UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

Commission file number 1-15967

 

The Dun & Bradstreet Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code:

(973) 921-5500

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one:)

 

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

 

THE DUN & BRADSTREET CORPORATION

 

INDEX TO FORM 10-Q

 

 

The Dun & Bradstreet Corporation

 

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

The Dun & Bradstreet Corporation

 

Consolidated Balance Sheets (Unaudited)

 

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

The Dun & Bradstreet Corporation

 

Consolidated Statements of Cash Flows (Unaudited)

 

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

THE DUN & BRADSTREET CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(Tabular dollar amounts in millions, except per share data)

 

Note 1 — Basis of Presentation

 

These interim consolidated financial statements have been prepared in accordance with the instructions to the Quarterly Report on Form 10-Q. They should be read in conjunction with the consolidated financial statements and related notes, which appear in The Dun & Bradstreet Corporation’s (“D&B,” “we” or “our”) Annual Report on Form 10-K for the year ended December 31, 2005. The consolidated results for interim periods do not include all disclosures required by accounting principles generally accepted in the United States of America for annual financial statements and are not necessarily indicative of results for the full year or any subsequent period. In the opinion of our management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the consolidated financial position, results of operations and cash flows at the dates and for the periods presented have been included.

 

All significant inter-company transactions have been eliminated in consolidation.

 

The financial statements of the subsidiaries outside the United States (“U.S.”) and Canada reflect three month and nine month periods ended August 31, 2006 and 2005, in order to facilitate timely reporting of our unaudited consolidated financial results.

 

Where appropriate, we have reclassified certain prior period amounts to conform to our current presentation.

 

Significant Accounting Policies

 

In preparing our unaudited consolidated financial statements and accounting for the underlying transactions and balances reflected therein, we have applied the significant accounting policies described in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. During the nine months ended September 30, 2006, we updated the significant accounting policy titled “Stock-Based Compensation” as follows:

 

Stock-Based Awards

 

On January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) or “SFAS No. 123R,” or “Share-Based Payments,” requiring the recognition of compensation expense in the income statement related to the fair value of our employee stock options and our 15% discount from market value, subject to limitations, under our Employee Stock Purchase Plan (“ESPP”). Determining the fair value of stock options at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise, the associated volatility and the expected dividends. Judgment is also required in estimating the amount of stock-based awards expected to be forfeited prior to vesting. For further detail on Stock-Based Awards, see Note 9 to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q.

 

Note 2 — Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106 and 132(R),” or “SFAS No. 158,” which requires the recognition of the underfunded or overfunded status of defined benefit postretirement plans (other than multiemployer plans) as an asset or liability in its statement of financial position and to recognize changes in the funded status through comprehensive income in the year in which the changes occur. SFAS No. 158 also requires measurement of the funded status of a plan as of the date of the employer’s fiscal year-end statement of financial position, with limited exceptions. SFAS No. 158 is effective for recognition of the funded status of the benefit plans for fiscal years ending after December 15, 2006 and is effective for the measurement date provisions for fiscal years ending after December 15, 2008. As of September 30, 2006, we currently estimate that we will reduce our total assets by approximately $230 million

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

to $250 million, our total liabilities by approximately $20 million to $30 million and our shareholders’ equity by approximately $210 million to $220 million, net of tax of approximately $115 million to $125 million.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” or “SFAS No. 157,” which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles (“GAAP”) in the United States of America and expands fair value measurement disclosures. SFAS No. 157 does not require new fair value measurements and is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are currently assessing the impact the adoption of SFAS No. 157 will have, if any, on our consolidated financial statements.

 

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” or “SAB No. 108,” which provides interpretative guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement for the purpose of a materiality assessment. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 in the third quarter of 2006 did not have an impact on our consolidated financial statements.

 

In July 2006, the FASB issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109,” or “FIN 48,” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” The interpretation sets forth a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We plan to adopt the provisions of FIN 48 as required on January 1, 2007. The cumulative effect of applying FIN 48, if any, will be reported as an adjustment to retained earnings at the beginning of the period in which it is adopted. We are currently assessing the impact, if any, that the adoption of FIN 48 will have on our consolidated financial statements.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” or “SFAS No. 154,” which changes the accounting and reporting requirements for a change in accounting principle. Accounting Principle Board (“APB”) Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements,” are superseded by SFAS No. 154, which requires retrospective application to prior periods’ financial statements of changes in an accounting principle. SFAS No. 154 applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS No. 154 also defines a restatement as the revising of previously issued financial statements to reflect the correction of an error. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 in the first quarter of 2006 did not have an impact on our consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 123R which revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” This standard requires companies to recognize in the statement of operations the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of the award (with limited exceptions). The cost will be recognized over the period that an employee provides service in exchange for the award, which normally would be the vesting period. We adopted SFAS No. 123R on January 1, 2006, as required by the SEC, under the Modified Prospective method. During the three month and nine month periods ended September 30, 2006, we incurred additional expenses of approximately $3.1 million and $10.5 million, respectively, related to stock options and our ESPP. In addition, SFAS No. 123R also requires the benefits of tax deductions in excess of the tax impact of recognized compensation expense to be reported as cash flows from financing activities, rather than cash

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

flows from operating activities. As a result, we reclassified $30.2 million from net cash flows from operating activities to net cash used in financing activities during the nine months ended September 30, 2006.

