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McClatchy Company 10-K 2007
Form 10-K
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended: December 31, 2006

 

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission file number: 1-9824

 

The McClatchy Company

(Exact name of registrant as specified in its charter)

 

Delaware   52-2080478
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
2100 “Q” Street, Sacramento, CA   95816
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: 916-321-1846

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class


 

Name of each exchange on which registered


Class A Common Stock, par value $.01 per share   New York Stock Exchange

 

Securities registered pursuant to section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    x  Yes    ¨  No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  Yes    x  No

 

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 .    x  Yes    ¨  No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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. (Check one):

 

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 Act).    ¨  Yes    x  No

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. Based on the closing price of the Company’s Class A Common Stock on the New York Stock Exchange on June 25, 2006: approximately $2,365,373,000. For purposes of the foregoing calculation only, as required by Form 10-K, the Registrant has included in the shares owned by affiliates, the beneficial ownership of Common Stock of officers and directors of the Registrant and members of their families, and such inclusion shall not be construed as an admission that any such person is an affiliate for any purpose.

 

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.

 

Shares outstanding as of February 23, 2007:

 

Class A Common Stock   

55,865,162 Shares

Class B Common Stock   

26,110,397 Shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Definitive Proxy Statement for the Company’s May 16, 2007 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 (incorporated in Part II and Part III to the extent provided in Items 10, 11, 12, 13 and 14 hereof).

 



Table of Contents

INDEX TO THE McCLATCHY COMPANY

2006 FORM 10-K

 

Item No.


        Page

     PART I     

1.

   Business    1

1. A.

   Risk Factors    7

1. B.

   Unresolved Staff Comments    8

2.

   Properties    8

3.

   Legal Proceedings    8

4.

   Submission of Matters to a Vote of Security Holders    8
     PART II     

5.

  

Market for the Registrant’s Common Stock and Related Stockholder Matters and Issuer Purchases of Equity Securities

   9

6.

   Selected Financial Data    11

7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    12

7A.

   Quantitative and Qualitative Disclosures About Market Risk    25

8.

   Financial Statements and Supplementary Data    26

9.

   Changes In and Disagreements With Accountants on Accounting and Financial Disclosure    52

9A.

   Controls and Procedures    52

9B.

   Other Information    53
     PART III     

10.

   Directors and Executive Officers and Corporate Governance    53

11.

   Executive Compensation    54

12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   54

13.

   Certain Relationships and Related Transactions and Director Independence    54

14.

   Principal Accountant Fees and Services    54
     PART IV     

15.

   Exhibits and Financial Statement Schedules    55


Table of Contents

PART I

 

ITEM 1. BUSINESS

 

Available Information

 

The McClatchy Company (“McClatchy” or the “Company”) maintains a website which includes an investor relations page available to all interested parties at www.mcclatchy.com. All filings with the United States Securities and Exchange Commission, along with any amendments thereto, are available free of charge on our website at www.mcclatchy.com/investor/. The Company’s corporate governance guidelines; charters for the following committees of the board of directors: audit, committee on the board, pension and savings plan, compensation and nominating committees; and the Company’s codes of business conduct may also be found on this website. In addition, paper copies of any such filings and corporate governance documents are available free of charge by contacting us at the address listed on the cover page of this filing. The contents of this website are not incorporated into this filing. Further, our reference to the URL for this website is intended to be an inactive textual reference only.

 

Overview

 

The Company dates from the California Gold Rush era of 1857. Its three original California newspapers—The Sacramento Bee, The Fresno Bee and The Modesto Bee—were the core of the Company until 1979 when the Company began to diversify geographically outside of California. At that time it purchased two newspapers in the Northwest, the Anchorage Daily News and the Tri-City Herald in Southeastern Washington. In 1986, the Company purchased The (Tacoma) News Tribune. The Company expanded into the Carolinas when it purchased newspapers in South Carolina in 1990 and The News and Observer Publishing Company in North Carolina in 1995. In 1998, the Company expanded into Minnesota with the acquisition of The Star Tribune Company. It expanded further in California with the purchase of the Merced Sun-Star and five related non-daily newspapers (the “Merced Group”) in 2004.

 

On June 27, 2006, the Company acquired Knight-Ridder, Inc. (the “Acquisition”) and subsequently sold 12 of the daily newspapers acquired in the Acquisition. On December 26, 2006, the Company entered into an agreement to sell the (Minneapolis) Star Tribune newspaper. Accordingly, the 12 former Knight Ridder newspapers which have been sold and the Star Tribune’s results are not included in any of the Company’s discussions of continuing operations in this Report.

 

The Company is the third largest newspaper company in the United States based on daily circulation (after the sale of the (Minneapolis) Star Tribune newspaper), with 31 daily newspapers and approximately 50 non-dailies located in 29 markets across the country. McClatchy-owned newspapers include The Miami Herald, The Sacramento Bee, the (Fort Worth) Star-Telegram, The Kansas City Star, The Charlotte Observer and The (Raleigh) News & Observer. In addition, the Company has a robust network of internet assets, including leading local websites in each of its daily newspaper markets, offering users information, comprehensive news, advertising, e-commerce and other services. The Company also owns and operates McClatchy Interactive, an interactive operation that provides websites with content, publishing tools and software development; Real Cities, the largest national advertising network of local news websites, including more than 140 newspaper websites; and 15.0% of CareerBuilder LLC, the nation’s largest online job site. The Company also owns 25.6% of Classified Ventures LLC, a newspaper industry partnership that offers classified websites such as cars.com and apartments.com.

 

The Company’s newspapers range from large dailies serving metropolitan areas to non-daily newspapers serving small communities. For the fiscal year 2006, the Company had an average paid daily circulation of 2,842,452 and Sunday circulation of 3,523,177.

 

The Company is committed to a three-pronged strategy:

 

   

First, to operate high-quality newspapers in growth markets.

 

 

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Second, to extend these franchises by supplementing the mass reach of the newspaper with direct marketing and direct mail products so that advertisers can capture broad appeal and targeted audiences with one-stop shopping.

 

   

And finally, to operate the leading local internet business in each of its daily newspaper markets.

 

Forward-Looking Statements—When used in this Report, the words “believes,” “expects,” “anticipates,” “estimates,” and similar expressions are generally intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including those discussed under the heading “Risk Factors that Could Affect Operating Results” in Part I, Item 1A that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report.

 

NEWSPAPER OPERATIONS

 

The operations and results of the (Minneapolis) Star Tribune newspaper are not included in any of the Company’s newspaper operations discussed below due to its pending sale.

 

Each of the Company’s newspapers is largely autonomous in its business and editorial operations so as to meet most effectively the needs of the communities it serves. Publishers and editors of the newspapers make the day-to-day decisions and, within limits, are responsible for their own budgeting and planning.

 

Each of the Company’s daily newspapers has the largest circulation of any newspaper serving its particular community, and coupled with a leading local website in each community, reaches a broad audience in each market. The Company believes that its broad reach in each market is of primary importance in attracting advertising, the principal source of revenues for the Company. Advertising revenues were 86% of consolidated net revenues in fiscal 2006 and 2005 and circulation revenues approximated 12% of consolidated net revenues in these years.

 

The Company’s newspaper business is somewhat seasonal, with peak revenues and profits generally occurring in the second and fourth quarters of each year. The first quarter is historically the weakest quarter for revenues and profits.

 

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The following table summarizes the circulation of each of the Company’s daily newspapers. These circulation figures are reported on the Company’s fiscal year basis and are not meant to reflect Audit Bureau of Circulations (“ABC”) reported figures. The acquired newspapers were not operated by the Company prior to June 27, 2006.

 

     2006

   2005

Circulation by Newspaper


   Daily

   Sunday

   Daily

   Sunday

The Miami Herald * (1)

   367,923    464,365    387,481    507,232

The Sacramento Bee

   283,561    323,271    293,350    334,234

The Kansas City Star * (2)

   260,535    360,221    262,891    368,918

Charlotte Observer *

   215,410    269,474    222,126    276,107

(Fort Worth) Star-Telegram *

   213,425    309,766    227,408    324,970

The (Raleigh) News & Observer

   171,971    211,501    171,794    211,490

The Fresno Bee

   155,697    180,288    160,769    186,454

The (Tacoma) News Tribune

   118,479    132,986    125,057    139,738

Lexington Herald-Leader *

   112,039    138,116    114,711    144,347

The (Columbia) State *

   107,163    139,476    113,878    142,345

The Wichita Eagle *

   88,505    138,880    90,511    146,707

The Modesto Bee

   82,064    87,073    83,859    88,944

Anchorage Daily News

   65,997    75,271    67,712    78,111

Idaho Statesman *

   64,825    85,260    64,895    85,924

The (Macon) Telegraph *

   58,000    74,299    60,563    79,540

Belleville News-Democrat *

   52,966    65,646    54,086    64,540

The (Myrtle Beach) Sun News *

   50,042    60,733    50,634    60,859

The Bradenton Herald *

   45,419    50,391    45,977    51,052

(Biloxi) Sun Herald *

   44,325    50,076    41,530    48,866

(Columbus) Ledger-Enquirer *

   43,429    51,756    44,855    56,035

Tri-City Herald

   41,484    44,036    41,956    44,843

The (San Luis Obispo) Tribune *

   38,233    43,446    39,838    44,517

The Olympian *

   33,268    40,189    33,572    41,462

The (Rock Hill) Herald

   30,961    32,568    31,575    33,021

(Pennsylvania) Centre Daily Times *

   24,656    32,288    25,358    33,514

The Bellingham Herald *

   23,146    29,667    23,485    29,981

The Island Packet

   20,164    20,806    19,854    20,509

Merced Sun-Star

   16,034    —      16,435    —  

The Beaufort Gazette

   12,729    11,329    12,537    11,326

El Nuevo Herald * (1)

   —      —      —      —  

The (Kansas) Olathe News * (2)

   —      —      —      —  

* Acquired on June 27, 2006 in the Acquisition.
(1) El Nuevo Herald circulation figures are included in The Miami Herald circulation figures.
(2) The (Kansas) Olathe News circulation figures are included in The Kansas City Star circulation figures.

 

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The following table summarizes total revenues for each of the Company’s daily newspapers. No revenues were recorded by the Company for the acquired newspapers prior to the Acquisition and the pro forma information (as if the Company operated all 31 newspapers for both years) is provided to allow the reader to better understand the relative size of each newspaper. See Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of the Company’s revenue trends.

 

Total Revenues by Newspaper (dollars in thousands)


   52-weeks
Pro
Forma
2006


   Pro
Forma
2005


The Miami Herald * (1)

   $ 345,298    $ 346,067

The Sacramento Bee

     254,741      259,741

(Fort Worth) Star-Telegram *

     236,777      241,428

The Kansas City Star * (2)

     227,364      237,595

Charlotte Observer *

     176,246      185,245

The (Raleigh) News & Observer

     136,138      136,843

The Fresno Bee

     111,825      105,440

The (Columbia) State *

     87,825      85,414

Lexington Herald-Leader *

     80,218      82,279

The (Tacoma) News Tribune

     79,592      79,712

The Wichita Eagle *

     66,393      67,676

The Modesto Bee

     65,943      63,861

Anchorage Daily News

     60,622      59,241

Idaho Statesman *

     58,099      55,405

The (Myrtle Beach) Sun News *

     45,203      41,052

The Bradenton Herald *

     38,051      35,875

The (Macon) Telegraph *

     36,731      39,267

(Biloxi) Sun Herald *

     36,320      33,524

(Columbus) Ledger-Enquirer *

     34,330      34,803

Belleville News-Democrat *

     31,615      34,203

The (San Luis Obispo) Tribune *

     30,893      30,748

The Olympian *

     27,046      26,039

Tri-City Herald

     26,235      26,376

The Bellingham Herald *

     19,975      19,316

The Island Packet

     19,307      18,082

(Pennsylvania) Centre Daily Times *

     18,612      18,108

The (Rock Hill) Herald

     14,009      13,984

Merced Sun-Star

     12,952      11,514

The Beaufort Gazette

     7,084      6,765

El Nuevo Herald * (1)

     —        —  

The (Kansas) Olathe News * (2)

     —        —  

* Acquired on June 27, 2006 in the Acquisition.
(1) El Nuevo Herald total revenues are included in The Miami Herald total revenues.
(2) The (Kansas) Olathe News total revenues are included in The Kansas City Star total revenues.

 

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The Company’s newspapers supplement newspaper publishing operations with an array of niche products and direct marketing initiatives, including direct mail. While the direct marketing operations are financially successful in their own right, they also help retain advertising in the newspapers. The newspapers also operate leading local websites in each daily newspaper market, offering users information, comprehensive news, advertising, e-commerce and other services. Online advertising has become one of the Company’s fastest growing revenue sources. The Company’s websites had approximately 2.3 billion page views in fiscal 2006. Together with the mass reach of its in-paper advertising, these lines of business help each of the Company’s newspapers maintain its position as a leading media outlet in each of its daily newspaper markets.

 

Other Operations

 

The Company’s rapidly expanding internet activities have produced robust local websites in each of its daily newspaper markets. These efforts are supported by McClatchy Interactive, the Company’s interactive media operation that provides newspapers with content, publishing tools, hosting services and software development. The primary mission of McClatchy Interactive is to be a technology and content partner to the Company’s newspaper internet sites. The Company’s internet operations are included in the operations of each of its newspapers, and, internet revenues (primarily advertising) and expenses are reported in the newspaper’s results. McClatchy Interactive also provides services to third party newspapers. Revenue from McClatchy Interactive is reported in “Other Revenues” in the Consolidated Statement of Income.

 

The Company acquired Knight Ridder Digital (“KRD”), Knight Ridder’s interactive media operation, in the Acquisition. The Company also owns Real Cities, the largest national advertising network of local news websites, including more than 140 newspaper websites. Real Cities also acts as a broker of online advertising, primarily in the national category. The Company continues to integrate the capabilities of KRD and its systems, where appropriate, with those provided by McClatchy Interactive. As it moves to one internet platform, the Company will marry the best of McClatchy Interactive and KRD to support and grow its newspaper and stand alone internet operations.

 

The Company owns 15.0% of Career Builder, LLC (“Career Builder”), the nation’s largest online job site, and 15.0% of ShopLocal, LLC (“ShopLocal”), a provider of web-based marketing solutions for national and local retailers. The Company also owns a 15.0% interest in TKG Internet Holdings, which owns 75.0% of Topix.net (“Topix”), for an aggregate ownership of 11.3%.

 

The Company owns 25.6% of Classified Ventures, LLC (“Classified Ventures”), a newspaper industry partnership that offers classified websites such as cars.com and apartments.com.

 

McClatchy Tribune Information Service (“MCT”), a joint venture of McClatchy and Tribune Company (“Tribune”), offers stories, graphics, illustrations, photos and paginated pages for print publisher and web-ready content for online publishers. All the Company’s newspapers, Washington D.C. staff and foreign bureaus produce MCT editorial material. Content is also supplied by Tribune properties and a number of other newspapers.

 

The Company owns 49.5% of the voting stock and 70.6% of the nonvoting stock of the Seattle Times Company. The Seattle Times Company owns The Seattle Times newspaper, and weekly newspapers in Puget Sound and daily newspapers located in Walla Walla and Yakima, Washington and in Portland, Maine.

 

In addition, the Company owns a 27.0% interest in Ponderay Newsprint Company (“Ponderay”), a general partnership, which owns and operates a newsprint mill in the State of Washington. The Company is required to purchase 56,800 metric tons of newsprint annually from Ponderay on a “take-if-tendered” basis at prevailing market prices, until Ponderay’s debt is repaid. The Company owns a 33.3% interest in SP Newsprint Co. (“SP”). SP is a newsprint manufacturing company in North America. The Company has an annual purchase commitment for 86,000 metric tons of newsprint from SP.

