Decline in yellow pages ad sales hurts Donnelley

R.H. Donnelley said it would start paying a dividend next year -- a move investors have been clamoring for -- but the announcement was overshadowed by disappointing third-quarter advertising sales for its yellow pages business.

Donnelley shares fell 12 percent Tuesday after the Cary-based company reported a 2.2 percent decline in yellow pages advertising sales. Shares of Donnelley, the nation's third-largest yellow pages publisher, are down 15 percent so far this year.

"There continue to be challenges with this business," said Signal Hill analyst Maurice McKenzie. "My sense is that trumped the dividend."

Ad sales were dragged down by the Florida and Nevada markets, which are suffering acutely from the housing slump.

Ad sales in those two states were down 7 percent, CEO David Swanson said during a conference call with analysts. Sales in the other 26 states where the company publishes directories fell "just over a percent."

Overall ad sales for the quarter were down 1.1 percent on a pro forma basis. Those numbers include advertising generated in the latest quarter and a year ago by Business.com, which was acquired for $345 million in August. Companies use Business.com to search for services, vendors and potential customers.

Ad sales are a leading indicator of future revenue for Donnelley, encompassing the total value of advertising included in print directories distributed during the quarter. The revenue from those ads is spread out over 12 months because customers make payments in monthly installments.

Investors have been so eager for Donnelley to pay a dividend that the company's comment in July that the Business.com acquisition could delay consideration of such a move was partly blamed for a 9 percent decline in the company's stock that day.

Donnelley said its annual dividend to shareholders, which will commence when it issues its first-quarter earnings in April, will amount to approximately 25 percent of free cash flow. This year the company projects it will generate about $600 million in free cash flow.

Few companies are initiating dividends these days, said Howard Silverblatt, a senior analyst with Standard & Poor's. Instead, companies tend to plow excess cash into repurchasing their stock, hoping to bolster their share price.

Nationwide, seven companies started paying a dividend this year, the same total as in all of 2006, Silverblatt said. That was well below a spike in 2003, the year Congress lowered the tax rate investors pay on dividends.

Also, fewer companies that already pay dividends are raising the payout amount -- 1,721 so far this year, down from 1,786 a year ago.

Swanson said the recent refinancing of $2.7 billion in debt reduced the company's interest costs, enabling it to start paying a dividend next year.

Donnelley's revenue in the third quarter totaled $669.9 million, up only slightly from a year ago.

Cash flow from operations totaled $156 million, down from $161.9 million a year ago.

Donnelley reaffirmed its guidance for the year. That includes a projection that ad sales will range between flat and 1 percent growth.

"We remain optimistic that the yellow pages business is a valuable, long-term business," McKenzie said. "We are encouraged by the actions the company has taken, over the past year or so, in terms of strengthening its position online, which we see as a critical growth engine going forward."