The McClatchy Company Q2 2008 Earnings Call Transcript

The McClatchy Company (MNI)

Q2 2008 Earnings Call

July 24, 2008 12:00 pm ET

Executives

Elaine Lintecum - Treasurer

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

G. Lynn Dickerson - Vice President of Operations

Robert J. Weil - Vice President of Operations - Midwest and Northwest

Chris Hendricks - Vice President of Interactive Media

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

Analysts

Peter Appert - Goldman Sachs

Alexia Quadrani - J.P. Morgan

John Janedis - Wachovia Capital Markets, LLC

[Jenny Lessor] - Lehman Brothers

Thomas Russo - Gardner, Russo & Gardner

David Clark - Deutsche Bank Securities

Hale Holden - Barclays Capital

Andrew Cohen - Tricadia

Edward Atorino - The Benchmark Company

Stephen Flynn - Morgan Stanley

Michael Angerman - Arcadian Group

Presentation

Operator

Welcome to the McClatchy second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Lintecum. You may begin your conference, ma'am.

Elaine Lintecum

Thank you, and thank you all for joining us this morning or afternoon, as it may be, for our second quarter conference call. This 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 President of Operations, Lynn Dickerson and Bob Weil, our Vice President of Interactive Media, Chris Hendricks, our Vice President and Chief Financial Officer, 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 you can reach me 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 our unaudited results and the full text of the 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 the company's 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 Form 10K filed with the SEC. Actual results may differ materially from those described during the call.

Now here's Gary Pruitt, our CEO.

Gary B. Pruitt

Thanks, Elaine. Hello, everybody. Today we reported income from continuing operations of $20 million or $0.24 per share for our second quarter. Excluding various one-time or unusual items, which are detailed in our earnings release, adjusted earnings from continuing operations in the second quarter were $17.3 million or $0.21 per share.

These results reflect the continuing tough revenue environment. Our advertising revenues in the second quarter were down in the mid-teen percentage range and continued to be hurt by the weak economy and the secular shift of advertising to the Internet. We've responded by intensifying both our pursuit of new revenue streams and cost control initiatives.

In the second quarter we reduced cash operating expenses by 9.1% excluding severance costs associated with our restructuring plan. We will continue to seek ways to reduce costs and I will speak to our outlook for the remainder of 2008 momentarily, but let's first review the second quarter.

Total revenues in the second quarter of 2008 were down 15.6% from 2007. Advertising revenues in the second quarter were down 16.8% and circulation revenues were down 5.2%.

Retail advertising was down 7.9% during the quarter. Much of the decline continues to come in the furniture and home furnishings area, reflecting the real estate downturn, and in department store advertising.

The declines in our newspaper advertising were partially offset by strong growth in online retail advertising. Online retail was up 80.7%, driven by banner and display advertisement.

Classified advertising revenues declined 28.1%. Here's a review by category:

Employment. In the second quarter, employment advertising declined 39% as hiring continued to be lackluster across the nation. Print employment revenues were down 45.3% while online revenues were down 27.3%.

Automotive advertising continued to struggle, down 17.8%. Our print advertising was down 27% while our online auto advertising was up 39.7% in the quarter, reflecting dealers' shifting spending to our successful Cars.com product in light of extremely challenging auto sales.

Finally, real estate. Real estate advertising was down 37.1%, with more than half of this decline coming from California and Florida. Print advertising was down 41.3%, but online real estate advertising grew 19% in the second quarter.

National advertising declined 20.4% in the second quarter. Our print performance continued to be hurt mainly by losses in telecommunications, which made up about two-thirds of our second quarter decline in this category and to a lesser extent by declines in the national automotive category. Print losses were partially offset by strong growth in online national advertising.

While online advertising is included in the results discussed above, we want to highlight some important trends in our digital business. We're pleased to see continued strength in both audience growth and advertising sales. Through the second quarter, unique visitors to our websites were up 24.7% following 41.4% growth in the first quarter. Online advertising revenue grew 12.5% in the second quarter of 2008, and revenues accounted for 11.8%  I'm sorry, let me make this clear -- online revenues accounted for 11.85 of total advertising revenue compared to 8.6% of total advertising revenue for all of 2007.

Excluding employment advertising, which has declined nationally both in print and online, our online advertising revenues grew 58.5% in the second quarter of this year. We are pleased to note that nearly 50% of our online advertising came from ads placed directly online. They were not tied to a print up sell. Online advertising continues to remain the fastest-growing segment of our business, and we remain among the top of our industry in terms of growth and online advertising revenues as a percentage of total advertising.