 

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The Company primarily uses the equity method of accounting for its investments in unconsolidated companies.

 

Raw Materials

 

During fiscal 2006, the Company consumed approximately 298,000 metric tons of newsprint compared to 156,000 metric tons in fiscal 2005 for its continuing operations. The increase in tons consumed was primarily due to the additional newspapers added in the Acquisition, offset partially by the conversion to lighter weight newsprint at certain existing operations. The Company currently obtains its supply of newsprint from a number of suppliers primarily under long-term contracts.

 

Newsprint expense accounted for 14.9% of total operating expenses in fiscal 2006 and in 2005. Consequently, the Company’s earnings are sensitive to changes in newsprint prices. A significant increase in newsprint prices would increase the Company’s operating expenses. However, because the Company has ownership interests in newsprint producers (Ponderay and SP), an increase in newsprint prices, while negatively affecting operating expenses, would increase its share of earnings from these investments. Ponderay and SP could also be impacted by higher energy costs and other factors that would affect their results. Management believes its newsprint sources of supply under existing arrangements are adequate for its anticipated current needs. The Company estimates that it will use approximately 400,000 metric tons of newsprint in fiscal 2007, depending on the level of print advertising, circulation volumes and other business considerations.

 

The Company is required to purchase 142,800 metric tons of newsprint annually from Ponderay and SP at prevailing market prices. See the discussion above; Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; and the financial statements and accompanying notes for further discussion of the impact of these investments on the Company’s business.

 

Competition

 

The Company’s newspapers, direct marketing programs and internet sites compete for advertising revenues and readers’ time with television, radio, other internet sites, direct mail companies, free shoppers, suburban neighborhood and national newspapers and other publications, and billboard companies, among others. In some of its markets, the Company’s newspapers also compete with other newspapers published in nearby cities and towns. Competition for advertising is generally based upon circulation levels, readership demographics, price, internet usage and advertiser results, while competition for circulation and readership is generally based upon the content, journalistic quality, service and the price of the newspaper.

 

The Company’s major daily newspapers lead their direct local newspaper competitors in both advertising linage and general circulation and readership in their respective markets, and its internet sites are generally the leading local sites in each of the Company’s major daily newspaper markets, based upon research conducted by the Company and various independent sources. Nonetheless, the Company has experienced a greater shift of advertising in the classified categories to online advertising and faces greater competition, particularly in the areas of employment, automotive and real estate advertising, by online competitors.

 

Employees—Labor

 

As of December 31, 2006, the Company had 16,791 full and part-time employees (equating to 15,250 full-time equivalent employees), of whom approximately 5.5% were represented by unions. Most of the Company’s union-represented employees are currently working under labor agreements expiring in various years. Twenty-one of the Company’s 31 daily papers have no unions.

 

While the Company’s newspapers have not had a strike for decades and do not currently anticipate a strike occurring, the Company cannot preclude the possibility that a strike may occur at one or more of its newspapers when future negotiations occur. The Company believes that, in the event of a newspaper strike, it would be able

 

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to continue to publish and deliver to subscribers, a capability which is critical to retaining revenues from advertising and circulation, although there can be no assurance of this.

 

ITEM 1A. RISK FACTORS THAT COULD AFFECT OPERATING RESULTS

 

Forward-Looking Information:

 

This report on Form 10-K contains forward-looking statements regarding the Company’s actual and expected financial performance and operations. These statements are based upon our current expectations and knowledge of factors impacting our business, including, without limitation, statements about litigation, successful disposition of the (Minneapolis) Star Tribune newspaper, tax and other benefits from the sale of the Star Tribune, advertising revenues, return on pension plan assets and assumed salary increases, newsprint costs, amortization expense, stock option expenses, prepayment of debt, capital expenditures, sufficiency of capital resources and possible acquisitions and investments. Such statements are subject to risks, trends and uncertainties. Forward-looking statements are generally preceded by, followed by or are a part of sentences that include the words “believes,” “expects,” “anticipates,” “estimates,” or similar expressions. For all of those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You should understand that the following important factors, in addition to those discussed elsewhere in this document and in the documents which we incorporate by reference, could affect the future results of McClatchy and could cause those future results to differ materially from those expressed in our forward-looking statements: general economic, market or business conditions, especially in any of the markets where we operate newspapers; impact of any litigation or any potential litigation; geo-political uncertainties including the risk of war; changes in newsprint prices and/or printing and distribution costs from anticipated levels; changes in interest rates; changes in pension assets and liabilities; increased competition from newspapers, internet sites or other forms of media reaching the markets we serve; increased consolidation among major retailers in our markets or other events depressing the level of advertising; changes in our ability to negotiate and obtain favorable terms under collective bargaining agreements with unions; competitive action by other companies; difficulties in servicing our debt obligations; other occurrences leading to decreased circulation and diminished revenues from retail, classified and national advertising; and other factors, many of which are beyond our control.

 

Additional Information Regarding Certain Risks:

 

The Company’s primary source of revenue is advertising, followed by circulation revenues. In recent years, the advertising industry generally has experienced a secular shift toward internet advertising and away from other traditional media. In addition, the Company’s circulation has declined over the last two years, reflecting general trends in the newspaper industry including consumer migration toward the internet and other media for news and information. The Company has attempted to take advantage of the growth of online media and advertising by operating local internet sites in each of its daily newspaper markets, but faces increasing competition from other online sources for both advertising and circulation revenues. This increased competition has had and may continue to have an adverse effect on the Company’s business and financial results, including negatively impacting revenues and margins.

 

Newsprint is the major component of our cost of raw materials. Newsprint accounted for 14.9% of McClatchy’s operating expenses for fiscal 2006. Accordingly, our earnings are sensitive to changes in newsprint prices. We have not attempted to hedge fluctuations in the normal purchases of newsprint or enter into contracts with embedded derivatives for the purchase of newsprint. If the price of newsprint increases materially, our operating results could be adversely affected. If our newsprint suppliers experience labor unrest, transportation difficulties or other supply disruptions, our ability to produce and deliver newspapers could be impaired and/or the cost of the newsprint could increase, both of which would negatively affect our operating results.

 

If McClatchy experiences labor unrest, our ability to produce and deliver newspapers could be impaired. The results of future labor negotiations could harm our operating results. Our newspapers have not endured a

 

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labor strike for decades. However, we cannot ensure that a strike will not occur at one or more of our newspapers in the future. As of December 31, 2006, approximately 5.5% of our full-time and part-time employees were represented by unions. Most of the Company’s union-represented employees are currently working under labor agreements, which expire at various times. McClatchy faces collective bargaining upon the expirations of these labor agreements. Even if our newspapers do not suffer a labor strike, the Company’s operating results could be harmed if the results of labor negotiations restrict our ability to maximize the efficiency of our newspaper operations.

 

The Company continues to evaluate its business and make strategic investments in digital ventures, either alone or with partners, to further its growth in its online businesses. There can be no assurances that these investments or partnerships will result in growth in advertising or will produce equity income in future years.

 

The Company expects to realize cost savings of approximately $70.0 million in the first year of ownership from the Acquisition, primarily by reducing redundancy in staffing for corporate and digital functions, and to a lesser extent, savings at the individual newspaper level through combined purchasing of products and capital expenditures. There is no assurance that these cost savings will be realized in the amount or timing that management has projected.

 

As of December 31, 2006, the Company had approximately $3.3 billion in total consolidated debt outstanding. This debt could increase the Company’s vulnerability to general adverse economic and industry conditions. Debt service costs are subject to interest rate changes as well as any changes in the Company’s credit ratings. Negative changes in credit ratings could increase the level of debt service costs and also affect the Company’s future ability to refinance certain maturing debt, or affect the ultimate structure of such refinancing. The Company expects to use the sale of the (Minneapolis) Star Tribune to reduce debt in the first quarter of fiscal 2007, and expects that over the next several years its primary use of cash flow from operations will be to reduce debt.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

The corporate headquarters of the Company are located at 2100 “Q” Street, Sacramento, California. At December 31, 2006 the Company had newspaper production facilities in 29 markets situated in 15 states. The Company’s facilities vary in size and in total occupy about 7.8 million square feet. Approximately 1.5 million of the total square footage is leased from others. The Company owns substantially all of its production equipment, although certain office equipment is leased.

 

The Company maintains its properties in good condition and believes that its current facilities are adequate to meet the present needs of its newspapers.

 

ITEM 3. LEGAL PROCEEDINGS

 

The Company becomes involved from time to time in claims and lawsuits incidental to the ordinary course of its business, including such matters as libel, invasion of privacy, intellectual property infringement, wrongful termination actions, and complaints alleging discrimination. In addition, the Company is involved from time to time in governmental and administrative proceedings concerning employment, labor, environmental and other claims. Historically, such claims and proceedings have not had a material adverse effect upon the Company’s consolidated results of operations or financial condition.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information:

 

The Company’s Class A Common Stock is listed on the New York Stock Exchange (NYSE symbol—MNI). A small amount of Class A Stock is also traded on other exchanges. The Company’s Class B Stock is not publicly traded. The following table lists per share dividends paid on both classes of Common Stock and the prices of the Company’s Class A Common Stock as reported by these exchanges for fiscal 2006 and 2005:

 

     HIGH

   LOW

   DIVIDENDS

Year Ended December 31, 2006:

                    

First quarter

   $ 59.64    $ 47.48    $ 0.18

Second quarter

   $ 50.64    $ 38.80    $ 0.18

Third quarter

   $ 43.80    $ 38.96    $ 0.18

Fourth quarter

   $ 44.95    $ 39.40    $ 0.18

Year Ended December 25, 2005:

                    

First quarter

   $ 76.05    $ 69.62    $ 0.13

Second quarter

   $ 75.85    $ 65.28    $ 0.18

Third quarter

   $ 68.40    $ 61.38    $ 0.18

Fourth quarter

   $ 66.46    $ 56.30    $ 0.18

 

Holders:

 

The number of record holders of Class A and Class B Common Stock at February 23, 2007 was 7,523 and 21, respectively.

 

Dividends:

 

The payment and amount of future dividends remain within the discretion of the Board of Directors and will depend upon the Company’s future earnings, financial condition and requirements, and other factors considered relevant by the Board.

 

Equity Compensation Plan Information:

 

Information regarding McClatchy’s equity compensation plans, including both shareholder approved plans and non-shareholder approved plans, is set forth in the section entitled “Securities Authorized for Issuance Under Equity Compensation Plans” in the definitive Proxy Statement for the Company’s 2007 Annual Meeting of Shareholders, which information is incorporated into Item 12 herein by reference.

 

Sales of Unregistered Securities:

 

None.

 

Purchases of Equity Securities:

 

On September 25, 2005 the Company’s Board of Directors authorized the repurchase of up to $200 million of the Company’s Class A Common Stock. The Company did not repurchase any of its common shares through February 23, 2007.

 

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LOGO

 

The Peer Group consists of:

 

     Belo Corp., Dow Jones & Co. Inc., Gannett Co. Inc., Journal Register Company, Lee Enterprises Incorporated, Media General Inc., The New York Times Company, The E.W. Scripps Company, The Washington Post Company and Tribune Company.

 

*$100 invested on 12/30/01 in stock or on 12/31/01 in index-including reinvestment of dividends.

Fiscal year ending December 31.

 

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ITEM 6. SELECTED FINANCIAL DATA (1)

 

    December 31,
2006 (2)


    December 25,
2005


  December 26,
2004


  December 28,
2003


    December 29,
2002


 

REVENUES—NET:

                                   

Advertising

  $ 1,432,913     $ 691,790   $ 663,302   $ 615,734     $ 589,495  

Circulation

    194,940       97,205     100,330     99,360       99,274  

Other

    47,337       18,485     19,641     20,011       22,088  
   


 

 

 


 


      1,675,190       807,480     783,273     735,105       710,857  

OPERATING EXPENSES:

                                   

Depreciation and amortization

    98,865       39,311     40,159     42,442       43,467  

Other operating expenses

    1,229,417       576,866     562,870     523,956       505,839  
   


 

 

 


 


      1,328,282       616,177     603,029     566,398       549,306  

OPERATING INCOME

    346,908       191,303     180,244     168,707       161,551  

NON-OPERATING (EXPENSES) INCOME:

                                   

Interest expense

    (93,664 )     —       —       —         —    

Interest income

    3,562       47     9     101       322  

Equity income (loss) in unconsolidated companies—net

    4,951       635     852     291       (1,418 )

Gain on sale of land and other—net

    9,128       231     295     (600 )     (625 )
   


 

 

 


 


      (76,023 )     913     1,156     (208 )     (1,721 )

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAX PROVISION

    270,885       192,216     181,400     168,499       159,830  

INCOME TAX PROVISION

    87,390       72,701     71,852     65,637       62,282  
   


 

 

 


 


INCOME FROM CONTINUING OPERATIONS

    183,495       119,515     109,548     102,862       97,548  

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES

    (339,072 )     41,004     46,328     47,360       33,668  
   


 

 

 


 


NET INCOME (LOSS)

  $ (155,577 )   $ 160,519   $ 155,876   $ 150,222     $ 131,216  
   


 

 

 


 


NET INCOME PER COMMON SHARE:

                                   

Basic:

                                   

Income from continuing operations

  $ 2.85     $ 2.56   $ 2.36   $ 2.23     $ 2.13  

Income (loss) from discontinued operations

    (5.27 )     0.88     1.00     1.03       0.74  
   


 

 

 


 


Net income (loss) per share

  $ (2.42 )   $ 3.44   $ 3.36   $ 3.26     $ 2.87  
   


 

 

 


 


Diluted:

                                   

Income from continuing operations

  $ 2.84     $ 2.55   $ 2.34   $ 2.21     $ 2.11  

Income (loss) from discontinued operations

    (5.25 )     0.87     0.99     1.02       0.73  
   


 

 

 


 


Net income (loss) per share

  $ (2.41 )   $ 3.42   $ 3.33   $ 3.23     $ 2.84  
   


 

 

 


 


DIVIDENDS PER COMMON SHARE

  $ 0.72     $ 0.67   $ 0.50   $ 0.44     $ 0.40  
   


 

 

 


 


CONSOLIDATED BALANCE SHEET DATA:

                                   

Total assets

  $ 8,054,710     $ 2,087,116   $ 2,049,400   $ 1,875,298     $ 1,981,561  

Long-term debt (3)

    2,746,669       154,200     267,200     204,923       471,615  

Stockholders’ equity

    3,103,624       1,565,591     1,423,004     1,216,017       1,057,329  

(1) On December 26, 2006, the Company entered into a definitive agreement to sell the (Minneapolis) Star Tribune newspaper of Minneapolis, MN. This transaction is expected to close in the first quarter of fiscal 2007. Results of the (Minneapolis) Star Tribune newspaper are included in discontinued operations for all periods presented.
(2) Information as of and for the year ended December 31, 2006 includes the newspapers and other operations from the Acquisition since the beginning of the third quarter of fiscal 2006.
(3) Excludes $530.0 million classified in current liabilities, as such debt is expected to be repaid with proceeds from the impending disposition of the (Minneapolis) Star Tribune newspaper.

