Sun-Times Media Group Q3 2007 Earnings Call Transcript

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Sun-TimesMedia Group (NYSE:SVN)

Q32007 Earnings Call

November 8, 2007, 4:30 pm ET

Executives

JamesMcDonough – Vice President and General Counsel

CyrusFreidheim - President and Chief Executive Officer

WilliamBarker - Chief Financial Officer

RickSurkamer - Chief Operating Officer

Analysts

BonnieWachtel - Wachtel & Company

EugeneFox - Cardinal Capital Management

JarrodCornell - K Capital

WilliamDobbs - Merrill Lynch

JenniferWallace - Summit Capital

Operator

Welcometo the Sun-Times Media Group third quarter earnings call. (OperatorInstructions) I'll now turn the presentation over to Mr. Jim McDonough, GeneralCounsel.

James McDonough

Thankyou. Certain statements made in this presentation are forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995. Forward-looking statements include, without limitation, any statementthat may predict, forecast, indicate or imply future results, performance orachievements, and may contain the words believe, anticipate, expect, estimate,project, will be, will continue, will likely result, or similar words andphrases.

Forward-lookingstatements involve risks and uncertainties which may cause actual results todiffer materially from the forward-looking statements. The risks anduncertainties are detailed from time to time in reports filed by the Sun-TimesMedia Group with the Securities and Exchange Commission, including in its forms10-K and 10-Q.

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

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

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

Cyrus Freidheim

Goodafternoon and welcome to the Sun-Times Media group third quarter conferencecall.

Thethird quarter brought many challenges to the company. The newspaper advertisingmarket in Chicago continued to be very tough. As a result, we havelaid on more aggressive actions which I will review with you briefly today. BillBarker, our CFO, will review the financials and the third quarter results inmore detail.

Weare simply not where we wanted to be in the third quarter. When we put ourturn-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 newmedia.

Weare pleased with the progress on three of the four, but the most criticalobjective, to stabilize print and advertising circulation, has not beenachieved as yet. The market for print advertising in the Chicago DMA hasdeclined between 6% and 10% in each of the last six quarters.

TheSun-Times News Group underperformed our competition by 5% to 10% points untilthe second quarter of this year, when the gap was narrowed to 2 percentagepoints 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 dohave the products and capability to be competitive, and that the actions wehave been taking are working. But our revenues continue to decline, furthereroding our operating earnings.

Ourproblem clearly is that the market for print advertising continues to declineat unprecedented levels. In absolute terms, our ad revenue in Q3 was downalmost $5 million versus last year, and that combined with our decline incirculation revenue accounted for all of the decline in the Sun-Times NewsGroup EBITDA, which is now close to break even.

BillBarker will report that in more detail.

Wehave 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 in2008 and beyond, which we knew in advance.

Wecommitted to have a talented, new team in place quickly, and we have. We've hadone change, our Chief Operating Officer of the Sun-Times News Group, JohnCruickshank, resigned in September to become the news God of Canada at CBC. Wewere able to replace him internally with Rick Surkamer, who joined us inFebruary. Rick is an exceptionally well-qualified executive who has substantialnewspaper experience with the Tribune, and general management experience withfour private equity and venture capital firms. Rick is fully engaged. Webelieve the team is as good as any in our industry.

Wecommitted to invest aggressively in our websites and mobile media channels, andwe are. The area of most dramatic industry decline is print classifiedadvertising, which year-to-date has dropped by 18% in the Chicago DMA,comparable to national trends. In addition to weak underlying markets in realestate and autos, classified is shifting to the Internet. In response, we aredeveloping robust offerings for classified on our websites. We are positioningourselves to benefit from the shift of classified to the Internet, asclassified to Internet revenue grows rapidly from its relatively low base toeventually compensate for the print losses. We have a strong position withclassified advertisers and intend to maintain that position through this shiftin channels.

Specifically,in the third quarter we have added a new, comprehensive residential real estatewebsite, searchchicago.com/homes, which allows people in the Chicago area to search thousands of homes over more than10 counties in Northeastern Illinois and Northwest Indiana. We already have one major sponsor signed up. Alaunch of searchchicago.com/homes completes the trio Search Chicago offeringsthis year in jobs, auto, and homes. These sites give advertisers and consumersan excellent complement to classified advertising in print.

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

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

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

Costreduction and reliability improvement programs laid out in our original planare all on target. As we had indicated, these savings were used to fundinvestments in IT and new media. This summer, the management team recognizedthat our plan was not producing the results we needed. Despite significantimprovement in our competitive position across our businesses, the weak marketin print advertising was preventing us from stabilizing ad revenue. We had madedramatic changes in the way we went to market and invested substantially inadditional sales representatives. As I indicated, we outperformed our market inthe third quarter, but ad sales continued to decline.