 

On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law. The Act provides a deduction from income for qualified domestic production activities, which will be phased in from 2005 through 2010. The Act also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales. In December 2004, the FASB issued Financial Statement Position (“FSP”) No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004.” FSP No. FAS 109-1 provides guidance on the accounting implications of the Act related to the deduction for qualified domestic production activities. The deduction will be treated as a “special deduction” as described in SFAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. In May 2006, the Treasury and the Internal Revenue Service issued final regulations relating to the domestic production activities. Based on these regulations, during the nine months ended September 30, 2006, we recorded tax benefits relating to this deduction in our effective tax rate of approximately $0.6 million, of which $0.4 million related to the nine months ended September 30, 2006 and $0.2 million related to the year ended December 31, 2005. We anticipate recording a tax benefit of approximately $0.7 million (inclusive of the $0.2 million related to the year ended December 31, 2005) for the year ended December 31, 2006.

 

 

Restructuring Charge

 

Since the launch of our Blueprint for Growth Strategy, we have implemented Financial Flexibility Programs. In each of these Programs, we identified ways to reduce our expense base and reallocated some of the identified spending to other areas of our operations to drive revenue growth. With each Program, we have incurred restructuring charges (which generally consist of employee severance and termination costs, contract terminations, asset write-offs, and/or costs to terminate lease obligations less assumed sublease income). These charges are incurred as a result of eliminating, consolidating, standardizing, automating and/or outsourcing operations of our business. We have also incurred transition costs such as consulting fees, costs of temporary workers, relocation costs and stay bonuses to implement our Financial Flexibility Programs.

 

For the three month and nine month periods ended September 30, 2006 and 2005 the restructuring charges were recorded in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” Under SFAS No. 146 the current period charge represents the liabilities incurred during the quarter for each of these obligations. The curtailment gains were recorded in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” and the curtailment charges were recorded in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” and SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits.”

 

Three Months Ended September 30, 2006 vs. Three Months Ended September 30, 2005

 

During the three months ended September 30, 2006, we recorded a $14.0 million restructuring charge in connection with the Financial Flexibility Program announced in February 2006 (“2006 Financial Flexibility Program”) and a $0.2 million restructuring charge in connection with the Financial Flexibility Program announced in February 2005 (“2005 Financial Flexibility Program”). The components of these charges included:

 

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

 

 

During the three months ended September 30, 2005, we recorded a $4.5 million restructuring charge in connection with the 2005 Financial Flexibility Program and a $0.2 million net restructuring charge for the International Business Machines Corporation (“IBM”) outsourcing agreement in connection with the Financial Flexibility Program announced in February 2004 (“2004 Financial Flexibility Program”). The components of these charges and gains included:

 

 

Nine Months Ended September 30, 2006 vs. Nine Months Ended September 30, 2005

 

During the nine months ended September 30, 2006, we recorded a $22.1 million restructuring charge in connection with the 2006 Financial Flexibility Program, a $2.4 million net restructuring charge in connection with the 2005 Financial Flexibility Program and a $0.3 million net restructuring curtailment gain in connection with the 2004 Financial Flexibility Program. The components of these charges and gains included:

 

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

termination actions. In accordance with SFAS No. 106, we were required to recognize immediately a pro-rata portion of the unrecognized prior service cost as a result of the employee terminations.

 

During the nine months ended September 30, 2005, we recorded a $22.0 million restructuring charge in connection with the 2005 Financial Flexibility Program and a $0.4 million net restructuring gain in connection with the 2004 Financial Flexibility Program. The components of these charges and gains included:

 

 

Since the launch of our Blueprint for Growth Strategy, we have eliminated approximately 5,000 positions through September 30, 2006, which included approximately 300 open positions, and approximately 4,700 employees that were terminated (via attrition and termination) under our Financial Flexibility Programs. These figures include the 220 employees who were transitioned to IBM as part of the 2004 Financial Flexibility Program and approximately 400 employees who were transitioned to Computer Sciences Corporation (“CSC”) as part of the 2002 Financial Flexibility Program. Under the terms of the CSC agreement, we outsourced certain technology functions in which approximately 400 of our employees who performed data center operations, technology help desk and network management functions in the U.S. and in the UK were transitioned to CSC.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

The following table sets forth, in accordance with SFAS No. 146, the restructuring reserves and utilization related to our 2006 Financial Flexibility Program.

 

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

The following table sets forth, in accordance with SFAS No. 146, the restructuring reserves and utilization related to our 2005 Financial Flexibility Program.

 

 

Actions under the 2004 Financial Flexibility Program have been substantially completed.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

Note 4 — Notes Payable and Indebtedness

 

Our borrowings are summarized in the following table:

 

 

Fixed-Rate Notes

 

In March 2006, we issued senior notes with a face value of $300 million that mature on March 15, 2011 (the “2011 notes”), bearing interest at a fixed annual rate of 5.50%, payable semi-annually. The proceeds were used to repay our existing $300 million notes which matured on March 15, 2006. The 2011 notes of $299.3 million, net of $0.7 million of discount, are recorded as “Long-Term Debt” in our consolidated balance sheet at September 30, 2006. The $300 million notes that matured on March 15, 2006 were recorded as “Short-Term Debt” at December 31, 2005.

