Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended December 31, 2006

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-6227

LEE ENTERPRISES, INCORPORATED

(Exact name of Registrant as specified in its Charter)

 

Delaware   42-0823980

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification No.)

201 N. Harrison Street, Suite 600, Davenport, Iowa 52801

(Address of principal executive offices)

(563) 383-2100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x   Accelerated filer  ¨   Non-accelerated filer  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of December 31, 2006, 39,681,705 shares of Common Stock and 6,365,098 shares of Class B Common Stock of the Registrant were outstanding.

 



                  TABLE OF CONTENTS

   PAGE
   FORWARD LOOKING STATEMENTS    1
PART I    FINANCIAL INFORMATION   
   Item 1.   Financial Statements   
     Consolidated Statements of Income and Comprehensive Income – Three months ended December 31, 2006 and 2005    2
     Consolidated Balance Sheets - December 31, 2006 and September 30, 2006    3
     Consolidated Statements of Cash Flows – Three months ended December 31, 2006 and 2005    4
     Notes to Consolidated Financial Statements    5
   Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    14
   Item 3.   Quantitative and Qualitative Disclosures About Market Risk    21
   Item 4.   Controls and Procedures    22
PART II    OTHER INFORMATION   
   Item 2(c).   Issuer Purchases of Equity Securities    23
   Item 6.   Exhibits    23
   SIGNATURES    23


FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a “Safe Harbor” for forward-looking statements. This report contains information that may be deemed forward-looking that is based largely on the Company’s current expectations, and is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those anticipated. Among such risks, trends and other uncertainties are changes in advertising demand, newsprint prices, energy costs, interest rates, labor costs, legislative and regulatory rulings and other results of operations or financial conditions, difficulties in integration of acquired businesses or maintaining employee and customer relationships and increased capital and other costs. The words “may,” “will,” “would,” “could,” “believes,” “expects,” “anticipates,” “intends,” “plans,” “projects,” “considers” and similar expressions generally identify forward-looking statements. Readers are cautioned not to place undue reliance on such forward-looking statements, which are made as of the date of this report. The Company does not undertake to publicly update or revise its forward-looking statements.

 

1


PART I FINANCIAL INFORMATION

 

Item  1. Financial Statements

LEE ENTERPRISES, INCORPORATED

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

      
 
Three Months Ended
December 31
 
 
(Thousands, Except Per Common Share Data)      2006       2005  

Operating revenue:

    

Advertising

   $   234,160     $   228,899  

Circulation

     52,271       51,587  

Other

     14,059       11,759  

Total operating revenue

     300,490       292,245  

Operating expenses:

    

Compensation

     113,012       110,923  

Newsprint and ink

     31,101       30,160  

Depreciation

     8,347       8,034  

Amortization of intangible assets

     15,081       13,847  

Other operating expenses

     75,446       70,484  

Early retirement program

     -           8,373  

Transition costs

     -           352  

Total operating expenses

     242,987       242,173  

Equity in earnings of associated companies

     6,505       6,303  

Operating income

     64,008       56,375  

Non-operating income (expense):

    

Financial income

     1,509       1,356  

Financial expense

     (23,435 )     (24,037 )

Total non-operating expense, net

     (21,926 )     (22,681 )

Income before income taxes

     42,082       33,694  

Income tax expense

     14,889       12,041  

Minority interest

     504       259  

Income from continuing operations

     26,689       21,394  

Discontinued operations

     (38 )     1,370  

Net income

     26,651       22,764  

Other comprehensive income (loss), net

     (148 )     980  

Comprehensive income

   $ 26,503     $ 23,744  

Earnings per common share:

    

Basic:

    

Continuing operations

   $ 0.59     $ 0.47  

Discontinued operations

     -           0.03  

Net income

   $ 0.58     $ 0.50  

Diluted:

    

Continuing operations

   $ 0.58     $ 0.47  

Discontinued operations

     -           0.03  

Net income

   $ 0.58     $ 0.50  

Dividends per common share

   $ 0.18     $ 0.18  

The accompanying Notes are an integral part of the Consolidated Financial Statements.

 

2


LEE ENTERPRISES, INCORPORATED

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Thousands, Except Per Share Data)    December 31
2006
   September 30
2006

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $     10,743    $       8,638

Accounts receivable, net

   127,720    115,353

Receivable from associated companies

   -        1,563

Receivable from sales of discontinued operations

   -        20,700

Inventories

   16,516    19,271

Assets of discontinued operations

   -        342

Other

   17,390    18,545

Total current assets

   172,369    184,412

Investments

   217,142    219,091

Restricted cash and investments

   99,810    96,060

Property and equipment, net

   324,379    327,252

Goodwill

   1,498,830    1,498,830

Other intangible assets

   965,831    980,912

Other

   22,150    23,252

Total assets

   $3,300,511    $3,329,809

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

Current liabilities:

     

Current maturities of long-term debt

   $     47,250    $     35,375

Accounts payable

   31,625    38,129

Compensation and other accrued liabilities

   60,742    58,457

Income taxes payable

   20,130    22,634

Dividends payable

   6,603    6,581

Unearned revenue

   38,598    38,624

Liabilities of discontinued operations

   -        523

Total current liabilities

   204,948    200,323

Long-term debt, net of current maturities

   1,458,727    1,510,459

Pension obligations

   38,051    38,420

Postretirement and postemployment benefit obligations

   100,858    100,231

Deferred items

   479,406    481,679

Other

   8,501    8,072

Total liabilities

   2,290,491    2,339,184

Stockholders’ equity:

     

Serial convertible preferred stock, no par value; authorized 500 shares; none issued

   -        -    

Common Stock, $2 par value; authorized 120,000 shares; issued and outstanding:

   79,364    78,974

December 31, 2006 39,682 shares;

     

September 30, 2006 39,487 shares

     

Class B Common Stock, $2 par value; authorized 30,000 shares; issued and outstanding:

     

December 31, 2006 6,365 shares;

   12,730    12,788

September 30, 2006 6,394 shares

     

Additional paid-in capital

   124,575    123,738

Retained earnings

   790,321    771,947

Accumulated other comprehensive income

   3,030    3,178

Total stockholders’ equity

   1,010,020    990,625

Total liabilities and stockholders’ equity

   $3,300,511    $3,329,809

The accompanying Notes are an integral part of the Consolidated Financial Statements.

 

3


LEE ENTERPRISES, INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     

Three Months Ended

December 31

 
(Thousands)      2006       2005  

Cash provided by (required for) operating activities:

    

Net income

   $ 26,651     $ 22,764  

Results of discontinued operations

     (38 )     1,370  

Income from continuing operations

     26,689       21,394  

Adjustments to reconcile income from continuing operations to net cash provided by operating activities of continuing operations:

    

Depreciation and amortization

     23,428       21,881  

Stock compensation expense

     2,103       2,091  

Amortization of debt fair value adjustment

     (1,857 )     (1,761 )

Distributions greater (less) than current earnings of associated companies

     95       (1,450 )

Other, net

     (13,319 )     1,732  

Net cash provided by operating activities of continuing operations

     37,139       43,887  

Cash provided by (required for) investing activities:

    

Purchases of property and equipment

     (5,756 )     (4,989 )

Purchases of marketable securities

     (26,914 )     (5,540 )

Sales of marketable securities

     22,043       16,844  

Decrease (increase) in restricted cash

     1,315       (14,977 )

Other, net

     2,136       3,434  

Net cash required for investing activities of continuing operations

     (7,176 )     (5,228 )

Cash provided by (required for) financing activities of continuing operations :

    

Proceeds from long-term debt

     28,000       10,000  

Payments on long-term debt

     (66,000 )     (38,000 )

Common stock transactions, net

     (805 )     2,734  

Cash dividends paid

     (8,255 )     (8,171 )

Financing costs

     -           (2,560 )

Net cash provided by (required for) financing activities of continuing operations

     (47,060 )     (35,997 )

Net cash provided by (required for) discontinued operations:

    

Operating activities

     (697 )     1,233  

Investing activities

     19,899       (59 )

Net increase in cash and cash equivalents

     2,105       3,836  

Cash and cash equivalents:

    

Beginning of period

     8,638       7,543  

End of period

   $ 10,743     $ 11,379  

The accompanying Notes are an integral part of the Consolidated Financial Statements.

