The McClatchy Company Q1 2008 Earnings Call Transcript

The McClatchy Company (MNI)

Q1 2008 Earnings Call

April 23, 2008 12:00 pm ET

Executives

Elaine Lintecum - Treasurer

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

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

Analysts

John Janedis - Wachovia

Analyst for Alexia Quadrani - Bear Stearns

Peter Appert - Goldman Sachs

Paul Ginocchio - Deutsche Bank

Eldeko Hildriss

Hale Holden - Barclays Capital

Philip Olson

Scott Schiffman - Lehman Brothers

Barton Crockett - J.P. Morgan

Ken Silver - CRT Capital

Todd Morgan

John Kornreich - Sandler Capital

Harry Dumont

Michelle Chadri

Craig Huber - Lehman Brothers

Bill Green

Presentation

Operator

Good afternoon. My name is Jessica and I will be your conference operator today. At this time, I would like to welcome everyone to the McClatchy first quarter 2008 earnings conference call. (Operator Instructions) Ms. Lintecum, you may begin your call now.

Elaine Lintecum

Thank you, everyone for joining us today for our first quarter conference call. The call is also being webcast at mcclatchy.com and the webcast will be archived for future reference.

Joining me this morning is Gary Pruitt, our Chairman and CEO; our Vice Presidents of Operations, Lynn Dickerson, Bob Weil, and Frank Whittaker; our Vice President of Interactive Media, Chris Hendricks; and our Vice President and CFO, Pat Talamantes. We are all available for questions at the end of Gary’s remarks.

We will be sticking to the one question per participant rule but I will be available after the call for follow-up questions, and I can be reached at the following phone number, 916-321-1846.

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

Reconciliations of non-GAAP amounts to GAAP reported amounts can be found on our website on the investor relations page. As a reminder, this conference call will contain forward-looking statements that are subject to risks and uncertainties, including among others, those described in the company’s 2007 annual report on our Form 10-K filed with the SEC. Actual results may differ materially from those described during this call.

Now here’s Gary Pruitt, our CEO.

Gary B. Pruitt

Thanks, Elaine. Hello. Today we reported a loss from continuing operations of $0.01 per share for our first quarter of 2008. Our results included two charges. First, a charge of $0.02 per share related to an amendment to our bank agreement that provides the company greater flexibility under our debt covenants, and a second charge of $0.01 per share for tax expense related to changes in prior period estimates.

If you adjusted for these two items, earnings from continuing operations were $1.6 million, or $0.02 per share for the quarter. These results reflect a continuing tough revenue environment. We have responded with strong cost controls to help offset the revenue decline.

In the first quarter, we reduced cash operating expenses by 10.5% and we will continue to reduce them.

Our total revenues in the first quarter of 2008 were down 13.8% from revenues in the first quarter of 2007. Advertising revenues in the first quarter were down 15.3% and circulation revenues were down 5.6%.

Advertising revenues have continued to be hurt more in our California and Florida newspapers due to the continued downturn of the real estate market in those states. Advertising in California and Florida was down 23.4%, reflecting 56% of our total advertising revenue decline.

Let’s look at our revenues by category, starting with retail. Retail advertising was down 7.5% during the quarter. The declines in our newspaper advertising were partially offset by strong growth in online retail advertising. Online retail was up 69%, driven by banner and display advertisements.

Classified advertising revenues declined 25.7% and here is a review by category; employment -- in the first quarter, employment advertising declined 33.4%, reflecting the continued national slowdown in hiring. Print employment revenues were down 39.0%, while online revenues were down 22.0%, reflecting the close tie between print and online upsells in the employment category.

Next, automotive -- automotive advertising was down 16.1%. Our print advertising was down 24.4% while our online auto advertising was up 37.7% in the quarter, reflecting the success of our cars.com product.

Finally, real estate -- real estate advertising was down 35.8%, with 65% of this decline coming from California and Florida. Print advertising was down 39.0% but online real estate advertising grew 8.7% in the first quarter.

Turning to national advertising, it declined 15.3% in the first quarter. Our print performance continued to be hurt mainly by losses in telecommunications and national automotive advertising. Print losses were partially offset by strong growth in online national advertising.

