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Executives

Samuel Jones - Chief Financial Officer, Executive Vice President and Treasurer

Peter McDonald - Chief Executive Officer, President and Director

Analysts

Shachar Minkove

Paul Connolly - Southwell

Amy Stepnowski

Andrew Peranick

George Schultze

SuperMedia (SPMD) Q4 2010 Earnings Call February 23, 2011 10:00 AM ET

Operator

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

Some statements made 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 trends 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 reports 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 callers can access the replay by calling (706)645-9291. The replay passcode is 37480660. The replay will be available through March 9, 2011. In addition, a live 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. And now, I'd like to turn the call over to Peter McDonald. Peter?

Peter McDonald

Thank you, Melissa. I'd also like to welcome everyone to SuperMedia's 2010 Earnings Call. We appreciate your time and your interest in our company. When we last spoke, I just joined SuperMedia. During that call, I stressed that I'll be focused on driving sales while maintaining our financial discipline. I indicated that our team will concentrate on profitable products, customers and markets while paying down our debt.

This morning, I will provide you with an overview of the direction we're going to drive profitable sales and maintaining financial discipline. I will turn things over to Dave, who will provide more color relative to our financials. We will then open things up for questions and answers.

Before I provide you with that overview, I'd like to first look back at some of the 2010 highlights. The first being our ability to pay down debt in 2010. In the fourth quarter, we utilized $185 million of cash to reduce the total debt obligation by $264 million under amendment to the term loan agreement. We also used $61 million during the quarter to pay down debt under the mandatory cash sweep. On a full year basis, we reduced total obligations by $579 million, reducing our debt from $2.75 billion to $2.17 billion.

On our full year EBITDA was $651 million, driven by aggressive cost management efforts. This is something that we see continuing in 2011. Finally, we saw improvements with respect to our bad debt, 390 basis points compared to full year 2009. I see this as a sign of an improving economy and a customer base that is getting healthier. We look for further bad debt improvement as we look into 2011.

Now let's turn to the approach we're putting in place. First, during the fourth quarter, I changed sales leadership. We brought in very talented individuals with a long track record of implementing our sales process to derive results. Next, we spent time with our advertisers, our media consultants and our management to better assess what we're doing right and what needed to be improved.

Several points became clear from these discussions. Our focus needed to change from selling a growing portfolio of new products to selling the customer the products that produce the best results for their business. The fact is, the needs of a new landscaper in Tampa are different from an established contractor in Buffalo. The auto mechanic in Dallas is different than the restaurant in New York. Based on this, I worked with key leadership in the various departments to determine the aspects of our current business that needed to change, such as how we train and compensate our sales team. We also looked at changes needed from operations and marketing to support the direction.

We've gained alignment from the board and we've taken our message across the country, meeting in person with every employee. We started in February and have traveled to the Northwest, California, to Chicago and New York. We will be finishing in the next few weeks with meetings in Tampa, Dallas, Philadelphia and D.C.

In these town halls, we talk about sales execution. We talk about aligning our cost structure around the customer base and needs. We discuss the need to pay down debt, the need to stabilize EBITDA. We talk about how the entire company will be approaching the business. We also talk about how we are selling the customer the robust local advertising products that produce the best results for their business. But we are simplifying what we do and how we do it, which will help with cost management.

We explain how we are adjusting our sales compensation to better support and reflect what our customer's needs are, and talk about how we are aligning our marketing efforts to support our sales force and the needs in the marketplace. We also explain to them and share the positive trends we saw in 2010 relative to possession, usage and customer call counts, and how that enhances our value proposition in the marketplace.

At the end of these meetings, our employees provide us with feedback, and I'm pleased to report that the company is embracing and aligning with our plan. We've told our employees that we see this as a long-term multistep plan that includes establishing proven, successful processes and standards that make sure the entire company is aligned and takes ownership with their part of the plan.

In closing, while we are disappointed with our top line results, we believe that focus, execution and expectations can drive upward results. Small and medium-size businesses need us more than ever as the local advertising market continues to fragment. I look forward to sharing our progress in the upcoming quarters.

Again, thank you for your time, and now to Dee.

