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Dun & Bradstreet (NYSE:DNB)

Q2 2010 Earnings Call

July 30, 2010 8:00 am ET

Executives

Anastasios Konidaris - Chief Financial Officer and Senior Vice President

Sara Mathew - Chief Executive Officer, President and Director

Kathy Guinnessey - Leader, Treasury and IR

Analysts

Michael Meltz - JP Morgan Chase & Co

Daniel Leben - Robert W. Baird & Co. Incorporated

Carter Malloy - Stephens Inc.

Peter Appert - Piper Jaffray Companies

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Operator

Good morning, and welcome to D&B's 2010 Second Quarter Teleconference. [Operator Instructions] I would now like to turn the call over to Ms. Kathy Guinnessey, Leader, Treasury and Investor Relations. Ms. Guinnessey, you may begin.

Kathy Guinnessey

Thank you, Laura. Good morning, everyone, and thank you for joining us today. In a moment, we will hear commentary on our second quarter 2010 performance, as well as our outlook for the remainder of the year and an update on our Strategic Technology Investment from Sara Mathew, our President and Chief Executive Officer; and Tasos Konidaris, our Chief Financial Officer.

To help our analysts and investors understand how we view the business, our remarks this morning will include forward-looking statements. Our Form 10-K and 10-Q filings, as well as the earnings release we issued yesterday, highlight a number of important risk factors that could cause our actual results to differ from these forward-looking statements. These documents are available on the Investor Relations section of our website, and we encourage you to review the material. We undertake no obligation to update any forward-looking statements.

During our call today, we will be discussing a number of non-GAAP financial measures, as that's how we manage the business. For example, when we discuss revenue growth, we'll be referring to the non-GAAP measure core revenue growth before the effect of foreign exchange, unless otherwise noted. When we discuss operating income, operating margin and EPS, these will all be on a non-GAAP basis, before non-core gains and charges. A reconciliation between these and other non-GAAP financial measures and the most directly comparable GAAP measures can be found in the schedules to our earnings release. They can also be found in the supplemental reconciliation schedule that we post on the Investor Relations section of our website. Later today, you'll also find a transcript of this call on our Investor Relations site.

With that, I'll now turn the call over to Sara Mathew. Sara?

Sara Mathew

Thank you, Kathy. Good morning, everyone. Thank you for joining us. Here's what you're going to expect on the call today. I'll begin with a review of the state of the business. I'll share my assessment of what is working well and what must be improved. I'll also provide an update on the strategy we shared with you at Investor Day in May, the exciting new product launches we have planned for later in 2010. Then, Tasos will provide the quarterly financial detail, and we'll close with Q&A. So you will have clarity on our results, our strategy and our expectations for the rest of the year.

Let me begin by setting some context. As a reminder, 2010 is a transition year for D&B, as we work through the weak sales overhang from 2009 and embark on a strategic re-platform of our core data and technology asset. This investment will allow us to systemically lower costs and significantly ramp up the pace of innovation. In fact, we will share details of several new products that will be launched in the fourth quarter of this year later on the call.

With six months behind us and in what appears to be an uneven economic recovery, we're pleased to report that we are on track to meet our guidance for the year. We've also made good progress on the strategic re-platform. I'll provide more perspective on each of these beginning with the review of the second quarter.

Last night, we announced the second quarter earnings. Revenue was down 3%, due primarily to a 6% decline in North America and partially offset by 11% growth in International. Operating income was down 6%, a sequential improvement from the first quarter. EPS was up 2%, the first quarter of growth since the third quarter of 2009. And year-to-date, we've generated free cash flow of $173 million.

As we assess our performance so far, approximately 2/3 of our business is doing quite well, while the remaining 1/3 needs to improve. Let me begin with a discussion of the areas that are working well. We remained very pleased with our performance in International. Revenue was up 11%, in line with expectations and largely driven by acquisitions, ICC in Europe and RoadWay in China, both of which are delivering their acquisition economics. We're on track to deliver our third consecutive year of double-digit growth in the region, and we expect this trend to sustain into 2011.

Our success in the International is largely driven by our strategy of focusing on cross-border customers and investing through acquisitions to increase our exposure to high-growth markets in Asia Pacific. As context, Asia Pacific has more than tripled in size over the past five years. We also have a seasoned management team on the ground. And as I shared with you at Investor Day, we now have new real-time data in Europe, as we've completed the redesign of a data supply chain in that market. As such, we can better leverage data as the basis of differentiation, and our unique cross-border value proposition resonates well with customers.

Looking ahead, we see further runway for growth as we have just launched DNBi in Europe and the early read is very positive. With a strong pipeline of prospects for DNBi and have already closed two sales. Customers tell us that DNBi helps them improve productivity and makes our data more actionable in their workflow. We expect to enter 2011 on a strong note. We are seeing a slowdown in Japan, which we believe will be with us for the rest of the year and this is factored into our expectations. We're working to sharpen execution and improve our value proposition in the market to strengthen performance as the year progresses. So in summary, International is an area that is performing very well.

Moving to North America. Revenue was down 6%, roughly the same level of decline we saw in the first quarter of 2010 and a little over a point behind expectations. From a product perspective, our Risk business was slightly better than expectations, but this was more than offset by weakness in Sales & Marketing. Tasos will share the details later in the call.

As we told you at the beginning of the year, we were not satisfied with certain portions of the North American business. As a result, we conducted an in-depth review of the business to explore options to restructure our portfolio and improve customer and shareholder value. This is not unlike the approach we took in 2004 to deal with the underperforming markets in International.

