Lee Enterprises, Inc. — Fiscal 2016 Form 10-K Summary
Business context and reporting period
Lee Enterprises is a local news, information, print and digital advertising company operating primarily in small and midsize U.S. markets. It operates 46 daily and 34 Sunday newspapers, nearly 300 weekly and specialty publications, digital platforms and TownNews.com. The company reports one operating segment.
The filing covers the 52-week fiscal year ended September 25, 2016, compared primarily with the 52-week fiscal year ended September 27, 2015. The company had approximately 3,976 employees and 55.6 million common shares outstanding as of November 30, 2016.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Operating revenue | $614.4 million | $648.5 million | Down 5.3% |
| Advertising and marketing services revenue | $373.5 million | $412.1 million | Down 9.4% |
| Subscription revenue | $194.0 million | $194.5 million | Down 0.2% |
| Operating income | $104.0 million | $109.4 million | Down 4.9% |
| Operating margin | 16.9% | 16.9% | Approximately flat |
| Adjusted EBITDA | $153.8 million | $163.3 million | Down 5.8% |
| Adjusted EBITDA margin | 25.0% | 25.2% | Down approximately 20 basis points |
| Net income | $36.0 million | $24.3 million | Up 48.1% |
| Income attributable to Lee | $35.0 million | $23.3 million | Up 49.9% |
| Diluted earnings per share | $0.64 | $0.43 | Up 48.8% |
| Cash flow from operations | $79.2 million | $74.5 million | Up 6.3% |
| Capital expenditures | $7.1 million | $9.7 million | Down 26.9% |
Reported earnings benefited from a $30.6 million insurance-settlement gain, a $3.1 million net gain on asset sales and lower interest expense. These benefits were partly offset by a $7.5 million non-cash increase in the fair value of warrants, $5.9 million of debt financing and administrative costs, and $2.2 million of impairment charges. Adjusted earnings attributable to Lee were $22.6 million, or $0.42 per diluted share, compared with $16.7 million, or $0.31 per share, in 2015.
Revenue, margins and operating trends
- Advertising and marketing services represented approximately 61% of revenue. Retail advertising declined 8.8% and classified advertising declined 13.6%, primarily because of lower volume from large retailers, big-box stores and automotive, employment and real-estate categories.
- Digital advertising and marketing services revenue increased 5.6% to $86.3 million. Digital national advertising increased 20.4%, mobile advertising increased 19.6%, and digital retail advertising increased 9.6%.
- Total digital revenue, including digital services, increased 6.6% to $100.5 million, or 16.4% of total revenue, compared with 14.5% in 2015. TownNews.com drove much of the 13.7% increase in digital services revenue to $14.2 million.
- Subscription revenue was essentially flat as price increases and premium content days largely offset declining print subscription units. Daily circulation was approximately 0.8 million units and Sunday circulation approximately 1.2 million units in the September 2016 quarter.
- Cash costs decreased 5.1% to $476.4 million; excluding workforce adjustments, cash costs decreased 4.8%. Compensation, newsprint and ink, and other operating expenses all declined, although self-insured medical costs increased by approximately $4.0 million.
- Adjusted EBITDA exceeded $153 million for the seventh consecutive year, but declined from 2015 as revenue contraction outpaced cost reductions.
Debt, liquidity and cash flow
- Principal debt declined by $108.7 million during 2016 to $617.2 million. Debt net of cash was 3.9 times adjusted EBITDA at year-end, compared with 4.4 times in 2015.
- Debt consisted principally of $385.0 million of 9.5% senior secured notes due 2022, $101.3 million of first-lien term debt due 2019 and $130.9 million of 12.0% second-lien term debt due 2022. The weighted average cost of debt was 9.7% before amortization of debt financing costs.
- Liquidity totaled $50.3 million, consisting of cash and approximately $33.3 million of availability under the revolving facility after letters of credit. Cash and cash equivalents were $17.0 million at year-end.
- Cash provided by operations was $79.2 million. Investing activities provided $34.5 million, including the $30.6 million insurance settlement and $9.9 million of asset-sale proceeds. Financing activities used $107.8 million, primarily for debt repayment.
