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Executives

Peter J. McDonald - Chief Executive Officer, President and Director

Samuel D. Jones - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

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

George Joachim Sebastian Schultze - Schultze Asset Management, LLC

SuperMedia (SPMD) Q3 2012 Earnings Call October 30, 2012 10:00 AM ET

Operator

Good morning, and welcome to SuperMedia's Third Quarter 2012 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) 585-8367. International callers can access the replay by calling (404) 537-3406. The replay passcode is 51095102. The replay will be available through November 15, 2012. In addition, a webcast will be available on SuperMedia's website in the Investor Relations section at www.supermedia.com.

At the end of the company's prepared remarks, there will be a question-and-answer session. And now I'd like to turn the call over to Peter McDonald. Peter?

Peter J. McDonald

Thank you, Jackie. Good morning, everyone, and thank you for joining us in our third quarter's earnings call. As usual, I will share some of the highlights from the quarter and then Dee will review the financials. Following our comments, we'll be happy to take your questions.

I will focus on 3 areas this morning. One, our progress towards completing the merger of SuperMedia and Dex One that we announced on August 21. Two, our EBITDA expenses and sales performance. And three, ongoing initiatives to strengthen our approach to customers. Let's start with the merger.

Dex One is a value-creating transformational event. The combined company will share -- will have over 3,000 marketing consultants serving more than 700,000 clients with local marketing solutions across social, local and mobile media. We will have a strong national footprint. There is very little geographical overlap between the companies, and we will have scale and scope to reach all national -- all local businesses, as well as enable national advertisers to efficiently target local markets with their messages.

The $150 million to $175 million in synergies we expect achieve, combined with the preservation of tax assets, will create significant long-term value. Over the past 2 months, SuperMedia and Dex One management have been working together through a disciplined process on plans to integrate the 2 companies. The cost process is being guided by an independent consultant who is an experienced financial executive with deep knowledge of the dynamics of local media marketplace and the operations of our businesses. He has a successful track record in helping companies integrate and realize synergies.

Merger integration planning is a 4-phased process. We have completed Phase 1 and are well into Phase 2. During which, we will -- we are designing the optimal structure and operating model for the new company. We are looking for transformation, not incremental result. There are 18 functional teams, each of which headed by a partner co-leaders from SuperMedia and Dex One. Their job is to look at the combined existing skills, assets and processes of the companies, take a clean sheet of paper, and define and design the best way to meet customer requirements, achieve competitive advantage and provide operational efficiency for the future.

Some key takeaways from our work so far are: We believe that we can achieve the $150 million to $175 million in cost synergies over the next 3 years that we included in the pro forma financials released. Each company has achieved industry-leading best practices in different areas. Adopting the best practices uniformly across both companies will benefit our customers and improve operational effectiveness and efficiency. We see these opportunities across a broad range of functions from technology, infrastructure to credit, to collections and market research, only to name a few.

SuperMedia and Dex One different strengths in digital solutions will enable us to select the social, mobile and local products that provide the best results for customers and offer them in all markets, while improving our efficiency in sourcing and fulfilling the solutions. Our sales teams have educated each other on Dex One's bundling approach and the attributes in different bundles we started offering this year at SuperMedia. It appears that certain approaches lead to the greater success from various customer segments. We believe, with this knowledge, we will help improve our client retention and grow across all of our markets. The sales and marketing teams have also identified potential ways to improve performance and efficiency by adopting the strongest attributes of different digital platforms and sales tools that each company has developed.

Two issues that always come up in mergers are culture and technology. Having run both companies and having a large knowledge of number of people for many years, I am confident there is a good fit in both areas. Our heritages are the same, we face the same market factors, serve the same types of customers and offer the same kind of solutions and value. The integration teams are working all together and making progress. I'm very pleased with the active exchange of ideas and shared commitment to create a successful new combined company.

Turning to day-to-day performance. Results for the third quarter year-to-date benefited from continued strong execution in driving down adjusted expenses by $182 million or 22.9% over year-to-date Q3 2011. The expense reduction contributed to a 440 basis-point improvement in EBITDA margin to 41.2% compared with 36.8% in Q3 2011. One of the areas that deserves recognition is the reduction in bad debt expense due to improved credit review policies for new and renewing clients and earlier intervention with clients who are not timely in their payments. On the top line, revenue recognized in the third quarter declined by 17.3% over the prior year period, while Q3 advertising sales declined 19.1%.

