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R.H. Donnelley Corporation (RHD)

Q2 2007 Earnings Call

July 26, 2007, 10:00 AM ET

Executives

Jennifer L. Apker - VP and Treasurer

David C. Swanson - Chairman and CEO

Steven M. Blondy - EVP and CFO

Peter J. McDonald - President and COO

Analysts

Peter Salkowski - Goldman, Sachs & Co.

Karl Choi - Merrill Lynch & Co., Inc.

Jeffrey Shelton - Natexis Bleichroeder Inc.

Mark Bacurin - Robert W. Baird & Co.

Michael Meltz - Bear, Stearns & Co. Inc.

Paul Ginocchio - Deutsche Bank Securities Inc.

Lisa Monaco - Morgan Stanley & Co., Inc.

Anthony J. DiClemente - Lehman Brothers Inc.

Frederick Searby - J.P. Morgan Securities Inc.

Presentation

Operator

Good morning ladies and gentlemen. Welcome to the R.H. Donnelley Second Quarter 2007 Results Investor Teleconference. At this time all participants are in a ¦listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. Please note that today's teleconference is being recorded as well as webcast live over the company's website at www.rhd.com. I would now like to turn the call over to Ms. Jennie Apker. Ms. Apker, you may begin.

Jennifer L. Apker - Vice President and Treasurer

Thank you and good morning everyone. I am Jennie Apker, Vice President and Treasurer at R.H. Donnelley. Hosting the call today are Dave Swanson, Chairman and Chief Executive Officer of R.H. Donnelley and Steve Blondy, Executive Vice President and Chief Financial Officer. Peter McDonald, President and Chief Operating Officer, is also on the call.

Certain statements made today may be forward-looking within the meaning of the Private Securities Litigation Reform Act. We call your attention to our press release for the quarter ended June 30, 2007 and the company's 8-K furnished to the SEC this morning, both of which discuss second quarter results. We also encourage you to review the company's other periodic filings with the SEC which set forth important factors that could cause actual results to differ materially from those contained in or suggested by any forward looking statement. Copies of R.H. Donnelley's SEC filings may be obtained by contacting R.H. Donnelley, searching its website at www.rhd.com or visiting the SEC website at www.sec.gov.

This transmission is the property of R.H. Donnelley Corporation. Any retransmission or broadcast with out the express consent of the company is strictly prohibited. To avoid confusion, we will use the term Dex to refer to our unified market brand and the term Qwest markets to refer to our 14 Western sate regions.

During today's call, we will focus on 2007 GAAP results and call out specific purchase accounting impacts rather than reporting adjusted results. Some of the items that will be discussed are non-GAAP financial measures. Also, today's references to EBITDA are before FAS 123 expense. You can find additional information about these non-GAAP financial measures as well as a reconciliation between these items and the most comfortable GAAP measures in the press release and related 8-K furnished to the SEC this morning. The press release is available on our website and can be accessed by going to www.rhd.com and clicking on Press Releases. Please review the risk factors described in the Safe Harbor language.

Now, I would like to turn the call over to Dave Swanson.

David C. Swanson - Chairman and Chief Executive Officer

Thank you, Jennie. Good morning everyone and thank you for joining us today. Before getting to our second quarter results, I would like to spend a few minutes on today's announcement that we have entered into an agreement to acquire Business.com, one of the leading business search engines and directories and pay-per-click networks for $345 million.

Over the last two years, we have been acquiring assets and building capabilities to help us take advantage of the huge opportunity that we have to leverage our brands, our content, our sales force and our servicing infrastructure to build a leading online and offline local commercial search business.

We started with the Dex acquisition where we gained one of the leading IYP [Internet Yellow Pages] players obviously in addition to a great directory business, with leading market share and usage in the 14 Qwest states. We followed that with the acquisition of LocalLaunch! that gave us a leading search engine marketing platform and capability to help small businesses get found efficiently and effectively on the major search engines and other tier 1 sites.

Today's announcement of Business.com builds on our plans by bringing us a leading destination site in a fast growing and profitable business in the b-to-b online media and search vertical. It also brings R.H. Donnelley some of the very best minds and technology for implementing important revenue and margin enhancing capabilities to our DexKnows.com asset and Triple Play product offering. These include a proprietary performance-based advertising platform and corresponding ad network capability. This will allow us to improve margins by provisioning search engine marketing advertisers on our own sites and partner sites first as opposed to just the major search engines. It will also make us more attractive to national advertisers and other businesses by better aligning our site to the way that these advertisers are used to buying online media.

Next, we get the capability to provision partner advertisers on DexKnows.com. This will allow us to better monetize site traffic from out of our footprint and will also create a more competitive bidding marketplace on the site; again, enhancing revenue. We get the ability for an advertiser to sell provision on a platform. While we don't believe that the average small and medium-sized business is going to do much self provisioning, this platform does enable national advertisers, agencies and network partners to efficiently purchase advertising on our site. And finally, we gain some enhanced web 2.0 functionality that can be used for ratings and reviews, expert-generated content strategies and much more.