Samuel Jones

Thank you, Peter, and 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 is referred to as adjusted pro forma. The GAAP result include fresh start accounting implemented in our 2010 reported results which does not provide for 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 full year 2010 results, revenues were $2.002 billion, a decline of 20.3% compared to 2009. Full year EBITDA was $651 million compared to $856 million in 2009, and our 2010 EBITDA margins were 32.5% compared to 34.1% in 2009. As we've talked about before, 2010 continues to reflect some measure of economic recessionary impacts, and as such, we have to maintain a concentration on managing cost as diligently as possible. As Peter mentioned, this will continue into 2011.

Fourth quarter revenues were $468 million, a decline of 18.8% compared to the same period last year. Fourth quarter EBITDA was $151 million compared to $195 million in 2009. EBITDA margins were 32.3% compared to 33.9%. As we have mentioned all year, process improvements and expense reduction efforts had allowed us to partially mitigate the revenue declines.

Full year free cash flow was $464 million and $91 million for the fourth quarter. As Peter mentioned, we were able to reduce our total debt obligation by $579 million in 2010, including the open market repurchase at below par, creating a pretax gain of $76 million. I will go through this transaction in more detail in a few minutes.

Looking at advertising sales for fourth quarter, ad sales declined 15.1%, a 580-basis-point improvement compared to the same period in 2009. This is comparable to results reported for the third quarter as well. Again, I would like to reiterate the timing lag of advertising sales, which flow to the reported revenues in future quarters.

Turning to our EBITDA results in more detail. Total operating expense excluding depreciation and amortization was favorable to last year by 18.4% or $305 million, reflecting gains from efficiencies across all aspects of our selling, cost of goods and G&A functions, including bad debt. With respect to selling expense, we reduced this by 14.6% or $99 million, primarily from efficiency gains and lower expenses associated with those gains.

Year-to-date cost of sales was favorable to last year by 10% or $58 million. This was primarily driven by lower print and distribution volumes as a result of continued efforts to optimize and gain efficiencies across all operational areas.

Our G&A expenses are favorable over last year by 37.2% or $148 million. This was driven by favorability related to our bad debt and a $40 million non-recurring, non-cash benefit associated with the resolution of state tax claims recorded in the second and third quarters of 2010, as well as continued efficiencies from all functions. Excluding the $40 million state operating tax favorability, G&A would have declined 27.1%.

To review the fourth quarter results on a year-over-year basis, selling expense reflected an 8.7% reduction. Cost of sales declined 15.2%, and G&A declined 33.3%. Our full year bad debt was 5.2% compared to our 9.1% in 2009. As Peter mentioned, a 390-basis-point improvement.

Turning now to cash flow. Full year free cash flow was $464 million, net of $45 million in capital expenditures. In the fourth quarter, we continued to delever the business, reducing our total debt obligation by $579 million on a full year basis.

As mentioned, this includes the impact of an amendment that was approved by our debt holders to allow for us to repurchase our term loan in the open market at below par. Under this amendment, we utilized $185 million in cash and repurchased $264 million of the term loan at below par. As I mentioned earlier, this resulted in a pretax gain of $76 million after related expenses.

We also repaid $61 million relative to the fourth quarter mandatory cash sweep, and our cash on hand at the end of December was $174 million. At the end of December 2010, the term loan balance is at $2.171 billion, a reduction of $579 million during 2010, and our net debt is below $2 billion.

Our cash flows and the resulting deleveraging in 2010 were driven by several elements: Strong expense management and resulting EBITDA of $651 million; a federal income tax refund of $94 million received in the second quarter relative to 2009; favorable working capital driven by improved collections; and our ability to defer our 2010 FIT [funds in trust] payment into the first quarter of 2011 based on our FIT estimate payment methodology; and the onetime impacts of fresh start accounting. A tax payment will be payable in first quarter of 2011 relative to our 2010 tax obligation.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from George Schultze of Schultze Asset Management.

George Schultze

I just wanted to ask a quick question about consolidation in the industry. I wonder if you had any thoughts about consolidation in the industry. I know there are a couple of distressed directories companies out there. I know that Dex One is operating post-reorg like you folks are. Do you believe that it makes sense for players in the industry to consolidate to continue reducing cost structure?

