Thryv Holdings Inc (THRY) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to R.H. Donnelley's Second Quarter 2004 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.

Copies of R.H. Donnelley's SEC filings may be obtained by contacting the Company, its website, or the SEC website at www.SEC.gov.

This transmission is the property of R.H. Donnelley Corporation. Any retransmission of broadcast without the expressed consent of the Company is strictly prohibited. Please note that today's conference 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 Mr. Jim Gruskin. Mr. Gruskin, you may begin.

Thank you, and good morning, everyone. I am Jim Gruskin, EVP-Finance at R.H. Donnelley.

On the call today are Dave Swanson, Chairman and Chief Executive Officer of R.H. Donnelley; Steve Blondy, Senior Vice President and Chief Financial Officer; Peter McDonald, Senior Vice President and President of Donnelley Media; and George Bednarz, Vice President, Publishing, Information Technology, and Corporate Planning.

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, 2004 and our Form 8-K furnished to the SEC yesterday, July 28, which both discussed our second quarter 2004 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 statements.

During this call today, we will refer to several non-GAAP financial measures in discussing the Company's performance. You can find additional information about these measures and a reconciliation between these measures and the most comparable GAAP measures in the press release and related 8-K furnished on July 28, 2004.

The separate press release related to the SBC transaction was issued on July 28, 2004. Each of the releases are available on our website, which can be accessed by going to www.RHD.com under Investor Relations.

In addition, the purchase agreement related to the SBC transaction will be filed with the SEC on Form 8-K.

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

Thank you, Jim.

Good morning, everyone, and welcome to R.H. Donnelley's Second Quarter Investor Call. I know that many of you have seen the press release we issued yesterday announcing our acquisition of SBC Communications' directory publishing business in Illinois and Northwest Indiana. I look forward to giving you some highlights of that important and exciting event for RHD, but before I get into the transaction, I want to provide you with a brief overview of our second quarter financial and operating highlights.

Afterwards, Steve Blondy's going to take you through the Company's second quarter results in more detail, as well as more color on the financial impact of the SBC transaction. We'll then, obviously, be happy to take your questions.

The second quarter was really an exciting time for us at R.H. Donnelley and was really a time of both transformation and growth for us. Most important, we continued to deliver solid financial results, stemming from our business process implementation. The benefits of our Sprint Publishing and advertising integration, including the systems conversion and business process changes, are evident in our Q2 numbers, particularly in our larger markets, which drove publication sales and revenue growth for the quarter. When the RHD business process rollout is complete in all of our markets, we believe our platform will continue to improve and be even more powerful.

I'm encouraged by improving advertiser renewal rates and a growing number of new business accounts in directories that publish during the second quarter.

The improved credit and collections processes put into place last year continue to have the desired results. By only accepting advertising from solid businesses that are likely to pay and likely to continue to be good customers into the future, we've increased renewal rates and reduced bad debt expense, which in turn, have enabled us to convert more sales into cash flow.

Meanwhile, the trends regarding new business sales remained positive. In our sales compensation plans for 2004, we focused incentives on the canvassing that's required to impact this part of our sales mix that's extremely important to grow the business. So renewal and new business sales are going very well.

Last quarter, I mentioned to you that the increases that we're getting from our existing advertisers were below our expectations, and that remains the case. Confidence levels and cash flows among the small- and medium-sized businesses are still not as high as we've seen in the past. We view that, however, as an opportunity to grow that part of our sales mix in the future.

Now, let me turn to the numbers.

In the second quarter, we generated EBITDA of $107m, bringing year-to-date EBITDA to $208.2m. While these EBITDA results are below last year's adjusted levels, remember that in 2004, we've absorbed more than $10m of expense from our headquarter's relocation and the SPA purchase accounting adjustments, neither of which were included in last year's first-half results.

Income before preferred dividends in the quarter was 33.1m, or 79 cents per diluted share. In addition, we repaid approximately 60.9m of debt in the quarter. Since the Sprint transaction of 1/1/2003, we've repaid over $390m in debt, reducing our leverage ratio to 4.7 times from 5.8 times. Our ability to generate significant value for our shareholders through deleveraging is one of the factors that we considered before deciding to move forward with the SBC transaction.

Publication sales for the second quarter, Sprint-branded directories, were $137.8m, up 2.2 percent from last year. Again, overall, we're pleased with these results, and we're very encouraged by the trend. And for those of you that were with us last year at this time, you'll recall that the second quarter was a difficult one, where we had essentially no sales growth. Many of our second quarter markets are home to military installations, like Fort Bragg, Fort Hood, Camp Lejeune, and Pope Air Force Base. And while these markets continue to have the expected economic issues associated with troop deployment, we were able to better plan for that and post solid gains in those markets.

Turning to DonTech, publication sales were down 1.5 percent in the quarter, reflecting the continued softness in the Chicago area economy during the prior two quarters. As a reminder, second quarter '04 pub sales represent advertising that was sold in the fourth quarter of '03 and the first quarter of '04.

Calendar sales for the quarter at DonTech, which represents the value of actual sales contracts signed up in the period, were down .5 percent from the previous year. And this primarily reflects the small declines in directories publishing in the third quarter of this year.

