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Executives

Haug Scharnowski – Director of Investor Relations

James P. Dolan – Chairman of the Board, President, Chief Executive Officer

Scott J. Pollei – Chief Financial Officer, Executive Vice President

Analysts

Peter Appert – Piper Jaffray

Jason Ursaner – CJS Securities

Jim Goss – Barrington Research

Robert Evans – Craig-Hallum Capital

Robert B. Kirkpatrick- Cardinal Capital

Adam Fischer – Burnham Asset Management

[James Kouinsidine] – [Kouinsidine Capital Management]

Dolan Media Co. (DM) Q1 2009 Earnings Call May 5, 2009 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to the Dolan Media Company first quarter 2009 conference call. (Operator Instructions) I would now like to turn the call over to Mr. Haug Scharnowski. Mr. Scharnowski, you may begin.

Haug Scharnowski

Good afternoon, ladies and gentlemen, and welcome to Dolan Media Company's first quarter 2009 conference call. On the call today from the company are Jim Dolan, Chairman, Chief Executive Officer and President, and Scott Pollei, Executive Vice President, and Chief Financial Officer.

By now, everyone should have had access to the first quarter 2009 earnings release, which went out today at approximately 3:00 pm Central Time. If you have not seen our release, you can find it on the Investor Relations section of Dolan Media Company's website at www.dolanmedia.com. In addition, a slide presentation supplementing this conference call is also available on our website. This call is being Webcast, and the replay and slide presentation will be available on the company's website for a period of 21 days.

Before we begin, we'd like to remind everyone of the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Today's prepared remarks contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. The words expect, believes, anticipates, estimates, continue, plans, will, outlook, guidance and similar expressions are intended to identify forward-looking statements.

These forward-looking statements are based on information currently available to us, and are subject to a number of risks, uncertainties and other factors that may cause our actual results, performance or opportunities to be materially different from those expressed in or implied by these forward-looking statements.

For a more detailed discussion on the factors that could cause actual results to differ materially from those projected in any forward-looking statements, we refer you to the risk factors contained in Dolan Media Company's annual report on Form 10-K filed with the Securities and Exchange Commission on March 12, 2009.

Except as required by federal securities laws, Dolan Media Company assumes no obligation to revise or update any forward-looking statements that may be made in today's release or call. Please note that on today's call, in addition to discussing GAAP financial results, the company will discuss various non-GAAP financial measures.

This non-GAAP information does not substitute for any performance measure described in accordance with GAAP. Today's earnings release contains a reconciliation between GAAP and the non-GAAP measures discussed in today's call as required by SEC Regulation G.

And with that, I would now like to turn the call over to Jim Dolan.

James P. Dolan

Thanks, Haug, and thanks to all of you for joining us on this call. We are extremely pleased with our first quarter results. Today we are reporting record revenues and earnings. As a result of our strong start to 2009 we are increasing our financial guidance for the full year 2009.

Before I discuss the details of our guidance, let's talk about what we are seeing in our business. During the first quarter, we issued solid results from our countercyclical revenue sources, which are mortgage default processing services and public notice advertising.

In particular, our newly acquired National Default Exchange, or NDEx, as we call it, had a very strong quarter. It contributed $22.6 million in revenues from processing about 50,400 mortgage default files during the quarter. This was an increase of 8,800 files, growing 21.1% from the same quarter last year, which was, of course, before we bought the business.

On prior calls, we referred to the growing overhang of seriously delinquent mortgages, defined as loans more than 90 days delinquent. This overhang continued to grow through all of 2008 for two reasons. First, serious delinquencies grew enormously, and second, referrals from delinquency into foreclosure held relatively steady at about 1% of total outstanding mortgages. In other words, the inflow into delinquencies grew at a record-setting pace, while the outflow of delinquencies into foreclosures continued at historically normal rates.

Banks and mortgage servicers were delaying foreclosure referrals, as various foreclosure avoidance programs were given a chance to take hold. We believe these programs helped the mortgage industry and the government gain a better understanding of which troubled mortgages could be restructured and saved, and which could not.

During the first quarter of 2009, many of the foreclosure moratoria expired, and the industry began to work off the overhang in delinquencies. Foreclosure starts grew. As a result, we experienced a year-over-year increase in foreclosure referrals in each of the markets we serve. Our proprietary research and our industry sources agree that foreclosure starts will be high in 2009.

We also believe that the weak economy continues to worsen the already challenged housing market. In particular, many of the markets we serve are especially hard hit by rising unemployment or by industry ties to the troubled automotive sector. These factors should further escalate mortgage delinquencies and foreclosures.

In our Business Information Division, we continue to see a weak market for display and classified advertising, as we expected. This is the worst recession that I've experienced since founding Dolan Media. We don't anticipate any improvement in the near future for display and classified ad revenues.

Our public notice revenues grew, softening the impact of the recession for us in this division. Thanks to effective cost controls, operating margins for the division increased 180 basis points over the previous year.

Now, let's talk about our guidance. Based on the first quarter results and favorable trends in our countercyclical revenues, we are increasing our financial guidance for the full year 2009. Previously, we expected total revenues of $236 million to $240 million. Now we expect total revenues to be $240 million to $252 million.

Previously, we expected Professional Services Division revenues of $148 million to $150 million. Now we expect division revenues between $158 million and $167 million. Previously, we expected Business Information Division revenues of $88 million to $90 million. Now we expect revenues between $82 million and $85 million.