- Mandatory debt maturities were $25.1 million in 2017, $25.0 million in 2018, $51.2 million in 2019 and $515.9 million thereafter. These amounts exclude excess-cash-flow, asset-sale and other required payments.
- Management expected 2017 capital expenditures of up to $10.0 million and no required pension contributions in 2017. Management also expected 2017 same-property cash costs, excluding workforce adjustments, to decline 2.5% to 3.5%.
Material changes versus the prior comparable period
- Revenue declined $34.2 million, driven mainly by lower retail and classified advertising, while subscription revenue remained broadly stable.
- Operating income decreased $5.4 million and adjusted EBITDA decreased $9.5 million despite a $25.3 million reduction in cash costs.
- Net income increased $11.7 million, largely because of the insurance-settlement gain and lower interest expense. Reported earnings therefore benefited materially from unusual and non-operating items.
- Interest expense decreased $8.2 million to $64.2 million as debt balances declined, although the weighted average cost of debt increased from 9.4% to 9.7% because lower-cost first-lien debt represented a smaller share of total debt.
- The company sold substantially all assets of its Provo, Utah newspaper operations in August 2016 and recorded a net gain on asset sales.
- The company expanded the Edison local-sales initiative into all markets beginning in the first quarter of fiscal 2017, with full implementation expected by the end of the second quarter.
- Stockholders’ deficit improved from $159.4 million to $128.5 million, but the company remained in a deficit position.
Guidance, outlook, commentary and risks
Management’s strategy emphasizes local news engagement, digital advertising and marketing services, audience revenue, continued cost reductions and using available cash flow to reduce debt. The filing does not provide specific revenue or adjusted EBITDA guidance for fiscal 2017, but it does provide the 2.5% to 3.5% same-property cash-cost reduction expectation and capital-expenditure expectation described above.
- The company’s ability to continue as a going concern depends on generating sufficient cash flow, maintaining debt-covenant compliance and repaying, refinancing or amending debt as required. The company was in compliance with its covenants at September 25, 2016.
- Advertising demand, print circulation and classified revenue continue to face secular pressure from digital platforms, changing consumer behavior and competition from other media.
- Digital growth may not offset print declines. Digital businesses also expose the company to technology, pricing, audience, cybersecurity and talent-retention risks.
- Newsprint prices were approximately 15% higher at the end of September 2016 than a year earlier. A $10-per-ton increase in 30-pound newsprint was estimated to reduce annualized pretax income by approximately $0.5 million.
- Approximately 16.4% of debt was floating-rate debt. A 100-basis-point increase in LIBOR, above applicable floors, was estimated to reduce annualized pretax income by approximately $1.0 million.
- Pension liabilities net of plan assets were approximately $55.1 million. Two multiemployer pension plans were in critical, or red-zone, status, and a bargaining-unit withdrawal could result in an uncertain withdrawal liability payable over 20 years.
- The company recorded $2.2 million of non-cash impairment charges in 2016 and reported significant historical goodwill and intangible-asset impairments. Further revenue or cash-flow deterioration could result in additional charges.
- The company has 6.0 million warrants with a $4.19 exercise price. Exercise could provide up to approximately $25.1 million of liquidity but would dilute shareholders; changes in warrant fair value can materially affect reported earnings.
Most important facts for investors to verify
- Whether advertising and classified-revenue declines stabilize and whether digital growth continues to offset print weakness.
- Whether management achieves the projected 2017 cash-cost reduction while preserving audience, subscription and digital investment.
- Whether operating cash flow remains sufficient for mandatory amortization, excess-cash-flow payments, interest and the large 2019 and 2022 debt obligations.
- The company’s ongoing compliance with debt covenants and the availability of revolving-facility liquidity.
- The effect of unusual items, including the insurance settlement, asset sales, warrant remeasurement and impairment charges, when assessing recurring earnings.
- Potential pension withdrawal liability, changes in pension funding requirements and the impact of newsprint, interest-rate and health-care cost inflation.
- Future dilution from warrants, stock awards and the December 2016 issuance of 832,500 restricted shares.