 

4


LEE ENTERPRISES, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1 BASIS OF PRESENTATION

The Consolidated Financial Statements included herein are unaudited. In the opinion of management, these financial statements contain all adjustments (consisting of only normal recurring items) necessary to present fairly the financial position of Lee Enterprises, Incorporated and subsidiaries (the Company) as of December 31, 2006 and its results of operations and cash flows for the periods presented. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s 2006 Annual Report on Form 10-K.

Because of acquisitions, divestitures, seasonal and other factors, the results of operations for the three months ended December 31, 2006 are not necessarily indicative of the results to be expected for the full year.

The Consolidated Financial Statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned, except for its 50% interest in Madison Newspapers, Inc. (MNI), 83% interest in INN Partners, L.C. (INN), 95% interest in St. Louis Post-Dispatch LLC (PD LLC) and STL Distribution Services LLC (DS LLC), and 50% interest in TNI Partners (TNI).

Certain amounts as previously reported have been reclassified to conform with the current period presentation.

References to 2007, 2006, 2005 and the like mean the fiscal year ended September 30.

 

2 ACQUISITIONS AND DIVESTITURES

All acquisitions are accounted for as purchases and, accordingly, the results of operations since the respective dates of acquisition are included in the Consolidated Financial Statements.

In 2006, the Company purchased a web-hosting business and national advertising network at a cost of $3,800,000 from PowerOne Media, LLC (PowerOne), in which the Company and MNI own minority interests and purchased a minority interest in INN in exchange for the forgiveness of certain notes receivable with a carrying value of $75,000. In 2006, the Company also purchased a weekly newspaper at a cost of $412,000. These acquisitions did not have a material effect on the Consolidated Financial Statements.

In September 2006, the Company sold several stand-alone publishing and commercial printing operations in Seattle and Spokane, Washington, and Portland, Oregon, a twice weekly newspaper in Oregon, and a daily newspaper in Rhinelander, Wisconsin. The Company received $33,198,000 in September 2006 and recorded a receivable of $20,700,000, which was collected in October 2006. In October 2006, the Company sold a weekly newspaper in Oregon. The transactions resulted in an after tax loss of $5,204,000, which was recorded in discontinued operations in 2006.

Results of discontinued operations consist of the following:

 

      Three Months Ended
December 31
(Thousands)    2006    2005

Operating revenue

   $  114     $10,436

Income from discontinued operations

   $   (16)    $  2,230

Loss on sale of discontinued operations

   (45)    -    

Income tax expense (benefit), net

   (23)    860
     $   (38)    $  1,370

In November 2006, the Company purchased a minority interest in an online employment application from PowerOne at a cost of $118,000.

 

5


3 INVESTMENTS IN ASSOCIATED COMPANIES

TNI Partners

In Tucson, Arizona, TNI, acting as agent for the Company’s subsidiary, Star Publishing Company (Star Publishing), and Citizen Publishing Company (Citizen), a subsidiary of Gannett Co. Inc., is responsible for printing, delivery, advertising, and circulation of the Arizona Daily Star and Tucson Citizen as well as their related online sites and specialty publications. TNI collects all receipts and income and pays substantially all operating expenses incident to the partnership’s operations and publication of the newspapers and other media. Each newspaper is solely responsible for its own news and editorial content. Income or loss of TNI (before income taxes) is allocated equally to Star Publishing and Citizen.

Summarized results of TNI are as follows:

 

      Three Months Ended
December 31
(Thousands)    2006    2005

Operating revenue

   $33,107    $31,837

Operating expenses, excluding depreciation and amortization

   22,113    21,095

Operating income

   $10,994    $10,742

Company’s 50% share of operating income

   $  5,497    $  5,371

Less amortization of intangible assets

   1,585    1,233

Equity in earnings of TNI

   $  3,912    $  4,138

Star Publishing’s 50% share of TNI depreciation and certain general and administrative expenses associated with its share of the operation and administration of TNI are reported as operating expenses in the Company’s Consolidated Statements of Income and Comprehensive Income. These amounts totaled $475,000 and $501,000 in the three months ended December 31, 2006 and 2005, respectively.

In January 2007, defined pension benefits for certain TNI employees were frozen at then current levels. As a result, TNI recognized a curtailment gain of approximately $2,100,000 in January 2007. See Note 7.

Madison Newspapers, Inc.

The Company has a 50% ownership interest in MNI, a company that publishes daily and Sunday newspapers, and other publications in Madison, Wisconsin, and other Wisconsin locations, as well as their related online sites. Net income or loss of MNI (after income taxes) is allocated equally to the Company and The Capital Times Company. MNI conducts its business under the trade name Capital Newspapers.

Summarized results of MNI are as follows:

 

      Three Months Ended
December 31
(Thousands)    2006    2005

Operating revenue

   $30,319    $31,267

Operating expenses, excluding depreciation and amortization

   20,817    22,819

Depreciation and amortization

   1,139    1,273

Operating income

   8,363    7,175

Net income

   5,186    4,330
     

Company’s 50% share of net income

   $  2,593    $  2,165

Debt of MNI totaled $2,167,000 and $8,014,000 at December 31, 2006 and September 30, 2006, respectively.

In 2006, MNI sold its Shawano, Wisconsin daily newspaper and commercial printing operation. MNI recognized an after tax loss of $1,002,000 on the sale.

 

6


4 GOODWILL AND OTHER INTANGIBLE ASSETS

Identified intangible assets consist of the following:

 

(Thousands)    December 31
2006
   September 30
2006

Nonamortized intangible assets:

     

Mastheads

   $    73,746    $    73,746

Amortizable intangible assets:

     

Customer and newspaper subscriber lists

   1,073,125    1,073,125

Less accumulated amortization

   181,257    166,240
     891,868    906,885

Noncompete and consulting agreements

   28,678    28,678

Less accumulated amortization

   28,461    28,397
     217    281
     $  965,831    $  980,912

Annual amortization of intangible assets for the five years ending December 2011 is estimated to be $60,174,000, $59,505,000, $59,172,000, $59,011,000 and $58,102,000, respectively.

 

5 DEBT

Credit Agreement

In 2006, the Company entered into an amended and restated credit agreement (Credit Agreement) with a syndicate of financial institutions. The Credit Agreement provides for aggregate borrowings of up to $1,435,000,000 and consists of a $950,000,000 A Term Loan, $35,000,000 B Term Loan and $450,000,000 revolving credit facility. The Credit Agreement also provides the Company with the right, with the consent of the administrative agent, to request at certain times prior to June 2012 that one or more lenders provide incremental term loan commitments of up to $500,000,000, subject to certain requirements being satisfied at the time of the request. The Credit Agreement matures in June 2012 and amends and replaces a $1,550,000,000 credit agreement (the Old Credit Agreement) consummated in 2005. Interest rate margins under the Credit Agreement are generally lower than under the Old Credit Agreement. Other conditions of the Credit Agreement are substantially the same as the Old Credit Agreement.

The Credit Agreement is fully and unconditionally guaranteed on a joint and several basis by substantially all of the Company’s existing and future, direct and indirect subsidiaries in which the Company holds a direct or indirect interest of more than 50%; provided however, that Pulitzer Inc. (Pulitzer), a wholly-owned subsidiary of the Company, and its subsidiaries will not be required to enter into such guaranty for so long as their doing so would violate the terms of the Pulitzer Notes described more fully below. The Credit Agreement is secured by first priority security interests in the stock and other equity interests owned by the Company and each guarantor in their respective subsidiaries. Both the guaranties and the collateral that secures them will be released in their entirety at such time as the Company achieves a total leverage ratio of 4.25:1 for two consecutive quarterly periods.

