Thryv Holdings Inc (THRY) 2006 Q2 法說會逐字稿

Welcome to the R.H. Donnelley's second-quarter results investor teleconference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. Please note that today's teleconference call is being recorded as well as webcast live over the Company's website at www.rhd.com. I would now like to turn the call over to Ms. Jenny Apker. Ms. Apker, you may begin.

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

Certain statements made today may be forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. We call your attention to our press release for the quarter ended June 30, 2006, and the Company's Form 8-K furnished to the SEC yesterday, July 31, both of which discuss the second-quarter 2006 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.

Copies of R.H. Donnelley's SEC filings may be obtained by contacting R.H. Donnelley, searching its website at www.rhd.com, or visiting the SEC website at www.sec.gov. This transmission is the property of R.H. Donnelley Corporation. Any retransmission or broadcast without the express consent of the Company is strictly prohibited.

During this call today, we will refer to certain non-GAAP financial measures in discussing the Company's performance. For example, we will be referring to adjusted pro forma results for the second quarter, which unless otherwise indicated reflect the consolidated results of R.H. Donnelley that exclude the impact of purchase accounting and include certain other adjustments.

You can find additional information about all non-GAAP measures and the reconciliation between these measures and the most comparable GAAP measures in the press release and related 8-K furnished on July 31, 2006. The press release is available on our website and can be accessed by going to www.rhd.com, and clicking on press releases. Please review the risk factors described in the Safe Harbor language. Now, I would like to turn the call over to Dave Swanson.

Thank you, Jenny. Good morning, everyone, and thank you for joining us this morning. As you read in our earnings release last night, this was a quarter of mixed results as we lead the Company through this year of transition and integration, on our way towards our goal of becoming a leading directional media company in terms of growth and profitability.

Cash flow, EBITDA, Dex integration progress, and net synergies this year are meeting or exceeding expectations. Ad sales, on the other hand, are below expectations, driven by a tough quarter in Illinois and more short-term issues in Dex than we originally anticipated.

I want to make it perfectly clear that we remain confident and committed to positioning the business to show sustainable growth in the 2% to 4% range by remaining focused on delivering products of choice to consumers, and great ROIC and service to advertisers, with our bundle of print and digital offerings.

Now let's review the quarter and our outlook. Advertising sales in the quarter were $725 million, a decrease of about 3.5%. The results represent another strong performance in the EMBARQ markets, offset by declines in both AT&T and Dex markets.

Let me provide some color beginning with Dex. We expected 2006 to be a challenging year for Dex, and it has been even more so. We knew sales campaigns for '06 publications were already underway when we announced our intentions to acquire Dex in October of 2005. So salespeople out west were dealing with the distraction and uncertainty surrounding the announced transaction for months prior to close, affecting first and second-quarter published directories.

Last quarter, we talked to you about the system-related issues Dex was experiencing and the significant customer impact. Specifically, advertising and billing errors. Compounding the issue were inadequate customer service processes and resources to respond to advertisers' complaints in a timely fashion.

This has been the single biggest surprise of the integration and the largest contributor to our softness in ad sales. Our systems and ops groups have worked tirelessly over the last 130 days or so tracking down the software and process problems that were causing the errors to occur.

We believe we have identified the majority of these root cause problems and have remediated the most serious offenders. We expect to have them all fixed by year's end.

These issues have impacted ad sales in a couple of ways. We have had some unhappy customers cancel their ads because they couldn't get anyone to respond their problems. But the bigger impact has been our lost productivity due to the enormous amount of extra time it is taking our sales force to work through this backlog of problems with our billing departments and customer service. It takes away time we could be selling new business, and it doesn't do much for morale either.

The good news is that we have worked through a backlog of nearly 15,000 advertisers that have claimed to have had errors in their ads or their bills, down to less than 2,000 advertisers today. To put that in some perspective, RHD East would have fewer than 100 unresolved complaints in the queue at any given time.

I'm also extremely pleased that we are now resolving over 90% of new customer complaints the same day as received. So the level of service the customers are receiving today has gone up dramatically as a result of implementing RHD customer care practices across the Dex footprint.

We have this difficult situation under control, but it did have an impact on Q2 ad sales; it will have an even greater impact on Q3 ad sales; and should then start to improve in Q4. This is one of the primary reasons for our revised ad sales guidance.

Another contributor of softness at Dex is that we had to slow down sales of some Internet products, not because of lack of demand for the products. Quite the contrary. Sales were exceeding the capacity of our vendors and our internal groups to fulfill them in a timely manner. We have been working to scale the processes and are now in much better shape than earlier this year. Nonetheless, it has held back 2006 performance.

