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Executives

Peter McDonald - Interim CEO

Dee Jones - CFO

Analysts

Joe Staff - Susquehanna

Jonathan Levine - Jefferies

Zachary Altschuler - DK Partners

Philip Grose - Castle Hill

Amy Stepnowski - Hartford

Andrew Permick - BTIG

Todd Morgan - Oppenheimer

SuperMedia Inc. (SPMD) Q3 2010 Earnings Call October 26, 2010 10:00 AM ET

Operator

Good morning, and welcome to SuperMedia’s Third Quarter 2010 Earnings Conference Call. With me today are Peter McDonald, Interim Chief Executive Officer, and Dee Jones, Chief Financial Officer.

Some statements by the company today during this call are forward looking statements. These statements include the company’s beliefs and expectations as to future events and turns affecting the company’s business and are subject to risks and uncertainties. The company advises you not to place undue reliance on these forward looking statements and to consider them in light of the risk factors set forth in the report filed by SuperMedia with the Securities and Exchange Commission. The company has no obligation to update any forward looking statements.

A replay of the teleconference will be available at 800-642-1687. International can access the replay by calling 706-645-9291. The replay password is 14663775. The replay will be available through November 9, 2010. In addition a webcast will be available on SuperMedia’s website in the investor relations section at www.supermedia.com. At the end of the company’s prepared remarks, there will be a question and answer session.

Now, I would like to turn the call over to Peter McDonald. Peter?

Peter McDonald

Thank you, Mellisa, and I would like to welcome every one to our third quarter earnings call. We appreciate your time and interest in SuperMedia.

While I may new to SuperMedia, I’m not new to the industry. For the past 35 years I worked across the country for many different companies. I started my career in New Jersey learning the business from the ground up in 1973. In 1985 I was recruited to RH Donnelly and worked in their New York operations. After some success, managing the incumbent environment I was asked to manage in the propriety business which stretched across the country.

In 1993, Dun & Bradstreet who owned RHD asked me to manage their business in the Mid West. Don-Tech, a partnership between Ameritech and RHD. Shortly after that I was recruited to run Ameritech Advertising Services. When Ameritech was purchased by FBC, I was asked to run their directory business. After that I went on a few boards, one of which was RHD.

In 2002, I went from the board position to an operating job focused on improving the Sprint directory business. In 2005 and 2006, we purchased two additional properties, Don-Tech and Dex. After integrating these businesses, I retired in 2008. Recently, I was recruited for this current position and I’m accoladed. I look to leverage my background and institute business processes that work in many different operations. I would be focused on driving our sales as well as financial discipline.

Our team will concentrate profitable products, customers and markets, while paying down our debt. We have some real quality people here and I look forward to working with them as we improve this business.

Before turning this over to our CFO, Dee Jones, I would also like to recognize and thank Scott Klein for his contributions to SuperMedia. He brought some creative marking ideas to this organization, which were having an impact like super guarantee. Again I thank you for your time and know that while new I’m experienced and focused on delivering results.

Now here’s D.

Dee Jones

Thank you, Peter. Good morning everyone. To begin the call, I would like to mention that our reported numbers are provided in GAAP format and non-GAAP, which are referred to as adjusted pro forma. The GAAP results include fresh start accounting implemented in our 2010 reported results, which does not provide comparability to prior periods. Reconciliations of the GAAP and adjusted pro forma results are included in the presentation appendix. In reference to our results on today’s call, I will be speaking to the adjusted pro forma numbers.

Looking at our year-to-date results, revenues were $1.534 billion, a decline of 20.8% compared to year-to-date 2009. Third quarter revenues were $489 million, a decline of 20% compared to the same period last year. Year-to-date EBITDA margins were 32.6% compared to 34.1% year-to-date in 2009. In this regard, we believe our process improvements and expense reduction efforts are showing some positive signs. However, much work remains to be done and we must remain focused on executing our plan.

For the third quarter free cash was $108 million and $373 million year-to-date. Our third quarter advertising sales trend continues to show less of a decline from prior quarters. As a comparison to the second quarter, there was a 150 basis point change. This resulted at 540 basis points change versus the third quarter of 2009. As mentioned in our previous earnings call, the advertising sales will have a timing lag that will flow to the reported revenues in future quarters.