This acquisition also advances our timetable for deploying these value add capabilities by at least 14 months over our original plans. Business.com is headquartered in Santa Monica, California and currently employs about 100 people, many of which are highly skilled technologists and strategists. The leadership team has a combined 70 years of experience building and running leading Internet companies. Revenues are expected to exceed $50 million in 2007 and they currently have about 6000 customers.

Jake Winebaum, Business.com's Founder and Leader is a very highly regarded Internet executive and has been acknowledge by Time Magazine as one of the Top 50 Cyber Elite and by Wired Magazine, who counts Jake as one of the Wired 25. Before founding Business.com, Jake led the Internet activities at Disney and managed high profile sites like Disney.com and ESPN.com. Upon closing, which we expect to occur some time in the third quarter, Jake will assume responsibility for all of RHD's interactive assets, strategies and activities as President of RHD Interactive reporting to me. Jake's vision, leadership and wealth of experience running successful Internet and media operations will have an immediate impact on our Interactive unit.

George Bednarz, who has done a superb job of building and leading RHDi was instrumental in developing the plans to acquire Business.com. George will serve as an advisor to Jake for the next several months and will eventually then transition into a leadership role at R.H. Donnelley.

With that, let me switch gears and review the results for the second quarter. I am pleased to report that we have capped off a solid first half for 2007. In the quarter, we continued to deliver strong financial results while at the same time executing on a number of milestone initiatives around our interactive strategy, our brand launch, our systems integration and modernization and the process of rolling out and selling our Triple Play product and service offering in the market.

Ad sales were positive in Q2, growing 0.2%, which represents about a 360 basis point improvement from the second quarter of last year. The AT&T markets led the way this quarter with significant improvement in the Chicago consumer print product performance and very strong digital product sales. EMBARQ markets contributed to the quarter with a slight gain, which is an improvement over Q1, but not the normal robust growth that we have come to expect from these markets. We continued to feel the temporary effects of the new systems and sales force automation project but also the economic fall off from the soft real estate market in Florida.

Qwest markets showed a slight decline in the quarter as a result of a couple of large markets under performing. Small and mid-sized markets continued to show improvement with many posting very nice gains. We are confident that once we are able to offer our LocalLaunch! search engine marketing solutions into the large Qwest metro markets, we will begin growing these larger markets as we've demonstrated in Chicago.

So at the halfway mark of the year, I would summarize our ad sales situation like this. The work we have been doing to improve both AT&T and Qwest market performance are working and both are on or ahead of plan. EMBARQ markets are performing below what we expected and could end up down slightly for full year 2007. The well publicized housing market issues and the influence it's having on the mortgage, real estate and home improvement-related categories is the biggest issue constraining our results right now. While the vast majority of our markets across the U.S. aren't really being dramatically affected, the ones that are, especially in Florida and Nevada are markets that have provided much of our growth over the last few years. So the impact is being disproportionately felt.

Finally, in the first half, sales from our digital products grew significantly in the first half of the year and we are very encouraged by that given that we had not yet rolled out DexKnows.com in the EMBARQ or AT&T markets and had only rolled out our LocalLaunch! search engine marketing products in Illinois and Orlando.

Looking at the second half of the year, we anticipate continued headwinds from this real estate and home service categories. And this will be particularly evident in Q3, due to it being a relatively small quarter and heavily weighted by the Las Vegas and Southwest Florida markets that are getting hit the hardest. We'll fell some impact in the AT&T markets from the conversion to our new systems in the Q3 results as that was all occurring while we were working our Q3 campaigns. We expect it to be less of an issue and the impact shorter in duration than what we experienced in EMBARQ.

On the positive side, we should see some lift in Q4 from the EMBARQ and AT&T rollout of our DexKnows.com product and our LocalLaunch! search engine marketing products in the Qwest and EMBARQ markets.

So we have a mixed bag in the second half. The bottom line: we have a lot of things moving in a very positive direction and exceeding our expectations. But as a result of more drag from the EMBARQ business this year, it's going to be a close call whether or not we end up hitting our goal of positive ad sales growth this year. That said, we remain very bullish on Triple Play and what this new suite of products and services means to our longer term growth prospects, particularly with the addition of the benefits from Business.com.

With that, I will turn the call over to Steve.

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Thanks Dave and good morning everyone. We continued to make progress on our deliver and delever goals in the second quarter. Here are the financial highlights. One, we delivered consolidated ad sales growth with healthy performance in our AT&T markets particularly gratifying. Two, we delivered strong EBITDA of $348 million after $8 million of purchase accounting impact and another $8 million of FAS 123 expense. And three, we delevered by $154 million while still investing in growth initiatives, especially on the branding and digital fronts. These highlights evidence another strong quarter and support our full year 2007 financial guidance.

