Key Questions Heading Into Earnings Season

With quarterly earnings reports set to pour in starting next week, I thought I'd provide a brief overview of what to look for in each of Northlake's individual stock holdings. Given recent volatility in stocks prices and growing concerns over the future of the US economy, 3Q earnings and guidance commentary may be the most important issued in several years.

Apple: With the stock surging to new highs, the bar has been set much higher for the quarter. Leaving aside the "beat and raise" mentality surrounding the shares, I'll be focused on overall margins and average selling prices for iPods. With NAND prices up, the massive beats in the last couple of quarters due to margin expansion are unlikely to repeat. This quarter could represent a normalized quarter, so I'd like to know whether margin levels are sustainable for FY08. One factor that will influence the answer is ASPs on iPods. The refresh of the iPod line announced earlier this month could boost ASPs which have trended sharply lower over the past year as the Shuffle and Nano have gained share relative to hard rive, high capacity iPods. Will the Touch and 160GB Classic shift ASPs upward?

Central European Media Enterprises: Will results in Ukraine bounce back such that the low end of 2007 guidance is increased? Will the surprising revenue gains in Croatia hold and lead to a quicker turn to profitability than expected? Are local currency revenue gains holding? Are estimates in Czech Republic, Romania, and especially Slovakia too low? Keep in mind that CETV is a big beneficiary of dollar weakness against the Euro.

For Comcast, Disney, Endeavor, NII Holdings, Regal Entertainment, and Rogers Communication, please follow the "Continue Reading" link immediately below....

Comcast: The quarter has been ugly with estimate cuts and sour sentiment pushing the stock to a 52 week low earlier this week. Has the bar been reset low enough? Was management being overly cautious in its commentary at conferences last week? How much is the housing slowdown contributing to slower subscriber growth? Is housing a greater factor than investors realize? If so, are investors overly worried about competitive pressures in a maturing broadband market and already mature multichannel TV market? Will margins surprise to the upside due the growing importance of phone susbscribers?

Disney: How much longer can Disney's industry leading, double digit operating income growth last? Does upside remain in the broadcast TV turnaround led by ABC? How much of a boost will ESPN get form its backend loaded revenue recognition? Are cost savings enough to offset incredibly difficult comparisons for the movie studio? Is performing across all windows (including merchandising) than assumed compared to the phenomenal merchandising success of Cars? Is theme park attendance holding in the US despite increasing signs of cutbacks in consumer spending? Is there still margin upside in theme parks?

Endeavor Acqusition/American Apparel: The deal is set to close in the next few months but faces a deadline. The company presented at a Wall Street conference on September 26th. I am looking for an update on timing of the closing? Will 3Q results mirror the great margins and same store sales enjoyed by AA in 2Q? 2Q results suggest guidance is too low. Is there upside to estimates? Does AA plan an equity offering after completion of the acquisition?

NII Holdings: Is there an update on the timing and level of investment to expand the network in Brazil and build the network in Chile? Has subscriber growth accelerated in Mexico will the completion of the geographic expansion of the network? Are margins starting to expand in Mexico now that investment levels are winding down and new subscribers are coming aboard? Is there any sign of slowing wireless growth throughout Latin America given the slowing economy in the US?

Regal Entertainment: What are the plans for excess cash on the balance sheet that was held back from the proceeds of the National Cinemedia (NCMI) IPO? Will margins hold, particularly on film costs, given the large number of massive hit movies in 3Q that burned out quickly (studios keep a much higher percentage of ticket revenue in the first week or two a movies is in theatres)? If upside occurs in 3Q, what will be done with the excess cash flow? Are acquisitions still the plan or does the possibility of another special dividend exist? Are apparently easy 4Q box office comps real? Does RGC have more upside from its ownership of NCMI than previously thought?

Rogers Communication: Is the slowdown in broadband and basic growth in US cable appearing in Canada? Can Rogers maintain the market share and margin expansion in wireless? Will the cracks that appeared in competing Canadian wireless company's 2Q results begin to impact Rogers? Is there an update on use of the rapidly growing and significant free cash flow? I'd like to see a much larger annual dividend or a special dividend? Are recent acquisitions of media properties likely to continue? How is the integration of recent acquisitions proceeding?

