3. Liquidity and Capital Resources

This section examines the Company's capital structure, including the sources of liquidity and the various financial instruments of its debt and preferred shares portfolio.

Financial Position

As at December 31, 2007, YPG had approximately $2.4 billion of debt net of cash and cash equivalents, or $2.9 billion including preferred shares issued during the first half of 2007. The net debt and preferred shares position has continued to improve from the end of the last quarter due to positive excess cash flow from operations. There were no new financing transactions during the quarter. The net debt to EBITDA ratio1 as of December 31, 2007 stands at 2.7 times compared to 3.2 times as of December 31, 2006. The net debt and preferred shares to EBITDA ratio¹ stands at 3.2 times as of December 31, 2007. The net debt to total capitalization stands at 27.4% compared to 30.3% as of December 31, 2006, and the net debt and preferred shares to total capitalization stands at 33% as of December 31, 2007.

¹ Latest twelve month EBITDA giving effect to the impact of acquisitions.

Revolving Credit Facilities and Commercial Paper Program

YPG currently has in place a $700 million senior unsecured revolving credit facility (the Revolving Facility).

The Revolving Facility, which is composed of two tranches, was amended on March 6, 2007 to extend the term of its tranches:

• a $500 million 364-day revolving tranche with a 2-year term-out option matures in May 2010; and,
• a $200 million 5-year revolving tranche matures in May 2012.

The total amount of the Revolving Facility can be used as back-up for the commercial paper program and for general corporate purposes. The 364-day tranche can be extended annually, subject to the Lender's consent. If not extended, any amount drawn may be converted, at our option, into a 2-year non-revolving term loan.

During 2007, given difficult market conditions in the Canadian money markets affecting commercial paper issuers, the Company decided to draw on the Revolving Facility to replace maturing commercial paper and to fund its short-term liquidity requirements. As of December 31, 2007, $72 million was drawn under the Revolving Facility.

The Revolving Facility is subject to customary terms and conditions including limits on pledging assets without the consent of lenders. This facility is also subject to the maintenance of a maximum ratio of funded debt to EBITDA of 4.25 times and a minimum ratio of EBITDA to cash interest expense on total debt of 3.5 times.

YPG Holdings Inc., a subsidiary of YPG, maintains a commercial paper program with an authorized limit of $500 million. The Revolving Facility serves as a back-up facility for the program. As at December 31, 2007, there was no commercial paper outstanding under the program, down from $242.8 million at the end of the previous year.

YPG was in compliance with all of its debt covenants as at December 31, 2007.

Medium Term Note Program

YPG Holdings Inc. has a total of $2.1 billion of notes outstanding under its Medium Term Note program with varying maturity dates between 2009 and 2036.

Exchangeable Unsecured Subordinated Debentures

YPG Holdings Inc. has a total of $300 million of Exchangeable Unsecured Subordinated Debentures outstanding (the Exchangeable Debentures). The Exchangeable Debentures have a maturity date of August 1, 2011 and are exchangeable at any time, at the option of the holder, for units of the Fund at an exchange price of $20.00 per unit. The Exchangeable Debentures are redeemable at par at the option of YPG Holdings Inc. after August 1, 2009, subject to certain restrictions. The Exchangeable Debentures also provide YPG Holdings Inc. with the option to repay the principal and interest in units of the Fund. An amount of approximately $13 million, representing the value of the exchange option, has been classified as a component of Unitholders' equity on the balance sheet. There has not been any exchange of the Exchangeable Debentures during the year.

Cumulative Redeemable Preferred Shares

YPG Holdings Inc. has two series of cumulative redeemable first preferred shares outstanding. On March 6, 2007, 12,000,000 cumulative redeemable preferred shares, Series 1 (Preferred Shares Series 1) were issued for gross proceeds of $300 million. A dividend of $1.0625 per share per annum is payable quarterly on the Preferred Shares Series 1, yielding 4.25% per annum. The Preferred Shares Series 1 are redeemable by the issuer at par for cash on or after March 31, 2012, or by the issuance of units of the Fund between March 31, 2012 and December 31, 2012. The Preferred Shares Series 1 are also retractable for cash at the holder's option on or after December 31, 2012 at a price equal to $25.00 per share plus any accrued and unpaid dividends in arrears.

On June 8, 2007, 8,000,000 cumulative redeemable preferred shares, Series 2 (the Preferred Shares Series 2) were issued for gross proceeds of $200 million. A dividend of $1.25 per share per annum is payable quarterly, yielding 5.0% per annum. The Preferred Shares Series 2 are redeemable by the issuer at a decreasing premium for cash on or after June 30, 2012, or by the issuance of units of the Fund between June 30, 2012 and June 30, 2017. The Preferred Shares Series 2 are also retractable for cash at the holder's option on or after June 30, 2017 at a price equal to $25.00 per share plus any accrued and unpaid dividends in arrears. An amount of $4.3 million representing the value of the redemption option has been classified as a derivative financial instrument on the balance sheet.

