The McClatchy Company (NYSEMKT:MNI) Q1 2019 Results Earnings Conference Call May 9, 2019 12:00 PM ET
Stephanie Zarate - Investor Relations Manager
Craig Forman - President, Chief Executive Officer
Elaine Lintecum - Vice President of Finance, Chief Financial Officer
Mark Zieman - Vice President of Operations
Scott Manuel - Vice President of Customer & Product
Conference Call Participants
Craig Huber - Huber Research Partners
Good afternoon, good morning and welcome to McClatchy's first quarter 2019 earnings conference call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please also note, today's event is being recorded.
At this time, I would like to turn the conference call over Ms. Stephanie Zarate. Ms. Zarate, please go ahead.
Thank you Jamie. And thank you all for joining us today for our first quarter 2019 earnings call. I am Stephanie Zarate, Investor Relations Manager and I will be available to answer any follow-up questions you may have after our call this morning. My phone number is 916-321-1931 and you can also find my contact information on our website.
This call is being webcast at mcclatchy.com and will be archived for future reference. Our earnings release was issued this morning before the market opened and I hope you have had a chance to review it. Joining me today is Craig Forman, our President and CEO, our Vice President of Operations, Mark Zieman, our Vice President and CFO, Elaine Lintecum and our Vice President of Customer and Product, Scott Manuel.
This conference call will contain forward-looking statements that are subject to risks and uncertainties that are described in our SEC filings. Actual results may differ materially from those described during the call.
Also, non-GAAP amounts discussed this morning are reconciled to the most directly comparable GAAP measures and schedules posted on our website or in the body of our press release.
Now I will turn the call over to Craig Forman.
Thank you Stephanie. Good morning and thank you for joining us today. We are happy to share with you in detail our first quarter results.
To begin, let's look at the context. Typically, the first quarter in the news industry is the weakest of the year, reflecting reduced advertising budgets and spending fatigue from the holiday season. Regardless, we saw promising sequential trends from both the fourth quarter and full year 2018 results and are posting our best year-over-year performance in operating cash flow in three years. While headwinds in our industry continue, we are seeing trends now that indicate we are headed in the right direction and here are some headlines.
We achieved an improving trend in adjusted EBITDA over the past two quarters. And to be clear, that excludes the impact of real estate sales. We grew the number of digital-only subscribers by almost 60% over last year. That is the twelfth consecutive quarter of growth in this key area of digital transformation. And in developments related our capital structure, we redeemed $4.6 million of our first lien 2026 notes at par on April 5 and we expect to reduce our first lien debt by approximately $32 million in the second quarter as a result of asset sales.
Let's take a closer look at these results. The trend in adjusted EBITDA is among the key milestones this quarter. It reflects our efforts to stabilize our operating results despite continuing headwinds in the print newspaper business. Excluding the impact of real estate gains recorded in the first quarter of 2018, our adjusted EBITDA improved sequentially to down 5.7% from the down 8.2% rate of Q4 2018 and is the company's best year-over-year performance in three years.
We are encouraged by this trend and remain steadfast in our focus on topline revenues, while managing our cost structure, all while making important investments in our digital transformation and I will share some more comments on those investments later in my remarks. We also continued to be strategic and resolved in taking cost out of our business and in making key investments to boost revenue generation. In the first quarter, we removed almost 10% of legacy costs from our business. We achieved this through disciplined cost reductions that were put into place in the second half of last year and in the first quarter of this year.
We announced in the fourth quarter of 2018 that we were shifting our organizational structure to become a functionally organized company, a more agile organization for the digital era, common in Silicon Valley, but still unusual in the print and legacy newspaper business. We are extending the structure to our advertising department and expect it to result in mid to high single digit millions in savings moving forward as well as improved revenue generation as we will discuss in just a moment. During our last conference call, we also discussed our voluntary early retirement plan, which we implemented in the first quarter and will result in savings of approximately $12 million this year.
Another positive trend we accelerated in the first quarter is continued growth in digital-only subscribers. As I mentioned earlier, we accomplished nearly 60% growth in digital-only subscriptions, reaching 179,100 by the end of the first quarter of 2019. And it is important to point out that not only is this the twelfth consecutive quarter of growth for our digital subscriptions, it's the most significant year-over-year growth we have seen in three years. Our focus on paid digital subscriber growth is a key performance measure in our continuing transformation and a contributor to the improvement in audience revenue trend this quarter.