 

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

The McClatchy Company (the “Company”) is the third largest newspaper company in the United States based on daily circulation (after the sale of the (Minneapolis) Star Tribune newspaper—see discussion below), with 31 daily newspapers and approximately 50 non-dailies located in 29 markets across the country. Twenty of its daily newspapers (the “Acquired Newspapers”) were acquired on June 27, 2006 in the Knight Ridder, Inc. (Knight Ridder) acquisition (the “Acquisition”)—see Note 2. The Company’s newspapers include The Miami Herald, The Sacramento Bee, the (Fort Worth) Star-Telegram, The Kansas City Star, The Charlotte Observer, and The (Raleigh) News & Observer. In addition, McClatchy has a robust network of internet assets, including leading local websites in each of its daily newspaper markets, offering users information, comprehensive news, advertising, e-commerce and other services. The Company also owns and operates McClatchy Interactive, which provides websites with content, publishing tools and software development; Real Cities, the largest national advertising network of local news websites, including more than 140 newspaper websites; and 15.0% of CareerBuilder LLC (“CareerBuilder”), the nation’s largest online job site. The Company also owns 25.6% of Classified Ventures LLC (“Classified Ventures”), a newspaper industry partnership that offers classified websites such as cars.com and apartments.com.

 

The Company’s primary source of revenue is advertising, which accounts for roughly 85% of the Company’s revenue in any given year (86% in fiscal 2006). While percentages vary from year to year and from newspaper to newspaper, retail advertising carried as a part of newspapers (“run-of-press” or “ROP” advertising) or in advertising inserts placed in newspapers (preprint advertising) generally contributes roughly 43% of advertising revenues at the Company’s newspapers (44% in fiscal 2006). Recent trends have been for certain national or regional retailers to use greater preprint and online advertising and less ROP advertising, although that trend shifts from time to time. Nonetheless, ROP advertising still makes up the majority of retail advertising. Classified advertising (including online classified advertising) primarily in automotive, employment and real estate categories, generally contributes about 41% of advertising revenue (39% in fiscal 2006) and national advertising generally contributes about 9% of total advertising (9% in fiscal 2006). Direct marketing and other advertising make up the remainder of the Company’s advertising revenues. Circulation revenues contribute roughly 12% (12% in fiscal 2006) of the Company’s newspaper revenues, depending upon the size and locale of the newspaper. Most newspapers are delivered by independent contractors. Circulation revenues are recorded net of direct delivery costs.

 

See the following “Results of Operations” for a discussion of the Company’s revenue performance and contribution by category for fiscal 2006, 2005 and 2004.

 

Critical Accounting Policies

 

The accompanying discussion and analysis of our financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The Company bases its estimates and judgments on historical experience and on various other assumptions that it believes are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. The most significant areas involving estimates and assumptions are revenue recognition, allowance for uncollectible accounts, amortization and/or impairment of intangibles, pension and post-retirement expenses, insurance reserves, and the Company’s accounting for income taxes. The Company believes the following critical accounting policies, in particular, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

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Revenue Recognition—The Company recognizes revenues from advertising placed in a newspaper and/or on a website over the advertising contract period or as services are delivered, as appropriate, and recognizes circulation revenues as newspapers are delivered over the applicable subscription term. Circulation revenues are recorded net of direct delivery costs. Other revenue is recognized when the related product or service has been delivered. Revenues are recorded net of estimated incentive offerings including special pricing agreements, promotions and other volume-based incentives. Revisions to these estimates are charged to income in the period in which the facts that give rise to the revision become known.

 

Allowance for Uncollectible Accounts—The Company maintains an allowance account for estimated losses resulting from the risk its customers will not make required payments. Generally, the Company uses the aging of accounts receivable, reserving for all accounts due 90 days or longer, to establish allowances for losses on accounts receivable. However, if the Company becomes aware that the financial condition of a customer has deteriorated, resulting in an impairment of their ability to make payments, additional allowances are reserved.

 

Acquisition Accounting—Pursuant to Emerging Issues Task Force No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination, McClatchy common stock issued on June 27, 2006 was valued based upon the average closing price of the McClatchy’s common stock from March 8, 2006 through March 14, 2006 (two business days before and after the terms of the Acquisition were agreed to and announced), or $52.06 per share. As a result, the fair value of the 35.0 million shares of the McClatchy’s common stock issued in the Acquisition was recorded at $1.821 billion, which was included in the total Acquisition purchase price of approximately $4.6 billion. The fair value of such shares declined to approximately $1.398 billion as of the Acquisition closing date (June 27, 2006), however, the decline of $423.0 million in valuation had no effect on the total Acquisition purchase price recorded. This difference is included in the allocation to goodwill in the allocation of the purchase price.

 

The Acquisition was accounted for as a purchase. Pursuant to SFAS 141, Business Combinations, the purchase price is being allocated to the assets acquired and liabilities assumed based upon their estimated fair values as of June 27, 2006, the date of the Acquisition. The purchase price allocation was primarily based upon an independent valuation report. The purchase price allocation, while substantially completed, is subject to further adjustments based upon completion of analyses of deferred income tax assets and liabilities and other items.

 

Discontinued Operations—On June 27, 2006, the Company acquired Knight Ridder and subsequently sold 12 of the daily newspapers acquired in the Acquisition. Four of the newspaper sales closed concurrently with the closing of the Acquisition and eight were held by the Company from two to 36 days. On December 26, 2006, the Company entered into an agreement to sell the (Minneapolis) Star Tribune newspaper. As a result, the Company has recorded the results of the eight former Knight Ridder newspapers and the Star Tribune newspaper as discontinued operations, including interest on debt related to the purchase of the newspapers. No gain or loss was recorded on the sale of the former Knight Ridder newspapers, but discontinued operations does reflect a write-down of the Star Tribune’s net assets to fair market value based upon its expected sales proceeds. See Note 2 to the Consolidated Financial Statements for more discussion of discontinued operations.

 

Goodwill and Intangible Impairment—In assessing the recoverability of the Company’s goodwill and other intangibles, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. The Company periodically analyzes its goodwill and intangible assets with indefinite lives for impairment. See the discussion of the sale of the (Minneapolis) Star Tribune newspaper below related to the write-down to net realizable value recorded in discontinued operations in fiscal 2006.

 

Pension and Post-retirement Benefits—The Company has significant pension and post-retirement benefit costs and credits that are developed from actuarial valuations. Inherent in these valuations are key assumptions including salary rate increases, discount rates and expected return on plan assets. The Company is required to

 

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consider current market conditions, including changes in interest rates, in establishing these assumptions. Changes in the related pension and post-retirement benefit costs or credits may occur in the future because of changes resulting from fluctuations in the Company’s employee headcount and/or changes in the various assumptions.

 

Financial Accounting Standards Board (FASB) Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans” requires recognition of (1) the funded status of a pension plan (difference between the plan assets at fair value and the projected benefit obligation) and (2) funded status of a post-retirement plan (difference between the plan assets at fair value and the accumulated benefit obligation), as an asset or liability on the balance sheet. As required, the Company adopted this statement on December 31, 2006 and its net retirement obligations in excess of retirement plans’ assets at December 31, 2006 were $297.9 million. This amount includes $181.0 million for non-qualified plans that do not have assets. Obligations in excess of assets for qualified plans netted to a $116.9 million liability.

 

The Company used discount rates of 5.5% to 6.5%, assumed salary rate increases of 3.5% to 5.0% and an assumed long-term return on assets of 8.5% to calculate its retirement expenses in 2006, based upon consultation with its outside actuaries. See Note 7 to the Consolidated Financial Statements for a more in-depth discussion of the Company’s policies in setting its key assumptions related to these obligations. For fiscal 2006, a change in the weighted average rates would have had the following impact on the Company’s net benefit cost:

 

   

A decrease of 50 basis points in the long-term rate of return would have increased the Company’s net benefit cost by approximately $4.4 million;

 

   

A decrease of 25 basis points in the discount rate would have increased the Company’s net benefit cost by approximately $3.9 million; and

 

   

An increase of 50 basis points in the future compensation rate would have increased the Company’s net benefit cost by approximately $2.9 million.

 

The Company has revised certain assumptions for its fiscal 2007 retirement plan calculations. See Note 7 to the Consolidated Financial Statements for assumptions used to value its year-end pension obligations and fiscal 2007 expense.

 

Income Tax Provision—The Company’s current and deferred tax income provisions are calculated based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the subsequent year. These estimates are reviewed and adjusted, if needed, throughout the year. Adjustments between the Company’s estimates and the actual results of filed returns are recorded when identified.

 

The amount of income taxes paid is subject to audits by federal and state authorities, which may result in proposed assessments. The Company’s estimate for the potential outcome for any uncertain tax issue is significantly affected by management judgments. Management believes that the Company has adequately provided for any reasonably foreseeable outcome related to these matters based upon currently available information. However, future results may include favorable or unfavorable adjustments to estimated tax liabilities when the assessments are made or resolved or when statutes of limitation on potential assessments expire. Additionally, earnings or deductions estimated to be in each jurisdiction by the Company may differ from actual amounts. As a result of these potential adjustments, the Company’s effective tax rate may fluctuate significantly on a quarterly basis.

 

As a result of the anticipated (Minneapolis) Star Tribune disposition, the Company’s mix of state tax jurisdictions has resulted in a lower overall state tax rate. Accordingly, the Company has recalculated its deferred tax liabilities and assets in the fourth quarter of fiscal 2006 at its new lower effective state tax rate. The Company’s effective tax rate was affected by similar calculations related to the Acquisition in both the third and the fourth quarters of fiscal 2006.

 

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Also as a result of the tax loss on the sale of the Star Tribune newspaper, the Company expects to receive net cash income tax benefits of approximately $160.0 million by 2008. The Company recorded a tax benefit in the fourth quarter of fiscal 2006 of $202.0 million when it wrote down the net assets of the Star Tribune newspaper to its fair market value based upon its expected sales proceeds. However, when the transaction closes (expected in the first quarter of fiscal 2007), the Company will recognize additional income tax expense (estimated to be $40.0 million) related to the dissolution of subsidiaries holding Star Tribune related intellectual property. These taxes will be recorded in discontinued operations.

 

Insurance—The Company is insured for workers’ compensation using both self-insurance and large deductible programs. The Company relies on claims experience and the advice of consulting actuaries and administrators in determining an adequate provision for insurance claims.

 

The Company used a discount rate of 4.75% to calculate workers’ compensation reserves as of December 31, 2006. A decrease of 25 basis points in the discount rate or a 10% increase in claims would have had an immaterial effect on total workers’ compensation reserves.

 

Stock-Based Compensation—The Company implemented Financial Accounting Standard No. 123 (revised 2004), “Share-Based Payments” (“SFAS 123R”), at the beginning of fiscal 2006 and recorded share based compensation of $7.1 million in the year ended December 31, 2006. See Note 10 to the Consolidated Financial Statements for a discussion of the methodology of calculating stock-based compensation.

 

Recent Events and Trends

 

Acquisition Transaction:

 

On June 27, 2006 (the second day of the Company’s third fiscal quarter), the Company completed the purchase of Knight-Ridder, Inc. (“Knight Ridder”) pursuant to a definitive merger agreement entered into on March 12, 2006 (the Acquisition), under which the Company paid Knight Ridder shareholders a per share price consisting of $40.00 in cash and .5118 of a Class A McClatchy common share. The Company issued approximately 35.0 million Class A common shares in connection with the Acquisition. The total purchase price was approximately $4.6 billion. In addition, the Company assumed $1.9 billion in Knight Ridder long-term debt at closing.

 

Prior to the Acquisition, Knight Ridder published 32 daily newspapers in 29 U.S. markets, operated websites in all of its markets and owned a variety of internet and other investments which consisted of: 33.3% of CareerBuilder and ShopLocal LLC (“ShopLocal”), 25.0% of Topix.net (“Topix”), 21.5% of Classified Ventures, 33.3% interest in SP Newsprint Company (“SP”), 13.5% interest in the Ponderay Newsprint Company (“Ponderay”) and 49.5% of The Seattle Times Company which owns The Seattle Times newspaper and weekly newspapers in the Puget Sound area, and daily newspapers located in Walla Walla and Yakima, Washington and in Portland, Maine and various other smaller investments. Knight Ridder was the founder and operator of Real Cities, the largest national advertising network of local news websites.

 

To consummate the Acquisition, the Company borrowed $3.076 billion under a new bank debt facility (see Note 5 to the Consolidated Financial Statements) and used the proceeds from the sales of four Knight Ridder newspapers (see Disposition Transactions below) in order to pay Knight Ridder shareholders ($2.7 billion) and refinance its and Knight Ridder’s bank debt ($498.0 million). The after-tax proceeds from the sales of the eight Knight Ridder newspapers sold after the Acquisition closed were used to reduce debt.

 

The Acquisition was accounted for as a purchase. The purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values as of June 27, 2006, the date of the Acquisition. The purchase price allocation, while substantially completed, is subject to further adjustments based upon completion of analyses of deferred income tax assets and liabilities and other items.

 

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Disposition Transactions:

 

In conjunction with the Acquisition, the Company divested 12 Knight Ridder newspapers for strategic and antitrust reasons. The divested newspapers were the Philadelphia Inquirer; Philadelphia Daily News; San Jose Mercury News; St. Paul Pioneer Press; Akron Beacon Journal (OH); Wilkes Barre Times Leader (PA); Aberdeen American News (SD); Grand Forks Herald (ND); Ft. Wayne News-Sentinel (IN); Contra Costa Times (CA); Monterey Herald (CA); and Duluth News Tribune (MN). The Company received cash proceeds of approximately $2.0 billion (net of transaction costs). In addition, the buyers assumed approximately $77.0 million of Knight Ridder retirement obligations related to certain newspapers. Four of the 12 newspapers were sold concurrently with the closing of the Acquisition. The remaining eight newspapers were owned for periods ranging from two days to 36 days following the closing of the Acquisition. The operating results of these eight divested newspapers for the periods they were owned by the Company, including interest expense and debt issuance costs related to bank debt incurred until their sales, are included in discontinued operations in the Company’s Consolidated Statement of Income. No accounting gain or loss was recognized on the sale of the 12 newspapers.

 

In July 2006, the Company sold 18.3% of its interest in each of CareerBuilder and ShopLocal, and 13.8% of its interest in Topix for an aggregate of $309.7 million in cash and used the after-tax proceeds to reduce debt. The Company retained a 15.0% interest in CareerBuilder and ShopLocal and an 11.3% interest in Topix. No accounting gain or loss was recognized on the sale of these investments.

 

In December 2006, the Company paid income taxes of approximately $787.0 million related to the disposition of the newspapers and investments discussed above.

 

On December 26, 2006, the Company reached a definitive agreement to sell the (Minneapolis) Star Tribune newspaper of Minneapolis, MN to Avista Capital Partners for $530.0 million. The Company expects a future cash income tax benefit equal to approximately $160.0 million related to the sale by 2008. The purchase covers the newspaper as well as other publications and websites related to the newspaper. The transaction is expected to close in the first quarter of fiscal 2007. In the fourth quarter of fiscal 2006, the Company recorded a write down of the Star Tribune’s net assets to fair market value based on the expected sale proceeds and included this after-tax charge of approximately $363.0 million in discontinued operations. Additionally, the results of Star Tribune’s operations have been recorded as discontinued operations in all periods presented.

 

Recent Accounting Pronouncements:

 

In June 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes–an interpretation of FASB Statement No. 109.” This Interpretation specifies requirements for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This Interpretation is effective beginning on January 1, 2007. The Company is currently evaluating the impact FIN 48 will have, if any, on its consolidated financial statements.

 

Advertising Revenues:

 

Classified advertising revenues slowed over the course of fiscal 2006 compared to fiscal 2005. The decline in classified advertising partially reflected an industry-wide slowdown in automotive advertising that began in 2004. In 2006, employment advertising began to slow in most markets. While real estate advertising remained strong in the first three quarters of fiscal 2006, increases in long-term interest rates and the resulting drop in home sales caused real estate advertising revenue declines at many newspapers in the fourth quarter of fiscal 2006. National advertising also declined in fiscal 2006 reflecting a slowdown in a number of segments including telecommunications and automotive manufacturing. These declines were partially offset by growth in retail, direct marketing and online advertising. See the revenue discussions in management’s review of the Company’s results of operations.