While online advertising is included in the results discussed above, we will continue to provide details of our digital advertising revenues separately to assist you in your analysis of our advertising results.

Online advertising increased 10.6% compared to the first quarter of 2007. Excluding employment advertising, which has declined nationally both in print and online, our online advertising grew 52.1% in the first quarter of this year. Online categories that are less reliant on upsells from print advertising are doing quite well.

McClatchy remains among the top of our industry in terms of online advertising revenues as a percentage of total advertising. Revenues from online ads were 11.3% of total advertising in the first quarter of 2008 compared to 8.6% for all of 2007. We expect that percentage to continue to grow.

In the first quarter, daily circulation declined 4.0% and Sunday circulation was down 4.4%. As we’ve mentioned before, we believe strategic reductions account for a portion of our declines. As we cycle over these strategic reductions, and as the economy begins to recover, we would expect circulation declines to lessen.

Our strategy is to expand the audiences we serve in print and online. Through the first quarter, unique visitors to our websites were up 41.4%.

Turning now to expenses, total cash expenses decreased 10.5% as we continued to rein in costs during this tough revenue environment. Compensation costs were down 7.4%, FTEs were down 7.5%. Fringe costs were down 15.0%, reflecting lower retirement and medical costs. Newsprint and supplement costs were down 19.8%, due to lower usage and to a lesser extent, lower prices than the 2007 quarter.

Our shift to lighter weight paper at our newspapers and web width reductions are paying dividends in our cost reduction efforts.

All other expenses decreased 10.6% as we grind out line by line cost reductions.

Net interest costs were $45.3 million and included the write-down of $3.4 million of deferred financing costs related to the recent amendment of the company’s bank credit agreement, which provides greater flexibility in the company’s leverage and interest coverage ratios.

Excluding these costs, our interest was $41.9 million, down 22.1%. Our effective borrowing rate on the bank debt in the first quarter was 5.0% and when coupled with our bonds was 6.1%.

While the amendment to the bank agreement calls for a higher spread over LIBOR, the federal reserve’s actions over the last several months have more than offset the impact on our interest costs. Our effective borrowing rate on our bank debt is currently 4.75%.

Our operations continue to produce significant cash, which we are using to pay down debt. Debt was down $76 million since the end of 2007 to $2.4 billion at the end of the quarter.

We have also launched a tender offer to repurchase $250 million of our public notes to reduce our cost of debt. The terms and conditions of the offer are set forth in an offer to purchase, dated April 23, 2008, today.

Earlier in the second quarter, we completed -- early in the second quarter, we completed the sale of the SP newsprint company and used the $53 million of gross proceeds to further reduce debt. We expect to pay taxes related to the gain in the third quarter of 2008.

We also expect the tax refund related to the sale of the Minneapolis Star Tribune to yield about $185 million in cash in the second quarter, which we will use to further reduce debt.

We continue to expect our debt balance at the end of 2008 to be approximately $2 billion.

Looking forward, the advertising environment continues to be weak. We expect revenues in the second quarter of 2008 to be somewhat better than our first quarter advertising results, with advertising revenues down in the low to mid-teen range.

In 2008, we will continue to focus our efforts in four areas. First, improving revenue performance with a particular emphasis on Internet advertising. Second, providing high quality public service journalism in both print and online. Third, growing total audience based on the unduplicated reach of our print and online products. And fourth, restructuring and reducing our costs.

As a hybrid print and online company, we continue to be the leading local media company in some of the best growth markets in the nation and we are working hard to position the company to benefit from a stronger economy once it turns.

Now we’ll be happy to answer your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Janedis.

John Janedis - Wachovia

Thank you. Gary, I like the tender and I’m wondering if on a going forward basis, you would consider a reduction in the dividend to fund another one, or would it delever, assuming that the ad environment doesn’t improve much going forward? Thanks.

Gary B. Pruitt

We have no current plans to reduce our dividend but as is always the case at McClatchy, we constantly review all options. But at the current time, we have no plans to do that. We will have to continue to assess the situation given our operating results and the ad environment.

John Janedis - Wachovia

Thank you.

Operator

Your next question comes from the line of Alexia Quadrani.

