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EarningCall_234000 | Hereâs the entire text of the prepared remarks from Dow Jonesâ (ticker: DJ) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good day Ladies and Gentleman and Welcome to the DowJones Companyâs Third Quarter Fiscal Year 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If any one should require operator assistance during the conference please press â*â â0â on your telephone keypad. As a remainder, this conference is being recorded. It is now my pleasure to introduce to your host. Mr. Mark Donohue, Director of Investor Relation for DowJones & Company. Thank you. Mr. Donohue you may begin. [Mark Donohue, Director of Investor Relations] Thank You, Good morning. Welcome to our Third Quarter 2005 Earnings Conference Call and webcast at www.dowjones.com. On this morningâs call Peter Kann, DowJonesâs Chairman and Chief Executive Officer who will touch very briefly on some highlights of third quarter, Chris Reid, the Chief Financial Officer will take you through the financial results. And then, Richard Zannino, our Chief Operating Officer will elaborate with operating highlights and forward outlook. Also on our call are Gordon Crovitz, Senior Vice President of DowJones and President of Electronics publishing and Karen House, Senior Vice President of DowJones, Publisher of Wall Street Journal. All will be available to take any questions you may have. For your benefits, the transcript page prepared remarks will be on our website shortly after the conclusion of this call. Also, this teleconference call will be available for replay starting at 12:00 p.m. Eastern Time today and at 11:30, 9:00 pm on October 27th. To access audio replay, please call 877-660-6853 and then our account number 286, the confirmation number 168674. Finally if you have any questions after the call, please feel free yourself on the investor relations at 609-520-5660 As we begin our call, let me remind you that weâll make certain forward-looking statements and then after to assist to you and understand the company earnings results. Actual results may materially differ from those presented here. Additional information concerning risk factors that could cause such a difference can be found in the Companyâs document filed with the Securities and Exchange Commission from time to time. Reconciliation of non-GAAP financial measures disclosed during this call are available on our earnings release which is available in the investor relations page of our website at www.DowJones.com. And with that, itâs a pleasure to turn the call over to Peter Kaan. [Peter Kaan Chairman and Chief Executive Officer] Good morning, thank you all for joining us. I will be brief and then my collogues will be elaborating our third quarter earnings result of about $0.12 per diluted share was inline with our original guidance, but down from the $0.15 per diluted share in the third quarter last year. We would pleased to see a turnaround then recent quarterly launched the plans at the Wall Street Journal with the modest gains that we posted in September and for the quarter. We are also extremely pleased with the performance of our electronic publishing businesses in the quarter. However, these positive results werenât enough to offset planned spending relating to our launch of the journals new weekend edition and some weaknesses elsewhere in the portfolio thatâs resulting in the decline in year-over-year earnings. And Chris and Richard are going to review those results with you and some details shortly. During this quarter we made a number of really significant move to strengthen our portfolio and improve profit. In early July, we announced we would be exiting our CNBC International Partnership resulting in annual savings of $15 million. I should note that our US relationship with CNBC is not affected. But about a month ago we launched the journalâs new weekend edition and we are very pleased with the initial results both from readers and advertisers. Readers embraced the new product based on a nationwide reader panel of 900 plus respondents, who have said they spend an average of 58 minutes with the weekend edition, which is even more than they spend with our Monday to Friday papers. Weekend edition has attracted many new advertisers as well as some who havenât been in the journal for some years and I trust you have seen the edition in that ad diversity but it includes advertisers like Home Depot, Lands End, Club Med, Aga stoves, Skybridge Private Air and many, many more. Positive reader research has strong advertiser feedbacks and continued marketing, are all going to help drive further interest and further weekend growth. Then last week we announced that weâll be making a series of innovative design and content enhancements to the journal in conjunction with shrinking our web width. Some of those are going to be introduced over coming months and now continue through 2006, comminuting in January 2007 with a reformatting to the 48-inch web width. And these changes will save the company $18 million a year largely from lower investment usage, starting in â07. And then finally on Monday we launched our new Compact Edition of the Journal in Europe and in Asia, these changes are expected to reduce annual operating loses by $17 million annually starting in 2006 while importantly at the same time benefiting readers and advertisers in part through more integrated front online offers. So, as you see we have got lots in our plate and we look forward to updating you on our progress of the media conferences in December, and with that Iâll turn it over to Chris for a review of the financial results and then heâll pass to this on to Rich Zannino. [Chris Reid, the Chief Financial Officer] Thank you Peter and Good Morning everyone. This morning Iâll update you on some of the key business drivers behind our third quarter financial results. The four special items third quarter 2005 Earnings per share were $0.12 compared to street consensus of $0.13 and $0.15 per share in the last year. The EPS declined the last year was driven by our investment in the successful September launch of the weekend edition of the Wall Street Journal, which cost us about $0.04 per share in the quarter. Before weekend edition, comparably EPS was about $0.16 per share in the quarter versus $0.15 in 2004. During the quarter, we recorded two special charges that net to 0, with a charge of $0.01 per share for appreciation of the contract guarantee reserve, which was offset by a special income tax gain of about $0.01 per share. Turning to our operating results, total company revenue was up 7% in the quarter to $421 million driven by the acquisition of MarketWatch and very strong organic growth that CEP and indexes and solid gains at NewsWires and in Ottaway, partially offset by the clients Barronâs US TV and International Prints. Third quarter operating expenses increased 8% of $405 million and included investments in MarketWatch and weekend edition excluding these and increase newsprint prices, comparable expenses were up less than 2% last year. In the quarter we reduced comparable cost of print publishing, as we continue to get our expenses inline with revenues and we invested those savings on organic growth initiatives at electronic publishing and in our Internet initiatives at Ottaway. For the year-to-date total expenses were up 7% on spending from MarketWatch weekend edition in newsprint leaving comparable expenses flat for last year. Third quarter operating income declined $4.6 million to $60 million and operating margin was 3.8% versus 5.2% last year. Pre-tax equity income was $4.8 million versus about breakeven last year driven by the elimination of international television loses as well as improvement at Factiva, Stoxx and Smart Money which more than offset reduced equity earnings resulting from the sale of Soucy. Net interest expense was up $4 million over last yearâs third quarter on an increased debt levels associated with borrowings to fund the MarketWatch acquisition and higher interest rates. Before special items, our effective tax rate was 36.6% compared with 41.5% in last yearâs third quarter including the benefit of the deduction for domestic production under the American Job Creation Act plus elimination of FF Soucy, which was subject to a 65%-effective tax rate. Looking at some other key figures, our third quarter ending head count totaled about 7425 and was flat with last yearâs third quarter for the employees associated with acquisitions. Total newsprint cost in the quarter were up roughly 8% with consumption down about 4% and an average cost per ton up about 12% versus comparatively low year ago levels from we managed to whole prices constant for the middle two quarters of the year. The big newsprint suppliers closed a number of high-cost mills over this summer effectively tightening supply and they pushed to a price increase of about $25 per ton in the third quarter. Suppliers announced another $35 price increase this October and while weâre not seeing any of this price increase yet on our purchases, we expected to settle in for about $25 per ton by the end of the quarter. Capital expenditures totaled $15 million in the quarter compared with $14 million last year. We are forecasting to spend around $70 million of total capital in 2005 including $3 million initial spending on our web-width reduction initiatives. As we announce last week, total capital spending over the next 15 months to reconfigure our 19 presses to 48-inch web width of total $43 million of roughly $2.25 million for press with $36 million of spending in 2006 and the final $4 million in 2007. In addition to P&L savings of $18 million per year this project will generate an after-tax return of about 26% for the payback period of less than three years, Rich will have more on a content format changes associated with this initiatives in a moment. Depreciation and amortization totaled about $27 million and was a $1.5 million about last year with higher expense from acquisition at electronic publishing offset by reduced depreciation on lowered capital spending in print publishing. Lastly our balance sheet and cash flow are strong, and we closed the quarter with debt of $511 million versus a debt level of $517 million at the end of last quarter and $197 million in the last yearâs third quarter. Our cash balance at the end of the quarter was roughly $18 million compared with about $21 million at the end of the third quarter 2004. And with that, Iâll turn it over to Rich. [Mr. Richard F. Zannino, Chief Operating Officer and Executive Vice President] Good morning all and thanks for joining us. We continue to battle a very difficult print advertising environment, which is adversely affecting us into in even greater extent, our traditional print competitor. From the near trend this environment is uncontrollable, we remain focused on the things we can control help drive long-term growth and shareholder value. The controlling cost, improving execution in making disciplined investments in the number of major new initiatives to improve quality, reduce cost, reshape our portfolio and sharply reduced our reliance and volatile B2B print revenue. The third quarter was another busy one in this regard, as we continue to identify and execute a number of bold new initiatives. We not only held on to hard-won cost cuts but identified others. As Chris noted, while total expenses were up 8%, comparable expenses were rough less than 2% during the third quarter. We launch weekend edition on September 17, and are pleased with its enthusiastic acceptance by reader and the incremental advertising and it is generating. We announced last weak of series of innovative design enhancement for the US Wall Street journal, which will culminate in a 20% reduction in our web width in January 2007. This will benefit readers and save about $18 million in the annual expenses or $0.13 per share. This past Monday, October 17, we launched new, more reader friendly and relevant compact print editions of the Asian and European editions of the journal and strengthen their linkage to wsj.com. This repositioning will also benefit readers and reduce annual cost by $17 million or $0.12 per share. In July, we announced the exit of our unprofitable international television partnerships with CNBC in Europe and Asia. This will eliminate about $15 million or $0.11 per share of annual equity losses. As weâve noted in the past our license agreement with CNBC in the US remains intact. And finally weâve nearly completely and fully successfully integrated MarketWatch. Looking on the third quarter results, total company revenue increase to nearly 7% driven by a 30% increase at electronic publishing and 2.4% increase at Ottaway partially offset by 2.5% decline at print publishing. Total company operating income declined about $5 million or 23% in the quarter solely due to planned operating losses from weekend edition. In our print publishing segment, we continued to feel the bite of a very difficult print ad environment. Total revenue in the third quarter seasonably our weakest quarter of the year, were down 2.5% from 2004 on a 2.8% decline in ad revenue. As flat advertising revenue at international and the US journals was more than offset by week ad results of Barron's and CNBC TV and last year down sizing with Far Eastern Economic Review magazine. Total expenses were held to an increase of only 2.3% print publishing even with the extra planned spending on weekend edition. In fact, excluding increased weekend edition in newsprint cost, core print publishing expenses were down about 5% in the quarter, as we reduced core cost, where revenue is stagnant to help fund the cost of weekend edition where we can grow revenue. This all netted to an operating loss of print publishing of $27 million versus the loss of $17 million last year. Weâre pleased with the early reader and advertiser response to weekend edition as the new edition is after a great start. A National Reader Survey conducted on the first issue shows that itâs an unqualified hit with reader as 96% of subscribers who received it read it was nearly nine out of ten subscribers saying that they read all three section. Spending on average 58 minutes reading it, with 96% saying theyâll read it again next week and initial reaction from advertisers to weekend edition has also been positive and inline with our expectation. More than 50% of the advertising is incremental in more than 50% of ad is consumer. Looking further at the journalsâ results from the third quarter, report to the modest gain in advertising lineage. But as we all know the print ad environment remains volatile. This was evident in our recent Monday to Friday ad results where July per issue lineage was up 5.8%, August was down 6.2%, in September was up 2% netting to an increase of up 0.6% in the quarter. Including weekend edition, lineage was up 3.6% in the quarter as modest gains in our all important financial and technology categories were bolstered by a 21% gain in classified advertising but then, offset by a 6.3% decline in our general ad category driven by industry wide softness and consumer advertising. In our financial advertising category, total Monday to Saturday linage was up 0.5% with gains in tombstone and retail advertising, partially offset by a decline at wholesale advertising. After a strong September where financial linage was up 15%, at this time, it looks like the financial category will fall back to slightly negative comp in the fourth quarter. Technology advertising was up 3.5% as strong gains and office products and personal computer advertising were partially offset by the plans and communications hardware and consumer electronic advertising. Weâre expecting fourth quarter tech comps to be quite strong as a number of large advertisers are planning large campaign. In the journalsâ general advertising category, which includes both B2B and consumer advertising, again linage was down 6.3% in the third quarter. On the B2B side we posted a 10% increase in advertising as increased corporate and media advertising were partially offset by declines in aviation insurance and professional services. We expect this positive trend in general B2B advertising to strengthen in the fourth quarter on strong professional services, corporate and insurance advertising. However in the third quarter, consumer ad revenue was down 17% due to double-digit industry wide declines in our key auto, travel and pharmaceutical categories. We expect this trend to improve in the fourth quarter as the travel categories strengthens, especially in weekend edition. Though it will remain negative on the weak auto and pharma advertising. Weekend edition which gives consumer advertisers access to our high spending readers where they most want to reach them at home in the weekend should help us regain positive momentum and continue our share gains against our traditional peer group in consumer advertising. In classifieds and other linage in the quarter, the journal posted a very strong 21% gain driven by continuing strong increases in real estate classified advertising. However, this heavy mix of low yielding classified ads resulted in the 3% overall decline in ad yields at the Wall Street journal. This occurred in spite of the fact that our Display Advertising Yield was up slightly during the quarter helped by a16% increase in color premium revenue in the quarter on an 8% increase in color ad pages. Also in print publishing at Barronâs total ad pages decreased 21% in the quarter while ad revenue declined 20% mainly due to declines in technology and automotive advertising. At the Asian and European editions of the journal, advertising linage increased 4% with ad revenue up slightly. A Monday of this week we launched our reformatted versions of the Asian and European edition into easier to read more cost convenient compact format and combined these print editions with new online counterpart. This repositioning will better serve the need of highly mobile international business readers as well as improved annual operating profits by about $17 million. We unveiled our latest initiative to better serve readers and reduce cost earlier this month when we announced that we would be making a series of innovative design and content changes to the US Print Journal. Culminating in a reduction in web-width in January 2007. As Chris noted, the capital cost of the project is estimated at $43 million to retrofit the journal 17 printing plans and 19 presses to the smaller page size. The journal will also incur about $13 million in one-time training, development and marketing cost for the project. Despite of this cost will be as follows: Weâll have minimal cost this year about $10 million in 2006 and $3 million in 2007. The newly formatted paper will launch in January 2007 and we expect to save in the range of $18 million on operating expenses. This is after about $4 million in non-cash depreciation expense. These savings will come mainly from newsprint and they will begin in January 2007. We also like to note that these savings are before any savings from contract printing opportunities likely to be afforded by the more standard 48-inch width. Overall, the project is expected to be diluted to 2006 EPS by about $0.07 per share and accretive to 2007 EPS by about $0.13 per share. Moving on now to electronic publishing, we had a terrific third quarter, total revenue increased 30% to $127 million. Operating income claimed 46% to $32 million and operating margins increase nearly 300 basis points to 25%. These gains were driven by the very successful acquisition of MarketWatch in January 2005 for strong organic revenue and profit growth at consumer electronic publishing and indexes and solid gains and our Newswires division. Newswires revenue was up 4% to $68 million in the quarter primarily driven by gains in newswires, domestic and international operations and at Dow Jones Financial Information Services. Our Indexes/Ventures business again posted a solid revenue gain in the third quarter, up 20% to $15 million driven by the continued strong growth in assets underlying many of our indexes. A consumer electronic publishing third quarter revenue increased a 127% due to the acquisition of MarketWatch together with very strong organic growth at the online journal. Paid subscriber to wsj.com at the end of the third quarter were a record 764,000, this is up 9% over the third quarter 2004 and daily unique visitors to the online journals were up 21% year-over-year. MarketWatch has now been nearly fully integrated of both the cost and revenue side. We have integrated much of news, IT, and back office function. And weâll use to have separate MarketWatch an online journal sales team selling their respective ads. We now have an integrated Dow Jones online network ad sales team which packages and sell all of our online advertising. This nearly across the board integration makes it difficult for us to accurately separate out in thus publicly report MarketWatch financials on a standalone basis. However, to provided more transparency we have to recast CEPâs 2004 revenues to include MarketWatchâs 2004 publicly reported revenue. On this recast basis CEPâs online ad revenues for the third quarter were up 23% and its total revenues increased 12%. On a year-to-date basis CEPâs online ad revenue were up 20% and its total revenues increased to 12%. We can also say that we have far exceeded our original cost synergy target and that to combine CEP and MarketWatch is far exceeding our profit expectations for the third quarter and year-to-date 2005 period. At our Ottaway newspaper segment, third quarter revenue was up 2% to $90 million. This was driven by a 3% increase in ad revenue including a 28% increase in Internet ad revenue. Linage was down 2% in the quarter as week auto classified advertising was partially offset by strong real estate advertising. Operating income decline 2% to $23 million due mainly to a 11% higher newsprint prices and investments in new Ottaway wide Internet initiatives and content management system. When complete these investments position Ottaway to significantly increase its future online revenue and profits. As a result, Ottawayâs operating margin declined to 130 basis points to 25.5%, but it remains among the highest in the community newspaper peer group. Looking forward we expect to print ad environment to remain difficult and choppy for us and our peers. Thus we are projecting a decline in per issue print advertising volume which together with planned losses from weekend edition will result in another sharp decline in profits at our print publishing segment. Ottaway will be less affected and weâre projecting basically flat profits. On the flip side, we see the online ad environment remaining robust and thus see another very strong performance in electronic publishing. Net, net though operating income across Dow Jones is projected to decline. On a more granular basis, based on current journal ad reservation it appears weâll post a mid-single digit decline in Monday to Friday linage in the fourth quarter. Adding in a fourth quarter weekend edition linage, we feel we can post a mid-single digit gain. Please note, that these estimates are based on pages we expect to physically run each day in the Monday to Saturday edition. We have not accounted for any shifting of Monday to Friday, advertising to Saturday, though we know so far itâs running at about 50% of Saturdayâs ad. In other words, weâre under estimating our true Monday to Friday linage expectation. In an event our Monday to Saturday linage is the most important measure and adding an increased revenue for MarketWatch and continued stronger organic growth at CEP and Indexes results in an increase in total company revenue of about 9% in the fourth quarter. On the expense line, we expect total operating cost to be up about 12% in the fourth quarter. However, most of this increase is due to this yearâs cost from MarketWatch and a full quarterâs expenses for weekend edition plus 15% higher newsprint prices. This leads comparable expenses up only 2% to 3% over last year. The above estimates together with another strong increase in equity income as result of existing unprofitable CNBC International ventures and improvements at nearly every other equity investment. Result in fourth quarter EPS before dilution from weekend edition in any special items in the mid to upper $0.30 per share range, below last yearâs $0.43 per share after about $0.05 to $0.06 per share of dilution for weekend edition we expect the EPS before special item to be in the low to mid $0.30 per share range. And with that, weâll turn back to Melissa to open the phone lines for any questions you may have. Melissa? THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234001 | Hereâs the entire text of the prepared remarks from Xcel Energyâs (ticker: XEL) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good morning. My name is Dennis and I will be your conference facilitator. At this time, I would like to welcome everyone to the Xcel Energy Third Quarter 2005 Earnings Conference Call. Thanks, Dennis, and I would like to welcome all of you to Xcel Energy's third quarter 2005 earnings release conference call. With me today is Ben Fowke, Vice President and CFO of Xcel Energy. We also have several others here to help provide answers to your questions. Some of the comments that will be made contain forward-looking information, significant factors that could cause results to differ from those anticipated are described in our earnings release and Xcel Energy filings with the Securities and Exchange Commission. Thanks, Dick, and welcome everyone. On today's call, I'm going to provide an explanation of our quarterly results, our outlook for the rest of year, our 2006 guidance and finally an update on our construction program in COLI. Starting with our results for the quarter, I'm pleased to report that Xcel Energy recorded earnings from continuing operations of $0.47 per share for the third quarter of 2005, compared with $0.40 per share for 2004. Total earnings for the third quarter 2005 were $0.47 per share, compared with $0.12 per share for 2004. As a reminder, we recorded a loss of $0.28 per share in the third quarter of 2004, largely due to an asset impairment charge related to our Seren investment. As you know, the core of our company is our utilities subsidiaries, which provided earnings of $0.46 per share for the third quarter 2005, compared with $0.41 per share for 2004. Utility earnings increased by $0.05 per share, largely due to higher electric utility margins which increased earnings by $0.10 per share and income tax benefits, which increased earnings by about $0.03 per share. These favorable results were partially offset by lower short-term wholesale and trading margins, higher utility O & M expenses, higher depreciation expense, and various other items. Each of these items decreased earnings by $0.02 per share individually, or $0.08 per share in total. Our holding company costs and results of other non-regulated companies provided earnings of $0.01 per share for the third quarter of 2005, compared with a loss of $0.01 per share last year. The change is primarily due to temporary timing differences related to accounting for income taxes under GAAP and our own reporting guidance. That summarizes our third quarter results. Now let's look into the details of the quarter. Starting at the top of the income statement, our base electric utility margins increased by $70 million for the quarter, largely driven by warm summer temperatures and weather-adjusted sales growth. In the third quarter of 2005, we benefited from temperatures in most of our major jurisdictions that were warmer than normal and significantly warmer than last year. In Minnesota, temperature humidity degree days were 26% above normal and 49% above 2004. In Colorado, cool degree days were 29% above normal and 86% above 2004. And finally, in the Texas Panhandle, cool degree days were 2% above normal, and 23% above 2004. As a result, favorable weather increased electric utility margins by $53 million, or $0.08 per share. In addition to favorable weather conditions, weather adjusted retail electric sales grew at 1.4%, increasing electric margin by $11 million. On a year-to-date basis, our weather-adjusted retail electric sales also increased by 1.4%. This is below our expectations for the year, and we have revised our year-end electric sales growth guidance range downward to 1.3% to 1.6%. We think the lower sales growth is a result of economic conditions and higher fuel prices. For more information on electric margins, please refer to our earnings release. Turning to operating expenses, our third quarter 2005, O & M expenses were $22 million higher than last year. The increase in O & M expenses was largely driven by higher benefit costs, accruals for various legal settlements and inventory adjustments. Overall, our year-to-date O & M expenses are about 6.5% higher than last year. When we experienced hot weather during the summer, we took the opportunity to increase our O & M expense levels to ensure that our operating system was in good shape. Compared with our original plans, we now expect our annual O & M spending to increase at our energy supply business unit. In addition, we also expect bad debt accruals to increase. We believe the increase in bad debt expense reflects a slowdown in the economy and the recent change in bankruptcy laws. Finally we recently made a donation to help our customers manage high-energy bills. As a result, I now expect our annual 2005 O & M expenses to increase to approximately by 5% compared with last year. Depreciation expense for the third quarter of 2005 was $13 million higher than 2004 levels. This is a continuation of a trend that we expected for the year. The increase is due to growth associated with normal system expansion and incremental depreciation for several large projects, including a new steam generator at Prairie Island and a new billing system. We expect recovery of these investments in future rate filings. During the quarter, we recognized approximately $11 million of income tax benefits, largely associated with prior periods. The benefits consisted primarily of research tax credits and a net operating loss carry back. As a result of these benefits, we have modified our effective tax rate assumptions to a range of 25% to 27% for 2005. That covers our earnings results for the quarter. Let me touch upon our year-end outlook. While we have modified some of our individual assumptions as detailed in our earnings release, our 2005 guidance range from earnings from continuing operations, remains at $1.18, to $1.28 per share. Through the first nine months we have benefited from warm weather and tax benefits, but these positive variations have been offset by higher O & M expense and lower sales growth. Based on the year-to-date results and our projections for the last quarter, we have narrowed the range and expect to end up in the lower half of our guidance range. Let's look ahead to next year. We are initiating our 2006 guidance range for earnings from continuing operations at $1.25, to $1.35 per share. Our 2006 assumptions are detailed in our earnings release. I'm going to spend a bit of time on two assumptions that are the most difficult to handicap. The realized revenue from our rate filings and the potential impact of high fuel costs. In 2005, we have or will file several rate cases as part of our regulatory strategy. In May, we filed a natural gas rate case in Colorado, requesting a $34 million rate increase, based on a return of equity of 11%. In June, we filed an electric and natural gas rate case in Wisconsin, requesting an electric rate increase of $53 million, and a gas rate increase of $8 million, based on a return of equity of 11.9%. Next week, we will file an electric rate case in Minnesota. Finally, later in November, we will file an electric rate case in North Dakota. As far as the timing of the rate cases, we expect a final decision in Colorado and Wisconsin cases at the end of this year, or the beginning of next year, with final rates in effect in early 2006. In both Minnesota and North Dakota, we will implement interim rates subject to a refund, which will be effective 60 days after the filing. We expect a final decision in both Minnesota and North Dakota in the summer of 2006. Now I know you have lots of questions about the Minnesota rate case. Since we haven't filed the case yet, I can't provide too much detail. After the filing is made, we will provide you with more details at the EEI meeting in early November. There are a couple things I can tell you. Overall, we expect to increase rates 7 to 9%. Approximately 61 million of the request is for decommissioning accruals; however, we are going to present various proposals to extend the collection period, which may lower the revenue requirements and the decommissioning accruals but will have no impact on earnings or cash flow. We are also looking at a different design to short-term wholesale margins, which would incorporate a sharing approach. This would provide us with an incentive and allow the ratepayers to share in the upside potential. We are requesting an 11% return on equity. Any time you file a rate case, there are regulatory risks. Clearly we are concerned about the high impact, the impact of high fuel prices on our customers; however, there are several key points to our case. We have increased investments to meet expanding customer needs and improve reliability. We have competitive rates, which are the result of careful cost management and two mergers, which allowed us to reduce our costs and avoid filing rate cases. Finally, we are environmentally responsible and lead the industry in developing renewables, promoting energy efficiency and reducing emissions. Our strategy is to file reasonable rate cases and get recovery of legitimate investments and expenses. We believe that our commission will provide us with reasonable recovery and it's important to note in our guidance range that we assume to get reasonable rate recovery. Another area of uncertainty is the impact of high fuel prices on our business. As you can see in our 2006 assumptions, we are projecting weather-adjusted electric retail sales growth of 1.3% to 1.7%. This is lower than our historic growth rate, and reflects our estimate of the impact of higher fuel costs on sales. We think this is a reasonable assumption, but it's very difficult to determine what impact $13 to $14 natural gas prices will have on customer usage. We will be closely monitoring this situation. In addition, we expect that higher fuel prices will increase working capital. We are in the process of expanding our credit facilities by $275 million to enhance our liquidity position. Increases in working capital will have some impact on our interest expense. Finally, higher fuel costs will potentially impact our bad debt expense. We have seen some impact in 2005, and we think our 2006 budget captures the potential exposure, but current prices are beyond historic levels and may provide our projections inaccurate. Overall, I think we have done a good job of capturing the impact of regulatory risk and higher fuel prices on our budget. I'm very comfortable with our guidance range but we are aware of the potential sensitivities. In addition to our 2006 earnings guidance, we have also updated our five-year capital expenditure forecast outlook as detailed in the earnings release. The forecast is not materially different from what you have seen in the past; however, we will continue to look at additional opportunities to invest in our utility business, particularly in the later years of our forecast. We will work very hard to obtain regulatory and legislative support necessary to make those investments attractive to our investors. If the past is any indication, for example, projects like Merck and Comanche 3, we will be successful. Next, I would like to provide you with an update on our major construction projects in COLI. We continue to make outstanding progress on the development of our new coal plant in Colorado. Permitting for construction of Comanche 3 is now complete. All environmental permits are in hand. Water rights have been obtained, county road access has been authorized and an annexation agreement with the City of Pueblo has been approved. Additionally a permit for ash disposal site was granted. And building permit applications will submitted as the project proceeds. In terms of project construction, oiler, turbine, air quality control systems, site development and stack contracts have been awarded, and the costs are in line with our expectations. At the site, the evaporation pond removal is complete, the stack foundation work has begun, and the site development contractor has begun preparing the site for construction. We expect to have the formal ground breaking ceremony later this year. We have also made good progress on the Merc project. We broke ground for the King plant rehabilitation project in April of this year. Details design work is nearly 70% complete, and approximately 90% of the contracts for equipment supply and construction have been placed. A large use of the long lead components like boiler, turbine and pollution control equipment have been designed and are well into manufacturing. The pilings, foundation and slabs for the new pollution control equipment and cooling towers will be completed by year-end. I'm happy to report that both projects remain on track and within our cost expectations. So now let me touch on everybody's favorite topic, our company-owned life insurance program known as COLI. As I mentioned in the past, there are two issues related to COLI, the first and most significant issue is the actual IRS dispute. The second issue is the potential accounting pronouncement from the FASB, which affects accounting recognition, but not actual cash flows. I will start with the IRS dispute. In October, the district court denied our motion for summary judgment in the IRS dispute. The court also denied the IRS motion for summary judgment, which asserted that PSCo had no insurable interest in the lives of its employees. The court did grant partial summary judgment to us, affirming that we had an insurable interest in the lives of our employees. A ruling and summary judgment is issued if there are no disputed issues of material fact. Generally speaking, it is difficult to prevail on a motion for summary judgment, so the denial of our motion is understandable. In this situation, the court decided that it would need a full hearing to determine the case, because questions of fact remain. We are pleased that the court affirmed that we have an insurable interest in the lives of our employees, litigation is currently proceeding with discovery and with the trial to be held sometime after 2006. We do not have a specific date yet for the beginning of the trial. Because the decision reached following that trial can be appealed, it may be another two to three years before the litigation is finally concluded. In any event, we believe our case has strong merits and we feel confident about our facts and circumstances. Now, let me touch on the FASB issue. In September, the common period expired on the FASB exposure draft on accounting for uncertain tax positions. There are more are than 100 comment letters submitted and many letters indicated significant opposition to the new rules. The FASB has since announced that the effective date of the potential new rules has been delayed until at least the first quarter of 2006. At this point, we believe there's considerable uncertainty about the FASB's eventual decision on this issue. They could revise rules, continue to delay the project, issue a completely new exposure draft or abandon the project. As a result, we will continue to record the tax benefits of COLI in our actual results and we'll continue to include the tax benefits in our guidance range. So with that, I will wrap things up. Overall, it was a good quarter. We are on track to meet our 2005 guidance, and our 2006 guidance represents excellent growth prospects. We have a solid strategy , one that works for us. Our build to core strategy is not changing, it is easy to understand, and it is low risk. Invest in our utility business, earn original return on that investment. We continue to balance and align the interests and the needs of our customers, the environment and our shareholders. Like any plan, it has its challenges, and the high-priced fuel environment will require Xcel Energy and its stakeholders to be forward looking. We have developed an action plan, which we shared with the public recently. Part of the plan includes donations of $5 million to the Salvation Army's Heat Share program, and other local programs in our service territories. We have also made significant investments in our utilities to improve reliability, increase capacity and reduce emissions. Clearly this increased investment is driving the case for rate cases over the next few years. Fair regulatory treatment will ensure that we can continue to make long-term investments that will benefit our customers. We recognize that it's important to be customer focused. Our view is that if we take care of our customers, our shareholders will benefit. So with that, let's open the lines up for questions. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234002 | Thank you for standing by, good day everyone and welcome to todayâs Altera Corporationâs Conference Call. Todayâs call is being recorded. At this time I would like to turn the call over to Mr. Scott Wylie, Vice President of Investor Relations for Altera Corporation. Mr. Wylie, please go ahead sir. Good afternoon. Thank you for joining us conference call which will be available for replay telephonically and on Altersâs website shortly after we conclude this afternoon. So listen to the webcast replay, please visit Alteraâs Investor Relations web page where you will find complete instructions. The telephone replay will be available on 719-057-0820, US code 258-712. Before we begin this afternoonâs call, I want to remind you that as we indicated in our earnings release we will offer our first quarter update on March 6 after the market closes. This update will be, it should be a press release, it will be available shortly after the market closes. During todayâs call we will be making some forward looking statements and in light of the Private Securities Litigation Reform Act. I would like to remind you that these statements must be considered in conjunction with the cautionary warnings which appear in our SEC filings. Investors or cautions of all forward-looking statements in this call evolve risks and uncertainty and the future events may differ from the statement made. For additional information please refer to the company Securities and Exchange Commission Filings which are posted on our website or available from the company without charge. Nathan Sarkisian Senior Vice President, CFO will begin todayâs call and John Daane, Alteraâs CEO will then offer some brief remarks before we open up the call to your questions. Prior to the Q&A session the operator will be giving instructions on how you can access the conference call with your questions. I would now like to turn the call over to Mr. Sarkisian. Thank you, Scott. Fourth quarter revenues of $281.9 million decreased 3% sequentially, slightly below the lower end of our guidance. New products decreased 5% sequentially with transitions in major programs offsetting the strong 43% new product growth we experienced last quarter. The Mainstream and Mature product categories also declined, both were down a little bit more than 1% sequentially. CPLDs increased 4%, FPGAs declined 3%, and other was down 16%. We indicated in our original guidance that due to several programs transitioning and some taking a pause after an initial ramp, that this would be a challenging quarter at the top line. We came in slightly under the lower end of our guidance mostly due to the magnitude of the anticipated shift. Communication was relatively strong, growing 4% sequentially. Wireline was flat and wireless was up. As anticipated, computer and storage was down sharply, 20%. Consumer fell 11% sequentially, more than we had anticipated. The real swing for us relative to our guidance was industrial where we had anticipated growth, but instead it declined 3%. Five of our top ten accounts grew in the quarter and they grew in aggregate, with the growth coming from communications accounts, as you might expect given the results of the quarter and the comm-centric nature of our top accounts. However, not all comm accounts in our top ten increased. Going forward, we will give top customer statistics for our top 18 accounts because we think this will give you a more accurate overall picture and a broader sampling. On this basis, the majority of accounts declined, and they declined overall. Now for some specifics on our operating results. Gross margins were strong at 66.7% and slightly ahead of our mid-quarter guidance. Included in this result is $1.5 million of benefit relating to the sale of inventory written off in 2001, which was down from our original guidance of $2.5 million of benefit. As predicted, some of the high margin programs that were soft in Q3 came back in Q4. Also, product cost reductions and softness in some high volume programs at aggressive pricing contributed to improvement in our gross margins. These factors more than offset higher than normal provisioning for excess inventory. Our non-qualified deferred compensation plan experienced a net investment gain, unfavorably impacting R&D by $400,000 and SG&A by $500,000 and benefiting other income by $900,000. Operating expenses came in at $112 million, including the $900,000 relating to the deferred compensation plan. Research and development spending was $53.6 million, taking a large jump from Q3 as we continued development on the Stratix II GX and HardCopy II families. SG&A was $58.3 million. Other income was $11 million, better than guidance due to the deferred compensation plan and also the favorable rate environment. Tax rate was on guidance at 20%. Net income for Q4 was $69.7 million or $0.19 per diluted share. Cash and investments held steady at $1.3 billion, even after share repurchases of $195 million for 11 million shares, testaments to outstanding cash generation in the quarter. Total share repurchases for the year were 20 million shares at a cost of $370 million. Total pipeline inventories increased by 3/10ths to 3.7 months overall within our targeted range of three to four months. Distribution inventories accounted for the majority of the increase Now, turning to guidance. John will highlight in further detail some of the program pauses and transitions that unfavorably impacted Q4 revenues. Most of these programs will resume growth and this puts us in much better shape as we enter first quarter. Our guidance is for a 4% to 7% sequential increase in sales. We will see continued strength in communications, particularly wireless. Computer and storage will grow, industrial will be about flat, and consumer will be seasonally soft. Orders to re-sales were below parity in Q4, turns required to achieve our Q1 guidance as of the beginning of the quarter is in the low-70s. Gross margins will be in the range of 65.5% to 67.5%. Guidance on spending is given assuming that the non-qualified deferred compensation plan will have neither a gain nor loss; that is, no impact. Iâm going to give spending guidance including the impact of equity compensation or share-based payments, but I will also note the estimated equity compensation expense Before I jump into the specific numbers, Iâm going to note a few items relative to our equity compensation plans for 2006. We grant equity to existing employees either in February or August depending on the organization and classification of the employees. Most officer grants are made in February. Grants to new employees are awarded shortly after they begin employment. In 2006, nearly all grants to continuing employees will be in the form of restricted stock units or RSUs. The notable exceptions to this will be John, who will receive only options, and myself, and I will receive a mix of options and RSUs. We believe that the shift to RSUs strikes a better balance between shareholder dilution and employee motivation and retention, at least in the present environment. Note that since we still have RSUs to grant in the quarter, that the estimate for impact to Q1 operating expense is subject to particular volatility. I also want to alert you to a major program that will also impact spending, particularly SG&A in 2006. We have just launched a program to replace our ERP system in first half of 2007. In the early phases of this program, lasting into second quarter, we will be engaging consultants to help us do some process reengineering and design the implementation. These costs will be expensed. In the back half of the year as we move into the actual coding and development phases, the external consulting cost as well as some of our own internal labor spending will be capitalized as part of the cost of the new system. These capitalized costs will then be depreciated as the system is placed into service in 2007. Our estimated cost for the program is approximately $5 million in expense and $20 million in capital. Given those assumptions, R&D will be approximately $62 million, including $8 million of equity compensation. SG&A will be approximately $76 million, including $12 million of equity compensation. We are guiding to $10 million of interest income and a diluted share count of 364 million shares. Total months of the inventory, including both distribution and Altera are expected to be in the range of 3.5 months to 3.8 months. For 2006, we are reiterating our prior gross margin guidance of 64% to 66%, and for our full-year operating expenses to be in the range of $545 million, including about $80 million of equity compensation. You will note that these full-year figures are very close to first quarter spending annualized. Let me explain. First our payroll taxes and certain employee benefits, such as 401(k) matching, take a large jump of approximately $5 million in the first quarter as the year starts anew and all the employees earnings are below the maximum withholding amount. Then these cost diminish through the year as employees hit the various ceilings. You have the same effect for the expenses associated with our ERP replacement project. High spending in the first and second quarter, and then that spending is capitalized in the back half. Finally, with the roll outs of Stratix II GX and the HardCopy II completing in the first half, our mask and prototype wafer expenditures are going to be front-end loaded. Offsetting these front loaded expenses is a hiring ramp in R&D as we add staff to support the development and roll out of 65 nanometer and other future products. Our core tax rate is estimated to be 14% to 16% for the year. The reduction from 2005 is primarily the result of two factors, first, we are earning a higher percentage of our income in lower tax jurisdictions, and secondly, the impact of expensing equity grants to employees on our statement of income has a favorable tax rate impact of 200 basis points to 300 basis points. Under the old accounting for equity compensation, APB 25, the corporationâs tax benefit of equity compensation expense was booked straight to shareholderâs equity. In the new regime, that tax deduction, essentially equal to the employees gain, is included in the effective tax rate. One last note before I turn the call over to John. Effective in first quarter, we will be recomposing our product categories. New products will consist of Stratix II, Stratix II GX, Cyclone II, MAX II, and HardCopy. The Mainstream products will consist of Stratix, Stratix GX, Cyclone, and MAX 3000A. All products previously included in Mainstream will be added to Mature. With our Q1 call, we will present four quarters of data on this basis to enable you to do apples-to-apples comparisons through time. John. Thank you, Wylie. As predicted in third quarter conference call, the fourth quarter was a temporary pause in our growth, driven by several customer program transitions. The Mainstream and Mature product categories each declined just over 1% sequentially, which is about what we would expect based on the product classification. Our new products declined 5%, or about $7.5 million. Nine customers declined in total over $17 million sequentially in new product purchases. Two of these customers drove most of the reduction in the computer and storage sector, one due to a production ramp pause, and the other due to inventory. Three of the customers were in communications, one had inventory and the other two paused because of the delay in purchases by an operator. The consumer segment declined due to cyclicality, but two specific customers drove a large majority, one due to inventory, the second due to a program end and note that we do have the chip in the new system which ramps this quarter. The final two of the nine customers were in industrial, one in military due to buying patterns and one in industrial due to inventory. By end market, the growth in communications and a decline in consumer and in computer and storage were forecasted; however, the decline in industrial was not and accounted for the miss-to-mid point of our guidance. The revenue decline from these nine accounts primarily impacted the Stratix and HardCopy product families, and secondarily Cyclone. Stratix and Stratix GX declined 11%, Cyclone 4% and HardCopy 42%. Removing these nine accounts from our 130 nanometer, removing these nine accounts, our 130-nanometer products grew sequentially and we believe that peak for this node is still well into the future. In Q4, our newest products grew sequentially with Stratix II up 30%, Cyclone II 69%, and MAX II 15% as we continued to add new prototyping customers and transition some to production. Of the nine accounts mentioned, we expect six of them to grow sequentially in Q1. Combined with the growth amongst our broad customer base in 130 nanometer products, and the continued strong ramp of our 90-nanometer products, we expect our new product category, as well as the company to resume growth in Q1. More on Q1 forecast in just a moment. Our success in 130 nanometer and 90 nanometer products is the result of our change in strategy five years ago. The decline in the communications industry in 2001 reduced the number of start-ups, which in turn eliminated a portion of the PLD prototyping market. Additionally, the shift in focus from time-to-market to that of cost reduction in the general electronics industry eliminated much of the production business for programmable as our chips were costly. PLDs correspondingly under performed the semiconductor industry in 2001 and 2002. Compounding this, Altera had mis-executed in the mid-to-late 1990s and was losing market share in FPGAs and CPLDs. To renew Altera and to achieve sustained long-term PLD growth, we had to regain competitiveness in the FPGA prototyping market and offer cost effective volume products to match our customerâs requirements. Starting in 2002, we introduced a revamped product line with Stratix for prototyping and low-volume production, plus Cyclone and a redesigned HardCopy for volume production Strategy wasnât the only change. We needed to focus, execute and involve the customer. Engineering and manufacturing execution has been stellar. Weâve focused our R&D return on investment over the last five years has been the highest in the programmable industry. Issued US patents, a measure of innovation, were 172 in 2005, bringing our total to over 1,100 patents. We have three times the number of total patents we had in the year 2000 and we expect our patent issue rates to continue to climb. The strategy change is paying dividends. For the third straight year, Altera was the fastest growing PLD company and by a wide margin in 2005. We added 2% PLD market share driven by FPGAs, which grew 13% year-over-year. Our new product category increased 73%, driving all of our growth in the year as Mainstream and Mature product categories declined 12% and 14% respectively. Year-over-year, Stratix and Stratix GX combined grew 40%, Cyclone 77%, HardCopy 167%, and we ramped Stratix II, Cyclone II, and MAX II. Products introduced since the year 2002 accounted for over 37% of revenues in 2005 and over 41% of revenues exiting the year. Moving forward, we have growth opportunities in each vertical market that we estimate from 2006 through 2010 total 17% compound annual growth rate for programmables, 18% with the addition of HardCopy, and 20% with market share gains. As our market share in the 130 nanometer and 90-nanometer nodes, the current growth engine of PLDs is significantly higher than our overall market share. I expected for the year 2006 and onwards Altera will continue to gain market share. For Q1, we are forecasting a 4% to 7% sequential increase in revenues with resumed new product category growth. We expect communications across wireless, telecom and enterprise and computer and storage to increase in the quarter. Industrial should be flat to slightly up, and consumer should decline due to cyclicality. Scott. We would now like to take questions. Please limit your questions to one at the time so that we give as many callers as possible the opportunity to ask questions during the call. Operator would you please provide instructions required for questions. Thank you. The question and answer session will be conducted electronically. If you would like to ask a question please do so by pressing the â*â followed by the â1â on your touchtone telephone. If you are using a speaker phone please make sure that your mute function is turned off to sure that your signal reaches our equipment. If you successively press â*â, â1â please do so again at this time to ensure that you are in the queue. Please note that you will ask a any tone indicating that you are in the queue. We will proceed in the order of your signal and take as many questions as time permits. If at any time you wish to remove yourself from the queue you may disconnect pressing â*â â2â, once again itâs â*â â1â at this time for question. We will pause for just a moment to similar raster. Okay thanks guys and thanks a lot for all of the clarity on the numbers. It seems as though your results and your main competitorâs results have been a little volatile in Q3 and Q4 and now you are guiding up stronger than they are in Q1. Can you just go through on, I guess what you think is going on out there, because it seems like this volatility quarter-to-quarter is little bit unprecedented in PLDs? Sure, Chris. I canât really comment on Xilinx specifically and probably direct you to them to get their guidance, or their numbers for Q3, Q4 and guidance for Q1. I would say we did see a very strong new product growth in calendar quarter Q3. We did guide going into Q4 that we were going to have some customer program transitions within our new product category that would result in a slowdown in our growth. That did occur. We do expect that our new category will resume to growth in calendar quarter Q1. If I look at Q4 in total, our Mainstream and New products declined, sequentially just slightly over 1%. Thatâs generally based on the classification that we have, which you should expect. Remember going back into the year 2004, we had strong Mainstream product growth in the first half only to find that that was inventory accumulation and have that leave in the second half of the year. So I think what we have seen is sort of a normal growth of our New products in Q3, maybe a little bit too strongly. I would say that the inventory accumulation in the accounts that I did mention, roughly half of the accounts that I mentioned, or did decline in Q4 because of inventory, those were not because of lead-time changes or anything resulting from Altera. They were all cases of the customer expecting that their product was going to have more success than it did, and ultimately they created an inventory position on their own. So from my perspective, we had a very strong Q3, a slight pause in Q4, and we resumed to growth again in Q1 and onwards with our new product growth. Great. And as my follow up, can you just clarify, you expect I guess flattish gross margins in Q1 and then 65% for the rest of the year; can you just go through those reasons again? Chris, this is Nate. We gave, as youâve seen, our October call guidance for 2006 gross margins in the 64% to 66%. I am clearly guiding to a number slightly outside of that range here in the first quarter. I want to signal that I anticipate volatility around the mean. The mean is 65, but I think we can see quarters at the lower end of the range and upper end of the range, and I will give you my best look as we start each quarter. Thanks, John. Could you just clarify the issue with respect to the industrial area where it was lower and you thought it was going to be flat or better? And also, just clarify in sizing product transitions; could you give us some sense of how that played out in the quarter and how it will play out going forward? And then lastly, just for Nate or maybe John, on the inventory, what is your expectation both in the channel and in Disti as you go forward through this first quarter? Thank you. A lot of questions in there Tim, so let me start with the industrial sector. We had expected the military and medical industries to increase. Generally, we have seen some very strong growth for several quarters in particular out of medical. They did not, were slightly down other than the military customer that I mentioned that was one of the nine accounts that was down in the quarter. Nothing specific in that as much as it, probably was just more timing of purchases, and so we would expect for instance the medical sector to up this quarter. So while industrial as a group was down, other than the two companies that I mentioned, we really didnât see any particular pattern. And again, we would expect to see things like military and industrial start to grow for us again. With respect to this product transition, you said that it was going to be quarter of product transition, what did you mean exactly, with the New being down? Yes. So, what I highlighted in Q3 call going into Q4 is, we did see some customers for instance in the consumer segment that had or had signaled that they had inventory. We had some customers in the computer and storage sector which had started their product ramp in calendar quarter Q3, had expected to slow down in Q4 before they resumed again in Q1. We also had a couple, for instance, a consumer company who ended one product in Q4. So they ramped that down and then they start, start ramping a new product in Q1. So naturally, you see one program end and a new program start over the course of two quarters. So thatâs what I meant in terms of program transitions. On the inventory and if you could give us what turns were this quarter? I think you were saying low-70s coming quarter? Yes, Tim, this is Nate. The turns were just above 70% this quarter, very close to 70% and you are correct, we are guiding to low-70s for this quarter. And I think your question with respect to inventories, how do I see that mix playing out between distribution and Altera? And we quit giving that breakout a few quarters ago and the reason is just because really thatâs the strategy that we play out over the course of the quarter depending on where we are seeing end customer activity and trying to position inventories between ourselves and distribution to keep high service levels with minimal inventory. So, thatâs something thatâs hard for us to give guidance. I guess given your comments about feeling pretty comfortable on the market share side, when I look at, I guess 3Q, 4Q and then 1Q. Look at the end markets fairly seasonal and I look at your growth and you had a slightly below seasonal third quarter, below seasonal fourth quarter and then off the Q4 below seasonal, is that just an artifact of kind of the bubble or how do you explain that, and is that a secular issue for the industry or how do you read that? Well, so, I think in the last two years, youâve seen a pattern within programmables of perhaps a stronger first half and a lighter second half the calendar year. We would state looking at the last two years plus, even looking back further, that there really is no strong correlation between any quarterâs performance and how weâve done in history. So in other words, you go back to 2004, we had a strong first half. Some of that was inventory accumulation. We had a very weak second half. That was the inventory flush combined with a very significant slowdown in the communications industry in Q4. We didnât see any of those factors in 2005. So, it would be hard for me to say that there is much correlation to history as to how we do in a particular quarter. We are very happy that we outgrew the programmable industry in the year. We are very happy that we also outgrew the semiconductor industry for the year. So we would say on a whole, we feel very, very strong, very solid about our overall results. Nate, I donât know if you have any other comments. Okay, thank you very much, Michael. Hi guys, one very quick one and then the main question. Nate, did I hear you right, the tax rate for this year is 14 to 16%? Correct, on a GAAP basis. But I want to make clear that everyone understands that included in that is about 2 basis points to 300 basis points relating to the expense of equity compensation. Okay. Understood, thanks. A question I guess for you John is, you profiled the top customers and what was happening with them individually. So, the first question is what percentage of revenues to those top nine guys account for? And then I know itâs difficult as you have got a lot of different customers, but when you are guys are looking at planning, I am just trying to get a sense for how indicative you think whatâs going on at those top nine or 20 type of customers is about whatâs going on in the end-markets as a whole for you? So the nine customers that I highlighted Mark were not necessarily the top customers in total for the company. They happen to be the top customers who declined in New product purchases. So if you looked at our New product category, it declined sequentially about 5% or $7.5 million. The group of the nine customers that I highlighted declined $17 million sequentially in new product purchases. If you take them out, actually our new products would have grown sequentially quarter-on-quarter. But the reason I was highlighting that is many of those were customers that we were highlighting coming out of Q3 that were customers that were going to go through some sort of program transition either because of inventory timing of their product ramp down as they ramped into a new sort of product line. And it was important that we highlighted what happened and where we were right and where we missed. So, I think, Mark, this is Nate. Sort of what I sense, reading between the lines of your question, is how do we plan, given that kind of volatility in that environment? I think that the short answer, at least from a production build perspective is that rather than trying to anticipate and build inventories based upon forecasted demand, we keep a die bank. We have done a lot of work over the course of the last couple of years to shorten our back-end cycle times, and so we are more in a mode of responding to demand rather than trying to anticipate demand. I donât know if that was helpful or not. Yes, fully understand. And I guess just for the record just to try to put those nine customers into perspective, what percentage of new product revenues and/or total revenues did they represent in Q3? I donât have the details, Mark, I apologize. They declined $17 million sequentially. They were still purchasing some of the customersâ product in Q4. But, and some of the customers by the way are buying other product from us. I just separated out the new product. But I donât have an analysis of Q3. Itâs the diff, the $17 million is the difference between Q3 and Q4, but I donât have in total what they purchased in Q3. Iâll just also add to Markâs question is that we have no 10% customers. We have a handful of customers in the 5% range. Then the question please. You painted a pretty interesting growth profile. I think you said starting in 2006, I wasnât sure if I caught that correctly. In light of that, I wonder if you could talk about what I guess, end-markets of growth that you think are most likely to contribute to those relatively high numbers? So, Glen, if you go back to the analyst presentation that we did in December, what we did by vertical market is give you a bottoms-up approach on each of the markets as to how much we thought that they would grow in programmables, how much we thought that they could grow in structured ASICs, which is our HardCopy product, which get to those numbers. And so what we can do is, all of that is public material, and we can forward on a chart that shows you that. I would say in general the growth is fairly balanced. Some markets are a little stronger than others. But we continue to see a very strong opportunity at this point of replacing ASICs. The ASIC market is still well over three times larger than the overall programmable market. We also see a very strong opportunity moving forward, replacing ASSPs. As costs of semiconductor design continue to rise, there are fewer products, fewer flavors of products being developed. We have the advantage of being able to take one chip, customize it, add soft IP cores and ultimately make a replacement for an ASSP, and so we see a big opportunity there as well as in things like micro-controllers with Nios and DSPs, ultimately doing DSP functionality on our chips. So, gain a very broad opportunity and a very strong growth opportunity. I would say in general, if you go back at look at the last several years, of Altera specifically, the last three years, we have been growing in excess of the 17% that we mentioned that we think programmables can grow in the next three or four years going forward. So I think there is very strong correlation, strong evidence to the numbers that we cite. And if you look into, I guess more the near-term, thinking maybe the next quarter-over-quarter or two and look at where the opportunities are specifically for you to gain share, are there any specific end markets or geographies where you think you are better positioned to gain share? Well, the results that you see in any given period of time were from design wins that came anywhere from one to four years ago, that are going into production at this point. And so there is very little one that can do in the programmable industry to impact market share in the short-term. As I mentioned, going into Q1, you would expect at this point now that we have a larger business base and consumer that that is going to act more like a cyclical industry for us and that it will grow in calendar quarters Q2, Q3, start to decline in Q4 and Q1. And thatâs what we are seeing this year. We would expect communications to continue to grow. As I mentioned, we see growth in communications for Q1 across the board in everything from networking, which we said I think about a year-and-a-half ago that we would start seeing growth in the back half of 2005. We did see that. We do expect that to continue this year as well as in wireless and the telecom side of the business. And then we expect to computer and storage to have very strong growth, particularly in storage as well as lot of opportunities that we have, they are going into production in the server and blade server area and so thatâs what we see for Q1. Q2 is a little bit too early to call for us at this point. Okay. And just one last question, which is your foundry partner, had talked about having some manufacturing glitches in Q4 and some distributors have suggested that there had been some temporary shortage of parts. Wondered if there was any impact that you saw in your reported revenues and if there is still any residual impact in Q1? There was no impact for us in Q4 due to any supply constraints. In general, between Q3 and Q4 our lead times have remained very short. There was a particular product issue on some older product for Q1. We think based on the recovery that all of the shortage actually will be contained in Q1. So, I would not expect that there will be any shortages of products or any impact on our revenues for Q1. yes I have couple of questions first, could you comment on, what the bookings spends have been so far this quarter, especially compared to the same point in last quarter? And then one for you John, Xilinx on their conference call talked about the opportunity within cell phones and via their CoolRunner products. I wanted to get your take on the viability of FPGAs in general in that end market and what efforts if any Altera has in that direction? Sumit this is Nate. Book-to-build this far, thus far in the quarter and then looking at end customer orders versus retail is positive and total orders are ahead of where we are at it in the corresponding period of Q3. Sumit, on the CPLD side, we have done a low-power product. That really has zero standby current which is what most battery-operated applications would be interested in. We have looked at this as to whether we would develop a specific product and we have not seen a return on investment. In other words, letâs say, you are in cell phones and you are shipping 1 million or 2 million units in some of the higher-end platforms, you are selling chips at $0.50. It just isnât adding up to enough revenue to justify the development of a specific program or specific family at this point. We do, still continue to investigate low-power products for the future with both FPGAs and CPLDs but have not done anything nor announced anything upcoming from Altera at this point. Hi, this is Hun Lee for Wu. Thank you for taking my question. I have two questions. First, I have heard that a long time Japanese distributor has picked up, has been stocking your competitorsâ product. So, are they, are they providing both part, both products for both you and your competitor or they have been stocking, stocking all your products? Hun, this is John. We did announce that we are going through a transition with a distributor; we did last year add two new distributors in Japan. We are transitioning away from one of our current distributors there. They announced today that they have signed an agreement with, I believe Xilinx to distribute their products, but the timing is such I believe is when they are through shipping ours they will pick up shipping theirs. This was something that Altera initiated. So, we donât see any down side in this transition at all. Okay. And another question is, you mentioned that the revenue down side is due to new programs transitioning from some of your customers, and is that, well, at mid-quarter guidance you havenât called that. So, is that pretty late on the radar for you guys, or can you guys be more, provide a little bit more details on that? No. Generally, Hun, I would say that the new program transitions that we did highlight, we did say in Q3 conference call. So, I think we were very upfront in knowing most of those programs and alerting people to the fact that we were going to see a slowdown in the companyâs growth in Q4 because of that. The one area that we were off was in the industrial segment, and again as I mentioned there were some other customers that were beyond the nine that I mentioned, particularly in medical and military that were a little slow in the quarter, that did cause us to miss to the mid-point of our guidance. However, there is nothing directional there, in other words we expect that those customers will return to growth with us this quarter, in calendar quarter Q1. Okay. So, I can safely assume that for the new, for the customers with transitioning programs they are going back to your products? Yes. And as I mentioned six of the nine returned to growth this quarter and the other three we would expect to see back in future quarters, in fact of the nine that I mentioned there were no products that were transitioning to competitors that I am aware of. Hi. Thanks for taking my question. I am here, I am presenting, but for Ben Lynch. But, did you see any back end tightness or any substrate price increases from third-party assembly test vendors or anything along that line? Hi. This is John. The back end has been tight I would say for well over six months both in substrates and in assembly capacity. That has not impacted Altera in any way. Generally our lead times has remained very, very stable and very short. In fact the shortest in the industry and we are operating with, I believe, the leanest inventory in the industry as well. So, really hats off to our manufacturing organization, and hats off to our partners who are really working very diligently to make sure that Altera is able to supply what it needs to the customer base. We continue to see tightness. We do not think at this point that that is going to impact Altera. But we do have to play these things a quarter at a time. Okay. And just to get back to tax rate, I mean, I understand 200 basis points and 300 basis points is coming from tax advantage for the DSOs, but could you talk about some of the kind of operational things you are doing here? Your tax rate compared to your competitors is substantially lower, and could you also comment if you are factoring in renewment of the R&D tax credit? A couple of companies have guided slightly higher tax rates, specifically TI, just because they are not sure about renewing of that legislation? We do not have the R&D tax credit factored into our tax rate guidance at least at the higher end of the range I provided. Certainly, as we go through the quarterâs booking, our actual tax rate, we will book the tax rate thatâs consistent with the law in effect of the time. In terms of relative comparisons between our tax rate and others in the industry, I am hesitant to go there. I think in general terms, we are benefited by the fact that a large portion of our revenue base is outside of the US and that has in many cases a favorable tax rate impact. I think many of others in the industry also have that characteristic. So, and beyond that, it is difficult for me to speculate as to what we might be doing differently vis-Ã -vis them. Thanks Bob, next question please. Yeah, hi guys, a quick question for you. At the recent analystâs meeting, Nate, you presented a picture that basically describe the overhang that Mainstream and Mature products still represented in the overall product portfolio and that how New products were going to accelerate the overall growth of the company. Can you quantify for us how much further decline we should expect to see in Mainstream, and when we would see that troughing, so that we could kind of say hey, this is the bottom and we can see from that point forward the New products and the New product portfolio is really accelerating the growth of the company? Well, Jeff that, I can answer your question. I think itâs going to be tough for other people, who did not see that presentation to put that into context. There is, it is difficult to say exactly when we think that that transition from legacy products to our newer cost reduced products has completed. The chart is still there, accessible on our website. You can kind of look at the curve yourself and draw the line from there. I think on the basis of a linear extrapolation at the rate we have progressing, it is sort of a year out, and thatâs in reference to the sort of what we regard as a one-time ASP decline as customers transition from as I said legacy products to new products. And then I would add that that is a specific comment to Altera, not necessarily a specific comment to the industry or our competitors because those charts were looking at how fast are legacy products were declining, were an Altera specific look. I think it will take a little bit longer for the industry to work through that. Yes, absolutely. And then, one housekeeping question if may. John, you have made comments twice on the call today about how lead times are stable and short, and best in the industry. Can you actually quantify what lead times are in Q4, were in Q4, and what they are heading into Q1 if you see any shifts in that, those expectations? Yes. Generally, Jeff, the product lead times that we have on the distributorsâ websites are anywhere from two to four weeks, for supply if itâs not in stock on various products as you know they may change one to two weeks in or out depending on particular mix in any given quarter. If I were to look between Q3 and Q4, there wasnât really any significant change in lead-time between any of the products. And really this quarter, we donât expect based on what we have seen that there is going to be any impact one way or the other in terms of lead times. As we did mention, we do have an issue on some of our older products, lead times temporarily, this quarter pushed out. We expect them to come back in as we are able to satisfy all the demand in the quarter. So, really I would say in general not much of an overall shift this quarter in lead times. Then we will just have to see as the year goes on. Great. And lastly if I may, are you seeing any changes or do you anticipate any changes in ASPs going forward. Any, do you see the tightness in the market allowing you to raise any prices, or is it the consistent long-term contracts you have from larger OEM? So as you know generally when we quote a chip, we give several years of pricing on that quote. So, specifically we will honor that and provide customers the price decreases. So, whether it is a strong year for semiconductors or weak year for semiconductors, the PLD industry has generally given cost reductions year-in, year-out to customers and they would expect that trend to continue going forward. We would like to remind everyone that it is â*â, â1â to ask a questions. We will take our next question Tristan Gerra of Baird Financial. Hi, could you talk about your market share position in wireless infrastructure and how this has progressed since the Stratix was introduced and also specifically in developing countries? Yes, Tristan, this is John. I think Altera had a very strong position within the 2G on space, specifically things like TDMA and GSM. I think we started to see some of that base erode in 2.5G although we still had a strong position there. By the time we got to 3G, I think our competition really was at the peak of their product cycle and that is when we were weakest with our product cycle and I would say generally the competition won a good bulk of the designs and early revenue in 3G. With the introduction of Stratix, we included multiply-accumulate structures. This was the first time anybody in the industry had done those. They work exceptionally for DSPs. We started to win back a significant portion of those designs. Today, if we look at the revenue that we have in wireless, we estimate that well over two-thirds of that revenue is in 3G systems and we believe that today, exiting the year, we have higher revenue than our competition. In other words, we are number one in market share within wireless overall, and we would expect to continue to gain market share in the year 2006. And then just as a quick follow-up, any insight you can give us in terms of wireless activity in developing countries? So, I think you are going to see the third-generation systems continue to ramp. China has announced that they are actually going to do licenses. I think that will help 3G shipments in 2006, 2007. I think you will see continued slow deployment in Europe and the US. Developing countries, you still see 2.5G deployed as well as discussing some 3G. We will see, there is a possibility that people will choose to go with 2G plus WiMAX as a cheaper platform rather than doing 3G, but I think that will take some time to see. So, in general, I think we are going to continue to see slow solid growth in that industry. We are growing faster than our end-customers in that specific industry as we are in more industries, in fact, I would say almost all industries, which shows that we are continuing to take market share from other products like ASSPs and ASICs. And we think the growth will be solid this year, although we are not anticipating in our years that there is going to be some explosion in the third-generation shipments. Hi, very thanks guys. just a couple of the question, hey John can you just run through those quarterly and yearly statistics you gave for all the different product families and I have just a brief follow-up. The sequential and the yearly that you talked about, I think you talked about MAX II was up 15% sequentially, and Stratix and Stratix GX, you kind of blazed through that. Please go through it again. So, for Q4, Stratix and Stratix GX declined 11% sequentially. Cyclone declined 4% and HardCopy declined 42%. And again, as I mentioned, if we remove those nine accounts, we would have seen 130-nanometer products actually grow sequentially. Then also in Q4, Stratix II was up 30% sequentially, Cyclone II up 69% and MAX II up 15%. And then for the year, Stratix and Stratix GX grew 40%, Cyclone was up 77%, HardCopy 167%, and then of course all of the Stratix II, Cyclone II, and MAX II revenue was new. So, there is no specific year-over-year number that we can cite there. In total, I also said that all of the products that we have introduced since the year 2002 accounted for 37% of revenues in 2005 and were 41% exiting the year. So, we are continuing to see very strong growth within the new product category. Great. And then just as a follow-up, can you talk about your expectations for relative growth in HardCopy, Stratix and Cyclone for 2006? We are not providing, Chris, any breakdowns of products or specifically what we would expect for products. We do expect HardCopy to have a very strong rebound in the next couple of quarters, as we have some of those programs that were going through transitioning start to ramp again and we continue to add new products. We would also expect of course Stratix and Cyclone to continue to grow as we feel the peak of the 130-nanometer node is still a few years out. So, we are expecting still to get very strong growth there. John, I would like to take you back on Chrisâ question if I could. Would you mind breaking out your in your comm revenue, roughly what percentage is wireless, what percentage is Wireline and what percentage is telecom. You may have mentioned that, I just didnât catch it, I apologize? No, itâs okay. We did not break it out, Jeff. Generally, what we have seen for the year is roughly wireless is about 40% of the communications number, telecom is about 40% and then our networking or enterprise number is about 20%. And for the year, we had, I would say fairly similar growth between all three of those segments. I would say that we expect all of the segments to actually do very well this year. We are continuing to grow. Enterprise, as you know, that was the market that we lost a lot of business in. And we said about a year-and-a-half ago we expected that we start seeing growth in that in the back half of 2005, as number of our design wins that took market share started to go in the production. That happened. We would expect that to continue. We always been very strong in telecom and we would expect to continue to grow our market share from ASICs in that space and grow. And then in wireless, as we have mentioned, we have come back very, very strong and we would expect that that segment will continue to grow for us as well. Great. So, in the wireless segment, the source of your growth has been primarily the 130 and 90 nanometer family, is that fair to assume? Thank you very much. Just to clarify the 20% growth that I think that you are expecting for 2006, you said. Are you looking at a relatively normal seasonal pattern for that? The reason I am asking is if one ends up in some slowish growth in September that really needs something like double-digit growth in those June and the December quarters, or is there something that makes the pattern of growth this year different from previous years? So, let me answer that. The numbers that I cited with the 20%, which consisted of a 17% compound annual growth rate for programmables, another 1% when you add on the opportunity for structured ASICs and then with the ability to continue to take market share, a 20% overall number is really our compound annual figure that we see from 2006 through 2010, as the opportunity. In any particular year, some years we may be lower, some years we may be higher. And in the semiconductor industry, it is very difficult to predict. If you look at the last three years, for instance in 2004, we were well above 20%. Last year, we were in the teens. So, it does depend on the year. And at this point, we are not providing any annual guidance. So, in other words, I am not giving any specific figure for 2006. We will treat each quarter as an individual one and just give guidance on a quarter-by-quarter basis. Before, we end today, a reminder. Altera will present at the Goldman Sachs Technology Investor Symposium in Phoenix on February 28, and on March 7, we will presenting at the Morgan Stanley Semiconductor & Systems Conference at Laguna Niguel. This concludes our todayâs conference call. Thank you for your participation and interest. |
EarningCall_234003 | Welcome to the Broadcomâs Fourth Quarter Fiscal Year 2005 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. At that time, if you have a question please press â*â followed by the â1â on your telephone. As a remainder, this conference is being recorded on Thursday January 25th 2006. Your speakers today are Scott McGregor, Broadcomâs President and Chief Executive Officer, Henry Samueli, Broadcomâs Chief Technical Officer and Co-Founder, Bill Ruehle, Broadcomâs Chief Financial Officer and Peter Andrew, Vice President, Investor Relations. Iâd now like to turn the conference over to Mr. Andrew, please go ahead sir. Thank you very much Adam, good morning and welcome everyone to Broadcomâs Q4 earnings conference call. I want to remind everyone that during this call we will discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we will provide on future revenue, gross margin and operating expense targets for the first quarter of 2006 or any other future periods and statements about prospects for our various businesses and the development status, and planned availability of new products. This will be clearly understood that our actual results may differ substantially from the forward-looking statements we make today. Specific factors that may affect our business and future results are discussed in the risk factor section of our 2004, 10-K and subsequent 10-Q and in our other SEC filings. A partial list of the important risk factors is set forth at the end of todayâs earnings press release. As always, we undertake no obligation to revise or update publicly any forward-looking statements for any reasons. Throughout this call, whenever we refer to pro forma financial results, we mean non-GAAP pro forma. The earnings release published today describes the differences between our non-GAAP pro forma and GAAP reporting and presents a reconsolidation between the 2 for the periods reported in the release. Please see the investorâs section of our website for reconciliations going back to the beginning of 2004, as well as for additional financial and statistical information including the information disclosed in accordance with SEC Regulation G. With I would now like to turn the call over to Scott. Good afternoon and thanks for joining us. The fourth quarter was a very strong quarter for Broadcom on many fronts. We grew revenue 18% sequentially to $821 million another record level for Broadcom. We experienced revenue growth in each of our target end-markets. We had record net income on both the GAAP and non-GAAP pro forma basis, and we grew cash in marketable securities by a $170 million to $1.88 billion. The drivers of this growth were simple, communications and convergence. Broadcom is benefited from a number of product cycles occurring within the communication, and perverts product end-markets. At home, work or mobile users one of the connected whether over a wired connection, via Ethernet, network or broadband modem or wireless, be wireless Lan, Bluetooth and Cellular. Cable, telephone, cellular and satellite operators are upgrading their networks to offer triple play services that include, high definition video, audio, voice and data services. These network upgrades are not only driving an upgrade of the end equipment to receive these signals, but also enabling the creation of new devices such as portable media players. Many of these product cycles are early in their evolution and Broadcom is investing aggressively to take advantage of these opportunities. Our broad product line, intellectual property portfolio and track record of superior execution are key competitive differentiators in this new connected and converge world. Broadcomâs strong performance is the driver behind 2 other announcements we made today, the first being the 3/2 stocks split and the second being the substantial increase in our share buyback program. We believe both of these actions will help create value for our investors. Iâll go into more detail in how Broadcomâs benefiting from these trends in a few minutes, but first Bill will give you an overview of our Q4 and full year performance, the stock split and the new buyback program and our guidance for Q1. Thank you, Scott. The financial overview in Q4â05 our growth once again exceeded our expectations. Our record quarterly revenue of 820.6 million was up more than 125 million or approximately 18% from Q3. This was the highest absolute dollars sequential revenue increase in our history. Compared with the year earlier revenue was up more than 281 million or 52% from Q4 of â04. Our pro forma gross margin of 53.1% was down 30 basis points from last quarter, inline with our guidance. Total pro forma operating expense was up 12.8 million or 5.8% from Q3, this was less than 1/3 the rate of our revenue increase. Pro forma operating margin climbed to 24.4% up from 21.5% of revenue in Q3 as we were able to realize significant leverage on our large top line increase. Pro forma diluted earnings per share of $0.50 were up at $0.11 from last quarter. On a GAAP reporting basis, our EPS equaled our pro forma earnings at $0.50 per share. Our full year 2005 results were also at record levels; revenue of 2.670 billion was up 270 million or 11.3% from 2004. Pro forma gross margin for the full year of 53.1% was up 2.2 percentage points from the 50.9% reported in â04. Pro forma EPS of a $1.47 were up $0.25 or just over 20% from the $22 reported for the full year of â04. On a GAAP reporting basis earnings per share for 2005 was $1.10 this was up $0.47 or 75% over the $0.63 reported in 2004. Our cash and marketable securities on hand increased by 170 million for the quarter, leaving us with a balance of 1.875 billion and for the full year cash and marketable securities increased by 600 million. Letâs take a look at the revenue and gross margin. In our October call, we said we expected Q4 revenue to be in the range of 765 million to 775 million, which would have been an increase of 10% to 12% over Q3. In the course of our November 9th analyst day presentation, we updated that guidance to say we expected revenue to be at or above a high-end of that range. In fact our bookings and shipments continue to be stronger than expected through out the quarter and we were able to see revenue just over 820 million, an increase of 18%. In the quarter, we experienced particularly strong sequential growth in Mobile Multimedia, and direct broadcast satellite and Bluetooth and Gigabit Switching and in DSL. For the full year, our biggest growth drivers as measured by absolute dollar revenue increase and an order of significance were Bluetooth, Mobile Multimedia, DSL, Gigabit controller, cable modem and Gigabit 5 and switching. Once again demonstrating the importance of the breadth of our product line. Our most significant decline was seen in our server chipset business, which declined over 200 million from year-to-year and that decline is now all behind us. And looking at our change in revenues from Q3 to Q4 our broadband communication sector increased by above 5%. Mobile and wireless increased by about 44% and enterprise networking increased by about 12%. In terms of revenue distribution for Q4, broadband communications accounted for approximately 30% total revenue, mobile and wireless were 33% and enterprise networking for 37%. And in Q4, Motorola was once again a 10% plus customer. Our Q4 pro forma gross margin at 53.1% was down slightly from the 53.4% reported last quarter. In our original guidance for the quarter, back in October we had anticipated a decrease of 50 to 100 basis points. In our November 9th analyst day, we updated that guidance to an expectation of a decrease of 50 basis points or less, or less. Our actual decline was 30 basis points; we experienced some change in product mix towards lower margin product and are continuing to see less pricing flexibility at the foundry level. Turning to operating expenses, total pro forma operating expenses of 235 million in Q4 were up 12.8 million or 5.8% with the last quarter, this included an increase of 9.7 million or 6.1% in R&D and an increase of 3.2 million or 5% in SG&A. The R&D increase was primarily from addition to 240 headcount, including 56 from our Athena acquisitions that we completed in October. Once again our revenue growth allowed us to be very aggressive in adding to our R&D capabilities. SG&A increase was primarily driven by higher legal cost and additional headcount. We increased our total worldwide company headcount by 285 to a total of 4287, this includes over 3,000 people in engineering, which puts our engineering total at just over 70% of our total headcount. As of year-end just over 25% of our employees were located outside the US, with by for the largest offshore concentration being in Asia. Our annualized revenue per employee was 766,000 up from $695,000 the previous quarter and up sequentially from the 640,000 reported in Q4 â04. Turning to profitability in Q4, on pro forma non-GAAP basis we generated operating profit of $200.6 million at 24.4% of revenue just reflected our ability to generate substantial leverage on our large revenue increase. Our revenue was up 18% sequentially, OpEx was up less than 6% and operating profit was up more than 34%. Our share count increased by less than 2% allowing us to also show good leverage of the EPS line. Our pro forma diluted EPS were $0.50 up 28% or 11% from last quarter. On a GAAP basis weâve recorded an operating profit of $175 million. Our GAAP diluted EPS were positive to $0.50, GAAP earnings in the quarter, included the tax benefit primarily related to Q4, reductions in certain foreign tax reserves. Looking now at the balance sheet, we continued our ability to generate substantial positive cash-flow increasing total cash and marketable securities by 170 million to an all time high of 1.875 billion. Our cash-flow from operations for the quarter was 134 million, our free cash-flow and increasingly our investors are telling us, this is the measure, its particularly important to them. Our free cash flow which is defined as cash flow from operation minus capital purchases was 117 million. During the quarter, we dispersed $33 million in cash per acquisition cost and $58 million in persuade of our stock buyback program. On the cash positive side, we collected 122 million from employee stock option exercises. Our inventory balances increased the same height as our revenue in response to our continued strong demand. Our days of inventory on hand remain constant, at 46. This is equivalent to our churns rate of 7.9, which is in line with our long term model. Our days sales outstanding decreased from 36 days to 34, the shipments for the quarter, were more front-end loaded, to accommodate our customerâs needs per shipment to support their holiday sales. There were couple of capitalization actions that we took in the quarter, as Scott refer to, given the strength of our balance sheet and our continuing desire to minimize share dilution. We have today announced that our Board of Directors has approved an increasing in our share buyback program. If you recall in April 2005, we implemented a program targeted repurchasing up to 250 million worth of our shares, over a 12 months period. To December 31st, of â05 we have repurchased 154 million of shares, on this program. As of today that authorization has been amended to allow the repurchases of up to and additional 500 million worth of shares over the next 12 months. We expect to begin those purchases at the end of this open. This will give us a capability to retire approximately 2% of our outstanding shares over the next 12 months. Weâve also announced today, a 3 per 2 stock split for shareholders a record at close of business on February, 6th. The distribution is expected to be effective on/or around February 21st. This is intended to be another shareholders friendly motive particularly with regard to enabling us to expand our shareholder base in the retail market for absolute price is an important criterion. At our current share price weâve ranked within the top 2.5% of all NASDAQ stocks in absolute price, and within the top 20% with the NASDAQ 100 stocks. Turning now to our guidance. When we gave guidance for Q4, we commented that we believe that some of strength we are experiencing was coming from purchases by our consumer oriented customers in preparation to the holiday selling season. Further more we said we thought possible revenue to decline in Q1 because of the increased buying of consumer related business as we are doing. As those of you who have been following Broadcom for sometime now weâve always been driven more by product cycles then by seasonality. We are pleased to be able to report that even with our increased consumer related business and some seasonality that we are experiencing in some product line our capable position several dynamic product cycles continues to prevail over seasonal factors. Therefore we now expect Q1 revenue to be up in the mid single digit on a percentage basis from Q4, to a range of $865 million to $875 million. We expected this growth to be broad based with the strongest growth expected to come from our broadband communication sector. We believe that gross margin for Q1 on a pro forma basis will be flat to slightly down, versus Q4. We expect the pro forma operating expenses will increase at a rate that is approximately equal to or slightly lower than our rate of related revenue increase. This rate of increase is driven partially by the new expenses anticipated as a result of the Sunwest acquisition, as well as increased headcount to support R&D and other programs. We expect the cash-flow generation to once again be quite strong in Q1. Now Iâd like to turn the call back over to Scott to provide some more perspective on the business. Thanks Bill, as I mentioned previously trends in communication and convergence have been key driver behind Broadcomâs recent success. Our ability to offer a complete solution to our customers would become a significant competitive differentiator. With the wired to wireless profits in voice, video or data, Broadcam has the products intellectual property and secure your execution track record to capitalize on these opportunities. Iâll now let you market highlights before opening the call to Q&A. We saw the greatest growth in our mobile and wireless products again this quarter, as revenue was up over 40% versus Q3, and up nearly 40% for the year. On the first of this month, Broadcom split the mobile and wireless business group into two parts to give additional management focus to each business. The first as what we called mobile platforms, focused on driving the adoption of our cellular base band and mobile multimedia processors into portable devices. This business group is led by Yossi Cohen a long time Broadcom executive who is most recently responsible for leading our very successful Bluetooth efforts. The second is wireless connectivity which Bob Rango is running. This group is responsible for our leadership Wireless LAN, Bluetooth, and Voice-over-IP lines business. These are ingredient technologies or functions that we look to populate throughout our other products. We expect to expand the breadth of our offerings in this group. For financial reporting purposes these 2 groups will continue to hold up in the revenue for the both will be consolidated and reported as our mobile and wireless target market, which we have in the past and will continue to disclose on a quarterly basis. Highlighting just how diverse our growth was in the fourth quarter, the key revenue growth drivers in mobile and wireless were Mobile Multimedia, cellular baseband Bluetooth and Wireless LAN. The conversions of audio, video and data into portable devices continues to drive demand for our mobile multimedia products. In the fourth quarter we shipped our new video card 2 architectural base products to multiple customers. Our success has been due to high quality audio and video at incredibly low power. These features have been highly sold after the cell phones and portable media devices audio, video and gaming functionality. In cellular baseband we experienced a strong Q4, driven by our 2G and 2.5G product refresh our biggest customer in the space. With respective to 3G, our progress remains on track. We have multiple design wins and continued to expect to 3G revenue contribution primarily in the second half of 2006. Demand for Broadcomâs Bluetooth solutions remains very strong. We believe we gained additional market share in the quarter driven by our continued success in the cellular handset space. We expect continued growth in Bluetooth product revenues driven by the following things. Number one, increasing adoption of Bluetooth within cell phones, two Broadcom continuing to add new cell phone customers, three the ramp of Bluetooth and other applications, such as PCâs, notebooks printers and headsets, and four a secret cause which is extensive set of Bluetooth software profile. Our Wireless LAN products also experienced another seasonally strong quarter. As we look into 2006, we believe that the Wireless LAN market is once again poised for another year of growth. A key driver of this growth will be the migration to the next generations, either 802.11n based products the IEEE confirmed the 802.11n drafts specification on January 19. As a leader in the Wireless LAN market Broadcom has been a significant contributor to the IEEE efforts. We are excited to see 802.11n, overcome a significant hurdle in introduction. We believe we are well placed to take advantage of this migration to 802.11n and for a number of reasons. First of all, following our highly successful 54G product release, Broadcom has a track record of success in insuring our customers that their products would be upgradeable via software to the final standard once itâs ratified. Second 802.11n offer significant throughput and rich improvements that could drive an upgrade of existing 802.11g and 802.11g products, third 802.11n opens up the opportunity for broad adoption of wireless multimedia distribution around the home in 2007 and 2008 and fourth we were able to integrate 802.11n functionality with in other devices such as broadband modems, Ethernet switches and set top boxes. Moving on to our broadband communications target markets, most broadband communication lines of business experienced strong double digit growth rates in 2005. This was the advantage of our DSL business. There were two key drivers to our success; we were the first to market with ADSL2plus we believe with we are the market leader in ADSL2plus driven mainly by strength in Europe which we expect to compliment with a strong ADSL2plus ramp in China and North America beginning this year. Secondly, highlighting broadcast ability to benefit from both communication and convergence trends, voice enabled DSL modems went from close to zero our CPE port shipments in Q1, to over 30% in Q4. Whatâs also interesting is that, many of our customers that are bundled in DSL and VoIP are also integrating Bluetooth, the wireless LAN, did not a complete home gateway. This is important for a couple of reasons, not only DSL vendors have wireless LAN, much less Voice-over-IP and Bluetooth experience in this is case significantly higher ASP opportunity for Broadcom. By the way we are seeing any seasonality in our DSL business and in fact itâs got double digit growth in the Q1 driven by winning market share. With respect to satellite set top boxes we continue to benefit from growth in overall subscribers, growth in the number of boxes per house hold, ramping with new customers and the mix shifts from standard definition to HD and CDR enabled boxes. Broadcom is experiencing stronger demand for next generation code access such as ABC, but also continued strong demand for MPEG-2 solutions. As we look into 2006 in addition to growth in each of our core broadband communication businesses we have another opportunity digital TV which we expect to become a revenue driver in the second half of the year. In our enterprise networking target markets the migration with Gigabit Ethernet continued on its steady progression. Given our market share leadership position and product depth and breadth Broadcom experience strong quarterly and yearly revenue growth trends on both the client and infrastructure side. On the Gigabit Ethernet client side, Broadcom maintained its market leadership position as we surpassed the 100 million unit milestone last week. As we look out into 2006, two new product initiatives have the potential to drive additional revenue growth and potentially even more market share gains on the Gigabit Ethernet client side. These are one ramping new products specifically designed to address the white-box market. Remember the Broadcam is historically very strong in the OEM market given our products performance software suite and our big target market with new features. So this is expanding our market leadership into a new customer sell. You are a potential driver in 2006, if the expected ramp of our two hygienic products when Intel ramps its black core chipset for servers. Broadcom continues to broaden its product offerings to adjust customers Ethernet needs all the way from the cell phone market up to enterprise and now as well. In the cell phone market Broadcom begins shipping I new line of highly integrated 5 and 8 port Robo switches that will enable not only lower cost and smaller quick print designs but also more hardware and software features which significantly simplifying us with installation and maintenance. In the enterprise market Alcatel, announced it has choice our next generation StrataXGS III Ethernet switched silicon to power their OmniSwitch 9000 family of 10 gigabit Ethernet switches with data voice and video broadcasting services. Finally, earlier this week we announced our intention to acquire Sunburst Corporation. This will get us deeply into the enterprise course switch of lot of market but also in the dimension of Ethernet market. Sunburst brings Broadcom a complementary set of products flexible forward imaging flat at manager, and scalable switch fabric, is all at the team of 41 engineers to help accelerate the migration of the Metro Market to Ethernet, triple phase services are being offered by cable and phone companies, growth in Broadcom through-in through-out, the home and the lower cost profile of Ethernet-based networks are driving the migration to Ethernet in the metro markets. So in summary, Broadcom success continues to driven by numerous large product cycles accruing between the communications and conversions end-markets. These trends are really happening today, our initiative is to be the leading communication semiconductor company and to engage these opportunities to the debt converts of our product line and in natural property portfolio and to superior execution. With that, I would like to announce the call over to operator for Q&A. Thank you and we will now begin the question and answer session. If you have a question, please press â*â then â1â on your touchtone phone. If you wish to remove from the queue please press the â#â sign or the â#â and if you are using a speaker phone you need to pickup the handset first before pressing the numbers. Once again, if you have any questions please press â*â then â1â on your touchtone phone. Thanks a lot, I guess I heard the talk on the most feasible areas as well, congratulations. And I guess somebody ask the obvious questions here which is, with the product cycle the biggest drift sometimes is this inventory or low in the ramp. You guys feel this comfort or what you guys comfort that weâre not going to see that any constituent given that strength that we see in last really three quarters? When we look the cost of our products and then we talk with our customers. We believe the inventory situation is well under control. We actually have a number of customers who have been calling in through all the four quarter and our production in many cases was limited by how many chips we can produce rather than the customer demand. So we believe the inventory situation is well under control. But we do continue to monitor that. And I guess this is the follow up on that. There is some panic of course some signs of panic in the supply chain of our actually products and backend tightness and some reason somewhere in front of tightness. Could you talk about, just how you are handling that dynamic and again what is your comfort beyond inventory that your customers on and of course ordering too much based on that? Well certainly there was tightness in the backend assembly and test in Q4, and I think the whole industry struggled with that a bit. But we continue to work closely with our customers and in many cases we have strong share in the markets, and have good visibility across a variety of customers. And we do our best access inventory and make sure it doesnât get out of hand. Okay. And then just a last question on Sunburst, we look that is kind of a model is there area which you can kind of use this, its kind of a penetration trend for example, like Voice-over-IP, where you are normally on the client side, is it likely that you are going to start pushing more into the, more of the infrastructure and some of these other product area? Well absolutely our goal is to really bring a lot of these technologies to bear and when you look at Broadcom itâs really the conversions we talked about where you can take the last of these recent technologies and combine it together. So we see this is a way to bring additional features. For example, a lot of carriers and lot of the service providers are looking a triple play or quadruple play opportunities. And frankly, there almost no companies other than Broadcom who can offer that type of technologies. Thanks and echoing congratulations clearly here. In the prior quarter you talked about the diversity of your business inside that no single segment was over, 12% of revenues. Can you give us an update on what potent the biggest percent mix would be in this quarter? Okay and then beyond that the operating margin leverage I thought it was probably one of more impressive metric as you delivered. What sort of operating margin targets we talking about now, is that 24.5 normally or is that something is within that are realistic expectation as we go to 2006, as well? I think itâs early to say that it is time for an update to our long term model which has been 20%, to 22%. We have always said we are happy to over achieve on that model. And certainly right now we have the capability of doing that, where we not, we comfortably evaluating that model. I would say we are not in the positioned either confirm or, change that model at this point. And the final question is on the multimedia processors, the optimized chip, is that still highly concentrated in one customer and if so, when do you expect diversification to occur in that? We are shipping to multiple customers today. We do have one customer that was larger than the others. But we do see that diversifying will be coming more distributed as cell phone customers began to ramp up there as well. Thanks, I remember this Wayneâs World movie where few were talking about but not being worthy but Iâll continue to maybe try to ask couple of questions here, one, a question of what seasonality can go both ways and obviously youâve been worried about having seasonality in the first quarter that hasnât tend out, this year you were accelerating throughout the year, is there any kind of qualitative content we can drive from â05 patterns or is that too early to talk about in â06? Because if they had a fast performance is no guarantee a future results, I think its, as you know and weâve always really been product cycle driven, so I wouldnât at this point we canât really assume seasonality as one sort or another. As you know, we had originally called that we might be seasonally soften Q1 and we now believe based on our backlog and expectations but thatâs not going to be the case. So where we go from here in terms of sequential increases, weâre not prepared to your guidance beyond the first quarter. Thanks Bill and one another question, real quickly excluding server works, you talked about that was down 200 million, was itâ05? What kind of growth rate do you think you saw in â05, was it 2 or 3 times your, the actual number, then I have quick follow up please. Well, we were up by $270 million, so with out the servers decrease it would have been 470, so we can do the marathon that whatever that number would come out, I havenât calculated it. Thanks and then one quick question on the handset baseband market, it seems like as if all your, wherever you are in the market thatâs the once place where you are not, maybe a top 3 player at this point, maybe I am wrong on that, but it seems like at least it was significant one. Could you talk a little bit about where we are in terms of rolling out, are you have design wins, are you an IOD testing or are these sort of if there is still we can content increase that you are expensing in with some of these customers, or do you have your in Bluetooth that your are selling page went into that, that would be great, thank you. Let me separate it in 2G and 2.5G where shipping base been today and in fact that was the reason why our sailor groups had tight good revenue in Q4. In terms of 3G we do have multiple designer wins and we expect to see significant revenue from that of a second half, not so much in the first half. But will begin in the first half to see some of the products going out. Thanks guys, and echoing congratulations. Maybe following up on 3G can you just talk about what at years in and on the 3G base stand side that is earnings the business, what metrics are you really been differentiation is. Well thatâs a very good question because, if you look at it, in the last 5 years, no major handset vendor has changed their baseband supplier. And so as the reason for that is because the software and all the rest of the work that they do to support a baseband is quite high and so there has to be a very compelling reason for them to change. So given that we have a number of compelling reasons, one of them is we have a very competitive product, there going to make lot of things into a single base band ship, we also are one of the only companies that can show them road map that only shows all the baseband technologies, but it shows all of the media and connectivity technologies like Bluetooth and wireless LAN, and a road map that can integrate those all together in the future. And thatâs was really compelling for these guys and they are eager to find some one who can take them on that road map. Cody this is Peter Andrew, this FYI you might want to come buy 3GSM both, where you can give more details what we are exactly doing differently in other new technologies that we have our unique which is enabling us to become a bigger player, not only in the 3G markets but also in the 2.5G markets. Thanks and is there any particular segment or is there that nature of the wireless base that have youâre finding yourself with more traction end or this is more attractive to? I think itâs a matter of timing, we entering things likely to in wireless LAN a number of years ago. And weâve been able to achieve, #1, #2 positions in those phases, in a fairly short period of time. We relatively new into areas like Cellular and some of the other wireless technologies, but we entered to win and so our goal is to become a top player in each of those technologies. And then just lastly you mentioned DSL would be up in the first quarter, can you talk generally about some of your other segments at least directionally, though it might have some sequential impact on those fronts. Well I gave some clues in the previous dialogue, in terms of what strong, and I canât breakout though the specifics ones for you Q1 sorry. But one comment we did make already is as we expected as a whole that our broadband group would be the strongest grower in Q1. Yes, thank you. I was wondering if you could go into developments on the Voiceover IP front, but firmly product line standpoint, I believe cable is an area where you are experiencing success, but also in dedicated Voiceover IP applications and maybe even as a percent to WiFi going into VoIP telephony. VoiP is one of those horizontal technologies that applies in a lot of different areas, and so the breadth we have enables us to do that, we demonstrated at CES a wireless VoIP phone based on 802.11n but also to video, so there is an example of a standalone phone and weâve seen a lot of interest both for the video as well as the non-video versions of VoIP phones, from the major players in the VoIP phone market. One of the things that particularly exciting though it adding VoIP capability to both DSL and cable modems and that market we think is really poised to grow, but the interesting things about that is that the cable operators can employ a voice enabled modem into a household and then down sell the capability to replace your phone service. And so itâs easier for them to put the voice capability in now, rather than waiting for the customer to actually water it, because it saves a truck holder to replace the modem. So we are seeing very strong pickup of voice in both of those markets and expect that to be a revenue driver for us going forward and it dramatically increases the average selling price of our cable modem and DSL. Is there anyway you can quantify how big this is getting for the company in terms of fractionate sales or growth rate. We donât quantify it for the company, but Peter you might have the statistics on the growth rate VoIP penetrations into those markets. Sure, well just to put into perspective Iâve got the DSL data here in my finger tips. If you look at roughly Q1 it was essentially 0% of our unit that we are shipping in the DSL space with VoIP-enabled. But the time we are into the Q4, we are probably around 30% of the DSL modems that we were shipping were VoIP-enabled. And I would say thatâs, answering Q4, itâs about the same metric also for the cable modem side in terms of being voice enabled. Also remember that just one new feature and function that we could add to those platforms, will also WiFi and Bluetooth, but we are seeing a lot of take ups especially in the European markets, of that complete home gateway solution. All right, thank you, one more if I could, are there any customers approaching the 10% mark or because of the diversifications happening are we on the cost of loosing Motorola, the 10% customers perhaps? Well actually when we look at our, if you look at it on an annual basis, we actually see that our customers are diversifying. So we are seeing more and more large customers which means the impact of anyone customer goes down. Hi, thanks congratulations. I donât mean to be the one that brings the patent, in terms of DSO expense as we go into 2006, when we have the mandatory expensing there, can you just help us frame to expense, if your other estimate what it was in Q4 and how we should think about in Q1. And also to Bill if you could just give the tax rate expectations for Q1 within, with out thatâs why they are being very helpful. Thanks. Okay, first of all tax rate expectations for Q1, on a pro forma basis remains at 10%, on GAAP it will harder to predict its typically it being running a little better than that on GAAP. In terms of what we expect DSO expense to be, first of all there is 2 line items on our current P&L, where theyâve already recognized our equity expense, those are the deferred compensation that relates options from people who work for our companies we had acquired. And also the restricted stock units we grated lives to, those already hit the P&L. If you look at our past 10-Qs, on the disclosure basis, has we been expensing options it would have been the total all end cost including RSUs and the other, I am sorry prior to acquisitions would have been above $100 million a quarter. For Q1, we expected to be probably little bit less than that, there is the more the old legacy options drop off and so there will be something under 100 million of expense for Q1, and out of that $100 million and some of them would have 25 million of that would already be incurred through because if you like to restricted share units or to deferred counts from acquisitions. Does that help you Seogju. Hi yeah, just on that 25 million thatâs already incurred, thatâs been in the pro forma numbers thatâs pulled out right? And we expect going forward we will continue to report both ways of it, we will get complete transparency in terms of what those expenses are and what the ongoing operating expenses are. Great thanks, and then lastly just on DSO, in terms of the share dilution at the analyst meeting if I recall correctly you talked about sort of targeting a net share dilution of about 3% with gross dilution of about 5% to 6% offset by share buyback, is that how we should think about it, and I guess with the new expanded repurchase program, I think you mentioned it takes about 2% of it. Hi guys, Bill question on gross margin, you have navigated the current slightness both in the backend and the front-end, pretty nice to be here. How should we take it to the rest of â06, for gross margins, you are wrapping several new products, that doesnât necessarily related into lower ASPs? Thatâs true, and as you know there is a whole lot of components to gross margins, so on the cost side its going to be harder, we believe that will be harder to come by significant decreases in our foundry cost just be negotiating better cost for the same part. Because capacity is tighter now than it had been. However, we continued to have aggressive programs to reduce cost and products by improving the products and sales and also we have expanded our second sourcing so that we can get to some better cost data there. We will be more dependent than ever on whatâs happening on the selling price side, and thatâs always a little bit unpredictable again to the extent, we are in the right point of product cycles, that seems to be favorable for us. We can, for the last few quarter, if you recall back in early 2005 we said we, we thought we are seen spike and we expected to comedown very quickly, weâve been happy to report its come down much less quickly than we have, that there still has been a trend line of our reduction in gross margin each quarter going forward, and we think for Q1 we are flat to possibly slightly down little bit for that period. So I think that kind of a trend line is probably most realistic to assume. Okay, thanks Bill. A question for you Scott, lot of growth drivers going on, if you think to â06 how would you rank order the top 3? And I realized in each of the 3 segments categories, there are several as you could please just give us a top 2, thanks? I think thatâs hard to, and as you pointed out we do have a lot of different growth drivers, so it depends a little bit how fast, for example 802.11n rolls out this year. So, it will be a little hard for us to pick the top 3, but there are lot of them in every single area and I think thatâs something different about Broadcom than many other companies, many companies are bidding on 1 or 2 growth drivers and we have a dozen or more. Good afternoon, this is Jenny Shea calling in for Jeremy. I just want to kind of hold in on your communications and convergence being here, you gave sort of market, adoption growth rate for your Voiceover IP shipping to adjust on cable modems. I was wondering in terms of the other ingredient technologies that you mentioned earlier, which one that you just expect to also experience similar growth rate in terms of units in convergence for â06? We believe that Multimedia is a really big area and today we are seeing that start to deploy in handheld devices, but just the ability to handle Multimedia and HD video streams and things like that, across the PC markets and other things. We think its going to be big. So taking that video technology and applying it for all the different devices is certainly a big area of convergence, also if you take voice we mentioned Voiceover IP applying to a number of different areas, and also bringing data to things like Cell phones, Cell phones will become more sophisticated will be able to run more applications to process data as you get some of the 3G cellular standards like HSDPA, HSUPA you will get decent data rates to the phones, which will make them a more attractive device for some of the personal information management kind of applications. So those are a few, but we see it as a very pronounced theme and driving a lot of the direction we are heading with our products. Okay, and I just a quick question on ADSL, do you expect to have any sort of product shipping towards the end, yeah I know you are more focused on ADSL2Plus you have the nice design win attraction there, which is not going to change, but for ADSL2. But we see the ADSL2 market is something that will happen more towards the end of this year. We certainly have some products there today and doing in and our ability testing with other semiconductor suppliers, so thatâs gone quite well. So we have design wins and again thatâs something thatâs going to ramp more in the second half. The story today is pretty much ADSL2Plus. Thanks, I guess I will trying to book a little bit longer term as you guys, just a little bit carried I think, that you guys post that well and still had a couple of areas you could have done that better. Scott in regards to kind of going back to Michaelâs question about 10% giving into the infrastructure side. Given that Intel was a big investor in that, in terms of VoIP it seems that the carrier market maybe a little bit, the most of the deployments were over there, are revolving out, is this more of a apply from the infrastructure side targeting the enterprise side as VoIP start to rollout there, and also in terms of taking a look at the underline architecture, we will be looking still in maintaining the net to also, kind of leveraging to some of the power quick or types of that power bases based on some of the feedback from Cisco? Well certainly we will see this is, as enterprise, but again itâs also a play for us in the metros, itâs a new area for us, we didnât scale into that states in the past. Its kind of interesting because there is a transition going on where today, a lot of the players in that space use custom Silicon or their basic strategy to do that and there is transition thatâs going to happen there to merchant silicon. And Broadcom wants to be the one to really jump on that and make sure that when they do transition from doing their own 86 to buying merchant silicon we wanted to be ours. So that motivated the timing of the Sunburst acquisitions a little bit. In terms of MIPS, MIPS has a lot of work still ahead and so we believe you can create very fast causes through in that space and in fact we put together broader team has invested over the last quarter, to increase the capabilities of our MIPS core team do faster, processors across the wired range. So we are still bullish on that. Okay, kind of expanding on that, even that Sunburst, I believe lot of that shouldnât so far has been more with in the regional networks for IPTV, Video on demand you mentioned in terms of lots of code action multimedia being a little bit stronger. What area can we look forward speaking in â06, as far as maybe additional left side during your call really when you are down and now stated 802.11 and the point was right about a lot of the, this person is still with uncompressed type of video, is this kind of on the big target areas in terms of such as metro and some of the video on demand, but also in terms of gateways particularly with in the cell phone market. Well I think it was very different market, so I mean certainly the high-end video on demand market is going to big going forward, you are actually right, using some of the codec technology we have, will enable much better efficiencies over those networks, because you can send the same TV program and have the bit or less. So thatâs certainly a good combination between the Sunburst technology and codec technology that we have, either SOHO market thatâs both there is a client opportunity, but I believe the home gateway market is going to be interesting. Its sort of curious to watch, because there is so many contenders for that market, between the set top box guys and the network guys and the TV guys and the PC guys and what not, and our position on that is diagnostic and then we want to be able to have all the technologies and so who ever wins in that space we want to be the ones who provide the silicon forum and so thatâs why you see us doing acquisitions to cover all of that, we have basically everyone of the last mile technologies covered, and we want to cover all of the multimedia and codec technologies as well. So whatever wins we are there, a good example of that is in the HT-DVD space, you saw us announce a chip there that supports both blue ray and HT-DVD, both on Microsoft Codecs with BC1 as well as the H264. So we are really trying to make sure that weâve got all the bases covered and we are the player that can integrate all of those pieces. I guess one last question on that as you mentioned as far as covering all the baseband technology, certainly pitching the eye work, where the semi area and with Sunburst its certainly lays out a good 10 big types of server and that, but what about in terms of some of the low lying beam as far as instant demand or even working a lot closer will favor you and thatâs the out the world. Well we certainly support integration with those things, but to be honest we believe in Ethernet, we believe Ethernetâs going to eventually be able to surpass a lot of those markets. May be not today, but when you start getting the ability to use the same cable and use the same protocols and fall back to the slower speeds, but also support the higher speeds, 10 gig Ethernet, rolling out over the next few years. We think thatâs going to be the big player and so we got most of our chips on that. And then certainly Greg, do you think the technology could take the top line of the business; it doesnât some of the legacy issues when itâs the ability as far as penetrating in some of the deeper areas of the infrastructure side? Okay, thanks. Bill Iâm sorry one at the housekeeping in terms of stock options is there anything in terms of the high restricted stock that would cause different taxation on those are would you reporting right now that we seem that close pretty much true? Hi guys, one of the questions have been asked and answered but just kind of solving into this conversions payment, it does seems as though you guys are getting very aggressive in terms of positioning for this conversions from the home whether its digital media that after a gateway, set top box, et cetera. Today we havenât seen much in the way of television penetration. And I know you guys have, have some work going on there. When do you think that the display area itself is going to pose a, another arena of growth for Broadcom? Well there are number of ways we could look at that displays our monitors today. Certainly donât represent a silicon opportunity for our current product. That going to be very simple display drivers and our power supply chips and generally we donât play the end market. Going forward, I think there is an opportunity as the monitor makers to look at the opportunity to add a sub $10 chip to a video monitor and make into digital TV. It gets very attractive, but you just stop shipping monitors and everything as TV. And you have a TV in every laptop and a TV in every PC, one of things we see as an opportunity is to take our very strong set top box technology moves that over into the digital television space. After all a digital television is basically a set top box that has a monitor and subtract the two things. So by creating some chips there, we believe we can go after that space and make it very attractive to make TV capability basically, you think it would surpass all the different products. Okay and that leaves to my follow-up youâve obviously, sort of some areas of our product in IP portfolio to strengthen your positioning. Do you think you need to acquire additional IP to maybe strengthen the position for the display markets? Or you guys sell it what youâve got? Overall, we always looking for opportunity to get the market faster or get access to other customers. So I wouldnât exclude it but we certainly have the capability today, to do digital television and to expand that into the displays that become TV market. I donât think itâs particularly interest to do power supplies and things like that. We are not a commodity semiconductor supplier we provide the high-end SOC, but to the extend those become part of the display market will certainly play there. Thank you, and good afternoon. In the mobile and wireless business, obviously some strong growth I think you said of 44%. Is there any comment breakdown or insights you can give to us and to the contributions from Bluetooth and wireless LAN. I understand Bluetooth have the largest piece but, maybe seasonally when you are grounded much about certainly it clears that, it did as if, kind of try to assume the kind of great somewhere later, any insights there? Iâm sorry we donât break that down. So I canât give you the exact number but we do believe we took share in the Bluetooth market in the fourth quarter. Okay, one area you didnât talk about was storage, as I missed too much, can you kind of insight to me give on, do you think â06 might be year that starts to develop or what do you think there? Well, we certainly look at that, I mean we didnât mention it, because we have so much of kind of things to talk about but that certainly a market we continue to monitor and look at. Okay and then on 3G lastly is there any updates you can give in terms of, you talk about two large OEM win any kind of additional updates there. Or additional customers you gained in the last quarter? Iâm afraid that prior to launching phones our customers are kind of shy, so we are not able to share any more details here. But we certainly will, when we can and those fell throughout the market. Hi, this is Hung Lee for David Wu. Thank you for taking my question and congratulation on the strong quarter. With as many new product lines going into the fact later this year or sometime in the mid of this year, do you expect any slow down in revenue due to product auditioning of your customers. Or do you expect, the revenue to be strong throughout the whole year? Well let me see if I can help you on a question. We donât give guidance beyond the next quarter. So I canât tell you anything in terms of future quarters. On the other hand there is nothing inherent in our models in transitions that will cause us to, have a revenue gap in our current customers as we transition to new product. Generally they buy product today and when we come up with the new product they buy the new product and one of our goals is a company has to add enough value and new futures to the new products. So that they have an ASP equal to a higher than the products the customer already buys. Yes, thank you for taking my call. Iâm not sure if you would address this or not. Could you gives us a thought DVBH and when we can expect to see Broadcom intersecting that technology associated with the acquisition of the Athena? Sure, this is Henry, yes DVBH is definitely an active area of R&D and the company as you mentioned with the Athena we have the RFID and we are of course working on the demod piece we have multimedia piece with the video core technology that we acquired from Apple Music. So all the pieces are following into place and it is a major focus of activity right now. So I donât have any specific dataâs to when will introduce our compete solution, but we are very active in that area. Have you guys could say is it fair to assume which youâve already out engaging with major OEMs or as I understand that there is already been kind of a first cycle design awards given for the early cash with Verizon and people like that. Thanks. Scott when you mentioned Bluetooth share gains at 4Q, can you characterize the applications possibly where you think you could share perhaps Notebook or PC, or headset how that works and, how that works going out into 2006? Well the biggest opportunities of Bluetooth, of course these days is cell phones and I think that dominates all of the other markets right now. We are starting to see markets like automotive and PC and some of the handheld consumer devices begin to show up as markets. But for the next year the handsets is where it is, we have design wins with most of the major handset manufacturers. And so thatâs where lot of our share gains have come from, as we get additional customers in that space and as they ramp their models up for some customers we have engaged with relatively recently and so as they populate our Bluetooth solutions especially our new 2045 chip that has enhanced data rate, and all the difference profiles, those are beginning to ramp up and so thatâs driving the additional share gains in those companies. Okay, thanks and on, anyway Ethernet you talked about some of the product initiatives that clearly expands your clients and going into â06, from infrastructure side, how does the option rates, how does the option rates going and where the penetration is and where the opportunities switching next year? Sure this is Peter, if you look at some deliberate data I believe last quarter, the estimated that the penetration rate of Gigabit Ethernet into the hub, switch and the router market was right around 36%. The good news is if you look forward based upon their expectations there are looking for a nice steady increase in terms of penetration rates. I think if I look at the numbers they are expecting I believe by the end of 2006 to roughly end the penetration rates right around 42% to 45% of the imports that are being shipped. Thanks good afternoon. This is actually Brian Curtis for Adam. I wanted to, you simple mentioned 802.11n as growth of in â06. And if I am correct I think wireless LAN ran through last couple of quarters here maybe three, if you want any, I mean what is the prospect for â06 and could you just, business unit growth, kind of, at the overall average? Well its hard to speculate exactly what the growth rate will be, so I canât answer you question is to whether the average or not, I think the two big growth drivers in the 802.11 space besides just the increase penetration of 802.11 into various devices, 802.11 in general has come down in price over the last couple of years, so that is very cost affective to make, just of our any device that cost more than $100 and afford to have a 802.11 networking in it. What we see as drivers going forward, our 802.11n which really improves both the performance as well as the range, did you get a factor of two better range and a factor of four more in performance. So we think people will pay for that and that will give us at average ASP increase across our, our range of 802.11n, 802.11 solutions. The other thing itâs going to drive it, I believe over the next couple of years is when we see the embedded space begin to pickup, its been fairly small to date, by overtime we believe 802.11 will go into things like cell phones, like games and other consumer devices and so there is an opportunity there as well that we hope to play and, so I, I believe there is a good future for 802.11 as a market, certainly the number of earrings will grow up dramatically and 802.11 and give this ASP outlook and that it gives us a big margin increase. Thanks, and then just, kind of going back in this mobile convergence, I mean, that means, you have all the components Wireless LAN, DVBH, Bluetooth, kind of, I wanted to need this rank, kind of those separate opportunities in the cell phone and also new, where do you see kind of convergence to those devices been appropriate, I know in a mobile talking Wireless kind of Bluetooth and third has Bluetooth and GPRS, just wondering what you call it from? Well Iâm going to decline the rank and I think its going to depend really on, on how far those market grow and itâs a little high to forecast that, its one of the reasons we want to make sure we cover all of those, so we get the best covered. Its interesting if you look at where the convergence is going to happen, weâre seeing Bluetooth as something with base convergence for example there are lot of cell phones we have a Bluetooth and FM radio in them and lot of headset makers want to save a chip and so it doesnât logically make sense to the Bluetooth and FM radio together but it saves board space in the cell phones and the, the headset makers want it so thatâs a big opportunity and I think most of the Bluetooth sockets that are out there today will change the Bluetooth that down over the next couple of years and that will reduce some of the suppliers. The baseband is a big discussion our how fast that has been, there is some people do believe the baseband was sort of vacuum of all the other chips in the phone and there are others who believe that as for as since it evolves particularly they will stay separate, I think both are probably right in the low-end market, I think the baseband will tend to stimulate the rest of the pieces in the higher-end phones and the more feature rich phones. I think youâll see rapid evolution of the different connectivity in multimedia and other pieces, so that wonât happen so quickly. And thatâs why you see as adopted strategy of making sure we got all those basis covered, because if it goes to a depth star baseband model we can play in that game and if it goes to the best of remodel on the parts we play there as well. I would like to thank everyone for joining us today, appreciate your questions and we look forward to seeing you in the quarter, thank you very much. |