While improved over last year, we still have not seen the long-anticipated turnaround in that Illinois business climate. However, we are encouraged by some of the recent economic data that suggests an improving employment picture in Chicago. We also believe that once we have full control of that business, we will be much better positioned to benefit as the recovery takes place. And maybe even more importantly, with full control of our operations there, we think we'll be able to drive results sooner even if the local economy remains sluggish.

Turning to our online product initiatives, I'm pleased to report that we're ahead of schedule in our 2004 goal of establishing online city guides and these digital searchable versions of our Yellow Pages products in 50 of our Sprint markets by year-end.

As of the end of the quarter, we had sites up and running in 30 of these markets, and the amount of traffic for these sites continues to grow. Our mission is to provide our advertisers with the same strong stream of prospects and customers that they've come to expect from us historically through our print products.

Our strategy is to evolve this process of referring buyers to sellers by offering our users a variety of new ways to source that same great and relevant buying information, and our goal is to ensure that consumers find our advertisers no matter where they look for the services and products that they seek.

So to sum up, during the second quarter in the markets that we control, we continued to deliver on the plan we outlined last year, and we look forward to achieving similar results in Illinois once we control the operations there.

Now, let me turn to the SBC transaction that we announced last night.

We've been hard at work on this for over a year, and I am really thrilled to be able to report today that we've reached an agreement with SBC to acquire their directory publishing business in Illinois and Northwest Indiana.

This deal gives us control over our operations and our future in the country's third-largest media market, a market where usage is very strong for yellow pages and where the Donnelley tradition and name is even stronger.

This transaction completes our transformation to a fully integrated yellow pages publishing and directional media company. As owner/operators, we will be able to fully leverage our experienced executive team to manage operations and capitalize on market opportunities in Illinois using the same RHD business processes that have succeeded in our Sprint operations.

We also expect to capitalize on our excellent local brand equity in Chicago and the rest of the territory by returning the Donnelley name to the directory covers in association with the SBC Yellow Pages brand.

This acquisition will also integrate readily into our existing infrastructure. Similar to the Sprint transaction, we are extremely familiar with these markets; in this case, through DonTech, our longstanding partnership with SBC, and its predecessors. But the story here really gets even better.

Peter McDonald and his team will handle the integration and leverage the same infrastructure and processes that drove the successful Sprint integration. I think to say that Peter is uniquely suited for this job is a gross understatement.

Not only does Peter have over 30 years as one of the industry's most successful leaders, but as many of you know, prior to rejoining Donnelley, Peter was president of SBC Directory Operations, as well as President of Ameritech Directory Operations, where he sat on the board of DonTech for several years. And prior to that, Peter was actually the president of DonTech itself and had full operating responsibility for the business that we're acquiring there.

Peter's hands-on experience with these people, products, and markets, combined with the expertise of his team that just completed the SPA integration, give me great confidence regarding this integration and the promise of improving results.

Furthermore, remember that we already do all of the pre-press publishing and database management for all of these 129 directories that we're acquiring in this deal, so there's really no publishing or IT conversion work required, as we had in the Sprint deal. And if you'll recall, we had to convert over 20m records in the Sprint deal from one publishing system to another. We have none of that to go through here.

We also gained the opportunity to fully leverage SBC's SMARTPages.com Internet Yellow Pages platform, becoming the exclusive reseller for that successful local search engine in Illinois and Northwest Indiana. We will simultaneously and aggressively also be rolling out our own city guide Internet products in these markets as well.

Finally, by eliminating the DonTech partnership accounting, we'll simplify our financial reporting and make it easier for investors to understand our results.

Now, while all of this is well and good, ultimately, our decision to pursue this transaction was driven by our goal to create sustainable shareholder value, which we intend to do by providing the kind of leadership necessary to drive results by investing in these markets, particularly in the sales and marketing functions, by implementing the proven RHD business process, and ultimately growing sales, which is what it's all about.

Now, even though you'll see that we're reducing our guidance for 2004 DonTech pub sales today from a little over minus 2 percent to closer to minus 3 percent, we would expect to see modestly improving results as we go through integration in 2005 and have medium- to longer-term growth-rate expectations for that marketplace of 2 to 3 percent.

To sum up, I'm incredibly excited about what's happening here at R.H. Donnelley. We're successfully executing our business plan and strategy. Business is great in our controlled operations, and we expect to achieve similar results in Illinois and Northwest Indiana once we can implement our business processes there.

With that, I'll turn the call over to Steve.

Thanks, Dave.

During the second quarter, we continued to deliver on our commitments, execute our business plan, and repay debt ahead of schedule. Although DonTech performance remained soft, publication sales growth in our Sprint-branded directories continues as planned and reflects the RHD business process we're implementing.

Specifically, pub sales in our Sprint markets during the second quarter grew 2.2 percent. This compares to 0.3 percent in last year's second quarter and brings year-to-date pub sales growth this year to 2.4 percent. Remember that pub sales represent same-store sales, highlighting our recent performance that is impacted by the deferral method of accounting according to GAAP.