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

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

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

InOctober, we outsourced all of our customer service call centers to Winnipeg, Canada. We will have a moderate reduction in costs, butfar more important, we will achieve significant improvements in customerservice, which will have a major impact on customer retention--our churn waswell above industry standards--and on new subscriptions. In both of theseoutsourcing actions we will avoid millions of dollars of investment to bringdistribution and customer service to competitive levels.

Wehave reduced the dimensions of several of our papers and special sections, andtightened 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%.

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

Afew examples, we dropped Fluff, a section devoted to celebrities and fashionthat drew no advertising. We combined and refocused several free shoppers andreturned them to reasonable profitability.

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

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

Inmy year with the management of the Sun-Times Media Group, no period has beenquiet, and we have had no normal periods. The third quarter stands tall as aperiod of major events and surprises. Let me go through a few. In July, thecriminal trial concluded and four former senior officers of the company werefound guilty. They will be sentenced later this month. Another former officerwho 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 ofthis year. We will file for a recovery when appeals are completed.

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

OurCompany's objectives in these negotiations are first to convert the super-votingright B shares into A shares and return control of our Board to ourshareholders; to settle the litigation between our company and Hollinger Inc.;to recover as much of the outstanding debt from Hollinger Inc. as possible; andto release our Company from any further litigation or indemnification expensesresulting from Hollinger Inc. actions. A mediator has been appointed by the Canadian Court to assist in the negotiation. We continue to behopeful that the situation will be resolved before year-end, though we can giveno guarantees.

Alsoin August, $48 million of the company's money invested in short-termasset-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 restructuringof the various trusts involved into longer-term debt instruments matching theunderlying assets. We have made it known to both the investor committee and ouradvisor, CIBC, that we need our cash now. We have taken provision of 10%, $4.8million, to recognize the likely markdown of the assets. We do expect to getour money back.

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

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

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

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

NowI'll turn it over to Bill Barker, our CFO, who will go through the financialresults.

William Barker

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

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

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

Otheroperating 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 theincrease was related to one-time costs associated with the implementation ofthe Tribune distribution agreements. The remaining $1.8 million increase wasrelated to planned increased investments in the IT and new media areas.

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

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

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

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

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

NowI'll give some additional background on our revenues, EBITDA, and some balancesheet items. On the revenue front, Q3 ad revenues for total Sun-Times NewsGroup, or STNG, were down 6% versus last year, and this decline was consistentbetween the Chicago Sun-Times and the suburban newspapers.

Q3circulation revenues for total STNG were down 7%, circulation revenues for theSun-Times were down 8%, and circulation revenues for the suburban papers weredown 6%. As we have mentioned previously, the Chicago Sun-Times accounts forjust under half of our combined ad and circulation revenues.

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

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

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

Wehave not yet begun to realize the financial benefits of two major marketenhancement projects we have recently announced: the Tribune distribution dealand the restructuring of our Southtown and Star newspapers. We expect to beginrealizing the financial benefits from these efforts beginning in the fourthquarter and continuing into 2008.

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

Giventhe current uncertain state of the market and the lack of a buy-sell pricingmechanism, it's very difficult to determine the precise value of ourinvestments. We believe the 10% adjustment to be appropriate at this time,based on several factors, including the actions of other companies withCanadian asset-backed commercial paper exposure, our knowledge of the qualityof the assets in the commercial paper conduits, and our internal estimates ofpotential 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, andwe will revisit our valuation at year-end, when more information on the timingand likely outcome of the restructuring efforts should be available. Theinvestor community leading the restructuring effort has targeted December 14thfor an update on the restructuring process.

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

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

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

Movingon to the liability section, we have $6 million of current installments oflong-term debt on our September 30th balance sheet, which was reclassified fromlong-term debt in the second quarter as a result of a change in controlprovision in our outstanding debt. The recent change in our Board of Directorstriggered the provision, and we completed the required $6 million redemption ofthe debt in October.

Regardingtax liabilities, we had a significant change in our reported deferred incometax liabilities and other tax liabilities. The change reflects the impact of avaluation allowance we have recorded against net deferred tax assetsaggregating $165.8 million. The valuation allowance was considered necessarybased on the losses experienced in recent years. Under accounting guidelines, thecumulative reported loss represents significant evidence that a company shouldnot recognize future tax benefits which depend on potential future generationof taxable income.

