Lee Enterprises, Inc. — Fiscal 2020 Third-Quarter Form 10-Q
Business context and reporting period
The filing covers the 13 and 39 weeks ended June 28, 2020, compared with the periods ended June 30, 2019. Lee operates local newspapers, digital media, advertising and marketing services, subscription products, commercial printing and TownNews digital services. Results include the BH Media Newspaper Business and The Buffalo News from their March 16, 2020 acquisition date.
- The Berkshire Hathaway transaction included 30 daily newspapers, 49 paid weekly newspapers, other print products and The Buffalo News, for a combined purchase price of $140.0 million.
- Lee operated 77 principally mid-sized local media operations following the acquisition.
- COVID-19 materially reduced advertising demand and disrupted local economic activity, while digital subscriber growth and acquired operations increased reported revenue.
Key financial metrics
| Metric | 13 weeks ended June 28, 2020 | 13 weeks ended June 30, 2019 | 39 weeks ended June 28, 2020 | 39 weeks ended June 30, 2019 |
|---|---|---|---|---|
| Total operating revenue | $182.5 million | $127.3 million | $426.2 million | $386.2 million |
| Operating income | $11.7 million | $20.0 million | $43.8 million | $60.3 million |
| Net income attributable to Lee | $(1.3) million | $5.8 million | $(1.3) million | $13.4 million |
| Diluted EPS | $(0.02) | $0.10 | $(0.02) | $0.24 |
| Cash provided by operating activities | Not separately provided | Not separately provided | $38.0 million | $43.8 million |
| Adjusted EBITDA | $26.3 million | $30.7 million | $71.8 million | $90.4 million |
Quarterly operating margin was approximately 6.4%, compared with 15.7% in the prior-year quarter. Adjusted EBITDA margin was approximately 14.4%, compared with 24.1%. For the 39-week period, operating margin was approximately 10.3%, compared with 15.6%, and adjusted EBITDA margin was approximately 16.8%, compared with 23.4%.
- Quarterly advertising and marketing services revenue increased 18.2% to $77.8 million, primarily because of acquired operations; digital advertising represented 33.1% of advertising and marketing services revenue.
- Quarterly subscription revenue increased 89.9% to $88.5 million, including $48.2 million from acquisitions and growth in digital-only subscriptions.
- Digital-only subscribers totaled nearly 222,000 as of June 28, 2020, an 85.4% increase over the prior year at Legacy Lee.
- Total quarterly digital revenue increased 15.0% to $42.4 million, or 23.2% of total revenue. For the 39-week period, digital revenue increased 7.3% to $116.3 million, or 27.3% of total revenue.
- Quarterly cash costs increased 59.4% to $157.4 million, while revenue less cash costs declined 11.9% to $25.1 million.
Balance sheet, debt and liquidity
| Balance-sheet item | June 28, 2020 | September 29, 2019 |
|---|---|---|
| Cash and cash equivalents | $56.7 million | $8.6 million |
| Total assets | $902.4 million | $555.2 million |
| Total debt, before unamortized costs | $576.0 million | $443.6 million |
| Total liabilities | $938.6 million | $592.0 million |
| Total deficit | $(36.2) million | $(36.8) million |
- Lee refinanced its prior debt with a $576.0 million, fixed-rate, 9.0% term loan from BH Finance, maturing March 16, 2045. BH Finance became the company’s sole lender.
- The refinancing funded the acquisition and repayment of $431.5 million of existing debt. There is no revolving facility.
- The company reported $36.7 million of excess cash flow for the quarter, used to repay debt in July 2020. Future excess cash flow payments are based on cash exceeding $20.0 million, subject to the credit agreement.
- Management stated that existing cash and expected cash flows should satisfy interest and principal obligations for the next twelve months and that the company was in compliance with debt covenants at June 28, 2020.
- Debt is secured by substantially all assets of Lee and certain subsidiaries, and the credit agreement restricts additional debt, liens, investments, acquisitions, dividends and other capital transactions.
Material changes versus the prior comparable period
- Reported revenue increased substantially because the acquired businesses contributed $91.2 million in quarterly revenue and $105.8 million for the 39-week period. Comparability is therefore limited.
- Despite higher reported revenue, operating income declined 41.3% for the quarter and 27.3% for the 39-week period as acquired costs, COVID-19 effects, ongoing print-industry declines and higher amortization offset revenue growth.
- Lee reported a quarterly loss attributable to the company of $1.3 million versus income of $5.8 million, and a 39-week loss of $1.3 million versus income of $13.4 million.
- Compensation expense increased 59.6% in the quarter, including $38.6 million of acquired expense, partially offset by a 22.4% same-property FTE reduction and approximately $10.0 million of furloughs or compensation reductions.
- For the 39-week period, operating cash flow declined to $38.0 million from $43.8 million, while investing cash outflows increased to $121.1 million, primarily because of the acquisition.
- The company adopted lease accounting under ASC 842, recognizing operating lease assets and liabilities, including the $56.2 million BH Lease right-of-use asset and liability at acquisition.
Outlook, management commentary, risks and unusual items
- Management expects COVID-19 to continue having a significant near-term negative effect. The duration, severity and recurrence of the pandemic, government restrictions, consumer behavior and availability of treatments or vaccines remain uncertain.
- Lee is pursuing cost reductions of approximately $100 million from December 2019 through September 2021 through centralized functions, system integration and elimination of duplicate cost structures.
- Restructuring costs, predominantly severance, were $2.9 million in the quarter and $6.4 million for the 39-week period.
- The company recognized $11.9 million of debt financing and administrative costs for the 39-week period, including a $9.6 million write-off of previously unamortized financing costs.
- The acquisition accounting remains preliminary. Valuations of property, equipment, intangible assets, deferred taxes, assumed liabilities and goodwill may change during the measurement period.
- Goodwill was $313.9 million and other intangible assets were $206.2 million at June 28, 2020. Management reported no impairment-triggering event as of that date but identified a risk of future impairment if market value, revenue, expenses or cash flows underperform estimates.
- The CARES Act permits deferred pension contributions and payroll-tax payments. Lee did not make pension contributions during the 39-week period and did not expect to contribute for the remainder of fiscal 2020.
- Principal risks include further print-revenue and circulation declines, advertising weakness, COVID-19 disruption, high leverage, absence of a revolver, covenant compliance, integration of the acquisition, cyber risk, newsprint and labor costs, and potential indemnification obligations relating to acquired businesses.
- A $10-per-ton increase in 27.7-pound newsprint would reduce annualized pretax income by approximately $0.5 million, based on anticipated 2020 consumption.
Investor verification points
- Verify the post-acquisition revenue, cost synergies and cash generation of BH Media and The Buffalo News separately from Legacy Lee results.
- Assess whether COVID-19-related advertising weakness and print-circulation declines could reduce cash flow below the level needed for 9.0% interest, excess-cash-flow debt repayments and lease obligations.
- Review the preliminary purchase-price allocation and sensitivity of goodwill and intangible assets to lower revenue, retention or cash-flow assumptions.
- Confirm the timing and amount of the $36.7 million excess-cash-flow debt repayment made in July 2020 and the resulting debt balance.
- Monitor compliance with the credit agreement, restrictions created by the lack of a revolving facility, and the company’s ability to maintain adequate liquidity.
- Evaluate whether the planned $100 million of cost reductions can offset pandemic effects without impairing operations, employee retention or product quality.