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Executives

Tyler D. Gronbach - Senior Vice President of Communications

Alfred T. Mockett - Chief Executive Officer, President and Director

Gregory W. Freiberg - Chief Financial Officer and Executive Vice President

Analysts

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Jason Alper

Unknown Analyst

Hondo Sen - Cetus Capital, LLC

Matthew Nelson

Dex One (DEXO) Q1 2012 Earnings Call April 26, 2012 8:30 AM ET

Operator

Good morning, and welcome to Dex One Corporation's First Quarter 2012 Results Conference Call. [Operator Instructions] Please note that today's call is being recorded, as well as webcast live over the company's website at www.dexone.com. I would now like to turn the call over to Mr. Tyler Gronbach. Sir, you may begin.

Tyler D. Gronbach

Thank you, Marianne. Good morning, everyone, and thank you for joining us today. We will begin this morning with comments from Dex One Chief Executive Officer, Alfred Mockett; and Chief Financial Officer, Greg Freiberg. Following their comments, we will then have time for some of your questions.

I would like to remind everyone, certain statements made today may be forward-looking as defined by the Private Securities Litigation Reform Act. We call your attention to our press release for the quarter ended March 31, 2012, and the company's Form 8-K furnished to the SEC this morning. These documents discuss first quarter 2012 results, as well as full year financial guidance and ad sales guidance for the second quarter. The 8-K also includes the results package, which provides additional information pertaining to our discussion this morning.

We encourage you to review these materials and the company's other periodic filings with the SEC, which set forth important risks and other factors that could cause actual results to differ materially from those contained in or suggested by any forward-looking statements. Electronic versions of Dex One's SEC filings can be obtained by contacting us, visiting dexone.com or visiting the SEC's website at sec.gov. A copy of the news release and results information package can also be found under the Investor Relations tab at dexone.com.

During the call today, we will refer to certain adjusted figures that are non-GAAP financial measures, such as expenses, EBITDA, free cash flow and net debt. Some of these exclude items such as impairment charges, stock-based compensation and long-term incentive program expenses, fair value adjustment and the impact of fresh start accounting. Additional information about non-GAAP financial measures, as well as a reconciliation between these items and the comparable GAAP measures can be found in the press release and related 8-K furnished to the SEC.

One final reminder, this call is the property of Dex One Corporation, and any retransmission or broadcast without the expressed consent of the company is strictly prohibited.

I would now like to turn the call over to Alfred.

Alfred T. Mockett

Thank you, Tyler. Good morning, everyone. On our year end Investor Call, I outlined 4 priorities for 2012. We made solid progress in each of these important areas during the quarter. We delivered strong digital bookings growth of 32% compared to the first quarter last year, ahead of our full year 2012 target. In the first quarter, bundled sales increased to 45% of total bookings. We are on track for bundles to generate more than half of bookings by year end.

We posted a 44% EBITDA margin in the first quarter, above both fourth quarter and full year 2011. We expect to retire $425 million of debt in the first 4 months of 2012.

Turning to top line performance. Bookings declined 13% and ad sales were consistent with our guidance of minus 16%. Results in the quarter were adversely impacted by a 21% decline in print, in part due to the greater concentration of large markets where the secular shift to digital marketing services is most pronounced.

Strong digital sales and bundled sales are helping to offset weak print performance. We are employing new tactics, such as digital-only sales teams to support growth and address the rapidly changing needs of customers.

We remain committed to growing our digital business as rapidly as possible while managing the print product to maximize cash flow. Digital increased to 22% of total bookings in the first quarter. The newer digital offerings, such as display, search engine optimization and premium search engine marketing sold through the proprietary DexNet platform helped fuel this growth.

Dex One is uniquely positioned to help local business navigate the complex world of digital marketing. We have assembled a broad solution portfolio that helps customers distribute their content across local, social and mobile platforms.

Earlier this month, Burrell Associates, a respected analytics firm, said companies like Dex One are making faster inroads into digital versus other local media, including television, radio and newspapers.

We constantly seek new and innovative ways to connect with customers. During the quarter, we hosted webinars and local market seminars, we launched our own online advertising and introduced a new web-based findability assessment tool that helps customers identify what they need to do to improve their online marketing efforts. This proactive outreach generated thousands of prospects which we are now cultivating.

In addition, we are placing special emphasis on bundles, efficient combinations of services and solutions. To put this initiative in perspective, bundled generated over $130 million worth of bookings in the first quarter. We expect that by year end, bundles will account for half of total bookings.