We also repaid $60.9m of debt in Q2 after bond interest payments of $47m. This brings total debt repaid this year to $149.5m and leaves us with just over 1.9b of debt, or approximately 4.7 times leverage.

Turning to the rest of the details, net revenue was $144.6m in the quarter, up 0.7 percent from adjusted net revenue of $143.6m last year. This reflects the impact of the deferral method as current quarter pub sales performance will amortize to revenue over the next four quarters. It also results from the final impact of the expired Yellow Book contract last year and the residual SPA purchase accounting adjustments.

Operating expenses before D&A in the quarter were $72.4m versus [$66.4m][ph] in Q2 last year. This increase reflects remaining costs associated with our headquarter's relocation that were originally anticipated in Q1 of this year, as well as increased advertising expense.

Expense in the quarter also included exceptional 401K contributions and remaining [costs uplift][ph] from the SPA purchase accounting. These increases were partially offset by lower bad debt expense and synergies in publishing and [IP][ph] resulting from last year's SPA integration.

After modestly lower partnership income of $34.8m, Q2 '04 EBITDA was $107.0m, compared to adjusted EBITDA of $112.5m in Q2 last year.

As Dave mentioned, this brings year-to-date EBITDA to $208.2m versus $211.1m in last year's first half. While these EBITDA results may at first appear lower than last year's adjusted levels, remember that in 2004, we've absorbed more than $10m of expense from our headquarter's relocation and SPA purchase accounting adjustments, neither of which were included in last year's results.

And last year's result in the first half also included approximately $3m of residual revenue from the expired prepress contract we had with a third party.

Second quarter DonTech publication sales were $89.4m, down 1.5 percent from last year. Meanwhile, calendar sales, which represent the value of contracts actually signed by DonTech in the quarter, were $119.5m, down 0.5 percent compared to $120.1m last year.

Resulting Q2 partnership income of $34.8m was down 1.5 percent from $35.3m last year.

As Dave mentioned, these declines reflect continued softness in the Illinois economy without the control to drive better performance.

As a result, we are lowering our expectations for 2004 DonTech pub sales to minus 3 from our original guidance of minus 2.2 percent. While unsatisfactory, we are confident that following the acquisition, we'll be better positioned to drive improvement in sales performance in Illinois.

Interest expense in Q2 was $37.5m, down 5.8m, or 13 percent, from 2003 adjusted interest expense in Q2 last year, due both to lower average interest rates and lower debt balances.

Income tax provision in Q2 was $21.5m versus $20.3m last year, reflecting this year's higher pretax income and our effective rate of 39.5 percent.

As a result of these items, income before preferred dividends in Q2 was $33.1m versus adjusted $32.5m last year. Adjusted earnings per diluted share in the quarter were 79 cents versus 81 cents last year.

Cash flow from operations in the second quarter was $52.8m, and free cash flow was $46.8m.

Relocation costs, incentive payments for stronger pub sales performance, and bonds' interest payments all consumed cash in the quarter.

Net cash used in financing activities was $45.5m, including $60.9m of debt retirement, partially offset by $1.7m of stock option proceeds, and $13.7m increase in checks in transit.

At June 30, total debt was approximately $1.94b, or about 4.7 times estimated 2004 EBITDA.

As a result of our decision to carry back 2003 net operating losses to prior years, we also expect to receive a net federal tax refund of approximately $40m in the third quarter. As a result, we are increasing guidance for both operating and free cash flow by $40m.

Excluding the SBC deal, 2003 -- I'm sorry -- 2004 free cash flow expectations are now 297m, or $7.04 per share from $257m, or $6.09 per share previously.

Now, on to the SBC transaction.

First, I'll discuss the terms, and then I'll review its impact on our financials.

We've agreed to purchase SBC's directory publishing business in Illinois and Northwest Indiana, including SBC's interest in the DonTech partnership for $1.42b in cash, net of a $30m DonTech partnership liquidation payment from SBC.

Similar to the SPA transaction, we expect a full tax-base step-up, thus deriving annual cash tax savings of approximately $30m for 15 years.

This deal gives us a 50-year exclusive license to publish SBC brand of directories in Illinois and Northwest Indiana, along with a [co-terminist][ph] non-compete agreement. We've also been awarded the exclusive right to sell advertising onto SMARTPages.com, SBC's [iwhyp][ph] platform in Illinois and Northwest Indiana for at least the next five years.

This acquisition significantly expands our reach. We're acquiring 129 SBC-branded directories, with circulation of approximately 10 million, serving more than 100,000 local and national advertisers. Combined circulation will now exceed 28m.

We'll be adding approximately 600 non-unionized employees, 450 of which are in sales. Once completed, we'll publish 389 directories in 20 states and boast pro forma 2004 revenue of over $1b and EBITDA of approximately $586m, assuming the transaction closed on January 1 this year.

We plan to finance this transaction with committed bank financing, led by J.P. Morgan and Bear Stearns. The transaction is expected to close in Q3 subject to regulatory approvals and customary closing conditions.

At 8.3 times acquired 2004 EBITDA of approximately $171m, the implied multiple compares favorably with recent directory acquisitions, as well as other publicly traded local media companies. However, in order for this to translate into meaningful shareholder value, we need to execute.

