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Edited Transcript of MNI earnings conference call or presentation 8-Aug-19 4:00pm GMT

Q2 2019 McClatchy Co Earnings Call

SACRAMENTO Aug 17, 2019 (Thomson StreetEvents) -- Edited Transcript of McClatchy Co earnings conference call or presentation Thursday, August 8, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Craig I. Forman

The McClatchy Company - President, CEO & Director

* Mark Zieman

The McClatchy Company - VP of Operations

* R. Elaine Lintecum

The McClatchy Company - VP of Finance, Treasurer & CFO

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Conference Call Participants

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* Craig Anthony Huber

Huber Research Partners, LLC - CEO, MD, and Research Analyst

* Michael A. Kupinski

NOBLE Capital Markets, Inc., Research Division - Director of Research and Senior Media & Entertainment Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the McClatchy Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Elaine Lintecum. Please go ahead.

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [2]

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Good morning, everyone. This is Elaine, I'm McClatchy's CFO, and thank you, Ben. Thank you all for joining us today for our second quarter 2019 earnings call. The call is being webcast at McClatchy.com, and it will be archived for future reference. Our earnings release was issued this morning before the market opened and I hope you've had a chance to review it. You will note that our Investor Relations Director, Stephanie Zarate is not on the call this morning. That's because just less than a month ago, she welcomed a new addition to her family and remains on maternity leave, so I'm her understudy for the second and third quarter conference calls this year.

Joining me today is Craig Forman, our President and CEO; and our Vice President of Consumer Products, Scott Manuel; and our Vice President of Operations, Mark Zieman.

The call will contain forward-looking statements that are subject to risks and uncertainties that are described in our SEC filings. Actual results may differ materially from those described during the call. Also non-GAAP amounts discussed this morning are reconciled to the most directly comparable GAAP measures and the schedules that are posted on our website are in the body of the press release.

And now I'll turn the call over to Craig.

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Craig I. Forman, The McClatchy Company - President, CEO & Director [3]

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Thank you, Elaine. Good morning from Sacramento, and thank you for joining us today. We're happy to share with you in detail our second quarter results. We're gratified to report continued improving sequential trends in adjusted EBITDA from both the fourth quarter and full year 2018 and the first quarter of 2019, and we are posting our best year-over-year quarterly performance in adjusted EBITDA since the fourth quarter of 2015. In fact, adjusted EBITDA in the first half of this year, excluding the impact of real estate gains and equity distributions, was down 4.2% and marks our best performance since 2010. These positive trends highlight that the accelerated digital transition we embarked upon a little over 2 years ago, not only pointed our company in the needed correct direction, but also accelerated the positive pace of that digital transformation despite unrelenting, and in some cases, intensifying industry headwinds.

Here are the headlines. We achieved an improving trend in adjusted EBITDA over the past 3 quarters. And to be clear, that excludes the impact of real estate sales and distributions from minority investments. We reduced our adjusted operating expenses by 15.3% from the second quarter of 2018, and have reduced adjusted operating expenses by more than $41 million in the first half of 2019 compared to the same period in 2018. We grew the number of digital-only subscribers by almost 52% over last year. That is the 13th consecutive quarter of growth in this key area of digital transformation. And we redeemed $32 million of our first lien 2026 notes at par on June 7, thus reducing the total amount of first lien debt outstanding to $268.1 million. We continue to focus on cash flow and asset sales as key metrics in delevering our balance sheet. No other material tranche of debt matures in the rest of this decade.

Let's take a closer look at these results. The trend in adjusted EBITDA is among the key milestones this quarter. It reflects our efforts to stabilize our operating results despite the continuing headwinds in the print newspaper business. Excluding the impact of real estate gains recorded in the second quarter of 2019 and equity distributions from CareerBuilder in the second quarter of 2018, adjusted EBITDA improved sequentially to down 3.2% from down 5.7% in Q1 2019, and down 8.2% in Q4 2018 compared to the same periods in the preceding years. This is the company's best quarter-over-quarter performance since the fourth quarter of 2015, and we have done it the right way, lowering expenses strategically to make our organization more efficient and effective, while investing intentionally in digital opportunities. We are encouraged by this stabilizing trend, and remain steadfast in our focus on top line revenues, while managing our cost structure, all the while making important strides in our digital transformation.

In fact, we removed $27 million of adjusted operating expenses versus Q2 2018, a reduction of more than 15% of legacy costs from our business this quarter, and more than $41 million in the first half of this year versus 2018. We achieved this through disciplined cost reductions that were put into place in the second half of last year and in the first half of this year.