EarningCall_234004 | Hereâs the entire text of the Q&A from QLogicâs (ticker: QLGC) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Q - Harsh Kumar]: Hi guys. Couple a question actually think, Anthony question maybe for you first. Can you give us some clean revenue numbers, or maybe an EPS estimate for the March '05 and December '04, for the existing business as it is? [A - Tony Massetti]: Prior periods Harsh, so we are looking at March, let me pull those together. Why don't we go on to the next question, and then I'll come back to you with those. [Q - Harsh Kumar]: Fair enough. Actually, that's fair. Question for H.K. Your company bought back $247 million worth of stock, roughly 7.5 million shares or so, current price, when I look at your share count in the September quarter, it's only down very modestly, like 2.5 million. What am I missing there? [A - Tony Massetti]: This is Tony, Harsh that was skewed toward the end of the quarter. So, if you recall, we announced the share repurchase with the Marvell transaction, which was August 29th. And then we waited 48 hours, as we normally do, on material information. And then we started to repurchase stock. So you had the benefit of that only through part of the quarter. So the average is only 90 million or so shares. [Q - Harsh Kumar]: So therefore, the next quarter, I mean the December quarter, when you report results, your share count should be substantially lower? [Q - Harsh Kumar]: And thank you very much, and then Troika can you give us a sense of it's breakeven, dilutive, accretive or some sense of numbers, etc.? [A - Tony Massetti]: Sure. For the December quarter, we have included in the guidance about a $0.01 impact to EPS for Troika expense, very minimal revenue. And then, looking into the March quarter, a $0.01 to $0.015 impact to EPS again, due to incremental expense and probably minimal revenue. [Q - Harsh Kumar]: Fair enough. And just a question for H.K. I think you said that the SAN infrastructure market is growing 20% to 25% revenue-wise; is that correct? [Q - Harsh Kumar]: When I look at your numbers, you're growing about 13% to 14% sequentially. So I guess, what am I missing here? Or should I assume that one of the number sets is incorrect? [A - H.K. Desai]: So, if you look at this thing, the 20% to 25%, when we say it, we talk about Fibre Channel, iSCSI, HBA, blade switches, switches, plus we also include the Fibre Channel to iSCSI router, and also the virtualization platforms. So you don't see those revenue, at least for a while, on some of this new product anyway. So you don't see the growth, what the growth rate is, average, about 20% to 25%. So we will start seeing that rate in the late year like, for example, the second half of '07 and probably '08. That's when our rate will go same way as the market. [A - Tony Massetti]: Harsh. Let me just give you those revenue numbers that you asked for. For the December quarter, revenue for continuing operations is 116 million and EPS $0.36; and then, for the March quarter, 111.7 million and $0.34. [Q - Harsh Kumar]: I would like to thank you Tony very much. [Q - Paul Mansky]: Actually, I wanted to work through the math with you real quick. So we are talking about 82.5 million shares. You're talking about revenue growth. You got roughly consistent gross margins, roughly consistent operating expenses. And yet EPS are going to be flat to down. What am I missing in that calculation? What is your interest income assumption? [A - H.K. Desai]: There's no (multiple speakers) flat to down. [Q - Paul Mansky]: 32 to 35 versus the 34 percent that we just put up? [A - Tony Massetti]: Yes. The high side would be up Paul. The missing piece there is the tax rate. We had a benefit in the current quarter. Tax rates were at 37.7% and we talked about 39 to 40 for the remaining two quarters. So the way you can look at it is that, at least for the December quarter, the tax rate would offset the lower share count from an EPS standpoint. And then, also, you have to include the impact of the Troika purchase, which, as I mentioned, was about a $0.01 impact to EPS. [Q - Paul Mansky]: Okay. And then, maybe now that we have the controller business out, how many 10% customers do you have presently? Continuing operations? [A - Tony Massetti]: We don't typically talk about that, only in the K. So we don't talk about that during the quarters. [Q - Paul Mansky]: Without naming names, you don't want to provide at least --? [A - Tony Massetti]: Just for consistency purposes, we don't report that. [Operator]: Aaron Rakers, A.G. Edwards. [Q - Aaron Rakers]: Yeah, thanks. I still am a little bit confused, in terms of Paul's question in regards to the math in the quarter. If I basically assume a 40% tax rate in the December period and even take your other interest income line, let's say, down to 5 million or so, I'm still coming up with EPS is still $0.01 ahead of your bottom-line high-end guidance. And I'm still a little bit confused. Can you help me a little bit further, maybe, where I'm missing the comments in terms of guidance for the December quarter? [A - Tony Massetti]: Sure. So, you should be thinking in terms of around 4 million for interest income going forward. So we've been running 6; with the stock repurchase, we should be around 4. And then, conservatively, we're assuming a slight decline in gross margins. So if you roll in those two factors, you should get more to the 34 range. [Q - Aaron Rakers]: Okay, fair enough. And I guess the next question is actually on the switching business, flat sequentially despite some healthy year-over-year growth. I think you guys had guided for revenue to be up 1 to 4% sequentially. Maybe you can talk a little bit about what you are seeing in that business and when you see this transition essentially playing out. Is it next quarter? Is it two quarters from now that we expect to see a resurgence in sequential growth in that business? And also, if you can quickly comment on this relationship with a Tier-1 OEM in the switching business, when you expect that to start to or essentially be announced? [A - H.K. Desai]: So if you look at the, what we said in this thing is that the key really is that even though we have tremendous growth in the port count for both blade and the 5000 series of products and even the 3000 series of products, I think the key really is that the pricing per port on our legacy SANbox2 8 and 16 compared to the new products is about 50%, anyway. So that's the reason even the port count is up; the unique items went up higher than the ports count, probably. And this is the reason, but I think that transition will probably be complete by December quarter. So, then, we will start seeing the normal growth rate with the port SAN unit. So that is the transition, really, which is there. Now, if you look at the market-wise, I said we have a lot of traction in the embedded switches, which is we won the IBM design, we also announced about the HP and Dell for the 2-Gig. We also work with some of this customer on the 4-Gig solutions, so we don't have all the design we need yet. We also are getting a lot of traction on the 5000 series of the product. On the channel, particularly, we have tremendous growth in the channel. We expect one OEM to finish the, actually, two OEMs already qualified the 5000 series. There is one more coming to the December quarter, and then there is one more probably coming to the March quarter, anyway. So we are getting a lot of traction for the new product, and most of the qualifications should be done with the OEMs. So I think probably FY '07, particularly even the December quarter might be good for the suite and then FY â07 probably be really good for the suite. [Q - Aaron Rakers]: And then again, just kind of following up, I think last quarter you had mentioned your expectation of landing an additional or new Tier-1 OEM relationship in switches. Any update there? [A - H.K. Desai]: Yes. So we get one more, which will be finished the qualification by December quarter, by December end. [A - H.K. Desai]: Sure. [Operator]: Andrew McCullough, CSFB. [Q - Andy McCullough]: Thanks just couple of questions. First, can you run us through the trends at your top 10 Fibre Channel customers that you saw on a sequential basis in the quarter? [A - H.K. Desai]: I don't have, really, data for the Fibre Channel. But if you look at when I used to give some data before on the Fibre Channel versus SCSI and so on, if you look at the continuing operations now we have about 60% are for revenue, 55% of revenue came from five customers. And then almost all of them are the Tier-1 OEMs. So I think there's a difference between what we used to have before versus now. And the second is also the trend is changing for us, the contribution from the OEM is because we also have a 26% of our revenue came from channel. So there's a lot of traction going in the channel area. So I think the customer mix is changing now, and we will see probably more trend and we will know more about it next couple of quarters, because this is a first transition quarter for us. [Q - Andy McCullough]: Okay, and just second question, now that the HDC business is going away and going to be off the books here shortly, how should we be thinking about seasonality in the March quarter, with a new look to the business model? [A - H.K. Desai]: I think that's a good question. So what we expect that we will see, we have seen this is seasonality always as strong in the March quarter, before. But also, the March quarter is normally strong for the disk control business in the past, because of the year-end for Fujitsu and in the past with Hitachi, anyway. So we still have a strong March because of the year-end from the disk control business. And I think that's going to go away now. So I think we will probably be seeing a normal seasonality with our large OEMs and system business. So we might see probably flat to slight decline in the March quarter compared to the December quarter. [Q - Kaushik Roy]: Even with the 40% tax rate, I'm still getting above $0.35. So, Tony can you give us any color on your OpEx expectations? [A - Tony Massetti]: We already talked about the $0.01 impact for the Troika acquisition, and then we're expecting probably 1 million to 2 increase sequentially in just ongoing business, mostly in the engineering and some in the sales and marketing line. [A - H.K. Desai]: I think we will probably give it next quarter, because we still have our PPG employees, so I think it's very difficult for us to give, anyway. But I think the key really is that I think what Tony is saying is there is an offset coming from a tax break we got in the September quarter. And we're going to lose about $0.02 because of that, and that is going to go offset by the lower share count. And then we have $0.01 more expense because of the Troika, anyway. So I think, if you look at this number and then also slight declines in the margins because the guidance we gave you, the 69% to 70% versus 70.4%, anyway. So if you look at all this number and if you look at the high end of the revenue, then I think we will see about $0.35. [A - H.K. Desai]: I think what we say and the key really for us on the virtualization, we are not really acquiring the business; we are acquiring the technology. We are more interested in the technology going forward, so we can probably put, we can use this technology on a different platform, so either you can use as appliance or you can use in the switch, or the switchblade, anyway. So I think we are more acquiring the technology, and whenever the revenue in the business will come, really, it will be part of this business unit. [Q - Kaushik Roy]: Okay, thanks [Q - Keith Bachman]: Could you talk about pricing trends in the HBA business and also channel inventory at an industry level? [A - Tony Massetti]: The pricing environment has been very stable. This quarter, when we look at like-for-like HBAs, we saw sequential declines of 1.5%. If I recall correctly, last quarter it was about 2%. The quarter before that, it was about 2.5. So it's been in that 2 to 3% range for many quarters, and, [A - Tony Massetti]: About the same. We don't think 0.5 point or 1 point is a big change. Looking forward, we're expecting in that 2 to 3% range. [Q - Keith Bachman]: And how about any comments the channel is becoming a bit more important to the industry. Is there any comments on any inventory levels that you are hearing about? [A - Tony Massetti]: Well, from a rev-rec standpoint, we retain the inventory in the channel. So that is our inventory and our books. And there has been no change in that from our standpoint. [A - H.K. Desai]: Our inventory levels remain really the same because it's all inventory (indiscernible) 38.54 the model, so no change. And the good news is that we have a very strong sequential growth in our channel business in the September quarter, which is about 13%. And if you look at for the continuing operations, even the June quarter, if you look at the number, our growth was about 13%, 13.5% sequential growth, anyway. So we have strong growth in the last few quarters on the channel side. [Q - Keith Bachman]: H.K., I want to come back to something you said before, because I'm not sure I got it right. You talked about what you saw for the HBA business, the long-term growth. I want to just make sure I capture that right. And specifically, what would you think the industry growth rate is? Now that you have stripped out the HDC business, what do you think the sequential growth is, would be, on the HBA side? [A - H.K. Desai]: So what we say is that the HBA number, yes, from the Dataquest to the IDC from the Gartner is a 19%, which include Fibre Channel HBA and the (indiscernible) 39.51 iSCSI HBA. So what we have done is we have lumped the both HBA, because both are really interconnect solutions. So it's a 19% over next few years. [Q - Keith Bachman]: And what do you think is on a sequential basis HBA? I'm not sure if you said the HBAs specific in terms of your guidance. [A - H.K. Desai]: Well, if you look at the couple of quarter we are normally growing about 4% sequentially, anyway. So that's really for the year for about 16%, 17%. [Q - Keith Bachman]: Okay finally I want any comments on how one of your large accounts, how that business is splitting up? Any comments on one of your competitors was called there and how that business may be unfolding? [A - H.K. Desai]: Splitting up, you said? [Q - Keith Bachman]: Any loss of share there? [A - H.K. Desai]: No. And we don't expect to lose any share there. [Q - Mark Moskowitz]: I wanted to know with respect to the acquisition announced yesterday, Troika Networks, in terms of any wiggle room, I think they have around 45 to 50 employees. Do you know at this point, do you anticipate to keep all those employees? Or what type of leverage opportunities are there? [A - H.K. Desai]: No, they don't have 40 to 45. They have about 30 to 35 employees, approximately. And we expect to keep around 30 employees. [Q - Mark Moskowitz]: Okay great. And then, as far as your switch business, how does the revenue break out with respect to switches, SAN versus the Company average in terms of OEM versus distribution? And have there been any major changes in that in the last quarter? [Q - Mark Moskowitz]: Okay. And then, just lastly, if I could, as far as the HDC business and I know the divestiture is almost closed here, so I don't want to talk about it too much. But I just want to get a sense of cash flow generation going forward. I think, in quarters past, the hard disk drive controller piece was about 30% or more of your cash flow, if I'm not mistaken, by my estimates. How should we expect your cash flow to look going forward? [A - Tony Massetti]: Sure. We generated $31 million cash from operations in the September quarter. I think for modeling purposes, you could estimate between $20 and $30 million. $25 to $30 million, I think, is reasonable. [Q - Mark Moskowitz]: Okay. And lastly, as far as the share buyback, have you announced a new plan there, given that you have already exhausted the 350? [A - Tony Massetti]: We have gone through the 350. And now, we haven't announced a follow-on buyback. But we will discuss that with the Board at the next Board meeting, and it's up to the Board. [Operator]: Adam Harkness from Mark Kelleher. [Q - Mark Kelleher]: Thanks. I want to talk a little bit about IBM and the blade servers and your Fibre Down initiative there. IBM had some great numbers out of their blade servers a couple days ago. How does the competition work there between you and your largest competitor, in terms of how you get on systems? How does that break out, and do you have any estimate of what your market share is on those platforms? [A - H.K. Desai]: If you look at IBM, we had a really good quarter with IBM in the September quarter and a lot of this growth came from the blade server side. It's silicon or the switchblade or also our HBA. So we have a really good quarter, and I don't think on the blade server we haven't seen any competitions yet as far as the HBA is concerned. [A - H.K. Desai]: Correct. So the way it is working right now is that all the blade servers, we provide the silicon, and they build their own mezzanine cards. So they are not changing the reform factor. They are still building the mezzanine cards for the 2-Gig. So what we have done in the 4-Gig is that we have taken over this design and instead of supplying them the chips we will be supplying them the mezzanine card ourselves. So we will build the card for them. And we have about three design wins from the major OEMs for that, for the 4-Gig. [A - H.K. Desai]: The single-channel HP-UX business, assuming that that is your opportunity of 4-Gig, can you give us an indication of what you think the mix of single versus dual-channel adapters is for HP-UX, and also the attach rate that is typically seen in those environments? [A - H.K. Desai]: I donât think, we cannot make any comment on that yet. There is nothing announced about the single-channel. But we have a good possibility of winning that business either as a silicon supplier or as our HBA. But I don't think we can make any comment right now on that. [A - H.K. Desai]: That's adapter business. The two-channel card is adapter business, and we have the design win. We ship them for the 2-Gig. [Q - Tom Curlin]: Okay. And without commenting on whether you have the single-channel, though, do you have any metrics on what the mix of duel versus single is within HP-UX environment? [A - H.K. Desai]: Even if I had the number I cannot give that out because I am giving out the customer information, which I can't. [Q - Dan Renouard]: Hi, thanks, two questions, one, deal close, you said you expected that to close sometime in the middle of the quarter. Is there any potential roadblocks, or is it just standard procedures? If you could address that, that would be great. And then, secondly, just high-level uses of cash, you talk about acquisitions as being a potential use of cash when you did the divestiture call. Is Troika it, or should we be thinking this kind of, should we expect more similar kinds of deals, or is this kind of it for a while? [A - Tony Massetti]: Sure, so the deal that you are referring to, I assume, is the Marvell deal. And we plan on that closing mid-quarter. And there has been no roadblocks there; it's gone very smoothly. So that's on track. And then, with respect to cash, I think it's really, the stock buyback has been a good use of the cash. And also, small technology acquisitions in such as Troika, I think, going forward, we would do much the same with the current cash levels. [A - H.K. Desai]: The only thing I want to add on that one is that this is , we the Troika acquisition is something which we will indeed where the market is going plus, if you want to continue in the suites business, I think we have to provide the functionality. Somewhere down the road, we have to install a virtualization blade to the mid-range and the small businesses. And I think that's one of the reasons we are really acquiring the Troika, from that perspective, anyway. So, going forward, if you see we are missing some technology, then we will go and acquire something for us, anyway. So, just like we said on the August 29th call, that if you find some technology and we are missing, then we will go and acquire that. So the cash is really for the buyback and some technology acquisitions. [Q - Dan Renouard]: Okay. Do you think or do you see holes or things that you would like to potentially fill, without giving any details, or you fairly satisfied, post-Troika? [Q âGlenn Hanus]: Maybe just a quick verification. In the past, other was iSCSI royalty and services. So now, you have pulled the iSCSI out of that and lumped that in with SAN infrastructure? Is that what you are doing now? [Q â Henry Naah]: Hi, guys. I was wondering if you can talk a little bit about what you think is impacting your revenues in the September quarter. Tony touched on it a little bit. Just looking at it in historical seasonality, it looks like the HBA market in terms of revenues was call it 19% last year in the December quarter, sequentially, and then the prior year was up about 11% sequentially. So I was wondering if you could kind of help us think that with your guidance for 1 to 5% sequential growth. [A - H.K. Desai]: I think that's a very good question. If you look at this thing, that guidance is very conservative. If you look at the December quarter, it's supposed to be a strong quarter. And it is a strong quarter for us last two years, 2004 and 2005, December quarter. So it's a very conservative, a couple of reasons for that, one is, if you look at our turn business, we'll have mostly turn business because we don't have much silicon business anymore. So everything is going to depend on the hub full versus the PO because silicon normally are about 13 weeks or 16 weeks lead-time, and we won't have that in the December quarter, because our disk controller and the tape drive control business will be gone. The second is also there is a lot more contribution is going to come in on revenue from our top five OEMs, and if there is anything happened to the OEMs, if they have product transitions or if their performance not that, that can have a bigger impact than what we used to have in the past, anyway. So you are right; it's a very, very conservative guidance we are giving. But I think we are just looking at all the factors and see what happens. [Q â Shaw Wu]: Thanks. Just back to the kind of SAS market, I realize you're out of the business, in terms of the hard disk controller side. Any interest in entering the SAS, like the RAID controllers or the SAS HBAs? Thanks. [A - H.K. Desai]: No, we don't have any interest to enter the SAS market from the host perspective, because it's more, really, a silicon market. What we believe that the two requirements here on the server side, one is to have a connect to the internal drives, which can be serial ATA or the SAS. The other one is to connect to the network storage, and our focus is on the network storage, because we grow a lot more value there versus just the silicon business to connect to the internal drives. So key for us is the iSCSI and Fibre Channel and that was strategy. [Q â Shaw Wu]: Okay thanks. If I may, just a quick question on the iSCSI market. Any update, in terms of do you anticipate more meaningful revenue in that area? Thanks. [Q â Shaw Wu]: I am sorry. Just asking about the iSCSI market, in terms of when you expect more like an uptake in that market, where you will see a revenue contribution. [A - H.K. Desai]: So I mean, we have seen some revenue contribution last couple of quarters, not that big number, anyway. And I think it all depends on, we have several design wins, as far as target silicon is concerned, and then we have some design wins on the iSCSI HBA or the mezz card, anyway. I think it all depends on really when the market happens. It's all, and there's a lot of qualifications we have done, too. So I think the key is really when the markets happen for that technology. We are (indiscernible) 52.24. So we cannot really predict anything on that area. [Q â Shaw Wu]: Okay sorry just one more, will you disclose the revenue that is the HDC and tape controller businesses? Is that going to be disclosed in a filing, or can you say like how much the revenue was this quarter? Thanks. [A - Tony Massetti]: Yes. We're not prepared to talk about that. And the footnote disclosure, we are still working with our auditors to figure out what the appropriate disclosure is there. It's all netted in disc-ops now. So that will be resolved when we file the Q. [Q â Douglas Whitman]: All my questions have been asked, thank you. I have one quick question, though. If you could go back on the acquisition, the numbers that you're giving, Tony, just for a housekeeping detail, does that include the effect of the dilution from the acquisition in that? [Q â Clay Sumner]: Thanks, just a couple of definition questions. In the SAN infrastructure bucket now, I understand it's HP revenues, switch revenue and then silicon. Can you say what the silicon piece is? [A - Tony Massetti]: No. We're not breaking that out. Are you looking for the number or what they are (multiple speakers)? [Q â Clay Sumner]: No, what it actually consists of. [A - H.K. Desai]: It consists of the Fibre Down silicon, which go in the blade server, for example, it's included on the RAID controller. We have some design for the initiator or the target side, so it's more the RAID controller and Fibre Down. And the Fibre Down will start declining for the 4-Gig over time, like I said in my script, over 12 to 18 months, because we're moving that from silicon to mezzanine card, anyway. So that revenue will start declining and we'll get that into the mezzanine card. [Q â Clay Sumner]: Okay, and then, in the other bucket, and Glenn asked about it already, but is that now just royalty revenue? [A - H.K. Desai]: And also, on the silicon, we also include the iSCSI silicon, for example, on the SAN infrastructure, which can be also the target or the down silicon. [Q â Clay Sumner]: Okay. So HBAs are strictly an HBA card? There's no host adapter silicon in that HBA piece? [A - H.K. Desai]: HBA is HBA plus will be HBA, Fibre Channel HBA, iSCSI HBA, Fibre Channel mezz card and iSCSI mezz card. [Q â Clay Sumner]: Okay and I guess one last one, do you have any plans to look at RDMA over IP investments? [A - H.K. Desai]: Yes. We are investing in the iSCSI technology for the future, also. Yes, we'll continue investing in the iSCSI, yes. [Operator]: Aaron Rakers. for your question. [Q â Aaron Rakers]: Actually, all my questions have been answered. But maybe one quick thing, did you guys give an update in terms of your expectation for tax rate now, looking out, let's say, into 2007? I know you had made some investments. Do we still expect the tax rate to decline, let's say, towards that 38, 37% range over the next year or so? [A - Tony Massetti]: Yes, we do expect the tax rate to come down in fiscal '07. So it's too early to say how much, but I think in that range, that 37% range, is reasonable. [Q â Paul Mansky]: Going back to Troika, do you see this acquisition being accretive over the course of maybe the next 12 months? I'm having a little bit of a hard time getting my arms around a business case for virtualization and the SMB over the next 12 months? [A - H.K. Desai]: So, I didn't clearly what I stated is that I cannot really, because we cannot say that we just temporarily we are talking about like next one to two quarters, so what the dilution is going to be from that. But I think that clearly, we're acquiring the technology, we are not acquiring a business. So we're really going to build a platform, which is going to go in solid technology is going to go in with our current product. For example, on the suite side, we have built the blade on the suite side, anyway. So this is really going to be part of those groups, anyway. So it will be part of the P&L and the revenue, part of the existing business, either suite side or the router, or whatever we decide to do, anyway. So it's a technology we're buying which is really going to lump in with the existing technology. [Q â Paul Mansky]: Okay, so it isn't really fair to say, given I'm walking away from that comment, meaning that maybe you're looking at doing something for a BladeCenter, for a BladeCenter in the future. So it really isn't fair to say that this is strictly SMB technology? [A - H.K. Desai]: No. You cannot say I can use this technology for anything. Anybody who needs some kind of virtualizations, we can use this technology, anyway. So it's like I'm acquiring around 30 engineers, for example, for that much money. And we will need this technology going forward. So it's really more a technology acquisition than the business. [A - H.K. Desai]: I know it, but I don't think I want to talk about it on the phone call. [Q â Tom Curlin]: If we assume that, Agere is the partner that just announced with you guys for 4-Gig Fibre Channel foundry; is that correct? [A - H.K. Desai]: I mean, the technology integration is not so difficult. And if we look at this thing, we started very heavily, anyway. So we can integrate this technology very, very easily on all different products. Thank you for joining us on our second quarter fiscal 2006 conference call. We look forward to discussing our third quarter fiscal 2006 results with you at our next quarterly conference call in mid-January. Also, we have several upcoming conferences that we will be attending. In November, we'll be presenting at the Bear Stearns mid-cap investor conference, the Morgan Keegan technology conference and the CSFB technology conference. In December, we will be presenting at the Lehman Brothers global technology conference and the UBS server conference. In January, we'll be presenting at the Needham growth conference. Please refer to our investor relations website at www.qlogic.com for any updates to the conference schedule. For any of you that will be attending the conference, we look forward to seeing you there. [Operator]: And again, that will conclude the QLogic conference call. We thank you for joining us and wish you all a great afternoon. Goodbye. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234005 | Good morning, ladies and gentlemen, and welcome to the Nestlé 9 months sales conference call. As usual, I will discuss the key numbers only, leaving more time for questionsâ¦. ... and I will take this first slide covering the safe harbour statement, as read, and will move directly to the highlights. The key message is that, even in a tough environment, our strategy is delivering, as demonstrated by an organic growth of 5.8%, and RIG, or real internal growth, of 3.8%. And this is not just due to our Pharmaceutical activities:- the Food and Beverage business achieved organic growth of 5.6% and RIG of 3.5%. These numbers, which are the result of a broad based, robust performance across the different regions and product categories, demonstrate the strong growth characteristics of our core food and beverage business. That strength is underlined by positive organic growth from each of our four food and beverage reporting areas:- Europe maintained its positive organic growth, whilst the Americas continued to be strong at 7.3%, Zone Asia Oceania and Africa improved to 7% and Nestlé Waters improved to 8.4%. Other activities achieved an organic growth of 10.7%. Pricing was 2%, as we attempted to recover increased input costs in certain categories. It was particularly strong in Milk products, Soluble coffee, Nutrition, and Roast and Ground Coffee. We continued to see pricing pressure in Nestlé Waters and Japan, as well as in Brazil due to the tax change there. These three businesses together represent over 10 billion of our 68 billion Swiss francs of sales at the 9 month stage, so it is fair to say that the 2% group pricing number understates the level of pricing taken elsewhere. This next slide gives you the breakdown of the sales evolution. Reported sales increased 4.8% to 67.7 billion Swiss Francs. I've already touched on the strong organic growth and RIG. We had a negative impact from disposals, net of acquisitions, of 0.8%, that number made up of a positive 0.8% contribution from acquisitions, mainly Wagner, and a negative 1.6% contribution from disposals, primarily Eismann. We are almost able to report a flat impact from foreign exchange, that number coming in at minus 0.2%, an improvement from minus 1.8% at the half year. On the next slide are the key currencies. A mixed picture compared to the same period of last year, although the good news is that the Euro and US dollar are not so far away from their average rates for the full year 2004. Zone Europe had organic growth of 1.6%, a slight improvement over the 1.5% at the half year. There is no change in the market trends in Europe. That is to say, conditions have remained tough. Overall, we have maintained our market shares, and I include the impacts of private label and hard discounters in that comment. We did best in PetCare and Soluble coffee, as well as Frozen Food, and worst in Chilled Dairy, due to France and Spain, and in Chocolate, due to Russia. Zone Asia, Oceania, Africa, or AOA, achieved the strongest performance of the Zones in the third quarter, with an improvement in the cumulative organic growth from 6% to 7%. I am pleased to be able to report that our predictions at the half year for Zone AOA have proven to be accurate:- the Middle East and South Asia continued to perform well, as we had forecast, whilst South Africa, the Philippines and Japan all achieved an improved performance, as promised. There were some expressions of disappointment at the Half Year about the growth rates in Nestlé's emerging markets. I hope that the performance in the third quarter in AOA and Brazil will put people's minds at rest. The Nestlé emerging market story is as strong and as rich in potential as ever it was. Now I will go into the detail of the organic growth performance by market, starting in Europe, with Germany. My comments on the performance of the categories within the markets are all based on RIG numbers for those categories. Germany was slightly lower at 0.5% organic growth. There was a mixed performance by category, with Culinary and Frozen Food improving, but Ice cream a bit weaker. Soluble coffee continued to be the best performing category cumulatively. In France also, there were some improvements and some that were slower, leading to an overall acceleration from 0.2% negative organic growth to 1.2% positive. Among those that accelerated were Frozen Food, Soluble coffee and Ice cream. There was also a good performance from our Foodservice business. Great Britain was the strongest cumulative performer in Western Europe, with 5.9% organic growth. Chocolate was a bit weaker but Soluble coffee accelerated a little. We do expect to see a slight slowdown in coffee to the year end. For our British-based listeners, the exciting news in Frozen Food is that Hot Pockets will be launched there this quarter, following successful introductions in France, Germany and Spain. PetCare Europe achieved a strong acceleration since the half year to 4.3% organic growth. In the East, Russia has continued to be weak. That said, things are looking up and I expect that we will return to historic growth rates next year. There are a number of reasons to support this belief: first of all, the market shares tell a good story: our coffee shares have been showing consistent gains through 2005, whilst we have halted the decline in Chocolate. We have cleaned out chocolate stocks in the trade and discontinued relationships with about 40% of our distributors. This means that we will be selling to consumer demand, rather than to distributor orders. Also, key measures such as credit days and working capital have improved significantly, whilst profitability continues above Group average. In the Americas, the US was unchanged from the half year, Frozen food, including Stouffer's, Lean Cuisine and Hot Pockets, Shelf stable dairy, particularly Coffee-mate, and Ready-to-Drink beverages continued strong. Nesquik is doing particularly well in schools, as the carbonated soft drink manufacturers pull out. We have put about 5,000 vending machines into schools for Nesquik. In Latin America, Brazil accelerated sharply to 5.2% organic growth, with good performances from the three biggest categories, Shelf stable dairy, particularly Ninho, Powdered beverages, particularly Nescau, and Chocolate. This acceleration by Chocolate confirms our comment at the half year that the 2nd quarter slowdown in Chocolate was simply due to the timing of Easter. Mexico went in the opposite direction from Brazil, being weaker across most categories as input cost-driven pricing slowed the RIG. That said, organic growth of 9.1% is an impressive performance. Moving to Zone AOA, Japan's RIG is now positive 1%, although organic growth remains at minus 1.1%. We achieved positive cumulative RIG and share gains in Soluble coffee, with new pouch packaging and the launch of a Mild Excella the catalysts. There was also continued strong growth in Chocolate. In the Philippines the organic growth increased from under 5% to 7.4%, with a good improvement in Soluble coffee, but I should remind you that this market is up against a very strong final quarter comparison. Africa's organic growth increased to 6.5%, from 2% in June. Both the Central/West and South/East regions contributed to the improvement. The Middle East continued to perform well, with 13% organic growth. That said, I expect that all eyes were on China following the product exchange earlier in the year. The organic growth in China halved from 7.5% at the half year to 3.7%. The good news, however, is that we achieved nearly 8% growth in September, so the signs are that we are over the worst, as our investment in communication starts to pay growth dividends. Shelf stable dairy actually had a higher cumulative 9 month RIG than it did at the 6 month stage. The situation is rather different in Infant Formula which is recommended by doctors and is not therefore supported by consumer communication: the recovery in this category may therefore be slower. I will repeat our half year forecast that we hope to be back to normal levels of growth in China in the second half of next year. Nestlé Waters achieved a strong acceleration from the half year to 9% RIG. Organic growth, at 8.4%, reflected negative pricing. Europe was about flat but both North America and the rest of the world were particularly strong, growing at about 17%. In the Other Activities, there were once again strong performances from Alcon, at 9.8% organic growth, and Nespresso, at around 30%. If Nespresso continues at this pace, it will be a one billion Swiss Franc brand by the end of 2006. Just for your information, the sales of Other activities are about 75% Pharmaceutical and 25% Food and Beverage. I have just discussed Waters, which contributed to an improved organic growth for Beverages of 7.8%. Soluble coffee's organic growth accelerated from 5.7% to 6.7%, reflecting strong pricing, as well as improved RIG in Japan. You have probably heard the main news in this segment, which is the launch of Partners Blend in the UK. This has had a good reception from the retailers. The other Beverage categories, Powdered beverages and Ready to drink beverages, have also performed well over the 9 months. In the powdered segment, Nesquik is doing well in Europe following its relaunch with added vitamins and minerals. Ready to drink beverages was particularly strong in the US. There was also a good performance from Beverages Partners Worldwide with 10% organic growth. Nestea is performing particularly well. Milk products improved its organic growth to 5.7%, with Shelf stable near double digit, which tells you that growth in Chilled Dairy continued to be negative. In Shelf Stable, Mexico was weaker but in line with the market, and this was more than compensated by improvements in Brazil, the US, the Philippines and elsewhere. Nutrition reached 4.9% organic growth, clearly impacted by the situation in China. Infant nutrition slipped back despite good performances in many markets, demonstrated by RIG of 9.4% in the Americas. Healthcare nutrition was over 10% organic, whilst Performance nutrition continued to be held back, primarily by tough comps with 2004. Ice cream dipped to 5.5%, due to a slowdown in Europe. The Americas continued strong, with Dreyer's delivering over 10% RIG. There was good growth also in Zone AOA. Nestlé is now the leader in the majority of the markets around the world were it is present, including the US. Next is Prepared dishes and cooking aids, where there was an acceleration to 4.2% organic growth. Both sub-categories accelerated during the third quarter. Chocolate improved due to Brazil, France and Germany. It continued strong in AOA, with 8% RIG. Sugar was less negative due to the US, whilst Biscuits improved significantly due to Brazil. PetCare was practically unchanged at 5.2% organic growth, with Europe a bit faster and North America a bit slower, as discussed on the zone slides. As usual, there is a strong finish to the product groups with Pharmaceutical products slightly higher than in June, at 9.4% organic growth. I am not intending to get drawn into a margin debate on this sales call, but I thought it would be useful to update you on the raw material environment. Inflationary pressure has continued in the second half of 2005, and the cost pressure remains significant for Nestlé. Our response has been continued pricing activity, demonstrated by the 2% group number, as well as a continued focus on our savings initiatives. You saw that in the first half we were able to compensate for most of this cost pressure. Turning to our prospects for the rest of 2005, I can confirm that the Nestlé Model of strong organic growth combined with sustainable margin improvement remains secure for the year. For 2005, we will deliver our target of organic growth of between 5 and 6% combined with an improvement in constant currency margins. The other good news is that the 2005 share buy-back is 80% complete. This means that a second programme can be proposed to the Board of Directors. Sylvain Massot, Morgan Stanley Following up on what you said on buy back, in the presentation you are talking about acceleration in 2006, maybe you can elaborate a little bit more on that. The second thing is on the price increase, we have seen the acceleration in prices all along the year, are you still taking price increases I am thinking about categories like Water in the US, what should we expect in terms of pricing in the next few quarters. Roddy Child-Villiers On the buy back the next Board meeting is in November and the proposal we made to the Board at that time, I canât at this stage give you any guidance on the size. They are already forecasts in the market and I canât give you any further guidance. On the pricing aspect, you mentioned Nestlé Waters, in North America we have tried some slight pricing increases but we have made it very clear that we are not prepared to sacrifice market share. So the sustainability of those pricing increases depends on the competitive reaction. Elsewhere there are some continued price increases in Milk so we are still taking price increases where the input costs demanded. Sylvain Massot, Morgan Stanley Maybe just to follow up on this, can you tell us whether there are any areas where you experience some resistance, some pull back on prices because clearly the third quarter results show that you get good RIG and a very strong pricing. Maybe you can elaborate a bit more on where pricing is more difficult other than water? Roddy Child-Villiers I think we have already covered it. Really is Japan, it is the most difficult market for us in terms of pricing. US Water has been difficult and as I said, it depends on the competitive reaction really, I think those are the two main issues. Arnaud Langlois, JP Morgan First could you talk a bit about the Pet Care business in Europe, it seems that it had a really good acceleration in Q3, and also I had a question about the North American Water business which has seen a stable acceleration in Q3. I would like to know whether you see that as sustainable or whether this was influenced by what happened in the first half of the US, especially hurricanes, have we seen any stockpiling from consumers. And obviously could you also elaborate a bit on the margin impact of this. Have you seen any margin pressure in the North American Water business. Roddy Child-Villiers Regarding Pet Care in Europe. There has been a good performance generally speaking, we have increased shares in the UK and France in particular, we are now the market leader in France. We have also increased shares in Italy and Spain, double digit growth has been achieved in most of the eastern European countries as well as in Switzerland. The growth is as it was at the half year, is primarily in the higher value brands such as Bakers, Pro Plan, VB/ONE, Darling is doing very well in Russia particularly, and also in the Single Serve Wet Cat segment. In terms of North America the category remains dynamic, we seeing PET (category of small formats) up year to date by 25% the total category up about 14%, the performance is pretty broad based so I donât think it is necessarily related just to the hurricanes. When I say broad based it is broad based in so far as it applies to Pure Life, and also applies to our international brands and the regional brands. I donât think people would go out and by Perrier just because there is a hurricane. Thomas Russo, Gardner Russo & Gardner Did you say that the share re-purchase was 80 or 18% complete on the billion dollar authorization year to date. Thomas Russo, Gardner Russo & Gardner Terrific, congratulations. The question about Nespresso which seems to grow at quite a sharp impressive rate. It seems to be growing at an accelerating rate as it gains in size. Could you talk a bit about the mix between equipment sales and capsule sales, roll out facilities and the way it is gaining traction and showing an accelerated growth? Roddy Child-Villiers I think Nespresso has been around 30% for a long time now. Talking to Henk Kwakman who runs the Coffee SBU and used to run Nespresso some years back, his forecasts then was a 30% growth and he was telling me that he had done that year in and year out and would continue to do it year in, year out. Clearly we have rolled out into more countries and that obviously gives it a broader footprint and opportunities for growth. But, it is clear that we are not seeing in that business any impact from the introduction of lower priced coffee machines by other players in the market. But the sales reflect the sales of the capsules. Thomas Russo, Gardner Russo & Gardner In China the infant formula issue in relation to doctor prescribed products, nonetheless as I toured China in early February through Walmart I seemed to see quite a strong offering of the product on display at Walmart so it maybe doctor prescribed but it seems to be available at the standard retailer. How does that allow you to market on the premises, or at the retailer independent of the doctor or is it indeed only a prescription product? Roddy Child-Villiers Thereâs a difference between the Infant formula products and the Growing Up milks. I think what you are seeing in Walmart would be the growing up milks, the Infant Formula milks, the ones for new born babies where the mother is not able to breast feed and it is those infant products that are recommended by doctors and are subject to WHO regulations, there is no marketing. But then, as I say the Growing Up Milks that you are seeing in Walmart, those are the milk products that are benefiting from the consumer communication. So it is a market segmentation issue effectively. Roddy Child-Villiers Thanks very much. For everyoneâs information you can follow the buy back on our web site. Each week we publish the latest state of play in terms of shares bought back. Martin Dolan, Execution Limited On the reconfirmation of the margin target by Mr Brabeck for the full year, can we assume that margins to the end of Q3 are in line with your expectations and that this comment takes into account any higher input costs from the US due to Hurricane Katrina? Roddy Child-Villiers You can assume what you like, but our margin forecast is based on the discussions that the Executive Board had in terms of past performance and the outlook for the rest of the year. Julian Hardwick, ABN Amro Could you talk a bit more about some of the raw material cost trends that you are seeing, I am particularly interested because the wire services are reporting Mr Brabeck as saying that he sees less pressure on raw material prices next year, which would seem to be a slight contrast with comments coming from some of your peers. Could you just give us a run through of the key drivers here? Roddy Child-Villiers I am always talking about 2005 rather than 2006. You might remember that at the half year we showed you an index of weighted average of raw material prices that covered the bulk of our traded raw materials. Since the half year that index has continued to rise. We are seeing particularly cost increases in PET and energy as you would expect and also some cost increases in coffee, albeit that we obviously have some cover in place. It is fundamentally the oil ones that are the most dramatic. Roddy Child-Villiers As you know our biggest food raw material is milk, that has remained stable at a high level and I think thatâs a fair comment, and other few raw materials we have seen grains and fats are down a bit. So, thatâs his reason I guess. He will talk more about that at the Press Conference that follows this call. Julian Hardwick, ABN Amro Could I ask when the Executive Board looked at the larger projections for the balance of the year, whatâs the most recent profit numbers that they have seen. What period of profits for the year, so far this year, have you actually had numbers for. Mark Lynch, Goldman Sachs Looking at the Europe performance I notice that pricing has gone up from 1.2% at the half year to 2.2% at the Q3 stage, thatâs quite a big increase. I think you talked about 10% price increases in soluble coffee at the half year, have you put through any other price increases in Europe at all? Roddy Child-Villiers Coffee is the main one. Thereâs a little bit in Dairy perhaps but thatâs really about it. There is a comp against this period of last year not against the first half of this year. But coffee would be the main one. Mark Lynch, Goldman Sachs Going back to Sylvainâs point at the beginning, what surprised me from these numbers is that you have managed to achieve both a good increase in price and a good increase in volume. As you look into the fourth quarter I would have thought that your pricing momentum would be sustained. Do you think you can continue to drive both to the same degree as you have done in Q3, or do you think we are seeing any potential buy in ahead of price increases in this quarter? Roddy Child-Villiers Coming back to your earlier question, there is also quite strong pricing in France across all categories, France is obviously a big market. It is very difficult for us to answer your second question, our guidance is that we will get to the 5 or 6% organic growth but to try and break that down in one quarter between pricing and RIG is quite difficult. But clearly it is difficult to see those trends changing much in the final quarter just because it is only one quarter in four so the rate of the sales is already there. Alain Oberhuber, Lombard Odier Darier Hentsch Can you give us a bit more highlights between the different segments, lets say the volume products and also the champagne products as you mentioned them, San Pellegrino and Perrier in Europe? Roddy Child-Villiers The outstanding performer in Europe has been San Pellegrino, thatâs done very well amongst the higher range products. It has done particularly well in the UK where it is up about 50%, but also in some of the other markets. Aquarel has continued to do well in Europe which is our low price water which is effectively a price fighting water against the private label. And thatâs doing very well, but its weight is still relatively small in our overall European sales. I think those are the two main winners that we have in terms of European performance. Alain Oberhuber, Lombard Odier Darier Hentsch To follow on France, could you give us some highlights of that region in water? Roddy Child-Villiers We report France and Belgium together, basically the organic growth was flat in France and Belgium. In France it was Perrier, Contrex and those higher priced ones that were more penalized and as I say it was Aquarel that did very well. And again San Pellegrino did very well, even in France. Thomas Schwarzenbach, Bank am Bellevue Is there any special effect in Q3 that would have accelerated the growth rate at the expense of Q4? Question on: Food & Beverage Margins John Cox, Kepler Equities You seem to be saying that thereâs no sign of any slow down in Q4 is that a correct assessment? Roddy Child-Villiers What we have said is that we will achieve our 5 -6% organic growth. John Cox, Kepler Equities Coming back to this whole margin issue. I know you are dancing around it a little bit. On the constant currencies you talk about an improvement for the Group as a whole, can you say that there will be an improvement just for the Food & Beverage business for the year as a whole. Roddy Child-Villiers This is only a sales call so I am afraid I cannot. We have never given a EBITA margin target for the Foods & Beverage business. James Amoroso, Helvea The UK performance in the press release was said to be continuing strong. I am assuming that was mainly Soluble Coffee as opposed to confectionary, would I be right in that? Roddy Child-Villiers Soluble Coffee accelerated somewhat, confectionary was a little bit slower. And something else that is doing particularly well in the UK, even if it is rather smaller, is Coffee-mate which we put a lot of activity behind and is up about 14%. John Parker, Deutsche Bank Could you flesh out a little bit more your comments on ice cream. I think you said you were market leader now in most of the countries in which you operated, can I read that to mean that you overall have gained share in ice cream and if you have got any more details on where you may have done that, that would be interesting. And specifically perhaps within ice cream in Europe you talk about, it was down I think you said, I was expecting ice cream to be a bit better this year because of the summer effect. Could you say whether that was a market issue in Europe or whether that was a share issue. I think you did say that you had been putting prices up generally in France. That strikes me as slightly against the trend of things at the moment, did I hear you right and could you perhaps explain whatâs happened there? Roddy Child-Villiers I havenât actually got with me the individual markets where we were the market leader, although I think thereâs a slide on the web site in a relatively recent presentation that lists them. We have been getting some shares, obviously the big news in that sense is the US, trials were announced in early November so I canât talk too much about that, but we have gained share there. In Europe I think the market as a whole was expecting ice cream to be better rather than worse this quarter, but we didnât have much of an August here in Europe and that does have an impact, even if there is an easy comparison from last year. It is interesting that we do have some quite good performances in Europe and some less good performances in Europe and our SBU head puts that down to the difference between excellent in execution and good execution. And the other thing to say about Europe is that we are much more excited about the level of innovation in Europe for next year, than we had this year. As you know the US this year had a lot of innovation and we expect that level of innovation to be happening in Europe next year. In France I donât know whether it is against the trend in terms of the pricing increases but we have certainly been able to take some towards the end of this year. There is also, I think, last year we had a negative price in this quarter last year. So, thereâs probably a comparative effect, and that would have been because of the Loi Galland. It is important to remember that the pricing is always a comparison against the previous year, the same quarter, rather than against the same quarter of the same year. Warren Ackerman, Citigroup At the half year stage it looks as though Japan was down 1.5% and it is now up 2.4%. Obviously a nice improvement in Q3. Could you flesh out what the key drivers were behind that? Roddy Child-Villiers I guess those are your Q3 numbers you are talking. Improvement in Japan was primarily driven by the strong growth in soluble coffee and as I said in my speech there are two things that we have done, one is launching Excella Mild. Excella is our biggest brand there, so this is a mild variation of the biggest brand. And the second thing is launching a soft pouch. Soft pouches as I expect you know are cheaper than glass jars because you can refill your glass jar. So thatâs been playing in terms of innovation and also through a lower price offering. That being successful in turning soluble coffee business from negative RIG to positive RIG over the last quarter and also our share is up 1%. Also performing well in coffee are the "three-in-ones" and the specialty coffees like Cappuccino. "Three-in-ones" is where we sell it with milk and sugar added. Chocolate has also continued to do very well, it is continuing to deliver double digit RIG, Aero is also being tremendously successful as well as KitKat. Important for the rest of the year, we are just coming into this peculiar Japanese season with the gift boxes, where people buy gift boxes of coffee and give them to their relatives, and this is a key part for us, because it is also very profitable. We have historically done very well in this sector and this is a key for us for the rest of the year. Warren Ackerman, Citigroup Have you seen any price pressure still coming through from the number two player in coffee in Japan, Ajinomoto, I think that was a big issue at the beginning of the year. Roddy Child-Villiers Pricing has continued to be a challenge for us and actually you can see that the pricing has got worse from the half year to the 9 months. Warren Ackerman, Citigroup Is it possible to give us a ball park number for what you think Japanese coffee price deflation is running at year to date? Roddy Child-Villiers No. Because the pricing is impacted by several actions. If we do a promotion, for example when we attach a small soft pack to a glass jar, this impacts pricing. Also there are different things that are impacting the numbers. There is still pressure, that is why we have said at Half Year that the Japanese margin will come off a bit. Warren Ackerman, Citigroup A question on Russia. We have been talking about it for the last 3 or 4 quarters and in the press statement it sounds like you are more confident that it is going to get better in 06. I think the issues we have been through before, include distribution. In terms of your confidence level for that improving can you tell us why you are so much more confident than you were earlier in the year? Roddy Child-Villiers I have tried to do that on the call. All basics of the business are going better. But I think it is important to remember that we had a change of management around April time. They took a look at the issue in Russia and I think if I use a medical metaphor they chose to cut rather deeper perhaps than the previous team cut. And, you know, if you have deep surgery it takes longer to recover than if you donât. So, it is taking a bit longer to recover, but equally having gone deeper the recovery is more secure. So, we are comfortable that, as I say, as of next year we will start to see Russia returning to its traditional growth rates. Thomas Russo, Gardner Russo & Gardner What update can you give us with your improvement with the work with the hard discounters, possibly Lidl in Europe? Roddy Child-Villiers The big news in Europe this week was that Aldi have announced that they will consider the idea of stocking branded goods. We have continued to do very well with Lidl we have expanded our coverage in terms of the markets in which we are present with them. We will at the full year give you an update on the growth of that particular channel. We said last year it was growing at 10% and certainly this year it is growing at more than 10%. And, we are delighted by Aldiâs announcement and we will be doing our best to ensure that they are our brands that are in there. So I think thatâs a good news story for Europe at the moment, the hard discounter channel. Roddy Child-Villiers Globeâs going fine, we are likely to slightly beat our 30% implementation of the systems target for the current year by adding Brazil and Central Europe to the implementations, so thatâs also a good news story thatâs going very well. Closing words Thank you for your questions and as I said before, Nestlé is on track to meet its forecast for the year made back in February, of achieving organic growth of between 5 and 6% combined with an improvement in constant currency margins. Thank you. |
EarningCall_234006 | Hereâs the entire text of the Q&A from Hewlett-Packardâs (ticker: HPQ) Q4 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Yes. Just, considering where we're seeing printer margins right now, how should we think about printer margins as targets going forward? That is, with margins near the low end of your 13 to 15% operating margin target range, should we, in fact, be thinking that they will shift down a little bit? Laura, this is Mark. Thanks for the question. I think we're sticking with our 13 to 15 range. In the 13.2 that we reported, there is some effect for Company-wide bonus that Bob described in some detail. So we think that's the range to continue to stick to. Okay. Great. Thanks. Looking at the enterprise profit, that was certainly far above what I was expecting for the quarter. Looking here, I mean, is this, how persistent, or how sustainable is this margin level, obviously, factoring in seasonal issues? And where there any events in the quarter that helped you that you may not see again going forward? And, I guess, how much restructuring was factored into that number this quarter? Bill, thanks. This is Mark. I'll let Bob add color. No specific, unique one-time events that were in the numbers that would cause it to be different in a forward-looking period. I do agree with your point about seasonality effects that definitely affect the performance of the business, so I wouldn't extrapolate you'd see the same result in a Q1. But no unique event that occurred in the fourth quarter that artificially pumped up results. And the profit performance was pretty balanced within the various elements of the segments, as well. As you know, we had seen, certainly, some weakness in our storage business, and as that product line has been refreshed, we saw, as Mark mentioned, nice growth, but with that, improved profitability. Been a lot of hard work in these segments, and it paid off in Q4. But due to, reinforce what Mark said, Q4 is always a very strong quarter for this highly-leveraged business. So don't extrapolate that level going forward. Yes, thank you. Can you comment on gross margin expectations? They were down year-over-year for the full year for the third straight year. Can you provide any sense on where you expect those to be? And, then, also, you have repeatedly alluded to significant employee bonuses being a drag on various segment profitability and overall profitability. I think the implication is that you feel that those bonuses can be a smaller hit to profitability next year. If that's the case, can you define or dimension the size of the employee bonus impact in '05 and what you're expecting for '06? And if it is dramatically lower, what kind of impact will that have on morale of the employees? Tony, I'll start with the gross margin. We, of course, are not going to give you any quantitative guidance on gross margin. You rightfully note the trend in gross margin, and some of that is just out there. We need to continue to take costs out, which we have planed to do, but we also believe that we're going to have to reinvest some of that improved competitiveness in lower prices, and that's going to continue to keep pressure on margin. Furthermore, we've seen, and may continue to see, strong growth in those elements of the product line that are a bit lower margin, be it PCs or industry-standard servers, whatever. So, we expect continuing pressures. We'll leave it open as to how much of that can offset by our efforts to take costs out. Yes, and, Tony, just one other piece of commentary on gross margins. I mean, there's nary a business in HP that has the gross margin that we report as a Company. So it's really a mix. So as much depends for us on where we get our growth and the mix of that growth by product line to determine what happens in overall HP gross margin. So it gets back into our discussion about our performance in storage and many of our other businesses, Software, that really can have a positive effect on gross margin over time. So that mix is a critical component. As it relates to bonus, I think what we're just trying to do is illuminate the fact that there is a bonus number in the results. Part of what we're doing is, there hasn't been a significant bonus here for a while. So I think that, back to your question on morale, it's probably a good-news thing. And I think the Company has worked very hard over the past several months to earn that. So that's point one. Point two, in the future, though, we're going to continue to index the bonus to improve performance of the Company. And so to the degree that we'll have a bonus, it will be based on the fact that we perform in a way that earns that bonus as it relates to our overall results. So I can't predict that for you at this point in time, other than to say we hope to pay a bonus. We like to expect to pay a bonus. But based on the fact that we, as a Company, perform on an ever-improving basis. Thank you. Mark, if I could ask a question on the printer pricing environment, and I guess related issue that I think you could argue is caused by the aggressive pricing that we've seen, and that would be install base churn. So in the first sense, we've seen Lexmark lower prices again. Is that something that you think you need to respond to? And then on the churn part of the question, given the lower prices that we've seen and, arguably, that printers are more disposable now, do you think that the average life of the printers in the install base is shrinking, which would imply a shorter duration of the annuity stream of supplies per unit of hardware investment? Hi, Richard, thanks. You had a little buzzing on the line as you were talking, but I'm pretty sure I got it. So, first, on the pricing, I will say, I do hear a lot of commentary about pricing, but we're not trying to be the âprice leaderâ in the marketplace. We have certain segments that are high-consumption, segments that we target. We think we know what the premium should be relative to competition, and we work within those models to try to get to the best destination that we think makes sense. So, I think overall, our view is that the pricing has got different factors in different parts of the market. We try to target where we take our price action. We think we know our model. And it isn't just relative to the competitor you named. There are several other competitors and several other segments, obviously, that we target as well. In terms of what's going with these, I don't have a data point to share with you that I can give you about the average length of time that a printer stays installed. So I wish I could help you, but I just don't have any data on that to share with you. Thanks. Yes, good afternoon. Thanks. Could you talk a little more about PSG, Mark, how sustainable are the improvements there? And what is unique about HP's business model there that's delivering this improvement, and is it sustainable? Maybe talk about your dual-sourcing of processors as well as, maybe, some of the product lines you're offering there. It seems that you're doing better than some of your competitors in the consumer space, and that's helping your results. Sure, I mean, a couple of points. One, I think that coming to the Company, just to make a brief bit of commentary, I really haven't heard of a lot of illumination about the consistent improvement in the PC business in the PSG organization. The improvement, Ben, it has really been going on over a period of time. So when you go look at what's happened over the past four years, it's been really steady improvement year by year, and, frankly, quarter by quarter. And I think it reflects a number of disciplines going on simultaneously. So you've got, certainly, a situation where I think we've done a good job with our supply line, I think we're doing a good job building things that people want to buy. We certainly got good strength in retail, which gives us good strength in consumer, and we've certainly got a strong situation in various global and international markets. So when you look at our ability to deal with multiple international markets where HP Co., has a very strong footprint, it's certainly a key strength for the overall PC business. But again, Ben, I would say, this hasn't been a one-quarter story. This has been a multi-quarter story, and, frankly, a multi-year story. And when you say, "is it sustainable," we expect the business to continue to perform. Sure. Thanks. I guess, I could just ask, when you look at your priorities, Mark, for the Company, I mean, one of the things you've done, the Software business, getting that to profitability is obviously one of the high priority items. Maybe you could talk us through how you got that business to or how they got it to profitability, and what your highest priorities are over the next quarter or so? Well, Richard talks about Software, and then I can talk about that. I think the Software business grew, which was the major driver of its improvement in profitability. If you looked at its sequential profitability, its break-even point actually went down by about 5 million sequential quarter-to-quarter. So that has a piece of it, in terms of its performance. But it would have been profitable, even if the break-even point had stayed at the same sequential point it had been in Q3. So I think it's a combination of growth, Andy, in addition to its ability to reduce its break-even point. We are working on both at the same time. And we're looking at refining our Software maintenance model, and when I say refining, just making sure that we run the business effectively, that we get a capture rate for Software maintenance and that we deliver great service as we do it. And as you do that, you begin to mature your Software model, you will see improved performance. So we're very focused on that business at growth, at the same time as being able to deliver a strong operational model. Overall for the Company, I would tell you that what we've been talking about for the past several months is, we're still working on the same things. And that's the fact that we're trying to get our costs right, we're trying to be efficient. And we announced what we did in July 19th, and we've got to continue on getting that executed. Bob described much of the action that we've taken, but we still have more to do to finish off the work that we've already announced. That's point one. Point, two, we're really trying hard to focus on driving growth and expansion, not just overall for HP, but in some of the key markets, and you mentioned one of them, Andy, in Software. So I think we're trying to do two thing at the same time, which is the fact to be efficient in our cost structure, be as efficient as we can at the same time as we focus on trying to grow the Company in key segments as well. Hi, thank you. Mark, I was hoping you could follow up on an earlier question regarding the improvement in Enterprise Server and Storage margins, and just maybe give us a sense of which products primarily drove the uptick in margins? Whether it was more related to improving gross margins or reductions in operating expense? And, then, finally, give us an update on where you are in the process of winding down proprietary processor and platform spend within that group, and whether wrapping up some of that proprietary spend had a significant impact on the improvement this quarter? Thank you. Well, Richard, I wish I could give you a crisp answer to your question, and I guess the good news about the answer is it was pretty broad-based performance. If I could give you one thing I would, but it really is a combination of the fact that we grew revenue, point one. Point two, we were more disciplined in our approach to dealing with pricing, which was point two. And I think the team did a marvelous job of trying to improve their performance in that area, which did have an effect on gross margin. And we were prudent in the way that we dealt with our expense structure. Some had to do with proprietary situations you've described, but at the same time, we were just tighter with a buck, would be the best way I would describe it. At the same time, when you look at Company R&D, Company R&D overall was roughly flat. So I think it's a combination of stories at the same time. And when you can put up good growth numbers you can be disciplined in your approach to the marketplace, and then you can be careful with what you're spending and make sure it's aligned appropriately. Good things tend to happen to the P&L, which is what happened in ESS. Good afternoon. Thanks. Just, Mark, if you could talk strategically about some of the new channel programs that you launched in November, and just what some of the key messages were, and reaction from your channel partners? Sure. We began the process of really trying to align our channel programs into channel performance. So I think the best way to think of it, Rebecca, is nothing more than what we would do in the Company, in the fact that if you're a channel partner and you're performing, meaning, not just higher volume, but more strategic content, that we align around that higher volume. We're going to align our channel compensation and try to align that to the performance of the partner. And like anything else, we do get the question a fair amount, are you going all direct, are you going all direct? And as we say, that's not our situation at all. We're trying to focus on getting into the kind of partnerships that really aligned around where we want to take the Company. So the reaction to it, I think has been pretty good amongst the key partners, because the key partners who are really performing really deserve a better opportunity in the marketplace. So we've had, generally, good reaction to it, and we're also trying to be focused at the same time as having greater predictability in the channel at the same time. And so all of these programs are aligned around performance, predictability, and we think will be a positive for the Company overall. Hi. Good afternoon. Just a quick question following up on your comments about commercial printing. I'm curious as to sort of the level of where commercial printing is running for your business right now, margins you expect, growth rates, and how do you see this growing over the next few years? Well, I probably won't go to gross margins and a few of those things, but what you've in the commercial printing world, and I'll particularly talk about the high-end printing market, but typically go to small and medium businesses. These are companies that typically do a lot of printing in a community, they typically have a high-end, perhaps, analog press. Most of that analog printing base is beginning to move to digital. And as that base moves to digital, we believe we're very well positioned with both our Indigo platform, which is, we think, the best digital printing press in the world. We believe we've added capability to that with Scitex, which really delivers big print, it allows you to, banners that would go across streets, that would go across buildings. So we think we can now come in with our traditional print offerings that you might think of from the Company in addition to Scitex, in addition to Indigo and really deliver the full experience for a printer. And there are numbers, tens of thousands of these printers, just in the United States, in addition, another group of tens of thousands that sit in Europe and around the world. And we want to bring that integrated proposition to those customers. And that includes, not only the printer, the supplies, and the service experience at the same time. So as a result, yes, it does have a positive opportunity for us in gross margin. I think the biggest issue that we've got to deal with there, though, is dealing with our go-to-market model and ensuring that we get to the marketplace and make sure we're participating in those decisions as that market does move from analog to digital. Hi, guys. Quick question on the Services business. Mark, you mentioned that you had the best profitability in the last two or three years, ex-the bonus accrual. I didn't hear you say, though, that Consulting Integration and Managed Services were profitable, however. And given the fact that you guys have been focused on maybe slowing the top-line growth to drive profitability up faster, I was hoping you'd give a little bit more perspective on that. That does seem like an area of possible improvement. And, then, also on the cash front, the acquisitions you've made recently have been mostly software focused. Is that likely where we're going to continue to see activity? Okay. I'll let Bob take the second one, but I'll give you the first one. So to your point, there were improved performances in both of those organizations. And so I would say that probably the best performance, I got to be careful with this Harry, but call it, roughly the best performance over the past several periods in both Consulting and Integration and in Managed Services. Now, I only caution you to say that didn't say they were great results. All I said, they were improved results. So I think that would be the best way to characterize it. And we've been working on trying to improve. And do I think we have more opportunity to improve, the answer is, yes. But at the same time we did show some improvement in the quarter. With regard to use of cash for acquisitions, very hard to forecast any number. We will see some cash outflow for Peregrine and a couple others here in Q1. The areas of focus, though, are no different than what we've talked about in the past, certainly software remains a field of interest. You've seen us do a couple of things in the printing space. Certainly, in Services we continue to look. We'll just have to see. I want to add just a little bit of color too, Harry. I mean, I think to Bob's point, I mean, we're, what you've seen from us is a relatively reasonable predictor of our behavior. I mean, we're certainly not trying to sneak up on anyone here. I mean, we've got areas of focus that are keen for us, and we want to deal with acquisitions that we believe are digestible and manageable. And I think our behavior has been indicative of that. Thanks. Mark, within your revenue guidance for Q1 and the full year, can you just shed some light on what your expectations are for demand trends in the various markets, i.e., consumer, enterprise, SMB, and federal? And, then, also, just from a geographic perspective? Thanks. Well, I think that the message that's the best I could give you, is that within the reason of little bit of difference based on geography, a little bit of difference based on some product segments and some customer segments, demand is roughly steady across the way that we, that we look at things, are stable, maybe that's a better word. So that's how we view things. They're, obviously, are a little different story in Western Europe than you may see in Eastern Europe. A little different story of a consumer than what you would see in high-end commercial. But in the end, I think the best way I could summarize for you, based on what we see, is a roughly stable local currency kind of environment. Hi. Thanks, guys. Bob, I wanted to go back to the share buy-back. What I thought I heard you say is you thought shares would be relatively constant. Was, A, that for the next quarter? Or were, B, you making comments as you talk about the '06 outlook, because I would assume that, in fact, with the pace of the recent buy-backs that share count would continue to work down. Would you help to clarify? Thanks. Sure. I meant to communicate a statement around expectations, steady state throughout '06. Now, obviously, something could change as we go forward. But to the second part of your question, keep in mind that we spent 1.4 billion in cash on share buy-back this quarter, and it just stayed constant. So it's, we're fighting with the increasing stock price. We're fighting increased issuance for stock option programs, as well as, an even bigger factor, is this common stock equivalent, which went up this past quarter over 20 million shares. So even though it's just an accounting entry, it does affect the EPS calculation. It all depends, whether we stay even, get ahead, or fall behind, that depends upon, primarily, what happens to the stock price, because that will drive, exercise behavior and it will drive the CSE calculation. Thanks, very much. I was wondering if you could quantify for us the impact of the bonus on the quarter in terms of the margin? No, Cindy, we are not going to quantify that. We have said what we're going to say about it. It was a significant number. Certainly, you saw how much improvement we had in our results, and that drives a significant number, but we're not going to quantify it. Thanks. Wanted to come around to the revenue guidance question. Looks like the midpoint of guidance for the top line is about 4, 4.5% revenue growth. Can you talk about the expectations from contribution, from acquisitions, and, then, tied to that, it looks like you're expecting a bit of deceleration in Q1 versus Q4. Can you talk about what areas or what product lines you expect slower growth? Thanks. Well, let me start with a bit of refuting the premise of the question. We, basically, are calling for steady, stable, constant currency growth. We had 6% constant-currency growth in '05, and we're calling for that same in '06. It's not going vary on a constant-currency basis, in our model anyways, much by quarter. So there's really no intended message about quarterly trends in all of this. It's, obviously, unknown exactly where currency will end up. And the growth rates will end up being different depending upon what happens to currency. But that's what we're looking for. Thanks. Just a question on the working capital. It's at its lowest level as a percentage of sales in years. How much of the improvement in the trade cycle, Bob, would you say is more structural versus a function of mix? And can you just give us an update on how much more improvement you might expect, particularly on the DSOs and inventory turns? Thanks. Well, first, with regard to receivables and DSO, the improvement that we've had is large largely structural. It does, of course, depend upon the environment, the credit environment, if you will, and how able people are to pay. And as you know, certainly U.S. businesses are in pretty healthy financial condition these days. But putting those kinds of factors aside, we have made structural improvements. It's not really a mix issue. And we should, therefore, expect things to continue at about the same level going forward. We are not predicting any noticeable improvement in DSO from this point forward. Inventory, we've also made good progress this past year. I should point out that after not doing quite as well in the prior year, so we needed to make that progress. But in the case of inventory, there still is room for further improvement in inventory. And don't want to go into now, all the efforts that are underway, but we're still not world-class in our inventory management. Yes, two quick things. One is, I didn't hear any commentary around SMB versus large enterprise, kind of relative strength. Maybe you can comment on that. And, then, secondly, Mark, maybe you could give me your thoughts on how you think the timing of Vista might impact business in '06. Oh, okay. Let me go into the, I'll make a comment on the Vista thing first. I think we factored that into what we delivered to you today in terms of guidance. There is some buzz out there about Vista, we'll see how it evolves. Second question, SMB versus the enterprise. Yes, I mean, again, I could tell you some stories about SMB in the Americas versus in Europe, and I could tell it to you versus the enterprise in both, but I think, while there is some color I could add , it's been relatively steady across those segments. So I can't give you any defining difference between the segments that would, I think, give any illumination. So let me stop there for today and say, first, thanks for your questions. Before wrapping up, I wanted to summarize today's call by saying that I am pleased with the Company's execution in the fourth quarter, that we had solid revenue growth, we saw improved momentum in margin expansion in some of our key businesses, we had good discipline, and we generated strong cash flow. We began the implementation of our restructuring program that will improve our cost structure and allow HP to become more competitive. We returned $1.6 billion to shareholders in the form of share repurchases and dividends. And we rewarded employees for their hard work by paying our first significant bonus in many years. That said, we know we have more work to do, but we are pleased with our progress today. We'll conclude today's earnings call with this we do look forward to seeing you at your Securities Analyst Meeting in New York City on December 13th. And let me thank you, again, for joining today's call. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your presentation. And you may now disconnect. Have a wonderful day. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. 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EarningCall_234007 | At this time I would like to welcome everyone to the KLA-Tencor Corporation Q2 2006 earnings conference call. Operator Instructions I would like to turn the conference over to Mr. John Kispert, President and Chief Operating Officer. Please go ahead, sir. Thanks. Good afternoon and welcome to KLA-Tencor's second quarter fiscal year 2006 earnings conference call. Again I'm John Kispert. Joining me on our call today is Rick Wallace, our CEO and Jeff Hall, our CFO. We're here today to discuss our fist quarter results for the period ended December 31, 2005. We released these results this afternoon at 1:15 p.m. Pacific time. If you haven't seen the release you can find a copy at our website www.KLA-Tencor.com or call 408-875-3600 to request a copy. Rick will lead off today's call with a discussion of industry developments and KLA-Tencor's specific progress and strategy. Afterwards, Jeff will review the financial results for our second quarter and then we will open up the call for questions until 3:00 Pacific time. On the investor section of our website, you will find a simulcast of this call which will be accessible on demand for two weeks. On the website you will also find a calendar for investor events and presentations at investor conferences. You will also find links to KLA-Tencor's securities filings. In those filings you will find descriptions of risk factors that can impact our future results. As you know, our future results are subject to risk. And any forward-looking statements we make are subject to those risks. KLA-Tencor cannot guarantee that those forward looking comments can come through. And although we take on no obligation to update those forward-looking statements you can be assured that any updates we do make will be broadly disseminated and available over the web. With that, I will turn it over to Rick. Thank you, John and thank you for joining our second quarter FY '06 earnings call. Today I will be talking to you about the current environment and our outlook for 2006, an update on KLA-Tencor products, the financial highlights for the December quarter and our guidance for the March quarter. Jeff Hall will then take you through the details of December results and then we will take your questions. 2005 saw a bottoming of orders for semiconductor capital equipment in the March and June quarters with strong growth re-established in December. KLA-Tencor revenue grew in 2005 in spite of the decrease in capital spending by semiconductor fabs. Our customers continued to invest in process control to speed their yield learning on 90-nanometer and ensure the qualification of next generation 65-nanometer fabs. The outlook for 2006 is even brighter. Semiconductor revenues are expected to grow a little faster in 2006 than the 7% growth of 2005. Most forecasts are in the range of 8 to 10% growth per semi revenues. While capital expenditures decreased in 2005, we expect them to grow in the range of 5 to 10% in 2006. The drivers for growth continue to be the transition to new 300-millimeter fabs, the growth of consumer electronics and the 200% bit growth of NAND. Memory was the strongest segment in the December quarter with significant NAND flash spending. But for the year as a whole, both memory and logic were above their long-term averages in 2005. Foundry was the lowest segment in 2005 at 24% of bookings but increased to 30% in December. While foundry increased orders from the low point of June, they are still below their average and we would expect them to increase orders as we go through 2006. Although most of the increase in booking comes from additions to current manufacturing capacities, our new tools are having great acceptance in 65-nanometer fabs where the yield learning challenges are the greatest. Our 2800 Brightfield inspection tool has won awards, head-to-head comparisons with competitive tools, orders, and repeat orders in 65-nanometer fabs. With its superior performance in capturing all types of defect, the 2800 is becoming the standard tool for yield learning at 65-nanometer. Our Puma 9000 darkfield inspection tool has demonstrated the highest defect capture at the highest throughputs, D-RAM, flash, and logic manufacturers all ordered Puma tools this quarter for their 90-nanometer manufacturing fabs as well as 65-nanometer yield learning. Measurement of critical dimensions at 65-nanometers is a major yield challenge for our customers as they need to make more measurements to control the shrinking lithography process window and they need to make new types of measurements such as image profiles. Our Spectra CD optical CD tool is finding increased adoption in 65-nanometer fabs as it makes all the measurements required at higher speeds and lower cost per measurement. Our E-beam based ECD 2 is also increasing its adoption at 65-nanometer as it provides better productivity through automation and matching and better measurements on difficult to measure structures. Staying on Moore's Law presents many technical and financial challenges to our customers and as 2006 proceeds, those challenges will start to come from 45-nanometer. We have been investing in the development of a complete suite of inspection and measurement products for 45-nanometers and we will introduce many of them in the first half of 2006. Now turning to the financial highlights for the December quarter. Our net orders were 513 million, up 17% from September. Revenue of $488 million was up $4 million from last quarter. Net income was $102 million or $0.50 per diluted share excluding non-cash equity based compensations. Including equity compensation net income was $77 million or $0.38 per diluted share. The same as the September quarter. Orders grew in December as our customers increased their investment in process control for leading edge capacity ramps and for yield learning at 65-nanometer. Looking ahead to the March quarter our guidance is as follows. Bookings in the range of up 15% plus or minus 10%. Revenue to be between 500 million and $510 million. And EPS in the range of $0.54 to $0.57 per share. Now Jeff will provide the details for bridging this operating EPS to GAAP EPS. We look forward to a second quarter of strong growth in our business. Our customers have been investing prudently in capacity over the last year. Fab utilization is at very high levels and customers have near term and strategic needs for increased 300-millimeter manufacturing capacity. Process control continues to be a growing part of their investment. Now I will turn the call over to Jeff Hall. Thank you, Rick. As Rick discussed, we are seeing an increasing level of bookings as our customers ramp 60-nanometer production capacity and 65-nanometer yield learning. As a result of this increasing demand from our customers we have begun to increase our production levels after three flat quarters. Turning to the quarter, let me remind you that we implemented FAS 123R in the September quarter and therefore the results we announced earlier today reflect the expensing of share based compensation. As you know, the implementation of FAS 123R impacts our financial statements in numerous ways. Which means current GAAP results are not comparable to those of previous years. Therefore consistent with the current Last Call I will focus my comments on the operating P&L, that is excluding share base compensation. And I will then discuss the impact share base compensation had on those results. We believe this approach best meets the needs of investors and analysts for comprehensive, compliant, and comparable data. As Rick mentioned, net bookings for the December ending quarter were 513 million which is roughly 17% higher than the September ending quarter and 7% higher than one year ago. This number also includes $4.7 million of orders that have been debooked in accordance with our booking policy that restricts actual booking to a set criteria. The set criteria mandates that technical specifications are signed off. Valid terms and conditions are finalized and delivery is scheduled within 12 months. We ended the quarter with approximately $755 million worth of backlog for unshipped orders. Remember, we do not include any service, consignment, or unreleased systems in this backlog number. This order of order backlog allows us to smooth our factory utilization and provide predictable execution from our supply chain. In addition, we have $412 million of deferred revenue that is related to products that have been shipped but not signed off by customers. This is invoiced systems revenue deferred under SAB 104. It includes no service revenue and is made up of tools delivered but awaiting written acceptance from the customer. We remain confident that we have a strong backlog shippable over the next six to nine months and our ability to maintain this significant level of both shipment and revenue backlog continues to help KLA-Tencor sustain profitability throughout any business cycle. The regional distribution of orders for the December quarter was as follows. The U.S. was 17%. Lower than its historical average of 25%. Taiwan was 18%, lower than its historical average of 20%. Korea, China, and Singapore combined were 32%, higher than their historical average of 20%. Europe was 12%. Lower than its historical average of 15%. And Japan was 21%. Slightly higher than its historical average of 20%. The product distribution of orders was, wafer inspection was approximately 45%. Reticle inspection was 23%. Metrology was 13%. Data storage was 2% and service was 17%. Turning to the income statement, revenue for the quarter was 488 million. Up about 1% quarter to quarter and down 8% from the same quarter last year. Gross margin was 56.9% for the quarter compared to 57.1% in the prior quarter. Operating expenses including both SG&A and R&D were 165 million. This expense level was up 2% quarter to quarter consistent with our forecast. This reflects our discipline in maintaining a balanced cost structure while we continue to focus on investing in new engineering programs and increasing application support of 300-millimeter ramps around the world. For the quarter, other income was $16.7 million and the effective tax rate was 21.8%. For FY '06 we anticipate that our tax rate will continue to be approximately 20%, plus or minus a few points depending on the renewal of the R&D tax credit and the resolution of various tax audits currently underway in multiple jurisdictions around the world. Net income for the December quarter was 102.5 million or $0.50 per diluted share. The impact of non-cash equity based compensation reduces this number by $0.12 per share and the approximate breakout is as follows. Cost of goods sold, $0.03. R&D $0.06. SG&A $0.08 and there was a tax benefit of o$0.05. In the March quarter we expect ongoing expense for share based compensation to also be about $0.12 the same as it has been for the last five years. We also expect to have an additional $0.03 to $0.04 of share based compensation as a one-time charge related to the retirement of our prior CEO. Turning to the balance sheet, cash and investments ended the quarter at 2.2 billion an increase of 44 million quarter to quarter. During the quarter, we repurchased stock valued at approximately 49 million and paid a dividend of 24 million. Inventory increased by 16 million to 412 million. This inventory growth can be attributed to increases in raw materials and work in process as we began to significantly ramp our production facilities during the quarter. Accounts receivable finished the quarter at 372 million, up 65 million from September. The increase from the previous quarter is attributable to higher revenue in Japan where normal payment terms are longer than in other regions. Capital additions related to fixed assets were approximately 18 million for the quarter. And depreciation was 13 million. So on a net basis including retirements, fixed asset increased by 5 million over the quarter. Head count ended the December quarter at 5570. Up 130 from September, mostly to support our production increases, field support, and new product introductions. In summary, we have had flat shipments in revenue over the past three quarters and are just now starting to increase production and shipment. And as a result of our backlog management we have been able to continue to fund our advanced development projects. So as revenue increases we will be able to keep our operating expenses near current levels, creating strong incremental margins going forward. This concludes our remarks on the quarter. We will now open the call for questions. Before I turn the call over, let me request that you refrain from asking multipart questions to give others some time. As always we are all on a tight schedule. Can you begin the polling, please. Rick, you talked about the industry growth at 5 to 10% for CapEx. Any thoughts on how the PBC segment should grow in 2006? Thanks. Yes. What we see in 2005, let's start with that, process control, KLA-Tencor grew at about 6% and the industry was down 4%. We think that trend of continuing to see growth expansion as a percent of the total capital will continue and our estimates now is that KT and process control should be able to grow at about 5% faster than industry CapEx. So if we end up at 8%, of course that would put us at 13, anywhere 13 to 15%. Hi, was wondering if you could characterize the customer climate right now? Clearly a better environment than we have seen during the early part of last year. But as you look at their plans and what they are trying to do, how would you characterize the environment to give some sense as to sustainability? Hi, Ed, thanks for the question. I think that the customers are -- have been very I guess cautious, prudent in their investments. But now are more optimistic than they have been in sometime and we are seeing that reflecting in the order activity. I would say that they are more positive. We do see the right kind of discussions happening. If you go back nine months the discussions were about capital expense and operate expense and now it's more about slots and support and how we can get tools to meet their needs. I think it's gotten more positive and we expect that to go on for sometime. Generally at this phase of the ramp, this is pretty early in a ramp and especially one that has had such modest investment levels coming off of modest investment and plus you have got high capital -- high utilization going on, now too. So pretty positive and pretty much across the board. The one area that hasn't really turned on or we don't forecast turning on is foundries which have been below their historical average. Hi, actually I had two quick things. Number one, can you tell us what the shipments were and can you guide shipments? Thanks. Okay. And then last thing for me, you gave us the orders by foundry, you said that 30% of the bookings were foundry can you complete that and give us what the percent for logic and also memory. Thanks. And if you can break memory out by D-RAM and flash possibly. Yes. Sure.. So we said that we had about 28% of logic. Foundry was about 30% and memory was at 42 and about 50% of the memory business was NAND. Congrats on a nice quarter. Just a quick question. The midpoint of the guidance puts you at 590 for bookings next quarter or for this current quarter. Assuming that it stays about that level or above, how would revenue trend for the rest of this year? Bill, John Kispert. Tough to tell. Obviously it goes up. With SAB nowadays it's when the customers actually sign off on it and as you know we have a lot of systems out there that need to get signed off. We have a lot of new product introductions that we've shipped that are still in our inventory too that will get signed off. I would say it's going to get higher as you get out into the June quarter. Again, difficult to tell exactly how much higher until we get actually into the quarter and we are talking to customers about what they are going to accept. So if I compare the shipment to revenue conversion rate now versus a year or two years ago it would be about the same? Yes. My point is I think it's difficult to draw on anything historic in this environment. We've shipped a lot more out there the last couple of quarters than you normally would in a flatter period like this. Some of this stuff is going to get signed off. I don't know if it's the June quarter or the following quarter in September is the answer and I don't know how to give you an algorithm to close on to. Good afternoon, guys. A couple of questions. First, when you start looking at bookings numbers at these levels, this plus or minor 10% variance you put in your guidance is really now starting to become meaningful numbers. I think if you look at the guidance for March the difference between the high and the low end is about 130 million. Is there really that much variance in your business today or can you help us understand why you are giving such a wide range on that and then I have a quick follow-up. Hey, John, John Kispert. It's really about a $60 million range the way I look at it. We told you 15%. If I just off the top of my head guess -- think about the number of opportunities we have for this quarter, I can think of four to maybe five opportunities that are well over $60 million. So the orders are much bigger in this environment. Why? Because there are more capacity buys at 300-millimeter. As we've talked about many times before we hate putting the Company at risk as far as trying pull in orders in the quarter to make a number. We feel real confident with the 15% and we see more upside than downside at this point. But 15% moving up from there is probably the best way to think about it. Great. And then quickly, guys, typically you tend to weather the downturns better in the process equipment group but because of that you tend to undergrow sort of trough to peak. Help me understand what kind of alpha you guys might have to bridge that gap this time as the process equipment space begins to heat up. Yes, I think there's two things and it's really the maturation of process control over the last five to ten years. Our adoption in production environments is much higher than what was, let's say in the four or five years ago. That is there's more inspection, more metrology per wafer per die. So that certainly will help us. The second piece that we've talked a lot about in the prior conference calls is our shipment level has been higher as we put out a lot of new products. And these are products we haven't announced yet. Over the next couple of quarters moving into Semicon West there will be more product introductions from KLA-Tencor around metrology and wafer inspection and a lot of those tools have been shipped already and so those -- and they're in our inventory right now. They are not in orders or revenue and those will turn on us to Bill's prior question too and that will certainly help growth on the high end. Good afternoon. Given the bookings and the shipment trends, it's pretty clear that you are going to go over your revenue peak from the last upturn. And in conjunction with that, with the rationalization you have been doing in your product platforms and whatnot, where are margins going to go? Last time we hit the peak it was like over 59% and it looks like you are going to be able to gain a lot of leverage. Can you talk a little bit about how we are supposed to model margins as we move into this upturn. This is Jeff. Our business model still holds. As we grow revenue and shipments into this upturn we are going to continue to deliver 60 to 70% incremental gross margins. We are going to start to see cycle times come down by 20 to 30% here pretty quickly, cost across our supply train start to drop, our support costs per unit fall, and that drives us into the 60 to 70% that we continue to drive all of our businesses to. So given that, that says that where the revenue rates are likely to go to that you will pass through the 60% gross margin mark this year? Brett, it all depends on obviously the top line. I mean, I don't know what you have in your modeling for our top line, but Jeff's point is whatever the top line is, you can add from this point going forward roughly 60 to 70% roughly incremental gross margin. Good afternoon. Thanks for taking my question. I think you had commented that Taiwan is still pretty weak. Can you help us understand from your perspective what's going on with the foundries right now. I mean, TS&C this morning mentioned they were at 104% utilization. It seems like you should be seeing orders coming from this region. It's a great question, Steve. We had 30% of our bookings last quarter were in foundry, but we said that that was below our historical average. And frankly in our March quarter we actually see it coming down from 30%. So they have been very cautious. The other factor with the foundries is we don't have a lot of visibility because they don't necessarily have a lot of visibility into their ordering pattern. And when they do order, they order big. So we are expecting sometime in 2006 that they are going to turn back on, but we are not modeling in the first quarter. Well, it certainly wasn't in the 60 million I was referring to because it's not -- we don't see it there. But you'd have to ask them, Steve. You mentioned you see foundry mix in March coming down. Can you tell us what you think logic and memory do as well and maybe tell us where they go. Sure. Yes, as I said, foundry is somewhere around 25%. I think logic is also going to be around 25% and we think memory is going to be strong. What we see right now is memory around 50% probably 30% of that will be NAND. So we do see some significant D-RAM spending also in the March quarter. Okay, thanks. A follow-on if I might, today how much of your business is driven by 65 and I'm curious as you have gotten more experience at that node, what do you think your opportunity is per fab relative to 90-nanometers at 65? Yes, sure, about 30% of our business is at 65 and below right now. And there is increasing opportunity as we look forward. John has actually worked on this model. John, you want to take that one? We have talked a lot through the years about a 90-nanometer and we expected about $250 million opportunity for us per fab as each fab actually fills out and fills up which has taken longer over the last couple of years. When we model the same -- and granted it's early for 65-nanometer, we see it increasing for us by about 20% to about 300 million per fab. Again, it's on average fab logic, memory, and foundry. And it's still early obviously, Raj. We haven't done a 65-nanometer fab yet so it's hard to tell. Yes. As NAND flash becomes a larger percentage of your business, are there any particular requirements that are different for NAND flash that change the concentration of product to NAND flash manufacturers or makes them more apt to spend earlier. Some of them are obviously running some relatively aggressive design rules here. Are they more aggressive in spending for metrology and causes control upfront? Could you give us a little into that? Sure. The NAND is a great example of Moore's Law, pushing people to advance design rules and also at the same time they've got this time to market challenge. So we do see aggressive spending in order to ramp up and they are pushing their design rules harder especially now. So it's more the design rule phenomena than it is anything about the NAND process design per se, but they are running at leading edge and they have a very aggressive time horizon so ramping quickly is a big challenge for them as they go forward. Is there any equipment mix differential in NAND towards one type of product or another that is different than a logic or foundry that you see? Two questions. The first one is, LAM gave a scenario of CapEx to be 7 to 10% up this year with wafer fab equipment up 15 to 17% and edge up more than that. The numbers you gave was process control compared to CapEx. Can you give us your sense as to where you see WFE versus CapEx and if process control can be above WFE? Yes. I hear your question. We do think that process control is going to be above WFE in terms of modeling WFE at 15 to 17%. Boy, that would be great. I think that is a big number. But it's so far out. We are looking out. We can see margin gets a sense of what's going on in June, but beyond that it's pretty much speculation. Other than customer body language which as I said is positive. Rick, do you think that WFE though is higher than CapEx this year wherever it plays out because there is more equipment than bricks and mortar and then the second question that I had is do you think that the sequential growth rate in orders is likely to be higher in the second quarter calendar than it is in the first? And that's it for me. Okay. I guess the first part of the question, I don't know. There is a lot of factors in there the test percentage that people are doing, different types of fabs. So not in a great position to talk about that. Second quarter what I can tell you is the June quarter for us has historically been stronger than the March quarter. And we don't see any reason why that that pattern would change this year. I'm referring to the absolute level of bookings, yes. Stronger June quarter. But obviously it depends -- we have this range and it depends where we end up inside of that range what kind of growth rate we see. But high utilization, a lot of customer confidence. So it feels pretty good. Can you give us some idea as you ramp to the 500 million level what's happened with R&D and SG&A expenses? Yes, I got it. Because of our backlog management we have been able to keep our funding for new projects high. So we -- at 165 million we don't think we have to increase much, 2, 3% from here as we move forward. Question, a follow-up on the foundry situation. Can you give a little bit more color about why their mix is different because they still are at 90-nanometer, they're also pushing 65-nanometer. Exactly why would their mix be different because it seems like they also don't, similar to Logic in terms of the metal layers and things like that. Why is it really -- why has it been lagging now for a little while? Thanks a lot. I don't know. I guess you'd have to ask them. They have been very careful in terms of their spending and very prudent. So I think that -- you listen to them now and their utilizations are running very high. Don't know why they are not spending more but I suspect, as we said, we are going to see that happening in 2006 probably not in Q1. Probably after that. Afternoon, Rick, could you talk about the reticle inspection business. Is that following the same cycle as wafer fab investment cycle given the tools are really high priced and would you be having some more newer tools? Any color you could give there about how the orders might look there? Yes, Reticle Inspection, I guess I say high value. We do have high value tools in reticle Inspection and we are both dealing with more and more challenging designs, the lithography designs are really pushing the reticle technologies and that's driving our reticle business. Also we are seeing reticle business in the fab lines. So we have that expansion as well. It looks good and we think that reticle is a solid business going forward and we'll benefit from this cycle as well. So is reticle inspection investment cycle is basically coinciding with WFE or is there some kind of a lag or any different pattern there or it's the same? Hey, Shekhar, John Kispert, I think the interesting thing about the orders we have gotten over the last couple of quarters out of our reticle inspection business is they really are around -- more around 90-nanometer and 65-nanometer. Just a little bit in the 65-nanometer. It's still more capacity buying that's going on. And the bulk of 65-nanometer and 45-nanometer is still in front of us. And it's kind of -- to your point, I think your question is that you tend to see that start before you see the wafer, in our case the wafer inspection in metrology pick up after it, why? Because people are qualifying the reticles and preparing for a ramp. We haven't seen that really pick up yet at the 65 node. Hi, thanks. Maybe you could just talk a little bit about Japan, that has been relatively strong over the last year or so. Do you see the projects? Can you move forward there? And do you think your historical average goes up a bit as Japan tries to take a leadership position again? Yes. We are modeling Japan that the March quarter somewhere around 20% and we finished at 21% last quarter and that is right at historical averages. It's lumpy. We do see projects moving forward there, we also have wafer manufacturing there and we've got reticle manufacturing there as well. But it is off of its historical number -- or not historical but the numbers we saw over the last several quarters. It's down some. But pretty solid. We think it will probably revert more to the norm of 20%. So you think it stays in this as opposed to going back to the higher percentage than it was some of the quarters last year. Congratulations on the quarter. I just want to come back, I think to this foundry question here. LAM research clearly driving for very strong bookings from the foundries and you guys do have longer lead times than them. So it does seem a bit strange and maybe this is kind of a hangover from Semicon Japan. But could one logical explanation not be that either you are seeing market share erosion at that customer base or maybe there is a delay in order placement lost they're evaluating rival tools. How should we think about that? Thanks. Yes, we model as we said at 25%. We don't see any evidence of share erosion. In fact quite the opposite. The last several weeks and few months we have seen continued success as I mentioned of our 2800 product in Puma gaining acceptance. So I don't think it's that. I think that our forecasting window is, as John said, there are large orders that can come in, in and out of the quarter. So in terms of specifics, we may also be doing better in other regions. I'm not really sure how to address it. It's not due to share loss. We will get the business when they spend the money. Timm, John Kispert. I think if you looked at just the raw dollars, we give you the percentages and the totals and you just do the math you'll see that foundries have been increasing steadily for us for the last couple of quarters. Maybe I did the math wrong. I just sort of did it back of an envelope, it looks like it's down about 4% sequentially at the midpoint of your guidance. Maybe I did the math wrong. Yes. It's up. It's up, Timm. And I think if you just did the dollar values on that you'd see that it's rising quarter on quarter the last couple of quarters. And we bottomed out and it's more than double than it was two quarters ago. My point is you just go back two quarters and you will see that it's up much higher over the last two quarters. That's all. Congratulations on nice numbers. I hate to beat the dead horse with the foundry, but I am just going to come back to an observation about the numbers. I think last quarter you mentioned that kind of the swing factor in your order rate, the 5% plus or minus 10% was the foundries and clearly foundry bookings did increase sequentially I think by my math about 51%. From 101 to 152 million. However, orders in Taiwan were down sequentially by 23%. So it is a little -- I guess we got the foundry bookings that we all thought, but I kind of thought the foundry bookings would be coming out of Taiwan. What is your observation as to when you think the Taiwanese bookings would start to increase, which I guess means we are trying to figure out when is TSMC going to place their orders with you and I think there's a general thought out there that they've started to pass out orders to other players and it seems unusual that you don't have them. David, it's the reason we give a range in our guidance, too. We are fully engaged with them. I feel real good about how we are positioned. Clearly in the foundry numbers that you guys got this quarter and in Taiwan numbers you got this quarter is a bunch of business from the largest foundries in Taiwan. And I expect us over, as Rick said over the next six months or so for it to get larger. The prediction of that I guess we are probably a little bit more reluctant to say which quarter it is. If it's this quarter or the next. Okay, fair enough. Just one final thing for me. Can you -- just observation on the U.S. bookings being down sequentially. I obviously think Intel increasing its CapEx substantially would we might see this number revert upward later on in the year? And then just remind us what were your peak order rates in 2000. Sure, on U.S. we did see U.S. as down as a total percent last quarter. We were at 17% but we are forecasting strong U.S. business this quarter probably close to 35% of our overall business. In terms of peak, John, you got that? High 600s. I think it probably got up to 700 in one quarter, but high 6s is what it was peaked. Just off the top of my head in history. Jeff, you have $11 a share in cash. Why not get more aggressive with the stock buyback. You guys' share count is essentially flat over the last few years when companies like Novellus have managed to get theirs down by about 15%. I would think this would be particularly important since you guys are relatively a little bit more heavy in the option expense and how it impacts KLAs P&L. I also have one more follow-up if I could. Well, we were the first in the industry to have a dividend three quarters ago, $24 million a quarter of dividend. We have a systematic buyback plan. Since we implemented our systematic buyback plan we've bought back about 17 million shares at an average price of $38. Over the last two years fully diluted share count is flat. We are in the market every day buying back shares and we are going to keep doing that. Well maybe these are actually then, interrelated. When I look at your gross margins including options I think your gross margins are around 55.5% or so of the quarter you just reported. If you are about to book roughly almost 600 million in orders, I assume that 600 becomes revenue at some point. At a 65% drop through, incremental drop through that would mean I think gross margins including options would go to about 57, 57.5%. A, does that sound right to you and I guess these two questions are really interrelated, but are there any other areas you guys can do to make up maybe another 200 plus bips of gross margins including options to actually hit a 60% including options? I'm not going to question your math, Steve. If your math is correct, it's correct. It sounds all right to me. I think the question is what are we doing to focus on gross margin basically going forward to get some more--? Well, I mean it's interrelated with the options as well. So I'm looking at it all in here and all in I think your gross margin 600 million are probably closer to around 57, 57.5 rather than the talk of our kind of 59, 60. I was just wondering is there any other cost control? Anything else you guys can do to actually do it even to approach a 60% gross margin like you were talking about before, even including option impacts. I guess one thing I would said is we've had this option impact for as long as I have been in the Company. I mean we've had options so it's always been there. It's just now that we are using Black-Scholes to tell you what the number is. But having said that, as you know don't take our eye off the gross margin. I will take you through a couple of the programs that are in the Company today to drive -- continuously drive down our cost per unit. One, and probably the most important is our common platform. We've cut the number of platforms in the Company over the last five years by about 30 to 40%. And that, of course, is going to speed up the learning not only in manufacturing and in service but also with our customers. There is a quicker time to learn how to build and maintain our equipment over time. And you are going to have a more common supply chain with the obvious pricing leverages there and the quickness. The second thing is a cycle time reduction which I think everybody knows is a big part of the leverage in the equipment industry. Especially in times like this when things start to pick up. You can see very quick material changes in the cycle time not only of building and installing but maintaining the equipment across the Company. And we've really focused on that as far as our training is concerned. You can see that in the head count we -- less head count per revenue dollar and so you will see that continue over the next couple quarters and so we are comfortable. So that's just two things I picked, Steve. I can give you a couple more but we are real comfortable with the margin expansion moving forward and passing a lot of that value back on to our customers. Great. Good quarter and congratulations to you on your new roles there. You guys sound like a solid team. Consistent message. Congrats. Good afternoon and thank you for taking my question. Again, congratulations on solid numbers. Could you share some thoughts on any strategy that you might have for the back end process control now that you are not foreseeing all this? And also if you could give us any update on the competitive landscape and the inspection area I believe one of your competitors has put out some eval tools which is getting pretty good reviews. Thank you. Thank you for the call and the question. On your two questions. Back end, we've said all along that there are different ways to look at these markets and these are really make/buy choices and we evaluate the different points of entry. So I'm not going to tip my hand and say how we are going to do it but you can rest assured if there is an attractive market and one we think makes sense we will pursue it. In terms of bare wafer, we always have competition and really no change in that. Our market share in bare wafer continues to be strong and really we are driving adoption of our new technology and the SP 2, very strong both with the wafer manufacturers and semiconductor manufacturers. So we expect customers to look at alternatives but we continue as you know to work very hard to win their business and so no real change in our performance there. I've got kind of a simplistic question. Let me run it by you. If I look at your guidance for bookings of 600, that's roughly 10% below kind of your prior peak of 680. And if I look at my numbers for CapEx, CapEx in '06 is going to be roughly 5 to 10% below the peak in 2000. So when you guys look internally at your sizing activities, how do you justify kind of running at a 600 to kind of $700 million bookings run rate for the rest of this year? Do you kind of look at it from the standpoint of end customers like memory coming down but foundry and logic customers filling the gap in the second half? Or is there a more philosophical reason why you think you could run at this kind of level for a sustainable period of time? Hey, Gary, John Kispert. The way we look at it is really we take a much simpler approach and we just talk to our customers and stay close to our customers. And add it all up and try to explain to you guys from what we see. And we've found through the years that that's the only way to do this. We could try to predict the second half and how high is high and how quick could we get to different highs. But instead what we try to focus on because we just -- through the years have realized that that's just not going to create any shareholder value. The way to do this is to stay close and to build a very flexible organization that can react quickly in either direction. So to say that we kind of model out over the next couple quarters as far as how high our orders could be, it's just not the way we look at things. We will take it a quarter at a time and build our capacity model around that. Did I answer your question? Yes. And just from a philosophical standpoint do you think that one reason you could kind of run at sustainably higher levels is that, A, maybe there is a higher kind of inspection metrology intensity at 65, 45-nanometer or B, maybe you guys are rolling out so many more compelling products on a more regular basis that there is just inherently chip makers are less able to kind of reuse tools in inspection metrology from you compared to process equipment. Gary, I think you hit the two key points. And the reason we bring out the new tools is because we have to bring out new capability to meet those demands at 65 and 45 and there is no question our customers are finding more and more challenges as they go to their advance design rules and asking us and working with us on providing those technologies. So part of our investment level, most of our investment level in R&D is to get those tools out and get those tools to market and as we said earlier you are going to start seeing those come out in the next couple of quarters as we roll out these new products. If you look at any bucket whether it is memory, foundry, logic, wafer inspection, reticle inspection, metrology or any region is there any top two buckets that you can think of right now that you could probably exceed the prior peak in terms of orders? Gary, that's a hard one. I don't have that kind of data in front of me. I will tell you we have people running every one of those businesses and every one of those regions and that's certainly their quest. And again it's back to when our customers want it and then of course our goal is to make sure they adopt as much as possible. Thanks a lot. Good afternoon. Couple of quick questions. First, following up on the question about reticle inspection. Do you think it can be a strong bookings in March and then secondly how is the demand from the Japanese wafer manufacturers? Thanks. Sure. Thanks for the question. Reticle inspection continues to do well and we expect the March quarter to be somewhere in the 15 to 20% of our overall business. Japan, as I said, we do see the wafer manufacturing supporting this 300-millimeter ramp and so we have got good business there. I think the one thing on wafer though, is the wafer capacity buys we probably had saw a stronger quarter in wafer capacity buys last quarter and so we do see that leveling off a little bit but we see some activity in the wafer fabs there as well. John, the reticle business, any of these applications addressing the flat panel display market and if not is there an opportunity there? Hey, Bill, it's Rick. No, not really opportunities in flat panel. There may be opportunities but it's not where we are focused right now though. We are focused on semi and we have enough challenges to address there. A couple questions on gross margins. Can you give us a little bit more color on why gross margins went down this quarter again? And then secondly, you said you said you will be ramping new products. Is this going to be a net positive because the design common platforms or is this going to be a net negative because you are going to be ramping up the manufacturing learning curve? Let me start with the gross margin question. What happened in December is exactly what we would have expected to happen in December. It's the beginning of an up cycle. We have got a bunch of new product coming out. Shipments and revenue have been flat for the past three quarters. So as we started to significantly increase our production we saw about $1 million of ramp related costs start to hit. Things like overtime, NPI materials, early stage systems testing. That stuff starts to hit the cost line and we are still ramping and the revenue hasn't come through yet. So as the revenue starts coming through like John was saying and I was saying earlier, cycle times are going to drop dramatically. The costs are going to drop across our entire supply chain. The support costs per unit go down. And we are headed for 60 to 70% incremental gross margin going forward from here. Hey, Phil, it's John Kispert. Certainly they are designed and we pointed them at markets with that in mind. What is always difficult until you fully ramp the products is to see exactly what the unit cost is going to be over time. Right now I don't see any reason why they won't be, given the common platforms and some of the things we have talked about. But you can never be sure until you have been through the ramp with the next generation of platform, next generation of the product. Right now it looks pretty good to us. Great, thank you very much for everybody participating on the conference call today. Our next conference call is currently scheduled for April 27, and we look forward to speaking with you next quarter. |