In the second quarter daily circulation declined 3.5% and Sunday was down 3.8%. As we have mentioned before, we believe strategic reductions account for a portion of our declines. We are continuing to look at the value of outlying circulation and reduce it where it makes sense, and we'll also implement limited subscription price increases at certain newspapers. As a result, circulation declines may approach the mid-single digit range as we implement these changes.

Our strategy is to expand our total audiences in print and online. We believe the unduplicated local readership penetration of our online and print products continues to be about 70% in most of our markets. We will continue to focus on growing this total reach for our advertising customers.

Turning next to expenses, total cash expenses decreased $15.2 million or 3.6% and, excluding the impact of severance and other charges related to our recently announced restructuring, these cash expenses were down 9.1%. And we will continue to cut costs during this difficult revenue environment.

Compensation costs were flat and include $23 million in severance costs related to the restructuring. Excluding these costs, compensation declined 10.1%. FTEs were down 9.4% from the second quarter of 2007. Please bear in mind that most of our cost restructuring occurred late in the second quarter, so the cost savings won't really be reflected in our results until the third and fourth quarters.

Newsprint and supplement costs were down 11.1% due to lower usage. Our shift to lighter-weight paper at our newspapers and [web] width reductions are paying dividends in our cost-reduction efforts here. All other expenses decreased 5.9% as we grind out line-by-line cost reductions.

Net interest costs were $36.7 million, down 26% from the second quarter of 2007. As Pat noted in our release, debt was down more than $370 million from the end of 2007 to $2.1 billion. In addition to lower debt balances, we are also benefiting from lower interest rates, reflecting earlier Fed rate reductions and the reduction in high-coupon bonds resulting from our tender offer. Our effective borrowing rate on bank debt in the second quarter was about 4.8% and when coupled with the cost of bonds, was 5.8%.

Looking forward, the advertising environment continues to be weak, and we expect revenues to continue to be down. But whether they improve from recent trends depends upon the direction of the overall economy. We are not standing idly by. We're investing significantly in our online operations, including adding sales staff, realigning sales incentives, and expanding training. We are working with industry peers and technology companies to offer the best online products. And in June we named Steve Bernard to a newly created position as Corporate Vice President for Advertising to better serve our large retail and national customers, both online and in print.

We are also focused on our cost structure. The continuing decline in print advertising means we have accelerated plans to become a smaller, more efficient company, well positioned for future success in an increasingly competitive environment. We are aggressively pursuing synergies with other newspapers, such as the announcement to partner with Pioneer Newspapers to print our Boise, Idaho and Bellingham, Washington papers beginning 2009 and the printing of our Modesto Bee by the Sacramento Bee starting in the fourth quarter of this year.

We are retaining our strategic focus on sales, news and online operations as we realign our cost structure, but we are also taking advantage of opportunities to streamline operations. Under our restructuring plan we expect $95 million to $100 million in savings over the next four quarters and to reduce non-newsprint cash expense in the low double-digit percentage range over the balance of 2008, excluding the severance and other one-time charges related to the plan.

We are committed to doing more if revenues continue to decline further. Our Board will meet during the third quarter to consider dividend policies, and we will look at additional cost-savings measures as necessary. We have met all of our financial obligations, including the financial covenants in our credit agreement, and we expect to continue to do so. We continue to monitor our financial position and have good relationships with our bank group, and we'll seek an amendment to our covenants if necessary. We expect to make further progress in deleveraging our balance sheets and expect total debt to be in the $2 billion range by the end of the year.

We are focused on continuing to be the leading local media company in some of the best growth markets in the country.

Thanks for listening. Now we'll be happy to answer your questions.

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Peter Appert - Goldman Sachs.

Peter Appert - Goldman Sachs

A question for Gary or Pat, I guess, but in terms of the loan covenants, can you just remind us what the major things are we should be keeping an eye on and where you're closest to perhaps tripping any of these covenants?

Gary B. Pruitt

Pat can address that.

Patrick J. Talamantes

Peter, debt was just under four and a half times at the end of the quarter based on the bank definition of our credit agreement, and the covenant is five times. Based on the bank amendment we entered into at the end of the first quarter, our leverage covenant is five times until the end of 2009, when it steps down to 4.75 times.

The interest coverage covenant, that ratio is around 2.9 times at the end of the quarter, and the interest coverage covenant itself is 2.75 times for the remainder of the life of the credit agreement.