We announced in the fourth quarter of 2018 that we were shifting our organizational structure to become a functionally organized company, a more agile organization for the digital era, common in Silicon Valley but still a trendsetter for legacy media. And in the second quarter of 2019, we extended our functional structure to our advertising department. This move helped in reaching $4.9 million in savings in the advertising department Q2 this year versus 2018, and while a change of this nature is temporarily disruptive, we expect it to result in improved revenue generation as we will discuss in just a moment. Another positive trend in the second quarter is continued growth in digital-only subscribers.

As I mentioned earlier, we accomplished nearly 52% growth in digital-only subscriptions, reaching 185,500 by the end of the second quarter of 2019. And this is the 13th consecutive quarter of growth for our digital subscriptions. Our focus on paid digital subscriber growth is a key performance measure in our continuing transformation and a contributor to the improvement in the audience revenue trend this quarter. We also measure our print subscribers who are digital users as well. Digital access to our news sites was a valuable feature of the home delivery subscription. We want to make sure that customers who are paying for our product are getting the most value for their money by activating and using our digital products. Print and digital is a powerful and convenient combination for our customers.

At the end of the second quarter this year, total paid digital customer relationships, including those combo print digital customers totaled 483,600, up 24.4% from a year earlier. This growth is a direct result of the investments and functional organization in our product and customer team. We discussed at length last quarter the strategic work this team is doing in data analysis and understanding our current and potential audience to optimize user experience and conversion opportunities. Because of these efforts, we have improved our ability to convert visitors to paid subscribers and sharpened our targeting for digital products. For instance, we saw after our analysis that tightening our paywalls to grow digital subscribers would be an intelligent trade-off despite softer ad revenues associated with fewer free page views.

Significantly, while we've grown and improved our platform and online offerings, we continue to see increased platform engagement, which is evident not only through our increased number of digital-only subscribers, but also through more active print digital subscribers. And such great new stories as the Miami Herald's award-winning investigation, Perversion of Justice, proves that good journalism, even showing light in the darkest corners, can move our society in powerful ways and remind customers of the unique and essential value of our business. The arrest and imprisonment of hedge fund manager and sex offender Jeffrey Epstein, and subsequent resignation of former U.S. Labor Secretary Alexander Acosta, demonstrated the power of the Miami Herald's accountability journalism after a multiyear investigation. Such stories increased both our ability to grow digital subscriptions and engagement on our sites. The impact of this story and the interest generated by it will be with our society for some time to come. Economically, this will have a slight but incremental impact in our third quarter. More significantly and over the longer term, it serves as a tremendous illustration of the type of news coverage we at McClatchy are doing day in and day out. Journalism that serves our communities, that underscores our mission to provide independent journalism in the public interest, that spotlights our commitment to essential and unique local news and information and that powers our digital transformation. More on all of this in just a few minutes.

In looking at our second quarter 2019 audience results, digital audience revenues were up 8.1% for the second quarter of 2019 compared to the same period last year, reflecting the strong growth in our digital subscribers. Digital-only audience revenues, associated with digital-only subscriptions, were up 57.6%. Total audience revenues were $80.3 million, 44.9% of total revenues.

Turning to our advertising business. During the quarter, we invested in our digital advertising team, adding new leaders to manage our functional organizational structure, with a dedicated focus on our customers to drive digital revenue and create new efficiencies. In keeping with a more agile organization, these leaders are aligning the advertising organization into key functional channel structures. While this process was substantially completed in the second quarter, we continue to bring on new talent and leadership for the new structure. A change of this nature will obviously include disruption, and that is reflected somewhat in our second quarter advertising results. But we believe this is a step that will improve our results for the long run, creating a strengthened sales organization with a sharper and more strategic customer focus, one that we expect to ultimately also drive new revenue. And as we noted earlier, it has also resulted in significant savings this year.

In the second quarter, total advertising revenues were $85.5 million, down 20.1% in the second quarter of 2019 compared to the second quarter of 2018. Total digital advertising revenues were 44.2% of total advertising revenues, and exceeded print advertising in our home-delivered and single-copy newspapers. Total digital advertising revenues were $37.8 million, down 18.7% over the same period in 2018, while digital-only advertising revenues were down 20.8% compared to the 2018 quarter. We are very focused on improving our digital results. We knew that we would face particularly difficult headwinds this past quarter and the first half of this year. As we discussed during our last call, the decline in digital-only advertising was driven in part by lower audience traffic compared to the second quarter of 2018. Reasons for the decline included a strategic tightening of website paywalls that accelerated page -- paid subscriptions and, to a lesser extent, a change in algorithms by a large platform company in the last half of 2018 that impacted us as well as the rest of the industry.