 

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Newsprint:

 

The Company incurred three newsprint price increases in fiscal 2005 and one newsprint price increase in fiscal 2006. Newsprint expense was 5.3% higher than pro forma newsprint expense in fiscal 2005, reflecting higher prices, offset partially by lower newsprint usage. Newsprint pricing is dependent on global demand and supply for newsprint. A significant increase in newsprint prices would increase the Company’s operating expenses. However, because the Company has ownership interests in newsprint producers (Ponderay and SP), an increase in newsprint prices, while negatively affecting operating expenses, would increase its share of earnings from these investments. Ponderay and SP could also be impacted by higher energy and other factors that would impact their results. The impact of newsprint price increases on the Company’s financial results is discussed under “Results of Operations”.

 

RESULTS OF OPERATIONS

 

The Company noted the following items related to the Acquisition and other matters that impacted fiscal 2006 results:

 

   

The Company issued approximately 35.0 million Class A shares in connection with the Acquisition. As a result, the weighted average diluted shares used to calculate earnings per share in fiscal 2006 increased to 64.6 million shares compared to 47.0 million in fiscal 2005. Weighted average shares in fiscal 2007 are expected to be in line with fourth quarter fiscal 2006 diluted shares of approximately 82.0 million.

 

   

The Company sold the 12 Knight Ridder newspapers identified as generally not fitting with its strategy. Eight of the 12 newspapers were held for periods ranging from two to 36 days following the closing of the Acquisition, and their results, including the interest expense and debt financing costs related to the debt incurred until their sale, are recorded as discontinued operations. The after-tax cash proceeds from the sales of the eight newspapers were used to repay the debt used to purchase them. No gain or loss was recorded related to the disposition of the 12 newspapers.

 

   

The Company sold part of its interest in CareerBuilder and certain other internet investments, which were acquired as part of the Acquisition, for $309.7 million and used the after-tax proceeds to reduce debt. The Company retained a 15.0% ownership in CareerBuilder and an interest in the other internet investments. No gain or loss was recorded related to the disposition of these investments.

 

   

The Company sold land in Roseville, CA that had been held since 1996 for $10.7 million and used the proceeds to reduce debt. The Company recorded a pre-tax gain of $9.0 million on the sale in the third quarter of fiscal 2006.

 

   

In December 2006, the Company entered in to a definitive agreement to sell the (Minneapolis) Star Tribune newspaper for $530.0 million in proceeds and is expected to receive an additional approximately $160.0 million in cash income tax benefits related to the sale by 2008. The sale is expected to close in the first quarter of fiscal 2007. The Company recorded an after-tax charge of $363.0 million to write down Star Tribune’s net assets to fair market value based on the expected sale proceeds in the fourth quarter of fiscal 2006 and included this charge in discontinued operations. Additionally, the results of Star Tribune’s operations have been recorded as discontinued operations in all periods presented.

 

   

The Company implemented Financial Accounting Standard No. 123 (revised 2004), “Share-Based Payments” (FAS 123R), at the beginning of fiscal 2006 and recorded share based compensation of $7.1 million in the year ended December 31, 2006.

 

   

As a result of the anticipated (Minneapolis) Star Tribune disposition, the Company’s mix of state tax jurisdictions has resulted in a lower overall state tax rate. The Company recalculated its deferred tax liabilities and assets at the new lower effective state tax rate. The effective tax rate was affected by similar calculations related to the Acquisition in both the third and the fourth quarters of fiscal 2006. The fourth quarter of fiscal 2006 income tax provision was reduced by $12.3 million, and the full-year

 

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tax provision was lowered by $18.1 million related to the Company’s lower state tax rates. This brought the annual effective tax rate on continuing operations to 32.3% for all of fiscal 2006. The effective tax rate on continuing operations is expected to be between 39.0% and 39.5% in fiscal 2007.

 

   

The 20 former Knight Ridder newspapers that the Company retained had recorded approximately $4.4 million in deferred online employment advertising revenues, which the Company was required to value at zero in the purchase price allocation. This resulted in a reduction of approximately $4.4 million in full-year fiscal 2006 online employment advertising revenues that would have been recognized had there been no change in control (“purchase accounting adjustment”).

 

   

The purchase price for the Acquisition has been allocated to the assets acquired and liabilities assumed based upon their estimated fair values as of June 27, 2006, the date of the Acquisition. The purchase price allocation, while substantially complete, is subject to further adjustments based upon completion of analyses of deferred income tax assets and liabilities and other items.

 

The results of the eight newspapers formerly owned by Knight Ridder and held by the Company for a short period of time in July and August 2006, and the (Minneapolis) Star Tribune newspaper are reported as discontinued operations in fiscal 2006. The Company’s results from continuing operations since the close of the Acquisition (and all pro forma amounts for prior periods discussed) include the operations of the 20 retained former Knight Ridder newspapers and all of its previously owned newspaper operations except for the (Minneapolis) Star Tribune newspaper.

 

The growth in revenues, expenses in fiscal 2006 compared to the same periods in fiscal 2005 resulted largely from the Acquisition. To facilitate an analysis of operating results, fiscal 2006 and 2005 have been prepared to include pro forma results from continuing operations for the full years. Pro forma amounts reflect the results of continuing operations of the Company as defined in the preceding paragraph. The financial results for Knight Ridder and the 20 newspapers retained by the Company included in the pro forma information were derived from the historical unaudited financial statements of Knight Ridder. The Company believes that the use of pro forma reporting of operating results enhances measurement of performance by permitting comparisons with prior historical data. Such supplemental pro forma data is not necessarily indicative of the operating results that would have occurred if the Acquisition had been completed as of the dates indicated.

 

Fiscal 2006 Compared to Fiscal 2005

 

The Company’s fiscal 2006 reporting period is a 53-week year versus a 52-week year in fiscal 2005. The Company estimates that income from continuing operations was higher by approximately $5.3 million in fiscal 2006 because of the additional week being reported.

 

The Company reported fiscal 2006 income from continuing operations of $183.5 million, or $2.84 per share, compared to $119.5 million or $2.55 per share in fiscal 2005. The Company recorded a loss from discontinued operations of $339.1 million or $5.25 per share relating to the results of the (Minneapolis) Star Tribune newspaper (see discussion below), which the Company intends to sell, and the results of the eight former Knight Ridder newspapers, which were sold subsequent to the closing of the Acquisition. The loss from discontinued operations includes a $363.0 million after-tax write down of the net assets of the Star Tribune to the agreed-upon selling price. The Company recorded income from discontinued operations of $41.0 million or 87 cents per share in fiscal 2005. The Company’s total net loss was $155.6 million or $2.41 per share including discontinued operations, compared to net income of $160.5 million or $3.42 per share in fiscal 2005.

 

Revenues:

 

Revenues from continuing operations of the Company in fiscal 2006 were $1.68 billion, up $867.7 million or 107.5% from fiscal 2005 revenues from continuing operations of $807.5 million, due primarily to the addition of the 20 former Knight Ridder newspapers beginning in the third quarter of fiscal 2006. Advertising revenues totaled $1.43 billion and circulation revenues were $194.9 million.

 

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On a pro forma basis, including all continuing operations of the Company for the full years of both 2006 and 2005, and stating 2006 on a comparable 52-week basis to 2005, total revenues in 2006 would have been $2.45 billion, down 0.4%, with advertising revenues of $2.09 billion, up 0.5%, and circulation revenues of $290.0 million, down 4.0%.

 

The following table summarizes the Company’s revenues by category for fiscal 2006 (a 53-week year) compared to fiscal 2005 (a 52-week year) on an as reported basis. The table also summarizes the Company’s revenue by category on a pro forma basis, which compares pro forma fiscal 2006 on a 52-week basis with pro forma fiscal 2005 (dollars in thousands):

 

     Fiscal Year

   Fiscal Year

 
    

(As Reported)
2006

53 Weeks


  

(As Reported)
2005

52 Weeks


  

%

Change


  

(Pro Forma)
2006

52 Weeks


  

(Pro Forma)
2005

52 Weeks


  

%

Change


 

Advertising:

                                       

Retail

   $ 623,675    $ 287,827    116.7    $ 891,378    $ 893,462    (0.2 )

National

     133,779      59,327    125.5      201,578      219,719    (8.3 )

Classified:

                                       

Auto

     136,372      83,157    64.0      196,971      217,244    (9.3 )

Employment

     183,649      97,112    89.1      283,054      279,700    1.2  

Real estate

     179,237      90,876    97.2      252,360      223,335    13.0  

Other

     56,661      25,682    120.6      87,114      89,341    (2.5 )
    

  

       

  

      

Total classified

     555,919      296,827    87.3      819,499      809,620    1.2  

Direct marketing and other

     119,540      47,809    150.0      178,997      158,629    12.8  
    

  

       

  

      

Total advertising

     1,432,913      691,790    107.1      2,091,452      2,081,430    0.5  

Circulation

     194,940      97,205    100.5      289,960      302,138    (4.0 )

Other

     47,337      18,485    156.1      73,095      79,565    (8.1 )
    

  

       

  

      

Total revenues

   $ 1,675,190    $ 807,480    107.5    $ 2,454,507    $ 2,463,133    (0.4 )
    

  

       

  

      

 

Retail advertising increased $335.8 million in fiscal 2006 or 116.7% from fiscal 2005 primarily reflecting the Acquisition. On a pro forma basis, retail advertising, including online and preprint advertising, decreased $2.1 million or 0.2% from fiscal 2005. On a pro forma basis, online retail advertising increased $6.5 million or 62.8% from fiscal 2005, while print ROP advertising decreased $15.8 million or 2.8% from fiscal 2005. On a pro forma basis, preprint advertising increased $7.2 million or 2.2% from fiscal 2005.

 

National advertising increased $74.5 million or 125.5% from fiscal 2005 primarily reflecting the Acquisition. On a pro forma basis, national advertising decreased $18.1 million or 8.3% from fiscal 2005. The declines were primarily in the telecommunications, automotive and airlines/transportation categories.

 

Classified advertising increased $259.1 million or 87.3% from fiscal 2005 primarily reflecting the Acquisition. On a pro forma basis, classified advertising increased $9.9 million or 1.2% from fiscal 2005.

 

   

Automotive advertising increased $53.2 million or 64.0% from fiscal 2005. On a pro forma basis, automotive advertising declined $20.3 million or 9.3% from fiscal 2005, reflecting an industry-wide trend.

 

   

Employment advertising increased $86.5 million or 89.1% from fiscal 2005. On a pro forma basis, employment advertising increased $3.3 million or 1.2% from fiscal 2005. On a pro forma basis, employment advertising would have increased by 2.6% in fiscal 2006 but for the purchase accounting adjustment, which prohibited the recognition of approximately $4.0 million in online employment revenues. The slowing in employment advertising began late in the second quarter of fiscal 2006 and continued throughout the remainder of the year.

 

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Real estate advertising was up $88.4 million or 97.2% from fiscal 2005. On a pro forma basis, real estate advertising increased $29.0 million or 13.0% from fiscal 2005. While this category remained strong through the first nine months of the year, real estate advertising declined in some markets in the fourth quarter of fiscal 2006.

 

   

Online classified advertising increased $50.2 million or 160.4% from fiscal 2005. On a pro forma basis, online classified advertising increased $21.2 million or 19.1% from fiscal 2005 and would have increased 22.7%, but for the purchase accounting adjustment discussed above.

 

Online advertising, which is included in each of the advertising categories discussed above, totaled $102.0 million in fiscal 2006, an increase of $66.6 million or 188.4% over fiscal 2005 primarily reflecting the Acquisition. On a pro forma basis, online advertising was $160.3 million and increased $29.2 million or 22.3% from fiscal 2005 and would have been up 25.3% if the revenues related to the purchase accounting adjustment discussed above had been recognized.

 

Direct marketing revenues increased $72.3 million or 158.0% from fiscal 2005 primarily reflecting the Acquisition. On a pro forma basis, direct marketing revenues increased $20.9 million or 13.4% from fiscal 2005 and were up primarily due to expanded direct mail programs and the addition of small niche products at various newspapers.

 

Circulation revenues increased $97.7 million or 100.5% from fiscal 2005 primarily reflecting the Acquisition. On a pro forma basis, consolidated circulation revenues decreased $12.2 million or 4.0% from fiscal 2005. The decline in circulation revenues primarily reflects lower circulation volumes, sales mix and promotional programs at certain newspapers.

 

Operating Expenses:

 

Operating expenses increased $712.1 million or 115.6% in fiscal 2006 related primarily to expenses added by the Acquisition. On a pro forma 52-week basis, operating expenses were up $32.0 million or 33.3% from fiscal 2005, due primarily to the additional depreciation and amortization resulting from valuing the tangible and intangible assets added in the Acquisition at fair market value. On a pro forma basis, compensation costs were up 1.0%, (down 0.6% excluding pro forma stock-based compensation expense of $16.8 million), with payroll up 1.3%, reflecting merit increases offset by a 3.1% reduction in head count. On a pro forma basis, fringe benefits were up 0.2%, primarily reflecting lower retirement expenses offset by higher medical costs. On a pro forma basis, newsprint and supplement expense was up 3.6% with newsprint expense up 5.3% and supplement expense down 4.6%. Newsprint price increases were partially offset by a decline in consumption. On a pro forma basis, other operating costs were up 1.3%.

 

Interest:

 

Interest expense for continuing operations was $93.7 million for fiscal 2006 reflecting the service costs on debt incurred to finance the Acquisition. In fiscal 2006, a total of $24.2 million of interest expense was allocated to discontinued operations related to debt used to acquire the (Minneapolis) Star Tribune newspaper, which is being sold, and the former Knight Ridder newspapers, which were sold in fiscal 2006. Interest expense allocated to discontinued operations in fiscal 2005 related to the (Minneapolis) Star Tribune totaled $7.7 million. See the discussion in Liquidity and Capital Resources below and Note 2 to the Consolidated Financial Statements. Interest income totaled $3.6 million reflecting income earned on cash accumulated from August to December 2006. Most of the cash was used to pay income taxes in December 2006.

 

Equity Income:

 

Equity income from the Company’s interests in the two newsprint mills, SP and Ponderay, and Classified Ventures was partially offset by equity losses from the other companies—the largest of which are CareerBuilder and ShopLocal.

 

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Gain on Sale of Land and Other:

 

The Company recorded a pre-tax gain of $9.0 million from the sale of land in Roseville, CA in the third quarter of fiscal 2006. This land was held for about 10 years and was sold to take advantage of the increase in property values in the Sacramento, CA area. The proceeds were used to reduce bank debt.

 

Income Taxes:

 

The income tax rate from continuing operations in fiscal 2006 was 32.3%, compared to 37.8% in fiscal 2005. Many of the Company’s new operations are in states with lower tax rates than its existing markets, lowering the Company’s effective state tax rate. The Company recalculated its deferred tax liabilities in fiscal 2006 at its new effective tax rate, which resulted in a reduction to fiscal 2006 income tax provision of $18.1 million. The effective tax rate for fiscal 2007 is expected to be in the 39.0% to 39.5% range.

 

Discontinued Operations:

 

Loss from discontinued operations in fiscal 2006 was $339.1 million or $5.25 per share including the write-down of (Minneapolis) Star Tribune’s net assets to fair market value of $363.0 million. Income from discontinued operations of the sold newspapers was $23.9 million excluding the write-down.

 

The Company sold the 12 Knight Ridder newspapers, which generally did not fit with its operating strategy or to assuage antitrust issues. Eight of the 12 were held for periods ranging from two to 36 days following the closing of the Acquisition, and their results, including the interest expense of $7.7 million and debt issuance costs of $9.2 million related to the debt incurred until their sale, are recorded as discontinued operations. No accounting gain or loss was recorded related to the disposition of the Knight Ridder newspapers.