Following the merger with Dex One, we plan to adopt a single methodology for reporting revenue and ad sales on both a consolidated basis and broken out by digital and print subsets. I can tell you today that we are seeing some strengthening in trends in sales. Existing clients are buying more of our digital solutions. Renewal rates are moving in the right direction across the board. Favorable renewal trends also confirmed that we are delivering measurable results for our clients. We see these results through thousands of tracking lines we used to quantify the number of leads and actions we provide to businesses each day. And these results are available for our clients to track online in real time. In addition to which, we send them monthly reports showing the calls, e-mails, forms, likes, clicks and impressions that SuperMedia delivers to them. We have put a strong emphasis on developing smart technology that enables us to add more value and deliver results to our clients across hundreds of online destinations while lowering our operating cost at the same time.

For our digital solutions, the key to matching each individual client at the lowest cost per action with the people searching for their product or service at any given moment is an invention we call the merchant platform. In September, we were awarded a patent for the merchant platform confirming its unique capabilities and advantages. Post-merger, we look forward to using this platform to deliver results to clients across our footprint and control traffic acquisition expenses.

The third quarter also saw the unveiling of additional initiatives to use online social and mobile media to create and nurture new leads for our own company. All of our promotion is now unified under the theme of Results and Relationships. We want business owners to know that there are local SuperMedia marketing consultants right in their communities with whom they can build strong relationships to plan and manage the full array of social, local and mobile media and deliver results. I encourage you to visit supermedia.com, which has been optimized to help business owners see how local media can pay off for them and how SuperMedia can help them succeed.

Local businesses can grade their website effectiveness, evaluate the quality of their listings across major search sites and visit our blog for tips on making the most of digital media. Click on Who We Are tab, and watch our new video showing how local SuperMedia marketing consultants put local businesses where everyone is searching. All this is being complemented with our individual Facebook pages for all of our local offices, and call-to-action advertising in all digital formats. The objective is to demonstrate our local media expertise and effectiveness by example, and generate leads which we can use to nurture relationships and create new clients.

Also during Q3, we received good news regarding our print directories. The Ninth Circuit Court of Appeals struck down the directory distribution ordinance adopted by the Seattle City Council in 2010, requiring us to obtain a license to distribute directories, pay a fee for each book distributed, participate in the city's redundant opt-out registry and advertise the city's registry on the front of each directory. This outcome is good for our clients, SuperMedia and the industry.

Let me return to the top of the merger for my last comment. I am pleased to say that we're making progress towards finalizing the terms of the amend-and-extend agreements with the Dex One and SuperMedia lenders. Once completed, the proposed agreements will be submitted to all lenders for a vote. Should we not receive 100% support from the lenders, the SuperMedia board has agreed to consider pursuing. However, we would not support an outcome that would impair the economic value to SuperMedia shareholders. Given where we are in the process, with the lenders, we do not expect the transaction would close before the first quarter 2013.

These are exciting times for our business. We are simultaneously working to execute each day to transform our company and deliver additional value to local businesses, plan for our merger with Dex One in order to accelerate and transform, and complete the very much dedicated efforts of our employees who make this progress possible.

And now, to Dee.

Samuel D. Jones

Thank you, Peter, and good morning, everyone. Before we begin, I would like to mention that some of the results I'm speaking to this morning are non-GAAP numbers. We have provided a reconciliation of GAAP to non-GAAP results in the appendix of this presentation.

Third quarter 2012 reported operating revenue was $330 million, a 17.3% decline for the quarter compared to the same period last year. Year-to-date reported operating revenue was $1.042 billion, a 17.2% decline compared to the same period last year.

Ad sales for the third quarter declined 19.1% compared to a 15.6% decline for the same period last year. As we explained during the second quarter call, our ad sales reflect the value of print directories that were primarily sold in the first half of 2012, and then published in Q3. In addition, our digital results reflected in the calculation are on an amortized basis such that what we sell in the current period is only partially reflected in the period results as we only report what is fulfilled and amortized in the period. While our reporting methodology is the same as always, the response to our new approach and trends we are seeing in the marketplace have not yet scaled and are not yet fully reflected in our results. As we move towards completion of the merger and integration, we are evaluating the most appropriate reporting methodology and metrics and we will make adjustments accordingly.