Samuel Jones

George, I appreciate the question. We have in the past, talked about the benefits, the potential benefits of consolidation in the industry. I don't believe we view that any differently today than we have in the past. These are somewhat synergistic businesses. We're all in a mode of addressing our expense structure and trying to gain efficiency as much as possible across this industry in light of the revenue trends that we've been facing. Consolidation within the industry would provide for some measure of benefit relative to that and provide for additional opportunities. The key to those types of opportunities is really about the timing being right for the players that may be involved and the perspective of those respective parties and finding the right economics and structures that make sense. We'll always look at opportunities to gain efficiencies within our own business, as well as across the industry as we look forward.

George Schultze

Could you comment on your revenues per employee? Bigger as compared to Dex One?

Samuel Jones

Yes, with respect to -- that question basically goes to margin comparisons against us versus Dex and those sorts of things as well. We did reduce during the year, over 1,000 employees. We're down to about 4,400, That'll get reported in the 10-K that'll get filed later this week. And so we're seeing good gains and efficiencies that manifests itself in our expense levels, with $300 million of reductions. Net of the $40 million operating tax, we took out over $250 million of expense in the business. So we feel like we did a good job of cost management, and we're diligent in that regard, in light of the revenue declines that we were facing. Relative to Dex, there's a number of elements that impact the differential between us and them. Some of which are extraneous and marketplace-driven, and where we operate. Some of which, we need to gain efficiencies and continue to improve and get out our own cost structures. And we're focused on that as we move into 2011.

Operator

Your next question comes from Amy Stepnowski of Hartford.

Amy Stepnowski

I was wondering if you could just comment at all, some other advertising-driven industries saw the fourth quarter revenue tail off in December. Advertising was much more difficult in December versus where it was in November and October, and then January proceeded to be an even more difficult month. Did you guys see any of that within your quarter, or as you look forward?

Peter McDonald

No, I don't think that we saw a tail off. Our trends continue to kind of mirror what we see in the economy, and relative to GDP and relative to employment. I think in our market, in our particular advertising section, is more closely aligned with those. And I think we're seeing consistent trends with those particular factors.

Operator

Your next question comes from Shachar Minkove of JPMorgan.

Shachar Minkove

Couple of quick questions, one on working capital. Obviously, it's been a good source of cash during 2010. In particular, one thing that popped out at me was the accounts payable spiking as it sequentially always does in the fourth quarter. Should we be thinking, should we be expecting some sort of catch up? What was the driver of that this quarter, in particular?

Samuel Jones

Well, as far as the payables, that I mean, typical year-end timing aspect of things moving the numbers there. I think as I look into 2011 with respect to working capital in total, I see it being a little more stable. We got some good favorability in 2010 relative to working capital, primarily from the collection side of the house, as we improved our days sales outstanding and our collections continue to improve. So good story for 2010. I see that being a little bit more stable in 2011 as I look forward. So I wouldn't anticipate that source of cash being as significant in 2011. And in the first quarter, you see a more normal element relative to the payables in that aspect of things. In addition, our federal income tax payment for 2010 will be made in the first quarter of 2011, and that created an opportunity for us from a cash deferral perspective in 2010, that will have to be made up in 2011. And as I look at 2011, our timing of tax payments will be much more normal. So good benefit from a cash flow perspective in 2010. We expect that working capital aspects of things and taxes will return to a more normal level in 2011.

Shachar Minkove

And just to that, I guess, you're alluding to the, I guess, the FIT. How much is that you were able to defer?

Samuel Jones

We'll probably see a payment along the lines of $70 million or so in the first quarter relative to 2010.

Shachar Minkove

Meaning $70 million higher than the first quarter?

Samuel Jones

Yes. We'll have to pay $70 million in first quarter 2011 associated with 2010 tax obligations.

Shachar Minkove

Can you give us a little bit of insight into how you're seeing pacings going in, I guess, we're now pretty much through a big chunk of the first quarter?

Samuel Jones

Yes. With respect to the first quarter, as we look at it versus the first quarter of 2010, and I do expect some measure of improvement in ad sales relative to first quarter of 2010 when we report the first quarter 2011. Because of the mix in markets that we deal with in the first quarter, if you recall in 2010, or look at the chart with respect to 2010 first quarter, was sort of the valley in regard to our ad sales results. And so we do have a little bit more challenged set of markets in the first quarter. But I do expect a measure of improvement against the first quarter of 2010. Maybe not quite as much as what we saw in the fourth quarter, but I am looking to see improved ad sales year-over-year in the first quarter.