 

The 2011 notes were issued at a discount of $0.8 million and we incurred underwriting and other fees in the amount of approximately $2.2 million. These costs are being amortized over the life of the 2011 notes. The 2011 notes contain certain covenants that limit our ability to create liens, enter into sale and leaseback transactions and consolidate, merge or sell assets to another entity. The 2011 notes do not contain any financial covenants.

 

On September 30, 2005 and February 10, 2006, we entered into interest rate derivative transactions with aggregate notional amounts of $200 million and $100 million, respectively. The objective of these hedges was to mitigate the variability of future cash flows from market changes in Treasury rates in the anticipation of the above referenced debt issuance. These transactions were accounted for as cash flow hedges, and as such, changes in fair value of the hedges that took place through the date of debt issuance were recorded in accumulated other comprehensive income. In connection with the issuance of the 2011 notes, these interest rate derivative transactions were terminated, resulting in proceeds of approximately $5.0 million at the dates of termination. The proceeds are recorded in other comprehensive income and will be amortized over the life of the 2011 notes.

 

Credit Facilities

 

At September 30, 2006 and December 31, 2005, we had a $300 million bank credit facility available at prevailing short-term interest rates, which expires in September 2009. At September 30, 2006, we had $101.0 million of borrowings outstanding under this facility with a weighted average interest rate of 5.61%. We borrowed under our facility during the nine months ended September 30, 2006 primarily to fund our share repurchase program. We had not drawn on the facility and we did not have any borrowings outstanding under this facility at December 31, 2005. This facility also supports our commercial paper borrowings up to $300 million (reduced by borrowed amounts outstanding under the facility). We had not borrowed under our commercial paper

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

program as of September 30, 2006 and December 31, 2005. The facility requires the maintenance of interest coverage and total debt to EBITDA ratios (each as defined in the agreement). We were in compliance with these requirements at September 30, 2006 and December 31, 2005.

 

Other

 

At September 30, 2006 and December 31, 2005, we had $0.1 million and $0.8 million, respectively, of capital lease obligations maturing within one year. At September 30, 2006 and December 31, 2005, we had $0.1 million of capital lease obligations maturing after one year.

 

At September 30, 2006 and December 31, 2005, certain of our international operations had non-committed lines of credit of $15.1 million and $17.2 million, respectively. There were no borrowings outstanding under these lines of credit at September 30, 2006 and December 31, 2005. These arrangements have no material commitment fees and no compensating balance requirements.

 

At September 30, 2006 and December 31, 2005, we were contingently liable under open standby letters of credit issued by our bank in favor of third parties totaling $4.9 million and $7.9 million, respectively.

 

During the three month and nine month periods ended September 30, 2006, interest paid totaled $9.0 million and $19.1 million, respectively. During the three month and nine month periods ended September 30, 2005, interest paid totaled $9.9 million and $18.8 million, respectively.

 

Note 5 — Reconciliation of Weighted Average Shares Outstanding

 

 

Stock-based awards to acquire 0.9 million and 0.1 million shares of common stock were outstanding at September 30, 2006 and 2005, respectively, but were not included in the quarterly or year-to-date computations of diluted earnings per share because the assumed proceeds, as calculated under the treasury stock method, resulted in these awards being anti-dilutive. Our stock options generally expire 10 years after the grant date.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

Our share repurchases were as follows:

 

 

 

 

Additionally, during the three months ended September 30, 2006, we repurchased 0.2 million shares of common stock for $11.9 million under a plan announced in August 2006 to mitigate the dilutive effect of the shares issued under our stock incentive programs and ESPP. This program expires in August 2010. The maximum amount authorized under the program is 5.0 million shares.

 

Note 6 — Comprehensive Income

 

Total comprehensive income for the three month and nine month periods ended September 30, 2006 and 2005, which includes net income and other gains and losses that affect shareholders’ equity, was as follows:

 

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

Note 7 — Contingencies

 

We are involved in tax and legal proceedings, claims and litigation arising in the ordinary course of business. We periodically assess our liabilities and contingencies in connection with these matters based upon the latest information available. For those matters where it is probable that we have incurred a loss and the loss or range of loss can be reasonably estimated, we have recorded reserves in our consolidated financial statements. In other instances, we are unable to make a reasonable estimate of any liability because of the uncertainties related to the probability of the outcome and/or amount or range of loss. As additional information becomes available, we adjust our assessment and estimates of such liabilities accordingly. It is possible that the ultimate resolution of our liabilities and contingencies could be at amounts that are different from our currently recorded reserves and that such differences could be material.

 

Based on our review of the latest information available, we believe our ultimate liability in connection with pending tax and legal proceedings, claims and litigation will not have a material effect on our results of operations, cash flows or financial position, with the possible exception of the matters described below.

 

In order to understand our exposure to the potential liabilities described below, it is important to understand the relationship between us and Moody’s Corporation, our predecessors and other parties that, through various corporate reorganizations and contractual commitments, have assumed varying degrees of responsibility with respect to such matters.