Bundles reduced the complexity of creating high-impact multi-platform marketing campaigns. We offer a range of solutions that come pre-configured with the right mix of products to generate the required quantity and quality of customer needs. Feedback from customers shows they like this approach. They prefer the simplified buying process, in addition to the measurements and tracking that we provide with bundles. With regard to our ultimate bundle, Dex guaranteed actions, customers value its inherent shared-risk, shared-reward nature.

We expect bundle penetration to increase over the coming quarter as we present the concept to additional clients, refine our sales techniques and complete the rollout of our bundle builder iPad app.

As we continue to develop and refine the value proposition for our customers, we are working to reduce our expense base. Greg will provide some additional color in a few moments, but I want to touch on what we call smart distribution, which offers a great opportunity to further reduce costs.

According to industry research, approximately 7 out of every 10 adults in the United States use the print Yellow Pages at least once a year, leaving 3 out of 10 people who prefer not to use the book. We have the opportunity to lower our printing and distribution costs if we can identify those consumers who prefer to use only our digital services to find a local business. We are tapping internal and external data sources to allow us to print and distribute substantially fewer books without affecting the value we deliver to local businesses and consumers.

Looking ahead, we are affirming our existing 2012 financial guidance and we expect second quarter ad sales of between minus 13% and minus 14%, consistent with our expectations of moderating trend over the remainder of the year.

Before turning it over to Greg, let me conclude by recapping the progress we have made during the quarter in the areas of people, partnerships and packaging.

First, people. We are on track to open 2 telemarketing centers in Denver and Omaha in the second quarter. Similar in configuration to our new facility in Kansas City, these centers will help to improve marketing consultants' efficiency and productivity by centralizing staff and eliminating telesales in local offices.

I mentioned some of the new products we rolled out this quarter with the help of our partners. We will continue to expand our partnership ecosystem as we constantly improve the quality and breadth of our digital solution portfolio.

Lastly, in terms of packaging. We have introduced digital-only bundles and variable term contracts to further simplify the buying process. We believe our commitment to people, partnerships and packaging best positions our customers to success in a complex and segmented marketing landscape.

With that, I will turn it over to Greg.

Gregory W. Freiberg

Good morning, and thank you, Alfred.

Let's start with the few highlights. We obtained credit agreement amendments in March. We successfully executed below-market repurchases of bank debt in March and the subordinated notes last week, utilizing approximately $100 million of cash to retire $240 million of debt, and we will retire $425 million of debt in the first 4 months of this year. Thank you to our lender group for their overwhelming support on their amendments to our credit agreements, I look forward to continuing to work together.

Let me note that during the quarter, we reduced the weighted average useful lives of our intangible assets to approximately 9 years. This does not impact the company's cash flow compliance with debt covenants or cash tax attributes. This change better aligns our expectations of significant cash flow generation from these assets over the next several years with the new amortization schedule. It also reflects our belief that declines in print will not abate and incorporate recent input from third-party specialists. As a reminder, our intangibles are primarily comprised of directory service agreements and local customer relationships. More details will be available in our 10-Q that we expect to file later today.

Turning to first quarter results. Net revenue was $344 million, down 12% from the prior year; bad debt was 3.2% of net revenue towards the low end of our normal range; total expenses were $195 million, a reduction of $21 million or 10% from a year ago, with production and distribution, selling and support and G&A all declining. Putting the numbers together, we achieved $150 million of EBITDA. Note that this is inclusive of $2 million of severance expense.

After deducting cash interest of $42 million, CapEx of $5 million and $30 million for use of working capital, we generated $73 million of free cash flow. The working capital use was comprised of a $7 million pension contribution, $3 million of cash tax payments and $6 million of restructuring payments, along with the normal seasonal timing factors that land in Q1. After the impact of semiannual note coupon payments, first quarter EBITDA to cash flow conversion was 49%. The midpoint of guidance implies an approximately 60% cash conversion rate in line with 2011.

At the end of the first quarter, net debt was $2.2 billion, leverage was 3.5x and the weighted average cost of debt was approximately 7.8%. In terms of guidance, we are affirming the existing full year financial guidance that we provided for net revenue, EBITDA and free cash flow. We expect to retire approximately $525 million of debt this year, which would reduce our net debt to approximately $1.9 billion at year end.

To wrap things up, we generated solid financial results in the first quarter and we remain focused on strengthening the balance sheet and managing our cost base while supporting robust digital growth. Thank you.

Operator, we are now ready to take questions. Marianne?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Lance Vitanza of CRT Capital Group.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Two questions, I guess. The first on the digital revenues and I apologize if you touched on this. But what percent of total revenues are now attributable to digital?