Our intimate familiarity with Illinois and Northwest Indiana and with DonTech's employees, together with our strategic focus and commitment to theses attractive yellow pages markets, should ensure the RHD business process readily takes hold. We have already developed detailed integration plans to manage a seamless transition and to substantially mitigate integration risk. And remember that we already provide pre-press services for all these directories in our Raleigh facility, obviating the need for a publishing conversion, as Dave mentioned.

One area that we will attack immediately is the billing and collections process, which is presently managed by SBC's Telco operations. While bad debt rates in the acquired markets compare favorably with most incumbent operations, once converted to our systems, we'll gain the same visibility, control, and best-in-class performance in accounts receivable that we enjoy today in our Sprint markets.

On a pro forma basis, RHD financial statements will also become easier to decipher as a result of this transaction. While initially we'll have to suffer 12 months of purchase accounting treatment following the consummation, thereafter, revenue and expenses from the business will be directly reflected in our income statements, rather than the cumbersome partnership equity accounting presentation of the DonTech structure.

During this transition period, we intend to again report adjusted results to improve -- I'm sorry, to remove the purchase accounting anomalies in addition to GAAP statements and compare these to the prior year as though the transaction closed at the start of 2003.

On this basis, we expect pro forma 2004 revenue of over $1b versus our previous guidance of [inaudible]. Likewise, we expect pro forma 2004 EBITDA of approximately $586m versus previous guidance of $415m.

As with the Sprint transaction, while we won't record revenue for directories published prior to closing our GAAP income statements due to purchase accounting, rest assured that we are purchasing and expect to collect the customer receivables for all these previously published books.

The transactions should be immediately and highly accretive to cash flow. We expect pro forma 2004 free cash flow to increase $86m to $383m from 297. In 2005, we expect this transaction to add more than $100m of free cash flow. As the deal will be entirely financed with bank debt, our weighted averaged diluted shares will remain unchanged at $42.2m this year, and assuming the transaction closes on August 31, we would expect pro forma adjusted revenue of $726m, EBITDA of $470m, and free cash flow of $327m for 2004.

In terms of capitalization, RHD will have approximately $3.4b of pro forma debt, or approximately 5.8 times estimated pro forma 2004 EBITDA, just under our leverage immediately following the Sprint transaction.

Together with our equity market capitalization, assuming conversion of existing preferred stock of $1.7b at yesterday's close, our enterprise value will be approximately $5.1b, or approximately 8.7 times pro forma EBITDA.

Thanks, everybody, for joining us. Now, let me turn the call back over to Dave.

All right. I know you're all anxious to get to the Q&A, but let me just wrap up our prepared remarks here with a summary of why we're so excited about our business and the transaction with SBC.

While the attractive fundamental characteristics of our existing business remain in place, the predictable revenues, the strong free cash flows, and a product that's always relevant for consumers and advertisers, the opportunity to expand our reach and distribute our products through new channels is what really excites us.

The SBC transaction completes our transformation from a sales agent and prepress publishing vendor to a fully integrated yellow pages publishing and directional media company. And as owner/operators with control over our destiny in all of our markets, we expect to be able to fully leverage our strong and experienced management team to capitalize on market opportunities for both our printed and online products.

Our history with SBC, the quality of the business, and our brand recognition in the Chicago market make this a compelling transaction for R.H. Donnelley. The acquisition of SBC's directory publishing business in Illinois and Northwest Indiana is a natural extension for our existing strategy. We look forward to a streamlined integration process and building on the successes of the Sprint transaction in the markets that we know extremely well.

Finally, and most importantly, we believe this transaction will deliver value to our shareholders.

This concludes our prepared remarks. Now, let's turn the call back to the operator for your questions.

Thank you. We will now begin the question-and-answer session. [Caller instructions.]

[Karl Schway][ph] of Merrill Lynch, you may ask your question.

Hi. Good morning. Couple questions. One, I wonder if you can drill down a little bit deeper into what steps you intend to make at the SBC directories once you take control, and if you can quantify the investments that you plan to make as a result. And, also, would there be any transition costs associated with the transition of the billing process from SBC over to you folks?

And second question is do you expect to be a cash taxpayer in 2005 after the deal? Thanks.

Let me just start with the question -- the financial questions that you asked, Karl, and then I'll turn it over to Peter to talk about the test that we plan to take at SBC.

As far as the investments, we've -- we're estimating that over the next 18 months or so, there will be approximately $20m of investments in sales and marketing, as well as all of our conversion and our integration processes, including the billing conversion that I mentioned. Those expenses will be over -- like I say, over the next 18 months or so.

As far as the cash tax position, I think it's fair to assume we are not going to be in a cash tax-paying position next year.

And, Karl, just [inaudible] the integration, we're going to take on the same process that we [inaudible] think it's a prudent business process that we used in the Sprint acquisition. We've already got the people in place, and we've already arranged the teams. We have -- we don't have to go through -- the integration of this is far less difficult, far less risky because we really don't have all of the data issues that we've had in the last one. The primary focus is going to be on the marketing and sales and impacting the investments that we're going to be making there to drive the top line.