 

In November 1996, the Company then known as The Dun & Bradstreet Corporation (“D&B1”) separated through a spin-off into three separate public companies: D&B1, ACNielsen Corporation (“ACNielsen”) and Cognizant Corporation (“Cognizant”) (the “1996 Distribution”). This was accomplished through a spin-off by D&B1 of its stock in ACNielsen and Cognizant. In June 1998, D&B1 separated through a spin-off into two separate public companies: D&B1, which changed its name to R.H. Donnelley Corporation (“Donnelley/D&B1”), and a new company named The Dun & Bradstreet Corporation (“D&B2”) (the “1998 Distribution”). During 1998, Cognizant separated into two separate public companies: IMS Health Incorporated (“IMS”) and Nielsen Media Research, Inc. (“NMR”) (the “1998 Cognizant Distribution”). In September 2000, D&B2 separated through a spin-off into two separate public companies: D&B2, which changed its name to Moody’s Corporation (“Moody’s” and also referred to elsewhere in this Quarterly Report on Form 10-Q as “Moody’s/D&B2”), a new company named The Dun & Bradstreet Corporation (“we” or “D&B3” and also referred to elsewhere in this Quarterly Report on Form 10-Q as “D&B”) (the “2000 Distribution”).

 

Tax Matters

 

Moody’s/D&B2 and its predecessors entered into global tax-planning initiatives in the normal course of business, principally through tax-free restructurings of both their foreign and domestic operations. As further described below, we undertook contractual obligations to be financially responsible for a portion of certain liabilities arising from certain historical tax-planning initiatives (“Legacy Tax Matters”).

 

As of the end of 2005, settlement agreements have been executed with the IRS with respect to the Legacy Tax Matters previously referred to in our SEC filings as “Utilization of Capital Losses” and “Royalty Expense Deductions.” With respect to the Utilization of Capital Losses matter, the settlement agreement resolved the matter in its entirety. For the Royalty Expense Deductions matter, the settlement covered tax years 1995 and 1996, which represented approximately 90% of the total potential liability to the IRS, including penalties. We believe we are adequately reserved for the remaining exposure. In addition, with respect to these two settlement agreements, we believe that IMS and NMR did not pay their allocable share to the IRS under applicable agreements. Under our agreement with Donnelley/D&B1, we and Moody’s were each required to cover the shortfall, and each of us paid to the IRS approximately $12.8 million in excess of our respective allocable shares. We were unable to resolve our dispute with IMS and NMR through the negotiation process contemplated by our agreements, and so we

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

commenced arbitration to enforce our rights and collect amounts owed by IMS and NMR with respect to the Utilization of Capital Losses matter. We may also commence arbitration against IMS and NMR with respect to amounts owed by them with respect to the Royalty Expense Deductions matter. We believe that the resolution of the remaining exposure to the IRS under the Royalty Expense Deductions matter and the foregoing disputes with IMS and NMR will not have a material adverse impact on D&B’s financial position, results of operations or cash flows.

 

Our remaining Legacy Tax Matter is referred to as “Amortization and Royalty Expense Deductions/Royalty Income — 1997-2006.”

 

Beginning in the fourth quarter of 2003, we received several notices from the IRS asserting that:

 

 

Finally, the IRS has asserted alternatively that, if the proposed adjustments described above are not sustained, certain business expenses incurred by Moody’s/D&B2 and D&B3 during 1999-2002 should be capitalized and amortized over a 15-year period.

 

We estimate that the net impact to cash flow as a result of the disallowance of the 1997-2002 amortization expense deductions and the disallowance of such deductions claimed from 2003 to date could be up to $75.6 million (tax, interest and penalties, net of tax benefits but not taking into account the Moody’s/D&B2 repayment to us of $29.5 million described below). This transaction is scheduled to expire in 2012 and, unless terminated by us, the net impact to cash flow, based on current interest rates and tax rates, would increase at a rate of approximately $2.0 million per quarter (including potential penalties) as future amortization expenses are deducted. On March 3, 2006, we made a deposit to the IRS of approximately $39.8 million in order to stop the accrual of statutory interest on additional taxes allegedly due for the 1997 — 2002 tax years.

 

We believe that the IRS’ positions with respect to the treatment of the royalty expense and royalty income are mutually inconsistent. If the IRS prevails on one of the positions, we believe it is unlikely that it will prevail on the other. We therefore estimate that the possible disallowance of deductions for royalty expenses paid to the partnership and the reallocation of royalty income from the partnership, after taking into account certain other tax benefits resulting from the IRS’ position, will not likely have a net impact to cash flow. In the unlikely event the IRS were to prevail on both positions with respect to the royalty expense and royalty income, we estimate that the net impact to cash flow as a result of the disallowance of the 1997-2002 royalty expense deductions, and the inclusion of the reallocated royalty income for all relevant years, could be up to $152 million (tax, interest and penalties, net of tax benefits). This $152 million would be in addition to the $75.6 million noted above.

 

At the time of the 2000 Distribution, we paid Moody’s/D&B2 approximately $55.0 million, but should the 1997 partnership transaction be terminated, Moody’s/D&B2 would be required to repay us an amount equal to the discounted value of its 50% share of the related future tax benefits. For example, if the transaction was terminated at September 30, 2006, the amount of such repayment from Moody’s/D&B2 to us would have been approximately $29.5 million. The amount of such repayment will decrease by approximately $4.0 million to $5.0 million per year.