Turning to our EBITDA results, third quarter EBITDA was $172 million compared to $209 million last year. As we mentioned in our release, we recorded $24 million of payable non-recurring non-cash items in the third quarter and $40 million on year-to-date basis associated with the resolution of certain state tax claims.

We’re continuing our efforts to mitigate the amortized revenue declines by reducing expenses. Year-to-date sales expense was favorable than last year by 16.3% or $86 million reflecting gains from efficiencies in the sales process. Year-to-date cost of sales was favorable to last year by 8.3% or $36 million. This was primarily driven by lower print and distribution volumes as a result of our optimization efforts in targeted markets.

Our G&A expenses are favorable over last year by38.3% or $119 million. The majority of this favorability was related to our bad debt and non-recurring non-cash benefit associated with the resolution of state tax claim. On our third quarter basis, 2010 versus 2009, the selling expense reflected 13.8% reduction, cost of sales declined 8% and G&A declined 52%. For the third quarter, back debt was 5.7%. This is 340 basis points improved relative to our 9.1% 2009 full year provision rate.

Looking at our reported cash flows year-to-date, free cash flow was $373 million net of $31 million capital expenditures. We made a $77million debt payment comprised of the required mandatory cash sweep of $75 million for the third quarter along with $2 million residual principal payment related to the second quarter cash sweep.

As mentioned on our previous earnings call, we received a net federal per income tax refund of $94 million in the second quarter offset by cash payments related to bankruptcy related item. Thus far in 2010, based on the fellow income tax estimate methodology, we have not been required to make a tax payment. As we close out the year, we will have a federal income tax obligation, which depending upon our estimation method, most likely would be payable in the first quarter of 2011.

Our cash on hand at the end of September was $331 million and our debt outstanding was $2.46 billion. As you also saw in our release, we announced today that we are currently in discussion with holders of our senior secured debt regarding an amendment to our term loan agreement that would permit additional flexibility to repurchase term debt in the market at prices below the face amount of term debt.

With that, operator, Peter and I are now ready to address questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from [Joe Staff] of Susquehanna.

Joe Staff - Susquehanna

To talk about few discussions with your lenders can you please update and give us some lead on where they are, how far down the path you have gone? Other than your buy back debt in the open market, are there any other discussions points been discussed?

Peter McDonald

Relative to what we announced today. We are in discussion with (inaudible) focused on our ability to repurchase debt in the open market as you probably know the credit agreement does provide for some measure flexibility with regard to that activity, but there is some timing limitation and some caps or limits as to how much we are working with the lender group at this point relative to those items. It’s a little bit preliminary to get too much into specifics there, but there should be more news shortly.

Joe Staff - Susquehanna

I would classify that as you guys having gone down the road a fair amount with respect to the discussion, is that fair?

Peter McDonald

We are making good progress in regard to that.

Joe Staff - Susquehanna

Peter second question please. Can you please explain the interim status for your title? Is their expectation of the company may choose someone else as CEO or is it your expectation hoping we need see that. I’ll see you coming out of retirement joining the company I’m trying to reconcile what is going on there in terms of the company’s expectation?

Peter McDonald

The way to look at it is, yes, I was brought out of retirement and the Board is really looking to close the loop on closing up to a full time CEO and so that should be happening fairly quickly.

Operator

Your next question comes from Jonathan Levine of Jefferies.

Jonathan Levine - Jefferies

Just a couple of questions. Can you talk a little bit in terms of where you are in regard to getting approval to limiting the printing of the white pages and talk a little bit in terms of what that mean in terms of your cost structure and then if you could give a little bit more color in terms of the decline in cost of sales in your margin, which have been (inaudible) in the low 70s increased a couple of hundred basis points in the third quarter, so if you can give a little more color on that? That would be great.

Peter McDonald

Yes, with respective to the cost of sales in white pages aspect of things and then we have made good progress with regard to several other states and approval in several of those states to stop printing the residential white pages and this picture that is residential white pages.