In addition, '06 is a labor negotiation year for many Dex employees, which creates an additional distraction for all involved. The good news is we finalized a new three-year agreement in the second quarter with the IBEW, which represents about half the Dex sales force, on time and without a work stoppage. Keep in mind that we still have to bargain the CWA contract later this fall.

Finally, the Q4 Dex ad sales numbers will be impacted by the elimination of some of the market overlaps that we knew we were going to have to deal with when we made the acquisition.

When you add all of these things to the normal integration issues one would expect with an acquisition this large, including rolling out the RHD business process, you can see how this is an awful lot for the Dex business to digest this year. The good news is they're all short-term in nature and should not affect our ability to grow the Dex business over the long term.

These are excellent markets in terms of economic growth and are full of opportunities. Our products, both print and online, are getting great usage, and the sales force, which we have found to be very talented, is reacting well to our customer-centric business philosophy. Bottom line is we continue to feel great about Dex.

Switching over to our AT&T markets, as I indicated on last quarter's call, we knew given the initiatives we had put in place for second-quarter publications that this was going to be a challenging quarter.

In addition to the impact of removing cover ads, tighter credit policies, and the scoping changes we have been talking about, we took on a significant project to normalize pricing and eliminate what was way too many discount plans in the big Chicago consumer directory. This resulted in some advertisers having an effective rate rollback; some advertisers faced steep rate increases; and there was a few out there that actually stayed about the same.

While we had certainly hoped and planned to try to sell through these changes, when it was all said and done many advertisers that had the rollbacks put the extra money in their pockets. And those that faced increases reduced ad sizes to maintain previous spend levels.

While these kind of initiatives cause us some short-term pain and setbacks, they position the Company for sustainable growth. The good news is we are cycling back now to sales campaigns where we began our marketing reconstruction efforts, and are benefiting from incremental usage generated by directory rescopes and enhanced content. These are also areas where we have fewer advertisers in delinquent payment status due to our stricter rules.

We have introduced significant new product features and content in these markets. In addition the Plus product was launched in Chicago. After only a couple of months this book has call volumes that exceed plan, and prove its positive impact on the market, and present a significant sales opportunity for us next year as it was offered free to advertisers this year.

We are also very excited that it looks like local sales in Illinois for Q3 will actually show growth for the first time in four years, indicating to us that our efforts are beginning to pay off.

National sales unfortunately will not turn the quarter yet in Q3, as they tend to be more negatively impacted by the pricing changes associated with our directory consolidation and rescope initiatives. So while we are not out of the woods entirely yet, we're getting closer.

We have a few more quarters of product changes and directory rescopes in some of our smaller AT&T markets, which will have some small impact on national and to a lesser extent local. But most of the initiatives that have negatively impacted results these last several quarters are now behind us, and we expect to begin to benefit from these significant initiatives.

You know, it is easy to miss how much we have accomplished in Illinois by focusing on the current results, which do not provide visibility into the strengthened foundation of that business. Many of our leading indicators, such as call volumes, new advertiser growth, advertiser payment habits, and renewal rates, are to starting point north and give us confidence in the outlook for growth.

Turning now to our EMBARQ markets, we continue to generate strong results with another quarter of robust growth from both existing advertisers and new accounts. The transition to the EMBARQ brand is proceeding smoothly. Las Vegas was the first book launched under the new brand, and we have received positive feedback from both advertisers and consumers in the marketplace.

We expect to benefit from EMBARQ's significant advertising investment, which will continue through the second half of '06. EMBARQ remains healthy and reflects the kind of stability and growth we are working to achieve with our other brands; and we foresee similar growth throughout the rest of 2006.

As we have mentioned many times, 2006 is a year of transition and integration. The second quarter reflects that upfront investment required to obtain the ongoing benefits from the changes. When we provided our guidance in March, Dex integration and improvement efforts in Illinois reduced our visibility into the full year.

In addition, certain items we experienced in the first quarter, such as the system issues and integration distractions, are going to continue to be a drain on resources and productivity, affecting this year's results. Some of these changes have taken longer and created more disruption that we anticipated. Some have been easier.

On balance, from an ad sales perspective, there have been more bad guys than good guys. As a result, we're revising our ad sales guidance to approximately $2.64 billion this year, which could represent around a 1.8% to a 2% decline.

On the other hand, in the earnings and cash flow department we have had more good guys than bad guys. EBITDA is expected to be at least $1.46 billion, representing a 54.5% margin, as we have offset the impact of lower ad sales with prudent expense management and greater net synergies. Free cash flow looks like it will come in better than expected at around $725 million. Steve would discussed these changes in more detail in just a moment.

Let me wrap up with an update on our current online results and efforts to develop a unified comprehensive local online search and digital product strategy. We continue to be excited about the growing level of interest and revenue from our online products and services. We have seen solid renewal rates and strong growth, particularly in our RHD East markets. DexOnline continued to be the go-to destination for consumers in our Western U.S. markets.