In a few minutes, I will share one key action as a result of this strategic review. But first, let me provide an overview of North America from a different angle, the way we serve our customers. We go to market in North America across six channels. Since we have not shared this view of our business in the past, I'll describe each channel with enough detail so you'll have greater understanding and better visibility into our North American business. Our largest customers are served through our Strategic channel. They represent approximately 20% of North American revenue. These are global customers who have large internal staff to handle their credit and marketing decision. These customers use D&B primarily for data, and they have their own internal applications for marketing and credit decisioning. Our Commercial channel focuses large to midsize company and represents about 40% of North American revenue. These companies have smaller staff and rely on us for both our data and solutions to improve their productivity. As an example, DNBi served as a workflow application to drive credit decisioning in this segment.

Our small business channel is the most diverse and to have smaller customers, some who are well-established all the way down to micro businesses. This channel represents about 25% of North American revenue. In this segment, our clients have very small or no full-time staff to manage their credit and marketing needs. This segment is also the most vulnerable to economic headwinds. The remaining 15% of North American revenue comes from Hoover's, the government channel and third-party resellers.

Today, our Commercial channel, government and Hoovers' business, which collectively represent about 55% of North American revenue, are all performing well. We are seeing underlying sales growth in the mid-single digit range, and we expect this growth to sustain into the second half.

For the three primary reasons why these channels are performing well. First, appliance recognizes strength of our value proposition. Second, we have a seasoned set of sales leaders in place. Finally, strong execution and a longer-term planning horizon have delivered consistent performance.

Let me provide additional clarity beginning with our Commercial channel, which, as I mentioned earlier, accounts for roughly 40% of our North American revenue. The Commercial channel was created early in 2009 to improve the efficiency and effectiveness of our sales force to customer consolidation. This consolidation allowed us to put the right resource against the right opportunities within our customer base, leveraging a combination of feet on the street and telesales to ensure appropriate coverage. We also upgraded talent and revamped the commission structure to drive higher levels of revenue growth.

Finally, we put an emphasis on multi-year deals to reduce execution risks and lock in customer spend. Our results in this channel had been better than expected. We have reversed the declines we saw in 2009, and we are now growing revenue with a much more cost effective sales model in place. DNBi has been one of the drivers of this growth.

We're also seeing good results in our government channel, where we just renewed the General Services Administration, or GSA, contract with an aggregate value of $135 million for an eight-year term including extension. Now as context, the GSA provides a government-wide platform of DNB solutions and uses our data and linkage capability to register and validate their vendors. D&B's unique data, DUNSRight Process and close partnership with the client drove this renewal in the second quarter. Importantly, and as I noted earlier, this is a multi-year deal, allowing us to lock in the customer spend with D&B. As added context, our government channel performed very well in 2009, and we expect a second consecutive year of growth in 2010.

We're also very pleased with the progress at Hoover's. As we said at Investor Day, we have re-platformed Hoover's to create a flexible infrastructure to innovate and more efficiently segment our customer base. We also noted that we doubled the number of records in the database. While Hoover's did not show revenue growth in the second quarter, we're seeing strong underlying performance with retention moving up over 10 points since the fourth quarter of 2009 before the re-platform. In addition, we've received very positive customer feedback on our new products. At this juncture, roughly 65% of Hoovers' customers have been migrated to the new platform, and this should translate to a stronger growth trajectory in the second half.

So in summary, about 55% of our North American business, the Commercial channel, government and Hoover's are all in good shape. When combined with International, roughly 2/3 of our business is performing well.

Let me turn to those areas where we must do better. Our Strategic channel that serves our largest customer and a small business channel, which together represents 45% of the North America business.

In the Strategic channel, which accounts for 20% of revenue, the primary issue was volatility in Sales & Marketing. While our legacy Risk products continued to be impacted by weak loan origination, that segment is improving and performed in line with expectations. The weakness in Sales & Marketing traces the de-scope renewals in the second quarter due to tight budget constraints at our customer. This reflects the desire by customers to focus their marketing efforts on building their existing business, versus prospecting for new clients. But now they continue to renew with us, but they are being cautious with their marketing spend.

Earlier this month, we made leadership changes in Strategic, with the leader of our government channel assuming responsibility for this segment. In many ways, the branches we serve within the government behave very much like our Strategic customer base. Both sets of customers expect best-in-class data and a consistent demonstration of new value to drive higher levels of revenue commitment to D&B. Our intent is to reapply best practices from the government channel to improve the performance in strategic. We will leverage a recent data investment to sharpen a value proposition. And in addition, we have a higher proportion of multi-year contracts in the second half, and that should help mitigate execution risks with these customers. As such, we expect an improvement in performance gradually over the remainder of 2010.

The second area where we saw declines is our small business channel, which represents 25% of our North American revenue and where the weak economy have severely impacted our customer base. Within the small business segment, there are two areas where performance is especially weak. Traditional marketing, which customers use to prospect for new business and credit self-monitoring or what we refer to as our Self Awareness Solutions for the micro segment. Regarding traditional marketing, we will address this issue with our technology re-platform, and new products will be launched towards the very end of 2010 or early 2011. I will discuss this in more detail later on this call.

On the small business credit side, we have made a strategic decision to partner our Self Awareness Solutions with Great Hill Partners and remove this drag from our North American portfolio. Tasos will provide the details of this transaction in a few minutes, but let me provide the strategic context.

Self Awareness Solutions helps micro business monitor their own credit. In 2009, this business recorded a net $70 million in revenue and is solidly profitable. However, it has been declining for several years and our retention rates are very low. We made a decision to partner in this space as it did not fit with our existing customer base and partnering offered the best option to create value for our customers and our shareholders. In a nutshell, we become the data supplier and our partner, Great Hill, will more fully develop this market for us. We've had a long history of success with partnerships of this nature, and it is an integral part of the business model at DNB. This partnership will address a critical drag in our North America portfolio and accelerate our core revenue trajectory. It also allows us to focus on those parts of North America where our value proposition is strong and where we are more optimistic about growth prospects.

