LEE ENTERPRISES, Inc quarterly report, Q2 FY2015

Lee Enterprises, Inc. — Fiscal 2015 Second-Quarter Form 10-Q Summary

Business context and reporting period

Lee Enterprises is a local news and information publisher operating print and digital platforms, including 50 daily newspapers, weekly publications, classified and niche products, and digital services. The filing covers the 13 and 26 weeks ended March 29, 2015, compared with the periods ended March 30, 2014. Results are seasonal and may not indicate full-year performance.

Financial performance and key metrics

Metric	13 weeks ended March 29, 2015	13 weeks ended March 30, 2014	26 weeks ended March 29, 2015	26 weeks ended March 30, 2014
Total operating revenue	$155.5 million	$154.1 million	$331.7 million	$331.5 million
Operating income	$20.2 million	$23.7 million	$57.7 million	$63.9 million
Operating margin	13.0%	15.4%	17.4%	19.3%
Operating cash flow	$30.2 million	$32.7 million	$76.1 million	$82.0 million
Operating cash flow margin	19.4%	21.2%	23.0%	24.7%
Net income attributable to Lee	$1.8 million	$1.5 million	$11.6 million	$13.4 million
Diluted earnings per share	$0.03	$0.03	$0.21	$0.25

Second-quarter advertising and marketing services revenue declined 4.9% to $97.7 million; subscription revenue increased 14.7% to $48.1 million, partly due to a delivery-cost reclassification and the full-access subscription model.
Digital revenue totaled $27.4 million in the quarter, up 33.9% year over year and representing 17.6% of operating revenue. Digital advertising and marketing services revenue increased 8.3%.
For the six-month period, reported revenue was essentially flat, while advertising and marketing services revenue declined 5.3%.
Six-month cash provided by operating activities was $39.5 million. Capital expenditures were $5.7 million, investing activities used $4.3 million, and financing activities used $40.5 million.
Cash and cash equivalents were $11.4 million at March 29, 2015, compared with $16.7 million at September 28, 2014.

Debt, liquidity and balance sheet

Principal debt outstanding was $764.3 million at March 29, 2015, compared with $804.8 million at September 28, 2014. Carrying value of long-term debt, net of current maturities, was $736.9 million.
Debt consisted principally of $400.0 million of 9.5% senior secured notes, $205.3 million of first-lien term debt, $150.0 million of second-lien debt at 12.0%, and $9.0 million of New Pulitzer Notes at 9.0%.
Weighted average cost of debt was 9.4%. Approximately 26.9% of debt was floating rate. Management estimated that a 100-basis-point LIBOR increase would reduce annualized pretax income by approximately $2.1 million, subject to applicable rate floors.
Available revolving-facility capacity was approximately $32.6 million; including cash, reported liquidity was $44.0 million.
Management stated that expected cash flows should satisfy interest and principal payments due over the next 12 months. The company was in compliance with debt covenants at March 29, 2015.
Debt maturities totaled $12.5 million for the remainder of 2015, $31.4 million in 2016, $27.6 million in 2017, $25.0 million in 2018, $117.8 million in 2019 and $550.0 million thereafter.
Total assets were $779.6 million, while total liabilities were $944.8 million and total stockholders’ deficit was $165.9 million.

Material changes versus the prior comparable period

Reported second-quarter revenue increased 0.9%, but revenue decreased 1.8% after excluding a $4.2 million net subscription-related delivery-cost reclassification. For six months, adjusted revenue decreased 2.7%.
Advertising declines continued across retail, employment, automotive, real estate and national categories, while digital advertising growth partially offset print declines.
Second-quarter operating cash flow decreased 7.7% and operating income decreased 14.7%; six-month operating cash flow decreased 7.2% and operating income decreased 9.7%.
Newsprint and ink expense decreased 17.9% in the quarter and 17.0% for six months, reflecting lower prices and lower usage. Compensation and other operating expenses increased.
Interest expense declined because of lower debt balances and prior-period non-cash interest expense, but debt-financing-cost amortization increased substantially following the 2014 refinancing.
Reported net income attributable to Lee increased in the quarter because of lower tax expense and a favorable warrant fair-value adjustment, but declined 13.6% for the six-month period.
Adjusted diluted EPS, excluding unusual items, was $0.02 for the quarter versus $0.05 and $0.24 for six months versus $0.29 in the prior-year periods.

Guidance, outlook, risks and unusual items

Management expected 2015 subscription revenue, excluding the reclassification, to increase approximately 2.5% to 3.0%.
Management expected full-year 2015 cash costs, excluding the reclassification, to decrease 2.25% to 2.75%; it indicated that greater cost reductions would be required during the second half of the year.
Capital expenditures were expected to total up to $12.0 million in 2015 and be funded through internally generated funds or revolver availability.
The full-access subscription model, introduced in April 2014, was expected to provide additional revenue as subscriber renewals occurred.
Unusual items included debt-financing-cost amortization, warrant fair-value gains, other non-operating items, workforce adjustments and the subscription-related expense reclassification. The warrant liability was $10.0 million at March 29, 2015, and related warrants could provide up to $25.1 million of cash if exercised.
Key risks include declining print advertising and circulation, dependence on cash generation and covenant compliance, refinancing requirements, high leverage and interest costs, commodity and energy prices, labor and healthcare costs, competition, economic conditions, potential impairment of goodwill and intangible assets, and legal or tax contingencies.
The company recorded a $2.3 million liability for a newspaper-carrier settlement and paid $2.2 million in April 2015. It also disclosed potential future withdrawal liability relating to a multiemployer pension plan, but the amount was not determinable.
Management stated that additional impairment charges could be required if economic, market or business conditions deteriorate. The filing states that the company’s ability to continue as a going concern depends on maintaining covenant compliance and refinancing or amending debt as it becomes due.

Important facts for investors to verify

Reconcile reported revenue and cost growth to the subscription-related delivery-cost reclassification and assess underlying trends.
Evaluate whether declining advertising and print revenue can be offset by digital growth and subscription pricing.
Review cash generation relative to mandatory debt amortization, pension contributions, capital expenditures and future maturities.
Assess refinancing risk associated with the $550.0 million of debt maturing after 2019 and the company’s dependence on continued covenant compliance.
Monitor warrant dilution, potential warrant cash proceeds and changes in the warrant liability’s fair value.
Review the potential multiemployer pension withdrawal liability, tax examinations, legal proceedings and possible impairment of goodwill and intangible assets.