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Executives

James P. Dolan - President, Chairman and CEO

Vicki J. Duncomb - VP and CFO

Scott J. Pollei - EVP and COO

Robert J. Evans - Director, Investor Relations

Analysts

Jason Kreyer - Craig-Hallum Capital Group LLC

Jason Ursaner - CJS Securities, Inc.

James Goss - Barrington Research Associates, Inc.

The Dolan Company (DM) Q1 2013 Earnings Conference Call May 2, 2013 8:30 AM ET

Operator

Welcome to the Dolan Company First Quarter 2013 Earnings Conference Call. My name is Lauren, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I’d now like to turn the call over to Mr. Bob Evans. Mr. Evans, you may begin.

Robert J. Evans

Thank you, operator. Good morning ladies and gentlemen and welcome to the Dolan Company’s first quarter 2013 earnings call. On the call today are Jim Dolan, Chairman, Chief Executive Officer and President; Scott Pollei, Executive Vice President and Chief Operating Officer; and Vicki Duncomb, Vice President and Chief Financial Officer.

By now, you should be able to access our first quarter earnings release, which we issued today at approximately 5 am Eastern. If you haven’t seen our release, you can find it on the Investor Relations Section of our website at www.thedolancompany.com. We’ve also posted a slide presentation supplementing this conference call on our website. Today’s earnings release and the slide presentation contain a reconciliation of GAAP financial measures to the non-GAAP financial measures we will discuss.

Before we begin, I’d like to remind everyone of the Safe Harbor statement. During this call, we will make forward-looking statements including statements about beliefs, expectations, plans, goals, projections, guidance for 2013 and circumstances we expect to affect our future operating results, including trends we see in mortgage foreclosures, efforts to mitigate foreclosures, public notice advertising and e-discovery.

These forward-looking statements are subject to risks, uncertainties and other factors that may cause our actual results to differ materially from those expressed in, or implied by, these statements. Information about such risks and uncertainties is contained in the Company’s filings with the SEC, in particular the risk factor and forward-looking statement sections of the Company’s quarterly and annual reports.

And now I’ll turn the call over to Jim Dolan.

James P. Dolan

Thank you, Bob, and thanks to all of you for joining us today. Let’s take a quick look at how the first quarter of 2013 compared to the previous year. Quarterly revenues were down 9% while adjusted EBITDA was down almost 44%. Our first quarter results were mixed. We are pleased that our e-discovery business experienced another strong quarter. We saw good growth with a review as well as our technology processing clients. In Mortgage Default Processing, however referral volumes remain depressed.

Let’s talk first about our National Default Exchange or NDeX. In our fourth quarter 2012 conference call we were cautious about default referral volumes in the first quarter of this year. This was due to the industry slow rollout of complex new procedures for handling defaults. As it turns out, our caution was well founded. For the first quarter, the pace of new referrals was down more than 30% year-over-year. This was true for NDeX as well as for the industry as a whole. Each mortgage servicer continues to follow its own timeline in deploying the new procedures to start each foreclosure referral and nearly all the timelines are slow.

New National Servicing Standards in the California Homeowners Bill of Rights introduced in January of 2013 continued to cause delays and to depress referral volumes. The political environment is harshly punitive for any servicer making any mistakes. This makes them all very conservative, very slow to refer cases and very interested in alternatives to foreclosure.

We began cost reductions at NDeX last year and have cut cost more aggressively in the first quarter of this year. Severance cost partially masked in the first quarter benefits, which should produce more visible P&L results in upcoming quarters. We are continuing these reductions in an effort to adjust NDeXs expense structure to match this current revenue base.

We continue to expect final referral volume to stabilize and increase in the future, but we don’t know when that will happen. So we will continue to cut costs of NDeX as well as work on generating new revenue streams. Given the current environment, we’ve decided to look at strategic alternatives for NDeX Indiana. We are exploring our options, which we expect to include the sale of the Indiana processing operation, along with licensing of our technology infrastructure.

As I said a few minutes ago, we’re quite pleased with the first quarter performance of our e-discovery company. DiscoverReady reported 34% revenue growth this quarter, which continues the strength we’ve been seeing in this business for the past couple of quarters. We saw growth from long-term DiscoverReady clients as well as good progress in developing new client relationships.

We are also encouraged that our higher margin technology processing business is starting to see stronger growth. This is an important piece of our long-term strategy for DiscoverReady.

During the quarter, we were notified that DiscoverReady had been granted a patent for its predictive coding technology. We believe this reflects DiscoverReady’s thought leadership in the industry were predictive coding is that the leading edge. More patent applications for DiscoverReady innovations are pending.

Once again, DiscoverReady represents the greater share of our overall business mix, accounting for approximately 35% of total company revenues for the first quarter. Our litigation support segment, which DiscoverReady is the largest part represented 42% of total revenues. We expect our e-discovery business to remain strong in 2013. We see many opportunities for growth in this industry.