Moving to the details, Q2 ad sales of $729 million grew 0.2%, representing tremendous improvement from our 3.4% decline in Q2 last year and further progress from Q1. EBITDA margin excluding the impact of purchase accounting and FAS 123 expense was 54.5% versus 55.1% in Q1. The lower sequential margin reflects strategic investments including increased sales training, new companion directories, the DexKnows.com launch, our new SEM product introduction, IT integration costs and new advertising. Second half margin will be further impacted by additional advertising to support the Dex market brand and DexKnows.com across our footprint as well as continued investment in our growing IYP and SEM solutions to extend our advertisers' reach.

In Q2, we paid $157 million of cash interest. Total interest accrued in the quarter was $199 million including the purchase accounting credit of $8 million, pick interest of $17 million and deferred financing cost amortization of $5 million added up [ph] and we converted 40% of EBITDA into free cash flow of $146 million in Q2 even after $24 million of CapEx and $36 million in working capital investments, both of which ramped up from last quarter. Working capital investment and deferred commissions, print and delivery costs reflects some seasonality of our publication cycle in the quarter while CapEx reflects higher IT integration costs. These two factors lead us to update the elements of our full year cash flow outlook that I will cover shortly.

Switching to capital structure. In Q2, we repaid $154 million of net debt, excluding pick interest and the purchase accounting fair value adjustment. That brings net debt at June 30th to $9.8 billion excluding the residual $181 million of fair value balance. Our weighted average pre-tax cost of debt was approximately 8.1% and our weighted average after-tax cost to capital remains around 7.5%.

On the refinancing front, we are monitoring the markets as call days on high coupon bonds approach in Q4 to be opportunistic about timing. Fortunately, we can afford to be patient for an accommodating market window. Meanwhile, we continue to repay borrowings from cash flow and as we've repeated, we'll be more specific about when and how we'll return capital to shareholders as we approach our leverage target of high 5s.

Before wrapping up, a brief word from a financial perspective about the Business.com deal. For a relatively modest and positive NPV investment, we are acquiring three key assets: a growing and profitable b-to-b site and ad network, world class technology and talent to accelerate and enhance our Triple Play rollouts and a strong leadership team with a proven track record and a bold vision for growth. Taken together, these assets position us to achieve the higher end of our 2% to 4% corporate growth objectives, a very good trade for under a quarter turn of leverage. The acquisition is fully financed and we'll provide further details regarding pro forma impact and synergies after the deal closes.

Turning back to '07 guidance and excluding the pro forma impact from Business.com, we are affirming all other metrics last communicated. However, we are updating our expectations for the components of free cash flow below EBITDA. We now expect cash interest paid of $725 million, a savings of $20 million versus previously due to lower average debt balances during the year. CapEx will be approximately $80 million, an increase of $10 million due to higher IT investment to support integration initiatives, and working capital and other changes in assets and liabilities will consume $20 million, an increase of $10 million from previously. As a result, our expectations for net debt excluding the fair value adjustments and before the Business.com financing remain at approximately $9.5 billion or 6.5 times leverage at year end.

In conclusion, we are on track to achieve our performance goals in 2007 while investing generously to grow the business. We continue to deliver strong recurring revenue, robust EBITDA and valuable tax benefits that translate to strong free cash flow and shareholder value creation.

That concludes our prepared remarks. Operator, we are now ready to take questions.

Question And Answer

Operator

Thank you, sir. At this time, we would like to begin the question and answer session of the conference. [Operator Instructions]. The first question comes from Mr. Peter Salkowski with Goldman Sachs. Sir, you may ask your question.

Peter Salkowski - Goldman, Sachs & Co.

Great. Thank you very much. Good morning everybody. Dave, I was hoping you could kind of go into a little more detail in terms of how the launch of the DexKnows is going. I know it's quite early, but just to kind of get a sense for how that's playing out in the non-Qwest areas. You said you had moved it into Las Vegas at this point. And then also maybe give a sense of how much marketing you've kind of spent at this point and if the actual cases are still due [ph]. I believe it was incremental $30 million in the second half of the year to support that launch.

David C. Swanson - Chairman and Chief Executive Officer

Yes, hi Peter, it's Dave. So, the launch of DexKnows, we are fully launched in 14 Qwest states as you know, and that's going well. We are really hitting it hard with the advertising support in Qwest and we are happy there. In terms of the others, we have rolled out the brand in Las Vegas, I believe, is to date the only large one. The site isn't actually up. We haven't loaded the data for use yet, but we are actually selling the DexKnows product in Las Vegas at this time. So it's still... we are still pretty early in that process and that will just kind of continue to build as we go through the year, Peter. So it's kind of going to leak [ph] its way in, it's like over the second half. In terms of the advertising support, Steve may have more detail, but we still fully intend on spending the full $60 million. And because of the way that we are rolling it out in AT&T and EMBARQ, it's like it's by nature going to be a little bit more back-end loaded but all things are on plan.