 

We have filed protests with the IRS Office of Appeals contesting the IRS’ assertions. We have also been attempting to resolve this matter with the IRS before proceeding to litigation. If we were to challenge any of the IRS’ positions in U.S. District Court or the U.S. Court of Federal Claims, rather than in U.S. Tax Court, the disputed amounts would need to be paid in advance for the court to have jurisdiction over the case.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

We have considered the foregoing Legacy Tax Matters and the merits of the legal defenses and the various contractual obligations in our overall assessment of potential tax liabilities. As of September 30, 2006, we have $70.2 million of net reserves recorded in the consolidated financial statements, made up of the following components: $0.9 million in Accrued Income Tax and $69.3 million in Other Non-Current Liabilities. We believe that these reserves are adequate for our share of the liabilities in these Legacy Tax Matters. Any payments that would be made for these exposures could be significant to our cash from operations in the period a cash payment takes place, including any payments for the purpose of obtaining jurisdiction in U.S. District Court or the U.S. Court of Federal Claims to challenge any of the IRS’ positions.

 

Legal Proceedings

 

Hoover’s — Initial Public Offering Litigation.

 

On November 15, 2001, a putative shareholder class action lawsuit was filed against Hoover’s, certain of its then current and former officers and directors (the “Individual Defendants”), and one of the underwriters of Hoover’s July 1999 initial public offering (“IPO”). The lawsuit was filed in the U.S. District Court for the Southern District of New York on behalf of purchasers of Hoover’s stock between July 20, 1999 and December 6, 2000. The operative Complaint alleges violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 against Hoover’s and the Individual Defendants. Plaintiffs allege that the underwriter allocated stock in Hoover’s IPO to certain investors in exchange for commissions and agreements by those investors to make additional purchases of stock in the aftermarket at prices above the IPO price. Plaintiffs allege that the prospectus for Hoover’s IPO was false and misleading because it did not disclose these arrangements. The defense of the action is being coordinated with more than 300 other nearly identical actions filed against other companies. Hoover’s moved to dismiss all claims against it but the motion was denied. In 2004, the Court certified a class in six of the approximately 300 actions, intending to provide strong guidance regarding the remaining cases. The Second Circuit Court of Appeals has granted the underwriters leave to appeal this decision. Plaintiffs have not yet moved to certify a class in the case involving Hoover’s.

 

Hoover’s has approved a settlement agreement that requires Hoover’s to agree to undertake certain responsibilities, including agreeing to assign away claims it may have against its underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for all of the approximately 300 cases. Thus, if the underwriters settle for at least $1 billion, no payment will be required by the issuers, but if the underwriters settle for less than $1 billion, the issuers are required to make up the difference. On April 20, 2006, JPMorgan Chase, one of the underwriters, and the plaintiffs reached a preliminary agreement for a $425 million settlement. If the settlement is approved by the Court, the issuers’ insurers would be potentially liable for $575 million. It is anticipated that any potential financial obligation of Hoover’s will be covered by existing insurance. Hoover’s currently is not aware of any material limitations on the expected recovery from its insurance carriers and we do not expect that the settlement will involve any payment by Hoover’s. If material limitations on the expected recovery should arise, Hoover’s maximum financial obligation to plaintiffs is less than $3.4 million. If the JPMorgan Chase settlement is approved, Hoover’s maximum financial obligation would be less than $2 million. On February 15, 2005, the court granted preliminary approval of the settlement agreement involving Hoover’s. The Court held a fairness hearing regarding that settlement on April 24, 2006, but has not yet issued a ruling. There is no assurance that the court will grant final approval to the settlement. If the settlement is ultimately approved and implemented in its current form, Hoover’s exposure, if any, would be covered by existing insurance. If the settlement is not approved, we cannot predict the final outcome of this matter. No amount in respect of any potential judgment in this matter has been accrued in our consolidated financial statements.

 

THE DUN & BRADSTREET CORPORATION

 

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(Tabular dollar amounts in millions, except per share data)

Pension Plan Litigation.

 

March 2003 Action

 

In March 2003, a lawsuit seeking class action status was filed in federal court in Connecticut on behalf of 46 specified former employees relating to our retirement plans. The putative class may be larger in that it includes current D&B employees who are participants in The Dun & Bradstreet Corporation Retirement Account and were previously participants in its predecessor plan, The Dun & Bradstreet Master Retirement Plan (“MRP”); current employees of Receivable Management Services Corporation (“RMSC”) who are participants in The Dun & Bradstreet Corporation Retirement Account and were previously participants in the MRP; former employees of D&B or D&B’s Receivable Management Services (“RMS”) operations who received a deferred vested retirement benefit under either The Dun & Bradstreet Corporation Retirement Account or the MRP; and former employees of RMS whose employment with D&B terminated after the sale of the RMS operations but who are not employees of RMSC and who, during their employment with D&B, were “Eligible Employees” for purposes of The Dun & Bradstreet Career Transition Plan.

