accrued for U.S. contingent tax liabilities. As we have accrued in each quarter for the interest and state income tax on U.S. contingent tax liabilities, that interest in tax has been accrued on an after-tax basis.

On our December 31st balance sheet, our other tax liabilities included a net deferred asset of $75.6 million related to the presumed deductibility of interest and state income tax related to the U.S. contingent tax liabilities. A $75.6 million deferred tax asset was netted directly against the related liabilities and the other tax liabilities line.

Given that we have now established a $165.8 million valuation allowance against these deferred tax assets, our reported deferred income tax liabilities of $88.9 million, and our reported other tax liabilities of $530.5 million, no longer include any offset related to future benefits of net deferred tax assets.

It important to note that the company still has access to the potential future benefits of these deferred tax assets, and can realize those benefits once the company returns to profitability. In general, the normal carry-forward period for a NOL is 20 years. However, in applying the proper accounting standard for balance sheet reporting purposes, we will no longer recognize these future benefits. In addition to impacting our balance sheet, the valuation allowance also impacted the tax line of our P&L in the third quarter for the $165.8 million.

Getting back to the balance sheet, our $530.5 million accrual for other tax liabilities relates to the ongoing IRS audit, as well as to other contingent tax liabilities in the U.S. in four jurisdictions. The $530.5 accrual is net of a $14 million deposit made previously with the IRS. The accruals relate to management fees, non-competition payments, and the effects of certain tax strategies that have been deducted in arriving at taxable income. Some of these deductions may be disallowed.

We are in ongoing discussions with the IRS with respect to the audit and are currently evaluating which, if any, of the items we may agree to upon receipt of the final proposed audit adjustments, and which items, if any, we may intend to appeal. A normal time frame for an appeal process ranges from 1 to 3 years.

We believe our September 30th tax accruals are appropriate. Given the sensitive nature of the discussions with the IRS, we do not intend to publicly disclose details regarding the basis upon which we have established our accruals. If there are any significant developments with the IRS, or we believe we need to adjust our accruals at any point in the future, we will communicate that information as appropriate.

And with that, I'll turn the call back over to Cyrus.

Cyrus Freidheim

Thank you, Bill. When I joined the management team a year ago, I recognized the difficulty of the task facing the company and the need for major change. This summer it became apparent, first, that we could not grow our way out of the problem because of the steeply-declining industry revenues, and second, that the transformation of our industry to digital news and information was occurring more rapidly than we anticipated.

We had to take even more aggressive actions. Our team has risen to the challenge, and we are transforming our company to a digitally-led news and information organization. We are also resizing our company in recognition of the realities of the market. We are outsourcing as many non-core activities as possible, and focusing our investments and resources on our core - the capture, analysis, and dissemination of news and information, and the delivery of a high-value advertising platform to our clients.

Our economic model is changing dramatically. Investments are focused on our growth engine, new media. We have a great brand, superb products, excellent market coverage, more readers than our competitors, and a top-notch team. We have world class columnists like Ebert, Novak, and Mariotti and Telander, and Sneed and Brown, and Marin, and I could go on with 10 more.

We have the pole position in sports, local politics and investigative journalism in Chicago. We understand the challenge, and are meeting with all of the intelligence, skill, and force we can muster. Our goals have not changed despite the rocky times we're going through. We are fully committed to improving shareholder value, and to strengthening our excellent franchise as we move into a rapidly evolving digital age.

Thank you and we'll open for questions.

Question-and-Answer Session

Operator

The first question is from Bonnie Wachtel - Wachtel & Company.

Bonnie Wachtel - Wachtel & Company

Thank you. Listen, I'm awfully sorry to begin on a negative note. I'm a fan of the Sun-Times, and I know you're working just terribly diligently to turn this around, but let me raise an issue that came up on the last conference call, which is one of the listeners said it would seem from an outside observer that the business solution to the problems is that Sun-Times and Chicago Tribune should merge, and the answer is, you could only do that if one of you was in a troubled situation - I can't remember who were you referring that to. Could you comment at all at, whether there would be any sort of a contingency plan in the works that might allow the two of you to discuss this and possibly go that direction, or at least comment on this idea again?