Debt under the A Term Loan and revolving credit facility bear interest, at the Company’s option, at either a base rate or an adjusted Eurodollar rate (LIBOR), plus an applicable margin. The base rate for the facility is the greater of the prime lending rate of Deutsche Bank Trust Company Americas at such time and 0.5% in excess of the overnight federal funds rate at such time. The margin applicable is a percentage determined according to the following: For revolving loans and A Term Loans, maintained as base rate loans: 0%, and maintained as Eurodollar loans, 0.625% to 1% (0.875% at December 31, 2006) depending, in each instance, upon the Company’s leverage ratio at such time. All loans at December 31, 2006 are Eurodollar-based.

The Company may voluntarily prepay principal amounts outstanding or reduce commitments under the Credit Agreement at any time, in whole or in part, without premium or penalty, upon proper notice and subject to certain limitations as to minimum amounts of prepayments. The Company is required to repay principal amounts, on a quarterly basis until maturity, under the A Term Loan beginning in September 2006. In addition to the scheduled payments, the Company is required to make mandatory prepayments under the A Term Loan under certain other conditions. The Company repaid the B Term Loan in full in 2006.

 

7


The Credit Agreement contains customary affirmative and negative covenants for financing of its type. These financial covenants include a maximum total leverage ratio (5.75:1 at December 31, 2006) and minimum interest expense coverage ratio of 2.5:1. None of the covenants included in the Credit Agreement is considered by the Company to be restrictive to normal operations or historical amounts of stockholder dividends. At December 31, 2006, the Company is in compliance with such covenants.

The Credit Agreement requires the Company to apply the net proceeds from asset sales to repayment of the A Term Loan to the extent such proceeds exceed the amount used to purchase assets (other than inventory and working capital) within one year of the asset sales. The Company expects repayments in 2007 to meet or exceed required repayments related to its 2006 sales transactions.

Pulitzer Notes

In conjunction with its formation, PD LLC borrowed $306,000,000 (Pulitzer Notes) from a group of institutional lenders (the Lenders). The aggregate principal amount of the Pulitzer Notes is payable in April 2009 and bears interest at an annual rate of 8.05%. The Pulitzer Notes are guaranteed by Pulitzer pursuant to a Guaranty Agreement dated May 1, 2000 (the Guaranty Agreement) with the Lenders. In turn, pursuant to an Indemnity Agreement dated May 1, 2000 (the Indemnity Agreement) between The Herald Company, Inc. (Herald Inc.) and Pulitzer, Herald Inc. agreed to indemnify Pulitzer for any payments that Pulitzer may make under the Guaranty Agreement. In December 2006, Herald Inc. assigned its assets and liabilities to The Herald Publishing Company LLC (Herald).

The terms of the Pulitzer Notes, as amended, contain certain covenants and conditions including the maintenance, by Pulitzer, of EBITDA, as defined in the Guaranty Agreement, minimum net worth and limitations on the incurrence of other debt. At December 31, 2006, the Company is in compliance with such covenants. In addition, the Pulitzer Notes and the Operating Agreement with Herald (Operating Agreement) require that PD LLC maintain a minimum reserve balance consisting of cash and investments in U.S. government securities, totaling approximately $99,810,000 at December 31, 2006. The Pulitzer Notes and the Operating Agreement provide for a $3,750,000 quarterly increase in the minimum reserve balance through May 1, 2010, when the amount will total $150,000,000. See Note 11.

The purchase price allocation of Pulitzer resulted in an increase in the value of the Pulitzer Notes in the amount of $31,512,000, which is recorded as debt in the Consolidated Balance Sheets. This amount will be accreted over the remaining life of the Pulitzer Notes, until April 2009, as a reduction in interest expense using the interest method. This accretion will not increase the principal amount due to, or reduce the amount of interest to be paid to, the Lenders.

Debt consists of the following:

 

(Thousands)    December 31
2006
   September 30
2006
   Interest Rate(s)
December 31, 2006

Credit Agreement:

        

A Term Loan

   $   926,000    $   926,000    6.25-6.26%

Revolving credit facility

   255,000    293,000    6.23-6.26    

Pulitzer Notes:

        

Principal amount

   306,000    306,000        8.05

Unaccreted fair value adjustment

   18,977    20,834   
      1,505,977    1,545,834   

Less current maturities

   47,250    35,375   
     $1,458,727    $1,510,459     

Aggregate maturities of debt during the five years ending December 2011 are $47,250,000, $95,000,000, $448,500,000, $190,000,000 and $285,000,000, respectively.

 

8


6 INTEREST RATE EXCHANGE AGREEMENTS

In 2005, the Company executed interest rate swaps in the notional amount of $350,000,000 with a forward starting date of November 30, 2005. The interest rate swaps have terms of two to five years, carry interest rates from 4.2% to 4.4% (plus the applicable LIBOR margin) and effectively fix the Company’s interest rate on debt in the amounts, and for the time periods, of such instruments. At December 31, 2006 and 2005, the Company recorded an asset of $4,957,000 and $4,350,000, respectively, related to the fair value of such instruments. The change in this fair value is recorded in other comprehensive income, net of income taxes.

At December 31, 2006, $1,437,000 of the asset amount noted above is related to interest rate swaps with a notional amount of $150,000,000 that expire in November 2007.

At December 31, 2006, after consideration of the interest rate swaps described above, approximately 56% of the principal amount of the Company’s debt is subject to floating interest rates.

 

7 PENSION, POSTRETIREMENT AND POSTEMPLOYMENT DEFINED BENEFIT PLANS

The Company and its subsidiaries have several noncontributory defined benefit pension plans that together cover a significant number of St. Louis Post-Dispatch and selected other employees. Benefits under the plans are generally based on salary and years of service. The Company’s liability and related expense for benefits under the plans are recorded over the service period of active employees based upon annual actuarial calculations. Plan funding strategies are influenced by tax regulations. Plan assets consist primarily of domestic and foreign corporate equity securities, government and corporate bonds, and cash.

In addition, the Company provides retiree medical and life insurance benefits under postretirement plans at several of its operating locations. The level and adjustment of participant contributions vary depending on the specific plan. In addition, PD LLC provides postemployment disability benefits to certain employee groups prior to retirement at the St. Louis Post-Dispatch. The Company’s liability and related expense for benefits under the postretirement plans are recorded over the service period of active employees based upon annual actuarial calculations. The Company accrues postemployment disability benefits when it becomes probable that such benefits will be paid and when sufficient information exists to make reasonable estimates of the amounts to be paid.

The Company uses a June 30 measurement date for all of its pension and postretirement medical plan obligations.

The net periodic cost components of the Company’s pension and postretirement medical plans are as follows:

 

      Pension Plans
      Three Months Ended
December 31
(Thousands)    2006    2005

Service cost for benefits earned during the period

   $        740     $      1,671 

Interest cost on projected benefit obligation

          2,325             2,213 

Expected return on plan assets

         (3,138)           (3,159)

Amortization of prior service cost

              (23)            -    

Amortization of net gain

            (234)            -    

Special termination benefits

           -               4,433 

Curtailment gain

           -                 (102)
     $       (330)    $     5,056 
           
      Postretirement Medical Plans
      Three Months Ended
December 31
(Thousands)    2006    2005

Service cost for benefits earned during the period

   $        595     $        844 

Interest cost on projected benefit obligation

          1,775             1,647  

Expected return on plan assets

            (528)             (518)

Amortization of net gain

              (18)            -    

Special termination benefits

           -                  659 
     $     1,824     $     2,632 

 

9


Based on its forecast at December 31, 2006, the Company expects to contribute $130,000 to its pension trust and $3,000,000 to its postretirement medical plans in 2007.

2007 Curtailments

In January 2007, defined pension benefits for certain of the Company’s employees were frozen at then current levels. As a result, the Company recognized a curtailment gain of approximately $2,850,000 in January 2007, including the Company’s 50% share of the $2,100,000 gain recognized by TNI. See Note 3.

In January 2007, defined postretirement medical benefits for certain of the Company’s employees were modified. As a result, the Company recognized a curtailment gain of approximately $1,940,000 in January 2007.

 

8 INCOME TAXES

The provision for income taxes includes deferred taxes and is based upon estimated annual effective tax rates in the tax jurisdictions in which the Company operates.