The other transitioned services, as you already know, that RHD already has all of these services in place as a result of the Sprint acquisition, and we've been underway working to make that a smooth transition.

Great. Thank you.

Thanks, Karl.

[Paul Genocchio][ph] of Deutsche Bank, you may ask your question.

Hi there. Couple questions. First one -- could you talk about the intangible amortization again, I guess book versus tax? It sounds like it's 30m for taxes, but only, I guess, gross up to 450m, which is quite different from the 1.4b acquisition cost. What's the difference?

Yeah, Karl -- I'm sorry, Paul, we don't have the details of the book amortization yet because that's a process. We've got to still go through all of our purchase accounting work to get that completed.

But as far as the tax goes, the $30m I mentioned is the annual cash tax savings, okay? So that's already multiplied by our anticipated 39.5-percent tax rate.

Okay, perfect. Okay, and then what do you think you're going to do after 5 years with SMARTPages?

And then, finally, can you talk about this debt that you're taking on, fixed versus floating, and other -- I guess, other traits about the debt you're going to take on for this acquisition? Thanks.

Let me just talk about some fixed floating, and then I -- I'll let Dave talk about the Internet stuff.

As of June 30, actual, we were about 76-percent fixed because of additional swaps that we executed in the second quarter in anticipation of this transaction. And immediately following the close of the transaction, assuming no additional swaps, we'll be right around 50 percent, and our intention would be to increase the number of fixed floating swaps -- floating to fixed swaps so that we would get back up to 70-percent fixed.

And, Paul, it's Dave. On SMARTPages, it's certainly our intent, and I believe SBC's as well, that our SMARTPages relationship is going to go on for a long, long time. It's just very difficult to craft long-term arrangements in that space because it's very unpredictable and highly driven by traffic, but we're very encouraged with what SBC's done with SMARTPages. As you know better than most, they've done an excellent job of generating traffic for that site, and, again, we think -- we'd like to think that it's going to be a long, long relationship.

If I could ask a follow-up -- thanks, David -- a follow-up to Steve, is it [inaudible] a 6-percent incremental cost to debt on that new debt? Is that correct?

Well, you know, at the end of the day, Paul, you have to assume a forward LIBOR curve, and I'd say if you assumed 6 percent in your model, that -- you know, it might be a little bit conservative, but that's probably a safe place to be.

And I'm sorry, if I could quick, Paul -- when you switch to billing -- to your new billing system, it sounds like you're [going to pull][ph] some working capital out. Is that why you're getting a slightly higher incremental free cash flow number than I am or [inaudible]?

And, second, when do you think DonTech EBITDA grows?

Well, I can't say why our numbers are different than yours because I don't know what your model is, Paul. But I don't think that we're necessarily assuming any big improvements in working capital management. I mean I think that, as I mentioned, the bad debt rates in Illinois are already pretty good, but the management of the billing and collection process through the telephone company is a little bit cumbersome and not something that gives us direct control over those operations, and it's our strategy to control all of our operations. That's part of the reason why we're doing this transaction.

As far as the long-term growth rate for the DonTech business, you said EBITDA growth, or what were you asking?

Oh, just when it turns around and starts growing again.

We're saying 2 to 3 percent.

That's long-term, right, but I'm sorry, when does it start growing again?

Probably in 2006. I mean it's -- you know, probably by 2006.

Thanks very much.

Thank you, Paul.

Michael Meltz of Bear Stearns, you may ask your question.

Hi, I have two questions for you. Can you just clarify the -- what you're expecting from the business, what EBITDA you're expecting in '05?

And can you also talk a little bit more now about competitive landscape in Chicago, as well as if you're seeing -- or what you're seeing in Las Vegas competitively? Thank you.

Well, why don't I start with the EBITDA question, and then -- we have not provided 2005 guidance in general, and I did answer the question about cash taxes, and hopefully, that will help you guys understand what's likely to happen, but, you know, we've got 171m of EBITDA, 2004 EBITDA, that we're buying. We are going to make some investments through the P&L in sales and marketing through some of these integration activities, but we're not providing specific EBITDA guidance for 2005 at this time.

Steve, is it fair to say that the 282 in '04 -- that's the business all in -- that’s going to be -- that could be down in '05? Is that what you're saying from the investment?

You know, that's conceivable, Michael.

Okay.

Michael, on the competitive landscape, I'll touch on Chicago and turn it over to Peter on Vegas. We're not seeing anything different in Chicago. It's kind of the same as it is every place else we do business. We're fully engaged in a duopoly environment and expect that it's going to be that way. Peter, you want to comment on Vegas?

Vegas -- a terrific market, as I think everyone knows. We continue to see growth in the marketplace. We went into the marketplace, along with two or three others that have been there for some time in a much smaller rate, and things continue to go as they have in the past.

Okay. Sorry to push the competitive question, but in Chicago, do you think the independent share is higher than in your other markets?

I don't have any reason to believe that, Michael, no.

Okay.

Mark Bacurin of Robert W. Baird, you may ask your question.

Good morning. Congratulations, gentlemen.

