Lee Enterprises, Incorporated (NASDAQ:LEE) Q2 2023 Earnings Call Transcript May 7, 2023

Operator: Welcome to the Lee Enterprise 2023 Second Quarter Webcast and Conference Call. The call is being recorded and will be available for replay at investors.lee.net. A link to the live webcast can be found at investors.lee.net. Now, I will turn the call over to your host, Josh Rinehults, Vice President, Finance. Please go ahead.

Josh Rinehults: Good morning and thank you for joining us. Speaking on this morning’s call are Kevin Mowbray, President and Chief Executive Officer; and Tim Millage, Vice President, Chief Financial Officer and Treasurer. Also with us today and available for questions is Nathan Bekke, Vice President, Audience Strategy. Earlier today, we issued a news release with preliminary results for our second fiscal quarter of 2023. It is available at lee.net as well as at major financial websites. Please also refer to our earnings presentation found at investors.lee.net that includes supplemental information. As a reminder, this morning’s discussion will include forward-looking statements based on our current expectations. These statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially.

Such factors are described in this morning’s news release and also in our SEC filings. During the call, we refer to certain non-GAAP financial measures, including adjusted EBITDA and cash costs, which are defined in our news release. Reconciliations to the relevant GAAP measures are included in tables accompanying the release. And now to open the discussion is our President and Chief Executive Officer, Kevin Mowbray. Kevin will open the conversation on Slide 3 of the earnings presentation for those following along.

Kevin Mowbray: Good morning, everyone, and thank you for joining us. The key themes we’ll cover on today’s call include Lee’s delivering industry-leading performance in a dynamic operating environment. We’ll also discuss how our Three Pillar Digital Growth Strategy is transforming Lee into a vibrant digitally centric company that positions us well to drive value for all stakeholders. And lastly, Tim will review our second quarter results, including reaffirming our FY ‘23 guidance. We are transforming Lee into a digitally centric company, and our subscription platform provides communities with valuable, intensive local news. Our Three Pillar Digital Growth Strategy is transforming Lee to a digitally centric company, which is transforming the mix of our revenue.

And we’re well positioned to drive value for shareholders as we continue to execute through our transformation. We are pleased with our industry-leading performance as Lee continues to be the fastest-growing digital subscription platform in local media. Digital subscribers grew 21% in our fiscal second quarter and now total 596,000 digital subscribers. Through our thoughtful data-driven approach to converting the vast addressable market of readers to our digital products, we’ve consistently outpaced the industry in growth. Over the last 3 years, we’ve grown digital subscribers nearly 50% annually. And what gives us even more confidence is we’re growing ARPU right along with our industry-leading unit growth. On the advertising side, we’ve created Amplified Digital agency several years ago, and we built it from the ground up.

Amplified deploys an omnichannel sales approach and provides a full suite of products and marketing services to local and regional advertisers. Amplified has earned $86 million in revenue over the last 12 months and has grown at a compound annual growth rate of 41% over the last 3 years, including meeting the industry and digital revenue growth. Growth in digital subscription revenue and digital advertising revenue is rapidly growing total digital revenue at Lee. Over the last 12 months, total digital revenue at Lee is more than $250 million, up 21% year-over-year. The significant growth of our digital strategy from our Three Pillar Digital Growth Strategy has transformed the composition of Lee’s overall revenue. When we first launched our Three Pillar Digital Growth Strategy, digital revenue represented only 21% of our total operating revenue.

And after 2.5 years of strong execution, digital revenue now represents 38% of our revenue. As we continue our transformation, we expect that by 2026, more than half of our revenue will be digital, allowing for more consistent overall top line revenue performance. Our industry-leading growth in both digital subscriptions and Amplified will continue to drive Lee to this inflection point. Our Three Pillar Digital Growth Strategy is guiding our digital transformation. We’re focused on expanding digital audiences, growing our digital subscriber base and revenue and diversifying and expanding our offerings for local advertisers. This strategy and execution are expected to result in $435 million of recurring sustainable digital revenue by 2026.