EarningCall_234008 | Hereâs the entire text of the Q&A from Baiduâs (ticker: BIDU) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you very much. Robin and Shawn, congratulations on your first quarter as a public company and the great results. I have three questions. The first is, as I look at the growth in the number of new online marketing customers, it's a record for you. And I was wondering if you would talk a little bit about the initiatives in terms of an internal sales force or other key priorities that have driven that benefit and if you expect that to continue at the rate of over 11,000? The second question is, as I look at your revenue for online customer, this is the first quarter that we haven't seen a meaningful increase sequentially in revenue for online customer. Is that a function of a lot of your new customers coming late in the quarter, which would, basically, the run rate was probably higher than that and so, it's not really showing the true growth or are the new customers that are coming on spending less than existing customers, so the weighted average doesn't increase as much? And then the last question is, as I look at your growth sequentially, how should I think about the growth in queries sequentially versus the growth in monetization sequentially? Thank you. I think for the customer number growth. We are very pleased that we added more than 5,000 GSM new active online marketing customers during the past quarter. I think that's a combination of several factors including the strong branding effect of our successful IPO and our more aggressive approach in investing in the distribution network and the sales force, including direct sales. We certainly cannot guide you on the increase in terms of customer number. But, we do think a number of active online customer is a very important matrix for our business. Active that part revenue per customer, probably Shawn can say some black on that. I think, Anthony, you are right. I think the fact is that, many of the new additional customers were added throughout the quarter. Many of them came in the latter part of the quarter, which contributed to somewhat a reduced per customers spending effect. But, I cannot quantitate to tell you exactly how that impact is. But, I think you're right. On your third question, I think it's definitely true that the number of queries continued to increase during the past quarter. Our revenue growth was attributable to a combination of traffic growth, customer expansion as well as our continued fine-tuning of our pay-per-performance platform. At this time, I'd like to say that we will only take one question each person for the first round. And if you have more questions, we'll be happy to come back to you later on. Hi. Morning, Shawn, Robin and Cynthia. Great quarter. Well, one question is, say in the first quarter, which are the top five industry groups of your customers? There has not been a significant change from our past experience. I think as mentioned during the road show, our industry representation is very diversified, as we serve actually, through the, I think over, close to 40 industries are represented in most of the top, 80% plus of our P4P revenue. Some of the usual suspects in the one third tends to be on higher than the others include e-commerce companies, then, of course, the manufacturing of healthcares and electronics. These are definitely the first top few that will come to my mind. But, there's not really a dominant factor. Good morning, Robin and Shawn. Congratulations on a great quarter and your first quarter as a public company. I had a question on the competitive landscape. Could you give us an update on how things are, especially with the Google and now with Yahoo and the Alibaba combined? You obviously have maintained the lead and they are the number one Web site in China. But, what have you observed in the industry in terms of push from the competition and what kind of reactions have you had to those in terms of either increasing your R&D spending or have you done any increased marketing spending and so forth? As many of you know, that we were not the first to provide Chinese language search. We were actually a latecomer in this area. We were quickly able to catch up and surpass everyone, including the companies you mentioned in the Chinese search space. We do realize that a lot of companies now realize the Chinese search has a big potential. So, we are prepared for more competition going forward. As of now, I think we are very focused on providing the best user experience and long-term growth. Because of our focused strategy, Iâm confident we will be able to maintain and expand our market leadership position. We do not see anything special during the past quarter in the competitive landscape. Good morning, Robin and Shawn. I have a question in terms of distribution. You mentioned earlier that Baidu opened up new office in Banjo. And do you have any targets for direct sales versus agency sales? And what is the margin impact of that? China is a very big country. Different areas have different characteristics. We've been working on our distribution system for a number of years, starting from the beginning of 2002. And it is still evolving. In different areas, we try different strategies and approach whichever well benefit the company in the longer-term. We believe that we will have a combination of direct sales and distributors for a very long time. In short-term, that the margin impact may not be so obvious for that change. We don't actually break down in terms of revenue between distributors and direct. And it will certainly change from quarter-to-quarter. We will do whatever is best for our longer-term growth. Thank you. Good morning, Robin, Shawn and Cynthia, as well. Let me add my congratulations. I'm going to stay on the distributor question. Could you maybe update us on the total number of distributors that you have, commenting on how many you added during the quarter, did you acquire any of them? And maybe comment, are you comfortable with the current size of your sales network in light of the recent push from Google, Sohoo and what is looking to be a really large sales force at Alibaba Yahoo that is being put together? Thanks. Yeah. In terms of number of distributors, there has been no significant change for our system. We think the number of distributors is not just the metrics for the efficiency or performance of our sales network. We actually look more on the sales efficiency performance for the number of sales people as well as the per salesperson performance. We, as I said before, have been working on this sales network, including the distributing system, for quite a few years. We believe we have the best understanding of the Chinese market, online marketing market, especially for the small and medium enterprises across the country. I think currently, we have the best sales network and we continue to gain momentum in this aspect. Hi. Good morning, Robin and Shawn. I have a question regarding your spending. I understand, you're investing heavily in R&D and SG&A for the new products and, as well as brand building. And I do agree, that's a great strategy at this stage of your business. But, I just wonder if you have any rationale in terms of the spending patterns, i.e., are you targeting any specific percentage of revenue when you make budget or is that more event driven, sort of sporadic spending pattern? Lea, this is Shawn here. Actually, when we look at our business, when we decide how do we spend our resources, we certainly do not have a number that would tie to a percentage of our revenue. Now, margin is not our target. It is not our primary driver. Anything in the near-term is not clearly what drives our investment strategy. As Robin mentioned, what we were looking at this market we believe is long-term growth potential. During the quarter, we invested very significantly in R&D and in sales distribution network strengthening that instead of direct sales. And none of those is tied anywhere to the near-term in a revenue growth or earnings impact. This is really appropriation for the long-term growth. Capex is another good example of that. We built a new data center. And associated with that, we have spent significantly more than what we did in any previous quarters. And that is something that we've done for the next few years and it will be good for our service to our users in few years to come. Yes, thanks for your time. That we have recently, Sohoo said that Sogo now has achieved about one-third of your traffic, up from one-fifth a couple of months ago. I wonder if you could comment on whether you are seeing any impact from their growth. And also, they are at some point in the near future going to start charging for their services on Sogo as opposed to just on Sohoo. And do you have any plans to try to have any campaigns to combat what might be fairly significant competition? Thank you. So far, their impact has been very minimal. We do not expect it to have a bigger impact for the near future. The market share for Baidu and the domestic Internet companies in China in terms of search are very different. We don't think that they will be able to become a serious threat for us any time soon. We don't expect to make any adjustments in terms of our sales network, marketing strategy based on their moves. Thanks. This is a question on the fourth quarter guidance. When you are projecting around 200% growth on a year-over-year basis, is there anything related to the seasonality? And also, is it mainly coming from the customer growth rather than the monthly spending growth? Thanks. Wallace, let me make sure I understand your question. Your question is the guidance for Q4, whether the revenue increase will come from the number of customers or perhaps more revenue. Is that the question? Okay, sorry. Well, Wallace, let me assume that your question is asking where the revenue growth that we projected for Q4, is coming from. As we continue to tell the investors, we believe the number of customer expansion in the foreseeable future will be the main driver for our revenue growth. Given the rapid pace of new customer additions, the impact on the per customer revenue is hard to predict. But, we do project that will be a very significant swing. I do need to add that seasonality is the nature of the business. When we do our future projection on revenue, we do take the seasonality into consideration. Q1, calendar year Q1 is generally the slowest quarter for our business. And when we decided on Q4, we do look at what we have done in the past, especially what's the Q-on-Q and year-on-year growth for Q3 and Q4 for the past few years. Yes, this is actually Victor Anthony in for Bob Peck. I just had a quick question about your product launches. If you have been making good progress on recent product launches; you talked about a few of them earlier in the call. What is it, your thoughts on future product launches relative to some of the recent launches by some services provided by US. For example, blogs, blog search, instant message, emails, toolbars, stop and search. I'd like to get a sense of which of these products actually make sense for the Chinese market and how are you guys thinking about that going forward. Okay, good. Okay, this is Victor Anthony in for Bob Peck. And the question I was asking was with regard to product launches. I know you guys have been making some decent product launch, good progress on launches in the past. You talked about a few products early in the call. I wanted to know how you are thinking about product launches relative to the searches provided in the US. Sure. Baidu is a market-driven company. We do seriously study the market needs and demands. We do seriously study our user requirements and user behavior changes. We have been innovative, we launched a number of new products during the past quarter and we will continue to do so. But, our philosophy is probably a little bit different from some other companies in this industry. When we launch certain new products, our goal is usually not for PR purposes only. We usually think that those products have the potential of becoming a very popular product or service. That's how we look at the product innovation. Thank you. I wanted to talk about the data center expansion. Could you guys comment on how much capacity, in terms of quarters, do you think you now have? Is this new data center going to take you through the next couple of quarters, through all of 2006? And when should we be expecting you guys to perhaps add a new data center or significant expansion to your existing one? Thanks. Well, our new data center has been added to accommodate our growth in the foreseeable future. It is a fairly significant addition. As you can tell, that depreciation expenses amounted to a quarterly increase of 67%. And I think our cap ex, that we made was rough. 85% of our Q3 Capex was spent on servers and the remaining was on some of the network equipments. It's something that, the Capex expansion will go in, the gross will be something sort of like a stairs. Once we make investment in the Capex, with, which we built a new data center, the Capex level will stay there for the near fourth quarter until the traffic growth reaches a different level. Then, we have to increase. So, we're not expecting the immediate quarterâs. We will be having a significant increase as we had experienced in Q3. And our next question, sir, is a follow up question from the line of Safa Rashtchy of Piper Jaffray. Please proceed. Yes, thank you. Robin and Shawn, I wonder if you could give us an update on the whole MP3 issue. Where are you in terms of the legal proceedings, what is the format of your music search offerings right now and do you think you might make some further changes in that? Safa, as many of you know, that we are only providing a search function for file sites or MP3. It's not a download service. We have been trying to communicate this both internally and externally. We believe that we have the largest user base in terms of visual entertainment. We are actually open to all kinds of options in terms of corporation mix it up of relevant parties. We believe we should be able to play a role as a search engine in the value chain. Having said that, I'll have Shawn to give you a more detailed update on the lawsuit proceedings. Right. Well, as you're probably aware, Baidu was a defendant in a number of MP3 related lawsuits. Specifically, there was probably eight of them. And they were brought against either by the major record labels or by the affiliates in China. Seven of those, the total number of the lawsuits were eight and seven of them were filed against us in the intermediate court in Beijing, except one who was entered in the lower court in the district court in Beijing. The one that was entered in the lower court, there was a lower court ruling, which the ruling was against Baidu and the actual result was, approximately one-tenth of the damage claimed by the plaintiff, was awarded to them. And that's a total of approximately less than $70,000 US in the amount of damage. Baidu believes that ruling was not with any merit and we have already appealed in the higher court. We continue to believe that Baidu's business practice and conduct is in compliance with laws and regulations in China. We are a search engine company. We do not upload or store or edit or download any MP3 services. I think the lower court ruling was based on a misunderstanding of the facts. Actually, the higher court proceedings are still ongoing. We cannot at this moment comment on any specifics, there's not any progress yet. We're still in the legal proceedings. And our next question, sir, is a follow up question from the line of Lea Howell of Thomas Weisel Partners. Please proceed. Hi, there. Just wondering if you have observed any trend in terms of the geographic locations of your new customer sign up? In another word, are most of your customers concentrated from tier one cities or more moving downstream to tier two or tier three? Lea, let me, Shawn here. Let me answer that question. We have not seen any drastic changes in patterns. Historically, what we have seen is that, our revenue, our customer base, fairly represents that of the economic, the pattern of Chinese economic development where the largest cities more in the coastal areas tends to be areas where we draw a majority of our customers. We've seen that pattern continue at this stage. Because we are in a very early stage in the paid search industry, I think almost every region has a great potential. So, as a result, I believe wherever we put our sales force, either direct or distributor, to work, we will be able to grow the revenue quicker than areas we donât have a presence yet. Hi, good morning. My questions also relate to the music search. Can you, because there are many stories about the new business model on the music search. Can you comment on the new business model people are saying about some fee-based feature? Also related to that, I see some brand advertising on the music search channel. Do you have a breakdown in terms of how much revenue from the music search channel? Thank you. As I mentioned before, we probably have the largest user base in terms of digital entertainment, both on our MP3 search and other searches, including the Web based search. A lot of people come to Baidu to look for entertainment or animated materials. So, we are happy that we are in the leadership position of this and we are open to all kinds of new business models that may help us to better moneterize our traffic and better serve our users and our customers. In terms of the potential changes, we, at this time, itâs not easy for us to say we will go with a paid model or continue the advertising model. But, at the end of the day, because of the demand for digital increment is so high, we believe we should be able to capitalize on that longer-term. Ming, should answer your question as to the proportion of the MP3 related revenues, we, in the past, in recent past quarters, our MP3 related revenues was a very significant amount of our total revenue. There has been around or less than 5% in recent quarters. And our next question is a follow up question from the line of Anthony Noto of Goldman Sachs. Please proceed. Mr. Noto, your line is open, sir. Thank you. Shawn, I know that you had mentioned that you will continue to invest and as did Robin. And I was wondering if you could give us a general sense of where you see margins going over the next couple of quarters? Is it fair for us to continue to think that EBITDA will continue to grow sequentially? And how should we think about margin expansion at a high level in terms of, maybe, incremental flow through? Anthony, as we mentioned in our, I think I addressed the question earlier, as well. When we look at our business, we're looking at the number one priority, we focus on is what our users are looking for and what our customers are looking for and how should we better provide them because we believe in the inherent leverage in the P4P business model. We believe, as long as we are able to grow our customer base and provide user preferred features and product services, that we are there for the long-term gain. In the near-term, we are now focusing on targeting in margin target or a leveraged target. But having said that, I think, like I said, it is the leverage that is inherent in our business and we will be making investment and we will be enjoying the benefits of leverage going forward. In terms of our current margin, I believe we are in line with some of the market leaders in the US, if you compare us with them on apples-to-apples basis, meaning either including or excluding the traffic acquisition cost. Because we are at such an early stage, the revenue size is relatively small. Margin could fluctuate depending on how we execute our strategy to invest and to grow our business. To give you an example, on July 1, the first day of Q3, we decided to take off a number of text links, sponsored links, that is not query sensitive on our Web page search results. That took away about $1 million US from our top line. We believe this kind of action would benefit our users and would benefit the company in the longer term. Although Q3 is the first quarter for the company as a public traded company, we didn't try to push the revenue higher and they try to show a better margin in expense of our longer-term growth. This is what we believe that we will do in the future, too. OPERATOR INSTRUCTIONS. And our next question is a follow up question from the line of Wallace Cheung of CSFB. Please proceed. Hi. Thanks. Just wanted to get an update on the Baidu union development because I find that the traffic acquisition cost as a percent of revenue actually has gone up by 3% from second quarter to first quarter. Is that meaning that you are getting more revenue from the Baidu union than you expected, that you measure? Thank you. Wallace, it's, the general trend in Baidu's business operations is that our organic traffic has been growing very rapidly, although our union traffic has been growing, but it's at a somewhat lower speed. We do see opportunities in the union funding continue to grow. There has not been any significant change in terms of the revenue share arrangement with union members. But, however, we are looking to initiative new avenues of increasing our affiliate traffic. There has not been any significant increase and we are not expecting a significant increase. But, we see that though we see that is now with that we could potentially grow. Wallace, does that answer your question? Good morning. I just wanted to check. I was thinking about revenue per customer correctly. I believe you suggested earlier your main growth driver going forward will be number of customers rather than sales revenue per customer. Do you find that new customers and old customers have fairly similar spend or do you find that the old customers are increasing their cost, by say number of hits over time while the new customers are populating new categories that initially lower cost per click and then getting up over time? We donât believe there are distinctions between the new customers and old customers in the aspect you just mentioned. The rather flattish revenue per customer really reflects that we add new customers to our customer base. Thank you. Maybe a follow up question on competition. I know you guys have commented on this, but do you think that you've outgrown or grown faster than the market this quarter, hence taking share? And if so, whom do you think you've taken share from? Or does your top line strength in many respects just reflect more of an up tick in the overall search market benefited by your IPO, if nothing else, that's bringing more query traffic to search in general in China? Thanks. Jason, it's really hard for us to give any concrete evidence on that because many of our competitors in this space do not disclose any information related to their page view or number of customers, that kind of thing. We believe that we are executing our strategy very solidly and we believe that we have added more customers than anybody else in this space during the past quarter. Jason, just to supplement Robin's point, it is not only the strong brand impact of IPO that has led to this, our revenue growth for the quarter. There are actually a number of factors. And the IPO, in fact, was only one of them. And I think the others are our improvement in effecting the sales and distribution and also of the traffic growth itself. And all that contributed to the revenue growth. Yeah, it's actually Victor Anthony again. I apologize if I missed this earlier. But, I wanted to get a mix of your headcount increase. I think you said earlier it increased about 300 sequentially from the second quarter. And second, I wondered if you could just comment about the traffic coming from outside of China to Baidu. Let me answer the first question in terms of headcount increase. The most significant headcount increase came from the area of sales and marketing. As we mentioned, we set up our direct sales forces in Banjo. That contributed almost half of the headcount increase for the quarter. But, next to that is really R&D area that we have increased close to 30% of our headcount in R&D. And that's an area that we want to continue to invest aggressively. In terms of traffic outside China, during our history, it's been always under 10%. As the Internet population in China keeps growing at a faster pace than other regions of the world, we believe that the domestic traffic will continue to appreciate in terms of percentage of the total traffic. Also, I believe that in the future, going forward, more Chinese will only need to search for Chinese information only. Previously, a few years ago, maybe people still need, a lot of people in a lot of cases, to access English information. And as you know, Baidu is a Chinese language search engine. We do not collect lots of pages in other languages. I think going forward, more and more people will find it sufficient to search for Chinese information only. So, that actually will work for us as time passes by. And our next question, sir, is a follow up question from the line of Wallace Cheung of CSFB. Please proceed. And, Mr. Cheung, your line is open, sir. Yes, sorry. Hi. I recognize that you have increased the first time deposit from 1,500 to 2,400 and the minimum deposit, as well. Should we expect revenue and customer deposit will increase even at much faster rate in the fourth quarter and then more quick quarter? Thank you. The increase in the initial deposit was just a measure to make our sales effort more efficient, especially for those deals that need sales face-to-face communication or multiple rounds of phone calls. We believe that businesses across China are not so sensitive about the initial deposit of 1,500 or RMB2,500. Also, it does not affect our top line or bottom line or margin or whatever. It's just for convenience. In the future, we may adjust it from time to time, but it's probably not going to play any important role in the business. And our business is very much a recurring business, so the initial deposit was not a big factor. And I think the real reason is the efficiency of the operations and the convenience for our customers. And our next question, sir, is a follow up question from the line of Ming Zhao of Susquehanna Financial Group. Please proceed. Thank you. I would like to get your thoughts on two aspects that may limit your growth. One is the online payment system in China is not mature. Two, many SMEs, they don't even have Web sites. So, do you think those will limit your growth? I think you are right that online payment system in China is not mature and the SMEs, many of the SMEs are not online yet. But, from our perspective, we actually see this as opportunities. We've been growing very fast during the past two years given that, despite the fact that these two factors are actually limiting factors. I have to say that more and more SMEs are getting online nowadays and payment systems have been improving. So, going forward, we will be less limited by these two factors. Hi again. You mentioned earlier that you removed a non-query specific link in July. Are you planning any other inventory changes in the near future? Thank you. Sure. I believe that the management mentioned earlier that you removed a non-query specific link at the beginning of July. Are you planning any other substantial changes in your advertising inventory in the near future? Yeah, let me answer that again. We do not have any plans to do, to make significant changes in our inventory. But, we are a user and market driven company and we do look at the long-term growth potential for our business. So, we will make adjustments from time to time if we decide that would benefit the company longer-term. OPERATOR INSTRUCTIONS And our next question is a follow up from the line of Dick Wei of JP Morgan. Please proceed. Hi. Robin, you mentioned earlier that you have made some enhancements to the P4P platform for Baidu. I wondered what are those enhancements and if that leads to any of the growth during the third quarter? And also, how is that P4P platform compared to some of your other competitors like Yahoo or Google? Thanks. Yeah. As I mentioned during our road show, P4P is a young model. We started to offer this back in the fourth quarter of 2001 and we continue to see that there is a lot of room for us to improve to better serve our users and customers. During the past quarter, we continued our efforts in refining those. That's including an adjustment of our click-through rate, coverage rate, the average clicking price, the position or location we show other links on our Web page to the search without page, the way our customers describe their Web sites, the title summary, the way they submit their key words, lots of places that we are making adjustments to better serve our customers and users. This is probably a combination of two slightly different business models between the old overture model and the current, say Google model. I would say our model is somewhere in between. Hi, Robin, Shawn and I have a question here. And I think one of your strengths for Baidu, which has been overlooked in your online community and Baidu Post Bar is the number three traffic contributor to your company. And what is your trend there and what do you see this part of the business continue to drive traffic and what are you committed to for your company? Thanks. Yeah, the Post Bar online community is not a simple community. It's not a simple online community. It's really a community for search users. The way it works is whenever a user is asking a query, only he or she will see a number of results that's available on the Internet. But also, we have a dedicated message board to that query. Users increasingly come to this kind of message board to discuss questions they have and share information. So, it actually functions as a supplement to our search result. And in that sense, we have been bridging a higher barrier to entry for our competitors in terms of search engine users. But, as you mentioned, the Post Bar community is tracking ever increasing percentage of our total traffic and users. And we would be open to explore an opportunity to better monetize that part of the traffic. OPERATOR INSTRUCTIONS And our next question is a follow up question from the line of Ming Zhao of Susquehanna Financial Group. Please proceed. Okay, thank you. I would like to ask you a question about the seasonality. Do you guys also experience same weakness in the first quarter? Also, in fourth quarter, I think your guidance implied about a high single digit quarter-on-quarter growth. Compared with third quarter, it's 20 plus growth. Is this a typical seasonality that will be in your business? Thank you. Yes, it is. Our business is inherently seasonal. And Q1, during which Chinese New Year happens, yearly the slowest quarter, as I mentioned before, when we give the Q4 guidance, we actually looked back for the previous year and yearly that the growth rate for Q4 over Q3 is slower than the growth rate for Q3 over Q2 for each year. And ladies and gentlemen, this does conclude the question and answer portion of today's conference call. I'd like to turn the presentation back over to the speakers for closing remarks. Once again, thank you for joining us today and please do not hesitate to contact us directly if you have any further questions. Ladies and gentlemen, thank you for your participation in today's conference call. This does conclude your presentation and you may now disconnect. Have a great day. 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EarningCall_234009 | Good morning. My name is (Jenny) and I will be your conference operator today. At this time I would like to welcome everyone to CIT Third Quarter Earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and the number 1 on your telephone keypad. If you would like to withdraw your question, press star 2. Thanks (Jenny) and good morning everyone. Welcome. Weâre delighted that youâre here with us today for a review of our third quarter results. After formal remarks by Jeff Peek, Chairman and CEO and Joe Leone Vice Chairman and Chief Financial Officer, we will move into Q&A. Now as you know, elements of this ca ll are forward-looking in nature and relate only to the time and date of this call. We expressly disclaim any duty to update these statements based on new information, future events or otherwise. For information about risk factors relati ng to the business, please refer to our SEC report. Any references to certain non-GAAP financial measures are meant to provide meaningful insight and are reconciled with GAAP in our Investor Relations Section of our Web site which is located at www.cit.com. Thank you Valerie and good morning everyone. As you have seen from todayâs announcements, our earnings, we delivered another outstanding quarter in which CIT demonstrated its agility in meeting both its immediate and long term objectives. Our diluted earnings per share incr eased 23% to $1.06 over the third of 2004. We exceeded our target return on tangible equity of 16% with a number of 17% for the quarter and 16.2% for the first nine months of 2005. Importantly, origination volume increas ed 34% to $8 billion from the third quarter of last year. Total managed assets were at 61.3 bil lion -- up 17% compared to last year. And asset growth was broad based this quarter and the new business pipeline remains solid. Now here are the business highlights for the quarter from my perspective. We saw important momentum in all of our sales initiatives which I talked about last quarter. We are making significant progress getting our sales organization mobilized and seeing very strong trends in new business. We also created a well resourced o ffice of sales and marketing at the CIT corporate level as well as chief sales officers in each of our business units. And we recruited an additional 133 salespeople during the quarter. As a result, virtually all of our sales managers are now trained in using these tools and forecasting capabilities to manage our client relationships giving us more detail on sales calls, conversion ratios and productivity. We continue to expand and establish relationships with companies such as Amazon.com, NEC Europe, Toshiba, Northrup Grumman, Arbyâs and Under Armor all of which added to our business in the third quarter. Now during the quarter, we made furt her use of our risk adjusted capital model to improve the composition of our portfolio. We continue to look for ways to sell under-performing businesses and reinvest the capital in other areas with stronger growth opportunities. This redeployment of capital allows us to achieve better long term returns for our shareholders. For example, in September, we initiate d a program to sell a number of vintage out of production aircraft as part of our strategy to maintain a modern fleet of airplanes capable of contributing positively to our risk-adjusted returns. And finally, after prolon ged negotiation, we took advantage of the strong commercial real estate market by selling our interest in Waterside Plaza, a residential complex in New York City. Now the net effect of these actions will be positive in terms of enhancing ongoing returns and the overall quality of our portfolio. Having stipulated the new investment in the sector would require improved return, we were pleased to see demand from international aerospace clients strengthen and the rental rates rebound. As a result, we are increasing our investment in this portfolio to take advantage of these opportunities. In August, we signed a purchase agr eement with aircraft manufacturer, Airbus. The new order covers 24 A320 aircraft to be delivered in 2007 and 2008 and five of Airbusâs new midsized aircraft, the A350 to be delivered in 2012 and 2013. We also have options to acquire additional airplanes as part of this order. We anticipate that when leased, these new planes will exceed targeted returns and will help us capitalize on our established market position as a leader in commercial aviation finance. We expect the demand for commercial aircraft to continue to improve along with the outlook in the international aerospace sector. We were also able to deliver on better capital discipline, improve balance sheet management and increase shareholder returns. Our commitment to improved returns produced an enhanced return on tangible equity of 17% and internal capital generation of nearly 15%. Consequently, we were able to follow-up our 23% dividend increase in quarter two with a $500 million accelerated stock repurchase program which returned incremental capital to our shareholders. Now let me also provide some updates on several acquisitions which will become growth engines in our portfolio. The acquisition of healthcare business credit corporation was quickly and efficiently completed on August 31st and the integration of these operations has exceeded expectations. HBCC is a full-service healthcare financ ing company that specializes in asset- based and cash flow financing in North America. And this acquisition accelerated our plan build out providing efficient cost-effective core platform to support the strong growth we see in this sector. We now have 65 new professionals on CITâs healthcare team which currently totals 140 members. We also continue to make solid progress with Student Loan Express. SLX improved quarterly results and itâs accretive to earnings ahead of expectation. And in the third quarter, total origina tions were $945 million with the school channel contributing 253 million -- a 49% increase from last year. During the quarter, we also ac quired over 16,000 new rail cars in a combination of discreet portfolio purchases and our normal deliveries solidifying our position with 81,000 rail cars as the youngest fleet in the industry. Operating at full economic utilization, we are benefiting from the strong demand to transport goods over the nationâs railway system due to the China effect as well as higher gasoline prices. Now I believe that CIT is off to a str ong start in the fourth quarter and weâre definitely on target to achieve our financial goals for 2005. We reiterate our guidance of operating earnings per share growing in excess of 20% from 2004 levels and return on tangible equity exceeding 16% for the entire year of 2005. The economic trends and business en vironment underlying our operations are favorable with a noticeable pickup in the month of October. Although we are working hard to reduce co sts in certain sectors to provide the necessary capital, our operating efficiency did not improve this quarter. While Joe will discuss the primary components of operating expense, let me just say that we are very focused on the need to reduce cost and increase productivity so that we can invest in some of our growth engines. We will eliminate additional expenses and streamline our infrastructure. In closing, CIT had a strong quarter and we remain confident about the execution of our strategy. We made significant progress on many of our business initiatives. I still see numerous opportunities to grow assets, improve efficiency and enhance shareholder returns. Now we will be providing additional insights into our business operations and information about our 2006 plan at CIT Investor Day on November 8 in New York City. And we look forward to seeing you all there. I will now turn it over to Joe, our Vice Chairman and Chief Financial Officer for a discussion of our financial results. Joe? Thanks Jeff. Good morning everyone. Let me start by giving you some more color on some of the highlighted or noteworthy items in the quarter. We sold our interest as Jeff said, in the residential real estate investment in New York City. We have been analyzing the sale of this property for quite some time and formerly commence the process in the summer given the strength in the real estate market. We held the property for over 30 years so we were carrying at a very nominal book value. We also took other capital management actions that Jeff mentioned to better position the company to deliver stronger returns. Let me give you more detail. We initiated the program and now intend to sell about 50 out of production aircraft with a book value of about 190 million. The planes average 19 years, are less fuel efficient than our core fleet. Itâs a mix of commercial, regional an d sub-business aircraft. And most are manufactured by manufacturers that no longer make planes. Some of the model types are (Donye) and Saabs and then we also had some MD 80s and DC 10s. Following these sales, we will have only two aircraft from - of these type in our fleet, both of which are with bankrupt carrier and our reserve (floor). The marketing process for these planes will extend into 2006. Jeff mentioned we accelerated the liqu idation of certain manufactured housing receivables and we wrote these receivables down to the estimated sales proceeds. With respect to Hurricane exposure, we set aside a $35 million reserve for losses and wrote down securitization retained interest by $7 million. This reflects our judgments, our best estimates of future losses that will result from these catastrophes and are based on the information we have currently available. Our gross exposure across all our businesses in the FEMA affected zones and other impacted areas is roughly $600 million including securitization. Our loss estimate related principally to 300 million of those receivables smaller ticket in home mortgages, vendor and equipment finance and factoring. In total, the loss estimate we put up was over $42 million. Additionally, we released an international tax reserve liability we had previously established as we have received a clearing opinion from local authorities. The EPS impact of the noteworthy items are as follows. Gain on real estate sale, about 34% positive. Release of tax reserves, about 8 cents positive. Write down of manufactured housing and air assets, negative by about 31 cents. And charges related to hurricanes to set aside of loss reserves and the retained interest, about 13 cents negative. My comments from this point forward will give you - will be based on the numbers excluding these items to give you a better view of operating performance trends. We had a very strong quarter. Asset growth was very broad based. Margins improved. Revenues were up 10% from a year ago with good topline growth. Credit losses were low and we had solid non-spread revenue, almost 40% of our revenues with low securitization (gates). Overall, very high earnings quality. Asset growth, as Jeff said, volume was up nicely from the prior year with higher volumes in all segments except equipment finance which we are reorganizing. Deal flow is strong in global vendor, communications and media, energy and our Canadian consumer businesses. We had over $3 billion of managed asset growth broad based. Factoring assets grew $1 billion. Itâs a seasonally strong quarter as retailers build up inventories ahead of the holiday season. Healthcare assets, very important in itiative, grew 600 million including the acquisition Jeff described. And the new business pipeline there is very strong. Trains and planes grew 300 million, principally rail where we increased the size of our fleet, plus some regional air growth. Specialty finance commercial grew 200 million reflecting strong vendor finance volume both in the US and abroad. Actual year to date US Dell volume is up. And internationally Dell volume is up very nicely year over year. Vendor volumes excluding Dell were also up from last year. While we continue to see pricing pres sures in the market due to strong and liquid markets, our net finance margin increased five basis points. That was a real positive in light of the increasing short-term rates and the flat yield curve. I think that reflects the product mix changes we've been making, a disciplined pricing strategy and our capital allocation strategy, not to mention a very effective funding program that serves us well in all parts of the cycle. Credit -- charge offs were lower than I expected, 46 basis points down from over - about 52 last quarter. And this is the first time we've been under 50 since the late '90s. We had very low loss levels in all commercial finance segments and overall recovery continued rather strong. On the US airline our gross exposur e to Delta is about $100 million and $57 to Northwest. At this time we have reserves allocated to US hub carriers and we feel that the amounts of the reserves are adequate given our exposures and our estimate of collateral values. Non-performers -- they were up solely because of placing about $85 million of the receivables from Delta and Northwest on non-accrual. Some of the receivables to Delta and Northwest have equipment values in excess of amounts due so we did not put about $40 million or so of those receivables on non-accrual. If you take out airline non-performance our non-performing loans actually declined. Delinquencies were not impacted by the bankr uptcies of these airlines as of at quarter end they were contractually current. We did see a sequential increase in specialty finance, some due to seasonality and some due to season. Consumer delinquencies excluding the acquisition of Student Lending were actually down from last year. Loss reserves increased to $653 milli on principally due to the hurricane provision. Twenty-eight million of the $35 million of the hurricane reserve ran through the provision and $7 million was a reallocation of existing reserves. When I look at the reserves in total of 153 basis points, that includes our hurricane loss estimates, our US sub-carry exposures and we feel are very strong given the portfolio mix and the credit performance we've had. Expenses -- Jeff gave you some overview. Expenses increased $9 million sequentially. That includes about $2 million in additional restructuring cost we set up this quarter. So the net remaining increase was about $7 million. Where did it come from? About $5 m illion was for increased incentive based compensation accruals, reflecting our strong income growth, good volume and return on equity performance. Those are the metrics we measure management on. Sales and marketing expenses increased about $5 million, $2 million of which reflects the build out of healthcare including the acquisition. Offsetting these increases was a bout $5 million of savings from our restructuring. Headcount was up about 55. We closed the healthcare acquisition and added sales personnel but we continued to streamline back office operations. Taxes -- our operating effective tax rate - our effective tax rate on operating results was about 34.6% and that's down from 39% last year and that reflects the international aerospace initiative and improved profitability overseas, particularly in global vendor finance. We expect our Q4 fourth quarter effective tax rate to be in the 35% area and that's in line with our overall year expectations. Update on our stock buy back program. As of September 30 we have received slightly over 10 million shares and we could receive an additional million shares plus depending on the stock price performance in the fourth quarter. For EPS calculations, our average share count declined almost 7 million shares this quarter. I anticipate another 3 million plus reduction in average share count in Q4. We issued the preferred. Jeff mentioned it. We talked about it on the last call. It's about our thoughts. We had a $500 million issuance of non-cumulative preferred - perpetual preferred. Three fifty was fixed at a rate a little over 6% and 150 is fixed for five years and floating thereafter. Both traunches are perpetually with par full options after five years. I think that's excellent pricing. And the net impact of these capital tr ansactions was replacing common stock with the cost of capital in the area of 12% to 15% with high equity preferred at a cost of 6%. This resulted in accretion in the quarter in EPS and a 1% improvement in ROI. Jeff mentioned internal capital genera tion remains strong and our capital ratio at 9.4% is in excess of the 9% our bottoms up analysis yields. So we continue to have available capital to support growth from strong earnings and a strong balance sheet. Let me comment on some businesses th at you frequently ask me questions on. First let's talk about aerospace. That's included in capital finance. Capital finance which has both planes and trains had an ROE over 12% this quarter with rail exceeding our target. Returns on the commercial aerospace fleet, while still below target, were up significantly from a year ago. Lease rates are up. Our tax structure is improved. And returns that we expect on new airplanes deliveries exceed 15%. All of our remaining 2005 deliveries and half of our scheduled 2006 deliveries are placed. We only had two aircraft on the ground and one had a letter of intent. Equipment finance -- equipment finance re turn on risk adjusted capital is over 12% in the quarter and that's up from 8% a year ago. So we're making progress. The business is now focused on its construction and diversified manufacturing industries and is making good progress also on streamlining infrastructure. Actually our expenses are down significantly from a year ago and the productivity of our sales force is improving and the new business pipeline is getting better. Home lending -- a strong quarter. Home lending volume from our network was strong at about $750 million .We had whole loan purchases about $650 million and whole loan sales of about $300. Portfolio margins were flat sequentially but at the end of Q3 we saw pricing trending higher. Let me talk about quality. Credit qual ity here remains very good with owned charge offs in the area of 80 basis points. The interest only product in our portfolio is 10% of the portfolio but we have - I average FICO scores on the segment of the portfolio above 650. We do not offer negative amortization products. We have a very - we had very experienced operators running this business and we have a very disciplined approach to managing it. Student Lending we outlined three obj ectives for 2005 for this business after we have after we made the acquisition. We wanted to grow the school channel, bring servicing in house and do better than an initial earnings guidance. Let me give you the report card. We signed almost 250 schools this year and third quarter volume from the school channel is up 49% from a year ago. Consolidation loan volume also continued strong. We are now servicing $1 billion of loan in CIT servicing center in Cleveland, up from just $200 million or when we acquired the business. And we're putting a significant amount of new volume into that center. The Student Lending acquisition was earnings neutral in Q1, accretive in Q2 and again accretive in Q3. And all of that is much better than we model. In an effort to run an efficient Q& A session we are asking that callers limit their questions to just one. If you have additional questions you can return to the end of the queue or call Investor Relations once this call is completed. Thank you. Once again if you have a question press star 1 on your telephone keypad. Please hold for your first question. In terms of the ongoing initiatives fo cused on kind of improving your return on capital, it was seeing a lot of activity in recent quarters. I was just wondering, you know, if there are other kind of clear parts of the portfolio that you are focused on potentially exiting and what kind of time line - how should we think about that? Well Michael I think two things. One is I think there will be continuous activity .We're going to continue to try to upgrade the portfolio. And so our strategic planning and capital planning discipline is, you know, every year we're going to be reevaluating the business as we have the amount of capital we have behind them and seeing if they make the returns. You know, we have a corporate hurdle of 15% today and maybe that goes up as the ROE goes up. Secondly, I think that you know, the two businesses - and Joe I think was very specific on it. The two businesses in '04 that didn't meet the hurdle rate, we've been working very hard on them. In capital finance particularly aerospace, you know, we see the light at the end of the tunnel there and the team has done a very good job there. And equipment finance is making very significant strides. So we're working hard on those busine sses that don't make the hurdle rate but, you know, you shouldn't be surprised from time to time, you know, to see us trade out of a business where we've determined that we can't fix it and the rates don't meet our criteria over time. And just for clarification, the sales in home equity that you make seemingly every quarter, that is more credit risked oriented? Or is that fee generation oriented? What's the thought process there again? Last quarter it was higher. It's a combination of things. But overall the overall objective we have and the team that runs that business has is to get the portfolio to a certain set of demographics that we're comfortable with from an overall risk perspective, whether they are credit metrics and or interest rate sensitivity metrics. I' guess I'll try to wrap it into one question. Looking at trends in new business volume relative to your asset growth and then sort of looking at the business lines, I'm still calculating a relatively high level of prepayments Can you just - is that correct and if you could just talk about prepayment trends in the quarter. Yeah I think prepayments are I'll say normal Chris. You know, whatever normal means. It's not the heightened level of prepayments we may have seen a year or so ago. We still see relatively high velocities in a lot of portfolios but we've seen that historically. For example, equipment finance, home lending for sure and a lot of our portfolios that we look at of that type -- vendor finance I'll throw into that category --have average durations in the two to three year areas. So we do have, you know, assets that turn relatively quickly and I think you're seeing that in the results. But I don't think the prepayment activity has been anything out outboard the norm. Now turning over to the bigger ticket ar eas I think that's more of a risk management analysis that maybe you're seeing being factored into the numbers, is we have been building our syndication function in the commercial side in a very robust way. We always had the capability. We have drawn it all together under one basket and one leadership. And with credit costs where they ar e, with economy where it is and the liquidity in the market that we see, we take the opportunity - probably took more of an opportunity in '05 than we did in '04 to manage the risk side of the portfolio in that way. So syndication sales. All right just a quick follow up and a suggestion if you could start, since that is getting to be a greater part of your story, if you could start disclosing - add sales and syndications in terms of the dollar amounts in the release that would be helpful. Okay thanks good morning. I guess the resiliency in the margins is probably most impressive this quarter, but toward the end of the quarter, you know, I guess the Fed kind of came out and made comments indicating that maybe there was a lot more tightening remaining. In light of that how do you guys think of product mix and pricing strategy going forward if we're going to go to a 4.50% or 5% Fed funds raise as opposed to maybe stopping at 4% like we thought maybe at the end of last quarter? Well I think our discipline on pricing has been pretty good and I think that was part of it. You know, as you know we're like 95% match funded. So I think the question really is if they continue to raise what's that going to do to the flow of business? Right now actually we're seeing a pretty good flow of business. I think people came back from the summer and decided that they wanted to move forward on a number of fronts. But I think you know, we're - if the rates go up we'll have to work on pricing. You know we have a portfolio of businesses and - Joel and, you know, some of them - if rates go higher and the economy is somewhat a little bit more a little weaker than the steam it has right now, we have other businesses that kick in in a more interesting and more profitable way, including our businesses that look at supplying capital to mid-sized businesses for restructuring or balance sheet improvement. So we think of it as a portfolio of businesses with some businesses getting a little weaker in higher rate environments and many businesses getting stronger. Thank you. Joe, did I understand you correct that the issuance of the preferred and the replacement therefore of some of the common added one percentage point to ROE and if thatâs the case, wouldnât that suggest that actually ROE declined sequentially? Yeah. It ended about 1% return on common equity. I guess the, you know, basic - overall basic earnings trend is higher. We do have the preferred dividend expense running through the earnings. So let me look at that one, Eric, and Iâll get back to you, but thatâs basically what the finance is. We have - instead of the dividends running through the capital account, now theyâre running through the earnings stream. So let me look at that arithmetic for you and weâll get back to you. Joe, just a clarification on the tax. You know, thereâs permanent improvement from moving some of the leases over to the Dublin location, right, but it sounded like you said it may jump back up to the low 30s in the fourth quarter. I just wondered if you could, you know, break that out and thenâ¦? Yes. The reported tax rate is about 30% and that includes the reserve release that we identified as a highlighted item. Taking that out, the tax regrade for the quarter was a little less than 35%. And weâre thinking about the tax rate for Q4 and all of â05 to be in about the 35% area. So think about it as basically flat, excluding that one-time reserve release that we profiled as noteworthy. Okay? Yes. I thought it was overall a really solid quarter. One area that kind of was just (really) relative to my expectations was operating expenses. Now I have no problem with them going up if youâre investing in your infrastructure but you had said before that operating expenses would drop (finesse) or the efficiency ratio would improve. Can you give us a direction of where we might be seeing that going from here? Well, weâre - I think as weâve said, weâre - operating expenses is probably one area that weâre sensitive about. Weâve been trying to streamline the backend, probably identified $40 to $50 million in cost savings this year. And as you saw in our second quarter charge, took charges to really locate about $25 million of those cost savings. And much of that is going into the front-end, whether itâs the cost of bringing on salesforce.com or I think at last count, we hired over 40 group leaders and senior originators in our large ticket business. So I think we continue to work hard on that and - but we are investing in the growth businesses and weâre investing in the sales force. Good morning. I have a question that I hope you guys did not address in your opening remarks, related to fee income as a percentage of your total revenues. And I wanted to know, this quarter was the - relatively smaller component of (seed) income related to narrow margins on your fee products or is it seasonal in nature and can you give me some guidance in terms of where fee income as a percentage of the whole pie goes over the next several quarters. Sure, Meredith. No, we didnât talk about that explicitly. I think the fee and other income, I call it non-spread revenue number, is very strong. It logs down a bit from Q2; Q2 was exceptionally strong. And we have some fees that are core that we carve quarterly, like factory commissions is, a varied annuity like component, that actually goes up seasonally as in the second half of the year. But other fees, some have some episodic nature to them. Having said all that, some of our new initiatives are intended to build that non-spread revenue component of our earnings. And I mean it in a - you know, in a value-added way. You can see that leasing gains were relatively stable quarter-to-quarter, securitization gains were relatively stable quarter-to- quarter. But the new business initiatives, whethe r theyâre healthcare, advisory on the M&A side, syndication, are all designed to continue to improve our overall level of spread - non-spread revenues. So my expectation is as these business build-outs take hold, that that fee component will grow. But having said that, not apologetic for Q3, I think itâs a very solid core performance with very strong baseline fees. Oh, I agree. I was just directional - that - your answer makes a lot of sense to me. Thanks. Valerie Gerard: Thanks, Meredith. Can we go to the next question, please? Good morning. (Bob Napelli) from Piper. A question, I was wondering if you could give a little more color on your healthcare business, on the size of that business, and maybe the makeup of the assets and the growth that you experienced in the quarter? Sure. Sure. You know, when we entered 2005, we had kind of one healthcare business which was vendor financed. We did finance cat scan machines. And weâve steadily grown that by bringing in people to cover various sub- segments, you know, such as large hospitals, skilled nursing centers, extended care. So we now have three or four different teams and our headcount grew to about 50 to 60 people and then with the acquisition of healthcare business credit, we added another 65 people. So weâre up about 140 people. I think originations in the third quarter were about 125 million, which is - and theyâve been running - I think the second quarter they were maybe 150 million. I think with the acquisition of HPCC, I think total assets in the healthcare sector are up a little over a billion dollars from about 300 this time last year. So, you know, this has been one of the growth engines weâve built in the portfolio and, you know, weâre excited about it and love the quality of people weâve been able to attract as well as the leadership of HPCC. What kind of return on equity are you getting and what kind of growth would you expect to get? Is that going to be one of the fastest growth businesses that CIT over the next several years? Well, weâre cautious but we think it will grow steadily. Weâre - you know, itâs 18% of the economy and it was less than 1% of our assets. So we thought we had a lot of headroom on that. And, you know, this is the first year theyâve been together so theyâll be profitable this year and we anticipate that theyâll make the corporate return, you know, in a reasonable period of time. My question is regarding the home equity business. With rates continuing to rise, I was hoping you can discuss your expectations for that business going into â06. Thanks. Sure. Thereâs been a lot of obviously news on home prices, home lending businesses specifically. We had a very strong third quarter. Clearly, lending volumes in the market could come down and I think many financial institutions have said that. We think weâre well positioned here. As I said, we have a very experienced management team thatâs been with the company a while. I think we have a very disciplined approach to doing - to look at our portfolio demographics, some of which I gave you and many of which we put in our Qs. And we think that as interest rates ri se and some of the more exotic products sort of get priced away from the marketplace, we have a core strategy that fits in very well in the marketplace. So having said that, overall, you know, refinancing boom could be over and home sales could be lower so we build that into our expectations. But the other side of it is we think we have a very competitive cost structure, a very smart credit screen, and a very experienced management team. So I think it could perform well in just about any environment. Hello. Thanks. So I guess on the expense side, as the initiatives - is the timing on this such that you bring in more talent, you create new incentives, and youâve changed the comp structure somewhat from last year. So the good news is we wonât see that fourth quarter bulge that occurred last year with bonuses and things like that. Is it more spread out over the year, is that one of the takeaways we should get from this? Well, I think - that sounded like a number of questions. But Iâll try - maybe I should pick the one I want to answer. You know, I would say Joe and the other folks are very much on top of the accrual and, you know, if you followed it during the year, you know, we have a fair amount of compensation in terms of restricted (sot) that we call performance shares. And part of - frankly, part of the increase in operating expenses has been us truing up every quarter what those performance shares are going to look like. So, you know, weâre watching the accruals quite closely. I think that if you look at the third quarter, you know, several of our businesses have some seasonality to them but what we were encouraged about was it was very broad-based in terms of asset growth coming from, you know, almost all of the portfolios, you know, with the exception of equipment finance where weâre - have done some⦠â¦and theyâre doing well. So we felt good about that and we think - we spend a lot of time focusing on sales and, you know, we think some of this coming through is the beginning of that focus and the beginning of the investments weâve made. Great. Thanks, Jeff. Could we go - or before we go onto the next caller, I think Joe wants to say something. Can I go back to Eric Wasserstromâs question regarding ROE? The net impact after preferred dividends and the buyback of the stock in the quarter was about 75 basis points on the ROE. So if you look at it quarter-to-quarter, then you get to a flat ROE. Why is that? If - for those of you who remember, la st quarter we had an abnormally low core tax rate because we had to true-up the tax rate for the full year in that quarter. So apples to apples, if you normalize the tax rates, the core ROE in the quarter is slightly better this quarter, excluding the highlighted - noteworthy and highlighted items versus last quarter. Eric, I hope that helps an d I hope youâre still on the phone; if not, IR is going to follow-up with you anyway. Can you give a little more color on your Capital Finance business? I was wondering if you could - it looks like - you know, just looking at the segment data that the income, if you back out the $86 million, was up substantially quarter-over-quarter. I was wondering if thatâs a clean look? And I was wondering if you maybe could give some discussion on - or some color on the pricing trends? Like would the lease prices on rail cars - I know they had gone up quite a bit from the trough a few years ago. Have prices continued to come up? And are you benefiting significantly from (low) of these rates running off? Well, I think we - lease trades both on rail and aerospace, you know, have come up quite a bit anecdotally on both claims and rail. Weâve seen 100% increases. Now youâll have to remember, we price maybe 20 - we repriced maybe 20% of the portfolio on an annual basis but lease rates for airplanes, as weâve said, have been probably year-over-year up 25% for your best plane. So - and as Joe said, weâre at 99% ut ilization both on rail and aerospace. So - plus weâre stretching out the terms of the lease when we reprice. So we like both of those businesses as well. Joe, do you have a comment on the numbers? Yeah. The ROE has improved significant quarter-over-quarter, you know, on an operating basis. And the rail business has had an outstanding year. Jeff, you know, mentioned some of the pricing trends. But we added portfolio in the quarter, we made some equipment acquisitions to fill out the fleet, as I mentioned earlier. So thatâs a plus. The airplanes, weâve mentioned the trends there. The other item in the quarter is we transferred some of the other plane businesses we had around the company like financing of the (Net Jets) business into Capital Finance in the quarter so we have some of that benefit. Having said all that, the core ROE, apples to apples, quarter-to-quarter, continues to improve, driven by the commercial aerospace improvement. Hey, guys. Thanks for the pronunciation. A couple quick questions; one, did you have any gains on sale of mortgage loans in the quarter, like you shifted some sub-(pry) mortgage loans last time (in and out)? Sure, Iâll take that. As I mentioned in the - in my opening comments, (Jordan Heimowitz), we sold $300 million of loans in the quarter. And generally, the pricing we see now and we see pricing, you know, somewhat lower than we did a year ago obviously we sold them for prices of over 2% or so. So there were some gains in the earnings from that. That was real good. Second is can you comment on the credit quality in the healthcare finance portfolio or is it too soon to kind of make an estimate as to how thatâs going? Iâd be happy to tell you how theyâre going. Theyâre going great. The delinquent - just about all of the receivables are current. We have less than 20 basis points of delinquency in the portfolio and obviously that includes the loans we acquired in the acquisition. Hi I wonder if you can just clarify the out of production aircraft that were sold and how those numbers show up between the June and the September break down of the portfolio? And I wonder how much of the value of those planes changed over the last 12 months as lease rates have gone up on desirable air craft? And did you not need to mark those to fair value because of the kinds of leases they were in or financings or and are theyâre other aircraft that are still in the portfolio that might not be marked to market? Which one is it? Iâll try to remember it all David, I donât know if I remember it all. First of all in the schedule - I think the first question you asked was in the schedule the airplanes where are these planes? And Iâve got two answers for you. One in the schedule of managed assets theyâre in assets held for sale. So look there under capital finance. On the schedule where we break out all the planes theyâre where they were. So, you know, if they were narrow body, they were in the narrow body; if they were in the US, they were in the US. We thought weâd show you all the metrics apples to apples, thatâs two. Three, I donât know the specific answer in terms of the values of the planes versus a year ago. Rental rates have improved somewhat so that would have to factor into our analysis. Yes -- less so, though. Less so and the going forward look as they would improve even less so. Iâd say lastly as you know and we talk about our accounting policies on this the long life asset policy is that undiscounted cash flow test. Our intent on these 50 aircraft is now changed so we have to value them at a lower of cost to market or, you know, or a current value standard. So thatâs what happened. Yes just wanted to follow up on the big increase in tangible book value per share in the quarter. I think it went up a 1.50. You know you only earned 1.06 is there market to market adjustment for the balance sheet that I missed that maybe you talked about earlier? You got me on that one. I think the share count is lower that should, that may enter into it. But I have to think about the arithmetic there because the share count is lower. I think, I mean the book value, you know, is changing but it may be the share count. But weâll get back to you so you got me on that. Just a quick question about sort of geography and the aircraft portfolio with, maybe with the disposal of the this quarter and it looks like international growth is certainly ramping up. Do you expect your portfolio to diminish in the North American market from kind of the 21% level going forward? I mean are you specifically targeting that or is it just sort of where the demand develops? The answer is we clearly anticipate that going down. So I mean the North American component I think will continue to decline as we deliver new aircraft. Thanks for your question (Mark). With that Iâd like to thank everyone for attending our call today. As always investor relations will be posting the prepared remarks to todayâs call on our website in about an hour. And weâll have a complete transcript hopefully by tomorrow. So with that please free to call Pam, (Steve) or myself with any questions and we look forward to seeing you on our investor day on November 8. Thanks have a great day. |
EarningCall_234010 | Welcome everyone to the Zale Corporation Third Quarter Fiscal Year 2006 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press *, then 1 on your telephone keypad. If you would like to withdraw your question, press the # key. Thank you. Betsy Burton, Chief Executive Officer, you may begin your conference. Thank you. Good morning and thank you for joining us for our third quarter conference call. I am Betsy Burton, acting Chief Executive Officer. With me on the call today are George Mihalko, our acting Chief Administrative Officer and Chief Financial Officer, Cindy Gordon, Senior Vice President and Comptroller, and David Sternblitz, our Treasurer. Before we begin, George will review the Safe Harbour. Good morning. Our commentary and responses to your questions on this conference call will contain forward looking statements including statements relating to our expected sales and earnings, future goals, plans and objectives. These forward looking statements are not guarantees of future performance and a variety of factors could cause our actual results to differ materially from the anticipated or expected results expressed in these forward looking statements. Information concerning some of the factors that could cause actual results to differ materially from those contained in the forward looking statement is available in our annual report and Form 10K for the year ended in July 31, 2005, and our quarterly report on Form 10Q for the quarter-end of January 31, 2006 as filed with the SEC. In addition, we will present non-GAAP financial information on this call. For a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to our third quarter 2006 earnings release dated May 17, 2006, today, which can be found on our corporate website, www.zalecorp.com under shareholder information, and then clicking on the news release icon. Thank you George. Iâd like to start by speaking to the various management changes since our last conference call, as well as the notification of an SEC investigation. First, our Chief Operating Officer, and most recently Mark Lenz, our Chief Financial Officer, were placed on administrative leave. Markâs leave was the result of failure to timely disclose in conversations with the auditors regarding the delaying of merchandise vendor payments for two weeks at the end of fiscal year ending July 31, 2005. As we stated in the release, the issue of delaying approximately $8 million in merchandise vendor payments does not involve revenues or earnings and the company believes that the fiscal year end balance sheet accurately reflect cash and payables. With regards to the SEC investigation, we have had discussions with the SEC staff and are cooperating fully. We are reviewing the items they raised, which relate to the areas of extended service agreements, lease, accrued payroll and the timing of certain vendor payments. We believe, based on our current knowledge, that our accounting was appropriate and complied with GAAP. Now letâs move on. I would like to introduce you to George Mihalko, our acting Chief Administrative Officer and Chief Financial Officer. George was formerly CAO and CFO for the Sports Authority until the merger with Gart Sports in August of 2003. Prior to that he has extensive retail experience at companies including Pamida and Pier One. I worked with George in my capacity as Chair of Audits for the Sports Authority, and am excited to have someone of Georgeâs caliber join the management team. The executive search for a new CEO is going well. We have identified several excellent candidates and continue to have discussions with them. It is important to note that the board recognizes that we are currently in the throws of finalizing holiday and that the speed of filling the job is not as important as finding the right fit. The brands are focused, energized, and proud of the work done to date, and work yet to be done. I can assure you, whether you call me interim or acting CEO, I am onsite and quite actively engaged in the business. Now on Q3 results. I am pleased with our comp store sales increase up 2.5%. This is on top of the 3.5% comp increase for Q3 2005. That fiscal performance was delivered during a period of significant leadership change is a testament to the strength of our employees and the strength of the brand. The 2.5% comp store increase translates to an EPS before non-recurring items of $0.24, which exceeds the high end of our guidance of $0.20-$0.22. With the exception of Pagoda, all brands experienced positive comps, including the all-important Zales brand, and if Italian charms were excluded from sales, Pagodaâs comp store increase would actually have been positive. Diamond fashion was a strong category across all brands, with circle pendants, and of course hearts being top performers. The Zales brand benefited from significant improvements in diamond solitaire as well, where we were missing category assortments last year. Zales Canada used an improved merchandise assortment along with an increase in direct sourcing to positively impact its business. Peoples achieved double-digit comps and 120 basis point improvement in gross margin over last year. Bailey Banks & Biddle had a solid quarter, driven by its successful customer parties, and fashion watches growing at a 20% run rate. Baileyâs continues to take its luxury business to another level, with its average check increasing over 21% in Q3 to $1,763.00 from $1,453.00 the year prior. Another standout for the period was Zales Outlets since emphasis on its bridal business continues to pay dividends and was a key driver in its success for the quarter. Comps were up in the strong mid single digits, and also delivered a 100 basis point improvement in gross margin versus last year. On a consolidated basis, gross margins were essentially flat to last year. In the Zales brand, gains due to direct forcing had been mostly offset by clearance and promotional cadence. The Zales brand in particular continues to move through non-going forward merchandise in order to refine its product assortment for holiday. While gross margin rates for the Zales brand was slightly below last year, gross margin dollars were actually higher, due to improving comps. Slightly higher gross margin dollars in the other brands were mostly offset by a larger than expected LIFO charge of $3 million. On the SG&A side, cents control contributed to earnings in line with expectations. Sometimes, management changes are a good thing. As we discussed on the conference call, John Zimmerman stepped up to the plate with a tall order to fill, and fixed the Zales brand in time to have a great holiday. I am pleased to report tremendous progress on that front. John is probably 70% complete on his merchandise reassortment, and is almost 100% complete in the all important bridal and diamond fashion categories. Orders are being placed and product is expected to flow into stores by the end of August. All stores will then undergo a major reset right after Labor Day. We are also in the process of pre-testing a new TV campaign, and will be adding back key promotion events to the holiday calendar. John has done a terrific job in bringing some of his successes in Canada to the Zales Brands. Some of the operational enhancements he has already made should continue to payout in the new fiscal year. Letâs now talk about fourth quarter forecast. We are quite pleased with our Motherâs Day results with overall comps in the low double digits, and strong results across all brands. Improved in stock positions, a more aggressive promotional stance, and increase in our marketing spend, and improved executive overall combine to build upon sales momentum from the third quarter. And although not the perfect product assortment, we are pleased that flowing more inventory into the stores has led to more of a serge of our diamond fashion and solitaire businesses in Zales brand. We also historically test product at Motherâs Day to determine key items to incorporate into our holiday plan, and we were pleased with some specific learnings. Since these two weeks represent approximately 25% of sales for the quarter, it is obviously important to the results. As you recall, we previously said we would not give guidance for Q4 until we had results for Q3. We are now forecasting comp store sales in the low to mid single digits and EPS of $0.0 to +$0.02. We also plan for a flat gross margin primarily due to increased promotional activity and repositioning the product assortment in the Zales brand. Remember, this is not a significant quarter in terms of dollar earnings. Our focus is on being ready for the all important holiday season and capitalizing on the momentum we had going into the new fiscal year. We will announce fiscal 2007 guidance when we announce results for Q4. Now, I would like to turn the call over to George Mihalko who will add some additional comments on the published financial. Thank you Betsy. I arrived at our corporate offices only two days ago, so itâs been a pretty steep learning curve to prepare for this conference call. However, you may have noticed that we have expanded the financial statements attached to todayâs press release by adding some data points for easier analysis. This also includes a table, which reconciles earnings of $0.24 per diluted share before non-recurring benefits and charges, which were listed in the first paragraph of todayâs press release to our reported GAAP net earnings of $0.35. First, I will review the composition of the third quarter income statement before moving onto the balance sheet. Starting with the Q3 income statement, comp store sales increased 2.5% while total revenues increased 4.3% when taking into account the loss of revenues from the daily stores, which were closed in this yearâs second quarter. Gross margin for the third quarter was 51.7% versus 52.3% last year. 50 of the 60 basis point decrease in gross margin was due to the $3 million LIFO charged absorbed in cost of sale. Moving on to selling general and administrative expenses. These expenses increased 160 basis points over last year. Executive severance and additional daily clothing cost accounted for approximately 100 basis points of this increase. Incremental operating costs resulted in a net 40 basis point increase and adoption of FAZ123-R related to stock compensation expense added 20 basis points. GAAP and soft rating earnings amounted to $28 million dollars versus $25 million last year, but included the one time benefit we had to record for the termination of a retirement benefit plan. Interest expense increased by $900,000. Our effective tax rate was slightly lower resulting in GAAP net earnings for the third quarter of $16.8 million versus $14.5 million last year. This equates to diluted net earnings per share of $0.35 this year versus $0.28 last year. The number of shares on which EPS are calculated decreased of course due to the companyâs repurchase of approximately $100 million worth of shares earlier this fiscal year. Now let me move on to the balance sheet. I think I can speak for Betsy as well as myself that we view the balance sheet as the source of funds for prudently reinvesting in and repositioning the operations of our various plants. The year over year changes in our balance are a reflection of this philosophy. Investments in inventory, as well as open market share repurchases are the primary reasons for these changes. In order to strengthen third quarter assortment, especially for the Zales brand, we invested in diamond solitaires and diamond fashion inventory. This also strengthened our merchandised positioning for Motherâs Day. At the same time we also had some gold and silver overstock remaining from the 2005 holiday season. Also, our U.S. dollar denominated inventories including a positive translation adjustment associated with our Canadian inventories due to the substantial increase over last year in the value of the Canadian dollar the U.S. dollar. Other current assets increased due to higher vendor receivable prepaid advertising and sales induced tax receivable. Accounts payable decreased primarily due to the earlier payment of federal income taxes, this year versus last year. The increase in long-term debt basically finances the changes in the balance sheet items that I just mentioned, as well as the $100 million share repurchase conducted earlier this year, which is reflected in the stockholderâs investment section of the balance sheet. The important takeaway though is that we are investing in our business, and we believe that these investments are starting to payoff operationally. Good morning. Betsy, I was wondering if you could talk a little bit about the degree of confidence youâre gaining in Zales with respect to repositioning the assortments, both in terms of having the assortments prepared for Christmas, in other words, what degree of confidence do you have that the assortments will be in optimal shape for optimizing the holiday as much as possible. Also, with respect to the assortment levels, maybe you could talk a little about the degree of fashion product, which was the big emphasis last year versus the more traditional solitaire and traditional diamond product assortment so that we get a better idea of what we might expect. And, with respect to the marketing program, could you talk about how you might want to see that change as we move into Christmas versus last year so that your traffic levels improve. Lastly, if you could talk about the sourcing side of Zales, whatâs going on with respect to the degree of product mail being directly sourced. Thank you. Sure, okay lot of questions. I have a high degree of confidence in the Zales repositioning. John Zimmerman, who is a known entity, has been working diligently, literally almost touching every sku trying to determine the right style-out for the new planogram. And, as I indicated earlier, he is 100% complete on the real key categories, which are the bridal and the diamond fashion. Betsy, could I interrupt? Last year, there was some issues with deliveries, the product coming in, they thought it would be in August and then they thought it would all be here in September, crossing our fingers for the beginning of December. Are those issues prevalent this year? No. I think a lot of that was due to over aggressiveness with regard to trying to negotiate the best cost, and also just pure lateness of trying to place orders. I think, in particular, the finished diamond market, the polished diamond market is a little bit soft and I think that weâve got some favorable trends working in our favor. I do not believe that there will be that disruption. I think also last year they tried to discontinue and run down the old selection prior to bringing in new products, so there literally was just a lack of product. The other thing I have confidence in, is that John has a methodology of determining how to put together an assortment based off of taking the bestselling sku and then offering them, you know white gold, yellow gold, different carat, weight, and because of that itâs worked for him very well in Canada and I think it will work very well here where we can dramatically expand the breadth of selection available to our customer, in particular in the diamond solitaire and diamond fashion areas. So I think I am very comfortable with his style, especially in terms of not taking extraordinary risk, sort of going with the tried and true, tweaking it a little, but again sticking with what we know our customer wants. In terms of the actual assortment itself I think it will be very much back to basics. As youâll recall last holiday, we pretty much had broken the diamond fashion business and the solitaire business by taking inventory dollars and planning them away from those categories and into gold and silver. What we found is that our customer really wants diamond fashion at holiday, so we are sticking to what we know our customer wants, giving them broader assortments and selection, and making sure we have the product. Again, that will be a shift back to where the assortment that we had which we know our customer wants. Again, shifting a little more of our emphasis back to our core competency, which is diamonds. But does that mean that this whole fashion jewelry emphasis that was thought to be so important last year has now diminished in terms of focus? We will still have a fashion component, and gold and silver are still doing quite well, but we will not be as lop-sided in terms of our inventory dollars being in gold and silver, and weâll be putting more back into diamond fashion. For instance, diamond fashion inventory was planned down 45% for last holiday, and we just did not have product that the customer wanted, and thatâs clearly something the customer wants for holiday. We did quite well; diamond fashion was a highlight across all brands. Yes, diamond fashion is absolutely hot right now whether itâs circle pendants, circles within circles within circles, everything diamond fashion seems to sell. In terms of marketing, we are clearly in the throws of testing a new marketing campaign. I think there will also be a tweaking of our media buy. Rather than spreaded out over a week, we are going to try to have heavier points directed to our key promotional events, which we believe will help increase foot traffic and get greater efficiency out of our marketing dollars. So, we are excited about some of the changes we are making in particular to the media buy, as well as the creative. Direct sourcing continues to be an initiative. As you can see, we are continuing in some of the brands to see as much as 100 basis points of improvement. Again, there is a little bit of noise in the Zale brand in particular because of the clearance and the markdowns to try to move through the products so that we can clear the way for the new product assortment. Good morning Betsy. Can you talk about the SEC investigation and any impact its having on recruiting a new CEO, and then along with that, whatâs the new timetable for expecting the âright personâ to be hired? In terms of the SEC investigation, again we are in discussion with the SEC. We do not at this point have any concerns about that affecting our CEO search. In think that the candidates that we have been in conversation with are still candidates, in other words, no one has dropped out as a result of the investigation. In terms of timeframe, I think the board is comfortable in that we had originally said 3-6 months, and I think we will still be able to deliver within that timeframe. We typically donât do that for competitive reasons. I would be reluctant to do that. But again, I think I did indicate the all-important Zale brand did actually have a positive comp, which is the headline. Thank you and good morning. Could you elaborate a little bit more on what youâve learned from Motherâs Day, Betsy, and also give us a little bit of a sense of what drove that strong business. Iâm curious if you were particularly or incrementally promotional besides those Zales clearances issues. But, were you particularly promotional to drive the double-digit comp over Motherâs Day, and help us reconcile that strong comp and the EPS guidance, which Iâm assuming has impacted the ongoing repositioning initiatives at Zales. Iâm wondering if there is anything else impacting it. Then, separately, we all know that medal costs continue to hit new highs. You had a LIFO charge in the third quarter. Could you talk about what youâre seeing in terms of raw materials pricing? Of how your costed out products are currently versus spot pricing, and whether or not we should be anticipating further LIFO charges given the ongoing increases in the medals markets. Thanks very much. Sure. Lets talk about Motherâs Day. At Motherâs Day, we found, in particular, certain price points and certain items were very successful. As you know, we ran a half-carat diamond circle pendant for $199.00, and it was extremely successfully. We had other categories in general that were just very hot, and I think overall it was a combination of our promotional cadence, but also just having the right product, and the right product assortment. There were a number of items that again we tried to determine their potential. We learned from that and incorporate that into our holiday offering. Again, it was just an overall great performance and I think by flowing a lot of product into the stores, the associates just had a lot more sell. The EPS guidance, if you sort of back into it, I think the prior management had guidance of $0.07, and I think if you look at the guidance that weâve given for Q3, relative to prior managementâs guidance, itâs in parity. In other words, weâre expecting a similar performance in Q4 to what we saw in Q3, and I think we all indicated all along that what we wanted to do is make sure we repositioned the company so that in the all important Q2, we had the product assortment right. So, I think that is still our focus. Again, this is a relatively unimportant quarter in terms of actual earnings, and if you look at the delta, in terms of the, lets call it, $0.07 between what consensus is and what were projecting, more than half of that is because of the Zale brand and the give-up of some gross margin in order to clear through the product inventory. With regard to medals, yes, the cost of gold gives us heartburn, and we have for the first time really hedged across all brands for the cost of gold in particular. So, we are very comfortable that we were able to hedge at a good price early enough in the game, and feel comfortable that because of that, we can price our program and be consistent in that pricing throughout the holiday season. One follow-up Betsy with respects to marketing. I know you talked about possibly reorienting the actual media buy. Can you talk about who the target customer will be and what the message might look like in the new Zales campaign, given last year was really a pretty significant departure that I think really wasnât what you had hoped in terms of drawing in a broader customer base or younger customer base. Who should be we expecting the revamped campaigns to be targeting? The campaign is really targeted towards any gift giver. Itâs Middle America, so at gift time we donât really sku male or female, itâs anyone again in the middle market. We are probably this year going to spend more on prime-time, just because thatâs where you can reach the most people, and I think that change will hopefully be a much more effective use of our dollars, even the frequency will not be as great. In terms of the costs themselves, it would be a combination of product and promotional spots. Obviously, weâre not going to talk about the theme itself, but weâre excited that we believe it will appeal to our customer base, and also help sell product and get foot traffic into the stores. And was the Motherâs Day TV campaign for Zales, was that using some of these revised filters, and did that meet your expectations? The Motherâs Day campaign, we did not have the luxury of really developing new creatives, so that was sort of a jerry-rig, we did the best we could, and that actually was reasonable and effective given the inability to develop new creatives. We were actually quite pleased. I think it was a combination of not just the creative, but also the promotions and the product itself. Thank you. Betsy, just following up on the marketing. Any decision to revert back to your prior agency? Weâve noticed the diamond store tag line coming back to commercials, so I donât know if any decision has been made to change back agencies. No, we are sticking with the Richards Group. We have however, changed creative teams within the agency, but there is no intent at this point of changing agencies. But, yes, you are correct in terms of, our belief is we really had a franchise built around the diamond store, and we felt that bringing that back, whether itâs in a subtle way, or even in a more direct way would be important to the success of our creatives. Okay, and could you share with us any lift youâre seeing in traffic in some markets where you did test the new marketing campaign? We have not tested it, the actual TV campaign itself. We are testing , so we really donât have any results from actual testing airtime of the commercials. Okay, then could you just give us a sense of maybe any traffic changes in the Zales comp? You mentioned obviously encouraging Motherâs Day trends. But if you could just aggregate ticket versus traffic in the comp? Actually traffic is driving the comps, not average tickets. So, clearly itâs a combination of customer count. We donât really have customer counters, but itâs increased traffic as well as increased transaction. Then you had mentioned that youâre adding back some promotion. When do you plan to add those promotions back, and how much did dropping those events last year cost you? The key events that we will be adding back are Veterans Day, Thanksgiving weekend, the first week of December, we had some bonus days advertised, so those are the key events that we did not anniversary last year, and that cost us about $ 22 million in sales last year for lack of those promotions. I think for the most part thereâs a little bit of clean up, in terms of Baileys just minor, but nothing out of the ordinary. Lastly, obviously we know of some of the vacancies at the senior level. Weâre hearing some other vacant spots in the person heading up diamond sourcing. Could you just speak to the upheaval and the changes on Johnâs team, and how solid that bench is? Okay. Adrianne, as you well know we really donât talk about personal issues and people in particular, but we actually believe that we have added some real strength into our diamond sourcing area. We took Gil, who is our President of Pagoda, who is our guru in terms of direct sourcing of gold, and he is now President of Corporate Sourcing in addition to Pagoda, and he now has someone that we took out of the Zale brand that is extremely strong in terms of diamonds, and is heading up the diamond sourcing underneath him. So, we actually added bench strength to the diamond sourcing area in particular. In terms of Johnâs area, he has done a great job of building his team. The nice thing about taking and merging the Peoples brand and the Zale brand to develop a North America brand is that you get to combine the merchandising teams so you can pick the best of the best. So, I think John is very confidant in his team, and again with the leadership that he can provide in think weâre very happy the bench. Hi, thanks, good morning. A couple questions. I guess the first one maybe if you could comment on the debt on the balance sheets. It seems to be a little higher than we were projecting, which ties into maybe your capital structure target/buyback thoughts for the year, and then maybe give us your cash flow estimates for 2006/2007. That would be great, thatâs question number one. I think that is higher for a couple of reasons. As George indicated, weâre building inventory, weâre putting more inventory into our stores. The other, youâre absolutely right, we did buy $100 million worth of stock, and as you know we usually pay that down when we get cash from the holidays. I think again, weâre investing in the business in terms of in particular product, and making sure we have the right product, and because of that, that is higher than what would normally be. We do not, at this point, since we are not announcing our fiscal 2007 numbers, we really are not prepared to give any pre-cash flow estimate at this point. We are still awaiting for some components of that plan, in particular what the impact will be of the change out in terms of itâs impact on inventory. Again, when we announce Q4 and give guidance for fiscal 2007, we will provide a look at what our free cash flow is expected to be. Okay. Would you also comment on youâre capital structure targets, how much debt, the EBITDA youâd feel comfortable running with, things like that as you progress through the year? Okay, then my second question. I think the question when you first started with the business recently, and relative to what youâre seeing in Kay and some of the other mall-based jewelry retailers, versus the off mall and online, I mean it certainly seems like the Zales division is under solved by different channels. Any thoughts of anything thatâs changed recently? We obviously are looking at Kay and their Jaredâs division, as they are aggressively looking to open more stores, and we are actually being a lot more aggressive with regard to looking at alternative locations. For instance, the outlet stores are doing exceptionally well, the powered center concept in selected markets, so we are looking at different locations. We will be testing our first free-standing out-lot Bailey Banks & Biddle, which I think most of the analysts liken Jareds more to our Bailey Banks & Biddle division than they do to the Zales division itself. I think we believe that we are clearly back on track in regaining market share, and donât know who the market share is coming from, but we are just pleased that we are seeing the positive traction. Okay, and with that to get down to flat earnings to $0.02, youâre assuming that the gross margin is coming in? Or is it on the SG&A side? Gross margin will be flat. In other words, because even though weâve got improvements due to direct sourcing, its being offset primarily in the Zale brand by the clearance of merchandise to make way for the new product assortment. Some of the brands have already priced up. We are waiting on the key Zale brand. We wanted to get through the Motherâs Day season, but we will be repricing, and will be complete with that pricing, and then we believe that because of our hedge, weâll be able to hold that pricing. With respect to Johnâs evaluation of the Zales brand, I believe that was talked about and we wanted to know where he is on that? I think there was talk of when John came in, he was going to do an evaluation of the brand from top to bottom, kind of take a look at it, do an analysis. Is that complete? Are they any conclusions from it that you can talk about? Sure. He has completed his analysis. He has made certain operational changes, which I call âimproved disciplineâ, and more importantly again the product assortment is what he felt was the biggest opportunity. I think we are investing in our people in terms of refocusing some of our training initiatives, and he has introduced some new incentives, which have energized our field, so I think he has made some good operational changes. Again, not reinventing the wheel, but simply taking some things that were working well for him in Canada, bringing them here, and again I call that the âlow-hanging fruitâ. So, he has completed that. A lot of the changes in terms of operational changes have already been put in place, and again the product assortment we hope to have everything redone and completed shortly after Labor Day. And with respect to diamond prices, I know gold prices are pretty hard to find, can you comment on how the diamond price is going? We are not as concerned about inflation in diamonds. Again, polished is sort of a soft market out there. So, the bigger story line is in gold and silver. Okay, but the majority of what you do is in diamonds, correct, so how much was it upwards last year? Or is it down? Betsy Burton Itâs not down, but itâs fairly constant. In other words, really the gold component is whatâs causing the inflation. Mark Bedinger The last question would be, in terms of a message that you send to customers, investors, what is going to differentiate Zales from the competition whether its now or looking forward to the holiday season? I donât mean just building up your assortment, your inventory, which is kind of a correction from last year, but really something that is going to set the company apart from Kay or Jared, to draw in the customers? Clearly, product is certainly something, but in addition to that I think that the Zales brand is in and of itself a differentiator. We have a tremendous amount of loyalty to the brand. We even have people come in and want to buy a Zale box to put a piece of jewelry in, so we just have a tremendous franchise. I think to go back to our roots; to recapture the hearts of the people who love Zales, I think is our real opportunity. Hi, good morning. With Motherâs Day up low double digits, it sounds like your quarterly sales guide might be a little conservative, or why so much lower than the Motherâs Day? Are you expecting some sort of deceleration? Well, itâs just that Motherâs Day is our one opportunity in terms of foot traffic in the mall. So, we develop a plan day-by-day, week-by-week. I donât believe its conservatism; itâs based off of actual plan by brand, which again I think is realistic, not overly conservative. Just to be clear, the previous original guidance for the quarter was $0.07-$0.08 per share, and youâre at $0.01 - $0.02, where is the delta there, especially since it looks like sales are coming in better than original expectations from prior management? Sure. About $0.04 is due to the Zale brand, and again the margin pressure due to the desire to move through as much of the non-going forward merchandise as possible. So, again, itâs driven by pressure in the Zale brand. Obviously youâve got increasing rents in payroll, and the actual comp sales will not offset the actual declining gross margin. So, thatâs really the story line. The other $0.02-$0.03 is in SG&A, which would be interest expense and options. So, itâs really much in parity if you look at what the prior managementâs guidance was for Q3, and what we ended up with, similar. I understand. With the SEC investigation, can you give us any update? Have they given you any specific information as to what they are aiming or what they are actually investigating? Betsy Burton They sort of highlighted in the subpoena the areas that they have of interest, and as we indicated before, primarily theyâre interested in the vendor payments. They are also looking into the lease accounting; theyâre looking into our extended service agreements and our payroll accruals. Itâs our belief, and again we are cooperating and communicating with the SEC, itâs our understanding that mostly these SEC investigations are fact-finding, and the SEC indicates in the subpoena cover letters that the fact of the investigation, and the issuance of the subpoenas does not mean that the SEC has concluded that weâve done anything wrong. So, we really look at this as fact-finding, weâre fully cooperative. A lot of these issues are issues that weâve had conversations and discussions with the SEC before. So, again, that is as much as we know at this stage. No, typically when you have as much turnover, especially when you have your CEO and your COO turn, I think thatâs probably a red flag. Just a couple housekeeping questions. Could you just clarify what that $0.17 retirement settlement benefit was, and also could you give us the store openings and closings during the quarter, and then just what the store base at the end of the quarter by division? Sure. We eliminated the medical retiree program, and that decision was in April, and because of GAAP, it is required that we record into the income for this quarter. So, it is a non-recurring event, just a decision not to continue with the medical retiree program. In terms of the store count, it was a relatively small number of stores opened, 14 stores opened in total and 5 kiosks. In terms of the closing, 11 closed, of which â¦Iâm sorry 15 kiosks. So, basically ups and downs basically, not a lot of net movement. Zales, 783, Gordons, 289, Baileys, 73, outlet 131, Peoples 172, Peoples 2 Carts, 75, Piercing Pagoda, 821, and then these three Master Jewelry stores. So, a total of 2,347. I got a couple questions. First of all, your cash taxes seem to be consistently running below the provisional rate, what do you expect that to be on a go forward basis, number one, and a percentage of the provision? And, secondly youâre other assets are up year over year, can you give us a little help on whatâs driving that? You know what, weâll get back to you on that. Thatâs not something that any of us were focused on, but we will look at that. In terms of other assets, it was in increase in vendor receivable. Okay, and can you tell us the inventory last year, the level of the inventory level last year excluding the Bailey Banks & Biddle stores that you closed? Can you share any comments with us regarding how flexible you can be in terms of managing inventory and/or marketing programs, as you look to the remainder of this calendar year, first half of your new fiscal year, if you need to be, in the event that consumer was down? Thank you. Iâm sorry, back to the Bailey Banks & Biddle inventory question, the decline in the inventory was $18 million. And could you re-ask your question? We were focused on the other one. Sure, if you could share any thoughts with us regarding how flexible you could be in terms of managing inventory or marketing programs if you need to be defensive in the back half of this calendar year? We are clearly flexible in how weâve managed through the inventory. I think the goal here is to make sure that there is no disruption, that we have a good product assortment at all times, and that we take a disciplined approach to moving through the non-going forward inventory. As you know, we have three main gift-giving occasions, youâve got Valentineâs, Motherâs Day and holiday, and two have come and gone. So, in terms of being aggressive on the marketing side probably would not be a good use of our marketing spend, so I donât anticipate any shift in our heavy dollar expenditure, which occurs in the holiday season. Let me ask a different way. How do you view the consumer going into the first half of your new fiscal year? Going into the first half, weâre very encouraged. We are definitely pleased with the traffic. We are pleased with the transactions. We donât, at this point seem to be concerned about the customer pulling back. I think that engagement rings, and then again diamond fashion at holiday are things that the consumer will continue to want to buy. I think they will buy them, itâs just who they chose to buy them from. We have not seen any resistance. Perhaps, the only potential concern is the Pagoda customer, who as you know, especially the teen part of the core customer basis might be impacted by the increase in gas, less disposable income. But, given itâs relatively diminutus impact on our consolidated; we really donât overall have any concerns about the flowing of spending. Good morning. I was wondering if you could just speak briefly to your moissanite product line and the concepts in which it is being sold, contributions to gross margins, and whether you see that selection expanding or contracting in the coming quarters. Sure, moissanite right now we treat it mostly on a trunk show basis, in particular in the Gordons division. The outlet division is actually bringing it in line into case. Itâs interesting, it is clearly a self-purchaser. We find that our Zale outlet customer tends to be slightly more affluent and we find it appeals to customers in particular who want big bang for the buck, and want to take it on vacation to the beach where they donât have to worry about their higher ticket, higher value jewels. So, it definitely has a place in our permanent selection in the outlet store, and again to be determined with regard to some of the other divisions. Congratulations on a good quarter. I just have one question. How would you characterize the new provisions to the training program youâre putting youâre Zales associates through as compared to say a year ago? Good question. I think there is more emphasis on product knowledge training, and weâre finding that is what our associates really want. It gives them greater confidence in their job. So, I think that the trading off of dollars what we used to put into what I call âsoft skillsâ, you know time management, leadership, etc., we are putting more of those dollars into actual product knowledge training, and in particular diamonds. Itâs an inhouse program. There is a certification program for diamondtologists, which we offer to all of our associates, sort of an online training they can take on their own time. Just a follow-up. Nice rebound in the stock in the last 20 minutes, youâve had about a 12-13 point percent swing. You were down 4, now youâre up 8. Just, in terms of George, for the extraordinary charges here, do you have the pretext dollars, and would they wall in SG&A, or was some of this influx goods sold as well? All of the items were either SG&A items or the benefit from settlement of retirement obligations, was a separate line item. Right, and the tax rate that I believe would apply to that was 37.2, so severance pretax was 3.6, the Bailey Banks & Biddle was 1.5, and then the benefit from settlement of retirement obligation is actually shown in the income statement⦠And just for your information, severance was really only the CEO and the COO. All other included in SG&A is normal course. Good morning and congratulations on a good quarter. One of the questions that I have. It just seems to me now that given the dramatic overturning of the management team, you have a new CEO search, and the beating that the stock has been taking over the last few months, as well as cheap evaluation both on earnings and on book value, it seems to me that now is a natural transition point to consider selling the company versus going through a new CEO search and essentially rebuilding the management team. I am curious why the Board of Directors isnât considering that? The Board of Directors has been really heroic here in terms of supporting me, and we meet literally weekly, whether physically or on the phone, and they have become very engaged. I think the Board recognizes the potential that the Zale brand has, and why put the company up for sale when youâve got the opportunity to fix it and provide the value to existing shareholders. The Board is very confident that we will be able to do that, and again the early indications are that the Board is correct. Does that answer your question? It did, I think that itâs something the Board should consider. Obviously the Zale brand has a lot of value and I think the Board should consider assessing whether or not you could get paid for that today, given all the private equity money out there, and given the risk inherent in essentially rebuilding the management team. I think itâs something that the Board should weigh as an alternative. I think the people feel youâve done a very good job since youâve been there in turning the business around. I think the results speak for themselves today. But, I think that given the work that youâve done, which is very impressive in the short amount of time, I think it could be a natural transition point where someone could pay you for a lot of the upside inherent in the brands right now. Yeah, I just had a follow-up. Betsy, on your last conference call three months ago you identified three major differences between Zale and Kay. I think product, advertising, and training of the store employees. Product, youâre obviously working on advertising. I guess weâll see how that plays out as we move into the holiday. I want to ask about the training and knowledge base of the store employees. What initiatives are being undertaken by management right now to close that gap between Zale and Kay? We believe that training has actually been one of our strengths. We also need to say that Kay would hire our people because we did such a good job of training them. I think weâve always had a good program, but we are trying to improve upon it, again in offering certifications, giving our people advance training, which gives them confidence in their jobs. I think we also are looking at training not just in the field, but also in the corporate headquarters as well in terms of testing some new indoctrination programs for buyers, etc. So, itâs a comprehensive approach to really investing in our people to make sure we give the customer what they want. So, what youâre saying now is that there really isnât a deficit, if you will, between the training of Zale employees versus Kay employees. Not knowing what their program is, it would be really hard for me to say, but I believe we find it very valuable, we feel very comfortable, weâve got a great training program, and again, if anything, weâre shifting more dollars away from some of the softer skills, not all of them. But, for instance, instead of time management being taught to all of our sales associates, we really are just going to do it with newly promoted or about to be promoted managers. So, being smart about what we teach, being a little more specific to the brand as opposed to generic training are some of the enhancements weâre making. I feel very comfortable that we have a great product knowledge-training program and that our associates are taking advantage of that program. Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234011 | Hereâs the entire text of the Q&A from Knight Ridder's (ticker: KRI) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Q: Yes Tony you are really showing pretty strong ad revenue growth, from a lot of your key markets right now, even San Jose is turning up pretty nicely, so I guess the question is Philadelphia and Kansas City remain kind of the burdens on the overall portfolio and youâve mentioned the retail issue with Philadelphia and I am wondering either you or Art can expand on how you are going to turn that. Thanks. A: I will be happy to tackle that one Doug. Youâre correct in pointing to Philadelphia principally and to somewhat lesser extent at Kansas City. Philadelphia the problem is spread across a number of categories, no doubt you are right, departments stores are a significant factor and has been through the year and until we really resolve through the merger itself, it will be difficult to notice the full impact of Federated May merger. Dillardâs has been hit hard also in a number of national categories, harder than other sectors, telecom, airlines, movies, our down performance in the computer categories is the entirety attributable to the share markets and of course National Auto as well. We have made a major effort in Philadelphia to strengthen the advertising sales efforts and I will much happy to be able to report that we are showing the result of that time factors that during the lag as we develop that effort. But we do have out of the top four positions in the advertising position there three are new players. Iâve mentioned it before, I will not go into too much detail. But we are doing a number of other things as well to drive advertising results in Philadelphia. We are focusing on the classified categories adding volume, sales pressure in all three categories, but we are adding parties in our retail advertising category and particularly new zoning efforts and news products to attempt strength, not only the large categories, but also small advertising within the Philadelphia market. Weâve increased our zoning particularly to start as the forecast. One of the important things that we are doing at Philadelphia is that we are trying to build our distribution of advertising throughout the non-subscriber component of the measure area there. We have a very good platform for that, in our trend shopper publication has reached small advertisers and they enable us to deliver free time advertising. Expanding the footprints of trends consistently through this year, and by this time next year weâll have added almost 200,000 households the footprints which was approximately 800,000 prior to reaching that additional number. We are also investing in capacity and production capacity in Philadelphia to grow these peripheral advertising accounts. We have invested in equipment, software and in sales pressure, those are the things we trying to do; we do expect to see results but we are facing a fairly tough quarter in Philadelphia principally because last year we earned $2.5 million, Pennsylvania treasury ad spend, it is just not going to recur. Kansas City just to give them little less than on that; but Kansas City has had something of a perfect storm in that it did enjoy significant ramp up in â04, in particular with the home furnishing category. Rapid finishing came into the market, this year has been about a shakeout. Nebraska has flattened, number of accounts have gone out of business, actually it is a major factor in shakeout. It had other out of business account so itâs been tough in Kansas City. For reasons that are not entirely clear, the telecom consolidation adversely or disproportionately affected Kansas city. However, we do see that trend turning Kansas City doesnât stay down long as it is a good solid growth market and we expect to see improvement performance there certainly in the next twelve months. Q: Thatâs a great answer and just as a followup I mean all else being equal would you; is it realistic to expect Philadelphia to start showing some positive momentum by the second half of â06 A: I would say absolutely, yes if we donât see that I would be deeply disappointed Doug. We have really put a lot of pressure there, the publisher there is under a lot of pressure and Knight Ridder corporate is very actively involved in and we expect to see that turnaround certainly by the half of next year. Q: Good morning, just a few questions, can you just give us the percent change from movie advertising and telecom in the quarter, also your pre-prints, what percent was that up in the quarter, and then lastly, your non-daily revenues what the annual run rate on those right now, please thanks. A: Itâs only due to the telecom and movies and pre-prints, telecom for the quarter was down 2.5%, movies down 68.3%, and then, pre-prints were up 3.2%. Iâm sorry what was the second half of the question? Q: Yeah, your non-daily publication, we have been talking a lot about recently, whatâs your annual revenue run rate there please? Q: Is it fair to say if you do the numbers, if you take out; your internet operations you take out this target publication that your daily newspapers for the quarter were down; half a percent give or take? Q: Okay Tony lastly have you given any thought over the years to divesting your Philadelphia newspaper given the big drag it is to earnings and the frustrations that is entailing you and your management? A: If you ask the question have we thought about divesting? No we have not and would not, we have no intention of doing that, cause we see Philadelphia very different from Detroit where we obviously own 50% and we were not running the business there we think long term Philadelphia is a very good market and we anticipate doing much better in future. Q: Hi good morning, a couple of questions. First I think you have been seeing some pressure on rates earlier in the year on the print side has not changed much into the third quarter and can you also talk about what of kind of rating prices you are getting on the online side. A: Let me talk about the online side. In online of the growth that your seeing, I would say that it is very side vertical. I would say about 60% of the recruitment growth is from rate increases and the other categories would be less of a percentage. A: In general weâve been doing one rate increase a year, but we opportunistically will take rate increases as we have potential, and we do it on a market-by-market basis A: On the print side, we certainly plan rate increases on a once a year basis and we expect they should be the same kind of rate increases that we saw in the recent years. So we donât see any change there. Certainly in the categories where we have seen substantial online growth auto being example, to some extent recruitment, we have seen some slippage on the print rate side, but it has been more than offset where with the performance that were getting on the online side. Q: Okay and just to wrap up, how do think your papers performed in Philadelphia and Kansas City relative to the overall advertising market there. A: Itâs pretty hard to tell on a run rates, contemporaneous basis. We just do not get quality information on market share, just close to that point in time. However Iâll say this that we know that in Philadelphia, because we have relationships with broadcast units there, they have experiencing significant down performance in their advertising. So I can tell you the Philadelphia the market itself is fairly consistent with what we are seeing in our newspaper Q: Hi there thank you. A couple of quick questions. One, could you just give us sense on what you are seeing in October right now in terms of newspaper ad trends and what you might expected in the fourth quarter relative to the third quarter in terms of rate of growth, and then also I apologize if you already quantified this, but I donât think you did. Did you quantify the expected cost saving from the lay-off from San Jose? A: Thatâs a little difficult to do. The lay-offs are in progress at this time and the period during which _____ buyout has not ended, so a little bit estimated I can tell you our severance cost that we recognized in the third quarter was 8.6 million and we certainly expect to outperform that number substantially next year with the savings in those newspapers, but it is 152 people that is what we are talking about and San Jose and Philadelphia have very high re-scale so. Itâs a big number until we now exactly whoâs going and if they were lower scale or how senior they were. We will not have the exact number; its a big number how run rate In October I think its really to early to give you exactly. A: I think itâs really too early to get the forecast on that, I mean, I have to serialize the quarter, but I think its really too early, anybody want to add something to that. A: The only thing I would say is that automotive continues to trend it out in the same vicinity of where it has been trending. Q: Okay, retail in particular was what I was wondering about. One of your peers had indicated they had seen little bit better September numbers and then it again weakened again going into October and I didnât know if you have experienced anything like that? A: I have been getting mixed results across the market and one of the thing that makes it difficult to _____. Q: Hi, thank you, just two quick questions. When do you cycle through the lightweight newsprint benefits? How many more quarters of that we are going to see, and in second the papers you picked up in the Northwest, are you feeling better about whatâs going to happen in Seattle, I know that your partner there has _____. What do you think your end game is there? Thank you. A: I think on Newsprint Paul that we cycle through most of the lightweight conversion, so I donât think youâll see much going into the fourth quarter in the next year. We will have further savings as the Kansas City plan comes up, because they are going to be on a different web with a different cutoff so there will be more savings there, but there, as Iâm on and on further out of the future Port Wayne will be converting over, there is a new press operations coming up there, but on the other properties most of the newsprint savings has been achieved with respect to lightweight. A: What we are looking is 48 inch and as a matter of fact we are going to get 48 inch with _____ for port Wayne. So we are looking at that issue. A: And the Seattle question, the end game, I donât know, Seattle is showing some improvement this year, over the last year, but I expect that all of the lawsuits will get settled. I think we would see settlement of that, you never know in Seattle, there are a lot of lawsuits and there are a lot of moving pieces. We have a Seattle Times court hearing coming up next week, as a matter of fact we will learn a lot more out of that, whatâs going on, and the status of the lawsuits and the status of all the legal action. Q: Thanks, wondering if you could discuss your expectations for circulation in the upcoming AVC audit, and related with the decline youâve reported for circulation revenues is in the quarter, how much of that is volume driven versus discounting, and where do you expect circulation revenues to go in the fourth quarter? Thank you. A: Let me tee that one up Brain. Circulation revenue excluding our newly acquired newspapers, we expect to complete the year down in this mid twoâs somewhere between the 2.3 and 2.8, as far as the impact of discounting and volume reduction it spread across the two certainly weâre seeing some fairly significant increases in discounting. So that is definitely a part of the equation, part of what weâre facing on circulation revenues. A: Well saying in general, we face more pressure in the larger Metro market, as a general statement, that would be what you see in discounting numbers if you look market to market. As far as the publishers statement the numbers will be very close to what our Q3 numbers are, we expect to end Q3 down 3.2% daily, and Sunday down 3.4%. A: I am trying to indicate that at the beginning, excluding the new properties Brian weâre looking at circulation revenues in the year to be down between 2.3% and 2.8% a year. Q: Thanks, Tony I wondered with all of the talk about the share shifts out of print on the Auto side and the real weakness we are seeing the numbers, can you try and just aggregate in your sense of how much of this is just weakening macro trend with automotive or a longer term shift out of interactive and on a segway related questions Cars.com, your property, what are they seeing in terms of that, the dealers who are only going with interactive now and completely showing trends, and what kind of growth you are getting there? Thank you. A: Let me start with the online side, we seeing nice growth in automotive but in no way are automotive dealers spending anywhere close to a significant portion of their total media spend in online, its still in the very low percentages, overall growing nicely, but I think there is bigger indicator in terms of what happening, its really a function of whatâs happening to those on the market place, our unit sales could have been lackluster, youâve got increasing competition with the consolidation, and I think what you are seeing here at least is to some extent cyclical, to a much lesser percent than an explanation that says that the share shifted online.. A: Weâve typically done better with domestic automotive dealers than we have with the imported dealers and they are struggling, and so, thatâs a factor and their business is just not very good. There are some signs that next year could be better year for us in that regard, but I think its still early to count on that. Q: One follow on question from the big picture prospective, sometimes you are caught in the details, but a lot of concern or noise was made about the fact that you and one of your competitors as well up in the peer group had decided to cut the editorial staff, do you think there is a re-think in terms of the newspaper model that will continue, and how much you really can support at this point from an editorial prospective? A: Well, I think that after we have these staff reduction, I think we will still be generously staffed, so Philadelphia Inquirer will have 425 people in their newsroom, and the Philadelphia Daily News will have 100 to 110 something like that. So between then we will have 535 right, I think thatâs still a great generous newsroom staff, and San Jose is to wind up about 280 and I think now thatâs a little more than one per thousand so, I think that we were overstaffed in those two places, and I think this is just a bringing them back into line. Q: Thanks, and I was wondering, you may have already addressed this, but I was wondering if you have any thoughts about the outlook financial advertising in the fourth quarter, any particular categories that appear promising. Secondly is there anything unique about the competitive marketplace in Philadelphia and even possibly Kansas City for that matter that would account for the weakness there, and in particular you had bought a few suburban publications to possibly flank your papers in Philadelphia and it seems that maybe further acquisitions there might be a little tough. Can you talk about what are your other options that you have to support your paper there, and possibly improve its competitive position, and any feeling on how the suburban Philadelphia papers are doing? A: Philadelphia is unique among our markets, in the competitive landscape and there are challenges there that are different than we faced in some of our other markets. Just a brief snapshot, the biggest difference is that this prime area has been largest, incorporating a number of daily competitors strung around the metro in the suburban communities. Our strategy for addressing that has really been a combination of trying to tailor our editorial strategy to cover to the local communities and then marry that with strong advertising programs in the smaller advertising. There is a similar strategy and itâs been tough _____. The key things for us it its new and I think helps us gain market share, is what I mentioned there when I responded earlier, and that is in the expansion of our shopper network into those communities. The matter displaced where we are making a substantial investment at this time, that shopper network incorporates some of those acquisitions you were referring to. Essentially thatâs the tool that we are looking to grow market share to stamp our footprint to counter the existing growth in competition. So in my respect Philadelphia is more challenging, more complex, as it has an entirely different competitive landscape. Kansas City, I believe is different, our competitive position there is extremely strong. There are not competitive dailies, we own a number of the suburban weeklies and one suburban daily there. So what we are experiencing in Kansas city I think itâs mostly attributable to the cost in the economic progresses of that metro. And I would associate some of that with the sequence of the events of experience, where we saw sprint again a major reduction, itâs a large component community, major reduction following the WorldCom merger. And now with the merger a lot of them certainly in further reduction and _____. Q: On the national advertising outlook for Q4, I think what we would say is youâve very little visibility. A couple of things I would just like to know, I remember Art mentioned when he talked about Philadelphia that we had a $2.5 million spend from the Philadelphia Treasury last year, but itâs not going to repeat. I think in automotives it is too early to tell, automotive inventories are low averages but thatâs because of the employee incentive programs but thatâs not true for all the manufacturers, its extensive for manufactures, need to bringing down their inventories to meet the spend in the fourth quarter, but once again we are not here to predict that, I think in telecom, it continues to lag due to the industry consolidation, weâve seen combined signals from those that remain out there competing, but hard to know whether those trends will begin in Q4 are lag in Q1. At this time I would like to remind everyone, if you would like to ask a question press â*â and the number â1â on your telephone keypad. Thatâs it, no more questions so. So if not we will see many of you in New York in December at our two conferences. The rest of us will be here but both will be available for calls if any of you have specific questions. So thank you very much for joining us. Goodbye. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234012 | Hereâs the entire text of the Q&A from Yahoo's (ticker: YHOO) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you. We will now begin the question and answer session. If you have a question press * then 1 on your touch-tone phone. If you wish to be removed from the queue please press the pound sign or the hash key. To ensure that all participants are able to ask questions, please limit yourself to one question. Once you have asked your question you will be immediately placed back into conference. If you are using the speakerphone you may need to pick up the hand set before pressing the numbers. Once again, if is there any questions, please press * then #1 on your touch tone phone. The first question comes from Imran Kahn from J.P. Morgan. Q: Yes hi, guys couple of questions. Terry you talked about improving moneterization. I was wondering if you could talk about you are doing in terms of gaining market share or in the base search market in the international market it seems like international is driving tremendous growth and your competitors have dominant market share there and secondly, you recently signed a couple of network partnership with like for example with iVillage, I was wondering if you could what drove the success I think it was a competitive win against Google to win those, were you more aggressive on the revenue sharing part or the technology win, could you comment on that? Thank you. A: This is Dan, again market share globally, we have been in the search business for two years, we are actually extremely pleased the overall market has been growing very rapidly we've been growing right along with it particularly in the United States. In Europe, we continue to pick up share in some of the larger countries and we continue to improve the product and improve the algorithm distribute it better distributed tool bars, there are a whole lot of things that we have in place that have actually been helping us very effectively and of course in Asia and certain key countries with our relationship with Alibaba in China in Taiwan, in Hong Kong and other places that we have tremendous market share already and continue to do all the necessary things in terms of improving the product, rolling out new product, getting better distributions. So, we have done a lot in that space. Q: Thank you very much. I was wondering you could comment on what strategic interest Yahoo may or may not have in portions of AOL. Sue, a question for you, it looks like the business has pretty strong momentum going into the fourth quarter if I look at the quarter over quarter growth rate in unique it is 8% and daily pages at 9% and that's faster than the rate of growth that you had in revenue it looks like you're building a lot of user activity that hasn't been moneterized yet as it relates to both branded and search could you comment on that and then in the fee business, similarly at a 13% sequential growth only 1% growth in revenue per unique user so it seems like there's some momentum in the fourth quarter from that unit growth and if you could give us a perspective and then last Terry, you had mentioned moneterization, could you specifically comment on what near term means it relates to increasing the fixed rate or coverage of sponsored leads on search on Yahoo.com? Thanks. A : So Anthony I hope we've got all this, Iâll be easy, Iâll start off on the AOL strategic interest I always say this here we go you and I on this call alone right. Is that 300 odd more people on the call and now listening I assume that to be the case. So Anthony I'm going to pass that question because we never discuss any of those items. So I will go on to Sue who will start to answer the next question. A: So Anthony, on the unique and daily page views growth in Q3 versus revenue and the Q4 momentum, I think it's worth just reminding everybody that the seasonality of unique users and page views tends to be often the exact compliment or the opposite of revenue. So, Q3 typically is a really strong quarter in users and usage and is typically a little bit softer quarter from a brand advertising perspective. So we have a little bit of unique relationship when you look at things sequentially it's a little hard to make a judgment, but I would say that year-over-year we saw very strong gains in users and in page views more North of 20% and that although very strong was still less than our overall revenue growth. We are seeing enhanced moneterization on both of the sides of our business. On the brand side a good proxy for the CPM side business look at marketing services revenue per page view and exclude search revenue from both then numerator and pages from the denominator. Just to give you some flavor in the US we saw that metric grow again in the double digits year over year, which is relatively consistent with what we've seen in the last few quarters. On the sponsored search side we think the key is really to focus on the fundamentals of the industry in terms of how many advertisers we have and how much revenue each of those advertisers are generating because how they allocate that is the functions of the tools they get and whether it is more inventory or revenue per search, but getting into the specifics on queries our worldwide trends on Yahoo sites and our affiliates again experiencing very healthy query gains up very strong double digits. On the RPS side although the country and product mix changes make it difficult to review the trends in aggregate, if you look at our own network in the U.S. to hold the variables constant which is how we quote it every quarter we think those are fairly representative of what we're seeing on an apples to apples basis and Q3 RPS in the US grew nicely again year over year as did last quarter and also rose sequentially. We're starting to see some of the matching algorithms that we've been rolling out. I'm moving now to number 3, the fee side. Yes, we saw very, very strong incremental subscriber growth in the quarter 1.3 million and we raised our forecast for the year. We are seeing very, very good gains from our collection of premium services. We talked about some of the specifics on the call, the content bundled with access as all of our access providers grow their subs and we start to benefit from Verizon plus the music launch and we're seeing very good gains overall.$3 to $4 ARPOs continue to be good for the year. The last question is moneterization and where is that going to go and I think I'll just reminding you what we said before, which is, when we acquired overture and need to me, we first focused on the algorithmic side. After that we got that fully launched we will turned our attention to the moneterization side of the equation and a lot of our operating plans this year were all about developing a product suite, a very sequenced product suite in terms of how we could we could improve our moneterization and we see that as all upside from where we are now. What we said is we expected to see some of those products start to hit and benefit in late this year and then the financial impact really to build throughout 2006. Since there's been a lot of speculation on exactly when that is and what we're doing I think I will share a little more transparency on the product suite that drives that. So just to review, Terry talked a little bit about the Yahoo publisher network, which was launched in beta in August and will be more widely available in beta in Q1 of 2006. So that's one important pocket of activity and that we expected and has already been launched. Second broad bucket is our improving matching capabilities. Over the last couple of quarters we've been rolling out new capabilities that enhance matching that leads to overall increased coverage and better RPS. We are continuing to enhance those tools to broaden our matching capabilities and we should see additional changes rolled out every quarter throughout the year, but as I mentioned before we're already starting to see some benefit from that and we expect that to grow in 2006 as well. The third and final broad bucket of various initiatives is concerned around improving our relevance and our quick through rates of our paid listings. Our matching initiatives is largely focused on coverage and these are largely focused on click threw and better tools to advertisers. Our plan now is to begin testing some of those initiatives in the first half of '06 with a broader rollout there after. All of these initiatives have been already much right on track and consistent with our original plan which is to have a sequenced series of products starting late this year building throughout next year and that's why we have been advising you that we expect the financial impact to grow throughout 2006. Q: Thank you. Just a couple of quick ones. Terry you talked about the integration of user generated content and professional content and I'm just curious how you look at that from a return on investment point of view. I'm just thinking that some of the investment that you're making could either be viewed as too small or too big in terms of some of the content that you're generating yourself and I'm also curious if you could discuss head count as you approach the end of the year, if we should expect to see an increase in the fourth quarter as big as we saw in the third quarter. A: I'll begin. I guess it depends on which side of the glass you're looking at if the expenditures are too large or too small. I consider them to be totally appropriate. So they are not large. This is not a sprint. This is an ability to Yahoo to take the leadership position and start to evolve a whole new industry as it relates to media and media content. And so don't look for any one thing that's either going to be wildly expensive or any one thing that's going to change the whole direction, but look to a series of things, some of which will be generated by Yahoo, some of which will be licensed and our partners with others as we've been doing in the past and a large portion of it will be user generated content that Yahoo will totally enable and give you users an opportunity to use our tools, post them, move them around our network from either their buddy list or their families or attach advertising links to it, and give them the ability to create businesses if you will. So we have I think a very exciting roadmap that includes some things that we're going to do on our own and many things that we're going to do with many others. A: Sure. Lauren, on the question of head count, yeah, we did have a very large increase in Q3, which was consistent with our expectations. We're really, really fortunate to have hired some of the talent that we've hired and as you can see from a lot of the product rollout that Terry talked about it's been a renaissance in terms of our overall product suite. We do expect to hire in the fourth quarter probably not quite at the pace that we experienced in Q3. Q: I'm trying to interpret the fourth quarter guidance. In particular, how much of the Yahoo China operations on both the revenue and operating loss basis are included in the numbers what percent of the quarter if you will and if you can think about Alibaba today does it currently make an operating profit?. A: Okay. Jordan, it's Sue. Looking at the Q4 guidance, there are a few things affecting our Q4 guidance. I think if you work through the math there's roughly about a $7 million quarterly impact for deconsolidation Alibaba, which is deconsolidation for not the whole quarter but a lot of it. China operations had been basically running at break even for the nine months. So no real impact from that. And then in terms of Alibaba specifically we really cannot comment on their financials. They have put out some forecasts in the past for their core B to B business, which would indicate they're quite profitable, but that's really a question for them. Q: Good afternoon. Terry, you talked about the growth in the top 200 advertisers well above I believe the 40% or so growth in the overall marketing services. Could you give us some more color on what you see in the broader base of your brand advertisers or let's say search advertisers. Is there a concentration among sort of a group of advertisers that are giving you a higher growth? Are your smaller advertisers going just as fast or not can I have it quick, Thank You. A: Baba, Itâs Terry. I would start off by saying our brand advertising business is terrific and it's very, very well-balanced so we're seeing great growth in terms of the amount of dollars being spent by many of the top, top companies in top, top categories whether that's auto to CPG or financial services and others. But let me say this, we're seeing across the board growth, frankly in both of our advertising businesses but across the board, so our smaller and more medium-sized advertisers are doing a much better job as well and it's not really limited to any one area or any one size company. It's companies more and more becoming more and more accustomed and more and more comfortable with brand advertising on Yahoo and it time to pick up their pace. So like the logic companies they started with very small amounts. They started to emerge into slightly larger and that process just continues each and every quarter. We're seeing it across the board in both small, medium and large advertisers. Q: Thanks. Good afternoon. A couple of quick questions. First congratulations on the Bell South signing. Do you think that given Bell South's footprint that that will ultimately be about half the size of the kind of revenues that you're generating with the SBC deal and on Verizon, given the fact that they have about a similar footprint to SBC but you're not exclusive, do you think that ultimately that could someday be the size of the kind of revenues you generate from SBC? And then secondly, Terry, on advertising inventory for the holidays, is that basically going to be the gating factor for your growth in branded advertising where everybody wants certain pages or is demand really the gating factor? Thank you. A: Okay. Mark, I'm going to start on the Bell South deal, which we are really pleased to announce. In principle this is a very similar co-branded service provided at no additional charged on those Bell South residential broad band subscribers for all tiers of service and the existing base will have the option to select the broad band service and new ones will be co-branded so in terms of the financial impact, this is not going to be launched until late '06 so I want make sure that you're counting that in and we don't expect any meaningful contributions in '06 itself. As I mentioned the structure of the deal is broadly similar to past broadband deals, we receive a monthly payment and Bell South participates in a revenue share. In term of economics gaining the nationwide presence was the most important factor to us, to add new users and expand our geographic footprint. Also when you compare it to recent deals that of Verizon or economics with Bell South reflect the factor we are initially the default offering for all new Bell South subs, which is a better position for us from a subscriber standpoint. In terms of the overall sub base, its sub base is roughly 2.5 million broadband users. So you can kind of play around with the map I think hopefully with those parameters. A: This is Dan. On the question of the advertising and the holidays in general demand and what are the gating factors, we have tremendous inventory as you know and Terry and Sue took you through some of the highlights of the actual, incredible growth we're seeing all through the network. Terry also mentioned that increasingly advertisers are taking us up on using targeting capabilities. As those get lot better. That helps us much more efficiently use our own inventory so we're able to create inventory based on a result of that. So based on the growth we have organically the number of services users are using which Terry mentioned are going up, the frequency in which people are visiting are going up and the fact that we're more efficiently able to target advertisers and find the kinds of consumers that advertisers want particularly the large ones, we think that we have plenty of inventory to continue to grow quite nicely. Q: Yes, thanks a lot. Two very quick ones Sue, could you comment a little bit on your growth on the proprietary side versus growth in the network. Tax seems to have stabilized from what it did last quarter when it was up a few hundred basis points and then Terry, you said earlier that you're expecting your strategy to unfold over the coming months. I was wondering if you could give us any more clarity on that. Thank you. A: Okay. Sure. In terms of the underlying growth of our search business, we really don't talk about the owned and operated piece but we do put out our tack numbers so there are a few things you can ascertain from that. You'll see it grew 5% quarter to quarter. Our overall tack rates stayed stable or even declined a tad, so the underlying growth of our affiliates you could probably infer from that was a little higher than our stated tax. I think one important thing to mention from that though is that I talked a little bit about MSN and that trailing down a little bit, so that mixed shift would tend to keep the reported tack relatively stable to down even though the underlying tack continues to see exactly what we've been expecting in that we have messaged you for the last two years, which is modest increases in both international and domestic. A: Hi, its Terry. So on voice over IP. Yahoo is already a significant player in the PC to PC product and I did mention that you could see future innovations in the upcoming months. Bear in mind, as you know, we did buy dial pad and that does give us capabilities to much improve what we currently have in the marketplace and we're also looking forward and tend to work together with a number of our access partners in their territories and we have been exploring opportunities of working together. Q: Hi. Can you please talk about the improved hot jobs offering? What has been the early feedback and have you seen much of a change in traffic and also is it safe to assume the listings business growth rate is in line with what it's been historically? Thanks. A : I'll take the first part and sue will take the second part. On the hot jobs it's actually been met with excellent response, it's the same philosophy as search, which is the ability to have the most comprehensive and relative offering. It's really opened up the marketplace to allow more users to come on in and be able to find what they that ear looking for. So we have been quite successfully, as we roll this out, really my been able to get more usage out of each user as they come back and come back repeatedly. This has been helping those that want to market through hot jobs have more listings on there. It actually helps the commercial listings as well because of the frequency and the intent of the user. So the early signs are quite good so far. A: On the listing side of the house, we have seen very consistent listings growth with what we've seen in the past and that is now all in our marketing services line. Q: Thank you very much. Two quick questions. One on local search based on this Whereonearth acquisition. What's your sense about when local search could become material? There are a lot of gating factors here. People have talked about local search for perhaps the last two years. It looks like the date has been immaterial, but what is your sense on when it does become material and what is the single biggest gating factor as you see it. Then a real quick question on the numbers. I think if we back into what the using the tack back into what non search marketing services revenue growth was, I think it was approximately we calculated around 10% which would actually imply an acceleration in year over year branded advertising growth. Any comment or feedback on those numbers? Thanks a lot. A - Dan: This is Dan, I'll take the first part of the local question. There's actually multiple parts to your question, which is when we talk about when does local become material, with if we talk from user perspective it is already material. Whether you come to yahoo and use Yahoo yellow pages or Yahoo local. It's quite substantial part of what users come to us today you search local search in yellow pages. So from that perspective it has been steadily gaining ground each and every year and it's actually a very large percentage of the queries that go in there. We've also expanded local to not just be in those sections but to make areas such as travel become more localized. So there is a number of things were doing that continue to keep us in the leadership position in the entire category. This particular acquisition will help with the moneterization side of local, which is to be able to more effectively target advertising to the local markets and in that world there's two groups. The big L which is the large advertisers who have the national budgets but also advertise locally and then there are small advertisers who have not really come on the web or are coming on to the web and the gating factor there of course is how do you get them on to the web. So that's going to take time. They're coming on more and more every day our small business offerings help that our yellow pages help that. Our feed system helps that and our Yahoo search marketing helps that so that's just going to continue to build over time. As you get a larger base of them, the ads get more relevant. On the big L, which is large advertisers targeting locally we've been quite successful with that and the kind of targeting capability that we have has been very effective in helping these advertisers expand how much marketing they do on us so there is not a day or a week or a particular product that change the moneterization. It just will keep building over time and become more material over time. A: So, just moving on to the second question, I'm trying to follow the math here. I'll just give you a couple parameters here. Our marketing services extax grew 6% as a whole sequentially quarter to quarter and I think I mentioned earlier that you saw tack was up 5%, but that our tack rate declined slightly so that would imply our affiliate growth rate was broadly consistent with the overall ones. Therefore I think your conclusion would be that owned and operating brand together grew roughly 6% quarter to quarter so I'm not sure how you got into 10% but I don't think we want to get a lot more clarity beyond that and I think you have a lot more parameters to work with there. Q: Thank you. If you could just give us a little bit more color on the branded side of your business specifically calibrates freezing upon your top properties and maybe how pricing is trending versus a year ago or last quarter and then if you could just clarify a comment you made earlier on the search side in Europe, did you say you were gaining market share in all of Europe or you were just gaining market share in some markets? A: This is Dan, I'll start and then we'll turn over to Sue for pricing. On the inventory question as I explained earlier, that given the natural organic growth of Yahoo which has been quite substantial as you saw this quarter and given the frequency in which users are returning all of which continued to go up quite nicely, we don't have an inventory problem in terms of the traditional ways. Plus our targeting capability is allowing us to take the largest advertisers who would normally be focused on one particular content area and help them be successful across the network. So that's some of the benefits of being able to use the Internet versus other medium and advertise. We've really doubled the number of advertisers that are using targeting capabilities over the last year so that's been a really big benefit for marketers and for Yahoo. The search in Europe, it's not in necessarily every country. We continue to maintain share most all major markets. In some cases we gain, but the overall message here is that the category is growing quite nicely and Yahoo continues to grow along with the category. We âve been in this market for just a short period of pretty time We're extremely pleased with our success and we actually have been adding new products and new capabilities and new relevancies which we think make us second to none at any of these markets so we look forward to the future. A: So just to conclude with the pricing question on the branded side just to take a step back, since we already do business with most of the nation's top marketers our primary focus is on depth over breathed driving revenue per advertiser over increasing the number of advertisers. In terms of the revenue per advertisers which is going very rapidly is split across pricing and inventory. I think I mentioned earlier that a really good proxy for pricing on the brand side is to look for the marketing services revenue per page view excluding search from the numerator and search pages from the denominator. On that basis pricing was up again in this quarter double digits as we've seen in most of the recent quarters that I can remember. We also had very nice growth in inventory as you saw from our overall page view gains. We said that was up 26%. That could include search and the rest of the network, but the point is that the overall attractiveness of the medium is causing more consumers to come we're seeing double digit gains in both in inventory and in pricing. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234013 | Hereâs the entire text of the prepared remarks from Lam Research's (ticker: LRCX) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good afternoon ladies and gentlemen welcome to Lam Research September Quarter 2005 Financial Results Conference Call. At this time all participants are on a listen only mode. Following todayâs presentation, instructions will be given for the question and answer session. If anyone needs any assistance at anytime during the conference, please press the â*â followed by the â0â. And as a reminder, this conference is being recorded today, Wednesday October 12, 2005. I will now hand over the conference over to the Kathleen Bela director of investor relations, Lam Research. Please go ahead. Thank you Robert. Good afternoon and thank you for joining us to discuss the financial results for the quarter ending September 25, 2005 and the business outlook for the December ending quarter. By now you should have received a copy of todayâs press release, which was distributed by business wire at approximately 1:00 pm. We are webcasting a slide presentation in conjunction with todayâs commentary. The presentation can be accessed through our website at www.lamrc.com. Here today are Stephen Newberry, President and Chief Executive officer and Martin Anstice, Chief Financial Officer. Except for historical information, the information Lam is about provide and the questions Lam answers during the call may contain certain forward looking statements, including but limited to statement that are related to the companyâs future revenue and operating expenses, management plans and objectives for future operations and product development, managements plans for continuing the companyâs stock repurchase program, global economic conditions including consumer sentiment and customer standing and the demand acceptance and competitiveness of the companyâs products. These statements are subject to various risks, uncertainties and changes in conditions, significance, value and effects that could cause results to differ materially and in ways not readily foreseeable, and which are detailed in the companyâs SEC report. We encourage you to read those reports in the entirety. Lam would also like to disclaim any obligations to correct or update give any of the information we are about to provide. This call is scheduled to last until 3:00 pm. We ask that you to please limit your questions to one per firm. I will now turn the call over to Martin for a review of our financial results. Thank You Kathleen. This afternoon we will discuss our September 2005 quarter financial results. Highlights today include a positive new audit inflection point, representing 3% growth sequentially. In line revenues at $321 million, earnings of $0.35 that were stronger than guided due in equal measure to our operational cost management, lower equity-based compensation expense and higher other income, and cash-in operations of $47 million consistent with our plan and strongly correlated with our earnings performance this quarter. New audit entered into backlog for the quarter up 3% at $326 million, adjustments out of backlog were $13 million and there were essentially no order cancellations. 300 mm applications represented approximately 78% of total systems new orders. Our strength at leading edge applications is reconfirmed by the proportion of orders at less than or equal to the 90 nm technology node of 76%, against our guidance of flat to down 5%, the 3% growth in new orders reported today was geographically concentrated in Asia notably Korea, Taiwan and Japan. As we anticipated, our systems new orders market segmentation was fairly balanced relative to overall ways of outspending comprising memory at 52% ID and logic 26% and foundry other at 22% of the total. Revenue of $321 million met the mid point of our guidance range. As a reminder our typical customer expectance cycle times have ranged between two and five months from the date of shipments to the customer. Our market share success is generally and particularly due to those in Japan, introduce the probability that first in SAB installations trends to the longer end of that expectance range, for that reason we remained focused on managing our equipment installations with customers. Our revenue guidance ongoing will continue to reflect our best estimate of likely outcomes. Shipments in the quarter were generally where we expected down approximately 21% sequentially. As we characterized in our prior earnings call, this change in our shipments level was in appropriate alignments of factory output to the pattern of orders over the last several quarters. To illustrate this point our shipments, book to bill for the last 12 months is 1.01, on new orders of 1.3 billion. Our September quarter book to bill was 1.16 our ending unshipped backlog increased by 31 million to 382 million. For more complete details on orders and revenues, geographic breakdown, please see our press release today and our website for a reconciliation of new orders, shipments, revenues, deferred revenues and backlog. Gross margins were approximately 48.6% in the September quarter including approximately 1.1 million or 0.3% points for equity based compensation. This performance exceeds the model we shared with you a year ago. Total operating expenses increased at a slightly slower pace than originally planned. We continue to target and incur expenses related to discretionary investments in R&D focused on leading edge, plasma edge, strip and clean. These investments were offset by lower equity based compensation expense and higher than anticipated vacation benefits. Accordingly total R&D expenses were contained below our original estimates. Worthy of note, our total company equity-based compensation cost, were $5.2 million less than our original estimate of up to $9 million. This reflects our current intentions to grant equity to certain executive offices later than originally planned pending shareholder approval for a minor incentive plan modification and separately the challenge with new expense item with limited history of RS use and specific knowledge of grand dates and our share price _____ is bringing to forecasting. As you might have expected, we where conservative with our equity compensation expense guidance in September the first quarter of adoption, our effective tax rate was 27.4% for the September quarter, our current expectations for the fiscal 2006 year remains 27% plus or minus 1% points. If the R&D tax credit is approved again this year our tax rate has the potential to reduce by 1% point from its estimate. Continuing the theme of prior courses, the cash outlay for the taxes was substantially lower than the income statements rate due mainly to the conversion of deferred tax assets into cash. Our reported income tax expense was $19 million, our consumption of deferred tax assets in the quarter was $15 million. We generated cash from operations of $47 million this quarter, driven primarily by profit levels and sustained industry leading worth in capital performance. We received $17 million from the exercise of employee equity plans and we used $79 million to repurchase 2.6 million shares at an average price of $29.76. For you convenience, we are adding a cash flow statement to our press release tables, we hope you find this addition useful. The total cash balance including restricted cash was $874 million at the end of September. Deferred revenue and deferred profits were $107 million and $64 million respectively. These balances exclude approximately $54 million of anticipated future revenue value for shipments made to Japanese customers where title has not yet transferred. These shipments are currently recorded as cost in the inventory. Capital expenditures were $5 million, depreciation and amortization announced to $6 million for the quarter. At the end of the period, net fixed assets were $40 million and we retained employment levels essentially flat at 2,200. We will now move to Steveâs comments. Thank you, Martin, and thank you for joining us. This afternoon I will recap the financial highlights, comment on the companyâs performance in this September quarter and on the industry environment and conclude with our guidance for the December quarter. The company delivered another quarter of excellent financial performance, I am particularly pleased with our cash generation and operating margin results in a period that represents the bottom for revenue in this cycle on a revenue decline from the peak of approximately 100 million or 24%. Our operating margin performance remained above our target model presented in November 2004. This is the first time in our history we have been able to handle a significant revenue decline and deliver strong operating profits throughout the downturn cycle. While we are proud of what we have accomplished, it is where we are headed that has our complete focus and engagement. Looking forward we believe we are positioned to continue to deliver excellent financial performance that meets or exceeds our target model of 19% operating margins at revenue levels of 350 million. Our market share momentum continued in this September quarter. Lamâs products were selected by customers in a number of regions representing leading edge market share gains that have positioned as well for fab expansions. Our experience in deep knowledge base in Etch sets our sales and support teams apart, and is often a key factor in both wining new share and extending our position. Etch is one of the most critical applications in the fab, due to the fact that Etch can compensate for upstream process variations and optimize downstream processes, which can lead to improved yield. In a sub 65 nm environment, the value of incumbency in Etch is increasingly important. With our world class support in product technology leadership, we expect to be successful at leveraging our current position to enable new market share wins. Examples of this our seven new application wins in the past two quarters on sub-90 nm applications and an expectation of five to seven additional new wins in the December quarter. I will turn now to the overall industry environment and outlook before concluding with our December guidance. We have begun to see positive signs and demands for equipment resulting from the continued strength in semi-conductor unit growth and higher utilization rates. Most recent data shows unit growth in the high single digit percentage range, price declines in memory have recently firmed as big growth from both DRAM and the NAND Flash markets have accelerated with this demand. Lead times in the semiconductor device industry remains short from a historical perspective as customers keep a tight leash on inventory. Semiconductor manufacturers are holding relatively low levels of inventory and managing supply to demand very carefully. Utilization is rising in general and particular is greater than 90% at less than a 130 nm. We see an aggressive move to 90 nm technology in the foundries driven by demand from fabulous companies and IVMs migrating to a fab like strategy, to our supplying devices for the upcoming game console product cycle and various consumer wireless products putting a significant load on leading edge output. Though foundries continue to remain cautious in placing new orders for equipment, we believe that they will need to increase their level of investment and new capacity in the next three to six months. This is supported by an analysis of foundry spending. In calendar year â05 foundry CapEx will decline 34% versus â04. If spending is averaged between calendar year â04 and calendar year â05 and then extended to â06, foundry spending needs to increase at least 20% to 25% to add the same capacity additions as were added on average in the calendar year â04 and â05 time frame. There is reason to believe that demand in calendar year â06 will require capacity additions at least equal to the average of the past two years. We expect to see continue strong investment for equipment in the memory sector. In particular the outlook for NAND Flash is strong, Flash bit growth is expected to be in the 100% to 120% per year range. While DRAM bit growth is expected to remain strong in the 50% per year range. As Lam is well positioned in the largest NAND Flash and DRAM producers our memory business remains very healthy. Lam has also achieved new market share wins in the expanding memory market in Korea, Taiwan and Japan, which we have orders in the September quarter above our forecast. We expect our strong bookings to continue in the December quarter, with memory customers representing around 60% of our bookings. As for the remaining market logic and IDN customers are continuing to invest at consistent levels with year-over-year spending roughly flat. I will now provide the guidance for the quarter, guidance on margins and earnings include the impact of equity-based compensation. We expect new order for December to increase approximately 5% to 10% over September levels. Shipments will increase approximately 30%, we expect to post revenue levels between $330 million and $350 million with growth margins being approximately flat relative to September. Operating expenses are expected to increase slightly to around $100 million, and this will result, in operating margins estimate of 18% to 20%, which is at or slightly above our target model performance. Earnings per share are expected to range between $0.34 to $0.39 per share on a share count 140 million shares. These financial numbers, again include $8-9 million of equity compensation expense. In summary, I am please with strong performance our employees delivered in the September quarter. We continue to execute to our objectives, and I believe our results both recently, and those attained over the last several years, represent a solid foundation upon which to achieve a level of performance that will result in enabling cost effective solutions for our customers, and the potential for strong returns for our shareholders. With that I would like to turn the call back to the operator to call for your questions. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234014 | Hereâs the entire text of the Q&A from CarMaxâs (ticker: KMX) fiscal Q3 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Ladies and gentlemen at this time if you would like to ask a question please press â*â then the â1â on your telephone keypad. Again ladies and gentlemen for questions or comments please press â*â then the â1â on your telephone keypad. We will pause for just a moment to come back to Q&A raster. Your first question comes from Matthew Fassler with Goldman Sachs. We have a couple of questions for you, let me start out by asking about the wholesale business because that seems to be where thereâs a lot of variability, if you will, in the P&L. It sounds like you had a sort of a unique arbitrage in the third quarter, because your buying was particularly disciplined based on your models. I guess the sellers bit. Whatâs your expectation in terms of the typical seasonal trend in wholesale grosses that you would see, I guess, typically your wholesale margins, I guess would go up sequentially from Q3 to Q4. Given that they were, that theyâve been high all year, I guess, and particularly high in Q3, would you continue to expect that to occur? A portion of that we will expect because one of things did is adjust the level of offer to our consumers. So some of the sustained benefit you saw early in the year in the first half certainly rolled into the third quarter and we anticipate being in the fourth quarter. In the fourth quarter we do expect to be positive. Itâs just that, youâre right; we did have a convergence of events that may make the over performance relative on a year-over-year basis less stellar, letâs put it that way. When you say Keith you expect to be positive, do you mean versus the third quarter or versus the prior year? Versus the prior year. I mean, I think that just the adjustments weâve made and how we put the offer together for the consumers is an ongoing benefit that we will sustain. Yeah, let me comment quickly, Matt, on a couple of the wrinkles in the third quarter. As you know, SUV prices were literally in collapse through the latter part of the summer and the early part of the fall and while we did quit buying SUVs in offsite auctions we continued buying SUVs at our stores and for some period of time we think we were about the only people out there willing to make appraisal offers, particularly on large SUVs. And as always happens, as youâve heard us talk about a lot of times before, at some point, price gets to the point where people say, gee, this is a pretty good deal and we saw SUV demand turnarounds during the quarter. So, the fact that we were in the market and demand turned around there, whereas demands for compact and mid-size cars continued significantly higher during this time of year than weâve ever seen it and therefore pricing, both of those things were kind of drivers behind that wholesale performance. So, it was not only our ability to put the right money on the car, but also to some degree our willingness to stay in the market making wholesale offers when nobody else is doing it on SUVs. Got you. I guess the second question that Iâd like to ask relates to your sales forecast; you sort of opened the Pandoraâs Box by talking about some of the shorter term trends so Iâll sort of try to wedge it open a little more. Yeah well, I guess you said that, clearly it sounds like the last ten days for them to drive the quarter down by a point must have been negative. Youâre talking to a rebound in the first three weeks of December, yet your guidance seems, kind of rooted in negative territory in the aggregate. Does this relate, so, is that forecast just a conservative forecast or does it relate to the fact that DRIVE really kicked in after the New Year? First and foremost, itâs driven by how good fourth quarter was last year. I mean the fourth quarter was really good. Itâs a really tough comp. I always tell you, you canât judge everything by one yearâs comps but even when you take DRIVE out it was a significantly better quarter than we expected and when we do the run rate trends trying to level everything out, thatâs the primary driver of what weâre forecasting. Weâre taking into account the first three weeks in December but weâre also taking into account that any three-week period in the third quarter could have been in a whole variety of places all over the map. So, we donât want to put too much weight on that. So I would, I would say that itâs modestly conservative but pretty much on trend. And on average I would say historically we do expect some level of weather to affect sales. The last year we didnât have a material impact on sales it was actually favorable. So, just our run rate normally puts that a conservative relative to last year in that it does anticipate some snow affecting some stores over the weekends and negatively impacting business. Got you. A final quick question. If you look at SG&A, the SG&A ratio relative to sales, I know thereâs lots of ways to look at it, but if we choose that one, you had slight negative leverage, an expense ratio slightly higher relative to sales, backing out CAF on a 3% used unit comp. What do you think, next year you need to do to hold the SG&A ratio flat, I guess given the store maturation point that you made but also I would think given the siphoning off of some of the separation costs? Well I think the biggest thing would be the store maturation points. I think, if youâre going apples-to-apples where the percentage of immature stores is about the same, I donât know, but I would hope that around 3% if you didnât get leverage youâd at least be flat. But you seem to intimate that I guess for three-quarters of the year the better part of three-quarters, that the average store age would be a bit younger, is that fair to say? So it averages out basically as in line. On average youâre saying for full year fiscal 2007 store age should be a non-factor. I wanted to, I guess; follow on Mattâs question on wholesale margins. So is this, should we think of this now as a mid-teens gross margin business on an annual basis? I know thereâs seasonality there. Yeah. That sounds a little strong. I mean, this was an unusually strong quarter. You know not only did we have the SUV benefit from a higher mix of SUVs, because they bottomed out and then rebounded significantly during the quarter. We actually saw price appreciation on the high fuel-efficient cars during the quarter, which is also very unusual for this time of the year and then the benefit of really not, there being a low supply of closeout models I think also created a unique environment. So I think double-digits appropriate, I donât know about mid-teens. Youâve done I think 14, 15, the last three quarters before this, and I guess thatâs the question historically itâs been more like 11, 12, and now itâs kind of taken this inflection point up over the past year really. I understand November is a little bit extreme. And the way, I think the way to think about it is there were a lot of things that happened this year where to some degree we were trading off wholesale margin vs. retail margin. And part of how that sorts out next year will depend on what the marketplace does and what the best way to respond to that is. I mean, we saw that that turned out to be a very valid strategy for addressing some of the curveballs the marketplace threw at us this year. The third quarter was a little different, but I think you wouldnât want to focus on just that wholesale margin in isolation from used car margins. That makes sense. And then geographically, I guess, any difference in regions other than what you mentioned with the hurricanes and particularly can you update us on how Los Angeles is doing? LA is doing fine. Weâre quite happy with LA, and the performance of LA is consistent with what we would want to do, to continue opening stores there and continue with the full advertising program, and as I said, weâve got two stores coming there. Chicago and the Midwest have been tough markets all year and all of the data that we have say that theyâve been tough markets for everybody, particularly Chicago so that continues to be a challenging area, not from a market share point of view but just from a sales point of view. I suspect that that has something to do with the stronger performance of domestic cars in the upper Midwest and the fact that thereâs been so much promotion in that area, but I canât really, I havenât been able to get the numbers to tie that down. Okay. And then on the opening plans for next year, are those going to be pretty equally weighted throughout the year, is there any lumpiness? So itâs, thereâre some openings in every quarter I believe so, but the other thing Iâll tell you is even where we sit, between now and when they actually open, weâll still have some more things moving around but itâs reasonably spread through the year. Good, a couple of quick questions. First, have you seen any change in the cannibalization trends as you have multi-store markets? I donât think one that we could talk about as a uniform trend. I think the adjustment we made in our thinking previously is part of our model now but beyond that, every market is unique. The things that drive cannibalization between two stores really have to do with shopping patterns, geography, where the rivers are, where the highways are, etcetera, so thereâs nothing I would point to as a trend that I think is meaningfully different. Okay, thatâs fair enough. Comfort with inventory levels, obviously the market has been changing a lot. Youâve mentioned your ability to buy SUVs, the buyer of last resort if you will. What is the comfort level with inventory levels at this stage? I think weâre very comfortable with where we are on inventory right now. We, literally, technically, at the end of November we had a little more inventory than we expected because the last 10 days were softer than the trends had been, but then December picked up nicely and we are right where we want to be and this is pretty much typically the bottom of the market. So itâs a good time for buying inventory and we bought, as you know, because there are fewer auctions and because of holidays, we buy and build a little early to be ready for the 13th week, the Christmas to January 1st period which is a big sales week and weâre right where we want to be for that. Okay. And then the last point is, and I guess this is a little bit more on the philosophical side, but is there a point where you think your business becomes less volatile. I guess Iâve been under the assumption as it continues to grow and mature and more stores, etcetera, we would wind up seeing less volatility but it doesnât seem to be playing out that way. I mean, is there a motto in your minds that at some point you become less volatile and more consistent? Well, look, thereâs no question that scale helps. And the bigger you get, I mean, just looking at anybody in the retail industry, the bigger you get, the more spread you are across regions, the more it balances out. Thereâs just no question though. There is a, you read the newspapers. Thereâs a knockdown drag out to the death battle going on in the auto industry and that, itâs clear that two of the largest auto guys in the world are really struggling to find the strategy and I think that just introduces some unanticipated volatility. How long that takes to play out before it stabilizes, I donât know. But everything we see says that if you step back and look at it on a year-over-year basis, itâs really short-term volatility, not long-term volatility, and so doesnât have any fundamental impact on the model. Itâs one of the reasons, believe me, whatâs going on in the domestic industry is one of the reasons weâve decided, gee, trying to outguess the quarter for you just isnât productive. And we want to focus on the year and get you to focus on the year as much as possible. I know you have shareholders, who want to see closer information, but we donât see anything yet that says itâs going to get easier for us to forecast quarter-to-quarter. But I think year-over-year, look, right now if we hit our range, weâll be at to slightly below the midpoint of the range for comps that we expect on a year. A couple of questions. Austin, could you talk about any changes that youâre seeing to the competitive landscape. Specifically, weâve been hearing from the NADA and folks like AutoNation that thereâs this renewed emphasis on the used business to boost overall margins and Iâm just wondering if you guys are seeing more activity from the franchise guys. I think if you were to step back and study Automotive News for a 10-year period you would see every time that new cars are bad thereâs a statement by various auto guys that, well, weâve renewed our focus on used cars. And itâs never been clear to us that that actually means anything in terms of, certainly, not in terms of change in fundamental behavior or the way they address the consumer or anything else. How much they inventory really is a function of how much risk do they think theyâre taking. So itâs a very dynamic and competitive market out there but we have not seen anything that suggests systematic changes in the way people are actually selling cars. AutoNation has announced that theyâre going to be friendlier with customers but as far as we can tell that doesnât mean theyâre going to quit negotiating or any of the other things that make it, theyâre not going to change their pay plan for instance. And when the salespersonâs pay plan is a function of the margin on the car, itâs pretty darn hard for the salesperson to be on the same page as the consumer. So thereâs not anything that we see globally at this point that really represents a trend there. And we certainly havenât seen anything that suggests people are either changing their sales methods or fundamentally altering their inventory levels. Itâs, good competitors and the best competitors are usually the private guys in each market, always focus on the used car market. They donât ever take their focus off the used car market and theyâre tough competitors every day and those guys are always out there. They tend not to be public companies. Okay. On the wholesale side of the business, in terms of the buy, maybe you could just touch on what youâre seeing at the auction level. Weâve been noting that the auction inventories have been going down and Iâm wondering if youâd attribute this to retail demand or do you think its fewer vehicles still coming off of lease and perhaps fewer program vehicles coming back for remarketing? Well, I think thereâs some fewer program vehicles just because of the hurricanes and things like that. People are, I think the rental car companies certainly kept their vehicles as long as they can keep them and thereâs a healthy demand there. And certainly weâre still in the cycle where there are fewer off-lease cars as weâre coming to the end of that cycle. And thereâs been pretty healthy demand in the wholesale market. I mean thatâs why price has held up so well. Having said that, this is the low point of the market every year, so relative to what we need to buy, weâre finding plenty of vehicles out there but itâs not as soft a market as it typically would be in December. I think I used to be an economist and I quit doing that and thatâs why. As weâve noted, weâre not that, weâre not any better at predicting than anybody else. Good morning. Austin, could you comment on the spreads between new and used car prices? How that progressed during the quarter given the fact that the Manheim Index and other indexes did indicate rising rather than falling used car prices? A - Austin Ligon Yeah, I think that the best indication we have is that actually new car prices in real terms also went up during the fall. And so to the degree that that was true, it allowed used car prices to rise. And as I said, the reality behind the index is by category of car, because when you disaggregate into the different types of cars, what you actually see is the compact and mid-size were really strong. I mean, prices were higher this fall than they were last January in absolute terms. So you were paying more for a car nine months later than you were back in January. Whereas SUVs, the large SUVs thereâs no description other than a total collapse in pricing. So while that averages up to an aggregate trend, whatâs really meaningful is the trend for each specific type of vehicle and that was driven by all these macro factors, the compacts and mid-size were driven by peopleâs concern about gas prices and to some degree about, by all the replacement volume of every sort going into the, into Mississippi and Louisiana. There were a lot of cars destroyed there and pretty much everybody there needed to get a vehicle. Some people had to get vehicles that didnât have them before because if you lived in New Orleans and didnât have a vehicle and youâve moved to Baton Rouge or Jackson or Atlanta now youâve got to get some kind of car. So, I think that particular type of car, particularly the compacts, given the gas price issue, they were very strong. So, I do think that new cars gave some leeway there, and the lower availability of closeout gave more leeway. But it was, it was all a variety of trends at the individual model level that was the real driver. Well, the answer is how much do you want to pay? The answer is, we havenât had difficulty, we had to pay more through August and September, certainly and into October. We actually reversed our policy at one point. I said earlier at one point we were not buying any SUVs at auction. During the fall we reversed our policy and we quit buying compact and mid-sized at auction because we saw the price value beginning to deteriorate. So, although the prices remain fairly strong, the sell-through rate softened somewhat and we were able to supply our needs from direct purchases at the stores. So, we havenât been unable to supply what we need that the challenge is always price and the question is always the trade-off there versus something else you could have in that inventory slot. But in general, actually, we are extremely happy with how we came through the fall on all of that. It was a, it was a very dynamic fall and weâre very pleased with how we were able to manage through that. Okay. Just two others. You mentioned the last 10 days of November you saw a significant slowdown. What do you think was behind that? I have no idea. I mean, we, at first I was running around getting everybody to do analysis on red tag pricing just to see is there any possible way that that could be having this effect. We certainly didnât see any customer flow from it. But all our analysis indicated and I think GMâs results indicated that that wasnât it. So, truthfully I have no idea. It just, traffic slowed down at the end of November and picked right back up at the beginning of December. So, itâs one of those mysteries you have now and then. Okay, and then, and then one final question. I see youâre opening a store, your first store in the Northeast, and I remember asking you a year or two ago about that, and you said that like many Sunbelt based retailers that are expanding the Northeast would be the last place you would start opening stores. So, I was just wondering what the rationale was for you to go up here at this relatively early stage of your companyâs nationwide expansion. You probably slightly misheard me. I certainly say New York is, New York is the last place weâll come in all likelihood not because we donât like it but because youâve got 20 million consumers there and you have to buy the entire TV market. And what we have said in general in the Northeast, in general, the Northeast is slower growing, the problem with Philly and Boston is not that theyâre slower growing and theyâre smaller than New York theyâre just tough markets to get into. Weâll eventually get there. New York will probably be last as weâll wait until weâre on national TV. The two markets that are most attractive in the Northeast in terms of economic performance, market attractiveness and scale of the TV market so that theyâre relatively easy to enter with a small number of stores are Providence and Hartford/New Haven. So, if, if I said, if I said what you just repeated I was, I misspoke because I was talking too shorthand. Weâve, we said before that Providence and New Haven were the ones in the Northeast that were on the relatively near list if we wanted to go there. Now, the bottom line in terms of why are we going, we went up there we had a look and we found some real estate that was attractive and we found a good piece of real estate in Hartford and a nice piece in New Haven. Weâre able to store both markets, which will give us good media efficiency. And, we thought that was a good opportunity. Itâs a good opportunity to sort of test out the Northeast, have a nice market up there and also, I donât think it will hurt at all to make it easier for the investment community to get there. But thatâs not why we did it. We did it because we think itâs a pretty good little market. Well, good luck with that, and Iâm glad now I can drive to one of your stores instead of flying there. Just one, one clarification, at the guidance you provided at the beginning of the year that was for earnings of $1.20 to $1.30, is that correct? Okay, great. And then on the small market youâre entering Charlottesville, can you, can you talk about what youâre going to do differently there and what you think the longer term opportunity is in terms of the number of stores you can have in small markets assuming thatâs successful? One of the things weâre doing in Charlottesville is weâre kind of skipping over a whole range of intermediate markets and going to, right now the smallest trade area weâve ever gone into is Fayetteville, North Carolina which is about 375,000 people and itâs within the Raleigh television market, so weâve already been advertising there for 10 years. Weâre skipping over a whole range of medium sized markets to try something quite a bit different in Charlottesville, which is a store with a physical format about half the size of our standard satellite store. We are not sure exactly what the inventory will be but, Iâm guessing in the 150 car range as opposed to 250. And weâll use a different staffing model for management, where we will size the management to the sales level and what that will probably mean is some of our managers will have to do dual tasks so they might work as business office manager one day and a sales manager the next day. We are pretty sure we can make this work and the numbers look pretty good. The reason weâre going to Charlottesville is its right down the road from Richmond where weâve been for 13 years and right down the road from Washington, where weâve been for 10 years. So itâs a market thatâs pretty familiar with us, and in some sense itâs the lowest risk of the very small markets we could go to. Itâs also a very self-contained market, and it has nice demographics. So, we think itâs a good place to do a relatively low risk but, but significantly different test. In terms of how many markets will this open up, if we can do it well, it will certainly open up. I mean if you grab yourself a book and look at the size of DMAs, Charlottesville is way down the list towards the bottom. So, it would open up everything between Charlottesville and any, and a half a million people. The other thing thatâs harder to estimate is how many small trade areas within large markets will it open up, because if you are, then the question gets to how much inventory do you need to be in a really peripheral or small trade area of Chicago. So, we donât know that yet. But the answer is more. And we think significantly more. So, we think, itâs something that, at some point we needed to do. Now is the right time to test it so that, so that we can figure out how to make it work and get this into our portfolio of development. Good morning. Thanks for taking my question. I have a question on your financing with Drive Financial, I understand the contract came up for renewal on December 1 and you had very favorable terms with them, I think only about a 4% discount. Has that been renewed yet and has it been renewed on similar terms? Yeah, we have an ongoing arrangement with them and theyâve had to make some minor modifications to the program. But overall, it will be very similar and we donât expect any material change either to the profit ratio that it brings on an incremental basis or the level of sales. Okay. It seems like every time we lower the prices that we are going to pay for cars for our wholesale operation that itâs successful. Are we beginning to, this is kind of a unique offer that we have. Iâm wondering if weâre thinking differently about the business, that maybe the wholesale business ought to operate at a profit? Well, obviously right now whether you want to call it an over-recovery of cost or profit, weâre clearly making money on wholesale cars beyond what our net cost is. And part of that, as I said, has been driven by our analysis of the last couple of years of whatâs gone into the new car market and how best to respond to it. Some of it has been cross-subsidization from wholesale to used car pricing when it was appropriate. And as you would imagine, knowing us, below the surface of what you can see in terms of this aggregate number, are dozens if not hundreds of tests that weâre running to try to understand the subtleties of how we should price wholesale cars, because the one thing we never want to do is we donât want to give people an offer thatâs unfair. We donât want to give an offer that would hurt sales. We donât want to give an offer that would reduce; weâre trying to increase the number of cars that we buy from consumers. Having said that, we do believe that it looks like this is a business where in fact the model that weâve evolved adds value that a wholesale car sold through one of our auctions may actually obtain the highest price it can in the marketplace. So, we want to behave intelligently to the degree thatâs true, but weâve tried to be very thoughtful and cautious and weâre running a lot of tests there. It does seem like there may be some value-added there that we ought to capture but this has been an unusual year, so thatâs why we donât want you to rush off and think this is what we should forecast going forward, because a lot of what we were able to accomplish at wholesale was really driven by some of the circumstances created in the new car market and therefore the late model used car market. Is there anything different in marketing that weâre thinking about given the kind of environment that we have with General Motors and Ford which probably isnât going to change for the next couple of years? What do we feel about our message getting across and do we think anything about that? Yeah, we, I mean we continue to run lots of tests in advertising, too, both in terms of, I mean as I think, every TV ad that we make we go out and test with consumers. And if it doesnât score well on, is this more likely to make you visit CarMax, then we donât run it even though weâve already made the ad. We also have been doing a lot of testing across media to understand what day part should we be buying, how should we run our ads within programs when we know we have a good ad that communicates, whatâs the trade-off between TV versus radio, radio versus newspaper, and particularly newspaper versus internet. I would say globally with us just like with everybody else, newspaper is losing and Internet is winning. So thereâs clearly a shift in media there. The Internet is evolving so much, particularly Google search and everybody trying to compete with that, that new opportunities are being created all the time. Google Local presents a really interesting new opportunity. We donât know how thatâs going to work for us. So thereâs a lot going on there. I will say that by and large it is not driven by anything that GM or Ford is doing. And I think theyâd be very pleased to know that you think things will go on like this for two years. I think⦠No, I donât think theyâre going to go out of business. But as you know, I tend to be on the negative end of the spectrum in terms of my suspicion that at least GM will probably have to go through some sort of restructuring. But our advertising is, thereâs not a lot we can do or anybody else can do when GM does something like employee pricing that would change behavior. As you saw, that was really good for us, though, because it drove a lot of people in the market and our appraisal offer. We upped the advertising on the appraisal offer. That worked pretty well and we got a lot of sales. So, really we are doing a lot on advertising, but itâs mainly to try to figure out how to get our message across more clearly and to more folks and to those folks who are actively in the market. Okay. On Austin, Texas and Charlotte, how close are these units going to be to existing units and how much cannibalization do we expect out of that? The Austin store, our existing Austin store is on the far north end of the market. Itâs actually right on the boundary of Round Rock where Dell headquarters is, and the second store will be 25 miles away at the other end of the market, southern end of the market on I-35. And if youâve driven through Austin or San Antonio recently that itâs almost impossible to get through that 35 miles. Itâs currently I think tied with I-95 as the busiest highway in the country. We think thereâs pretty good separation in Austin. In Charlotte, the store will actually be in Gastonia, North Carolina which is a different town altogether, itâs in the Charlotte television area, but itâs actually a mid-size town west of Charlotte and we think thatâs a pretty good gap and a pretty good separation there too. So these two, my best guess would be, arenât hugely cannibalistic, but thatâs just my best guess. So it looks like cannibalization is really going to go down some by the end of next year, because we donât have much else. I mean Fredericksburg I guess is not going to cannibalize that much. Fredericksburg will potentially cannibalize some from Richmond and some from DC. And you never know with LA, LA still got a lot of room. And I doubt that weâll see a lot of cannibalization from these two stores. But we do our best job that we can to predict. Iâll tell you, for instance, we just built two satellites in Miami. One of them cannibalized more than we thought and one has cannibalized quite a bit less. So, itâs always a little bit tricky to figure it out. I wouldnât try to change my estimate based on any expectation of change in cannibalization. And I guess we have a lot of mid-sized markets in the plan, because this is what weâre really finding is the best place to put stores. No, look, I mean, the best place to put stores ultimately is large markets. Our strongest market is unquestionably Washington, Baltimore. Mid-sized markets are really good places as we have described when we started the growth plan, the great thing about mid-sized markets is theyâre on average lower risk because theyâre easier to enter, you only have to add one or two stores. And here, weâve added LA as our large market in the portfolio right now and we are starting to work on some other large markets that would require two, three or four stores to enter. We havenât announced them yet but I mean you can just look at the map and look at our prior behavior and you can pretty well guess what they would be. And those will be coming over the next several years. So, weâll continue to try to have a mix out there, where a portion of our portfolio, 20, 25% or so will be larger markets in the future. And putting two stores into Columbus, Ohio I guess in prior years we probably would have put one in and then another one would have followed a few years later. Are we doing the same thing in Hartford? In Columbus, itâs true that Columbus is a market that four or five years ago, we would have tried to start with one store. The way Columbus lays out, it works a lot better with two stores to begin with and so thatâs what we did, and we got two great pieces of real estate, we believe. So we did that. Hartford and New Haven are two separate markets and itâs two markets within a single DMA and everything weâve learned says all other things being equal that it would be better to go ahead and start with both of them if you can. Yeah, Winston-Salem, Greensboro, you get better advertising leverage from day one. But in general, weâre finding if you can clearly identify two distinct trade areas like in Las Vegas or like in Austin, like in Columbus, all other things being equal, we think it would be better to go ahead and do both of them to begin with. Youâve touched on this quite a few times. I might ask it a little bit more directly. I mean in the event of a GM bankruptcy or a major restructuring here, where they may go through a reduction of brands, just wondering how you might navigate that environment and maybe specifically sort of your experience with the Oldsmobile cancellation in the past, really how you dealt with that? It had virtually no impact on us. Look, the problem that GM has and weâve told them this, we are agnostic as to what cars we sell. Whatever the consumer wants to buy, weâll sell. GM has always underperformed as a percent of our mix relative to the number of cars theyâre producing, which tells us that theyâre producing a bunch of cars nobody wants to buy. And Iâve believed for a long time that they need to have at least one more or maybe two brands go away. So as far as we can tell, Oldsmobile had no impact on us. The excess cars that GM is making are the cars of last resort in the market. And nobody wants to buy them and theyâre not very attractive. They have a hard time getting shelf space at our lots. So, their disappearance, if they werenât, if somebody else didnât come in and produce cars to supplement that, could reduce the overall level of new car sales and make a little bit less inventory available, each yearâs sales is only a small portion. On the other hand, it certainly looks like the Koreans are doing everything they can to fill in the gap at the lower end of the price spectrum and Toyota just announced I think today that theyâve decided to go full speed ahead with a 10% production increase this year. So, I think the Japanese and the Koreans and to some degree the Europeans are more than willing to step in and try to fill that gap in volume. And net, I think that would be good for the used car marketplace, because it would result in a mix of somewhat higher demand cars out there. But I donât want to underestimate the potential, volatility that that sort of restructuring might create. But ultimately I think it would be positive. Then on the wholesale profits that youâve been posting, a lot of dealers have been using data provided by Manheim as far as pricing there, their wholesale vehicles and their purchases. Have you been increasing your use of that data or, you purely are just using your own data? Weâve always used Manheim data. We use more of Manheim data on a more timely basis than anybody, believe me. And the same thing from ADESA, we use the Manheim data, the ADESA data. We use the Black Book data from Hearst and remember we have an enormous source of weekly wholesale data from our own wholesale auctions. So, we use all of that plus we use, we capture every time we make an offer on a car, did we buy it or not, and we have that available to our buyers so that they can see, look what appears to be the correct offer price in the market right now. So, we certainly incorporate Manheim data in depth and granularity and very quickly but itâs only one of the sources. Okay then just real quickly on the Charlottesville store, I mean it seems to us that there are plenty of markets, large dense DMAs that you can work into. I know you talked about this a little bit. But what do you feel like youâll gain in this small market. It does seem like you have plenty of room for growth in these larger markets still. Just step back and look at, take Boston or Philadelphia, either one. You probably need, for either of those stores to open the market, you probably need a minimum of five stores. And how hard is it to get five great sites in Boston. Ask Home Depot, ask Target, ask any of the guys who have done it. Weâll eventually be able to do it. But itâs very hard to assemble those sites, have them ready and open and be advertising efficient all at the same time. And so what you want to do is you donât want to go take on several of those markets at the same time. And right now, weâre working on LA. At the opposite end of the spectrum, there are hundreds of smaller markets and trade areas, some of those smaller trade areas are in large markets. So, for instance, Frederick, Maryland, which is part of the Washington-Baltimore DMA, so itâs part of a large market, but its 35 miles north of Rockville, so it really operates as an isolated market. To make a Frederick work, we probably need a smaller store like weâre going to test in Charlottesville. So, this is not, letâs go to Hooterville strategy instead of Philadelphia, itâs part of having a portfolio of stores that will let us address every trade area, whether itâs a separate small market or a small market within a large trade area, within a large market. Does that make sense? I had a question on the finance side, I think twice now this year once in the first quarter and now again in the third where youâve been able to lower the loss assumptions on your previously securitized receivables. And just trying to understand, get a better sense of the market conditions that have allowed for this and what you foresee on that front heading into next year. Part of the challenge is that as we evaluate our performance, one of the things that introduces a little challenge for us to really assess what ultimate losses are going to be is the fact that weâve put in a new scorecard in 2003. So part of what weâve had to do is to discern how much is market and how much is our own new scorecard. And as we gain more experience with that, as the portfolios mature, we can get more confident about our level of adjustments. But generally if you look at the asset-backed securitization market, youâll hear that overall thereâs been about a 40% improvement over the last couple of years and⦠In loss rates. And we think a lot of that is due to just the general economic conditions, mortgage refinancing where people were flush with cash for a variety of reasons, and lower overall interest rates. So thatâs really the best we can assess from the overall market. And then itâs really looking, drilling down on our own portfolio and trying to assess which is which and trying to make sure that weâre making the appropriate adjustments. Okay. Do you think that the increase in short-term rates could lead to a moderation in these lower loss rates going forward? If itâs moderation, I donât think it will be material. I really think that itâs more the overall economic impact. The fact that mortgage refinancing really have fallen significantly and the cash coming from that and credit card balances were dropping, whether that goes back the other direction, all of those things put it more at risk in the future. So itâs not really one single factor as far as just interest rate. First of all, Austin, I know that the Board is really running the show on this but in terms of the search for your successor, any update that you could give us? Itâs underway. We have a search firm that weâre working with and weâve all met with them and talked with them. I think theyâll do a good job. We knew some common candidates that I thought would fit and that the headhunter thought would fit, which was a nice start that we had some commonality there. So itâs underway and beyond that, weâll see how long it takes. Itâs, typically, it doesnât happen overnight but weâre all eager to start seeing some candidates. Got you. Second question is actually a follow up from the last one, on credit. Just looking at the history of your adjustments, was it the default rates that you had in fact, that you took down again in the third quarter? And I believe that the range, just to try to get the magnitude of that, the range that you had out last quarter was 1.6 to 2.16. Do you know what the magnitude of the reduction was here? Yeah. And does this reflect your real-time experience? In other words, to what degree do you try to make this a sustainable average as opposed to an individual quarterâs experience? Part of the reason we donât do this every quarter is the timing of this particular adjustment is because weâre going through peak season. There is a seasonality to losses and so we look at it very carefully. The good news is that our more mature portfolio, the early 2003s, where we have the more experience on our data, are getting so mature that they help us ground a better basis for how much of that is really attributable to our scorecard. So the further those develop, the better weâll get at being able to isolate the scorecard versus the market conditions and thatâs the piece thatâs really been challenging for us. And so thereâs always been a little caution until you see another yearâs worth of data and really that means going through this time of the year and seeing peak seasonal losses, thatâs when you get another benchmark where you can gain more confidence to say, yes, that is an ultimate loss rate. As weâve said all along, over the longer-term, we believe the purity and integrity of the credit data that weâre able to collect, given no negotiation on the car or the trade, knowing what negative equity is if any, should give us over the longer term a better scorecard and a better ability to evaluate people. And I think part of what weâre seeing here is some of that long-term benefit. So if we look at, just to have the numbers in front of me, six quarters ago, I guess in the August quarter of 2004, you were still at 2%, 2.0% and I think youâve taken it down three times, once last year and then twice now this year. You would say that that is, would you say that thatâs more a factor of your own understanding of your own performance or of market conditions that have been, as you described, pretty constructive for you? Yeah, itâs really, itâs the combination of those two factors. And the other opportunity there is that we donât necessarily on new originations wants to just drive down losses. What it does is it allows us to find opportunities where we should be buying based on doing more analysis on our own data and not necessarily help support sales versus drive down losses. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234015 | Hereâs the entire text of the prepared remarks from Royal Philips Electronicsâ (ticker: PHG) Q3 2005 conference call. The Q&A is here. Guenther Hollfelder HVB Group - Analyst Niels de Zwart Rabo Securities - Analyst Bert van Dyck Financial Daily - Analyst Bram Cornelisse Merrill Lynch - Analyst Didier Scemama ABN Amro - Analyst Nicolas Gaudois Deutsche Bank - Analyst Uche Orji JP Morgan Chase & Co - Analyst Janardan Menon Dresdner Bank - Analyst Matthew Gehl Goldman Sachs - Analyst Antoine Badel CSFB - Analyst Francois Meunier Cazenove - Analyst Thomas Brenier Societe Generale - Analyst Luc Mouzon Exane BNP Paribas - Analyst Sean Murphy Nomura Securities International - Analyst Jerome Samuel CDC IXIS Capital Markets - Analyst Eric de Graaf Petercam - Analyst Jan Berghuis Kempen & Co - Analyst Bert van Dijk Het Financieele Dagblad â Media Operator Welcome to the Royal Philips Electronics third quarter results 2005 conference call on October 17, 2005. For the introduction by Mr. Pierre-Jean Sivignon, Chief Financial Officer of Royal Philips Electronics, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. [OPERATOR INSTRUCTIONS]. Please note that this call will be recorded and is available by webcast on the website of Royal Philips Electronics. I will now hand the conference over to Mr. Pierre-Jean Sivignon. Please go ahead, sir. Pierre-Jean Sivignon - Royal Philips Electronics - CFO Ladies and gentlemen, good morning. Let me first tell you that I am very proud to be there with you today, for what is my first conference call for these third quarter results of Philips Electronics. So let me welcome you to this conference call for the 2005 third quarter results. I will make a few introductory remarks and then open up the call for your questions. This quarter has shown a continuation of the implementation of our value-creating strategy, of liquidating our financial holdings and reallocating resources to higher margin businesses, or buying back our own shares. Let me be more specific. Firstly, we have disposed of 1,740m from a financial holding mainly being TSMC, Atos Origin, and LG Philips LCD. Secondly, we have completed the Stentor acquisition costing 175m, and announced the acquisition of 47% of Lumiled for approximately 765m. Thirdly, we announced the second share buyback program in 2005 for 1.5b, for which we actually purchased 347m of share in the third quarter alone. Fourthly, we continue to improve our underlying performance as well as maintain our financial discipline. A few words on our strong performance in this quarter. Comparable sales growth versus a year ago was strong in Medical, DAP, Consumer Electronics and Lighting. In Semiconductor we had slightly higher sequential growth than we expected. Much of the growth is a result of our investment in innovation, in the context of some weakness in some of the markets that we are serving. In Medical we increased our underlying results, excluding MedQuist, and some Stentor acquisition related items. Our order intake continues on a positive trend, with a 9% comparable increase versus one year ago. DAP has had success with newly introduced products, and is on track for the expected annual growth rate of approximately 7%, with an IFO margin of 15 to 16%. Consumer Electronics has had an excellent sales quarter, and remains on track to deliver the annual 4 to 4.5% IFO margin as from the end of 2005. This is based on the successful implementation of their business renewal program. Based on increased R&D in recent years, Lighting has again shown sales growth of approximately double GDP, compared to the historical one-time GDP. The higher R&D is continuing, and we expect to see the start of deliveries of some new products starting early 2006. Semiconductors has shown more strength than we had anticipated which, coupled with the early benefit from their own business renewal program, has had a marked impact on their results. In other activities, we still need to do some more work to reduce the run rate of the negative results. But these have our full attention, and we hope to be able to update you on this in the not too distant future. I'm very happy to say that the corrective actions we took on inventory at the end of the second quarter has proved to be successful, and that the percentage is now lower than one year ago. In fact, it is the lowest ever for the third quarter at Philips. Our cash flow has been very strong, particularly due to the sale of some of our financial holdings, amounting to 1,714m. At the same time, we did buy back our own shares to the extent of 347m. Overall this has led to a zero net debt position at the end of the quarter. During the fourth quarter we expect to pay 765m for the Lumiled acquisition, as well as continue the share buyback program. I will now open up this call for your questions. |
EarningCall_234016 | Hereâs the entire text of the Q&A from Starbucksâ (ticker: SBUX) Q4 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Ladies and Gentlemen, at this time Iâd like to remind everyone, in order to ask a question please press â*â, then the â1â, on your telephone keypad. Again as we asked please limit yourself to one question please. Hi, thanks. First, would you talk about your experience developing some of your larger international markets such as Japan and the UK? And how what you have learned in these markets affects the way that you accelerate your development in China, particularly from an ownership structure and from a competitive standpoint? And then as a follow up to that, since your perspective for China is long term, can you discuss your willingness to take short-term losses in China as you develop the market and the necessary infrastructure building required over the next couple of years? This is Howard. You have asked a number of questions. Let me try and the experience we had in the UK and Japan were quite different, so let me briefly describe that for everyone. We, if you remember, we acquired a small business in the UK that was up and running and that gave us a start and a foundation of about 50 stores. We had to convert those stores, and briefly we were also competing with lots of competitors at the time who were all vying for the same leadership position. I think if you accelerate the time from when we made the acquisition to today, we have demonstrated in very short order, five years or less, that we became the leader. We went after high profile locations. We established the brand. And we established the relevancy of the Starbucks experience and the third place experience. That third place experience in the UK is similar to Japan, but the way we got there was different. In Japan, we were competing with old line Japanese coffee stores that were very, very different than the kind of competition we had in the UK. And the differentiation in terms of the coffee quality, the experience, the non-smoking, all the things we did in Japan to distinguish Starbucks, were embraced very quickly. We have approximately, I think 600 or so stores in Japan today and a little bit less of that in the UK, but I'm proud to say that both, in both markets we have resulted in unquestionably the leader. In China, we're educating that market to what quality coffee is. That is similar to the experience we had in Japan and the UK, but there is a difference. One big difference is that we are noticing that the physical environments of Starbucks stores are very, very relevant and very strategically important to the Chinese way of life. And specifically what I mean by that is in the afternoon and evening we have been very surprised, almost stunned to see how the Chinese customer is using Starbucks stores as an extension of their home and office. In many ways it's because that the Starbucks stores are bigger than where people live. The commuting distances are very long. And because of this, the Chinese people are coming to Starbucks in waves that we did not anticipate or have that same experience in the UK and in Japan. The other thing that has surprised us is the level of awareness about Starbucks. The iconic nature of the western brands and how familiar young Chinese people are we're being swept into that in ways that have been very positive. The Chinese young consumer is very aspirational, and again, because of how Starbucks has been revered as a Western brand, we're benefiting from that. As I mentioned in the text, opening up outside of Beijing and Shanghai in places like Qingdao and Dalian, what that has demonstrated to us is that in areas, in places that are more rural than in metropolitan cities like Beijing and Shanghai, we're also seeing very positive results and this is giving us I think a lot of optimism. But this is a very complex, difficult market to both enter and succeed in, but we are off to a very, very good start. And I would say cautiously that the market is much, much larger than we previously anticipated. And with that, Howard, we will continue to make the proper investments there to build the infrastructure in there to achieve the size that we think is potentially available. Just to pick up on that I, to answer your question very directly, we are willing to sustain losses in order to pursue what we think is the biggest opportunity outside of North America. Fortunately, at the present time it has, the business has been profitable enough, that our current ownership structure that there have not been any significant losses. But we are willing to do that if we can make the prudent investments as Jim said to pursue the opportunities. Hi. Just looking at the fiscal â06 earnings per share goal, looks like you exceeded consensus with the fiscal fourth quarter EPS but you kept your EPS target for fiscal â06 identical. I was just wondering if there's any thinking that went into that, that we should be aware of. Thanks. Thank you, Mark. The primary thinking is it's really too early in the year to make any adjustments. We've put a lot of time and effort into our operating plan for fiscal â06, and while we're off to a good start to the fiscal year, it's too early to make adjustments. Great, thanks very much. Question on the food programs, both lunch and breakfast. It seems as if the lunch rollout has been fairly aggressive. I know it's currently in over I believe 3,200 stores, which is up over a thousand versus last year, and the please here I guess the breakfast rollout is going to be accelerated. I was just wondering if you can give us an update on the rollouts, just kind of the progress you're seeing in both the lunch and breakfast business and what type of boost you expect to give to sales going forward from each of these two initiatives? Thanks. We said that the lunch and the breakfast are about $30,000 per store per year. And the acceptance that we've seen, and I'll address warming first, has given us the momentum to launch this into up to 600 stores as I just mentioned in three additional markets. Weâre finding it more than just that incremental pick-up of revenue. We're finding that weâre offering our customer, whether it's lunch or breakfast, a value type of, a valued addition to their visit to the stores. And we're able to help them with their time-starved schedules by offering them this quality of sandwich both morning and lunch, at lunchtime to go with their quality beverage. So as we continue to see the momentum pick up in the markets that we're in, we continue to see opportunities outside of those markets to grow this business. Yeah, hi guys, great quarter. Just had a question on the composition of the comp store sales in the US, it sounded like when I was reading through the press release, 5% price, 5% check average, which would suggest 2% mix. Can you talk about the driver or the components of mix there and also the components of the traffic growth? Are you seeing increased frequency of the existing customer or new users or some combination of both? Thanks very much. To pick up on the first one, the mix increase is due to a number of things. One is the fact that we're increasing the amount of food that we're selling per transaction. We're increasing the amount of music that we're selling per transaction, so both of those add to the average check, as well as the fact that we are promoting and introducing some more indulgent beverages as we go through the year. So all three of those things contribute to a higher average revenue per transaction. It's a little hard to say, we believe that the increased transactions are due to both more frequent visits by existing customers as well as definitely new customers. Hi. I know it's early in the year but can you give us a little bit of detail what you're expecting as far as what's behind your EPS guidance for 2006 on the COGS side, specific to your two major guys which are dairy and coffee? Thanks directionally, better or worse than what you have seen in the contracts and prices that you bought in 2005. The primary driver of the increase in cost of goods that we referred to is green coffee. We have great visibility to the coffee that's coming into our system because we purchase it on long-term contracts, and we maintain a fairly significant inventory primarily of un-roasted coffee. And we're looking at about a 10% increase in the green coffee costs that pass through our P&L, maybe a little bit more this year. But that's all built into our targets. We're expecting approximately the same dairy costs that we had a year ago. And those are the two primary commodity costs that enter into our cost of goods sold. But didn't we have a spike in dairy in Q1 this year that I guess are you anticipating a similar run up seasonally in first quarter of â06 calendar? No, our dairy prices were relatively steady this year. We had a, we had a spike in the summer of the previous year which we didn't have this year. So we got some favorable comparisons toward the end of fiscal 2005 in dairy. But a fairly, fairly steady price throughout the year in 2005, and we expect to have a fairly steady price through 2006. Very close, within a couple of pennies per gallon of the Starbucks composite dairy gallon year-over-year. Hi. The international is really spectacular. Can you talk about how much of that's being driven by Japan and the UK and how sustainable it is, particularly for Japan? And maybe give us an update on additional capacity for your ready-to-drink product in Taiwan as with Japan? Craig, I'll start. I think what's really important to note here is that, the word that I would use to categorize what is happening internationally for Starbucks, and this is well beyond Japan and the UK, is the relevancy of the Starbucks experience. And the fact that we are as relevant in the UK and Japan as we are in the Middle East, in Malaysia, in China, in Spain, in Greece, in Paris, demonstrates that we are one of the few retailers that has the potential to create a global enterprise that probably does not have to be changed or refined or altered for local taste and local markets. The stores look and feel the same. It's the same exact quality of coffee. It's the same soft seating. It's the same music. And what we have learned over the years is that the international customers do not want it changed. They want the authenticity of the Starbucks experience. And that's what's so exciting. In terms of what's driving the profitability, there are a number of markets that are doing well. Clearly, the size of the market in Japan and the UK in terms of number of stores is significant, but we are making very strong strides across many different markets that are quite diverse. In terms of capacity on ready-to-drink, I don't know if you have talked to people in Japan, but we had the good fortune and the misfortune of being out of stock the first day in the ready-to-drink business in Japan, because the demand was too high. And we are now trying to play catch-up with our partner Suntory in finding the capacity and the supply to take advantage of the marketplace. But we have a good problem on our hand in both Japan and Taiwan, which demonstrates the power of the brand. And we have plans now to examine that as we have already announced in South Korea and other markets on a go-forward basis. To add to that, Howard, the maturity of our partner base as well as the leadership team that Martin Coles has put in place to head up some of these MBUs, the market business units, are seasoned in Starbucks and when you couple that with all of the experience and how well it travels plus the innovation, it is a very exciting opportunity that we see continuing to grow. And just to put a little more quantification on it, the international income from equity investees increase was primarily driven by Japan because of the size of the Japanese business compared to the others. And that's where you see most of the influence on our P&L from Japan is in that line. Although almost all of the other, I think can I almost all maybe all of the other businesses also contributed, but because of its size, Japan contributed the majority of the increase in that particular line. In the rest of the international business, as Jim mentioned, we're getting good leverage over the entire system so that the incremental stores are contributing each incremental store is contributing slightly more because of the fixed base being in place. And because of their size and good performance, the UK and Canada contributed a lot too, both showed solid improvement year-over-year, and they're both very large markets, so good progress in almost every aspect of our international business. Thanks. Jim you mentioned at the outset some speed of service opportunities still within the company. Could you just update us where that metric stands now? Maybe how much it's improved over the past year and what more specifically I guess you're doing in â06 to improve the speed of service? Well, first of all, on the initiatives it's a continuation of fine tuning what we're currently using in our stores and what we have used for the past two or three years, with the addition of scanners. Scanners have just been launched this past quarter, and we're starting to see some productivity improvements there. But whether it's drive-through or whether it's through our renovations, we are continuing to take the behind the bar scene, looking for more product, productive ways to get the customers through, at the same time enhancing their experience and applying that logic to the drive-through windows as well as the physical drive through drive, the driveways, if you will, as you enter that store. But the speed of service metrics, Michael, do you have⦠Well, it's a little, it's a little difficult to talk about. But the primary metric that we measure is how long the average person stays in the line. And the good news is that when we speed the line up more people step into the line because it's more, it's more an issue of how long an individual is willing to stand in line as it is or how deep a line they're willing to join. And another one thing, that this is contrary to what we have been saying with regard to speed of service is we also want to make sure that we maintain our position of not being a fast food purveyor. We certainly want to increase the speed of service and be as efficient as possible, but we view ourselves, and have for 30 plus years, as a retailer and as a merchant. And we do not want to dilute the integrity of why people come in our stores for a level of speed of service that is going to put us in the transaction business. That's not our business. Hi, a question on the international business. Can you give us any more granularity on whether there are any specific initiatives that are yielding the improved gross margin and store operating expenses or is it simply just a matter of an increased sales base? It's primarily an increased sales base, but in each individual market the management teams are working on the things that they can do in their market to help. In Japan, for instance, there's been an effort as they get bigger to do more local sourcing. And when a market is small, sourcing from the US is the most economical thing to do because of our ability to buy in quantity is more important or more significant than the transportation expenses. As markets get larger they can source more and more things locally, get the high get the better prices, either off of our contracts or through their own contracts, and reduce the shipping expenses and in some cases the actually reduce the raw material costs. And so those are the kinds of things that are across all markets, but each market has its own list of things that it needs to do to get better. And also as Howard mentioned, as the experience and the customers experience with the stores as a third place, such as China continues to grow, it too drives the ticket and the transaction growth. Hey, guys. Congratulations. You had a big increase in other operating expenses and in your comments you said it was due to higher payroll expense payroll-related expenditures to support the entertainment business and then you also mentioned the opening of Seattle's Best licensed coffee locations and ready-to-drink coffee launches. I assume you put that in the order of their ranking. Could you maybe give us some color on these cost increases? In particular, should we see higher ongoing expenses due to the entertainment business in particular? Thanks. Well, you're correct. That we do put almost, we always try to put the items of explanation in the order of magnitude. The increases in the payroll associated with the entertainment business is to develop an expertise within the company that will allow us to continue to create the CDs and the recordings and the compilations that have been so successful in the last 12 months and to also bring us up the technology and learning curve with regard to things like the CD burning stations and the musical coffee houses that we expect in the next several months to open in Miami and in San Antonio, and to be ready and prepared for the sort of the next generation of entertainment delivery. So there, it takes a lot of people to develop that expertise, and we're pursuing it. And Seattleâ¦. And like music, Seattle's Best with our licensing relationship with Borders was a startup. And we started from zero stores to over 120 now, and it too required an initial investment to put a team in place to drive that business separately from our Starbucks business. I think we have had a long history in which our shareholders have significantly benefited from of investing ahead of the growth curve, and we see an initiative that we feel is really going to stick. And we think that the music and other forms of entertainment and the SBC opportunity is well within those confines to invest ahead of the curve and are going to bring long-term value for our shareholders. And just to tie to next year, I think these three these three areas have probably reached an intermediate term plateau in terms of expenses. Next year the increases in other operating expenses are going to be due to our efforts to build our team in China and the infrastructure necessary to take advantage of that opportunity. Hi, good afternoon, going back to China just for a minute. Can you talk a little bit more about the unit economics that you're seeing in that market and also talk about your expansion plans in China, more in the near term and the mid-term, say the coming year and maybe the next couple, few years going out? Well, what I can say about the unit economics is that although we have different ownerships in different markets and so the way it's reflected in our P&L varies somewhat but it, but at the store level, unit economics in China are excellent. The average transaction, number of transactions is significantly below some of our high volume markets like the US or Japan. But the economics at the store level are actually superior. And that makes us encouraged in the short term, and it also makes us even more encouraged at the leverage we can obtain as those transactions grow. Having just returned from spending an extended period of time there, I think what's so encouraging about the opportunity we have is that the local officials, the local mayors and the local government officials in provinces that we're interested in, really view the Starbucks experience and the Starbucks brand as a sense of, almost a validation for their own community. And we are now being invited in and being discussed at levels that we didn't have a year or two ago because we were unproven. Also I think that people can see that there's a sense of pride that the Chinese young customer has in the Starbucks experience, and that is driving opportunities that we did not have when we first began. I do want to go back to something Michael said, is that we really have to build a world class Chinese-centric team of Starbucks people here. And this is one of the largest and most interesting and biggest opportunities we have, but it also is very complex and is going to require a very disciplined, highly methodical approach to getting it right. And as we have done in the past, we're going to have to invest ahead of the curve. Hi. Can you update us on the Starbucks Card redemptions, activations during the year? And are there further expansion opportunities internationally with the card? I can give you a little bit of feel for the metrics. For fourth quarter, both activations and redemptions were up over fourth quarter last year in the range of 15 to 20%. We're continuing to see growth in the program generally and as a percentage of retail revenues. That activity has added about 10% of those sales. And that's equivalent to the level that it was last quarter or fourth quarter last year. We're continuing to use the Starbucks Card as an opportunity to find new customers through sampling and other marketing activities. We also have expanded our business to business activities pretty significantly. Over a number of years various companies have approached us about purchasing the Starbucks Card and using it as an incentive for their customers or their employees to somehow mode of a change behavior, and that's worked very successfully. We're currently in the process of working with a major financial institution that's in the process of purchasing in excess of $2mm worth of Starbucks Card activations. So that part of the business has become pretty significant. Ladies and gentlemen, that is the allotted time we have for Q&A today. I turn the conference back to management for any closing remarks. Great thank you. Thank you so much for joining us today. Our next call for first quarter fiscal 2006 will be on Wednesday, please note that February 1st. And at that time we will also include our January revenues. Thank you very much. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234017 | Hereâs the entire text of the prepared remarks from Exxon Mobilâs (ticker: XOM) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. I would like to turn the call over to the Vice President of Investor relations and secretary Mr. Henry Hubble, please go ahead Sir. Good morning and welcome to ExxonMobiles teleconference on our third quarter 2005 financial and operating results. Overall we had a strong quarter, we achieved a number of important milestones while successfully dealing with the many challenges brought about by the Hurricanes. I will have more to say about those in a few minutes. Before I start Iâd like to draw your attention to our safe harbor language. Please note that estimates, plans and projections are forward-looking statements. Actual results including resource recoveries volume growth and product outcomes could differ materially to the factors I discussed and factors noted in our SEC filings. Please see filings stated factors affecting future results and the Form 8-K we furnished this morning, which are available through the investor information section of our website. Please also see the frequently used terms the supplement to this morning 8-K and the 2004 financial and operating review on our website. This material defines certain financial and operating terms that we use today, shows Exxon Mobilâs net interest in specific projects and includes information required by SEC regulations G. Now I am pleased to turn your attention to the specific results. It has been a quarter, marked by strong commodity prices, operating and supply challenges due to the hurricanes and the achievement of several important project milestones. Exxon Mobiles third quarter net income was $9.9 billion or $1.58 per share. These results include a $1.6 billion dollar gain from the transfer of our 25% interest in a Dutch gas transportation business. Excluding this gain normalized earnings were $8.3 Billion $1.32 per share. This was an increase of $2 billion versus the third quarter last year. I know many of you are interested in understanding Hurricane impacts on our business. The focus of our work continues to be on helping the affected communities recover, through rapid response to the needs of our customers and restoring our facilities as quickly as possible to ultimately reduce the impact on every one. Regarding our operations, on onshore productions facilities did receive some limited damage that curtailed production. Today weâve restored much of our production but due to the stormâs impact on industry infrastructure it will take more time to reach pre-hurricane production levels. In our refining and chemical operations the hurricanes primarily affected the Shamrock Refinery joint venture in New Orleans. And our refinery and chemical complex in Boma, Texas. At this time Boma has restarted and is in a process of returning to normal operations. Chalmette is completing repairs with a base startup immanent. Our two other Gulf Coast refineries Baytown and Baton Rouge were each impacted only for a short period of time. Although our operations are returning to normal, reduced volumes and higher cost will also impact the forth quarter. Focusing now on the industry the hurricanes had a significant impact and resulted in rapid changes in commodity prices. Due to the loss of industry refining capacity refinery margins increased while marketing and chemical products margins were compressed. With the rise in prices consumption was reduced and additional imports were attracted. In short the market worked and in recent weeks prices have to declined. Iâll discuss additional details of the hurricane impacts when I comment on the results of the business segment. But first I would like to highlight some of the key milestones that occurred during the quarter. Since our last earnings discussion weâve achieved a number of significant milestones in the planning, development and execution of major products in each of out business units. Let me start by commenting on the six major projects that achieved milestones in the third quarter. They reflect the discipline of our investment process and I think it is worth noting the decisions to make these investments were made years ago at a different point in the commodity cycle and today we are recognizing the results of what has been achieved. Our performance demonstrates the strength of our project management expertise and our ability to successfully employ our industry leading technology. In the upstream, the first phase of our Sakhalin-1 project in offshore Eastern Russia began production. The financial phase of the project is expected to produce 50,000 barrels of oil per day by the end of the year, and 250,000 per day at by the end of 2006. Initial gas sales of about 50 million cubic feet per day will rise to 250 million cubic feet per day by the end of the decade. Despite the projects complexity and the challenging environment the product start up was on time and the unit development cost is within 10% of expectations. In July we began production at the $3.5 billion Kizamba B project on Angola Block 15. Exxon Mobile designed the worldâs largest floating production storage and offloading vessel for use at this location. The benchmark development came online five months ahead of schedule. With Kizomba A these projects lifecycle time records with the lowest unit development cost for products of their scope. Gross production from Angola Block 15 is currently over 550,000 barrels of oil per day. We continue to advance our global LNG strategy with the commencement of several important activities by our Qatar joint ventures. In August LNG train-4 RasGas 2 project was successfully commissioned. The project is among the largest LNG manufacturing facilities in the world today. And was constructed on time and within budget. In September RasGas 2 and the Chinese Petroleum Company signed a 25-year 3 million ton per annum LNG supply agreement to commence in 2008. RasGas train 3 awarded the EPC contracts they for trains 6 and 7, two world-scale 7.8 million ton per annum LNG liquefaction trains. Technology extensions that capitalized on economies of scale had been key factors in making to Qatari LNG cost competitive for export worldwide. In Malaysia Exxon Mobil installed Guangtong-E gas compression platform. Once fully operational in 2006 the new platform along with the two existing nearby platforms will have a combined handling capacity more than 800 million cubic feet of gas per day. In Europe we completed the restructuring of our Dutch gas operations, with the transfer of our 25% interest in the Dutch transportation business. The transaction added $1.6 billion to net income in the third quarter. Exxon Mobileâs exportation opportunities were further expanded in two-acre standards. In September our subsidiary was awarded 20 contiguous blocks in the U.K. North Sea. The award constitutes approximately 1.2 million acres and it is the largest single license award in the history of the U.K. continental shelf. In October National Oil Corporation of Libya announced that Exxon Mobile has submitted the winning bid for exploration rights in Contract Area 44. This 2.5 million acre offshore block nearly the size of Connecticut marks Exxon Mobiles first commercial venture in Libya in more than two decades. In the downstream we signed a five-year supply agreement in which Exxon Mobile will supply private label oils to Caterpillar factories and dealer worldwide. The agreement continues the long-standing successful partnership between the Caterpillar and Exxon Mobile. In chemical we announced a plan to increase the production capacity of Isopropyl Alcohol at the Baton Rouge and Louisiana facility, already the largest IPA plant in the world. The expansion project, which is scheduled for completion in late 2006 will increase the Isopropyl Alcohol capacity to 300-kilo tones per year. Turing to the business line results, may find useful to refer to the earnings reconciliation provided in the IR supplement. Excluding the $1.6 billion gain on the Gasunie restructuring upstream earnings of $5.7 billion were up $1.8 billion or 46% versus the third quarter of 2004. Higher realizations of $2.1 billion were partially offset by lower volumes. The net affect of other earnings events was balance positive. We continue to capture the benefit of strong industry conditions, with upstream after tax earnings of $16.0 and $0.68 per barrel for the quarter. Worldwide crude sales realizations were $58 per barrel up more than $18. Our oil equipment volumes decreased 4.7% versus the same quarter last year. Entitlement impacts, asset sales and hurricane effects reduced volumes by 3.6%. Lower European gas demand and higher maintenance activities further decrease volumes by approximately 2%. New project divisions more than offset normal field decline. Liquids production decreased 58,000 barrels per day or 2.3% versus the same quarter last year. Excluding entitlements asset sales and hurricane related downtime liquids productions was up 1.8% at work programs and project divisions primarily in Africa, the North Sea and the U.S. more than offset mature field decline. Gas volumes decreased 764 million cubic feet per day or about 9% versus the third quarter of 2004. Entitlements, asset sales and hurricane related downtime reduce gas volume by approximately 3%. Primarily lower demand in maintenance activities in Europe accounted for the reminder. Work programs and project divisions offset mature field decline. Turning to the sequential comparison versus the second quarter of 2005 upstream earnings increased about $820 million excluding the gain on the gas and restructuring. Realizations improved by about $1.2 billion and were partially offset by the $350 million impact of lower volumes primarily due to lower seasonal gas sales, hurricane impacts and plan maintenance activities. Liquids production declined 1% sequentially as mature field declined entitlements and hurricane related downtime were essentially offset by additions due to work programs and startup of Kizamba B. Gas production was down 11%primarily due to normal seasonal gas fluctuations in Europe and hurricane impacts. Before we move to the downstream results let me summarize the upstream hurricane impacts. Third quarter volumes were down approximately 50,000 oil per equivalent barrels per day due to hurricanes Rita and Katrina. Today weâve restored 70% of the production impacted by these two hurricanes. We estimate the fourth quarter upstream volume metric impact will be approximately 80,000 oil equivalent barrels per day. For further data on regional volumes please refer to the press release in IR supplement. Turning to the down stream, despite the hurricane effects third quarter 2005 refinery throughput and petroleum product sales remained strong. U.S refinery margins grows rapidly do to the hurricanes but marketing margins were break to negative in the U.S. for much of the quarter. Overall third quarter downstream normalized earnings of $2.1 billions were up the approximately 725 million over the third quarter of 2004. Year-on-year higher industry refinery margins of $1.1 billion were partially offset by weaker marketing margins of 250 million. Marketing margins were the lowest point of the year. Year-on-year the net volume and refinery operations impact was a negative $140 million. As stronger refinery operations were more than offset by hurricane impacts. Following the hurricanes Exxon Mobile maximized gasoline production from all of our refineries which were operating in the U.S. and increased imports from the overseas of affiliates to meet U.S demand. Our refineries outside of the hurricane impacted areas achieved best ever reliability performance for the quarter. We set 38 new monthly unit rate or production records during the quarter and ran seven crude to new Exxon Mobile and 40 new to individual refineries. We continue to economically increase our refining capacity to improving the reliability of our operations and making selective capital investments to grow capacity. Sequentially third quarter earnings decreased by about $100 million. Higher refining margins contributed an additional 360 million and were offset by lower marketing margins. Volume and operational impacts largely due to the hurricanes reduced earnings by approximately $60 million versus the second quarter. Looking directly at the impacts of the hurricanes on our downstream operations, refinery throughputs in the third quarter were reduced by about 140,000 barrels today. In the fourth quarter of 2005, we expect all refinery operations to return to normal and anticipate hurricane impact at about the same level as the third quarter. Turning to chemical, as I mentioned earlier the loss of refining capacity led to a compression of the chemical margins, however demand remains strong. Third quarter normalized earnings of $470 million were down by nearly $530 million versus the third quarter of 2004. Primarily as a result of lower margins, the rapid increases in feed stock cost outpaced the increase in product prices. Against the background of unprecedented industry outages demand remained generally firm as customers continue to restart ahead of announced price increases. Third quarter sales volumes were the highest quarter year-to-date although down versus the third quarter of 2004. The product mix resulted in a positive earnings impact. Excluding the gain from the sale of shares sign effect year-to-date earnings in chemicals now stand at $2.6 billion, nearly 400 million more for earnings generated in the first three quarters of last year. These year-to-date results demonstrate the strength of our chemical business model featuring integrated operations and advantage feed stocks. Sequentially third quarter chemical earnings decreased by about $350 million. Weaker margins accounted for 460 million of the decline. Our sales volumes of nearly 6 % versus the second quarter added a $110 million. Turning now to the corporate and financing segment. Corporate and Financing expenses of $29 million were down about $18 million from the third quarter of 2004. Primarily due to higher interest incomes. Our cash balance was $34 billion and debt was $8.5 billion at the end of the third quarter. During the third quarter, Exxon Mobil purchased $5 billion worth of shares to reduce shares outstanding. Overall during the quarter we purchased 91 million shares of our common stock for the treasury at a gross cost of $5.5. billion. CapEx in the third quarter was $4.4 billion up $780 million from the third quarter of 2004. Primarily due to planned upstream activity. At the end of the third quarter you did a CapEx spending total $4.4 billion approximately 1.7 billion higher than the CapEx level at the end of the third quarter of 2004. Additional capital spending in our OBL projects and the acceleration of Qatar LNG activities will result in full year CapEx of approximately $18 billion. The effective tax rate for the third quarter was 42%. Before we move to the Q&Aâs Iâd like to take a moment to summarize the key messages from this morningâs call. Our records third quarter results reflect the strong commodity prices and our fundamental business model that is disciplined, straightforward and focused on generating value while managing risk. Despite challenging industry conditions we have maintained our focused on operating safely and efficiently. We are proud of our people and the businesses we are responding to unprecedented events caused by the hurricanes. Evidence of our superior project management skills continues to be displayed by our delivery of startups on time we are ahead of schedule, had cost on budgeted better. Our broad and diverse portfolio projects, creates ongoing opportunities to continue to bring new resources online. That concludes my prepared remarks and Iâd now be happy to take your questions. Thanks. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234018 | A replay of this call will be available starting at 12:30 p.m. Central Time today. You may access the replay by dialing 888-203-1112 and referencing pass code 3784827. The speakers today will be Mr. Larry Washow, President and Chief Executive Officer, Mr. Gary Castagna, Senior Vice President and Chief Financial Officer, and Ms. Jennifer Melsheimer, Investor Relations Manager. Thank you. And welcome, everybody. Hope you've had a chance to look over the results that we sent out this morning. Overall a very good quarter. Sales on a consolidated basis, as you can see, up about 15 percent for the quarter. Gross profit numbers similar to â04, although weâll talk about some of the segments here in a minute. Operating profit more than a 50-percent improvement. And down to the bottom line, earnings per share of 37 cents compared to last yearâs 27, plus, of course, we had the 14-cent-a-share amended tax return benefit that came through in the third quarter of last year. So overall weâre very pleased with the operating results for Q3. Looking at some of the segment data. The minerals side, good sales growth as you can see. You'll note that the gross margins are down a touch. And again, weâre working very hard and continuing to battle the every-increasing energy prices and having fairly good success, but obviously not 100 percent, in recovering the additional cost. But the good news is that GS&A, our expenses for the year, are flat. For the quarter it shows a reduction in GS&A on the mineral side, and that really relates to a situation last year in the third quarter where we took a substantial accrual towards bad debt expense for a couple of metal casting customers. So the year-to-date numbers are more representative there, but certainly GS&A spending this year up modestly across the board. The environmental segment, kind of the star of the show, I guess, in the quarter. Really strong virtually up and down the line. Good sales growth of better than 20 percent, modest overhead growth. Margins in that case did improve, and, again, weâre looking at the strength around the world helping that out and when you get down to the operating line, very, very nice growth in the operating percentages and dollars recorded by environmental. I should mention in both cases, minerals and environmental, the international business was very strong in the quarter. It doesn't represent the biggest share of our business by any means, but on a percentage growth basis we really see very good things happening in Asia and other parts of the world. So very encouraging from that perspective. Environmental, the primary contributors, oil field services, part of our waste water group, certainly had a very strong quarter, and the lining side continued to do very well, again, with our six plants around the world. Looking down the line. Transportation, good quarter. We had a lot of business obviously and they're certainly the beneficiary of that. But also looking at higher value, higher margin business outside of our own reflected in better operating earnings there. I should mention one other earnings benefit. Certainly the minority interest again, primarily our partners at India making a nice contribution, and thatâs something we expect certainly going forward will continue. So all in all a very good quarter. OK. Yes, just I'm picking it up from where Larry had led it in terms of our operating performance for the quarter. Really the summary there is very strong operating leverage that we achieved as gross profit really dropped to the operating line, and that allowed operating profit to improve by 55 percent over the third quarter of the prior year and operating margin increasing nicely to approximately 11 percent compared with the eight percent in the prior year quarter. One other matter to note. We mentioned in the earnings release in the quarter our effective tax rate did increase over what we had mentioned before in the past in terms of our expectation. Year to date the effective tax is now 27.1 percent, and that sequentially increased from 22.4, and that results from a charge related to a valuation allowance on certain deferred tax assets that is part of our review of those assets in the quarter. We made a judgment based on really understanding the complexities of the tax situation and deductibility of certain costs that we have held as assets that there was question that it was perhaps less than likely that we could achieve those deductions in the future, and we elected to record this valuation allowance of $1.5 million in the current reporting period. So that is an issue that we think is dealt with, of course, in this quarter and don't expect an impact on that hereafter. If you exclude that particular charge, the effective rate for the quarter from being 33 percent would have been approximately 25 percent. Also very positive for the quarter were our minority interest in joint venture investments. They contributed three cents per share in the quarter as compared with one cent in the prior year. We mentioned in the past certainly a lot of developments of the investments we have in India. We have two investments there, both of which have been performing extremely well in the last year. In terms of our financial position as of the end of the quarter, debt certainly as a percentage of capitalization has increased since the end of the year, but actually has remained consistent at 14 percent from the prior quarter. Working capital nudged down slightly from the end of the second quarter and now stands at 151.8 million. Cash flow from operations, 17.5 million from the first nine months of the year compared with 13.2. So we are seeing a moderation essentially of the working capital growth that weâve seen over a period of time which we hopefully expected to come through and hope to continue to push hard for in the fourth quarter. Capital expenditures at $20 million for the first nine months as compared with 12. Again, and we indicated this year the considerable investments going on really around the world again with the company. So this is really on track with where we believe the cap ex will be by year end at approximately 24 to 25 million. Acquisitions in the quarter were obviously small. We did announce an acquisition of a business related to our environmental segment and contracting services that was reflected in the quarter. Also in the quarter we did have some payments related to prior acquisitions with respect to earn-out payments to former owners of those businesses. And then finally on the quarter, and in terms of financing activities we did execute some stock purchases in the quarter. We purchased 104,000 shares in the quarter, aggregate cost of 1.9, almost $2 million actually at an average price of $18.70 a share. Then that leaves us with approximately $8 million remaining in the authorization from our board from 2004. Thank you. The question and answer session will be conducted electronically. If you would like to ask a question today, you can do so by pressing the star key followed by the digit one on your touch-tone telephone. If you are joining us on a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one if you would like to ask a question today. Good morning, Larry and Gary. How are you? I was wondering if you could expand on your new nano-bentonite antiviral â that has the antiviral properties and whatâs happening there. Yes, we had an announcement mid-September about the initial results that we have seen. And certainly weâre encouraging that there could well be some interesting development opportunities in that regard. It is early days. We do have work to do. But the lab that conducted the work for us on the three viruses weâve tested so far was very enthusiastic and quite surprised at the results. Obviously the path forward is to determine how exactly this could be applied. We talk in the (poster) we presented about creams as an example or hand-washes or that type of thing. So weâve got some ideas on where to go with this and weâre working with some people on the outside. But itâs very encouraging, and I think itâs, to me, indicative of our continuing research effort. Even though weâve been around 80 years and do lots of things with bentonite, we certainly don't believe weâve captured all of them yet. Larry, does that mean that itâs more a topical application like hand-washing soap and things like that or that has to do more with any kind of antiviral vaccines or what? Itâs really early days. Certainly the obvious applications would be, you know, hand-washes and filters and things of that nature. We certainly ourselves don't know enough about exactly how the application could potentially work on the human side internally, so thereâs work that needs to be done there. And weâre certainly looking forward down the road to doing that. Yes, just had one more quick question. On the minority interest and joint ventures you mentioned â I guess that related to the two in India. Are there are others? Is the China one involved at all? No, our investments in China are now on a fully consolidated basis. The other joint venture and minority interest that we have, we have a 50-percent interest in a Japanese bentonite company and we have a investment â a couple of different investments in Egypt that are approximately 25 percent equity investments, and Mexico where we have a 49-percent investment. Thank you. Good morning. Hey, Larry, I was just hoping to break down a little further the progression that weâve seen in the mineral segment over the past four or six quarters. The margins have stabilized somewhat right around 20 percent on the gross line amid the higher commodity costs. But then you've seen the sales growth add to the mid-teens, you know, earlier this year and then into the low teens here. Is that a function of you guys trying to maintain the price amid the higher oil and gas prices? Well, weâre certainly trying to maintain the margins, you know, as best we can obviously. And earlier in the year the cost increases were actually going through at a greater rate than they are now. Some of the reflection you see there is somewhat higher pricing leverage early on. Now, we did â or do indeed see continuing cost pressures, but, you know, it seems to be at least a little more ameliorated than it was and somewhat balanced here as we go forward, obviously depending what happens with petroleum and natural gas for us. But I think in terms of the growth side, you know, we certainly had a good strong start to the year, weâre still seeing very strong growth on the sales side in Asia. One of the factors here that shows up probably more this quarter than previous, our detergent business we mentioned a couple times has been a bit softer in the last couple quarter than it has â last year, which happened to be for them a very strong third quarter. So thatâs an element that we didn't really get growth in that area that we would normally expect in a previous years, certainly, and quarters had. So overall I think the growth profile is pretty good, but there are, as always, thereâs a couple spots weâd like to see better. OK. Detergent. You guys are amid an unfavorable product schedule or a cycle. If I remember correctly, is that something that would be a temporary lull or itâs something that you would need to alleviate over the course of, you know, four or six quarters. No, itâs temporary. Typically itâll be a two or three-quarter type thing, and weâre a good two quarters into it. So we should see some â we will see some improvement here fairly quickly. OK. Looking at the domestic metal casting business, is the problems that weâre seeing from the domestic manufacturersâ potential for further production â capacity reductions there, is that having an effect on your outlook? Itâs really hard to say, again. We fortunately are in a position in the metal casting side where we deal with all the manufacturers, not just the domestic guys. So it seems like the units being built and sold continue at a pretty high rate, albeit not all of them, the domestic producers. At the same time, and weâve talked about it in the past, a substantial component of the growth this year has really been in the heavy equipment sector. That seems to be doing well, although you hear some rumblings from those guys that it may be slowing a bit and the rail building sector, which is still way behind. So we don't think that oneâs going to slow down for quite some time. So I guess on an overall basis, yes, you â automotive, we would expect to see a little bit of an impact if they continue to reduce the number of cars being built. But on an aggregate basis not substantial. OK. Can you give a little bit of detail on what your cap ex went towards this quarter and what stages you're at in the major projects? Yes, I think that â we don't have it right down to the project, but certainly the bigger investments this quarter have been in Europe with our Spanish plant that weâre building, a liner plant. Thatâs probably the biggest component really kicking into this quarter. Did kick off a new metal casting facility in China this last quarter as well. So those will be probably the two major sort of greenfield projects that we were into. Good morning, guys. I was wondering maybe, just as a follow-up on the cap ex question, could you give us an update on the facility in Spain in terms of the lining? In other words, types of volumes you'll see through that and when it will be fully running. The Spanish facility, itâs well under construction now and we expect shortly after the first of the year, sometime by, you know, no later than sort of mid-first quarter that should be in production. Weâre servicing that market now from our Polish plant and U.K. plant. So incrementally we don't expect, you know, a big volume jump right away. Itâs certainly going to give us a logistics advantage and leaving us opportunities to increase our market share there. But weâre pretty well represented already in the marketplace. So itâs going to make it more cost effective, itâll give us an opportunity to improve margins, and it will give us I think ultimately a bigger market share as it goes forward. Are there other places where we may see down the road another plant or is this something in terms of â as you look out in terms of growth sufficient for the demand. Weâre looking at that right now. And, again, given the nature of the logistics requirements here, several locations really are an advantage provided they're situation appropriately. So that would be our third â our third plant in Europe ((inaudible)) see if it makes sense to have one farther south or farther east at this point. But we think weâre in pretty good shape right now. We have a client in China thatâs pretty well positioned, but thatâs a very big country, so weâll have to see over time if that really will suffice for the entire country. And with our joint venture partner weâre in the process of building a facility right now in India which we think is going to be a good market as well. OK. You mentioned India. I think the comments or the prepared comments were about continued strength. And I â if I recall, it was roughly three cents for the quarter, the contribution. How should we interpret or read into those comments about continued strength? Does that mean five to six cents for the full year and then next year we should see 10-15-percent growth on that or â if you could add additional color on maybe the business and how that would translate into the operating results. If you look at the kind of results year-over-year, I think last year was probably a penny, this yearâs three cents. So itâs really been growth. And a lot of that â not all, but a lot of that â is India. And our partners there are very active in a number of markets beyond kind of our traditional bentonite market. Bauxite in particularâs been very strong. It looks like that will continue. They're into some other minerals as well, but itâs really the Bauxite thatâs kind of been driving the good results over there. We do expect that to continue. How much that can grow from here, itâs hard to say exactly. We do expect to see more growth and I think they'll continue to be a good solid contributor. Percentage-wise, again, I don't know exactly because we only get a relatively small portion of that growth because we own 22-odd percent of the company as a whole. So the growth that weâve seen over the last year is obviously pretty substantial from an earnings standpoint as it relates to that portion. OK. On the automotive front with the number of the press news stories on some of the foundry issues and suppliers, are you seeing any more pressure there as it relates to some of your customers that we should be thinking about in terms of, you know, whether itâs something like you had last year in the third quarter where you took a reserve? At this stage we don't think so. Again, the industryâs had a pretty good shake-out over the last five years. And the guys who went through the bankruptcy route last year were primarily those who were trying to get some leverage and who were successful in doing it, actually, with the contracts that they had with some of the major car companies. And the â you know, I canât say like the lesson has been learned, but I think the message has been delivered anyway and our customers today seem to be in pretty good position to continue to do what they do and maintain their business and be profitable. And so weâre â you know, weâre still fairly bullish on the â on the metal casting market. One more than Iâll hop in queue â or back in queue. Can you talk about where weâre at in the cycle on pricing and perhaps flow-through of the increased costs that you are seeing and the ability to pass those either along in surcharges to your customers or in cost recovery mode so that we see the additional leverage that you saw in the current quarter? Or on the other â on the flip side, any ânegativeâ surprise that could come through because you're not able to pass cost along. Yes, it varies a lot by market, quite frankly, and the â you know, the environmental side weâre â weâve been pretty successful in passing through any of the cost increases and maintaining margins. The mineral side is more complicated. When you get into things like our products where weâre buying packaging and putting material in and then shipping it, we have a big chunk of the costs there that are somewhat variable and have been increasing over the last several months. Itâs harder there to continue to get the price increases in the margins, and I think thatâs going to continue to be the case. But weâre we'll positioned there and I think the customer base we have, the larger portion of it, are the majors that understand the nature of whatâs going on. So they're working with us to make sure that, you know, it all comes out reasonably o'clock for both of us. But that area probably more than others is going to be a challenge. But I think you've seen most of that reflected in the margin already. You know, weâre down sort of 900 basis points from last yearâs third quarter and down a little bit over Q2. And I don't expect to see further deterioration on the mineral side. All right. At some point strategically do you â I mean, if itâs â is there business you should â you were thinking about walking away from because you're not able to get your response or the response you need in terms of accepting the price increases? I mean, itâs always an option, but weâre pretty cautious about that. But certainly if thereâs a situation, and it would probably be with a small customer that just doesn't want to, you know, take it forward, yes, we would be willing to walk away. But, again, I think the majors that are the real powerhouses in any of our businesses understand the nature of whatâs going on. Good morning, guys. Iâve got a fairly long list of questions. If you look at the 17 â roughly $17 million of sales gains for minerals and environmental together, geographically where do they come from? All over. But I would say when you look at the â at the mineral side, itâs certainly the U.S. and Asia primarily. If you look at the environmental, thatâs probably a little more distributed, but again, Asia moving up very nicely in their business as well. Probably dollar-wise it had been, because on the metal-casting front obviously thatâs a bigger component of the entire company, and that market certainly with pricing and volume has been strong. And on the environmental side, actually, the water treatment business, primarily related to the oil field services, had a very strong quarter. And that is still predominantly a U.S. business, although we did see some new business in emerging markets there as well, too. But dollar-wise thatâs a â itâs a big component. Haven't really seen that yet. Again, as we talked â you know, depending on the (car builds) and things that could certainly be something we should keep a very close eye on. But so far itâs really â itâs continued to be strong. And, again, itâs more than just the automotive, as Iâve said. So itâs a marketplace for us that looks very good right now and we expect that to continue. Historically when weâre kind of running well itâs in the low 20s. I mean, itâs not a â you know, itâs not like the environmental where you're going to see a 35-percent margin. But certainly I would like to see it a couple, three points higher than it is. And how long do you think itâs going to take you assuming energy prices stay flat from this point forward to restore those margins? : I would hope that we could see some improvement, you know, within the next couple quarters to get back to kind of the historic levels. Probably take a year I would imagine at least. One year. OK. I noticed that you have an awful large amount of your working capital in receivables. To what extent is that due to a lot of orders in September or just a lot of orders from international accounts? Yes, thatâs actually probably on both counts, the contributors, in terms of seeing the actual gross level of the receivables increase. Day sales outstanding is around 70 days, and actually thatâs a fairly comparable overall number to where we were at the end of the last quarter. But both in the international side, especially the environmental segment, itâs peak quarter. Those tend to be the longest collection cycle customers and so thatâs probably the biggest reason that you see the bump up. I presume you'd â you're looking forward to converting a fair amount of working capital to cash here in the fourth quarter. All right. You â just incidentally, you talk about debt-to-total-capital. On a net debt-to-total-capital basis you're I think just a little light of 10 percent. And if you â you know, and if you bring those â if you take â if you collect 30 or $30-some-odd million worth of receivables itâll come down net in the fourth quarter, itâll come down significantly below that as well. Certainly that. And again, we are, though, going to be continuing investing in cap ex in the quarter as well. So it would definitely under normal patterns â historical patterns of the company have seen the fourth quarter be our largest operating cash flow generator. Actually, I think it was other way. I didn't have a significant impact. The base businesses really accounted for I think we say 93 percent of the sales growth. The remaining growth of sales was attributed primarily to foreign exchange. We did have an acquisition in the quarter, but it just was very minor impact to the quarter. Thatâs mainly because if you look at it on local currency basis, weâre virtually self-hedged. We are looking at some activities in terms of trying to keep more balance there. But for the most part weâre balanced. I have one conceptual question on R&D. The company has been fairly inventive in terms of new applications of clays, Nanocor, what you're doing in the toiletry and cosmetic field, and now the antiviral applications of nano-bentonite. Why â conceptually, why don't we see you stepping up your R&D as the company is growing and try to accelerate some of these developments? Thatâs a good question, and we actually are expanding our R&D capability, primarily overseas, in the last couple quarters. It doesn't really show up yet in our spending. I think in the next couple quarters you'll see that come through because clearly there are some opportunities here that just take a bit more â a bit more work and a bit more skill than we have available at any given time. So you will see the R&D spendings continue to â probably not just creep up, but it would move up, you know, reasonably well over the next few quarters. Well, I don't know. I guess I could say â and that, in terms of surprises, certainly from an operating level, I don't know whether we would necessarily attribute anything that was either a spike or a detriment, say ⦠Well, weâre fairly aggressive in our internal expectations. So weâre not unhappy where we are for sure. But, you know, we really expect our business to continue to grow pretty aggressively. All right. But the results you've reported here in the third quarter were pretty much in line with your budgeted expectations? Hi, good morning. Congratulations on a good quarter. Could you circle back and just speak a little more in detail about the antiviral work? It seems that, from a footnote, that it traces back to, say, seven, eight years. And I'm wondering what the â what the framework of this was, how it started and where you're going as far as do you plan to enter the clinic soon or â can you give us some color on that? Yes, itâs â I mean, the use of bentonite in various activities like this has been around for quite some time. Some of our scientific guys, you know, looking at what was going on today said maybe it would even work on some of the more difficult viruses that are out there today just because of the nature of the surface and what we can do, whether we can modify this material. The theory was to potentially attract the protein sort of ends of different viruses. And the work that has been done so far suggested that is exactly whatâs happening. We don't even â at this stage we canât even define the mechanism, to describe exactly whatâs going on. So weâve got a lot of lab work going on as well as just getting into a little bit more practical work to see if we can get some real-world testing out there and see how applications might be working for this material. It is early days. You know, I think itâs pretty exciting stuff, but it is early days. Weâve got a lot work to do. And we haven't â we haven't even, quite frankly, considered the prospects of going into, you know, the pharmaceutical type applications which would clearly take a partner who has that sort of skill set. But that â to us anyway thatâs a ways down the road. Weâve got â weâve got some more work to do here. Good morning. Great quarter. Just a couple quick questions. Most of mine have been answered. Larry, I know you brushed on the subject of obviously how weâre dealing with higher costs. But specifically in pet product I know clearly last quarter you discussed fuel surcharges and some other initiatives aimed at reducing the impact that obviously weâre seeing both from petroleum-based products as well as higher resin costs. But can you â can you just discuss in a little more detail the success you're having in offsetting that and kind of where are we on a lag basis relative to getting that catch-up? Yes, weâre still â weâre not where we need to be yet, but we are making progress. And itâs, quite frankly, a little bit disappointing, because we had finally kind of gotten through this whole surcharge thing on the fuel related to transportation, and then over the last couple months the resin costs have just skyrocketed. In fact, resin availability in some cases itself is a big problem. So now weâre kind of back into the mode of, well, hereâs the real world guys and the resin pricing is what it is, and to provide that package weâre going to have to raise the price, or we can offer some alternative packages which people are taking a look at. So weâre actually making very good progress on the transportation fuel cost which was significant to us here over the last few months, and the resin packaging cost is having an impact. So it â weâre a little behind where Iâd like us to be, but I think we were making good progress. And, again, for the most part the guys that are the professionals in this business, the big consumer products companies, understand whatâs going on and they are working with us to try to figure out, you know, how we get through the whole process. But if thereâs one area that really does have a â have an impact on margins still â and weâre not out of the woods yet completely as Iâd like us to be â it would be that products area. OK. And just quickly, you had mentioned sources and supply. You know, Iâve heard too that there have been some suppliers that have had to declare (force major) on contracts. I mean, have you run into that in any of your markets? Not yet. I mean, we certainly had to scramble some and weâve been, you know, hand to mouth in areas where â especially on the packaging side again. But generally speaking, so far anyway, weâve not had any of the (force major) activity impact our business. OK. Quickly on â just moving on to environmental. I mean, obviously a very, very good quarter in terms of the operating margins and overall sales growth. I guess if you look at this quarter in general, was there any â you know, clearly weâre obviously realizing pricing and operating leverage in this business. But can you â was any specific segment thatâs maybe a higher margin business, did it contribute at a higher level to kind of, you know, result in this operating margin kind of growing at, you know, up to 16 percent as opposed to just saying this is more of a culprit of operating and pricing leverage. Yes, I think the real plus for the quarter â and itâs starting to come into its own in a positive way â is that â is that waste water part of our environmental segment, and particularly the oil field services. And if you'll recall, a year plus ago we bought a company to add that group that does well testing, determining sort of materials that are in gas or oil wells. That business is booming. I mean, as you would expect given the oil prices and gas prices, anybody that has a rig has it operating and is trying to identify what they've got by way of wells. So thatâs been a real plus for us. At the same time our traditional offshore business, the hurricanes notwithstanding, in both the North Sea, off West Africa, and the Gulf have really, really been strong. So some of this relates to kind of the whole demand cycle on oil and gas just given the pricing thatâs out there, and weâre positioned well, I think, to continue to be a participant in that growth and that segment provided we can get, you know, enough people and equipment and everything we need, which so far we have. It should really continue to grow, and it is a very â itâs a very nice margin business when itâs running at the kind of rates itâs running now. And the last one. I know thereâs obviously some seasonality in the business, but is it fair to say that, again, given some of the leverage weâre seeing and the strength in the oil field services business, I mean, is this â I guess as a stated goal of the company is a 14 to kind of 15-percent operating margin, is that from your perspective an achievable kind of baseline? Yes, yes, environmental for sure. Yes, I think thatâs a very realistic target in terms of where we should be and need to be given the kind of gross margins that that business can deliver. OK. And, lastly, in just in terms of hurricane-related issues, what products of yours specifically in environmental would you possibly perceive to kind of benefit, as obviously we have this huge reconstruction going on in Louisiana and Mississippi. I would think that some of your lining technologies might be in higher demand. I mean, can you point at any past hurricanes or significant, you know, issues that saw kind of a spike in demand for specific products? Yes, typically what happens â and it did with â I think it was Andrew was the one where there was a tremendous amount of damage that had to be disposed of. The major reclamation companies â or waste companies, rather, typically will open up cells in their landfills faster than they had anticipated because they just got a huge influx of waste. And the amount in this case is enormous. How forget how many, you know, millions of cubic yards. Itâs just a tremendous amount. And we will see more activity on the â on the waste side from landfills. When the reconstruction starts we typically participate certainly on the commercial building side with waterproofing, which will be a benefit, I think. The downside is the oil field service itself in the Gulf. Even now weâre not as active out there as we would normally be. But thatâs a temporary thing. I think by November thatâll substantially be back around. So on a net basis â and itâs a terrible way to get business and I don't even like to talk about it â but on a net basis it actually turn out that weâll probably have a modest plus as a result of the hurricanes. Hey, Gary, how are you? Two quick questions maybe for you, Gary. Do you have any insight into the cap ex budget for next year at this point? Just on the outlook I would say, that itâs probably not far away from where we are at the present time. Every year we find new areas to invest in, and I think the full plan next year will still have some new greenfield type investment or certainly reconstruction in some areas where we need to really add capacity. So I think given just the overall infrastructure of the company, the â certainly the mid 20s is probably a starting point as to where we look at a annual cap ex outlook. OK, thatâs helpful. And in terms of â I know there have been a lot of tax initiatives you guys have had underway over the last couple of years that go a number of years back. Is there anything else in the near future that one way or the other would impact your â either recovery of previously paid taxes or the tax rate going forward? On the recovery front, I mean, last year â and in fact itâs reflected in the results of last year not only as part of the reason why we actually had a net benefit of income tax last year, we also had a prior period adjustment reported last year relating to federal income taxes that are now under audit. It does quite a bit of time, but you're looking at the aggregate level of potential recovery there in excess of $10 million related to our past efforts that are still pending. We do not foresee any other different initiatives per se that would be like a cash flow impact, but that are certainly of the nature of what we just executed in the last year. In terms of where tax rates are, really the major impact points of tax rate are the depletion deduction that weâre allowed for our domestic mining activity. And then you really have the effect of lower tax jurisdictions and our overseas location. So the mix of our business â and I guess this is another indicator of our positive international development â as weâre getting more earnings from foreign locations it tends to bring down the overall tax rate. OK. And then a bigger picture question related to acquisition opportunities or kind of non-organic growth opportunities. Can you â can you kind of talk about where you might focus your efforts and, you know, I guess how much capacity you have to grow the company that way? Certainly, financially we have the capacity to do a lot. Itâs really a question of finding the right fit. We have looked at just in the last quarter a couple of very interesting potentials, one for environmental, one for minerals. In both cases for a lot of reasons it got a little richer than we thought would be appropriate for us. But weâre continuing â weâre out there, weâre looking at things all the time, and if itâs a good fit weâre quite ready, willing, and able to take something on and add it to the business, certainly recognizing that that is an element of our growth strategy going forward, is to continue to grow through acquisitions, whether thatâs renewed technology or other skill sets or other markets that weâre not participating in. In the â in the absence of those types of opportunities or, you know, an unwillingness to pay prices that are â that are being sought, would you continue to repurchase your shares or would you consider other opportunities to distribute that cash flow? Yes, we certainly still have the $8 million left for share repurchase. And as you know we do that sort of opportunistically, we think, as we see what happens with the share pricing. And thatâll continue. We have the authorization to do that. The board obviously on the dividend policy has been pretty consistent over the years and does a distribution in the 30-percentish range of earnings typically. And thatâs move up nicely pretty much year over year for the last several years. So thatâs another mechanism obviously to provide a return to shareholders. And we do â you know, even with the â without acquisitions, the organic growth does consume cash and â as we expand and grow in businesses we currently participate in. One quick example, the detergent area that I mentioned, which was primarily European-based when we bought it. We will now have activity there in Asia, in the U.S. as well, and thatâll require new facilities and investment. Even though itâs not another acquisition, itâs certainly expanding our business levels as a result of an acquisition a couple years ago. And that happens fairly frequently. Thatâs good. I just wanted to follow up on one of the other Callerâs questions and your answer to that about the long-term gross margin expansion â or return, I should say, for minerals. Obviously the resin and the transportation costs will be contributors to getting back to more historical norms. But is there anything else there that you see in the next 12 months? Well, some of the things weâre doing beyond that â certainly we have identified and are continuing to work on productivity and efficiency improvements that can certainly leverage, you know, better margins. And part of that is weâre running the plants pretty hard right now, but we certainly think we can continue to eek out improvements and without large investments in additional capital get more productivity, more volume through the facilities that we have. And thatâll give us somewhat better margins. Itâs a tough call, though, Ralph, as to how quickly you see a return there and not knowing exactly whatâs going to happen in all the energy areas, which I probably should mention, too. We have some â for example, some operations that use natural gas as a drying fuel. We could be more cost effective in things like coal, and we try to do that where we can to convert back. So as conversions takes place thatâs beneficial as well. So thereâs lots of little things. Thereâs not any one thing thatâs going to get us back into kind of the low 20s where Iâd like to see it, but itâs going to be a series of sort of incremental small things in both the pricing and internal processing that hopefully will get us there over the next, you know, year, year and a half. OK. And so it wouldn't necessarily even depend on one particular use, like just pet products, it would be across the board in minerals. Oh, yes. I mean, a lot of it really is related to volume and processing and efficiencies and things like that internally that clearly we can â can and do continue to try to improve. Yes, I just wanted to see if you could add any more color, Larry, on some of these new growth opportunities or historical growth opportunities that maybe we haven't seen further commercialization or advancements, particularly on Nanocor or HBS. I wonder if you could elaborate on that, where things stand and if you're seeing increased volumes of materials or dollars being spent. It looks like itâs relatively flat in terms of cost year over year. Yes, in the case of Nanocor, you know, as weâve talked in the past it is â you know, thereâs definitely some interesting market opportunities out there in various stages, primarily early development. Weâre â you know, weâre not projecting or expecting giant leaps of revenue or anything to occur in that area any time soon. But certainly in some of the specialty areas, especially in some of the niche markets, itâs encouraging. The HBS activity continues to go pretty well. Weâve got some products coming out again, and the evolution of that business is basically getting formulated into products, which typically takes a bit of a cycle. And weâve got kind of a nice base of business now. And the challenge going forward, as these other products come out and get formulated into new ones, you know, to really see that revenue continue to grow, and we certainly expect that to be the case. But, again, on a relative basis when you're looking at the sort of sales we are this year, the growth in HBS and Nanocor â weâll take all we can get, believe me. But itâs not going to have a material impact on the overall numbers. But in terms of the expectation or what you had indicated about increased R&D dollars and maybe as a strategic effort and expansion in that area, are you contributing more dollars to historical efforts or are these more with the recent announcements on the antiviral side more into new markets going forward? Itâs a lot of â itâs a lot of newer things. Obviously some will go into improving what weâre doing now. But weâve got other areas that we think are pretty interesting that weâve got a lot of developments. Again, early days in the R&D side, but continuing to broaden the base of business. And a final reminder, it is star one if you would like to ask a question. We do have a follow-up from Caller. Hey, guys. I thought of a more â when you look at the sequential movements from seasonally or otherwise into the fourth quarter and then as you look into 2006, is there anything you can help us with regarding, you know, the pace of growth or any change in your expectations for the long-term targets you've set for the company. I think weâre still pretty comfortable, with kind of where we are in terms of obviously looking to grow the sales line at double-digit type rates. And whatever that turns out to be, the bottom line itâll be a better rate than that. And I think thatâs still pretty realistic, weâre pretty comfortable with that. A lot of questions today on kind of the automotive section. I mean, obviously if a big sector goes into a big slump somewhere in the world that could have an impact on us. But we continue to believe that the strength we have is being as diversified as we are geographically as well as in different markets. Nobodyâs ever insulated, but I think weâre â itâs a little softer cushion we have maybe if things happen, the slow-down in China or slow down in the U.S. or speed up in Europe, weâre positioned we think to kind of leverage that into continuing growths in our ((inaudible)). |
EarningCall_234019 | Hereâs the entire text of the Q&A from China Medical Technologiesâ (ticker: CMED) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you. Ladies and gentlemen if you wish to ask a question, press â*â followed by â1â on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press â*â followed by â2â. You may begin by pressing â*â, â1â to ask your question. And we ask you to keep your question to a minimum of 1 question. Thank you. As a reminder, ladies and gentlemen, â*â â1â to register your question. And, at this time Mr. Tsang, there are no questions in the queue sir. I do apologize, our first question, just a moment. Our first question will come from the line of Richard Lou (ph) with RJC Capital Management. You may proceed. All right, why is there little damage to surrounding cells at around the, the cancer tumors of, from your ultrasound system? Because the, the size of the focal point 3 x 3 x 8 millimeters so and also, ultrasound has good therapeutics of the eruption so the collateral damage to the healthy tissue, is minimum. As a reminder, ladies and gentlemen, to register your question it is â*â â1â. And our next question will come from the Weidong Huang with TimesSquare Capital Management. You may proceed. I want to ask you, if you maybe could tell us a little more about you effort to expand HIFUâs presence in the US. If you could maybe give us some idea as to what timeframe do you expect to enter the US market? As of today, we have shipped our first equipment to the University of Washington and Seattle and it is going to be installed very soon and we are going to start the animal testing before we submit the IDE application only next year. So, we are expecting to start the human clinical trials in 2006 and according to our FDA lawyer, we are going to apply for 2 applications which is uterine fibroids and pancreatic cancer, it will take us approximately a little bit over 3 years to complete the whole process. So, thatâs the constraint for the FDA approval. If we can complete the FDA according to our lawyers time frame. And, meanwhile, we are also talking to our lawyer here to see if there is a possibility to use some of the FDA clinical cases to apply EU and Japanese FDA approval. I see, okay. You mentioned there is a multinational company, medical supplier that has also entered the HIFU market, could you elaborate on that? Since, the International Symposium of Therapeutic Ultrasound, just occurred in Medical School, Harvard Medical School 2 weeks ago, one of the 3 major medical companies they had a research paper announcing that they are developing HIFU equipment by themselves and they are planning to start the CE or clinical application for uterine fibroids next year. I am not sure, if we could announce their name, it should be. I think we are better not to disclose their name. Okay, you mentioned some of these pipeline timeframes for your non-invasive thermal sensor as well as your automated version of the ECLIA system, you can say, yearend for the thermal sensor and the second half of 2006 for automated ECLIA system, are you talking about fiscal â06 or calendar â06? Calendar 2005 and weâre going to choose several large off-schedules, to do the clinical trial first. But this new capability, does not need to go through Chinese FDA approval, it just needs to use several clinical trials to further validate the data. And for the fully automated system of the ECLIA analyzer, weâre also talking about the calendar year, the second half of calendar year 2006. Hi and also congratulations. Can you give a little more granularity on the guidance youâve provided in terms of how that splits out between, the HIFU and ECLIA? The guidance we give is revenue for the whole year. And, you see the second quarter results for HIFU and ECLIA also demonstrate strong growth. The HIFU currently composes about 60% of our total revenue, and we expect those similar results for the entire year. When we mentioned seasonality we have already discussed the historical track records. So, we expect that the next quarter, December quarter, should be the best quarter for HIFU sales. Okay. And Iâm sorry because I did miss most of your prepared remarks. As it relates to the infrastructure support for ECLIA what exactly, what kind of resources are you adding there? Is it service support, additional sales people? What should I be thinking about over there and how many people are you adding? The ECLIA operations commence September, last year. So, itâs slightly over one yearâs operation. And we are adding people continuously to strengthen the sales and marketing team as well as the R&D team. Of course, the production team for the ECLIA is also enlarging. And, we are also innovating or expanding our ECLIA reagent facility as well, in order to meet the increasing demand for the ECLIA reagent. Okay, in terms of the growth in ECLIA, how did that split between systems, and the analyzers versus the reagents? And, can you talk a little bit about the number of placements and the kind of growth you are seeing there in terms of instruments? Yeah, last year, although there was only a seven-month operation, the revenue coming from the ECLIA is about 5 million. And for the two quarters, first two quarters this financial year, the revenue from ECLIA system is about, 6.5 million. So, you can see from the results that these two quarters have already exceeded last yearâs. And, turning to the equipment sales, compose about 60% of our ECLIA revenue. In long term we expect the revenue from ECLIA reagents will be at least half of our opening from ECLIA sales. Okay. But, in terms of instrument placements and the gains you are making on instrument placements, can you be a little more specific? Yeah, by the end of last year, we will have about 450 units of ECLIA systems sold. And, up to September end, we have totally about 900, 900 units of ECLIA, in accumulation, that is including our 450, sold last year. Okay, and the raw material cost in components that are going what perhaps should we think of those? What are they? Yeah, these just lie in place because, we keep deleting best cell quality raw materials which will increase slightly of course, but this is not significant, that is slightly increasing our overall cost. Another reason is the, sales mix because our gross margin for different kinds of reagents is different. So, this is another reason for the change of our gross margin. Okay. And also, I guess, you are still placing a large number of units probably more than, more than you had a year ago. Does that have an impact as well, the mix between reagents versus instruments? Yeah, particularly about sales mix, we have taken gross margin for HIFU and ECLIA and as well as the ECLIA reagents because we have over, now over 30 types reagent kits sold. It will affect the gross margin slightly but because they are lagging large differences in gross margin. So, it affects us slightly. Our gross margin for this quarter is 69.8. So, you see itâs just fine by about 1%. Hi good morning and congratulations on both the IPOâs as well as the quarter. I was wondering there are too many companies in the US that are growing, are US listed that are growing 20, 30 or even in their case between 40, to 80% year-over-year, but their price earnings are pretty multiple in the, anywhere from the 20 times range depending on what numbers you use. I was wondering whatâs your plan to actually get out to, meet investors over the next, two, three months, in terms of, and trying to get your story out there and, getting to meet the broader investor base? No. Actually, my question was, youâve a great story but it seems like the low multiples reflected on kind of a combination of using the new company and maybe not enough investors knowing your story. So, are you planning to go and meet investors either in Asia or US or Europe in the next quarter? Yes, we have no control on the life of multiples, but we need to have plans to pull more of our company or at least have more communication with the investor. In fact, after this earnings call, currently we are now in New York and we will have about one weeksâ time to meet our investors in the States to tell them more about us. So, we will have other communication as well to strengthen our communication with both existing and potential investors. Great, thank you. And, just in terms of follow-up, I donât know, maybe if you brought focus on the GE medical ownership of China Medical. Can you tell us when this relationship started and will it add in terms of, is there potential to do things together either with them entering into China or China Medical entering into US, for future business opportunities? The discussions between GE and the company started actually from 2001, and by the time of 2003, GE made a decision to invest into our company and before the IPO the held about 20% of the shares and now itâs diluted to about 14.6%. And thatâs a little bit of history. And for the co-operation right now GE is the supplier of the one of key components of the HIFU equipment. They supply the product ultrasound for us to use as imaging, targeting and location device, during the achievements of feeders. And also, they have at present been chosen to be our global distributor for HIFU system. Currently, they havenât exercised this option yet because; we havenât started the FDA process. Thatâs pretty much of the relations between the two companies. Hi, just a follow-up to that last question regarding GE. If this arrangement on the uterine fibroids expansion of the indication for your technology for European approval, if that arrangement with GE, would you be disclosing something like that? The current FDA and CE application is done by the company. By ourselves fully and we are not working with GE on those applications. Well, we mentioned the last company because we are aware that it is a very large medical equipment company announced its plans to start the FDA application in Europe and they are possibly going to start the FDA application. So, itâs a clear indication that many large companies are considering HIFU and its potentials. And at this time there are no further question in the queue, I would like to turn it over to Sam Tsang for closing remarks. Once again, thank you for joining us today. Please donât hesitate to contact us if you have any further questions. Have a good day. Bye. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234020 | Thank you very much and good afternoon everyone. Welcome to our conference call to review Q4 2005 results. Susan Lyne our president and CEO will speak about some of our recent initiatives and I will talk about our recent performance and our guidance for 2006. Our prepared remarks should take about 20 minutes and then I will open it up to your questions. Let me remind you if you prefer to listen in on the web you can go to marthastewart.com and go to the investor relations link and follow it to the web cast. An audio archive will be available on marthastewart.com later today and weâll leave it there for a couple of weeks so that you can access it at your convenience. Before turning the call over to Susan Iâll remind you that our statements that are made pursuant to the private securities litigation reform act of 1995 as amended. These statements do not guarantee our future performance and involve certain risks and uncertainties which are difficult to predict. Actual future results and trends may differ materially from what is forecast in forward looking statements, due to a variety of factors. No I will turn things over to Susan. Thank you Howard. Good afternoon everyone and thank you for joining us on our Q4 and year end 2005 earnings conference call. Iâve been looking forward to this call because we have strong results to report and because directionally I believe the company is in excellent shape. Our Q4 results outpaced expectations, with operating profit improvement in every segment. Revenue increased 40% to $84.5 million; OIDA (operating income before depreciation and amortization, and non-cash stock compensation) was $11.7 million ahead of our earlier guidance of $11 million, and $13.4 million better than last year. Revenue growth was seen across every segment but rose most sharply in our publishing business where ad pages at Martha Stewart Living were up a stellar 133% with ad revenue growing ahead of pages and consumer trends continuing to show strength. This trend is continued into 2006. We expect full year pages to increase another 35-40%. As Howard said, he will take you through the full financial results later in the call but Iâd like to turn now to 2006. Iâm going to take my section of the call then Iâll turn it back to Susan to walk through the guidance. In the 4th quarter, we continued to build on our recovery, with year over year improvements in every business segment. As Susan said, total revenue in the quarter increased 40% or $24 to $84.5 million while our EBITDA increased $13 million to $11.7 million, ahead of our guidance. Earnings per share excluding non-cash equity compensation was $.19 in the quarter, compared to an EPS loss, excluding non-cash equity compensation of $.03 in the prior year period. In publishing, advertising pages at Martha Stewart living increased 133% with advertising revenue increasing ahead of page growth. Circulation revenue in Martha Stewart Living also increased in the period. In broadcasting, our results included a full quarter of our Martha television show and six weeks of revenue and profit from the launch of our satellite radio channel. Our internet direct commerce segment reflects advertising revenue of $1.7 million relative to $200,000 in the prior year quarter. Given the high margin nature of advertising revenue and disciplined expense control, we were able to report our first profitable quarter. Corporate expenses increased largely due to higher year over year consulting and difficult comparisons with prior year. The quarter also included a non-cash charge of $4.1 million associated with divesting of shares covered by a warrant granted in connection with the airing of the final episode of the Apprentice Martha Stewart. To date, none of the shares covered by the warrant have been exercised. I would also like to clarify the potential share dilution related to the warrant. Of the 2.5 million shares covered by the warrant, all have a strike price of $12.59. Assuming full vesting, upon the exercise of the shares, Mark Burnett will need to provide the company a value of $31.5 million, either in cash or in stock. Therefore, the actual dilution based on the exercise of all shares is approximately $650,000, only 1% of our total shares outstanding. For the first quarter of 2006 we expect to report revenue of $60 million with an OIDA loss of $3-$3.5 million. Our operating loss is expected to be in the range of $8.5 million to $9 million. Factors contributing to the first quarter results within each segment are as follows: For publishing, first quarter revenues are expected to be approximately $35 million, while OIDA is expected to be approximately $1 million, an improvement of over $8 million, year over year. Revenue and operating results reflect higher advertising and circulation revenues at Martha Stewart Living, resulting from higher ad pages and subscription copies sold as well as the continued reduction in our losses in Everyday Food and principally to lower subscriber acquisition costs. The quarter will also include an investment of approximately $1.5 million in blueprint magazine. Broadcasting revenues are expected to be approximately $12 million, as we benefit from a full quarter of our new syndicated show and our new radio program on Sirius. OIDA for the first quarter will approximate $500,000. Full year guidance. For the full year we are forecasting revenues of $270-$280 million with OIDA in the range of $10-$12 million including a $5 million investment in Blueprint magazine and a $3 million investment in developing our internet business. We anticipate reporting growth in all business segments. Highlights for 2006 include strong growth in advertising pages and revenue in Martha Stewart Living magazine, the full year benefit of our satellite radio channel and the Martha show in our broadcasting segment, an increase in the minimum guarantees with K-Mart as well as the benefit of our TB Home program, partially offset by the development of our craft program. In our internet direct commerce segment, we anticipate reinvesting the incremental revenue and online advertising back into the business to allow the segment to break even in 2006. Corporate costs will also come down as we cycle through some of our unusual specialties. We anticipate CapEx of $7 million in 2006, just over half of which will be used in the development of our new web platform. Now let me turn it back over to Susan. Letâs get back to the priorities for 2006. We are committed to delivering free cash flow in â06 and weâre just as focused on laying the groundwork for long term sustainable growth. To do this, we will stay focused on ad revenue goals and on building the ratings for our syndicated television show. Our strategic focus is on three areas that we know can be primary drivers in the future. First, our internet business. Strong Q4 growth in our internet traffic and revenues along with user trends on the web in general, give us confidence that this segment can become a significant contributor in the future. Iâll address the specifics of this in a moment. Second, our demographic reach. The 25-45 year olds are big consumers of lifestyle information and an increasingly important target for advertisers. We will leverage our lifestyle expertise and our publishing infrastructure to tap this somewhat younger, aspirational audience. And third, new merchandising businesses. Smart licensing programs seeded now will support consistent and steady growth for many years to come. Weâre focused on categories where our brands carry equity, where we have the expertise to improve on existing products and where the market opportunity is great. Our KB home initiative is a terrific example of this. Itâs a long term, high margin business. The companyâs expertise in home style and our aspirational brand, together with the quality, value and innovation of KB Home. The first community of 655 Martha Stewart Homes in Raleigh, NC will open to the public on March 9th. Based on very strong initial consumer response, we recently concluded an agreement to expand the initiative nationwide. In the first phase of the new agreement, we will help design an additional 1,200 homes in and around Atlanta, Charlotte, Houston, Orlando and Daytona Beach. The contract also calls for MSLO to create a line of interior and exterior home products or design options in a range of categories, floor categories, lighting fixtures, bathroom fixtures, kitchen cabinets, hardware, window treatments, doors and closet organizers. These products, called Marthaâs choices, will be available exclusively in KB studios nationwide. To frame the economics of this business, of the 1,800 lots in communities that will be opened by year end, we anticipate closing on approximately 200 homes in â06 and receive a 6,500-8,500 per home, exclusive of Marthaâs Choices. We are not prizing Marthaâs Choices until license agreements for the products are completed. Weâre currently reviewing several other attractive locations for future development with KB Home including Las Vegas and Southern California, but the potential revenue of those weâve signed on for is in the range of $11-$15 million. And with all of our licensing deals, we have no inventory or capital costs. Our principal cost is our design staff and studios. Martha has taken a very active, hands-on role in this program, working with our design teams to create unique environments that will add significant value to the homes KB builds. We are providing stylistic input on elevations, floor plans, materials, creating new functionalities to open plan kitchen and pantries, laundry rooms and closets and applying classic design styles to fireplace mantels, moldings, cabinets and bookcases. We are working with KB Home suppliers to find superior options for home buyers throughout the houses from faucets and tiles to sinks and countertops. Nine model homes and three town home models in Raleigh also feature Martha Stewart signature furniture and paint. Last month we announced another new merchandising partnership that will expand our product offerings and distribution channels. This one is EK success and DPCR Golderamer to create, market and sell Martha Stewart craft products. The first line of products, which will be introduced late this year or early next year will be paper based craft and scrap booking merchandise. Iâm going out on a limb here and guessing that no one on this call is into scrap booking, but at over $3 billion in annual sales it is the fastest growing piece of the $30 billion market. Despite the sale of craft products at big boxes as well as thousands of independent stores, there still is no national brand in this category. We see that as a huge opportunity for our company and for our brand. This is the first licensing agreement that weâve struck that also includes equity in the venture. The value of which is tied to specific hurdles and itâs an excellent partnership. With EKâs successes, superior manufacturing capability and DPCRâs interest in the category, we are looking for additional ways to capitalize on our expertise and brand equity in this crafts arena. Since Martha returned to the company in March, we have fielded a vast array of business opportunities. While many offered tempting short term returns, weâve taken a disciplined approach to assessing new ventures, with an eye to building the company we want to be 5 or even 10 years from now. Martha Stewart home and Martha Stewart Craft are both high margin, long term businesses that offer a multitude of synergistic opportunities across MSLOâs other segments. Our internet business is a top priority for 2006. The most important trend being cited in this digital world is personalization; self-expression, community and video are all concepts that speak to our strengths. Our multimedia library and highly trafficked lifestyle categories are vast, complimentary and evergreen, and easy to slice and dice to accommodate user preferences. Our core community has a strong connection to our brand and we believe they would relish connecting with each other and sharing their own ideas. And with some simple applications we can allow users not to access creative ideas and templates but to act on them online. Given all of these factors along with the fact that women 40+ are among the fastest growing internet user group, we are well-positioned to make the internet a significant revenue drive. But to realize the revenue targets weâve set for â07 and â08, we need to make a strategic investment now. This will allow us to make much more of our content available online and to strengthen our internet team, especially in the ad sales area. It will buy us the software we need to improve our navigation and search functions and make how-to content with relevant video clips, and to strengthen the links to commercial sites where our products are sold. We will spend only where itâs wise and where feasible, weâll forge strategic partnerships to enable consumers to interact with our content in a unique way. A key component of this build out will compliment our initiative, offering digital templates for scrap booking and allowing users to manage their scrap booking projects on our site. We saw significant Q4 growth in our internet segment. 41% in unique users, 43% in page views, along with very strong ad revenue increases. As a result of that growth, we are forecasting a $3 million EBITDA profit in â06 for internet direct. By reinvesting that profit in the business and delivering break-even results in the segment, we expect to position the company for much greater returns going forward. Our internet growth in Q4 coincided with Marthaâs return to daily television. The Martha Show has created a halo effect on many of our businesses, reflected in increased newsstand sales, unique visitors to Marthastewart.com and corporate ad sales. Weâd initially forecast a modest profit for the show, but based on current ratings which have stabilized around 1.8, we are now forecasting a modest loss in the range of $1-$2 million. Martha has been picked up for a 2nd season and has already been cleared for â07, â08 in over 90% of the country, and last month received 6 Emmy Award nominations. As I mentioned earlier, we plan to turn our expertise in lifestyle publishing towards a new audience. I tend on these calls to focus on publishingâs revenue growth, which has clearly outpaced expectations this year. But its worth noting that our magazines have won every award of note this year, from ASMEâs design and general excellent award for Kids and Martha Stewart Living, to Adweekâs launch of the year for Everyday Food. In the spring this enormously talented team will introduce Blueprint, a new magazine aimed at a younger customer with a busy life. Expanding on Livingâs core areas of expertise, Blueprint will also cover fashion, beauty, fitness, travel, technology and culture. We anticipate investing $5 million in the new title in â06. The first test issue will go on sale in May with an initial rate base 250,000. Our research continues to tell us that demand for our companyâs expertise and products is very strong. And, that favorables for both the Martha Stewart brand and Martha herself are higher than ever. As weâve learned over the past few years, the loyalty of our customers is remarkable. Through even the most difficult times, our core customer base supported us, continuing to buy our magazines and products. Whatâs interesting to note, in retrospect, is that when Martha returned, other, including advertisers and perceptive partners, came back, too. We believe our goals for 2006 are ambitious as they should be, but obtainable. As always we will listen to consumers and we will continue to respond by providing the content and products they want in all the places they want to find them. Susan, on the internet strategyâ¦Martha Stewart Livingâs been down this road before and the outcome was not particularly a good one. Whatâs different this time and wouldnât it make sense, like youâve partnered in other businesses, to perhaps partner with somebody to really lever the internet opportunity. And then, Howard, can you just update us on the rate base current and outlook for the monthly magazine, the Living magazine. Let me start this by talking about whatâs really different about our strategy this time. Initially we had a commerce play on the internet. It was our catalog business primarily, with some content but it was complimentary content. What we realized was that we really are not experts enough in certain areas, assortment inventory, delivery, and really factored into how we are defining our partnership, commerce partnerships, going forward. They are licensing partnerships that are very high margin and that allow us to do what we do really well which is to design and conceive of products. This is a different play. This is a content play. As I said, we have phenomenal multimedia libraries. Print, video, audio ⦠and making that available and really tapping what is an increasingly robust advertising market for the internet, is what gives us confidence going forward. I think that when the company first got into the internet like a lot of people, it was not clear exactly where the business opportunities lay. Thatâs a lot clearer now. There is a model that is working very well, an advertising model. That does not mean we will not do some offerings for pay at a certain point, but our clear focus is on content, ad-driven, free content. Actually, let me just add one other thing because you had a second part of your question. We will partner where itâs appropriate. Our investment here is relatively small; weâre not talking about investing many tens of millions of dollars. As I said, this is a three million dollar investment this year and some capital investment as well. But still relatively small. And where it is more effective for us to partner than to build, we will do that. We will also partner build traffic. So, we are deep into those kinds of conversations and I think we have a very good strategy going forward. And to Susanâs point we already have traction with the Q4 ad revenue of $1.7 million relative to $200,000, prior year. On the rate base with Martha Stewart Living, we increased it with the January issue to 1.9 million from 1.8 million a year ago, so itâs about a 6% increase. On top of that, we increased rates about 5%. And, because of the strong ABC numbers, the strong circulation numbers, the on the upside. Howard could you just give us a little color on the cash in the quarter. It was actually a little lower than we expected. Closer to the $120 rangeâ¦is that largely a function of the payment from K-Mart? And then secondly, if you could just give us a little bit more color on Everyday product performance at K-Mart. You said it was down slightly. If you could just give a little more color on that in the quarter and what youâre thinking about for â06. Thanks. On the cash balance, we have the receivable from K-Mart of about $27 million. Thatâs due to us at the end of the month. And we get that check on time so that the end of February the cash balance will go up to about $120 million. Thereâs also some changes in working capital. In the whole business, revenue is up $24 million, so receivables go up about that amount. You have the TV show, you have circulation increases and we spoke about the merchandising increase. On the K-mart number, the year to date number, weâre up about 11.7% in comp store sales and last year weâre down about 4% in comp store sales. So the 4% is relatively good out performance to K-mart and the 11%, 11.7% is pretty strong year to date comp category performance. Great, thank you. Howard, you went through the number on publishing, advertising and circ performance, can you just clarify for me, what was segment advertising and circ up and what was MSL advertising and circ? My second question, Susan you mentioned the opportunity with the KB Homes. Is the margin at that business as you see it; is it much different than the 70% margin that you currently report at your merchandising segment? And then I have one last question, Iâll follow up. Iâll start while Howardâs getting those numbers for you. No, this is a very similar margin to our K-Mart business; I would say 70-75%. On the Martha Stewart Living, the ad revenue grew 160% and circ was up 12%, with both newsstand and subscriptions up a comparable amount. So that should give you a flavor for the rest of the business. Let me justâ¦I can tell you as a highlight how each business did or how each publication did. Each publication was up in total circulation revenue and in ad revenue. I donât have the actual percentages here but if you the Martha Stewart Living numbers I just gave you, you could come up with a rough approximation for each publication. But each one was up in sub and in ad revenue. Okay. And last question, the comment that you made on the K-mart performance, you gave â05. What was K-mart performance in Q4? Good morning guys. A couple of quick questions. First, given that youâre going to be cash flow positive this year in the cash balance you have and the lack of debt, Iâm wondering if the company is considering in any way, shape or form some type of recapitalization because right now obviously your cost of capital is your cost of equity, which definitely doesnât allow you to create leveraged equity returns as youâre going through this inflection point in all your core businesses. Iâm wondering if you could comment on whether there are any ideas on that front and on the part of management. Second, I was wondering if you would comment on whether the company is looking into other businesses on the television side, such as home shopping because it seems there would be a natural fit for the Martha Stewart brand and what you have going on there. And finally, if you could give us any update on the negotiations that youâre having with Sears. We think about this all the time and really we would be prepared to do that if there is a reason to do it. We are certainly looking at the optimum ways to use that cash for a period of time it was really a safety net for us. But I think if you look at the businesses weâre beginning to build right now, you can probably make some assumptions about the arenas of interest for the company going forward, if we were to make an acquisition. But we will only do that if something is really right where we feel like we can, by making an acquisition that we can make most businesses better. So nothing to report there right now. And in terms of home shopping, we look at all kinds of things. But again, I wouldnât comment on any particular area. And what was the first question? Nothing to report there. As weâve said before, we have a very strong K-Mart contract. Itâs good for our shareholders; itâs good for our company. If we were to be able to strike an agreement with Sears that was good for our shareholders, we would absolutely do that. But in the meantime, we are building our merchandising business very nicely in new channels and with new product lines. Great. And just one last question. I noticed a couple of weeks ago you name Jill Greenthal to your board of directors and obviously given his reputation as a banker, sheâs not there to do nothing. Iâm just curious as to what inspired that choice and if thereâs anything you can say related to that appointment. She was clearly just an excellent board candidate. Sheâs only been to one meeting thus far so I think itâs premature to talk about how she might be helping our company. But I will say that she is an excellent addition to our board. We have a very strong board now. I think we have a mix of competencies on that board that will allow us to get guidance as we build the company. Thank you and good morning. Just to go back to your original premise, I should say that youâre half wrong or half right, depending on where you are on the scrap booking. My wife is an avid scrap booker, so sheâs just waiting for it. That makes me happy. We went out with a very small team to Las Vegas to the craft show and put up a display, really without any products, just with our brand and with some of the how-to ideas weâve been publishing for years in that area, and the reaction was astounding. There was not a person who did not stop by the booth and say, whatever youâre selling, we want it. Whatever happened to the days of scotch tape? On the publishing side, can you talk about I guess the combined losses of everything under Martha Stewart Living and where you see that going in â06. And then, with Blueprint and Body & Soul youâre doing and I guess we have to put everyday food in there, and then also an acquisition, can you talk about your thoughts going forward? Whether youâre going to do more on the magazine side? Whether it will be a startup or an acquisition and there will be significant areas? You didnât highlight that. And then lastly, would you talk about the TV show as far as what you would have to see to have a renewal for â07? Let me start with the magazine piece of it. Iâll let Howard do the financial piece of it. But, I would just say that we have enormous expertise and enormous talent in our publishing area. We do see a real opportunity in a somewhat younger, busy lifestyle demographic. And, we are quite convinced that we can launch a title far more cost-effectively than buy a title. Youâre talking about a $5 million investment this year and probably a total investment to profitability of about $20 million. To buy a title that would get us to that point would be in the $100 million range. This is a very, very vibrant part of the magazine consumer universe. Thereâs a lot of ad dollars there. We talk a lot about what the next Martha Stewart Living will be in our portfolio. How we build a second magazine that will be a large contributor to our EBITDA. And this is one of those arenas that we believe has that potential, clearly. Not a niche magazine, but a mass magazine. And Dennis, let me walk you through the numbers. In â05, Body & Soul lost about $5 million, that loss is going to be cut in half in â06 and the newsletter is actually going to be profitable next year. Letâs talk about Blueprint, that $5 million investment. Again, that investmentâs coming down from almost $5 million in â05 to about half that in â06. And then Living and Weddings are going to be profitable. Let me talk about the show for a minute. What we do know about the show right now is that advertisers love it. We have had extremely satisfied advertisers on our show and I know that the local advertising market, the station markets has also had great success with advertisers. Itâs a very advertiser friendly show and it tends to attract an audience that does purchase. So, thatâs all to the good. The 1.8 number we are doing now is still the highest rating for a first year show, since Dr. Phil. Even Ellen was a 1.7 her first year. Itâs a comfort TV universe that Iâm sure you hear on all your media company calls. But our 1.8 is actually a fine number for most of our stations. And for a lot of our stations, we are doing significantly better numbers and theyâre thrilled. So we are very heartened about the longevity of our show right now. We are. Three of the larger cross-platform deals weâve done were GE, Buick and Motrin, have been very perceptual, the advertisers. I think our ability to create larger programs for them has actually made long-term, committed advertisers. There are no further questions at this time. Mr. Hochhauser I turn the floor back over to you and any closing remarks you may have at this time, Sir. This does conclude todayâs Martha Stewart Living Omnimedia teleconference. You may disconnect your lines at this time and have a wonderful day. Copyright policy: All transcripts on this site are copyright Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234021 | Hereâs the entire text of the prepared remarks from Comverse Technologyâs (ticker: CMVT) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. My name is Carol and I will be your conference facilitator today. At this time I would like to welcome everyone to the Comverse Technology Third Quarter 2005 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakersâ remarks there will be a question and answer session. Thank you. Now Iâd like to turn the call over to our host Mr. Paul Baker, Vice President of Corporate Marketing. Thank you, Carol. Hello, I am Paul Baker, Vice President, Corporate Marketing and Communications for Comverse Technology which is traded on NASDAQ, ticker symbol CMVT. With me on the call today are Kobi Alexander, our Chairman and CEO, and David Kreinberg, our Executive Vice President and Chief Financial Officer. Also joining us for the question and answer session will be Zeev Bregman, CEO of Comverse Network Systems Division. Before starting the call, Iâd like to mention that certain statements that are not historical are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. The words estimate, project, intend, expect, believe, and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risk and some uncertainties. Any of the number of factors could cause the actual results, performance or achievements of the Company to be materially different from those that maybe expressed or implied by such forward-looking information. These risks and uncertainties, as well as others, are discussed in greater detail in the filings of the Company with the Securities and Exchange Commission, including its most recent Annual Report on Form 10-K and subsequent Quarterly Reports on Form 10-Q. All documents are available through the SECâs Electronic Data Gathering Analysis and Retrieval system or EDGAR, at sec.gov or our website at cmvt.com. This call is the property of Comverse Technology Inc., any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Comverse Technology Inc., is strictly prohibited. Certain numbers and percentages have been rounded maybe approximation. The content of this conference call is time sensitive and reflect the Companyâs perspective as of December 06, 2005. By now, you all should have seen a copy of our press release which was issued after market closed this afternoon. If you have not received this release, please refer to businesswire.com or our website at cmvt.com. Please refer to our press release and website for reconciliation of our GAAP and pro forma net income discussed on this call. We undertake no obligation to update the content of this call even if events, circumstances or expectations change after this call. Any questions regarding our guidance and our business model should be addressed during this conference call, as we do not intend to address guidance and modulated increase following the call. Our guidance today, represents our best current estimate recognizing as always that forecasting beyond the immediate future is difficult. During todayâs call Kobi Alexander will present his perspective on our business and market trend, and David Kreinberg will present a more detailed review of our third quarter results and financial guidance. We will conclude with a question and answer session. Thank you, Paul. Hello everyone and thank you for joining us today for review for our fiscal 2005 third quarter ended October 31, 2005. Our third quarter revenue was $299 million, up 21.8% year-over-year and up 4.6% sequentially. Our pro forma earnings per diluted share was $0.17, and was $0.02 better than our guidance. Pro forma net income was up 113.6% year-over-year and up 21.8% sequentially. Pro forma operating margin was 10.2%, up 120 basis points sequentially. Our GAAP earnings were $0.18 per diluted share, and was $0.04 better than our guidance. GAAP net income was up 140% year-over-year and up 10% sequentially. Please refer to our press release for a fully consolidation of our GAAP and pro forma net income. Our Verint Systems unit contributed 26% of the Companyâs third quarter sales posting year-over-year sales growth of 22.3% and sequential growth of 4.7%. Ulticom contributed 4% of the Companyâs third quarter sales. Our Q3 orders backlog grew sequentially by $57.6 million to a record $646.2 million at October 31, up 9.8% sequentially and up 35.5% year-over-year. Looking ahead, we are increasing our pro forma revenue guidance for fiscal 2005 fourth quarter ending January 31, 2006 from $296 million to approximately $325 million. This guidance assumes we will close our acquisition of the GSS division of CSG Systems by mid-December. At $325 million, we would expect pro forma earnings per diluted share of approximately $0.18, up $0.02 from our previous guidance. We are also introducing preliminary guidance for fiscal year 2006 ending January 31, 2007. For Q1 ending April 30, 2006, we expect pro forma revenues of approximately $367 million and we expect sequential revenue growth of $12 million per quarter for the remainder of the fiscal year. We expect quarterly pro forma diluted earnings per share for fiscal 2006 as follows: for Q1 $0.19, for Q2 $0.20, for Q3 $0.21 and for Q4 $0.21. This results in fiscal 2006, full year pro forma revenue guidance of $1.5 billion and fiscal 2006 full year pro forma diluted earnings per share guidance of $0.81. Our Network System division sales were up 25.5% year-over-year, and were up 5.1% sequentially. This division's mission is to be the first choice of telecommunication service providers for solutions, which enhances the Total Communication experience. These solutions are designed to increase Average Revenue Per User or ARPU and the foster competitive differentiation and churn reduction for our approximately 400 communication service provider customers. We are leveraging this substantial customer base through a range of applications designed to deliver fast ROI and for the implementation of product upgrades designed to improve the functionality, utility, and cost of ownership of our installed base. Comverseâs systems provides an open services environment through which wireless and fixed network operators can offer a comprehensive suite of tightly integrated services including among others call answering, call completion, call management services, data, messaging and content delivery services, and real-time pre-paid, post-paid, and converged billing solutions. Our solutions are enabling an expanding area of popularity in emerging communication applications for wireless and fixed network operators. We have successfully leveraged our considerable installed base of call answering customers for the sale of additional enhanced services and the infrastructure that enables mobile data applications. Revenues from our next-generation messaging, data, content, and billing solutions were 69% of the Network Systems division sales. Our next generation InSight Open Services Environment continues to gain traction in both existing Comverse accounts and as a catalyst for competitive displacements and penetration of new accounts. We continue to advance our market position in multimedia messaging, in text messaging, and in the emerging wireless music applications arena with our Ringback Tone solution. We also continue to increase our presence in the billing space. Our pending acquisition of GSS is designed to further position us for long-term leadership in the overall billing market, and in particular in the emerging converged billing segment. We also continue to see customer activity in emerging next-gen services such as wireless video applications, visual voicemail and mobile instant messaging. We believe that the underlying long-term growth trend for telecommunication enhanced services usage is healthy and with over time, enhanced services will become more and more important in the generation of traffic and ARPU for network operators. Our customers indicate that value-added services will continue to expand in importance and gradually will contribute a much larger proportion of the revenues than they contribute today. We believe our heavy R&D investment, our vast installed base, and our cost-effective modular evolutionary approach to providing new applications and functionality to our customer positions us well for continued market leadership and to deliver on our mission to be the first choice of telecommunication service providers for solutions that enhance the total communication experience. Our Verint Systems subsidiary which as of October 31 was approximately 68% owned by Comverse Technology and is publicly traded under the ticker symbol VRNT represented 26% of the Companyâs sales during the third quarter. Verint sales were up 22.3% year-over-year and a 4.7% sequentially. Verint is a leading provider of analytic actionable intelligent solutions for communication interception, network video security, and business intelligence. Verint solutions power actionable intelligence by capturing structured and unstructured information from voice, video, and IP networks, applying advanced analytics to unearth critical intelligence, and delivering this intelligence to decision makers for effective action. Verintâs actionable intelligent solutions for security, which accounted for nearly 70% of Verint's third quarter sales, grew 4.3% sequentially and 29.9% year-over-year. Verintâs actionable intelligent solutions for business intelligence grew 5.7% sequentially and increased 8.1% year-over-year. Further more Verint achieved record levels of pro forma operating and net income. We believe the emphasis on security and the focus on anti-terrorism will present new opportunities for Verint. Verintâs communication interception products are sold to law enforcement and intelligence agencies around the world. These products enable the interception, recording, and analysis of communication over a wide variety of wireline, wireless, and IT networks to obtain actionable intelligence and for evidentiary purposes. Verint's network digital video security actionable intelligent product provides intelligent recording and analysis of captured video, primarily for security applications and are sold to government agencies in public and private organizations for using facilities such as airports, public buildings, critical infrastructure, correctional facilities, and corporate sites. Verint's business intelligence products consist primarily of multimedia monitoring and analytic tools used to generate actionable intelligence primarily in support of contact sensor customer relationship management efforts and video system to allow enterprises and institutions to improve operations, process, and performance, and for margin improvement through theft and fraud prevention. Verint is a leader in all its major markets serving over 1,000 organizations in over 50 countries. Our Ulticom subsidiary which as of October 31, was approximately 68% owned by Comverse Technology and is publicly traded under the ticker symbol ULCM generated 4% of company-wide sales, excluding sales to Comverseâs Network Systems division. Ulticom is a leading supplier of service enabling network-signaling software. This software is enabling technology for a variety of intelligence network-based communication services such as real-time billing solutions, and is also embedded in the architecture of several providers of next generation IP soft switching products. Overall, we have a leading position in our major markets, and we believe that in our major areas of operation, we have a competitive product offering, a strong new product and application development pipeline, and a large customer base into which these new products can be sold. And we have the financial strength and stability, including: at October 31, a record $2.3 billion in cash and short-term investments including record net cash of $1.8 billion. Thank you, Kobi. Sales for the three months ended October 31, 2005 ere $299 million, up 21.8% year-over-year and up 4.6% sequentially. Our pro forma earnings per diluted share was $0.17, and was $0.02 better than our guidance based on an average diluted share count of 216 million. Pro forma net income was up 113.6% year-over-year and up 21.8% sequentially. Our GAAP earnings was $0.18 per diluted share, and was $0.04 better than our guidance. GAAP net income was up 140% year-over-year and up 10% sequentially. Please refer to our press release for full reconciliation of our GAAP and pro forma net income. The Companyâs Network Systems DivisionsâQ3 sales were up 25.5% year-over-year, up 5.1% sequentially, and generated 69% of the Companyâs third quarter sales. CNS' pro forma operating margin was 9.6%, up 190 basis points sequentially. Trilog and AccessMP based systems, software, and services enabling call answering and related applications generated 31% of the Network Systems division sales. Next-generation messaging, data, and content solutions, and billing platforms contributed 69% of divisional revenues. Verintâs generated 26% of company-wide sales. Verintâs total sales were up 22.3% year-over-year in Q3 and were up 4.7% sequentially. Verint security activities represented nearly 70% of Verintâs quarterly sales and grew 29.9% year-over-year and 4.3% sequentially. Verintâs business intelligence sales grew 5.7% sequentially and grew 8.1% year-over-year. Looking at regional activity, sales percentage contributions were as follows: The Americas, 'mid 30s', Europe, 'high40s', and the remainder in Asia Pac and the rest of the world. Our orders backlog was a record $646.2 million, up $57.6 million or 9.8% sequentially, and up 35.5% year-over-year. Our pro forma operating results were as follows: gross margin for the quarter was 59.9% compared with Q2 60.2%. Our pro forma operating margins were up 120 basis points sequentially to 10.2%. Net Research and Development expenses were $65.6 million, and SG&A expenses were $83.1 million. Interest and other income, including minority interest and equity in affiliates was $13.5 million. Quarterly cash flow from operations was $33.8 million. Turning to our balance sheet, DSOs were 85 days. Advanced payments for customers were $119 million. Inventories were $131 million. The Company ended the quarter with record cash, cash equivalents, bank time deposits, and short-term investments of $2.3 billion, including record net cash of $1.8 billion and record working capital of $2.3 billion. On December 1, 2005 our outstanding $87.3 million of 1.5% convertible debentures matured and was repaid in full. As of October 31, 2005 we had record assets of $3.1 billion and record shareholders' equity of $1.9 billion. Our guidance today is presented within the context from geopolitical uncertainty and as such our ability to forecast with accuracy and confidence beyond the immediate future is difficult. We are increasing our pro forma revenue guidance for fiscal 2005âs fourth quarter ending January 31, from $296 million to approximately $325 million. This guidance assumes we will close our acquisition of the GSS division of CSG Systems by mid-December. At $325 million, we would expect pro forma earnings per diluted share of approximately $0.18 based on the diluted share count of approximately 216.5 million, up $0.02 from our previous guidance. We are also introducing preliminary guidance for fiscal year 2006 ending January 31, 2007. For Q1 in the April 20, 2006 we expect pro forma revenues of approximately $357 million and we expect sequential revenue growth of $12 million per quarter for the remainder of the fiscal year. Pro forma revenue guidance reflects the impact of the expected write down of deferred revenues associated with the our pending GSS acquisition. We expect quarterly pro forma diluted earnings per share for fiscal 2006 as follows: For Q1 $0.19, for Q2 $0.20, for Q3 $0.21, and for Q4 $0.21. Pro forma earnings per diluted share excludes the impact of purchase accounting adjustments related to the write-down of deferred revenue, amortization of intangibles, and other acquisition-related costs, as well as stock-based compensation charges and their minority interest and income tax effects. A very preliminary estimate of the our GAAP EPS would be $0.05 lower than pro forma in Q4 and $0.12 lower than pro forma in each quarter in fiscal 2006. We expect fourth quarter interest and other income including minority interest and equity in affiliates to be approximately $13 million and to average about $12 million per quarter throughout fiscal 2006. We expect our diluted average share count for fiscal 2006 to be approximately $217.5 million. To summarize our newly introduced full-year fiscal 2006 preliminary guidance yields expectations for fiscal 2006 pro forma revenues of $1.5 billion and fiscal 2006 full-year pro forma earnings per diluted share of $0.81. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234022 | Hereâs the entire text of the prepared remarks from KongZhongâs (ticker: KONG) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good day, everyone, and welcome to KongZhong's Third Quarter 2005 Earnings Results Conference Call. For the duration of the presentation, all lines will be placed in listen-only mode. A question and answer session will follow the main presentation. Operator Instructions And I would like to hand the call over to Mr. J.P. Gan, and I will be standing by for the Q&A session. Please go ahead. Thank you. Thank you, operator. Hi. I'm J.P. Gan, Chief Financial Officer of the Company. Welcome to KongZhong Corporation's third quarter 2005 earnings conference call. If you don't have the press release, please go to our website at ir.kongzhong.com for press release. We also have a presentation there. Thank you. Good evening and good morning. We are pleased to announce that we have exceeded our guidance by growing the Q3 revenue by 10% sequentially and 64% year-over-year, to reach a new record of $20.25 million. We're also proud to announce that we have been able to increase our revenues again for the thirteenth straight quarter since our inception. Our solid performance was the result of our broad and diversified product offerings and a focused execution. We believe we continue to hold the leadership position in the 2.5G services on China mobiles network. In the meantime, we have made a significant progress in diversifying our revenues generated from China Unicom, China Telecom and China Netcom. About 6% of our revenues came from these three operators in Q3, while there was only 2% in Q2. In terms of 2.5G services, we achieved 6% revenue growth in Q3 over Q2. We expect to see continuous 2.5G revenue growth in Q4, driven by the growth in MMS. We anticipate our MMS revenues to grow fast from the Q3 level, as the transition to the MMS MISC platform has been stabilized. We expect the transition to the MMS MISC platform for the remaining provinces to be smooth. We expect our Java revenues to be around about flat in Q4. After we have achieved around 35% Q-to-Q growth in Q3, we believe the Java game market in China is beginning to take off. In terms of 2G services, we achieved 22% revenue growth in Q3 over Q2. Our strategy in Q4 is to focus on the growth of 2.5G services, especially MMS services. Thus our revenue from 2G services may be flat or show a little growth over Q3. We also believe that there is still much growth potential left for the 2G services in the long run. In addition to revenue growth, we have started to make more effort to promote our free Kongzhong media lap portal. We will leverage our Kongzhong user base content, distribution channels and editorial teams to develop and promote this portal. We believe wireless Internet is now at a very early stage in China and it's very worth investing. So to summarize, we will continue to deploy our diversified growth strategies for different platforms and operators. Our major focus in Q4 will be the growth of MMS services. And as the leader in the 2.5G market in China, we believe we are in an ideal position to capture the market growth opportunity in the 2.5G and upcoming 3G services in the future. Thank you, Yunfan. I will go over some of the financial highlights. As Yunfan mentioned, we had a record-breaking quarter in terms of revenues. We grew our revenues 10% sequentially, to over $20 million. As discussed in the previous conference calls, our WAP did decline by 2%, which is much better than the previous quarter's decline of 4.6%. The decline in WAP is more than offset by our MMS and Java growth. Our 2G business continues to perform well, as it grew by 22% sequentially to $5.87 million. We have grown our revenues from China Unicom, China Telecom and China Netcom. Revenues from these three operators in the third quarter was $1.2 million versus $346,000 in Q2. The changes in revenue mix had some negative impact on our gross margin, which declined to 60%. I will agree that our gross margin decline was because we paid higher transmissions charges to mobile operators for using their channels and networks to mainly promote our Java Games and gain market share. Net transmission charges paid to the operators increased by $644,000, or a little over 56% from the second quarter of 2005. This is roughly 3% of our gross revenues. During the third quarter, we made a $3.5 million one-time non-recurring provision related to the pending settlement of the class action lawsuit. We announced that we have entered into an MOU with the plaintiff on September 14. We are now in the final negotiation stage for definitive agreement to hopefully settle the lawsuit. The settlement will also be subject to court approval. The one-time provision and the $129,000 in legal expenses related to the class action lawsuit represents approximately 18% of our total revenues in the quarter and about $0.10 diluted earnings per ADS. Excluding the $3.6 million in expenses related to the class action lawsuit in the third quarter, and $326,000 in legal expenses in Q2, our operating spend increased by 7% from the second quarter. It is in line with our revenue growth. Our net income in the quarter was $3.4 million and the diluted EPS was about $0.10. If we had not incurred the class action lawsuit related expenses of $3.6 million, our net income would have been a little over $7 million and our diluted earnings per ADS would have been $0.198. Finally, our cash flow was extremely strong in the third quarter. We generated over $10 million in operating cash flow, mostly due to favorable change in net working capital. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234023 | Good morning and welcome to the Kellogg Company 2005 Third Quarter Earnings Call. This call is being recorded. All lines have been placed on mute to prevent background noise. After the speakerâs remarks there will be a question and answer period. If you would like to ask a question during this time, simply press * and the number 1 on your telephone keypad. If you would like to withdraw your question, please press the # key. Also, please limit yourself to one question during the Q&A session. Thank you. At this time I would like to turn the conference over to Mr. Simon Burton, Kellogg Company Director of Investor Relations. Mr. Burton you may begin your conference. Good morning everyone. Thanks for joining us for a review of our third quarter results and for some discussion regarding our strategy and outlook. With me here in Battle Creek are Jim Jenness, our chairman and CEO, David Mackay, president and COO; Jeff Boromisa, CFO; and Gary Pilnick, general counsel. We must point out that certain statements made today, such as projections for Kellogg Companyâs future performance, including earnings per share, net sales, margin, brand building, operating profit, innovation, costs, interest expense, tax rate, cash flow, working capital, share repurchases, and debt reduction are forward-looking statements. Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, please refer to the second slide of this presentation, as well as to our public SEC filings. A replay of todayâs conference call will be available by âphone through Thursday evening, by dialing 888-203-1112 in the U.S. and 719-457-0820 from international locations; the passcode for both numbers is #3783244. The call will also be available via webcast, which will be archived for 90 days. Now let me turn it over to Jim Jenness, chairman and chief executive officer. Thank you, Simon, and good morning, everyone. We are pleased to report our third quarter and year-to-date results. As we anticipated, our strong business momentum and excellent execution continued in the third quarter⦠and as we discussed last quarter, we took advantage of this performance and dramatically increased our investment in future growth. Reported net sales growth was 7.3%, which built on the very strong 7.2% growth we posted in the third quarter of last year. Internal net sales growth, which excludes the impact of foreign exchange, acquisitions, and divestitures, was 6.6 percent. This was growth on growth, as internal growth in last yearâs third quarter was an impressive 4.8 percent. Our goal remains sustainable growth, and we can achieve this only by continued reinvestment. In fact, we again made significant investment in future margin improvement through both brand building and cost-reduction projects in the third quarter⦠and as always, the up-front costs are embedded right in our earnings. We intend to increase our investment in brand building again in the final quarter of the year to drive sustainability. However, despite this increase, our continued momentum gives us the confidence to raise our earnings guidance for the year to a range between $2.32 and $2.34 per share. We have realistic targets and clear operating principles that guide how we run our business every day. Our goals havenât changed and we intend to make significant investment in future growth in 2006, as we remain committed to our long-term strategy of growing cereal, expanding snacks, and pursuing selected growth opportunities. Net sales increased by 7% due to strong sales growth and a contribution from foreign currency exchange of less than 1 percent. Internal sales growth, which excludes the effect of foreign exchange, was also nearly 7 percent. Operating profit increased by 2%, and internal growth was 1 percent. This growth was generated despite a significant, double-digit increase in brand-building investment. Up-front costs related to cost-reduction initiatives were approximately 4¢ a share. Our year-to-date operating profit growth is 7 percent; year-to-date internal operating profit growth is 6%, right in line with our long-term target of mid single-digit growth. Earnings per share increased by 12% due to operating income growth, lower interest expense, and a lower tax rate and year-to-date cash flow of $915 million exceeded last yearâs total of $860 million. Letâs look at each of these results in more detail. Slide 5 shows the components of the third quarterâs sales growth. Reported sales growth was 7.3%; internal sales growth was 6.6% driven by gains in price, mix and tonnage. Keep in mind that this growth adds to very strong internal growth of 4.8% posted in the third quarter of last year. In addition, growth was balanced and both mix and price contributed. Youâll remember that, at the end of the second quarter, we indicated that we intended to make significant investment in brand building in the second half of the year. Well, slide six details this growth for the third quarter and the progress weâve made year-to-date. While we havenât changed our long-term strategy to increase investment in brand building at a rate greater than sales growth, we far exceeded it in the third quarter. We had the ideas. We had strong innovation around the world. And we took advantage of our current business momentum and strong results. In fact, brand-building investment, which includes advertising and consumer promotion, but not trade spending, increased at strong double-digit rate in the third quarter. We recognise that this investment, not spending on trade, is the way to build brands and support innovation. And of course, we are committed to continuing this strategy in the fourth quarter of 2005 and in 2006, we expect to again increase our investment in brand building at a rate greater than sales growth. In a moment, David will review each of our businesses in more detail. But first, let me turn it over to Jeff Boromisa, who will walk you through our financial results. Thanks, Jim. Good morning. Gross profit margin decreased by 90 basis points to 45.2% during the third quarter⦠but note that, year-to-date, our gross profit margin has expanded by 30 basis points, slightly less than our long-term target of 50 basis points a year. Much of the decrease in the third quarter resulted from absorbing all of the 4¢ of up-front costs in COGS. This was more than 1¢ greater than in the third quarter of last year. We also faced competitive conditions in a couple of our businesses, which impacted our gross margin. In addition, we were also affected by the same higher energy, fuel, and benefit costs faced by much of the industry. However, due to our cost saving initiatives, we were able to offset these increases during the quarter. Now letâs turn to operating profit growth by business. Slide 8 shows the growth in internal operating profit in each of our geographic reporting areas in the third quarter; this growth excludes the impact of currency translation. In North America, internal operating profit growth was 2.2 percent. This was mostly a result of a very significant, double-digit increase in investment in brand building. In Europe, operating profit growth declined by 10.3 percent due to increased competitive activity and continued investment in brand building. This investment has also increased at a double-digit rate so far this year. And in Asia/Pacific we posted internal operating profit growth of 7.9 percent. While brand-building investment decreased in the quarter due to the timing of programs, for the year-to-date period, brand-building investment has increased at a double-digit rate. This quarterâs growth was strong and we invested heavily in the business. Remember, too, that total up-front costs in the quarter added to approximately 4¢ per share. Interest expense in the third quarter was lower than last year, partially as a result of the retirement of debt earlier in the year. The tax rate in the third quarter was 30%; the year-to-date tax rate of 31.7% is broadly in-line with our new expectation for the full-year rate to be approximately 32 percent. The lower tax rate was attributable to several discrete items which were recorded during the third quarter. In 2006, we expect full-year interest expense to be slightly lower than this yearâs level and we expect the full-year tax rate to be between 31 and 32 percent. Slide 9 shows the excellent improvement weâve made over the years in core working capital measured as a percentage of sales. Getting to this industry-leading level has been a significant driver of cash flow over the years and we are very pleased with this performance. Letâs now turn to slide 10 and a discussion of cash flow. Year-to-date cash flow through the third quarter was 915 million dollars versus 860 million dollars in 2004. The increase was a result of strong earnings growth and a year-over-year reduction in benefit plan contributions. This is very strong year-to-date performance and we continue to expect that we will meet full-year guidance for cash flow between $950 million and $1.025 billion in 2005; this does not take into account the impact of additional benefit plan contributions that are planned for the fourth quarter; these contributions will reduce cash flow by up to $240 million. Separately, the Board of Directors has increased 2005âs share repurchase authorization to $675 million. This increase will allow us to repurchase approximately $400 million more of our shares by the end of the year; we had repurchased approximately $260 million of our stock through the end of the third quarter. Turning now to slide 11 and our debt level in recent years; year-to-date, we have reduced debt by approximately $450 million. While debt will increase over the next few months, primarily as a result of share repurchases and benefit plan contributions, we remain committed to the continued long-term repayment of net debt, or reducing total debt less cash. Slide twelve shows our return on invested capital over the past four years. We are very pleased with this progress, as focus on return is very important to us. It is an integral part of our broader operating principles and we are confident that we are concentrated on the right drivers of ROIC. Now, letâs turn to slide thirteen and our financial outlook for the remainder of the year. Slide 13 shows our outlook for the full-year 2005. The financial flexibility we saw at the end of the first half allowed us to invest more heavily in brand building and innovation in the third quarter and we will continue this in the fourth quarter; this is what drives sustainability. In addition, we expect the business momentum that weâve seen through the first three quarters to continue and expect mid single-digit internal sales growth in the fourth quarter⦠which is higher than our long-term target. As Jim mentioned, we continued to execute cost-reduction projects in the third quarter that we expect to complete in 2006. Almost all of the costs that weâve absorbed thus far this year, and that weâve identified for next year, are associated with the closure of two snacks bakeries. We still expect these costs to total approximately 15¢ for the full year, or approximately 3¢ in the fourth quarter. And as we discussed in last quarterâs conference call, we dramatically increased the amount of investment in brand building and future growth in the third quarter and you should be anticipating a significant increased investment in the fourth quarter, as well as possible investment in financial and operational initiatives. As you all know, the price of fuel, energy, and energy related supply costs continue to increase or remain high. To put it into perspective, we anticipate that fuel and energy costs for the full year will be an incremental 12-13¢. We have seen some commodity deflation, but it was our focus on cost-reduction initiatives that offset most of this unexpectedly large fuel and energy cost inflation. In addition, we continue to expect that increased benefit and healthcare costs will negatively affect EPS by approximately 6¢ for the full year. There is no doubt that our focus on sustainable, consistent performance, and the significant investment weâve made, has allowed us to weather these headwinds relatively well and despite these headwinds, we do still anticipate that we will post mid single-digit operating profit growth in 2005, right in-line with our long-term target. And we also feel comfortable raising our earnings guidance to a range between $2.32 and $2.34 per share. Now letâs turn to slide 14 and a first look at 2006. We expect low single-digit internal net sales growth in 2006, which is right in line with our long-term target and we expect to meet this target despite the very difficult comparisons set throughout 2005. Our suppliers and fuel and freight providers continue to voice inflationary concerns. However, our long-term target is for an annual improvement in gross margin of 50 basis points and we expect to achieve this goal again in 2006 and, we expect to do this despite our projections for increased energy, fuel, and commodity costs. Itâs early and prices have been volatile, but we currently expect these costs to adversely affect EPS by approximately 13¢ to 16¢ for the year. We will be able to give you more clarity about this at the end of the year, but we will work to offset these increases, much as we have in 2005. We also expect that benefit costs will have an additional 3-7¢ negative effect on earnings. This is a significant cost impact after recent commodity inflation. Fortunately, our topline growth and strong execution have positioned us well to absorb the large cost increases and still deliver our goal of high single-digit earnings growth. Much like in previous years, we will also continue to reinvest in future growth and we have currently identified cost-reduction projects of 5-6¢ per share. As always, we are constantly evaluating new cost-saving projects and, as we highlighted at CAGNY, opportunities for investment in future growth, which will require start-up cost absorption. Consequently, we expect to identify, and execute, more of these projects during the balance of 2006 and we expect the total investment to be approximately equal to 2005âs level; as always, the total funding for these investments is included in our earnings guidance. Despite this investment, and significant cost pressures, we anticipate that operating leverage, productivity savings, and mix improvement will allow us to meet our long-term target of mid single-digit operating profit growth in 2006. As you know, weâve posted tonnage growth for a number of quarters, due largely to the success of our innovation and brand-building programs. Weâve had tremendous success with many new products, but have also seen many of our existing products increasing in popularity as well. Consequently, we have decided that we will add capacity to help us better meet this increasing demand this is a very high return use of our cash and, consequently, we expect that cash flow for 2006 will be in a range between $875 and $975 million and that cap ex will be approximately 4% of sales. We have continued to reduce debt and expect that interest expense will again decrease next year. In addition, we expect to have a sustainable tax rate of between 31 and 32 percent. Slightly lower interest expense, and fewer shares outstanding, should lead to high single-digit earnings per share growth; also right in-line with our long-term targets. Remember, though, we havenât included the effect of expensing options in 2006âs guidance; we anticipate this will have an EPS effect of approximately 8 cents. We are very pleased we can provide an outlook that is again right in line with our long-term targets. Even with the difficult cost environment, we continue to believe that our realistic targets focus our entire organization on the right metrics. With that, let me turn it over to David. Thanks, Jeff. Letâs now take a look at our results by business segment. Slide fifteen shows the quarterly break-down of internal growth posted by each of our North American businesses. We are very pleased with these results, and they are particularly impressive given the strong growth posted by the Retail Snacks and Frozen and Specialty Channels businesses in 2004. Now, letâs look at the North American businesses in more detail. Strong sales growth in our North American Retail Cereal business continued in the third quarter and we had excellent base sales growth. Internal sales growth of 11% added to last quarterâs growth of 10% and built on a 1% comp last year. And remember, too, that 2004âs results built on a 10% comp, so three-year growth has been impressive as well. This strong performance puts our quarterly share, through the end of September, at 33.9%, up 0.8 from the same period last year. Growth in the U.S. during the third quarter was broad-based across brands and we saw excellent growth from new brands such as Smart Start, two new flavours of Crunch and Special K Fruit and Yogurt⦠and we also saw good growth from existing brands such as Mini Wheats and Kashi. In fact, Kashi brands GoLean Crunch, Organic Promise Autumn Wheat, Heart to Heart, and Kashi 7 Whole Grain Flakes all grew at a double-digit rate in the quarter. The Canadian business also posted excellent growth on strong innovation launched in 2005, such as Special K Vanilla Almond, Extra, Tonyâs Turbos, and All-Bran Strawberry Bites, which added to our already strong All-Bran franchise. These products, combined with strong retail programs and effective brand-building investment led to double-digit growth on a difficult mid single-digit comp. As we mentioned, we increased our investment in brand building throughout the company and North America was no exception. Total brand-building investment in the third quarter increased at a high rate behind many of the brands I just mentioned including Crunch, Smart Start, Special K, and Mini-Wheats. And, as we detailed in our presentation at the Prudential conference in September, we have a significant amount of both brand-building investment and innovation planned for 2006, some examples of which are pictured on the slide. Slide 17 details the very strong growth posted by our North American Retail Snacks business in the third quarter. The quarterâs 6% growth built on a very difficult comp of 9% in the third quarter of last year. In fact, weâve posted strong broad-based growth across these categories over the past two years. While certain categories are stronger than others at times, we are very pleased with this history of good results and are committed to continuing our success in the future. Slide 18 details the results posted by each category in the third quarter. Our Pop-Tarts toaster pastries business continues to be strong. In fact, we currently have 85% category share and we have increased this share by about 1.5% so far this year. The lower sales posted in this quarter simply reflects the timing of programs and the strong double-digit growth posted in the third quarter of last year. Innovation has been strong this year and we have more planned for 2006. We saw strong growth in the crackers business in the third quarter. This was driven by strength in the base businesses such as Cheez-It, Townhouse, and Club and by strong innovation such as Cheez-It Fiesta and Club Sticks. Our cookie sales decreased in the quarter as the early positive effect of innovation such as Chips Deluxe Right Bites and Gripz, and Fudge Shoppe filled cookies in two varieties, was offset by the effect of the discontinuation of various products including two flavors of low-carb cookies. It is worth noting, though, that our three largest brands, Chips Deluxe, Fudge Shoppe, and Sandies, which account for approximately two-thirds of our cookie sales, all posted strong gross sales growth. So, we saw better results where we are focused and we are effectively managing ongoing SKU rationalizations. The wholesome snack business was again very strong in the third quarter. New products such as Special K bars and All-Bran bars continued to post very strong, double-digit growth, and even existing products such as Rice Krispies Treats and fruit snacks added to the strong results. Itâs interesting that, while Rice Krispies Treats benefited from the recent introduction of Split Stix, the base business is posting good growth as a result of the strong execution of our DSD system. In Canada, high single-digit sales growth was driven by the introduction of Froot Loops Winders, the Raisin Bran bar that we introduced earlier this year, and the two varieties of All-Bran bars that we introduced last year So, we remain very pleased with our snacks business and the excellent results posted over the last two years. Slide 19 shows that the Frozen and Specialty Channels business posted internal sales growth of 8% in the third quarter. This resulted from strong growth from Eggo, Morningstar Farms, and the Specialty Channels business. Eggo posted strong double-digit sales growth as a result of strength in both base sales and good innovation. Toaster Swirlz and an expansion of our pancakes line are both doing well in the market and we have new innovation coming in the first quarter of 2006. Morningstar Farms posted mid single-digit growth as a result of strong brand-building programs and category expanding innovation. The Meal Starters products we launched last quarter are doing well, and we have a lot of innovation planned for Morningstar Farms, too, including vegetable snack bites in two varieties, which will be out in the first quarter of 2006. Our Specialty Channels businesses also did well in the quarter. This group of businesses continues to execute very well and achieved great results despite a difficult mid single-digit comparison. Slide 20 shows the reported and internal sales growth posted by Kellogg International in the third quarter. Reported sales growth was 4 percent. Internal growth, excluding FX, was 3 percent. You will notice that the strengthening U.S. dollar has significantly narrowed the spread between reported and FX adjusted growth. Now, letâs take a look at the results by geographic area. Slide 21 details the internal net sales growth posted by each of our international areas in the third quarter. Europe posted internal sales growth of more than 1% driven by gains in both cereal and snacks. While we have resolved the issue with the retailer we referenced last quarter, we continued to see an effect as we work to return to normalized levels of distribution and promotional activity; this continued effect decreased sales growth across Europe by approximately 1% in the quarter. We gained almost a point of cereal share in the U.K. during the quarter and this came primarily from innovation and brand building. Special K Purple Berries, Coco Pops Rocks, and Crunchy Nut Nutty all contributed to the share gain. The U.K. continues to be a highly competitive market with significant promotional and buy-one-get-one-free activity. In addition, we saw good growth in various other countries across Europe including Italy, the Benelux region, and most others⦠France posted strong growth as a result of excellent innovation and brand-building programs. These recently introduced new products, and additional programs planned for the fourth quarter, give us confidence about our business across Europe for the remainder of this year. Latin America posted internal sales growth of 10% on high single-digit cereal growth and double-digit snacks growth. In Mexico, the regionâs largest business, we launched a new variety of Extra, new varieties of Choco Krispies and Froot Loops, and a Cartoon network-themed cereal. We invested in brand-building programs for Choco Krispies and Special K with good results. In snacks, we launched Special K Chocolate bars and new Nutri-Grain bar flavors launched in Q2 are doing well. We have new innovation planned for the fourth quarter including snacks and cereals such All-Bran Yoghurt and Kelloggâs Go!... And we have just launched a new Amaranth Bar under a new brand, Nutri DÃa, in two flavors in Mexico. The Caribbean, Argentina, Brazil, Venezuela, and Columbia all posted very strong growth in the quarter and in Columbia, we launched All-Bran Flakes with good results. The Asia Pacific region also posted 1% internal sales growth. A good innovation program drove the recovery of the cereal business in Australia. New products which shipped during the quarter include Be Natural brand Muesli in three flavors, Crunchy Nut Clusters, Just Right Tropical and a new variety of Guardian. The snacks business declined due to the timing of innovation and very difficult, double-digit comps. In Asia we saw a slight decline in sales in a competitive environment. Japanâs sales declined, but we did see growth from innovation in Japan with Cocoa Flakes, Genmai Sesame, Frosties Plus, and Special K. And we will begin to support Special K with brand-building programs shortly. And in Korea, after a difficult year last year, a health-oriented advertising campaign and good brand building added to the sales growth of various brands including Black Bean Flakes and Frosties. We remain encouraged by our performance in Asia Pacific and have good innovation in the markets, although, we would caution