Thanks, Mark.

Steve, could you give us some sense -- I know you don't want to give specific guidance, but you did throw out $100m of extra free cash flow for '05? And it sounds like you're assuming a rate somewhere in the, you know, 5.5-percent range and no cash taxes, but, you know, I guess I'm more curious about synergy expectations in that 100m, as well as the incremental spending for, say, sales and marketing and conversion costs.

Right, right. Well, this transaction is not being driven by expectations for cost synergies, like we had in the Sprint transaction. If you look at the pub sales, the total pub sales and the margin that SBC's been getting out of this business, it's probably a little bit higher than what might be healthy for long-term growth. And so our plan is to make some of these investments in order to be able to achieve the growth targets that we believe the market is capable of delivering to us. Does that kind of answer your question?

Yeah, I mean I guess -- I don't know when you'll be giving specific guidance for '05, but I guess at that point, you'll kind of lay out for us what the incremental investments are for DonTech, as well as any savings that might be achieved through the integration of the billing function?

We will probably provide our '05 guidance either at our -- the time we announce Q3 earnings or shortly thereafter.

Okay. On the new debt, could you walk us through what the important covenants and/or restrictions may be?

I'll give you a high level on that. Previously -- actually currently, we have out there four companies that we need to comply with in our credit agreement. There's a senior leverage. There's a total leverage. There's interest coverage, and there's fixed charges coverage. And as a result, we're basically amending our existing credit agreement to get this financing completed. And as a result, we're actually improving the terms once again. Remember, last fall, we improved the terms of our credit agreements. In this case, we're actually removing the fixed charges covenant altogether, so there will only be three covenants going forward. And we've got specific cushions that we've negotiated that make us very comfortable.

As far as the terms themselves, we're actually extending the maturities on term loan A and term loan B each by one year, and with respect to term loan A, we're actually lowering the spreads, the LIBOR, from 2-and-a-quarter to 200. So we're feeling pretty good about that.

That's great. And then just a couple quick questions regarding the quarter. Could you give us what the calendar sales were in Vegas this quarter versus last? I know you said there's still growth happening there, but just curious to see if we're seeing a slowing of the growth trend in that market given the new competitive entrant?

Mark, we actually don't report calendar sales for any of our Sprint-branded business. We used to report calendar sales when we were the sales agent, but that's because commissions were payable based on calendar sales, but since we completed this print acquisition, we stopped reporting on calendar sales from any Sprint business.

But just directionally, I mean have you seen at least a slowing of the trajectory of the growth in that market?

This is Peter. I think the -- you know, I think as we continue to improve the RHD business process, a tight impact on that market, and we're not seeing it slow. If anything, we're seeing it go the other way.

That's great. And then, Steve, just real -- one final one. Could you tell us specifically what the [relo][ph] costs and the extra 401K costs related to SPA were in the quarter?

The [relo][ph] costs in the quarter were about $4m, just a little bit -- maybe between 4 and $5m.

The 401K costs, I'm not going to give you a specific number. They were not related to SPA, though. Actually, there was a -- at the time that we spun off from Dun & Bradstreet, we inherited a 401K plan that was a little bit of a relic, and we needed to make sure we coughed up contributions to make sure that all of our employees were -- are properly taken care of.

[That's it][ph]. Okay, great. Congratulations again.

Thank you.

Bill Meyers of Lehman Brothers. You may ask your question.

Thanks, a few questions.

Steve, first, I guess given you're sensing for flat revenue and increased investment in 2005 through the SBC acquisition, can you walk us through the math that gives you $100m of free cash flow next year or from the 87m this year? That's the first question.

The second question is with respect to guidance. I know you updated your free cash flow guidance to reflect a $40m tax refund and the lower JV income, but have you made any changes to the core revenue and EBITDA assumptions?

And then I guess, just lastly, in terms of taxes, could you give us some background in terms of where the $40m tax refund came from? I think that was about a $12m refund in the previous quarter. Anything that we should be looking for --

[Inaudible]

-- sort of on a going-forward basis?

I tell you what. Could I try to -- let me try to answer them one at a time because I can't write them down as fast as you're asking them. Okay? Is that okay?

Sure.

And so the first question was $100m free cash flow and where that's coming from.

Well, we were buying $171m of EBITDA. We're borrowing $1.45b of bank debt, and we're going to repay that on an average basis over the course of the next, really, 16 months if you assume that we're closing on August 31. So our bank debt's going to be down. You can assume an interest rate and calculate what the interest -- the cash interest expense is on that. Zero (0) cash taxes, modest uses of working capital and capital expenditures, and that's the only other thing that consumes cash. So I don't think it's that hard to get to $100m.

As far as the $40m in federal income tax refund, what that resulted in, basically we filed our 2003 tax return. We're accounting for our income and our tax returns on the same basis that we use for revenue, GAAP revenue, under the billed method, so when we collect the cash. And as a result of that, we ended up with NOLs last year that we carried back to prior periods.

The $12m of tax refund that we got in the first quarter was an overpayment that we made in 2002 that we discovered last year and were able to recover in the first quarter.