From a strategy standpoint, we're driving several key initiatives to ensure we have a strong value proposition to offer advertisers for many years to come.

We are in the final stages of developing the next generation online search product to support efforts to consolidate our multiple online brands and URLs into a single unified platform. The new site, which will go online later this fall in the West, will include significant new features and functionality such as draggable maps, map-based search much like you see with Google Local, compare pages much like Orbitz.com, user-generated itineraries for multistop shopping, and personal contact lists to help consumers build customized online Yellow Pages of businesses they prefer or that have been referred by friends.

On a less glamorous but equally as important note, we're developing enhancements to our systems infrastructure to ensure we can support multiple sales channel strategies, efficiently distribute enhanced content across multiple media, and offer more flexible advertiser products.

We are working with Amdocs, our publishing systems vendor, on a jointly-funded project to develop a suite of next-generation back office tools to better enable our systems and sales force to sell digital products with the flexibility and efficiency the Internet affords. We believe this investment in our systems and processes is critical to our long-term success.

As you know, we have deployed [click] bundles across our footprint with great success. We are also testing different iterations of search engine marketing products and services, and will use that intelligence to further enhance our offering and ensure that we continue to deliver the leading, local search engine marketing solution for the small and medium-sized business.

We are also continuing to pursue distribution partnerships, like the one we recently formed with Yahoo search marketing, by which we provide our advertisers with greater exposure to consumers through alternative channels of distribution. We believe partnerships like this one provide benefits to us and ultimately greater value to the advertiser.

Finally, content aggregation continues to be a very critical element of our overall strategy. We believe it will be the single most important differentiating factor as consumers develop their online local search habits. As such, we're building on Dex's leadership here and have launched several programs, including e-mail marketing, telemarketing, and utilization of our direct sales channel, to collect even more content.

Our intention is to continue to provide the consumer with the most comprehensive, current, and relevant content on local businesses online and off. We believe these initiatives position us well to achieve our stated growth targets of 2% to 4% annually regardless of how consumers' search habits evolve.

As the world of local search continues to expand from the core print offering to new distribution platforms, so will R.H. Donnelley. We remain focused on strengthening our market position in print, while broadening the solutions we offer advertisers to insure we can satisfy their need for high-volumes of ready-to-buy leads directed to their businesses. I would now like to turn the call over to Steve.

Thanks, Dave. Today we referred to adjusted results reflecting the Dex transaction as if it closed on January 1 and removing all purchase accounting entries. Please carefully read our press release and 8-K for more details.

Second-quarter free cash flow of $194 million and EBITDA of $385 million both exceeded expectations. We once again converted half of EBITDA into free cash flow, reinforcing the superior value of our EBITDA compared to other companies. Stronger margins and cash flow reflect exceptional net synergies and disciplined cost management, encouraging us to increase '06 guidance for these two critical metrics, notwithstanding softer ad sales.

We repaid $204 million of bank debt in the quarter, and net debt at year-end should be around $10 billion. Let's review these items in greater detail.

Strong controls in bad debt management, publishing operation, and IT costs, along with robust net synergy performance, overcame soft ad sales and net revenue during the quarter. We said Q2 ad sales would be tough on our last investor call, and we tightened expenses to protect profits.

Q2 EBITDA margin of 56.9% before $9 million of FAS 123(R) expense also reflects our second-half weighting of integration costs. Q2 cash interest payments were $163 million, while accrued interest expense of $211 million included accretion of discount notes and deferred financing cost amortization. Q2 free cash flow includes $209 million from operations and CapEx of $14 million.

Now let's switch to capital structure. Net debt at the end of Q2 was under $10.3 billion, having repaid over $200 million during the quarter. In April, we amended our credit agreements to reduce rates on more than $3 billion of bank debt and to conform pricing across the facilities. These rate reductions should save us $8 million annually.

In Q2, we also executed $1 billion of new interest rate swaps, which increased the fixed-rate portion of our debt portfolio to 90%. At June 30, our weighted average cost of debt was 7.9%, reflecting the new swaps and amendments.

Finally, we are revising 2006 guidance as follows. We now expect ad sales to be at least $2.64 billion this year, representing a 1.8% to 2% decline from 2005 pro forma results. This change reflects greater than anticipated impact from Dex integration and our remaining turnaround efforts in Illinois. As Dave mentioned, we are encouraged by Q3 Illinois ad sales performance, as our investments there are starting to pay off.

We have lowered '06 revenue outlook to at least $2.68 billion in concert with ad sales; but notwithstanding, we expect EBITDA before FAS 123 to exceed previous guidance of $1.46 billion, representing a margin of 54.5%, which is 100 basis points higher than the previous midpoint of our guidance due to higher net synergies and efficient expense management.