Another way to express our growing digital footprint combines the number of digital-only subscribers with print subscribers who are also digital users. As you may know, digital access to our news sites is a valuable feature of a paid subscription. We want to make sure that customers who are paying for our products are getting the most value for their subscription dollars by activating and using our digital products. Print and digital is a powerful and convenient combination for our customers. And at the end of the first quarter this year, total paid digital customer relationships, including those combination print/digital customers, was 474,400, up 34% from just a year earlier.
This growth is a direct result of the investments and functional reorganization in our product and customer team. We discussed at length last quarter the strategic and intentional work this team is doing in data analysis and understanding our current and potential audience to optimize user experience and conversion opportunities. Because of these efforts, we have improved our ability to convert visitors to paid subscribers and sharpened our targeting for our digital products.
For instance, we saw, after our analysis, that tightening our paywalls to grow digital subscribers would be an intelligent trade-off, despite softer ad revenues associated with lower page views. Significantly, while we grow and improve our platform in online offerings, we continue to see increased platform engagement, which is evident not only through our increased number of digital-only subscribers and active print/digital subscribers, but also in the increased time spent on our sites.
In looking at our audience results, digital audience revenues were up 9.4% in the first quarter of 2019 compared to the same period last year, reflecting strong growth in our digital subscribers. Digital-only audience revenues associated with digital-only subscriptions were up 50.4%. Total audience revenues were $83.1 million, a record 46.1% of total revenues. While audience revenues were down 3.7% in the first quarter of 2019, that reflects a nearly 200 basis point improvement over the 5.6% decline rate in the same period of 2018.
The rate of decline in the first quarter of 2019 is also a sequential improvement to both the fourth quarter and full year 2018 trends. We believe this improvement reflects the shift of print readers to digital readers as well as growing new digital-only subscribers and that our success in improving digital readership is helping to stabilize audience revenue trends.
Turning to our advertising business. During the quarter, we invested in our digital advertising team, adding new leaders to manage our functional organizational structure with a dedicated focus on our customers to drive digital revenue and create new efficiencies. In keeping with a more agile organization, these leaders are aligning the advertising organization into key functional channel structures and this process is expected to be completed by the end of the second quarter. This new structure will not only strengthen our sales organization and sharpen its customer focus, we believe it will also drive new revenue and as we noted earlier, it will also result in significant savings this year.
In the first quarter, total advertising revenues were $85.2 million, down 14.7% compared to the first quarter of 2018. The rate of decline in total advertising revenue improved by 200 basis points compared to the decline of 16.7% in the first quarter of 2018, even with lower digital advertising revenues this quarter.
Now as I have said before, digital transformation such as the one McClatchy has embarked upon are never smooth. This is the first quarterly period in many years when digital-only advertising did not grow and it's due, in part, to our strategic decision to tighten our paywalls which are generating more paid digital subscriptions. Still, both total digital and digital-only advertising revenues exceeded print newspaper revenue in the quarter, in line with our full year expectation. And importantly, our total revenue results in the first quarter were stable with full year 2018 revenue trends and improved over 2018 first quarter trends by 80 basis points.
We saw a slower news cycle year-over-year impact our national digital advertising. The lower page views and engagement led to reductions in digital lines of business, including our programmatic video and search revenues. But while news cycles may ebb and flow, we believe that our essential local journalism will continue to drive engaged audiences and digital revenue.
So we had a combination of events that resulted in this soft start to the year in digital-only advertising, but that shouldn't mask some real bright spots hidden within the number. While national digital revenue declined, we saw the largest growth in digital-only retail revenue, up nearly 8%, that we have seen in more than a year and the best total digital retail growth, up nearly 4%, that we have seen since 2016.
Retail is still a volatile category for us, but this is the first quarter in more than two years where our combined print and digital retail revenue has declined in the single digits, which is much better than the double digit declines we have been experiencing over the past few years. So perhaps, we are seeing a lessening of the retail apocalypse that has dragged down our print and digital bundled revenue for so long.
We also continue to see very impressive growth from our Excelerate Digital agency. Excelerate contributed almost $18 million of our total digital revenues in the first quarter, up more than 400% versus Q1 last year. So this has turned into a material business for us that keeps getting stronger.