Earnings Looking Good So Far

Between Wednesday's market close and Thursday's market open, four stocks held widely by Northlake clients reported earnings and held conference calls. Apple (APPL) did quite well, NII Holdings (NIHD) was solid, Regal Entertainment (RGC) was as expected, and Comcast (CMCSA/CMCSK) was a little below my expectations. Overall, I am quite satisfied with the start of earnings season as far as Northlake stocks are concerned. Here is a brief recap of each report:

Apple reported another great quarter. Following a day or two of controversy over the first weekend sales of iPhones, Apple reminded us that business momentum in Macs and iPods remains excellent. Earnings of 92 cents crushed analyst estimates of 73 cents. Revenues were a little better than expected as Mac sales came in at 1.7 million units vs. estimates of 1.6 million and iPod shipments of 9.8 million were at the high end of estimates. The big story, however, was margins which again expanded sharply as Apple's brand strength is allowing it to maintain prices as commodity costs for memory collapse. Looking ahead, management is assuming that commodity costs increase and new products have lower price points, so guidance calls for EPS of just 65 cents in the September quarter. I expect that to be too low but memory prices have definitely increased. Management also did a good job on the call of reigning in overly bullish iPhone estimates. Overall, Apple proved that its operating momentum remains intact and that future earnings power maybe above street estimates. I see another 15-20% upside in the stock on the basis of new product introductions that will drive December quarter earnings.

NIHD reported better than expected subscriber growth, in line revenues and EBITDA, and a few penny shortfall in EPS. The stock fell sharply on Thursday but I think that was due to the market not the earnings report. Looking ahead, management raised 2007 guidance for revenue, EBITDA, and subscriber growth. More importantly, NIHD announced new investments to expand the networks in Brazil and Chile. Brazil has been performing great the last few quarters and is a very large market. Chile is a brand new market with significant potential and a profile that looks favorable for NIHD's push-to-talk Nextel cellular service. The timing of the new investments is good as NIHD has completed the expansion of its network in Mexico, its largest market, and will begin to reap the financial benefits as subscriber growth accelerates with launch expenses winding down. Brazil and Chile should insure an another leg of growth that will extend the outlook for at least 25-30% growth annually out to 2011. NIHD is a true growth stock with substantial upside as long as Latin American stock markets do not collapse.

Regal Entertainment's results closely tracked the 1% increase in the box office for the second quarter. Initial estimates of 2Q box office called for an upper single digit gain which left me worried that the earnings report would disappoint investors. However, the stock has held in well even as the market had dropped indicating that the pullback in the shares earlier this month compensated for weaker than expected box office. July is off to a fantastic start with box office up 11% and a strong film slate against easy comparison for the rest of the summer. I'd like to take profits in RGC shares for clients that don’t need high income if the renewed box office momentum pulls the stock back to new highs. I think that will happen.

Comcast reported mixed results that were greeted poorly by investors. The fact that they reported mixed results on such a bad day in the market led the shares to perform worse than reality. Revenues and operating cash flow grew 12% and 13%, respectively, just short but very close to estimates. Digital TV and VOIP telephony subscribers comfortably exceeded estimates while basic cable TV and high speed internet subscribers fell short. During 2Q, Comcast made a huge effort to ship digital TV set top boxes ahead of new regulations on July 1st that requires new box technology. This effort hurt the execution in other products and held back the results. I am very confident that operating trends will accelerate in the second half of the year. The acceleration should allay investor concerns about competition from Verizon and AT&T and lead the stock to much higher levels.

Positions Recap at The Turn of the Year

As 2006 draws to a close and a new year begins, I thought it would be appropriate to provide a brief update on the positions held in almost all Northlake-managed accounts.

Model-Driven ETFs: I'll get a fresh update on the Market Cap and Style models over the New Year's weekend but I expect the signals favoring growth and mid caps to remain in place. The growth signal is strong, while the mid cap signal is weak. Current investments held as a result of these signals include the S&P 500 (SPY), the S&P 400 Mid Cap (MDY), and the Russell 100 Growth (IWF).