Peter Salkowski - Goldman, Sachs & Co.

And then if we could talk a little bit more about the Business.com acquisition. I know the press release mentioned cash and deferred purchase accounting or purchase considerations. Do you think you can talk a little about how much cash there might be versus the deferred part? And then I am assuming the deferred part is sort of an earn-out situation. Any sense over what period of time the management and senior people at Business.com are locked in for?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Hey Peter, it's Steve. So, and just to put a finer point on the advertising, in the first half $17 million invested in advertising; it was $7 million in Q1 and another $10 million in Q2. And so the back half of the year will be the balance of the $43 million. On the Business.com, we haven't broken out the details of how much it is cash versus deferred, but we do have a fairly strong retention program in place that will keep these folks focused on our sort of combined business objectives over the next three years. And we think that's a pretty decent amount of time for us to make the kind of progress we need to.

David C. Swanson - Chairman and Chief Executive Officer

And one other thing I would add to that, Peter, I think the fact that Jake is really enthusiastic in my conversations with him over the last several months, Jake is very enthusiastic over taking a larger role in RHD's overall interactive point [ph] is also a very good sign. He sees the opportunity in what we are going to be able to do and how to leverage some of the assets that they bring to the party against the bigger business. So I think all of that bodes well for the longevity here.

Peter Salkowski - Goldman, Sachs & Co.

Yes, I mean obviously, it seems like it was a build versus buy strategy for you guys with regards to Internet and the same with media, the route which you took. I know you mentioned doing a 14... speeding up your timeline by 14 months.

Unidentified Company Representative

Yes.

Peter Salkowski - Goldman, Sachs & Co.

Lastly, and then I'll let others ask questions. Just finally on the real estate, I know you mentioned it in your call and also in the press release. Just a sense I guess you can give like what percentage of revenues sort of get impacted by the real estate and are you really just seeing people not buying advertising or are you seeing out of... people going out of business that are related to the real estate area and therefore no longer in the books or paying for their advertising on a going forward basis? What is sort of the overall impact and how long do you think it will take before this kind of shakes out?

Peter J. McDonald - President and Chief Operating Officer

Peter, it's Peter McDonald. How are you? The biggest impact that we have seen, as we have said, is really Vegas and Florida. And when you look at the rest of the country, the housing permits is something to look at. The rest of the country is about a negative 10 in terms of housing permits, which affect real estate mortgages, home improvements. Give you an idea of the impact in Vegas, it's like 34% and if you look at Florida, it's down like 28%. So that's why we are feeling a little bit more pain than the other places. In terms of the headings, it's a few percentage points in each of those markets, but it's enough to cause us some short-term pain with this economy.

Peter Salkowski - Goldman, Sachs & Co.

I appreciate it. I'll open it up for others.

Operator

The next question comes from Mr. Karl Choi with Merrill Lynch. Sir, you may ask your question.

Karl Choi - Merrill Lynch & Co., Inc.

Hi, good morning. A few questions here. According to the Journal, the cash flow for Business.com is around $15 million. I wonder if you can confirm that. And does this acquisition push out your ability to pay cash dividend?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Hey Karl. We are not providing financial performance information on Business.com other than to say revenues north of $50 million this year and the company is profitable. So can't confirm what the Journal printed. As far as dividends go, as I mentioned, less than a quarter turn of EBITDA in terms of leverage. So maybe it delays our ability to pay a dividend by a quarter or two at the most.

Karl Choi - Merrill Lynch & Co., Inc.

Okay. And with this acquisition, do you feel like you have all the major pieces with respect to your digital strategy or do you think you need to make another maybe platform like acquisition?

David C. Swanson - Chairman and Chief Executive Officer

Karl, we got a lot in this acquisition. It's one of the things that really attracted us to it in addition to just the great fundamentals of the business itself. We got an awful lot of the technology and platform capabilities that we needed for DexKnows.com.

Karl Choi - Merrill Lynch & Co., Inc.

And lastly, is there any plan to replace DexKnows with Business.com or are you going to have both brands?

David C. Swanson - Chairman and Chief Executive Officer

Our plans are to operate both brands.

Karl Choi - Merrill Lynch & Co., Inc.

Great. Thank you.

Operator

The next question comes from Mr. Jeff Shelton with Bleichroeder. Sir, you may ask your question.

Jeffrey Shelton - Natexis Bleichroeder Inc.

Thanks. The acquisition of Business.com, does this indicate that you are thinking more of a national strategy for DexKnows?

David C. Swanson - Chairman and Chief Executive Officer

Well, Jeff, it's a great question. It's one that we banner about all the time and we look at based on if we believe it's like that we can add incremental EBITDA and revenues. By doing that, it's like then that's the strategy that we may likely deploy. But I wouldn't necessarily connect the dots but this acquisition takes us down that road.