 

There are four counts in the Amended Complaint. Count 1 claims that we violated ERISA by not paying severance benefits under our Career Transition Plan. Count 2 claims that our sale of the RMS business to RMSC and the resulting termination of our employees constituted a prohibited discharge of the plaintiffs and/or discrimination against the plaintiffs for the purpose of interfering with their employment and/or benefit rights in a violation of ERISA. Count 3 claims that our summary plan description failed to reasonably apprise participants and beneficiaries of their rights and obligations under the plans and that, therefore, the actuarial reduction beneficiaries incur when they leave D&B before age 55 and elect to retire early cannot be enforced against them. Count 4 claims that the interest rate used to actuarially reduce early retirement benefits is unreasonable and, therefore, results in a prohibited forfeiture of benefits under ERISA. The plaintiffs sought payment of severance benefits; equitable relief in the form of either reinstatement of employment with D&B or restoration of employee benefits (including stock options); invalidation of the actuarial reductions applied to deferred vested early retirement benefits, including invalidation of the plan interest rate used to actuarially reduce former employees’ early retirement benefits; attorneys’ fees and such other relief as the court may deem just.

 

In September 2003, we filed a motion to dismiss Counts 1, 3 and 4 of the Amended Complaint. The Court granted the motion to dismiss Counts 1 and 3, and requested that the parties conduct limited expert discovery and submit further briefing regarding Count 4. In November 2004, after completion of expert discovery on Count 4, we moved for summary judgment on Count 4 on the ground that the interest rate is reasonable as a matter of law. Plaintiffs’ counsel stipulated to dismiss with prejudice Count 2. Plaintiffs’ counsel filed a motion to amend the Amended Complaint to add a new count challenging the adequacy of the retirement plan’s mortality tables, which we opposed. On June 6, 2005, the Court granted D&B’s motion for summary judgment as to Count 4 (the interest rate issue) and also denied the plaintiffs’ motion to further amend the Amended Complaint. On July 8, 2005, the plaintiffs appealed the ruling granting the motion to dismiss Count 3, the ruling granting summary judgment on Count 4, and the denial of leave to amend their Amended Complaint. Oral argument before the Second Circuit took place on February 15, 2006, and we are awaiting a decision.

 

September 2005 Action

 

A lawsuit seeking class action status was filed in September 2005 in federal court in the Northern District of Illinois on behalf of a current employee relating to our retirement plans. The putative class may be larger in that it includes current or former D&B employees who were not grandfathered under The Dun & Bradstreet Master Retirement Plan and who participated in The Dun & Bradstreet Master Retirement Plan before January 1, 2002 and who have participated in The Dun & Bradstreet Corporation Retirement Account at any time since January 1, 2002. A Motion to Transfer Venue to the District of New Jersey was filed on January 27, 2006 and was granted on March 31, 2006.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

There are five counts in the Complaint. Count 1 claims that we violated ERISA by reducing the rate of an employee’s benefit accrual on the basis of age. Count 2 claims that the cash balance plan violates ERISA’s “anti-backloading” rule. Count 3 claims that D&B failed to supply advance notice of a significant benefit decrease. Count 4 claims that D&B failed to provide an adequate Summary Plan Description. Count 5 claims breach of fiduciary duty based on allegedly misleading plan communications. The plaintiff seeks (1) a declaration that (a) D&B’s cash balance plan is ineffective and that the D&B Master Retirement Plan is still in force and effect, and (b) plaintiff’s benefit accrual under the cash balance plan must be unconditional and not reduced because of age, (2) an injunction (a) prohibiting the application of the cash balance plan’s reduction in the rate of benefit accruals because of age and its conditions of benefits due under the plan, and (b) ordering appropriate equitable relief to determine plan participant losses caused by D&B’s payment of benefits under the cash balance plan’s terms and requiring the payment of additional benefits as appropriate, (3) attorneys’ fees and costs, (4) interest, and (5) such other relief as the court may deem just.

 

On July 5, 2006, we filed a Motion to Dismiss, pursuant to Fed.R.Civ.P. 12(b)(6), on the grounds that (i) the complaint is barred by the statute of limitations and the doctrine of laches, (ii) the cash balance plan does not discriminate on the basis of age, (iii) the cash balance plan does not violate ERISA’s anti-backloading rule, (iv) D&B complied with ERISA § 204(h) by providing sufficient advance notice of the plan amendment, (v) D&B’s Summary Plan Description fully complies with the requirements of ERISA, and (vi) plaintiff failed to state a claim for breach of fiduciary duty. Plaintiff filed his opposition to the Motion to Dismiss on September 11, 2006. We filed our reply October 11, 2006 and are awaiting a decision.

 

Other Matters

 

In addition, in the normal course of business, D&B indemnifies other parties, including customers, lessors and parties to other transactions with D&B, with respect to certain matters. D&B has agreed to hold the other parties harmless against losses arising from a breach of representations or covenants, or arising out of other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. D&B has also entered into indemnity obligations with its officers and directors of the Company. Additionally, in certain circumstances, D&B issues guarantee letters on behalf of our wholly-owned subsidiaries for specific situations. It is not possible to determine the maximum potential amount of future payments under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by D&B under these agreements have not had a material impact on our consolidated financial statements.