you that we face a relatively difficult comp in the fourth quarter driven by growth in Australia last year. Our strong topline growth, driven by innovation and aggressive brand building, has helped us absorb the significant upturn in energy and fuel related costs faced by most manufacturers. This momentum has given us the flexibility to absorb these costs and continue our approach of focusing on the generation of sustainable growth in the future. Now Iâll turn it back to Jim In summary, we are pleased to report another quarter of strong results. We are confident that 2005 will be another year of sustainable growth performance where we deliver against our long-term targets, build positive momentum, and invest in our business for sustainability, despite the significant pressures facing us and the industry. More than ever, as we look to 2006, our confidence in our sustainable business model is strong. We remain committed to running the business with realistic goals in-line with our long-term targets of low single-digit sales growth, mid single-digit operating profit growth, and high single-digit earnings growth. We have a focused business strategy and Volume to Value and Manage for Cash operating principles that drive the right behavior. And we will continue to make significant investments in future growth. We will continue to increase our investment in brand building at rate faster than sales growth. We will continue to drive mix improvement through value-added innovation. We will continue to find cost-saving investment initiatives. And we will continue to pursue selected growth opportunities that are sources of possible, incremental revenue growth. We recognize that we have to improve. Our success wouldnât be possible without the dedication of our employees around the world, and their ability to execute. And with that, Iâd like to open it up for questions. Thank you. Once again, if you would like to ask a question please do so by pressing the * key followed by the digit 1 on your touch tone telephone. Also, if you are using a speaker phone please make sure your mute function is off to allow your signal to reach our equipment. Once again please press *1 to ask a question. Additionally, please limit yourself to one question. Our first question comes from Christine McCracken with FTN Midwest. Clearly you are no exception â fuel and energy are a big deal and it looks like it will continue to be a big deal. But I am a bit surprised with the guidance given some of the other levers that you've had to pull. I am wondering if you are expecting to be able to pass any of this along. Clearly you can't comment on price increases, but are you seeing any reluctance on the part of retailers to increase prices or maybe you can just comment on your ability to pass through some of these cost pressures. First of all, as you know, we just can't comment on pricing, but I would like to take you back to your question on our guidance. For 2005, at the high end of our guidance there at $2.34, itâs right in line with what we have been basically saying we were going to deliver. And within that, please keep in mind the very strong increase in brand building that we have in place and have been executing against, which is really an investment for us in the future to help our sustainability. Within that, we are also absorbing significant energy and fuel costs which really came and started to hit more in the second half of the year. So we see this and the guidance we are giving as really a confidence-builder for us in our model, how we go about doing it, and that sustainability and what we have been on for the last four years is exactly the right focus ultimately to deliver value to our shareholders over time. Okay. But with the lower tax rate you are expecting lower interest expense, some of, I guess, these positive factors that you have working for you next year. Is it more about the pricing? Have you not been able to pass that through at this point? Christine, I want to make one comment and then I'm going to turn it over to Jeff. Keep in mind that our guidance for 2005 here, the $2.34, recall last year we had an extra week. So if you just try to normalize it and go to the high end of our guidance, that $2.34 without the extra week really gives us some strong performance. Yes, and Christine, for next year what we kind of pointed out, is that we are seeing additional costs for next year in the commodity arena. Probably 2/3 of that is related more to fuel and energy, but that's about a $0.13 to $0.16 on-cost or headwind for us next year. And benefits still remain to be high, benefit costs for us. And looking at where discount rates are and inflation on health care, that's driving up our costs another $0.03 to $0.07 on top of this year. So there's $0.16 to $0.23 of headwinds. Considering that we are right on track with our long-term guidance is really evidence that this model of sustainability is working. We are able to offset a lot of that because of our cost-savings initiatives we have been executing over the years. The other fact is we have also allowed in our guidance for next year the continuation of reinvesting in these cost savings projects. So that $0.15 that we did this year is very similar to next year's thinking, although we haven't identified all of the projects and we are currently working through our list of evaluation of them. But we feel good about the guidance. It is exactly what we have been saying the last four years. I am just trying to get my hands around these comments about brand building. I mean, on the one hand I see that SG&A over revenues was unchanged year-on-year, so what happened? Maybe G&A was down and brand building was up? But can you just comment on that because the numbers I am looking at seem to indicate that as a percentage of sales brand building was flat. And if you can just explain there. I think most of that goes on the SG&A line except for the inserts that go on the cost of sales line. But please expand on that. I am just trying to understand. And also related to brand building, how much of that would you say is discretionary, and how much is more the market forcing you to spend more on advertising. Some other companies may opt to be more aggressive on pricing. You have a different strategy but that means you have to spend more on advertising. So it's not that we should give you kudos for spending more on brand building and investing for the long term as it's just what the market is demanding you do given your strategy. I will take the first part of your question. When you look at SG&A, we have a continual focus here on optimizing our overhead area. And as you remember, last year we had a couple large cost savings projects to help on that line item. Those types of savings in our overhead area through SAP implementation, through the restructuring that we did in Europe are basically funding a lot our brand building and that's what we look to do going in the future. On discretionary spending, it is discretionary. Itâs brand building; it is not price-based. So we are talking about support behind innovation. We are talking about incremental advertising either new campaigns, new ideas that we are talking to consumers about it. We are talking about value-added promotions as far as inserts and on-packs. We are not talking about price-based activity. So it isn't driven by so much a competitive demand which typically reflects itself in tactical activity. It is very strategic in nature. We said in the second quarter given the strength of the business, we had a lot of innovation in Q3 and a lot of opportunities to increase our brand building. We took that opportunity, which we believe is absolutely right, to drive our brands to grow our top-line growth, which I think is reflected in the third quarter. And we want to continue doing that forward because in our view it is working. Great. If you can expand on those two markets. You mentioned you were facing more competitive pressures than expected, I assume one of them was Europe? One of them was the UK in particular, where there was a lot of buy-one-get-one activity, a lot of tactical activity going on. Which I can also tell you does appear to have calmed down a little bit although it is always relatively aggressive there. And that was probably the key market. I mean all the markets in which we compete around the world are competitive by nature, especially the larger ones but that's ongoing. Jeff so you are saying $0.05 to $0.06 in charges for '06 but most likely to be increased by $0.15 and pretty similar to what you did in '05 the way you gave guidance. But as you increase those charges does that mean that your GAAP guidance would change or you would just absorb the higher $0.10 in charges? Yes. We have identified $0.05 to $0.06 going into next year. We have included in our guidance the assumption of using the full $0.15. I would just like to expand on our confidence in our business model, that included in our guidance is not only the $0.15 of similar upfront cost activity that we had last year included in the guidance of '06, but also brand building at a rate greater than our sales growth. And we are absorbing that into the business. So we see the funding of this as real positive. I believe you mentioned earlier that you are expecting capital expenditures for '06 of 4 % of sales. What do you anticipate it being for '05? Right now year-to-date we are about 2.8%, slightly below the 3% target. We do see that increasing in the fourth quarter. We will probably be closer to 3.5% by the end of the year. And for next year, our guidance is, really due to capacity constraints that we have across the businesses across lots of our different businesses, to increase that to 4%. But it's really driven from a capacity standpoint. I wanted to check and see if you could expound a little bit on your strategy for free cash flow use. You are obviously increasing your share repurchase authorization both for this year and then looking into next year. Also, I guess you said that in the short term, debt is going to increase partly as a function of the share repurchase activity. Can you tell me, going forward, what your priorities for free cash flow are going to be? If you expect debt to continue to decline in 2006? And how that may jibe with your strategy for improving your credit rating. At the end of the second quarter, as we talked a little bit on the conference call, that we were going through this process of evaluating the different alternatives of our cash flow, and there's certainly the share repurchase and increasing that is part of that result. We think that that's certainly a great avenue for our cash flow. The other one is we are doing some benefit funding here in the fourth quarter, which helps us for next year. And when we talk about the $0.03 to $0.07 of benefit increase next year, thatâs with the assumption of doing this funding â so you can see how big those cost increases are. The other important avenue, when we look at cash flow, is having available debt capacity for the Company. That if there is an acquisition that comes up that is makes a lot of sense and is a good fit for the Company, that we can transact that without any problem. So that's the other third part that we looked at. So going forward, certainly in the short-term, debt will certainly not go down in the fourth quarter. We do see it stabilizing essentially where it is at the end of this year for next year, but our long-term commitment is to continue to look at reducing debt, look at net debt which is debt less cash, and try to bring that down over the long term. Just on the cereal category, one question I guess with two parts. Could you give us the category growth that you saw in the quarter? And also, it looks as though there is some suggestion that maybe private label is taking their price up a little bit. If you could talk a little bit about the pricing environment in U.S. cereal as well. Sure. The IRI data said the category was down 0.2. When you reflect non-measured channels, we believe the category grew between 2 and 3% for the quarter. And on your question specifically regarding private label, it does appear in the third quarter that their average price per pound is up about 1.5%. And it was down through the first half. That's in the IRI data. Okay. And if you could give us a breakdown, if you would, David, on the volume price on that 11% sales increase in North American cereal. If you look at the IRI data for Kellogg reported was 1.5%. Non-measured channels, Terry, you can use 3% to 5%. It always falls somewhere in that 3 to 5 range. Year-ago we had the price increase. We typically protect price increase promotions. So year-ago trade expenditure, based on the price increase promotions was higher, so this year it was lower by 1% or 2%. And actually in the third quarter of this year our trade and coupon spend was also down 1% or 2% versus year-ago. So that's broadly it. We have reconciled it back as we typically do. The biggest swing clearly is in non-measured channels in the 3% to 5% range. But a very good quarter for us, and we are very, very pleased. Our base sales were up, as you know, and while our incremental was slightly down, we had a very strong quarter in innovation and brand building. I would like to get a better understanding of what is happening with your gross margins. If you step back, I think they were up 110 basis points Q2, granted that was particularly strong. Now they are down 90 basis points. How does that break down based on what is happening on the margin between higher fuel and energy costs versus the competitive dynamics in a couple of markets that you had referenced? Yes, we are down about 90 in the quarter; we are up about 30 basis points year-to- date, so slightly below our target of 50. But energy and fuel has been a component now. The increase in the quarter is quite large. We do have cost savings projects that help mitigate and bring that down, but certainly if we didn't have the energy fuel increases, that would have probably contribute about 1/3 of that 90 basis points. The other thing that you have to see is that on our cost savings initiatives there was about $0.01 more in up-front costs this quarter versus last year. So that has a contributing effect also, that's probably 1/3 of it also. And then the rest is the competitive environment we see in Europe. And the $0.12 to $0.13 number you flagged for fuel and energy for the year, what would that have been coming into the second quarter? Because that's not a number you've shared with us before. How much has that comp gone up over the last couple of months in your forecasting? I haven't got the exact number but I would expect, David, it would have been probably half than that, maybe slightly less than that. You look at the price of natural gas today versus where it was six to nine months ago, it's jumped incredibly high, as have packaging and energy-based costs gone up across the board, as well as the price of diesel remaining extremely high. And our forecast is that all those things are starting to come through. So it would have been significantly less than half, I guess. But I can't give you an exact number because we didn't work it out on a quarter-by-quarter basis. In the spirit of one question here, looking at your decision to expand capacity here, I am not quite sure, David, I understood your response to Terry's question about the split between volume and pricing in cereal. If you could clarify that in the midst of answering this question. You've put that off capacity expansion to a great extent, and a great part of volume-to-value has been over the past few years, taking the pricing to avoid having to break ground on new facilities in a category that is growing between 2 and 3% in the U.S. First, are you expanding capacity in cereal? And secondly, could you just get a little bit more granular about what the current pricing environment is as far as price mix's contribution to the 11% growth in North American cereal? Yes, we are expanding capacity in cereal. Some of it is driven by mix, where our capacity in certain product lines which have grown extremely fast over the last year or two has meant that we just don't have the capacity to service those and maintain the service levels that our trading partners expect of us. So some of it is forced through that. If you look at volume-to-value, we continue to grow price mix but volume is also up, which we believe is a very positive thing. And across the board, as we look at the categories in the future and our current capacity constraints across some of the products we are seeing grow pretty fast now, it is clear that we need to make this very high return investment in CapEx. Also, Jon, when you look at capital allocation within the Company, these types of projects have the highest internal rate of return, and it gives us a stronger sustainable cash flow in the future with these types of investments. If you look at volume and sales, volume was slightly over half of the sales for the third quarter, about 60% in North America. I want to ask this in a very general way. You highlighted energy and benefit costs this morning. This isn't the first time we've heard of these pressures from different companies. And you broke it out in pennies â it looks like 9 percentage points or so hit EPS growth in both '05 and '06 from these things. And it appears that every major supplier to the grocery channel has been or plans to in the near future retailer customers for a significant price increase, and not just on list, but promoted prices. Because of the significant price pressure and the fact that it has lasted for several years now, do you see price increases as generally being â I am not talking about Kellogg's â generally being more readily accepted in the future? I think all I will do is respond on what we are seeing affect our business. But, as you have heard already, we don't comment on what pricing activity we may or may not take ourselves. I think most companies are feeling the cost pressures we are feeling. It certainly has come faster and heavier than we predicted, even 3 to 6 months ago. And even though we are doing a projection now for '06, it could swing, because energy and fuel costs are very volatile. We believe the numbers we have given you are a pretty good reflection of where we think '06 is going to end up. And we are seeing a lot of our supplies of raw materials actually come through because of the incremental freight that they are having to bear in their P&Ls as well. A theme that we have tried to communicate here is that the way the way the Company has been managed over the last several years around sustainability and around realistic goals is really serving us well as we come into this area of some unpredictability relative to these input costs. So our confidence in delivering dependable growth to our shareholders is really what we are feeling very strong and very positive about despite these pressures. One point I wanted to clarify and that's on the commodity cost for 2006. I think you said $0.13 to $0.16, something like that. You mentioned that cost savings or efficiencies would overcome that. So should we assume it is mostly from the upfront cost programs, that the savings from those programs are roughly $0.13 to $0.16 for the coming year. Is that a reasonable estimate for next year? Yes, Chris, when you look at that on-cost, itâs not only commodities but it is also benefits. But, yes, we are getting benefits from those prior cost initiatives, and we are also working on having more cost initiatives for next year. But, yes, that's part of the model that Jim was explaining. We feel good about the guidance because we do have these types of projects that are offsetting those types of costs. Chris, just to expand on my earlier comments. If you look at the shape of '06 and what we are laying out, our guidance is exactly the same story we've been on and the same performance levels we have been on for four years. Our strategy continues to be around growing the cereal business, expanding snacks business and looking for close-end selected growth opportunities. We are absorbing significant costs both in a benefit area and in the commodity area and while we are doing that we are still funding our brand building at a rate greater than net sales growth. We are funding up-front cost initiatives in that guidance of $0.15. And as Dave and I have gone around our world looking at plans for next year â the quality of the ideas and the investment opportunities â we feel very good about. And as Jeff pointed out, we have got the financial flexibility within this overall package of how we look at 2006 that if something comes up that we are interested in from an acquisition standpoint we have the financial flexibility to get it. Okay. Along those lines, Jim, as we are looking at 2006 guidance in my model â if you assume that commodity costs are overcome by efficiency initiatives, and we'll hope that to be true, and you have flat up-front costs year-over-year, it does imply more of a reliance on more sort of one-time items like the lower tax rate, the increase in the share repurchase authorization and activity hopefully coming through. Is the missing link then, really, the brand building? I guess it could be substantial, no doubt, but it's been up so substantially now the last four or five years. Is that sort of the missing link for the guidance next year? I am not sure if it is the missing link, Chris. Our brand-building initiative will continue to go up at a rate greater than sales. But we are always working to cut costs. And that's an ongoing program, not only from those cost savings initiatives we have executed in the past. It is our ongoing programs to help reduce costs. I think the only other thing, Chris, is because we have a lot of cost-saving initiatives we will be able to offset some of those costs. At this stage, we are working to find more, but that is a fairly significant jump in 2006 commodity, energy, and fuel-based costs. I think, to Jimâs point, that even with that we are pretty much on guidance for where we have been the last four years. This kind of follows up on some of the questions that have been asked earlier. Maybe this is more of a statement and you will react to it. It seems to me that we are seeing a bit of a change here. Price mix is, since when Carlos took over and put on the Volume to Value strategy and the Manage For Cash, price mix has been a significant contributor every quarter. This quarter it was the lowest it's been in years. capex is moving up as a percentage of sales, and that has historically been kept low along with the working capital. So I guess there are a few things. One is, is ROIC likely to flatten out? And if these capex projects are such high-return projects, why would you â I mean it seems to me if they are such high-end projects because you have such momentum in cereal and snacks, wouldn't you scale back on the lower return projects which I assume are the cost savings projects that you have been tackling over the last few years? It seems to me that there is a bit of a change going on here, and that's what the stock is reacting to today, which is down significantly. Well, first of all, Eric, I would say that our level of capex, even as you think about it moving up as we have indicated, is still â relative to the industry â a very strong position to be in. And so keep that in mind, and keep in mind that our commitment to running this business against realistic targets for sustainability is what we are going to continue to drive into the business as we move forward, and that's what you are seeing. Yes. I would also add, if you look at volume-to-value in principle, you have seen the wheel, you know the component parts, nothing has changed. The fact that volume grows, I would have thought that would have been a net positive. We are still driving price mix, the combination of the two has really helped us. And we continue to drive innovation and brand building, which is all part of volume-to-value. So I don't think really much has changed, to be frank. Yes, but Dave, if you go back in the last few years, you emphasized price mix and not volume, and the idea was that you had such low capacity utilization that that price mix benefit really just fell to the bottom line so strongly. But now itâs kind of more volume-related so you have to add in relatively high cost capex. Unless you're willing to kind of go on record and say, well, the incremental capex has, I don't know, a 30 or 40% ROI versus what would be a typical project like on-cost savings which I think you said has got to be 20. Yes, I think, Eric, going from around 3% to 4%. I think the industry average is 4 or greater, so it's not a huge move. And we have seen growth in some areas where we had limited capital. And therefore, we have got to add it. Our job is to actually service what consumers want. If they want things where we don't have capacity, we are going to add it. As we look at our mix at the moment that's happening on a couple of brands. Those returns are going to be great for us, and it hasn't taken a capex above the industry norm. And, Jeff, does that translate into ROIC being kind of flat in '06 or even down if you boost capex by so much? No, Eric, on the return on invested capital, we still see it moving up because simply on the share repurchase activity that we are doing, we feel we will be in a strong position. Also by reducing some of our cash on the balance sheet, we'll also be helping us in the future on that. Thank you. That does conclude the question-and-answer session today. Mr. Burton, I would like to turn the conference back over to you for any additional or closing remarks. |
EarningCall_234024 | Hereâs the entire text of the Q&A from Flextronicsâ (ticker: FLEX) Q2 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Okay, thank you. Could you perhaps go into a little more detail as to just the flattish revenue on a quarter-to-quarter basis? Obviously understand the things that you explained on the call that you sold some of your businesses and that Alcatel and Siemens cell phones had come off, but the cell phone numbers were actually not that bad quarter-to-quarter on the call. And it seems that a couple of the other areas seem to be off more, industrial, medical, obviously consumer comm infrastructure, and so on. Yes. We clearly have seen some softness pretty much across the board in the customer base. We were hoping some of the new programs we have coming on like Nortel and Kyocera would offset the down side of some of the big cell phone programs going away, and they continue to go away alternatively. We had strength in the cell phone business, which, per your comment. But at the same time, the rest of the business all, a lot of them kind of across the port seemed to get a little bit softer. So it's kind of what we said, as it came out of July and August and started getting visibility into September, October, we saw it getting a little bit softer over the last couple months. There's no doubt we're in the middle of trying to deal with a little bit of that softness. Well, it definitely had in September and it definitely did in October, when we looked at it. We'll take a another really big look at it in the first week of November, but for sure for September, October they were both disappointing months for us. Hi, good evening. Just following up on that briefly. You said that in the middle of September there was some softness. Could you specifically identify some of the end segments or was it really across the board in terms of consumer, printers, comm infrastructure or just provide a little bit more detail there? Yes. I think some of the segments may have been customer product specific. It's hard to tell. But without question with us, it was across the board. It was reasonably linearly across the board. It was just, everything was just a little bit softer in September than we anticipated, and everything was a little bit softer even than that in October, with the exception of cell phones, which showed very good strength. And then just a question on the inventory. It looks like you built a couple hundred million dollars of inventory at the end of the quarter. Was that partly from taking on more Nortel assets or was it because lead times had stretched? Why, I guess I'm just trying to figure out why you built inventory going into when demand was kind of softening. Yes, it's a combination of things. The Nortel block of inventory continues to increase for us. We took on the operation in Shutodun(ph) which is a substantial amount of inventory. And the other thing is we had a little bit of down side in some of our revenue expectations, as we just mentioned, a little bit of softness, which I think contributed to some of it. I think there was a third effect, which is some of the new programs, some of the cell phone programs are actually being constrained right now by some components. That created some inventory build for us, which had there not been any shortage problems, component shortage problems, we'd been able to ship those phones. So, I think it's really a combination of all three of those things. Good afternoon. Could you give us an idea of the, if we take the revenue that you're now forecasting for the year, which looks like it's going to be, you take the bottom of the range at $15.4 million and the top of the range is 15.8 versus 15.9 last year. How much of that decline are the divested companies, roughly? Okay. So if we look at what you're forecasting now, how does that compare with what you were thinking, let's say, three months ago when you were, I think, telling us that the year would be $0.80 to $0.90? Based on your guidance now, it looks like the year's going to be $0.67 to $0.71. So what were the sales expectations? I'm trying to get a sense of how much lower the sales are than what you expected three months ago. Okay. So where in your business is the biggest part of that? Can you discuss that? Where is the decline from your expectations taking place? I could try to answer that. It's hard to really pinpoint to one thing. I think the timing of the Nortel thing maybe slipped a little bit, some of the new program divestitures slipped a bit a little bit, kind of across the board. I think there's a little bit of softness. We mentioned some continuing softness coming in. We actually weren't sure about July and August, and when we get into those periods, we usually just kind of hold the current guidance from our customers flat. It came back in September, October a little bit lower. So I think it's a combination of all those things. We've seen, really, an across the board, for our kind of programs, we've seen an across the board kind of reduction, and I think it goes anywhere from everywhere from consumer all the way through to the industrial and the infrastructure, everything really. Even some of the automotive was affected, which we didn't anticipate. So I think it's, I mean, with us, it was a very broad base, it wasn't just one thing that we can go point to. And also, the deterioration from Alcatel and Siemens was faster than we had expected to be honest. So, we really expected, when Siemens decided to divestiture, we thought we were going to see more revenue for a period of time, and that's come undone pretty quickly. Well, but you're looking ahead six months from now, and you're looking at significantly lower sales than most the December quarter and the March quarter than you had been originally been anticipating, because the total's down by a billion or more from what you originally had been anticipating. So what you're, are you saying that you don't think there's going to be any pickup in these things? Between now and the end of March? I think we need to clear something up here, Tom. We're not saying a billion dollars less revenue in the last two quarters? No, no. I'm saying that from three months ago your revenue expectation seemed to have slipped by something like a billion dollars. For the year, our old estimates were 16.4 to around 17. Now, reflecting the September results with the remaining forecast, it's 15.4 to 15.8. Even in September, you could argue it was 300 million, because our September guidance was 3.8 to 4.2 and we came in around 3.8. So, you're taking ranges here, and I would also like to remind you, Alex, back in June, coming off the June quarter when we provided the guidance, June was actually stronger than expected, if you'll remember that. Right. So at the end of June, we had customers taking their forecasts up. Okay? And then it was somewhat stable in July and August. Then beginning in mid-September, we saw a pretty -broad based reduction in forecast demand from our customers. Yes. Would you expect then to continue forward? Do you have a feeling this is the economy as a whole, the end markets, or you're losing some business to somebody else in the Far East or what is it? We, as broad based as we saw the decline, we can't help but think there's probably some economic impacts here, some overall economic impacts. We're not aware of any programs that we really lost. We can't put our finger on anything like that. We just think there's some general softness out there. I think some of the programs are, might be our customer specific competitiveness in their marketplace. There's probably a few programs like that that we don't necessarily see carry across to others. So I think it's a combination of those. There's really no event. There's no real loss of customer outside of the Alcatel, Siemens, which is all wrapped up this last quarter. But it's pretty much across the board. One final thing then. Do you have any sense at all that the increase in energy costs in the economy, the increase for consumers and in that sector, transportation, is causing them to cut back on purchases of the kinds of things that you make? Any sense of that? So it's hard for us to tell what all the drivers are. I mean, certainly energy prices, rising interest rate concerns, job markets, unprecedented level of natural disasters. At some level, it must have had an impact. But the other thing is there is some evidence that some of our customers are not doing as well in the market place, potentially as well. I think they're both appropriate. Because there are elements of the economy that are actually pretty strong that we can see. So I think it's a combination of both, Alex. I think it's some of the economic slow down because it is as broad based as it is, and I think in some cases, maybe some of our customers didn't do it, but I'm sure you guys will go out and do channel checks. I mean, we can't think of anything we're losing or losing market share on or anything else. In fact I'm going to add something to that, which is, we don't like to talk about at Flextronics from a management perspective, we don't like to talk about broad, macroeconomics. That's for analysts. There's all kind of hoop-la for them to do that. It just always sounds like excuse making to us. We tell you what we see, which is there has clearly been some across the board declines. They're not huge. There are some. And it's our job to grow through that. As you can see from the numbers that we're giving guidance on, even with that we're still expecting some pretty good year-over-year growth starting again in the March quarter. We're comfortable we can do that with additional programs that we're winning and ramping up. That's our jobs as managers is to offset weakness in individual companies or individual sectors for the economy, as a whole, and find ways to grow our business. I think we're going to be able to do that after a relatively short flat period. Great, thanks. Two questions here. First can you talk about the deterioration quarter-over-quarter for Siemens and Alcatel? How big of a decline are we talking about here? Somewhere at 25 million, maybe a little bit more, but obviously somewhere in that range. I don't know the exact number. Can we talk a little bit about the current capacity realization for the firm? I know guys you announced a new facility in India, building a new facility in Mexico. I've heard recently that you're looking to expand in New Hampshire. Can we talk about real capacity realization right now and expectations for future construction? We're not actually building any capacity in New Hampshire, that's for sure. We're expanding, and we'll continue to expand in virtually all locations in China. We'll expand printer circuit board capacity this year and probably next year flexor capacity we'll expand flexer capacity, we'll expand metals, both plastics and metals, in both north and south China and we'll be looking, we just brought on several hundred thousand square feet this year in China, which is almost all full and we'll probably expand another 700 or a million square feet in China this coming year. India, as you mentioned, is correct. Juarez, we're bringing out some capability and so, kind of virtually, all those markets are in need of capacity. A lot of it is, we just see what the future looks like, and it looks pretty robust for us. Some of these programs take a little bit longer. And one of the things we've said in the past is we're starting to get a longer look at what our future bookings look like, our future revenue look like because we're so early engaged in the processes now, much earlier than ever before. What that means is a longer period for start-up costs, and we might be working on programs for nine months, even 15 months, before they really mature. This is kind of new for us and kind of a result of us bringing on all our components and our vertical technologies, as well as the design capability that we have. As far as restructurings, we've done bits and pieces. This is also a reason some of the revenue has come out. We've actually sold a couple operations in Sweden in the last quarter, which we did in June. We sold an operation in Italy. At the end of June, we are in process of closing an operation in France. We closed an operation in Finland just about two months ago. A lot of this stuff is actually nickel and dining some of the revenue out of our business, as well. So, we'll continue to tweak things here and there, but most of the restructuring that we have underway is contemplating a lot of that, and the risk that we have, which has particularly been in Europe in terms of overcapacity, is actually falling away very quickly and very nicely. So when we look out into calendar year '06, what do you expect for restructuring charges? In the $50 to $100 million range, do you think that's accurate? It's hard to tell. It sounds like a lot to me. I don't know what's left in the restructuring. Maybe Tom can Yes. I think that does sound high, as well. We really don't forecast what level of future restructuring, if anything, we have that far in advance. So we'll certainly let you know when we know. Okay. Great. Maybe a last question here. Do you have the percentage of sales for Sony, Erickson and HP in the September quarter? Yes. So, we're going, starting last quarter, we just started identifying them as greater than 10%. And that's because our sales increases or decreases for those customers, they'll correlate directly to their revenue activity because there's changes in inventory. We've gotten too many questions with people trying to reconcile our change in the revenues to that particular customer, to their revenue performance. So both were in excess of 10% of revenues, and we're just going to leave it at that. Let me add one thing, one other thing. You have to keep in mind the depreciation in the quarter was 85 million and capital expenditures were 54 million. So in fact we are less than replacing the equipment. And so the 54 million shows up as we're going to build a place in Juarez and we're going to do stuff in India and all that kind of stuff, but you have to remember that depreciation's coming out at even a higher rate. Net, net, we are reducing plant and equipment, not increasing it. Two quick question you had mentioned business slowing a little bit from developing a model here, even excluding the divestiture, this is rather sequential growth, whether the company has problems, can you comment on that, I am just curious if anywhere about five years what if the business slows? Just looking at the sequential growth in the quarter, adding back the divestitures, this is the slowest sequential growth you guys have had in almost 20 decades. You mentioned business slowing could you meaningfully recently. When was the last time you saw business slowing to this degree? Was it 2001? 2002? Hey, Brian, there is a lot of static on your phone. We cannot understand you, so we're going to ask you to go out of the queue and come back in. Thanks. I want to talk about margins a little bit, if I could. First just some clarity on why they were down 40 basis, why the gross margin was down 40 basis points sequentially, despite revenues being relatively flat from June to September, was that all mix related? And, secondarily, you had talked about some targets previously, gross margin being over 7.2 by the end of the year, operating over 3.6. Is that still doable? And just kind of a larger question here. You've talked a lot about ramping programs, which hurt margins. You talked about ramping factories, which hurt margins. What happened to ODM? What happened to printed circuit boards? Is there a reason for us to really assume, realistically, that margins are going to be increasing in the next six quarters? Okay. A lot of questions there, Mike. So the sequential decline in gross margin, 30 basis points of that decline can be attributable to the divestiture activity, and the remaining would be attributable to the start-up costs that Mike has outlined. Operating margins, gross, divestitures are adversely impacting the operating margins. We're getting a benefit on SG&A reductions from the divestitures, so there's very little operating margin impact from the divestitures. As we said on the call, in the future quarters, Mike, on a full quarter basis, not for the September quarter but going forward, future quarters gross profit will be impacted by 100 basis points from the divestitures. We'll pick up 65 basis points of SG&A and operating margins on a full quarter basis will only go down 35 basis points, as a result of the divestitures. Of course, then we would pick up additional earnings from either reductions in interest expense from debt buybacks or a reduction in shares outstanding through stock repurchases. I think what we need to stay focused on is that while the gross margins are going to go down as a result of these divestitures, alternatively the net profit is going to hold relatively steady once we redeploy the cash in the way we decide to redeploy it. These businesses carry very, very high SG&A rates with them. We have to make sure we don't get too focused on the gross margin and stay more focused on the operating profit, which is more applicable. The second part of your question is do we realistically anticipate these to go up time and the answer is, yes, you should. We are right in the middle of a very substantial restructuring. The amount of business, if you take a billion dollars of cell phones out that's already running, the learning curves already paid for, and to take it out and replace it by a bunch of smaller, more complex programs is very different and new programs is very difficult. And this is all effecting, and we're still able to achieve the 3.4% operating profit for this quarter, but it would be better. And do we anticipate it get can better next year? We think so. A lot of these programs that we've run have already been underway for some period of time, which includes Nortel and Kyocera will be at full learning curve by January. But we won't be fully invested in the vertical integration activities until we get to the next cycle of their products. So to go get the component technology, such as plastics and camera modules and those kind of things designed into the next generation phones is what's really required to go achieve a maximum profitability in these programs. A lot of that work's going on now. I think that work will carry on until the first half of next year. I still think we'll earn very respectable margins like we are today. Without doubt, going forward, we actually do anticipate, we're making a lot of investments in technology that we've mentioned, the duplex circuits and printed circuit boards, all of which have higher profit margins than the regular business. We actually do expect the margins to be going up and, without doubt, the investment profile is built around those margins going up. The other thing I might want to add, you know Michael mentioned about doing $54 million of capital this quarter and taking $85 million of depreciation amortization. A lot of those investments are investments in higher-margin technology kind of programs that take a little bit longer to mature, but they're building us a competitive position for the future. When we think about what it takes to go compete long-term in the marketplace, these things are absolutely required. And we're still able to take all these investments, and still be able to generate a delta between delta between depreciation and amortization, and then CapEx the net, and then number's still generating $30 million a quarter of cash flow. So we actually think it's nicely in balance. Thanks, good afternoon. From the debt buy-back side of things, you guys bought back it looks like around $200 million this quarter. I'm sorry if I missed this. Do you expect to buy back some more debt in the near term, given that you have not been able to buy back stock or probably won't be able to buy back stock until next year? Would you use up most of the proceeds on debt, most of the proceeds from the divestiture on debt? And then secondly, within the comm business, the Telco business, Nortel was ramping this quarter, and I think Mike McNamara outlined at our conference recently that it was running around a $1.2 billion runrate roughly, if I strip out that ramp, it looks like the comm infrastructure business was down 20% quarter-over-quarter. Can you provide more flavor maybe geographically on where we saw most of the weakness or any kind of flavor around that business? Thanks. Scott, I'll take that. The last question first. The comm infrastructure was down primarily as a result of the divestiture of the network services business, which was all comm infrastructure type revenue. Okay? With regard to future debt and stock buybacks, we're going to be very opportunistic and very patient around this stuff, so I do think it's reasonable to assume that we're going to be in the market during the quarter buying some debt back, but that is conditioned on what the prices and the, of what the prices of both the stock and the debt. So, we, this Singapore law was scheduled to change in September and got delayed three months, so we think we'll be able to buy stock back beginning in January. If that means our stock is at such a level, we'll just sit on the cash and wait till January to start buying stock back, that is something certainly we're going to evaluate. So I think it's reasonable to assume that we'll be buying back debt, depending on what the market value is. And I hate to say that because that will probably drive the pricing a little bit higher, make it a little less attractive, people knowing that we're in the marketplace doing that. We are going to be keeping an eye on the stock price and the date upon which we could go in the market and start buying stock back. So we're patient, we are opportunistic. And we are going to deploy the excess cash in the manner that best increases the return for our shareholders. Just to follow-up on that comm business, excluding the Nortel ramp and the impact of the divestitures, what did the comm business do in the quarter, Tom, roughly? I'm not getting too specific here. I don't think I have that data available at my fingertips, Scott, but you could attribute around $80 million of the sequential decline. Actually maybe more on a sequential basis, maybe a little more than $80 million associated with the divestiture of network services. There's also a little bit of semiconductor revenue in the comm infrastructure space, as well. The rest would just be attributable to some of the broad-based demand fluctuations that Mike spoke about earlier. Yes. I have a little bit of a lead-in to it. Which is I'm just wondering if maybe executive management's fairly consistent overestimation of the near-term momentum of the Company's business, is sort of filtering through the culture of the Company and is resulting in this consistent misforecast of the outlook. I have a few examples. Quarter revenue missing by 5%, EPS by 10% and then characterizing Flextronics as a winner within the industry. And I'm just wondering what executive management is going to do in the near term to try to correct this cultural issue. For example, is executive management willing to suspend its own variable bonus compensation to, until it forecasts and accurately hits its forecast for financial metrics? Thank you. So I think we'll let Michael talk about the culture, but I'll talk a little bit about the numbers that you referred to. So our revenue, reported revenue in the September quarter was $3.88 billion, and our guidance was $3.8 billion to $4.2 billion, so that is in the middle, toward the lower end but certainly in the middle of our guidance expectations. In June, the high end of our revenue guidance was $3.9 billion, and we did $3.9 billion of revenue in the June quarter. So I guess I would dispute a little bit the fact that we've overestimated the expected revenue in the near term. Obviously, the further you go out in time, the more difficult it is, and we can only give you the best information we get from our customers at the time that things change and we try to let you know when things change. But I think in June and September, our revenue estimates were inside our range of expectations. Michael, do you have any comments about this? Yes, I do. I'll add a couple of things. First of all, cash flow was way above forecast. It's interesting that when you have periods of time like this and you get inappropriate questions like we just got, the market tends to, many investors tend to focus on it's great when earnings are going up and cash is going down and now earnings are flat, cash is going way up, and I would suggest to the listeners that you follow the cash because, if you look at how much cash is being generated by the companies out there, I think you're going to find that we're clearly one of the winners. Flextronics has a long history of compensating executives based on performance. When we don't grow earnings, we don't get bonuses. If anybody wants to go and check, there was a period of time a few years back when the Flextronics executives all gave up all of their salary in exchange for stock options, and today the stock is below that stock price, so everybody gave up a year of salary to show our respect for the need to provide performance and so there won't be any bonuses this quarter and depends how the future is. We will do that appropriately, and I actually think that question was inappropriate. We'll take one more question and then call it a day for today. Good evening. Are you guys, with respect to the Nortel ramping, are you guys in a position to give us an idea how much incremental revenue is expected from Nortel in the December and March quarters? Well, what we've said, Todd, is we expect total Nortel revenue for the year to be in excess of a billion dollars, and we continue to believe that estimate's appropriate and that really hasn't changed. So we picked up a facility in late August, kind of. There's one month of revenue from the facility we picked up in the September quarter, and then we have one more facility in Canada that we expect to pick up sometime in the March quarter. And, therefore, we think by the end of the fiscal year, all of the factory transfers will be complete at that time. So for the year, it's a little bit more than a billion dollars incremental revenue, and I don't think we really want to split it out by quarter. Okay. And I know you gave only two quarters of outlook. I guess we should assume that September and December quarters should, you know what? I'll pass on that question. Thanks very much. Okay. Thanks very much. We understand that we've suggested that growth is going to start again after the December quarter. That's obviously something we're going to have to show you. We're going to continue to generate cash and we're going to deploy that in effective way that Tom talked about. We appreciate your calling in. We hope to see many of you on November 8 in New York and we'll look forward to talking to you again. Thanks for calling in. Bye now. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234025 | Hereâs the entire text of the Q&A from Salesforce.comâs (ticker: CRM) Q3 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you todayâs question and answer session will begin that is electronically. If you would like to ask a question please do so by pressing the â*â key followed by the digit â1â on your touchtone telephone. If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment. Weâll take as many questions if time permits. Once again please press â*â, â1â on your touchtone telephone to ask a question. Our first question today would be from Kash Rangan from Merrill Lynch. Thank you very much, congrats on the quarter. One question for you Marc, and one for you, Steve. Question for you, Marc, how do you see the landscape changing as you get into 2006 with cable now tucked into Oracle and there is increasing volume talks from the big three Oracle SAP march talked about getting into the on-demand market. How do you see that changing the landscape positively or negatively? And question for you, Steve, with the cash flow as strong as it has been this quarter, almost equal to last yearâs full-year cash flow, how do you see this on a quarter-to-quarter basis moving forward? Do we get more predictable? Or was there any one-time thing that really helped the cash flow this quarter? Thanks. Congrats again. Thanks Kash. In regards to competitive situation, also before I go on, I misspoke. I think I said during my comments that we are the third-largest independent provider of on-demand business applications in the world. Actually, I meant to say that as of this quarter, we now passed what is now the second-largest provider of on-demand business services in the world, WebEx. And we are now the largest independent provider of on-demand business applications and the world delivered on-demand. In regards specifically to the competition, we as you know, have a rapidly changing competitive environment, at the beginning of this quarter of course, there was a very large independent CRM company out there, Siebel but its now basically suffered the same fate as PeopleSoft. We expect the same market dynamic to take hold. And so weâre optimistic about that from a competitive position. But also of course, weâre cautious. Weâre watching what everyone is doing. Microsoft is making announcements; everyone is making announcements. But in terms of technology, we are really the only ones who have really delivered kind of the solid incremental improvement. And also, we are the only ones that have been able to deliver the solid customer success in both the small, the medium and the very large deployments. So we are very optimistic about the competitive situation, and we are excited. Certainly, there was a large CRM company out there that is essentially disappearing and getting integrated into Oracle. And so from an independent CRM perspective, that makes us certainly one of the largest stand-alone independent CRM providers in the world, is an exciting place to be right now and doing it all on-demand. And with regards to the cash flow comments, clearly we do manage the cash flow and it is a very important metric that we look at. We had an extraordinary quarter this quarter as everybody was focused on managing the business from operations. Itâs still tough to do the predictable part as we still ramp up our growth in a variety of countries in the world. And as you know, the big drivers of cash flow are net income, changes in receivables, and timing of payables and accruals. So we had a great quarter. Itâs a key focus for us. But also, weâre still in this heavy ramp cash flow area. It is going to be tough to be predictable for a while cash. Thanks a couple questions. Steve, you could explain why we are going up to a 45% tax rate next year. And also, is there more evaluation reserve left to be reversed? And any comments on subs for Q4? Good questions, Rick. On the valuation reserves, there is some. But those will all go to the equity, so they wonât necessarily impact the profit and loss statements going forward. A lot of the valuation reserve is around stock options. And those will go like I said to equity. With regards to the 45% tax rate, typically, a company will, as theyâre growing, they start to make income and they start to pay income taxes, which is a good thing I guess. With our international expansion, we have issues around where we make profit versus where we have deductible net operating losses. That causes this rate to be slightly higher than you would expect from most companies in this growth phase. But I think youâll see that start to moderate over time. But for next year, our current estimates, and we will certainly revise these as we get into our budgets, look at our specific geographic mix of revenue and income and where we are having losses versus where we make money. But this our best guess at this time. But I think also you can anticipate it will moderate over the next couple years as well. Subs at Q4, we havenât necessarily been giving guidance. The revenues will give you a good indication of our expectations of the business going forward. But itâs like we said and I said in my commentary, subs are certainly an area that we manage to. But itâs tough to predict those because our customers drive that number so much. There was a lot of add-on business that we got. We talked about in Marcâs component as well as mine a lot of existing customers got to add on. But we also added 1,800 new customers, which is the top number. So I canât give you the percent breakouts, but it was good business across the board. New customers coming on, the 1,800 new customer adds was fairly significant for us. But we also in terms of subscriber adds had great add-on business from existing customers. So again, it was across the board not so much in big, big deals though like we have had in previous quarters. This was just good solid business across all aspects of it. Thanks guys. Just one question on Mirrorforce launch, at least the first phase. We talked a lot about obviously the cost of this. Iâm wondering what you might be able to comment on the opportunity from the revenue side may be, especially from the large end of the market, if there are people demanding this type of failsafes back end for you and may this unlock some bigger business down the road? Well, as you know and as I commented, salesforce.com has been building a datacenter. We built our business on a datacenter that is located in Northern California. And honestly, we just outgrew that architecture, we outgrew the datacenter, we outgrew the power and the bandwidth available in that datacenter and on and on and on. We have our customers come in on a regular basis, and they do detailed reviews of our infrastructure technology as well as security and so forth. And we really believed that it was time for us to upgrade that datacenter. We made a decision when we said, okay; we are going to cut loose this old datacenter. We want to not only build a brand-new datacenter with a state-of-the-art architecture built on the latest technology, but also we want to be able to build a mirror of that data center. And so we built a brand-new data center in Northern California. And we have also built a brand-new datacenter in Northern Virginia. And Iâd have been to both datacenters. In my opinion, they are state-of-the-art. This weekend, we cut the old datacenter loose, so we cut the cord. We moved all the data, the applications, the software, everything from the old datacenter into our new datacenter architecture and turned it on for all of our customers worldwide. And that datacenter was live and operational at 8:30 San Francisco time on Saturday night. Since then, that datacenter has been running just fine. And now our attention is focusing on our Northern Virginia datacenter to create not only just a hardware mirror, which is what it is today. So in many ways, it is redundant that if for some reason we were to lose the entire datacenter, we would cut over and work to cut over to that Northern Virginia datacenter. Weâre now working to make that a live mirror or replicated, fully replicated mirror datacenter so that if for some reason we lost the Northern California datacenter, it would be an automatic failover to the new Northern Virginia datacenter. We expect that software transition to happen this quarter. So we are very excited about the new datacenter architecture. The majority of that investment occurred in this quarter and partially in the second quarter as well. And we are very excited to be on this new infrastructure. We today have this very solid infrastructure. We serve all of our customers worldwide with tremendously fast response times and excellent reliability out of our datacenter. And we expect that over time to add other datacenters. And, but when we are going to do that and where they are going to be located is something that I donât think we are willing to talk about this point. Hi guys, a question about 2007. From an operating margin perspective, it appears you are going to be hiring fairly aggressively in sales and building out infrastructure. Steve or maybe Marc, can you guys talk a little bit about how we should think about margin expansion for the next year or so relative to your growth opportunities? And what is the dynamic in as much as you can quantify this between points of revenue growth versus operating margins? Let me just comment on that briefly, and then Iâll pass it to Steve. Unlike a lot of enterprise software companies who today are trying to maximize their maintenance revenues amid declining topline growth and try to milk their existing customers for these kinds of additional fees, our approach is very, very different. And that is we believe we are in a new segment, a new market and a new opportunity. And we intend to capitalize on it. Now you have been following our company for a long time as most of the analysts on this call. Youâll know that that is not a new mantra for salesforce.com. We have said for a long time that we are in aggressive expansion and investment mode. And honestly, as these competitors kind of just vanish, we are more energized by that and feel that it is in our interest to expand our company on a global basis, not only in infrastructure which I just mentioned, but in distribution capacity and a lot of different areas. This is really becoming our time. But to maximize that and to get the market share that we believe is opportune for us, we need to invest and invest heavily. And thatâs very much reflected in our FY â07 guidance. So while youâre seeing again very strong topline growth for any other midsized enterprise software company, perhaps some of the highest that youâre seeing in that sized company, we are also investing very strongly and we want to be able to continue to invest very, very strongly as well. Here I think Jason, a good example is, we talked about adding Steve Russell to Asia-Pacific based out of Singapore and going after the areas between south of Tokyo and north of Sydney. So youâll see us continue to ramp that region. Also keep in mind and weâve discussed this before, we serve a lot of customers in over 47 different countries. But we donât have our physical presence there yet. And this is going to take some time to build out. One is, and letâs not forget the US, we donât have a physical presence in a lot of major cities in the US, which we are going after let alone Europe and Asia. So we certainly are going after growth. We certainly respect the profit margins and the goals there, but theyâre going to remain modest vis-à -vis going after market share, increasing our distribution and getting presence in all the countries we want to be in for our customers. Okay, just one follow-up on that. Was there a change within the last say 30, 60 days as you started looking at your planning to accelerate the investment in infrastructure and hiring, given some of the moves by Oracle acquiring Siebel and Microsoft? Well, I think that, we could not forecast specific actions like that. But certainly, we can forecast the general movements, we donât think that companies are getting excited about buying big software packages and buying big hardware packages and trying to put it all together when they get this very affordable, low-risk approach with our service. And now as you know with the AppExchange, we are trying to get our customers to diversify their portfolio salesforce.com inside their companies, how do we want them to use us in new and exciting ways. And this means that what we are trying to do is push, we want to push the topline numbers in the topline revenue growth. And we want to push the topline subscriber number. We want a market share gain. And so this year, we have been able to get that. And we feel, if you look at this fiscal year compared to last fiscal year, this has been a very solid year for us so far. And we are by our guidance on the fourth quarter; you can see that we feel good about that as well. But next year is another pivotal year for us. And I do not want to say that every year is a pivotal year for us but it is. It is another pivotal year for us that we need to be able to execute, at Salesforce, we have a tremendous vision around the end of software as you know. But there are three values that are extremely important to us and they are the customer and partner success but also growth is very important to us as well as execution. And to make these things happen to make that values combination really occur internally, we need to invest. And the datacenter change is just a great example because it not only shows what weâre preparing for in terms of new customers coming in but also the tremendous accomplishment of our employees and technical teams in making this very smooth datacenter transfer. So this is very much our mantra ongoing. Yes good quarter. A few questions. One, I donât know if you could please give us any update on churn? Has that changed at all from the last number you gave? And also for Steve, any thoughts on cash flow, free cash flow for full year â06 and â07? And then I have got some separate questions. You know, Laura, we talked about churn last quarter, and we probably wonât give any updates for a while longer on that, continue to say however weâre focused on customer retention and customer success. And I think the fact that we had such strong, good add-on business from existing customers is testament to the fact that we are providing solutions that people love to use and keep adding to their organizations. On cash flow going forward, like I said, itâs a major focus for us but it is still tough to predict given the build-out that we have and the growth in the business that we are experiencing right now. Suffice it to say itâs one of the key metric focuses for the management team. Also switching gears and maybe this is a question for Marc, so far, since Oracleâs announcement that they are going to acquire Siebel, is your sense thatâs been a net positive when you talk to your salespeople and your customers in terms of creating a decision point in the Siebel base that benefits you? Honestly, there is, two net positives if you want to put it that way. First of course is Siebel essentially becoming part of Oracle, creates tremendous uncertainty for the seeable customer base and prospect community. And so for our salespeople, they can sell into that uncertainty and we are optimistic that we can train them and execute with them to be able to do that. And thatâs a process that we are engaging with. And then two, of course Microsoft I am sure you saw, 2 weeks ago or a week ago now, coming along and announcing that they are moving in on-demand; that on-demand is the future. Itâs the future of technology, just about every major CEO of a software company has now said on-demand is the future and it is the way their company is going. I am sure you saw Henning Kagermannâs comments last week to Dow Jones Newswires, to Chris Writer. I am sure that you have seen all of the software CEOs say that the future is on-demand. Weâve been saying that for about almost 7 years now; it will be 7 years March 8th. But we have done something different. We have written the code. And youâve got to write the code; you have got to build the software. You have got to get the datacenters. You have to create the scaleable infrastructure. One thing thatâs very unique about our offering is, as you know, we have very large customers. And we announced ADP with 6,100 live subscribers all the way down to companies with one user or five users. Thatâs a very unusual thing in the software industry to see a technology company that has created one piece of code that can run small, medium and very large companies. So while itâs very exciting on the high end with kind of the capitulation of Siebel and kind of their disappearance as Tom Siebelâs departure from the software industry entirely, as well as in the low end with Microsoft telling all their customers that the future is on-demand. We are excited about the market trends. But we have to execute, and thatâs really the key. Every quarter is a new quarter. Every day is a new day. Every month is a new month here. We donât take anything for granted. The software industry, you know itâs very tough; itâs very competitive. They have a lot of competitors out there. We probably must have over 100 competitors, is my guess. And they are all selling against us and honing their messages and trying to figure how they are going to beat us. Our job is to take our investment and to win those deals. That is a day-to-day process. And we just have to continue to be able to execute that. Fortunately for us, this quarter was very good with strong subscriber growth and strong customer growth and strong revenue and net income and then some. But every quarter is a new quarter, and we try to do our best every day. And that is how we take it, one day at a time. Thank you I wanted to just follow up on the earlier cash flow question. Any, even high-level sense of what may be percentage of revenue we may see that traps the cash flow in 2007, any high-level ideas? And then AppExchange is that, can you give us a sense of what percentage you factor that into set the revenue guidance for next year, what sort of contribution we might look for that for next year? On the cash flow Brendan, a couple of things here where we are early stages on our â07 planning, I just want to throw that in. And then secondly I guess, we have not typically given guidance around cash flow at this time. Again, itâs a focus for us, but itâs also a difficult metric at the moment to take a look at because of the wide-ranging investments that we are making. Marc, do you want to talk about AppExchange? Yeah, I would be delighted to, when we look at AppExchange for us and, Iâm not going to avoid your question with this answer, but I want to give you an honest answer. And that is itâs taken us almost 7 years as I mentioned to get salesforce.com to where it is today, people always tend to overestimate what you can do in 1 year in our industry and underestimate what you can do in 1 decade. And we have a 1 decade dream at salesforce.com, and we have our targets for where we want to be after a decade. Weâre almost 70% into that timeframe, and we feel good about where we are right now but we have higher goals of course. Now with the AppExchange, it is not even live yet; it is coming live this quarter. And we look at it exactly the same way. We have got a 10-year horizon for this product. We think that salesforce.com is a killer app. I will be totally honest with you; I think AppExchange has the potential to be our second killer app. But itâs not going to be an overnight sensation. Thatâs not how it has been architected; that is not what itâs about. AppExchange is going to require investment. Itâs going to require time; itâs going to require caution over a long period of time. There is a lot of things that we have to do right to make AppExchange work. AppExchange is a great idea. Itâs one of the most exciting things I have ever worked on, as I have mentioned. But we need to focus on it over a long time. I personally work on a lot of the plans for that product. As you probably know, Iâve got some spectacular engineers and architects and product managers and business development executives on that. But we will need time to make that happen. We then of course announced it in September. And then we will need to grow it and extended enhancement. Itâs not kind of a consumer product, which starts out, you launch it. And 9 months later, it gets replaced with something else like a new TV or the next version of the iPod or something like that. This is something that you really take a long-term view on. And thatâs what weâre going to do to make this successful. Yes thank you. A couple questions. First of all, you talked a number of times about investment in the Salesforce. Could you give us a little color on how do you plan to do that? Is it really just in geographies, where you donât have as broad a presence? Or is it more on the enterprise side or inside sales versus enterprise etc? Just how you think youâd like to expand going into â07? And then second, on Mirrorforce, I am trying to balance some of the comments that suggest that much of the investment has already taken place. And it appears from where you are at least in turning it on, that it appears to be true. Iâm trying to balance that with sort of the commentary that gross margins will still be under pressure as we enter the fourth quarter. Can you tell us what still has to be done with Mirrorforce? And then kind of when, that step function will be, 90% or 100% complete? Well first and foremost in distribution, in our distribution strategy, it is an essential part of our business. We do need to invest in it. We have not found other channels to be able to sell our product other than our self. There have been other companies who have come along and tried to develop other channels and have failed at that. We donât think the traditional channels are totally ready for that. Weâre working in trying to develop those channels. We hope that ISVs and software developers can participate in the AppExchange, could be another channel for example. But very much our distribution is self-made and self-executed. And as the Company scales, as it goes into new geographies, as it goes into new markets, as it goes into a different sized companies, we need different types of different distribution. But again, those are self-executed initiatives, and so they do require our own investment. I will let Steve comment on the Mirrorforce investment going forward. But let me first just give you a little bit of color that the investment that we just made was kind of a step function up. That is, we did just make, I think we characterized it on the call last time, this $50 million investment in Mirrorforce. This was a significant investment. These datacenters, thereâs three of them that are replacing one. The three datacenters are two production mirrored datacenters. But also, we have this new development datacenter, and these are world-class initiatives. And it did require us to initiate a step function that we were willing to kind of bear down and take the majority of which was in the third quarter and partly in the second quarter but now we assume in our expense run rate. But let me just say of course we will buy more technology of course as we continue the lifespan of this Company. And we expect to continue to upgrade and update our systems over time. But these step functions donât happen every day. Marc is right in that keep in mind we have leased a fair amount of our equipment. So as we bring on the leases, we start to expense it, a lot of the equipment obviously showed up in the last quarter. So you got the step function up. Now the fact that they turn on the solutions in the fourth quarter means we will have some amount of expenses that will be there in the fourth quarter as well. But itâs a big step function year over year that you should look at. And since it is a fairly large expense in the third and fourth quarter, then youâll start to see the leverage come about as we grow our subscriber base going into next year. I will give you my honest answer. There are certain groups in IBM that I think really understand how to work with us. And weâve tried very hard to work with those groups over the last 5 or 6 years that we have been out in the marketplace. A great example is the WebSphere group. You probably know that IBM has done extensive integration work between WebSphere and our service. Our customers can buy WebSphere, build applications, but use salesforce.com data to drive WebSphere applications. And we really like IBMâs WebSphere organization. However, as we have moved around in the company and talked to different organizations at IBM and of course we have some very senior former IBM executives in our Company, including Jim Steele who is my President of Worldwide Distribution, who was 22 years at IBM, including running significant parts of their Asian-Pacific and Americas businesses. Not all parts of IBM really understand what it is we do, why we are successful, how we are successful and what we can offer customers. I think IBM is a company that is in transition. They have done a great job at advertising on-demand and educating people on on-demand. They do some beautiful television commercials. They just have no products. So we thank them for that market development. But we just have not seen them be able to understand how to work with a company like ours to be perfectly honest with you, except in isolated situations like the leadership in their WebSphere group. I donât expect anything honestly. I do not have a lot of optimism about IBMâs ability to deliver an on-demand, nor have I in the past as you know. Maybe a follow-up on that as well. IBM has been closely aligned with Siebel. But what are you seeing directly out of Siebel as a competitor? I recognize they are not everywhere. But they have been fiercely aggressive in trying to win business in the past. Do they still have that same posture here right up until now? Or has anything changed in terms of what you have observed tactically out of them as a competitor? Well, very good question. First of all, the first part of your question, as you know, Siebel built their on-demand product on DB2 and WebSphere. And that did not go very well for Siebel as far as we can tell. As you know, theyâve had fairly pathetic growth in on-demand. But when we talked to customers, we believe that Siebel has suffered substantial quality issues also with their product, including poor performance by IBMâs datacenters. They have not had the same level of customer success that we have been able to deliver our customers. For more information on that, you should just talk to their customers. I think that will bring you the information that you are looking for. But also let me say that we believe that much in the same way that PeopleSoft has disappeared out of our opportunity pipeline over the last year since they have been acquired, we expect that that very well could happen as well with Siebel. Itâs still too early to tell. I do not want to give unbridled optimism in an area thatâs unknown. But customers do not respond well to this type of acquisition situation. They lose confidence in the vendor. They tend to stop looking for them for new solutions. That may be different than existing Siebel customers, who are trying to lower their long-term maintenance agreements by buying licenses or additions in any specific quarter. But this is not something that we thank the customers are very excited about going forward. Yes thank you. Steve, just a quick one first on capital expenditures. It sort of bounced around for three quarters. I think it was nine and then three and now five. Can you just help us understand I know youâve got to build out the datacenter, but a lot of that is leased. So Iâm just trying to understand what is making up those numbers? And then as we look into next year, would you expect CapEx to actually be up year over year? Well, you are right. We do lease a lot of equipment. We also have and did buy some software and other capital assets over the last two or three quarters. You have to keep in mind as well as we add offices, we have to capitalize leasehold improvements as well. So youâve got a number of effects going on because of our expansion. We are more focused on cash flow from operations than capital asset growth. But it does happen just because of those couple activities. For next year, we havenât gotten into the budgeting cycle enough to know. Certainly, we will continue to invest. As Marc said, we add datacenter equipment on a fairly routine basis. We are adding offices on a fairly routine basis as well. So you should expect us to make future investments. But it is not an area that drives the company. Itâs really more focused on cash flow from operations. Great., maybe one just for you, Marc. Obviously pricing was something we looked at last quarter. It seems to be a little bit more stable this quarter. Iâm just curious as to, clearly at least some accounts; you would have had more competition from a pricing perspective from Siebel. Is that changing at all? And in addition to that, just how do you sense customers are, viewing the prices you charge? Are they still very much willing to pay? Or do you have to give incremental discounts to some of the larger accounts? Thanks. Well, pricing is extremely interesting part of our business because we do have a new pricing model. Customers have to learn about kind of this new on-demand pricing model, where you kind of have less risk because youâre paying over a long period of time. Thereâs more consistency. Customers really have not I think appreciated this change from kind of the typical end of the quarter license slam. And I would say that weâve seen a lot of change in the pricing situation over the last few quarters. And I think thatâs probably reflected in our results. One thing that we probably will see changing going forward is as we get ready to release our winter â06 version, I expect that we may have some different products, combinations and pricing combinations for customers. So that I think will probably be the only change that we will really see in pricing going forward is our own implied pricing changes, which you will see as we get ready to bring our winter â06 production with some exciting new high-end features associated with that product. Hi thank you. I was just wondering back to the cash flow question, I am sorry to keep hitting this, should we expect that your cash taxes paid are also going to be similar to 45%? Or is that just a P&L 45% we should⦠It is a P&L 45%. Because now that we have the deferred tax assets, youâre going to see us have the ability to have expense and tax cashes paid differently. So, what type of cash tax rate should we be modeling? Because I think thatâs what everyone is kind of perplexed by, is what type of cash flow number are we going to have next year and with net income, with peopleâs EPS numbers coming down due to the higher tax rate, how do we think about the cash taxes to adjust for that? If you have the tax, I mean certainly, we are looking at that. But again, weâre early in budget. It has a lot to do with country mix. The effective tax rate that we have the tax expensed is driven by a lot of that. It is virtually impossible at this time to tell you what that tax cash is going to be. And I am probably, not an area Iâm going to go to right now just given the state of the budgets and where we are at. We can talk further later on this year when we give the Q4 guidance. But that number is pretty darn hard to call based on the taxing jurisdictions you are in. You guys know we are focused on cash flow from operations. Weâve done very, very well this year. I donât think that attitude is going to change. But really it is about changes in receivables, it is about the net income you deliver, and itâs about changes in deferred that really drive cash flow from operations. The tax cash payment is not going to be a big driver. Hi guys. Another great quarter. I just had a question on the Service and Support group. Iâm wondering how many user adds came from this group in Q3? And then how many total subs are in this group and what percent of your total subs this could represent at some point? Well, itâs a great question, and I wish I had the answer honestly. I do not know if you saw the slides from our Salesforce Service and Support announcement. But I would just characterize that product as roughly about 10% of our business. That probably is not an exact number; thatâs an approximate rough scale. Thatâs how many customers we roughly said we had in that area that are using this type of functionality and product. There is certainly an opportunity for us to expand in our sales customers the use of service and support. We are working to identify a demand in our customers for this product. Weâre marketing aggressively to them. And like AppExchange and my comments there, this is a long-term initiative for us. We are in this one only about a year. For where we are after a year, we are very comfortable. We think that thereâs more work to do. We have made substantial investment in the Salesforce Service and Support group over the last I would say, 6 months. We hired a new Vice President and General Manager to run the group. She has done a fabulous job. She has also added a number of product management and marketing and business development executives. We have hired quite a few new developers. And we are looking to invest in the long-term in the Salesforce Service and Support product line. And I am cautiously optimistic that this also could be another very substantial way for us to be able to expand inside of our existing customers. That said, let me just a step back and say Salesforce as a product remains our primary product that weâre selling. It is where we are closing most of our deals. It is our Trojan horse. It is the product that goes in to the customer first. And from there, we expand through sales or Service and Support or through AppExchange applications. And we feel very, very good about the direction there and the potential of that product. Hi, just a quick question on the winter release and what sort of features will be in there to tantalize the option of that exchange? Okay, well thank you for that question. In the winter â06 release, there is of course the whole AppExchange platform as you know, Peter. There is the ability to build applications for the AppExchange, which is an integrated and inherent part of the winter â06 release, builds your tabs, your forms, your workflow and so forth. But of course, thereâs a major new feature in the winter â06 release, which is the ability to save your application. We have never had a save button before. You can hit save, and it packages all that stuff up. And then you can save it off to the directory, either a private or a public directory. And that ability to save apps, weâve never had it before. So we donât know how many apps are going to get saved. But we are going to teach people how to save apps. We are going to go out and encourage developers to build and save apps. And then customers are also going to find something else thatâs very exciting in the winter â06 release. You have seen, Peter, Iâm sure you seen the Multiforce technology, which was the on-demand OS and the ability to switch between multiple applications, right? And that has evolved into AppExchange, as you know. You are going to find the ability to go right to that menu, switch between different apps. And then, youâre going to see that there is a more function there. So you will click on there, youâll say, oh good, itâs Salesforce. So, go to the Service and Support product, oh go to the custom recruiting application or product management application Iâve built. And then it will say more. And then when you go to more, it will bring you the AppExchange and you will say, oh, and now add this additional application. And it will automatically get populated into that menu. Your data will automatically be integrated. The applications will have the same user interface that you are already familiar with, the same data model. Your security model will get inherited automatically. So those are the key functions for AppExchange for the winter â06 release. And Iâm really, really looking forward to seeing how customers like this technology. I think it will take two or three quarters before we know what kind of traction we have with this. But we are really excited about this opportunity. Thank you Steve, on the cash flow statement, the amortization of deferred commissions has been down year over year for several quarters in a row now, while the revenue is growing 70 to 80%. Can you just walk us through that dynamic? Is there a change in the amortization schedule? And also, Marc, relative to the API calls that you referenced, can you shed any light on the nature of the systems that are making the API calls? In other words, what part of that mix is exchange servers versus ERP apps or other CRM systems or database calls? Mark on commissions, nothing has really changed. Again as youâll know, we amortize commission expense. What shows up on the balance sheet is a function of the types of business that we have. If we have a lot of small business, it doesnât tend to have longer-term agreements and tends to be on shorter quarterly billings. So you will have some influence there. But thereâs no changes at all in our programs, and there wonât be until next year. On the API calls to enterprise, I donât⦠Well, hereâs the deal. I donât actually now. I guess we could look at it, I donât really know where all those different API calls are going. Customers are just doing more types of integration. Some of it is happening on the desktops, which is what you mentioned. A lot of it is happening on the enterprise. I can tell you for large customers like Cisco, while we are tightly integrated with their internal systems through a secure Web services messaging, thatâs true of a lot of our large customers and so you see deep integration on the enterprise as well as on the desktop, and itâs really across the board and I have not actually seen any characterization of it internally before. And that does conclude our question-and-answer session and also our conference call today for salesforce.com. We do appreciate your participation. You may now disconnect. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. 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EarningCall_234026 | Hereâs the entire text of the prepared remarks from BankRate.com's (ticker: RATE) Q3 2005 conference call. The Q&A is in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Executives: Rich Ingrassia, Roth Capital Partners, Analyst Yousef Squali, Jefferies and Company, Analyst Colin Gillis, Adams Harkness, Analyst Mark Monane, Needham & Company, Analyst Bill Roy, Jacob Asset Management, Analyst Good morning, everyone. And thank you for joining us on this conference call to report Bankrate's Third Quarter 2005 Financial Results. With me here in our New York Office is the Company's President and CEO, Tom Evans, and joining us on the phone from Florida is Bob DeFranco, our Senior VP and Chief Financial Officer. Let me take a minute to go over the format for the call today. First, Tom will give us results and color on the quarter. Bob then will give us some details on the financial results, and then we'll have some time for Q&A at the conclusion. Standard Disclaimer Omitted. So, with that being taken care of, let me introduce you to Bankrate's President and CEO, Tom Evans. Tom. Thanks Bruce. Welcome everyone. By now, I hope you've seen the press release we put out this morning covering our third quarter 2005 results. First, we will talk about the quarter and give you a feel for the strength of our business. And then we'll walk you through the state of our cost-per-click launched on October 1. By all accounts I can tell you that we were very pleased with our performance in the third quarter. We saw an increase in overall revenue, traffic to the site remains strong and we successfully launched the new cost-per-click platform on our rate tables. For those of you who had a concern, that Bankrate is highly mortgaged and re-fi dependent, we have some interesting results from our first month of CPC, that will go a long way in dispelling that notion. We'll get into that in detail later. But just to recap, revenue for the third quarter was up 31%, pre-tax income was up 106%, gross margins were up and operating margins were up in the quarter. Page views were up over the same quarter last year by 17% and we added $5.2 million in cash in the quarter. Thanks Tom. Good morning everybody. As Tom just mentioned, we're very pleased with the results for the quarter ended September 30, 2005. Total revenue reported for the third quarter of $12.4 million, was 2.9 million or 31% better than the $9.5 million reported in Q3 last year and slightly exceeded last quarter to become the highest total revenue quarter in the Company's history. Excluding barter revenue, total revenue was 11.9 million, up $3.1 million or 35% over Q304, and was about 300,000 or 20% over last quarter. We continue to intentionally reduce barter revenue, which was down 31% from Q3 '04 and 39% from Q2 '05 as we are much more interested in monetizing our available page views through paid advertising. For the nine months ended September 30, 2005, total revenue of 35.2 million was 2.9 million or 31% ahead of the same period in 2004. Traffic ad revenue in Q305 or 6.6 million compared to 4 million in Q3 '04, the 2.6 million or 64% increase resulting from 17% more page views in the current quarter and higher CPMs. Page views in Q3 '05 were 107.8 million versus 92 million in Q3 '04, and were 6 million or 5% lower than the 113.8 million in Q2 '05 reflecting a bit of sluggishness in September, but October date has rebounded back to anticipated levels. For three quarters of 2005 we served 332.6 million page views, 15.8 million or 17% more than the same period in 2004. Our mortgage lead aggregator program continues to perform as planned. Our two partners, LowerMyBills and iHomeowners used approximately 31% of available ad impressions during Q3 '05, compared to the almost 60% of the seven aggregators used in 2004. Higher CPMs generated almost 700,000 or 41% more revenue in Q3 '04, and in nine months the aggregators used approximately 35% of available ad impressions, and revenue was up 1.9 million or 35% on higher CPMs. Contributing to the strong graphic ad sales in Q3 '05 was our ability to monetize the additional inventory made available by the aggregator program. Our CPMs increased 36% in Q3 '05 compared to Q3 '04 and over 50% for the nine-month of 2005 compared to 2004. During Q3 new advertisers and new business with existing advertisers included Bank of America, American Express, Ameritrade, Washington Mutual, Wilmington Trust, and State Farm Insurance. For the nine months ended September 30, '05, graphic ad revenue was 18.6 million compared to 12.1 million in the same period of 2004, a 6.5 million or 53% increase. Hyperlink revenue in Q3 '05 of 4.1 million was up about 700,000 or 20% from Q3 last year, and was 363,000 or 10% better than last quarter despite a 23% decline and a number of advertisers from a year ago, due to consolidation in the industry. For the first nine months of 2005, Hyperlink revenue was 11.3 million and essentially the same as the same period in 2004. We have made up the year-over-year shortfalls of the previous quarters in pricing and the Yahoo! CPC rate table launch in April. Our hyperlink business model changed dramatically as of October 1 as we migrated at a cost-per-click model on our rate table. And Tom is going to give you a lot more color on the progress today. Print, publishing and licensing revenue of 1.2 million for Q3 '05 was down about 12% from Q3 '04 as the decline in the number of consumer mortgage guide advertisers reflects the continued softness in the newspaper advertising. For the first nine months of 2005, print, publishing and licensing revenue went up 3.5 million was down about 14% compared to the same period in 2004. On a positive note, our license editorial content and rate data business continues to run about 10% better than last year. Net income for Q3 '05 was 2.7 million or $0.16 per diluted share and exceeded the consensus estimate of $0.14 per diluted share. Our income tax provision for the quarter was 1.6 million and represents the non-cash utilization of deferred tax assets throughout the remaining net operating loss carry forward periods. In Q3 '04 net income was 1.2 million or $0.13 per diluted share with no income tax provision. Income before taxes of 4.3 million was 2.2 million or 109% better than the 2.1 million reported in Q3 '04 and was 241,000 or 6% better than the 1.1 million reported in Q2 of this year. And Q3 '04 included a $390,000 legal settlement charge. For September 30, 2005 net income was 7.1 million or $0.42 per diluted share compared to 6.5 million or $0.41 per diluted share for the same period in 2004, and remember, with no income tax provision in 2004. Income before taxes of 11.4 million was 4.9 million or 75% better than the 6.5 million reported in the same period last year. Our gross margin for the third quarter was 76% and our operating margin was 32%, both improvements over the 74% and 20% respectively in the third quarter last year. Excluding barter expense, other expenses for Q3 '05 of 4.9 million were about 820,000 or 20% higher than the comparable 4.5 million in Q3 last year. That excludes the $390,000 legal settlement charge in Q3 '04. Sales expenses were up slightly following the increases in revenue. Legal and accounting fees were higher as well as our management incentive plan accruals, but we continue to improve our operating efficiencies. Excluding barter and the legal and severance charges from last year, other operating expenses as a percentage of revenue has dropped from 48% in 2003 to about 40% so far in 2005. Our cash flow showed a dramatic increase this quarter increasing 5.2 million. We generated over 12.2 million in cash from operations in the first nine months of this year compared to 6 million last year and end of the quarter with over 40 million in cash, up 13 million from a year ago. I will now back to Tom, who is going to talk about the other business items of the quarter and what to expect in Q4 and what we envision for 2006. Thanks, Bob. Let me just make one correction. I think I heard Bob say in Q3 '04 net income was 1.2 million or $0.13 per diluted share. It was 2.1, I think he flipped those numbers. I just wanted to make that correction. So, let me take a few minutes to cover several subjects that are undoubtedly of interest to the audience we have today. First, let me put some color on the quarter which Bob just covered in detail. Then I will discuss the October 1st cost-per-click launch and give you a sense of how it is going. Third, I will talk about some of the trends. We think we will have a positive impact on our businesses we look forward to next year and finally to give you an update on our planned entry in the aggregator business on January 1 that we talked about previously. In the third quarter, we continued to see a number of positive things happening in our business. First, we saw a continuation of the moment in our graphic advertising side of the business, as more advertisers continue to make larger commitments to both the Internet and the Bankrate in particular. Our ad sales staff is now firmly in place and doing a great job, and we continue to see CPM and sell-through rates improving. We believe there is an even greater growth opportunity in graphic advertising. So, we have recently added three more ad sales people to our staff. One each in San Francisco, Chicago, and New York. We now have 16 full-time ad sales people on our staff and we think that for now that's probably the right level. In the fourth quarter, graphic ad sales bookings was very solid and our momentum for 2006 is very small. Another positive development in the quarter was the distribution of traffic, both in terms of the sources from which it came as well as the channels that picked up traffic. You have heard me talk before about what I think is one of the most important and most often overlooked components of evaluating Internet companies and that's organic traffic. In the quarter, 88% of the traffic at Bankrate came to us free. Of that, 72% came organically or directly to Bankrate, our highest quarterly percentage ever. 60% came through our co-brand partners and 12% came through paid search. We're really pleased with those numbers as we have seen -- we have all seen the competition for traffic and the cost of buying traffic doing nothing, but increasing over time. So, we are feeling great about that development. We believe organic traffic is one of the core strengths of our Company and of our business model. On the website, we are pleased to have seen an increase of traffic to the rate table and an increase to our deposit channel. In fact, 30% of our traffic in the quarter went to the deposit channel and has increased beyond that to over 14% in this current month. It really does confirm what we have stated all along, that if interest rates rise, there is a accessory in our model as people come to Bankrate to find the best rates and to make deposits. In fact, we have got some pre-interesting data this year in a minute when we talk about the CPC activity. I am also happy to be able to tell you that for the first time in a while we had some positive developments on the print of our business. This July, we have signed 17 new newspaper agreements, which will begin late in this quarter, and early next year. While it's great that those new agreements will contribute almost $1 million to the print and licensing revenue line next year, we also like the impact that it has in the visibility and branding of Bankrate, and in a vital way on the organic traffic to our website. And we think that there might be several other growth opportunities on the print side in the next three to six months. We are doing a better job there. We are delighted to finally be seeing some positive moments on the print side. So, all in all, it was a good quarter. Margins increased, expenses were held in check, revenue increased and cash increased dramatically. As most of you know, on October 1 we launched cost-per-click pricing on all the rate tables on Bankrate.com. I can hardly begin to describe the amount of work that went into building the necessary technology, documentation, marketing, and admin, budgeting and tracking tools for advertisers that were required for us to make the change from a flat fee to the cost-per-click pricing model. Additionally, we had to notify the advertisers that we were doing it, cancel all the 350 plus rate table contracts, train them on a new billing, budgeting and tracking tools, and get them all signed up and running by October 1. So, I suspect obviously, everybody would like to know what happened. I am pleased to tell you that initially, 89% of the hyperlink advertisers have signed up and are currently running on our rate tables. We have 49 new advertisers and 34 advertisers who for one reason or another have left Bankrate and has come back to try CPC. And I can tell you that we had pretty aggressive goals for the transition and it has exceeded our expectations. So the team did a great job and as you can see, we didn't spend a ton of money doing it. Now, please understand that we launched CPC with pricing that was intentionally not terribly aggressive, so that we would make it easy on advertisers and minimize the cycle shot of a pay-for-performance model. We are now 26 days into this new model, but we like what we have seen. We haven't had any markets where we have seen any meaningful decline in the number of lenders on our rate table, so, that's good for the consumer and for the integrity and value of Bankrate. And we have seen the ad budgets allocated by the advertisers to be large enough to meet consumer demand, which is also great news. However, I think the biggest and the pleasant surprise to us is that deposits are making up almost 40% of the cost-per-click revenue, which we think is a very cool sign. As rising interest rate environment, there is obviously, greater interest in CVs and money market accounts. In the past, we would have no way to take at that age of that shift from a revenue standpoint. It simply would have been a dynamic that we'd have had no chance to monetize. Now with cost-per-click, we are getting a direct benefit from the fact that consumers come to our site to find the best CV and money market rates, click on those institutions and make deposits. It's one of the many benefits of CPC and creates a more elastic model. It's a little early to make a definitive declaration and the fourth quarter is traditionally the lightest in terms of quick activity, which is one of the reasons that we pick Q4 to launch CPC, but again, we like what we see. Last year, we generated $3.2 million in revenue from hyperlinks in the fourth quarter. Previously, we have said with the launch of CPC, we expect to beat that number in this fourth quarter by at least 20% with a fair amount of net incremental revenue going to the bottom line. After 26 days of watching the hyperlink business performance, we are confident with that guidance. In fact, with the Yahoo! CPC revenue added to that, we are expecting at least a 30% lift over last year's Q4 from our hyperlink business. And we are eager to watch the business become even more profitable in future quarters as we begin to treat pricing and as we have talked about before by product and by market. Many of you have heard us talk previously about the fact that we wanted to be able to be in the business of generating and selling our own leads. Similarly, you have heard my Mike Tire analogy where we create the environment to generate the lead. We'll allow someone else to sell them and make the larger margin off of our customers. We have learned through our aggregator RFP of last fall and in watching the performance this year that this is the business we wanted to be able to run internally. I am not able to be more specific today, but we are still committed to that strategy and our timing remains unchanged. We are headed for a January launch and we should be able to give you more specifics on that very soon. That said, in January 1, we will be devoting some of our ad position to our own aggregator strategy. This year, as Bob mentioned, almost 40% of our ad position went to our two aggregator partners, LowerMyBills and iHomeowners. We will probably reduce the amount of that inventory we allocate to our aggregator somewhere between 10% and 15%. Why? Basically for two reasons. First, we believe that we have the demand for the 85% to 90% of our graphic ad inventory for next year from non-aggregator advertisers. And second, we believe we can integrate that aggregator capability into other areas of our website that will not cannibalize existing ad positions that we can sell to graphic advertisers. So we feel like, we will be able to have our cake and eat it still or maybe I should say have a piece and eat it still. The initiative we have been working on going forward relative to this strategy is to integrate the aggregator into as many of our co-brand and affiliate deals as we can. Again, this is another way for us to be able to monetize the traffic at Bankrate content, and the rate tables drive in areas other than our own website. We have envisioned down the road, dozens of Bankrate co-brands and affiliate sites carrying our content with our rate tables generating CPC revenue and our aggregator generating lead revenue at no cost except the revenue share with those partners. It will take time to sell through and covert those relationships, but once done, really creates a win-win for us and for our partners and develops two new revenue strengths. So, I'm sure you want me to quantify this, give some guidance on our CPC conversion, on our aggregator strategy and what it will mean to the finance at the Bankrate in 2006. At the risk of irritating everyone, I like to beg off on that for the time being. So, we will have more to say about the specifics of our strategy and what we believe the financial impact would be in 2006 in a few weeks. We are very excited about the impact that we think a fully optimized cost-per-click business, and generating revenue from leads will have in our business. Finally, as for industry trends there are several things that have been well documented that we believe will have a positive impact in our business in 2006, purchasing a credible number of ad dollars moving towards the internet. Paid search has forced advertisers to evaluate return on investment in their spending, and when that happens, the internet is a measurable and more efficient medium. So, advertisers are moving dollars accordingly, and it is a big trend and it's good for us. Second, we also believe that as the mortgage market tightens and slows down, that advertisers will have to work harder and spend more to reach their customers and keep their businesses cranking. As that happens, they will be willing to pay more to reach those customers. We think that will translate to having to pay more for the leads and more clicks and more for ads, all good for Bankrate. So, we believe the near-term and long-term trends are beneficial to us. One last question, one last comment on this year's guidance. You may have seen in our press release that we increased our revenue and EPS guidance for this year. Again, we are being somewhat conservative by protecting revenue between 47 million and 47.5 million, pre-tax income of 14.5 and 15 million, which will put us at about 70% increase over 2004 and will bring pre-tax EPS between $0.85 and $0.88. Let me mention something that is both important, may have a short-term impact on expenses, which we factored into that guidance, I just mentioned. We have been impacted by Hurricane Wilma that swept across Florida this past Monday morning. Our building shut down. We are out of power. We have lost our phone service and several of our employees have had damage to their homes and properties, but be assured the Bankrate website has not been affected by the hurricane. So, business is operating and the consumers couldn't even tell. However, groups of our employees are working at a local motel, which happens to have power. Others are working at emergency trailers that we ordered immediately after the hurricane passed. We will incur some expense from this effort that we factored into the guidance update, I just gave. However, as in last year, we will surely get this money back in the form of an insurance settlement sometime next year. We had the same situation occur to us in September of 2004. We were impacted by the hurricane not as far of our business, but as far as our expenses and we did receive as you know, from our financial reporting, a settlement of those expenses which covered those in a subsequent quarter in 2005. We expect the same thing to happen to expenses to be slightly up for this quarter as a result. I am sure there are questions. So, I will stop here and we'll take your questions at this point. With one caveat, no one is permitted to beat me up over being conservative about the estimates in the guidance. So, with that, the first question please. |
EarningCall_234027 | Hereâs the entire text of the prepared remarks from Broadcom's (ticker: BRCM) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Welcome to the Broadcom Third Quarter Fiscal Year 2006 Earnings Conference Call. During presentation all participants will be in a listen only mode. Afterwards we welcome back to Question and Answer session, at that time if you have a question, please press â*â followed by the â1â on your touchtone phone. As a reminder this conference is being recorded, Thursday, October 20th, 2005. The speakers for today are Scott A McGregor, Broadcom's President and Chief Executive Officer, Henry Samueli, Broadcomâs Chief Technical Officer and Co-Founder, Joe Ruehle, Broadcomâs Chief Financial Officer and Peter Andrew, Senior Director of Industrial Relation. I would now like to turn conference over to Mr. Andrew. Please go ahead. Thank you very much Christine, and welcome everyone to Broadcom Q3 2005 Earnings Conference Call. Before I turn the call over to Scott, I would like to alert everyone that during the call we will discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we will provide on future revenue, gross margin and operating expense target for the fourth quarter of 2005 or any other future period as well as statements about prospects for our various businesses and the development sales and plan availability of new products. It should be clearly understood that our actual results may differ substantially from forward-looking statements we make today. Specific factors that may effect out business in future result are discussed in the risk factors section of our 2004 Forms 10-K and subsequent 10-Qâs and in our other SEC filings. Our partial list of these important risk factors is said forward at the end of todayâs earnings press release. As always, we undertake no obligations to revise or update publicly any forward-looking statements for any reasons. Throughout this call whenever we refer to proforma financial results, we mean non-GAAP proforma. The earnings release published today, describes the differences between our non-GAAP proforma and GAPP reporting. And presents the reconciliation between the two for the periods reported in the release. Please see the investor information section of our website, for reconciliation going back to the beginning of 2003, as-well-as for additional financial and statistical information, including the information disclosed in accordance with SEC regulation G. Now before I turn the call over to Scott I would like to make one very quick announcement. Broadcom will be hosting our 2005 analyst-day in Santa Clara on November 9th, which we also, which we will also be Broadcasting, via webcast. For more details regarding analyst-day, please see our September 30th press release. With that let me turn the call over to Scott McGregor, Broadcom's President and CEO. [Scott McGregor, President and CEO] Good afternoon and thanks for joining us. The third quarter was another strong quarter for Broadcom. We grew revenue nearly 15% sequentially to $695 million, another record level for Broadcom. We have record net-income on both the GAAP and proforma basis and we grew cash and marketable securities by $158 million, even after paying out $242 million in settlements, share buybacks, and funding and acquisition. The record revenue level in the quarter was once again very broad based. This breadth and diversity of our product in the intellectual property portfolio differentiate Broadcom from many of our peers. I will talk more about our diversity later, but bottom line Broadcom had a great Q3. We expect another strong quarter in Q4. We will continue to invest aggressively to expand our communications product portfolio into new and emerging wired and wireless end markets. We believe that these efforts combine with our diversity, would directly benefit our shareholders and serve to strength and relationships with our customers. Let me now turn the call over to Bill to go into greater detail on our Q3 performance as well as to give our guidance for Q4. Thank you, Scott. Just take a look at some overview numbers at quarterly revenue of $695 million, which is up more than $90 million or just under 15% from Q2. Our proforma gross margin of 53.4% was down 30 basis points from last quarter. Total perform operating expense was up $21.4 million or approximately 10.7% from Q2. And we were able to show perform in non-GAAP operating margin up to 21.5%, which is increase from the 20.6% reported in Q2. Our proforma diluted earnings per share of $0.39, were up $0.05 from our last quarter. On a GAAP reporting basis, we are profitable for the eighth consecutive quarter reporting diluted earnings per share of $0.35. And as Scott indicated our cash marketable securities on hand increased by $158 million, inspite of some extraordinary displacements. Leaving us for the balance of just over $1.7 billion. In our July call, we said that we expected our Q3 revenue to be in the range of $660 million to $665 million, an increase of 9 to 10% over Q2. Our actual results showed a sequential revenue increase of 14.9% to a total of $695 million. Weâve experience particularly strong growth in Bluetooth, Wireless Lan, Mobile Multimedia, Cable Modem and our entire Gigabit Ethernet product lining including switches, controllers and points. Compared with Q3 of â04, our revenue was up $48.5 million, which is 7.5%. With that growth and perspectives what we called our server chip-set business had suffered a well publicized decline, that business was down by about $56 million, year over year. Therefore in the absence of that decline, we would have been by a $104 million versus prior year or 18%. In terms of revenue distribution for Q3, broadband communications accounted for approximately 34% from total revenue, mobile and wireless were approximately 27% and enterprise networking for 39%. And looking at our growth in revenue from Q2, broadband communications increased by about 5%, mobile and wireless increased by about 47% and enterprise networking increased by about 8%. In Q3, we had one customer who accounted for 10% of more revenue and that was Motorola. Our Q3 proforma gross margin at 53.4% was down slightly from the 53.7% reported last quarter. Weâve experienced some change in product mix towards some slightly lower margin products. And in addition with the industry demand improving, weâve been unable to secure boundary and simply in test pricing on a quite a favorable basis, as we had in recent orders. Turning to operating expenses, our total proforma operating expenses of $222 million in Q3 were up $21.5 million or 10.7% from the prior quarter. This included in an increase of $14.6 million or 10% in R&D and an increase of $6.8 million or 12% in SG&A. The R&D increase was primarily from the addition of headcount. We added 203 heads in the quarter, including 80 of which 75 are engineers from our silicon acquisition. Our stronger than expected revenue growth allowed us to be very aggressive and adding to our kit product detail facilities and we did that. Our SG&A increases primarily driven by a higher level of legal costs and by additional headcount. We increased our total company headcounts, by 264 to worldwide total of 4,002. This includes almost 2,800 people in engineering who represent 69% of our total headcount. Our annualized revenue per employee was $695,000 in the quarter, up from $647,000 in the previous quarter. We look at the profitability in Q3 on a proforma non-GAAP basis, we generated operating profit of $149 million at 21.5% of revenue, this moved our profitability towards the high end of our target range of 20% to 22%. Our proforma in diluted earnings per share was $0.39 up $0.05 from last quarter. Our weighed average shares outstanding increased by 20 million shares in the quarter, of which 15 million were driven by the treasury stock method of fight to outstanding options, as our average stock price increased from a little over $33 in Q2 to little over $42 in Q3. On a GAAP basis we reported an operating profit of $94 million, our largest reconciling item between GAAP and proforma operating profit was $35 million cash in-process R&D, related to our silicon acquisitions. Our GAAP diluted earnings per share was above $0.35. Additional GAAP expenses including the in process of R&D as just mentioned, as well as certain stock based compensation and other items, were partially offset by income tax benefits relating to certain points securities. Looking to the balance sheet we increased our total cash and short and long term marketable securities by $158 million but itâs just over $1.7 billion. So, some of the extraordinary disbursements we have an quarter included $110 million related into settlement of our securities class action litigation, which we announced last quarter. We also disburse $54 million of net acquisition cost and we disburse $77 million in repurchasing our stock under our stock buyback. On the cash positive side we collected $219 million from employees stock option exercises. In terms of other working capital items, our inventory balances increased modestly in response to our continued strong demand. Our days of inventory on-hand increased from 44 days to 46 days. That is equivalent to trends rate of 7.9, which is in line with our long-term model. Our day sales outstanding in receivables decreased slightly, from 37 days to 36 as our shipments remained pending. Looking ahead to the fourth quarter when we gave guidance for Q3, we commented that we believe that some of the strength we were experiencing was coming from purchases by our consumer oriented customers, in preparation for the holiday selling season. Weâve been pleased to see booking trends throughout the third quarter and so far into the fourth quarter remained strong, giving in itâs confidents of revenue in Q4, is also expected to be strong. For Q4 we do expect to see continued broad based strength across future of our major businesses. Overall we expect Q4 revenue to be up approximately 10% to 12% compared to Q3 to a range of $765 million to $775 million. We believe that some of the strength in our Q4 outlook is coming from our success and entering a number of very large, fast growing consumer oriented business. These businesses are more acceptable to seasonal spending patterns. As those of you who followed Broadcom for sometime now, our revenue is always been driven more by our product cycles and by seasonal spending patterns. However, given the growing portion of our business that is been derived from consumer oriented end markets we believe that it is prudent to expect that our total revenue in Q1 â06 will be slightly lower than in Q4 of â05. It is also important here to make a note of the diversification point, Samueli will elaborate on little more on his remarks. For more than 20 separate lines of business within Broadcom no single line of business accounted more than 12% or revenue in Q3 and this within the typical pattern in recent quarters. Weâve obvious benefited this at any weakness in a particular market segment is not likely to have a major impact on our total Company to growth. We believe that gross margin for Q4 on a proforma basis will be down from Q3 of our suppliers, particularly in assembly and test, retire rates of utilization and therefore how we made the base with in selective cost increase. We also expect our mix of business, we once again Bias starts slightly lower margins. We are looking for proforma gross margin to be down from Q3 by about 50 to 150 basis points. We expect the proforma operating expenses will increase better to slower rates in this past quarter and at a slower rate in our expected revenue increase. And we expect our cash flow generation, once again be quite strong in Q4. At this time I would like to turn the call back over to Scott. Thanks Bill, all often the topic I started earlier, we saw Broadcom as very diverse here at the same time highly focused or this might have first seen contradictory its actually quite accurate. Broadcom has a very broad product line intellectual property portfolio and customer base focused on wired and wireless communications for the transmission of voice, video and data. Here to highlights, in how diverse our business is. Broadcom is focused on three targeted âMâ markets, each of which grew on a sequential basis in Q3, one is much as 47%. Only one customer was more than 10% of sales in the third quarter. All of our top five customers want product from us for multiple business groups. Our top 10 products represent was some 30% of the total sales. Those single line of business accounted for more than 12% of our sales, and we produced well over a million chips a day on a daily basis from five different wafer suppliers with no one of them over 50%. This diversity in breath is the result of our strategy to drive the conversions of many different technologies products and end markets. This is important to customers as Broadcom is better able to be a one stop provider for all of their voice, video and data needs whether over a wire or wireless medium today, so both to offer a road map of future features of functions. Diversity is also important to our employees as it provides them with the wide verity projects to work on as well as the opportunity to see broad adoption of their work into products. Finally it is important to shareholder, because the same benefits of portfolio diversification, many of you use in managing your portfolios by the Broadcom in the way we manage our business. The execution on this diversification strategy, can you able to seen by comparing Broadcomâs growth versus the semiconductor industries association or SIA growth estimates. Broadcom has consistently out grown the overall industry and based on SIA estimates for overall growth in 2005, Broadcom is once again poised to out grow the industry. I will now give you a few market highlights before turning the call over to Q&A. Our global in the wireless group was the fastest growing group this quarter as revenue grew 47% sequentially, driven by the sales of Bluetooth, Mobile Multimedia, Wireless Lan, Voice Over IP solutions. When differentiating Broadcomâs from many of our peers in wireless is but aggressively investing in the wireless technologies, that define the mobile platforms of the future, such as Wireless Lan, Bluetooth, Wideband CDMA BBAH and Mobile Multimedia. We are driving differentiation by offering higher levels of integration so is value added softwareâs such as security to setup in our Bluetooth software profiles and we are able to leverage many of these ingredient technologies such as Bluetooth, Wireless Lan, Mobile Multimedia and Voice Over IP into our other product lines, such as broadband modems, set top box and others. With respect to Bluetooth, the market remains very robust. Instat recently raised their expectations for this market to 323 million units for 2005 up from their prior 2005 estimative of 264 million units. This would represent more than a doubling of the market versus 2004. If we look at the largest market segments, selling of our handsets Instat also raised their 2005 estimates from 158 to 237 million units. This represents on a tax rate of about 35% in a segment where we have a strong and growing market position. I want to send a quick note of congratulation to our Bluetooth group, during the quarter they were awarded Marauders supplier of the year award. Marauder award largest manufacturer of Bluetooth model for cell phones and in Marauder 71-year history Broadcom is the first non-Japanese supplier to win this award. So this is indeed a significant honor. Mobile Multimedia products grew in the quarter, driven by the ramp of our next generation multimedia processors are based on the Video Core II architecture. This product has been adopted in the next generation portable devices that are able to play mp3 as well as video, as an example of how Broadcom is able to extend our existing product line for both new and existing customers. We have again proven our ability to enter new market and gain significant market share. Broadcom is also recently announced its intention to enter another a new end market, mobile digital TV, DVB-H technology, the Wi-Fi Athena semiconductor acquisition which closes this week. Athena brings a strong engineering team on the RS side which when combined with our video core, more power, high performance multimedia engine, enables us to provide a very compelling solution to the mobile digital TV market. Broadcomâs Wireless Lan businesses continue to grow as we believe a number of our customers are getting ready for the holiday season. We believe 802, 11-G will still be the primary standards this holiday season. And Broadcom is the market share leader in not only 3G, Wireless Lan overall. We believe that the next growth cycle in the Wireless Lan market will be driven by the adoption of 802 11N in incorporating MYMO, which is multiple-in, multiple-out technology. To accelerate the standard setting process Broadcom is partnering with 29 other companies, help accelerate the adoption of 802 and 11-N. We expect standard phase MYMO products to hit the market in our early 2006. In the cellular handset market we continue to make excellent progress on getting our customers products to the final stage of IOT testing. Our expectation for Broadcomâs 3G ramp remains on track. In the GSM and GPRS markets our largest customers Sony Ericsson has been going through a product refresh and they have announced a follow-on products using Broadcom Silicon. Based on the ramp of these new products, and some small initial 3G revenues we believe that our sale of handset business will sequentially grow in the fourth quarter. Within our broadband communications group, broadband modem revenues grew nicely in the quarter on both the CPE and CEO side. The key driver for our success in these markets present being approach the market with new protocols and features in our integration roadmap. As an example, to help drive the adoption of voice into the cable modem markets, Broadcom earlier this week announced our second generation of single chip cable modems integrating Voice Over IP. This solution eliminates the separate DSP and runs the Voice on Rhythm on a dual credit mix core enabling the whole new reveal of integration or at the same time lowering middle materials, accelerating the time to market for our customers. Itâs important to point out that seven of our customer products incorporating with the chip is already, have already received pack of cable certification and headed for production as we see. The adoption of voice in the DSL modems is as just strong in the cable modem market. And in Q4 we look to triple the number of voice enabled modems we ship. In DSL 2 market, we are also progressing well with solutions for both CL and CPE. Well, Asia certainly the main market for media sale, we are seeing a high to put interest and near term opportunities in Europe it carries preview ramping up for the up coming world cup by offering triple play services. Within the set-top box markets Broadcom continue the benefit from the mix ship from the low to high end in cable set-top boxes over satellite set-top boxes benefited mainly from new customer expansion. We believe that the set-top box market is in equilibrium with respect to inventory levels. While we shipping into the market, it does appear to be selling true. As we look forward, we see continued units, new customer in ASP growth opportunities. For example just this week, LG announced they were selected as the first supplier for high definition Stb, by direct TV using Broadcomâs new MPEG-4 technology. For us this is a new customer, a new service provider all using our latest technology. In enterprise networking, the migration to Gigabit Ethernet continued on itâs growth path on both client and infrastructure side. On the Gigabit Ethernet client side Broadcom maintained its market leadership position and surpassed the 76 million unit milestone growing revenues in all three segments of the market, mobile, desktop and server. With respect to our next generation converts matrix CNET family we expect to see to solutions ramp in the first half of 2006. In addition to the TCP and IP offload functionality being high on usually switched with, we are also seeing a lot interest in the iSCSI functionality. To address the next major speed step up to 10 gigabit within servers, we extended our roadmap with the acquisition of Silicon Technologies. The Silicon architecture is similar to our own internal architecture meaning that we are going to be able to quickly leverage our high performing software series function, such as TCP-IP offload, audio made for clustering and iSCSI under the higher speed pipe. On the infrastructure side, we experienced another double-digit revenue growth quarter in Gigabit Ethernet switches and pipes. As carries continue to transition their networks to Ethernet and adopt our vision of using Ethernet everywhere this is opened up an opportunity for Broadcom to sell our Ethernet based product into new markets including metro-Ethernet, IPB Slam, (indiscernible)21:35 infrastructure and PAN equipments. We made progress in the quarter securing design vent in each of these new areas. Even our optical business was strong driven by the demand for OC 192-5. In addition to these expansion opportunities Broadcom won a number of new switch and radar platforms with our 32 and 64 bit broadband processors. As also extending our prior offerings in to other end markets including game platforms, printers and other applications. So, in summary, we had a very strong broad based growth quarter. Broadcom is powering this communication revolution by offering the widest array of wired and wireless networking option. And by breaking down the layers of complexity enabling us to connect in the most efficient manner possible. With that I like to call over to operator for Q&A. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234028 | Good morning, ladies and gentlemen, and welcome to the AT&T first quarter earnings release 2006 conference call. (Operator Instructions). Please note that this conference is being recorded. I will now turn the call over to Mr. Rich Dietz, Senior Vice President of Investor Relations. Mr. Dietz, you may begin. Thank you, Christine and good morning, everyone. Welcome to our first quarter conference call. I'm Rich Dietz, Head of Investor Relations for AT&T, and with me on the call today is Rick Lindner, our Chief Financial Officer. We're delighted to have you with us today. Our earnings release, investor briefing and supplementary information were all issued earlier today, and they are available on the Investor Relations page of our website. On this call, we will speak to a set of presentation slides. They are available on that same web page at www.att.com/Investor Relations. Before we get started, I need to cover our Safe Harbor statement and remind you that information set forth in these presentations contains estimates and other forward-looking statements that are subject to risks and uncertainties. The actual results may differ materially. These presentations may contain certain non-GAAP financial measures. Reconciliations between the non-GAAP financial measures and the GAAP financial measures are available on the Company's website. A discussion of factors that may affect future results is contained in AT&T's filings with the Securities and Exchange Commission. AT&T disclaims any obligation to update or revise statements contained in these presentations based on new information or otherwise. I would also call to your attention on slide 4 of our presentation. This slide contains information regarding filings related to our proposed merger with BellSouth. Now turning to slide 5, let me provide you some backgrounds on our segments. As you know, this quarter marks our first quarter of combined operations following the merger of SBC and the former AT&T. In our fourth quarter's results, which were released in January, we had a partial quarter of former AT&T results. In that interim quarter to provide continuity, we presented legacy AT&T results as a separate segment. This quarter we are well underway with our integration and as a result, we have combined results into new segments that reflect how we are managing the business. We have a wireline segment which contains and combines the wireline operations of SBC and the former AT&T. We have a wireless segment which is unchanged --that is Cingular. We have a directory segment. That includes Yellow Pages, plus our electronic directory business. The fourth segment is other. It includes results from equity investments and Telmex and America Movil, Sterling Commerce, corporate operations and our equity earnings from Cingular are shown in this segment as well. To help with trending, we have made available supplemental information on the Investor Relations page of our website. This includes quarterly GAAP statements based on the new segments for the past eight quarters. You will also find pro forma statements that show 2004 and 2005 quarterly and full-year revenue results for product categories and wireline customer groups. I hope you find this information helpful, and of course, if you have any questions with material, please contact anyone in our Investor Relations team. Turning to slide 6, let me add a brief update on the BellSouth merger approval process. As you know, AT&T and BellSouth announced an agreement to merge on March 5. In the few weeks since then, we have moved ahead quickly and taken the first steps to get the various approval processes underway. We filed with the Securities and Exchange Commission on March 31, and based on our past experience, we expect a shareowner vote sometime this summer. Also, on the last day of March, we made our filings with the Department of Justice and we submitted applications to the FCC. There are six states in the BellSouth region that have an approval process. Notices are required in three additional BellSouth states. Applications are required in 12 other states and in a few foreign countries. All of these applications and filings have been made. We have made a good start in the processes and will believe it is reasonable to expect the approvals can be concluded to allow closing of this transaction by the end of this year. Now we would like to review our EPS comparisons which are on slide 7. The adjustments are straightforward and follow the format that we have previously used. In the first quarter of 2006, our adjusted EPS was $0.52. Starting at the top of the first column and working down, reported EPS was $0.37. We add back $0.06 of Cingular merger integration and intangible amortization costs. We also add back $0.09 of costs related to the AT&T merger, and the result is an adjusted EPS of $0.52. Please take note of the adjustment amounts detailed in the footnote on the slide. In the first quarter of 2006, approximately two-thirds of the adjustments are for non-cash items such as amortization of intangible at both AT&T and Cingular and accelerated depreciation at Cingular. Adjusted EPS in the first quarter a year ago was $0.34. Walking down the column on the right, reported EPS was $0.27. We had $0.07 of Cingular merger-related costs, resulting in an adjusted EPS in first quarter of '05 of $0.34. So our reported EPS in the first quarter of 2006 was $0.37. That is up 37% versus the year earlier first quarter, and our adjusted EPS was $0.52. That is up 53% versus comparable results in the year ago first quarter. With that as background, I will now turn to Rick Lindner, AT&T's Chief Financial Officer. Thanks, Rich, and good morning, everyone. It is great to have you with us for the first full quarter of results from the new AT&T. As you have seen, we had a very good quarter. Cingular Wireless delivered outstanding progress. Churn continues to move down. Margins continue to move up. ARPU is stabilizing. Data growth was very strong, and subscriber growth was encouraging. We also delivered growth in regional consumer and small business. In the past you saw SBC deliver seven straight quarters of wireline revenue growth, and our end region results this quarter continue that trend. There are encouraging signs in enterprise. Volumes are strong, and we see positive indications of pricing stability. We are off to a strong start in terms of AT&T merger integration, and we are on track with our targets for the year. Our adjusted operating income margin in the first quarter was 17.2%, which is above the full year range we gave you in January. So strong margins, good EPS growth and solid momentum; all-in-all, a very good quarter. Slide 10 shows our earnings per share trajectory, and as Rich detailed for you, adjusting for merger-related costs in the first quarter we had EPS of $0.52. As you see on this slide, this is our fourth straight quarter of sequential and year-over-year growth in adjusted EPS. Our EPS growth drivers are straightforward. First, contributions from wireless have increased substantially, and there is a great deal of additional upside ahead. Second, we continue to execute well in wireline. Third, we have begun to realize some SBC/AT&T merger synergies. Although we have just begun to scratch the surface, the big opportunities lie ahead. And finally, the AT&T merger itself was accretive to adjusted earnings from the outset with contribution growing as synergies are realized. Wireless is a key driver of our EPS growth, and we have a quick recap of Cingular's first quarter starting with slide 11. The bottom line is merger integration is working, and Cingular is producing very positive results. Network performance is on an upward curve. Customer service has improved as well, and the result is a substantial reduction in churn. In each of the past several quarters, Cingular has led the industry with the highest gross adds. Now not only are more people choosing Cingular, more people are staying with Cingular as well. Overall churn was 1.9%, postpaid churn was 1.6%; both were Cingular's best ever. Over the past two quarters, both were down 40 basis points. These are very good trends, and we are confident there is more to come. Lower churn comes from delivering on the fundamentals -- the fewest dropped calls of any national provider, broad coverage, feature-rich attractive handsets, exclusives in both handsets and content and great customer care. Lower churn combined with continued strength in gross adds resulted in a net subscriber gain of 1.7 million with postpaid adds up more than 40% versus the previous quarter. Cingular's revenue growth was also strong, above 9% for the second straight quarter. The details are on slide 12. The drivers are strong subscriber growth and stabilizing ARPUs with impressive growth in data ARPU. Over the past year, subscribers are up more than 5 million and overall ARPU declined just 2.3%. If you went back a year ago, ARPU declines were mainly about overall pricing and primarily customer migration to new plans. At this point, the numbers reflect different factors, primarily the impact of reseller ARPU, which tends to be lower and brings down the overall average. But Cingular's ARPU, excluding impacts from the growth in reseller subs, was actually up year-over-year, and that was driven by higher data ARPU. Data ARPUs are up dramatically, as you see on this slide. In fact, we have added $0.89 of data ARPU in just the past two quarters as more customers have data capable handsets and as applications and content become more compelling. I would point out that the first quarter data ARPU of $522 is an overall average. We include in the base all 55.8 million of our subscribers. If we were to calculate the average on our postpaid base or on our 25 million or so active data users, data ARPU obviously would be much higher. In the first quarter of 2006, Cingular delivered 91 million multimedia messages and nearly 7 billion text messages. To drive further increases in data usage, Cingular is aggressively pursuing new products and services from the SLVR with iTunes to video services to new devices. We have just begun to realize the potential in wireless data, and with Cingular's Spectrum and its 3G deployment we expect to do very well. The other key area where Cingular is delivering good progress is in margins, which we show on slide 13. Cingular's adjusted margin in the first quarter was 31.9%, up 90 basis points sequentially and up 640 basis points over the past year. These numbers are more impressive when you consider the strong subscriber growth we had in the first quarter and the fact that more than 7% of the subscriber base upgraded handsets during the quarter. There is a lot of activity underway at Cingular that promises to drive down costs: network integration, streamlining systems, customer care and billing system conversion. While we have made tremendous progress in these areas, a great deal of margin upside lies ahead. Cingular continues to manage the unwind of its California/Nevada joint venture with T-Mobile and now has 71% of their customers on their own network in those markets. Cost will continue to decline as more and more of our customers fall onto our own network. Network integration activities are on schedule. Just over half of overlapping GSM cell sites have been integrated. Increased cost savings will fall into the second half of 2006 and the beginning of 2007 as Cingular largely completes GSM network integration. 97% of Cingular's minutes and 89% of its handsets are now GSM. Plus, their substantial opportunities will begin to sunset Legacy billing systems. Cingular still has a large set of cost reductions ahead, and as AT&T acquires 100% ownership of Cingular, we look forward to 1,000 basis points of margin opportunity on a $36 billion business. There is no other company in our industry with that magnitude of opportunity. Let me turn now and talk about our combined wireline business. As Rich mentioned earlier, our wireline segment now includes both the former SBC and the former AT&T wireline operations which we are integrating. Because the old organizations have been combined in some areas, what I have for you on slide 14 is a look at these revenues by customer categories as additional background to the new wireline segment. The growth rates shown here are pro forma, meaning the operations whose results are included in the categories are consistent for all periods. Pro forma results are available on our website as Rich mentioned earlier. Starting at the top, we have regional business. This includes small and medium business customers in our former SBC 13-state region. These revenues grew 7% in the first quarter. Our regional consumer revenues grew 2.1%, and together our combined regional small and medium business and our regional consumer revenues totaled $5.6 billion and had a combined first quarter growth of 3.8%. As you know, through the end of 2005, SBC had seven consecutive quarters with wireline, consumer and business revenue growth, and these results demonstrate that trend is continuing. The next customer category is enterprise, which combines former AT&T and former SBC large business operations. Revenues in this category totaled $4.5 billion in the quarter with a 6.9% decline as reported. As we mentioned last quarter, the former AT&T sold a payphone business that had been included in this category. Excluding those revenues from the year ago first quarter, enterprise revenues declined 6.1%. Next is wholesale. Again, this combines former AT&T and former SBC wholesale with revenues of $2.9 billion. Excluding a couple of positive items in the year ago quarter, wholesale revenues were essentially flat. As reported, they are down 2.2%. In the first quarter, these four revenue categories added up to $13 billion with an overall decline of 1.4%, and excluding the wholesale items and the payphone revenues, the overall decline would have been very slight, just over 0.5%. Also, shown here are the former AT&T national mass market customers. That is consumer and small business, both stand-alone, long distance and local bundled service. The first four categories shown on this slide are customers we are managing for long-term growth. In the national mass market areas, we have a different targeted strategy. In part, the strategy is to focus on cash flow. In the first quarter, our direct margins in national mass market were stable at just over 50%. For that portion of the national mass market base that is located in our local service regions, especially where we have a chance to offer our full line of broadband and bundled services, we will work to convert some of this space to regional bundles. Now let's take a deeper dive into some of these customer categories. Slide 15 shows regional small and medium business. Again, revenues were up 7%, and we had four straight quarters of mid single-digit pro forma growth in this category. Access lines increased modestly in the first quarter as they have over the past several quarters. Churn and voice revenues continue to be very stable. We had double-digit data revenue growth led by dedicated Internet access, virtual private networking and DSL. Business DSL net adds were stable and with increasing ARPUs. More than half of our DSL sales in this category were for speeds above 1.5 megabits. Transport revenues were led by strong growth in Ethernet, Metropolitan optical networks, as well as growth in DS1s, DS3s and SONET. Bottom line, continued solid performance in regional small and medium business. Slide 16 shows results from regional consumer, which are driven by broadband and bundling. We increased our total in region DSL line base by 511,000 in the quarter to more than 7.4 million. Nearly 90% of our first quarter DSL net adds, or 457,000 were consumer. As you see in this chart, our DSL penetration of consumer primary lines at the end of the quarter was 27.7%. That is up 810 basis points in one year, and in our best region, California and Nevada, consumer DSL penetration is above 33%. Higher speed products made up more than a one-third of our consumer DSL sales in the quarter, and our DSL churn is at our lowest level ever; in fact, lower than our basic voice churn. Despite cable competition, retail consumer line losses were generally consistent with recent quarters, up just slightly in primary lines. Retail consumer access lines declined by 267,000 and additional lines which reflect migration to DSL accounted for 40% of that total. The remainder were to wireless, cable and VoIP providers and CLECs. Combining DSL access lines and video, we added 223,000 retail connections in the quarter and 775,000 over the past year. Because of our success in broadband and bundling, our consumer ARPU was up 5.7%. We continue to grow revenues in our regional consumer business. We continue to have success with our strategy of bundling and broadband penetration. Now let's turn to enterprise. The highlights are on slide 17. We are seeing a continuation of the overall trends that we showed you in fourth quarter results. There are four main factors at play in this space. Second, volumes are strong in data circuits, IP-based data services and in long distance. In fact, long distance minutes were up sequentially in the quarter, the first time that has happened in the past five quarters. Data circuits volumes, DS1s and DS3s, were up nearly 7% and 23% respectively. Third, technology migration is a constant with customers moving from packet-based service to IT data. We are capturing this migration with our outstanding portfolio of services, including virtual private networks, hosting and managed Internet services. Fourth, we continue to see indications of more stability in pricing. Pressures remain obviously, but in enterprise voice and data, the gap between average price in the portfolio and price points in current sales has narrowed. In total, our enterprise revenues declined 6.9% in the first quarter. That compares with declines of 9% and 8.8% in the quarters before. If you were to exclude from first quarter 2005 the revenues from the payphone unit that AT&T sold last year, then the year-over-year decline would have been lower at 6.1%. 46% of our enterprise revenues in the first quarter came from data. Our enterprise data revenue grew slightly in the first quarter, and that compares with declines of around 4% in each of the two preceding quarters. So again, as we saw last quarter, there are encouraging signs in enterprise. No one should expect a one quarter turnaround, but with our networks, our product sets, our commitment to customers and with solid management, we will move enterprise revenue into positive territory. Slide 18 shows our results in wholesale. Wholesale revenues totaled $2.9 billion in the first quarter, and as you see in the chart on the bottom right of this slide, this revenue stream has been very steady. Nearly 40% of our wholesale business comes from data services, and data and long distance combined represent two-thirds of the total. Our first quarter wholesale LD revenues were up 13% with strong volume growth in both domestic and international. Local wholesale declined, reflecting the ramp down of UNE-P. We saw a decline in local wholesale connections of 274,000. That is the smallest decline we have seen in six quarters, roughly half the decline we saw in the fourth quarter of 2005. Wholesale data was down slightly, reflecting pricing pressures offset by volume growth, particularly in DS1s and DS3s. As I mentioned earlier, if you remove a couple of positive one-time items in the year ago quarter, wholesale revenues were essentially flat. Before moving on to merger integration and margins, let me add a few comments on revenues from a product perspective and specifically data revenues. The highlights are on slide 19. We have data revenues, as you know, in several customer categories, but primarily they reflect business, wholesale and consumer DSL. In the first quarter, data made up more than 30% of our total wireline revenues. That percentage has grown. It was about 28% a year ago on a pro forma basis. In the first quarter, our total data revenues grew 2.6%, and as you see in the chart on the upper left, that was our best growth in the past five quarters with improved growth rates every quarter. As you see in the chart on the bottom left, retail data revenues grew 4.8%, also our best in five quarters. Three-quarters of our total data revenues come from retail. Data transport revenues were up 1.6% with good volume growth. DS1 and DS3 volumes were up throughout 2005, reversing declines in 2004. Packet data declined 12.5%, reflecting migration from frame relay to EVPN and managed Internet services, which are part of our IP data category. IP data continued its double-digit growth, up 14%, partly due to this migration and also due to strong volume growth in these areas, as well as in DSL and hosting. As you see in the pie chart on this slide, 83% of our data revenues come from transport and IP, both of which have good growth. So overall a solid quarter for data revenues. First quarter has also been busy in terms of merger integration. Slide 20 provides an update. As we outlined in January, we expect expense savings from these merger synergies to be in the $600 million to $700 million range this year. While we are still very early in terms of execution, based on our progress to date, we are very much on track with the targets we laid out. Our frontline enterprise sales force consolidation is complete. We are now able to sell a number of our high-end enterprise product services down markets to our regional small and medium business customers. Detailed project planning is complete for network integration, and build out began this month. We expect to have all Legacy SBC mass market LD traffic migrated to the AT&T network by the fourth quarter of this year. We had a total force reduction in the first quarter of 3,400, and we are ahead of schedule on our merger force targets. As we said in our analyst conference at the end of January, we expect expense savings synergies to grow from the $600 million to $700 million this year to $2 billion or more in 2007. In addition to merger synergies, we have made further progress in improving our cost structure. Our productivity initiatives have contributed to the margin expansion that is shown on slide 21. Our adjusted operating income margin in the first quarter was 17.2%. That is up 200 basis points versus the year ago first quarter and up 100 basis points sequentially. It is well above our 2006 guidance of 15% to 16%. Obviously we are pleased with this result. Our margins and our operational progress in both wireless and wireline add to the confidence we had in the three-year outlook we provided for you in January. So by way of closing, let me recap that outlook. We expect to deliver double-digit adjusted EPS growth in each of the next three years. Following the BellSouth merger, we expect to return to overall revenue growth in 2007. That is versus pro forma results for 2006. We expect to generate strong and growing free cash flow after dividends: $2 billion this year even with heavy integration spending; $4 billion or more next year and more than $6 billion starting in 2008. We also expect to return substantial amounts of cash to shareowners through our strong dividend and through an expanded share repurchase. $10 billion of repurchases by the end of 2007 with at least $2 billion coming this year. Well, that concludes my remarks this morning, and at this time I believe we are ready for Q&A. Good morning, guys. A quick question for you, Rick, on the margins. Obviously some strong numbers here in the first quarter, but considering we expect the wireless margins to really continue to shine through the rest of the year, that 15% to 16% guidance that we have for the year would suggest that wireline margins are going to really decline from what we saw here in the first quarter. Could you talk a little bit about that, maybe if there is some upside to the margins going forward here? Secondly, along with that, update us on the Lightspeed plans and expectations for spending there? If I remember, you expected around I think it was 460 to 575 in additional spending in Lightspeed, mostly in the second half. Is that still the right number, and how do you see that progressing? We are definitely pleased with margins in the first quarter. We are very pleased with the momentum that we have in the business on a number of cost initiatives, both related to the merger and, frankly, outside of the merger some initiatives that we have been underway with for some time. I think as we look forward in the balance of this year we will have some improvement I think from a cost standpoint obviously as we ramp up merger synergies. We will have some costs in the second half of the year primarily related to Lightspeed rollout. As we said in our meeting in January and the guidance we provided, we expect about $0.08 to $0.10 worth of additional expense pressure this year from Lightspeed, and that primarily occurs as we get into the commercial launch phase in the second half of this year. But even with that, we are very pleased with first quarter results. We are very pleased with the momentum we are seeing. We are still early in the year, so I don't think we will change our guidance at this point. But clearly I think if we continue those trends, we are poised to be at the upper end of that range or beyond it. Thanks very much. If we could talk about the DSL for a second, obviously some strong net add numbers, but not so much data on the overall DSL revenue impact on the ARPU trends. Perhaps you could address that? Thank you. And also on the consumer long distance, we are not getting that data anymore. Where does that stand? Thanks, Simon. DSL, as you said, we had a strong quarter in terms of net adds. We are actually seeing ARPU on the consumer side of things pretty stable in the last two or three quarters in the low $30 range. DSL ARPU, as I mentioned in my remarks on the business side, has been increasing. Business DSL ARPU is up in the mid-50s for us. We are seeing good success in several areas with respect to DSL. One is we have had all-time highs in terms of the percent of gross sales at higher speed tiers. We were in the mid-30s as a percent of sales in consumer at higher speed tiers. We were over 50% in business in higher speed tiers. But that really only tells half the story, because we are also migrating existing customers up into higher speed tier products. So, for example, if you look at a snapshot of our DSL base at the end of the first quarter compared to a snapshot of our DSL base at December 31, what you would see is that while we added 511,000 customers, we actually increased customers on our higher speed tiers by about 530,000. So the combination of the sales and the migration has been positive there. Yes, it would be our 1.5 MB to 3 MB product, and then of course in business, we have had a 6 MB product out there, and we are launching speeds up to 6 MB in consumer, in fact, this week. DSL revenue growth was good this quarter. I may need help well on the exact number here, Rich; I think we were up at about 17% and 2.6% or so sequentially. So again stable ARPUs and we're adding customers there. Long distance as well in the consumer business in regional consumer continues to grow. I will have Rich get you the number on the consumer long distance, but it was up, if I recall correctly, about 10% or so. Just a quick follow-up on the margin side and a clarification. The margin guidance does not include the proportion that serves Cingular, correct? Could you give us a sense for how much of the margin improvement has been seen from the legacy SBC initiatives that you guys implemented last year with headcount reduction versus some of the new things you have done this quarter with the new AT&T deal? Well, it is tough to break the two apart, Mike, because obviously we have had a number of initiatives ongoing. We also took the opportunity last year to stop some spending and to take some costs out of the business largely through attrition in anticipation of the AT&T merger closing. So those pieces kind of come together. We are ahead of plan both in terms of our total force reduction at 3,400 in the first quarter, and we are ahead of plan in terms of merger reductions related to force in the first quarter. So I think those are both good signs. As you know, about 55% to 60% of our expense savings in the merger are force-related, so that is an important piece of it. I think the other thing in terms of the merger this year will be movement of traffic on our network. Our plans, as we mentioned earlier, will be to move essentially all of the Legacy voice traffic that is off net to move it onto the AT&T network. We will also move a substantial amount, about 40% or so, of private line circuits that are off net will move on net. We also have some circuits that are provided for frame and ATM customers that are provided by external carriers. We will move about 90% of those on net this year. We continue to show good progress, in addition, outside of the merger on the cost side in a number of areas in our basic business. For example, in DSL we have moved more of our sales to alternate channels, both retail channels, as well as Internet sales. That has helped us to take some fixed costs out of the business. On top of that, another factor helping us is that our DSL churn levels have dropped to really the lowest levels ever. As I mentioned in my remarks in the presentation, it actually dropped to below basic voice churn. So all of those are positive signs all helping us to take some costs out of the business. The other area related to the merger that is important to us is leveraging the scale of the Company in terms of everything that we buy. We have targets set for this year for procurement savings, and we have already negotiated and have in place contracts that will provide us about 40% of those savings already. So really showing good progress across the board. Rick, just as a quick follow-up to what has happened in the enterprise marketplace, could you give us a sense if you're seeing anything different when you're selling those services in your region versus in Verizon's region with their new MCI acquisition? Yes, I think it is pretty early to tell that. I could not tell you that there are any significant differences there at this point. Two questions if I could. First, on the line side. Rick, last year in first quarter we actually saw a small uptick in the primary access lines. This quarter I think they actually declined on a sequential basis from the fourth quarter, which is usually kind of soft. I'm wondering if you could speak to some of the drivers of the primary access line decline in the quarter, specifically with respect to what maybe Comcast did in the quarter with promotional changes, that sort of thing. The second question would be on the enterprise segment. You talked about the good recovery we're seeing and leveling off of the data segment. If you back into the voice side of that category, it looks like the voice was down about 12.5%. Could you talk about whether that is decelerating, accelerating? How is the other half of that revenue segment moving along? Sure, David. In terms of consumer lines in our first 13-state territory, as you said, last year first quarter was a very good quarter for us in terms of consumer lines. If you think about the point in time we were in there, we were a quarter or so right into the change of the UNE-P rules. So we were seeing some players that had been very active in the market become less, much less active in the marketplace. We were much earlier there in terms of I think cable entry into markets. So, as we go into 2006, I think first-quarter results are pretty consistent with our expectations. We expected to see a little bit of an uptick in our retail line losses. That is simply as a result of having a fairly full cable entry in our regions, primarily both Time Warner and Comcast, offset by the fact that we have largely worked through the reductions and the transition of our wholesale base from UNE-P to commercial agreement. So we are seeing much lower declines there than we had for the past several quarters. But I would say the line trends are pretty consistent with our expectations. I think the important thing for us -- and it was just another data point in proving that out this quarter -- the important thing for us is to continue to grow revenue connections. So DSL and video will become more important to us in the consumer space as we go into the second half of the year. Those revenue connections will continue to help offset any line losses and drive growth in both ARPUs and revenues in the consumer space. Your other question was in enterprise and specifically on the voice side of enterprise. As I mentioned earlier, we had pretty good growth, a better trend in terms of volumes on the voice side, and actual some sequential growth in LD minutes in our enterprise base in the first quarter, which was very encouraging to see. We really tracked two different sets of prices in enterprise. We tracked the point of sale price. In other words, what are we seeing in the marketplace? What are new contracts being signed at, or what are contracts being renewed at? We are seeing that point of sale pricing begin to stabilize. I think, as we look forward, I think our expectation is that point of sale pricing will stabilize this year. That is the trend that it is on. Obviously as customers renew contracts, and those contracts on average tend to be probably in the three-year timeframe, there is a delta between the pricing that is embedded in our base and the point of sale pricing, and that will take some time; at least 18, 24 months certainly to work through on the voice side once the point of sale pricing has stabilized. That is what we are seeing in the trends. There is really nothing new there, but we are seeing the delta between the average price in the base and the point of sale price narrow. That is obviously important. And the other important factor certainly is that we're seeing some encouraging signs in volumes. So if I could just quickly follow-up on that would be to say that in the enterprise category as a whole was flattening data revenue and voice at negative, say, 12.5%. The average of those being about down 6%, which has been a big improvement largely on the data side. Would you expect to see the rate of leveling off of that start to moderate a little bit over the rest of the year? Well, it is difficult to say, David. There are three factors that go into that. One is sales activity volume growth, which right now looks encouraging. So I think that is going to help us as the year goes on. We saw a nice uptick in the first quarter in terms of new contracts signed and closed, for example, versus what we were seeing in fourth quarter and what we were seeing in earlier quarters last year. So reception in the marketplace is good. That is a positive. Then the other two factors are the trend that occurs in the point of sale price and then how quickly that migrates through the base. We would look for some continued improvement as we go forward over the next couple of years overall in the revenue trends and enterprise. Just a quick update following on some of these wholesale scenes. What are you seeing on the high chassis circuits? What is the growth there coming from wireless customers and then other retail? Can you give us an update on the Homezone product and how that is tracking? What are expectations are for that as you start to roll that out? Okay, Frank. Good morning. High cap circuit volumes have been increasing, and they have been strong both in wholesale as well as in retail. I think in the wholesale side certainly there is a lot of volume growth that is being driven by wireless in that space. As more carriers roll out and expand their data offerings and build their 3G networks and as more traffic moves to wireless, we would expect that growth to continue. So strong growth there both on the retail and the wholesale side. There is some obviously some pricing pressures, and those pricing pressures have kept high cap to us this quarter, a slight negative in wholesale. Although when you look at it trend quarter to quarter, I would say overall the trend in terms of revenues there has been relatively flat. We are seeing obviously some growth in high cap revenues on the retail side where volumes have also been strong. Homezone is in trial right now, and it is going very well. We would expect to roll it commercially late this quarter. We will roll that out focusing on a lot of areas, particularly those areas that won't have access to Lightspeed in the short term. A couple of questions. First, on just cable Voice over IP exposure. If you take a look at some of the more mature markets where you have faced VoIP competition from the cable companies for awhile, what would porting activity indicate at this point? Are losses declining? Are they flat? Are they accelerating in those markets? Can you give us any sense as to the magnitude on sort of a more granular level? The second question relates to content. We are obviously approaching IPTV launches this summer. Where are we on content at this point? How do the rates compare to some of the larger cable companies? An answer to that would be great. On the cable VoIP question, obviously we have had cable competition, some of it circuit switched, for a long time. So those are maybe some of our better markets, in terms of comparison. You do see it -- as you would with any product rollout --you do see it flatten out over a period of time. It is just a question of the base gets to a certain size, churn begins to catch up. Further, when you look at our base and you look at our Company overall, you have to put cable and VoIP competition in perspective. Today it is kind of amazing to me in some respects because when we talk about cable VoIP competition, we're talking primarily about consumer, regional business. That is about 16% to 17% of our total revenues today. Sometimes it feels like we spend 50% to 60% of our time talking about it, but it is about 16% to 17% of revenues. Then you back off of that base, customers where we have bundled those customers with DSL or we have bundled them already with video service through dish. Then you look at the remainder of that base and you look at the usage those customers have and whether or not they are of such a profile that they tend to be more of a target or more at risk. Pretty soon you start to get down to even a total of that risk that is no more than about a third of that total consumer base. Then obviously we are working against that base to bundle those customers and protect them going forward. So in a lot of respects I think the discussion around cable competition and impact on the business, certainly with the profile we have today, is somewhat overblown. On the content side in terms of video, we have a number of content deals done. We don't see any issues with respect to either our current controlled launch or our commercial launch later this quarter. Pricing is coming in where we have expected it from a business case standpoint, so there has not been really surprises there from a pricing standpoint. I think overall if you would compare our projections versus cable, what you would see is content as a percent of revenues for an average customer that is probably a little higher than the average cable subscriber. And because the packages we will be selling and the fact that our customers will be all digital, all IP-based, those revenues will be higher. So the gross margin dollars, if you will, per customer will be pretty consistent with what I think you see in a typical cable franchise. Rick, if I can just follow up on the first question real quickly as it relates to small business and whether you're seeing a cable company show up there at all. They would indicate that they have had roughly two-thirds of small businesses with plants that they could eventually offer Voice over IP. You guys have had great results in sort of accelerating results on the small business side, which would kind of indicate they are not showing up at all. Any comment on that? I think where we have seen them has been primarily in some areas around providing high-capacity circuits and providing them at fairly low prices. It has been targeted in certain areas and has not really, as you have mentioned, really has not impacted our success or our growth in that marketplace. Most of my questions have been answered. Maybe two final questions here. The free cash flow and EPS outlook that you provided, does that include any bidding and build out activity you may do in the upcoming AWS auctions? If you could sort of talk about your perspective on those auctions in terms of your involvement? The second question would be the size of the inter-company eliminations between the legacy AT&T and legacy SBC. It seemed a bit larger than our expectations. If you could talk about what the size of that was and what the primary categories were, that would be very helpful. First of all, we are working with Cingular in terms of looking at the upcoming auctions and have not finalized a strategy. I think you should expect to see us file and be involved in the auctions. It is a significant amount of Spectrum that is coming on the marketplace, but we have not finalized a strategy there. When you look at Cingular, as you know, the Spectrum depth that we have at Cingular is very strong. It is facilitating our rollout now of 3G. As we continue to roll out UMTS with HSDPA, we pick up additional efficiencies in terms of the volume we can carry on that network, both on a voice as well as from a data standpoint. But we will follow the auctions closely and see if there are opportunities to pick up some Spectrum at values that we feel are attractive in certain areas. I guess the question though is, is that activity likely to be significant enough to cause you to revise downward your double-digit EPS growth and the free cash flow outlooks that you have provided? That activity certainly would not alter our EPS guidance. From a cash flow perspective, I feel very good about our projections and the trajectory of the business for both this year and next year. I would anticipate we would be able to incorporate at this point any activity in the auctions within that. I don't have specific numbers in front of me on the inter-company eliminations. Obviously we have gone through in the pro forma we filed and we have that data. It is embedded in what we filed for both 2004 and 2005 pro forma. But if I remember correctly, we were in the $2 billion or so range in terms of eliminations when we were looking at this previously. I think it would be probably best for us to follow up with you one-on-one, and we would take you through that in detail. Well, thanks, folks. At this point, I would just offer a couple of closing comments. In January we provided to you in our analyst meeting in New York fairly extensive guidance for the next three years for AT&T. I think overall reaction to that guidance was positive. But, as you would expect with I guess most things on Wall Street, there was also some skepticism. In March we followed that up with an announcement of our agreement to acquire BellSouth. Again, reaction I think overall was positive as the logic of that transaction was readily apparent. But again, some expressed concern. Some about the timing of the deal, some about valuation issues. What I would tell you, though, is our management team is confident about achieving both the guidance we provided, as well as the value of the merger with BellSouth. For us the best way to validate our belief with you is by delivering consistent results each and every quarter. So we are pleased with this first full quarter of the new AT&T as I think it provides another data point supporting our view of the business. Cingular had a strong quarter with improving network performance, customer growth, churn, data ARPU and margins. Their results confirm the significant opportunity ahead for us in wireless. Our regional consumer business operations had another quarter of growth in both revenues and margins, and our ability to deliver these results, despite competition from cable and others, demonstrates I think the ability we have both to compete and to transform the business as the market evolves. Trends in enterprise and wholesale are improving with solid volume growth and encouraging signs in market pricing. Customer response to the merger has been positive, and it gives us confidence in our ability to return these segments to positive revenue growth. Overall costs and margins in the first quarter, as we talked about today, were better than expected. The merger plans are on track, and there is good momentum on both merger and business as usual cost initiatives. Finally, BellSouth also announced a very good first quarter last week with positive revenue growth in both wireline and directory, record DSL sales and better than expected margins. I think all of these things are good signs for our business, and we look forward to building on these results going forward. OperatorThank you. This concludes the AT&T first quarter earnings release for 2006 conference call. Thank you for your participation. You may all disconnect at this time. |
EarningCall_234029 | Good afternoon. My name is Michele, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the TXU Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time simply press "*" then the number "1" on your telephone keypad. If you would like to withdraw your question press "*" then the number "2". Thank you. Mr. Hogan, you may begin your conference. Thank you, Michele, and good morning everyone. Thank you for joining us to discuss TXU fourth quarter results. The press release was issued this morning. If you do not already have a copy, the release and financial statements are available on our website, www.txucorp.com, under Investor Resources. The presentation exhibits for this call are also on the website, and when we refer to slide numbers, we'll be referring to the slide number in the title of the slide of the exhibit. The replay of the call will be available on our website approximately two hours after we finish, it will also available via telephone for one week at phone number 706-645-9291 with the conference ID 4270967. During this call we will make forward-looking statements, which are subject to various risks and uncertainties. Discussion of factors that could cause actual results to differ materially from management's projections, forecasts, estimates, and expectations are contained in the Company's SEC filings. I encourage to you read them. Our slide presentation and discussions on this call may include certain non-GAAP financial measures. For such measures a reconciliation of those measures to the most directly comparable GAAP measures, is available on our website under Investor Resources in the presentation slides for this call. With me today are John Wilder, Chairman and CEO; Kirk Oliver, Executive Vice President and Chief Financial Officer; David Campbell, Executive Vice President, Planning, Strategy, & Risk, and a number of other Senior Executives to assist with questions as needed. With that I will turn the call over to John Wilder. Thanks Tim and good morning. I will take off our call today with an assessment of our '05 performance and summary of our turnaround plan and a quick update on the gross strategy we outlined at the yard. Kirk will review the financial results and David will discuss our risk management position in our outlook. We will then be pleased to take your questions. As slide 1, shows we had a very solid year. Operational earnings with the top of our outlook range and improved by 136% relative to '04. Operating cash flow also exceeded our estimates and increased by 42% relative to last year. Slide 2, demonstrates our both of our business segments contributes to the strong performance. Compared to '04, EPS was up 60% for TXU Electric Delivery and 152% for TXU Energy Holdings. Stepping back from the numbers, I like to offer my overall thoughts on the year. I give us heat-rate of be maybe at the E plus. We are proud of our accomplishments, these included terrific year and peaceful generation, discipline cost management in retail and a very challenging commodity environment. Record safety performance and strong growth in Electric Delivery but we also know what we need to do better. We need to drive higher productivity on the cost line in our plant mine operations, to even further in improving the reliability of our delivery network, and we store profitability in a retail business that delivers great customers service and products. This is what we focus in '06. As most of you know we launched a three-year turnaround program in mid '04. I am happy to report that we are full year ahead of schedule. Slide 3, highlights the co-elements of the turnaround. We try to maintain our reluctance focus on our hallmark to successful industrial companies. Operational excellence, market leadership, a straight risk return mindset for all key business positions and a rigorous performance management system. We believe that executing against these four elements in the way we can deliver top quartile performance in earnings and cash flow growth rates returns and financial flexibility. As Slide 4 shows we made good progress across the broad range of metrics. This '03 our financial performance improved sharply. Operational EPS is grown by 230%, operating cash flow by 56% and free cash flow by 109%. Return on invested capital reached 15% in '05 the highest in the industry. Our credit metrics have also improved significantly. The interest/EBITDA ratio was up 63% to 4.9, while the ratio of debt to EBITDA has decline by 34% from 4.7 to 3.1. These absolute improvements of both they achieve from bottom quartile to top quartile in the industry. Operationally, we have made good progress to particularly in improving the production of our lignite coal fleet and nuclear plant since '03. Last year our coal plants set a record for all-time production and Comanche Peak achieved its highest ever output in a year with dual refueling outages. Our emphasis on cost leadership has reduced total SG&A and operating cost by 20% since â03. Our most important cost achievement has been to reduce fixed cost by over $1 billion or 27% while simultaneously increasing earnings in cash flows. Everyone knows how extremely difficult it is to achieve substantial fixed cost reductions without negatively impacting in earning and cash generating power of a company. Today our business is far more resilient to withstand potential stock, then it was 2 years ago. Market leadership with our emphasis on customers is the most significant label of our wholesale and retail businesses. The volatile commodity markets of the past year have created some real challenges for retail, which essentially made no money last year, improving the economics of the business as a key priority for â06. The business didnât make significant performance improvements in key customer service metrics. Since â03 call answer times have declined 96% PUC complaint for down 58%, and retail bad debt has dropped 56%. Wise product illustrates the success we made in mitigating the risk we faced at the start of the terminal. And weâve executed the risk return industrial mindset weâve whittled them down to the structural risk that are inherent in our core businesses. The natural gas most volatile commodity risk that we faced, we have instituted a comprehensive hedging program that David will describe later. Performance management is the fourth hallmark of high-perform industrials and we made a descent start. Weâve aligned our business scorecards, performance catalog, and incentives around the key value levels that drive the high performance, and we put our top leaders to succession planning in personal development reviews. But truly transforming the performance culture of a large organization takes time, and a discipline consistent focus. Let me quickly update you on our growth initiatives. As we discussed the DTI our goal over the next 5 years is to create two industry leaders. Our regulating wireless company that will efficiently manage new investments and redefine customer service levels to effective deployment of technology and a de-regulated power company with quality, scale and its markets in a high performance culture. Let me start with the electric delivery as described on slide 6. This business has the great advantage of its high growth service territory, for demands forecasts to grow 2%, 3% annually through â08. Weâve launched a plan that includes average annual CapEx in excess of $800 million over the next 3 years to grow and to achieve top as on the reliability in cost. 75% of this capital funded through serving new growth or through efficient capital trackers. Weâve already rolled our technology that is sufficiently improved in reliability but our deal with current communications will really shake it up. This partnership will enable us to create smart grid of the future, as technology such as broadband over power lines were deployed over the next 5 years. Weâve will be able to enhance our automated meter reading capabilities, monitor and control our systems, so we can take action before an outage curves and increase network security. And the rate settlement, Electric Delivery agreed to recently has expected to provide rate certainty through â08, allowing full focus on operations and service. This is a great business with great prospects. Slide 7 describes, TXU Energy strategy, which centers on returning the retail business to profitability. The retail market is tough, with our recent Price-To-Beat adjustments; we believe we can get closer to achieving our target net margin of 5% to 10%. More pieces would have suggested these marginal levels are ultimately needed to reward retailers for the substantial rest of decade. For us with seven years into deregulation, net margin in the UK, the worldâs most competitive power retail market have begun to stabilize in the 5% to 6% range. Net margins in other retail markets range from 15% both from 5% to 15%, with exposure to less than 20% of the volatility in power. Slide 8 shows net margins in Texas averaged almost 10% for the first 2 years of market open and prior to the volatile commodity market moves. And finally, based on acquisition cost and price discounts of 7% to 10% and TXU will have about a 0% net margin with an incumbent margin of 5%. Since net margins collapse to less than 5%, seven competitors have left the market in â05 alone. Net current four curves retails to achieve a net margin of roughly 5% in â06. And we are targeting a residential customer churn of 8%. Given what we have seen over the past two years term may stray higher or lower, but our outlook range can accommodate this volatility, each current point reached out from a penny of EPS. Slide 9 compares pricing and net margins across cost; TXUâs market along with TNMP is projected to have the lowest prices in net margins in â06. The average competitive offer across the same reflects the reality of the marketplace. Attackers were pricing relative underline those prices so discounts go up in higher price regions. In â06 the TXU retail team will continue to innovate, deliver great service and manage cost. In â05 we made a good start, weâve reduced staff by 20%, cause SG&A by 16% and decreased bad debt expense by 44%. We have lowered cost to serve the $5/MWh were 25% better than our nearest competitor. Our customersâ response times were the best, and we are delivering some great new products and services. The TXU Energy Rewards+ ⢠Royalty program is going to nearly 200,000 participants. Last fall TXU Energy launched the Peace Of Mind program to help customers manage price risk and so far customer response has been very positive. Velascoâs strategy will highlight TXU powers, which is shown on Slide 10. The ERCOT market is important to power, so let me elaborate a bit more on it. Its one of our largest and fastest growing power markets in the nation. It's driven by population growth that will see an estimated $5.5 million new Texas by 2015 and its economy is growing at nearly 4% per year with the same diversity and resiliency as the broader US economy. Yearly demand growth is equivalent to the capacity of our new 1500 Megawatt plan. In the near-term TXU Power grow strategy focus on two new coal plans, Old Grove and Sandow in â05. We believe no other developer can match their structural advantages, which are shown on Slide 11. Let me highlight just four of these advantages. First is a low cost fuel supply with the $0.60 to $0.80 MMBtu advantage over TRC. We now have lower build cost based on access to previous infrastructure creating $250 million advantage and I would like to add we are not finished yet to driving our capital cost down. Growths appear operating capabilities with a 5% higher capacity fraction and $15 of be appear cost advantage and finally an expiry online phase turning on project that would deliver our value destroying return into project that clears our straight investment returns standards. These facilities will employ about a $1 billion in advance to machines control technology that were reduced thatâs self to our machines by 80% and not the machine by 70% relative to be average co-plan. Since we announced these projects at EEI we have kept the permitting start to schedule on track, reduce capital cost and outgrow by more than $150 million and improve both the mining and operating plans. This progress has increased the value of investment by over 300 million. Over the next three years we expect to make a capital investment of nearly $6 billion in Texas, more than doubling our historical investment levels. As Slide 12 shows we stand out as one of the states largest investors. Slide 13 highlights the far reached consensus Texas investments will have for jobs and the state economy. In conclusion TXU achieved solid results in â05, we are head of schedule and our turnaround in driving continuous performance improvement across the businesses. We are focused on areas where we need to the better. Our success is earnest the right to grow and we are progressing with a prudent achievable strategy; it uses our industrial mindset to put up businesses advantages to work for our owners and our customers. And now Kirk will discuss our financial results in more detail. Thank you John, and good morning everyone. Since most of the details are covered in our earnings release, I will keep my remarks brief as I recap the highlights of reported and operational earnings and TXUâs key financial metrics. If you move to Slide 14 our fourth quarter 2005 reported net income available to common shareholders was $356 million or $0.74 per share as compared to last yearâs fourth quarter reported net loss of $625 million or $16 per share. Operational earnings were $0.86 per share, a 153% increase over the $0.34 per share in the fourth quarter of 2004. Fourth quarter 2005 reported earnings include a $0.02 per share charge for the cumulative effect of a change in accounting principles reflecting the accrual of an asset retirement obligation in accordance with the adoption of a new accounting standard FIN 47. And a $0.10 per share extraordinary loss arriving from an agreement to a quarterly equity interest in a lease trust which resulted in consolidated of the trust. The least trust owns 9 combustion turbines leads to TXU and has related debt outstanding. The fourth quarter 2004 reported earnings included a $0.53 per share loss from discontinued operations and a $0.02 per share benefit from the cumulative effect of a change in accounting principles. Reported net income for the full year 2005 was 1.7 billion or $2.50 per share compared to our net loss to common stock of 386 million or $0.64 per share for 2004. Operational earnings for the year were $3.33 per share, 136% increase over the $41 per share in 2004. The 2005 reported earnings per share include a cumulative effect of adoption of FIN 47 and the extraordinary loss previously discussed as low as $0.01 per share in income from discontinued operations and special credits totaling $0.31 per share primarily related to income tax benefits and insurance proceed associated with the litigation settlement expenses. 2005 reported earnings per share also reflect the effect of the true-up in the second quarter 2005 related to the accelerated share repurchase in 2004. To calculate the 2005 diluted earnings per share net income is reduced by $490 million or $1.02 per share. Reported and operational earnings per share for the fourth quarter and fully year period are based on average share accounts that reflected the 2 for 1 stock split, which occurred on December 8, 2005. In addition the various between the quarter and full year periods were affected by 12 million shares of common stock repurchased in November, and other shares repurchased in 2004 as discussed in the earnings release. As outlined at EEI, TXUâs forward outlook also reflects an additional authorization by the board of directors to repurchase $22 million shares this year. TXU Corp. delivered strong operational results for 2005 due mainly to the ongoing successful execution of TXUâs performance improvement program. Higher result were driven by increase contribution margins in the TXU Energy Holding segment reflecting record setting performance and productivity for base low generations lead. A solid performance of TXU electric delivery and corporate wide cost reductions. On a consolidated basis operating cost and SG&A expenses decreased by more than $200 million from 2004 to 2005. The 153% increase in operational earnings per share for the quarter was mainly attributable to improvements in contribution margins, reductions in SG&A expenses, the effect of lower average shares outstanding, partly offset by higher interest expense. As shown on Slide 15, excluding the $0.10 benefit of lower average shares, the TXU Energy Holding segment improved $0.47 per shares or 157% primarily due to an increase in contribution margin reduced SG&A expenses and increased gains on sales of assets primarily under the utilize land. We expect to continue to monetize under utilized assets such as land in 2006 excluding the benefit of lower average shares the TXUâs Electric delivery segment was down at any further quarter, reflecting an increase in contribution margins that was more than offset by increase cost and depreciation, reflecting increased investment levels to improve reliability. Corporate expenses increased $0.04 per shares primarily due to an increase in net interest expense. Operational earnings for the full year 2005 were 1.6 billion or $3.33 per share an improvement of 136% and at the upper end of the outlook gains that we provided at EEI. Significant drivers of the improved results in addition to the $0.79 per share benefit of lower average shares outstanding included improved contribution margins of $1.47 per share, reductions in SG&A expense of $0.32 per share and reduce preference stock dividends. Operational earnings per share at TXU Energy Holdings excluding the effect of reduced average shares improved 91% in 2005 relative to 2004. The main drivers of $1.21 per share increasing contribution margin for higher retail and wholesale prices driven by higher natural gas prices and record production and lower fuel cost from our lignite coal fire generation fleet in part due to reduce operating cost in TXU mining operations. The eccentrics were somewhat reduced by higher wholesale purchase power costs, increased business market sales volumes, decreased net revenues from hedging and risk management activities and customer attrition. The other major contributor to TXU Energy Holding segment improvement during the year was a decreased in SG&A expenses of $0.22 per share. The SG&A expense improvement primarily reflects the benefits of the Cap-Gemini Energy outsourcing agreement and a $41 million decrease in retail bad debt expense. With low or negative retail headroom, bad debt expense reductions continue to be more valuable than volumes lost due to customer churn. The improvement in TXU Electric Delivery operational earnings was driven primarily by increased revenues of $168 million or $0.26 per share. Revenues increased due to the effect of warmer weather relative to last year, customer growth in the home service territory and higher transmission and distribution tariffs. These higher revenues were accompanied by increased operating cost primarily due to increased expenses relating to reliability improvement projects and higher depreciation and amortization expense. Our operational improvement initiative continue to drive substantial improvements in returns, cash flow and financial flexibility measures. Strong credit metrics is an essential element of TXUâs cap allocation model and we are pleased with the substantial progress made in this area over the last two years, as John discussed earlier. In addition to improving the key credit metrics the company deployed significant capital to reduce financing cost and improve the risk profile of the company. Over the course of the year the company redeemed $300 million of preference stock and refinanced $95 million operating lease in favor of lower cost financing. The company is also paid over $270 million net of insurance proceeds to several lawsuits from 2002 relating for the failure of the companyâs former European operations and other challenges that the company faced during that year. The company no longer faces the distraction that other risk associated with these major lawsuits. We also maintained ample liquidity levels currently in excess of 2.8 billion and reinitiated our commercial paper programs to reduce the cost and increase the efficiency of short-term borrowings while improving cash flow management. In summary, as shown on Slide 16, we increased our expectations through the year twice during 2005 from an original range of $2.82 to $2.93 per share up $0.15 to 325 to 335 per share in November. If you exclude the $0.03 per share effect of cash flow Hurricane effectiveness in the quarter that David will discuss further in a moment, we exceeded that range slightly. Including that effect operational earnings were at the top end of the range of $3.33 per share. We are pleased by these improved financial results, so we certainly recognize more can be done. We continue to execute against the balance scorecard of financial improvement measures. I will now turn it over to David. Thanks Kirk, and good morning, Iâll focus on three issues this morning, recent steps that we have taken in implementing our hedging and risk management strategy, changes in the national gas kerosene CEI, board outlook. As we described at EEI TXU leverages its strength in balance sheet in a complementary generation in retail businesses to manage its commodity market exposures. Under this approach we consider the retail consumer load to be a near-term hedge to base full generation. In addition, we supplement the hedge by selling power and natural gas boards through market transactions. Through DI we've further reduced our gas exposure in the next three years. As shown on Slide 17 through additional market transaction weâve now hedged our estimated natural gas exposure by more than 95%. All of being equal of $1 move in natural gas prices, when decreased the company re-bid by less than $10 million in 2007 and less than $20 million in 2008. Over the past month we have also entered in the forward contract for natural gas in 2009 and 2010 producing our long position in both of those years by 50 million 10MMBtu. The hedging program enables us to increase a certain of our cash flows over the next three years, when we are undertaking a significant investment program. Slide 18 highlights the degree of volatility reduction that the hedge provides in various alternative gas scenarios. For example in the event of $2.50 per MMBtu up or down shift in the natural gas curve in each of the next three years, our cash flow would have swung by more than 800 million during that period without the hedging program as opposed to roughly 100 million today, assuming no other changes to plant assumptions. This risk production gives us greater flexibility to pursue the growth oriented investment program that John described earlier. The hedging program also creates the potential personal quarterly volatility, such as $0.03 impact that Kirk described in the fourth quarter. This volatility arises from the fact that the natural gas transactions represent a hedge against future power sales for purposes of cash flow hedge accounting. If the forward value to the gas hedges change more than the forward values of power hedge ineffectiveness gains or losses arise. As you know, changes in forward power prices in our cost results primarily from gas price or Heat-rate changes. The mechanics of the hedge are such the changes in the forward Heat-rate in tandem with changes in gas prices since we started the program and result in ineffectiveness. TXUâs generation portfolio has an underlying exposure of these Heat-rates. So the hedge program in absence converts the portion of the Heat-rate line to a March market position. In total based on the current size of the natural gas hedging program, a 0.1 MMBtu per megawatt hour change in the market Heat-rate in both '07 and '08 can cause up to roughly 30 million pre-tax in cash flow has an effectiveness. As Kirk mentioned in fourth quarter the total ineffectiveness loss was 10 plus 25 million. On a go forward basis, we will continue in gas sales in other channels such as industrial sales, wholesale origination and structure transaction to manage our overall position. Chipping into natural gas market slide 19, shows price movements since November, 1st. While the 2006 forward curve has dropped to the $10 range, 2007 and 2010 forward natural gas prices have increased by more than $1 per MMBtu per year. As Slide 20, show these price increases combined with our ongoing hedging activities, drive an increase in our estimated 5-year growth rate. With no changes to other elements of the plan, the 5-year estimated growth rate has improved from 2.7 annually to 6.2% today. A $1 upward or downward move in the 2010 gas curve which shift the growth rate due to 3.9% or 8.6%. For 2006, we are maintaining our operational earnings outlook range of 550 to 575 per share. And our outlook for 2007 growth remained to 2% reflecting an estimated $0.15 per share increasing cost associated with the plan 75-day outage to replace steam generators at unit 1, our Comanche Peak nuclear plant. I will now turn it over to questions. As a reminder ladies and gentlemen, if you do have a question or comments, press "*" "1" on your telephone keypad. And your first question comes from Vikas Dwivedi. Well, thank you. On Slide 17, is that your retail natural short position falling almost 25% between â06 in â08, and thatâs - look like itâs outpacing the 8% to 10% attrition overall, is that coming from the large industrial segment or, just trying to understand where that extra loss is coming from on volume? This is David, you got it right, the retail short position is a combination of attrition of our PTB load, both residential and small medium business but it is also the roll-off of fixed price contracts in the large industrial segment. So thatâs why the total decline is a little more than just residential churn, itâs also the role off of fixed price contracts. Okay thanks, and kind of lagging into that, as that happens your hedging requirements go up, your natural links goes up, and so, is that going to pose any collateral issues, because of the size of the hedge reserve or are there any kind of collateral efficient ways to manage that link? Yeah, this is Kirk Oliver, it will require some collateral to be posted and of course we run a lot of analysis on what we would expect in a worst case, and if you take a look at the liquidity weak area, we are at about $2.9 million of liquidity right now, so we have plenty of room for posting collateral. Hi John. It looks like youâve hedged about 50 million MMBtuâs of the net links in 2009, and 2010 so excluding Sandow and Oak Grove, does this imply that youâve hedged about 25% to 30% of the net links in 2009 and 2010? And would you consider hedging more, since the backend of the curve is up about a bug 50 over the last several months? We are looking at it everyday John, we saw the market gets to a spot that we liked, when it kissed 9, we thought that was a good level for us to take some of the links off the table, the back in fact of as you know, but weâll keep our eyes on it, and we would expect to overtime takes some of that links off, we just have to find the right market conditions for us. And just to refresh my memory, youâve previously said that you expect Sandow to actually have a PPA for about 75% of the output? And then, so you would obviously factor that in to your increase length as you look to hedge out more of 2009 and 10 and beyond? Okay and then just one other question probably for Kirk. Can you just clarify what your comments was on the tax rate, which is from the litigation settlement, and perhaps what tax rate is used in your '06 guidance? Our tax rate for '05 was, I want to say 31% will get it here in a second, 32%, in our '06 guidance, its I think a little higher, I think we probably use in our statutory we are 35%. In net cash flow ineffectiveness number that - thatâs in the operating numbers, I just want to make sure I heard that right? Great. And a broader question for you. You know as we look at everything that you accomplished at the beginning of the presentation and then we look at the things that you have yet to address like, the single nuclear plant operating risk. Then one of the thing thatâs not on that list is the fact that you guys are obviously very concentrated in one market: the Texas market. As you look out past the execution of your Texas strategy, can you refresh our memory on whatâs your out of Texas strategy is in, how you expect to try to execute that over the course of next 12 to 24 months? Sure Greg. Our only out of Texas strategy that we have right now is in our Power group, we got an operating hedge both in terms of running these coal plant at high production levels and at low cost levels, its about 30% to 40% broadly across all the other coal plants in the country so. We continue to look for opportunities to scale into some of those positions particularly in the fully restructured markets so of the North East and PJM. We are going to have to be patient, all of these transactions have gone at fair prices, but quite frankly prices that are materially greater than our new build economics, and thatâs the economic tension that weâre juggling the most, now as we look our gross strategy, our new build economics are about $0.60 on the dollar of, what we call the second owner strategy. So we think about allocating capital, I believe you are going to see us allocating more capital to new build coal generation than current production simply because of that strong economic advantage that the new builds presents themselves within the market today. So these markets change all the time as you know youâve been following this industry a while Greg, and one year and as a class we will be very favor in the next year it wonât. So we will just have to keep our eye on it. We are looking at some creative ideas and creative structures with others they just take a while to bake and certainly any strategy that depends on acquisitions which that strategy does you have to deal with the counter party, so you have to work at their pace, and on the time schedule so thatâs our only out of Texas growth strategy that we have right now. Two areas I wanted to touch on little bit, one was on the Sandow and Oak Grove, the two coal operations, could you talk a little bit John about environmental hurdles and when looking at doing those types of expansions in Texas versus other parts of the country, could you just frame that a little bit? Sure Scott, Iâll start with, well there is really not much of a sales in a positive quite frankly. We have an accelerated permitting provision in Texas, that was part of an Executive order that the Governor signed, though if they, plant uses Texas Resources which our plans do as there is a very strong possibility weâll get a permit within about a year, itâs required order from the Governor. And other most, probably the most important thing to mention is not only the favorable and appropriately favorable encouragement that the Texas government is putting in place for companies like to issue go coal plants. When you look at the admissions record of these new coal plants, they were wilder with gas plant so, they're highly efficient, from the knocks and stocks standpoint. As I mentioned in my remarks we are going to put a billion dollars of capital into our plans on the backend to make these real coming efficient plants and we are not, we are going to have the typical of protest and, we are going to have the same crowd that shown up at the last 3 decades, they want to talk about these things but the reality is itâs good for Texas, the Government supports it, and the technology is very efficient today. Okay and then John, a little bit on some kind of sense something on the retail past away, and few questions or kind of heading out of I guess, just want to frame this a little bit, I know that is hard to say with any specificity because this is so long-term, and this business is still on the early stages but, when you kind of think about the EBIT margins in retail business is I think should 5% to 15%, it seems like that many types of businesses that often gravitates to high single digits 7, 8, 9 %, something like that, that we have analyzed, and we are trying to understand is there a point in time at which lets say by 2009 or 2010 there is enough shakeout to where you stop loosing, you know the attrition rate slows down significantly but it migrates toward that type of margin, how do you guys tend to think about that because obviously it also affects the hedging, they are the natural hedges in place? Hi, Scott, when you look at the other markets, they are more advanced than ours, for example, like the UK, which you described is exactly what happens, there is a market share shake out, it takes place the first, 3 to5 years of the market as customers who have a propensity who want to change and select different suppliers do that. The incumbent normally takes the incumbent for a while to kind of to get their act together, like its taken a while to get to surface levels at the right spot, get their segmentation fall through and get the pricing plans in place but, they have a good knowledge of the business and normally there is a broad group of customers that want to stick with them, weâve analyzed this on so many different ways and we keep getting around to a 5% to 10% net margin, if you look at the forward curve today through â08, the margin doesnât even get 5%, so we see a lot of room frankly for margin improvement between now and the end of the decades if we can get our execution model right, also as I mentioned some from our remarks weâve had a shakeout with this last volatility spike that we had last winter. There a number of the retailers went out of business, so thatâs a good thing, thatâs a natural market evolution, some of the new attackers are going to come in with a weak business model and sale. And some of the customers that switch to them for maybe a small discount are going to find that coming back to real and tried in TXU is a good thing in terms of the trust and securities that we can provide them, as there electricity provider so, we are, itâs been a tough business for us, and we started out at good margins as that one chart that I showed indicated, but itâs been long downhill really painful slide for us, but, we believe we got them back to okay levels in â06 and we would expect to grow those margins on over the next 2, 3, 4 years. Couple of questions, first just to clarify, that the coal plants are now down to only about $1100 per Kilowatt cost? You know Steve, we continue to look at different ways to fund the both businesses, gross strategy, both of deliver gross strategy and the power gross strategy, we look good all kinds of different ideas to see if we can get a funding advantage of cost of capital advantage, we donât have anything to report we just keep talking and it was being to speak a different ways to get these business funded so thatâs really about all I can tell you. Okay any comments on the recent commentary by Chairman Hudson on that, we looking a place to be potentially at the end of the year? Yeah I mean, I just comment the interesting conceptual idea but from our standpoint itâs really not in the interest of the customers, the economics really donât support that well and most important thing just not lawful. These margins where they are Steve, there is just no way we are going to have a working functioning market unless to gives the attacker a margin to go after. All the market research that we do is pretty convincing and that 90% of customers know about competition and 90% of the customers know they can switch and, all they want to know if they can choose their own supplier and they could fire us at any day that they want to and quite frankly, they do that more frequently than we would want them to, so we just canât see a reason and not like the market fixes. Markets going to determine which suppliers need to be in business, the customers are going to make that determination, they are making that everyday and we just need to leave this, let this string go real fashion way, which is fleeted down the marketplace. Okay one last quick question, how are you managing basis spread risk between your gas hedges which I assume when we have 9x in Texas? Steve, we managed the overall basis risk as part of the overall hedge program so lets something our wholesale markets group take the caps for us on the hedges, so the Heat-rate changes that I talked about that impacted in the quarter, our Heat-rate changes relative to 9X so its something that we actively manage as part of the hedge program in part of our overall, in the near-term its part of our overall fuel sourcing management in this part of the hedge we just extend that at overall growth, we understand the gas markets in the chip channel recently well in the interface, its something which manages our growth. Good morning, as a follow-up to Steveâs question, John, previously youâve given indications that the strategic reduce associated with Oncore would probably take the first half of 2006, do we suppose this still takeaway in terms of that timeframe? Hi Tim, Iâd probably ask for a little more time in that, I think it will take the balance of â06 and quite frankly it even could take beyond that. We are spending all our time at least most of us are Kirk and some guys are spending some time on the funding but the rest of us are spending all our time on building these businesses and if we can find a more efficient way to fund them, well than thatâs great around the hedges that creates a little bit better business but for the most part we are putting all our effort on building up this CapEx plan and delivery in getting these new coal plants built in power. So you know how these things go, the markets going to determine this, its going to be the funding market that determines which direction that you go on any funding plan and weâll just keep an eye on it. Okay and separately, can you give us an update on the settlement that youâve reached in terms of Oncore and where you stand with the individual cities of who has approved or how much of that has been approved? The settlement was signed off with the Steering committee of the cities a few weeks ago in early January. Now each one of the cities will have to pass an ordinance document, we anticipate that could probably take about three months, we will also offer that same settlement to cities that didnât participate in the particular Steering committee that we negotiated with, which we have done in our previous settlement. Those cities could take, perhaps 6 months to get ordinances passed, so thatâs kind of a rough timeline I think at what we are looking at Okay and one last question for Kirk, Kirk, you have holding company test is coming due here in 2006, could you discuss the refinancing plans for that debt? Good, just a quick question, I was wondering if I can follow-up a little bit more on your comments that any, at the kind of changes, that were been talked about or contemplated or unlawful, what gives you that degree of confidence and can you take us back to that lawsuit in July of 2002, where the commission tried to model with the price to be, and let us know, how much of that is protected by, what happened in July of â02 and how much of this protected by things that havenât yet been tested in the core, I am trying to understand how much of this been sort of locked in by previous core presence, and how much is has not yet been tested, I recognized this is the smallest, I have recognized that the price should end at year end of '06 anyway? Well, I will start you out, Jack and Mike McCall is going to jump in and I am to go down into the more of nitty-gritty of the law. One of the provisions was referred to and the open leading was a more detail provision that might give the commission the ability to make an adjustment for those tests had undergone a true-up proceeding, I know you know it, we didnât have a true-up, we reached a comprehensive settlement on spending cost in 2000 and in fact the commission expressly ordered that TXU not filed for participate in the true-up, so even under the most technical provisions of the law, if the host true-up were to be lawful which we think on the surface its not lawful, anyway because, you didnât have true-up, it just doesnât apply to us, on at Mike and Tom who worked on the law, and its good amount of curtail when it was formulated in the past to jump give you some more details. Thanks john, this is Mike McCall that's exactly right, that particular provision, as the law was intended to true-up, the Price-to-Beat after the commission, it made determinations around strategy cost and final fuel factor balances and things of that nature and it was only intended to simply protect the competitive market because as those TNT prices went up to reflects stranded cost that one of the raise the Price-to-Beat coincident with that change, obviously for us none of that applies as we settle that stranded cost, I think it would be a pretty significant extension of that law to try an outcome and then apply it, at the later ends of, we have two, the transition to the fully competitive market. Just, to be clear procedurally you guys settled your stranded cost proceeding, you agreed you it at zero stranded cost, zero strain of benefits, did that settlement procedurally fill in this whole chew-up of finite cost proceedings or did that's all mean that there was no chew up, which one you are seeing? We were actually ordered not to file a true-up proceeding and, because we werenât adjusting the TMB rates to reflect stranded cost. Yes sir, and then, just the next questions are, on the cash settlement of the stock buyback when do you expect to settle up the $500 million? Got it. And what else, just in terms of hedging the long-term John, so you are basically saying that because gas prices on the back end of the curve are up a $1 or $1.50, that do you think your long-term growth rate goes from 3 to 6, is that what you said? That includes the new coal plants, the coal plants we announce Oak Grove and Sandow in '05 does not include any acquisitions. Hi guys one quick question John, when you think about the long-term strategy outside of kind of the backend and the forward strip, what do you think of this kind of the biggest risk? The biggest risk for us has been and, will continue to be natural gas risk Michael, we are building length, weâve been very honest in forthcoming about that. We also have Heat-rate risk that goes along with it, but we believe we are at a kind of bottom of the cycle if not the bottom of the cycle on Heat-rates and our costs there going to improve slowly overtime as this economy grows out of the last CCGT build out that we had in the late 90's, so they are growing natural gas, I think that we have as a result of loosing market share in our retail business, and increasing production out of our solid fuel plants. We will manage it through a combination of hedging and a very strong balance sheet, well, you probably see us looking more like, or managing our risk and more a like a big strong independent, Mike manage its risk with the exception that we have this retail short that is, not normal or not evident in most of the independent E&P companies. But relative to the E&P companies our natural gas risk is long dated, itâs like a 40-year perpetual gas fuel, we donât have you know 5 and 6 or over these like the RSS, so we think its important to have that structural position with our retail business, in fact we have been spending a good bit of time this last quarter that I did mention in my remarks and no one else mentioned of trying to build-up our originating capability in our wholesale business to get smarter and better and selling out some of the swing and more structural ways and more, 4,5,6 year plus a blocks of power, we are going to be putting a lot of effort on that over the next year or so. Hi, you know, at EEI back in November you talked about improving your credit metrics and it looks like youâve done some of that already, have you had any discussions recently with the rating agencies about trajectory of your credit ratings? We talked to them all the time, Josh, we give them quarterly reports in written form, Tony Horton, our treasurer and his team spend a lot of time with them, Alex Kirk and Tony to jump in and see if they can have any color for you with, we have one comment that I will make is, we havenât provided any of the rating agencies with a written plan that we havenât substantially over-performed. I think substantially, the first plan we provided them a couple of years ago would have probably had high three type coverage ratios in it now we are kissing 5, so I can kind of go on and on but we fleet every major financial flexibility target that we have ever provide them and we think overtime that the agencies are going to understand how this model works, understanding how resilient and strong this business is and we will get the right credits forward, but I will ask one of the finance guys to kind to jump in and give more color. I think Josh, we talked to them on an ongoing basis, in fact I think Tony talked a couple of them yesterday, I am looking across the favorable item in ED and we tried to keep them updated and let him know what we are doing and make sure they are aware of everything in advance so are they becoming public, they have given us no indication of any move in any direction at this time. Hi, just a couple of quick ones if I could. I was looking at your appendix table, D as in dog and in appendix table C, and I apologize that if you already address this point but my question is the following. The volume of the sales as market customers substantial small business customers, use of decline by say 10% on average on weather adjusted terms year-over-year. The number of retail electricity customers in the residential and the small business markets declined by 1.5% to 2% year-over-year, I was wondering if you could explain to me why the volume declines were currently so much larger on the weather adjusted basis than the customer declines? Sure if you, Jim Burke who runs our retail business is going to give you probably more details then you want on the dynamics of the retail market. Hi this is Jim, the table D at the top right number that you see their the 9.3% decline in customer account for residential year-over-year. If you look at that, that matches to weather adjusted on table C of 7% decline, fall dramatically. One thing to keep in mind that we are looking to bring out more disclosure on this metric is that this is accounting weather adjusted numbers so we take it, we accrued volumes, and we take the beginning and ending customer counts to drive those. If you actually look at the slow month volumes because we get the meter results and we do true-up the volumes, they were actually down year-on-year weather adjusted not 7% but 5.2% so the mix is actually been favorable on the residential lockers during 2005. And so what we are going to do going forward is try to give you the accounting data, but also breakout some of the operating metric data that gives more to the slow month, so that you can see these types of trends more cleanly overtime. Okay, is this the number that you all give for customer change in the quarter i.e. on appendix table D, residential customer for example going down by 1.9%, is thatâ¦? That is the year-over-year change but if you go to table C in which we are going to look at for instance on average KWH for customer, if you look down you see a minus 3.4% Or the average for residential customer, thatâs using accounting data, so it looks like we've had a quarter-over-quarter reduction of 3.4%, if you use the actual flow the volume meters after the fact and we true-up the volumes it actually down 0.5%. And so the customer account data is accurate, the accounting data that you see includes all the accrued estimates and what we are trying to do is breakout some of the operating metric that put the appropriate volume in the right month. Let me take a stab at that, the appendix table D if you look at the 1.9% compares Q4 '05 to Q3 '05. And then on the appendix table C that 11.9% in the very first row is the year versus year comparison, they are comparing Q4 of â05 versus Q4 of â04. Okay understood, and then the second question if I could is, the assertion in table N of the text, I believe its on Page 11, you make the point that you are maintaining retail short position, for further read it out a footnote 7, say that the retail portion of your sales acts as a short position involve, net margin remains out at a lower sustainable range of 5% to 10%. Given the forward curve for gas prices that we have on Slide 19 at the presentation, you have a big year rough estimate of what the attackers cost is right now given the $10.25 in gas prices in â06 and â07. Well I guess what I was, when I was thinking of is there, their cost of acquisition including in a sustainable margin of 5% to 10%, because that would seem to tell me the level at which you can price your target now? Well, if you refer to slide 9 in the deck, thatâs what we are trying to lay out there was where the net margins look on a territory by territory basis and you can see that the top part of those bar chart represent the average discount we are seeing in the market. In most of the market TNMP, TXU and even CNT you see that the discounts provided actually erode all the net margin the incumbent has and that does not even include cost of acquisition. So you have to have obviously less discounts than youâd have net margin residing in the incumbent economic plus to cover the cost of acquisition. Okay, so I would read this as, okay alright, I think I understand Iâll work from that. Thank you very much for your patience, I appreciate it. Just a few quick questions, the $29 million with the Landfield, its sound like that was going to continue or you are going to have similar stuff in 2006 and what had you, is that correct and whatâs leading to those land sales whatâs that about? Hi Paul, we have asked â the acreage number, but I canât remember is off the top of my head, weâve got a many real estate business inside of this company that we spend time on, we got small team that goes into market and sells off parcels of land or sells of some more old buffer space around old gas plants that we donât use and we make 30 to 50 million bucks a year off that, we should probably be able to do that over, I donât know in the next three to five years. Before tax, okay. And in terms of the tax reversal, with the 35% tax say thatâs you are expecting in 2006 I would assume that thatâs probably not in your 2006 guidance, is that correct, any more on that? Yes, thereâs some credits followed by production expense credits, that we have reserved against when back when we wrote down some of the generating equipment that we had for Oak Grove, and since we are now building that plant weâve gone ahead and release those credits. Okay and then, finally when we look at Slide 9, I just want to clarify this and a medium immediate loan but it looks like you guys are using 9X settlement strips when calculating the margins and the economics of the retail business, and we have seen some basis differential between Texas and 9X, and I was wondering a) Am I reading that correctly does that based on 9X? And b) is, is there any differential any economic is that significant or substantial if youâre to use the basis differential if you use the taxes GAAP price, if you follow me? Well, this is David, what we try to do in the modeling is, we use the heat-rate economics or heat-rate results data to see, so, it wonât create a difference whether you use a different gas prices, we try to model it up what the forward market is for ERCOT Power prices. So itâs easier to track the 9X the market but if we use the 9X versus the HST gas price, we use the relatives, the relevant heat-rate for the difference of gas that weâre using. Okay, excellent then finally the coal plant sale, there has been some discussion in the media and I just was wondering if you could just sort of talk about the speculations that you guys are actually thinking of selling coal plants to survive because you guys are actually building coal plants and I donât know if you could just, if you can, what the thought process is with respect to, where some of these rumors whatever might have generated or, you know Iâm saying? Sure, I will give you that Paul, I think thatâs the same kind of general source that is stoking the fire about the Electric Delivery business, weâre in these capital markets all the time trying to find ways to fund these businesses. And we are in the market trying to find ways to fund our power growth strategy. And we look at a lot of difference ideas, weâve looked at wide variety of funding ideas around our power growth strategies from the project financing, corporate financing to bringing in partners to, about every kind of ways you could imagine, we havenât settled down on a funding strategy yet, we donât know that is the strategy will beat just good old fashioned, use of corporate cash flows to build out those plans. But weâll keep looking at it, and if we can find something around the hedges that helps us out weâll do it, but, there is not big, these arenât big items at least in terms in terms of the overall economics of the company and we might be able to shape the cost that capital buy, one-tenths of a point or 2/10s of the point or something like that, but itâs not, we donât see it has been adjusted substantial value driver and the underline value of the business, it helps and you need to look at it, but if we do pull something off on either of those fronts I wouldnât expect a big increase in values. But I tell you what, they sure do serve as a big source of rumors. And itâs amazing to us, how many bad rumors have been applied to those two efforts. But, weâll live with this, because if we can shave a little cost, we want to do it. Thank you all for joining us today. The Investor Relations team will be available on the telephone today if you do have any further questions. Thank you for joining us good bye. |
EarningCall_234030 | Good day everyone and welcome to the Google Inc. Fourth Quarter 2005 Earnings Conference Call. This call is being recorded. With us today from the company is the chief executive officer. Dr. Eric Schmidt, the co-founder and president of technology Mr. Sergey Brin and the Co-founder and President of products, Mr. Larry Page and the Chief Financial Officer, Mr. George ?. At this time I would like to turn the call over to Miss Kim Shevel, Director of financial relations. Good afternoon. Welcome to our 4th quarter 2005 earnings call. On the call today are Eric Schmidt, Chief Executive Officer, George Reyes, Chief Financial Officer, Larry Page, founder and President Products, Sergey Brin, Founder and President Technology, Omid Kordestani Senior Vice President, Global Sales and Business Development and Jonathan Rosenberg, Vice President Market Management. This call is being web cast from our investor relations website. Additionally, our press release issued a few moments ago is now posted on our website. A replay of this call will be available within a few hours. Some of the comments they will make today are forward looking including statements regarding our operational performance and margins, the prospects for growth in online advertising and our business, our continuing ability to grow and innovate, our expected traffic growth, the growth of patterns of our absence network and Google website, the potential for the services we develop to benefit our users and partners, the brand expansion of our international operations, our expected investments in our business, the nature of expected capital expenditures for 2006, our expense growth, our expected stock-based compensation expense, the expected dilution related to equity grants to employees, our future provision for income taxes and our effective tax rate, our planned investment in socially or economically progressive measures our expectations with our sector and mobile business, our strategic relationships including our planned acquisition of DMARC and our relationship with AOL and the rate of introduction of new products and services. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control. These forward-looking statements speak of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these forward looking statements to reflect events or circumstances that occur after this call. Please refer to our SEC filings including our report on form 10K, for the year ended December 31, 2004, and our report on form 10Q for the quarter ended September 30, 2005, as well as our earnings release posted a few minutes ago on our website, for a more detailed description of the risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the investor relations section of our website. Also, please note that certain financial measures used on this call such as EPS, Net Income, Operating Margin, operating Income, Adjusted EBITDA and free cash flow, will be expressed on a non-GAAP basis and have been adjusted to exclude charges related to stock based compensation or SBC and in-process R&D or IPR&D as well as contribution to the Google Foundation in the 4th Quarter. We report our GAAP results as well as provide non-GAAP, operating income, net income, operating margin, EPS, adjusted EBITDA and free cash flow on a supplemental basis in our earnings release. Reconciliations of all non-GAAP financial measure to GAAP financial measures are also included in the earnings release, which may be obtained by visiting the investor relations section of our website. And with that, Iâd like to turn the call over to Eric. Tucows Inc. (AMEX: TCX) is the largest Internet services provider for hosting companies and ISPs. Through 7,000 partners globally we provide millions of email boxes and manage over five million domains. Tucows remains one of the most popular download sites on the Internet. Tucows Inc. makes the Internet easier and more effective by reducing business complexity for our B2B and B2C customers as they acquire and deliver services to millions of Internet users around the world. Well thanks very much, Kim. Iâd like to thank everybody for joining us on the call today. Iâll begin with some introductory comments and then turn it over to George for some more detail on our financial results. After George goes through the numbers, Larry and Sergey will comment on the quarter and some of the initiatives that we have underway. And after that weâll have Omid and Jonathan join us as they did last quarter, to take your questions. Iâd like to remind everybody that our policy is not to give any forward guidance and we are going to continue that policy for the indefinite future. We are very pleased with these results and hope that youâve had a chance to look at the press release already. We had very strong growth in our core search and our core ad business. 22% quarter over quarter growth and 86% topline revenue growth since Q4 â04. We saw and in fact delivered expected and in fact delivered seasonal strength in both traffic and monetization, all very good indicators for the future. Our focus at Google is on the end-user experience and frankly more and more time that people spend online will be spent using Google online in one way or another. And the products and improvements that we make are geared toward enhancing user quality and really changing the way people use this sort of amazing thing that is the internet. This approach, the end-user experience, is the core to our culture and to our recruiting efforts and the way we manage the company. We see very tremendous opportunity for growth at this point. We have new, innovative products that deliver the value to our technology into different channels. It looks, based on our analysis, that the international markets are highly under penetrated, with tremendous forward growth, as we build out our operations there, and weâll talk about that some more. The expansion of our advertising network continues apace, continues to be very, very strong. But perhaps most important, we believe the rate of innovation will increase in 2006 as we continue to bring the most talented minds into Google and our unique innovation model delivers amazing new products. So we take a long term view of the business and weâre going to invest for the long term and make some really big bets. So with that, let me turn it over to George to take you through the exact numbers. Thank you, Eric. First, I will go through 4th Quarter results in detail, and then summarize our annual results. But before we get started, as a reminder, we report both GAAP and non-GAAP financial measures. Non-GAAP earnings exclude charges related to stock-based compensation, in-process research and development and a contribution to the Google Foundation of $90 million. In our earnings release, we have included reconciliations to GAAP for all of the non-GAAP measures, including EPS, net income, operating income, operating margins, adjusted EBITDA and free cash flow. So letâs jump in and get started. As Eric mentioned, we achieved strong revenue growth during the 4th Quarter. Revenue grew to $1.919 billion, an increase of 22% over the 3rd quarter and an increase of 86% year over year. GAAP operating income in the 4th Quarter was $570 million. This compares to GAAP operating income of $529 million in the 3rd Quarter, an increase of 8%. Non-GAAP operating income for the 4th Quarter was $718 million. This compares to $596 million in the 3rd Quarter an increase of 20% sequentially. GAAP net income for the 4th Quarter was $372 million, compared to $381 million in the 3rd Quarter. Non-GAAP net income for the 4th Quarter was $469 million, compared to $437 in the 3rd Quarter. GAAP earnings per share for the 4th Quarter were $1.22 on 305 million diluted shares outstanding, compared to $1.32 for the 3rd Quarter on 290 million diluted shares outstanding. Non-GAAP earnings per share for the 4th Quarter were a $1.54 on 305 million diluted shares outstanding, compared to $1.51 for the 3rd quarter of 2005, on 290 million diluted shares outstanding. Non-GAAP operating incomes, non-GAAP net income and non-GAAP EPS are all pro-forma measures, computed net of certain material items, namely stock-based compensation, in-process research and development charges, and the contribution to the Google Foundation of $90 million made in the 4th quarter of 2005. In Q4, the charge related to stock-based compensation was $58 million, compared to $46 million in Q3. In-process research and development charges were immaterial in the quarter, compared to $21million in the 3rd quarter. GAAP tax benefits related to stock-based compensation charges and the contribution to the Google foundation have been excluded from non-GAAP net income and non-GAAP EPS. The tax benefit related to stock based comp was $14 million in the 4th quarter and $11million in the 3rd quarter. And the tax benefit related to the contribution to the Google foundation in the 4th quarter was $37 million. Net cash provided by operating activities was $658 million for Q4, compared to $647 million in Q3. Now, Iâll go into some more details on revenue and expenses. As I mentioned a moment ago, total revenue grew 22% sequentially, and 86% year over year to $1.919 billion, demonstrating the continued success of our advertising solutions. Revenue growth was driven by expected seasonal gains in both traffic and monetization. Both Google.com and the Google network experienced strong growth during the quarter. During Q4, the mix in revenue continued to shift toward Google.com sites, as revenues from our Google sites increased 24% sequentially to a record $1.098 billion. While revenue from the Google network, third party sites that display ads provided by Google, increased 18% over Q3 to $799 million. Revenue from our own sites represented 57% of total revenue in the 4th quarter as compared to 56% in Q3. And revenue from the Google network represented 42% of total revenue, down from 43% in Q3. Weâre very pleased with the growth in both AdSense for search and AdSense for content, as our search partners experienced strong 4th quarter performance and we continue to add publishers to our network, extending the reach of our advertising platform. This quarter, revenue from international operations was $735 million, an increase of 18% over the prior quarter. International operations contributed 38% of total revenue compared to 39% in Q3 and 35% in Q4 of â04. The UK contributed 14% of total revenues as compared to 15% of total revenues in the third quarter. The decrease in international revenue, in UK revenue as a percentage of total revenue, is attributable to foreign exchange and to seasonal trends, both of which I will explain further. We experienced an unfavorable impact to revenues due to the strength of the dollar relative to foreign currencies, primarily the Euro, the Pound and the Yen. Had foreign exchange rates remained constant from Q3 through Q4, our revenues would have been $12 million or roughly .6% higher. Had foreign exchange rates remained constant from 2004 through 2005, our revenues would have been $40 million or 2.1% higher. In addition, we saw stronger seasonal trends in the US than in the international business in Q4 with weaker December spending in certain verticals in the UK. Last year the effect of this trend was offset by favorable impact from foreign exchange and from the addition of AOL Europe in Q4 of 2004. We continue to see good progress in our international operations. Overall, our international business had a strong quarter, with very healthy growth in Europe, Asia, central and South America. We continue to see international expansion as a key area of opportunity and investment. We remain under-penetrated in several markets and are focusing our efforts on building out our infrastructure and bringing more localized products to these markets. Turning now to costs and expenses. As all of you know by now, at Google, cost of revenue is comprised mainly of traffic acquisition costs or TAC, expenses association with the operation of our data centers, credit card processing charges and amortized expenses associated with purchased and licensed technologies. In the 4th quarter, cost of revenue increased to $775 million, up from $654 in the 3rd quarter, but decreased as a percentage of revenue to 40.4%, from 41.4% in the previous quarter, primarily due to a reduction in TAC as a percentage of revenue, which Iâll discuss next. TAC, or the revenue share we pay to our partners, increased to $629 million in Q4, from $530 million in Q3. TAC as a percentage of advertising revenue decreased from 34% in Q3 of 2005 to 33% in Q4. This decrease is related primarily to revenue mix, as revenue from Google.com sites increased relative to revenue from the Google network. In Q4 of 2005 R&D spending increased to $157 million from $152 million in Q3. R&D spending as a percentage of revenue declined to 8% from 10% in the prior quarter. The decrease in R&D as a percentage of revenues is due primarily to a reduction in IPR&D charges in connection with acquisitions, as well as with the seasonality of engineering hiring in the month of December. You should fully expect to see growth in this expense line as the pace of innovation at Google accelerates. Turning to the sales and marketing frontâ¦sales and marketing in Q4 was up $155 million, an increase of 47% from $105 in Q3. As a percentage of revenue, sales and marketing increased from 7% in Q3 to 8% in Q4. This growth is attributed primarily to the development of global marketing programs such as our toolbar distribution deals, expansion of our global sales force and investments in Asia and Latin America. G&A increase to $114 million in Q4 from $92 million in Q3, an increase of 23%. On a percentage of revenue bases, G&A stayed flat with the prior quarter at 5.9%. Turning to stock-based compensation, stock-based comp charges grew in Q4 to $58 million from $46 million in the previous quarter, primarily related to Google stock units issued in Q4 and those that were issue previously. Our non-GAAP results are net of these charges, after the related tax effect. Stock based compensation in 2006 will be significantly greater than it was in 2005 as a result of our adoption of 123R, effective January 1, 2006, which requires the expensing of all stock-based compensation. We currently anticipate the dilution related to all equity grants will be in the 1-1.5% range in 2006. As we discussed on our last call during the 4th quarter, we contribute $90 million to the Google Foundation. This was a non-recourse, non-refundable donation and was recorded as an expense in Q4. We do not expect to make further donations to the foundation for the foreseeable future. We do however expect to make equity and other investments in for-profit enterprises that aim to alleviate poverty, improve the environment and achieve other socially or economically progressive objectives. We expect these investments to be made primarily in cash and to be valued at approximately $175 million over the next 3 years. Turning to operating margins, our non-GAAP operating margin in the 4th quarter was 37% of revenues; weâre down slightly from the prior quarter as revenue growth and a more favorable revenue mix were than offset by significant investments in all areas of our business. Our GAAP operating margin declined primarily as a result of a $90 million donation to the Google Foundation in Q4. Now Iâll turn to taxes. Our effective tax rate for Q4 increased to 41.8% this quarter and to 31.6% for the year, above expectations of approximately 30% for the year. The amount of tax expense we recognized in any particular quarter is driven by our estimates for the year. And as weâve said in the past, our estimates for the year are sensitive to the mix of earnings in the US and overseas. These estimates are complex and 2005 was the first year we realized any reduction to our effective tax rate as a result of profits earned overseas under our international structure. At the end of the year, we must true up the tax provision for the year, which could and in the case of Q4, did have a disproportionate impact on the 4th quarter. In calculating our true up for the year, the proportion of expenses allocated to international operations was greater than we expected. Primarily as a result of this a greater percentage of our profits were taxed at a higher domestic tax rate, which resulted in a greater effective tax rate, compared to our expectations. Keeping in mind the complexity of projecting tax rates, we expect our effective tax rate for 2006 to be approximately 30%. Looking at liquidity, net cash provided by operating activities for Q4 totaled $658 million as compared to $647 for Q3. Free cash flow, another non-GAAP measure of liquidity, is defined as cash provided by operating activities, less capital expenditures. This quarter we generated $413 in free cash flow, as compared to $354 in Q2 and $309 in Q4 or â04. Our capital expenditures in the quarter were $245 million, primarily reflecting purchases of servers and networking equipment as well as acquisitions of additional office space. Adjusted EBITDA, defined as net income before interest, taxes, depreciation, amortization, IPR&D and stock-based compensation, increased 21% to $814 million or 43% of revenue in Q4, up from $672 million or 43% of revenue in Q3. Our cash, cash equivalent and marketable securities balances were just over $8 billion at 12/31 of this past year, up from $7.6 billion at the end of last quarter. Days sales outstanding, or DSOs increased to 33 days from 31 days last quarter. This reflects the growth of our international business where credit terms tend to be longer as well as the extended credit to certain customers in the US. Full year 2005 revenues increased 93% to $6.1 billion. International revenue accounted for 39% of total revenue, up from 34% in 2004. GAAP operating income was $2 billion, compared to 2004 GAAP operating income of $640 million, which was impacted by a charge related to a legal settlement in 2004. Looking forward, we will continue to invest heavily in our global infrastructure, including servers, networking equipment, and data centers, with a smaller proportion on real estate investments. On a worldwide basis, we grew to 5,680 full-time employees as of December 31, 2005, as compared with 4,989 employees as of September 30, 2005 and 3,021 employees as of December 31, 2004. So, to summarize, we are very pleased with our Q4 results. As we have previously emphasized, we are investing aggressively in our business and scaling rapidly to pursue enormous opportunities for long term growth. We will fuel innovation through deliberate and appropriate investments in R&D and in our core infrastructure as well as through acquisitions. We believe these investments are critical to achieving our mission and to maintaining our competitive advantage. Thank you George. We spend a lot of time at Google focusing on our users. Weâre always finding new ways to serve their interests better. I want to talk about three areas where weâve been targeting our innovation. We see the users want more personalized products that they can tailor to their needs. We see that theyâre always looking to find more information easily. And we recognize that users are seeking new ways to get information using devices other than their PCs. During this past quarter, we introduced several new products and services that we think will help meet these needs. On personalization, weâre learning that as people use Google more, they want more targeted results. So weâre bringing information to our users in more personalized ways. For example, our personalized search feature takes previous search history into account when presenting results and is now available in 12 languages. Users can set up Google News to get stories based on their preferences through the Google accounts login. We also launched 12 new local editions of Google News, expanding the reach of news information tailored to users. More recently, we announced Google Personalized Home for mobile devices. A new service that enables users access to their personalized Google home page on their mobile phones and PDAs. And just this week, we announced a beta version of Google Toolbar that offers the ability to store bookmarks and access them from anywhere and other new features. To provide people with more information, we worked with more partners to add new content to our services. Google book search and a related library project, provide new ways for users to locate material that previously couldnât be searched online. Google Base collects even more information about a wider diversity of new types of searchable content. The way we organize and present the content allows us to give users more targeted search results. We broadened the scope of Google Video so that users can search across the wide range of videos from many new content producers. Weâve already announced deals with CBS, the NBA, Charlie Rose and others, and expect to announce more in the coming quarter. Finally, we are also giving our users more ways to access information. Last quarter, we released versions of both Gmail and Google Local for mobile devices. Anyone with a Gmail account can now easily get messages from their mobile phone. With Google Local now integrated with maps, users can access business listings, maps, driving directions and more on their mobile devices. RIM recently announced the release of Google Talk on their Blackberry hand held devices. We introduced Google personalized home for mobile, covering both seams that I discussed previously. In addition, we signed agreements with Motorola and T-Mobile to provide search services to millions of mobile phone users. We believe that mobile applications are essential in bringing the internet experience to users in countries where mobile usage outpaces broadband. Overall, weâre continuing to make progress towards our mission to organize the worldâs information and to make it universally accessible and useful. Looking to 2006, we expect o launch more products that bring more information and more content to our users. Now Iâll turn the call over to Sergey. Thank you Larry. First Iâd like to share some thoughts on our advertising business. At Google, we have built a user-centric business, meaning that ad-serving is based not only on when and where the advertiser wants an ad to be shown, but more importantly, when and where the user wants to receive the information. We have encouraged our advertisers to use an always-on approach to their campaigns, rather than a more traditional flight-based approach. And we are now really reaping the benefits of this approach. Changes we have made within our sales organization are enabling us to address advertisersâ needs in a more targeted way. The 4th quarter was the first full quarter with a vertically organized sales force in addition to a growing inside sales channel. And, we have been reaching out to both Fortune 500 customers and medium-sized businesses more effectively. Larger companies are now including interactive advertising as significantly and increasing components of their overall marketing budgets. They are making more investments in technology and in partner relationships to help them to scale and to better measure ROI. Ford Motor Company has successfully partner with Google to execute integrated lead-generation and branding campaigns for years. During the quarter, Ford was the first automotive advertiser to run a major placement within our site targeting program. This campaign generated awareness around the launch of the new Ford Explorer, as well as promoted Fordâs sponsorship of the Road to Kona Ironman competition. Alongside our larger advertisers, we continue to see many smaller, less well-known advertisers building their businesses through AdWords, as we help them drive qualified leads to their site and grow into larger companies. Our platform creates a level playing field that allows small and medium businesses to take advantage of the same features, such as site-specific targeting, regional targeting and conversion tracking to ensure their message reaches their intended audience. We are also providing more flexibility for all of our advertisers. During the quarter, we introduced AdSense on-site advertisers sign-up, where publishers can sign up new advertisers directly from their websites, and AdWords separate content bidding, which enables advertisers to place separate bids for ads that run on content sites, giving advertisers more choice and more control over their ad placement. As always, we are focused on improving the quality of the ads that we serve and will continue to make product improvements that better match ads to queries and to content. In Q4 we renewed several important AdSense partnerships including InfoSpace, Terra Networks and Span end result, Key Online and ECBig Globe, Business.com, WebMD and C-Net. We also signed new deals with PBS, Encyclopedia Britannica and Merriam Webster. And per our announcement in December, we have also extended our relationship with AOL. We continue to develop innovative ways to extend our competencies to other media channels. In addition to our continued testing of outplacement and print publications, this month we entered into an agreement to acquire DMARC, a digital solutions provider connecting advertisers directly to radio stations, through an automated media platform. We plan to integrate our AdWords platform with the DMARC solution in order to provide another distribution channel for our advertisers and ultimately to increase overall spend with Google. So, switching gears before wrapping up, Iâd like to talk about some of the great progress we have made toward building out the business internationally. In November, we opened offices in Brazil and Mexico and increased the size of sales and operations teams in regions where we still have large opportunities to increase our penetration such as in China, Japan and India. We continue to rollout localized versions of our products in new languages, which is essential if we are to meet the needs of different users and different markets. This quarter, we rolled-out sixteen languages for Google analytics, 12 languages for Google personalized home page and 15 languages for Google desktop, among many others. As we look forward, we will intensify our efforts to build out our infrastructure overseas and to develop products that are tailored to individual markets. We will continue to develop tools for our advertisers to help them better understand and improve their ROI. And ultimately, our goal is innovation. We hope to create new and better ways for advertisers to connect with their customers wherever they may be. Eric, over to you. Thanks very much Sergey. So we had a strong Q4, full of product enhancements, many partnerships, ongoing improvements to our platform and all very consistent with the relentless focus that we have on user experience and the integrity of our search results. We see the revenue and profitability expectations of the quarter and weâre scaling this business rapidly and weâre investing for the long term. This is a distribution scale business of, in my opinion, enormous proportions focusing on end-users, billions of them. When we build a product we need to think in terms of the billions of users that are in so many different countries. We need to create access points for all devices so they can get this information and weâre focused on executing our business as scale with the lowest cost for capital and the highest performance delivered in the industry. From my perspective, this remains a unique and historic opportunity. Putting more data on the server and information on every kind of device: mobile phones, moving information from personal computer to personal computer, personal computer to mobile, without having to figure out things like what files server, all of those kinds of things are something that people have been clamoring for for a long time. Weâre not yet finished getting all the information into Google into the hands of end-users around the world. So looking at 2006, lots of investment in better search tools, more personalization, much more content, a lot more focus on the advertisers. Weâre already seeing strong monetization from our existing advertisers and many more advertisers are joining. We get feedback from our advertiser cycle. Feedback in the cycle causes us to provide better monetization per query, more services and more ways of making money as this market grows and as our reach grows. We have more advertising clients with brands. And those advertising clients with brands are learning how to use our technology to solve their business problems. Weâre also applying this to different mediums. Leveraging technology in other innovative ways; new user access points, mobile phones, consumer electronics, television, radio with the DMARC acquisition, print, click to call, all either launched or under development here at Google. From a corporate perspective, we are growing our talented employee base. Great technical people, great business leaders all around the world. Weâve added Shirley Tillman and Anne Mather two outstanding individuals, to our board. Google is still completely committed to the fundamental mission of getting all of the worldâs information easily accessible and useful. Weâre going to do very, very well here. So with that, we look very much forward to spending some more time with you at this yearâs analyst day on March 2nd and Kim, is it time to go to question? Thank you, if youâd like to ask a question, please press *1 on your telephone at this time. Again, thatâs *1 if youâd like to ask a question. If you are using a speaker phone, please be sure that your mute function is turned off to allow that signal to reach our equipment. Thank you very much, two quick questions. First, George, if I were to normalize for the differential in your tax rate, am I correct in basically seeing that there is a 24, 25 cent differential which basically puts you back at $1.78? And second, Sergey, what are your plans regarding the offering of rich media display formats to your network of publishers? Can you just talk about time-in? I understand you guys are doing a small beta right now. Should we expect revenue share to be similar to that of the Ad Network program? This is George, as youâre correctly starting to figure out here, really most of the mess was related to the tax impact and thatâs sort of the gap to consensus. I think thatâs the question you were asking. Yes, this is Sergey. We have increasingly offered more and different kinds of ways to put advertisements on line. Weâve been somewhat conservative. As you know it took us a while to allow image advertising within AdSense, but we allow it now. And we have now increased the number of different formats and sizes that we offer. I expect that we will continue to do so, but we will want to be cautious that the formats we allow have restrictions that mean that the websites that run AdSense always have a peaceful presentation. We wouldnât want really outrageously flashy things to just distract everyone from the website and for that website as a result to not want to participate in AdSense. That said, weâre definitely open to lots of new great media formats from interactive and obviously the offline ones of print and radio that I already mentioned. Thank you, two questions. As you lok at the other types of medium, print and radio, is it push or pull thatâs taking you there? Do you have existing clients who are coming to you saying weâd love to see you come up with advertising solutions for those media or are those just areas you find interesting in the meat of innovation? And just real quickly, any more color on the UK vertical weakness you mentioned George? Why donât we add Omid and Jonathan to the conversation since theyâre on the line. Omid, do you want to start with advertising? Sure, thanks, yes. I think itâs really a combination. Weâre really trying to figure out how to reintegrate the advertising solutions with more of the successful model we have of measurability. For example, weâre very impressed by DMARC and the solutions theyâve provided already with the bringing of a level of automation that is very similar to our model. Now, the ROI models are going to be very different and weâre going to look for working with our existing customer bases to expand into these new formats and mediums. The other is really, frankly, again as I mentioned weâve organized our sales organization to be really much more focused industry by industry and figure out how, again, to best serve the needs of the Fortune companies, the major accounts and what weâre finding is that all of them have a lot of interest in figuring out how to bring more measurability and how to expand and integrate more solutions across different formats. Hi Mark, this is Jonathan. Just building on Omidâs answer real quickly and Iâll cover the UK, I think that it really is our ability to offer a unified platform for all media to our advertisers and extend the accountability of online to other media that youâre really going to see. So it is both a push and a pull model, but itâs really getting to that more unified platform that I think is critical. The UK answer is a little bit nuanced. You tend to see monetization in the UK is doing fabulously well, overall. We tend to see a little bit of the reverse kind of seasonality in the UK