But to conclude, about 55% of the North America business is performing well, and we're taking actions to address the areas that needs to improve. As such, we expect to the North American business to gradually improve over the second half, and our expectations for the full year are unchanged. Our North America business will be down slightly in 2010, while International will grow double digits. This implies that we expect to have a stronger second half versus the first half of 2010.

In terms of profitability, I am very pleased with our results. Our operating income trends improved sequentially and our EPS growth rate turned positive for the first time since the third quarter last year. Our 2010 financial flexibility program helped offset the weakness in North American revenue to ensure we deliver on the bottom line. In a moment, Tasos will provide an update of the drivers of this performance and the reasons why we expect this trend to continue in the second half.

Let me close with an update on our Strategic Technology Investment, which was shared with you at Investor Day in May. I am pleased to report that the project is progressing according to plan and on budget, and we are just beginning to see the exciting new possibilities that lie ahead.

As a reminder, we committed to deliver three critical milestones in 2010. First, we said our global data coverage would increase from 158 million records to 175 million by year end. At the end of the second quarter, we have 168 million records and we're on track to hit our year-end target. We also expect to meet our linkage and scoring commitments for the year, as this is a critical environment and a critical requirement for the Strategic channel.

Second, we said we will complete the migration of our Data Center to the new facility in Arkansas by the third quarter. As of the end of Q2, we are about 80% complete with the migration, and the last 20% will be completed by October. The redesign of our data supply chain will follow immediately thereafter.

Finally, we said we would deliver two new products in the fourth quarter of 2010, specifically Web services and the relaunch of dnb.com. I am pleased to report that both these reports or both these products are on track. And in addition to these commitments, we believe we can deliver more.

Let me provide additional details on each new product initiative. I'll start with dnb.com because it's representative of the exciting possibilities that lie ahead for D&B. Now as a bit of context, dnb.com is slightly over $100 million in revenue and have been declining at a double-digit rate. The new dnb.com will be launched in the fourth quarter to address critical pain points that our customers have shared with us over the past few years. Specifically, customers want better navigation within the website, ease of ordering and the ability to customize their reports to conform to their needs. Today, we cannot provide them with these options, and this diminishes the customer experience and narrows the market opportunities before us.

We intend to address these issues with the new D&B launch in the fourth quarter. However, this is just the beginning. We will have two more upgrades to dnb.com in the subsequent months, including an entry-level Risk product to address a key competitive gap we have today. We will also have a retail version that will dramatically simplify the purchase process. Each of these products will be targeted towards a different market segment. New products will be developed in Ireland, and subsequent innovation, that is, Version 2 and Version 3, will be delivered at a fraction of the original cost. This helps confirm our hypothesis that innovation can be delivered at a much lower cost with the new platform.

Moving to the second commitment of new products that is creation of Web services, primarily for dnb.com, we will now have both Web services to dnb.com, as well as Web services for a large customer. This will allow them too easily configure our data and embed it into their workflow. In addition, we will launch our newest Web service solution, D&B360, leveraging the concept of Data-as-a-Service, or DaaS. With this option, customers can easily embed D&B's data directly into an existing third-party application or other workflow tool. Now if you joined us for Investor Day, you probably saw a working prototype at one of our demonstration booth. This is now a product and it will be available for launch in the fourth quarter.

We will target D&B360 towards leading business application companies such as CRM and sales force automation providers, where the customer needs for our data is strong, but they do not have internal staff to drive implementation. We just entered into an agreement with salesforce.com to seamlessly embed our D&B360 data into their application and we will be launching the service in the fourth quarter of 2010. Of note, this is mostly a new market for us, as we have a 2% overlap between our Sales & Marketing customer base and salesforce.com customers.

Finally, we intend to launch a more robust set of prospecting product within the traditional market space, leveraging the new Hoover's platform. Today, these products represent about 5% or less of our business and have been declining at strong double-digit rates. This is due to the weak value proposition in the market that is becoming increasingly digital. We believe we can use the new scalable Hoover's platform more fully to bring new and better solutions to market, leveraging the digital capabilities of Hoover's. We expect the first new products to be available to customers very late in 2010 or early 2011.

So we are pleased with our progress against this important investment and remain confident in our strategic direction. Early customer feedback on all these new products is very positive, and our team is now focused on market execution. We expect these initiatives to strengthen our underlying performance in North America and build momentum as we enter 2011.

So with that, let me turn the call over to Tasos to provide the quarterly financial review.

Anastasios Konidaris

Thank you, Sara, and good morning, everyone. I would like to cover two topics with you this morning. First, I'll begin with a review of our second quarter performance, followed by key financial highlights, including details of our partnership with Great Hill Partners.

Let me start with North America where revenue declined 6% in the second quarter. As we expected, our Risk Management business improved sequentially from the first quarter of 2010. However, our Sales & Marketing business declined more than anticipated. Let me provide more details by product line beginning with Risk Management. As we said at the beginning of the year, we expected our North America Risk business to improve gradually over the first quarter, as we cycle through the deferred impact of lower demand for our products last year. As a result, RMS was down 5%, an improvement from minus 7% in the first quarter.

We are also seeing an improvement in underlying demand for our RMS products. This improvement is due to continued growth of DNBi to increase penetration and price lifts, and a slowing decline in our transactional products. These results are reflected in North American deferred revenue, which increased 3% during the second quarter, continuing the positive growth trajectory that began in the first quarter.

The deferred revenue increase, as well as working through the overhang from last year's lower sales, bodes well for a continued gradual improvement of RMS. In addition, our future RMS growth will benefit from two initiatives. First, we will eliminate the drag on the business by partnering our Self Awareness Solutions. Secondly, we will begin to benefit from new products such as the re-platform dnb.com in the fourth quarter.