Peter Appert - Goldman Sachs

In terms of the reconsideration of the dividend policy, Gary, can you give us any further color? Would the family be amenable to the elimination of the dividend for a period of time?

Gary B. Pruitt

Well, all I can say is that the Board is going to consider the dividend policy in its upcoming meeting. I really don't want to speculate as to the outcome or to other, you know, to other's feelings about it. It will be considered in the upcoming meeting. Nothing really to add to that.

Operator

Your next question comes from Alexia Quadrani - J.P. Morgan.

Alexia Quadrani - J.P. Morgan

Any, I guess, early comments on how July's trending? And then maybe this is too early to read into it, but it looks like Florida didn't get worse in June while the rest of the markets generally saw deterioration. Is it too soon to assume that we may have a little bit of a bottom there?

Gary B. Pruitt

Okay. Well, July - we're on 544 fiscal calendar, so July is five weeks. We have three weeks in the books, two still to go, and after three weeks it's tracking about the same as June. But that doesn't mean it will end the same as June. It might be better; it might be worse. So we have two weeks yet to go. Visibility is limited. But so far it's tracking similarly to June.

And as far as Florida goes, you're right. Florida did show some improvement, but it's too early for us to put a great deal of confidence in that. We've seen some head fakes before in some of our regions and in some of our papers. So while we're hopeful, I can't be confident that we're going to see improvement there yet.

Operator

Your next question comes from John Janedis - Wachovia Capital Markets, LLC.

John Janedis - Wachovia Capital Markets, LLC

Can you guys dig in a little bit more on the half of the online ads that were placed online only? Meaning, if you look back over the past, I don't know, quarter or year or so, what percentage of those were either print only or up sells, and also what kind of price increases have you been seeing there?

Gary B. Pruitt

Okay, well, I'll begin to address it generally, and then Chris Hendricks, our VP of Interactive can add more to it.

When we started our online efforts a decade or more ago, virtually all online ads were up sells from print or a combination buy with print. And even as late as 2006, 70% of the online revenues were tied to print in that way. And now year-to-date nearly 50% of our online revenues come from ads that are placed online only. This is significant because it's establishing a separate, independent business from our print product.

Now we're not kidding ourselves. We know that our brands are helpful, promotion in the paper is helpful, so I don't mean to suggest that it's a completely independent entity. After all, we're using similar content. But it is establishing an independent advertising base and with increasingly strong demand, and as a result we've priced aggressively as advertising has increasingly switched to the Internet.

But I'll let Chris address more of the details of that.

Chris Hendricks

In the detail what you have is you have CareeerBuilder products, you have Cars.com products, you have banner advertising, private party web order entry that comes on for online purchase, video advertising, niche products and e-mail. All of those categories have seen significant growth year-over-year in the online only segment. We price, as Gary said, accordingly to derive value out of it, but those categories are really booming for us, especially in the display retail side, which is your banner advertising category. But also, as Gary mentioned, the Cars.com category is also seeing significant growth.

So we're pushing hard here. We've increased our sales pressure in these areas, made it easier for people to buy but also tended to be aggressive in the pricing so that we get the value that we deserve for it.

Does that answer your question?

John Janedis - Wachovia Capital Markets, LLC

As a follow up - Chris, yes - is it fair to say that retail would be above that 50% threshold?

Chris Hendricks

Retail? Yes.

Gary B. Pruitt

Retail - no. I mean, when you say 50% threshold, it's growing faster than 50%, John, but it's certainly not 50%.

Chris Hendricks

Of the retail classification.

Gary B. Pruitt

Yes. In the retail category, is most of it tied to a print combo or not?

Chris Hendricks

Most of it in the retail category right now is not tied.

Gary B. Pruitt

It's not. So it is over 50?

Chris Hendricks

Right. But it's not 50% of the retail [inaudible].

Gary B. Pruitt

Right.

Operator

Your next question comes from [Jenny Lessor] - Lehman Brothers.

Jenny Lessor - Lehman Brothers

What is your outlook for newsprint price increases for the remainder of the year? In other words, are you expecting newsprint prices to increase roughly about $20 a month for the reminder of the year? And then also are you considering any other significant asset sales to lower your debt?

Gary B. Pruitt

Thank you. Pat will address the newsprint pricing question, and I'll address the asset sale.

Patrick J. Talamantes

Well, pricing is certainly trending upward based on capacity reductions, higher manufacturing costs and currency issues. We expect to be able to offset most of those increases in the third quarter through continued conservation efforts, but we'll have to see if we're able to continue to do that in the future. We started to have better conversations with some suppliers and would note that the newspaper industry usage is down substantial, capacity utilization in the newsprint industry is down, and building a business based solely on exports because the dollar is currently weak is not likely to be a winning strategy long-term.