We are cycling over the impact of that algorithm change in the third quarter. The recent restructuring of our advertising division also impacted sales in the second quarter. As part of that reorganization, dozens of our key sales employees took on new roles, and we transferred thousands of accounts to our new classified call center. We stood up a centralized small business team to handle smaller transactional advertisers, and make outbound sales calls, and we re-vamped our sales tracking with boarding and forecasting tools to reflect this new functional structure. While it was definitely a heavy lift, the bulk of that effort is now behind us, and we're confident it will improve our digital focus, productivity and most importantly, our revenue trends. In fact, we expect to see improving digital-only revenue trends in the second half 2019.

Even during our reorganization, we've also continued to see improvement from Excelerate, our digital marketing agency, whose revenues improved 81% in Q2, and 112% in the first half of 2019. And we will also benefit from easier comparisons in the second half of 2019 compared to 2018.

Before turning the call over to Elaine to review our quarterly results in more detail, I'd like to focus on the cornerstone of our business: local journalism, and a significant new leader added to the senior ranks of McClatchy to oversee this important part of our business. In May, we elevated Kristin Roberts to VP of News. Kristin was formerly our Executive Editor for Politics and Regional Editor for our East Coast newsrooms, including the Miami Herald and 7 other newsrooms. She is the first woman to lead news at McClatchy in the company's 162-year history, although she is by no means a lone pioneer. After all, I, today, lead the company in a role once occupied by one of the genuine pioneering female leaders of a major American media company, our storied president, Eleanor McClatchy. Today, our corporate executive team is evenly balanced by gender, and our focus on diversity is a priority and continues through the 30 communities throughout America that together make McClatchy. But back to Kristin. She's a great journalist with a strong digital track record. Before joining us, she served as national editor at Politico, where she guided that online source's coverage of the 2016 Presidential Race. She came to Politico from National Journal, where as managing editor, she oversaw newsroom-wide operations. And Kristin has hit the ground running, adding key editorial talent and leadership throughout our communities.

McClatchy newsrooms continue to produce extraordinary local journalism with national impact. I've already mentioned the Miami Herald's accountability journalism in year's long investigation, Perversion of Justice, and its impact. It is but one example of our investigative journalism. Collaboration was a feature of the second quarter in many of our 30 markets. In California, for example, the Sacramento Bee joined other news outlets in our state to release Destined to Burn, a multimedia examination of the risk posed by wildfire to the lives of millions of Californians. Another hallmark of our journalism in the second quarter was data-driven reporting. The Charlotte Observer helped to uncover how the city found itself in an affordable housing crisis, and the data team in our Washington Bureau helped 5 local newsrooms unearth new information that showed for the first time the White House had reversed transportation spending to benefit rural communities. With the addition of a military and Veterans Affairs correspondent, McClatchy produced incisive reports, examining issues affecting servicemen and women, the threat of rising cancer deaths among veterans, how immigrants serving in the U.S. Military are being denied citizenship at a higher rate than foreign-born civilians, and through the Called to serve series, took a look at why small towns rank high in military recruitment efforts. We could not be prouder of the work that our newsrooms have produced, and congratulate all of our reporters and editors for their tireless work and contributions to local journalism that strengthens the communities we serve.

Finally, in the first quarter, McClatchy partnered with the Google News initiative to launch 3 local news outlets in communities that have limited sources of local news to test sustainable models for local journalism. The Compass Experiment will share with the industry what works, to scale successful new approaches. This quarter, we announced that The Compass team will start its work in a city that will soon lose its daily newspaper, Youngstown, Ohio.

Now I'll turn the call over to Elaine, to discuss our specific financial results for the quarter.

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [4]

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Thanks, Craig. We reported an adjusted net loss of $11.4 million in the second quarter. Adjusted EBITDA was $28.6 million and our adjusted EBITDA margin improved by 1.3 percentage points to 16% versus 14.7% in the second quarter of 2018. Excluding real estate gains from second quarter of 2019 and equity distributions from CareerBuilder in the second quarter of 2018, adjusted EBITDA was $26.3 million, down 3.2% from the second quarter of 2018, and as Craig noted earlier, this was a sequential improvement over both the first quarter of 2019 and the fourth quarter and full year of 2018. Total revenues were down 12.6% in Q2 compared to the same period last year. While Craig has covered our 2 major sources of revenues in detail, that is audience and advertising, I'll recap briefly.