We are encouraged by the activity we are seeing across the states in being able to get at that. Having said that, the order magnitude of that activities certainly worth going after and we are seeking the adjustments would be measured in. The easiest way to put it would be measured millions as opposed to tens of millions. The magnitude will not insignificant. It is certainly not going to drive all of that what we need to get out on the expense side of the house. We got to stay after in a rationalizing all aspects of the book as well as our approach in regard to all processes across the organization to get at the expense structure we need to end up with.

The second question, could you repeat that Jonathan, sorry.

Jonathan Levine - Jefferies

I just was looking for more color in terms of the margin, your margin seems have improved, gross margin by a couple of hundred basis points, the first quarter and second quarter in low 70s?

Dee Jones

The margin with respective to cost of sales and selling of both see an improvement as a result of the expense reduction on the selling front. We have seen improvement as far as in our ability to be more efficient with sales force most of that segment of the income statement is driven by employer related expenses in those activity.

On the cost of sales side, we’ve got paper and ink, printing and distribution activities as well as traffic and some of the other elements of the business that flow in to that. We are looking for efficiencies on all pieces of the income statement to drive that. When we step all the way down to EBITDA margin, you have to make sure that you adjust for the non-recurring state tax claims, but again we have been able to mitigate to a degree the amortized revenue declines with expense reductions albeit whenever we need to be on either of those line items as yet.

Jonathan Levine - Jefferies

Stepping back to the white pages, what states were have you already got an approval marked to print the white pages at this point?

Peter McDonald

We got approval in the State of Texas and New York with most recent, but the third off the top of my head. I don’t have the full and complete list. They have been public releases in regard to the states that we have got an approval around.

Jonathan Levine - Jefferies

How has most of that already run through, the cost of sales on or is that kind of?

Peter McDonald

The impact of that will flow through as we publish books across those states and those have been very recent events probably got a little bit in regard to certain publications, but I’d say that the bulk of those dollars are yet to come as we publish books in those states because it has been fairly recent events in most of the states.

Operator

Your next question comes from Zachary Altschuler, DK partners.

Zachary Altschuler - DK Partners

My first one is on the Q2 presentation you talked about medium months and how you guys are recognizing better possession and usage in months that you advertise. I wonder if you could throw out some commentary on what ad expense has been and where do you see it going forward?

Peter McDonald

You are referring to our media stint.

Zachary Altschuler - DK Partners

Yes.

Peter McDonald

Our advertising expense?

Zachary Altschuler - DK Partners

Yes, exactly.

Peter McDonald

We have been running a little bit behind last year the timing of our advertising program was more spread out evenly throughout the year as opposed to last year one was a little more heavily loaded in the first part of the year. We certainly analyzed the opportunity to be more efficient with advertising spend as we moved through the course of the year. I wouldn’t say that it is going to be dramatically different by the time we close out the year, but it certainly is an expense there that we got to balance the benefit against the cost and we are always looking to be more efficient with it, but I’d say for the full year it will be in the range of where we were last year.

Zachary Altschuler - DK Partners

I realized you are only on the job a few days, but I was wondering if you could provide some commentary on where you see the internet strategy going forward with obviously you have been on a lot of partnerships, you guys have struck up recently, but then there is also the flipside of building out of your own comprehensive site. How do you view that going forward?

Peter McDonald

Well Jack, first you got it right that I’m only on the job here a few days and we are looking at all options and I haven’t landed on anyone particular one. You can say that from the philosophy we are driving towards the most profitable options that are out there in the market place.

Zachary Altschuler - DK Partners

Just one more, on client loss again in the last quarter presentation you said that you saw a 50% improvement in the first half of the year versus second half of ‘09, is there any color you can write on how that churned into the back half of this year?

Peter McDonald

I’d say it’s very consistent with the first half of the year. The improvement that we have seen is regard to churn, but having said that it is still a tough small and medium business marketplace out there. We are still seeing churn in the client base that we need to improve, but we have seen continued progress in that regard even through the third quarter similar to what we saw in the first half.

Zachary Altschuler - DK Partners

Just one last thing, I definitely appreciate you guys are going down the path again (inaudible) called you guys structure as such out there tenders so that all (inaudible) participated as oppose to the market purchases?

Peter McDonald

I appreciate the perspective.

Operator

Your next question comes from (inaudible).