James McDonough

We have contingency plans for all manner of things, which of course we can't divulge at this point in time, but believe that we are covered on virtually every possible avenue that we can or might take.

Operator

Your next question comes from Eugene Fox - Cardinal Capital Management.

Eugene Fox - Cardinal Capital Management

Could you please talk about, if possible, when you talk about the Sun-Times, and the community newspapers, the amount of overhead that you're allocating or, said differently, what the relative margins of these papers might be on a pre-allocation basis?

William Barker

Gene, if you look at the P&L that's out there, if you look at other operating costs, which would be below the sales and marketing line, those are primarily what are being allocated out. So you have revenue, you have cost of sales, which is direct to each of the groups, sales and marketing, which is largely direct, there's a little bit of allocation in there, but largely direct, and then other operating costs which are largely the shared and centralized stuff that we allocate out. So if you're looking for a more direct margin before allocated costs, I would probably cut off the P&L after sales and marketing.

Eugene Fox - Cardinal Capital Management

And if we were going to allocate that, we would do it on sales basis, because that's the way you all allocated it?

William Barker

That's how we do it, yes.

Operator

Your next question is from Jarrod Cornell - K Capital.

Jarrod Cornell - K Capital

Would you mind repeating what you said about the U.S. tax liability in terms of the breakdown, what the initial deposit was and what the gross in terms of penalties and interest was?

William Barker

The total number on the balance sheet and other tax liabilities is $530.5 million. That is net of a $14 million deposit that was made to the IRS previously.

Jarrod Cornell - K Capital

And just to be clear, what does that $14 million deposit relate to?

William Barker

That was a prior negotiation with the IRS, and it was part of some ongoing dialogue with them on trying to settle some other issues, so it's a deposit that we have there that we can apply to other tax liabilities or tax exposures we're going to have.

Jarrod Cornell - K Capital

And what was the timing of that deposit? When was it made?

William Barker

I don't have that information but -

Cyrus Freidheim

Over a year ago.

Jarrod Cornell - K Capital

We of course saw Lee Enterprises report earlier today definitely positive EBITDA margins of significant size. I mean just in terms of framing the discussion, in terms of margin potential, is that something that you're striving towards? Is that a good benchmark to associate with the community side of your operation?

William Barker

Well, there are a number of benchmarks out there, Jarrod, and that is certainly one of them, and we are looking at all of the benchmarks, and we're trimming them away and looking at the specific percentage that they're spending in the various areas that results in those kind of EBITDA. So the answer is yes, we're looking at that. Not all of our community papers are the same, in the sense that similarly with somebody like Lee, so we're looking for varying models for each one of them, but that certainly is one of the benchmarks.

Jarrod Cornell - K Capital

And then just lastly, in terms of an update on an actual number that we could associate with your cost savings program, it sounds like there could be some update in December, at least internally. Is that going to be shared with the general investor public?

William Barker

What we plan to do is what we have been doing, and that is that each time we come up with a major event, and prior to the time that actually it is fully implemented, we will announce it, as we did with the Tribune deal and as we did with the Southtown Star, and we'll continue to do that. So you'll be updated as each of these cost reductions gets framed up, where we don't plan to give an overall number.

Operator

Your next question is from William Dobbs - Merrill Lynch.

William Dobbs - Merrill Lynch

I have a question about your newsprint inventory position. Obviously you're a different format, you use less newsprint and that's good, and prices have been plummeting. We just had consolidation to form the biggest newsprint company in the word, and people are starting to cut capacity, differential between Europe and the U.S. newsprint market is as big as it's ever been. Any thoughts on locking into in some newsprint prices for the foreseeable future so that that's not another headwind that we're battling possibly in the future?