 

Note 8 — Divestitures

 

As part of our Blueprint for Growth Strategy, we implemented our international market leadership strategy which has led to various dispositions over the years. During the second quarter of 2005, we sold our equity investment in a South African company. We received proceeds of $5.3 million and recognized a pre-tax gain of approximately $3.5 million in the second quarter of 2005 in “Other Income (Expense) — Net.”

 

Note 9 — Stock-Based Awards

 

On January 1, 2006, we adopted SFAS No. 123R using the Modified Prospective method. Prior to the adoption of SFAS No. 123R, we applied APB No. 25 and related interpretations in accounting for our plans. Accordingly, no compensation cost was recognized for grants under the stock option programs and ESPP.

 

Under the Modified Prospective method, compensation cost associated with the stock option programs recognized for the three month and nine month periods ended September 30, 2006 includes (a) compensation cost for stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provision of SFAS No. 123, and (b) compensation cost for stock options

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

granted subsequent to January 1, 2006, based on the grant-date fair value under SFAS No. 123R. SFAS No. 123R also requires us to estimate future forfeitures in calculating the expense relating to stock-based compensation as opposed to only recognizing these forfeitures and the corresponding reduction in expense as they occur. As a result, we have adjusted for this cumulative effect and recognized a pre-tax reduction in stock-based compensation of $0.5 million, related to our restricted stock and restricted stock unit programs during the first quarter of 2006. As required under the Modified Prospective method, results for prior periods have not been restated.

 

For periods prior to the adoption of SFAS No. 123R, the following table summarizes the pro forma effect of stock-based compensation on net income and net income per share as if the fair value expense recognition provisions of SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” had been adopted.

 

 

Stock Option Programs

 

Under The Dun & Bradstreet Corporation 2000 Stock Incentive Plan (“2000 SIP”) and Non-Employee Directors’ Stock Incentive Plan (“2000 DSIP”), we have granted stock options to certain employees and non-employee directors to purchase shares of our common stock at the market price on the date of the grant. Stock options granted under the 2000 SIP prior to February 9, 2004 generally vest in three equal installments, beginning on the third anniversary of the grant. Stock options granted under the 2000 SIP on or after February 9, 2004 generally vest in four equal installments beginning on the first anniversary of the grant. Stock options granted under the 2000 DSIP generally vest 100% on the first anniversary of the grant. All stock options generally expire 10 years from the date of the grant. The 2000 SIP and 2000 DSIP provide for the granting of up to 9.7 million and 0.3 million shares of our common stock, respectively.

 

Accordingly, compensation cost is recognized on a straight-line basis over the vesting period. For stock options granted after the adoption of SFAS No. 123R, the compensation cost is recognized over the shorter of the vesting period or the period from the grant date to the date when retirement eligibility is achieved. The total expense associated with stock option awards recognized during the three month and nine month periods ended September 30, 2006 was $2.9 million and $9.8 million, respectively. Total income tax benefit associated with the stock option programs for the three month and nine month periods ended September 30, 2006 was $1.1 million and $3.6 million, respectively.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table:

 

 

Expected volatilities are derived from the historical volatility of our common stock. Expected terms are determined using the simplified method for estimating expected option life, as prescribed under SAB No. 107. The risk-free interest rate for corresponding expected terms of the stock option is based on the U.S. Treasury yield curve in effect at the time of grant.

 

A summary of stock option activity under the stock option programs as of September 30, 2006 is presented below:

 

 

The total intrinsic value of stock options exercised during the three month and nine month periods ended September 30, 2006 was $8.2 million and $53.6 million, respectively, and includes D&B and Moody’s employees that exercised D&B stock options. See Note 7 to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q for further discussion on the separation of D&B and Moody’s Corporation in September 2000.

 

A summary of the status of our nonvested stock options as of September 30, 2006 is presented below:

 

 

Total unrecognized compensation cost related to nonvested stock options at September 30, 2006 was $20.1 million. This cost is expected to be recognized over a weighted average period of 2.4 years. The total

 

THE DUN & BRADSTREET CORPORATION

 

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(Tabular dollar amounts in millions, except per share data)

fair value of stock options vested during the three month and nine month periods ended September 30, 2006 was $1.3 million and $12.8 million, respectively.

 

Cash received from stock option exercises for the three months ended September 30, 2006 and 2005 was $4.2 million and $3.9 million, respectively. Cash received from stock option exercises for the nine months ended September 30, 2006 and 2005 was $26.6 million and $15.2 million, respectively. The expected tax benefit associated with the tax deductions from stock option exercises totaled $5.6 million and $28.4 million for the three months ended September 30, 2006 and 2005, respectively. The expected tax benefit associated with the tax deductions from stock option exercises totaled $33.3 million and $33.1 million for the nine months ended September 30, 2006 and 2005, respectively. The expected tax benefit includes D&B employees exercising both D&B and Moody’s stock options.

 

Restricted Stock and Restricted Stock Unit Programs

 

The adoption of SFAS No. 123R did not change our accounting for restricted stock and restricted stock units. The cost associated with our restricted stock and restricted stock units has been included in net income. The fair value of restricted stock and restricted stock units is determined based on the average of high and low trading prices of our common stock on the grant date.