Japan: EWJ has underperformed this year but I am sticking with it as my theme is that Japan is emerging from a multi-decade period of underperformance for its economy and stock market. Nothing has occurred this year that challenges my assumption. I look for Japan to move back toward global leadership for stock market returns in 2007.

Apple Computer: Not much more to say here. I am bullish because I think Mac sales will continue to surprise on the upside as Apple reaps the benefits of orienting the company towards delivery and manipulation of digital content. I think upside of over 25% exits.

Central European Media Enterprises: CETV remains my favorite stock. I think it is headed north of $100 in 2007. CETV is the best play on the emerging and booming economies of Central and Eastern Europe. The fact that management has consistently met or beat their goals and delivered on their promises supports my bullishness.

Disney: DIS had a great 2006 with the shares rising more than 40%. I don’t expect a repeat performance but I believe estimates are too low and investor caution toward the 2007 growth rate is unwarranted. As these fears fade, I think the shares can trade to $38-40.

Endeavor Acquisition Corporation: The closing of EDA's acquisition of American Apparel will create a hot new specialty apparel stock that should attract analysts and investors. If American Apparel hits the numbers contained in Endeavor's latest SEC filing the shares are very cheap relative to other teen focused retailers. My target ranges from $10 all the way to $18 depending on how strong financial results turn out.

Regal Entertainment: It took awhile but RGC shares ended the year strongly and produced about a 12% total return after adding in 90 cents in dividends since my initial purchase in March. The worst box office comparisons are over and investors are likely to look ahead to a blowout 2Q when three of the biggest blockbusters of all-time will hit theatres (Pirates 3, Spiderman 3, and Shrek 3). RGC shares should also benefit from the IPO of National Cinemedia which will likely lead to a boost in shareholder value as RGC uses its share of the proceeds. RGC is set to provide another year of double digit total return.

Rogers Communications: RG is poised for another year of greater than 20% growth led by continued to rapid growth in the Canadian wireless market where RG is the market leader. Canada is running several years behind the U.S. in wireless penetration which sets up a repeat performance of recent growth trends. RG also will benefit from the rollout of the triple play in its cable business, the largest in Canada. I think the shares can trade to the low $70s, producing a return of over 20%.

That is a recap of what Northlake owns today on behalf of its clients. As always, these are several potential ideas in the pipeline and my favorable opinion of any stocks currently held could change. There is no way to predict the timing of those things but one thing you can count on is that I will post commentary on any changes right here as they occur.

Happy New Year!

Making Money In Media Despite Weak Ad Spending

According to data from TNS Media Intelligence, advertising spending in the U.S., excluding paid search, fell by 0.3% in May 2006. According to TNS, this is the first comparable monthly decline since the advertising recovery began in May 2002. Network TV and newspapers suffered the biggest declines during May. Areas showing growth included non-search Internet advertising and Spanish language TV networks.

Even with May's decline, ad spending as measured by TNS is up 3.9% for January through May but compared to 1Q06 GDP growth of 5.6%, that is a poor performance. In fact, one notable facet of the current economic expansion is that advertising growth has lagged GDP growth. Historically, advertising expenditures rise faster than GDP when the economy is expanding, which is why the media is classified as a cyclical growth industry. This year's slower-than-GDP advertising growth is especially troubling given the fact that May's downturn coincided with 2Q06 GDP growth of just 2.5%. Plenty of forecasters think that even slower growth lies ahead for economy, possibly even a recession....

With recent data supporting the idea that non-Internet advertising might be turning into just a cyclical industry, it is no wonder that ad-supported media stocks have seen their stock market valuations contract. And with plenty of signs that slower economic growth is baked in for at least a few quarters, bullish investors expecting media stock valuations to expand may have a long wait.

To invest successfuly in mediae stocks against a weak ad spending environment, you have to stick with trading ideas, special situations, or companies offering sustainable multiyear growth. Northlake's portfolio does just that and continues to include Central European Media Enterprises (CETV), Disney (DIS), NTL Incorporated (NTLI), and Regal Entertainment (RGC); CETV and DIS for growth, RGC for a trade, and NTLI as a special situation

I Am Famous. Sort Of.