 

9 EARNINGS PER COMMON SHARE

The following table sets forth the computation of basic and diluted earnings per common share:

 

      Three Months Ended
December 31
(Thousands, Except Per Share Data)    2006     2005

Income (loss) applicable to common stock:

    

Continuing operations

   $26,689     $21,394

Discontinued operations

   (38 )   1,370

Net income

   $26,651     $22,764

Weighted average common shares

   45,972     45,587

Less non-vested restricted Common Stock

   399     327

Basic average common shares

   45,573     45,260

Dilutive stock options and restricted Common Stock

   64     140

Diluted average common shares

   45,637     45,400

Earnings per common share:

    

Basic:

    

Continuing operations

   $    0.59     $    0.47

Discontinued operations

   -         0.03

Net income

   $    0.58     $    0.50

Diluted:

    

Continuing operations

   $    0.58     $    0.47

Discontinued operations

   -         0.03

Net income

   $    0.58     $    0.50

Dividends per common share

   $    0.18     $    0.18

In the three months ended December 31, 2006 and 2005, the Company had 1,050,000 and 444,000 weighted average shares, respectively, subject to issuance under its stock option plan that have no intrinsic value and are not considered in the computation of earnings per common share.

 

10


10 STOCK OWNERSHIP PLANS

Stock Options

A summary of activity related to the Company’s stock option plan is as follows:

 

(Thousands, Except Per Share Data)    Shares    Weighted
Average
Exercise Price
   Weighted
Average
Remaining
Contractual
Term (Years)
   Aggregate
Intrinsic
Value

Outstanding, September 30, 2006

   939     $37.96      

Granted

   304       28.72      

Exercised

   (1)      21.50      

Cancelled

   (3)      36.69            

Outstanding, December 31, 2006

   1,239     $35.71    7.2    $961

Exercisable, December 31, 2006

   774     $37.09    5.9    $249

Options to purchase 1,030,000 shares of Common Stock with a weighted average exercise price of $38.46 per share were outstanding at December 31, 2005.

Total unrecognized compensation expense for unvested stock options as of December 31, 2006 is $2,770,000, which will be recognized over a weighted average period of 2.2 years.

Restricted Common Stock

The following table summarizes restricted Common Stock activity during the three months ended December 31, 2006:

 

(Thousands, Except Per Share Data)    Shares   Weighted
Average
Grant Date
Fair Value

Outstanding, September 30, 2006

   335   $43.91

Granted

   194   28.72

Vested

    (96)   45.45

Forfeited

      (2)   35.70

Outstanding, December 31, 2006

   431   $36.78

The fair value of restricted Common Stock vested during the three months ended December 31, 2006 totaled $2,727,000.

Total unrecognized compensation expense for unvested restricted Common Stock as of December 31, 2006 is $9,770,000, which will be recognized over a weighted average period of 2.1 years.

 

11 COMMITMENTS AND CONTINGENT LIABILITIES

Capital Commitments

At December 31, 2006, the Company had construction and equipment purchase commitments totaling approximately $7,708,000.

St. Louis Post-Dispatch Early Retirement Program

In 2006, the St. Louis Post-Dispatch concluded an offering of early retirement incentives that resulted in an adjustment of staffing levels. 130 employees volunteered to take advantage of the offer, which included enhanced pension and insurance benefits and lump sum cash payments based on continuous service. The cost totaled $17,778,000 before income tax benefit, with $9,124,000 recognized in 2005, $8,373,000 recognized in the three months ended December 31, 2005 and $281,000 recognized in the three months ended March 31, 2006. Approximately $7,000,000 of the cost represented cash payments made, with the remainder due primarily to enhancements of pension and other postretirement benefits.

 

11


PD LLC Operating Agreement

In 2000, Pulitzer and Herald Inc. completed the transfer of their respective interests in the assets and operations of the St. Louis Post-Dispatch and certain related businesses to a new joint venture (the Venture), known as PD LLC. Pulitzer is the managing member of PD LLC. Under the terms of the operating agreement governing PD LLC (the Operating Agreement), Pulitzer and another subsidiary hold a 95% interest in the results of operations of PD LLC and Herald holds a 5% interest. Herald’s 5% interest is reported as minority interest in the Consolidated Statements of Income and Comprehensive Income. Also, under the terms of the Operating Agreement, Herald Inc. received on May 1, 2000 a cash distribution of $306,000,000 from PD LLC (the Initial Distribution). This distribution was financed by the Pulitzer Notes. Pulitzer’s entry into the Venture was treated as a purchase for accounting purposes.

During the first ten years of its term, PD LLC is restricted from making distributions (except under specified circumstances), capital expenditures and member loan repayments unless it has set aside out of its cash flow a reserve equal to the product of $15,000,000 and the number of years since May 1, 2000, but not in excess of $150,000,000 (the Reserve). PD LLC is not required to maintain the Reserve after May 1, 2010. On May 1, 2010, Herald will have a one-time right to require PD LLC to redeem Herald’s interest in PD LLC, together with Herald’s interest, if any, in DS LLC, another limited liability company in which Pulitzer is the managing member and which is engaged in the business of delivering publications and products in the greater St. Louis metropolitan area. The May 1, 2010 redemption price for Herald’s interest will be determined pursuant to a formula yielding an amount which will result in the present value to May 1, 2000 of the after tax cash flows to Herald (based on certain assumptions) from PD LLC, including the Initial Distribution and the special distribution described below, if any, and from DS LLC, being equal to $275,000,000.

In the event the transactions effectuated in connection with either the formation of the Venture and the Initial Distribution or the organization of DS LLC are recharacterized by the Internal Revenue Service (IRS) as a taxable sale by Herald, with the result in either case that the tax basis of PD LLC’s assets increases and Herald is required to recognize taxable income as a result of such recharacterization, Herald generally will be entitled to receive a special distribution from PD LLC in an amount that corresponds, approximately, to the present value of the after tax benefit to the members of PD LLC of the tax basis increase. The adverse financial effect of any such special distribution to Herald on PD LLC (and thus Pulitzer and the Company) will be partially offset by the current and deferred tax benefits arising as a consequence of the treatment of the transactions effectuated in connection with the formation of the Venture and the Initial Distribution or the organization of DS LLC as a taxable sale by Herald. In 2005, the Company was advised that the IRS, in the course of examining the 2000 consolidated federal income tax return in which Herald Inc. was included, requested certain information and documents relating to the transactions effectuated in connection with the formation of the Venture and the Initial Distribution. The Company participated in the formulation of Herald Inc.’s response to this IRS request for information and documents. In 2006, the IRS concluded its examination without adjustment related to the Venture or the Initial Distribution and the Company considers the matter closed. The related statute of limitations expires in December 2007.

Upon termination of PD LLC and DS LLC, which will be on May 1, 2015 (unless Herald exercises the redemption right described above), Herald will be entitled to the liquidating value of its interests in PD LLC and DS LLC, to be paid in cash by Pulitzer. That amount would be equal to the amount of Herald’s capital accounts, after allocating the gain or loss that would result from a cash sale of PD LLC and DS LLC’s assets for their fair market value at that time. Herald’s share of such gain or loss generally will be 5%, but will be reduced (but not below 1%) to the extent that the present value to May 1, 2000 of the after tax cash flows to Herald from PD LLC and from DS LLC, including the Initial Distribution, the special distribution described above, if any, and the liquidation amount (based on certain assumptions), exceeds $325,000,000.

The actual amount payable to Herald either on May 1, 2010, or upon the termination of PD LLC and DS LLC on May 1, 2015 will depend on such variables as future cash flows, the amounts of any distributions to Herald prior to such payment, PD LLC’s and DS LLC’s rate of growth and market valuations of newspaper properties. While the amount of such payment cannot be predicted with certainty, the Company currently estimates (assuming a 5% annual growth rate in Herald’s capital accounts, no special distribution as described above and consistent newspaper property valuation multiples) that the amount of such payment would not exceed $100,000,000. The

 

12


Company further believes that it will be able to finance such payment either from available cash reserves or by accessing the capital markets. The redemption of Herald’s interest in PD LLC either on May 1, 2010 or upon termination of PD LLC in 2015 is expected to generate significant tax benefits to the Company as a consequence of the resulting increase in the tax basis of the assets owned by PD LLC and DS LLC and the related depreciation and amortization deductions.