Liquidity

On December 31, 2007, cash and cash equivalents amounted to $53.3 million. This amount does not include any investments in asset-backed commercial paper. In addition to cash and cash equivalents, YPG Holdings Inc. may issue additional notes amounting to $500 million under its commercial paper program and access another $128 million under its Revolving Facility. Alternatively, if additional notes are not issued under the commercial paper program, YPG Holdings may access the full $628 million available under the Revolving Facility.

Unit data

As at February 13, 2008 outstanding unit data was as follows:

The units are voting and participate equally in the income, losses and capital distributions of the Fund. In February 2006, 19,000,000 Exchangeable Units of YPG LP (exchangeable for units of the Fund) were issued as a partial consideration for the acquisition of TMC, one of two companies from which we have built our Vertical Media business. During the first half of 2007, 5,000,000 Exchangeable Units of YPG LP were exchanged for an equal number of Units of the Fund. On January 18, 2008, 3,185,000 Exchangeable Units of YPG LP were exchanged for an equal number of Units of the Fund. As a result, on February 13, 2008, 10,815,000 Exchangeable Units of YPG LP remain outstanding. The units are included in the outstanding unit data.

No options were granted following the inception of the Fund.

YPG Holdings Inc. also has a total of $300 million of Exchangeable Debentures which are exchangeable at any time, at the option of the holder into units of the Fund at an exchange price of $20.00 per unit.

YPG Holdings Inc. has also issued 12,000,000 Preferred Shares Series 1 for gross proceeds of $300 million and 8,000,000 Preferred Shares Series 2 for gross proceeds of $200 million. Both series of preferred shares are redeemable by the issuer under certain conditions through the issuance of units of the Fund.

On August 22, 2006, the Fund issued 25,000,000 warranted units. Each warranted unit consisted of one unit of the Fund and one-half of a warrant. One full warrant provided the holder the option to buy one unit of the Fund at a price of $17.50 until December 14, 2007. No warrant was exercised and the warrants expired on such date.

Contractual Obligations and Other Commitments

¹ Including Exchangeable Debentures

² Principal amount

Obligations under capital leases

We enter into capital lease agreements for office equipment and software. As of December 31, 2007, minimum payments under these capital leases up to 2014 totalled $17.5 million.

Operating leases

We rent our premises under various operating leases. As of December 31, 2007, minimum payments under these operating leases up to 2019 totalled $184.1 million.

Purchase obligations

We use the services of outside suppliers to distribute our directories and have entered into long-term agreements with a number of these suppliers. These agreements expire between 2008 and 2012. As at December, 2007, we have an obligation to purchase services for $29.4 million over the next five years. Cash from operations will be used to meet these purchase obligations.

Sources and Uses of Cash

Consistent with the directory and classified publishing industry, the Company has minimal capital spending requirements combined with low operating costs.

Cash flow from operating activities

Cash flow from operating activities increased by $94.2 million to reach $695.5 million in 2007. The changes reflect the additional Adjusted EBITDA contribution of $123.1 million during the year. This is partly offset by increased payments of financial charges associated with new debt instruments and dividends on preferred shares. The variance in change in operating assets and liabilities for the year is mainly due to the timing of payment of certain accounts payable and accrued liabilities related to restructuring and special charges in connection with our business acquisitions.

The Company generates sufficient cash flow from operations to fund capital expenditures, distributions, working capital requirements and to service its debt obligations. Please refer to Distributable Cash in section 4 to understand the impact of new tax proposals from the Federal Minister of Finance on cash flow from operating activities.

Cash flow from (used in) investing activities

Cash used in investing activities decreased during the year from $1,237.4 million in 2006 to $414 million in 2007. During the year, we acquired the assets of Aliant, LesPAC and Vertical Guides LP representing cash outflow of $341.6 million. We also made a strategic investment in Call Genie Inc. (Call Genie) of $5 million. During 2006, we acquired TMC and Trader Canada creating our second and complementary platform in the Vertical Media segment, for a cash outflow of $899.8 million.

Transition Capital – In relation to the acquisitions of TMC and Trader Canada, an amount of $10 million was identified as pre-funded capital for purposes of integrating the combined Vertical Media businesses of which $10.8 million was spent during 2007 and $15.6 million on a cumulative basis. The increased scope of systems' integration resulted in higher than projected transition capital expenses.

Transition Capital – In relation to the acquisitions of TMC and Trader Canada, an amount of $10 million was identified as pre-funded capital for purposes of integrating the combined Vertical Media businesses of which $10.8 million was spent during 2007 and $15.6 million on a cumulative basis. The increased scope of systems' integration resulted in higher than projected transition capital expenses.

Maintenance capital expenditures increased from $18.8 million in 2006 to $22.9 million in 2007. Higher maintenance capital expenditures reflect spending associated with recent business acquisitions.

Capital spending for new initiatives increased from $16.4 million for 2006 compared to $21.2 million for 2007. The increase is due to the implementation of Customer First during the year.

Leasehold Improvements – During the year, we incurred $11.5 million of leasehold improvements related to our new Trader office premises in Ontario and Québec. In our Directories segment, we incurred $4.7 million of leasehold improvements during the year for our premises in Winnipeg and Burnaby.