I Am Famous. Sort Of.

Back on August 1, 2006, Jim Cramer of CNBC and theStreet.com, did a segment on Comcast on his nightly Mad Money TV show. During the segment, Cramer tells viewers how for the past year everyone hated Comcast. Everyone that is except, yours truly. Cramer says “"Birenberg's the only guy to have gotten this right..When everyone else was running from it, he rushed to it!" Check out the whole segment by clicking below. I am mentioned about two minutes into the segment.

Now I am sure clients will want to know why I didn’t buy Comcast for all of their accounts. The answer is that I limit my holdings to just a half dozen or so stocks at any one time. So while I liked Comcast, I liked the stocks I held in client accounts even more. Of course, I don’t always get every stock pick right. In this case, I would have been better off if Comcast was in all of Northlake’s managed portfolios. Nevertheless, I am proud of my analysis and very pleased that it was recognized.

Updating Individual Stock Positions

In the extended entry, please find an update on individual stock positions currently broadly held across client accounts. Click the "Continue Reading" link immediately below to see the updates on Apple Computer, Central European Media Enterprises, Lions Gate Entertainment, Motorola, Sears Holding, SBS Broadcasting, and Walt Disney....

Northlake remains long Apple Computer (AAPL) after reducing the position in the upper $40s when it reached the initial target I established when shares were initially purchased early in 2005. With AAPL shares making new highs, the expectations for the company's upcoming quarterly earnings release have been raised. The street is expecting results above the conservative guidance offered by management on the last conference call. From surveys conducted by sell-side analysts it appears that AAPL is maintaining momentum in iPods and computer sales. I think this will lead to an optimistic Christmas selling season forecast from management and the Street leading to further gains in the shares between now and year end.

Central European Media Enterprises (CETV) shares have moved up and stabilized in the mid-$50s following on the heels of the buyout of SBS Broadcasting (SBTV). The buyout multiple on SBTV supports CETV shares in the low to mid-$50s. CETV faces a seasonally weak third quarter followed by what I expect will be a very strong finish to the year. I think investors will be focused on management guidance for the fourth quarter. If the street is satisfied with the fourth quarter outlook, I think CETV shares can head into the $60s.

I've been wrong on Walt Disney (DIS) shares since establishing a position in the spring at $26. Since the purchase, DIS has suffered two strikes but I still think the key catalysts are ahead so I'll wait to see if DIS can fight off strike three. First, DIS reported June quarter earnings that failed to beat expectations as I had anticipated. The fault laid primarily in home video due to the suddenly weakening growth rates in DVD sales. The second strike again from the studio business. This time the culprit was a multi-hundred million dollar write-off from a series of flops coming out the Miramax studio at the end of the Weinstein Brothers tenure. The Street anticipated weak results form these films but nothing of this magnitude. Hurricane Katrina also has pressured DIS shares due to fears of reduced discretionary spending on the part of the consumers. I am going to hang on to DIS shares through the next quarterly earnings report because I think the turnaround at ABC and a strong upcoming slate of films sets up 2006 (starts October1) as a big year. The street has low expectations now which means the bar has been reset to a level that should be easy to hurdle.

It appears as though SBS Broadcasting (SBTV) will not be receiving a better buyout offer than the 46 euros from Premira and KKR. The shareholder vote is coming up on October 3rd and with the offering circular having been out for more than two weeks time seems to have run out. Each one cent move in the euro versus the dollar is worth 45 cents. The deal was assumed to be worth $56 based on a $1.21 exchange rate. The exchange rate remains close to that level. I plan to tender client shares and expect the deal to close in late October. If clients are short on cash for a new position, SBTV shares could be sold ahead of the tender offer.