Before turning the call over to Elaine to review our quarterly results in more detail, I would like to focus briefly on the cornerstone of our business, independent local journalism in the public interest and we had a lot to celebrate in the first quarter. The Sacramento Bee is one of eight media outlets that took part in an unprecedented collaboration examining the deadliest wildfires in California history called Destined to Burn. This investigation found that one in 12 of California's homes are located in areas that faces severe wildfire threat and the steps that should be taken to avoid another catastrophe.
Our Miami Herald broke a series of explosive stories that received national attention. Trump Tourism: Access for Sale, that series focused on a former day spa owner who became a Republican donor and quickly gained access to the executive branch and an inner circle of politicians and officials. The series documented how Cindy Yang entered Republican donor events at Mar-a-Lago and created a business targeted to overseas Chinese nationals seeking entry into Republican power circles.
Two McClatchy newsrooms were recognized as finalists in this year's Pulitzer Prizes. An explanatory reporting to Miami Herald was cited for its work on Dirty Gold, Clean Cash, an investigation into how gold purchased from Latin America comes from outlaws laundering their profits from drug-related sales. And in the commentary category, the Kansas City Star's Melinda Henneberger was recognized for examining and I quote "In spare and courageous writing, institutional sexism and misogyny within her hometown NFL team, her former governor's office and the Catholic Church."
Finally, McClatchy honored the accomplishments of 10 of its newsrooms in it's annual President's Award, which celebrates the work of our journalists who focused on local accountability journalism that safeguarded the most vulnerable in their communities and led to needed reforms, the best illustration of how local news and media is essential in the public interest. We couldn't be prouder of this work that's been honored and congratulate all of our reporters and editors for their tireless work and contributions.
Now let me turn the call over to Elaine to discuss our specific financial results for the quarter.
Thanks Craig and hello everyone. We reported an adjusted net loss of $21 million in the first quarter of 2019 reflecting, in part, our seasonal slowdown in advertising revenues. Adjusted EBITDA was $16.4 million in 2019's first quarter. That was down 5.7% when excluding real estate gains from the first quarter of 2018 and as Craig noted earlier, this was a sequential improvement over the fourth quarter decline of 8.2% in the fourth quarter versus 2017. We continue to provide adjusted EBITDA excluding the impact of real estate activity due to the volatility that real estate transactions can add to EBITDA depending upon the timing and the size of the property sales.
We had no asset sales from the first quarter of 2019, but reported $3.1 million of gains in the first quarter of 2018. Including the impact of those gains in the comparison, our adjusted EBITDA was down 19.9%, still a sequential improvement from the 26.5% decline in the fourth quarter of 2018 on a like basis. In anticipation of a question, wondering if McClatchy has any remaining desirable real estate left to sale? The answer is yes and we will discuss that shortly.
Total revenues were down 9.3% in the first quarter compared to the same period last year. Our revenue decline was unchanged from the decline reported for full year 2018 and an improvement over the 10.1% decline realized in the first quarter of 2018 compared to its previous year. We saw these types of sequential improvements in trends in many of our revenue categories in the first quarter as we gain traction in our total revenue efforts.
While Craig has covered two major sources of revenues, audience and advertising, I will recap briefly. Total audience revenues were down 3.7% in the first quarter compared to the first quarter of 2018, which is an improvement in the rate of decline from not just the first quarter of last year but also sequentially from the fourth quarter and full year of 2018. Advertising revenues in the first quarter were down 14.7% compared to the same quarter last year and as Craig mentioned earlier, we had our first quarter of digital-only revenue decline of 5.2%, while total digital advertising was down 5.8% in the quarter.
A portion of the impact from digital advertising revenues was in our digital national category. Typically between 60% to 70% of national digital advertising is made up of programmatic revenue. We are rolling over not only a strong first quarter in 2018 where we reported a 23% growth in national digital advertising but also a slower news cycle and a reduction in page views that impacted our programmatic results. Remember that while programmatic is an important source of supplemental revenue, it's not our core advertising strategy.
We believe that prioritizing audience growth and converting readers to digital subscribers is more important in the long run to our overall growth strategy. Digital results were also impacted by an overall decline in digital classified advertising and of course, as Craig mentioned, this masks strong improvement in digital retail advertising and sales at our Excelerate digital agency.
We saw improved trends in print advertising which was down 21.5%, including in-newspaper advertising and our preprinted inserts. All print categories had improved trends over the first quarter of 2018 with the exception of direct marketing where we continue to eliminate some unprofitable products in distribution.