Rick Surkamer

We anticipate that newsprint prices next year will begin to creep back, and we are purchasing as inventory levels that we're comfortable with relative. We're not in the business of speculation, however, we're in the business of managing our turns, and assuring we get the ultimate best price from the best supplier. We've gone through a pretty significant contraction in the number of suppliers, and therefore we believe that our program, our pricing, and our current supply base will continue to provide us with extremely competitive pricing going forward, and expect that that will continue into next year.

Operator

The next question a follow-up question from Eugene Fox - Cardinal Capital Management.

Eugene Fox - Cardinal Capital Management

I have a couple of questions. Given the comments that you made about the change in the deferred tax asset, I presume the $563 million number for U.S. taxes has basically been increased essentially as a result of that change, so the economics of the U.S. tax liability really haven't changed from what we saw last quarter? That was my first question.

William Barker

Yes, that's correct, Gene.

Eugene Fox - Cardinal Capital Management

Second of all, when we think about your community newspapers, how much variation is there in the underlying EBITDA or operating margin of those businesses; are we being weighed down by several or a few papers that are doing materially worse? Or how should we think about the performance of the group of them? Just an aggregate measure such as the one that you all gave; what else can you tell us about what's going on amongst those papers?

Cyrus Freidheim

Let me just state the ground rule that we're going to use. We are not going to give out the individual profitability of the various groups or individual newspapers, as no other company does that, and we think that competitively would be disadvantageous to us. We will say there's quite a spread in profitability, and we are taking major actions to correct the problems of the low-performing units, and the Southtown Star action is an example of that. That's a concrete example of what we've done. But we have a number of other actions ongoing in the various suburban groups, as well as the Chicago Sun-Times, to improve profitability to some industry benchmark levels.

Eugene Fox - Cardinal Capital Management

A follow-up to that. I know that you all have made a major increase or program of increasing sales and getting accountability out to the field on the community newspapers. How much of the issues that you have are related to simply that process taking time versus structural impediments in many of these papers? And again I understand we're talking at a high level, but I know you all added a lot of sales people, and made major changes in strategy.

Cyrus Freidheim

I think, Gene, those changes did bear fruit to the extent that we went from trailing our competitors by 10 percentage points to actual parity, or a little bit better than parity, and we can't judge individual papers on that basis, because that's not the way the data are collected, but we do know that we are, as a group, ahead of our competitors in this region in terms of performance against the market. We think that they had some very significant favorable impact, the changes that we made. Our problem is that being on the market or a little bit ahead of the market is not good enough if the market is declining at the rates it has.

Eugene Fox - Cardinal Capital Management

That I know, but what I guess I'm trying to figure out is when you hire a lot of sales people, some of them are good and some of them are less good, and is the difference in performance, or at least and of it, associated with uneven performance on the sales side, or if there are other issues in aggregate that are differentiating performance, it would just be helpful to understand the kinds of issues that you're seeing and perhaps then the kinds of actions you're taking.

Cyrus Freidheim

Well, as one might expect, anytime with any organization the size that we have, in the sales area, there are star performers and not-so-good performers, and we do have an evaluation program to both compensate and then if performance doesn't improve, to weed out the weak performers, and we continue to do that.

Other than the market condition, we don't see any structural problems. We are continuing to tinker with the organization to make sure we've got the correct balance of centralized and decentralized resources, and we continue to make adjustments to that, but we don't see anything fundamental as we did last year, when we made the significant change to decentralize and particularly our retail sales force.

Eugene Fox - Cardinal Capital Management

One last question. When you're looking at your performance, I know one of the initiatives that you talked about was training the sales people more fully and expanding your Internet and online staff. When you have looked, is it the case that the performance of your community newspapers, the ones that are performing better, are they performing better because they have done a better job of moving to the Internet?

I'm just trying to understand--obviously the Internet is growing--but I'm trying to figure out is that truly a differentiating factor for performance of the community newspapers, or does it have more bearing and fruit for the Sun-Times?

William Barker

I think you're talking about a couple of different things here. If you look at our sales trend, it's pretty even across the businesses. We talked about Sun-Times is down 6% and total suburbans were down 6%, and although we have a pretty wide range in profit margins, adjusted EBITDA somewhere north of 10% and somewhere below breakeven, but if you look at sales trends, there's not that big a swing between the two.