Jeffrey Shelton - Natexis Bleichroeder Inc.

Okay. And how long do you think it would be before you were able to introduce a PDA platform on DexKnows given the acquisition?

David C. Swanson - Chairman and Chief Executive Officer

It will kind of vary over the course of it. There is different components of PBA that we'll introduce. Just getting performance-based ads on the gutter and on the side is a fairly quick execution, but there is other much more sophisticated components of PBA that will be introduced like over the next 8 months, something like that.

Jeffrey Shelton - Natexis Bleichroeder Inc.

Okay. And last question, you indicated that the quarter you had strong online performance. Are you able to break out either in absolute dollar terms or let's say growth year-over-year?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Yes, you know what, Jeff, it's like you know how I've avoided doing that because I just think that it abdicates on our responsibility to grow the business. And so I avoid doing that. I'd love to get everybody excited by the amount of growth that we are seeing there, but I just think it's taking you down the wrong path.

Jeffrey Shelton - Natexis Bleichroeder Inc.

Okay, thank you.

Operator

The next question comes from Mr. Mark Bacurin with Robert W. Baird Company. Sir, you may ask your question.

Mark Bacurin - Robert W. Baird & Co.

Hi, good morning. A couple of things. First on Business.com, Steve, I appreciate you are not going to sharing the financial metrics, but over $50 million of revenue. Can you give us any sense of how fast that's growing?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Well, I think there was a number that was published last year by Inc. magazine that indicated that their '06 revenue was in the $30 million range or high 20s or something. And that number is probably not far off.

Mark Bacurin - Robert W. Baird & Co.

Okay, that's all organic without any [ph] acquisitions?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Correct.

Mark Bacurin - Robert W. Baird & Co.

Great. And then just on the financing, as you said, the funding is a couple of quarters of free cash flow. Is there anything in the debt covenants that do you have to get waives with regard to mandatory deleveraging because this will obviously slow down your ability to pay down debt?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

No. We have been making voluntary prepayments. We are way ahead of any kind of covenants along that line Jeff. But just to clarify... I am sorry, Mark... just to clarify, I said maybe it's up to a quarter turn. So it's not... I wouldn't say it's a couple of quarters; I'd say maybe it's a quarter or two.

Mark Bacurin - Robert W. Baird & Co.

Okay. And then just one of things you highlighted here was the fact that you are actually picking up a technology platform and it was a build versus buy decision. Should we read into that there we should see some pretty meaningful reduction in CapEx in the out years given that this would be a fairly large technology investment that you would have had to make internally?

Unidentified Company Representative

Yes, I think that's probably a fair question. This doesn't tend to be a very capital intensive business. So I don't think that we'll see it necessarily in the CapEx numbers, but I think where it will more likely show up is in the margins.

Mark Bacurin - Robert W. Baird & Co.

Okay. And then just a couple of other quick ones. In the past you've talked about the cost to achieve synergies related to the Dex acquisition and what the actual synergies being recognized are. In my understanding, you've obviously got some incremental ad spending going on this year, but can you give us any update with regard to that kind of $50 million number you've thrown historically?

Unidentified Company Representative

What we said Mark was $75 million of costs to achieve over the three year timeframe and last December we updated the synergy number from $50 million of synergies to 75 by the end of the third year. And I think we are still hanging on to that. We'll give you a full synergies update I think probably same time again this year, probably in New York in December.

Mark Bacurin - Robert W. Baird & Co.

Okay. And then just last, real quick on the Dex, last year you guys had the billing issues and there were some credits that had to be issued. And seemingly, I think you should have a pretty good... or easier comps I should say in the back half of this year. I was just wondering when do we actually start to see those easier comps and whether that is factored into your growth expectations.

Peter J. McDonald - President and Chief Operating Officer

Mark its Peter, you're right, last year we were doing with lot of claims and other issues there in Dex and we have pretty much have those behind us. We are seeing significant number of the Dex markets grow they are recurring revenue moving in the right direction and we continue to be optimistic about all of the activities taken place with integration.

Mark Bacurin - Robert W. Baird & Co.

So Peter, do we not incrementally easier comps from them I mean and we get the easier comps I guess at this point or is there still easier comps in the back half for the year?

Unidentified Company Representative

I mean as we are moving in the right direction. You know in the last four quarters we continually improved you know over the prior year. Then Mark just on the customer service side, on the claims and adjusted side we are going to start to see dramatic improvement in the back half of this year from last year because that's a differed and amortized expense for us.

Mark Bacurin - Robert W. Baird & Co.

Right.

Unidentified Company Representative

So the cash benefits, we are already seeing, you're going to start to see that show up in the revenue realization in the back half of the year.

Mark Bacurin - Robert W. Baird & Co.

Okay, perfect. Thank you.

