Overview

The McClatchy Company (the Company) is the third largest newspaper company in the United States, with 30 daily newspapers, approximately 50 non-dailies, and direct marketing and direct mail operations. McClatchy also operates leading local websites in each of its markets which extend its audience reach. The websites offer users comprehensive news and information, advertising, e-commerce and other services. Together with its newspapers and direct marketing products, these interactive operations make McClatchy a leading local media company in each of its premium high growth markets. McClatchy-owned newspapers include, among others, The Miami Herald, The Sacramento Bee, the Fort Worth Star-Telegram, The Kansas City Star, The Charlotte Observer, and The News & Observer (Raleigh).

McClatchy also owns a portfolio of premium digital assets, including 14.4% of CareerBuilder, the nation's largest online job site, 25.6% of Classified Ventures, a newspaper industry partnership that offers two of the nation's premier classified websites: the auto website, cars.com, and the rental site, apartments.com and 33.3% of HomeFinder, LLC which operates the online real estate website HomeFinder.com. McClatchy is listed on the New York Stock Exchange under the symbol MNI.

The Company's primary source of revenues is print and digital advertising, which accounted for 77.6% of the Company's revenues for the second fiscal quarter of 2009. While percentages vary from year to year and from newspaper to newspaper, classified advertising revenues have steadily decreased as a percentage of total advertising revenues, primarily in the employment and real estate categories and to a lesser extent the automotive category. Classified advertising revenues as a percentage of total advertising revenues have declined to 28.2% in the second fiscal quarter of 2009, compared to 33.3% in the second fiscal quarter of 2008, and to 38.5% in the second fiscal quarter of 2007, primarily as a result of the economic slowdown affecting classified advertising and the secular shift in advertising demand to digital products.

While revenues from retail advertising carried as a part of newspapers (run-of-press or ROP advertising) or in advertising inserts placed in newspapers (preprint advertising) has decreased year over year, retail advertising has steadily increased as a percentage of total advertising up to 52.7% in the second quarter of fiscal 2009 compared to 48.4% in the second fiscal quarter of 2008 and to 43.7% in the second fiscal quarter of 2007.

National advertising revenues as a percentage of total advertising revenues remained relatively similar year over year and contributed about 9.0% of total advertising revenues in both the second fiscal quarter of 2009 and 2008. Direct marketing revenues and other advertising revenues made up the remainder of the Company's advertising revenues in the second fiscal quarter of 2009.

While included in the revenues described above, all categories of digital advertising are performing better than print advertising. In total, revenues from digital advertising decreased 3.8% in the first half of 2009 compared to the first half of 2008 while print advertising revenues declined 33.3% over the same periods. However, employment advertising revenues, which have been negatively affected by the economic downturn, are down substantially in both print and digital. Excluding employment advertising, digital advertising revenues grew 24.7% in the quarter and 26.6% in the first half of fiscal 2009, compared to the same periods in fiscal 2008. Also, digital advertising revenues represented 16.5% of total advertising revenues in the second fiscal quarter of 2009, up from 11.8% of total advertising revenues for the second quarter of 2008.

Circulation revenues increased to 19.0% of the Company's revenues in the second fiscal quarter of 2009 from 13.5% in the second fiscal quarter of 2008. Most of the Company's 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 the three and six months ended June 28, 2009 and June 29, 2008.

Critical Accounting Policies

Critical accounting policies are those accounting policies that management believes are important to the portrayal of the Company's financial condition and results and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company's 2008 Annual Report on Form 10-K includes a description of certain critical accounting policies, including those with respect to revenue recognition, allowance for doubtful accounts, acquisition accounting, goodwill and intangible impairment, pension and postretirement benefits, income taxes, and insurance. There have been no material changes to the Company's critical accounting policies described in the Company's 2008 Annual Report on Form 10-K.

Recent Events and Trends

Advertising Revenues:

Advertising revenues in the second quarter and first half of fiscal 2009 decreased as a result of the continuing weak economy and the secular shift in advertising demand from print to digital products. Management believes a significant portion of the advertising downturn reflects the current economic cycle. See the revenue discussions in management's review of "Results of Operations".

Newsprint:

While on average newsprint prices in the first half of 2009 were higher than in the first half of 2008, newsprint prices fell in each month of 2009. Newsprint pricing is dependent on global demand and supply for newsprint. Significant changes in newsprint prices can increase or decrease the Company's operating expenses and therefore, directly affect the Company's operating results. The impact of newsprint prices on the Company's financial results is discussed under "Results of Operations".