Previously, we expected net income of $15.5 million to $18 million. Now we expect net income attributable to Dolan Media Company between $21 million and $24 million. Previously, we expected adjusted EBITDA of $66.4 million to $68 million. Now we expect adjusted EBITDA between $70 million and $75 million.

We expect total operating expenses to be 83% to 84% of revenues. Previously, we expected minority interest expense of $2 million to $3 million. Now, we expect non-controlling interests of $4 million to $4.5 million. Previously, we expected interest expense of approximately $8.5 to $9 million. Now we expect it to be approximately $7.5 million. Previously, we expected cash distributions to minority partners of $1 million to $1.5 million. Now we expect cash distributions to holders of non-controlling interests to be $3.5 million to $4 million.

Previously, we expected net income per diluted share to be $0.53 to $0.61. Now we expect a net income attributable to Dolan Media Company to be $0.70 to $0.80 per diluted share. Previously, we expected cash earnings per diluted share to be $0.90 to $0.98. Now we expect a range of $1.09 to $1.19. For the remainder of 2009 we expect our effective tax rate to be 39%.

As always, our guidance excludes any effective acquisitions in 2009. It also assumes no material effect from government and lender based programs focused on foreclosures.

And now I will turn the call over to Scott.

Scott J. Pollei

Thank you, Jim. As Jim indicated during his remarks, we were very pleased with our better-than-expected financial results in the first quarter. Revenues for the first quarter were $63.9 million, approximately $4 million over expectations. This revenue outperformance flowed all the way to the bottom line.

Adjusted EBITDA was $21.6 million, again approximately $4 million over expectations. Revenue growth during the quarter was primarily driven by operations from our 2008 acquisitions. In particular, we had strong performance of NDEx, which significantly contributed to our over performance in revenues. Revenues for the quarter increased $22.4 million, or 54%, compared to the first quarter last year.

The Professional Services Division, which consists of APC, NDEx and Counsel Press grew revenues of 124.3% year-over-year to $42 million. Acquired revenue growth was 125.1%, or $23.4 million, and represented the division's revenue growth during the quarter.

For the three months ended March 31, 2009, we serviced approximately 91,000 mortgage default case files for our customers, compared to approximately 36,600 during the first quarter last year. As Jim mentioned during his remarks, as the first quarter progressed, we experienced favorable trends in growth and foreclosure file volume in all the markets we served. Revenues briefly lagged foreclosure file volume in the Michigan and Indiana markets because of the timing of when these files were opened during the quarter.

While we are on this topic, we want to remind you that, historically, mortgage default file volume and thus mortgage default processing revenues, tend to be lower in the second quarter of each year, because homeowners received income tax refunds that they can apply toward their residential mortgages.

At Counsel Press, revenues were flat on a year-over-year comparison. During the quarter, Counsel Press processed 2,200 appellate files, approximately 100 more than in the first quarter last year. The slight increase in file volume was offset by lower average revenue per filing.

In our Business Information Division, revenues declined by $900,000 or 3.8%, compared to the first quarter last year. Our display and classified advertising revenues decreased by $1.3 million or 16.3%, due to a 9.3% decrease in the number of ads placed in our publications, as well as a decrease in the average price per classified and display ad across our publications.

Our public notice revenues increased $700,000 or 6.2%, as we experienced a 6.1% increase in the number of public notice ads, primarily foreclosure-related, placed in our qualified publications. The acquisition of the Mecklenburg Times in 2008 also contributed $200,000 to the growth in public net revenues this quarter.

Circulation revenues decreased slightly by $100,000 or 3.1%, compared to the first quarter last year. Our consolidated operating expenses for the quarter were $50.9 million, an increase of 52.8%, from $33.3 million last year.

Total operating expenses for the quarter represented 79.6% of total revenues, a 60 basis point decrease from the first quarter 2008. For 2009, we believe that our total operating expenses, as a percentage of revenue, will be higher than the first quarter as we begin to accrue for year-end bonuses for executive officers and other managers, as well as continue to increase headcount at APC and NDEx.

Our consolidated direct operating expenses were up 65% to $22.9 million. Direct operating expenses, as a percentage of revenues during the quarter, increased to 35.8%, compared to 33.4% for the same period last year.

The increase in direct operating expenses as a percentage of revenue is due to the change in mix. As discussed in previous calls, our mortgage default business has a higher direct operating expense, and as its share of our overall business increases, the direct operating expense percentage will also increase.

Sequentially, our direct operating expenses declined as a percentage of revenue from 36.7% in the fourth quarter of 2008 to 35.8% this quarter. This decline was a result of operating leverage in our mortgage default business. The dollar increase in direct operating expenses is mainly attributed to a $9.1 million year-over-year increase in direct operating expenses in the Professional Services Division, which was attributable primarily to operating index in the mortgage default processing services business from Wilford & Geske, both of which were required in 2008.

In the Business Information Division, our direct operating expenses decreased $100,000 as a result of lower production and distribution expenses. During the quarter we also had a $4.6 million or 28.8% year-over-year increase in selling, general and administrative expenses. As a percentage of total revenues, SG&A expenses declined significantly to 32.4%, compared to 38.8% in the same period last year.

This decrease in percentage is largely due to expense control efforts that have been put in place in our various businesses, as well as a significant increase in revenues recorded in our Professional Services Division in the first three months of 2009 from the NDEx acquisition. As mentioned previously, we would expect the SG&A margin to increase slightly for the remainder of 2009, as we accrue for bonuses, incur additional non-cash stock-based compensation related to equity awards and additional integration of related costs.

