Lee Enterprises, Inc. — Fiscal 2016 First-Quarter 10-Q
Reporting period: 13 weeks ended December 27, 2015, compared with the 13 weeks ended December 28, 2014. The interim financial statements are unaudited. Lee operates local newspaper, digital media, advertising, subscription, commercial printing and related businesses, primarily in Midwest, Mountain West and Western markets.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Operating revenue | $168.4 million | $177.2 million | Down 5.0% |
| Operating income | $36.4 million | $37.5 million | Down 2.9% |
| Operating cash flow | $43.6 million | $46.0 million | Down 5.2% |
| Operating cash flow margin | 25.9% | 25.9% | Flat |
| Income attributable to Lee | $11.2 million | $9.8 million | Up 15.2% |
| Diluted EPS | $0.21 | $0.18 | Up $0.03 |
| Net cash from operating activities | $21.1 million | $22.3 million | Down $1.2 million |
| Unlevered free cash flow | $45.8 million | $46.0 million | Down $0.2 million |
Advertising and marketing services revenue declined 8.8% to $105.6 million, reflecting lower retail, classified and national advertising. Digital advertising and marketing services increased 7.2% to $21.8 million, or 20.6% of advertising and marketing services revenue. Subscription revenue was essentially flat at $50.4 million. Commercial printing, digital services and other revenue increased.
Cash costs declined 4.9% to $124.8 million. Compensation decreased 5.3%, newsprint and ink decreased 24.4%, and other operating expenses decreased 2.3%. Average full-time equivalent employees declined 7.5%, while newsprint volume decreased 11.3%.
Interest expense declined 8.8% to $17.1 million due to lower debt balances. Income before taxes increased 13.0% to $18.7 million, and the effective tax rate was 38.3%, compared with 39.4% in the prior-year quarter. Adjusted diluted EPS was $0.22 in both periods after excluding unusual items.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $11.8 million at December 27, 2015, compared with $11.1 million at September 27, 2015.
- Principal debt outstanding was $704.0 million, consisting primarily of $395.0 million of 9.5% senior secured notes, $169.6 million under the first-lien term loan and $139.4 million under the second-lien term loan.
- Total debt declined from $725.9 million at September 27, 2015, primarily through scheduled and voluntary repayments, note repurchases and asset-sale-related payments.
- Approximately $32.9 million was available under the revolving facility. Including cash, reported liquidity was $44.7 million.
- The company reported compliance with its debt covenants at December 27, 2015. Final debt maturities extend from March 2019 through December 2022.
- Total liabilities exceeded assets, resulting in a total stockholders’ deficit of $146.8 million.
Material changes and unusual items
- Revenue contracted because of continued print advertising declines, particularly in retail and classified categories, partially offset by digital growth and cost reductions.
- The company recorded a $525,000 gain on extinguishment of debt after purchasing $5.0 million principal amount of senior secured notes.
- Workforce adjustment costs were $604,000, compared with $211,000 in the prior-year quarter.
- On January 15, 2016, the company received $30.6 million from an insurance-related subrogation recovery tied to a 2009 production-facility loss. It used $20.0 million to repay the first-lien term loan and expected to use some remaining proceeds to repurchase notes or make additional term-loan payments. A gain was expected to be recorded in the quarter ending March 27, 2016.
- The company early adopted the new deferred-tax classification standard retrospectively, reclassifying $15.7 million in the September 27, 2015 balance sheet.
Outlook, risks and contingencies
- Management expected 2016 cash costs, excluding workforce adjustments, to decrease 3.5% to 4.0% and anticipated capital expenditures of up to $10.0 million.
- Management expected operating cash flows to satisfy interest and principal obligations due over the following 12 months and stated that no significant current-year income tax payments were expected because of net operating loss carryforwards.
- The company’s ability to continue as a going concern depends on maintaining covenant compliance, generating sufficient cash flow and repaying, refinancing or amending debt as required.
- Key risks include declining advertising and subscription demand, competition and digital migration, newsprint and energy costs, interest rates, labor costs, execution of planned expense reductions, refinancing risk and potential covenant or debt defaults.
- A 100-basis-point increase in LIBOR, if above contractual floors, would reduce annualized pretax income by approximately $1.7 million. A $10-per-ton increase in 30-pound newsprint would reduce annualized pretax income by approximately $532,000.
- The company has significant goodwill and intangible assets following approximately $1.3 billion of impairment charges since 2007; further deterioration in market conditions or projected cash flows could result in additional non-cash impairments.
- Tax examinations remain ongoing. The company also faces routine legal matters and a potential multiemployer pension withdrawal liability whose amount and timing were not determinable.
Investor verification priorities
- Verify the sustainability of cash flow and liquidity against scheduled debt amortization, excess-cash-flow requirements and maturities beginning in 2019.
- Track whether digital advertising growth can offset continuing print advertising and classified declines.
- Confirm the amount and accounting impact of the insurance recovery in the subsequent quarter.
- Review covenant compliance, refinancing options and the company’s capacity to reduce its substantial debt burden.
- Reconcile GAAP results with adjusted EBITDA, operating cash flow and unlevered free cash flow, including the treatment of asset sales, workforce adjustments and debt-related costs.
- Monitor newsprint pricing, pension funding, tax audits, potential multiemployer withdrawal liability and impairment indicators.