Analyst for Alexia Quadrani - Bear Stearns

Actually, this is Sylvia in for Alexia. Just a few quick questions. I’m just wondering if you can comment on April trends. Is it similar to expectations for the remainder of the quarter, in the low to mid-teens range?

Gary B. Pruitt

Yes, we expect for the quarter to be in the low to mid teen range. We would expect April to be within that range as well. Our comparisons ease in the last two months of the quarter but we may see more deterioration in the economy and advertising results as well, so that’s the reason we are hedging in that low to mid-teen range. But we think each of the months will be in that low to mid-teen range.

Operator

Your next question comes from the line of Peter Appert.

Peter Appert - Goldman Sachs

Thanks. Gary, this is an unfair question but that’s what we specialize in on the sell side.

Gary B. Pruitt

But that’s okay -- I’m going to give you an unfair answer.

Peter Appert - Goldman Sachs

Excellent. As long as it’s accurate -- so you’ve done this incredible job of managing costs here over the course of the last several years and it just feels like you’ve got to be running out of strength in terms of things to do. So what is next? You can’t keep cutting the headcount, I assume, by 7.5% per year. So that was the unfair question.

And then the fair question is I’m hoping Pat could give us some sense of what the equity line looks like over the balance of the year with SDL.

Gary B. Pruitt

Okay. Well, Pat will handle that equity question and I will address the cost issue. We do feel we are doing a good job on the cost side. We feel we have no choice. Given the revenue trends, we are simply going to have to reduce costs and we do believe that we can sustain a good record on cost throughout this year. We’ve got -- we face increasing newsprint prices later in the year and that will work against us. But on the other hand, we are looking at further efficiencies throughout the company and would expect that when you exclude the -- any severance costs and the effect of newsprint pricing, we should be able to sustain a double-digit run-rate on expense decline and that’s what we are working towards.

And Pat, I’ll turn it over to you to handle the equity line question.

Patrick J. Talamantes

Thank you. Let me answer the question in part by just reviewing what happened in the quarter and I think that will be instructive for the balance of the year. Losses on our newsprint investments grew in the quarter from $3.1 million to $4.8 million due to lower prices year over year and higher costs. That includes SP Newsprint, which we just sold at the beginning of this month. Almost all of the newsprint loss in the quarter was from SP.

Losses in our Internet investments also increased in the first quarter from $3.1 million to $4.9 million, largely because of the successful cars.com campaign, which included Super Bowl ads and as you know, CareerBuilder also advertises on the Super Bowl and in Q1. So we do expect our Internet investments to be profitable for the balance of the year.

Our remaining investments, including the Seattle Times Company, $2.2 million, up from $1.8 million last year and on our D&A line that’s in part part of that equity loss line that’s related to these equity investments, we had $1.3 million of expense versus $1.7 last year. However, in Q2 we’ll see $2.2 million of D&A on the equity line as we will no longer recognize that D&A credit that we had with SP. That D&A credit of $2.2 million we expect for the second quarter would be our new run-rate going forward.

So all in all, we do expect substantial improvement over the balance of the year on the equity line.

Gary B. Pruitt

We are focused on every line on the income statement, including the equity line, and look forward to improving it.

Operator

Your next question comes from the line of Paul Ginocchio.

Paul Ginocchio - Deutsche Bank

Thank you. With The Seattle Times selling the Maine newspapers, is that going to free up any cash for you to pay down debt? Thanks.

Gary B. Pruitt

McClatchy owns a little less than half of The Seattle Times Company, and The Seattle Times Company owns some papers in Maine that they are looking to sell. And I think most of those proceeds will be used to reduce debt for The Seattle Times Company. So we would not expect that we would get any of those proceeds to reduce our debt.

We do think it improves the value of our investment in The Seattle Times, so we think we will benefit from it but we will not get cash proceeds to pay down debt.

Operator

Your next question comes from the line of [Eldeko Hildriss].

Eldeko Hildriss

How much debt did you buy back in April?

Gary B. Pruitt

We haven’t bought back any debt in April. We just issued the tender offer today. We just put it out with the simultaneous release with our earnings release, so we are just kicking off the tender announcement today. So we would hope to get $250 million in debt repurchased but we will have to -- it remains to be seen. We’ll see what happens with the tender.