 

In addition, on December 26, 2006 the Company reached a definitive agreement to sell the Star Tribune newspaper of Minneapolis, MN. The sale is expected to close in the first fiscal quarter of 2007. In the fourth quarter of fiscal 2006, the Company recorded an after-tax charge of $363.0 million to write down the Star Tribune’s net assets to fair market value based on the expected sale proceeds and included this charge in discontinued operations. Additionally, the results of Star Tribune’s operations, including $7.3 million in interest incurred on the debt used to finance its purchase, have been recorded as discontinued operations.

 

Fiscal 2005 Compared to Fiscal 2004

 

As discussed above, the Company entered into a definitive agreement for the sale of the (Minneapolis) Star Tribune on December 26, 2006. The fiscal 2005 to fiscal 2004 comparisons reflect the Star Tribune as a discontinued operation.

 

Income from continuing operations was $119.5 million or $2.55 per share in fiscal 2005, compared to $109.5 million or $2.34 per share in fiscal 2004. Income from discontinued operations was $41.0 million, or 87 cents per share relating to the results of the Star Tribune newspaper, which the Company intends to sell, compared to $46.3 million or 99 cents per share in fiscal 2004. Total net income in fiscal 2005 was $160.5 million, or $3.42 per share including discontinued operations and was $155.9 million or $3.33 per share in fiscal 2004.

 

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Revenues:

 

Revenues in fiscal 2005 were $807.5 million, up $24.2 million, or 3.1% from revenues in fiscal 2004. Advertising revenues were $691.8 million, up $28.5 million, or 4.3% and circulation revenues were $97.2 million, down $3.1 million, or 3.1%, from fiscal 2004.

 

The following table summarizes the Company’s revenues by category for fiscal 2005 compared to fiscal 2004 (dollars in thousands):

 

     Fiscal Year

 
     2005

   2004

  

%

Change


 

Advertising:

                    

Retail

   $ 287,827    $ 288,680    (0.3 )

National

     59,327      59,621    (0.5 )

Classified:

                    

Auto

     83,157      89,297    (6.9 )

Employment

     97,112      84,422    15.0  

Real estate

     90,876      75,554    20.3  

Other

     25,682      26,324    (2.4 )
    

  

      

Total classified

     296,827      275,597    7.7  

Direct marketing and other

     47,809      39,404    21.3  
    

  

      

Total advertising

     691,790      663,302    4.3  

Circulation

     97,205      100,330    (3.1 )

Other

     18,485      19,641    (5.9 )
    

  

      

Total revenues

   $ 807,480    $ 783,273    3.1  
    

  

      

 

Retail advertising decreased $0.8 million or 0.3% from fiscal 2004, but includes a reclassification of ROP advertising to classified advertising in a zoned edition of The Fresno Bee that totaled $1.1 million. Excluding this reclassification, retail advertising was flat. Online retail advertising increased $0.4 million or 12.9% from fiscal 2004, while print ROP advertising decreased $3.7 million or 2.0% from fiscal 2004 (or $2.6 million excluding the reclassification discussed above). Preprint advertising increased $2.4 million or 2.3% from fiscal 2004.

 

National advertising decreased $0.3 million or 0.5% from fiscal 2004. The declines were primarily in the telecommunications, automotive and airlines/transportation categories, offset by gains in other categories.

 

Classified advertising increased $21.2 million or 7.7% from fiscal 2004 (up 7.3% excluding the reclassification).

 

   

Automotive advertising decreased $6.1 million or 6.9% from fiscal 2004, reflecting an industry-wide trend.

 

   

Employment advertising increased $12.7 million or 15.0% from fiscal 2004 and was up at most of the Company’s newspapers.

 

   

Real estate advertising was up $15.3 million or 20.3% from fiscal 2004, with gains at most newspapers, but with most of the growth ($14.2 million) at the Company’s California newspapers.

 

   

Online classified advertising increased $8.8 million or 38.8% from fiscal 2004, with much of the growth ($5.3 million) in online employment advertising.

 

Online advertising, which is included in each of the advertising categories discussed above, totaled $35.4 million in fiscal 2005, an increase of $9.3 million or 35.6% from fiscal 2004. The increase in online advertising revenues was attributable to increases in online retail advertising and online classified advertising as discussed above.

 

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Direct marketing revenues increased $7.9 million or 20.9% from fiscal 2004 and were up at most of the Company’s newspapers.

 

Circulation revenues decreased $3.1 million or 3.1% from fiscal 2004 primarily reflecting lower circulation volumes. Revenues were also reduced by increased payments to carriers to offset higher gasoline costs and changes in the sales mix between single copy and home-delivered newspapers.

 

Operating Expenses:

 

Operating expenses increased $13.1 million or 2.2% in fiscal 2005. Compensation costs were up 1.7%, with payroll up 0.5% reflecting merit increases offset by lower head count. Fringe benefits were up 6.6%, primarily reflecting higher retirement and medical expenses. Newsprint and supplement expense was up 4.1%. Newsprint price increases were partially offset by a decrease in consumption. Other operating costs were up 3.2% largely due to increases in postage related to new direct marketing programs and other items. Depreciation and amortization expense decreased 2.1%.

 

Income Taxes:

 

The income tax rate from continuing operations in fiscal 2005 was 37.8%, compared to 39.6% in fiscal 2004, and was lower primarily due to a qualified production activities income deduction enacted in 2005 and successful resolutions for certain tax matters.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Sources and Uses of Liquidity and Capital Resources:

 

The Company’s cash and cash equivalents were $19.6 million as of December 31, 2006. The Company used $600.3 million of cash from operating activities in fiscal 2006, due primarily to income tax payments made in December 2006 related to the sale of the former Knight Ridder newspapers of $690.3 million, which is included in cash used by discontinued operations (see Note 8 to the Consolidated Financial Statements). The proceeds for these sales are reflected in the investing activities section of the Statement of Cash Flows and are discussed below. Cash provided by continuing operations was $203.8 million, $144.8 million and $135.1 million in fiscal 2006, 2005 and 2004, respectively. The increase in fiscal 2006 resulted largely from the Acquisition.

 

During the last three years, the Company has made voluntary contributions totaling $105.5 million (including $31.5 million in fiscal 2006) to its defined benefit pension plans to maintain adequate funding of its pension obligations, and to help reduce pension expense with the earnings on the contributions. Given the increase in its pension assets from market returns over the last few years and the increase in long-term corporate bond yields at year end 2006, the Company does not expect to make contributions to its plans in fiscal 2007. The Company may be required to, or may voluntarily opt to, make additional contributions to its pension plans in future years.

 

The Company used $543.1 million of cash from investing activities in fiscal 2006. The largest investing uses of cash were $2.8 billion to acquire Knight Ridder and $65.2 million for purchases of property, plant and equipment. These uses were partially offset by the proceeds from the sale of the 12 former Knight Ridder newspapers ($2.0 billion included in cash provided by discontinued operations—see Note 8 to the Consolidated Financial Statements) and $320.3 million in proceeds from the sale of equity investments and land. Additionally, there are $5.3 million of capital expenditures previously incurred by Knight Ridder that were paid by McClatchy and are reflected in the Company’s Statement of Cash Flows in 2006.

 

The Company generated $1.2 billion of cash from financing sources in fiscal 2006. Sources include cash drawn from its new credit facility to complete the Acquisition and to refinance existing debt ($3.2 billion), offset by subsequent repayment of bank debt and commercial paper ($2.0 billion) and payment of $26.8 million in debt

 

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issuance costs. The Company paid $40.0 million in dividends in fiscal 2006. The Company also received $4.1 million in proceeds from issuing Class A stock under employee stock plans in fiscal 2006.

 

Debt and Related Matters:

 

Through June 27, 2006, the Company used its senior unsecured revolving credit facility, which was initially put into place in 1998 to finance the purchase of The Star Tribune Company, and refinanced in 2004 primarily to become a back-up facility for commercial paper. The re-financed facility provided borrowings of up to $500 million. This credit agreement was refinanced with a new $3.2 billion senior unsecured credit facility (“Credit Agreement”) entered into in connection with the Acquisition. At the closing of the Acquisition, the Company’s new Credit Agreement consisted of a $1.0 billion five-year revolving credit facility and $2.2 billion five-year Term A loan. Both the Term A loan and the revolver are due on June 27, 2011.

 

On June 27, 2006, McClatchy borrowed $2.2 billion under the Term A loan and $876.0 million under the revolving credit facility. The Company has subsequently repaid $1.1 billion of the Term A loan and $210.2 million of the revolving credit facility, primarily from proceeds received in the sale of the eight former Knight Ridder newspapers, net of taxes paid on the tax gain on the sale (see Note 2 to the Consolidated Financial Statements). A total of $264.0 million of funds were available under the revolving credit facility at December 31, 2006.

 

Also in connection with the Acquisition, the Company assumed $1.9 billion of debt from Knight Ridder, including $1.6 billion in publicly-traded notes (“bonds”). The bonds were valued at $1.5 billion as of June 27, 2006 (see Note 5 to the Consolidated Financial Statements). Bonds with a face value of $100.0 million are due on November 1, 2007 and the Company expects to use its revolving credit facility to refinance the bonds, and accordingly has recorded the bonds as long-term debt.

 

In December 2006, the Company entered into a definitive agreement to sell the (Minneapolis) Star Tribune newspaper for $530.0 million in proceeds and is expected to receive approximately $160.0 million in cash income tax benefits related to the sale by 2008. The sale is expected to close in the first quarter of fiscal 2007 and the Company intends to reduce debt with the proceeds. Accordingly, as of December 31, 2006, the Company recorded $530.0 million of its debt as a current liability in its Consolidated Balance Sheet.

 

Debt under the Credit Agreement bears interest at the London Interbank Offered Rate (“LIBOR”) plus a spread ranging from 37.5 basis points to 125.0 basis points. Applicable rates are based upon the Company’s ratings on its long-term debt from Moody’s Investor Services (“Moody’s”) and Standard & Poor’s. A commitment fee for the unused revolving credit ranges from 10.0 basis points to 20.0 basis points depending on the Company’s ratings. Standard & Poor’s has rated the facilities “BBB” and Moody’s has rated the facility “Ba1.” Under the structure of the facilities, the Company will pay interest at LIBOR plus 75.0 basis points on outstanding debt and its commitment fees are currently at 15.0 basis points.

 

The Credit Agreement contains financial covenants including a minimum interest coverage ratio (as defined) of 3:00 to 1:00 and a maximum leverage ratio (as defined) of 4.75 to 1.00 through September 30, 2007, declining over time to 4.00 to 1.00 on December 28, 2008 and thereafter. At December 31, 2006, the Company was in compliance with all debt covenants.

 

At December 31, 2006, the Company had outstanding letters of credit totaling $70.2 million, including $64.1 million assumed in the Acquisition, securing estimated obligations stemming from workers’ compensation claims and other contingent claims. These letters of credit have been reduced in early fiscal 2007 reflecting reduced collateral requirements by the Company’s insurance carriers to $57.7 million, and will be reduced by an additional $4.9 million related to the (Minneapolis) Star Tribune once its sale is closed.

 

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Contractual Obligations:

 

The following table summarizes specific financial obligations under the Company’s contractual obligations and commercial commitments related to continuing operations as of December 31, 2006 (in thousands):

 

     Payments Due By

     Total

   1 Year or
Less


  

1-3

Years


  

3-5

Years


   After 5
Years


Included in the Company’s balance sheet:

                                  

Long-term debt (a)

   $ 3,276,669    $ 530,000    $ 212,950    $ 1,640,332    $ 893,387

Pension obligations

     258,738      6,723      13,446      13,446      225,123

Post-retirement obligations

     71,593      10,478      20,957      20,957      19,201

Tax reserve obligations

     35,036      —        35,036      —        —  

Workers compensation obligations

     28,938      9,162      19,776      —        —  

Other long-term obligations (b)

     23,955      6,487      11,458      5,278      732

Other obligations:

                                  

Purchase obligations (c)

     21,198      20,558      640      —        —  

Operating leases

     56,870      12,862      17,509      10,850      15,649

Stand by letters of credit (d)

     65,213      —        —        65,213      —  
    

  

  

  

  

Total

   $ 3,838,210    $ 596,270    $ 331,772    $ 1,756,076    $ 1,154,092
    

  

  

  

  

 

The Company has no material capital lease obligations.

 

(a) Amounts represent bonds net of discounts and includes $530.0 million of bank debt as 1 year or less and $100.0 million of bonds as 3-5 years as discussed above.
(b) Primarily deferred compensation and future lease obligations.
(c) Primarily capital expenditures for property, plant and equipment.
(d) In connection with the Company’s insurance program, letters of credit are required to support certain projected claims and obligations.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

A hypothetical 25 basis point change in LIBOR for a fiscal year would increase or decrease in the annual net income by $2.0 million to $2.5 million.

 

See the discussion at “Recent Events and Trends—Operating Expenses” for the impact of market changes on the Company’s newsprint and pension costs.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO FINANCIAL STATEMENTS

AND FINANCIAL STATEMENT SCHEDULES

 

     Page

Report of Independent Registered Public Accounting Firm

   27

Consolidated Statement of Income

   29

Consolidated Balance Sheet

   30

Consolidated Statement of Cash Flows

   31

Consolidated Statement of Stockholders’ Equity

   32

Notes to Consolidated Financial Statements

   33

 

All other schedules are omitted as not applicable under the rules of Regulation S-X.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of The McClatchy Company:

 

We have audited the accompanying consolidated balance sheet of The McClatchy Company and subsidiaries (the “Company”) as of December 31, 2006 and December 25, 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. We also have audited management’s assessment, included in the accompanying “Management Report on Internal Control Over Financial Reporting,” that the Company maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management’s Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting of the former Knight Ridder, Inc. newspapers, which were acquired on June 27, 2006 (the “Acquired Newspapers”). The Acquired Newspapers constitute approximately 73 percent of net assets, 80 percent of total assets, 51 percent of revenues, and 39 percent of income from continuing operations before income tax provision of the consolidated financial statement amounts as of and for the year ended December 31, 2006. Accordingly, our audit did not include the internal control over financial reporting at the Acquired Newspapers. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and December 25, 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

As discussed in Note 1 to the consolidated financial statements, in 2006 the Company changed its method of accounting for share-based payment arrangements to conform to Statement of Financial Accounting Standards No.123(R), “Share-Based Payment.” As discussed in Note 7 to the consolidated financial statements, on December 31, 2006 the Company adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”

 

/S/ DELOITTE & TOUCHE LLP

 

Sacramento, California

March 1, 2007

 

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CONSOLIDATED STATEMENT OF INCOME

(In thousands, except for share amounts)

 

     Year Ended

     December 31,
2006


    December 25,
2005


   December 26,
2004


REVENUES—NET:

                     

Advertising

   $ 1,432,913     $ 691,790    $ 663,302

Circulation

     194,940       97,205      100,330

Other

     47,337       18,485      19,641
    


 

  

       1,675,190       807,480      783,273

OPERATING EXPENSES:

                     

Compensation

     652,582       321,312      316,089

Newsprint and supplements

     231,068       103,292      99,252

Depreciation and amortization

     98,865       39,311      40,159

Other operating expenses

     345,767       152,262      147,529
    


 

  

       1,328,282       616,177      603,029

OPERATING INCOME

     346,908       191,303      180,244

NON-OPERATING (EXPENSES) INCOME:

                     

Interest expense

     (93,664 )     —        —  

Interest income

     3,562       47      9

Equity income in unconsolidated companies—net

     4,951       635      852

Gain on sale of land and other—net

     9,128       231      295
    


 

  

       (76,023 )     913      1,156

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAX PROVISION

     270,885       192,216      181,400

INCOME TAX PROVISION

     87,390       72,701      71,852
    


 

  

INCOME FROM CONTINUING OPERATIONS

     183,495       119,515      109,458

INCOME (LOSS) FROM DISCONTINUED OPERATIONS,

                     

NET OF INCOME TAXES

     (339,072 )     41,004      46,328
    


 

  

NET INCOME (LOSS)

   $ (155,577 )   $ 160,519    $ 155,876
    


 

  

NET INCOME PER COMMON SHARE:

                     

Basic:

                     

Income from continuing operations

   $ 2.85     $ 2.56    $ 2.36

Income (loss) from discontinued operations

     (5.27 )     0.88      1.00
    


 

  

Net income (loss) per share

   $ (2.42 )   $ 3.44    $ 3.36
    


 

  

Diluted:

                     

Income from continuing operations

   $ 2.84     $ 2.55    $ 2.34

Income (loss) from discontinued operations

     (5.25 )     0.87      0.99
    


 

  

Net income (loss) per share

   $ (2.41 )   $ 3.42    $ 3.33
    


 

  

WEIGHTED AVERAGE NUMBER OF COMMON SHARES:

                     

Basic

     64,415       46,606      46,382

Diluted

     64,645       46,996      46,815

 

See notes to consolidated financial statements.