While our EBITDA certainly exhibits less seasonality than cash flow, anticipated lower second-half revenue and the timing of cost to achieve synergies will be weighted towards the second half foreshadowing modestly lower margins for the balance of the year and obscuring the full benefit of synergies.

We are also increasing free cash flow guidance to exceed $725 million, reflecting strong first-half performance. Large bond interest payments and accelerated CapEx in the second half will mutate the flowthrough of strong $426 million first-half cash flow performance.

We are leaving original CapEx guidance of $75 million unchanged. Though year-to-date CapEx is below the run rate this implies, we expect IT integration costs to pick up in the second half.

Net debt at year end should be around $10 billion, indicating leverage of 6.8 times.

Last, we are modestly lowering estimates for fully diluted share count to between 72 and 72.5 million shares, implying free cash flow per share exceeding $10 this year. With our stock trading recently in the low 50s, $10 of free cash flow per share approaches 20% yield for equity investors.

In conclusion, we are in full execution mode. We are on track to exceed first-year synergy targets. We are converting healthy EBITDA margins into robust cash flow. And we're building a strong foundation for sustainable 2% to 4% growth.

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

(OPERATOR INSTRUCTIONS) Anthony DiClemente, Lehman Brothers.

I have two questions, first on the growing EBITDA and free cash flow. I mean, it seems like now your free cash flow yield on market cap is over 20%; but your stock is down 25%; and yet you are today raising your free cash flow number.

I am just wondering, first off, if there is any point where you realize that your stock is at such a value that you kind of pause on the deleveraging and look to buy back some stock, just given the compelling value in the marketplace.

Then my second question is related to online. It does seem like many investors are looking at the Internet and online as more of a foe than a friend to the directories business. So I am just wondering if you have done -- if you have made any progress in negotiating with Google, with Yahoo, with MSN on agreements to share your content with them. If so, if you can give us just any color incrementally on what those deals look like or might look like in the future. Thanks.

Anthony, I will start with your second question on online, and I might need -- there was a couple in there, so if I need to follow-up just prompt me.

But you know, as I kind of tried to indicate in my comments, we are in full swing in kind of developing and building out what will be; it's like our unified strategy. That clearly includes leveraging relationships with these people in a couple of ways.

One is through these distribution agreements, or I think they're better characterized as syndication agreements which Dex has done a very good job of. We continue to have conversations about getting RHD East into those agreements, if and when we can get the data from RHD East in a platform that is portable over there, which we don't have today. So that is one of the holdbacks there.

But the other way that we're leveraging them and that we're very excited about is through these search engine marketing products, where we are leveraging the eyeballs. It's like the people that use Google and Yahoo and these major search engines, to direct them through these pay-per-click programs to our advertisers. That has been very well received.

Will that come to -- as analysts, is there any way you can quantify that just in terms of percentage of the business today, or three years from now? Or maybe even just talk about the type of economic arrangement that that looks like.

Yes, I think all I can say, Anthony, is still in the whole scheme of things very small; growing rapidly; and it's early days. We are still not sure that the products and services that we're offering today in that area are really the right ones. You have to experiment a little bit in the marketplace, which is what we're doing right now.

But there is no doubt in my mind it is going to become a significant portion of our product service offering in the future.

Okay, fair enough. Then on the first question on the possibility of buyback versus deleveraging?

You know, Anthony, we have heard from several of you, both on the analysts' side as well as some of our investors, with that question. I think to put a finer point on it, what is the logic of repaying bank debt that is inexpensive when the stock looks like such a great bargain?

That is something we spend a lot of time talking about as management and with our Board. I think at 7 times leverage, it is important for us also to focus on responsible cash applications. So, that is the line that we are walking right now.

For the time being we have concluded that we need to focus on delevering; although where the stock has been trading lately, it forces us to continue to evaluate those alternatives.

So you know, if we have a change in our intent we will let you know. But it's something that clearly is of great interest and current topic, topically, of discussion.

Good. Thank you very much.

Peter Salkowski, Goldman Sachs.

Just a couple of quick questions, first of all on the ad sales. Certainly for the second quarter, a little disappointing; and then expectations for the second half of '06 it sounds like down again, certainly in the third quarter. If you could give some sort of visibility expectations or possible -- you know, how far out before we get to the 2% to 4% growth in revenue? Sort of what does '07 look like? Maybe even a possibility of going a little forward into that?

Then on the other question, going back to the electronic products, I know you have had the -- Dex has had the Web Clicks product for some time now. I was wondering if you could give some sort of data behind customer renewal rates, average dollar per spent by advertiser. Some sort of numbers behind that, that is going to give us a sense for how advertisers are receiving that product.

I know you said you have a pipeline of people trying to get into that and handling that situation. But if you can give us some numbers behind that, I would really appreciate that as well.