Lions Gate Entertainment (LGF) has been in the news recently following its attempted hostile acquisition of Image Entertainment (DISK) and the launch of its latest film, Lord of War, featuring Nicholas Cage. Image is a small distributor of DVDs which would fit in well with LGF and provide lots of cost savings opportunities. If the deal is struck at a reasonable price, it should provide a boost for LGF's earnings in the years ahead. Image is one-tenth the size of LGF so this is not a make or break deal for LGF. Lord of War has had a moderately disappointing box office run so far. LGF is only the distributor of the film and did not pay for the high production cost of the film. I am not sure what the economics are of the distribution deal but with the film headed to a total box office in the $25 million range I don’t think the below expectations box office is likely to hurt LGF's earnings. Upcoming catalysts for LGF shares are the ongoing superb sales and rentals of the Crash DVD and the sequel to the company's horror hit Saw which is due in theatres this Halloween. LGF shares should rebound from recent weakness.

Things have been quiet at Motorola (MOT) since half of client positions were sold at my initial target price in the low $20s. MOT shares have continued to rise as the outlook for continued market share gains against a better than expected global handset market has excited investors. It does not appear the introduction of the iTunes enabled ROKR phone will be a major catalyst for the shares. Analyst estimates for 2006 have been rising steadily with consensus now at $1.24. Several analyst are well above consensus with many the mid $1.30s range. I think MOT shares will continue to rise as consensus moves closer to the bullish analysts. A target of 20 times possible 2006 earnings of $1.35 is my goal for exiting my position.

Sears Holding (SHLD) shares remain under pressure since the company reported mixed second quarter earnings. Besides fears about the ability of the two struggling retailers to produce shareholder friendly financial results, SHLD is also under pressure due to fears about consumer spending in light of high gas prices and expected elevated home heating costs this coming winter. The shares did rebound sharply last Thursday when there was major purchase by an insider between $115 and $120. I am looking to buy back positions that were sold in client accounts above $160 if the shares get near the $115 level again in the near future.

Schwab Lowers Trading Costs

I received an email from Schwab today announcing that they are lowering commission charges for clients with $50,000 to $1,000,000 in assets at Schwab. The accounts do not all have to be managed by Northlake Capital Management to qualify. The new commission schedule for qualifying clients is $12.95 per trade for up to 1000 shares and 1.5 cents per trade above 1,000 shares. Presently, the schedule is $19.95 per trade for up to 1,000 shares and 1.5 cents per share above 1,000 shares....

To receive the lower schedule, clients must be enrolled in Schwab's eConfirm program (confirmations sent via email). Eventually, Schwab will require enrollment in their eStatement program as well (monthly statements sent via email). If you are receiving eConfirms now whenever a trade is completed in your account, you need to do nothing. If you receive, confirmations in the mail, please provide me with an email address and I will prepare the paperwork to enroll you in eConfirms. As soon as I know about eStatements, I will get the information out to you.

As far as I know, there is no change to the $9.95 per trade, regardless of size, for clients with over $1 million in assets. If you have over $1 million in assets at Schwab and have not been paying $9.95, please call or email me so I can link your non-Northlake accounts and get you the preferred rate across all accounts.

Schwab has a competitive commission schedule and is a good partner for Northlake in terms of custody, trading, and portfolio accounting. I appreciate their efforts to maintain low commissions.

Explaining Quarterly Conference Calls

One of my most important jobs as a money manager is to keep up with the latest corporate news. During the first half of each calendar quarter, much of this work is done by listening to the quarterly conference calls companies conduct when the y report their quarterly earnings. Typically, a company will report its earnings via press release before the stock market opens in the morning or shortly after the market closes. A conference call is usually scheduled within a few hours of the press release, although sometimes companies report after the close hold their conference calls the next morning. I use a service named CallStreet to find out when the conference calls will occur. For the week of October 18, Call Street lists about 750 scheduled conference calls! There are about 30 by companies I care about for one reason or another, and I have 18 listed on my calendar. I'll probably listen to 5 to 10, read transcripts of another 5 to 10, and rely on Wall Street research for the balance....

While this seems daunting and continues for at that pace for about three weeks every "earnings season," I think it is important to get broad exposure to these calls. I follow virtually every industry but my expertise is in media and telecom stocks. It is crucial for me to place each company's results and comments in perspective to what is happening with their comments. For example, this past week, most of the major newspaper companies reported earnings and held calls. I listened to Gannett and Dow Jones live and relied on transcripts and Wall Street research for E.W. Scripps, New York Times, and Knight-Ridder.