 

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CONSOLIDATED BALANCE SHEET

(In thousands, except share amounts)

 

    

December 31,

2006


   

December 25,

2005


 

ASSETS

                

CURRENT ASSETS:

                

Cash and cash equivalents

   $ 19,581     $ 3,052  

Trade receivables, net of allowances of $12,732 in 2006 and $2,008 in 2005

     311,785       94,444  

Other receivables

     36,477       3,902  

Newsprint, ink and other inventories

     52,097       15,456  

Deferred income taxes

     248,753       13,197  

Prepaid income taxes

     88,836       10,520  

Newspaper assets held for sale

     563,589       1,173,620  

Land and other assets held for sale

     231,029       —    

Other current assets

     23,192       7,026  
    


 


       1,575,339       1,321,217  

PROPERTY, PLANT AND EQUIPMENT:

                

Land

     204,692       30,587  

Building and improvements

     382,206       192,004  

Equipment

     811,173       426,820  

Construction in progress

     36,401       24,203  
    


 


       1,434,472       673,614  

Less accumulated depreciation

     (458,496 )     (399,849 )
    


 


       975,976       273,765  

INTANGIBLE ASSETS:

                

Identifiable intangibles—net

     1,369,046       28,153  

Goodwill-net

     3,559,828       317,572  
    


 


       4,928,874       345,725  

INVESTMENTS IN UNCONSOLIDATED COMPANIES

     520,213       23,515  

PREPAID PENSION ASSETS

     32,457       118,337  

OTHER ASSETS

     21,851       4,557  
    


 


TOTAL ASSETS

   $ 8,054,710     $ 2,087,116  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

CURRENT LIABILITIES:

                

Current portion of bank debt

   $ 530,000     $ —    

Accounts payable

     139,501       31,965  

Accrued compensation

     135,363       42,694  

Income taxes

     47,330       62  

Unearned revenue

     82,524       28,679  

Newspaper liabilities held for sale

     83,806       109,934  

Accrued interest

     33,697       156  

Accrued dividends

     14,727       8,415  

Other accrued liabilities

     45,166       4,824  
    


 


       1,112,114       226,729  

LONG-TERM DEBT

     2,746,669       154,200  

OTHER LONG-TERM OBLIGATIONS

     385,410       40,509  

DEFERRED INCOME TAXES

     706,893       100,087  

COMMITMENTS AND CONTINGENCIES

                

STOCKHOLDERS’ EQUITY:

                

Common stock $.01 par value:

                

Class A—authorized 200,000,000 shares, issued 55,795,162 in 2006 and 20,526,126 in 2005

     557       205  

Class B—authorized 60,000,000 shares, issued 26,116,397 in 2006 and 26,224,147 in 2005

     261       262  

Additional paid-in capital

     2,182,544       350,825  

Retained earnings

     1,016,023       1,217,927  

Deferred stock compensation

     —         (1,799 )

Accumulated other comprehensive loss

     (95,761 )     (1,829 )
    


 


       3,103,624       1,565,591  
    


 


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 8,054,710     $ 2,087,116  
    


 


 

See notes to consolidated financial statements.

 

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CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

 

     December 31,
2006


    December 25,
2005


    December 26,
2004


 

CASH FLOWS FROM OPERATING ACTIVITIES:

                        

Income from continuing operations

   $ 183,495     $ 119,515     $ 109,548  

Reconciliation to net cash provided by continuing operations:

                        

Depreciation and amortization

     98,865       39,311       40,159  

Contribution to pension plans

     (31,545 )     (32,984 )     (40,956 )

Employee benefit expense

     21,819       12,416       8,574  

Stock compensation expense

     7,149       536       —    

Deferred income taxes

     (33,982 )     4,697       13,993  

Gain on sale of land

     (9,047 )     —         —    

Equity income in unconsolidated companies

     (4,951 )     (635 )     (852 )

Other

     170       2,673       3,240  

Changes in certain assets and liabilities:

                        

Trade receivables

     6,346       (1,953 )     (6,725 )

Inventories

     2,052       (2,711 )     (1,716 )

Other assets

     (12,051 )     10,821       4,754  

Accounts payable

     11,769       9,368       561  

Accrued compensation

     8,230       (4,120 )     4,154  

Income taxes

     6,405       62       —    

Other liabilities

     (50,954 )     (12,230 )     331  
    


 


 


Net cash provided by operating activities of continuing operations

     203,770       144,766       135,065  

Net cash provided (used) by operating activities of discontinued operations

     (804,073 )     48,768       49,925  
    


 


 


Net cash provided (used) by operating activities

     (600,303 )     193,534       184,990  

CASH FLOWS FROM INVESTING ACTIVITIES:

                        

Acquisition of Knight Ridder—net of cash received

     (2,771,595 )     —         —    

Proceeds from sale of equity investments and other

     320,328       —         —    

Purchases of property, plant and equipment

     (65,244 )     (42,116 )     (38,061 )

Equity investments

     (3,435 )     (10,400 )     —    

Purchase of Merced Group

     —         —         (40,984 )

Other—net

     649       614       580  
    


 


 


Net cash used by investing activities of continuing operations

     (2,519,297 )     (51,902 )     (78,465 )

Net cash provided (used) by investing activities of discontinued operations

     1,976,186       (12,399 )     (9,145 )
    


 


 


Net cash used by investing activities

     (543,111 )     (64,301 )     (87,610 )

CASH FLOWS FROM FINANCING ACTIVITIES:

                        

Borrowings from term bank debt

     2,200,000       —         —    

Repayments of term bank debt

     (1,100,000 )     —         (347,000 )

Net borrowings (repayments) from revolving bank debt

     665,795       —         —    

Repayment of Knight Ridder debt

     (389,261 )     —         —    

Net proceeds (repayments) of commercial paper

     (154,200 )     (113,000 )     267,200  

Payment of cash dividends

     (40,008 )     (28,899 )     (22,253 )

Payment of debt issuance costs

     (26,762 )     —         (2,045 )

Other—principally stock issuances

     4,379       10,861       8,191  
    


 


 


Net cash provided (used) by financing activities

     1,159,943       (131,038 )     (95,907 )
    


 


 


NET CHANGE IN CASH AND CASH EQUIVALENTS

     16,529       (1,805 )     1,473  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     3,052       4,857       3,384  
    


 


 


CASH AND CASH EQUIVALENTS, END OF YEAR

   $ 19,581     $ 3,052     $ 4,857  
    


 


 


 

See notes to consolidated financial statements.

 

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CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands, except share and per share amounts)

 

    Par
Value
Class A


  Par
Value
Class B


    Additional
Paid-In
Capital


    Retained
Earnings


    Deferred
Compensation


    Accumulated
Other
Comprehensive
Losses


    Total

 

BALANCES, DECEMBER 28, 2003

  $ 199   $ 264     $ 325,599     $ 956,003             $ (66,048 )   $ 1,216,017  

Net income

                          155,876                       155,876  

Change in fair value of swaps

                                          782          

Minimum pension liability

                                          63,677          

Other

                                          (40 )        
                                         


       

Other comprehensive income

                                          64,419       64,419  
                                                 


Total comprehensive income

                                                  220,295  

Dividends declared ($.50 per share)

                          (23,200 )                     (23,200 )

Conversion of 120,000 Class B shares to Class A shares

    1     (1 )                                     —    

Issuance of 184,096 Class A shares under stock plans

    2             8,228                               8,230  

Tax benefit from stock plans

                  1,662                               1,662  
   

 


 


 


         


 


BALANCES, DECEMBER 26, 2004

    202     263       335,489       1,088,679               (1,629 )     1,423,004  

Net income

                          160,519                       160,519  

Minimum pension liability

                                          (200 )     (200 )
                                                 


Total comprehensive income

                                                  160,319  

Dividends declared ($.67 per share)

                          (31,271 )                     (31,271 )

Conversion of 40,000 Class B shares to Class A shares

    1     (1 )                                     —    

Issuance of 246,019 Class A shares under stock plans

    2             10,859                               10,861  

Issuance of 40,000 restricted Class A shares under stock plan

                  2,335             $ (2,335 )             —    

Amortization of deferred stock compensation

                                  536               536  

Tax benefit from stock plans

                  2,142                               2,142  
   

 


 


 


 


 


 


BALANCES, DECEMBER 25, 2005

    205     262       350,825       1,217,927       (1,799 )     (1,829 )     1,565,591  

Net loss

                          (155,577 )                     (155,577 )

Minimum pension liability

                                          (623 )     (623 )
                                                 


Total comprehensive loss

                                                  (156,200 )

Adjustment to initially apply FASB Statement No. 158, net of tax

                                          (93,309 )     (93,309 )

Dividends declared ($.72 per share)

                          (46,327 )                     (46,327 )

Conversion of 107,750 Class B shares to Class A shares

    1     (1 )                                     —    

Issuance of 34,988,009 Class A shares for acquisition of Knight Ridder, Inc.

    350             1,821,126                               1,821,476  

Issuance of 132,582 restricted and Class A shares under stock plan

    1             4,141                               4,142  

Reversal of deferred compensation

                  (1,799 )             1,799               —    

Stock compensation expense

                  8,014                               8,014  

Tax benefit from stock plans

                  237                               237  
   

 


 


 


 


 


 


BALANCES, DECEMBER 31, 2006

  $ 557   $ 261     $ 2,182,544     $ 1,016,023     $ —       $ (95,761 )   $ 3,103,624  
   

 


 


 


 


 


 


 

See notes to consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. SIGNIFICANT ACCOUNTING POLICIES

 

The McClatchy Company (the “Company”) is the third-largest newspaper company in the United States based on daily circulation (after the sale of the (Minneapolis) Star Tribune—see discussion below), with 31 daily newspapers and approximately 50 non-dailies in 29 markets across the country. Twenty of its daily newspapers were acquired on June 27, 2006 in the Knight Ridder acquisition (the “Acquisition”)—see Note 2. The Company’s newspapers include The Miami Herald, The Sacramento Bee, the (Fort Worth) Star-Telegram, The Kansas City Star, The Charlotte Observer and The (Raleigh) News & Observer. In addition, McClatchy has a robust network of internet assets, including leading local websites in each of its daily newspaper markets, offering users information, comprehensive news, advertising, e-commerce and other services. The Company also owns and operates McClatchy Interactive, an interactive operation that provides websites with content, publishing tools and software development; Real Cities, the largest national advertising network of local news websites, including more than 140 newspaper websites; and 15.0% of CareerBuilder LLC, the nation’s largest online job site. The Company also owns 25.6% of Classified Ventures LLC, a newspaper industry partnership that offers classified websites such as cars.com and apartments.com.

 

The consolidated financial statements include the Company and its subsidiaries. Significant intercompany items and transactions are eliminated. In preparing the financial statements, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Discontinued operations reflect the results of the 12 newspapers acquired as part of the Acquisition (see Note 2) that have subsequently been sold for strategic or antitrust related reasons. Four of the 12 newspapers were sold concurrently with the closing of the Acquisition. The remaining eight newspapers were owned for periods ranging from two days to 36 days following the closing of the Acquisition. The operating results of these eight newspapers for the periods they were owned by the Company (including interest expense and debt issuance costs related to bank debt incurred until their sales) are included in discontinued operations in the Company’s Consolidated Statement of Income in fiscal 2006. No accounting gain or loss was recognized on the sale of the 12 newspapers.

 

On December 26, 2006, the Company reached a definitive agreement to sell the (Minneapolis) Star Tribune newspaper of Minneapolis, MN for $530.0 million in proceeds and is expected to receive an additional approximately $160.0 million in cash income tax benefits related to the sale by 2008. The sale is expected to close in the first quarter of fiscal 2007. The Company recorded an after-tax charge of $363.0 million to write down the Star Tribune’s net assets to fair market value based on the expected sale proceeds in the fourth quarter of fiscal 2006 and included this charge in discontinued operations. Additionally, the results of Star Tribune’s operations, including interest expense directly attributable to the Star Tribune, have been recorded as discontinued operations in all periods presented.

 

Revenue recognition—The Company recognizes revenues from advertising placed in a newspaper and/or on a website over the advertising contract period or as services are delivered, as appropriate, and recognizes circulation revenues as newspapers are delivered over the applicable subscription term. Circulation revenues are recorded net of direct delivery costs. Other revenue is recognized when the related product or service has been delivered. Revenues are recorded net of estimated incentive offerings including special pricing agreements, promotions and other volume-based incentives. Revisions to these estimates are charged to income in the period in which the facts that give rise to the revision become known.

 

Cash equivalents are highly liquid debt investments with original maturities of three months or less.

 

Concentrations of credit risks—Financial instruments, which potentially subject the Company to concentrations of credit risks, are principally cash and cash equivalents and trade accounts receivables. Cash and

 

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cash equivalents are placed with major financial institutions. The Company routinely assesses the financial strength of significant customers and this assessment, combined with the large number and geographic diversity of its customers, limits the Company’s concentration of risk with respect to trade accounts receivable.

 

The Company provides an allowance for doubtful accounts as follows (in thousands):

 

     Year Ended

 
     December 31,
2006


    December 25,
2005


    December 26,
2004


 

Balance at beginning of year

   $ 2,008     $ 2,242     $ 2,395  

Charged to costs and expenses

     13,029       4,239       3,960  

Amounts written off

     (2,305 )     (4,473 )     (4,113 )
    


 


 


Balance at end of year

   $ 12,732     $ 2,008     $ 2,242  
    


 


 


 

Inventories are stated at the lower of cost (based principally on the first-in, first-out method) or current market value.

 

Property, plant and equipment are stated at cost. Major improvements, as well as interest incurred during construction, are capitalized. Capitalized interest was $2.1 million, $0.6 million and $0.4 million in fiscal 2006, 2005 and 2004, respectively. Expenditures for maintenance and repairs are charged to expense as incurred.

 

Depreciation is computed generally on a straight-line basis over estimated useful lives of:

 

   

5 to 60 years for buildings and improvements

 

   

9 to 25 years for presses

 

   

2 to 15 years for other equipment

 

Stock-based compensation—The Company adopted Statement of Financial Accounting Standards (“SFAS”) 123R effective December 26, 2005, the first day of the 2006 fiscal year, using the modified prospective method. Prior to fiscal 2006 the Company accounted for stock-based awards using the intrinsic value method in accordance with APB No. 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, stock appreciation rights, restricted stock and purchases under the employee stock purchase plan (“ESPP”), to be recognized in the financial statements based on their fair values. The modified prospective method requires that compensation expense be recorded at the beginning of the first quarter of adoption of SFAS 123R for all unvested stock options and restricted stock, based upon the previously disclosed SFAS 123 methodology and amounts. At December 31, 2006, the Company had six stock-based compensation plans. Total stock-based compensation expense was $7.1 million in fiscal 2006 and $536,000 in fiscal 2005.