Alfred T. Mockett

Well, it's 22% for the first quarter.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

22%. And just to confirm, that's pure digital revenue, right? That's not print that's bundled with digital as well?

Alfred T. Mockett

That is pure digital, yes.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Okay. So 22% of your business is digital, and digital bookings are growing at 32%?

Alfred T. Mockett

That's right, yes.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Okay. And then just on the balance sheet, could you review -- I heard the comments that you made, Greg, but could you review in just a little more detail what you've done so far? I heard $100 million of cash to retire $240 million of debt. And if I remember correctly, you used $27 million of debt to acquire -- to take out about $98 million of the bond, so I guess that implies that you used $63 million of cash to take out $140 million of bank debt, is that right?

Gregory W. Freiberg

It's closer to $70 million of cash to take out about $140 million of bank debt.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Okay. And then going forward, could you review what flexibility you retain to do incremental repurchases below market of both the bonds and the bank debt?

Gregory W. Freiberg

Certainly. So we have about $20 million of cash that could be available to do below-market repurchases between now and the end of the year. About 1/3 of that could be addressed against the sub notes and the balance against the bank debt. The other comment I'd made is, if we did not utilize that cash between now and the end of the year, most of that could also -- would rotate into next year and we'd have that option next year as well.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Is there anything in the amendment that allows you for incremental capacity in 2013 perhaps based on excess cash flow and the like?

Gregory W. Freiberg

There is. And the amendment that we've received actually extends through the end of 2013. So in 2013, the borrower's portion of excess cash flow would be available to be applied against the bank debt. In addition to that, we're allowed to upstream $5 million per silo for a total of $15 million to Dex One Corp. that could not be used to address the sub notes.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Okay, terrific. And then lastly, so the $425 million of debt that you expect to repay through the first 4 months of this year, that's obviously the $240 million that you've done to date? And then the balance, is that scheduled amortization or is that you intend to be back with below-market repurchases, or...

Gregory W. Freiberg

The balance is the scheduled amortizations and cash sweeps.

Operator

Our next question is from Jason Alper of Tejas Securities.

Jason Alper

A couple of questions. First, on your table that walks from EBITDA to free cash flow for the quarter. I know it's the working capital and other number of $30 million is slightly higher than it typically is. Could you go into that a little bit, perhaps?

Gregory W. Freiberg

Certainly. Since I hit on the couple of the points in the prepared section, I'll just recap that and I'll give you a little more color for that. $7 million was pension contributions, $4 million is in restructuring payments, $3 million is in tax payments and the balance, I said, was seasonal factors, but that's largely contributed of bonus. And then also in the first quarter of the year, it's difficult to do prepaid but you enjoy the benefit for the rest of the year.

Jason Alper

Okay. The pension component of that, is that going to be a reoccurring expense?

Gregory W. Freiberg

Our policy is that we fund to 80% of the projected benefit obligation, and so that's a calculation that's done each quarter. And dependent upon where that lands, there's a top up. That calculation in the first quarter resulted in a $7 million contribution.

Jason Alper

And is that based on assets and return assumptions and...

Gregory W. Freiberg

Absolutely. That's it.

Jason Alper

So I'm assuming your discount rate went down this quarter?

Gregory W. Freiberg

Yes. There's a whole process and I won't go into too much detail but it's what you'd expect.

Jason Alper

Got you. Another question about your debt levels. Obviously, you -- when you're looking at the chart on Page 5 of your presentation, which details term loan levels going from Q4 to Q1 of this year, it looks like there are some excessive of payments above and beyond -- you obviously had the below-market repurchases, you had -- I assume, you made the unpaid sweep for 2011 payments?

Gregory W. Freiberg

Yes.

Jason Alper

And then you also had your amortization. It looks like some of the entities had some excess payments above and beyond that, is that the case?

Gregory W. Freiberg

That is the case. And also as part of the amendment that we received, we have the ability to prepay some of the future amounts. And a situation where that makes sense is where there's negative carry. For example, there is a required payment next quarter but I'm required to keep the cash on the balance sheet this quarter, I'd rather just go ahead and make the payment this quarter and reduce that negative to carry by 3 months.

Jason Alper

Okay. Because one of the numbers that leaps out for example is Dex East, it looks like above and beyond the scheduled amortization that there was another $32 million of payments? That's above and beyond amortization and last year's unpaid sweep?

Gregory W. Freiberg

That's it.

Jason Alper

That's it? Okay. Would that be characterized as a voluntary prepayment that would then reduce future amortization?