Total audience revenues declined 5.3% in the second quarter compared to the same quarter in 2018, as print declines offset growth in digital audience revenues. Advertising revenues in the second quarter were down 20.1% compared to last year, while trends in print and direct marketing advertising remained relatively unchanged, digital-only advertising declined due to the headwinds Craig reviewed earlier. Our improvement in the trend of adjusted EBITDA during the quarter was a result of our focus on cost controls, even while continuing to invest in our business. We reduced adjusted operating expenses by 15.3% compared to the second quarter of '18, and we did it the right way, focusing on legacy cost and process improvements in our business.

During the second quarter, we rolled out the new advertising structure aligned around channels to reduce redundancies, create more digital focus, standardize and streamline our processes and procedures and generally make us more efficient and effective. These changes resulted in some workforce reductions, but they've also created additional positions and capabilities, including standing up a new centralized call center. To date, the changes coupled with the impact of our early retirement program in the ad department have resulted in $5.6 million in savings, most of which came in the second quarter, as Craig mentioned earlier.

We expect full year 2019 savings related to the ad department reorganization to be in the high single-digit millions of savings. We continue to benefit from our early retirement program and the outsourcing of our printing operations in Tacoma, Washington, both of which were implemented in the first quarter of this year. In the second quarter of 2019, our average full-time equivalent employees declined 22.3% to approximately 2,800 FTEs from the second quarter of 2018, as we focus on restructuring and running our business more effectively and efficiently. And while we have reduced our ranks over the years, we've done so strategically. For instance, at the end of the second quarter, our editorial staff made up 31% of total FTEs. Not only are they the largest department within the company, they are extremely efficient. Our page views per newsroom dollar spend is up 71% from when we began measuring this KPI in 2015.

As we transition to a more digital company, we continue to have newsprint -- have savings in newsprint and third-party printing costs. Our newsprint savings are coming from volume declines and strategic changes we have made, such as reorganizing our print product and moving to digital-only additions on Saturdays in some small markets. In the second quarter of 2019, our newsprint volume declined by approximately 22%, while the average price has increased 27 -- I'm sorry, 2.7% over the second quarter of 2018. That price differential reflects the holdover of tariffs that drove up prices in 2018 but are clearly reversing now. We expect to see average newsprint price declines in the third quarter as we have used the higher-priced newsprint bought during the tariff period. And as I have reminded you in prior calls, our newsprint costs are now only about 4% of our total cost structure.

Now turning to the balance sheet. On June 7, 2019, we completed a partial redemption of $32 million of our 2026 notes at par. As of quarter end, our principal debt outstanding was $708 million, and our average interest rate is 7.9%. We finished the quarter with $19.6 million in cash resulting in net debt of approximately $689 million. At of the end of the second quarter, we had $39.4 million of total borrowing capacity under our revolving credit facility, and no amounts were outstanding. Our capital expenditures were about $1 million in the second quarter and about $1.2 million for the first half of 2019.

I'd like to briefly touch on pension efforts and our expected contributions before turning the mic back to Craig. We expect to make a required pension contribution of approximately $30 million in the fourth quarter of 2019. Our funding requirements are currently subject to pension funding legislation that expires next year. And while we are a couple of -- while there are a couple of different proposed legislative reforms being considered in D.C. currently, given the level of expected contributions that will likely be required from the company without legislative release, we decided it would be proactive just as you've come to expect of McClatchy. Accordingly, and as previously disclosed, we filed an application for a waiver of minimum required contributions to our defined benefit pension plan with the IRS. Specifically requesting a waiver of the minimum required contributions for our fiscal year 2020, which are estimated to be approximately $120 million. This would be paid in installments beginning in April 2020, but with the bulk of those payments due September 15, 2020, or afterwards. There can be no assurance that the IRS will grant the requested waivers, and we do not expect to provide periodic updates prior to a definitive ruling by the IRS, which is expected to take some time.

As we noted in our press release, if the waivers are not granted or we do not see legislative release before mid-2020, it could have a material adverse effect on our liquidity. I know a number of you are going to ask me to handicap the likelihood of getting a waiver, the passing of legislation or both, and I cannot opine on either -- on their deliberations on either of those or the outcome of it. What I can say is that we plan ahead at McClatchy, and we try our best to control our own destiny. And that's why we have applied for the waiver a full year before this becomes an issue for the company. We want to be sure we have sufficient time to work with the IRS and provide all of the information they need for their determination.