Total capital expenditures for the year amounted to $73.8 million. We expect capital expenditures to decrease to approximately $55 million in 2008.

Cash flow from (used in) financing activities

Higher average units outstanding in 2007, combined with an increase in the level of cash distributions per unit, resulted in an increase in distributions to unitholders from $517.3 million in 2006 to $580.1 million in 2007.

Off-Balance Sheet Arrangements

(See Notes 21 and 25 of the Consolidated Financial Statements of the Company for the year ended December 31, 2007).

Operating leases

The Company has $184.1 million in outstanding commitments under various leases for premises and equipment up to 2019.

Guarantees

In the normal course of operations, we have entered into agreements that contain certain features which meet the definition of a “guarantee” as defined by CICA (Canadian Institute of Chartered Accountants) Accounting Guideline 14, Disclosure of Guarantees. These are customary in the industry.

YPG has entered into agreements which contain indemnification of its trustees and officers to indemnify them against expenses (including legal fees), judgments, fines and any amount actually and reasonably incurred by them in connection with any action, suit or proceeding in which the trustees and/or officers are sued as a result of their service, provided they acted honestly and in good faith with a view to the best interests of the company.  YPG benefits from directors' and officers' liability insurance which we purchase. No amount has been accrued in the consolidated balance sheet as of December 31, 2007 with respect to this indemnity.

With the acquisitions of ADS, TMC, Trader Canada, MTS, Aliant, LesPAC and Vertical Guides LP, YPG has entered into many agreements whereby we agree to indemnify and hold harmless the vendors from and against any and all claims, liabilities, costs and expenses arising out of, based upon or related to:

• any breach by the Company in the performance of its obligations under these agreements; and,
• any breach of a representation contained therein.

Furthermore, agreements entered into by TMC and Trader Canada, prior to their acquisitions, contain indemnifications similar to the ones described above. No amount has been accrued in the consolidated balance sheet as of December 31, 2007, with respect to these indemnities.

The nature of these guarantees prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay to counterparties.

Financial and Other Instruments

(See Note 23 of the Consolidated Financial Statements of the Company for the year ended December 31, 2007).

The Company's financial instruments consist of cash and short-term investments, accounts receivable, other investment, accounts payable, distributions payable, short-term and long-term debt, exchangeable debentures, preferred shares and interest rate derivatives.

Derivative Instruments

We use various derivative financial instruments to manage our exposure to interest rate risks on debt financing. YPG does not hold or use any derivative instruments for speculative trading purposes. We formally assess, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in our hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

We manage interest rate exposure by having a balanced schedule of debt maturities, as well as a combination of fixed and floating interest rate obligations. We have entered into interest rate derivatives to manage this exposure.

We currently have outstanding two interest rate swap agreements for a nominal amount of $75 million each totalling $150 million to hedge the Series 6 Medium Term Notes. We receive interest on these swaps of 4.65% and pay a floating rate equal to the three month Canadian Banker's Acceptance plus a spread of 0.28% and 0.35%. The swaps mature on February 28, 2011 matching the maturity date of the underlying debt. As at December 31, 2007 and 2006, the interest rate swaps met the criteria for hedge accounting.

Taking into consideration the debt instruments outstanding, the preferred shares, the cash and the above-mentioned derivative instruments, our fixed-to-floating ratio was 94% fixed rate as at December 31, 2007. There were no derivative transactions during the year.

While the counterparties of these agreements expose YPG to credit losses in the event of non-performance, we believe that the possibility of incurring such losses is remote. This is due to the creditworthiness of the counterparties, all of whom are highly-rated financial institutions with strong credit ratings.

The Preferred Shares Series 1 and 2 contain options for redemption. These options meet the definition of an embedded derivative. They are recorded at their fair value on the consolidated balance sheet with changes in fair value recognized in earnings.

The carrying value of outstanding interest rate derivatives was $0.1 million and the carrying value of embedded derivatives was $4.3 million on December 31, 2007. The carrying value is calculated as is customary in the industry using discounted cash flows with quarter-end market rates. For 2007, we reported an unrealized gain of $2.7 million on derivatives. In 2006, there was no gain or loss on derivatives.

Short-term investments

Credit risk associated with short-term investments is minimized substantially by ensuring that these financial assets are placed with creditworthy counterparties. An ongoing review is performed to evaluate changes in the status of counterparties.

Accounts receivable

YPG is exposed to credit risk with respect to accounts receivable from customers. With our billing and collection services agreements, Bell, TELUS, MTS Allstream Inc. and Bell Aliant receive money from customers on behalf of YPG. There are no individual customers that account for 1% or more of revenues and there are no accounts receivable from any one individual customer and certified marketing representative that exceeds 5% of the total balance of accounts receivable at any point in time during the year. Included in trade accounts receivable of $225.3 million at December 31, 2007 is $46.6 million (2006 - $46.5 million) to be remitted by Bell, $26.8 million (2006 – $23.9 million) to be remitted by TELUS, $3.6 million (2006 - $4.4 million) to be remitted by MTS Allstream Inc. and $4.5 million (2006 - $0.5 million) to be remitted by Bell Aliant under their respective billing and collection services agreements.