Operator

The next question comes from Mr. Michael Meltz with Bear Stearns. Sir, you may ask your question.

Michael Meltz - Bear, Stearns & Co. Inc.

Hi, I think I have four questions. Dave, just to clarify, you're talking about Q3, and I understand it's seasonally small. With ad sales flat for the first half and you're saying you still hope to grow for the second half, can you just talk a little bit about how bad are you thinking Q3 will be just to put it in perspective for us? And then related to that, Steve, on the EBITDA side you're essentially saying $700 million of EBITDA in the second half. Can you give us a sense as to how you're thinking about Q3 versus Q4, then I have two follow ups?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Well, let me go first here. We have been kind of... we are [indiscernible] offering guidance on a quarterly basis, but clearly, our EBITDA was strong in the first half of the year and... give you a sense here... I've got some numbers. I think to hit our 14.40 guidance for the back half, the first half we did 7 in the quarter, so the back half would be 7.15 if you just do the math.

Michael Meltz - Bear, Stearns & Co. Inc.

Yup, I was subtracting options, but yup, I hear you. And so --?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

That's before FAS 123R. The FAS 123R charge was lower in the second quarter than in the first quarter.

Michael Meltz - Bear, Stearns & Co. Inc.

Which quarter do you think will be bigger in terms of EBITDA?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

I'm not going there. I think that you should expect it to be fairly stable, though, because the way we deal with deferred amortized revenue is... the only think I'd say is that the bulk of the advertising expense that we put into place, or the investments into place in the back half of the year is likely to come more in the fourth quarter than in the third quarter.

Michael Meltz - Bear, Stearns & Co. Inc.

Okay. On the ad sales side, Dave?

David C. Swanson - Chairman and Chief Executive Officer

Mike, I think I have telegraphed the thing pretty darn good compared to the forward visibility you get out of most people. It's as simple as Q3 is going to be tough, Q4 is going to have to be a good quarter. But there is nothing dramatic here, but it's just that simple.

Michael Meltz - Bear, Stearns & Co. Inc.

Okay. A question, Steve, just to clarify, you said the leverage could delay your dividend by a quarter or two your ability. Can you just... I don't understand why it would delay your ability. I may delay your decision. Can you just clarify that?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Yes, I think that from a sort of a target leverage point of view, we have said high 5s; we otherwise expected that we would be there by the end of next year. We'd be below 6 times leverage by the end of next year and this might delay us by a quarter. So if we were going to start paying out dividends sooner than when we reached our target leverage, as I said, that we would consider doing, we've been considering what the right approach there is that we are going to stick to that. That's our policy framework that it might delay us by a quarter.

Michael Meltz - Bear, Stearns & Co. Inc.

Okay. And on Business.com, in terms of the business growing this year, doubling revenues this year, and it has 30% margins, what type of growth rate ballpark should we be expecting going forward? Conceptually, is this a 20% grower or do you think this is a 50% grower?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

We are not providing guidance on 2008 or forward years at this point Michael, so please stay tuned.

Michael Meltz - Bear, Stearns & Co. Inc.

Great. Thank you.

Operator

The next question comes from Mr. Paul Ginocchio with Deutsche Bank. Sir, you may ask your question.

Paul Ginocchio - Deutsche Bank Securities Inc.

Thanks. Just two questions. First on Business.com, did you look at maybe joining other people sort of national Yellow Page or local search platforms and sort of what led you to make a decision to try to build your own instead of again, maybe joining up with something that's already established? And then second on sort of maybe some of those markets that are having more issues... if you take Minneapolis for instance, is Minneapolis a personnel-related issue or is it a market specific issue or how should we think about some of the issues at the bigger markets? Thanks.

David C. Swanson - Chairman and Chief Executive Officer

I'll start and then I will hand it over to Peter. Paul, it's like we are always looking and talking to everybody about all the different options out there. And our decision to buy versus partnering there is we wanted control over the PDA platform, and that technology and we felt that that was very important. And in the final analysis, we felt like the financial characteristics of the acquisition would be better for us due in part to the potential for synergy realization between Business.com and our core business. And we just pick up resident in the company some very critical core competencies and thought leadership. And all in, it's the best decision that we could find out there. So we are very comfortable with that.

Peter J. McDonald - President and Chief Operating Officer

Paul, it's Peter. Relative to large markets, I think we are encouraged when we look at Chicago as a large market where we have been able to put in our Triple Play. Large markets are different from small and medium-sized markets in that I think the advertisers have a lot more opportunities to purchase advertising in many different ways. And it's probably the biggest thing that we come up against, and I think that we are very encouraged by what we've seen in the large market of Chicago when we introduced the entire Triple Play.

Paul Ginocchio - Deutsche Bank Securities Inc.

So. In some of the markets you are currently in that are struggling, that are outside of Florida and Nevada, what do you think it takes to sort of turn those and does it take as long as it does to turnaround Chicago? Thanks. That's it.