And now I'll turn the call back to Craig to discuss our outlook and take any of your questions.

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Craig I. Forman, The McClatchy Company - President, CEO & Director [5]

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Thank you, Elaine. As we look to the second half, it's important to note that our mission to produce public service journalism has a direct correlation to our results. The Miami Herald's award-winning investigation into the secret plea agreement secured by serial sex abuser Jeffrey Epstein, proved accountability increases audience as the community sought to understand the local impact. We believe the boosts to our digital audience in subscriptions that have been aided by the interest in this story and others -- other local stories that have a national impact, will feel both the advertising and audience revenues as we look to the second half of 2019 and beyond. In the full year 2019, we expect digital subscribers to continue to grow and largely offset the continuing declines in print circulation, resulting in low single-digit total audience revenue declines for the full year 2019. We expect digital-only advertising to improve in the second half of the year, and total digital and digital-only advertising revenues to surpass newspaper print advertising for the full year 2019, as print advertising becomes a smaller percent of total revenues. While product offerings and collaboration efforts in digital advertising have steadily grown, we will continue to adjust news and advertising content, paywall strategies and our mix of advertising and audience revenue initiatives as we pursue the best experience for our digital customers. We will be persistent in reducing operating expenses to align expense and revenue performance, while making additional investments in our news and sales organization.

Over the last 3 quarters, we have shown continued progress in improving the trend in adjusted EBITDA. And we continue to work towards stabilization of EBITDA. We are focused on improving revenue trends and the continuing transformation of our business to become a more digital media company while continuing to support our loyal print customers who remain a profitable part of our business. We will continue to monetize assets that are not strategic to our business. Elaine has several buildings being marketed or that are under contract for sale, and though the timing of real estate sales is hard to predict, we are hopeful that we will see more real estate transactions during 2019. We plan to use those proceeds from any asset sales as well as free cash flow to reduce debt and debt service costs in the second half of 2019, or depending on timing, in early 2020.

In summary, over the past 2 years, we have maintained a disciplined and unrelenting focus on accelerating the pace and cadence of our digital transformation in a time of fierce headwinds for local media companies. And we are making progress. We're making headway in stabilizing our operating results, most recently through cost control. We're moving forward aggressively, putting revenue growth as our top priority. The investments and strategic changes we've made to strengthen our capabilities in customer, audience and advertising are seeing green shoots. Digital subscriptions are growing, our advertising team is reaching new customers, and serving loyal ones in new and more efficient ways, while building a pipeline connecting national advertising to our local news brands.

Local journalism has never been more important to our communities across the country and to our democracy. Note that with our editorial staff representing, on average, 31% of total FTEs at the end of Q2 2019, it's the highest percentage of total head count since before the great recession. This is not by coincidence. It's because we know that a solid product is the most critical asset of any business. We remain steadfast in our purpose: To provide local news and information that is essential to the distinct communities we serve.

And with that, we're happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Michael Kupinski with NOBLE Capital Markets.

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Michael A. Kupinski, NOBLE Capital Markets, Inc., Research Division - Director of Research and Senior Media & Entertainment Analyst [2]

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Congratulations on beating my adjusted EBIT number. I know you guys have been going through a lot of cost-cutting there, and it really was pretty remarkable that you were able to get that type of margin on the weak revenues. Regarding the expenses, I was just wondering if you can give us some thought on how this trends for the second half of the year. In particular, you commented, Elaine, about the Saturday editions -- the digital Saturday editions and that you rolled that out to some of the smaller markets. What was the impact of that in Q2, first of all? And then secondly, what are the prospects that you might continue to roll that out into other papers as you go forward? And if there's any insight on the types of expense savings that you get there versus the revenue contributions, that would be great.

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Craig I. Forman, The McClatchy Company - President, CEO & Director [3]

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Michael, thank you for the commentary on the extent to which our focus on cost control has resulted in stabilization of adjusted EBITDA even amid these revenue headwinds. And of course, you among others have commented on the scale of the transformation at McClatchy, which is now approaching a 50-50 split, print and digital, and that I think puts us near the top of the league tables for similarly situated companies. There may be 1 or 2 other public companies that have slightly more digital than print. But I think we're at the top -- or near the top of the league tables if that continues to be the underlying fundamental structural change in our industry. On the Saturday editions, I think, at a high level, what you have to note is that you want to make sure that you retain our customers at a high LTV, even as they transition to being both print and digital customers. And this year has been a story of experimentation in several markets as we move to a much more robust Friday, Saturday print offering, a Saturday digital-only offering connecting to the same customers, and then a robust Sunday offering. And you've seen that roll out gradually as we've tested and learned in some of our smaller markets. I'm going to throw it over to Elaine to discuss what we can release about those internals, which as you know, we don't really report publicly. Elaine?