Let me say more about each of these initiatives. First, as Sara mentioned, we have established a strategic partnership with Great Hill Partners to distribute our Self Awareness Solutions to the micro small business market. As per the terms of the agreement, D&B is selling substantially all of the assets and liabilities of our Self Awareness Solutions to Great Hill. D&B will receive $10 million in cash upfront and is entitled to annual royalty payments with guaranteed minimums from the buyer for data and brand licensing. Based on the minimum level of future payments, we estimate the value of the deal to be about $100 million. In terms of profitability, this divestiture will be neutral to operating income. At the same time, the transaction will eliminate about two points of drag to RMS revenue growth.

Our second growth initiative is a relaunch of dnb.com in the fourth quarter of this year. We expect this launch to revitalize our transactional Risk business as we enter the fourth quarter of 2010. While the impact of this initiative in 2010 is small, it will create momentum as we enter 2011. In summary, we expect our Self Awareness partnership and the launch of dnb.com will further improve the RMS trajectory going forward.

Let me now move to Sales & Marketing where revenue declined 10% in the second quarter, after being down 1% in the first quarter. There were two primary drivers of this decline. First, as mentioned earlier, the pace of the economic recovery has been uneven and this is impacting our customers' marketing spending. As context, coming out of 2009, our largest customers were beginning to increase their marketing spend with us in anticipation of an economic revamp. Late in the second quarter, we saw those customers pull back on their prospecting plans, and this negatively impacted our results. Additionally, through June, we have been affected by the timing of about $5 million of contracts, as renewal has shifted to the third and fourth quarters of 2010. This impact will reverse itself and will account for three points of growth in the second half of the year.

Finally, our traditional Marketing products continue to be impacted by secular shift to digital marketing, so we're in the process of accelerating the transition of those products to our new Hoover's platform to counter these trends as we move into 2011. As a result of the benefit from timing and overall improved sales execution, we expect S&MS to deliver modest growth in the second half of the year.

Let me now turn to our Internet Solutions, which accounts for about 10% of total North America revenues. Internet Solutions declined 6% in the second quarter, slightly ahead of our expectations. This performance represents a sequential improvement from Q1 2010 and Q4 2009 when revenue was down 7% and 10%, respectively. In addition, our second quarter 2010 performance was against tough comparisons. As we discussed last year, in the second quarter of 2009, we had a one-time licensing deal that adversely impacted our cumulative quarter revenues by about five percentage points. As Sara discussed earlier, the re-platform of Hoover's has had a very positive impact on the overall business. The improved trajectory reflects increased renewal rates and an uptick in advertising, offset by the overhang from the lower 2009 sales as a large portion of Hoover's revenue subscription base.

So to summarize, we expect an improved revenue performance in the back half of 2010 in North America, mostly due to continued improvement in RMS and Hoover's and a modest growth in S&MS. As such, we expect overall North America revenue to be down slightly for the full year, with a better performance in the second half.

Let me now turn to our International operations, where total core revenue increased 11% in the second quarter. Organic revenue was up 3% and acquisitions contributed eight points of the growth. Organic growth was lower than in the first quarter of 2010, mostly due to an expected slowdown in Japan. However, organic revenue was positive in both Europe and Asia Pacific.

In Europe, which accounts for approximately 60% of our International revenue, our business was up due to the ICC acquisition last year and continued strength in our cross-border business. We expect our European organic growth to improve in the second half of the year due to the launch of DNBi in Europe as well as continued strength in our cross-border business.

In Asia Pacific, which accounts for approximately 40% of our International revenue, we continue to see strong double-digit growth in China and India. As we discussed in the past, Asia Pacific is an area of strategic importance to us, as we see opportunities to expand our footprint and gain access to the higher growth markets in this region.

In summary, we're very pleased with our International business. And looking ahead, we expect our total International revenue to continue to grow at low double digit rates.

Let me now turn to our total company profitability. From a total company perspective, in the second quarter, we generated $107 million of operating income in line with our expectations. While this was down 5.5% from last year, it represents a substantial improvement after double-digit declines in the last two quarters. Our performance reflects the strength of our flexible business model, which is especially important in these uncertain times. As a result, in the second quarter, we were able to improve operating income trends by about five points versus first quarter on roughly the same amount of revenue due primarily to our 2010 financial flexibility program.

Looking ahead, we expect further sequential improvement in our operating income trend due to our scalable business model and the sustainable nature of financial flexibility actions. Two examples of such actions are the redesigning of our North America sales model, which improved productivity, as well as the migration of our Data Center, which is reducing the costs of our technology infrastructure.

From a foreign exchange perspective, we expect revenue and operating income headwinds of approximately $9 million and $4 million, respectively, for the remainder of the year based on today's spot rates. These amounts have been factored into our guidance for the year.

Moving on to earnings per share. Our diluted earnings per share was up 2% in the second quarter, in line with our expectations and reversing declines in the last two quarters. This performance reflects our operating income results as well as the accretive impact of share repurchases and slightly lower taxes.

Let me now close with a discussion of our free cash flow. We continue to generate a lot of cash at D&B due to our capital-efficient business model and disciplined approach to cash deployment. As a result, in the first half of the year, we generated $172 million of free cash flow compared to $192 million in the prior year's similar period, in line with our expectations. About half of the decline is due to our Strategic Technology Investment, which we began this year, and the other half relates to lower operating income year-over-year, all of which are factored into our guidance.