Income Taxes

The Company files income tax returns with the IRS and various state tax jurisdictions. From time to time, the Company is subject to routine audits by those agencies, and those audits may result in proposed adjustments. The primary issues in audits currently in process or being contested relate to the appropriate determination of gains, and allocation to the various taxing authorities thereof, on businesses sold in 2001. The Company may also be subject to claims for transferring income tax liability related to businesses acquired in 2000. The Company has considered the alternative interpretations that may be assumed by the various taxing agencies, believes its positions taken regarding its filings are valid, and that adequate tax liabilities have been recorded to resolve such matters. However, the actual outcome cannot be determined with certainty and the difference could be material, either positively or negatively, to the Consolidated Statements of Income and Comprehensive Income in the periods in which such matters are ultimately determined. The Company does not believe the final resolution of such matters will be material to its consolidated financial position.

In June 2006, the Company received a notice of deficiency asserting transferee liability for federal income taxes and penalties, excluding interest, totaling $25,200,000 related to the acquisition of assets by the Company in 2000. In August 2006, the IRS rescinded the notice of deficiency and issued a letter, which allowed the Company to initially pursue this matter at the IRS Appeals level. In February 2007, the IRS informed the Company that it does not intend to pursue the claim. The related statute of limitations expires in December 2007.

Litigation

The Company is involved in a variety of legal actions that arise in the normal course of business. Insurance coverage mitigates potential loss for certain of these matters. While the Company is unable to predict the ultimate outcome of these legal actions, it is the opinion of management that the disposition of these matters will not have a material adverse effect on the Company’s Consolidated Financial Statements, taken as a whole.

 

12 IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In July 2006, the FASB issued Interpretation 48, Accounting for Uncertainty in Income Taxes, which is effective for fiscal years beginning after December 15, 2006. Interpretation 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement 109. Interpretation 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the Company has taken or expects to take on a tax return. The Company has not completed its evaluation of the effects of Interpretation 48 on its Consolidated Financial Statements.

In September 2006, the FASB issued Statement 157, Fair Value Measurements, which defines fair value, provides guidelines for measuring fair value and expands disclosure requirements. Statement 157 does not require any new fair value measurement but applies to the accounting pronouncements that require or permit fair value measurement. Statement 157 is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate that the implementation of Statement 157 will have a material impact on its financial position, results of operation, or cash flows.

In September 2006, the FASB issued Statement 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, which amends Statements 87, 88, 106 and 132(R). Statement 158 requires the recognition of the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and recognition of changes in that funded status in the year in which the changes occur as a component of comprehensive income. Statement 158 is effective at the end of 2007. Had Statement 158 been adopted at September 30, 2006, the Company’s assets would have increased and liabilities would have decreased in the aggregate amount of $44,191,000, less the related income tax effect, and stockholders’ equity would have increased by $44,191,000, less the related income tax effect. Actual adjustments have not been determined as the related actuarial computations have not been performed.

 

13


Statement 158 will also require the Company to change its measurement date from June 30 to September 30, beginning in 2008. The change in measurement date will require a one-time adjustment to retained earnings, the effect of which cannot be determined at this time. None of the changes required will impact the Company’s results of operations or cash flows.

 

Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion includes comments and analysis relating to the Company’s results of operations and financial condition as of and for the three months ended December 31, 2006. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes thereto and the Company’s 2006 Annual Report on Form 10-K.

NON-GAAP FINANCIAL MEASURES

Operating Cash Flow and Operating Cash Flow Margin

Operating cash flow, which is defined as operating income before depreciation, amortization, and equity in earnings of associated companies, and operating cash flow margin (operating cash flow divided by operating revenue) represent non-GAAP financial measures that are used in the analysis below. The Company believes that operating cash flow and the related margin percentage are useful measures of evaluating its financial performance because of their focus on the Company’s results from operations before depreciation and amortization. The Company also believes that these measures are several of the alternative financial measures of performance used by investors, lenders, rating agencies and financial analysts to estimate the value of a company and evaluate its ability to meet debt service requirements.

A reconciliation of operating cash flow and operating cash flow margin to operating income, the most directly comparable measure under accounting principles generally accepted in the United States of America (GAAP), is included in the table below:

 

(Thousands)    Three Months Ended
December 31, 2006
   Percent of
Revenue
  Three Months Ended
December 31, 2005
   Percent of
Revenue

Operating cash flow

   $80,931    26.9%   $71,953    24.6%

Depreciation and amortization

     23,428       7.8         21,881      7.5    

Equity in earnings of associated companies

       6,505       2.2           6,303      2.2    

Operating income

   $64,008    21.3%   $56,375    19.3%

Adjusted Income From Continuing Operations and Adjusted Earnings Per Common Share

Adjusted income from continuing operations and adjusted earnings per common share, which are defined as income from continuing operations and earnings per common share adjusted to exclude matters of a substantially non-recurring nature, represent non-GAAP financial measures that are used in the analysis below. The Company believes the use of adjusted income from continuing operations and adjusted earnings per common share provide meaningful supplemental information to investors and financial analysts with which to evaluate its financial performance by excluding matters that may not be indicative of its core business operating results and are of a substantially non-recurring nature. The Company also believes that both management and investors benefit from referring to these non-GAAP financial measures in assessing the Company’s performance and in forecasting and analyzing future periods that are not likely to include the adjusted items. References to these non-GAAP measures should not, however, be considered a substitute for income from continuing operations and earnings per common share presented in accordance with GAAP.

A reconciliation of adjusted income from continuing operations and adjusted earnings per common share to income from continuing operations and earnings per common share, respectively, the most directly comparable measures under GAAP, is set forth below under the caption “Overall Results” .

SAME PROPERTY COMPARISONS

Certain information below, as noted, is presented on a same property basis, which is exclusive of acquisitions and divestitures consummated in the current or prior year. The Company believes such comparisons provide meaningful information for an understanding of changes in its revenue and operating expenses. Same property comparisons exclude TNI and MNI. The Company owns 50% of TNI and also owns 50% of the capital stock of MNI, both of which are reported using the equity method of accounting. Same property comparisons also exclude corporate office costs.

 

14


CRITICAL ACCOUNTING POLICIES

The Company’s discussion and analysis of its results of operations and financial condition are based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to intangible assets and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Additional information follows with regard to certain of the most critical of the Company’s accounting policies.

Goodwill and Other Intangible Assets

In assessing the recoverability of its goodwill and other nonamortized intangible assets, the Company makes assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. The Company analyzes its goodwill and other nonamortized intangible assets for impairment on an annual basis or more frequently if impairment indicators are present.

The Company also periodically evaluates its determination of the useful lives of amortizable intangible assets. Any resulting changes in the useful lives of such intangible assets will not impact the cash flows of the Company. However, a decrease in the useful lives of such intangible assets would increase future amortization expense and decrease future reported operating results and earnings per common share.

Pension, Postretirement and Postemployment Benefit Plans

The Company evaluates its liability for pension, postretirement and postemployment benefit plans based upon computations made by consulting actuaries, incorporating estimates and actuarial assumptions of future plan service costs, future interest costs on projected benefit obligations, rates of compensation increases, employee turnover rates, anticipated mortality rates, expected investment returns on plan assets, asset allocation assumptions of plan assets, and other factors. If management used different estimates and assumptions regarding these plans, the funded status of the plans could vary significantly, resulting in recognition of different amounts of expense over future periods.

Income Taxes

Deferred income taxes are provided using the liability method, whereby deferred income tax assets are recognized for deductible temporary differences and loss carryforwards and deferred income tax liabilities are recognized for taxable temporary differences. Temporary differences are the difference between the reported amounts of assets and liabilities and their tax basis. Deferred income tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

The Company files income tax returns with the IRS and various state tax jurisdictions. From time to time the Company is subject to routine audits by those agencies, and those audits may result in proposed adjustments. The Company has considered the alternative interpretations that may be assumed by the various taxing agencies, believes its positions taken regarding its filings are valid, and that adequate tax liabilities have been recorded to resolve such matters.