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [4]

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Sure. First of all, we'll take the question about the editions, and then we'll talk a little more broadly about the second half in terms of cost savings. So we've rolled it out before market, and it has been what we would consider to be a very strong success. And as Craig mentioned, we have provided more robust editions on -- print editions on Friday and Sunday. We have had only 2 customer's subscriptions that have canceled as a result, and we've seen no meaningful change in advertising at all. And so net-net, this is really positive. Look, these are small markets that we've rolled them out to, and so the savings are not huge because they are the small markets. But we have seen it be successful. And so as we go forward, we might roll out to other smaller and maybe even some medium-sized markets. We don't have any intentions at this point of rolling them out to our major metro markets. But it has been successful and we take it on a market by market basis and are doing, I think, a good job in tracking it for our customers and finding out where it can be successful. I think as we look to the second half, we would expect that cost savings will continue to be in the high single digits, and so we'll continue to control those costs. And I think that will be very helpful as we go forward into the second half and expect to see improved digital-only advertising, which will help complement those cost savings as we look to the bottom line. I hope that answers your questions. I know it's a multiquestion, and I'm not sure if I answered it clean.

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Michael A. Kupinski, NOBLE Capital Markets, Inc., Research Division - Director of Research and Senior Media & Entertainment Analyst [5]

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Yes. You did. On the Compass, on the employee compensation expenses particularly, that number came in lower than expected. Were there additional severance agreements and things like that, that happened in the second quarter? I believe I know that there were some in the first, but how -- can you just tell me in terms of the FTE reduction, kind of remind me what you did in the -- maybe the first half of this year?

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [6]

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Sure. So the early retirement incentive program that we implemented in the first quarter was quite successful, but it occurred in the last month of the first quarter. So most of the impact it did is found in the second quarter. And then the advertising reorganization that we talked about, where we have $5.6 million in savings in the advertising department through June, but $4.9 million of that came in the second quarter. And a large piece of that, although not all, was compensation. So those are the 2 big moves that we've made. And then finally, let's not overlook the fact that we did outsource Tacoma, which is a good size, one of our larger, kind of medium-sized markets in the -- at the beginning of the year. And so those savings will also roll through and we'll have full effect in the second quarter. And all of these things that I'm talking about will continue to benefit us in the second half of the year. Mark, did I miss anything?

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Mark Zieman, The McClatchy Company - VP of Operations [7]

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No. I think that's right.

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [8]

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Yes. So those are the big savings in the compensation area.

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Michael A. Kupinski, NOBLE Capital Markets, Inc., Research Division - Director of Research and Senior Media & Entertainment Analyst [9]

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And then on the real estate sales, what is currently on the market right now?

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [10]

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We're under contract with a couple of properties: 1 in Tri-Cities, Washington; and the other in Bellevue. We -- the largest property that we are marketing right now is the building in Tacoma that is on the market. And then there's a couple of other smaller properties being marketed. Only 2, the 2 smaller ones I mentioned are under contract. Tacoma is not yet, but we have got a lot of interest in it.

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Michael A. Kupinski, NOBLE Capital Markets, Inc., Research Division - Director of Research and Senior Media & Entertainment Analyst [11]

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Got you. And then just a quick comment -- my final question here, I was wondering if you can comment regarding the prospective merger between Gannett and [GateHouse] Media? What your thoughts are on that merger? How this might affect you, what it might affect in terms of the industry? Just your general thoughts about the merger?

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Craig I. Forman, The McClatchy Company - President, CEO & Director [12]

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Michael, we appreciate the question, but obviously, we really can't comment for obvious reasons. We'll just have to see how the industry continues to evolve. But that actually, the transition, just to wrap this up. I very much appreciated your comments and the question about Saturday. I'll just try to extrapolate, move out to the 5,000-foot level and talk about how it shows the change at McClatchy over the next 2.5 years. There's 3 points to be a successful digital company that this successful transformation shows: first, you have to be a digital company that understands data and your customer. And to Elaine's point about actually losing solely 2 customers, okay, albeit 4 smaller markets, but the number of win backs was something higher. And the win backs come because you actually have the data that allows you to understand how to win back those customers, who can be walked through the online acquisition funnel that they may have been intimidated by because they might not be digital-native customers. And in the case of transitioning to digital print combo customers, you also need to have a strategy to invest in product so that your product is actually robust enough to be worthy of retaining those customers.