Peter J. McDonald - President and Chief Operating Officer

No, it won't... I don't see it taking as long. There are different issues. We had to do some product, print product issues in some of the Illinois markets that are different than we have in the Dex markets. And so I don't see it as the same, but once again, we haven't rolled out the full Triple Play in the... with our new LocalLaunch! product in the Dex markets.

Paul Ginocchio - Deutsche Bank Securities Inc.

Thank you.

Operator

The next question comes from Ms. Lisa Monaco with Morgan Stanley. Ma'am, you may ask your question.

Lisa Monaco - Morgan Stanley & Co., Inc.

Good morning. Peter or Dave, if you could just give us some perspective on previous economic cycles, particularly when real estate is a big factor. Kind of how long does it take advertisers to, I guess, their spending habits to change on the downside and then pick back up? Thanks.

Peter J. McDonald - President and Chief Operating Officer

Lisa, I'm trying to think of... I mean this probably one of most severe that I've seen the housing market. I don't know that I have any good data for you that would say this is how long it's going to take, but I think that we've clearly seen the bulk of our activity in 2007 or the impact's been in 2007 stronger than what I think we had anticipated in markets like Florida. I don't remember last time that Vegas was at a minus 34% in building permits or minus 28 in Florida.

Lisa Monaco - Morgan Stanley & Co., Inc.

Okay.

David C. Swanson - Chairman and Chief Executive Officer

And Lisa, part it is actually... it's not so much the duration of the downturn in the economic cycle as it relates to this as it is how quickly the advertising ends up getting out of the books. And we've taken... while those... a lot of those heading and the growth in those headings have provided a lot of growth for us over the last several years, again, what we are feeling is that a lot of the advertising as these mortgage companies go out of business and some of these other real estate supported business go out, they get out of the system fairly quickly. And once they are out, our exposure to that then is pretty limited.

Lisa Monaco - Morgan Stanley & Co., Inc.

Right. But presumably, it sounds like you are just starting to... we've heard a little bit of this from you that you were starting to feel the impact in the first quarter. So in terms of the books just occur once a year, do we still have to go through a whole another cycle within the next year to get some of those advertisers out of the books?

David C. Swanson - Chairman and Chief Executive Officer

Well, as we've indicated, we know we are going to be taking some of it in Q3. Some of our... we have Vegas and a lot of our big Southwest Florida market publish in Q3. So we are going to see a lot it coming out there.

Lisa Monaco - Morgan Stanley & Co., Inc.

Okay, and then Steve, two questions. Could you just elaborate on your increase in CapEx and then working capital and other and then if there is anyway now that you guys have spent a lot more time on the digital front kind of where you see margins fall out going forward? Thanks.

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Well far as the investment in the business, I think there is really two different things going on. On the CapEx side, it's a little bit more investment in the IT integration activities associated with the consolidation of our Amdocs platform as well as some of the corporate systems that we've put in place. And as far as working capital, that really, as I mentioned, relates to commissions and print and paper and delivery costs that reflects more of a cyclical high in the second quarter like in particular relating to Illinois. So I think that as far as the margins go, what we have said is we are really more focused on growing EBITDA dollars than on necessarily protecting any particular margin. I think while we are not prepared to get specific about what kind of margins Business.com delivers, they are lower than our historical print margins. And so as our business mix shifts, it's conceivable that our margins go down, but it's kind of too soon to say.

Lisa Monaco - Morgan Stanley & Co., Inc.

Thank you.

Operator

The next question comes from Mr. Anthony DiClemente with Lehman Brothers. Sir, you may ask your question.

Anthony J. DiClemente - Lehman Brothers Inc.

Hi, good morning. On your expense growth, Steve, I was just hoping you could remind us. We saw about a 5.7% growth in your operating expenses in the quarter. Just remind us the key drivers of the growth in your expenses as we head into the second half and if you could also give your thoughts on what you think your long-term expense growth trends are. And then the second question I have is on the question regarding Florida and Vegas and kind of the pressure you're seeing from the housing market, what are your thoughts around how you would compare the pressure that you're seeing in those markets to pressure that you're independent directors, competitors are seeing in those markets? What's the dynamic there when you kind of see a little bit of a downturn in real estate between the incumbent and the independent? Thank you.

David C. Swanson - Chairman and Chief Executive Officer

Peter, why don't you go ahead and take that second first and then we'll have Steve answer the first one.

Peter J. McDonald - President and Chief Operating Officer

Anthony, I think the... what we are seeing is as we've had in the past couple of years, two, three, four, five competitors, independents coming to the markets. I think it's impacting them more as we are seeing some of them drop out because what I am hearing from our advertisers is the utility book or the incumbent book is kind of one they have to be in. And then they have got two or three or four others to chose from. And so my suspicion is when I see some of them leaving the business, that it's probably having a tougher impact on them.