Revenue Recognition

Advertising revenue is recorded when advertisements are placed in the publication or on the related online site. Circulation revenue is recorded as newspapers are distributed over the subscription term. Other revenue is recognized when the related product or service has been delivered. Unearned revenue arises in the ordinary course of business from advance subscription payments for newspapers or advance payments for advertising.

 

15


Uninsured Risks

The Company is self-insured for health care, workers compensation and certain long term disability costs of its employees, subject to stop loss insurance, which limits exposure to large claims. The Company accrues its estimated health care costs in the period in which such costs are incurred, including an estimate of incurred but not reported claims. Other insurance carries deductible losses of varying amounts.

The Company’s reserves for health care and workers compensation claims are based upon an estimate of the remaining liability for retained losses made by consulting actuaries. The amount of workers compensation reserve has been determined based upon historical patterns of incurred and paid loss development factors from the insurance industry.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In July 2006, the FASB issued Interpretation 48, Accounting for Uncertainty in Income Taxes, which is effective for fiscal years beginning after December 15, 2006. Interpretation 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement 109. Interpretation 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the Company has taken or expects to take on a tax return. The Company has not completed its evaluation of the effects of Interpretation 48 on its Consolidated Financial Statements.

In September 2006, the FASB issued Statement 157, Fair Value Measurements, which defines fair value, provides guidelines for measuring fair value and expands disclosure requirements. Statement 157 does not require any new fair value measurement but applies to the accounting pronouncements that require or permit fair value measurement. Statement 157 is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate that the implementation of Statement 157 will have a material impact on its financial position, results of operation, or cash flows.

In September 2006, the FASB issued Statement 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, which amends Statements 87, 88, 106 and 132(R). Statement 158 requires the recognition of the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and recognition of changes in that funded status in the year in which the changes occur as a component of comprehensive income. Statement 158 is effective at the end of 2007. Had Statement 158 been adopted at September 30, 2006, the Company’s assets would have increased and liabilities would have decreased in the aggregate amount of $44,191,000, less the related income tax effect, and stockholders’ equity would have increased by $44,191,000, less the related income tax effect. Actual adjustments have not been determined as the related actuarial computations have not been performed.

Statement 158 will also require the Company to change its measurement date from June 30 to September 30, beginning in 2008. The change in measurement date will require a one-time adjustment to retained earnings, the effect of which cannot be determined at this time. None of the changes required will impact the Company’s results of operations or cash flows.

EXECUTIVE OVERVIEW

The Company directly, and through its ownership of associated companies, publishes 56 daily newspapers in 23 states and more than 300 weekly, classified and specialty publications, along with associated and integrated online services. The Company was founded in 1890, incorporated in 1950, and listed on the New York Stock Exchange in 1978. Before 2001, the Company also operated a number of network-affiliated and satellite television stations.

In April 2002, the Company acquired ownership of 15 daily newspapers and a 50% interest in the Sioux City, Iowa daily newspaper (SCN) by purchasing Howard Publications, Inc. (Howard). This acquisition was consistent with the strategy the Company announced in 2000 to buy daily newspapers with circulation of 30,000 or more. In July 2002, the Company acquired the remaining 50% of SCN. These acquisitions increased the Company’s circulation by more than 75% and increased its revenue by nearly 50%. In February 2004, two daily newspapers acquired in the Howard acquisition were exchanged for two daily newspapers in Burley, Idaho and Elko, Nevada.

In June 2005, the Company acquired Pulitzer. Pulitzer published 14 daily newspapers, including the St. Louis Post-Dispatch, and more than 100 weekly newspapers and specialty publications. Pulitzer also owns a 50% interest in TNI. The acquisition of Pulitzer increased the Company’s circulation by more than 50% to almost 1.7 million daily and more than 1.9 million Sunday, and revenue, on an annualized basis, by more than 60%. In 2006, the Company sold the assets of The Daily News in Rhinelander, Wisconsin, the smallest of these newspapers.

 

16


In 2006, the Company sold the assets of its publishing and commercial printing operations in Seattle and Spokane, Washington and Portland, Oregon.

The Company is focused on six key strategic priorities. They are to:

 

   

Grow revenue creatively and rapidly;

 

   

Emphasize strong local news;

 

   

Accelerate our online innovation;

 

   

Increase circulation, readership and online audience;

 

   

Nurture employee development and achievement; and

 

   

Exercise careful cost control.

Certain aspects of these priorities are discussed below.

More than 75% of the Company’s revenue is derived from advertising. The Company’s strategies are to increase its share of local advertising through increased sales pressure in its existing markets and, over time, to increase readership and circulation unit sales through internal expansion into existing and contiguous markets and enhancement of online offerings, augmented by selective acquisitions. Acquisition efforts are focused on newspapers with daily circulation of 30,000 or more, as noted above, and other publications and online businesses that increase the Company’s operating revenue.

Increases in same property advertising revenue in the three months ended December 31, 2006 more than offset increases in same property operating costs, resulting in growth in operating cash flow, operating income and earnings from continuing operations.

 

17


THREE MONTHS ENDED DECEMBER 31, 2006

Operating results, as reported in the Consolidated Financial Statements, are summarized below:

 

     Three Months Ended
December 31
   Percent Change
(Thousands, Except Per Share Data)    2006    2005    Total   Same Property

Advertising revenue:

          

Retail

   $132,643    $131,346       1.0%      1.0%

National

       17,902        17,659       1.4        1.4  

Classified:

          

Daily newspapers:

          

Employment

       19,248        20,091      (4.2)     (4.2)

Automotive

       14,038        14,212      (1.2)     (1.2)

Real estate

       14,891        15,387      (3.2)     (3.2)

All other

         9,502          9,177       3.5       3.5 

Other publications

       11,424        10,479       9.0       8.8 

Total classified

       69,103        69,346      (0.4)     (0.4)

Online

       10,913          7,134    53.0   53.0

Niche publications

         3,599          3,414       5.4       5.4 

Total advertising revenue

     234,160      228,899       2.3       2.3 

Circulation

       52,271        51,587       1.3       1.3 

Commercial printing

         4,210          4,320      (2.5)     (0.7)

Online services and other

         9,849          7,439    32.4   18.9

Total operating revenue

     300,490      292,245       2.8       2.5 

Compensation

     113,012      110,923       1.9       0.2 

Newsprint and ink

       31,101        30,160       3.1       4.3 

Other operating expenses

       75,446        70,484       7.0       5.7 

Early retirement program

       -          8,373       NM       NM 

Transition costs

       -             352       NM       NM 

Total operating expenses, excluding depreciation and amortization

     219,559      220,292      (0.3)     (1.4)

Operating cash flow

       80,931        71,953    12.5   12.9

Depreciation and amortization

       23,428        21,881       7.1       6.5 

Equity in earnings of associated companies

         6,505          6,303       3.2   

Operating income

       64,008        56,375    13.5  

Non-operating expense, net

      (21,926)       (22,681)      (3.3)  

Income from continuing operations before income taxes

       42,082        33,694    24.9  

Income tax expense

       14,889        12,041    23.7  

Minority interest

            504             259    94.6  

Income from continuing operations

   $  26,689    $  21,394      24.7%    

Earnings per common share:

          

Basic

   $      0.59    $      0.47    25.5%  

Diluted

           0.58            0.47    23.4      

Day exchanges in the quarter affected results in varying degrees. Newspapers owned before the Pulitzer acquisition, which account for approximately 60% of revenue, recorded 14 Sundays in the three months ended December 31, 2006, compared with 13 in the prior year quarter. Sundays normally generate more advertising revenue than any other day of the week. In December 2006, however, the last two Sundays preceded holidays, which tends to diminish retail and classified advertising. The former Pulitzer newspapers use period accounting and were not affected by day exchanges.

In total, acquisitions and divestitures accounted for $1,077,000 of operating revenue and $1,001,000 of operating expenses, other than depreciation and amortization, in the three months ended December 31, 2006. Acquisitions and divestitures accounted for $80,000 of operating revenue and $63,000 of operating expenses other than depreciation and amortization, in the three months ended December 31, 2005. For the three months ended December 31, 2006, total same property operating revenue increased $7,248,000, or 2.5%.