 

The Company issued a total of 65,000 shares of restricted Class A Common Stock to its Chief Executive Officer: (1) 40,000 shares on January 25, 2005, at the Company’s closing stock price of $70.55, which vest on January 25, 2009, subject to certain performance criteria and (2) 25,000 shares on January 24, 2006, at the Company’s closing stock price of $58.05, which vest over four annual installments, subject to certain performance criteria, beginning on January 24, 2007. At this time, the Company expects such performance criteria to be met and is expensing the related stock-based compensation over the respective four-year periods.

 

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During fiscal 2005 and 2004, if compensation costs for the Company’s stock-based compensation plans had been determined based upon the fair value at the grant dates for awards under those plans consistent with SFAS 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):

 

     2005

    2004

 

Net Income:

                

As reported:

   $ 160,519     $ 155,876  

Add stock-based compensation included in net income, net of income taxes

     327       —    

Deduct stock-based compensation under fair-value method for all awards, net of income taxes

     (4,840 )     (4,650 )
    


 


Pro forma net income

   $ 156,006     $ 151,226  
    


 


Earnings per common share:

                

As reported:

                

Basic

   $ 3.44     $ 3.36  

Diluted

   $ 3.42     $ 3.33  

Pro forma:

                

Basic

   $ 3.35     $ 3.26  

Diluted

   $ 3.32     $ 3.23  

 

Stock based compensation, net of taxes, would have reduced discontinued operations by approximately $540,000 in fiscal 2005 and $580,000 in fiscal 2004 or approximately one cent per share in each year.

 

Deferred income taxes result from temporary differences between amounts of assets and liabilities reported for financial and income tax reporting purposes. Determination of deferred income taxes related to the Acquisition is preliminary and is subject to change based upon further review (see Note 2).

 

Fair Value of Financial Instruments—Generally accepted accounting principles require the disclosure of the fair value of certain financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate fair value. The Company estimated the fair values presented below using appropriate valuation methodologies and market information available as of year-end. Considerable judgment is required to develop estimates of fair value, and the estimates presented are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair values. Additionally, the fair values were estimated at year-end, and current estimates of fair value may differ significantly from the amounts presented.

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

 

Cash and equivalents, accounts receivable, accounts payable and current portion of long term debt. The carrying amount of these items approximates fair value.

 

Long term debt. Market values quoted on the New York Stock Exchange are used to estimate the fair value of publicly traded debt. To estimate the fair value of debt issues that are not quoted on an exchange, the Company uses those interest rates that are currently available to it for issuance of debt with similar terms and remaining maturities. At December 31, 2006, the estimated fair value of long term debt was $2.8 billion compared to a carrying value of $2.7 billion.

 

Comprehensive income (loss)—The Company records changes in its net assets from non-owner sources in its Statement of Stockholders’ Equity. Such changes relate primarily to valuing its pension liabilities, net of tax effects.

 

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The following table summarizes the changes in other comprehensive (loss) income (in thousands):

 

     Pre-Tax

    Tax

    After-Tax

 

Year Ended December 31, 2006

                        

Minimum pension liability

   $ (1,038 )   $ 415     $ (623 )
    


 


 


     $ (1,038 )   $ 415     $ (623 )
    


 


 


Year Ended December 25, 2005

                        

Minimum pension liability

   $ (334 )   $ 134     $ (200 )
    


 


 


     $ (334 )   $ 134     $ (200 )
    


 


 


Year Ended December 26, 2004

                        

Minimum pension liability

   $ 106,128     $ (42,451 )   $ 63,677  

Fair value of swaps

     1,303       (521 )     782  

Other

     (67 )     27       (40 )
    


 


 


     $ 107,364     $ (42,945 )   $ 64,419  
    


 


 


 

Segment reporting—The Company’s primary business is the publication of newspapers. The Company aggregates its newspapers into a single reportable segment because each has similar economic characteristics, products, customers and distribution methods.

 

Earnings per share (“EPS”)—Basic EPS excludes dilution from common stock equivalents and reflects income divided by the weighted average number of common shares outstanding for the period. Diluted EPS is based upon the weighted average number of outstanding shares of common stock and dilutive common stock equivalents in the period. Common stock equivalents arise from dilutive stock options and are computed using the treasury stock method. The anti-dilutive stock options that could potentially dilute basic EPS in the future, but were not included in the weighted average share calculation were 2,166,088 in fiscal 2006, 531,698 in fiscal 2005, and 16,786 in fiscal 2004.

 

Reclassifications—Certain prior period amounts have been reclassified to conform to the 2006 presentation.

 

New Accounting Pronouncements—In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes–an interpretation of FASB Statement No. 109.” This Interpretation specifies requirements for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This Interpretation is effective beginning January 1, 2007. The Company is currently evaluating the impact FIN 48 will have, if any, on its consolidated financial statements.

 

NOTE 2. ACQUISITION AND DIVESTITURES

 

Acquisition Transaction:

 

On June 27, 2006 (the second day of the Company’s third fiscal quarter), the Company completed the purchase of Knight-Ridder, Inc. (Knight Ridder) pursuant to a definitive merger agreement entered into on March 12, 2006, under which the Company paid Knight Ridder shareholders a per share price consisting of $40.00 in cash and .5118 of a Class A McClatchy common share (the Acquisition). The Company issued approximately 35.0 million Class A common shares in connection with the Acquisition. The total purchase price was approximately $4.6 billion. In addition, the Company assumed $1.9 billion in Knight Ridder long-term debt at closing.

 

Knight Ridder published 32 daily newspapers in 29 U.S. markets, operated websites in all of its markets and owned a variety of internet and other investments which consisted of: 33.3% of CareerBuilder LLC

 

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(“CareerBuilder”) and ShopLocal LLC (“ShopLocal”), 25.0% of Topix.net (“Topix”), 21.5% of Classified Ventures LLC (“Classified Ventures”), 33.3% interest in SP Newsprint Company (“SP”), 13.5% interest in the Ponderay Newsprint Company (“Ponderay”) and 49.5% of The Seattle Times Company which owns The Seattle Times newspaper and weekly newspapers in the Puget Sound area, and daily newspapers located in Walla Walla and Yakima, Washington and in Portland, Maine and various other smaller investments. Knight Ridder was the founder and operator of Real Cities, the largest national advertising network of local news websites.

 

To consummate the Acquisition, the Company borrowed $3.076 billion under a new bank debt facility (see Note 5) and used the proceeds from the sales of four Knight Ridder newspapers in order to pay Knight Ridder shareholders ($2.7 billion) and refinance its and Knight Ridder’s bank debt ($498.0 million). The proceeds from the sales of the eight Knight Ridder newspapers sold after the Acquisition closed were used to reduce debt.

 

Acquisition Accounting:

 

Pursuant to Emerging Issues Task Force No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination, the McClatchy common stock issued on June 27, 2006 was valued based upon the average closing price of McClatchy common stock from March 8, 2006 through March 14, 2006 (two business days before and after the terms of the Acquisition were agreed to and announced), or $52.06 per share. As a result, the fair value of the 35.0 million shares of McClatchy common stock issued in the Acquisition was recorded at $1.821 billion, which was included in the total Acquisition purchase price of approximately $4.6 billion. The fair value of such shares declined to approximately $1.398 billion as of the Acquisition closing date (June 27, 2006), however the decline of $423.0 million in valuation had no effect on the total Acquisition purchase price recorded. The difference is included in the allocation to goodwill in the allocation of the purchase price below.

 

The Acquisition was accounted for as a purchase. Pursuant to SFAS 141, Business Combinations, the purchase price is being allocated to the assets acquired and liabilities assumed based upon their estimated fair values as of June 27, 2006, the date of the Acquisition. The purchase price allocation was primarily based upon an independent valuation. The purchase price allocation, while substantially complete, is subject to further adjustments based upon completion of analyses of deferred income tax assets and liabilities and other items.

 

The allocation of the purchase price to the fair values of the assets acquired and liabilities assumed as of June 27, 2006, subject to future adjustments, is presented below (in thousands):

 

Current assets

   $ 335,378  

Land and other assets held for sale

     231,013  

Property, plant and equipment

     706,012  

Investments in unconsolidated companies

     802,292  

Advertiser and subscriber lists and other intangibles

     692,000  

Newspaper mastheads

     683,000  

Goodwill

     3,242,251  

Other assets

     5,486  

Newspapers held for sale

     1,990,269  

Current liabilities

     (438,779 )

Long-term debt

     (1,899,700 )

Pension and other long-term obligations

     (357,814 )

Deferred income taxes

     (1,357,759 )
    


     $ 4,633,649  
    


 

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The following table summarizes, on an unaudited pro forma basis, the combined results of continuing operations of the Company for fiscal 2006 and 2005 as though the Acquisition had taken place on the first day of each fiscal year (in thousands):

 

     2006

    2005

 

Revenues

   $ 2,497,457     $ 2,463,133  

Income from continuing operations

   $ 185,570  (1)   $ 222,681  (1)

Income from continuing operations per diluted share

   $ 2.27     $ 2.74  

(1) Includes $18.1 million of income tax benefits related to the Company’s recalculation of its deferred tax liabilities and assets.

 

Disposition Transactions:

 

In conjunction with the Acquisition, the Company divested 12 Knight Ridder newspapers for strategic and antitrust reasons. The divested newspapers were the Philadelphia Inquirer; Philadelphia Daily News; San Jose Mercury News; St. Paul Pioneer Press; Akron Beacon Journal (OH); Wilkes Barre Times Leader (PA); Aberdeen American News (SD); Grand Forks Herald (ND); Ft. Wayne News-Sentinel (IN); Contra Costa Times (CA); Monterey Herald (CA); and Duluth News Tribune (MN). The Company received cash proceeds of approximately $2.0 billion (net of transaction costs). In addition, the buyers assumed approximately $77.0 million of Knight Ridder retirement obligations related to certain newspapers. Four of the 12 newspapers were sold concurrently with the closing of the Acquisition. The remaining eight newspapers were owned for periods ranging from two days to 36 days following the closing of the Acquisition. The operating results of these eight divested newspapers for the periods they were owned by the Company, including interest expense and debt issuance costs related to bank debt incurred until their sales, are included in discontinued operations in the Company’s Consolidated Statement of Income in 2006. No accounting gain or loss was recognized on the sale of the 12 newspapers.

 

In July 2006, the Company sold 18.3% of its interest in each of CareerBuilder and ShopLocal, and 13.8% of its interest in Topix for an aggregate of $309.7 million in cash and used the proceeds to reduce debt. The Company retained a 15.0% interest in CareerBuilder and ShopLocal, and an 11.3% interest in Topix. No accounting gain or loss was recognized on the sale of these investments.

 

In December 2006, the Company paid income taxes of approximately $787.0 million related to the disposition of the newspapers and investments discussed above.

 

On December 26, 2006, the Company reached a definitive agreement to sell the (Minneapolis) Star Tribune newspaper of Minneapolis, MN to Avista Capital Partners for $530.0 million. The Company expects a future cash income tax benefit equal to approximately $160.0 million related to the sale by 2008. The purchase covers the newspaper as well as other publications and websites related to the newspaper. The transaction is expected to close in the first quarter of fiscal 2007. The Company recorded a charge of $565.0 million to write down the Star Tribune’s net assets to fair market value based on the expected sale proceeds in the fourth quarter of fiscal 2006 and included this charge in discontinued operations.

 

The Company recorded a tax benefit of $202.0 million when it wrote down the net assets of the Star Tribune newspaper to its fair market value based upon its expected sales proceeds. However, when the transaction closes (expected the first quarter of fiscal 2007), the Company will recognize additional income tax expense (estimated to be $40.0 million) related to the dissolution of subsidiaries holding Star Tribune related intellectual property. These taxes will be recorded in discontinued operations.

 

Additionally, the results of Star Tribune’s operations, including interest on debt incurred to purchase it, have been recorded as discontinued operations in all periods presented. The Company intends to use the proceeds from the sale of the Star Tribune to reduce debt.

 

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Revenues and loss from discontinued operations, net of income taxes, for fiscal 2006, 2005 and 2004 were as follows (in thousands):

 

     2006

    2005

    2004

 

Revenues

   $ 423,058   (3)   $ 378,635     $ 380,103  
    


 


 


Income (loss) from discontinued operations before income taxes (2)

   $ (522,531 ) (3)   $ 71,011     $ 76,161  

Income tax benefit (expense)

     183,459       (30,007 )     (29,833 )
    


 


 


Income (loss) from discontinued operations

   $ (339,072 ) (1)   $ 41,004     $ 46,328  
    


 


 



(1) Includes an after-tax charge of $363.0 million to write down the net assets of the (Minneapolis) Star Tribune newspaper to fair market value based upon its anticipated sales proceeds.
(2) Includes interest expense allocated to discontinued operations of $24.2 million, $7.7 million and $9.1 million in fiscal 2006, 2005 and 2004, respectively.
(3) Includes revenues of $61.2 million and loss before income taxes of $14.6 million related to the eight divested newspapers owned for periods ranging from two days to 36 days following the closing of the Acquisition.

 

NOTE 3. INVESTMENTS IN UNCONSOLIDATED COMPANIES

 

The following is the Company’s ownership interest and investment in unconsolidated companies and joint ventures as of December 31, 2006 (dollars in thousands):

 

Company


   % Ownership
Interest


  

Carrying

Value


CareerBuilder

   15.0    $ 230,506

Seattle Times Company

   49.5      102,228

Classified Ventures

   25.6      98,259

SP

   33.3      40,666

Ponderay

   27.0      26,162

ShopLocal

   15.0      10,993

Topix

   11.3      9,956

McClatchy Tribune Information Services

   50.0      773

Other

   Various      670
         

          $ 520,213
         

 

The Company primarily uses the equity method of accounting for these investments.

 

The Company generates revenue from CareerBuilder, Classified Ventures and ShopLocal products for online listings placed in its markets. In fiscal 2006, the Company recorded $32.3 million in revenue related to CareerBuilder products, $16.0 million related to Classified Ventures products and $2.0 million related to ShopLocal. The Company also had $2.0 million, $6.1 million and $0.1 million in expenses for products and services provided by CareerBuilder, Classified Ventures and ShopLocal, respectively, related to the uploading and hosting of online advertising on behalf of the Company’s newspapers’ advertisers. As of December 31, 2006 and as of December 25, 2005, the Company had approximately $11.3 million and $6.7 million, respectively, in amounts payable to CareerBuilder, Classified Ventures, SP and Ponderay. In fiscal 2005, the Company recorded $6.7 million in revenue related to Classified Ventures products and $2.6 million in expenses for products and services provided by Classified Ventures. Transactions between the Company and these related parties and other equity investees were immaterial in fiscal 2004.

 

The Company has an annual purchase commitment for 86,000 metric tons of newsprint from SP. The Company is required to purchase 56,800 metric tons of newsprint of annual production from Ponderay on a "take-if-tendered" basis at prevailing market prices, until Ponderay’s debt is repaid.