Thevaluation allowance relates to deferred tax assets with respect to net operatingloss carry-forwards, and the tax benefit attributable to future deduction ofinterest and state income tax accrued for U.S. contingent tax liabilities. As we have accrued ineach quarter for the interest and state income tax on U.S. contingent tax liabilities, that interest in taxhas been accrued on an after-tax basis.

Onour December 31st balance sheet, our other tax liabilities included a netdeferred asset of $75.6 million related to the presumed deductibility ofinterest and state income tax related to the U.S. contingent tax liabilities. A $75.6 milliondeferred tax asset was netted directly against the related liabilities and theother tax liabilities line.

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

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

Gettingback to the balance sheet, our $530.5 million accrual for other tax liabilitiesrelates to the ongoing IRS audit, as well as to other contingent taxliabilities in the U.S. in four jurisdictions. The $530.5 accrual is netof a $14 million deposit made previously with the IRS. The accruals relate tomanagement fees, non-competition payments, and the effects of certain taxstrategies that have been deducted in arriving at taxable income. Some of thesedeductions may be disallowed.

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

Webelieve our September 30th tax accruals are appropriate. Given the sensitivenature of the discussions with the IRS, we do not intend to publicly disclosedetails regarding the basis upon which we have established our accruals. Ifthere are any significant developments with the IRS, or we believe we need toadjust our accruals at any point in the future, we will communicate thatinformation as appropriate.

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

Cyrus Freidheim

Thankyou, Bill. When I joined the management team a year ago, I recognized thedifficulty of the task facing the company and the need for major change. Thissummer it became apparent, first, that we could not grow our way out of theproblem because of the steeply-declining industry revenues, and second, thatthe transformation of our industry to digital news and information wasoccurring more rapidly than we anticipated.

Wehad 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 informationorganization. We are also resizing our company in recognition of the realitiesof the market. We are outsourcing as many non-core activities as possible, andfocusing our investments and resources on our core - the capture, analysis, anddissemination of news and information, and the delivery of a high-valueadvertising platform to our clients.

Oureconomic model is changing dramatically. Investments are focused on our growthengine, new media. We have a great brand, superb products, excellent marketcoverage, more readers than our competitors, and a top-notch team. We haveworld class columnists like Ebert, Novak, and Mariotti and Telander, and Sneed andBrown, and Marin, and I could go on with 10 more.

Wehave the pole position in sports, local politics and investigative journalismin Chicago. We understand the challenge, and are meetingwith all of the intelligence, skill, and force we can muster. Our goals havenot changed despite the rocky times we're going through. We are fully committedto improving shareholder value, and to strengthening our excellent franchise aswe move into a rapidly evolving digital age.

Thankyou and we'll open for questions.

Question-and-Answer Session

Operator

Thefirst question is from Bonnie Wachtel - Wachtel & Company.

Bonnie Wachtel - Wachtel &Company

Thankyou. Listen, I'm awfully sorry to begin on a negative note. I'm a fan of theSun-Times, and I know you're working just terribly diligently to turn thisaround, 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 thatthe business solution to the problems is that Sun-Times and Chicago Tribuneshould merge, and the answer is, you could only do that if one of you was in atroubled situation - I can't remember who were you referring that to. Could youcomment at all at, whether there would be any sort of a contingency plan in theworks that might allow the two of you to discuss this and possibly go thatdirection, or at least comment on this idea again?

James McDonough

Wehave contingency plans for all manner of things, which of course we can'tdivulge at this point in time, but believe that we are covered on virtuallyevery possible avenue that we can or might take.

Operator

Yournext question comes from Eugene Fox - Cardinal Capital Management.

Eugene Fox - Cardinal Capital Management

Couldyou please talk about, if possible, when you talk about the Sun-Times, and thecommunity newspapers, the amount of overhead that you're allocating or, saiddifferently, what the relative margins of these papers might be on apre-allocation basis?

William Barker

Gene,if you look at the P&L that's out there, if you look at other operatingcosts, which would be below the sales and marketing line, those are primarilywhat 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 largelydirect, there's a little bit of allocation in there, but largely direct, andthen other operating costs which are largely the shared and centralized stuffthat we allocate out. So if you're looking for a more direct margin beforeallocated costs, I would probably cut off the P&L after sales andmarketing.

Eugene Fox - Cardinal Capital Management

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

William Barker

That'show we do it, yes.

Operator

Yournext question is from Jarrod Cornell - K Capital.

Jarrod Cornell - K Capital

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

William Barker

Thetotal 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

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

William Barker

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

Jarrod Cornell - K Capital

Andwhat was the timing of that deposit? When was it made?

William Barker

Idon't have that information but -

CyrusFreidheim

Overa year ago.