Third quarter 2012 adjusted EBITDA was $137 million, a 12.7% decline compared to the same period last year. Adjusted EBITDA margin was 41.5%, a 220 basis-point improvement compared to 39.3% in the same period last year. Year-to-date adjusted EBITDA was $429 million, a 7.3% decline relative to the same period last year. Adjusted EBITDA margin was 41.2%, a 440-basis point improvement compared to Q3 2011 year-to-date of 36.8%.

Looking at expenses, year-over-year adjusted expenses declined 22.9%. Selling expense declined by 21.9%, cost of sales declined 20.2%, and G&A expenses declined 30.9%. Our expense reductions have been consistent across all functional areas of the business. Year-over-year, the expense declines are due to lower head count, lower print and distribution quantities, reduced bad debt and numerous other initiatives across all functions. The bad debt expense provision rate for the quarter was a 0.6% and 1.4%, year-to-date.

Year-to-date free cash flow was $225 million, consisting of cash from operations of $234 million, less capital expenditures of $9 million. In the third quarter, we paid $36 million towards our debt. Year-to-date, we have reduced the total debt principal by $270 million. Of that, $154 million was repaid at par, and $116 million was at below par, which brings our debt balance to $1.475 billion from $1.745 billion at 12/31/11.

In closing, our Q3 results are consistent with our expectations relative to full year 2012 forecasted financials that were communicated at the time of the merger announcement. This concludes the Q3 financial results.

We're now ready to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Lance Vitanza with CRT Capital Group.

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

I've got a couple. First on the merger, on the synergies. It looks like you're expecting about a 10% reduction in the combined companies' cash OpEx. Can you remind me where you expect those synergies to come from? The buckets?

Samuel D. Jones

I mean, when we put out the merger determination, I think we showed the broad categories of synergy opportunities that we've identified. As Peter mentioned, we're still continuing to go through the integration planning process to help us to nail down more specifically where those areas would come from. But as you would expect, in the area of the G&A and the area of IT and technology, in relation to the vendors and our platform cost, all those elements we're anticipating will help contribute towards those synergy opportunities. But I believe the merger documentation did identify some broad categories for you and we're still looking at those same basic areas.

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

Okay. And then how should we be thinking about merger-related cost savings in the context of 2 businesses which are already reducing cash OpEx by 20-something percent, quarter in quarter out? Will the synergies essentially cannibalize cost savings we would have otherwise seen going forward?

Samuel D. Jones

Well, I mean, as we move forward and we move through this and the merger documentation reflected standalone cases, and combined with synergies, and each of those 2 respective standalone cases did include cost initiatives and cost takeouts as we moved forward. And we'll have to continue with that activity and those initiatives. The way we'll manage the business on a go-forward basis is we're going to have to get at maximum efficiency is whether you call it a synergy or whether you call it a baseline cost save, we're going to be about driving towards total -- total cost reductions that we can maximize and efficiencies in any area that we can find regardless of whether it's categorized as a synergy or a basic cost save.

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

Okay, and I guess to the point, if I just look at your numbers for the past few quarters, ad sales have been stuck at down -- down about 19% year-over-year. The adjusted EBITDA declines are getting a little bit worse. In Q1, your EBITDA was down 4%, it was down 5% in Q2, down 13% in Q3. Absent a merger with Dex One, is this what you would expect we have to look forward to?

Peter J. McDonald

I mean, on a stand-alone basis, we would continue -- we're going to continue to look for opportunities and efficiencies. Obviously at the base of expenses, swings a little bit. Those absolute dollar opportunities are diminished a little bit. But we'd certainly look to continue to drive efficiencies. If you remember, towards the back half of last year, we started to see a margin improvement across the group. We were in, I think, on a year-to-date basis last year, at this time, were at 36% to 37% margin. But Q3, for example, was in the 39% range. Obviously indicating and reflecting that we've gotten at some meaningful expense saves then. So the comps are getting a little more challenging relative to that, but we certainly do expect that we're going to continue to find opportunities to reduce expenses, either on a stand-alone basis or at a merged level. But certainly, one of the benefits of the merger and the merger opportunity is that it does allow for a broader base of expenses against which you can find efficiencies and cost savings.

Operator

[Operator Instructions] Your next question comes from the line of Samuel Fekind [ph] with ALJ Capital.

Unknown Analyst

Just a question on your G&A. I mean, if I look at last quarter -- or last year, Q3, it's $48 million, and this year, it's four -- if you could kind of talk about what is, I guess, what is the actual -- I mean, I don't know how much of that is timing. You guys talked about bad debt expense and I can't imagine the whole difference being bad debt expense. But if you kind of breakdown what the differences are?