In June 2008 and again in September 2008, the Company announced plans to reduce its workforce, as the Company streamlined its operations and staff size. The workforce in 2008 was reduced by approximately 2,500 positions. The workforce reductions resulted in total severance costs of approximately $45 million which was accrued and largely paid in 2008. Savings from the restructuring, including compensation savings, are expected to be approximately $200 million annually, and the Company expects about $140 million in savings to be realized during fiscal 2009.

In March 2009, the Company announced additional restructuring efforts which included reducing the Company's workforce by 15% or 1,600 full-time equivalent employees, the freezing of the Company's pension plans and a temporary suspension of the Company matching contribution to the 401(k) plan as of March 31, 2009. The Company's restructuring plan also involved wage reductions across the company for additional savings. The Company's chairman and chief executive officer (CEO) declined his 2008 and 2009 bonuses and other executive officers did not receive bonuses for 2008. In addition, effective March 30, 2009, the CEO's base salary was reduced by 15%, other executive officers' salaries were cut by 10%, and no bonuses will be paid to any executive officers for 2009. In addition, the Company reduced the cash compensation, including retainers and meeting fees, paid to its directors by approximately 13%, and the directors declined any stock awards for 2008 and 2009. Much of the expected expense reductions from this plan, which are largely permanent in nature, began to be realized in the second quarter of 2009. A total of $23.7 million in severance related costs associated with this restructuring plan were incurred through June 28, 2009 and were largely paid by the end of the second quarter of 2009.

In May 2008, the Company purchased $300 million aggregate principal amount of its outstanding debt securities for $282.4 million in cash obtained from its revolving credit facility and recorded a pre-tax gain of $19.5 million. The Company purchased $150 million, $130 million and $20 million of its outstanding principal amount of debt securities maturing in 2009, 2011 and 2014, respectively. The gain includes the write-off of approximately $2.8 million of net unamortized premiums related to these securities.

On May 21, 2009, the Company launched a private debt exchange offer for all of its outstanding debt securities for a combination of cash and newly issued 15.75% senior notes due July 15, 2014 (New Notes). The New Notes are senior unsecured obligations and will be guaranteed by McClatchy's existing and future material domestic subsidiaries. The exchange closed on June 26, 2009 and the Company exchanged $3.4 million in cash and $24.2 million of New Notes. In exchange for the cash and New Notes the Company retired the following outstanding principal amount of debt securities maturing in the respective years: $3.3 million in 2011 notes, $11.1 million in 2014 notes, $53.4 million in 2017, $10.8 million in 2027 debentures and $23.8 million in 2029 debentures. The Company recorded a pre-tax gain of approximately $44.8 million in the second fiscal quarter of 2009. The gain was equal to the carrying amount of the exchanged securities less the total future cash payments of the New Notes, including both payments of interest and face amount, and related expenses of the exchange.

In connection with the debt tender offer described above, the Company entered into an agreement on May 20, 2009 to amend the Credit Agreement which, among other things, allows it to use its revolving credit facility for up to $60 million to repurchase its 7.125% Notes due June 1, 2011 or its 4.625% Notes due November 1, 2014, subject to certain conditions.

See additional discussion of the impact of these capital transactions on the Company's results of operations and financial position in Note 4 to the consolidated financial statements and the Liquidity and Capital Resources discussion below.

Equity Investments:

On March 31, 2008, the Company, along with the other general partners of SP Newsprint Co. (SP), completed the sale of SP, of which the Company was a one-third owner. The Company recorded a gain on the transaction in the second fiscal quarter of 2008 of $32.0 million. In May 2009, the Company settled post-closing working capital adjustments resulting in an additional $0.9 million in expenses which were recorded in the second fiscal quarter of 2009. The Company used the $55 million of proceeds it received from the sale to reduce debt in the second fiscal quarter of 2008 and received $5 million of proceeds on March 2, 2009 that had been recorded as a long-term receivable, which was used to reduce debt.