Unidentified Analyst

I was just trying to think about your cost structure here and can you give me a sense on if revenues go down by let us say a dollar what is that your EBITDA?

Dee Jones

Yes, you are talking about direct variability in regard to the cost structure. We have talked to you in general terms in that regard in the past and normally what we have talked about is that if you don’t take direct action in regard to a change in the revenue stream, you’re probably dealing with $0.80 to $0.85 on the dollar implication on a direct variability. Having said that we always looking for ways to impact our cost structure and take action to ensure that we are as efficient as we possibly can be. Your question is regard to direct variability, but there are elements of cost structure that we are always examining and looking to get at.

Unidentified Analyst

I assume that you’re going through some cost reduction actions now. Is there more easy cut with that impact future quarters, can you give us a size on how much you could shrink your cost base?

Dee Jones

If you look back, we have been going through cost initiative activities since latter part of 2008 and into 2009 and continue those through 2010. You’re seeing that in some measure of the results in expense reductions that you see on individual line items on a year-to-date basis and within the quarter itself. We will continue to be steadfast in looking at expense opportunities as move forward. We do believe there’s oppurtunity in that regard but as our policy has been in the past we don’t provide a lot of guidance as to those elements as we look out.

Unidentified Analyst

Could you give me what your head count was exiting bankruptcy and what you think your head count to be at the end of 2010?

Dee Jones

We’re looking at continuing to reduce headcount. It has been meaningful through this part of the year as far as the amount of headcount reduction. We were a little bit over 5,000 at the end of December, 2009 when we exited. So, yeah, between 5,000 and 5,500, we have made meaningful reductions relative to that. I’m not going to forecast the number for the end of the year, but suffice it to say we have made good progress.

Operator

Your next question comes from Philip Grose of Castle Hill.

Philip Grose - Castle Hill

I wonder if you could provide more color on the customer take up of products like SuperGuarantee and [Outline]? Looking for the 2011, your portal, what percentage of your customers are taking the SuperGuarantee? How is that versus your expectations? How many customers have taken in internet on this product?

Peter McDonald

When you look at the SuperGuarantee you have to remember that is more a consumer orientation that benefits the advertisers because of utilization of our products. We don’t disclose the various metrics around the SuperGuarantee for competitive reasons, but we’re pleased with the activity and the results of SuperGuarantee program. We have heard good stories from our advertisers and they are pleased with regard to the SuperGuarantee program.

Initially all of our advertisers are covered by the SuperGuarantee program as long as there is a minimum level of outstanding activity with those advertisers and they stay in good graces with regard to the program as well as their payments to us. So essentially, all of our advertisers are covered to the degrees that they meet their minimum requirements. So its not a function of our clients or advertisers taking up or adopting the SuperGuarantee program those advertisers in the right categories in the appropriate categories are nearly recovered by the SuperGuarantee and it’s the function of the consumer for utilizing the SuperGuarantee as they seek providers of services that they’re after. So, its really more of the usage, possession and usage and activity play for advertisers through the consumer activity.

Philip Grose - Castle Hill

So there is no cut off in terms of business size that the company can benefit from the SuperGuarantee?

Peter McDonald

No, the SuperGuarantee is a coverage that’s provided to all the advertisers to the degree that they’re in the appropriate categories; we don’t cover all categories SuperGuarantee, but to be there in an appropriate category and they’re in good standing with us, as well as and good standing is for minimum requirements of the SuperGuarantee and servicing their clients.

Philip Grose - Castle Hill

Can you give any color on what’s your internet only customers level is, or what was you need take up 2011 is internet only?

Peter McDonald

We don’t break out the individual pieces between print and internet.

Operator

The next question comes from (inaudible) of D. Shaw.

Unidentified Analyst

Just a couple of questions. First of all, if you look at your G&A and you net out that expense, it’s a number that was flat Q3 over Q2 and the number that actually went up Q2 over Q1, if you back out the $60 million in Q2 and the $24 million in one time cost and in Q3. Can you think about why that you had difficult cutting into that line item and whether you see any other opportunities there?