Year-over-year depreciation and amortization expense increased by $1 million and $2.9 million, respectively. These increases are due to the increased levels of finite live intangibles and property and equipment, most notably due to the NDEx acquisition.

Operating income for the quarter was $14.4 million, compared to $9.8 million for the same period last year. Operating margin of 22.6% for the quarter was down 90 basis points year-over-year, as we reported higher amortization and depreciation expense, primarily related to acquisitions. Net interest expense for the quarter was $2 million on an average debt of $153.7 million, compared to $1.3 million of net interest expense for the prior year period.

Other income of $1.4 million was the result of the net gain on life insurance proceeds on the company-owned life insurance of Michael Barrett, the senior officer at NDEx. Our effective income tax rate for the first quarter of 2009 was 33.3%, compared to 40.7% in the first quarter of 2008. The decrease in our effective income tax rate in the first quarter was due primarily to the receipt of the non-taxable life insurance proceeds paid upon the death of Mike Barrett.

We are very pleased with our strong earnings. Net income attributable to Dolan Media Company for the quarter was $8.6 million or $0.29 per diluted share, compared to $0.16 per diluted share in the first quarter of 2008. Of the $0.29, $0.24 came from operations and $0.05 came from other income previously described.

This quarter, we adopted FAS 160, which requires, among other things, that we change our presentation of net income, and net income per diluted share, to net income attributable to Dolan Media Company, and net income attributable to Dolan Media common stockholders per diluted share, respectively.

In addition, we now refer to the 15.3% interest in the American Processing Company, or APC, held by our law firm partners or their affiliates, as non-controlling interests, or NCIs. These NCIs used to be called minority interest. FAS 160 now requires us to also record a liability equal to the redemption value of the non-controlling interests. Changes to this liability are charged to additional paid-in capital on the balance sheet.

There are also now two measures of earnings per share. The first is net income attributable to Dolan Media Company divided by diluted weighted average shares outstanding. For the first quarter 2009, that number is $0.29 per diluted share. The comparable number was $0.16 per diluted share for the same period last year.

The second measure takes net income attributable to Dolan Media Company and deducts the adjustment to the liability, which was recorded as additional paid-in capital, and divides that difference by the diluted weighted average shares outstanding. For the first quarter of 2009, that number is $0.18 per diluted share. There is no comparable number to this metric from last year, as FAS 160 was not yet effective until January 1, 2009.

Please refer to our earnings release and our unaudited consolidated financial statements in our Form 10-Q for the first quarter of 2009, once filed for specific information about FAS 160, and how it affects us. We estimate that for the full year 2009, we will report an $0.18 per diluted share reduction in net income attributable to Dolan Media Company per diluted share related to the NCIs.

As mentioned earlier, adjusted EBITDA for the first quarter was $21.6 million, an increase of 60.1% from $13.5 million in the prior year period. Our adjusted EBITDA margin for the quarter increased 1.3% year-over-year to 33.8%. Adjusted EBITDA for the first quarter excludes the net gain in life insurance proceeds of $1.4 million.

Our cash earnings in the quarter were $10.5 million, or $0.35 of cash earnings per diluted share. In the first quarter of last year we reported cash earnings of $6.5 million, or $0.26 per diluted share. Note that during the first quarter, we revised our calculation of cash earnings and cash earnings per diluted share to account for a non-cash compensation expense. We also revised it to exclude the non-recurring items of income and expense which, for the three months ended March 31, 2009, was a previously mentioned net gain in life insurance proceeds.

I would now like to discuss our balance sheet and cash flow characteristics during the first quarter. We continued to generate strong cash flow operations. We primarily used cash during the quarter to make $4 million in required principal payments on our senior debt, capital expenditures of $800,000 and increased working capital requirements of $11.7 million.

The working capital increase resulted primarily from a significant increase in accounts receivable due to increased sales during the quarter. Our DSO at the end of the quarter was 76.6 days, compared to 62.6 days at the end of 2008. The increase in DSOs is primarily related to Trott & Trott payment of a significant portion of its accounts receivable early at 12/31/08, which it did not pay early in the first quarter of 2009.

Also consistent with our agreements with customers, the number of unbilled files and past due costs in connection with NDEx's California Processing Operations Group, increasing accounts receivable from that operation.

At the end of the first quarter, we had $6.1 million of cash on the balance sheet, an increase of almost $3.7 million from the end of 2008. Our leverage ratio at the end of the first quarter was 2.1 times total debt to trailing 12 month pro forma EBITDA compared to a leverage ratio of 2.3 times at December 31, 2008.

With that, we would like to turn the call over back to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Peter Appert – Piper Jaffray.

Peter Appert – Piper Jaffray

Jim, can you give us any additional color on what you are seeing in some of the individual geographies, and in particular, how much of the index business, or the index growth, is coming out of California?

James P. Dolan

Well a fair amount is coming out of California; a fair amount is coming out of Texas. Generally, the southern portions of the country are seeing more foreclosure activity right now for a lot of reasons. Not that we're not seeing growth in the northern states, but the growth rates are steeper in all of the southern states, and Texas is showing more growth earlier than we had thought a few months ago.

Peter Appert – Piper Jaffray:

Okay. So, even though you already had high market share in Texas, you're still showing meaningful percentage unit growth there.

James P. Dolan

Correct.

Peter Appert – Piper Jaffray

Okay. Then how about just some color on the pace of activity in April. Is it sustained?