On June 30, 2008 (the first day of the Company's third fiscal quarter), the Company sold its 15.0% ownership interest in ShopLocal, LLC for $7.9 million and used the proceeds to reduce debt. The Company reduced its carrying value of ShopLocal to match the sales price. In addition, Classified Ventures, LLC identified potential goodwill impairment at a real estate-related reporting unit and as a result, the Company recognized an estimated charge related to this investment in the second fiscal quarter of 2008. The final charge was determined and recorded in the second half of 2008 when Classified Ventures completed its impairment analysis. The total non-cash pre-tax charges related to impairments of internet investments, including ShopLocal and Classified Ventures, in the second fiscal quarter of 2008 were $21.5 million.

NYSE Listing:

McClatchy was notified on February 4, 2009 by the New York Stock Exchange (the "NYSE") that it is not in compliance with the NYSE's continued listing standards. The Company's average share price over the previous 30 trading days was $0.98, which is below the NYSE's quantitative listing standards of a minimum of $1.00 per share. On June 30, 2009, the NYSE announced that the Securities and Exchange Commission approved the temporary suspension of the share price requirement through July 31, 2009; hence the Company has until January 7, 2010 to become compliant with the listing standard.

On April 14, 2009, the Company was notified that it is considered below the criteria established by the NYSE because its total market capitalization had been less than $75 million over a consecutive 30-day trading period and its reported shareholders' equity in its Annual Report on Form 10-K for the fiscal year ended December 28, 2008 was less than $75 million. On June 2, 2009 the Company was notified that the NYSE received approval from the SEC to amend the NYSE's continued listing standard applicable to average market capitalization and shareholders equity through October 31, 2009. The average market capitalization requirement has been lowered from no less than $75 million over a 30-trading-day period to no less than $50 million over a 30-trading-day period and the stockholders' equity requirement has been lowered from no less than $75 million to no less than $50 million. As a result of these changes, the Company is now considered in compliance under the NYSE's amended continued listing standard for market capitalization and stockholders' equity.

RESULTS OF OPERATIONS

Second Fiscal Quarter of 2009 Compared to Second Fiscal Quarter of 2008

The Company reported income from continuing operations in the second fiscal quarter of 2009 of $42.0 million, or $0.50 per share, compared to $20.1 million, or $0.24 per share in the second fiscal quarter of 2008. Earnings included, among other items, an after-tax gain of $28.3 million on the extinguishment of debt and $7.4 million (after-tax) of accelerated depreciation on equipment related to outsourcing printing at various newspapers in the second fiscal quarter of 2009. The Company's total net income was $42.2 million, or $0.50 per share including discontinued operations in the second fiscal quarter of 2009, compared to $19.7 million, or $0.24 per share in the second fiscal quarter of 2008.

Earnings in the second fiscal quarter of 2008 were positively impacted by a net of $2.7 million in after-tax items including the impact of: a $19.4 million after-tax gain on the sale of a one-third interest in SP Newsprint Company (SP), a $12.3 million after-tax gain on the extinguishment of debt related to a second quarter 2008 bond tender, and were negatively impacted by $13.2 million in after-tax charges related to implementing a previously announced restructuring plan, $13.5 million in after-tax impairment charges of certain internet investments and a $2.2 million charge for tax expense related to certain discrete tax items.

Revenues:

Revenues in the second fiscal quarter of 2009 were $365.3 million, down 25.4% from revenues of $489.7 million in the second fiscal quarter of 2008. Advertising revenues were $283.7 million, down 30.2% from advertising in the second fiscal quarter of 2008, and circulation revenues were $69.4 million, up 5.0%.

The following summarizes the Company's revenues by category, which compares the second fiscal quarter of 2009 with the second fiscal quarter of 2008 (dollars in thousands):

                                     Quarter Ended
                                                               %
                     June 28, 2009       June 29, 2008      Change
Advertising:
Retail              $       149,442     $       196,497       -23.9
National                     24,141              36,682       -34.2
Classified:
  Auto                       23,627              35,997       -34.4
  Employment                 15,148              40,423       -62.5
  Real estate                18,692              34,412       -45.7
  Other                      22,690              24,312        -6.7
Total classified             80,157             135,144       -40.7
Direct marketing
  and other                  29,921              38,005       -21.2
Total advertising           283,661             406,328       -30.2
Circulation                  69,351              66,055         5.0
Other                        12,323              17,300       -28.8
Total revenues      $       365,335     $       489,683       -25.4

Retail advertising decreased $47.1 million, or 23.9% from the second fiscal quarter of 2008, primarily reflecting the impact of the economic recession. Print retail run of press (ROP) advertising decreased $37.3 million, or 34.6% and preprint advertising decreased $15.4 million, or 20.1%. Digital retail advertising increased $5.7 million, or 48.1% from the second fiscal quarter of 2008.