And then finally, and this is where it really gets nuanced and tricky, there was some temptation to actually lower expense around some white glove service that we put into place in those markets because we didn't have a high call volume in the initial week. The temptation would've been to take even additional cost-savings and just move on. But we realized that it's actually in the second week or the third week that the call volume increases as our longtime customer say, hey, what's going on? And you remind them when they call in, well, we told you this was going to happen, and let's stay with you as we migrate you to being a print and digital user. That's the kind of thing that has been typical of sophisticated digital enterprises, including those in the telco world and other worlds that have gone through these kind of migration paths, but hasn't always been in the case of legacy newspaper companies. That's the kind of digital company that we're leading now, and that's one of the reasons why we don't want to pat ourselves too much on the back. These are small markets we continue to test and learn but that's why the revenue split is increasingly reflective of a very mixed revenue model.

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Operator [13]

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(Operator Instructions) Our next question comes from Craig Huber with Huber Research Partners.

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Craig Anthony Huber, Huber Research Partners, LLC - CEO, MD, and Research Analyst [14]

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Just a few questions. Maybe we could start with the big picture here. Just given the trends you talked on the advertising here and your various cost, your various 30 products you have in the marketplace. Are you seeing any material difference in the local economies out there when you talk to your various large advertisers? Or is all the pressures -- just launch of the secular pressures, just curious, any change in economy in your discussions, say now versus roughly 6 months ago, say.

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Craig I. Forman, The McClatchy Company - President, CEO & Director [15]

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Yes. So that's a very good question, Craig, and we watch it pretty acutely as you do. I think in general, at a high level, you'd have to say no. That in fact, while there's always of course huge differences when you have 30 different markets as diverse as Miami, Biloxi and Tri-Cities and Eastern -- and Central Eastern Washington, and these are very different markets and we, and if you're going to be successful, it's because you're essential locally, which means you need to understand the local equivalent. I mean it's sort of the same response if you asked all the governors and the various different regional feds, what's the difference in your local economy? Of course there are local economic differences, but at a high level, I'd say we don't see profound local economic differences that would be a response that -- we have secular challenges in region A or region B. Of course, we move to a regional structure, which allowed us to rationalize costs and also reflect our kind of digital repositioning, so I think we get a pretty good insight as to whether or not there's 1 in particular, and sometimes we see it although that hasn't been a characteristic of the most recent quarter. We'll have a big weather event that might actually change things in 1 place or another. That was not a characteristic of Q2.

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Craig Anthony Huber, Huber Research Partners, LLC - CEO, MD, and Research Analyst [16]

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Okay. That's helpful. And then could you just talk a little bit further about the retail advertising trends? Obviously, it got a little bit worse here year-over-year in the quarter. Can you just about maybe department stores versus grocery stores, just on the subsegments and then maybe where some of the extra pressure may be coming from?

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Craig I. Forman, The McClatchy Company - President, CEO & Director [17]

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Sure. Let me throw that over to Mark for the detailed analysis.

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Mark Zieman, The McClatchy Company - VP of Operations [18]

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Sure. In Q2, we saw retail ROB in preprint revenue actually improve by 3 points over Q1, and that was actually the best levels since Q4 2014. Digital retail revenue declined by that same amount in Q2 versus last year due to some declines that we're seeing on the digital side in political, banking and some grocery accounts. Retail's still a volatile category for us. We're seeing lot of bankruptcies in this space over the past few years, still a struggling sector. Our top 60 advertisers or so were down about 24% in Q2, and that trends about the same as our run rate for Q1. And they make up about 15% of our total ad revenues. Trend lines improved for many of those accounts, and several actually showed year-over-year gains from last year, while we won't go into them specifically, but we had some drugstores, we had some homebuilders and others that were up. But we also saw cuts from many and in the -- and some of those were in the grocery categories. That's pretty much the retail look.

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Craig Anthony Huber, Huber Research Partners, LLC - CEO, MD, and Research Analyst [19]

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Also let's talk about pricing for a couple of minutes. On your home delivery pricing out there and also for digital-only, are there any markets you can talk about where maybe you've raised price? Or just also curious, your overall comment about where you're sort of at with pricing for digital-only? And also with this print home delivery. In terms of do you feel you have any room to raise prices? I know there's a volume elasticity issue here, of course.