Jarrod Cornell - K Capital

Weof course saw Lee Enterprises report earlier today definitely positive EBITDAmargins of significant size. I mean just in terms of framing the discussion, interms of margin potential, is that something that you're striving towards? Isthat 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 oneof them, and we are looking at all of the benchmarks, and we're trimming themaway and looking at the specific percentage that they're spending in thevarious areas that results in those kind of EBITDA. So the answer is yes, we'relooking at that. Not all of our community papers are the same, in the sensethat similarly with somebody like Lee, so we're looking for varying models foreach one of them, but that certainly is one of the benchmarks.

Jarrod Cornell - K Capital

Andthen just lastly, in terms of an update on an actual number that we couldassociate with your cost savings program, it sounds like there could be someupdate in December, at least internally. Is that going to be shared with thegeneral investor public?

William Barker

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

Operator

Yournext question is from William Dobbs - Merrill Lynch.

William Dobbs - Merrill Lynch

Ihave a question about your newsprint inventory position. Obviously you're a differentformat, you use less newsprint and that's good, and prices have beenplummeting. We just had consolidation to form the biggest newsprint company inthe 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. Anythoughts on locking into in some newsprint prices for the foreseeable future sothat that's not another headwind that we're battling possibly in the future?

Rick Surkamer

Weanticipate that newsprint prices next year will begin to creep back, and we arepurchasing as inventory levels that we're comfortable with relative. We're notin the business of speculation, however, we're in the business of managing ourturns, and assuring we get the ultimate best price from the best supplier. We'vegone through a pretty significant contraction in the number of suppliers, andtherefore we believe that our program, our pricing, and our current supply basewill continue to provide us with extremely competitive pricing going forward,and expect that that will continue into next year.

Operator

Thenext question a follow-up question from Eugene Fox - Cardinal CapitalManagement.

Eugene Fox - Cardinal Capital Management

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

William Barker

Yes,that's correct, Gene.

Eugene Fox - Cardinal Capital Management

Secondof all, when we think about your community newspapers, how much variation isthere in the underlying EBITDA or operating margin of those businesses; are webeing 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 anaggregate measure such as the one that you all gave; what else can you tell usabout what's going on amongst those papers?

Cyrus Freidheim

Letme just state the ground rule that we're going to use. We are not going to giveout the individual profitability of the various groups or individualnewspapers, as no other company does that, and we think that competitivelywould be disadvantageous to us. We will say there's quite a spread inprofitability, and we are taking major actions to correct the problems of thelow-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 otheractions ongoing in the various suburban groups, as well as the ChicagoSun-Times, to improve profitability to some industry benchmark levels.

Eugene Fox - Cardinal Capital Management

Afollow-up to that. I know that you all have made a major increase or program ofincreasing sales and getting accountability out to the field on the communitynewspapers. How much of the issues that you have are related to simply thatprocess taking time versus structural impediments in many of these papers? Andagain I understand we're talking at a high level, but I know you all added alot of sales people, and made major changes in strategy.

Cyrus Freidheim

Ithink, Gene, those changes did bear fruit to the extent that we went fromtrailing our competitors by 10 percentage points to actual parity, or a littlebit 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 performanceagainst the market. We think that they had some very significant favorableimpact, the changes that we made. Our problem is that being on the market or alittle bit ahead of the market is not good enough if the market is declining atthe rates it has.

Eugene Fox - Cardinal Capital Management

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

Cyrus Freidheim

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

Otherthan the market condition, we don't see any structural problems. We are continuingto tinker with the organization to make sure we've got the correct balance ofcentralized and decentralized resources, and we continue to make adjustments tothat, but we don't see anything fundamental as we did last year, when we madethe significant change to decentralize and particularly our retail sales force.

Eugene Fox - Cardinal Capital Management

Onelast question. When you're looking at your performance, I know one of theinitiatives that you talked about was training the sales people more fully andexpanding your Internet and online staff. When you have looked, is it the casethat the performance of your community newspapers, the ones that are performingbetter, are they performing better because they have done a better job ofmoving to the Internet?

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

William Barker

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

Eugene Fox - Cardinal Capital Management

Iguess what I was asking, Bill, is, those entities that made higher margins, arethose the ones that have moved more rapidly, or have a higher percentage ofsales or revenue that's coming from the Internet, or is that not a fairconclusion?

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'ssome place we're going to invest and grow, its going to be awhile before it hasreal 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 saythat's a differentiating factor.

Operator

Thenext question a follow-up question from William Dobbs - Merrill Lynch.