 

Prior to 2004, restricted stock and restricted stock unit grants were generally vested on a cliff basis over three years of service. Compensation cost associated with these awards are generally recognized on a straight-line basis over three years. Beginning in 2004, certain employees were provided an opportunity to receive an award of restricted stock or restricted stock units in the future. That award is contingent on performance against the same goals that drive payout of the annual bonus plan. The restricted stock or restricted stock units will be granted, if at all, after the one-year performance goals have been met and will then vest over a three-year period on a graded basis. Compensation cost associated with these grants is recognized on a graded-vesting basis over four years, including the performance period. Total expense associated with restricted stock, restricted stock units and restricted stock opportunity was $1.5 million and $2.4 million for the three months ended September 30, 2006 and 2005, respectively. Total expense associated with restricted stock, restricted stock units and restricted stock opportunity was $5.2 million (including a reduction of expense of $0.5 million related to accumulated effect of forfeiture assumption) and $9.1 million for the nine months ended September 30, 2006 and 2005, respectively. Total income tax benefit associated with restricted stock, restricted stock units and restricted stock opportunity was $0.6 million and $0.9 million for the three months ended September 30, 2006 and 2005, respectively. Total income tax benefit associated with restricted stock, restricted stock units and restricted stock opportunity was $1.8 million and $3.5 million for the nine months ended September 30, 2006 and 2005, respectively.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

A summary of the status of our nonvested restricted stock and restricted stock units as of September 30, 2006 is presented below:

 

 

Total unrecognized compensation cost related to nonvested awards was $20.4 million at September 30, 2006. This cost is expected to be recognized over a weighted average period of 2.8 years. The total fair value of shares vested during the three month and nine month periods ended September 30, 2006 was $0.4 million and $9.7 million, respectively. The total fair value of shares vested during the nine month periods ended September 30, 2005 was $5.6 million. The expected tax benefit associated with the tax deductions from vested shares for the three month and nine month periods ended September 30, 2006 was $0.1 million and $3.7 million, respectively. The expected tax benefit associated with the tax deductions from vested shares for the nine month period ended September 30, 2005 was $2.1 million.

 

Employee Stock Purchase Plan

 

Under the ESPP, our employees can purchase our common stock at a 15% discount from market value, subject to certain limitations as set forth in the ESPP. The total expense recognized for the three month and nine month periods ended September 30, 2006 was $0.2 million and $0.7 million, respectively.

 

THE DUN & BRADSTREET CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

(Tabular dollar amounts in millions, except per share data)

Note 10 — Pension and Postretirement Benefits

 

The following table sets forth the components of the net periodic cost associated with our pension plans and our postretirement benefit obligations.

 

 

We previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005 that we expected to contribute $32.4 million and $12.4 million to our Non-Qualified U.S. and non-U.S. pension plans and the U.S. postretirement benefit plan, respectively in 2006. As of September 30, 2006, we have made contributions to our Non-Qualified U.S. and non-U.S. pension plans and the U.S. postretirement benefit plan of $20.4 million and $9.1 million, respectively. For the three month and nine month periods ended September 30, 2006, we received government subsidies of $0.9 million and $1.4 million, respectively, related to the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.

 

We also recognized a curtailment gain of $0.4 million for our postretirement benefit plan for the nine month period ended September 30, 2006, of which $0.3 million was related to the 2004 Financial Flexibility Program and $0.1 million was related to the 2005 Financial Flexibility Program (see detail in Note 3 to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q).

 

We incurred a curtailment charge of $0.3 million for our UK Pension Plan in the second quarter of 2005 and $0.1 million for the U.S. Qualified Plan in the third quarter of 2005 related to the 2005 Financial Flexibility Program. In addition, we recognized a curtailment gain of $0.1 million and $5.8 million for our U.S. postretirement benefit plan for the three month and nine month periods ended September 30, 2005, respectively, related to the 2004 Financial Flexibility Program.

 

Note 11 — Segment Information

 

The operating segments reported below are our segments for which separate financial information is available and upon which operating results are evaluated by management on a timely basis to assess performance and to allocate resources. Our results are reported and managed under the following two segments: U.S. and International (which consists of operations in Canada, Europe, Asia Pacific and Latin America). Our customer solution sets are Risk Management Solutions^TM, Sales & Marketing Solutions^TM, E-Business Solutions^TM and Supply Management Solutions^TM. Inter-segment sales are immaterial and no single customer accounted for 10% or more of our total revenues during the three month and nine month periods ended September 30, 2006 and 2005. For management reporting purposes, we evaluate business segment performance before restructuring charges because restructuring charges are not a component of our ongoing income or expenses and may have a disproportionate positive or negative impact on the results of our ongoing underlying business (see “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the heading “How We Manage Our Business” in this Quarterly Report on Form 10-Q for further details). Additionally, transition costs, which are period costs such

 

THE DUN & BRADSTREET CORPORATION

 

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(Tabular dollar amounts in millions, except per share data)

as consulting fees, costs of temporary employees, relocation costs and stay bonuses incurred to implement our Financial Flexibility Programs, are not allocated to our business segments.

 

 

 

 

 

THE DUN & BRADSTREET CORPORATION