So the suppliers are riding a wave of macroeconomic factors that they're doing very well with. It remains to be seen whether they're going to be able to continue to get the kinds of price increases that they've been getting lately.

Operator

(Operator Instructions)

Gary B. Pruitt

And I wanted to follow up in answering Jenny's second quarter there about asset sales. As you saw, in the last quarter we did sell Shop Local and thought that made strategic sense for us in cleaning up that partial ownership we had. So we continue to evaluate our assets, look for opportunities that we think will be strategic, streamline the company, help reduce debt, so we'll continue to do that and look at and evaluate all of our assets as we move forward.

Operator

Your next question comes from Thomas Russo - Gardner, Russo & Gardner.

Thomas Russo - Gardner, Russo & Gardner

Back to Chris' observation about the online only portions of the digital advertising, to what extent, Chris, would you think that your efforts here will be enhanced by the activation of the Yahoo partnership, and where do you stand in the process of that activation?

Chris Hendricks

Tom, right now in the Yahoo activation we have seven sites who are participating in Phase 1. Phase 1 does not include a full application, that is, we do not have access to the full Yahoo advertising platform. We began moving our site onto the Yahoo platform in October of this year, and we expect to finish that complete transition by the end of Q1 of 2009.

So far there the results have been favorable. McClatchy is doing a very good job in selling in the Phase 1, even though it does not, again, have the entire platform and give us the full functionality. Our expectations that we had earlier in this are still the same. We do expect it to be of significant benefit to us beginning in '09, but won't get a full run on it, obviously, until 2010, where we have a full year. But we still expect significant revenues in the '09 timeframe.

Thomas Russo - Gardner, Russo & Gardner

As to the remarkable performance of the online only this quarter, how much of it involves this quirky accounting that we experienced with CareerBuilder during the first year in terms of the strength of the comparison? Is there anything that's specific to the CareerBuilder accounting?

Gary B. Pruitt

No, that has no effect on it whatsoever.

Operator

Your next question comes from David Clark - Deutsche Bank Securities.

David Clark - Deutsche Bank Securities

Direct marketing was up in June and decent for the quarter. Could you talk a bit about the trends there and why that piece of business seems to be working okay for you? And then second, could you give us an update on the Miami land sale, will it still close in the fourth quarter and the price range, the after-tax price range, you've given previously, is that still looking good?

Gary B. Pruitt

Okay. I'll address the Miami land sale, and I'll turn it over to our Vice Presidents of Operations to discuss the direct marketing question.

As far as the Miami land sale, we still expect the Miami land sale to close in the fourth quarter, and it is a $190 million sale, after tax about $115 million. And we're in contact with the buyers, and they plan to move forward with the sale. So we expect it to close in the fourth quarter.

And I'll turn over the question concerning the direct marketing to Bob Weil, VP of Operations.

Robert J. Weil

Yes. The strategy of McClatchy has really been focused for a long time on diversifying our revenue stream, and over the last several months we've spent a lot more time creating new direct marketing opportunities with niche publications and with special direct mail pieces. That's driving much of our success.

For example, in Kansas City we launched a new young reader publication earlier this year, and it's really been hugely successful. We expect to have over $2 million in revenue this year from it, and we are doing similar kinds of things with niche publications in some of our other regions as well.

Operator

Your next question comes from Hale Holden - Barclays Capital.

Hale Holden - Barclays Capital

My understanding of the Miami land sale was that the buyer had up to a $10 million discount if they closed in August. Can you give any color why they pushed it back and didn't take that discount?

Gary B. Pruitt

Yes. I think the way it works is, if I remember the contract right, I think it's they had a $10 million discount if they closed by the end of the second quarter and a $5 million discount if they closed by the end of the third quarter. And they had always planned to close in the second half, likely the fourth quarter. We wanted to provide an incentive to close early, but I believe their expectation from what they've told us, remains to close in the fourth quarter and, as a result, that would be the full price, the $190 million without the discount.

They're planning, you know, a - they're looking at getting - they're in the process of getting retail leases signed up, making further plans, working with the government, the local government, so I think in terms of their financing and other plans, the fourth quarter's the timeframe they've always worked under, so that's what we're pointing towards as well.

Operator

Your next question comes from Andrew Cohen - Tricadia.

