What’s next for Lee?
So, let’s not forget that there is a reasonably robust business here. The problems are that (a) the business is not as robust as it used to be and (b) the business may not be robust enough to make a $142.5 million debt payment due this spring.
Because Lee is unlikely to have the cash to pay off that loan, its auditors questioned the company’s ability to remain a “going concern” in the annual report filed on New Year’s Eve. The report sent shudders through the company and prompted a number of questions I will endeavor to answer below. But first, a bit of perspective:
While Lee is in a distinctly unpleasant position with respect to its shareholders and lenders, it is important to note that the business generated $207.2 million in operating profits last year on sales of a bit more than $1 billion. Its operating margin of 20.1% surpasses that of Exxon Mobil Corp., which generated a 19.1% margin in the last 12 months. And Lee’s profitability positively blows away Wal-Mart, the largest Fortune 500 company, whose margins were only 7.4% in the prior 12 months.
As rich as Lee’s profits are, however, they used to be richer. Its earnings before interest, taxes, depreciation and amortization (EBITDA) were 30.7% lower in 2008 than in the previous fiscal year. And that’s a big problem for a company that shouldered some $1.4 billion in debt to buy Pulitzer in 2005 in the expectation that rising sales and profits would enable it to repay the loans.
Unfortunately for Lee and several other publishers who also loaded up on more debt than they can handle, newspaper ad sales began collapsing after reaching an all-time industry high of $49.4 billion in 2005. (In 2008, sales probably were no better than $38 billion, reflecting a 23% plunge in just three years.) You can blame the collapse on major changes in the behavior of consumers and marketers, aggravated last year by the scariest economy since the Depression.
Now, Lee is in danger of having its shares dropped from the New York Stock Exchange and its auditors have warned that the company may default on its loans. Here are answers to the most frequently asked questions about these unsettling developments:
Q. If Lee had an operating profit of $207.2 million, why did it report a net loss of $888.7 million for the fiscal year ended on Sept. 28, 2008?
A. Operating profit, or EBITDA, reflects the difference between sales and the actual costs associated with operating a business. The net income calculation reduces EBITDA by such items as depreciation and amortization of assets, one-time events like plant closings or dispositions, and, in the case of Lee, a $1 billion loss associated with writing down the value of the Pulitzer acquisition. The $1 billion loss, which represents an accounting adjustment and not an actual outflow of cash, is the primary reason the company posted a $888.7 million net loss despite a $207.2 million operating profit.
Q. Why did Lee declare a loss of $1 billion on the $1.46 billion it paid to buy Pulitzer in 2005?
A. Accounting rules require a company to periodically re-evaluate the assets carried on its books. If the assets are found to be worth significantly less than their book value, the asset is deemed to be “impaired” and the company is forced to reduce the asset to its current fair-market value. The value of the Pulitzer acquisition was dropped by 68.5% for two reasons. First, the acquired properties are expected to generate lower sales and profits in the future than originally were projected. Second, the value of newspaper properties has collapsed in the time since Lee bought Pulitzer. The average value of newspaper stocks fell 83% in 2008 and Lee’s shares plunged 99% in the same 12 months.
Q. Why did Lee’s auditors question the company’s ability to continue as a going concern?
A. Given the weakness of the newspaper industry and the economy as a whole, the auditors are concerned that Lee will not be able to generate enough cash to make a $142.5 million payment due this spring on a portion of the debt it assumed when it bought Pulitzer. Failure to make the scheduled payment would trigger provisions in Lee's other borrowings that would require immediate repayment of the rest of its $1.4 billion in debt. If Lee cannot make the payment on the Pulitzer note this spring and cannot persuade its lenders to relax the terms of the other loans, then it would find itself in default on most, if not all, of its $1.4 billion in debt.
Q. What happens when a company defaults on its debt?
A. A number of things can happen, ranging from the shutdown of the business (which would be extremely unlikely in this case) to a bankruptcy filing where the company goes to court to prevent its creditors from foreclosing on the loans and seizing the assets of the business. If Lee cannot renegotiate its debt with its lenders, the company may be forced to file for Chapter 11 bankruptcy protection in substantially the same way that the Tribune Co. did in December.
Q. What happens when a company files for bankruptcy protection?
A. A Chapter 11 bankruptcy prevents lenders from seizing the assets of the business while the company reorganizes itself with an eye to emerging eventually from bankruptcy protection. This typically creates an environment where the company can negotiate better terms on its debt. A company under the supervision of a bankruptcy court will be permitted to renegotiate bills owed to vendors on everything from newsprint to rent, likely enabling unpaid trade debts to be settled for cents on the dollar. The company generally has the right to walk away from unnecessary leases on real estate, equipment and vehicles.
Q. What happens to the employees in a bankruptcy filing?
A. Wages, vacation pay, benefits and other obligations to employees usually are unaffected by a bankruptcy filing, but union contracts in some cases can be altered or abrogated. If part of the company’s reorganization plan includes reducing costs – and it usually does – then some jobs may be eliminated.
Q. How can the company avoid bankruptcy?
A. The surest way a company can avoid bankruptcy, of course, is by coming up with the cash necessary to pay its loans on time. The chief means to that end are improving sales; cutting costs to boost profitability, or selling assets like real estate, vehicles, presses or individual newspapers. In the absence of sufficient cash, a company also can urge its lenders to renegotiate its loans, which Lee is seeking to do. If the lenders are willing, the many possibilities include forgiving part of the debt, exchanging some or all of the debt for equity and extending the deadlines for repaying the loans. In almost every case, the restructuring of its debt will cost a company millions of dollars in legal and banking fees, as well as higher interest rates on its remaining debt.
Q. Lee has been warned that its shares may be removed from the NYSE. What does that mean?
A. The Big Board forbids a stock from closing at less than $1 per share for 30 consecutive sessions. Unless Lee’s shares rebound from the sub-$1 level where they have been since Dec. 1, the company is days from having its shares exiled to the Pink Sheets, an electronic trading platform for so-called penny stocks. The company said on New Year’s Eve that it will file a plan to cure the problem, but provided no details.
Q. What does it mean if Lee’s shares go off the NYSE?
A. Delisting per se is not that big of a deal. Absent an event like a loan default, business can proceed as usual for a company no longer traded on the Big Board. The resolution of the looming debt payment – whether through renegotiation, bankruptcy or otherwise – is the truly significant challenge for Lee’s management. But that is small comfort for the company’s stockholders, who watched the value of their shares sink 99% last year. The entire market capitalization of Lee was only $18.5 million on Dec. 31, 2008 vs. $677 million at the first of the year. As illustrated in the chart below, Lee’s shares have lost more than $2 billion in value since yearend 2004.