It is Dave. I will start again with the second one and then let Peter take the ad sales growth. But first on the Dex Web Clicks, one of the things that I referred to, there is great demand in the marketplace. But Dex being kind of pioneers with that product, they got actually got out in front of their ability to fulfill a little bit.

So the numbers for Web Clicks in Dex in '06 are somewhat muted because we literally had to slow it down, because the infrastructure was unable and the vendors were unable to fulfill Web Clicks on a fast enough basis to be satisfactory to customers.

So listen, I think that -- I don't have average value order numbers with me or anything. But suffice it to say, this is a strong product offering that is going to be an important part of the portfolio that we are offering out there to satisfy the different user needs, be it print, IYP, or search.

Peter, this is Peter. Relative to the ad sales, a quick way to look at this is when we took over EMBARQ we had some challenges; put in our processes; and we have had continued strong growth for three or four years in a row now.

When we look at AT&T, I think that Dave talked about it a little bit. We're finishing that first year -- or the first full cycle I should say -- of directories. As we said in the investor conference that we would see some positive growth in Q3 in local, and we have seen that.

I can tell you that all of the things that we have in place to be the product of choice up there, to really increase the usage in the consumer, and then the return on investment to the advertiser, we're seeing up there. The numbers are starting to show.

Our bad debt or the accounts that are delinquent right now are going in the right direction; they are decreasing.

So we look at the value proposition that we went through to change the products, to drive the right value equation in that marketplace, we feel good that we have got most of it behind us. We have done the right things in the products there. So we feel optimistic about growth in 2007 relative to AT&T.

When we look at Dex, we have it 100 and something days, whatever. These are all short-term issues. The claims are real. The issues that we had to deal with there are short-term in nature. I am very pleased with the receptivity of the RHD business process in the Dex markets; and they are as strong as we thought, maybe even stronger.

So I think that if you look at our management team and think about our potential in these markets, that is why Dave and I haven't really changed. We still believe, everything we have seen, 2% to 4% is clearly what these markets should grow long-term.

Thank you very much. I have a quick question on the competitive or sort of the competitive print books that have come into markets. Have you seen a pickup in the Dex markets given the acquisition and an opportunistic by some of your print competitors to come in there?

I think earlier in the year Verizon launched. from what I read somewhere, three new books on some of the Dex markets. I am just wondering what sort of impact you have seen competitively there.

Every one of our markets has probably three-plus competitors. I think that this is not a new phenomenon. You always take your competitors seriously. But what happens is kind of the incumbent directory does fairly well; and the independent books that come in, they start trading off [you]. Because most of those are done on more of a pricing. You know, who can give the biggest discount?

So while there is a little bit more increasing competitive directories, we don't see that changing our thoughts about how we should grow this business.

You haven't seen any sort of pick-up sort of (inaudible)?

No.

Okay, thanks, guys.

Paul Ginocchio with Deutsche Bank.

If I could just ask a question about Chicago. I guess the Consumer Yellow Pages and the B2B, were published in the quarter. Any way to get a view on how they are trending? Any operational metrics or financial around those two important AT&T books?

Then second on the cash flow increased guidance, it sounds like $8 million of the increased guidance has come from lower interest expense. Can you just talk about where the other, I guess it is $17 million, is coming from? Thank you.

Paul, I will start on Chicago. B2B was a Q1 book. Consumer was a Q2. Again, we made a lot of changes, as I talked about the pricing changes; we also made a tremendous number of product changes; also introduced a Plus directory in that marketplace; and we have done a lot of things.

If you haven't seen it, if it is not the best-looking major metro market book in terms of its development, I don't know what is.

You know, it's a little early for us to start talking about metrics because it's only been on the street a few months. But one of the things that you know we watch very closely are call volumes. We are seeing positive early trends in both call volumes from the Big Book and incremental call volumes in the Plus book.

Dave, if I could just follow up on that. You said you had cut your price but some people pocketed or still reduced ad size. I guess, why would they reduce ad sizes when it was already cheaper? That sure doesn't make sense to me.

Say it again, Paul?

You had said that you had -- obviously you reduced some prices or you cleaned up your pricing structure in Chicago. For some people rates went down; but even with lower rates they still, it sounded like you said earlier, cut their ad sizes, which seems kind of odd.

Well, yes, we had a little bit of all of that. There are some people that -- the ones that had their rates go down, they didn't necessarily cut their ad sizes; but the whole idea was for those customers we needed to upsell them into a larger add size to hold their spend. We were not as successful at that as we had hoped.

Okay, okay, that's clear. Thank you. But you won't give us a pub sales number for the Chicago consumer book?

Paul, as you know, we don't break out. We have had 660 books out there. We don't break them out.

