Lee Enterprises, Inc. — Fiscal 2019 Second-Quarter Form 10-Q
Reporting period: Quarter ended March 31, 2019, comprising 13 weeks; year-to-date period comprises 26 weeks ended March 31, 2019. Comparable periods ended March 25, 2018. Results are unaudited and may be affected by seasonality.
Business context
Lee operates 50 local media markets and manages 30 additional Berkshire Hathaway media operations. Its businesses include newspapers, digital advertising and subscriptions, digital marketing, TownNews web-hosting and content-management services, commercial printing and delivery. The BH Media management agreement provides a fixed annual fee of $5 million plus potential variable fees.
Key financial metrics
| Metric | 13 weeks ended Mar. 31, 2019 | 13 weeks ended Mar. 25, 2018 | Change |
|---|---|---|---|
| Total operating revenue | $122.7 million | $127.8 million | (4.0%) |
| Advertising and marketing services | $62.9 million | $71.6 million | (12.0%) |
| Subscription revenue | $45.1 million | $46.0 million | (1.9%) |
| Other revenue | $14.7 million | $10.3 million | 42.9% |
| Revenue less cash costs | $21.1 million | $23.5 million | (10.3%) |
| Revenue less cash costs margin | 17.2% | 18.4% | Down 120 bps |
| Operating income | $12.6 million | $16.6 million | (24.1%) |
| Operating margin | 10.2% | 13.0% | Down 270 bps |
| Net income attributable to Lee | $(2.7) million | $2.2 million | Decline |
| Diluted earnings per share | $(0.05) | $0.04 | Decline |
| Adjusted EBITDA | $23.6 million | $26.1 million | (9.5%) |
| 26-week year-to-date metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total operating revenue | $258.9 million | $271.6 million | (4.7%) |
| Operating income | $40.3 million | $46.4 million | (13.2%) |
| Net income attributable to Lee | $7.7 million | $37.2 million | (79.4%) |
| Diluted earnings per share | $0.14 | $0.67 | (79.1%) |
| Adjusted EBITDA | $59.7 million | $65.7 million | (9.1%) |
| Cash provided by operating activities | $27.8 million | $35.1 million | $(7.3) million |
Financial condition, cash flow and debt
- Cash and cash equivalents were $16.7 million at March 31, 2019, compared with $5.4 million at September 30, 2018.
- Total debt was $476.5 million principal, or $453.6 million net of debt issuance costs and current maturities. The debt consisted primarily of $385.0 million of 9.5% senior secured notes and $91.5 million of 12.0% second-lien term debt.
- The first-lien term loan was repaid in full in November 2018. The revolver was undrawn, with approximately $21.4 million available after letters of credit. Total stated liquidity, including cash, was $38.1 million.
- Weighted average debt cost was 10.0%. The revolver expires December 28, 2019; the senior notes mature March 2022 and the second-lien term loan matures December 2022.
- Year-to-date investing cash outflow was $7.5 million, including $5.7 million for acquisitions and $2.5 million of capital expenditures. Financing cash outflow was $9.0 million, primarily debt repayment.
- Management expects 2019 capital expenditures of up to $11.0 million and believes operating cash flow and available financing will fund near-term requirements.
- Lee reported compliance with its debt covenants at March 31, 2019. Net debt was 3.65 times trailing-twelve-month adjusted EBITDA.
Material changes versus the prior comparable period
- Print advertising weakness, particularly in retail, big-box and classified categories, drove the principal revenue decline. Digital advertising increased 5.3% in the quarter to $24.1 million and represented 38.2% of total advertising revenue.
- Subscription revenue declined modestly despite pricing and premium-content initiatives. Digital-only subscribers increased 55.5% to approximately 65,000.
- Other revenue rose substantially, supported by TownNews growth, the BH Media management agreement and acquisitions. BH Media management fee revenue was $3.9 million in the quarter and $6.5 million year to date.
- Cash costs decreased 2.6% in the quarter and 3.5% year to date, primarily from lower compensation and operating costs. Compensation declined as average full-time-equivalent employees decreased 8.7% in the quarter and 11.4% year to date.
- Newsprint and ink costs increased 3.3% in the quarter and 6.0% year to date because of higher prices, despite lower consumption.
- Restructuring costs increased to $2.8 million in the quarter, including a $0.5 million estimated withdrawal liability related to a multiemployer pension plan.
- Prior-year results benefited from a $2.0 million non-cash postretirement curtailment gain and a $24.9 million favorable tax adjustment related to the 2017 Tax Act. These items make year-over-year net income comparisons less representative.
- Quarterly results included a $2.8 million non-operating expense from the change in fair value of warrants, compared with a $0.6 million gain in the prior-year quarter. Excluding the warrant adjustment, quarterly income attributable to Lee was approximately $0.1 million.
Guidance, outlook and risks
- Management expects same-property cash costs to decline 4% to 5% in fiscal 2019.
- Management expects near-term interest and principal payments to be satisfied through operating cash flow and certain asset sales, but states that going-concern capacity depends on covenant compliance and the ability to repay, refinance or amend debt as required.
- The revolver’s December 2019 expiration and the large 2022 debt maturities are significant refinancing and liquidity considerations.
- Key operating risks include continued declines in print advertising and circulation, digital competition and technology changes, newsprint and energy prices, labor costs, cybersecurity and information-system failures, economic conditions, regulatory changes and the ability to achieve planned cost reductions.
- A $10-per-ton increase in 30-pound newsprint was estimated to reduce annualized pretax income by approximately $0.3 million, excluding TNI and MNI and LIFO effects.
- Lee has substantial goodwill and intangible assets, including approximately $1.3 billion of historical goodwill impairment charges; further declines in market value or operating performance could result in additional impairment.
- Warrants representing up to 6.0 million shares have a $4.19 exercise price and could provide up to $25.1 million of liquidity if exercised, while also creating potential dilution.
- The company adopted the new revenue standard on October 1, 2018 without a material transition adjustment. It planned to adopt the new lease standard using an optional transition approach in fiscal 2020; the ultimate balance-sheet impact was not yet clear from the filing.
Investor verification checklist
- Verify the timing and terms of refinancing or other arrangements for the December 2019 revolver expiration and the 2022 maturities.
- Monitor advertising trends, print circulation, digital subscriber growth and whether digital revenue growth can offset print declines.
- Reconcile adjusted EBITDA and leverage calculations to GAAP results, including warrant fair-value changes, restructuring costs and other adjustments.
- Assess recurring operating cash flow after debt service, acquisitions, capital expenditures and required second-lien excess-cash-flow payments.
- Track newsprint pricing, employee reductions, restructuring charges and multiemployer pension liabilities.
- Evaluate potential goodwill and intangible-asset impairment and the dilution or liquidity effects of the outstanding warrants.