The structure of the call is for the CEO, COO, and CFO to recap quarterly results, discuss the company's outlook (or "guidance" in Wall Street lingo), and take questions from Wall Street analysts and portfolio managers. The calls usually last one hour with the recap and guidance taking 15 to 30 minutes. For larger companies, the Q&A is usually limited to the analysts that work for the major brokerage firms like Goldman Sachs and Morgan Stanley. For mid-size and smaller companies, the Q&A is often open to anyone as long as you are pre-registered with the company.

For most large company calls, I listen to the webcast. The webcast is designed to insure that the company is meeting its Regulation Full Disclosure requirement of disseminating material information simultaneously to all interest parties. I can’t ask questions on webcasts, but that is usually not a problem as my goal on conference calls is get a sense of how management feels about its current and future results and how Wall Street is likely to react in the short and long term. It is unlikely I will gain much insight from asking one specific question. I find it more valuable to listen to management's tone and phrasing when they are recapping the results, and, especially to listen to how management interacts with and reacts to the questions from Wall Street analysts and portfolio managers.

One thing that many investors don’t understand is that what matters on Wall Street is how the quarterly results are relative to expectations, rather than how the results are in an absolute sense. Furthermore, understanding what expectations are built into the stock is crucial to formulating a strategy for trading a stock in response to new information such as a quarterly earnings report and conference call.

To help gain better insight into the quarterly conference call process, below is a series of postings I wrote for StreetInsight.com in anticipation of and during Dow Jones quarterly earnings call on October 14th. StreetInsight.com is the professional level service of theStreet.com designed for professional money managers. It costs over $2,000 to be a subscriber, for which you receive daily commentary from actual portfolio managers including yours truly. Contributors write about their market outlook, the trades they are completing for clients, and the research they are dong on industries and companies. Another service of StreetInsight.com is to provide live commentary on quarterly conference calls of important companies.

Sorry for the length of this post, but I hope you find it interesting and gain some insights into the workings of Wall Street and Northlake Capital Management. Without further ado, here is my work on Dow Jones as an example of the "quarterly conference call." It starts with a preview, then gives and a brief immediate reaction to the press release, followed by a recap of the call and the question and answer session, and concluding with a brief summary.

Dow Jones Reports Tomorrow
10/13/04 02:05 PM EDT

Dow Jones & Co. (DJ:NYSE) reports on Thursday morning. I'll be covering the call for Street Insight, and I'm sure Mr. Kass will be watching closely given his long position in DJ shares.

Since peaking last fall and winter above $50, DJ shares have traded to the low $40s. In the last few months a tight range has developed between $40 and $42 on average volume. The shares jumped Tuesday on good volume on the back of a new buy recommendation from Lehman Brothers. The shares trade at more than 30 times 2004 estimated EPS of $1.28 and at 25 times current estimated 2005 EPS of $1.65. Enterprise Value to EBITDA, a widely used valuation measure for media stocks, is 12 times for 2004 estimates and 10 times for 2005 estimates.

DJ maintains a premium valuation to the newspaper group due its perceived operating leverage and possibly due to its private market value.
Current expectations for the quarter are for EPS of 15 cents on revenue of $401 million. EPS would be flat on a year-over-year basis on a 6% increase in revenue. On September 8, management guided EPS to 14 cents from prior guidance of 20 cents. The 20 cent number had been as high as 24 cents early in the year when it looked like a strong first quarter was the beginning of a long awaited upturn in Dow Jones fortunes.

The culprit in the missing recovery is lagging business-to-business spending in the Wall Street Journal. In particular, technology and telecom have continued weak. Other categories like financial, travel, auto, luxury, classifieds, and consumer electronics have shown reasonable growth.
The bull case for DJ is that the company has the highest operating leverage among the newspaper group and ultimately a recovery in technology ad spending will lead to strong earnings and EBITDA growth. Evidence of the operating leverage is seen in consensus fourth quarter 2004 estimated EPS of 49 cents, up 14%, on a projected 5% gain in revenue.