Now, I'm not sure I answered all your questions. There was one in the middle there that I think I might've missed.

I'm showing that the other question was just with respect to guidance. You've already updated your free cash flow guidance given the tax refund, and your assumptions on DonTech are given sort of on revenue declines.

Right.

But have there been any other changes to your sort of core revenue and EBITDA growth or, you know, revenue and EBITDA [indiscernible]?

None other. None other than what I said, no.

Thank you.

Thanks, Bill.

Arnold Ursaner of CJS Securities, you may ask your question.

Hi. Could you focus a little bit on your 2005 strategies for DonTech and how you hope to see the improvement in growth in '05? And is it more driven by the industry or more company-specific actions you plan to take?

Hi, Ernie. It's Peter. We're pretty excited. I've had -- as Dave mentioned, I've had a lot of experience in this marketplace, and I think that, as Steve alluded to, that we're going to be investing in the sales and marketing process, and that will be the key investment and the key drivers.

And I think, once again, when we take a business process which, you know, I've been involved with for quite a few years, and we take it -- the area of [indiscernible] business process and put it in to the marketplace, I think with the alignment that we'll have today where we have complete control over the market, as we've done in the Sprint process, you can see the kind of turnaround that is possible.

And I think, Arnold, you'll remember where we were with Sprint when we were purchasing that property. It was in the minus category, and today, it's in the plus 2 to 3. So we -- Arnie, we really see that if we apply the same disciplines and rigor to the business that we have in the other markets in Chicago or in the Illinois properties, we think we can do the same thing.

Peter, will you -- one of the things that helped drive your growth in the past is changing comp to reflect performance. What -- can you tell us what the current status is and if you intend to, in fact, make it more performance oriented?

Yeah, Arnie, the -- we're going to look at compensation as one of the many elements. There may be as much as 55 different things that we'll look at. This is a business where execution really makes a difference. There isn't one silver bullet, as we've talked about in the past, but if you get all of the function operating at the highest level, you can really make a difference. Compensation will be one. How we assign markets, how we can play the sales force, on and on and on, is our part of the process that is continually in markets from coast to coast, and the positive impacts that we're looking for.

Peter, if you could remind me, if you would, you've had a scenario where Southwestern Bell basically absorbed the bad debt expense of the JV, and it -- it has impacted your growth rate of adding new clients over the last two, three years. You know, minus where we are in that process, whether we've completely anniversaried that, and if so, how will you as an owner/operator perhaps change any policies you may have on bad debt?

Well, Arnie, it's true that we have a cap on our bad debt expense in the DonTech structure of 3.7 percent. And our partnership income is protected in that regard.

But, you know in our Sprint market, and we've talked about this at length, we don't believe that the minimal bad debt is necessarily the -- like 0 bad debt is not the objective. The objective is to establish credit policies that allow for rational growth in new business sales, and what I can tell you is the bad debt rates in the DonTech markets are in the 5-percent range, and that's as good as just about any incumbent publisher that we're aware of.

Okay, thank you.

[Douglas Arthur][ph] of Morgan Stanley, you may ask your question.

Yeah, I'm wondering if you can elaborate sort of over a 3- to 4-year period what a potential target EBITDA margin at DonTech might be. Thanks.

Well, you know, we've said all along that our goal is not to maximize EBITDA margin, but we think that the right EBITDA margin for these businesses is in the -- it's kind of mid- to high 50s. So, you know, call it 57-, 58-percent range. And that's not to say that the business doesn't have considerable operating leverage because it really does. The incremental margins on incremental dollar of revenue are much higher than that. However, our strategy is not to try to extract maximum cash from the business in the first year or any individual year but rather to take that money, that excess margin, and reinvest it in the business to provide more value to our customers, and that will spur higher revenue growth. And at the end of the day, you've got to grow the top line in order to succeed in these markets, and that's what we intend to do.

Okay.

Thanks, Doug.

[Andy van Houghton][ph] of Deutsche Bank, you may ask your question.

Yes, and I wanted to follow up on Paul's question about sort of the mix of floating and fixed-rate debt. Do you think at some point the Company might consider when the deal is finished to actually term out some of the bank debt with a high-yield issue, either a new one or an add-on to your existing high-yield notes?

Yeah, it's a good question, Andy. At this point, we have no intent to doing that. You know, we always look at all sorts of financing proposals that our brethren on Wall Street find opportunities to pitch to us. But we looked at the possibility of financing part of this transaction in the bond market and concluded that it was much more efficient for us to do it in the bank market. So until somebody comes to us with a financing structure that appears much more attractive than the bank market, I think we'll stick with this. I think we can basically [inaudible] bank term loan A, term loan B structure with the corporate swaps in place gives us a lot of flexibility, not only in terms of lower costs but also the ability to prepay without penalties.

Great. Thank you very much.

Thank you.

[Brad Serbian][ph], J.P. Morgan, you may ask your question.

Thank you, and congratulations on this transaction. A couple questions.

One, I'm sure -- you know, it looks like you'll be at like a [Dax][ph]-type leverage level, but can you just comment on the ratings agencies? I’m sure you've been in talks with them and what you think will transpire there?