During the first quarter revenue from our Business Information division declined by almost 11%, mostly due to lower public notice advertising revenues. The default slow down affecting NDeX also affected the plot related public notices. Other revenue categories in the Business Information division were flat or modestly down.

We continue to work on improving this division’s cost structure to improve EBITDA margins. During the quarter, we decided to pursue strategic alternatives for a Legislative Information Services of America and for DataStream.

Today in our earnings release we’re maintaining the initial 2013 revenue and adjusted EBITDA guidance we set in our 2012 fourth quarter earnings release. As a reminder, this guidance excludes our NDeX operations because the regulatory and marketplace disruptions and default processing have made it impossible to forecast near-term referral volumes. We simply don’t have enough forward visibility for NDeX.

For 2013 we expect DiscoverReady to continue growing at a double-digit rate and the litigation support segment to grow at a low double-digit rate as well, with positive EBITDA leverage. This is a slight improvement from our fourth quarter conference call comments.

Given the near-term headwinds and default related public notice advertising, we expect our Business Information division in 2013 to produce revenue and adjusted EBITDA that are somewhere between flat to down 10% compared to last year. This is a slight decline from our fourth quarter conference call comments. Our guidance excludes any effect of future M&A activity. It also is subject to assumptions, which are detailed in our earnings release now available on our website.

Now I will turn the call over to Vicki.

Vicki J. Duncomb

Thank you, Jim, and good morning everyone. As we noted in today’s press release, we’re pursuing strategic alternatives for NDeX Indiana and portions of our Public Affairs Intelligence Group. For 2012 the combination of these businesses accounted for an aggregate of $11.4 million of revenue and a negative $3.2 million of adjusted EBITDA. Because of the steps we’ve taken with these businesses, the results are reflected in our first quarter 2013 financial results as discontinued operations.

Our first quarter 2013 and 2012 results has been adjusted to reflect this accounting. We will provide the effect of this change in our subsequent 2012 quarterly reporting. After adjusting for discontinued operations, our first quarter revenue decreased by 8.5% to $54.7 million compared to the prior-year.

Similar to recent quarters, we continue to experience two very different revenue trends in the Professional Services division. Litigation support revenue driven by strength in the e-discovery business reported a strong quarter, up 24.5% to $22.9 million. DiscoverReady our e-discovery business grew by 34.2% this quarter and saw across the board strength in the business, while maintaining a healthy price line of new client prospects.

At NDeX where operations remain depressed due to a continued slow down in the pace of foreclosure referrals, revenue was down 32.4% to $16 million. This is a continuation of the trends we’ve previously identified. Revenue for the business information segment was down 10.8% as public notice advertising experienced a slowdown related to the same factors that affected NDeX.

Net loss attributable to The Dolan Company was $7.2 million, or $0.25 per diluted share. This loss includes a $10.7 million impairment charge related to the discontinued operation highlighted earlier, which was partially offset by the reversal of a $5 million purchase price hold back from the ACT acquisition. Cash earnings were $159,000 or one penny per diluted share.

Adjusted EBITDA decline 44% to $5.7 million. The adjusted EBITDA decline was primarily the result of the negative operating leverage that came from more than a 30% decline in default files received for processing, which was partially offset by the strength at DiscoverReady. The Company’s direct operating margin declined to 51% from 55.6% last year. This is primarily the result of negative operating leverage experienced at NDeX.

SG&A expense for the Company declined by 6% to $23.2 million. This is a reflection of cost reduction efforts across the Company, primarily decreases in employee cost. As we stated previously, we have implemented more significant cost cutting measures at NDeX in the first quarter and we will continue to do so until we see greater stability in that business. Further, we have taken a fresh look at the expense structure for the entire Company in an effort to improve our margins and cash flow.

During the quarter, we continue to make progress in improving our balance sheet. Principal payments for preferred stock sale reduced our net debt to $147.8 million at the end of the first quarter as we lowered our leverage ratio to 3.9 times debt to trailing 12 months pro forma adjusted EBITDA. This is a reduction of net debt from a $162.5 million at the end of 2012. We were in compliance with all of our debt covenants at the end of the first quarter.

I’d also like to note that early in the second quarter we received an income tax refund of $11.2 million, which has been used to further reduce our debt. Clearly challenges remain for 2013. But we will continue to work hard to improve our earnings and cash flow and we will try to deleverage our balance sheet as quickly as possible.

And now, I will return the call to Jim.

James P. Dolan

Thanks, Vicki. And echoing what Vicki just said, although we certainly acknowledge our near-term challenges primarily related to mortgage defaults, we do remain resilient and encouraged about our future. We are very excited about our e-discovery business and the balance growth we’re seeing in as Review and Processing segments. We believe this will continue and that DiscoverReady can be a much bigger and more profitable operation than it is today.