Slide 8 offers an in-depth look at Pillar 1 focused on expanding digital audiences with local journalism as the foundation. This encompasses everything from coverage of breaking news and local business to in-depth investigative reporting that leads to meaningful change in the communities we serve. Our goal is to expand our audiences by providing compelling local content using best-in-class storytelling that reflects an uplift to communities we serve. We’ve made significant progress in Pillar 1 by improving the user experience in our digital products and hiring top digital native talent. We’ve redesigned our digital products and improved our multimedia presentation with an emphasis on video and audio. While Pillar 1 is all about driving readers to the top of the subscription funnel, Pillar 2 is all about converting more of our vast addressable market to digital subscribers.

We’ve made tremendous progress in this area as we have 596,000 digital subscribers today. As we learn more about our readers, that information will inform our sophisticated marketing tactics that are aimed at converting readers to subscribers. We have made a lot of progress on our digital subscription strategy, and one of the proof points that gives us confidence is the growth in our known user base. Knowing our readers allow us to put the right offer in front of the right user at the right time. And we’ve grown our known user base by more than 100% in 6 months. We now have nearly 12 million known users. Also of importance, we’ve maintained solid conversion rates driving the growth in digital subscribers. Our Pillar 2 strategy is working and is expected to drive 900,000 digital subscribers and more than $100 million of highly profitable digital subscription revenue by 2026.

Turning to Slide 10, our third pillar focuses on diversifying and expanding our offerings for advertisers, both through Amplified and our owned-and-operated digital products. With advanced data-driven ad techs, specialized category expertise, scalable custom video content and powerful first-party data access, Amplified is a strong partner for local and regional businesses looking to drive growth. We continue to see a significant growth runway as we execute on this strategy. While Amplified the growth engine for our top line digital advertising revenue, our massive owned-and-operated digital audience fuel high-margin digital advertising revenue. Our owned-and-operated properties attract massive audiences, and we’re offering more video inventory and branded content opportunities to boost digital advertising revenue.

Execution of our Pillar 3 tactics is expected to drive $310 million of annual digital advertising revenue in 2026. Our full year outlook for 2023 total digital revenue is $270 million to $285 million. By 2026, we expect total digital revenue to be $435 million and digital revenue will make up more than half of our total revenue. Our total digital revenue will be led by the continued rapid growth of both Amplified Digital and our digital-only subscription revenue. Here are some key takeaways to our digital transformation. Lee is the fastest-growing digital subscription platform in local media. We have more than 600,000 digital subscribers and a vast addressable market sufficient to achieve our goals of 900,000 million subscribers and more than $100 million of digital subscription revenue by 2026.

And on the advertising side, Lee is the fastest-growing digital marketing service provider, and our Vision platform uniquely positions us to reach local advertisers’ high demand for our digital marketing services. This is expected to drive more than $300 million of digital advertising revenue. We are incredibly proud of the digital transformation well underway at Lee. Our Three Pillar Digital Growth Strategy is driving our industry-leading growth and transforming the composition of our revenue. As we move through our transformation and achieve our long-term goals, we expect to drive significant value for our shareholders through converting debt to equity and through repositioning Lee as a digital company. We couldn’t be more proud of our progress this team has made and remain confident where Lee is headed.

And now I’ll turn it over to Tim with more details on our second quarter results.

Tim Millage: Thank you, Kevin and good morning everyone. Total operating revenue was $171 million in the second quarter. Digital revenue growth continued at a strong pace with total digital revenue up 12%, driven by a 39% growth in digital subscription revenue. At the end of the quarter, we have 596,000 subscribers to our digital products, a 21% growth over the prior year. On the advertising side, digital advertising revenue increased 7% compared to the second quarter last year, driven by 20% growth in revenue at Amplified Digital. Amplified revenue totaled $22 million in the quarter. As seen in the broader industry, our print revenue performance continues to be challenged. On the advertising side, we’re seeing the impact of the broader slowdown in ad spending from both national accounts and local accounts.