In summary, we feel we're tackling the uneven economic recovery effectively and decisively. Our proactive efforts and financial flexibility have allowed us to deliver bottom line expectations despite the volatility we experienced in S&MS. Looking forward, you can expect us to have the same diligence in the back half of the year as we continue to navigate the rest of the year. We remain on track to deliver our guidance for the year and expect a stronger second half performance in 2010.

With that, let me turn the call back to Sara for her closing remarks.

Sara Mathew

Thank you, Tasos. So to summarize, about 2/3 of our business is performing well, and we are taking actions to improve the trajectory on the remaining 1/3.

In North America, Risk Management is gradually improving as we cycled through the weak sales from 2009, and the DNBi product line remains strong. We've addressed one drag in the North American RMS portfolio and expect to improve the trajectory in the second half.

In S&MS, our pipeline is strong, and we expect the benefit from the timing of contracts and strengthened execution to improve trajectory in this segment. In International, we should close 2010 with the third consecutive year of double-digit growth and expect to sustain this trajectory into 2011.

Our core capabilities and financial flexibility are working very well, and we expect a continued improvement in operating income as our revenue improves and we benefit from the actions that Tasos discussed earlier. So we are on track to meet our annual guidance: specifically, revenue growth between 1% and 3%, operating income of negative 2% to positive 2%, EPS between 1% and 6% and free cash flow of $240 million and $270 million.

Let me provide a few final thoughts after six months as CEO. The uneven economic recovery is challenging us in many different ways, yet it is also bringing out the best in us as a leadership team. We have a clearly defined strategy and a path to transform our business from an old-fashioned data company to one that is more insightful and innovative in the marketplace. Our strategic investments are progressing very well. We are energized and enthused by early customer reaction to our new products. We know we have a powerful set of assets, and we intend to make them even stronger. The Hoover's re-platform, which we launched just in February, is only the beginning. We intend to replicate that success in other areas, and our early focus will be in those areas where our current performance is the weakest. So over the next 18 months, you can expect to see a level of new product launches that are unparalleled in our recent history. This, we believe, is what we need to return the North American business to sustainable growth.

Finally, we expect to deliver our commitments for 2010, and we are committed to deliver improved performance in 2011. We stand behind the expectations we shared with you at Investor Day in May regarding 2012, more specifically, returning North America to mid- to high-single digit revenue growth and overall company margins at 100 basis points above 2009.

I'd like to close with a message to our team members who are on the call today. Thank you for the hard work and commitment to win in what is an exceptionally tough environment. I am proud of your leadership and relentless focus on execution. Thank you again. And that concludes our prepared remarks. Let me now open the call for questions. Laura, if you are on the phone, could you open the line, please?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Shlomo Rosenbaum from Stifel, Nicolaus.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Number one, on the competitive environment, I know we had talked a little bit about kind of at the low end, there was more competition last year. Are you seeing this right now in terms of the competitiveness in DNBi in some of the pricing environment over there?

Sara Mathew

Sure. On the competitive environment, DNBi is mostly a midsized customer product. It's workflow application. It does very well in that space. So one of the things we've recognized is we do have a competitive gap at the low end, both from a price standpoint and well as a complexity standpoint. So when I discussed the dnb.com relaunch, the first version of dnb.com will be targeted to existing customers, which is the people we have on the product right now. Version two will actually tackle this issue. We will have an entry-level risk product that will be priced competitively, will be very easy to navigate, and this will essentially close our gap within that space. So we're actually excited about what we have coming in order to systemically tackle this issue, which is where we see competition from, we would say, a whole range of known competitors, the larger ones that you follow as well as several smaller ones that use online products to actually provide a very simple and easy interface to customers. The one other final thing I would add is this is a very large market, and there is incredible amount of room, and there is a piece of this market that we believe at D&B we should own. The far end of it, which is the micro segment, that is a space that we don't believe we should play in. We're not going to focus on that space. Instead, we're going to go arm Great Hill Partners. We'll give them the data, and we will have them go after that very, very small end. We believe we should be able to own the other end of more established small businesses.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Then moving to International, expectation is that double-digit growth is going to continue in 2011. Should we start to see an acceleration of organic growth or should we expect there'll be additional acquisitions over there?

Sara Mathew

You should see an acceleration in organic revenue growth even in the second half of 2010. The slowdown in Japan was anticipated. We should see that very gradually recover although we don't believe Japan is going to be back to where it was in 2009 as an example. We also have the launch of DNBi, and I got to tell you, the DNBi launch in Europe is going very well. I mean it's just been launched a couple of weeks. We've got two sales. We're very pleased with both of them. Both were competitive wins. The sales force is really starting to crank up. There's a huge pipeline out there that they're going to go after, and we're seeing the much of the performance that we saw at the initial launch of DNBi. We expect there will be strong double digits from conversion of existing customers over to DNBi, but more importantly, customers are telling us that the features and functionality of DNBi is far superior to the competitive product, and the first sale that we had, which was a competitive win, they actually used our product for a month before they decided to give the business to us. So we believe that will also help our business in the second half.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Just if you can give more specifics into the visibility into the second half's revenue, that you'll be able to meet the guidance, part of it is just the Sales & Marketing Solutions. What confidence do you have that some of that is going to come back? And then how much of it are you betting on kind of the D&B conversions to really drive the rest of it?