James P. Dolan

Well, I mean, these things don't turn on a dime, so what was happening at the end of the quarter is not changed that much.

Peter Appert – Piper Jaffray

And how about any color on any new geographies or expansion beyond your six states?

James P. Dolan

What – we've said something with many investors recently about this, it's getting hard to be very clear about which states were are in and are not in because some of our large service or clients are asking us to do selected things in multiple states beyond the 6sixstates where we officially and publicly are, and we are doing that.

And so we're full-service in six states and we are partial service in more than six, and it's an individual client thing. So it comes and goes a little bit. We're working on expanding geographically as well as within the states where we are to build market share. We're doing both things.

Peter Appert – Piper Jaffray.

Right. And when might we anticipate that you would be active in additional states beyond what you are doing on a one-off basis?

James P. Dolan

Well not to be too coy about this, Peter, but what we've said and what we are doing is that we are expanding into states when clients want us to and we will, after the fact, when we have sufficient and material volume in a given new geography, tell the world, by the way we are in that geography. It is going to be an after the fact announcement rather than ahead of time.

Peter Appert – Piper Jaffray

And in all of these cases, you're not specifically partnering or looking to acquire back office operations from existing law firms, correct?

James P. Dolan

Well, I wouldn't say clearly we're not doing acquisition work. We're having conversations with acquisition targets. Our preference continues to be to launch organically. That's better for us in a number of ways, but we haven't completely stopped the acquisition conversations. No.

Peter Appert – Piper Jaffray

Then last thing and I'll let someone else get on. The integration of the NDEx business in terms of the back office operations, how is that progressing and how meaningful do you think the margin leverage associated with that might be over the course of the next year or two?

Scott J. Pollei

We're on pace, Peter ,with the integration work we're doing and I think actually in the first quarter you saw the meaningful leverage we got. The revenue overage for the most part was in the APC units and primarily coming out of NDEx, and as you saw we were $4 million over our revenue expectation, and the bulk of that fell through the adjusted EBITDA line.

Operator

Your next question comes from Jason Ursaner – CJS Securities.

Jason Ursaner – CJS Securities

Could you try and quantify the seasonal impact that the income tax refunds might have on the mortgage defaults?

Scott J. Pollei

What we've seen in the past is maybe a 5% decline in volume from the first to the second quarter.

Jason Ursaner – CJS Securities

So, in terms of the revenue and EBITDA guidance, you spoke to the countercyclical revenue continuing to grow at a faster rate than the decline in cyclical revenue. So with no major seasonality, just annualizing Q1 seems to put you outside of these ranges.

Scott J. Pollei

Well, I think if you look at the revenue line the high end of our range actually is very close to an annualization of that. So if you knock a few points off in the second quarter you're within the range. I want to caution people about the expenses. I spoke a little bit about it. The first quarter was kind of the perfect storm for us from an expense standpoint.

As you know last fall, when we were uncertain as to what the political ramifications were going to be of the new election and things like that, we were very cautious in our expenses and as people left we didn't replace them, and where there were variable costs that we could tighten down on, we did. On the business information side, where there were some operations that were really in full investment mode, we stopped making those investments and made some cuts.

So in the first quarter, we had really screwed down the expenses and we got terrific leverage out of the business because of that. As we continue to see volume increases where people have left in the APC business, that includes both the legacy APC and NDEx, we've started to replace some people because they're working awfully hard and we've got a lot of work to do, so I want to caution people that, as we look forward, I don't think you can multiply the Q1 times 4 and expect that to hold.

The other thing is that on the SG&A side we have historically always booked our bonuses and comps, and that's company-wide, not just for the executives, in the fourth quarter. So that it hopefully a meaningful number and we would expect to see that again. So we expect to see a few points off that or increase on the SG&A from the 32 up a percent or two over the full year.

Jason Ursaner – CJS Securities

And the Treasury Loan Modification program, I think, was announced on March 4, and internal bank moratoria expired at various times. Would you say the Q1 foreclosure volumes were still somewhat impacted by government interference?

James P. Dolan

They were at the beginning. It clearly – the gates opened up as the quarter progressed and from beginning of quarter to end, there was a striking difference and a weekly flow of foreclosure referrals.

Jason Ursaner – CJS Securities

And, I understand that you – when you've entered a new state and there is material work you'll publicly announce it. Could you maybe go through some of the underlying characteristics of maybe Florida, Arizona, Nevada, or where certain states where there may be a problem are?

James P. Dolan

What kind of problems you mean?

Jason Ursaner – CJS Securities

Where there's congestion within the law firms.

James P. Dolan

Oh. Okay. You can have problems from various vantage points so I wanted to clarify. Well for us, the number one driver is where do clients wish we were, and when the mortgage servicer clients, along with the laws firms express a strong preferences for us to be somewhere we try hard to do what they ask because that's basically why we're here.

That said, we have a preference for high growth states. We have preference for states that have continued growth going forward instead of a spiky up and down future ahead of them. We have a bias in favor of non-judicial states because the foreclosures are simpler and faster, whereas the 16 judicial states tend to be more complicated and slower and have working capital implications if you're going to launch into a judicial state.

Jason Ursaner – CJS Securities

Okay, and to date it seems as if a lot of the foreclosure volume has been the sub-prime loans, which only makes up about 15% of all of the loans. As this shifts with the option ARM recasts, I guess what is your view on foreclosures by type of mortgage versus more event-driven from unemployment?