Steven M. Blondy - Executive Vice President and Chief Financial Officer

As far as the expense growth goes, Anthony, I kind of gave you a bit of a litany during my prepared remarks. I think in the second quarter it was primarily IT expense and advertising as far as the larger specific components. But we also invested more heavily in sales training, more companion directories, the DexKnows launch. I guess that a lot of that is advertising, but there is more than just advertising, new SEM product launch etcetera. So, and of it's going to be integration expanses like we talked about in our cost to achieve synergies analysis and some of it's going to be ongoing.

Anthony J. DiClemente - Lehman Brothers Inc.

So is there any way that you can kind of handicap for us, is more than half of it one-time in nature and or more than half of it ongoing? And how would that dovetail into what you think your long-term expectation is for operating expanses, let's say, over the next two to three years?

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Well, when we provided guidance for this year, we identified $44 million of expenses that we were making investments in the business on those things that I was just enumerated. And we said that those... that $44 million was an ongoing expense. So it gives you some sense of that. As far as the ongoing expense growth, I mean it's important for us to make sure that expenses are growing no faster than revenue, right, so that we can grow EBITDA. That's what we are aiming to do. And this year and last year, we had expense associated with the integration activities that should go away and start to release the synergies next year.

Anthony J. DiClemente - Lehman Brothers Inc.

Okay, gotcha. Thanks Steve.

Operator

The next question comes from Mr. Fred Searby with J.P. Morgan. Sir, you may ask your question.

Frederick Searby - J.P. Morgan Securities Inc.

Hi, thank you. Two questions, one, given what's happening in the bank market and the little stumble we are having there or the loans leverage. I wondered with your refinancing specifically, can you comment on whether this is going to impact you and what your thoughts on refinancing some of the higher interest rate debt and how current market conditions may impact that? And then secondly, I know it's small for you, but national advertising and print's been so weak and other media. Can you just comment specifically on how that's trending versus your bigger... with local sales? Thanks.

Steven M. Blondy - Executive Vice President and Chief Financial Officer

Okay. Well, I'll start with the bank market. Clearly, the high yield markets are not as accommodating this month than they were in previous months this year. And so we are watching what's going on. Our call dates for the high cost debt are November and December, and so we are watching what's going on and fortunately, we don't have to do a deal or fund a bridge. I mean we are in a situation where it's really opportunistic for us to refinance and we can be patient. Peter?

Peter J. McDonald - President and Chief Operating Officer

Fred, well, relative to national, in our industry the national market seems to be following very closely with what's going on locally, best way to look at it. Not a big change.

Frederick Searby - J.P. Morgan Securities Inc.

So you're actually seeing growth there?

Peter J. McDonald - President and Chief Operating Officer

In many of our markets, we are seeing growth with national.

Frederick Searby - J.P. Morgan Securities Inc.

Okay. Alright. Thank you.

Operator

The last question comes from Mr. Maurice McKenzie with Signal Hill. Sir, you may ask your question.

Unidentified Analyst

Hi. Good morning. This is Justin Brown for Maurice McKenzie. I have two questions. One is what percentage of your existing print customer base is b-to-b versus b-to-c and what percentage of those b-to-c customers are already engaged in search engine marketing? And a follow-up question to that is can you elaborate on your initiatives on mobile search?

David C. Swanson - Chairman and Chief Executive Officer

Yes Justin. Off the top of my head, I couldn't tell you exactly how many of our customers are actually b-to-b versus b-to-c, but there's quite a lot of them. When you think about the categories that we call on, copier services, janitorial services, it's a pretty good sized number. So we're going to get kind of an interesting synergy out of this acquisition as it relates to that. Sorry, the second part of your question was --

Unidentified Analyst

Just your initiative in mobile search, if you guys have considered that and when do you think you will look into that?

David C. Swanson - Chairman and Chief Executive Officer

Yes, we watch it and at least to date Justin, we are kind of operating under the assumption that mobile search is really morphing to Internet search. And we'll certainly see that, it's like with the new iPhone and things like that. So a lot of the kinds of relationships we have with companies like Google etcetera, we are getting our advertisers found that way. One last thing I will tell you we've also been looking very closely at the voice... I forget the word... the voice recognition directories or 411 type thing.

Unidentified Analyst

Sure.

David C. Swanson - Chairman and Chief Executive Officer

While there is nothing I am willing to talk about on the call today, you will be hearing some things in the future about how we are looking at that.

Unidentified Analyst

Great. Thank you guys.

David C. Swanson - Chairman and Chief Executive Officer

Okay. Well, listen, I want to thank everyone for taking time this morning to discuss our plans to acquire Business.com and our second quarter earnings. We certainly covered a lot of important material today and realize that you might still have a question or two. So if so, please feel free to contact our investor relations team and I am sure that they will be there to help you out. Thanks again and have a good day.

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Source: R.H. Donnelley Q2 2007 Earnings Call Transcript
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