Sara Mathew

Sure, Shlomo. I'll start with the high level and then I'll go into Sales & Marketing, which is where in the second quarter we had weaker-than-expected results. So I want to just, at a high level, remind everybody that North America for 2010 will be down slightly. That was a commitment we made early in the year, and we believe that is about right. There were essentially three factors that'll improve North America, and I'll start with the RMS business. We will essentially have mostly worked through the overhang from 2009, and so you should see a natural lift in the back half coming from working through the overhang. Second, we will partner it with, I would say, the micro business where we struggled the most. This has been a strong double-digit decliner. That should add two points of growth to the North American RMS category. And finally, the new product introductions, while they will not give us a lot in the fourth quarter, they should give us some, coupled with the NCA, the new customer acquisition activity, which we had talked about at Investor Day, which should also give us a lift. Now let me move to Sales & Marketing in terms of the second half. We think there are three factors that should drive the growth. Tasos alluded to one of them in his comments, and that is the positive impact of timing. We had some specific timing issues. This is one of the reasons why we don't provide quarterly guidance because quite frankly, sometimes, our deals tend to be lumpy, and we try to work with the customer, and that sometimes results in deals shifting quarter-to-quarter, so that's one factor. The second factor is we have a much higher percentage of multi-year deals, and I talked about this in my prepared remarks, multi-year deals like the government contractors. When a customer has a strong relationship with us wants budget certainty, and we usually lock them in for three years with growth every year. We have a much higher percentage of multi-year deals in the second half than we did in the second quarter. And then finally, I talked and alluded to the traditional products that we are going to relaunch, not much impact in 2010 but that gives us confidence as we enter 2011. So the first two factors should result in very modest growth in Sales & Marketing in the second half, and if you combine both of these, you will see that North America will be down slightly. International will deliver double digits. We are very confident of that.

Operator

Our next question today comes from Michael Meltz from JPMC.

Michael Meltz - JP Morgan Chase & Co

Just on Shlomo's question there, I'm not going to ask you for quarterly guidance, though I'd like it. But if North America, even if you take out the drag from the divested business, you're saying you're going to decline a little bit for the full year, I think it implies the second half up. I think it's like 1% to 3%. You're saying Sales & Marketing will be up modestly. I think it has to be up more than that to get there or that risk is actually going to grow in the second half. Can you just actually quantify a little bit more, Sara, exactly if this is such a weakness?

Sara Mathew

Sure. So one thing you should remember is removing the drag out of our numbers will actually improve the North America-as-a-whole trajectory by about 1.5, so that's one piece. It's about two points in Risk Management. In terms of the back half, we expect North America to probably be down low singles in the third quarter, and fourth quarter, we do expect growth, and that comes from Risk Management actually improving because when you take this drag out, yes, Risk will improve. And if Risk doesn't improve, as you know Michael, the math will not work because Risk is a predominant part of our North American business. It's about 60%. Sales & Marketing will be low growth, and yes, the math will work. If you want, I can have Kathy and Tasos help you with your model, but we do have the math, and yes, it does work.

Anastasios Konidaris

Michael, this is Tasos. Up modestly means positive territory as compared to up modestly versus Q2. So that may be the piece you're missing, and feel free to follow up with us later on, if you want.

Michael Meltz - JP Morgan Chase & Co

And then I appreciated the new breakout of the six channels. If you look at the 45% of revenues that aren't growing, if I do the math, that would imply that that's down high teens, and with the strategic, the larger customers, where is that trending versus high teens this year?

Sara Mathew

So let me just give you the math. If half the business is up mid-single digits and the business in North America as a whole is down, you are right. It won't be teens, but it'll be double digits, so just to get the math right in terms of where we're at, and again, Tasos can help you with this some more. If you look at what happened in the first and second quarter, you will find that the issues occurred in the strategic channel, and strategic, as a channel, has much more Sales & Marketing than the other channels. So said another way, if you look at the Commercial channel or the Small Business channel, those businesses tend to have more risk. If you look at strategic, it actually has more Sales & Marketing, so we've got it very contained within a group of customers. The strategic channel has about 40 customers, and we haven't boxed within that space. We do believe in the back half, with more multi-year deals and the timing benefit, we should see an improvement. It will not be at growth in these channels, but it certainly will get a lot closer to flat as opposed to being in the strategic channel, down strong double digits in the second quarter.

Michael Meltz - JP Morgan Chase & Co

I know the mechanics around the sale. There's a few moving pieces. I just want to clarify those. So the $10 million sale or upfront cash and then the royalty, that $10 million, that's not incorporated in your guidance, right, to hit the EBIT number?

Sara Mathew

That's cash.

Anastasios Konidaris

No, that's going to be cash. That's not part of our guidance.

Michael Meltz - JP Morgan Chase & Co

Sara, you said on DNBi in Europe, trends thus far have been pretty good, and you mentioned there was a competitive win there. I mean are you generally facing Experian or Coface or non-traditional players in that area?

Sara Mathew

We have a group of competitors. Remember, we're in the U.K., Belgium and Netherlands. In U.K., we face Experian. In Netherlands, we face a company called Graydon. Coface is in Benelux, but it's not as material as Graydon, for example. Coface is faced by our partner, Altares, in France, and as you could imagine, we work together to essentially ensure that we get competitive wins in France, but that is not reported in our numbers. The example I gave you was in Netherlands, and it was a competitive win with a competitor in that market. And we also see significant opportunities against others because we have a superior product in a market that is still quite antiquated in terms of the use of credit reports to do credit decisioning because as you know, credit insurance is pretty significant there.

Operator

The next question comes from Carter Malloy, Stephens Inc.

Carter Malloy - Stephens Inc.

Referring back to the International questions, just curious if you could maybe size Japan for us and/or the DNBi opportunity. I'm just trying to get a handle on the acceleration of organic from 3% to double-digit growth.

Sara Mathew

Sure. So Asia Pac is about 40% of the International business. Japan is slightly less than half of Asia Pac. So it's significant within Asia-Pacific, and it's probably, what, 17%, Tasos, of International, revenue roughly something like that in the teens?

Anastasios Konidaris

Yes.

Carter Malloy - Stephens Inc.