 

18


Advertising Revenue

Same property advertising revenue increased $5,204,000, or 2.3% for the three months ended December 31, 2006. Same property retail revenue increased $1,261,000, or 1.0%. Same property average retail rate, excluding preprint insertions, increased 0.9%. Same property preprint insertion revenue increased 4.2%.

Same property classified advertising revenue decreased 0.4% for the three months ended December 31, 2006. Higher margin employment advertising at the daily newspapers decreased 4.2% on a same property basis, and same property real estate classified revenue decreased 3.2%. Same property automotive classified advertising decreased 1.2% amid a continuing industry-wide decline. Same property average classified rates decreased 2.9%.

Advertising lineage, as reported on a same property basis for the Company’s daily newspapers only, consisted of the following:

 

     Three Months Ended
December 31
    
(Thousands of Inches)    2006    2005    Percent Change

Retail

   3,733    3,754    (0.6)%

National

      203       229    (11.4)     

Classified

   3,959    3,934       0.6     
     7,895    7,917    (0.3)%

Online advertising increased $3,779,000, or 53.0%, on a same property basis, due to rate increases and expanded cross-selling with the Company’s print publications. Advertising in niche publications increased 5.4% on a same property basis, due in part to new publications in existing markets.

Circulation and Other Revenue

Same property circulation revenue increased $667,000, or 1.3%, in the current year quarter. The Company’s unaudited average daily newspaper circulation units, including TNI and MNI, decreased 0.3% and Sunday circulation decreased 1.0% for the three months ended December 2006, compared to the prior year. In spite of modest declines in circulation, the Company is reaching an increasingly larger share of its markets through rapid online growth, as well as through additional specialty and niche publications.

Same property commercial printing revenue decreased $30,000, or 0.7%. Same property online services and other revenue increased $1,407,000, or 18.9%.

Operating Expenses and Results of Operations

Same property compensation expense increased $226,000, or 0.2%, in the current year quarter. Same property full-time equivalent employees decreased 1.4% year over year. Normal salary increases and associated increases in related payroll taxes contributed to the increase. Same property newsprint and ink costs increased $1,288,000, or 4.3%, in the current year quarter due to newsprint and ink price increases, offset by a decrease in usage. Newsprint prices, which had been increasing since the summer of 2002, began to decrease in September 2006. Same property newsprint volume decreased 4.7% due to migration to lighter weight paper and narrower page widths. Same property other operating costs, which are comprised of all operating expenses not considered to be compensation, newsprint and ink, depreciation or amortization, increased $3,862,000, or 5.7%, in the current year quarter. Expenses to maintain circulation, postage and outside printing costs contributed to the growth in other operating expenses.

In 2006, the St. Louis Post-Dispatch concluded an offering of early retirement incentives that resulted in an adjustment of staffing levels. 130 employees volunteered to take advantage of the offer, which included enhanced pension and insurance benefits and lump sum cash payments based on continuous service. The cost totaled $17,778,000 before income tax benefit, with $9,124,000 recognized in 2005, $8,373,000 recognized in the three months ended December 31, 2005 and $281,000 recognized in the three months ended March 31, 2006. Approximately $7,000,000 of the cost represented cash payments made, with the remainder due primarily to enhancements of pension and other postretirement benefits.

 

19


Transition costs related to the acquisition of Pulitzer totaled $352,000 for the three months ended December 31, 2005. Such costs are not included in same property comparisons. Transition costs are comprised of costs directly related to the acquisition of Pulitzer that are separately identifiable and non-recurring, but not capitalizable under GAAP.

Operating cash flow improved 12.5% to $80,931,000 in the current year quarter from $71,953,000 in the prior year. Operating cash flow margin increased to 26.9% from 24.6% in the prior year quarter due to the inclusion of one-time costs in the prior year quarter, and a 12.9% increase in same property operating cash flow. Same property operating cash flow margin increased to 29.9%, from 27.1% in the prior year quarter.

Depreciation and amortization expense increased $1,399,000, or 6.5%, on a same property basis. In 2006, the Company, based on its most recent analysis and in conjunction with its ongoing requirement to assess the estimated useful lives of intangible assets, concluded that the period of economic benefit of certain identified intangible assets related to the Pulitzer acquisition had decreased. As a result, the weighted-average useful life of customer lists was decreased from approximately 21 years to 17 years, resulting in the increase in amortization expense.

Equity in earnings of associated companies increased to $6,505,000 in the current year quarter, compared to $6,303,000 in the prior year quarter. TNI, which uses period accounting, had 14 weeks of business activity in the three months ended December 31, 2006, compared with 13 weeks in the prior year quarter. Operating income increased 13.5% to $64,008,000. Operating income margin increased to 21.3% from 19.3%.

Nonoperating Income and Expense

Financial expense decreased $602,000 due to lower levels of debt, partially offset by higher interest rates.

Overall Results

The Company’s effective income tax rate decreased to 35.4% from 35.7% in the prior year quarter. The Company believes, absent unusual tax settlements, that its effective income tax rate in 2007 will approximate the rate in the three months ended December 31, 2006.

As a result of all of the above, earnings per diluted common share increased 23.4% to $0.58 per share from $0.47 per share in the prior year quarter. Excluding unusual costs, as detailed in the table below, diluted earnings per common share, as adjusted, were $0.58 for the three months ended December 31, 2006, compared to $0.59 in the prior year quarter.

 

      Three Months Ended December 31
      2006    2005
(Thousands, Except Per Share Data)    Amount    Per Share    Amount    Per Share

Income from continuing operations, as reported

   $26,689    $0.58    $21,394     $0.47

Adjustments to income from continuing operations:

           

Early retirement program

   -           8,373    

Transition costs

   -                352      
             8,725    

Income tax benefit of adjustments, net

   -             (3,133)     
   -    -        5,592       0.12

Income from continuing operations, as adjusted

   $26,689    $0.58    $26,986    $0.59

LIQUIDITY AND CAPITAL RESOURCES

Cash provided by operating activities of continuing operations was $37,139,000 for the three months ended December 31, 2006, and $43,887,000 for the same period in 2005. Increased net income was more than offset by changes in working capital, accounting for the change between years.

Cash required for investing activities totaled $7,176,000 for the three months ended December 31, 2006, and $5,228,000 in the same period in 2005. Capital expenditures account for substantially all of the usage of funds in both the current year and prior year periods.

 

20


The Company anticipates that funds necessary for future capital expenditures and other requirements will be available from internally generated funds, its Credit Agreement or, if necessary, by accessing the capital markets.

In 2006, the Company entered into the Credit Agreement with a syndicate of financial institutions. The Credit Agreement provides for aggregate borrowings of up to $1,435,000,000, including a $450,000,000 revolving credit facility. The Credit Agreement also provides the Company with the right, with the consent of the administrative agent, to request at certain times prior to June 2012 that one or more lenders provide incremental term loan commitments of up to $500,000,000, subject to certain requirements being satisfied at the time of the request. The Credit Agreement matures in June 2012.

In 2005, the Company filed a Form S-3 shelf registration statement (Shelf) with the SEC, which has been declared effective. The Shelf gives the Company the flexibility to issue and publicly distribute various types of securities, including preferred stock, common stock, secured or unsecured debt securities, purchase contracts and units consisting of any combination of such securities, from time to time, in one or more offerings, up to an aggregate amount of $500,000,000.

The Shelf enables the Company to sell securities quickly and efficiently when market conditions are favorable or financing needs arise. Net proceeds from the sale of any securities may be used for general corporate purposes, including repayment or refinancing of debt, working capital, capital expenditures, acquisitions or the repurchase of common stock, subject to conditions of existing debt agreements.

Cash required for financing activities of continuing operations totaled $47,060,000 during the three months ended December 31, 2006, and provided $35,997,000 in the prior year quarter. Debt repayments and dividends accounted for the primary usage of funds in both years.