We are also exploring all of our options to make NDeX a viable and profitable business in the current depressed and (indiscernible) environment. This may include a greater focus on providing technology services on a recurring basis and less reliance on revenue from processing, unless we can do so when margins that makes sense to us. We believe the NDeX business model is changing for the better. The plan of course is to build a stronger and better performing company that rewards our investors for your support.

With that, I will turn the call over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from George Sutton from Craig-Hallum. Please go ahead.

Jason Kreyer - Craig-Hallum Capital Group LLC

Hey, good morning guys. This is Jason on for George. Just wondering if you can give a little bit more color on the NDeX Indiana and the Public Affairs Group and why specifically you’re targeting those divisions for the strategic alternatives?

James P. Dolan

NDeX Indiana is – it’s been our bottom line disappointment and that’s why it’s getting early attention from us. It’s something that has been on our watch list for a while because it now is our only State that has judicial foreclosure activity, which is very, very slow and very challenged. And we’re not in business to loose money, and we’ve been loosing money there and so that’s why Indiana is up first. We are paying attention to our business model in all of the NDeX operations, but in the highest priority for activity is really right there.

In the Public Affairs Intelligence Group we like the business still, but the investment cycle is running longer than we thought and we’re still in the investment stage and when we look at our stated goal of paying down senior debt, which we’re doing and our desire – strong desire to continue supporting DiscoverReady’s strong growth. We’ve decided to make some forced rank priority type choices and that means that these two parts of Public Affairs Group just don’t make the cut right now. So, we’re looking for something to do within that makes sense probably with the new [order].

Jason Kreyer - Craig-Hallum Capital Group LLC

Okay. That makes a lot of sense. Thank you. And then regarding the California Homeowner Rights Bill and the new servicing standards, do you expect that those will have more of a one-time effect depressing the Q1 volumes? Are those going to kind of continue to linger throughout the year?

James P. Dolan

There is such a steady drumbeat of things that are happening in the foreclosure based at California Homeowners Bill of Rights is just one and although it’s a big one, that’s a giant market and California tends to be a leader among States, so what California does, other States end up – think of as being a good idea. We can’t forecast what other States are going to do, but we expect a little bit more. There also will be more federal controls from the new federal agency and we don’t know what that’s going to be, but we think its going to be choppy for quite sometime and that’s why we’re interested in evolving our business model, so that a reliance is more on the technology end of things and on the human services part of things.

Jason Kreyer - Craig-Hallum Capital Group LLC

Okay. And then lastly from me, you talked about some cost cutting measures that you’ve taken in the NDeX segment and just wondering if we should expect that Q2 would reflect all of these measures or it will see continued improvement into Q3 as these programs extend out?

Vicki J. Duncomb

Hi, this is Vicki. I think you’re going to see continued improvement and they’re going to flow through into the third and the fourth quarter.

Jason Kreyer - Craig-Hallum Capital Group LLC

Great. Thank you.

Operator

Thank you. And our next question comes from Jason Ursaner from CJS Securities. Please go ahead.

Jason Ursaner - CJS Securities, Inc.

Good morning. Just – by the time you reported Q4, you already had a pretty good indication of the level foreclosure starts was going to be down, just given what came in the first couple of months and you were clear that the cost you took out probably weren’t going to match the change in business environment in the short-term. So, I’m just wondering if you could quantify some of the costs you did take out and what we should expect to see in terms of profitability for the segment in Q2, once the benefits of those costs are measured and maybe you’re in more of a normalized environment.

Scott J. Pollei

Jason, this is Scott. We are not giving guidance for NDeX. This year we’ve been consistent within that and that – its because we just don’t have the clarity about what the volumes are going to be and we’re not going to – we don’t have specific cost takeouts which is there following through the lateral part of Q1, there is a severance in there that [masks it] and then there is continuing cost takeouts that are happened in right now, so we’re just not in a position to provide that.

Jason Ursaner - CJS Securities, Inc.

Could you ever tried, I guess, this may relative to your Q4 volume was? How the structure might work, just because it is – I mean it isn’t in guidance at all.

Scott J. Pollei

Are you saying in terms of volume or …?

Jason Ursaner - CJS Securities, Inc.

No, I mean, I understand that you don’t have a great visibility on the volume side, but you should have a pretty clear indication of what you’re taking out from a cost perspective. I mean it’s a relatively high fixed cost business, I guess, I want to – I’m trying to get out and (indiscernible) where the leverage point should be at this point.

Scott J. Pollei

You take an over – half a million, I think from – so far.

Jason Ursaner - CJS Securities, Inc.

Okay.

Scott J. Pollei

So $6 million annualized and we’re not stopping.

James P. Dolan

We are not done with it.

Jason Ursaner - CJS Securities, Inc.