James P. Dolan

Well they're a couple of different things that you are asking about in there. First of all, the type of loans, the sub-primes, we are well past the peak in sub-prime loan activity when it comes to foreclosures, and we are well into the Alt-A loans as projected in the past by our experts and the industry itself.

So the projections are holding up. We see more Alt-A work to come and, in fact, more work in the future for conforming or for prime loans. Now the resets and the option ARMs and things like that, that's across many types of loans, and while they certainly are an accelerant for foreclosure activity in any of those three types of loans, they themselves are not a type of loan that we track

So, you find more options and option ARMs and things like that in the Alt-A type loans. They are a bigger proportion of that, so we're seeing lots of that activity now. But that alone is not a driver of what's going here.

Operator

Your next question comes from Jim Goss – Barrington Research.

Jim Goss – Barrington Research

Thank you, just one point of clarification first about the guidance. If you get down to the EPS line you mentioned a $0.70 to $0.80, and the first quarter $0.11 adjustment you mentioned I am assuming includes some current element and some catch up element perhaps because, then you mentioned an $0.18 NCI full year charge and I just want to make sure that the $0.70 to $0.80 then translates into something like $0.52 to $0.62, which isn't tremendously different from the $0.53 to $0.61 prior guidance after the now NCI rather than minority interest? Am I correct in thinking that?

Scott J. Pollei

You are correct, Jim. I guess what we're trying to point out, though, is that the $0.70 to $0.80 really is the comparable number to our original guidance of the $0.53 to $0.61 because that $0.53 to $0.61 did not include the NCI charge. You know, that's an interesting bit of accounting literature, where you take a change in the balance sheet and shove it into an EPS calculation, but I don't make the rules.

Jim Goss – Barrington Research

All right, but –

Scott J. Pollei

It's a little bit bizarre as far as we're concerned, but we're stuck with it.

Jim Goss – Barrington Research

But then the $0.53, the earlier one, did include the minority interest deduction, but you're saying the minority interest is not exactly the same as the NCI?

Scott J. Pollei

No, and the $0.70 to $0.80 does include what they now call the non-controlling interest –

Jim Goss – Barrington Research

Right.

Scott J. Pollei

– which is the same as minority interest, so that is an apples-to-apples comparison.

Jim Goss – Barrington Research

It is.

Scott J. Pollei

This put value that we're having to flush through the two-class system of EPS calculation is something totally new.

Jim Goss – Barrington Research

And the notion of an actual put, I mean this is sort of a theoretical thing. They don't actually have an ability to dismantle agreements at any point in time?

Scott J. Pollei

Oh, no, no. This non-controlling interest, the law firm partners or the investors, the minority holders, in the non-controlling interest, they do have actual puts and so the Michigan Group and the Indiana Group both have put rights that go into effect August 1st of this year and then the NDEx or Texas Group, theirs is actually four years out.

Jim Goss – Barrington Research

Okay.

James P. Dolan

Now, we should clarify that if they do exercise the put, when they have the right to do that, which is not today, but in the future, the payment for that is in a note over three years. It's not an immediate cash burden to the company.

Scott J. Pollei

And, then, we would foreclose, not foreclose, that's not the right word. But if you look at the balance sheet it's $21.5 million is the redemption amount today. If you assumed that, in fact, that were paid off tomorrow, we would not have the $4 million current year cash disbursements. So it's kind of a – call it $22 million over four bucks is the purchase price today.

Jim Goss – Barrington Research

Okay, now, there was another comment that I think you made, Jim, earlier on about the growing overhang of seriously delinquent mortgages, but the outflow was at the 1% normalized rate.

James P. Dolan

During 2008, yes.

Jim Goss – Barrington Research

And during 2008. Now, is there a presumption on your part that that normalized rate increases over a certain period of time as we work through the overhang?

James P. Dolan

Well, I think that's the best and maybe even the only tool available to work off the overhang is to release things from delinquency, put them into the foreclosure process and flush them through the system and that, I think, is largely the reason why we're seeing foreclosure growth in the first quarter and, in fact, we think we'll be seeing it through much of 2009 and probably beyond that too.

Jim Goss – Barrington Research

Now, do you have any timeframe over which the current problems work through the system? Is it a –

James P. Dolan

No.

Jim Goss – Barrington Research

– several year process or –

James P. Dolan

Well, we think it's a multi-year. It's not an easily calculable one because it is controlled by the executives of the mortgage servicers, that they are being restrained on how they release things into foreclosure. They know better to put them all in at once.

That would ruin the housing market even more and they all realize that if they release too many into foreclosure, they wind up owning them at the end of the foreclosure process and they do not want anymore REO assets than they already have. So it's something they are managing with a businessman's eye toward making this work for the long term, which we applaud.

Jim Goss – Barrington Research

And then finally, the – I think, case files you mentioned were 91,000 in Q1 2009 versus 36,600 in Q1 2008? Is there some full year estimate you'd apply to that? Is that a run rate or does that go down in the second quarter as you mentioned because of the seasonal decline and what might the full year number look like?

Scott J. Pollei

That's not a metric that we've really given guidance on in the past, Jim.

Operator

Your next question comes from Bob Evans – Craig-Hallum Capital Group.

Robert Evans – Craig-Hallum Capital

First, just to clarify [gains] again. The $0.70 to $0.75, does that include the life insurance gain?

Scott J. Pollei

Yes.

Robert Evans – Craig-Hallum Capital

Okay, it does.