Andrew Cohen - Tricadia

Just back to that Florida land sale, you've been speaking with them. Do you have any color on what their financing situation is for lining up the debt financing? And if they're speaking to tenants, have they signed any anchor tenants or are they close to signing any anchor tenants for that space?

Gary B. Pruitt

What we would say is, you know, we don't want to speak for the buyers. We don't know their financing situation, but we do know that they expect to close and have reassured us that they plan on closing. And we don't know the details, nor do we feel comfortable disclosing their particular retail lease arrangements and plans on that front. I can just tell you that the news has been positive and they expect to close.

Operator

Your next question comes from Edward Atorino - The Benchmark Company.

Edward Atorino - The Benchmark Company

Regarding the timing of the charges in the second quarter, does that suggest that the rate of decline in compensation will be greater in the second half than in the first half as you begin to absorb the benefit of the downsizing?

Gary B. Pruitt

Yes, it does.

Operator

Your next question comes from Stephen Flynn - Morgan Stanley.

Stephen Flynn - Morgan Stanley

The $30 million in severance charges associated with the June 16th announced layoff of the work force, was any of that in the $23 million number realized in the second quarter and, if so, what's remaining and when will that be realized?

Gary B. Pruitt

Yes, I mean, that $23 was a subset of the $30. So in other words, that was part of that $30. So there is a small remaining portion that would hit in the third quarter. But most of those severance costs have already hit in the $23 to $25 million range, and few of the benefits have hit yet. They really start in the third quarter.

Operator

Your next question comes from Michael Angerman - Arcadian Group.

Michael Angerman - Arcadian Group

I'm calling to basically you a question at a slightly higher level. When I look at your company right now I see about $400 million in market cap and about $2 billion in debt. When you look out three to five years with your company and you think about where the newspaper industry is going, can you give us a sense for how you see your business in three to five years assuming that maybe most of your revenues come from the Internet? Let's say all of your newspapers are online and they're all doing really well online, how do you see your business changing in the next three to five years so that you could really move to a new business model where you're a profitable company again like you used to be?

Gary B. Pruitt

Okay. Well, you know, visibility is certainly limited, so that means I can say almost anything, right? No, I - to treat it seriously and as - our best projection would be that as we look out three to five years, we expect the company to continue to migrate and evolve towards a hybrid print and online company, still probably generating more revenue from print than online, but being much more evenly balanced between the two on a 24-hour news cycle, 24hour products online. Once a day we stop that cycle and go to print because there will still be a large demand for print.

And our online revenue may be slightly less than our print revenue. We see it growing quickly, but print nonetheless holding probably a majority still at that time. But our cash flow coming more from online than print because its margins are higher without the newsprint, without delivery costs, gasoline, etc. And we also see a broader portfolio of print products, niche products, lifestyle products, and a matching lifestyle products online in verticals, and direct mail to allow advertisers to have a one-stop buy at McClatchy in our markets to reach the newspaper subscribers and those who don't read the newspaper.

We see ourselves diversifying our revenue base as a local media company, picking our markets carefully and expanding our audience reach as other media outlets proliferate and as a result their audience fragment. So we see ourselves maintaining our mass reach and being the only medium that maintains its mass reach, and then, as the leading local online site in targeted advertising vehicles and targeted direct mail.

So with online we can go down to the individual or database marketing and with the newspapers still keep our broad reach. We don't think print will go away in this timeframe. We think that there will still be a demand for print products as far out as we can project. But we will be a smaller and more efficient company in our operations. We expect that over time we would be less vertically integrated, focusing increasingly on our core businesses, the news and advertising sale businesses, and see that process continuing over many years.

So while we've - this is a difficult transition, and the visibility is limited because we know that there are structural changes going on with advertising demand shifting to the Internet, but we also know that a lot of what's going on is cyclical, and it's very difficult to tease out how much each is contributing to the downturn. But we know there is a successful business model here, and we know that we're operating in good markets long-term. And we know our operations are efficient and our online operations are successful. So we do see a strong future there as a hybrid Internet and print company.

Operator

(Operator Instructions) There are no further questions at this time. Are there any closing remarks?

Gary B. Pruitt

No. I wanted to thank - just this - I wanted to thank everyone for listening in, and we look forward to weathering this difficult transition and better results in the coming quarters. Thank you very much.

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Comments

[forwoodenboats:]

MNI...Didn't they install the diving board at the La Brea Tar Pits so that they and the rest of the Marxist rags on the Dinosaur Death Watch could make a big splash on their way out?
MNI.PK...has a nice ring to it, don't you think?

2008 Aug 25 03:03 PM