Peter J. McDonald

Yes, I mean, obviously the biggest element or the biggest component of the save in G&A is bad debt. The experience there has seen strong improvement. As I mentioned, the provision rate is 0.6 for the quarter, 1.4 or so on a year-to-date basis. That's being driven by improved collections and improved experience, actual experience rate was in the low to mid-2% range on the quarter. And then we're able -- because of that and the profile at the receivables balance, we were able to take about $5 million off the balance sheet in the quarter. So G&A is contributing there as well. We have seen reductions in the functional expense areas of -- as you drive expenses down, those saves have diminished a little bit. But we have been able to continue to find efficiencies in our contract services cost and some of our employee-related cost, as well as total benefit cost across the board have contributed towards savings. So those are the basic elements of the relative savings in G&A.

Unknown Analyst

Is that a fair rate for G&A going forward or is this a little low? I mean, how should I look at that?

Peter J. McDonald

Well, on the quarter itself, with the favorability that we reflected in bad debt, and the balance sheets say but wouldn't say that, that 0.6 is inappropriate going forward rate. We do think that we've done a good job with that, but I don't know that I wouldn't say or characterize it as being a steady state at 0.6. Bad debt in this business is in the 2% or 3% to 4% range and we would expect normal course uptick in bad debt expense in that regard. The other components of G&A, I think we'll see steady-state to continued efficiency opportunities in that area. We're always looking in the G&A area to find efficiencies and we'll continue to do so. But other than the bad debt, I would say that the baseline that we're starting point is reasonably stated on the quarter other than the bad debt component of G&A.

Unknown Analyst

And can you also talk about the post-employment benefits amortization line for the $29 million, what exactly that entails?

Samuel D. Jones

The post-employment benefit line on the GAAP financials reflects our board decision's that we announced, I believe, in the second quarter, and that's flowing through the income statement in that fashion. The Board chose to adjust the plans around our post-employment benefit obligations across the numerous groups to which we were paying post-employment benefits. That began or was effective in the second quarter, effective September 1 for most of those groups, although there's a various -- there's various elements to that plan. And what happening there is the reflection of the elimination of the majority of that other post-employment benefit obligation.

Unknown Analyst

And just lastly for me. You mentioned the prepacked bankruptcy route [ph] going that way. Is there -- what's your ability to use the NOLs then at Dex One? Is that -- is that jeopardized in any way or you guys have the same ability, I mean whether it's done unanimous consent or prepacked?

Samuel D. Jones

Yes, we're looking at constructs and alternative execution paths across a wide range. And we are absolutely focused on preserving those tax assets regardless of the execution methodology that's employed.

Operator

Your next question comes from the line of George Schultze with Schultze Asset.

George Joachim Sebastian Schultze - Schultze Asset Management, LLC

So based on what you said, I'm curious what the timing is that you expect now for the closing for the proposed merger?

Samuel D. Jones

It's hard to say and pinpoint a specific date at this point. Suffice it to say, George, that it's taking longer than what we would like. We see the benefits of this transaction as strong, and we'd like to get it done as quickly as possible. Obviously, it's a pretty complex transaction. We're working and pressing as hard and as fast as we can to get it executed. How long exactly it takes is going to probably depend upon the path and the route that we have to take to get it executed. But it potentially goes into the first quarter, it could be sooner, it could be later, dependent upon the elements of it and what we run into as we work through that aspect of it, but we're driving as fast as we can to try to get it executed because we see the clear benefits of the transaction.

George Joachim Sebastian Schultze - Schultze Asset Management, LLC

Okay. In the press release, it states that the Committee of Lenders rejected the proposed amendments. Can you give us some or color as to why they rejected it? Did it have to do with the requirement to get 100% consent and the inability to get that? Or was there something else beyond that?

Samuel D. Jones

Yes, I don’t want to get too much into specifics around the amend-and-extend, but suffice it to say, it's a normal course negotiation and all the terms and conditions around those amend-and-extend or -- and have been were subject to debate with the lender groups. So we're working through that process with the committee and the agents and hopeful to get a resolution as quickly as we can such that we can get to the broader end of the group. But it wasn't just about execution methodologies. The debates are about numerous elements of the amend-and-extend.

Operator

[Operator Instructions]

Peter J. McDonald

Operator, looks like, with the situation on the East Coast, I think our questions have come to an end here. So appreciate everybody's attention. And we'll talk to you next quarter.

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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