Gregory W. Freiberg

That's absolutely right. We prepaid the second quarter.

Operator

Our next question comes from Chad Quinn [ph] of Bennett Management.

Unknown Analyst

You said that the free cash flow conversion from EBITDA was 49% yet the midpoint for the full year guidance is 60%. Can you reconcile that difference? And is it just the seasonal differences or timing of the pension payment? And how do you get to that level?

Gregory W. Freiberg

Chad, it's Greg. So that is -- precisely, it goes back to those seasonal items in the first quarter that dragged it down. So that will turn as we go into the rest of the year. What I'd also point out, in the first quarter, we had the semiannual interest payment on the notes, so we stand at full year guidance.

Unknown Analyst

Okay. And were cash taxes in any way influenced by the debt buybacks?

Gregory W. Freiberg

Right. So the debt buybacks, they do, as you know they generate cancellation of debt income. And we were, through our process, able to offset that. So then net-net of that is it did not require an additional tax payment on our behalf.

Operator

Our next question comes from Hondo Sen of Cetus.

Hondo Sen - Cetus Capital, LLC

Alfred, can you talk a little bit about the evolution of the digital rollout and bundles? Where you are kind of in product development, geographic rollouts, sales force and partnership? Who you're looking to further partner with?

Alfred T. Mockett

Okay, certainly. Well, first of all, I think we've done a tremendous job on rounding out the digital portfolio. It's probably the most competitive digital portfolio in the marketplace today. Coming into this, I said we'd make, build, buy or partner decisions. In most of the areas, we chose to partner and that has allowed us to really be more capital efficient in investing in the digital business, and also has given us faster route to market and a very cost-effective route to market. I mean, so far, we've got a portfolio of more than a dozen partnerships. And just to give you a quick rundown, working with Gigya on the social registration credentials, Google is a big SEM partner of ours and we're in the top tier of partner relationships. We're working with Hostopia on mobile website creation, Ooyala with the video hosting, PaperG on display advertising creation, distribution reporting. We're working with StudioNow now on custom web video, xAd on their mobile advertising network and of course, we've got relationship similar to the one with Google on SEM with Yahoo! and Bing. YellowBOSS, our partner on reputation management tools and Yelp for user content reviews. So that's the partner ecosystem as we see it. We'll be expanding it in future months as we continue to add to the digital portfolio of capabilities.

Hondo Sen - Cetus Capital, LLC

Got it. Appreciate that. In terms of geography, where have you rolled out so far and when do you expect to complete the rollout?

Alfred T. Mockett

Okay. Well, the growth at the moment is fueled substantially by our existing 28-state patch defined by the print business. We're leveraging those print relationships to sell the digital. We've also now rolled out teams of digital-only sort of hunters in the 12 major metros to overlay the traditional sales force. And in addition to that, we're expanding beyond our traditional footprint. We have trials going on in Philadelphia, Atlanta and Dallas.

Hondo Sen - Cetus Capital, LLC

Got it. Appreciate it. And Greg, just quick question on the guidance. The EBITDA, does that include any restructuring charges?

Gregory W. Freiberg

It does. There's -- well, I'm sorry. It has -- it does include it. I think it's about $5 million -- no, I'm sorry, about $2 million, that was the $2 million of severance expense I called out.

Operator

Our next question is from Matt Nelson of RBS.

Matthew Nelson

A couple of questions. One is I think you said the forecast for the full year is for a debt pay down $525 million, and you have accomplished $425 million of that by the end of April, is that correct?

Alfred T. Mockett

Yes, that's correct.

Matthew Nelson

So if I go -- if I look at Page 10 which is the forecast of amortization payments for the rest of the year, that encompasses the full hundred difference. Does that mean that you anticipate no excess cash flow paydowns?

Gregory W. Freiberg

That's, if we did do an excess cash flow, what would be an addition to that. So the $525 million does not incorporate additional below-market buydown. But I just want to leave this, we retained that optionality and that's something that I want to keep a close eye on and when and where whether that makes sense.

Matthew Nelson

But I mean with respect to the cash flow sweep mechanism, so there's no contemplated sweep?

Gregory W. Freiberg

No, sorry. So this -- the amortization here in this sweep, it's inclusive. So that's incorporated within that.

Matthew Nelson

On this Page 10 schedule?

Gregory W. Freiberg

Yes.