Eugene Fox - Cardinal Capital Management

I guess what I was asking, Bill, is, those entities that made higher margins, are those the ones that have moved more rapidly, or have a higher percentage of sales or revenue that's coming from the Internet, or is that not a fair conclusion?

William Barker

No, it's a very good question, good point, but we really haven't seen that yet. Again, Internet revenues are about 4% of our ad revenue base, so while it's some place we're going to invest and grow, its going to be awhile before it has real big magnitude on the numbers out there. So everybody is going after it, some are doing it a little bit better at it than others, but I wouldn't say that's a differentiating factor.

Operator

The next question a follow-up question from William Dobbs - Merrill Lynch.

William Dobbs - Merrill Lynch

I think in the last conference call, we talked about possible asset sales and you wanted to keep things as a group. Has the thinking changed on that along with the thinking on the cost cuts; would we think about disposing individual assets as buyers appeared, or strategic buyers, or financial buyers, if there are any left, for assets that we might have, and could this be a situation where selling certain assets separately might get us to a better ultimate value for the company?

Cyrus Freidheim

At this point we are not in the business of selling the assets. We are, as any company is, always open to listening to inquiries that we might have, and so we're not opposed to selling, but we are not actively doing so.

William Dobbs - Merrill Lynch

If I could just follow-up quickly on the newsprint with Rick. Rick, in the newsprint market for a buyer your size, how long are you able to go out and sign contracts for?

Rick Surkamer

First of all, we don't share our agreements in the public, but we do have annual terms with our suppliers, and many of those are related to competitive market pricing. All suppliers are treated equally in terms of that pricing if they achieve an average that we expect from them, and secondly, we expect them to achieve significant performance in our press rooms. So we balance both of those, because the productivity of the newsprint, as well as the price of the newsprint, influence the net total cost of that relationship with that supplier. So that may change quarter-to-quarter, to your question, if a supplier's run-ability is not where it should be.

Operator

And the next question is a follow-up question from Eugene Fox - Cardinal Capital Management.

Eugene Fox - Cardinal Capital Management

Can you take about the competitive environment both from online competitors, as well as local, the Tribune, and other factors that you're seeing, so we understand the pressures, the alternatives that your customers have in the marketplace?

Cyrus Freidheim

On the print side, the Tribune is as aggressive as ever, but they've been a long-term competitor, and so they're known well. Probably the biggest factor that they've changed in the dynamics of the market is the RedEye, which started off about 4 or 5 years ago, and went up just when I joined the team here, they were 90,000, and they went to 150, and now they've announced they're going up to 200,000--and they're free, as I think all of you know--200,000 along with suburban weekend delivery on an as-request basis. So they're being very robust, and based on the advertising we've seen, they do a decent job of getting advertising, in particular, in specific niche markets.

On the Internet side, the biggest competitors for Internet advertising are really not the newspapers, but rather some of the major international players, and we recognize that, and we are both in discussions on partnerships, as well as taking a number of our actions on our own, to assure that we have a strong position in the marketplace.

The competitive advantage we have clearly is the local nature of the news and information that we can provide on our sites, and we're moving aggressively to stake out that claim as the place in the Chicago area for local news and information, and whether we have partners or not will depend on the attractiveness of those partners from a profitability point of view.

Eugene Fox - Cardinal Capital Management

Have you all changed your approach or your reaction to the Tribune's changes with the RedEye?

Rick Surkamer

RedEye represents primarily an entertainment advertising tool, and if you look at the majority, Gene, of the advertising in the product, that's a segment that they attack most aggressively with it. We believe that it certainly can hurt us on our entertainment category, particularly in the city, but we also believe that there are those who buy a newspaper and also pick up a RedEye. We're just not sure what that data is today, but it fills a niche for certain people, but also on the other side of it, there are many who carry both products with them, depending on the time of day.