Dee Jones

Yeah, I mean, with regard to base piece of the G&A program, you’re right, bad debt is the biggest portion of that. There’s a lot of elements could play into this in line we have been successful of getting reductions in the core features of the G&A element. However, you must remember there are some one time event and one time activities that did occur in 2009. If you look back at the K and the activities that influences G&A in 2009, there were some various settlements and activities around that that were one time in nature that makes the comparison a difficult one on a year over basis when you actually laid out the those pieces.

So we would you feel like we’ve got to continue to get it G&A be more efficient in that piece of the business. When we pull out bad debt and the other pieces it’s relative to the other two line items, its not huge number, but we’re certainly going to look to get out additional opportunities on that on that line out of the income state. It’s difficult year over year comparison, because some of the elements that flow into that line item such as legal settlements and other activities that influence the 2009 results. So you need to look back at 2009 in order to get a coming comparison.

Unidentified Analyst

You also mentioned earlier in your tenure remarks about not having paid any cash taxes in 2010 and the potential for paying taxes in the first quarter of 2011. Should we think about that in terms of some total of tax that you recruit for throughout the year becoming a cash payment, next year or what’s the right way of thinking about that?

Dee Jones

Basically I was trying to give a little bit of clarity around the cash flow aspects and the timing of those cash flows. We’re at cash expires as much of you folks know. I disclosed my effective rates in that 36%, 37% range. I don’t see a change in that on a permanent basis. This year having come out of the chapter 11 and the emergence in the manner in which our estimation methodology have flowed through we haven’t had to pay taxes as we move through the year. So, I do expect most likely in the first quarter that we’ll be making a, a payment relative to 2010 taxes.

Again as we finalize the full year and the full year of 2009, the netting of the refund that we had in our first quarter, will probably be a little bit of benefit there flowing into the 2010 tax on base, but the majority of that payment will actually occur in the first quarter 2011 most likely.

Unidentified Analyst

You reported free cash $108 million, but you look at your EBITDA and you back out, the $24 million one time that your interest expense and your CapEx, you get a number that’s a lot lower than that. I’m wondering what the differences were? I assume it’s the mix of working capital and some other stuff?

Dee Jones

Yeah, the major drive there is working capital. We have seen some measured improvements in our day sales outstanding and the timing of our collections and in that regard that would flow in the positive working capital element. So, as the bad debt has improved we have also seen improvements in our day sales outstanding, that’s influencing the timing of the cash flows. So, in that regard we’re pleased with the timing of those flows. We’ll see where day sales outstanding flatten out as we move forward.

Operator

Your next question comes from Amy Stepnowski of the Hartford

Amy Stepnowski - Hartford

Could you tell us again what the bad debt expense was as percentage of net revenue this quarter? Could you just comment on performance in large markets versus small markets, if you’re seeing any particular weakness on one versus the other?

Dee Jones

Yeah on that bad question, we had a provision of 5.7% in the quarter. I believe its 6.7% on a year-to-day basis.

In regard to change of the ad sales activity, we have seen improvements across vast majority of our markets whether they be on urban or rural. In recent times we’re beginning on a downturn, publishing a little bit bigger hit in the larger markets than the smaller markets and they were all impacted by the downtown as you would expect.

As we started this year chain line improvement in the chain line, we’re getting that from the vast majority of our markets. We still got some difficult ones from a geographic perspective; it’s more geography than it is urban versus rural in that regard as far the change and Florida still is up-market place right now for, as an example. So you’re still seeing some measure difficult there, but as far as the small, large market aspects of things, I’d say that we have seen some measure of improvement in all those markets.

Amy Stepnowski - Hartford

Just a follow-up, you noted Florida, could you maybe just give us a couple other of the market that are particularly that are more difficult than other some of your geographic basis?

Peter McDonald

We’re seeing movement in all the markets, like I said Florida is still a tough market, a couple of other areas out there, but we don’t normally break it down to that level of specificity, but you’d say that California going into the market was more difficult. We have seen a little bit of recovery in California than say Florida as an example. Texas has been a little of a difficult market for us. Getting too far into the specifics, I think is the practice.

Operator

Your next question comes from [Andrew Permick] of BTIG

Andrew Permick - BTIG

I just have a few questions and want a bit of a follow-up. In the second quarter of conference call you stated there is a 50% improvement in client loss, which you said that improved as well in the third quarter or is steady?