And then, secondly, you've fielded a lot of questions, so my main question was really asked. I'm just trying to understand better the structural differences in the DonTech properties beyond the fact obviously Illinois and Indiana sound a little slower-growing than Vegas and Orlando, but I mean is Yell in there, who -- competitively? And is there anything beyond -- problematic beyond the fact in the region that, you know, you have a little bit slower-growing demographics, and, you know, specifically with other media being more aggressive. I mean I'm trying to figure out -- you've talked about [inaudible], I guess, the Illinois area being a little bit to local media in the past, so I'm trying to figure out what would prevent you from getting it up to the rest of your properties' -- the Sprint properties'-type growth rate.

Okay. Well, first of all, with respect to leverage, we don't know what [Dax's][ph] leverage is for sure, but what I've been told is that it's closer to 6.6 times and pro forma for this deal, we're going to be just under 5.8 times.

As far as the rating agencies, you know, we have been talking to them. I don't have any news for you at this point in terms of their ratings. I can tell you that the leverage this time is slightly lower than the leverage was last time when we completed the Sprint deal, so you might reach your own conclusions.

As far as the demographics in the marketplace, I don't know, Dave, do you want to --?

Yeah, in terms of the differences between this and the other, you know, while you're right that we see that economy not having the same potential as, you know, kind of our Sprint markets, especially our top-10 Sprint markets, which really are in very good markets in terms of economic growth, it's -- there's still -- there's a tremendous amount of opportunity in these markets, and we really believe that by putting some focused heat and light on them, that we should be able to achieve very nice growth rates there.

In terms of competition, it's essentially the same as we experience everywhere else and I think that everyone else is seeing. It's just a business that has gone from the old monopoly to a new duopoly, and we see it everywhere and are comfortable that we can achieve nice growth in that environment.

Yell went into Vegas this year. I mean is Yell in this market? Are they coming in? How many independents do you face? And do you have any other updates on the competitive landscape? Has Yell gone into any of your significant markets?

Yeah, Yell is in this marketplace, both Chicago and the surrounding Illinois areas; has been for some time, either on their own or through acquisitions that they made along the way. Nothing really new going on there. You know, we're fully engaged and been fully engaged.

Other than Vegas, Peter, I'll kind of turn to you. Anything else?

No, I think you got it right, Steve. You know, Chicago's interesting and, really -- there's really only two competitors. In many markets, there's four or five or six competitors, and Vegas we have a number, and Yellow Book's in there, and that's pretty normal business as usual.

Just one thing I would add, Fred. I think this is important that -- I believe it's fair to assume that our pro forma revenue growth rate may be diluted slightly for this transaction because I agree with you that, you know, while Chicago is the third largest media market in the county, and Chicago boasts some of the highest Yellow Pages usage of any market in the country, the demographics there are not as -- they're not growing as fast. The economy's not growing as fast as Las Vegas and Southwest Florida.

On the other hand, under the existing partnership structure, we were subject to a flat to declining partnership income in our EBITDA, and I think as a result of this transaction, while we may see slightly declined or kind of diluted growth in top-line on the pro forma combined basis, that our pro forma EBITDA growth rate will actually go up.

Thank you very much.

[Ian Wise][ph] of Bear Stearns, you may ask your question. Mr. Wise, your line is open. Mr. Wise, please check your mute button.

We have time for one more follow-up question from Paul Genocchio. Sir, your -- you may ask your question.

Just could you give us an idea how much of the SBC directories you've bought or Chicago, is Chicago -- if you can give us any breakdown of the spread of revenues?

And, second, it seems that you're slightly lower in guidance for DonTech, and you [certainly][ph] haven't changed your overall EBITDA guidance. You slightly improved -- increased your outlook for the Sprint EBITDA going in the second half of the year. Thank you.

Yeah, we don't have perfect insight into SBC's [inaudible]. We think that Chicago represents about 10 to 12 percent of their total directory business.

Illinois.

Just Illinois; I'm sorry. Not just Chicago; Illinois and Northwest Indiana.

As far as our EBITDA guidance goes, Paul, we had previously talked about $112m of partnership income from the DonTech partnership, and, you know, we think that number's probably still pretty good. You know, maybe it's 111m, but it's not going down any further than that. So I don't -- I don't think that you should assume that we're somehow -- there's some kind of uptick in our [indiscernible] EBITDA that is covering that.

Okay, great. And, sorry, to get back to that first question, if you have 455m of incremental revenues, somewhere around there, what -- I'm sorry, what percentage of that incremental revenue that's now consolidated is Chicago, and what's the second market? Is it Indianapolis?

We're not marketing --

Sorry, sorry, sorry.

-- to Indianapolis, Paul. Really, it's the Chicago and Chicago land is what we've said before is like the main Chicago and the suburbs all around Chicago is roughly, you know, two-thirds to three-quarters of the revenue, and the rest of it is downstate.

Great, thanks.

Operator, do we have any other questions?

Not at this time.

All right. Well, listen, thank you all for your attention and interest in R.H. Donnelley. It's obviously been a very exciting time for us here, and we really look forward to updating you on our continued progress later this year. Thank you.