It's principally an entertainment-related advertising vehicle, and they have recorded in public that they sell synergy with it through their Metro mix and some of their national programming, which is all about clubs and bars. We do have some smaller niche competitors in the city that are free, that I think they've hurt more than they have us on the advertising side for certain.

Cyrus Freidheim

And on circulation, we haven't seen a major impact on our circulation as a result of their escalation of their free circulation this past year.

Operator

And we'll take one last question from Jennifer Wallace - Summit Capital.

Jennifer Wallace - Summit Capital

I have two questions. The first is a follow-on to the newsprint question. I understand that you guys aren't in the business of holding newsprint inventory, but I do believe that its standard operating procedure in the newspaper business to either get forward pricing or lock in long-term pricing.

I would imagine that in a time like this, when prices are plummeting and you can see forward that there are capacity reductions coming on, locking in a lower price today for as long a term as possible, like 3 years, would make sense to me. Are you looking to lock in aggressive prices on newsprint, given that that is still a reasonably large part of your cost structure?

Cyrus Freidheim

A 3-year window is a significant window, as you know, in the newsprint industry. This last year, in 12 months alone you've seen a significant change, and here we are just 13 months later, it's gone back up again. So I'm not comfortable with 3-year hedging, quite candidly, because I think the newsprint industry has accelerated its ability to adjust to supply and demand.

We expect that the consumption of newsprint for the industry, if you've looked at some of the data from the associations, will continue to plummet in newspapers because of circulation challenges and advertising. Therefore, the bigger question isn't a 3-year timeframe, but rather, will these mills be able to adjust their overall capacities to an industry which is suffering with significant declines?

I'm in no position to forecast that for the industry, but I do know that if we continue to manage our suppliers, and consolidate our suppliers, and I said that earlier, that's a premise that I shared, we had more suppliers than we needed, we now have fewer, and we have further opportunity. By doing that and extended their buy and allowing them to supply us with more, we negotiate better prices and better performance over the next year, and that's as comfortable as I am sharing the detail of our newsprint supply arrangements.

Jennifer Wallace - Summit Capital

And my second question is a follow-up on the earlier question about Lee Enterprises. Clearly, they are a group of community newspapers, and I think their operating margins were like 23 or 24% and their net margins were 5%. In addition, they saw flat advertising revenues once they added together online and print.

It would strike me that unless there are huge structural issues that would keep us from getting there, that's kind of a reasonable target, and even if there are structural issues, something between where we are today and 24% operating margins would still leave room for significant cash flow improvements in your business. Am I looking at this correctly?

Cyrus Freidheim

Directionally, sure.

Jennifer Wallace - Summit Capital

I mean, I'm just saying if we've got revenue of $400 million, and we can get to 10% operating margins, this business could and should be generating $40 million a year in operating earnings. If we could get to 24% operating margins, that's $100 million.

Cyrus Freidheim

And that's nirvana. We'd love it. We're looking that's benchmarks, and I think more important than just the overall aspiration, which we have, it's to focus on the line items and determine where we should make our cuts, and we're doing that.

Jennifer Wallace - Summit Capital

I would just imagine that if we can't get the business to that level of profitability, someone can, and it would be worth, perhaps, more to them than it would be to us.

Cyrus Freidheim

I think that one of the things we have to keep in mind when we look at any of these, in comparison with us, if we look at it on an aggregated basis, like the bottom line, is to look at their markets, and Lee, one of their great charms is they focus on non-competitive markets and that gives them a whole lot more flexibility in a lot of areas than we have. All of our markets are competitive. Sun-Times is certainly in deep competition, and each one of our suburban newspapers has competitors as well, including the Chicago Tribune in the suburbs.

Jennifer Wallace - Summit Capital

I don't want to belabor the point, but even if you took their margins of 24% and cut them in half, that would be 12%, which would still quite be respectable.

Cyrus Freidheim

Right, right. We have the same aspiration as you do, absolutely.

Operator

Ladies and gentlemen, we thank you for your participation in today's conference call. This does conclude your presentation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!