Our improvement in the trend of adjusted EBITDA during the quarter was aided by our focus on cost controls, even while continuing to invest in our business. We reduced adjusted operating expenses by 9.7% compared to the first quarter of 2018 and we did it in the right way, focusing strategically on legacy costs and process improvements in our business.
During the first quarter, we announced that we would be aligning to a more functional organizational structure. We brought our advertising and product teams together, rolled out new advertising structure aligned around channels to reduce redundancies, create a more digital focus, standardize and streamline our processes and procedures and generally make us more efficient and effective. As Craig mentioned, these changes will result in some workforce reductions but they also create additional positions and capabilities, including standing up a new centralized call center.
We also announced our early retirement program that resulted in small savings in the first quarter, but will have approximately $12 million in savings over the next three quarters. In the first quarter, we outsourced our printing operations in Tacoma, Washington. This move occurred at the beginning of February and results in lower compensation and general operating costs. It also freed up real estate for a potential sale in the near future.
In the first quarter of 2019, our full time equivalent employees declined 18.9% to approximately 3,000 FTEs, as we focused on strategically restructuring and running our business more efficiently. As we transition to a more digital company, we continue to have savings in newsprint and third-party printing costs. The majority of our newsprint savings are coming from volume declines.
In the first quarter of 2019, our newsprint volume declined by approximately 22%, while the average price increased 15.5% over the first quarter of 2018. Now that price differential reflects the holdover of tariffs that drove up prices in 2018. Newsprint prices have already begun to revert to more normal market pricing but comparisons were running tough until early in our third quarter. As I have reminded you on prior calls, our newsprint costs are now only about 4% of our total cost structure.
Now turning to the balance sheet. As of the end of the first quarter of 2019, our principal debt outstanding was $745 million and we had $17 million in cash resulting in net debt of $728 million. On April 5, we redeemed $4.6 million of our 2026 notes at par as a part of our excess cash flow sweep. On April 26, 2019, we completed the sale of a small distribution center in Miami, Florida and we expect to complete another sale of real property soon. We expect the net proceeds of these transactions to allow us to reduce first lien debt by approximately $32 million by the end of the second quarter of this year.
And I know your first questions will be which property and when will it close? So let me say upfront, we have agreed with the buyer to keep details confidential until the transaction closes. And therefore, I will not be able to answer those questions. But we will certainly disclose more detail when we can.
We had approximately $42 million of total borrowing capacity under our ABL credit facility, with no amounts drawn at the end of the quarter. And our capital expenditures were about $1.2 million in the first quarter of 2019.
And now I will turn the call back to Craig to discuss our outlook and take any of your questions.
Thank you Elaine. In the full year 2019, we expect to see growth in digital audience revenues. Digital subscribers are expected to continue to grow and largely offset continuing declines in print circulation, resulting in low single digit total audience revenue declines for the full year 2019. We also expect total digital and digital-only advertising revenues to surpass newspaper print advertising in each quarter and for the full year 2019 as print advertising continues to become a smaller percent of total revenues.
We expect digital-only advertising to improve in the second half of the year. And while the mix of digital advertising and audience revenue will continue to change as we pursue the best experience for our digital customers, we expect full year growth in total digital revenues, which includes both advertising and audience digital revenue.
Of course, we will remain persistent in reducing GAAP and adjusted operating expenses and we will continue to monitor cost over the next three quarters to align expense and revenue performance while making additional investments in our news and sales organization. We have already mentioned a few changes we made specifically in the first quarter regarding our early retirement program, our sales centralization and functional organizational change and outsourcing of printing at our Tacoma News Tribune newspaper, all of which will aid in a quarter-over-quarter reduction of operating expenses throughout the rest of this year.
And with that, we are happy to take your questions.
[Operator Instructions] And our first question today comes from Craig Huber from Huber Research Partners. Please go ahead with your question.
Thank you. A few questions here. The 5% or so decline in digital-only you mentioned, do you think that was from tightening the paywalls? Can you maybe just tell us when did you actually tighten the paywalls? Or when do we annualize you think?
Craig, it's Craig Forman here. So we have been doing this gradually over the course of the last, well, really, two years since I took over as CEO. But really in the last 12 to 18 months as the team in our product and customer organization, which is headed by Scott, has been making more robust our technology platform. So it's been gradual over the course of the last several quarters.
I think, Mark, who's with us as well, can give us the best context of the trade-off. So let me throw it over to Mark to talk a little bit about that trade-off between advertising and customer revenue.