DJ has seen its fortunes sag sharply since the 2000 peak when the company earned $3.32 with EBITDA of $600 million. In 2004, consensus calls for $1.28 in EPS and $280 million in EBITDA. In 2000, the Print division (mostly WSJ) had EBITDA of $465 million. In 2004, the division will contribute only $80 million in EBITDA.

Bullish analysts believe DJ can move toward its peak earnings over the next few years as a full ad recovery develops. In that case, DJ would be a high growth stock in a dull newspaper industry, justifying the current premium valuation to the group. If I were interested in the newspaper group, I'd keep a close eye on DJ. After all, why bother to own a stock if you don't have the potential for operating or financial leverage. Arguably, DJ could have both with free cash flow providing a form of financial leverage.

On the call, I'll be looking for commentary on the fourth quarter advertising outlook, with particular emphasis on the technology sector. I expect that fourth-quarter guidance will be below consensus, but I am probably not alone in that view given very poor September ad trends at the WSJ. I'll also be looking for further color on the company's recent announcement of a Weekend Edition. Finally, deployment of free cash flow and possible future acquisitions will be of interest.

Dow Jones Lowers Guidance
10/14/04 9:49 AM EDT

As outlined is yesterday's preview, Dow Jones (DJ:NYSE) did, in fact, guide 4Q lower, now looking for slightly above 2003's 43 cents vs. a current consensus of 49 cents.

The culprit appears to be continued weakness in advertising at the Wall Street Journal, which declined 10% in September, 6% for the entire third quarter, and is expected to be "down slightly" in the fourth quarter.

More color on this report in our coverage of the earnings call at 10 a.m. EDT.

Third-Quarter Overview
10/14/04 10:03 AM EDT

Dow Jones reported third quarter earnings of 15 cents on revenue of $395 million. The EPS was in line with lower guidance issued by management in early September, while revenue was about $6 million below expectations. Fourth quarter EPS were guided to "slightly above" fourth quarter of 2003's 43 cents. This is below current consensus estimates of 49 cents.

In its press release, management notes that the third quarter results were hurt by a 6% decline in linage at the Wall Street Journal due to "very weak" technology advertising. Financial advertising also was weak, while Classifieds showed growth. September was the worst month of the quarter for the Journal, with linage falling 10%. Management notes that despite the weakness in their flagship, the company was able to produce revenue growth due to continued gains in its Electronic Publishing and Community Newspaper divisions. A portion of the gains in Electronic Publishing were due to acquisitions, however.
The 7% EPS gain on a 5% gain in revenue, while the company's largest operation saw revenue declines, does indicate that management is applying strict cost controls. However, without a return to strength in business to business (B2B) advertising, investors will likely not see the operating leverage that potentially sets Dow Jones apart from other newspaper companies. Slightly up EPS guidance for the fourth quarter indicates that operating leverage will remain elusive and that the Dow Jones story remains at least a few months away from seeing the key catalyst it requires.

Looking further at the release, Print Publishing revenue fell $4 million or 1.9% in the third quarter. As mentioned, the Wall Street Journal saw a 6% revenue decline in the quarter. The International edition saw a revenue decline of 20% in the quarter, with September tumbling 28%. Barron's ad pages fell 5.1% in the quarter and 2.8% in September with one less issue. The weak top line results led to an increased operating loss in the seasonally weak quarter of $16 million versus $11 million a year ago.

Electronic Publishing revenue grew 23% in the quarter to $98 million driven by acquisitions. Operating margins in the division expanded from 21.5% to 22.2%. Indicators of internal growth include a 2.8% gain in Dow Jones Newswire terminals and an increase of 2.2% in Wall Street Journal Online subscribers.
Ottaway Community Newspapers saw a 4.9% gain in revenues to $87 million. Ad linage grew 4.4% in the quarter and September saw an 8.8% gain. Operating margins expanded 60 basis points to 26.8% driving an operating income gain of 7.9%.

The press release did not include a balance sheet but did note that debt was $197 million at the end of the third quarter, down from $215 million in the second quarter and flat year over year. Dow Jones has a strong balance sheet.

Additional Highlights
10/14/04 10:17 AM EDT

Management is reviewing the quarter basically covering data included above. A few additional highlights include:

Seventh straight up EPS quarter.