This impacted both the print side as well as contributed to a modest slowdown in growth of digital advertising. On the print subscription side, we’re seeing continued higher-than-historical unit erosion, which is keeping our full access revenue trends down closer to industry trends, and we do expect these trends to continue for the remainder of the fiscal year. Cash costs were down 10% as we responded quickly to the soft revenue environment. Adjusted EBITDA totaled $14 million in the second quarter, with year-over-year trends dramatically improved as we cut the first quarter trend in half. As a result of the continued secular decline in print revenue, combined with a soft advertising environment, we continue to identify opportunities to further optimize our cost structure.

For the fiscal year, we expect to realize between $86 million and $96 million in cost benefits from business transformation initiatives executed midway through last year and new initiatives executed midway through the second quarter of this year. These actions include reductions to our base of costs that are directly tied to print, particularly in distribution, manufacturing, corporate services as well as print advertising. The $76 million of annualized cost reductions executed in the middle of the second quarter will have a $48 million cost benefit in fiscal year 2023. In addition to the permanent cost actions, there are a number of temporary cost actions that will have a $12 million benefit on costs this year. While we remain focused on operational excellence and reducing the cost structure of our print business and growing profits, our main priority is to drive long-term sustainable digital revenue growth.

Therefore, we continue to invest in talent and technology in areas of our business tied to our digital future, and our commitment to high-quality local news remains steadfast. The targeted investments will drive our digital future and will impact our cash costs in fiscal year ‘23. We expect the investment we’re making in new talent and technology and the increased digital cost of goods sold to increase our total cost by approximately $25 million this year. These costs will have a short-term impact on our margin profile but are expected to drive Lee’s digital transformation. Moving to Slide 17. We continue to strengthen our balance sheet. The principal amount of debt at the end of the second quarter was $460 million, down $3 million from last quarter.

As a reminder, our credit agreement with Berkshire Hathaway, our sole lender has favorable terms that are incredibly important for us as we execute our strategy. It allows us the ability to make the necessary investments that fuel our recurring sustainable revenue growth. The agreement was executed in 2020 and have a fixed interest rate and a 25-year maturity. These favorable terms have been incredibly helpful in the rising rate environment we have seen over the last few years. In the second quarter, we did not make any pension contributions, and we do not expect to make any for the remainder of fiscal year 2023. Finally, we continue to identify opportunities to monetize non-core assets, which facilitate accelerated debt repayment. We closed $5.6 million of asset sales this fiscal year through the second quarter and have identified an additional $30 million of non-core assets to monetize, which are in various phases of the sale process.

As a reminder, with solid execution of our Three Pillar Digital Growth Strategy as well as our commitment to improving our balance sheet, our goal is to achieve our long-term leverage target of under 2.5x. On Slide 19, we’re summarizing our fiscal 2023 outlook. Despite the dynamic operating environment, we are reaffirming our guidance due to the swift actions taken by the team. Total digital revenue is expected to be in the range of $270 million to $285 million. Hitting the midpoint represents modest back half improvement, driven by continued strong digital subscription revenue growth and strong growth at Amplified. Digital subscribers are expected to total 632,000 at the end of the year, and we are highly confident as the back half unit growth can moderate a bit and still achieve our guidance.

Adjusted EBITDA is projected between $94 million and $100 million. Despite the macro environment, we have reset our projections and taken swift action on the cost side, taking $76 million out of the organization, and that gives us the pathway to back half adjusted EBITDA growth and achieving within the range of our full year outlook. And with that, I will turn it back over to Kevin to wrap up.

Kevin Mowbray: Thanks, Tim. Under the guidance and oversight of our Board of Directors, our leadership team’s continued execution of our growth strategy sets the stage for significant long-term value creation. Our Three Pillar Digital Growth Strategy is the foundation of our investment thesis, and the execution on that strategy is at the core of creating value for shareholders. To wrap up, I’d like to thank the entire Lee team for their efforts of driving our transformation. We have the right Board, the right team and the right strategy, and I believe we’re well positioned better than ever to create long-term value for our readers, our users, advertisers and shareholders. This concludes our remarks. The team will remain on the line for any questions. Operator, please open the line for questions.