Cash provided by discontinued operations totaled $19,202,000 in the three months ended December 31, 2006 and $1,174,000 in the three months ended December 31, 2005. Cash generated from the sales of discontinued operations was the primary source of funds in the current year quarter. Cash generated from operations was the primary source of funds in 2005.

Cash and cash equivalents increased $2,105,000 for the three months ended December 31, 2006, and increased $3,836,000 for the same period in 2005.

INFLATION

The Company has not been significantly impacted by general inflationary pressures over the last several years. The Company anticipates that changing costs of newsprint, its basic raw material, may impact future operating costs. Price increases (or decreases) for the Company’s products are implemented when deemed appropriate by management. The Company continuously evaluates price increases, productivity improvements, sourcing efficiencies and other cost reductions to mitigate the impact of inflation.

 

Item  3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risk stemming from changes in interest rates and commodity prices. Changes in these factors could cause fluctuations in earnings and cash flows. In the normal course of business, exposure to certain of these market risks is managed as described below.

INTEREST RATES

Restricted Cash and Investments

Interest rate risk in the Company’s restricted cash and investments is managed by investing only in securities with maturities no later than May 2010, after which time all restrictions on such funds lapse. Only U.S. Government and related securities are permitted.

Debt

The Company’s debt structure and interest rate risk are managed through the use of fixed and floating rate debt. The Company’s primary exposure is to the London Interbank Offered Rate (LIBOR). A 100 basis point increase to LIBOR would decrease income from continuing operations before income taxes on an annualized basis by approximately $8,310,000, based on $831,000,000 of floating rate debt outstanding at December 31, 2006, after consideration of the interest rate swaps described below, and excluding debt of MNI. Such interest rates may also decrease.

 

21


In 2005, the Company executed interest rate swaps in the notional amount of $350,000,000 with a forward starting date of November 30, 2005. The interest rate swaps have terms of two to five years, carry interest rates from 4.2% to 4.4% (plus the applicable LIBOR margin) and effectively fix the Company’s interest rate on debt in the amounts, and for the time periods, of such instruments. Certain of the Company’s interest-earning assets, including those in employee benefit plans, also function as a natural hedge against fluctuations in interest rates on debt.

At December 31, 2006, after consideration of the interest rate swaps described above, approximately 56% of the principal amount of the Company’s debt is subject to floating interest rates.

COMMODITIES

Certain materials used by the Company are exposed to commodity price changes. The Company manages this risk through instruments such as purchase orders and non-cancelable supply contracts. The Company is also involved in continuing programs to mitigate the impact of cost increases through identification of sourcing and operating efficiencies. Primary commodity price exposures are newsprint and, to a lesser extent, ink and energy costs. Newsprint prices have recently begun to decline, after rising for more than four years.

A $10 per metric ton newsprint price increase would result in an annualized reduction in income before income taxes of approximately $1,730,000 based on anticipated consumption in 2007, excluding consumption of MNI and TNI. Such prices may also decrease.

In January 2007, Abitibi-Consolidated Inc. and Bowater Inc. announced a merger of the two companies. The merger would significantly increase the market share of the combined company from that of the individual companies and is expected to create substantial operating efficiencies. The Company acquires newsprint and specialty paper products from both Abitibi-Consolidated Inc and Bowater Inc. At the present time, the impact on pricing of products sold to the Company as a result of the merger cannot be determined.

SENSITIVITY TO CHANGES IN VALUE

The estimate that follows is intended to measure the maximum potential impact on fair value of fixed rate debt of the Company in one year from adverse changes in market interest rates under normal market conditions. The calculation is not intended to represent the actual loss in fair value that the Company expects to incur. The estimate does not consider favorable changes in market rates. The position included in the calculation is fixed rate debt, the principal amount of which totals $306,000,000 at December 31, 2006.

The estimated maximum potential one-year loss in fair value from a 100 basis point movement in interest rates on market risk sensitive investment instruments outstanding at December 31, 2006 is approximately $6,862,000. There is no impact on reported results or financial condition from such changes in interest rates.

Changes in the fair value of interest rate swaps from movements in interest rates are not determinable, due to the number of variables involved in the pricing of such instruments. However, increases in interest rates would generally result in increases in the fair value of such instruments.

 

Item  4. Controls and Procedures

In order to ensure that the information that must be disclosed in filings with the Securities and Exchange Commission is recorded, processed, summarized and reported in a timely manner, the Company has disclosure controls and procedures in place. The chief executive officer, Mary E. Junck, and chief financial officer, Carl G. Schmidt, have reviewed and evaluated the disclosure controls and procedures as of December 31, 2006, and have concluded that such controls and procedures are effective.

There have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, such controls during the three months ended December 31, 2006.

 

22


PART II OTHER INFORMATION

 

Item  2(c). Issuer Purchases of Equity Securities

During the three months ended December 31, 2006, the Company purchased shares of Common Stock, as noted in the table below, in transactions with participants in its 1990 Long-Term Incentive Plan. The transactions resulted from the withholding of shares to fund the exercise price and/or taxes related to the exercise of stock options. The Company is not currently engaged in share repurchases related to a publicly announced plan or program.

 

Month    Total Number of Shares
Purchased
   Average Price
Per Share

November

   35,184    $28.47

 

Item  6. Exhibits

 

Number    Description
31    Rule 13a-14(a)/15d-14(a) certifications
32    Section 1350 certification

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

LEE ENTERPRISES, INCORPORATED  

/s/ Carl G. Schmidt

  Date: February 9, 2007

Carl G. Schmidt

Vice President, Chief Financial Officer and Treasurer

(Principal Financial and Accounting Officer)

 

 

23

Rule 13a-14(a)/15d-14(a) certifications of CEO & CFO

Exhibit 31

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Mary E. Junck, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q (Quarterly Report) of Lee Enterprises, Incorporated (Registrant);

 

2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;

 

3. Based on my knowledge, the Consolidated Financial Statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Quarterly Report;

 

4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

 

  a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;

 

  b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this Quarterly Report based on such evaluation; and

 

  d) disclosed in this Quarterly Report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

 

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the Audit Committee of Registrant’s Board of Directors (or persons performing the equivalent functions):

 

  a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to affect the Registrant’s ability to record, process, summarize and report financial information; and

 

  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: February 9, 2007

 

/s/ Mary E. Junck

Mary E. Junck

Chairman, President and Chief Executive Officer


CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Carl G. Schmidt, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q (Quarterly Report) of Lee Enterprises, Incorporated (Registrant);

 

2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;

 

3. Based on my knowledge, the Consolidated Financial Statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Quarterly Report;

 

4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

 

  a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;

 

  b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this Quarterly Report based on such evaluation; and

 

  d) disclosed in this Quarterly Report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

 

5. The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the Audit Committee of Registrant’s Board of Directors (or persons performing the equivalent functions):

 

  a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to affect the Registrant’s ability to record, process, summarize and report financial information; and

 

  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: February 9, 2007

 

/s/ Carl G. Schmidt

Carl G. Schmidt

Vice President, Chief Financial Officer and Treasurer

Section 1350 certification of CEO & CFO

Exhibit 32

The following statement is being furnished to the Securities and Exchange Commission solely for purposes of Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350), which carries with it certain criminal penalties in the event of a knowing or willful misrepresentation.

Securities and Exchange Commission

450 Fifth Street, NW

Washington, DC 20549

 

Re: Lee Enterprises, Incorporated

Ladies and Gentlemen:

In accordance with the requirements of Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350), each of the undersigned hereby certifies that to our knowledge:

 

(i) this quarterly report on Form 10-Q for the period ended December 31, 2006 (Quarterly Report), fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

 

(ii) the information contained in this Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of Lee Enterprises, Incorporated for the periods presented in the Quarterly Report.

Dated as of this 9th day of February, 2007

 

/s/ Mary E. Junck

   

/s/ Carl G. Schmidt

Mary E. Junck     Carl G. Schmidt
Chairman, President and     Vice President, Chief Financial Officer
Chief Executive Officer     and Treasurer

A signed original of this written statement required by Section 906 has been provided to Lee Enterprises, Incorporated and will be retained by Lee Enterprises, Incorporated and furnished to the Securities and Exchange Commission upon request.