B2B advertising remains volatile and weak tech spending expected to continue in fourth quarter.

Color remains a bright spot with ad pages up 13% in the quarter against a very tough comparison. Color pages are up 26% year to date.

Newsprint costs up 7%, spilt evenly between volume and price.

Advertising Revenue
10/14/04 10:24 AM EDT

Management notes that ex-technology, ad revenue would have been up low single digits due to strength in color, consumer, classified, wholesale financial, and professional services advertising. Also, ad revenue is growing faster than linage indicating pricing is holding. The benefits of color ads are evident in this measure of advertising yield.

Tech Advertising Driven Lower
10/14/04 10:29 AM EDT

Tech advertising was driven lower by software companies. Some went dark, some went elsewhere. Mgt is working to bring those that went elsewhere back. I'd note this weakness is consistent with the horrid results from a broad array of software companies over the summer. Mgt feels spending will remain weak for tech in the fourth quarter but will not as bad as in the third quarter.

Expected Ad Rev at Journal
10/14/04 10:32 AM EDT

Mgt is moving on to guidance. Ex-technology expect low-single-digit ad increase at Journal but weak tech will result in mid-single-digit revenue decline at Journal.

Expenses and Operating Profits
10/14/04 10:48 AM EDT

Overall revenue for DJ will be up mid-single digits. Expenses up 5% but ex acquisitions, newsprint, and currency only up 1%. Operating profit will rise double digits resulting in slightly positive EPS growth. Again, this is lower guidance than current consensus. Worth noting that the stock is holding well despite the guidance and shares pushed above top end of recent trading range yesterday. As always, how the stock reacts to news can be as important as the news itself.

Queries on Ottaway Margins, Electronic Publishing and More
10/14/04 10:59 AM EDT

Q: Why are Ottaway Margins Up?

A: Solid top line mostly. Margins are approaching unsustainably high level and may fall in this division in 2005.

Q: What is the interest in share repurchase?

A: Company has list of 5 conditions for share repurchase, 4 of which are now met. However, working on new five year plan for whole company and prefer alternative investments with higher return than share repurchase. This sounds like a "no" answer as acquisitions will continue.

Q: What is the growth rate in Electronic Publishing ex-acquisitions and how do acquisitions impact margins?

A: 9% internal revenue growth and acquisitions are dilutive to margins. This leaves upside to future margins which is important given that Electronic Publishing is a growth area for the company.

Q: More color and revenue growth vs. linage at the Journal?

A: Yield while good was not as strong as prior quarters due to mix issues. Classifieds are gaining share due to weak B2B and are a low-yield area. Also commented on weakness in IPO tombstones and noted too much attention is paid to this as even down 50% it is only costing the Journal 1% of its total ad revenue.

Q: How do you approach acquisitions? What is interesting?

A: Focus will be on electronic publishing and Ottaway Community Newspapers. Do not expect any "huge" deals. Several hundred million per year is likely and no strain on balance sheet or cash flow.

Comments on the Weekend Edition
10/14/04 11:20 AM EDT

Q: Anecdotal comments on Weekend Edition?

A: Very positive reaction so far from advertisers, particularly in consumer and financial areas. More enthusiastic about prospects now than before announced. Still will be dilutive in '05, more so in '06 due to full year of publication.

Summary: Lack of Visibility on Operating Leverage Restricts Enthusiasm
10/14/04 11:57 AM EDT

I'm a little surprised that DJ shares are not acting worse given the guidance. On the call, none of the analysts seemed concerned and they certainly weren't confrontational. I think the guidance was expected despite the higher consensus estimates.

For DJ stock to work big, the company needs to accelerate B2B growth in its print publications. Consumer growth is fine, but carries higher costs as the Journal is a B2B publication, and expanding to consumers requires investments as with Personal Journal and Weekend Edition.

Overall, the fact that the stock is holding up despite another delay in the development of the story is a good sign. This fact -- more than the recent quarter or what I heard on the call -- makes me a bit more interested in DJ. I'm not long and don't plan on getting long in the near term. However, on my list of priorities, DJ has moved up a bit.