Q&A Session

Operator: I have a question from Michael Kupinski of Noble Capital Markets. Your line is open.

Michael Kupinski: Thank you. A couple of questions. First of all, congratulations on your solid quarter. You indicated that you went through around the cost cuts last year and then, again, initiated further cost reductions. And I was wondering, in this latest quarter, was the – were there any cost reductions that were related to the last announcement effective in this quarter? And if so, how much of that $76 million that you were talking about in annualized costs were effective in this quarter?

Tim Millage: Yes. As you mentioned, Mike, the second quarter results did have a partial quarter impact, not quite half a quarter. We had about $9 million to $10 million impact in the quarter. And we do expect the reductions that we took in the second quarter, which, when annualized, were about $76 million. The full year impact is $48 million.

Michael Kupinski: And were – so was there – is there any way to kind of give us a thought or color on how much of that $76 million would have been in this quarter? I know it was mid-quarter, but…

Tim Millage: Around $9 million to $10 million impact.

Michael Kupinski: $9 million to $10 million, okay. I’m sorry, I missed that. And then can you talk a little bit about the digital margins in the quarter and how they are trending? Can you just kind of give us some thoughts about that?

Tim Millage: Yes, I think it’s a really good question. I think from a – on a subscription side, with the scaling of digital subscribers and scaling of that revenue, every incremental dollar that we see there is really almost pure profit. So we are seeing good scaling of the margins on the digital subscription side. On the Amplified, on the digital advertising side, I think the same thing is also true. We’re seeing some really good growth in top line revenue on Amplified, and the costs are not scaling in correlation with that. So we’re seeing some margin improvement on the advertising side as well. So I think the bottom line is, as we move through our digital transformation, we are seeing a good margin expansion of that digital business, which is great.

Michael Kupinski: Got it. And your total subscription revenue was a little stronger than I was looking for. You indicated that trends are pretty positive there, and you could even see some moderation in the second half. I assume that, to hit your target, it seems like you’re trending above your guidance at this point, but you might be just a little cautious. Maybe you can add a little color there? And then also, were there any rate increases in there that were effective in the quarter that might – accounted for a little bit better revenue trends?

Tim Millage: Yes. So our 632,000 digital-only subscriber guidance does imply some back half moderation. And one of the things that we’ve always talked about is we’re trying to drive units and rate transact overall revenue. And so this isn’t going to be a perfectly linear unit growth because we’re pulling rate levers as well as unit levers. And so as we continue to grow revenue, some quarters, we will see higher-than-expected unit growth. And in some quarters, we expect higher-than-expected ARPU growth. And what we saw in the second quarter was 20% plus growth in units and low double-digit teens growth on rates that’s driving that 39% growth in revenue, and we expect that to continue in the back half.

Michael Kupinski: Got it. Well, good results. Thank you.

Tim Millage: Alright. We have some questions on the web.

Josh Rinehults: Yes. Our first question is, have you considered and considering adjusting the frequency of your daily print products this year?

Tim Millage: Yes. So over the last 3 to 4 years, we have been able to retain a lot more of our print subscribers and more of our print subscription revenue relative to others in the industry. And that said, we are seeing unit declines accelerating in 2023, resulting in revenue trends closer to what the rest of the industry has seen for a couple of years. You may have seen we did announce in one of our markets to move to produce a robust, high-quality print product 3 days a week. And we’re evaluating our print products with the goal of continuing to provide our local communities with robust, high-quality local news and the best possible print product in our local markets, at the same time as managing the cash flow and these revenue streams as they mature. That is it from questions over the web.

Josh Rinehults: And with that, I’d like to thank everybody for your interest in Lee and thank you for joining the call today.

Operator: That concludes today’s conference call. Thank you all for joining. You may now disconnect. Everyone, have a great day.