Peter McDonald

I wouldn’t look at that on a sequential quarter basis because you are dealing with different markets and different basis of clients, but as I stated the churn rate in the third quarter was relatively stable with what we were seeing in the first half of this year?

Andrew Permick - BTIG

On those clients loss, can you comment at all about how many of those was called voluntary versus involuntary, although some of that you decided to discontinue the relationship because of credit issues or things like that versus businesses that shuttered or went away?

Peter McDonald

Credit cancel has improved relative to all of last year and say the first quarter, that manifest itself in the bad debt rate as well, as you see the bad debt rate improved, the nature of the business that your credit cancels the one that you refer to as involuntary cancellations does show improvement.

I would say there is a little bit bigger influence of improvement in credit cancels as we look at, but certainly client churn is continues to be a focus for us as far as ensuring that we keep our client base and as that debt continues to improve, I’d anticipate the credit cancel will continue to improve as well.

Andrew Permick - BTIG

In terms of bad debt expenses, is there a normalized level to the expense that you can kind of speculate what that might be or maybe even historically what you target as a normalized level of bad debt expense as a percentage of revenues.

Peter McDonald

We have got publicly in the past about fact that much more normal level, in more normal times, in more normal economic circumstance, it is probably in the 4% to 4.5% range, but that depends on a lot of variables and a lot of (inaudible) factors, but that’s going to have a look at it.

Andrew Permick - BTIG

Alright, one final question. Relative to the net advertising sales and the improvement you are seeing there were just in decline in terms of year-over-year on a quarterly basis. Can you comment at all about again how much of that has to do with businesses that have completely decided to stop advertising versus those that have maybe traded down for a lack of better word to a lower package with you trying to just conserve passion filled economic cycle fully kicks in?

Dee Jones

As we look at our decrease in cancel in the revenue results, we are seeing influence and impact in both of those regards cancels as well as decreases as we move through the economic circumstances of 2008 and 2009 and first part of this year and that today it continues to influence the small and medium business environment.

We will say that, as I noted previously that the cancel level and rate has seen improvement. We are probably seeing a little bit more of a decreased orientation and a pure cancel orientation as we look out, but we still got client churn that we need to address and we got to get at the advertise the wallet share that to support the value proposition that we bring to the marketplace. We got to improve in both of those areas both decrease and cancel as we look forward.

Operator

Your final question comes from Todd Morgan of Oppenheimer.

Todd Morgan - Oppenheimer

We are just trying to make sure I’m understanding the bad debt section correctly. The bad debt position in the quarter was about $20 million and I think that’s based on the 5.7% bad debt expense that your talked about the presentation and the GAAP revenues you reported. Is that the right math?

Dee Jones

Yeah, generally speaking it’s 5.7% against that.

Todd Morgan - Oppenheimer

There is also $7 million of adjustment to G&A that’s part of the first start accounting that you (inaudible) in the press release. I think that’s probably the add back for the bad debt expense from the revenues that would have been reported before the first start adjusted revenues. Is that right?

Dee Jones

That’s correct. As you plough those revenues in you have got income expenses line item influences that happen to match up with that and one of those is a bad debt impact.

Todd Morgan - Oppenheimer

So then hopefully that’s correct if I add those two members together to get a pro forma bad debt expense. If I do the same process for the prior three quarters you have obviously improved pro forma bad debt expense pretty dramatically. It was 8% at the beginning of the year and now its about 5.5 or so. How much of that is a formulaic improvement and how much of that is really subjective assessment of the receivables quality and what the collections are going to be because that’s obviously a pretty good move?

Dee Jones

Yeah obviously as you look at your income statement you land on a provision rate. There’s a lot of test and activities that go into that but we have seen improvement in actual collections experience. As we move forward, as I mentioned earlier, our day sales outstanding has also shown improvements. All of those influence how you assess the appropriate provision rate in regard to the income statement. So, I am not sure that I can break it down between what’s formulaic and what’s not but it is a function of that we are seeing in regard to our collection activities and our assessment of the base of receivables that we have outstanding.

Operator

Thank you. This concludes today’s teleconference. As a reminder, an archive version of this call will be available on the website at supermedia.com under the investor relation section. You may now disconnect your lines at this time and have a great day.

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