Lee Enterprises, Inc. — Fiscal 2016 Third-Quarter Form 10-Q
Reporting period: 13 and 39 weeks ended June 26, 2016, compared with the periods ended June 28, 2015. Lee operates local print and digital news, advertising, subscription, commercial printing and related media businesses, primarily in the Midwest, Mountain West and West. The company reported 49 daily and 37 Sunday newspapers, nearly 300 weekly and niche publications, and approximately 0.9 million daily and 1.3 million Sunday subscribers, including associated companies.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | 39 weeks 2016 | 39 weeks 2015 |
|---|---|---|---|---|
| Total operating revenue | $150.9 million | $158.7 million | $466.2 million | $492.4 million |
| Operating income | $24.7 million | $24.8 million | $79.8 million | $82.6 million |
| Net income | $4.4 million | $2.1 million | $35.4 million | $14.2 million |
| Income attributable to Lee | $4.1 million | $1.9 million | $34.6 million | $13.4 million |
| Diluted EPS | $0.08 | $0.03 | $0.64 | $0.25 |
| Adjusted EBITDA | $36.9 million | $39.3 million | $116.6 million | $123.3 million |
| Operating cash flow | Not separately provided | Not separately provided | $65.8 million | $66.1 million |
Quarterly revenue declined 4.9%, while operating income declined 0.8%. Adjusted EBITDA decreased 6.0% in the quarter and 5.4% year to date. The implied operating margin was approximately 16.3% in the quarter and 17.1% year to date, versus approximately 15.7% and 16.8%, respectively, in the prior comparable periods.
- Quarterly advertising and marketing services revenue declined 8.6%; retail declined 6.9% and classified declined 14.0%.
- Quarterly subscription revenue declined 0.5%. Digital services revenue increased 15.3%.
- Digital advertising and marketing services revenue increased 4.9% to $22.2 million in the quarter; total digital revenue increased 6.2% to $25.8 million.
- Quarterly cash costs declined 4.7%, reflecting lower compensation, newsprint and ink, and other operating expenses. Average full-time equivalent employees declined 8.7%.
- Year-to-date cash costs declined 5.0%, while newsprint and ink costs declined 19.2%.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $65.8 million, compared with $66.1 million in the prior year.
- Investing activities provided $29.6 million, including a $30.6 million insurance settlement related to a 2009 production-facility loss. Capital expenditures were $5.8 million versus $7.7 million.
- Financing activities used $84.7 million, primarily for $89.3 million of debt repayments. Cash increased $10.7 million to $21.9 million from September 27, 2015.
- Principal debt outstanding was $640.3 million at June 26, 2016, consisting primarily of $385.0 million of 9.5% senior secured notes, $119.5 million under the first-lien term loan and $135.7 million under the second-lien term loan.
- Revolving-facility availability was approximately $33.1 million; total liquidity, including cash, was $54.9 million.
- Net debt to adjusted EBITDA for the last twelve months was 3.95 times, compared with 4.6 times at June 28, 2015. Weighted average debt cost was 9.6%.
- Stockholders’ deficit was $123.1 million at June 26, 2016, compared with $159.4 million at September 27, 2015.
Material changes and unusual items
- Year-to-date income attributable to Lee increased by $21.1 million, primarily because of the $30.6 million insurance-settlement gain and lower interest expense, partially offset by lower operating income and related taxes.
- The insurance proceeds were used principally to repay debt: $20.0 million reduced the first-lien term loan, and most of the remainder funded repurchases of notes with a $10.0 million face value at a discount.
- The company repurchased $15.0 million principal amount of notes during the first 39 weeks and recorded a $1.25 million gain on extinguishment of debt.
- Excluding the insurance settlement and warrant fair-value adjustments, adjusted diluted EPS was $0.28 year to date versus $0.25 in the prior year. Quarterly adjusted diluted EPS was $0.08 versus $0.05.
- Goodwill remained $243.7 million, while net other intangible assets declined to $166.2 million from $186.0 million, principally due to amortization.
Guidance, outlook and risks
- Management expects fiscal 2016 cash costs, excluding workforce adjustments, to decline 3.75% to 4.00%.
- Capital expenditures are expected to total up to $10.0 million in fiscal 2016.
- Management expects operating cash flows and certain asset sales to fund interest and principal payments due over the next twelve months and states that the company was in compliance with debt covenants at June 26, 2016.
- Debt maturities extend from 2018 through 2022, but the company’s ability to continue as a going concern depends on cash generation, covenant compliance and its ability to repay, refinance or amend debt when required.
- Key risks include continued declines in print advertising, subscriptions and classified revenue; digital-transition execution; newsprint and energy costs; labor and healthcare costs; interest-rate exposure; refinancing and covenant risk; potential impairment of goodwill and intangible assets; legal and tax contingencies; and competition.
- Approximately 18.7% of principal debt was floating rate. A 100-basis-point increase in LIBOR would reduce annualized pretax income by approximately $1.2 million, subject to applicable rate floors.
- A multiemployer pension withdrawal liability may arise; the amount and timing cannot currently be determined and would be funded over 20 years if assessed.
- Management had not determined the impact of newly issued lease, share-based compensation and revenue-recognition standards. The effect of 2016 federal overtime regulations was also under evaluation.
Investor verification checklist
- Verify the sustainability of revenue trends, particularly retail and classified print advertising declines and the growth rate of digital revenue.
- Reconcile adjusted EBITDA and adjusted EPS to GAAP results, including the insurance settlement, warrant fair-value changes and debt-extinguishment gain.
- Review debt-amortization requirements, excess-cash-flow payments, maturity dates, covenant compliance and available revolver capacity.
- Assess whether operating cash flow remains sufficient for debt service, capital expenditures, pension contributions and other obligations without relying on asset sales.
- Monitor potential impairment charges, tax examinations, legal matters and the multiemployer pension withdrawal claim.
- Evaluate the effect of newsprint pricing, healthcare and labor-cost inflation, interest rates and regulatory changes on future margins.