Operator

Your next question comes from Hale Holden.

Hale Holden - Barclays Capital

Can you give us an update on the Florida land sale? Obviously the trends in Florida real estate have changed quite a bit in the two-and-a-half-years that it’s been outstanding, so I was just curious on your confidence level on closing.

Gary B. Pruitt

Right. We still expect the deal to close and have been in close touch with the buyers and they have received governmental approval for development and are working with future tenants on the site, and so we know that they want to close and continue to work towards closing. We don’t take it for granted because you are right. The real estate situation and the credit markets are very difficult and we are staying abreast of it. But based upon our best knowledge today, and we aren’t -- as I said, we are in touch with the buyers regularly, we expect that that deal will close in the fourth quarter and importantly, we’ve already received $10 million from the buyers that is a non-refundable deposit.

And if they are unable to complete the deal, we would receive another $2 million. So we hope it doesn’t come to that and we expect that the deal would close. These are substantial developers and have put a lot of money into this deal already, so we know they want to close.

Operator

Your next question comes from [Eldeko Hildriss].

Eldeko Hildriss

Already answered. Thank you.

Operator

Your next question comes from Philip Olson.

Philip Olson

Can you give us borrowings outstanding under the revolver and the term loan? And I guess how you intend to fund that tender? And is it fair to assume that 250 would be the maximum amount of debt you could buy back, given the restricted payments basket as part of the revised credit agreement?

Gary B. Pruitt

Thank you for that question. I’ll turn it over to Pat to address it.

Patrick J. Talamantes

At the end of the quarter, we had bank debt outstanding of $982.7 million; $550 million of that was in our term loan and the balance was under our revolving credit. Our revolving credit at the end of the quarter was $750 million. Since the end of the quarter, of course, we closed on the sale of the SP Newsprint company, so those numbers may have improved somewhat as a result of that.

We are looking to fund the buy-back with proceeds under our revolver. You can see that we’ve got plenty of capacity to be able to do that. And I think you are mixing the $250 million cap up in our amendment a little bit. The $250 million cap only applies to buy-backs of bonds or equity. But in the case of bonds, it’s only those bonds that mature after 2011, so for those bonds that mature in 2009 and 2011, of which there is $500 million, we are unlimited on that.

Elaine Lintecum

But we expect the tender to be $250 million, as indicated in the press release.

Operator

Your next question comes from the line of Scott Schiffman.

Scott Schiffman - Lehman Brothers

Thank you. I guess for Gary and Elaine, regarding the credit agreement and the recently amended leverage ratio, if you look at your annualized EBITDA going off of first quarter results, and then you consider your year-end debt target of about $2 billion, it seems like that implies that leverage will be north of five times and you could be in jeopardy of violating that leverage ratio. So can you just address that and would you have to see another amendment? Just your thoughts -- thank you.

Gary B. Pruitt

To get into the details of that question would necessitate us giving a cash flow projection, which we have not done and won’t do at this time. I would just say that we expect to meet the bank covenants and feel confident in our ability to meet the bank covenants at the end of the year.

Patrick J. Talamantes

I guess I would also point out that the first quarter is historically our low quarter for EBITDA every year, so you can’t necessarily just annualize the first quarter results as a forecast.

Gary B. Pruitt

Yeah, that’s a good point. It’s by far our weakest quarter, and smallest quarter. So we feel that we are in a good position given our bank covenants.

Operator

Your next question comes from the line of Barton Crockett.

Barton Crockett - J.P. Morgan

I was wondering if you could elaborate a little bit on the double-digit expense reductions that you are talking about ex newsprint and other items. What do you cut when you do that and what impact does it have on the business?

Gary B. Pruitt

Well, what we want to do is we want to make sure that we maintain our ability to generate revenue and so we want to make sure that the revenue engine is fully revved and fully staffed and we are working as hard as we can to improve revenue performance, particularly in the online side but also in print and direct marketing.

And then we look to -- we are constantly asking the question if we started a news company today, what would it look like? How would it be structured and not looking at legacy cost structures but looking ahead to how we would be structured if we opened today? Taking advantage of technology to operate more efficiently in terms of centralized technology and computer systems, which allows us to be more flexible in staffing and to look at more efficient ways of sharing and operating throughout the company, and not being burdened by legacy cost structures.