 

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NOTE 4. INTANGIBLE ASSETS AND GOODWILL

 

Intangible assets and goodwill, along with their original weighted-average useful lives consisted of the following (in thousands):

 

     December 31, 2006

     Gross
Amount


   Accumulated
Amortization


    Net Amount

   Weighted
Average
Amortization
Period


Intangible assets subject to amortization:

                          

Advertiser and subscriber lists

   $ 817,701    $ (148,427 )   $ 669,274    14 years

Other

     26,161      (9,389 )     16,772    8 years
    

  


 

    

Total

   $ 843,862    $ (157,816 )     686,046     
    

  


          

Other intangible assets not subject to amortization:

                          

Newspaper mastheads

                    683,000     
                   

    

Total

                    1,369,046     

Goodwill

                    3,559,828     
                   

    

Total intangible assets and goodwill

                  $ 4,928,874     
                   

    

 

     December 25, 2005

     Gross
Amount


   Accumulated
Amortization


    Net
Amount


   Weighted
Average
Amortization
Period


Intangible assets subject to amortization:

                          

Advertiser and subscriber lists

   $ 143,701    $ (116,027 )   $ 27,674    24 years

Other

     8,161      (8,067 )     94    4 years
    

  


 

    

Total

   $ 151,862    $ (124,094 )     27,768     
    

  


          

Other intangible assets not subject to amortization:

                          

Pension

                    385     
                   

    

Total

                    28,153     

Goodwill—net

                    317,572     
                   

    

Total intangible assets and goodwill

                  $ 345,725     
                   

    

 

Changes in identifiable intangible assets and goodwill in fiscal 2006 consisted of the following (in thousands):

 

     December 25,
2005


    Additions

   Disposals/
Adjustments


    Amortization
Expense


    December 31,
2006


 

Intangible assets subject to amortization:

   $ 151,862     $ 692,000      —       $ —       $ 843,862  

Accumulated amortization

     (124,094 )     —      $ (5 )     (33,717 )     (157,816 )
    


 

  


 


 


       27,768       692,000      (5 )     (33,717 )     686,046  

Mastheads and other

     385       683,000      (385 )     —         683,000  

Goodwill—net

     317,572       3,242,251      5       —         3,559,828  
    


 

  


 


 


Total

   $ 345,725     $ 4,617,251    $ (385 )   $ (33,717 )   $ 4,928,874  
    


 

  


 


 


 

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Intangible assets subject to amortization acquired in fiscal 2006 consisted of the following (in thousands):

 

     Amount

   Amortization
Period


Advertiser lists

   $ 602,000    13 years

Subscriber lists

     72,000    8 years

Software and content syndication

     12,000    5 years

Other

     6,000    10 years
    

    

Total

   $ 692,000     
    

    

 

The Company also acquired $683.0 million of mastheads in fiscal 2006 which are not subject to amortization.

 

Amortization expense for continuing operations was $33,717,000, $4,948,000 and $5,221,000 in fiscal 2006, 2005 and 2004, respectively. The estimated amortization expense for the five succeeding fiscal years is as follows (in thousands):

 

Year


   Amortization
Expense


2007

   $ 59,950

2008

     59,941

2009

     59,910

2010

     59,232

2011

     57,837

 

NOTE 5. LONG-TERM DEBT

 

As of December 31, 2006 and December 25, 2005, long-term debt consisted of the following (in thousands):

 

     December 31,
2006


   December 25,
2005


Commercial Paper

     —      $ 154,200

Term A bank debt, interest at 6.12%

   $ 1,100,000      —  

Revolving bank debt, interest at 6.10%

     665,795      —  

Publicly-traded notes:

             

$100 million 6.625% debentures due in 2007

     100,025      —  

$200 million 9.875% debentures due in 2009

     212,950      —  

$300 million 7.125% debentures due in 2011

     304,512      —  

$200 million 4.625% debentures due in 2014

     172,705      —  

$400 million 5.750% debentures due in 2017

     359,848      —  

$100 million 7.150% debentures due in 2027

     90,717      —  

$300 million 6.875% debentures due in 2029

     270,117      —  
    

  

Total debt

     3,276,669      154,200

Less current portion

     530,000      —  
    

  

Long-term debt

   $ 2,746,669    $ 154,200
    

  

 

The publicly-traded notes are stated net of unamortized discounts and premiums (totaling to an $89.1 million discount as of December 31, 2006) resulting from recording such assumed liabilities at fair value as of the June 27, 2006, the Acquisition date. The notes due in 2007 are expected to be refinanced on a long-term basis by drawing on the Company’s revolving credit facility and accordingly, are included in long-term debt.

 

Through June 27, 2006, the Company used its senior unsecured revolving credit facility, which was initially put into place in 1998 to finance the purchase of The Star Tribune Company, and refinanced in 2004 primarily to

 

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become a back-up facility for commercial paper. The re-financed facility provided borrowings of up to $500 million. This credit agreement was refinanced with a new $3.2 billion senior unsecured credit facility ("Credit Agreement") entered into in connection with the Acquisition. At closing, the Company’s new Credit Agreement consisted of a $1 billion five-year revolving credit facility and $2.2 billion five-year Term A loan. Both the Term A loan and the revolver are due on June 27, 2011.

 

On June 27, 2006, McClatchy borrowed $2.2 billion under the Term A loan and $876.0 million under the revolving credit facility. The Company subsequently repaid $1.1 billion of the Term A loan and $210.2 million of the revolving credit facility, primarily from proceeds received in the sale of the eight newspapers, net of income taxes paid on the tax gain on the sale (see Note 2). A total of $264.0 million of funds were available under the revolving credit facility at December 31, 2006.

 

In December 2006, the Company entered in to a definitive agreement to sell the (Minneapolis) Star Tribune newspaper for $530.0 million in proceeds and is expected to receive an additional approximate $160.0 million in cash income tax benefits related to the sale by 2008. The sale is expected to close in the first quarter of fiscal 2007 and the Company intends to reduce debt with the proceeds. Accordingly, as of December 31, 2006, the Company recorded $530.0 million of its debt as current liability in its Consolidated Balance Sheet.

 

Debt under the Credit Agreement bears interest at the London Interbank Offered Rate ("LIBOR") plus a spread ranging from 37.5 basis points to 125.0 basis points. Applicable rates are based upon the Company’s ratings on its long-term debt from Moody’s Investor Services (“Moody’s”) and Standard & Poor’s. A commitment fee for the unused revolving credit ranges from 10.0 basis points to 20.0 basis points depending on the Company’s ratings. Standard & Poor’s has rated the facilities “BBB” and Moody’s has rated the facility “Ba1.” Under the structure of the facilities, the Company will pay interest at LIBOR plus 75.0 basis points on outstanding debt and its commitment fees are currently at 15.0 basis points.

 

The Credit Agreement contains financial covenants including a minimum interest coverage ratio (as defined) of 3:00 to 1:00 and a maximum leverage ratio (as defined) of 4.75 to 1.00 through September 30, 2007, declining over time to 4.00 to 1.00 on December 28, 2008 and thereafter. At December 31, 2006, the Company was in compliance with all debt covenants.

 

At December 31, 2006, the Company had outstanding letters of credit totaling $70.2 million, including $64.1 million assumed in the Acquisition, securing estimated obligations stemming from workers’ compensation claims and other contingent claims.

 

The following table presents the approximate annual maturities of debt, based upon the Company’s required payments (adjusted for management’s expectations regarding the notes due in 2007 and the proceeds from the sale of the (Minneapolis) Star Tribune as discussed above), for the next five years and thereafter (in thousands):

 

Year


   Payments

2007

   $ 530,000

2008

     —  

2009

     200,000

2010

     —  

2011

     1,635,795

Thereafter

     1,000,000
    

       3,365,795

Less net discount

     89,126
    

Total debt

   $ 3,276,669
    

 

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NOTE 6. INCOME TAXES

 

Income tax provisions related to continuing operations consist of (in thousands):

 

     Year Ended

     December 31,
2006


    December 25,
2005


   December 26,
2004


Current:

                     

Federal

   $ 103,807     $ 58,654    $ 49,701

State

     17,565       9,350      8,158

Deferred:

                     

Federal

     (4,748 )     2,836      11,165

State

     (29,234 )     1,861      2,828
    


 

  

Income tax provision

   $ 87,390     $ 72,701    $ 71,852
    


 

  

 

The effective tax rate for continuing operations and the statutory federal income tax rate are reconciled as follows:

 

     Year Ended

 
     December 31,
2006


    December 25,
2005


    December 26,
2004


 

Statutory rate

   35.0 %   35.0 %   35.0 %

State taxes, net of federal benefit

   3.9 %   3.8 %   3.9 %

Impact of change in state apportionment factors

   (6.7 %)   —       —    

Amortization of intangibles

   —       0.3 %   0.1 %

Other

   0.1 %   (1.3 %)   0.6 %
    

 

 

Effective tax rate

   32.3 %   37.8 %   39.6 %
    

 

 

 

The components of deferred tax assets and liabilities recorded in the Company’s Consolidated Balance Sheet on December 31, 2006 and December 25, 2005 are (in thousands):

 

     2006

    2005

Deferred tax assets:

              

Compensation benefits

   $ 125,651     $ 8,203

Basis difference, newspaper held for sale

     214,298       —  

State taxes

     15,147       3,300

Other

     15,997       2,383
    


 

Total deferred tax assets

     371,093       13,886

Valuation allowance

     (12,600 )     —  
    


 

Net deferred tax assets

     358,493       13,886

Deferred tax liabilities:

              

Depreciation and amortization

     656,052       43,808

Investments in unconsolidated subsidiaries

     107,932       1,716

Compensation benefits

     —         54,931

Other

     52,649       321
    


 

Total deferred tax liabilities

     816,633       100,776
    


 

Net deferred tax liabilities

   $ 458,140     $ 86,890
    


 

 

NOTE 7. EMPLOYEE BENEFITS

 

The Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans” effective December 31, 2006, as required. SFAS 158 requires recognition of (1) the funded

 

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status of a pension plan (difference between the plan assets at fair value and the projected benefit obligation) and (2) funded status of a post-retirement plan (difference between the plan assets at fair value and the accumulated benefit obligation), as an asset or liability on the balance sheet. An increase in accumulated other comprehensive loss related to an increase in the minimum liability of $1.0 million, or $0.6 million after-tax, was recorded prior to the adoption of SFAS 158. As a result of adopting SFAS 158, the Company increased accumulated other comprehensive loss for its continuing operations by $80.4 million, consisting of previously unrecognized prior service costs of $0.9 million, previously unrecognized net losses of $79.5 million, and a related net deferred tax asset of $32.2 million. The reduction also decreased prepaid pension costs by $66.1 million and increased pension obligations by $14.2 million.

 

The Company recorded an increase in accumulated comprehensive loss of $75.9 million, net of a related deferred tax asset of $31.5 million for (Minneapolis) Star Tribune plans being assumed by the buyer (see Note 2).

 

The Company sponsors defined benefit pension plans (“retirement plans”), which cover a majority of its employees. Benefits are based on years of service and compensation. Contributions to the plans are made by the Company in amounts deemed necessary to provide the required benefits. The Company made $40.0 million in voluntary contributions to its plans in fiscal 2005 (including $7.0 million to Star Tribune plans) and made an additional contribution of $40.0 million in early fiscal 2006 (including $8.5 million to Star Tribune plans). No contributions to the Company’s plans are currently planned for fiscal 2007.

 

The Company also has a limited number of supplemental retirement plans to provide key employees with additional retirement benefits. The terms of the plans are generally the same as those of the retirement plans, except that the supplemental retirement plans are limited to key employees and provide an enhanced pension benefit. These plans are funded on a pay-as-you-go basis and the accrued pension obligation is largely included in other long-term obligations.

 

Pension expense, assets and obligations include the impact of adding plans and benefits for new employees added in the Acquisition. In addition, the (Minneapolis) Star Tribune related plans which are expected to be assumed by the buyer have been excluded from expenses in continuing operations and other disclosures below.

 

Benefits related primarily to non-unionized employees of the (Minneapolis) Star Tribune (“Plan O”) were previously included in the McClatchy Retirement Plan, and have been spun-off into a separate plan as of December 31, 2006. Plan O is being assumed by the buyer (see Note 2), and accordingly, estimated costs related to this plan as well as plan assets and liabilities have been removed from the Company’s pension disclosures from continuing operations. Amounts of Plan O assets and obligations at December 25, 2005 and changes in these amounts during fiscal 2005 remained a part of the McClatchy Retirement Plan, and are therefore are included in the reconciliation of the funded status of the Company’s pension plans for fiscal 2005. All other separate Star Tribune plans which are being assumed by the buyer of the Star Tribune have been excluded from this disclosure.

 

The elements of pension costs for continuing operations are as follows (in thousands):

 

     December 31,
2006


    December 25,
2005


    December 26,
2004


 

Service Cost

   $ 17,832     $ 13,642     $ 12,769  

Interest Cost

     59,636       22,300       20,396  

Expected return on plan assets

     (68,221 )     (29,255 )     (28,569 )

Prior service cost amortization

     8,860       5,247       3,307  

Actuarial loss

     186       212       383  
    


 


 


Net pension expense

   $ 18,293     $ 12,146     $ 8,286  
    


 


 


 

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No material contributions were made to the Company’s multi-employer plans for continuing operations in fiscal 2006, 2005 or 2004.

 

The Company also provides or subsidizes certain life insurance benefits for employees. The elements of post-retirement expenses for continuing operations are as follows (in thousands):

 

     December 31,
2006


   December 25,
2005


   December 26,
2004


 

Service cost

   $ 485    $ 2    $ 3  

Interest cost

     2,172      253      252  

Actuarial loss

     —        —        (4 )
    

  

  


Net post-retirement benefit expense

   $ 2,657    $ 255    $ 251  
    

  

  


 

Expected benefit payments to retirees under the Company’s retirement and post-retirement plans over the next ten years are summarized below (in thousands):

 

     Retirement
Plans


   Post-retirement
Plans


2007

   $ 64,874    $ 10,820

2008

     67,446      9,530

2009

     70,350      7,475

2010

     73,456      6,593

2011

     77,123      6,598

2012-2015

     470,958      33,555
    

  

Total

   $ 824,207    $ 74,571
    

  

 

Post-retirement benefits above do not reflect an expected federal subsidy totaling approximately $3.2 million over the life of the plan.

 

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The following tables provide reconciliations of the plans’ benefit obligations, fair value of assets, funded status and amounts recognized in the Company’s Consolidated Balance Sheet at December 31, 2006 and December 25, 2005 (in thousands):

 

     Pension Benefits

     Postretirement Benefits 

 
     2006

    2005

    2006

    2005

 

Change in Benefit Obligation

                                

Benefit obligation, beginning of year

   $ 526,190     $ 451,315     $ 4,232     $ 4,134  

Service cost

     19,481       16,827       485       2  

Interest cost

     65,239       27,512       2,172       253  

Plan participants’ contributions

     —         —         1,465          

Actuarial (gain)/loss

     35,621       47,085       6,606       307  

Gross benefits paid

     (44,844 )     (16,826 )     (5,625 )     (464 )

less: federal subsidy on benefits paid

     —         —         246       —    

Acquisition

     1,091,630       —         62,012       —    

Spin-off of Plan O

     (138,624 )     —         —         —    

Other

     —         277       —         —    
    


 


 


 


Benefit obligation, end of year

   $ 1,554,693     $ 526,190     $ 71,593     $ 4,232  
    


 


 


 


Accumulated benefit obligation, end of year

   $ 1,449,074     $ 455,111       N/A       N/A  
    


 


               

Change in Plan Assets

                                

Fair value of plan assets, beginning of year

   $ 451,243     $ 396,930     $ —       $ —    

Actual return on plan assets

     169,953       37,069       —         —    

Employer contribution

     35,394       34,070       4,160       464  

Plan participants’ contributions

     —         —         1,465       —    

Gross benefits paid

     (45,765 )     (16,826 )     (5,625 )     (464 )

Acquisition

     864,793       —         —         —    

Spin-off of Plan O

     (147,063 )     —         —         —    

Other

     (143 )     —         —