National advertising decreased $12.5 million, or 34.2% from the second fiscal quarter of 2008. The declines in total national advertising were reflected across many segments in this category of advertising. However, digital national advertising increased $1.1 million, or 26.9% from the 2008 quarter.

Classified advertising decreased $55.0 million, or 40.7% from the second fiscal quarter of 2008. Print classified advertising declined $46.8 million, or 45.4%, while digital classified advertising decreased $8.2 million, or 25.7%. The digital advertising decline resulted primarily from lower employment advertising. Digital automotive and real estate categories declined less than the employment category on a relative basis because the employment category has been hit harder by the recession. A review of the major classified categories follows:

· Automotive advertising decreased $12.4 million, or 34.4% from the second fiscal quarter of 2008, reflecting an industry-wide trend. Print automotive advertising declined 43.9%, while digital automotive advertising declined 3.1% from the 2008 quarter.

· Real estate advertising decreased $15.7 million, or 45.7% from the second fiscal quarter of 2008, also an industry-wide trend. In total, print real estate advertising declined 52.2%, while digital advertising fell by 2.4%.

· Employment advertising decreased $25.3 million, or 62.5% from the second fiscal quarter of 2008, reflecting a national slowdown in hiring and therefore, employment advertising. The declines were reflected both in print employment advertising, down 68.0%, and online employment advertising, down 54.8%.

Digital advertising revenues, which are included in each of the advertising categories discussed above, totaled $46.7 million in the second fiscal quarter of 2009, a decrease of 2.9% as compared to the second fiscal quarter of 2008. However, excluding employment advertising, the category most affected by the current cyclical slowdown, digital advertising grew 24.7% compared to the second fiscal quarter of 2008.

Direct marketing decreased $8.2 million, or 21.8% from the second fiscal quarter of 2008 reflecting the same trends as retail advertising discussed above.

Circulation revenues increased $3.3 million, or 5.0% from the second fiscal quarter of 2008, primarily reflecting higher circulation prices at most newspapers, partially offset by lower circulation volumes. Average paid daily circulation declined 12.4% and Sunday circulation was down 8.5% in the second fiscal quarter of 2009. The Company expects circulation volumes to remain lower in fiscal 2009 compared to fiscal 2008 reflecting primarily the Company's focus on reducing costly circulation programs deemed to be of lesser value to its advertising customers and, to a lesser extent, changes in readership trends. However, price increases are expected to more than offset the impact of volume declines, resulting in circulation revenue growth.

   Operating Expenses:

  Operating expenses in 2009 and 2008 include restructuring charges and the 2009
amounts include accelerated depreciation on equipment related to the outsourcing
of printing at various newspapers (collectively considered "unusual items"). The
following table summarizes operating expenses, excluding the impact of these
unusual items on operating expenses in the 2009 and 2008 quarters (in
thousands):

                                                                   Three Months Ended
                                                           June 28,                  June 29,
                                                             2009                      2008                      change
Operating expenses as reported                           $     320,547             $     445,968             $     (125,421 )
Less unusual items                                              14,581                    23,312                     (8,731 )
Operating expenses excluding unusual items               $     305,966             $     422,656                   (116,690 )

Compensation expense                                     $     140,127             $     229,057                    (88,930 )
Less compensation-related restructuring charges                  4,017                    23,312                    (19,295 )
Compensation excluding restructuring charges             $     136,110             $     205,745                    (69,635 )

Non-GAAP measures should not be considered a substitute for GAAP measures. However, operating expenses excluding unusual items provides meaningful supplemental information about the Company's underlying results of operations, and management believes it assists investors and financial analysts in analyzing and forecasting future periods.

Operating expenses in the second quarter of fiscal 2009 decreased by $125.4 million compared to the second quarter of fiscal 2008. Operating expenses in the second quarter of 2009 included $4.0 million in compensation-related restructuring charges and $10.6 million of accelerated depreciation on equipment related to the outsourcing of printing at various newspapers. Operating expenses in the second quarter of 2008 included $23.3 million in severance and benefit plan curtailment gain related to its restructuring plans. Operating expenses in 2009 excluding the restructuring items and the accelerated depreciation decreased $116.7 million, or 27.6% from the 2008 quarter.