It’s a difficult but essential process that this company has gone through in the past as it has had to transform itself over the past century-and-a-half. And so while we understand it is difficult, it is essential and we think we are going about it in a way that keeps an eye to the future and puts the company in a position to be stronger once the economy returns.

We are not being shortsighted. We are not cutting off our nose to spite our face, or being penny-wise or pound-foolish or any other cliché that comes to mind, but rather making the company more efficient in a permanent way to improve our performance long-term.

Operator

Your next question comes from the line of Ken Silver.

Ken Silver - CRT Capital

What was your CapEx in the first quarter?

Patrick J. Talamantes

Sure. Our CapEx in the first quarter was $5.4 million. And I guess I should say, just elaborate on that a little bit -- we have in the first quarter looked at our forecast for the balance of the year and actually into 2009, and expect capital to be in the high $20 million area, absent other developments.

Gary B. Pruitt

So high $20 million for ’08 and ’09. So you figure maybe 30 for each year or so. And we would give you an update if there was any other extraordinary circumstances that would change those projections but that we think is a run-rate for the next two years.

Operator

Your next question comes from the line of Todd Morgan.

Todd Morgan

Thank you. Pat, can you help me think a little bit more about the cash tax rate, or your level of cash taxes going forward?

Patrick J. Talamantes

I think the way we’ve guided investors in the past is to calculate cash taxes in your models by adding back amortization expense and any equity losses, or subtract any equity income before tax affecting the income.

We’ll do a little bit better than that this year because of tax refunds we’ve received this year just excluding the Star Tribune tax refund. And so that’s generally how I would think about it and that should land you with a pretty good result.

Operator

(Operator Instructions) Your next question comes from the line of John Kornreich.

John Kornreich - Sandler Capital

A couple of quickies; refresh my memory, please -- the Florida land sale estimate that you have been giving out previously was what?

Gary B. Pruitt

It’s a $195 million deal if it closes in the fourth quarter.

John Kornreich - Sandler Capital

And you’ve got 10 already?

Gary B. Pruitt

Yeah, we’ve received 10 already.

John Kornreich - Sandler Capital

And I assume that that’s in the $2 billion estimate at the end of the year?

Patrick J. Talamantes

Keep in mind, John, that after tax it’s 125, and we’ve already -- so it’s 115, call it 115 that we would actually receive this year after tax.

Operator

(Operator Instructions)

Gary B. Pruitt

I just wanted to make sure that John heard the final piece of that, so yes, it is included in that estimate. We think we would be in the $2 billion range with or without the Florida land deal, in that broad range of approximately $2 billion.

Operator

Your next question comes from Michael [Renarey].

Harry Dumont

A quick question for you guys, or two questions; are you still on track for your tax refund this quarter? And I have a follow-up on a broader question.

Gary B. Pruitt

You better get it in now because they are cutting people off after one question, if you are still there or have you already gone over the abyss?

Harry Dumont

Okay, I’m still here. So the other question then would be as you look into the -- you know, as you say, you are remaking the company and the sort of model of, you know, if we started the company from scratch today, how would it look. Does the future company include classified ads? And how low do you think those -- you know, as you model that out in the future, does that go from whatever it is going to be this year, $150 million, $200 million, whatever it is going to be to down to the very low single millions? Or is that something you think that you will be able to always sort of hold on to in some manner, shape, or form?

Gary B. Pruitt

Okay. Thank you. As far as the tax refund goes, yes, we will -- we do expect to receive that tax refund in the second quarter. We expect it to be -- and this is the tax refund related to the sale of the Minneapolis Star Tribune last year. We expect that tax refund to be $185 million in cash this quarter. We had previously received a benefit of $15 million tax benefit related to that sale in the first quarter and so the total benefit from that sale on a tax basis is $200 million, but 185 yet to come.