Scott J. Pollei

That it was the $0.70 and $0.80 and, of that, about a nickel is from the life insurance gains.

Robert Evans – Craig-Hallum Capital

Okay, and other than that everything also is apples-to-apples?

Scott J. Pollei

Yes.

Robert Evans – Craig-Hallum Capital

Okay, and your EBITDA margin, I think, is 33.8 this quarter. How should we think about EBITDA margin as we kind of sequentially go through the year and on a full year basis? I mean is it – I guess, the question is, is this a sustainable EBITDA margin?

Scott J. Pollei

Bob, I think with the other, you know, assuming that the SG&A and well, that directive is pretty much in line, but if SG&A moves up a little bit over the year, the adjusted EBITDA margin would go down a bit. I mean we still expect that over the full year we will have a better EBITDA margin this year than we did last year.

Robert Evans – Craig-Hallum Capital

Okay, I mean the intermediate term is, I mean, in this quarter, wasn't far away from mid-30s. I mean is the mid-30s EBITDA margin something that you think you can consistently get too?

Scott J. Pollei

Well, I wouldn't say quarter to quarter necessarily.

Robert Evans – Craig-Hallum Capital

No.

Scott J. Pollei

If you recall, last year, we were higher in the first quarter than we were for the balance of the year and I, you know.

Robert Evans – Craig-Hallum Capital

No, I'm saying more on an annual basis and I'm not saying necessarily this year, obviously, but –

Scott J. Pollei

Yes, I do. I mean I think we've kind of said in the past that we were shooting in to try and increase it a point of two every year up into the mid-30s.

Robert Evans – Craig-Hallum Capital

And again, kind of as it relates to the broader foreclosure market, Jim, can you comment, you know, given the data that you have and outside experts, best guess at where, what timeframe peak foreclosures might come and then how should we expect that? How should we expect the trend to go after we reach peak?

James P. Dolan

Well again, part of that depends upon the decision makers of the servicing companies because they can affect that directly. I think that also each state has its own cycle of return to recovery and states that have had the biggest challenges in their real estate markets in the past will have the biggest challenges returning normal. I mean the western States, California, Nevada, Arizona, States like that, will have a difficult time getting back to what anyone calls normal.

Robert Evans – Craig-Hallum Capital

For how long?

James P. Dolan

Some states will not have quite that much.

Robert Evans – Craig-Hallum Capital

For how long on the western states? I mean are we talking one, two years, three or four years?

James P. Dolan

Well, I think, I mean that's, again, subject to decision makers and what they decide to do with the servicing companies. It's definitely multi-year. Is it two years, three years, four years, it's in that range of somewhere before we see getting back to normal probably as a country. But for individual states, some of them will take longer than that to get back to normal.

Robert Evans – Craig-Hallum Capital

And would you be willing share from a – I think that you said you were doing a multiple states in terms of partial services, could you elaborate in terms of how many states you're doing partial services rather than – I know you're at six full service.

James P. Dolan

Not really, these are specific client projects. That a client came to us and said, in one case, would you do 20 states of something and we said, yes. And we know that it's not long term nor is it permanent, but it's a chance to prove ourselves, so I think it would and could even be misleading if we identified the individual states in very much detail.

Robert Evans – Craig-Hallum Capital

Well, I'm not asking for the states, I was just wondering how many states you might be doing projects in, even if it was partial?

James P. Dolan

Oh, probably more than a dozen.

Robert Evans – Craig-Hallum Capital

Okay, and the Q2, again, just want to make sure that we are not getting ahead of ourselves. I think you said from a seasonal standpoint maybe down 5% from a professional services standpoint and we should see higher SG&A, anything else we need to take into account as we view Q2 versus Q1.

Scott J. Pollei

Well, we talked about the weakness in the advertising. That's going to continue.

James P. Dolan

Bob, let me say one thing about the seasonality, I don't want us to get lulled into complacency here in thinking that this is turning into a normal year. Normally a 5% drop sequentially quarter to quarter would be what you would expect in foreclosure activity. I'm not sure we're ready to call this a normal year.

Robert Evans – Craig-Hallum Capital

Sure, sure.

James P. Dolan

All we can do is say what we've seen in the past but that doesn't necessarily mean we'll see things like that this year.

Robert Evans – Craig-Hallum Capital

Right. No, right, but obviously we don't want to be too aggressive either from our modeling standpoint, and so display and classified we're going to see probably a continued down trend there, is that fair to say?

James P. Dolan

Yes it is.

Robert Evans – Craig-Hallum Capital

And then public notice I think you were up 6%? I mean is that the rate growth rate to think about for Q2 in the year?

James P. Dolan

I think that's a reliable conservative growth rate, yes.

Robert Evans – Craig-Hallum Capital

Okay.

James P. Dolan

This public notice is somewhat of a lagging component of foreclosures, not a big lag but a month or two. I would not forecast much more than that for foreclosure public notice growth right now.

Robert Evans – Craig-Hallum Capital

Not much more then than what happened in Q1 or –

James P. Dolan

Yes.

Robert Evans – Craig-Hallum Capital

Okay, and as we look at SG&A just, I know we're looking for at best SG&A on an absolute dollar basis because it's harder to guess the revenues out of the equation, 5% to 10% type of SG&A growth? Is that the right way to think about it on an absolute dollar standpoint or is that still too conservative?

Scott J. Pollei

No, I think that's probably right. I would say between 5% and 10%.

Robert Evans – Craig-Hallum Capital

On an SG&A absolute basis?