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [20]

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So Craig, this is Elaine, and I could turn it over to Scott for some additional detail if needed. But generally, we have any kind of metric model that we use. And so we -- rather than looking at kind of markets, we look all the way down to the household level as it relates to pricing the print product. And then as it relates to the right pricing, the digital product, while we have intro rates, those move up pretty quickly. So if you look at the underlying statistics in terms of digital-only subscribers, they grew 51%, almost 52% in the quarter, while the digital-only revenues grew nearly 58% in the quarter, which reflects the fact that those enterprises move up and then they begin to amortize over the period that the subscriber is taking. And so I think while there are pricing strategies that happen all the time, we don't look at it as much by market as we look at it by household and individual. So is there anything that, I think that pretty much covers how we look at that.

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Craig Anthony Huber, Huber Research Partners, LLC - CEO, MD, and Research Analyst [21]

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My last question, Elaine. If I heard you right, I think you said you thought costs in the second half would be down high single digits. I guess, if you can confirm that? I'm just looking at my model here. If that plays out -- if I look at my model here, it looks like in the second half of last year, taking out the one-time items, if you're down, say, high single digits, the absolute dollar amount of cost in millions, like you infer like in the third quarter is up versus what you reported in the second quarter? Am I -- is that...

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [22]

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So I don't have your model, and I haven't looked at that. But what I can tell you is that we do expect that costs will be aligned with revenues. We expect improving digital-only advertising revenues in the second half. We do think, clearly because of the reorganization in the advertising department, the e-rip outsourcing that we've done, other things that we've talked about that we will see declines in cash expenses in the high single-digit range. Now if needed, there may be other cuts. Again, we tend to align that with where things are going in advertising. And so we think that we are working towards continued stabilization of operating cash flows. I don't have the ability to discuss your model with you on the call, but if you want to follow up with me later, we can do that.

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Craig Anthony Huber, Huber Research Partners, LLC - CEO, MD, and Research Analyst [23]

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But Elaine, if I could just ask, does it seems correct to you that costs sequentially in the third quarter versus what you reported in the second quarter would actually be up sequentially? The cash cost, put aside D&A and the various one-time items?

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [24]

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No, it does not. So I don't know without taking a look at it, Craig.

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Craig Anthony Huber, Huber Research Partners, LLC - CEO, MD, and Research Analyst [25]

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Okay. So you're saying that you think the third quarter costs should be down versus the second? Also down high single on either base from a year ago? Understood.

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [26]

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I think it will be down on a quarter-over-quarter, year-over-year basis, is what I'm telling you.

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Craig I. Forman, The McClatchy Company - President, CEO & Director [27]

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So Craig, just to wrap up on that. So I think the take away is, look obviously stabilization on the adjusted EBITDA lines has been a key priority, and I even mentioned it in a very early call. In a transforming business such as our sector, and also with the changes in technology and consumer adoption, local media, as you move to a more digital enterprise, it takes a number of quarters to reach a normalized operating environment, and we're still on the trajectory to reach that. But if you look at the key milestones, the stabilization on that operating line, coupled with total paid digital customer relationships approaching $0.5 million, slightly under, those are key milestones of a business in transition. And so we continue to execute against that and maybe I'll just wrap it up by saying Elaine used the word proactive, and I think that's been the case, certainly in our time here together and Elaine's 3 decades of service in McClatchy. And I just remind people of the call that this is a company that have delevered billions of dollars in debt, we gave you the net numbers, including that tranche, which is the sole tranche that matures in the 2020s. So substantial maturities don't occur until the next decade. And with $1.3 billion set aside in the pension, it's also a reflection of a company that's been proactive in funding its defined benefit plan. And so maybe I'll just wrap up by saying, I think you can be certain that this company will continue to be proactive, both the management team and the Board of Directors, as we continue to work forward on this transformation, which, as all of you know, is not easy, but one where we're very committed to.

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Operator [28]

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This concludes our question-and-answer session. I would like to turn it back over to management for any closing remarks.

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R. Elaine Lintecum, The McClatchy Company - VP of Finance, Treasurer & CFO [29]

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Thank you, Ben. We would like to thank all of you for joining us today and for your continued interest in McClatchy. And should you have questions that you were unable to ask during the webcast in this call, please reach out to me at (916) 321-1846 or via e-mail, you can reach me at elintecum@mcclatchy.com. Thank you and have a great day.

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Operator [30]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.