Okay. And there's the incremental cash flow increase.

Yes, what I said was $8 million annually on the amendment, so that -- we got that done in April. So this year it will be around $6 million from that. The balance of it is really due more to increased visibility from that, from sort of when we first gave guidance till today.

We started our guidance with more than $700 million, and we always thought it would be more than $700 million; we didn't know precisely how much more. Now we've got greater visibility and greater confidence. We are saying it's going to be at least 725, which means it could be more than 725.

Right. So Steve, if it means -- but EBITDA hasn't changed; so it must be through working capital, if it's not interest or taxes. Is it because you've tightened up credit policies at Dex and SBC and that's helped?

Well, some of it is credit policy. (inaudible) Bad debt performance is certainly part of it as well.

So bad debt and working capital?

Bad debt is part of working capital. But that is also part of it. But again, it is just increasing our confidence factor how much more than $700 million we believe is achievable, as opposed to trying to lay it off on this item or that item.

Okay. Thank you.

Jeff Shelton with Bleichroeder.

Your ad sales guidance for the full year down I guess 1.8% to 2% would imply an improvement over what you just reported in the third quarter. It sounds like Dex is going to have another difficult quarter in the third quarter. So, curious as to how you see the trends over the third and the fourth quarter.

Second question, Steve, you indicated that you tightened expenses in the quarter to protect profits. Curious as to what expense areas you consider discretionary and how that might impact future ad sales growth. Thanks.

Just a little bit of color on kind of the going out is -- Dex, as I kind of talked about, is -- we are going to be feeling some of these issues in Q3 and Q4, no question.

Illinois gets a little bit better, as we talked about. Q2 is kind of -- we always felt was going to be the low-water mark, and that one starts to improve in the back half of the year. And EMBARQ just continues to do what it traditionally does.

And the expense question?

You know, I think it is really related to G&A expenses. I think we have been more efficient. I think it's also we have not spent as much to get at some of the synergies that we thought might have happened in the first half of the year. So.

But it's really -- I think your question is spot on, because we have got to make sure that we're not getting after expenses which will affect future ad sales. So we are pretty careful about that.

Okay. The $50 million synergies related to the Dex acquisition, you're still holding to that $50 million number; you just realized that a little bit faster? Is that correct?

Both getting after some of the benefits faster and also, at least in the first half of the year, not costing us as much to get after them. Although I think it is still too early to be changing either our total synergy number or cost to achieve number. But I think that is something just kind of stay tuned to.

Okay, thank you very much.

Michael Meltz with Bear Stearns.

Just a couple clarifications, please. Steve, just so I'm clear, the first questioner on this call, they asked are you averse to taking up leverage for buybacks if the stock stays close to $50. I don't think I understood your answer to that.

Then on Paul's question, what is your full-year interest expense expectation this year? Then I have one follow-up.

Okay. Well the question actually wasn't so much would we be willing to take up leverage to buy back stock; but would we be willing to maybe redirect cash flow to buy back stock. I think that is the way the question was asked.

I think our answer is -- that is a good question. It is something we are studying, because we believe there is a lot of merit to that possibility. We have yet to reach a conclusion or to pull the trigger; but that is something we are studying carefully. So it is very topical.

As far as the interest expense, Michael, we're not providing specific guidance on interest expense this year. So $211 million was the adjusted number for the quarter. I think best we can do right now, I think, is to suggest that you annualize that number.

Okay, and on the buyback, you are doing work on that. Is it your sense that covenants would allow buybacks?

Well, we are constantly looking at what is the right application of cash flow. It is not something that we just started doing in the last couple weeks. But certainly where the stock -- the way the stock has been behaving encourages us to kind of turn up the heat on some of that analysis. So.

As far as the covenants go, look, we've got a lot of debt. We've got obligations to our bondholders and our banks; and we have every intention of upholding those. So we have got some modest availability to do things like buybacks or acquisitions, and we are constantly looking at that.

The other what part of the question that you didn't ask, and neither did Anthony, but it's ultimately -- if we make a decision to buy back stock it also suggests that we don't have another way to put the money to work that could generate a better return. We think there actually are some pretty interesting opportunities for us to put money to work in the areas of Internet and search, etc., that we are comparing to buying back our stock as well.

So we want to make sure that we're doing the right thing to manage the business for the long run, as opposed to just reacting to the current quarter.

Okay. Just so I'm clear on Peter's answer to the ad sales question, so you are saying Sprint will be up next year, Chicago should be up next year, Dex is a short-term issue. That implies to me that you're expecting ad sales to grow in '07. Is that fair?

Yes, that is fair, Michael.

That being said, should we expect EBITDA to grow in '07?