Sure. Yes. Thanks Craig. Yes, we have continued to tighten the paywall and we have made some adjustments to that again in Q1, which led to some of the decline in digital revenue that Craig mentioned. We also cycled over, as Craig said, a softer news cycle this year versus last year. Both good and bad news can drive traffic to our websites. And sadly, we had a couple of tragedies last year, including the Parkland shooting and the FIU bridge collapse in Florida that drove a lot of traffic in Q1 2018, especially Miami.
And although we are happy that we didn't have similar tragedies this year, the softer news cycle led to less pages, fewer pages for us. And that in combination with tightening the paywall and some algorithm changes by Yahoo, all sort of conspired to take down our digital traffic to the extent that it hurt our programmatic revenue. So of course, a lot of that will cycle over in the coming quarters and those are temporary setbacks, but part of it was purposeful, in that we are happy to make a trade-off in advertising revenue for audience revenue if the overall revenue result is favorable.
And because of the investments we have made in our analytics team, that Scott can talk more about, we know that to be the case and so we were able to adjust that now and you are starting to see the impact of that.
This is Scott. To bridge on that, we are continuing purposeful experimentation on all aspects of that conversion funnel. We are constantly testing the porousness of our paywall meter to encourage our audiences to sample the product. We are now incorporating propensity to subscribe signals so that we can show the right offer at exactly the right time to drive and maximize the conversion rate. So as Mark said, all of these analytics capabilities are flowing through the entire product now and helping drive improving those conversion rates to convert digital subscribers.
So Craig, I know you have another question, but let me just bring it home here. I know the temptation to draw a straight line model with the sole sensitivity being paid digital customers and paid digital customer relationships versus adverted page views. But that's not the way really to look at the model in the digital transformation. The sensitivity of the model includes the percentage of inventory sold directly versus programmatically.
It includes the actual yield per incremental avail of advertising within a digital page. It includes value-added services layered on top of digital subscribers. So there is a lot that goes into the new evolving business model. And each one of those different drivers has a different sensitivity.
So when Scott and Mark talk about how we evolved this business, that's a huge reflection of just the major strides we have made. We now have the data that allow us very good insights to understand our sensitivities and that's the kind of thing you need to be a successful digital enterprise. I would say a lot of traditional print newspaper companies weren't able to do that and it's a point of real strength that McClatchy can.
Thank you for that. And Elaine, if I could ask, I would just like to make sure I understand it from my end. Can you just go through those cost saving numbers you expect to roll through for the remaining three quarters of the year, including from the restructuring this quarter?
Sure. What we have disclosed is that we expect the early retirement program to contribute approximately $12 million in savings in the compensation line. We have also talked about the fact that we are centralizing the advertising department now and we expect several million dollars in savings coming from that. We haven't finished quantifying that because there will be some additional hiring of new positions.
A good portion of that would be in compensation but not all of it. And certainly, it comes with opening up a new centralized call center and doing some other things. And so those are the two big drivers. But we continue to do things like we have outsourced Tacoma and we are having some savings coming through from that.
We will continue to see, as we become a more digital company, newsprint savings and we expect newsprint savings to go forward. And so, that all adds up into the overall guidance that we have given in terms of expenses.
And then my last question, Elaine, for CapEx. How low can you drive that down to this year?
Well, we have given guidance that we expect CapEx to be between $6 million and $10 million this year and we haven't changed that guidance.
Do you think that's somewhat reasonable for next year? I know it's early.
I think as we have continued to outsource that has meant that there's less CapEx that's needed to keep the business moving in terms of just maintenance CapEx and that's largely where we are at now. And most of our investments in the digital side of the business flows through in OpEx. And you have seen what we are capable of doing in OpEx.
Yes. Craig, it's another interesting reflection. You have been such an experienced person in the industry. As cloud services and other virtualized aspects of the technology ecosystem become more relevant to digital enterprises, that's some of the reason why you are able to see us have a sharpening scalpel with regard to things like CapEx.
Well, thank you. There's no question you guys have done a great job over the years on your cost front. Thank you.
And ladies and gentlemen, with that, we will conclude today's question-and-answer session. I would like to turn the conference call back over to Stephanie Zarate for any closing remarks.
Thank you Jamie. We just like to thank you all for joining us today and your continued interest in McClatchy. Have a great day.
Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.