Matthew Nelson

Oh, perfect. Okay, that's my disconnect. Okay. And then another question on ad sales, the chart on Page 2. If I look at the last 4 quarters of ad sales, that range of -- the improving range of down 17%, down 13%, how do I reconcile that to the sales, the revenue decline in the first quarter of '12, which is around 12%? Should I absent some one-time events, should that be a proxy as I look at kind of the last 4 quarters of ad sales numbers for the current quarters of revenue decline?

Alfred T. Mockett

Well, we need to work through a cascade with you on this. I mean, bookings are total guaranteed contractual value of all business coming in the door. We're generally selling 3 to 6 months ahead in bookings. And ad sales, once again, is sort of, generally, sort of a quarter ahead. And then the revenue recognition is pro rata 12 months for a 12-month contract for most of the product portfolio.

Gregory W. Freiberg

And Matt, what I'd add there is, with the transition that we have going to digital, it really is starting to change the assumptions that we've always long-held in the industry, and there can be much more rapid revenue recognition with some of the products.

Alfred T. Mockett

Yes, because we start revenue recognition with digital as soon as we turn the service up.

Gregory W. Freiberg

Yes.

Matthew Nelson

Got it. But that revenue recognition in digital is also reflected in these ad sales numbers, right? It's just on a different -- there's no lag there as opposed to the 3-month lag on the print?

Gregory W. Freiberg

There's no lag, right. So digital could be a booking and ad sales and start revenue much -- in the same quarter.

Alfred T. Mockett

Yes.

Matthew Nelson

Right. So what I'm trying to do is that if I look at the -- if I go from one quarter '11 through fourth quarter '11 absent the Digital impact, where I should really be looking at second quarter '11 or first quarter '12, none of those numbers are as good as down 12%, which is what we experienced in revenue for the quarter. How do I reconcile that?

Gregory W. Freiberg

It comes back to digital recognition that's immediately going into revenue within the quarter.

Matthew Nelson

But...

Alfred T. Mockett

With that said, I think just...

Matthew Nelson

I think I get it, I think I get it. That 16 -- for example, that one quarter '12 number of negative 16% has in it a very positive digital number and a very negative print number.

Alfred T. Mockett

That's right. Historically, the first quarter, as you can see from last year's data, is always our weakest quarter. We've always been challenged in that quarter because there's a heavy concentration of large metro books in the west, such as Portland and Denver and Albuquerque and Colorado Springs, Boise. And it's in those major metros in the west where we're seeing the greatest secular shift from print solutions to digital solutions. But the rest of the portfolio of books is very much better balanced throughout the rest of the year. So we always expect a continuous improvement trend after the first quarter.

Operator

Our final question comes from Jason Alper of Tejas Securities.

Jason Alper

I was hoping perhaps that you could comment on trends you're seeing in prints. The decline in print seems to be stubbornly high. If we had talked 1.5 years, 2 years ago, we might have talked about some moderation in that and we haven't really seen it. I was hoping if you could maybe discuss that a little bit.

Alfred T. Mockett

Yes, sure. Well, if you look at our industry, it peaked in 2006 and industry-wide print has declined at 19% to 20% a year, pretty much straight line. We're working on the assumption that, that continues. And now that said, historically, as a print publisher, we're a damn fine print publisher, we've always managed to outperform the market by 2 or 3 points. I think we have a competitive advantage with our approach on bundles. Bundles work for us in a number of ways. First of all, it improves the sort of stickiness of the client relationship, it helps improve customer retention. Within the bundle, we're seeing our average sale per customer better than outside the bundle. Within the bundle, we're getting sort of better digital growth on the back of the print product, and also the digital product's helping the print product in the rate of decline of print seems to be less within the bundle than outside the bundle, where people still want to buy print à la carte. So I believe as bundles begin to bite further on in the year, that's how we're going to get a handle on that print decline.

Well, thank you to everyone for joining us today. Our sales results reflect the impact of 2 separate but linked solution sets. A Yellow Pages product that is in secular decline but generating cash and a rapidly growing dynamic digital business. In transforming this business, we have built a strong channel by attracting, training and encrypting the right people. We've assembled a portfolio partnership arrangements with world-class digital companies to support the delivery of a robust set of marketing solutions and delivered simple and cost-effective packages, making it easy for marketing consultants to sell and customers to buy.

I am proud of what the team has accomplished at Dex One in the last 18 months. We have dramatically expanded the digital product portfolio, while continuing to reduce costs and pay down debt. We will continue to take steps to strengthen our balance sheet and grow our digital business. We have significant near-term liquidity, generate industry leading EBITDA margins and have valuable tax attributes to facilitate excellent free cash flow conversion. Thank you for joining us.

Operator

This does conclude today's conference call. You may disconnect your phones at this time.

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