Okay. I think that was my only question. I appreciate it guys. Thanks.

Operator

Thank you. And our next question comes from Jim Goss from Barrington Research. Please go ahead.

James Goss - Barrington Research Associates, Inc.

Hi. So Jim are you suggesting basically that your goal with NDeX at this stage is to start off being at first consulting service and also – almost make it like a sale and lease back proposition where you might find some other perhaps private party who would be willing to do the operations and you would have at least once there is some level of stability and certainty with the rules that you could create the tools that they could use to perform the services efficiently and then you would be paid as and sort of a royalty basis or some relationship of that nature?

James P. Dolan

Well, conceptually what we want to do is isolate the highest value things we think we can offer to clients in the sector and then concentrate on doing that, which happens to be technology and things related to technology. So, it’s operating the systems and I think it’s the Veritas platform supporting those and dealing with the compliance needs and the other related regulatory needs that are special to the sector. We are good at that. There have been lots of audits of our operations. We’ve done extremely well. We began – we think to have a reputation in this sector among the servicers and the client support being well there, so we’re trying to go with our strength. And now the other part of the operation we think is (indiscernible) by somebody else with some of the situation could be the law firms, that might want to buy this back and there are third parties who are interested. There are other ways to transition out of this and put it in the appropriate hands. I can’t comment on what those are likely to be State by State, but we think this is the right direction for us to go. So it’s less a consulting thing Jim than it is a technology platform with a lot of compliance insight. And it would be a more LIBOR revenue stream and the promise of better margins.

James Goss - Barrington Research Associates, Inc.

Okay. And you wouldn’t have the people intensity, which creates at high fixed cost risk component that’s always there. Now if you were able …

James P. Dolan

If you think about software as a service direction, that’s how we think about it.

James Goss - Barrington Research Associates, Inc.

No, I mean that makes sense. What share of the profitability of the overall activity do you think occurs to the technology side versus the functional element?

James P. Dolan

We don’t even about that way. So, it’s not something I can even comment on this. Not how we look at it.

James Goss - Barrington Research Associates, Inc.

The thing I’ve wondered lately is with real estate markets now coming back. It seems like that will also create somewhat of a solution to the problems that some might have been close to with – unless things have been sort of any urgent foreclosure for sometime, so that might actually diffuse the whatever opportunity you might have had in terms of playing out the [soft] real estate market because if the real estate market becomes better then SaaS itself somewhat doesn’t it?

James P. Dolan

Well, yes. The question of whether this is a recovery, it’s really an open one right now. There is an over hang, there are a lot of foreclosures that are out there not being addressed and it is hard to say what will happen to those. It was an interesting piece in the news as best we can about Zombie foreclosures in which servicers stop short of actually completing it because they don’t want to have the burden of paying taxes and dealing with the REO properties, which leaves the ownership and couple of funny limbo situation where foreclosures are just frozen midstream and not completed. We are seeing some of that too. It’s hard to know where the markets really going. Is this an straightforward recovery or is there a surge of (indiscernible) may hit the market, yeah as foreclosures reserve it. There are lot of inputs here that are unknown.

James Goss - Barrington Research Associates, Inc.

Maybe a last thing in this area, early on I think was there a certain level of sort of a normalized foreclosure rate that might have been a million or something like that and now the rules have changed a lot and I’m wondering if there is a different normalized rate that any equilibrium would sort of converge and that’s different from other (indiscernible) before?

James P. Dolan

I can give you what we’ve been saying to investors about this and we got this from a number of industry sources (indiscernible) the old normal was of an 800,000 foreclosures per year and that’s based on a number of total mortgages outstanding and so, that’s really about the driver. We expect it to be more mortgages in the future, so we expect a new normal in the future at some point, we can never imagine being normal again will be a 800,000 to 1 million per year. So that – that’s hard to say when that will happen. So it’s likely there will be a steadily rising number of foreclosures into the future, but we don’t know what the path of that will be.

James Goss - Barrington Research Associates, Inc.

Okay and finally what sort of leverage do you think you need to be at with current level of business, you said it about 3.9 times now?

James P. Dolan

While we’ve – (indiscernible) longer we like 2.5 as sort of a normal run rate. That’s the [times] EBITDA, that’s our comfortable neighborhood and we can handle higher than, and we have handling higher than that, but as far as the rate capital structure mix, we like about 2.5 times.

James Goss - Barrington Research Associates, Inc.

Okay. Well, thanks very much.

James P. Dolan

Thanks, Jim.

Operator

Thank you. (Operator Instructions) And at this time, I’m showing no further questions.

James P. Dolan

I want to thank everybody for your kind attention this morning. I know it’s a busy morning and we’re very busy working on our business model here and we’re very focused on doing the right things for shareholder value. And once again, thank you very much.

Operator

Thank you. And thank you ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.

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