Operator

[Operator Instructions] Your next question comes from Paul Connolly of Southwell Partners.

Paul Connolly - Southwell

Do you have an idea what your tax rate is going forward for 2011?

Samuel Jones

Yes. I mean, we're pretty much a cash tax payer. We don't have a significant shield of any sort. It'll be in the 37-ish range.

Paul Connolly - Southwell

And then just following up on what you were just saying, looking for improvement in ad sales in the first quarter, is the natural gross number higher this next quarter?

Samuel Jones

Are you referring to year-over-year first quarter 2011 versus -- 2011 on a sequential quarter basis, I do not expect improvement in that trend when I look at first quarter because of the mixed markets and the dynamics that play there. Foreign markets are a little heavier influence, we're seeing economics down there. They're still continue to be challenging along with a couple of other markets in the mix that will probably mitigate the degree of improvement we'd like to see in first quarter. But I do expect to see year-over-year same-market comparison type improvement when we look at first quarter results.

Operator

Your next question comes from Hondo Sen [ph] of Fides [ph].

Unidentified Analyst

Could you give a little color in terms of what you saw in customer accounts? Specifically, some of your largest versus smaller accounts and how that trended over the quarter?

Samuel Jones

With respect to full year, we'll support client counts in the 10-K when we file it on the end of this week. It's going to reflect probably a 14% to 15% decline year-over-year in client counts. Retention running fairly consistent with last year in the very low-80% range as far as retention. Our focus as we move forward is around renewal and improving those trends as far as retention is concerned. We did see the loss of clients across all the sectors or pieces of the client segmentation that we would do, large clients, medium and small. Albeit probably the lower-end clients seeing more of the decline than the upper-end clients in client count. But when the big spenders -- when we see cancels in the big spenders, it's tougher to make up. But the good news is that with the big clients, you see more decreases than you do necessarily outright cancels. So you're looking for the opportunity to bring those programs back as we move forward.

Operator

Your next question comes from Andrew Peranick of BTIG.

Andrew Peranick

Just a follow-up on the last comment you just made. Can you speak a little more as to -- amongst the diversity of your customers, what you're seeing in terms of the spend for your larger customers versus your smaller average spend customers?

Samuel Jones

Yes, I mean decreases is more impactful at the upper end of clients. Our average value per order did decline slightly in the period and the total year. But I wouldn't say that was a dramatic impact as far as an average value per order. It was a mixed bag as far as high-end customers versus low-end customers, but we did more decrease at the high-end than we did at the low-end, albeit their programs are bigger, they have more room to make adjustments. You see more of an influence of credit and cancellation rates in regard to the low-end clients.

Andrew Peranick

In your conversations with your larger customers, have they mentioned about maybe increasing their spend in 2011?

Samuel Jones

Yes, that's a mixed bag. I mean I think we've got a set of clients that certainly are true believers in this product. They've seen improved call counts, we see the effects of some of the things that we're doing is further possession and usage and those sort of things. It's up to us to get that value proposition, the story out there, and start driving improved programs. So you get a mixed bag.

Andrew Peranick

You mentioned earlier that you still see some negative economics in Florida. Can you maybe talk a little more just geographically about where there might be some areas of strength versus where you're still seeing some weakness?

Samuel Jones

We do have a set of markets that are improving a little bit faster. One thing I do want to clarify, we have seen improvement across all the markets. It's just a certain of them are lagging as to the degree of improvement, Florida being one of those. Our downstate New York, markets continues to be a little bit challenged as well. But midwest markets are -- upstate New York markets, those areas seem to be leading as far as being able to come out of this. California markets also seem to be gaining some level of traction.

Andrew Peranick

I know you spoke a little bit about kind of trends you're seeing so far in the first quarter. Are you planning on changing your stance on kind of giving guidance on investor day? Some of your competitors have started to give a little more transparency in terms of some different measures to look at the top line as well as some EBITDA guidance and cash flow guidance?