I think that certainly that is our intention. We're not providing guidance yet, Michael. But as I think you know, if ad sales are down 1.8% to 2% this year, the way we recognize revenue provides a bit of a drag on revenue. In order to be able to grow EBITDA in the face of that kind of drag, then we need to get after more expenses.

So it is too early to say that, but I think we are committed towards growing EBITDA. Because ultimately, that is more important than protecting margin, for example.

Understanding the drag, though, you think, though, you could grow EBITDA next year?

Absolutely.

Thank you very much.

Mark Bacurin with Robert W. Baird & Co.

A couple questions, I guess maybe to follow-up first on that ad sales question. Given that ad sales I guess is the leading indicator for what the reported sales will be over the next 12 months, and it looks like ad sales will be down this year, is that too much of a headwind for you to overcome, such that you will actually have reported revenues that are flat to down next year? Or do you actually think you can get that to be positive as well?

Great question, Mark. Again, we're not providing guidance for next year yet, so this is all preliminary. But I think it is going to be close. It is going to be close, and it's going to depend on how much we can grow ad sales by next year, and it is going to depend on whether we can get that done in the first half of the year or whether it takes us towards the back-end of the year to get to that growth.

Understanding I guess some of the issues as it relates to Dex and obviously the rescoping project at AT&T, but I'm also curious as to whether or not you think the softened economic environment has played any role.

It certainly sounds like maybe on some of the pricing changes, that people are willing to put money back in their pocket, maybe their own concerns about the economic environment.

So I was just curious, of that 3.5% decline, if there is any way at all to quantify how much of that may be influenced by the economy?

Mark, it's Peter. I wouldn't pass it off to the economy. I think that the issues in Illinois are around the product and [trading] the product of choice and driving the right things in the marketplace. Has really nothing to do with the economy. The economy out in the western part of the country for our business we find very strong.

Okay, then maybe, Peter, you could talk also about the transition at Dex to the Amdocs platform. You guys went through a similar platform shortly after the Sprint deal and it seemingly went very smooth and didn't have a lot of these same issues. So I am wondering what is different on the Amdocs conversion at Dex that has caused more problems than what you guys experienced through that process.

Mark, it's Dave. Let me take that one. Because what is happening right now has nothing to do with a conversion. What is happening right now is just simply the -- as you know Dex installed a new Amdocs system, some -- it took a while -- some 24 months ago. It has been a -- when you do this for the first time, it is a very tough putt. The execution on that conversion is what is causing all of these problems today.

The conversion of an integration of legacy RHD systems and Dex systems is 18 months in front of us yet. We won't even get to that for probably another 18 months. So it is two different issues as opposed to what you were referring to with Sprint, which was the consolidation of systems.

Are the problems with the Dex conversion to the Docs system issues at Amdocs, or a combination of Dex and Amdocs issues? I guess I am curious as to whether or not there is any recourse you guys have with Amdocs on lost sales.

You know what? I certainly don't want to lay blame. We have been a great supporter of Amdocs over the years and had a lot of success with our systems.

But historically where you get into trouble with these conversions, Mark, is in the testing environment for your data. It's how much, how clean you have that data before you let it move over onto the new environment. The majority of the problems that we are having are driven by a -- less rigor associated with that data cleanup before you switch over than we have ever done in any of our conversions.

Just one other piece to that is that late last year, just at the time that the new billing system came online, Dex also had decided to outsource their customer service operation. So the transition of customer service to the outsource vendor didn't go as smoothly as we would have hoped it would.

Have you made any changes with regard to that specific issue?

Yes, we have increased the staff there. We have implemented some very strong processes that we have developed at RHD in terms of customer service. As I said on the call, we feel great about what is happening there right now.

We are actually getting -- Peter will tell you -- he gets 10 notes a day from the Dex sales force thanking us for what we're doing on the customer service side of the business right now.

Mark, it is something that I don't know that I have ever seen in my career. But to have a sales rep actually right thank you notes to customer service for taking care of the customers is a little bit unusual.

But it's also very gratifying, because I think they appreciate RHD's focus on the customer. At the end of good day, you have to win customers every single day; and I think we are focused on that.

Okay, great. Two more quick ones. Steve, could you talk about $75 million was the original goal for costs to achieve synergies over, I think, a three-year time frame. It sounds like you're doing better than that. Any update to what that number might be?

Then second question is, as it relates to your large private equity shareholders, do you have any comments or discussions with them about the stock price? Obviously, I wouldn't assume they would be interested in selling down here; but any interest in potentially increasing their stake [if] high free cash flow yields.

Yes, great question. On the cost to achieve synergies, what we're saying is that it's too soon to come off that $75 million number; although there are some early encouraging signs that it may not cost us that much. But I think it is too early to go there.

On the private equity investors, look, I think it is clear they are in the private equity business, not the public equity business. So their general leaning I think is to sell. But they have also made it very clear that they are not sellers anywhere near the current stock price.