Compensation expenses decreased $88.9 million, or 38.8% from the second fiscal quarter of 2008 and included the restructuring charges discussed above which were higher in the 2008 quarter than in the 2009 quarter. Excluding the effect of restructuring charges, compensation expense was down $69.6 million, or 33.8%. Excluding the restructuring charges, payroll was down 32.4% and fringe benefits costs declined 40.4%. Average headcount decreased 31.3% from the second quarter of 2008 and retirement and medical costs were also down.

Newsprint and supplement expense was down 29.1% with newsprint expense down 30.7%, primarily reflecting lower newsprint usage. Supplement expense was down 20.5%. Depreciation and amortization expenses increased $7.0 million from the second fiscal quarter of 2008 and include the $10.6 million in accelerated depreciation on production equipment. Other operating costs were down $24.5 million, or 21.2%, reflecting Company-wide cost controls.

Interest:

Interest expense for continuing operations was $34.3 million for the second fiscal quarter of 2009, down 6.4% from the 2008 quarter primarily reflecting lower interest rates and debt balances. Interest expense in the 2009 fiscal quarter included a $0.4 million charge related to the write off of deferred financing costs as a result of the amendment to the Company's bank credit agreement as of May 20, 2009. Excluding the 2009 write-off from the second quarter, interest expense declined 7.4% as compared to the second quarter of 2008.

Equity (Loss) Income:

Income from unconsolidated investments was $2.5 million in the second fiscal quarter of 2009 compared to a loss of $0.4 million in the second fiscal quarter of 2008, due primarily to improved financial results at the internet-related companies in which the Company has ownership interests.

The Company sold SP at the beginning of the second fiscal quarter of 2008 and recorded a gain on the sale of $32.0 million. In May 2009, the Company settled post-closing working capital adjustments resulting in an additional $0.9 million in expenses which were recorded in the second fiscal quarter of 2009. In addition the Company recorded charges totaling $21.5 million in the second fiscal quarter of 2008 related to estimated impairments of certain internet investments.

For an expanded discussion of transactions and events related to the Company's less than 50% owned companies, see Note 3 to the consolidated financial statements.

Gain on Extinguishment of Debt

In the second fiscal quarter of 2009, the Company recorded a pre-tax gain on the extinguishment of debt of $44.8 million relating to a private bond exchange offer for cash and 15.75% senior notes due July 15, 2014. In the second fiscal quarter of 2008, the Company recorded a pre-tax gain on the extinguishment of debt of $19.5 million relating to a bond tender offer for cash. For further information, see Note 4 to the consolidated financial statements.

Income Taxes:

The income tax rate from continuing operations in the second fiscal quarter of 2009 was 25.9% compared to 46.1% in 2008. The rate in the second fiscal quarter of 2009 was impacted primarily by state income tax accruals, various discrete tax adjustments, and an adjustment of tax expense to reflect the change from the first quarter benefit tax rate of 21.4% to the revised year-to-date effective tax rate of 50.8% for the first six months of 2009.

First Six Months of 2009 Compared to First Six Months of 2008

The Company reported income from continuing operations in the first six months of 2009 of $4.3 million, or $0.05 per share, compared to $19.1 million, or $0.23 per share in 2008. The Company's net income was $4.7 million, or $0.06 per share including discontinued operations in the first six months of 2009, compared to $18.8 million, or $0.23 per share in the first six months of 2008. Net income in both years was impacted by the events discussed in the quarterly results above.

Revenues:

Revenues in the first six months of 2009 were $731.0 million, down 25.3% from revenues of $978.0 million in 2008. Advertising revenues were $568.4 million, down 29.9% from advertising in the first six months of 2008, and circulation revenues were $137.8 million, up 2.9%.

The following summarizes the Company's revenues by category, which compares the first six months of 2009 with the first six months of 2008 (dollars in thousands):

                             Six Months Ended
                    June 28,      June 29,         %
                      2009          2008        Change
Advertising:
Retail              $ 297,257     $ 387,255       -23.2 %
National               51,695        74,907       -31.0 %
Classified:
  Auto                 47,501        71,383       -33.5 %
  Employment           32,342        86,864       -62.8 %
  Real estate          38,430        69,835       -45.0 %
  Other                43,435        47,273        -8.1 %
Total classified      161,708       275,355       -41.3 %
. . .