Peter McDonald

As we've talked about in the past, it hasn't been our policy to provide guidance. In the present, we're not looking to change that. We do provide guidance, our ad sales as a forward-looking measure. We talked about possession, usage and those elements. But ultimately, you have to be able to monetize those statistics. And ultimately, our view is that perform a test to derive the value of this enterprise, and that's where our focus resides right now. So I don't look to change dramatically the policy with respect to guidance at this point.

Andrew Peranick

And so then I guess that the last, if you will, kind of guidance numbers that were out there were relative to your bankruptcy projections last year. I assume they're no longer valid?

Samuel Jones

Yes. I mean you can see from our results and how it formed against [indiscernible]. We're at a new base, a new point, and so I wouldn't look to those very heavily.

Andrew Peranick

One final question on costs. With kind of some of the turmoil we're seeing in some of the commodity markets, especially oil and gas prices at $4 pumping and getting higher. How should be thinking about distribution expense in 2011 versus 2010?

Samuel Jones

Yes, our contractual distribution expenses, for the most part, outsourced with partners that I've worked with, some very well and very effectively in establishing the rates as we look forward. And I don't see significant change in that in 2011 as far as our rates for distribution.

Operator

Your next question comes from Matthew Aronski [ph] of Citigroup.

Unidentified Analyst

If you guys continue to generate cash in 2011, would we expect you to do another tender offer?

Samuel Jones

As you know, with respect to the amendment that we put in place with our lender group that we're able to execute on in December. It was essentially an opportunity to utilize up to $185 million of cash as that amendment was written, and we were able to successfully utilize that full amount. So absent an additional amendment relative to that term loan agreement, we wouldn't have the capacity to make such a tender offer. And in addition to that, we'd have to -- we utilized a good amount of cash in 2010 relative to that activity. And so you would want to have to build enough cash to create a meaningful impact there. So we're looking forward, but without an amendment, and with wanting to build cash sufficient to make a meaningful play there, I wouldn't see that in the very near term.

Unidentified Analyst

But as you go forward through 2011, if you've built up that cash, it's something you could potentially do?

Samuel Jones

I mean, sure, we've got cash with requirements they're going to take, as you know, the normal amount of cash out relative to at-par paydowns, but as we build cash, we look at all alternatives to maximize the efficient use of that cash.

Operator

[Operator Instructions] Your next question is a follow-up from George Schultze of Schultze Asset Management.

George Schultze

I wondered if you could please comment on opportunities for growth in the online business? Or also, in something like a partnership, or something with somebody like Google or otherwise?

Peter McDonald

Sure, George. I think when it comes to the online area of our business, we are very well positioned because of our relationships in our -- I think our best asset is our sales force. And so we're actually looking at all different platforms because the way we look at it is, although YellowPages is the core of our business, we believe that the local advertiser needs to be able to have the options of every available digital product out there. So we look at this as probably, in the coming years, as the key driver to much of our growth.

George Schultze

What kind of growth do you expect going forward in that regard?

Samuel Jones

Yes, George, as we've talked about before, we haven't broken out internet and digital products because we see it as another medium, but we also don't provide guidance in that regard. And regard to your question is, as to partnerships, we're certainly open to and always looking at partnerships that make sense for our position in the marketplace and in providing value to our advertisers.

George Schultze

And do you currently have any deals that you currently operate under with Google?

Samuel Jones

Well, we have relationship with Google. It's been in place for a period of time. And we view them as an important partner for us in providing a robust, complete offering to our client base.

Operator

Your final question comes from Sam Sakain [ph] of ALJ Capital Management.

Unidentified Analyst

Just following up with the question about the online. You guys used to put out numbers with unique visitors to the site. Do you guys no longer do that? Or is there any way we can get some numbers on that?

Samuel Jones

Well, there [indiscernible] numbers with respect to the broad industry and regarding unique visitors, it's not necessarily always indicative. But in the 10-K, we'll probably report -- I think for the last report that came out, was around 35 million unique visitors across the Superpages.com network. That's mostly to rank -- we rank pretty well in regard to unique visitors with our Superpages.com network.

Samuel Jones

Thanks, everyone. We appreciate the questions and answers.

Operator

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

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