Scott J. Pollei

Yes, that's right.

Operator

Your next question comes from Robert B. Kirkpatrick – Cardinal Capital

Robert B. Kirkpatrick – Cardinal Capital

Jim, could you talk about the M&A environment? We've seen quite a change in the last 90 days, both in the economy and in the financial markets, but I'd be curious as to your observations.

James P. Dolan

It's very, very – I'm groping for the word here – it's a target rich environment let me put it that way. There are a lot of things out there that want to get sold, and there is a paucity of financed buyers out there. So it's a very good time to have a strategy and to have financing and to look for things to buy, and that goes for practically every area of our business.

Robert B. Kirkpatrick – Cardinal Capital

And Scott, could you address the available firepower that you think you have for acquisitions?

Scott J. Pollei

Well, with our existing debt facility we've got a $40 million revolver that we have not drawn on. Now the reality is that we would need to keep at least $15 million of that available, maybe $20 million of that available just for working capital contingencies or needs like that, so but we do continue to accumulate cash.

At the end of the quarter we had $6 million, a little over $6 million, and we've done a good job in April of continuing to accumulate more cash, but practically speaking we're limited to maybe $25 million in the very near term of availability so we're talking not very big deals.

We have also had discussions with our lenders about availability and we've had good conversations. I think that we do have the ability to go out and redo our debt facility. I will tell you that we are the happy recipients right now of a 2.9% interest rate on our debt. My guess is that if we go back and need to get more money for a pending acquisition that there'll be a floor instituted so we'll be paying something over that going forward, but.

Robert B. Kirkpatrick – Cardinal Capital

So that would clearly impact the price that you – or the valuation you would be willing to pay in an acquisition?

Scott J. Pollei

Exactly, it has to be a meaningful acquisition for us to want to go through that.

Robert B. Kirkpatrick – Cardinal Capital

And Jim, can you –

James P. Dolan

Unfortunately Rob, in many cases prices seem to be much lower than I've seen in many years.

Robert B. Kirkpatrick – Cardinal Capital

And is that more concentrated on the publishing side because of the difficulties of the economy or is this in potentially other services that you could offer to the legal community?

James P. Dolan

It seems to be everywhere, in all of the sectors in which we're interested.

Robert B. Kirkpatrick – Cardinal Capital

And then with the death of Michael Barrett could you talk about how that might change either the operations of NDEx or the efforts of Dolan Media in that field?

James P. Dolan

Well, nobody's ever ready to lose somebody like Mike Barrett. He was a one of a kind but Mike did a good job of preparing his company before he sold it and us through the transition period for his absence from the business whether it was from retirement or from what happened to him when he finally died.

There's a very deep bench there. There are very solid people at the top of that company that Mike trained and I put in place and who are running things in the new regime post closing for many months before Mike passed away. Integration has taken that into account and we were planning around and through these people to weave us all together all along.

So Mike's title with us was Emeritus. That was an intentional title, and he did not have day to day responsibilities. Most of what he did was involved with client relations, which is something that Dave Trott, who's the Chairman of APC, has always taken as his prime job, too.

So we've seen no lapse in that whatsoever. We've made sure through our regular marketing meetings that Dave runs with all of our sales people and all of the attorneys, that the ownership of the relations stays strong and we don't see any hiccups at all.

We miss Mike tremendously, I wish he were here, but I must say that from a business standpoint we do not see much effect of his being gone.

Robert B. Kirkpatrick – Cardinal Capital

Okay, and then, Scott, you motioned that the tax rate was depressed a bit in the quarter due to the fact that the $1.4 million was considered tax free. If I back that out, is that kind of the best estimate of what the tax rate should be for the balance of the year?

Scott J. Pollei

Thirty-nine percent should be for going forward if for the most part if we backed out the life insurance proceeds it would have been 39% in the first quarter.

Operator

Your next question comes from Adam Fischer – Burnham Asset Management.

Adam Fischer – Burnham Asset Management

I wanted to talk a little bit about the loan modification opportunity that we've discussed in past calls, what opportunities you're seeing there, whether you've included any incremental revenue in your guidance, just talk around what you're seeing there?

James P. Dolan

Yes, we continue to see a lot of loan modification activity the clients are asking us to undertake for them. It's not yet a formal part of what we do and in the way we had expected it to be this time because Fannie and Freddie have still not completed the full set of rules and regs that everybody wants so that it can become a formal part of the process. But there's high demand for that.

Our numerical activity in that area is high and is growing steeply. The dollars per modification are still relatively low so it's not yet a material part of our revenue stream, but we hope it is by the end of the year.

Adam Fischer – Burnham Asset Management

So I should kind of read in between the lines there. You haven't included any of that in your guidance because you don't think that it will matter until maybe Q4 or something.

James P. Dolan

That's correct, and we can't tell when it will start to matter, so we just beg the question about not including it.

Adam Fischer – Burnham Asset Management

Okay, maybe you talked about this through the call but can you talk about your market share? Looks like you might have tweaked up a little bit in the quarter?

James P. Dolan

Well, it's very hard for us to calculate market share on a very precise basis and now because of the lumpiness of the releases from delinquency into foreclosure, our sense is that we are at the very least holding our market share. Maybe increasing a little bit, but because we can't come up with very precise numbers to support that, you notice we didn't say that in the script.

Adam Fischer – Burnham Asset Management

Sure, okay, and then when you're working with these couple of the servicers in new states where the kind of one-off opportunities, what does the pricing look like there?