As far as classified ads go, I would say that in some ways my prediction isn’t very important. We know directionally where classified is headed and as a result, we know how to behave to maximize our results. But I will tell you that we are operating the company assuming that print classified will decline, as structurally that advertising moves increasingly to the Internet, which handles that advertising well. And we would expect that we would -- that increasingly -- you know, we sell those ads together, print and online, and we offer that -- only we offer that solution locally and it’s an advantage because print classifieds are not going to zero, particularly in the auto and real estate side, where you have major display advertisers, builders and car dealers, who will continue to advertise more akin to say retail display advertising but it is categorized within classified.

And employment is the category that will be -- will migrate most and already has migrated most to the Internet. And we expect that we will be the local leader in each of those classified categories. And as a result, we feel we need to own a piece of successful Internet companies in each category.

So in the employment area, we own 14.4% of CareerBuilder, the leading online employment company in North America, and doing well internationally. We think that’s a quite valuable asset and we think that it provides us with best of breed products online. In auto, we own 25.6% of cars.com, the number two auto solution online and in the rental category, apartments.com. We own 25.6% of that as part of Classified Ventures as well, and then also 25.6% of Homescape and a developing real estate solution that we working with Tribune, Gannett, Washington Post, and [Belo] on.

So we expect to own best-of-breed classified solutions online in all of our major categories. We expect to be the local leader in each of those categories but we recognize that we will not have the same share online that we have in print historically because there is more competition and the barriers to entry are lower. Still we’ve got the biggest sales staff, we’ll have the best products. We have owned a substantial piece of these companies to hedge our position and we know that the print franchise is not going to zero -- it is going to be maintained at a lower level but still bears -- especially in the automotive and real estate area, and we also know that given the readership, advertisers will continue to go there because we are still reaching about half of the adults in the community in our markets in print. And then when you look at online and print together on an unduplicated basis, we are reaching approximately 70% of the adults in each market.

So it’s a powerful medium and a powerful way to advertise, but no doubt print will be declining, online will be growing, and you can expect us to behave accordingly.

Operator

Your next question comes from the line of Michelle [Chadri].

Michelle Chadri

I do have a quick question; with the downsizing and restructuring of the organization, how do you think it is going to affect your employees and your overall vision for talent management?

Gary B. Pruitt

Well, we do understand that we say it’s a double-barreled challenge of both the structural shift as the Internet takes share from existing media, including newspapers, and the economic downturn. And we understand that the economic downturn is not permanent. It is short-term, but nonetheless painful. And so as I said, we want to look ahead and structure the company in a way that makes sense for our permanent operations, not a -- not in a way that straightjackets us or prevents us from selling advertising or producing quality journalism. We think that we want to operate as efficiently as possible, making sure that those areas that drive quality and performance most are maintained.

And it’s always difficult to operate in an economic downturn and maintain employee morale. It’s a constant management challenge that any manager in the world faces during a recession, and we are no different from that.

But McClatchy is a high quality company and we’ve had -- we’ve been able to attract and retain some of the very best talent in the industry, and I think it’s reflected in many of the journalistic awards we’ve won and in our online performance, et cetera. I think you can see the quality of the people working at McClatchy and their resilience in a downturn.

Operator

Your next question comes from Craig Huber.

Craig Huber - Lehman Brothers

A CapEx question -- can you just reiterate your CapEx guidance for this year?

Gary B. Pruitt

Sure. We expect it to be approximately $30 million, and the same next year, high 20s to 30.

Operator

Your next question comes from Bill Green.

Bill Green

When I look at the bonds for which you tendering, it is clearly focused very much on the front-end and I’m just wondering to the extent that you don’t receive enough bonds tendered, is it your intention to extend the tender to the rest of the capital structure or do you believe you would raise the prices for the tender?

Patrick J. Talamantes

Our offer stands as it is and at this point, we wouldn’t want to speculate on what we might do based on investor reaction.

Operator

At this time, there are no further questions.

Gary B. Pruitt

Okay, well, thank you. We appreciate the interest and we look forward to better quarters ahead. Thank you very much and I just want to remind you, if you have follow-up questions, please don’t hesitate to call Elaine Lintecum, our Treasurer and Investor Relations Manager. And again, she can be reached at 916-321-1846. Thank you very much for your time. Goodbye.

Operator

This concludes today’s conference. You may all disconnect.

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