So if that part is in decline, then can you give us a sense of what you see the DNBi opportunity as in Europe? So I'm just trying to get a handle on how we accelerate growth from 3% organic to double digits?

Sara Mathew

Right. We said a slowdown, Carter, in Japan. As you may recall, Japan has a joint venture with our partner, TSR [Tokyo Shoko Research], and we have a large competitor called TDB [Teikoku Data Bank] in that market. What we had been doing over a period of time is actually bringing more and more customers into the D&B TSR joint venture because it allows us to bring our cross-boarder value proposition and a value-added solution to customers in that market. So that resulted in fairly high growth early on, and now what we have seen is a slowdown primarily due to the economic conditions in that market. We're not talking about declines per se, so just to make sure you get the math. Tasos, do you want to add anything?

Anastasios Konidaris

Yes, I just want to clarify something, right? So when we said this low total, low double-digit revenue growth in International, not organic double digit. That's number one. Number two, as we said on Investor Day, our expectations about organic revenue growth in International is sustainable mid- to high-single digit. So that's what we're talking about going from a 3% in Q2 to mid- to high-single digit organic, and then we have the acquisition of ICC we did last year and Roadway in China that will get us to low double-digit International revenue growth.

Carter Malloy - Stephens Inc.

On taxes, they were lower this quarter, but what do you see those as going forward?

Anastasios Konidaris

Yes, so what we see is -- yes, we're seeing kind of full year core tax rate to be about 35%. You know we don't give quarterly guidance. Typically, our fourth quarter tax rate is significantly higher than that just because our North America operating income in the fourth quarter is substantially higher, so you have a mix issue there. So I think that should give you what you're looking for.

Carter Malloy - Stephens Inc.

You guys named off a number of new initiatives. I was curious what falls into the E-Business category, and if there are other new targets there outside the new Hoover's platform. And I know you guys had launched PowerProfiles recently, if you had other things like that in the pipe or how even that was trending itself?

Sara Mathew

Sure, so what we're doing with traditional marketing, which is our prospecting products, which we believe could go digital, we're going to essentially build new products off the existing re-platformed Hoover's to actually migrate customers over. This is a much better customer experience and a better value proposition, so that is actually going to go more digital because we believe that is a secular trend, which is the reason why traditional Sales & Marketing has been struggling possibly since 2009. It's just the value profit's just out of line. Beyond that, dnb.com, especially the entry-level product, will have the capacity to be essentially a digital brand as well. Even now, people interact with us through dnb.com primarily online, but the way we structure contracts is we don't allow them to work with us directly online. The retail version of dnb.com will also be an online product. So yes, we will be migrating more and more of this to be no sales perhaps, just traffic coming into and because it's very easy to use, very simple reports, the ability to come to D&B to get data. The last product I talked about D&B360, which I've described as Data-as-a-Service or DaaS. Let me just provide a little more colored commentary around that. You have all heard of Software-as-a-Service. That was a salesforce.com's business model. You've heard of Platform-as-a-Service. This is what Apple provides to iPhone app developers. Data-as-a-Service is essentially putting our data in the cloud and allowing anybody to be able to access it. So the step one is the agreement with salesforce.com, which allows us to seamlessly embed our data into the salesforce application. Today, we have a small product in Hoover's called Access Hoover's, but you really have to buy into Hoover's before you get this functionality. Now what we're going to do is make D&B data available to all of salesforce.com customers, and it'll be seamlessly embedded, and this is going to be a new market for us because we have very little overlap with salesforce customers. I talked about 2% between our Sales & Marketing customers and salesforce.com, about 10% if you take all our customers and all their customers. And we're very excited about the opportunity for us as we look in Q4 and into 2011, and that's going to be digital, pure digital.

Carter Malloy - Stephens Inc.

And just a function of mix or of your customers versus competitors within Sales & Marketing? Just trying to get a handle on -- you've had some competitors publicly saying that they're growing those businesses in sales and marketing.

Sara Mathew

Yes, our Sales & Marketing business is clearly not as penetrated as Risk, and part of it is we have some data gaps that, as you know, we're working to fix, which is e-mail addresses, which is becoming an important form. We've closed that gap only just recently and in addition, to be able to interact completely online and have tools that are simple and easy to use to do basic prospecting and to be able to do basic market analytics. So what we're trying to do is take a different approach. It's really become more of a data provider and allow our data to be embedded in as many applications out there, which allows us to penetrate a space that we've struggled to penetrate for the past several years, and we think this is one way to go after it, and as you can imagine, we're talking to other CRM providers and other people who are very interested in having our data in their cloud. So this you should see, Carter, as just the beginning, and the sales force agreement was really for us to fully understand this so we can exploit it even further with other manufacturers.

Carter Malloy - Stephens Inc.

On DNBi, can you size the opportunity that you see in Europe with the launch there?

Sara Mathew

It's built into our expectations of double-digit growth and then showing we have momentum in organic growth, to Tasos' point, as we go into 2011.

Operator

Our next question comes from Dan Leben, Robert W. Baird.

Daniel Leben - Robert W. Baird & Co. Incorporated

Tasos, you mentioned that deferred revenue growth was 3% in the U.S. Help us understand that in the context where the subscription revenue mix was up three points or 5% and DNBi's mix was up nine points or 17%. Why wouldn't that number be 5-plus percent with -- at base, being the increase in the subscription mix plus some pricing?

Anastasios Konidaris

Yes, I think the primary reason here we may have some seasonality related to our deferred revenue, how it's coming in. That's number one. And then also, we have a big part of our business, which is SaaS, which is the agreement with Great Hill Partners. So that's been declining significantly as you can see from the last schedule of our press release, and so that actually has a negative drag on the deferred revenue quarter-over-quarter. Does it make sense? I mean I can follow up with you later on with more specifics.