James P. Dolan

Well, it's pretty much the same pricing everywhere. The pricing is set in a soft way by Fannie and Freddie nation-wide and so there's never any price negotiation. There's never any request for discounts nor are discounts offered. It pretty much is what it is. This is a legal services business. It's already, I must say pretty efficiently priced so there's not like there's a lot of fat in the system and no one's expecting us to do anything unusual to get market share that way.

Operator

Your next question comes from [James Kouinsidine] – [Kouinsidine Capital Management].

[James Kouinsidine] – [Kouinsidine Capital Management]

Yes, I just wanted to clarify two things, gentlemen. One, if you make an acquisition would that be accretive or do you make dilutive acquisitions?

Scott J. Pollei

We strive to make them accretive in year one.

[James Kouinsidine] – [Kouinsidine Capital Management]

So that's – you don't make any that aren't accretive in year one? That's your goal.

Scott J. Pollei

That's our goal.

James P. Dolan

That's the goal, yes.

[James Kouinsidine] – [Kouinsidine Capital Management]

Second thing is just to clarify because I think there's some confusion because of the comments you mentioned that getting back to this Q2 estimate and in a normal year that foreclosures drop 5% and so people I think jump to the conclusion that oh y God, the numbers are going to be down 5%. But they you mentioned that this isn't a normal year because there's a lot more foreclosures than there are in a normal year. So isn't it safe to assume that the business might actually be up in the second quarter?

Scott J. Pollei

Well, we don't give quarterly guidance I guess and I'm kind of – we're giving you annual guidance and in the past we've seen some dips. Two years ago we did and last year we did, but I don't want to be a whole lot more precise than that.

James P. Dolan

Jim, in the past when we've been able to do analyses after the fact the dip in the second quarter seems to be a result with an increase where people flip back behind again and go back into foreclosure in quarters three and four. So over a full year basis it kind of doesn't matter. But within the year you do see some swings that we think are tax refund related.

We didn't want anyone to be misled by what we think may happen last quarter or this coming quarter.

Operator

Your next question comes from Jason Ursaner – CJS Securities.

Jason Ursaner – CJS Securities

Hi, just for clarification on the puts, it's the law firm partners that can put their ownership of APC, but Dolan Media would still have the agreement with the underlying law firm?

James P. Dolan

Absolutely correct. For many, many years.

Jason Ursaner – CJS Securities

And the multi-state contracts, is this work just loan modification work or does it also include mortgage default work?

James P. Dolan

Well, I wouldn't say contracts. Let's don't use that term because that's not how this works. The business is distributed by the servicers to law firms, or in California, directly to us. So I'm sorry. I got stuck on the word contract and missed the rest of your question.

Scott J. Pollei

It's for both modification and some other foreclosure services as well.

James P. Dolan

Right.

Jason Ursaner – CJS Securities

Okay, and is it being done at existing APC facilities externally from the state where the file is?

James P. Dolan

We are able from our Dallas, our suburban Dallas and suburban Detroit operations to do anything anywhere in the country.

Jason Ursaner – CJS Securities

And in terms of launching this would be where you go in a new state and hire the law firm, correct?

James P. Dolan

Correct.

Jason Ursaner – CJS Securities

Which would kind of invert the chain that's been previously from the acquisitions?

James P. Dolan

Yes.

Jason Ursaner – CJS Securities

And how would that affect margin and pricing that you get from the law firm if you're hiring them?

Scott J. Pollei

It's not a lot different because we still have to – the law firm still needs to be able to make money and so at least at this point as we model it out it's very similar to what we currently have.

Jason Ursaner – CJS Securities

And in terms of the servicers increasing their REO portfolios that you spoke about? Does this create a change in mix with more file opening events as opposed to eviction events that they're not going through it? And would that have an impact on revenue per file and margin?

James P. Dolan

Well, REO is a piece of property that did not sell in the foreclosure auction and therefore remains on the books of the servicer of the ultimate owner of the paper. So in that sense there's a file would not be opened possibly if they did not want to evict. And you are seeing more servicers or more owners of mortgages simply saying to the previous owners how'd you like to rent so there's no foreclosure cost there.

So that does reduce the revenue opportunity there for us in that last step. On the other hand it's not like we're used to getting that because if you go back to normal times before this foreclosure bubble began, an eviction was really fairly rare and the rent, really, it was fairly uncommon. So it's not something that we're accustomed to and it really wouldn't be a reduction in revenues compared to historical numbers.

Jason Ursaner – CJS Securities

Well, I guess I'm asking not a reduction but just in terms of when you look at the total foreclosure numbers would the percent that normally correlates to eviction be less because they're not being forward with that and that may be increasing the mix of new foreclosure events?

James P. Dolan

That could change the mix, yes. It could.

Operator

(Operator Instructions). Your next question comes from Bob Evans – Craig-Hallum Capital.

Robert Evans – Craig-Hallum Capital

Just one item of clarification on the minority interest I believe you said the guidance was 4 to 4.5 for the year? Is that correct?

Scott J. Pollei

Yes.

Robert Evans – Craig-Hallum Capital

That's apples-to-apples calculating it the way that you did in '08?

Scott J. Pollei

That's correct.

Operator

(Operator Instructions). We have no more questions in queue.

James P. Dolan

Thank you, everybody. Thank you for joining us on this call and for your attention to our company.

Operator

Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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Source: Dolan Media Co. Q1 2009 Earnings Call Transcript
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