So I think as far as their intentions, though, while they certainly discuss the Company with us, ultimately it is their call. They've got registration rights and we have got obligations to be responsive to them.

Okay, thanks a lot.

Lisa Monaco with Morgan Stanley.

Dave, I realize that you don't give specifics on the ad sales numbers in the quarter. But can you give us a little bit more color for the three directory groups in terms of the magnitude of declines at the Dex group and the AT&T group? Or can you give us some color by region? Or can you strip out the large Chicago consumer book? What would ad sales be excluding that book?

Are there any Dex markets that are growing right now? Then I have a few follow-ups. Thanks.

Lisa, I will try to give you a little bit there. In the quarter, as we predicted, AT&T was the biggest offender; and it was, I will add, it's an unusually large quarter for Illinois. So it has the effect of having more of an impact than it does in most quarters. You know, and Dex was down a little.

I think Lisa in answer to your question about -- are we growing any markets in Dex? The answer is absolutely yes. As we have put in the process, we have gone through the RAC process where we do look at markets individually; and we have put in our field marketing to be closer to this. I would have to say that as a team we are very encouraged by what we see.

I think as Dave has said, a lot of the things in Dex are just kind of short-term, kind of transitional issues as they wrestle with some different things. We are 90% to 95% through all of the issues that we talked about in AT&T.

I think you can look at the local Q3 where we are saying it will be positive, just to give you an indication of, you know, for the first time in I guess four years, you can see an indication of what we think is ahead of us.

So from my perspective it's been a painful 12 months, looking at some of this stuff and going through some of these issues. But I think that we have characterized it today as pretty short-term and fixable.

We feel very good, looking at the meters and some of the leading indicators we look at to measure which way the business is going.

Okay. Then just two separate questions. Dave, can you just elaborate on the union contract which you recently negotiated? What was the compensation increase there?

Then Steve, I'm not sure if you broke out what the amortization of deferred financing costs was in the quarter.

Lisa, as far as the IBEW, first we don't talk about the compensation for the bargaining. But I would say that we are very pleased that we finished on time. Both parties were very satisfied. I think it speaks to a little bit, I think, when you look at this, the relationship that we have.

As Dave said, the people in Dex or the sales force especially in Dex is reacting very positively to the customer-centric kind of approach that R.H. Donnelley is taking. So I look at that as a vote of confidence in our ability to work in the labor environment. We still have the CWA that is coming up in October.

As far as the deferred financing costs, you'll see all the details in our 10-Q coming out, I guess, it's next week. But it was a little bit less I think in the second quarter than the first quarter, about between 5 and $6 million.

I also mentioned that the discount notes are accreting; and that number was about $15 million in the quarter, just over $15 million. That number is not going to change going forward on a quarterly basis. So about just over $60 million a year on the accretion of the discount notes while they are outstanding.

Okay, great. Thank you.

Lauren Fine with Merrill Lynch.

I'm actually on for Karl Choi. I guess I'm just trying to understand, sticking with the second quarter, since we already knew about the backlog of errors, was the incremental surprise just what you were describing, I guess, as more or less unhappy customer contract cancellation?

Then separately, the investment in the next generation of back office, that sounds like incremental spending. I am wondering if you could quantify that.

Then finally, you said you're still comfortable with the 2% to 4% long-term growth rate. Could you break that out by market? You have given that in the past in terms of long-term growth forecasts.

Lauren, what was the first one again?

Just trying to understand the incremental surprise in the quarter, since you already knew that you were working through the backlog of errors. I'm just wondering what was really incremental per se, or the biggest piece of it. (multiple speakers)

Good question. It is the impact. While we knew we had the errors, what you don't know is the impact that it is having on your actual sales results that soon. You have the problem; but now how is it going to manifest itself in customer cancellations and lost productivity as you try to work your way down out of that? That we had no visibility into.

Okay.

On the infrastructure investments to modernize our systems, to help facilitate online products and stuff, the good news there is it is a very small incremental investment on our part. Much of the expense there is being shouldered by our partner in those systems, Amdocs. So it doesn't rise to really kind of changing anything on our side.

Can you be more specific? Like less than $10 million, is that what you're trying to signal?

I think what we have said typically is that CapEx runs around 2% of revenue. This year and next year probably we are in the 3% of revenue range. So (multiple speakers) dimensionalize it. Is that helpful?

Yes.

As far as the by-market stuff, I think it has really not changed what we have said before. I think it is 3% to 5% in the Sprint markets; it is kind of 1% to 3% or so in Chicago; and it's kind of 2% to 4% in Dex.

Perfect, thanks.

I just want to thank everyone for your interest today. If you have any follow-up questions, please don't hesitate to contact Jenny Apker. Have a great day.