Daniel Leben - Robert W. Baird & Co. Incorporated

The 3% deferred revenue growth was sequentially not year-over-year?

Anastasios Konidaris

It was year-over-year.

Operator

[Operator Instructions] Our next question comes from Peter Appert, Piper Jaffray.

Peter Appert - Piper Jaffray Companies

Sir, the D&B360 offering sounds pretty interesting. Do you have a sense of how big you think the revenue opportunity might be? And how do you think about the pricing of this offering?

Sara Mathew

It will be priced per seat. I can tell you that, and those are the exact factors that we will be working over the next few months so that we ensure that we get this right. We have, if you think about the way salesforce.com works, its pretty much worked per user. That's pretty much what their model is, and so if you want to get this D&B access, you pay a little bit more. How we actually price, we want to make sure it's margin accretive to what we have today, and that I think something I'm not yet ready to give you specifics on. Once we have a price list, it'll be public. I can share that with you, but we do believe there's a large opportunity out there, and we have to figure out how we can tackle all of it. A big part of this will be marketing because we have to make sure that people who use salesforce.com today know that the service's available. It will be automatically available, almost like turning a switch on, and D&B data will flow right in. One thing I'm going to do, Tasos, as a suggestion, is we have the new D&B360 marketing piece, which we should probably get out to some of our investors. They can at least get a sense for how this will work.

Anastasios Konidaris

That's a great idea.

Sara Mathew

And we think this opportunity will build all the way going into 2011, don't have specific site I feel comfortable putting out yet, but it's critical to our trajectory as we go into '11.

Peter Appert - Piper Jaffray Companies

And then just following up on an earlier question, I hear what you say about the macro factors impacting the Sales & Marketing business, but what gives you the confidence that you're actually not losing market share in this business?

Sara Mathew

Well, what we do is to have a very close, thin view on everything that we lose to competition, so that is actually tracked in our salesforce.com users. So we actually track all competitive wins and all competitive losses, and we're not seeing anything significant there. The other factor is retention, so our retention held up really well in the second quarter. But what we saw is a much smaller renewal because of fewer deliverables, so a de-scoping of the spend as opposed to an elimination of spend. So it's those two factors that tell us that customers now are really trying to do less with us. And finally, these are our largest customers, so where we have the issues was with the 40 strategic customers that I discussed, that channel, so actually, we can get our arms around it. We can actually tell you by deal exactly what happened. We know there were no competitive losses, but yes, they did shrink it, in some cases, fairly dramatically, and they all came into the first quarter with a much different view. Our pipelines in Sales & Marketing still remains very strong, but I think what we're seeing is prospecting for new clients is clearly under more pressure but existing business. So in other words, prospecting within that client base is actually holding up quite well, and Optimizer is an example of the one that plays more in that space, but our traditional products play more in the prospecting space.

Operator

You have a question from Shlomo Rosenbaum from Stifel, Nicolaus.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

I just have a question on the divestiture. You referenced a net revenue number, going from net revenues $70 million to net revenues $50 million that's being divested. Could you just discuss what's being held on to, what part is being excluded and just a little bit more details on the structure over there as well?

Sara Mathew

Sure, so I'll ask Tasos to get you through the numbers, but the return's simply $70 million was the net number for 2009. For 2010, we actually had the business for over half the year, and then we don't have it for the second half. The business is also declining in strong double digits, so as you would expect, there is a smaller business in 2010 than there was in 2009. We're not holding on to any part of the business, but we are the provider of data. So the way you should think about this strategically is we are arming Great Hill Partners to go exploit this micro market more fully. The micro market, as you may recall, is credit on self. These are very small businesses, and we try -- they usually need a DUNS Number to do business with the government or to do our business with other businesses, so we help them with that, and then we keep an ongoing view of their credit ratings. And what we're doing is giving this to Great Hill. We think it's a terrific partner. The CEO of the new unit has a tremendous amount of experience in the Small Business space, and he will look to leverage our data, our brand to exploit this further for us. So we're actually not keeping very much other than the data. The DUNSRight asset is ours. We're licensing the brand, and we're giving them right -- in a very restrictive way but just related to credit on self with some micro customers and for them to exploit, and these are customers who want more than just credit. And Great Hill will be able to provide the full suite of products, and they have made a decision to invest pretty heavily into the space, which is a reason why we picked them as a partner. It's not unlike the way we picked our International partners in 2004. Did that help, Shlomo?

Anastasios Konidaris

And Shlomo, the difference is thousands, so the difference between what you will call the gross and the net, and we did not disclose the gross for confidentiality reasons. It's really the payments we were receiving from Great Hill. So that way, we ensure the operating income neutrality that we spoke about.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

So there is some revenue from this deal that's retained there? Royalty payments?

Anastasios Konidaris

Exactly.

Sara Mathew

It's royalty payment. It's just like we did the International partnerships. We pay the royalty because we are providing services called data...

Anastasios Konidaris

Similar...

Sara Mathew

Through this partner.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

So if you went back into 2009 and looked at the part that's being excluded, you would've included into your base revenue what the royalty payments would have been at that point in time?

Anastasios Konidaris

Exactly. That's why we gave you that $71 million of last year and the $51 million this year to ensure consistency in the year-to-year growth, Shlomo.

Operator

That does conclude our question-and-answer session. I'll now turn the call back over to Ms. Sara Mathew for closing remarks.

Sara Mathew

Thank you, Laura. On behalf of all of us at D&B, I wanted to thank you for your time. If any of you have additional questions, please feel free to call myself, Kathy Guinnessey or Roger [Roger Sachs]. Take care, and at this point, we're going to be signing off. Thank you, operator.

Operator

That does conclude today's conference. Thank you all for participating. You may disconnect at this time.

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