William Dobbs - Merrill Lynch

Ithink in the last conference call, we talked about possible asset sales and youwanted to keep things as a group. Has the thinking changed on that along withthe thinking on the cost cuts; would we think about disposing individual assetsas buyers appeared, or strategic buyers, or financial buyers, if there are anyleft, for assets that we might have, and could this be a situation where sellingcertain assets separately might get us to a better ultimate value for thecompany?

Cyrus Freidheim

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

William Dobbs - Merrill Lynch

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

Rick Surkamer

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

Operator

Andthe next question is a follow-up question from Eugene Fox - Cardinal CapitalManagement.

Eugene Fox - Cardinal Capital Management

Canyou take about the competitive environment both from online competitors, aswell as local, the Tribune, and other factors that you're seeing, so weunderstand the pressures, the alternatives that your customers have in themarketplace?

Cyrus Freidheim

Onthe print side, the Tribune is as aggressive as ever, but they've been along-term competitor, and so they're known well. Probably the biggest factorthat they've changed in the dynamics of the market is the RedEye, which startedoff about 4 or 5 years ago, and went up just when I joined the team here, theywere 90,000, and they went to 150, and now they've announced they're going upto 200,000--and they're free, as I think all of you know--200,000 along withsuburban 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 gettingadvertising, in particular, in specific niche markets.

Onthe Internet side, the biggest competitors for Internet advertising are reallynot the newspapers, but rather some of the major international players, and werecognize that, and we are both in discussions on partnerships, as well astaking a number of our actions on our own, to assure that we have a strongposition in the marketplace.

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

Eugene Fox - Cardinal Capital Management

Haveyou all changed your approach or your reaction to the Tribune's changes withthe RedEye?

Rick Surkamer

RedEyerepresents primarily an entertainment advertising tool, and if you look at themajority, Gene, of the advertising in the product, that's a segment that theyattack most aggressively with it. We believe that it certainly can hurt us onour entertainment category, particularly in the city, but we also believe thatthere are those who buy a newspaper and also pick up a RedEye. We're just notsure what that data is today, but it fills a niche for certain people, but alsoon the other side of it, there are many who carry both products with them, dependingon the time of day.

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

Cyrus Freidheim

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

Operator

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

Jennifer Wallace - Summit Capital

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

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

Cyrus Freidheim

A3-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 herewe are just 13 months later, it's gone back up again. So I'm not comfortablewith 3-year hedging, quite candidly, because I think the newsprint industry hasaccelerated its ability to adjust to supply and demand.

Weexpect that the consumption of newsprint for the industry, if you've looked at someof the data from the associations, will continue to plummet in newspapersbecause of circulation challenges and advertising. Therefore, the biggerquestion isn't a 3-year timeframe, but rather, will these mills be able toadjust their overall capacities to an industry which is suffering withsignificant declines?

I'min no position to forecast that for the industry, but I do know that if wecontinue to manage our suppliers, and consolidate our suppliers, and I saidthat earlier, that's a premise that I shared, we had more suppliers than weneeded, we now have fewer, and we have further opportunity. By doing that andextended their buy and allowing them to supply us with more, we negotiatebetter prices and better performance over the next year, and that's ascomfortable as I am sharing the detail of our newsprint supply arrangements.

Jennifer Wallace - Summit Capital

Andmy second question is a follow-up on the earlier question about LeeEnterprises. Clearly, they are a group of community newspapers, and I thinktheir operating margins were like 23 or 24% and their net margins were 5%. Inaddition, they saw flat advertising revenues once they added together onlineand print.

Itwould strike me that unless there are huge structural issues that would keep usfrom getting there, that's kind of a reasonable target, and even if there arestructural issues, something between where we are today and 24% operatingmargins would still leave room for significant cash flow improvements in yourbusiness. Am I looking at this correctly?

Cyrus Freidheim

Directionally,sure.

Jennifer Wallace - Summit Capital

Imean, I'm just saying if we've got revenue of $400 million, and we can get to10% operating margins, this business could and should be generating $40 milliona year in operating earnings. If we could get to 24% operating margins, that's$100 million.

Cyrus Freidheim

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

Jennifer Wallace - Summit Capital

Iwould just imagine that if we can't get the business to that level ofprofitability, someone can, and it would be worth, perhaps, more to them thanit would be to us.

Cyrus Freidheim

Ithink that one of the things we have to keep in mind when we look at any ofthese, in comparison with us, if we look at it on an aggregated basis, like thebottom line, is to look at their markets, and Lee, one of their great charms isthey focus on non-competitive markets and that gives them a whole lot moreflexibility 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 suburbannewspapers has competitors as well, including the Chicago Tribune in thesuburbs.

Jennifer Wallace - Summit Capital

Idon't want to belabor the point, but even if you took their margins of 24% andcut 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

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

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