relative to the United States, over the holidays. There are also some specific issues just related to how the calendar worked and number of relatively high monetization days that slightly adversely impacted that. But itâs mostly just the reverse Christmas trend that you see in the UK, which is simply a cultural and vacation-related issue. Thank you. I was hoping you could drill down a little bit more on the sales and marketing line which came in certainly higher than we were expecting. You talked about obviously growing out the sales force. Can you sort of give us some guidance in terms of how far along you are in this process in building up the sales force and also how much of a factor that was versus some of the other things you mentioned around toolbar distribution and expansion in Asia and Latin America? Thank you. Hi, this is George Reyes. So, I think the best way to address this question is, over the course of the last year and all of these earnings calls that weâve had, I think weâve made it very clear that we are focused on growing our business and international expansion, in particular. So I think the way you should look at the increase in the sales and marketing line is just as a logical extension of that. We think the opportunity ahead of us, particularly in international markets I just exceptional and what youâre seeing is the investments that need to be made to sort of harvest that opportunity. Thanks. Iâm curious and maybe this ties into Dougâs question a little bit as well, as you look forward in 2006, do you see the same kind of incremental growth in operating expenditure? I think in the quarter you did $75 million higher operating expenditure than you did in 3Q. Is that the type of pace or growth in total operating expenditure that you can envision? Yes. As you guys know by now we donât give explicit guidance, but let me try and sort of replay my tape one more time. So we think the opportunity ahead of us, especially in international markets, is exceptional. So weâre going to continue to invest at these rates. And thatâs sort of the agenda here. Thanks very much. The growth in the Google network websites was a little bit lower on a relative basis than I had expected, and I was wondering if you could provide any details related to that? Thanks a lot. Hi, this is Omid. We actually have had very good success in renewing contracts and signing new ones as Sergey mentioned. It just has to do with the fact that some of the biggest partnerships are in long term contracts with us and that there werenât any really new significant, major amounts of traffic both in terms of content or search that we added to the network. From their end, weâre experiencing nice growth in traffic, seasonality was nice in the commerce sector and we also are continuing to focus on partnering. Are a number of these contracts that you speak of up for consideration in 2006? Is the pipeline looking like you want it to look like? I think people are kind of wondering why the revenues were the way they were for that particular area. This is Eric. In general, the contracts are multi-year contracts and so theyâre pretty locked in from a business model perspective. The benefits that we offer advertisers for improved RPM, that is literally revenue growth per query per advertiser, and so forth, are new to both Google.com and the partner network. So what youâre really seeing is that the aggregate growth of the partner network is growing somewhat slower than the total growth of Google.com, which is also mirrored in some of the market share analysis that people are showing. And, itâs hard for us to predict whether that will continue, but it has been a trend for some time. We are reasonably indifferent to which category gets the growth, although if Google.com grows, thereâs more of a private contribution, because we keep 100% of that rather than doing a rev share with the partners in the TAC relation. Thanks for taking my question. It has to do with new consumer products. Some of the new products that you launched last year have received mixed reviews. For instance, Google video. Iâm wondering if you could sort of grade yourself in terms of how well you think those initial launches were; if it were less than a 10 or a 9, what might you do different to improve the user experience there? And then just secondly, we havenât heard much about Founder Awards in a few quarters. Iâm wondering do you have any updates? Recent awards? Or is that a reflection of innovation within the company? Thanks. Maybe we could have a founders comment on that then Jonathan add as well. I was going to comment that we tend to ship products very early and in Beta, precisely so that we can experiment with them. Larry or Sergey? We have always done that. In fact we launched AdWords like that and it took us a while to get to the model that we have now. We actually hadâ¦we didnât have pay-per-click initially. This is sort of how Google has always worked in that we love getting things out really early, we love experimenting with them, we love having a huge pace of innovation. And so Iâm actually very, very happy with our process. Weâre launching a lot of different things that people are really interested in. The teams that are doing those are learning a tremendous amount. Video has actually gone through three iterations already. And, it has been tremendously successful. Weâve gotten huge numbers of videos on there. We just recently launched the paid videos and we expect to do a lot more along those lines. And I couldnât be happier with our progress there. Sergey will talk a little bit about Founders Awards. Yeah, this is Sergey. If you think over the past year, weâve certainly had a number of very exciting, successful products that we are already pleased with and that have already repped great rewards for our company. It takes a little while, sometimes, to really assess that value and be able to appropriately reward those employees. But we do have one cycle of founders awards; it should happen in the next few weeks. There have just been a number of other important things weâve had to attend to that have probably delayed that a bit more than we should have. And, we look forward to really giving those out because I think that Iâm not going to pre-announce them now on the earnings call, but I think theyâre well-deserved and most people will be very happy. With regard to some of the less mature products, I think weâre going to give them some time to see where they take us and really evaluate their overall benefits to Google as a company and to our end users. Thank you. I was wondering if you could talk a little bit about gmail. Specifically, what kind of traction youâre seeing there both in end users as well as monetization and what you think as that product starts to mature, how you think on a relative basis monetization within that offering will look versus the monetization in your core search business. This is Sergey. We are still in the phase of gmail where we are focusing on innovating on the features, the experience. We are spending an increasing proportion, but still a relatively small proportion of our engineering resources, focusing on the monetization. We are relatively comfortable that over time, once we decide to make that push, much as we did in search only after a couple of years of focusing almost exclusively only on the search experience. We are comfortable that thatâs a very valuable service and will have some significant financial benefits. Hi, this is Jonathan, just building on what Sergey said. We measure user satisfaction very, very carefully. So thatâs one set of feedback which we get. We also did extend the signups to several additional countries. I think there were 8 or 9 countries that we extended to in December. And we also launched some new features towards the end of Q4. We added some simply things that people had been asking for in the satisfaction studies, just vacation auto-responder and RSS speeds and contact groups and viewing as HTML. So we made a lot of improvements in mail and in other media forms. But over time I think what youâre going to see is that weâre going to have different inputs into the out systems that are better and more appropriately tailored for the different product set. And gmail will certainly benefit from that as we crack the monetization code there. Thank you. Question along the lines of the international business. You referred to it as under penetrated. Iâm curious if you were referring to market share or penetration of search on the internet or monetization or perhaps all of the above? If it is monetization, can you give perspective on how effective you view your monetization in the non-US markets versus the US markets? This is Eric. Maybe Omid and I can answer that together. I said it because when I look at where those markets are compared to the US, I see them a couple of years behind the level of penetration and monetization in the US. In some cases, itâs simply because advertising online is new. In some cases, itâs because we were later on a relative basis of entering the market. And in some cases, itâs because e-commerce is still a new and fast-growing thing. If you look at the difference between the United States and Western Europe, for example, it took a couple of years for the model in the US to really take off in Western Europe. Our Western European revenue growth in the last year has been nothing short of amazing. And in fact, it looks like international growth, ignoring quarterly fluctuations, will continue to outpace US growth for the foreseeable future. So, we have made a decision to invest in many of the international markets to bring them up to the scale of the more mature markets of the United States and Western Europe. Omid? Thank you Eric. Yes, as Eric mentioned, this is a big focus for us and it was highlighted by several operations that got established last quarter from Brazil to Mexico, Poland, Israel, the European regions and Turkey. And I think the good news for the sector is that what weâre seeing is that our ROI based measurable form of advertising is really working everywhere with similar levels of interest. Itâs just the maturity levels. So, even in a market like Japan, for example, that is pretty well established, the level of targeting and direct work with the clients is not at the level of sophistication that we see here in the States or the Western Europe. So weâre very busy taking the learnings and the best practices from the US and extending it where it makes sense. And then establishing our operations so that we can be on the ground and localize the products properly, localize our operations and attract talent from both a technical standpoint and business operations. Thank you. Just a couple of quick ones please. Iâm just wondering if you could update us in any fashion on how the AOL relationship is going in terms of just putting your heads together and figuring out how youâre going to leverage the content and your ad sales force. And then secondly if you can give us any quantitative update on how youâre doing in penetrating the Fortune 500. It seems like youâve had some more visible success and with the vertical channels selling, it would seem that that would have helped as well. And for any quantitative or qualitative update there would be great. I think Omid and I will answer this as well. This is Eric again. On the Time Warner/AOL deal, we were very, very excited to announce a five year plus extension to that. Itâs a very deep partnership involving quite a bit of video and other kinds of display advertising as well as much more integration with the sales force. That deal is signed and weâre busy planning all sorts of collaborations between the two companies. What I like about it is that itâs an extension of what weâre doing already, so thereâs no hiccup, no negative, no hurt. Because of timing we were able to take advantage of it. So thereâs a new set of products flowing through. Weâre spending a lot more time with the sales force training them on the new technologies and weâre beginning to plan for some of the new display and video collaborations that we contemplated in our deal. Omid? Thanks Eric. Weâre really focusing the organization to monetize the business at many levels. Weâre offering the Fortune 5000 companies the ways to customize site targeting, for a really good examples of those you may have heard about were advertising in the entertainment industry like Paramount, very successful in using site-targeting to drive awareness of their movies before a movie launch. Drive sales of DVDs once itâs released Chrysler, Honda, StarCom, MediaVest have been also some of the other major users of site-targeting. So what weâre really doing is trying to again understand best how the Fortune companies are trying to work with us and share with them industry-specific, vertical specific knowledge of performance and really use all the tools and all the products we have available today and the new ones that weâre bringing forth to just improve their experience and bring measurability and reach of greater audience. And, weâre very pleased with our progress. Thank you very much. I wanted to focus on three areas that I think youâre generating very little revenue from if not any at all. Specifically, Google images, Google local and then Google China. I think the last time we touched base you were generating zero revenue in Google China, is that still the case? Second part of the question, Google images, I believe youâre not generating any revenue from. Itâs a sizeable vertical with 25 million unique visitors according to Media Metrix. Whatâs the methodology and when do you think you will monetize that and what are some of the considerations for getting factors? And lastly, Google local, there seems to be a lot of innovation going on in Google local and click to call would be a great way to monetize that. If you could comment, thanks. This is Jonathan. Weâve certainly done some experiments that you may have seen with images and it certainly is an area where we have significant traffic. What we typically see there is that people who go to images are looking for just that, theyâre looking for an image. So, one of the things that weâre still trying to crack the code on there is what is the right context sensitive ads to offer? Certainly you can sell them images, but Google already supplies a reasonable number of images that are free. So, although we have a lot of traffic there, it has not yet proven itself to be one of the more monetizable vehicles, although there are certainly experiments that weâre going to continue on there. As far as the question related to China, I donât know the specific answer on that. Omid may well know the answer on that. Hi, yes. China, we actually have both the online availability, the advertising available so that customers can come through the online channel and weâre very actively building our direct capabilities there. One of the things thatâs important, obviously, is having all the right infrastructure on licensing available for us to be able to operate locally. So weâve been very focused on just establishing ourselves. Weâve had great success actually in signing up resellers and the results from working with these resale appointments have been excellent, actually, in terms of a number of advertisers have actually joined our online program. And weâre looking forward to establishing direct relationships with both agencies and clients directly as our capabilities are getting built up. And Iâm sorry, I donât think I answered your question on click to call, I mean, thatâs obviously an exciting area and I think as we mentioned on the call last time, weâre testing the ability for users to speak directly to advertisers when they find them on a Google search results page. Itâs free, they do it over the phone, they donât have to dial an 800 number, we keep the number private and you know, whatâs obviously exciting there is that youâre connecting somebody expeditiously and directly to a place where theyâre reasonably likely to consummate a transaction. Whether it be a restaurant or an organization or a store. So, the monetization opportunity is obviously very significant. And to add to that on just the local front, as you mentioned, we believe that local is a very great opportunity. And, I think weâre going toâ¦we have been experimenting, weâll continue to experiment. We donât want to rush to have the wrong advertising solution. But, we believe itâs such a fantastic opportunity that weâre investing a lot of effort to do it. Yeah, I just have two quick questions. One is, could you comment a little bit more on DMARC? And besides all the radio opportunity there, are there other opportunities that it provides, such as TV, video advertisement placement, pod casting advertising, etcetera. What opportunities does that technology provide? And number two, how should investors think about Google as a software and a hardware company? When we think about, particularly these transportable data centers, when we think about devices in the home, dub them Google Cubes or what have you, or even I believe the Linux system of Ubunto, how should we think about where Googleâs going next and the opportunities in front of it? I wanted to talk about DMARC, I donât know about the second question. On DMARC, it is a very exciting opportunity. It took us a while to figure out that there was this possibility of the radio market, based on its structure, based on its technology, based on the existence of a company such as DMARC. And, we are, as you know, experimenting with print. We donât know exactly how it will work. We are optimistic. I suspect that advertisers want greater access, better accountability, more unified framework for their ROI and so forth, I suspect thereâs great demand for all those things. And, as a greater consequence, we can generate greater revenue for the publishers. But, this really requires a lot of testing and development and understanding of this specific market. So I canât forecast the success of any of those but I have great optimism. I would add on the DMARC side that this space is a vast space and so this acquisition lets us go in there with a very, very differentiated product and tied to our advertising system, should provide a significant growth in scale, globally. On your question about sort of hardware and software company aspects, you mentioned Ubunto, which is a Linux brand, we use it internally but we have no plans to distribute it outside of the company. Thereâs an awful lot of speculation about Google playing in those markets. The Google PC, those kinds of things. To me, most of those are people projecting the last one, not the next opportunity on us. And from my perspective, those are not very interesting business opportunities; theyâre well covered in the market, we partner with many of the players and we would much prefer to deepen our partnership with them than to go into competition with them. We are relentlessly focused on this new end-user experience, which is multi-platform and based on the internet and thatâs where our future is. Thatâs where the growth is, thatâs where the revenue and monetization is. And, as I mentioned earlier, itâs so large, it makes no sense to divert our resources to these other and somewhat smaller opportunities. Operator The final question comes from Trina Choudry at JMP Securities. Miss Choudry, please go ahead. Iâm hearing no response, would you like to take another question? Thank you. If we compare the 3rd quarter sequential results with the 4th quarter results, I think you said on your last call your query growth was kind of flatish, I donât want to put words in your mouth, so please correct me if need be. And the revenue growth was pretty powerful so the monetization increase sequentially in the September quarter was very high. In this quarter, you in your press release and on the call you talked about seasonal strength in traffic and also in monetization. Could you give us a little more color on the differences in the degree of incremental monetization you had in the 4th quarter versus the degree of incremental positive monetization you had in the 3rd quarter? Thanks. This is Eric. We saw both strong user traffic in the December quarter as well as continued improvement in the monetization. I wouldnât characterize them as being on the monetization side as being materially different than the rate of improvement that we saw in Q3. We are continuing to invest heavily in improvements in quality; those improvements in quality and many other enhancements that we offered in our product line, result in continuous improvement every quarter in monetization on a constant flow of traffic. In addition to that, traffic grew quite strongly, perhaps because of seasonality, perhaps because of gains in market share, perhaps because of all the new products, or perhaps because of a combination of all three. But we know that both are working and when both are working well, we see very, very strong resonant growth, which is of course wonderful. What Iâd like to do now since weâre run out of time is go ahead and wrap up by saying that to all of you first, thank you for taking the time to be on the call. Weâre very, very pleased with our performance on every level. The financial, the pace of innovation, the growth, the quality of the leadership in the company, the positioning that weâre in today. This is a very exciting industry to be in and itâs getting increasingly more interesting every day. Weâre veryâ¦weâre still very much in the early stages. I think in my view, making tremendous progress of realizing the long term vision that weâve outlined over the last year or so, with you to organize the worldâs information. And weâre tirelessly committed to delivering this value to our users and to our shareholders. We are innovating at scale and weâre seeing strong user growth and strong revenue growth. And again, you see that in our numbers, you see that in our comments. Life online through Google, information plus search plus advertising, making all of that seamless, is not just the Holy Grail for the company but it also provides tremendous operating efficiencies, revenue growth, and we believe all told very strong cash flow and profit growth. As an example, very, very large advertisers now see the ability to take large sets of businesses that they have and spread them across a pretty wide variety of products offered in many different markets through Google. The multiplicative effect, which you get by strong revenue growth, strong user growth, strong product line growth and many new advertisers is what is going to, currently we believe, continue to deliver very, very strong growth here in the company. So thank you very much again to our users, our partners all of our employees, our shareholders. Iâm very, very sure 2006 is going to be an exciting year for Google. So with that, thank you very much. Tucows Inc. (AMEX: TCX) is the largest Internet services provider for hosting companies and ISPs. Through 7,000 partners globally we provide millions of email boxes and manage over five million domains. Tucows remains one of the most popular download sites on the Internet. Tucows Inc. makes the Internet easier and more effective by reducing business complexity for our B2B and B2C customers as they acquire and deliver services to millions of Internet users around the world. |
EarningCall_234031 | Hereâs the entire text of the Q&A from Netflixâs (ticker: NFLX) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Operator]: The question-and-answer session will be conducted electronically. If you would like to ask a question please do so by pressing the â*â key followed by the #1 on your touch-tone phone. If you are using a speakerphone, please make sure your mute function is turned off the allow your signal to reach our equipment. We will proceed in the order that you signal us, and we'll take as many questions as time permits. Once again, please press â*â, #1 on your touch-tone phone to ask a question. [Q - Gordon Hodge]: Hi, good afternoon. Just a couple of things. One, it is this looked as though, based on the high level of free trials in the quarter, that a lot of the sub adds may have come towards the end of the quarter, and that would be consistent with the fact that you raised guidance at the very end of the quarter rather than at your analyst day. I'm wondering if could you comment on that or it was decline in ARPU, was that more related to a mix issue with the lower price plans in there? And then also the disk purchases look rather low in the quarter. At least low relative to the other quarters. You've got much higher users now. I'm just wondering if you're enjoying economies there, or is it just sort of a one-off situation in the quarter. Thanks [A â Barry McCarthy McCarthy]: Hi, Gordon. It's Barry, thanks for the questions. I heard three of them. One about the timing of sub growth, one about ARPU, and one about content purchasing. [A â Barry McCarthy]: Well, with respect to sub growth we had quite a bit of momentum coming into the quarter and you see in that part in our earnings release in the mix of free versus paid subscribers. The update in the guidance was as much about the settlement as it was about an update on the business, but since we were updating people about the settlement, we felt compelled to give you the full picture. With respect to ARPU, it has declined and not reflects the continued popularity of the lower price plan, which are also contributing to the improvement in gross margin in part as Reed mentioned, then lastly, you're right, disk purchasing was down in the quarter by quite a bit, it was about 13% of revenues. We'll see a slight, which is low historically, as you know, we've been in the high teens. We'll see a slight increase probably next quarter by a couple hundred basis points maybe, something in, let's call it the mid teens, 15%, 16% range. So the personalization software that we've been developing and integrated into the website has been working quite well for us, as we mentioned, that is contributing to the decline in purchasing and to increased margins. [Q - Gordon Hodge]: Terrific. Then just, I guess, I didn't really ask the question very well, on the subscriber adds, did you notice an appreciable change when blockbuster took prices up in terms of an acceleration in the adds of subscribers and is that continuing into Q4? It would appear that it is, but, [A â Barry McCarthy]: Gordon, there's no question that the blockbuster price increase helped, but there was no inflection point in the quarter. For example, the price that they actually did but the week that they actually increased prices, it's as much also helped by their lack of marketing and general weakening state which affects the service level, it affects the marketing and it affects the pricing. So all of those factors combined make for a weakened competitor and for a stronger competitive environment for Netflix. [Q â Glen Reid]: Yeah, hi. Just quickly following up on the ARPU question, is it still the case, or maybe could you kind of elaborate more just on the dollar contribution or the gross profit contribution, between your say your 999 plan and your 17.99 plan. Are they still roughly equivalent some is that really the case? And I guess the second thing, there's been some talk, in the last few days about a blockbuster-Amazon partnership that's sort of been going around. I'd love to get your thoughts on that in terms of how it might affect your business. Thanks. [A âReed Hastings]: Glen, it's Reed. I'll take the second part and let Barry do the first part. We've heard the same rumors but then we've been hearing them for nine months. So this' anything really different happening there, and I think what we've shown is blockbuster spent about $300 million trying to compete against us, and we've held together and, in fact, you know, accelerated our business, returning a substantial profitability, looking at great profit streams next year, so would it have to be, another $300 million investment to knock us off our momentum in some slight way at smaller levels we wouldn't feel it. So we look at it and say very unlikely to see again, again the key thing is not whether there's partnership of advertising, it's whether there's another round of $300 million of investment, and we look at that and say it's fairly unlikely, that we're just too far ahead for them to be willing or able to do that. [Q â Glen Reid]: So would that mean that you wouldn't necessarily feel compelled to revisit your sort of marketing spending caps that you've kind of laid out? [A âReed Hastings]: Well, let me separate it again in the two cases. One case, which is blockbuster, can do anything they want if they're not able to spend another $300 million, there's almost no chance that they will make an impact against us. [A âReed Hastings]: If, for some reason, they've got another 300 million to invest, either through partnership or anything else, and they choose to invest it through on-line we think it's highly you know likely, given the port return on their current investment, but that would ratchet up the competitive environment and we would have to respond in a variety of ways. So that always stands out there, I think a very low percentage chance because they've already spent $300 million there in a weekday. We've accelerated where our distance between them and total adds that grown over the last year. So that kind of double down thing is always possible but extremely unlikely. [A â Barry McCarthy]: I think the question was about the comparability between the plans around contribution margin, which is gross margin less the fulfillment cost. And we had previously said they were roughly equivalent, and we still like what I'll say about it today, we like the economics quite a bit. You can see the increased profitability in the plans reflected in the increasing gross margin of the business. [A â Barry McCarthy]: It's not as specific as you like, I know, but I think directionally it answers your question. [Q â Heath Terry]: Great. Actually, I was just wondering if could you go maybe a little bit more in-depth on what you are feeling these days about the possibility of any kind of new trend into the space, specifically Amazon, he is special as you're looking at what they doing in Europe, and then also if could you talk strategy evolving around the launch of your video download service and certainly understand the thought process behind that. As you look at potential investments for growth, does international and possibly revisiting some of the plans that you had previously about international make any sense from where you sit? [A âReed Hastings]: Heath. If Amazon DVD rental service in the U.K. were a roaring success and taking the country by storm, I think everyone would be more concerned about their likelihood of entering in the U.S. Given what we know about Amazon's DVD rental service in the U.K., that it's appreciably behind video Island and love film and behind blockbuster in the U.K., number four in the market, the prospect of Amazon expanding relatively on successful initiative is fairly small because they're a very thoughtful, rationale player. So always possible, don't see anything that indicates' likely again because they're in the market. If they were, motivated enough they would have entered earlier this year and a small entry like they've done in the U.K. where they're still number four a year later would be inconsequential to us. Next you asked about downloading. Anything specific? I could go through what I said on the script but we tried to give a good explanation there, which is, the TV channels have a lot of the content locked up exclusively, that's why Comcast, movie link, apple, and us don't have much content. That will shift over time, and it's unfortunate, and the consoling factor is that the larger we get, the bigger profit base and the bigger subscriber base we have when that content eventually is available for licensing, and when it is, it will be available to everybody just like music is. [Q â Heath Terry]: Okay no, actually what I was asking about when I mentioned downloading was less actually about downloading but with your decision not to do downloading. Like I said, I completely understand the strategy there, or to hold off and downloading until it makes more sense for you. Does that put you in a position to maybe revisit some of the international expansion plans that you had previously does that make sense from where you said? [A âReed Hasting]: We'll continue to invest in downloading as appropriate, but obviously lighter than we would if we had launched. In terms of international its something that we look at from time to time and the way that we approach it is the core business profitable enough that we can afford the investment in international and still deliver on our 50 to 60 million earnings guidance for next year and the 50% growth there after. So we look at it as it's international is one way put it to the growth, another way is invest in marketing in the U.S. We trade those off against each other, so nothing imminent, but it is something that we continue to look at. You want to add anything to that Barry? [A â Barry McCarthy]: We don't feel like we're missing any opportunities internationally, as we watch by way of example the U.K. market develop. It's developing slowly. The economic proposition appears to be challenging, and there are some small and competitors who are capital constrained who are battling each other to a draw at the moment, it seems. [A âReed Hastings]: And the U.S. is growing so fast we look at it and say 20 million subscribers in the next five years, will concentrate on the U.S. for the most part, and grab that 20 million, serve them. [Q â Heath Terry]: Catch him Thank you. [Q â Safa Rashtchy]: Hi this is Safa Rashtchy. What is driving the decrease in SACA is that where do now its penetration increase or is that the sharing music cues with friends? Can you just give us more color on the decrease in SAC? [A âReed Hastings]: SAC has stayed amazingly stable over the last two years between $35.0 and $38.0. So, in the middle of, the big blockbuster storm, it only moved up to $38.0. So, the macro look has been enormously stable. It's more efficient till down this quarter to do with effectiveness of our program, the weakening competitive environment, continued improving execution in scale. One of the things that we shared in our analyst day is that if you look in our more developed markets, such as the bay area. It's not that SAC has skyrocketed as we gone the deeper penetration, it's that SAC is actually less. So as we grow we're getting scale economies and in the bay area we estimate our SAC between $25.0 and $35.0 per subscriber. In other words, appreciably less than international average. So that portends really well for us as we get to those kinds of 10% penetration levels across the nation. [A â Barry McCarthy]: Reed made a great case for why it is that we should be forecasting a lower SAC and we're not, so let me try to at least articulate our thinking so that walk away from the call imagining that we've sandbagged our plan here, which really isn't our intent. In each of the last two quarters we have expected SAC to come in higher and depart from the trend. We have spent aggressively and made, what, in respective proven to be relatively conservative assumptions with that response rates on some of the spending we have done. I think from a planning perspective, that's the right approach, because in the alternative, if we fall behind, and we overshoot on SAC, there's no way to meet the plan numbers, we'll get crushed. So that's the approach we took the last two quarters. We're going to continue to take that approach as we begin to bring some new advertising vehicles more heavily into the mix, and until we've got a consistent history that shows we should be more aggressive in our assumptions that about response rates we will continue to be relatively conservative. The reason we've changed our approach on the guidance through '06 by not giving a range but given you as below which we will not fall, which I characterize as the bottom of the range, because our goal is to spend the marketing dollars and we made very well be more productive in terms of yield from the SAC perspective in which case subs will be considerably higher than we have been forecasting, and that's just fine but you should have the comfort knowing that we'll be in a $50 to $60 million range for income on a pretax basis next year regardless of what happens from our growth perspective. And, of course, historically that hasn't been the case we overshot one subscriber growth, because we were managing to a SAC number, we have, I'll say, overshot from marketing spending and it came out of the bottom line. [Q - Youssef Squali]: Yeah thank you. Hi Beary, Hi Reed, two questions first I am trying to understand why they switch to the fixed market and budget strategy at a tame when your competitor is weaker and when you can grow fastest, why has the focus changed to profitability? [A â Barry McCarthy]: We said fixed marketing, not small marketing, so if you look at our report you'll see we spent about $33 million in marketing up from low 20s in Q2. So don't interpret us we're backing off at all. We are pushing the growth a level hard or we're doing it in a way where we can feel very dependable in terms of delivering our earnings. [A â Reed Hastings]: Yes in the range of as a percent of revenue, about 15% on low side I think and 24% on the high side in the Q1 time frame when sub growth has really been rocking. The latest quarter we were 19%. I think you can expect us we are sitting in the 19%, 20% range. So we feel like we've put the hammer down on spending and we have taken advantage of all of the scale economies in the business that have contributed to increased profitability. I think we made the argument last quarter, and invested it in incremental marketing. So we share the same view that you do, which is that this is an opportune time to pursue growth in the presence of a weakened competitor, the and we are. [Q - Youssef Squali]: Will you be playing with promotional discounts or introduce lower prices, say, for instance, 799 as a plan? [A â Barry McCarthy]: Well, we may test a number of different things, Youssef, and we'll give you an update if any of them work and we can be confident of their success, but of course, it will be smart for us to test many different things. [Q - Youssef Squali]: Okay and lastly, I guess, Barry McCarthy, and you guys pushing back the download service, would you still be spending 1% to 2% of your revenues on R&D as you said before? [A â Barry McCarthy]: Well, if we don't spend it on downloading, we're going to reinvest in incremental subscriber growth and marketing, provided, of course, that the marginal acquisition cost per subscriber still works within the framework of our economic model, and I think it will. So if it's not going into downloading we invest in the market and we'll drive for faster growth. Now, one more word about this investment of marketing and faster growth. Over the long run, I think we will have a more valuable enterprise on a net present value basis. Since each sub is profitable over their life, the sooner we bring in a sub, the more valuable the enterprise is going to be, and the faster we'll drive bigger profits if not in the current quarter then in the next couple of years. So it's good for the business and I think it's good for investors. [Q - Dennis McAlpine]: Thank you and good afternoon. Couple of clarifications, could you say what that postage assumption was for next year? Was it 37 to 39? [A â Barry McCarthy]: Yeah, $0.02 each way, Dennis, so they discuss already in back so two plus two, four cents. [Q - Dennis McAlpine]: Okay. And then when you talked about the purchasing being down, I think you said 14% or, so did you increase the rev share, and what do you see happening to rev share going forward, particularly as you go into Hi-Def DVD? [A â Barry McCarthy]: Dennis, there's a slight increase in rev share but it really different kinds on which studios have the hot films of the quarter and now we are, let share with them as suppose to any strategic evolution. In terms of Hi-Def, DVD none of that has been worked out so it may be more or rev share or may be less rev share and we will get a chance to talk to the studio sort it out the plans from up around and pricing of Hi-Def, as you know that perhaps not all of the investors do conduct expected time is middle to late next year in terms of the launching of the first movie following on the launch of play station 3, potentially of HD-DVD, depending on the format. [A â Reed Hastings]: I want to make a correction. I think I heard we retail a rev share was up slightly. Rev share it was actually down in the quarters. So if the content cost across the aboard, we are actually important contributors to increase profitability because of some of the things we're doing from a personalization standpoint on the website. [Q - Dennis McAlpine]: Can you update us where you are with the Tivo arrangement given what you are talking about down loading is that down, where those, that still proceeding, or what's happening there? [A â Barry McCarthy]: Yeah there's no work going on right now. We love those guys, and we just don't have any content. So there's not really any point of doing anything at this point. [Q - Dennis McAlpine]: One last thing. You were willing to put Wal-Mart out of its misery by taking over its operation. Would you consider doing the same thing for blockbuster? [A â Barry McCarthy]: Now I think it would be a potential significant FTC issues there. So it not clear that we will be able to be in a pre desire to, so for now works very well for us because we having them in the market, creates a lot across, we grow the market category, we've done very well since they've been in, so may be in our interest to actually have them stay as, you know, a relatively not strong balance sheet and be in the business in a small way. So we're not particularly eager for anything to change over there. [Q - Jim Friedland]: Thank sir first the quick question on the tax rate assuming you have to start booking taxes even though they're non-cash. If you exclude the stock-based comp impact should we just use a 40% rate and then the second question is on usage. On a like for like basis have you seen any different usage patterns with the lower price plans and is usage still continuing to sort be flatsish to slightly down on the core three DVD plan? Thanks. [A â Barry McCarthy]: Jim, with respect to the tax rate I'd use a 42% number. Overall, usage has come down significantly, not on a normalized basis, which reflects the shift in plan mix. Historically, Q3 has been a heavier period of usage than either Q2 or Q4 on a normalized basis. And the last thing I'll say about usage which is in answer your question directly, but tells you roughly how we're feeling about the level, usage in the quarter was almost exactly, within 100th of a disk where, we expected it to be. And we're liking the current usage levels. [Q - Doug Ernst]: Good afternoon. Daniel Ernst, but thanks for taking the call. Two questions if I might. Could you give us an estimate what you think cash flow is for 2006 based on your assumptions for beginning to pay taxes during the year? And then secondly, kind of looking at your guidance for the year in subs and also for your longer-term goals of 20 million, if I look back over the last five years or so you've touched 8, 9 million homes already, kept 3.6 million of them. Are you seeing in your gross homes that you touched, two, three years ago to be (indiscernible) 47:52, and coming back and trying service, or you getting your growth from new subscribers? Thanks. [A â Reed Hastings]: Daniel, it's Reed. I'll take the second part and leave the first part to Barry McCarthy. We're seeing the growth all around of people who come back to the service and new people, and so, for example, in the San Francisco bay area, we've continued to see net adds, so you're looking at gross adds we mentioned, coming in the figure of total people touched, but ultimately what drives the P&L is net adds so we put a lot of focus on, now watching trends and that. And in the bay area towards nationally, we've seen an acceleration in net adds, I talked about it nearly tripling from a year-ago in terms of net adds, and in the bay area we're still seeing an acceleration of net add. And if you think of the S curve of growth in terms of canât understand at what point will we saturate we're still on the first half of that S curve where net adds is still accelerating and I will see that one going for ever eventually net adds will still stop increasing and we will continue to grow but at a constant rate, like DirecTV, which grows by about a million and a half a year of net subs over the last ten years. So again, our net adds are still accelerating, so we still haven't even hit the halfway mark in the S curve of growth and even in the bay area where we're 11% of households, the net add rate is still growing. So that's what gives us the confidence in talking about those very large numbers such as 20 million subscribers in the 2010 to 2012 period. And I turned Barry McCarthy handle the quick as the question. [A â Barry McCarthy]: The question was with regards we could give about free cash flow in â06 and what (indiscernible) 49:38 was due to the impact of taxes. We don't provide free cash flow guidance for '06. And the answer to the second part of the question is there will be no impact on free cash flow from taxes. It's entirely a GAAP accounting issue. At some point we'll make the determination that it's likely that the business will consume on a go forward basis that roughly $125 million in NOLâs that we expect to finish the year with at a 42% tax rate that will translate into something like if we booked it all of at one time that is $53 million one-time gain that will get run through the P&L. And then for accounting purposes we appear to be a fully taxed entity, and so it will affect the GAAP net income number we report but for so as the IRS is concerned, we'll continue to consume that $125 million NOL even after the business becomes profitable for tax purposes, and that will happen at a different time than does it for GAAP purposes, primarily because of the treatment that has to do with the stock options expensing. [Q - Doug Ernst]: Okay, understood. But will that give me the cash flow guidance could you give me range of Capex for '06? [Q - Frank Christina]: Thanks two questions. I apologize that if you answered this already but the phones were over choppy. In terms utilization did you give a stat as to whether or not it was up or down year-over-year? [Q - Frank Christina]: Oh, thank you Sorry. Did you give the stat as to whether or not it changed year-over-year? [Q - Frank Christina]: Okay. And then the other question is, with regards to the cash flow it seems like that you had an atypical decrease accounts payable, and I was just curious what that was, that's historically risen. If you could give us some color there. [A - Barry McCarthy]: Yeah, we think about the combination of AP and 52:03 (indiscernible) expansion AP with a quite a bit in the current quarter. It's primarily related to a decrease and content purchasing. [Q - Gordon Hodge]: Yeah, sorry, but here's one on the whole notion of tipping the stores. Curious if you think you're pretty close to doing so and if so would that, cause you to be really aggressive, at least on a short-term basis, I guess to test that hypothesis that you can do in the and would you then be cut prices, for instance, or more be aggressive in a particular regional area, would that be the other way you to think about a test of the, [A - Barry McCarthy]: No Gordon, remember that the stores have five and ten-year leases, so you can't get short-term, let's run aggressive pricing for summer and, change the flavor of the market. So it's really of long-term trend and what we're seeing in the bay area video stores closing, and a number of block busters closing that's the positive trend for but again, it will play out over five years because the lease has come up they just get non removed. I think to get out of the leases. So, you know, that's the real constraint, and, let me rather losing money because of low sales in those stores will it high penetration. So by continuing to drive penetration up, we continue to lower their efficiency in the stores and you see that in the earnings about competitors or lack thereof, and you think that will be a continuing trend going forward as we grow. [Q - Gordon Hodge]: So this isn't a sharp change it your track on your part in terms tinkering with prices more. Thatâs more gradual? [A - Barry McCarthy]: You know really the price were we seen is, the elasticity is substantial but we'll only do the price if the elasticity is enough that we end up at the same or better place from an earnings point of view. [Operator] Derek Brown, Pacific Growth Equities. [Q - Derek Brown]: Thank you. My question kind of relates to the how guys anticipate the mix of subs coming in by the various price plan, I mean that based on kind of the general framework you guys are giving for '06 is it seems like there's quite a bit coming in at the lower end, and I'm wondering if that's by design or by accident or people rotating from current price plans downstream at all? [A - Barry McCarthy]: We're pretty agnostic in terms of the different price plans what. we do want to do is get subscribers on the plan that makes sense for their profile because then they're more like to stay with us, and that's part of why our retention has been improving, churn dropping is we're doing a better job of getting someone that's a very casual movie person to be on the 999 program and someone who is a very heavy-duty movie person to be on our $24.0 four-out program. So when you match the (indiscernible) 55:21 person they're more likely to stay with you for a long time. As you mentioned before the gross profit dollars, profound pretty similar across the plans, which allows us to be agnostic. So we really don't try to, for example, we have a free trial for all of the plan. If we wanted to steer people we could have a free trial just on one or two of the plans what we found is that on balance it works better to let people choose the plan that makes sense for their life, so other than the revenue the other factors, if you take it down to the gross profit line you get much more stable. [A - Barry McCarthy]: To say this while giving way on a revenue per disk basis we really like what we're seeing in the business. [Q - Glen Reid]: Just again real quick on the tax issues, just so I'm clear, there is no cash tax impact, it's really a GAAP tax, and we should be modeling 42% starting when? [A - Barry McCarthy]: Yes, I think 42% is as good an assumption as any other, and it's not a tax issue, it's a bookkeeping issue for GAAP purposes. The timing is uncertain. I think the bid and the ask is somewhere between the fourth quarter of this year, which I think is probably unlikely, but within the realm of possibility, and the outer limits I would say the third quarter of next year, assuming that we're operating the bottom line along the lines of our forecast. [A - Barry McCarthy]: It's about developing and conveying to our auditors and us collectively reaching the conclusion that there's more than a reasonable likelihood that we will be able to utilize in future periods the NOLâs that we've accumulated. [Q - Glen Reid]: Okay. And then one other question, just back to the marketing issue. Have you guys sort of found any particular marketing, whether it's TV, Internet that's become more effective, less effective, and how do you think you'll sort of proceed with your marketing strategy, you know, based on what you've seen in terms of effectiveness? [A â Reed Hastings]; Well, we're getting better and better as we get bigger in terms of our on-line buying, in terms of our TV buying, print, radio, direct mail, all the vehicles that we use, and any channel can work depending on its price. So by having multiple channels we're able to be very diversified mix, so if pricing drops in one area, we'll tend to pour little more money into that pricing rises in another area we'll shift money out of it. In that way we have a very flexible and diversified platform for our acquisition spending. [Reed Hastings co founder and CEO] Great. Thank you to everybody on the call. Look forward to talking with you in another quarter. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234032 | Hereâs the entire text of the prepared remarks from 51Jobâs (ticker: JOBS) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good day, ladies and gentlemen. Welcome to the 51job, Inc.âs Third Quarter 2005 Conference Call. At this time, all participants are in a listen-only mode. Following todayâs presentation, instructions will be given for the question-and-answer session. If anyone should assistance at any time during the conference, please press the â*â key followed by the digit â0â and an operator will assist you. As a reminder, this conference is being recorded today. Now I would like to turn the conference over to your host, Ms. Linda Chien, Investor Relations Manager of 51job. Please go ahead. Thank you, operator, and thank you all for attending this teleconference with 51job management. With me today are, CEO Rick Yan and CFO Kathleen Chien. Management will discuss un-audited financial results for the third quarter of 2005, which is for the three months ended September 30, 2005. A press release containing third quarter results was issued earlier today and a copy can be obtained through our website at ir.51job.com. Before we begin, I would like to remind you that during this call, statements regarding targets for the fourth quarter of 2005, future business and operating results constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and as defined in the Private Securities Litigation Reform Act of 1995. These statements are based upon managementâs current expectations, and actual results could differ materially. Among the factors that could cause actual results to differ are the number of recruitment advertisements placed, sales orders received and customer contracts executed during the remaining weeks of the fourth quarter of 2005; any accounting adjustments that may occur during the quarterly close; fluctuations in the value of the RMB against the US dollar and other currencies; behavioral and operational changes of customers in meeting their human resource needs as they respond to evolving social, economic and political changes in China; introduction by competitors of new or enhanced products or services; price competition in the market for the various human resource services that the company provides in China; and fluctuations in general economic conditions. For additional information on these and other factors that may affect the companyâs financial results, please refer to the risk factor section of the companyâs filings with the Securities and Exchange Commission. 51job undertakes no obligation to update targets prior to announcing final results for the fourth quarter or as a result of new information, future events or otherwise. Thank you, Linda. Good morning, everyone, and thank you for joining us. I will begin todayâs call with an overview of third quarter highlights. Then, Kathleen will go through our financial results in more detail. Following her comments, I will discuss current operating conditions and provide our outlook for the fourth quarter of 2005. Then we will open the call to your questions. We are pleased to announce that third quarter revenues and EPS came in above expectations. Total revenues were RMB161 million, or approximately US$20 million. This was higher than the range of RMB145 million to RMB155 million we guided to in August. Although revenues exceeded our forecast by only about 4% compared to the upper end of the range, profitability was 60% higher than expected. Excluding the foreign currency translation loss, adjusted value to earnings per common share were RMB$0.48, greater than the $0.22 to $0.30 range we forecasted. In Quarter 3, we achieved a record gross margin level of 54.7%, 1% higher than Quarter 3 2004 and more than 4% higher than Quarter 2 2005. One of the main competitive strengths of our business model is the scalability of our service infrastructure and the operating leverage we can achieve with revenue growth. With actual cost of services and operating expenses tracking close to our budget, the revenues we generated above our Quarter 3 forecast essentially flow straight into our bottom line. We are especially pleased with the results in light of our observation that the growth in market demand for HR services continues to lack last yearâs levels. We aim to build upon our success in Quarter 3 with continued efforts to drive top-line growth and achieve further margin improvements. A key highlight of the third quarter was the continued solid performance of the online recruitment services business. We are encouraged by the growing customer and job seeker acceptance of our online platform this year. Unique employers using our online services reached over 34,000 in the third quarter, which was 10,000 more than last yearâs Quarter 3. Another bright spot in Quarter 3 was the growth of the other HR related services business. Excluding revenues from the stationery business we exited late last year for like-to-like comparison, revenues for the other HR services segment increased almost 84% over Quarter 3 2004. This segment includes several HR related products and services, such as corporate training, business process outsourcing and software tools and applications. As a pioneer of these newer value-added services, we believe that we are well-positioned to capitalize on the growing development and sophistication of the human capital market in China. Overall, we are pleased that we successfully executed our strategic initiatives in the third quarter, which resulted in our exceeding financial targets and substantially improving profitability. We aim to build upon this momentum for the remaining of the year. Thank you, Rick. Third quarter total revenues were RMB161 million, a 21% increase over the same quarter last year. Excluding the stationery business, which we ceased to actively operate in November of 2004, total revenues grew 27% over the same quarter last year. Year-over-year growth was driven by increased recruitment advertising volume, higher number of customers and a contribution of new cities. Our print advertising revenues rose 20% over Q3 2004, primarily due to higher page counts, which were partially offset by lower average revenue per page. The estimated number of print advertising pages was about 3,100 compared with 2,400 pages in last yearâs third quarter. As we extended our geographical footprint into smaller-sized cities and the revenue contribution increases, we expect the overall trend in average revenue per page to decrease over time. However, please note that changes in our average revenue per page do not necessarily reflect our margin trend. You can see that although average revenue per page was 7% lower than last yearâs Q3 level, our gross margin this year was 1% higher. Online recruitment services revenues grew 37% to RMB44 million in Q3. The increase was driven primarily by a higher number of employers using our online platform and unique employers using online recruitment services were over 34,000 in the third quarter this year compared with over 23,000 in Quarter 3 of last year. Gross margin came in at 54.7% compared with 53.7% for Quarter 3 of last year, compared to Q2 of 2005 gross margin improved by about 440 basis points on economies of scale and improved efficiency. Sales and marketing expenses for the quarter were RMB28 million. The increase over Q3 2004 was due to the expansion of our sales force and increased spending on promotional and brand building activities. Compared to the second quarter, sales and marketing expenses increased slightly in absolute amounts, but decreased by approximately 80 basis points as a percentage of net sales. General and administrative expenses for the third quarter were RMB22 million and increased over the prior yearâs level, primarily as a result of higher professional services fees, public company expenses, additional costs related to opening more offices and increased personnel. Sequentially compared with Q2; G&A expenses decreased by approximately 60 basis points as a percentage of net sales. Operating income was RMB30 million versus RMB33 million for the third quarter last year. Compared with the second quarter of 2005, operating income increased 62% as a result of improved gross margin and operating leverage. On July 21 of this year, the Chinese government changed its policy to permit the RMB to fluctuate within a band against a basket of certain foreign currencies. This resulted in an appreciation in the value of the RMB against the US dollars. At the end of the third quarter, the exchange rate per US$1 was approximately RMB8.09 compared with the previous peg of RMB8.28. As the RMB is our functional currency, capital selling (ph) standards require translation of our foreign currency assets into RMB at the end of each reporting period. Therefore, the appreciation of the RMB in Q3 resulted in a corresponding RMB10.6 million foreign currency translation loss on our US dollar assets. This foreign currency translation loss is a non-cash item and does not impact our cash earnings or cash flow. Excluding the foreign currency translation loss, non-GAAP adjusted net income for Quarter 3 was RMB27.5 million and adjusted fully-diluted earnings per common share were RMB 48 cents. Expressed in US dollars and reflecting the common share to ADS ratio, our adjusted fully-diluted earnings per ADS was US$0.12. Turning to GAAP results, net income for the third quarter was RMB17 million compared with RMB24 million in the same period last year. Fully-diluted earnings for Q3 were RMB 30 cents per common share, which is equivalent to US$0.07 per ADS. I am pleased to note that our share count this year is almost 85% higher than in Q3 of last year as a result of the new common shares issued in our IPO and the conversion of preference shares, which both occurred in early October 2004. We increased our cash and investment balance at the end of Q3 to RMB885 million from RMB865 million at the end of Q2. During the third quarter, our use of cash included the repurchase of approximately 232,000 ADSs in the open market for an aggregate consideration of US$3.3 million. Also, in October, we signed a letter of intent to purchase a new office complex in Zhangjiang High Technology Park. This complex is expected to become our new corporate headquarters and to house our technology and online operations. The purchase price of the new premises is approximately RMB114 million and we expect to incur additional expenses associated with taxes, renovations, moving and other related activities. We expect to begin occupying the new complex in late 2006. Thank you. Similar to our observations earlier in the year, our market assessment continues to indicate that the growth in market demand for recruitment services has been more moderate in 2005. We have heard similar feedback from a cross-section of HR managers stating that they had fewer new positions to fill and less employee turnover this year when compared with 2004. We believe that recruitment activities have been generally slower in 2005 when compared with 2004 across the industry. We closely monitor competitor publications and websites, and our analysis continues to validate our market leadership position in print advertising and online recruitment services. Because our competitors are private and any financial results they might disclose may not be prepared under US GAAP standards, we rely on operational matrices, such as the number of advertising pages per week, the number of job postings and traffic reached to gauge our performance against the rest of the industry. By each of these measures, we remain the clear leader, with strong local presence in more than 20 cities, combined with the premier national brand for HR services. We also believe that our business model is unique among the industry for achieving growth and, at the same time, sustainable profits. Many of our competitors have adopted strategies that call for continued sacrifice of near-term profitability in the hopes of generating future returns. Many of these competitors started their business a few years ahead of us and also received venture funding earlier than we did. When we raised our first and only round of venture funding in early year 2000, we were the market follower. Over the past five years, despite the later start, we successfully grew and became the market leader in the industry. We also turned profitable in 2002 and have achieved two consecutive years of increased profitability. Our track record of achieving and strengthening our market position, market leadership position while, at the same time, improving profitability is unmatched in our industry. We will continue to be disciplined to deliver profitability and returns in the near-term while further positioning and growing our business for the long-term. In the fourth quarter of last year, we experienced a marked decline in sales in the latter part of December, a situation that we have not seen in our past history. Based on conversations with customers, we attribute the sales slowdown primarily to HR departments depleting their budgets earlier in 2004 and to many hiring managers taking holidays at the end of the year. We will be monitoring this situation closely this fourth quarter to see if last yearâs late December slowdown signaled a new incidence in seasonality and customer behavior pattern in our business. Based on current market and operating conditions, our total revenue target for the fourth quarter of 2005 is in the range of RMB140 million to RMB150 million, which would approximate a growth of 16 to 25% over fourth quarter 2004 revenues. Our fully-diluted EPS target for the fourth quarter of 2005 is between RMB 20 cents and RMB 30 cents. Please note that this EPS range relates to our business operations and does not factor in foreign currency translation losses or gains that may arise from any future RMB revaluations. For the rest of the year, we remain focused on executing our business model and driving sales productivity. In line with our traditional spending patterns, we expect to increase expenses in preparation for the seasonally strong first quarter. The period after Chinese New Year holidays is typically a strong season for recruitment advertising. As such, we will be making appropriate investments in our operations to ensure that we meet customer demand and maintain our high services standards during this traditionally busy period. Chinese New Year falls in late January in 2006 compared with mid-February this year. The HR services industry in China remains underdeveloped and under-penetrated. As the market leader and the premier brand in the industry, we believe that we are best positioned to capture revenue opportunities from this continuing development. With the industryâs most visited websites, widest geographical footprint, largest direct sales force and broadest HR product portfolio, we are a leading choice amongst HR managers in China. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234033 | Ladies and gentlemen thank you for standing by, welcome to the Public Service Enterprise Group Fourth Quarter 2005 Earnings Conference Call and webcast. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session for members of the financial community. At that time if you have question, you will need to press â1â followed by the â4â on your telephone. As a reminder this conference is being recorded, Thursday February 2nd, 2006 and will be available for telephone replay for 24 hours beginning at 1â Oâclock PM Eastern Time today until 1â Oâclock PM Eastern Time on February 3rd 2006. It will also be available as an audio webcast on PSEGs corporate website at www.pseg.com. I would now like to turn the conference over to Sue Carson, Director of Investor Relations, please go ahead. Thank you and good morning. We appreciate you listening in today, either by telephone or over our website. I will be returning the call over to Thomas OâFlynn PSEG Chief Financial Officer for review of our fourth quarter 2005 results and a discussion of key issues, but first I need to make a few quick points. We issued our earnings release this morning, Incase you have not seen it the copy is posted on our website www.pseg.com. We expect to file our 10-K with the Securities and Exchange Commission later this month, which will contain additional information. In todayâs webcast Tom will discuss our future outlook in his remark and so I must refer you to our forward looking disclaimer. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance they will be achieved. The results or events forecast in our statements today may differ materially from actual results or events. A last word on of our businesses is contained in the various reports that we filed with the SEC. As a reminder our guidance speaks as of the date it is issued, any confirmation or updating guidance will only be done in a public manner, generally in a form of a press release, a webcast such as this, or in 8K or other SEC filings. PSEG may or may not confirm or update guidance with every press release, as a matter corporate policy we will not comment on questions regarding guidance during one on one meetings or individual phone calls. In the body of our earnings release we provided tables that reconciled net incomes to operating earnings for both the quarterly and year to date results. Weâve adopted this format to improve the readability of the release and provide the required reconciliationâs between the GAAP terms net income, and income from continuing operations to the non-GAAP term operating earnings. Operated earnings exclude merger related costs, operating earnings is with our standard for comparing 2005 results to 2004 and 2006 in all of our businesses. We excluded merger related cost so that we can better compare our current period results with prior and future periods. By excluding the merger related costs our results and guidance are consistent with the way Exelon is treating the merger related costs. Attachments to the press release provide the required reconciliation between the GAAP terms net income and income from continuing operations to the non-GAAP terms operating earnings for each of our major businesses. Finally, Tom will take your questions at the conclusions of prepared remarks, in order to accomplish this call effectively we would appreciate it if you limit yourself to one question and one follow up, thank you and I will now turn the call over to Tom Thanks Sue, good morning everyone, thanks for joining us. Hope you got a chance to review our release, we put out earlier this morning, on this call I will go briefly over our results for the quarter and the full year 2005, I will also discuss our expectations for 2006 the overall market environment and finally the current status for our pending merger with Exelon. Briefly, operating earnings for PSEG were $226 million for the quarter, which excludes $6 million after tax, merger related costs and increase of a $116 million with $0.46 per share in the fourth quarter of last year. For the full year operating earnings also increased by $116 million, with $0.41 share. I will talk more about the cause of this substantial what we expect to be sustainable increase in operating earnings in a few minutes. Power reported operating earnings of $105 millions or $0.42 per share for the quarter, more than four times the $23 million or $0.10 per share contribution last year. For the full year, Power contributed $418 million or $.1.71 to PSEG results. This was an increase of $76 million or $0.28 share over 2004. PSE&G our utility, reported operating earnings of $68 millions, or $0.27 per quarter, $4 million improvement from last year. For the full year PSE&G reported operating earnings of $347 millions or $1.42 a share, $5 million increase. And finally holdings reported their operating earnings of $74 million or $0.30 per share for the quarter, an increase of $34 million from last year. For the year, holdings had a record year with operating earnings of $196 million, a $61 million increase over 2004. Summarizing the contribution by business, Power 44% PSE&G 36 % and Holdings 20%, good balance. When I go through the three major businesses, I will be using earnings per share to describe the various impacts. Our Power improvement to our performance was the key to this significant increase in earnings per quarter in the full year, overall the five units of PSEG Neclear fleet had a quarterly capacity factor of 93% versus 64% of the fourth quarter 2004. For the full year of our five unit fleet operative had a 90% capacity factor despite Hope Creek been out from most of January. This represented an 8% improvement over the 82% of capacity factor for 2004. For 2006 the plan anticipates an overall capacity factor slightly above 91%. Weâve made very good progress with operational improvements at the site since the start of the nuclear operating services agreement with Exelon last January. Our corrected maintenance backlog has reduced by 75% and is now the best in Exelon fleet. Upgrades to the facilities and improved communication to improve the work environment for the employees. We have also improved a capital and online efficiency. We appreciate that we still have work ahead of us, before we achieve the performance level for the Exelon fleet. However, we are very pleased with our progress to-date and remain firmly committed to achieving this objective. From a financial perspective, Nuclear was a very strong contributor in the fourth quarter, they are the only ones, contributed the fueling average in the active vessel head replacements in a world record 25 days, that is 17 days ahead of our original schedule. Also during the quarter all three New Jersey units performed well, and had a combined capacity factor that was 8% higher than planed, these two improvements provided 483,000 more megawatt hours into this system the, the time when prices average about $80 per megawatt hour. The higher energy prices were driven by the onset of cold weather in the region which increased natural gas prices. This combination of high prices increased nuclear output added about $0.09 to operating earnings for the quarter. The strong fourth quarter we experienced in 2005 directly in subcontracted fourth quarter of 2004 and Hope Creek was on an extended outage for most of the quarter. In the release we indicate a 2005 benefit of $0.22 in the fourth quarter related to replacement power cost in 2004, $0.14 in the extended Hope Creek outage and $0.08 for replacement power during the oil spill on the Delaware river the last December that shut boat sailing for more than a week. As a reminder Hope Creek wanted to go with itâs refueling outage under the Nuclear Operating services agreement with Exelon in the Spring. The fall this year Salem 2 will undergo a refueling outage consistent with the 18 month refueling cycle for all three Jersey plants. 2005 was also a year for improved operations for our coal fleet, we improved availability over 9% from 75% to 82%. The continued execution of our established 36-month plan, we an overall reduction of 20% in the total outage days, and our capacity factor increased from 66% to 73%. The year also saw record runs at each of our Bridgeport Harbor and Mercer stations. The absence of O&M comps associated with the Hope Creek outage in the fall of 2004, was somewhat offset by higher O&M cost (indiscernible) in the quarter. The net O&M benefit for the quarter was $0.07 per share, for the full year O&M was about $0.09 per share lower than 2004. We also saw year-over-year increase in depreciation and interest with our BEC plant in Albany coming on line mid year and a full year impact of Laurenceburg which came online in mid 2004. Turning now to the market environment, in the fourth quarter the increase in natural gas and energy prices resulted in mark-to-market losses of $0.04 per share for our non-trading energy related hedge positions. For the full year mark-to-market account accounting reduced margins by $0.05 per share. The vast majority of transactions we entered into a power are not subject to mark to market account. The few contracts that do require this treatment historically, not had a significant impact on our overall results. We recognize several that companies perform out mark to market accounting, we have now taken a step, we will do our best to clearly identified these impacts within power and potential holdings. The summary of the 28% improvement from 2004 to 2005 that power can be found in attachment 7th of the press release. Operating income for power in 2006 is expected to be in the range of $475 million to $525 million. The midpoint in this range represents an $80 million increase over our 2005 results. The key drivers to this increase are the higher prices for our nuclear and coal output. And it was realized because of the rolling nature of a forward hedge positions. The continued improvements in operations both into nuclear and fossil. There are three major items that will mitigate some of this gross margin improvement. Number one higher depreciation and interest gross facilitating with the commercial operation of the Linden facility in full year of the BEC. Secondly increase on land cost and finally lower Nuclear Decommissioning Trust or NDT earnings. Perhaps earning PSE&G. For the quarter the utility reported a slight improvement in earnings from $64 million to $68 million a increase of $0.01 per share. For the quarter the weather was about normal but slightly colder than the fourth quarter last year, which counts for most of the difference. For the full PSE&G reported earnings of $347 million, an increase of $5 million from 2004 but, a decrease in the earnings per share contribution of $0.02, due to higher shares outstanding. Expected earnings for 2006 in the utility are $315 million to $335 million, the reduction of $10 million to $30 million. Most of the reductions about $17 million due to the assumption of normal weather for the year. The part of settlement of 2004, electric based rate case, a $64 million annual depreciation credit was established. This credit expired on December 31st 2005. As part of settlement PSE&G was required to make a financial filing with BPU in November of 2005 to support the corresponding increase in rate offset for the lost of this depreciation credit. This issue would expected to be resolved before the first of the year. However, we now expect the decision to be delayed until after the first quarter. The cause of this delay on both cash and earnings which adds to $5 million pretax per month. Later this month we expect to file updated financial for our GAAP based rate case. We are expecting a decision in September 2006 with new rates effective October 1st. Now to holdings, to systemize our strategy to opportunistically monetize the absence of energy holdings, in late December we announced the sale of interest in the Seminole plant in Florida, a gain a $0.18 per share. Earlier this week we announced the sale of our two plants in Poland, we expect the proceeds will be about $300 million after-tax which compares to the book value of about $110 million. The gains in Seminole is included in Holdingâs quarterly results of $74 million or $0.30 per share. While the sale is a significant contributor to the $34 million increase in Holdingâs results for the quarter, it was not the only driver. Operations at Global primarily Texas and South America, produce strong results earning $0.08 more in the fourth quarter 2005, than in the same period of â04. Offsetting these favorable earnings were cost associated with redemption of 2007 bonds, premium payable to bondholders, one is in cost, online swaps totaled $0.04 per share for the quarter. It was also $0.04 loss year-over-year in the KKR portfolio due to Miles (phonetics) losses in the portfolio, in 2004 disposition gains not returns. Our remaining investment in the portfolio is about $6 million. Turning back to our Texas investment we had $0.01 loss from Mark-to-Market accounting related to a multi-year market contract we signed in the year-end. Such contracts provide financial stability but also increase our exposed to the mark-to-market impact. During the year Holdings also made $400 million of cash distributions to PSEG in the form of dividends and redemption for preference units. In addition Holdings called for redemption of all $309 million outstanding for the 2007 sedimentary quarter percentage bond in late December and closed on that a few days ago. Looking forward to â06 Holdingâs expect to earn $155 million to $175 million, excluding any gain from the sale of the assets in Poland. $25 million to $45 million reduction from â05 record earnings is essential to the absence of the favorable impact from the Seminole sale we just saw. We expect Holdingâs to contribute to 15% to 20% of PSEGs overall results in 2006. Now for review of financial cash flow. Tax from operations excluding changes of working capital was fairly consistent with last year. Higher commodity prices will provide meaningful growth of power but it will result in increase working capital requirements in the form of cash collateral posting and fuel purchases. In the near term these factors increased working capital requirements by about $500 million at Power during 2005. In support of these higher collateral needs during the fourth quarter PSEG and Power established an additional $1.125 billion of bilateral credit agreements with various maturities. We are very comfortable with our liquidity position and as of the year end PSEG had total liquidity available of $2.5 billion and joint PSEG and power facilities of approximately $1.9 billion available. Despite the working capital needs I discussed earlier total excess cash available to pay down debt which include the asset sales securitization financing and offshore tax activity was about $150 million positive. In addition operating cash flow, this includes about $950 million of additional items. Namely Holdings $525 million of net proceeds from asset sales and offshore cash, totaling net proceeds of $325 million from sale of Waterford and PSE&G an 100 million of securitization bond that were issued since September. As I reminder, last month, we announced a $0.01 increase in our quarterly dividend, this was a third consecutive annual dividend increase we provided to our shareholders, demonstrates the continuing cash and earnings strength of PSEG. As you are likely aware the BGS auctions will start shortly, New Jersey will auction off 1/3 of itâs residential and small commercial load for a three year period. With this structure most Electric consumers in New Jersey pay an annual price based on the average prices for past three years. In an rising price environment this helps to minimize the impact to customers. Iâll brief you with the merger. Last week the Pennsylvania PSC approved our merger with Exelon. In New Jersey earnings for the merger review have been extended and are now expected to conclude on February 27. This will leads to enable the PGM market monitor to complete an analysis of the bears alternatives through asset sales, we provided in late December. The asset sale alternatives were all consistent with the proposed sale of 4000 Megawatt fossil generation, and the virtual divestiture of 2600 megawatt to Nuclear generation was approved by Fork last summer. Settlement discussions began December and expected to resume after the hearings conclude. Schedule dates for the administrated law judges and initial decision and final order from New Jersey BPU will be extended as a result but no firm date has been set. We expect to complete all the regulatory reviews including the DOJ and closed the merger late in the second quarter of 2006. It may occur earlier I the settlement is concluded and accepted by New Jersey BPU. That concludes my remarks and I will now open up for questions. Thank you. Ladies and Gentlemen we will now begin the question and answer session for the members of the financial community. If you have a question please press the number â1â followed by the number â4â on your telephone, you will hear three tone prompt acknowledging your request. If your question has been answered and you wish to withdraw your polling request you may do so by pressing the â1â followed by the â3â. If you are on a speaker phone, please pickup your handset before entering your request, one moment please our first question. Tom, could you just mention to us, what is the average in the â06 forecast for power, what kind of that average PGS implied prices there for the BGS market that you will be serving in New Jersey. Could you share something, previously you guys had provided as part of your presentation, what the average embedded price was in the context , could you share, what the average embedded price is right now for 2006, based on which the power forecast is based on? Yeah. Ashar, I say it no.1 on any commentary on the BGS, the price or any market there, I think, itâs with the auction, the FP auction starting on Monday, I wonât need to stay away from any market commentary. In general, I think, itâs part of that, we just want to need quantify or specify what ever assumptions were, I tell you that, when we put out our guidance, it was griping end of 2005, so it was generally a longer line of the market at that time, since that time, has been some putâs and takeâs, generally comfortable with where we are at this point, but it was generally consistent worth the market towards end of the year. Okay but could you just, you canât give us a data point as to, what is that right price in your forecast right now. What are you expecting your - the sales, I guess, you have some old contracts and new contracts and all that, but what is the current embedded price is right now in the portfolio, is this is something you can give some measure? No, I think, all I can say is just regards to the PGS contracts, the public number that will last the end of May of â06, informed to get our forecast, we use generally the end kind of market numbers. I am not trying to duck your question, I was still want to get any indicators at a certain point of time, our price of PGS was X. I would say that late in the year, I think, itâs a third quarter call and at EEI, we talked about general forward hedge percentages, you may remember, we talked about nuclear and coal generated about 80% of megawatt hours while like 90% of our margin in megawatt hours if you will. At the end of the year, I think, in November EEI in our earnings call, just before that, we said, for â06, we are about 85% to 90% sold on nuclear and coal, in â07 we are about 65 to 75, in the following year, â08 we have about 35 to 50. Those are generally good numbers, we nearly happy with things that we generally look to sell 75% or more of our output coal for an 20 to 24 month period, I think, those themes are still there, I think, what we would BGS so close, we probably wanted to stay away from ticking in time those numbers to the extent there is any meaningful updates in those other script are okayed that we file by the end of February. We havenât any up dates on those. Okay, and Tom previously you had indicated that you would based on where you were last year, I guess there was language that you expected double digit earnings growth going forwards? Is just, I am just trying to is that is to reaffirm Greg, you are seeing double digit earnings growth beyond â06 for the next two or three years going forward, is that a better statement? Yeah, what we said is, we put our guidance growth â06, it was so good with 3.45 to 3.75 and then we said the expected earnings per share growth in each of â07 and â08 to be 10% or more of that base. Yes, we still go ahead. Okay, and then can I just ask you went through the power guidance for â06 and you said the impact were positive were the higher prices and the rolling nature and the negative toward the high depreciation, the O&M and the nuclear NDT. Could you quantify any of these either on the negative or on the positive, so we can do the offsets, what you are facing? Yeah, I have just couple of thing right now and then I should talk to that question, but in general the NDT, the net contribution of that, this year is going to be around $0.16, $0.17 range. Thatâs above consistent with where it was in â04, but on a normal year, we just release balancing from realignment of some of that funds and in normal year we expect it to be a few penny. So, thatâs a $0.14, $0.15 differential or reduction from â05 to â06. The other plant there is Linden and thatâs going, we expect that to come online in April or May. And just ballpark numbers, the cost of that. The asset cost about $1 billion, and so if you can see fairly easily figure out that weâve got depreciation that about 40 year period and there is also got IDC on that reflects 7%. So, thatâs going to cause an increase in depreciation and relevant interest cost. Those are the big pieces other pieces BEC will be online for full year. Obviously those plants we can see margin, at least the gas fire powered plant increase the gas prices, energy margin is minimal in the nearly years, they will buy those plants within capacity in, and we expect that our profitability as our RTM is more firmly in place. Thanks, just quickly can you go through the guidance for each of the segments again, I guess, I heard power 4.75 so 5.25 Holdings is 1.65 to 1.75? Yeah. normally you still do. Power you are right 4.75 to 5.25, E&G is 3.15 to 3.35 and then Holdings is 1.55 to1.75. 1.55 to 1.75 and then we got up an offset at the parent and yes, it was up year shares outstanding, we need to put in that offset for the parent, its in the 70, 80 offset negative range, which is expenses and financing cost. Okay, and in terms of potential reaching a settlement in New Jersey, I guess in the past both Public Service and Exelon has indicated that they were optimistic about potentially being able to reach a settlement rather than having a go to a litigated decision, would you, would that sort of remain the case today as well? Yeah, we something catch up, thatâs a reasonable expectation, Paul, it is consistent with how we manage things in the past, if you look at the year â04 (phonetics) rate case, we had as the major restructuring, we had back then 5, 6 years ago thatâs consistent. I would say that for the next few weeks Dr. Bowring the market monitor for PJM, is scheduled to put some information forward to the BPU and I believe it will be public to the PJM, that will be over next few days, he is on the â he will be providing some testimony next week and then we will back, late in February. So, during that process we will obviously be adhering to the schedule, after that point of time, there will be an opportunity, we have had some discussions in December, but obviously the last since the start of the year there has been very active and productive schedule. But, after that point of time there will be an opportunity, we have, try to atleast welcome us if it possible. No, we continue to have a dialogue. We have no material updates, obviously continue to have interaction and dialogue with those folks, it is taking longer than we had initially, potentially anticipated but we continue to have fruitful dialogue and I think we are making progress. Right in that, I should stay away from these specific playback, right Paul. Hi, good morning. Had a question here on in Q4 for, in the power segment, you guys reported $41 million in other income, how much of that was NDT related or it was something else there? Yeah Iâd say the lions share, that would be the NDT. Of the $0.15, $0.17 that I mentioned I think they are our share that was largely third quarter and fourth quarter. When you guys gave out your 2006 guidance, you guys talked about PJ and after revising a $3 per kilowatt year. Has that changed much since you guys came out with that rate last year I means that seems to even below what you guys talked about in 2005 and going into 2005. Any near indications there Tom. No weâve not seen need for changes in â06 capacity prices. The real discussion on capacity prices would be in the development of the RPM that would impact â07, â08 obviously thereafter. So there hasnât been material changes to â06. And in regards to the Energy Holdings and the repatriation, how much money did you guys bring back because of the job back then did any of that report as a gain in earnings that we might to look to strip that? Now itâs 242 we pay tax and that costs us $11 million. So those actually is an offset because we paid a modest 5% tax on, those 242 I think is in our press release. Okay, and then deprecation, can you just remind on the BEC side and how much more additional deprecation would you expect there, what was the total cost of the plan? Okay and then the last question I have was on a 64 million depreciation, what you guys are saying is that it you guys wonât be able to deal with this until atleast into the first quarter so thatâs more than less employing that there is $15 million at the pre tax is going away is that embedded in that guidance that you gave or this is sort of everything is going to be incremental. No itâs not. I think the guidance we put out last October, November contemplated that we would get reasonable resolution of that effective January 1st but obviously a headwind if I call it, this fortune tend to grow up the organization. Okay. And just one more thing, In the old days you guys, in 2004 you guys just talked about the trading in BGSS items in your power division to generating about a $150 maybe $200 million of gross margin, now that everything is going on is that still the case or is that a number that is now sort of changed. Itâs till a change, I think itâs come down if you look at year-over-year itâs probably come down about $30 million if you look at overall activity which would include BGSS, it would include other assets activities we have like FTR and AR it would also include a modest amount of trading that we do. I think Iâd say our trading â05 to â04 is not been a substantial part of that business but it was a lower number. Some of that market activities and then also we have had some attrition of folk to be honest as the merger is pending is not easy on people frankly as this anxiety and we had some attrition that has caused us to bow down activities. So when we are thinking of the modeling aspect at least for now we should think of that as a sort of a run rate of the lower end of that like the 150 and then but going forward with merger of Exelon do you anticipate that ramping back up to more that 200 range. Yeah I think that a strategic discussion with ourselves and Exelon we have not done joint business planning if you will, you need to be careful with DOJ and other things out there but having some modest increase is not unreasonable. Good morning guys. Just wanted to ask a couple of questions, couple of confirmations. Now, I know Oyester Creek is run by Exelon but could you give us more updates on whatâs happening there lately. I know thereâs been a couple of reports about Oyster Creek, I just wanted to -? I ask you to stay away from that, that part of plan would speculation sure, the Exelon folks would happy to address any question. No, We really in fact, we need to be very careful about information sharing from a regulatory standpoint so, no. We are obviously doing a great job Bill Lader and his team, they are at the island, where our three plants are, two Salems and Hope Creek, they are obviously doing a great job for us. So that is really where I am going to comment on. And secondly I wanted to ask you about the 630 projected merger closing date. Could you outline the top two things or maybe the top one thing that could delay the merger also top one or two things that could speed up the merger. I think the major piece, the two outstanding things are DOJ and BPU. I think the we are just thought that, general thought that the BPU would be the critical path that schedule the month of January was productive in terms of we had a lot of witness up, got through the schedule, Dr. Bowring was the market monitor for PJM, and is a very important person, we in late December, filed on two scenarios on the 4000 megawatt to divesture that we think is consistent with work. It (phonetics) consistent while it seems that we had to date we did put more, look at two scenarios out there, Dr. Bowring has in his evaluating notes, he will make that information available and then there will be some additional hearings at the BPU and he will have an opportunity to talk about those and have some Q&A so thatâs going to be February. That is on next week and then theyâll come back in late February. After that then there will be the proceedings will still go along but there would an opportunity to have the settlement discussions. The current date for the BPU to reach a settlement is May 15th as I think in my prepared remark said we would expect that to be delayed and that there is no specific timeline but Dr. Bowring scheduled pushes things out four, five weeks. So that could cause a delay as much as of that period of time in the form of schedules. But as we said before we hope to have an opportunity to have some reasonable settlement discussions and I think that is going to be the major determinant of time. Operator instructions Our next question from the line of Clark Orsky (phonetics) from KGP Asset Management, please proceed with your question. Yeah, I had a couple questions on holdings. The proceeds from the Polish plant sales, what is the plan there, are you going to take out more debts that Holdings, that hold any hope? Yeah, we have not made any firm determinations at this point, obviously if you look at â05 we paid up about $400 million upto PSEG, paid off $320 million or so including the premium in terms of debt retirement. As there is been in the general practice we look at general full in coverage ratios. Look to provide some fairness to the PSEG bondholders but also look to buy some cash upstairs, so the closings are not expected for number of months, it was just announced a couple of days ago. The center of agreements isnât expected for a number of months, we will accept that as we go along but no firm plan to this time. I think it was $1.7 billion, that was the full or the 300s so the 300 GAAP redeemed a couple of days ago so $1.4 billion in about that range. Okay and I guess just on Just on the Texas plants, I think you said you entered into some contracts or whatever I was wondering what the hedge position for â06 is. We generally are with our project finance, we are project financings down there in both, definitely while we are looping we generally 50% or more like with 75% hedge on our one year basis. Yes we had a Texas was a good pick up from â05 to â04 we are seeing a good pick up in parts spreads and in the contract we had talked about we did sign a multi year contract generally multi year contracts we are able to get normal hedge accounting on for a variety of accounting reasons we were not able to get a hedge accounting, it makes senses for us and it is only a penny now the reason that we are bring it up is just that it may increase, we are likely to do it getting mark-to-marketing issues going up going forward. Hi. just a couple of questions, how much power do you generate for the year? and what do you expect for you know, I know your guidance, what are you sort of assuming, I know you gave me the-? And my last question is just how much debt you had at the end of the year at the parent please? Unconsolidated. I mean they have to circle back again that number its probably about $1.5 billion so we may circle back you in, including taxes, but we are preferred to note, things of that nature. For this year we will, we shook them down over time in cash generation to page down debt over 2 years. Okay and then what did you guys talk about in terms of stated strategy that you had in Connecticut, once the contract ends at the end of this year, with the power prices that you guys are getting out there right now but the step up is quite significant depending on what you guys plan to do with that? We havenât specifically addressed our market strategy, we obviously aware of what is out there in the markets and there is liquid market out there, so we donât give hedge ratioâs market by market. But, as you know there was obviously the opportunities for us to use the market to look things beyond, to look at opportunities beyond the expirations of our contract at the end of this year. Just in terms of lie cap, we have been involved in lie cap discussions, the recent settlement we have not signed on to, we think there is some improvement that could be done, we continue to be in active participant in that process we think that number of constructive pieces of it. There are some and that would be some CapEx, will be consistent with our, generally consistent with our CapEx that we provide on a five year basis. I think itâs a â07, â08 generally in the plan we provide a CapEx, how do you look forward every K, we would be doing that in our K that we be filing at the end of the month. And then was there anything down about, I believe is it Hudson that you guys were looking at any update on that? No update on that from what was in our Q with our settlement there are issues with us running that after the end of this year it is a very valuable plant for PJM and we have been some discussions as out lined in our Q with environmentally, it is largely the New Jersey authorities on thinking about managed way to continue that had that plants available but there is no material updates from our Q, I mean its pretty well online. Thatâs correct. That at this point if I am clear the lifecycle of Hudson itâs very clear on our minds its Bridgeport is an extremely valuable plant it here to stay there is some CapEx we need to deal with it, generally consistent with our table, Hudson is more subject to discussion. Tom, could you just provide, I believe there is some upgrades on the nuclear coming up could you just provide us the timeline of those upgrades or they have been done I thought they were â06, â07 timeframe. Itâs more â07, â08. Itâs been, the nuclear industry has had some other issues with a couple of other plants that have upgrades and thatâs slow down approval process. â07 and â08 timeframe. Okay and then just going back to what you said, you said it was the output for about 50000 and if I heard you said same output in â06 and in the beginning part of the call you said nuclear and coal is about 80% correct? Hi, a couple of follow ups. The fuel costs, are those expected to go, it would sort of go next year I donât know how your coal, how you are hedged on coal, just a general? In general we did see fuel cost to be, we asked the question before but fuel cost ton for ton, we thought it was going to be in a 13% to 15% increase â04 to â05 it would be probably more like 20% increase, there is some deliverability issues and other things or these-. Thatâs what I think 20% that ton for ton youâll find the total of coal is larger good news cause plants are doing more. Sure, sure and then just on your â on the sales that you make and it prices you hedged when the BGS comes up whatever price you get is the price get and you donâtâ and so all your hedge sales are just on the, on what you donât call, BGS is that, how it works, we knew itâs at 85%. The numbers that I threw out, I think Ashar asked me, I threw out the hedge ratios, they were in our EEI presentation 85, 96, 75, 35, 50 thatâs on our expected total coal in nuclear output, which is the lion share obviously the margin, in large we have shown pieces of them in our IR stuff in the past, we had to get CGF contracts that we are through that, to the extent that doesnât do all the full hedging that we want then we look at other contracts that, the contracts that just the counter part is a general contract that within PJM or various liquid markets. We generally I donât want to go into BGS capacity but we generally have capacity here and we are, we have facilities that are in New Jersey generally situated in goods parts relative to load and we generally have BGS contract coming often then we would have generation available, that could be used. Priceless. Right so, whatever, you generated 50 gigs of what is chunk of it, a portion of that be BGS, some price we will find out and then the large remaining stuff you sold last I guess some point last year and what point at throughout the year you sort of a the hedge out remaining piece. I mean, generally I mean if you assume the hedge ratio that I talked about and time aggressive then things will allow other things were added, sometimes BGS contract sometime the general market contracts, we generally think that kind of forward look is low forward that we want try to maintain some have a little more head, sometimes a little less hedge depending on variety of factors. And I guess that problem that I am having is your, may be you guys are very constructive but on the guidance, like if I sort of take it, so what I think to be genesis kind of look like and sort of our prices were last surely, you hedged that sort of hard to get the numbers you to talking you about. For big centers if you look at â06 price, â06 price is quite good. But as we said in November we are 85% or 90% hedge. No but I may be unfaking though, even faking sort of those lower sort of mid â05 prices and then throwing in something for the BGS seem like I am missing something. Actually, I said should be $18 million of after tax incremental margin for prices and amounts about, by then it is offset, as I said is up so that you are right, there is some probable assets other than it offsets and I mean, O&M, NDT and Linden, where you will see depreciation. And ITC, so happy I threw it off. Okay thanks everybody for joining in, we are also very pleased with our year end results, we think we got a business model with balances and earnings growth, and proven risk management and we are pleased that we had some very good numbers coming out of all our businesses and also look forward to continue progress, and in terms of the merger with Exelon. |
EarningCall_234034 | Here's the entire text of the prepared remarks from Motorola's (ticker: MOT) Q3 2005 conference call. The Q&A, which followed the prepared remarks, is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we'll incorporate your corrections. And please note: we have paid to have this conference call transcribed, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Operator: Good Afternoon. All lines have been placed on a listen-only mode until the question and answer segment of todayâs call. I would also like to inform everybody that todayâs call is being recorded. If you have any objections, please disconnect at this time. I would now like to introduce Mr. Ed Gams Senior Vice President and Director of Investor Relations. Mr. Gams, you may be begin. Good afternoon everyone with me in this call are Edward J. Zander Chairman and Chief Executive Officer of Motorola, David W. Devonshire Executive Vice President and Chief Financial Officer, Brain Gerics Executive Vice President and President of Mobile Devices Business, Gregory Brown Executive Vice President and President of Gov. & Enterprise Mobility Solutions Business and Dane Maloney Executive Vice President and President of the Connective Home Business. All of whom will be participating in the Q&A portion of this call. An Internet slide presentation is accompanying this conference call. The presentation can be viewed by the visiting www.motorola.com/investor the slides will be advanced automatically as our presentation proceeds. We strongly encourage you all including those listening on the telephone to also view these slides while you listen. A replay of this webcast including the questions and answers will also be available on our website at approximately 8 pm central time today. A number of forward-looking statements will be made during this conference call, forward-looking statements are any statements that are not historical facts. These forward-looking statements are based on the current expectations of Motorola and there can be no assurance that these expectations will prove to be correct because forward-looking statements involve risks and uncertainties Motorolaâs actual results could different materially from these statements. Information about factors that could cause and in some cases have caused such differences can be found in todayâs earnings press release on pages 70 through 80 of Motorolaâs Form 10-K for the fiscal year December 31, 2004 and Motorolaâs other SEC filings. This conference call is occurring in the afternoon of October 18, 2005. The content of this conference call contains time sensitive information, but is accurate only as of the time of this live broadcast. If any portion of this conference call is re transmitted at a later date, Motorola will not be reviewing or updating the material that is contained here in. This conference call is exclusive property of Motorola Inc. and any redistribution, retransmission or rebroadcast of this call in any form without expressed written consent of Motorola is strictly prohibited. Now I would like to introduce Ed Zander. Thanks Ed and good afternoon everyone. Itâs a beautiful summer day here in Chicago actually it is Fall day here in Chicago, but it feels like summer. In fact we are all sitting here in our conference room with our White Sox rally caps, yes I did change colors and am leaning from First World Series in 46 years. I hope all of you back in New York and Boston will be rooting hard for the Sox this year. Itâs been a long time and it has probably been a long time since Motorola has had a quarter like the recent one, which is Q3. We are very pleased with our results so, I want publicly thank all of our hard working employees worldwide who are responsible for making it happen. We continue to profitably grow market share with great products and increasing levels of customer satisfaction. Our quality of earnings as measured by only ratio continue to improve quarter-over-quarter and year-over-year. And in addition our vision of CMOS mobility has continued to be embraced by our customer worldwide. Let me give you some key take ways for the quarter, David will talk about financial in a minute. First we had record companyâs sales for any quarter $9.4 billion up 26% from a year ago. Second, we had record profit dollars for any quarter. Third, we achieved a new company milestone for quarterly operational margin, 12.6% that excludes significant items. We now had been above the 11% only for three of the past four quarters. Earning per share including significant items is up 67% from a year ago. We are neck-to-neck cash for Motorola $8.4 billion after repaying a billion dollars in debt and buying back 350 million more stock. We generated over $1 billion in operating cash flow, 19 consecutive quarter of positive cash flow. We actually had record mobile device sales and unit shipments, year-to-year we had 38.7 million. Our market share is up 5.5% from this time a year ago and 1% quarter-over-quarter to 19%. Our mobile devices hit for the first time in a very long time a 11% only excluding the organization charges. We see more growth ahead. Our guidance for Q4 revenue is above this mornings press call consensus. As for the few other things, our supply chain initiatives are going according to plan. You probably some of this consolidation activity this past quarter we are very pleased with the progress the team is making. We also had significant good new key people this year. One on this CIO Patricia Morrison, we also weighted some very senior marketing talent and in the technical area. Our brand is strengthened and I do have to point out that our Chief Marketing Officer Geoffrey Frost is nominated as one of the ten best marketing chiefs in North America. In summary, it was a great quarter, now we get to do it again in Q4. Thank you very much Ed. As Ed indicated we had a very-very strong quarter in earnings growth and record sales, sales were up approximately 26% first is the strong Q3 in 2004. Earnings per share results from continuing operation were $0.69 per share compared with $0.18 per share in Q3 of 2004. Our earnings per share include several significant items shown here and listed in our press release, which aggregates to a combined impact of $0.39 per share of income. Earnings per share for Q3 2004 included several significant items also shown here and listed in our press release, which, aggregate to a combined zero impact per share of income. Excluding these items from our results, earnings per share in the current quarter would be $0.30 up our growth in 67% versus last yearâs demonstrating excellent earnings leverage on our sales growth of 26%. Looking at our sales trend for the first three quarters of the year, you can see that we have continued to achieve solid top line growth the 26% sales growth of Q3 brings our year to date sales growth to 17%. Our guidance per sales growth in Q4 is of a similar rate to our year-to-date growth rate. Gross margin was down 220 basis points from Q3 last year but decrease in gross margin percent versus prior year is largely attributed to our mixed shipment sales through the mobile device business, which has the lower gross margin than the corporate average as well as an increase in low tier unit sales within the mobile device segment. Mobile devices in Q3 â05 represented 59% of our total sales up from 53% in the third quarter of 2004. In R&D, we continue to increase our investment in our future with R&D spending higher on a year-over-year basis. However, R&D decreased as a percentage of sales by 120 basis points to 9.1% from 10.3% due to our strong sales growth. We continue to believe that measuring R&D as a percentage of gross margin is a better way to determine the effectiveness of R&Dâs spending. As you can see from this chart we improved on this specimen by 170 basis points from the third quarter of last year. SG&A expenses - we continue to make very good progress in reducing SG&A as a percentage of sales. It is the G&A portion that is declining while we continue to invest in sales and marketing efforts. Reduce in G&A expenses as the percentage of sales and in absolute dollars remains an area of focus for us. The G&A portion of SG&A for the third quarter of â05 was down 16% from the third quarter of â04. Another measurement we look at to measure productivity is revenue per employee on per quarter rolling average basis. Here again you can see the continuous improvement that weâve made. Our revenue per employee has improved over 45% since 2003 and we remain focused on making further productivity improvements in the future. Looking at our operating earnings trend, our operating margin continues to show steady improvement on a year-over-year basis. In the quarter operating margin rose 310 basis points compared to Q3 last year. Itâs been many year since we generated over 11% operating earnings in the third quarter. In fact we generated over 11% operating margin in 3 of the last four quarters. Excluding the $91 million reorganization charge we incurred in the third quarter, operating margin would be 12.6%. On a year-to-date basis operating margin excluding reorganization charges would be 11.6%. We continue to make steady progress towards achieving our long term operating margin goal of 13% to 15% while at the same time growing faster than our competition. Cash flow, our cash flow performance in the quarter was outstanding. We generated $1.1 billion in operating cash flow and 19 consecutive quarters of positive operating cash flow. Capital expenditure was approximately $200 million, giving us free cash flow of approximately $900 million. During the quarter we have reduced our gross debt by $1 billion and we also repatriated approximately $4.5 billion in cash to the US and a tax benefit of $251 million. Our debts in total capital ratio has now decreased to 21.5% from 28.4% at the end of 2004 making great progress towards our goal of less than 20% by the end of the second quarter of â06. We ended the third quarter at $8.4 billion net cash positive up $900 million during the quarter and up $3 billion year-to-date in 2005. To give you a full update on share repurchase program, as you recall back on May 19 we authorized a $4 billion repurchase over three years. During the third quarter we purchased approximately 16.6 million shares at an average price of $21.29 and up to date we purchased approximately 25.7 million shares from more than half of billion dollars. Our guidance for 2005 we are working at sales in the fourth quarter of between 10-3 and 10-5 up 16% to 19% versus the fourth quarter of â04 and EPF of $0.32 to $0.34 per share. Our fourth quarter tax rate is estimated at 36% and the number of outstanding shares is forecasted at a level at about the same level as the third quarter of 2005. I would like to just give you few comments, regarding 2006 and as much as it was, a lot of unusual activities that occurred in 2005. First expensing our stock options begins as you all know in the first quarter of 2006. Our estimated annual impact is between $250 and $300 million spread fairly evenly by quarter. Second you know we have had significance gains from investments, from the sale of investments in the first quarter, second quarter and third quarter of 2005. We donât anticipate this to occur again in 2006. Third as you model the first quarter of 2006 just keep in mind at the first quarter of 2004 and 2005 both represented slightly less than 20% of our annual EPF, excluding the various significant items we have highlighted in each of our operating earnings releases. Lastly our estimated tax rate for 2006 was round about 36% comparable to the 2005 actual full year tax rate, excluding the various significance items we highlighted in our earnings release. Thank you very much and now Iâll turn the meeting back over to Edward. Thanks David, I am going to take you relatively quickly through each of the businesses and then we will get on to your questions. First Q3 mobile devices as I said earlier Ron and his Team just knocked the cover off the ball in unit sales, operating earnings and market shares and every area that we measured. In term of what were the overall highlights, many of you ask me whatâs after RAZR and the answer is more RAZRs. We are just getting started. It is the best selling clamshell in the world. Units per RAZR doubled again, we sold more than 6.5 million in the quarter alone. Remember last year I think for the entire year it was around three quarters of a million. I canât think of another iconic device in the entire electronic space that has sold more in one quarter. We launched 13 new handsets during the quarter including Rockaway One with iTunes, three GUMTS units were up more than 40% versus the prior quarter and iDEN business just had a great quarter with record performance and we won another GSMA award and it is upping its pole position in the high growth markets and Iâll talk more about that in just a few minutes. In terms of market shares, now 19% global share clear number two and weaning. Strength is unmatched in North America we strengthened their, strengthened Latin America, number two in Europe, number three in North Asia with number two in China and number three in high growth markets with a specific attack plan in India. The numbers I think you have seen from the press release sales up 41% year-over-year, operatings are up 52% year-over-year, operating margins in double digits at 10.7% on a GAAP basis if you factor out one time charges for supply chain in the organization, the mobile devices margin is a 11% which is just really great in terms of where we come from over the past several years. Unit shipments are up 66% significantly outpacing all major competitors. We ship 44% more than the number three competitor during Q3 and we expect that gap to wind in Q4. In 38.7 million units we ship more than number four, number five combined for the quarter. Market share is up both year on year and sequentially. We estimate our present position as I said earlier at 19% on a total climb of over just about 205 million units for the quarter. In terms of the Global share and market share I think I covered some of this but I am going to go through each of the geographies. In North America we are clear number one, in three out of four top levels of operators we are now reaping 33% market share units up 12% and 50% versus last year. We expect RAZR to move into CDMA in US and PEBL and SLVR were launched this quarter and we are focusing as you can see here in expanding our CDMA and continuing to strip from the brand. Latin America, kind of the same story. We are number one in the market, number one in Venezuela, Argentina, Brazil we gained five points if share in Mexico and this was a tremendous quarter for Latin America. We doubled the volume up Q3, 2004 RAZR the D170 and C115 are some of the hottest brands in that space. Europe, number two and growing. It is the best quarter ever with RAZR the clear winner. 14% market share 4 points over Q3, â04 expect further gains here also with SLVR L6 and PEBL V6 this quarter continuing to build brand in sheer here too. North Asia we are up 19% versus Q2â05 and 12% versus Q3 â04. RAZR is ahead across the region where GSM is number one mid tier in China. We now have the number one CDMA product, the RAZR in Korea, D70 is number one PDA in China and here again our focus on retail and distribution is beginning to deliver results. We are excited about our prospects of moving forward in this important area of the world. And finally an area that I have been spending some time on together with Rod and the management team in the high growth markets. I always talked about connecting the rest of the world, tremendous opportunity not only for low-end devices but all of our product lines. We are building a position across cost-to-price tiers, we are leveraging our role in the GS&A drive to connect the unconnected. Our demand is huge financial level such as the C115 has a tremendous and a great market for mid and high tier products such as RAZRs. So we are building our position. India is a particular area that we have focused on and expect to see great things in 2006 as we penetrate the Indian market. In terms of units and ASPâs, ASPâs were flat when comparing to Q3, 2005 to Q2, 2005. Unit shipments will up across all technologies. GSM units comprised again more than 70% of all Motorola units shift, yet another quarter over 50% in sequential increase with low share volumes. We improved market share, operating earnings and operating margins for Q3, 2005. We expect the sequential increase in operating earnings and margins during Q4 and deliver solid ASP performance as a result of new products introductions. And going to channel of inventories during Q3 our world wide channel of inventories continue to below industry averages. In terms of products there it is again RAZR its hot its all over the world. We expanded the availability to consumers by launching our CDMA version for China, RAZR became the best selling handset as I said earlier in Korea in September and RAZR black turned up the heat for demand around the world. With more than 12 million units to date sin consumer hands RAZR is the must have that you simply must have. Keep in mind when people refer to RAZR this is a family of products, even if you see RAZR for many years to come and as we just showed you GSM black and the CDMA version and next we will do more colors, Maria Sharapova in Wimbledon, to a lot of famous people in Hollywood, the pink RAZR is creating a sensation and you will see it in retail in time for the holidays. We also launched Rocker V1, we are excited its just a beginning. We have got more to do in positioning in North America. We got off to a mixed year results. We did ship over 250,000 units in just 30 days. Actually we are pleased with the response outside the United States in Europe and Asia. Itâs a great phone that delivers camera, blue tooth, messaging, web access and music with awesome play back time. It is not an iPod player but itâs a great phone first product from Motorola that delivers an awesome audio experience with a familiar and easy to use iTune interface. Little more about music. I believe really itâs a killer map of 2006. 10% of all music revenues today are ringtones. 3G networks and removal flash memory will enable over the year loading of music as well as providing for 100s if not 1000s of songs in a single device within the next couple of quarters. You donât need a PC to load music. Example in Japan 20% of Japans total music market is ringtones and full songs that load over the year to mobile devices. Revenue in Japan is almost half a billon, CDDIâs 1204 has loaded 17 million songs and it takes 30 to 40 seconds with PG networks, same is true in Europe and starting in Brazil. So stay tuned itâs certainly happening. In terms of other products the people ask me the 6.5 million raises, what about the other 32 million well here is some of them. We have new GSM products across the board 30 new handsets, _____. Next is here is what they are in CDMA with a 328 x 12 to 64 and so forth. Our iDEN business is strong as I said earlier weâve launched five new iDEN handsets, which just keeps us going and we are hopeful we will be working with on our next generation products and as 3Gâs we announced Motorola had won the first tender of the GSMA program to connect the unconnected. During Q3 we were again honored by the GSMA by winning the second tender, in which we announced two new models of C113 and C113A. GSA program is very important both for the industries, consumers and in the developing world, by providing a portable access to wireless communication doors are opening to economic development and opportunity and we are really exited about that program. Looking ahead to Q4 just keeps continuing, we are now shipping two customers PEBL V6, we think it is a hot product that really brings the passion together with the functionality I think you can see some of the capabilities here, with VGA camera, broadband connectivity and much more. We are also shipping to customers now, the ultra slim and cool Sliver L6 with tri-band connectivity and VGA camera and more. We are manufacturing right now with Sliver L7, itâs the worlds thinnest design, quadband, push-to-talk over cellular bluetooth VGA and we expect to ship this during the quarter. We are now manufacturing our GSM entry level devices to complete the line up in GSM. We are now manufacturing RAZR, EDDO this is the ultra fast CDMA, EDDO RAZR with megapixel camera feature packed. We expect to ship this this quarter we will announce more details a little bit later. We are also manufacturing other CDMA products here is the V325, which I think is going to be a real great product in the mid tier. Now manufacturing our 3G RAZR itâs ready to rollout in the US MTS market to megapixel camera streaming video and we expect this to be a hotline for a carrier customers. And there are more 3G devices as you can see here across the lineup from the 1070 and 770 that gives us broad strength in 3G capability. And finally Iâve been talking the seamless mobility before, we are rolling out first seamless mobility with _____ in partnership with British telecom, our first GSM over IP model delivers push-to-talk over cellular functionality and seamless transition from GSM to wifi networks and back again. We are really excited about this and this will out this quarter. The commitment for the team is same as it was last quarter, grow market share profitable and wickedly compelling, as Ron likes to call products, rich experienced quality, efficiency and the guidance as you see here in sales operating earnings and operating margins up versus the same period last year and up sequentially in Q3. Network business was also just a great quarter with AG and his team, sales of $1.6 billion operating margin of 17.1% sales up 7% with cup comparison year ago in sales increased 25%, sales performance came from Europe, Middle East, Africa. Operating earnings increased due to product cost reduction continued cost control and a real favorable sales mix. While we are very pleased with the quarters operating margin and I would love AG to do this every quarter, we continue to guide you to 12% to 15% in this business as a long term operating margin. Q3 GAAP earnings included a $5 million reorganization expense and without this the operating margin would have been 17.4%. After great things happening here we introduced our Moto wi4 product portfolio with utilizing compasses and IP core access network services and devices to drive delivery of comprehensive _____ solutions, I think there this is a big feature, we are seeing a lot of activity in the press on this. Our CDMA 2001 1xCDDO worlds broadband solution was selected by United States as they continue to rollout of Accessâs broadband services. We signed a multi million-dollar contract with Philippines Smart Communications for our canopy products. I think this is really exciting, canopy continues to expand distribution worldwide and has added over 50 distributors this year we now have over 5,000 customers worldwide. We delivered more in the IMS based push-to-talk solutions to 44 wireless carriers in 33 countries. We now have over 1.2 million subscribers, that continues to grow. And we continue to progress in developing leading position in Wireline infrastructure solutions. Motorola is progressing and we progress on the schedule with a rollout of our optical access solution with Verizone under our five-year contract announced in April, weâve progressed Verizoneâs lab evaluations to initial field deployments. We expect general appointment status in fourth quarter â05 and scaled appointments should begin in 2006. And as we announced last quarter we have won a major IPTD contract with SPC along with Verizone over dispositions Motorola to be the market leader for IPTD solutions to airline carriers. Our guidance in Q4 as I said earlier, is for sales to be up and operating margins down versus Q4 of last year, we expect operating earnings to be in the 12% to15% range as the sales mix we charge to what we believe would be the norm going forward. Again this is not a caution, this is a great business, we have targeted and in our modeling we want you to be confident with the 12% to 15% range of where this is going. Government Enterprise Mobility Solution, sales in the quarter was 1.6 billion up 4% from last year. The government and enterprise portion of that business experienced 7% sales growth in Q3 while automotive sales were down 7%. Q3-GAAP earnings included a $52.0 million reorganization expense, without that operating margin was 14.3 up 70 basis points. Operating earnings reflected continued strong performance in our government enterprises business and a second sort of modest profitability in our automotive business, which as you will remember lost money in Q1. Whatâs happening interspace with homeland security, I donât have to tell you with whatâs happening around the world recently, the need for all kinds of product and services Gregory Brown and his team provide has just gotten more exciting but more in demand. One example of this in this quarter was the O2 railway in United Kingdom. O2 railway is our largest single public safety customer, our system performance in part led to two new contract awards value collectively at approximately $100 million. We continue to win state local governments in the United States. During the quarter we won several multimillion-dollar awards for our interoperable systems. We now have won contracts in 29 of the 33 statewide interoperable digital systems in the United States. In addition we talk a lot about MASH as this continues to gain lots of traction, we began to ship the new 4.9 gigahertz motomash multi radial broadband product and we also unveiled Mistrack which delivers a wireless broadband indoor outdoor location system for first responders. We expect a high demand for this mission critical product in the prior market when it becomes commercial available in 2006. Automotive, at lower sales in earnings versus last year but it was modesty profitable, Greg is doing a great job in turning this around and we do have an issue as you know worldwide in the automotive industry and we are feeling that we are now back to profitability. We are continuing with our strong emphasis on operational and cost improvements, infact new lifetime sales awards in automotive for Q3 exceeded a billion and were awarded in all regions and all product lines. One major award is from GM for the next generation telematrix control unit, Motorolaâs telematrix control unit currently more than 50 GM vehicle models and was the sister behind GMs on star offerings, and GM has stated itâs plans to make the onstar RV available in all GM models by 2007. For this entire government enterprise mobility segment, our guidance for Q4 sales and operating earnings to be up versus Q4 last year driven by growth in the government and enterprise business offsetting a decline in automotive. And finally and certainly not the least Dan and his team down in Horshum just had a bang up quarter, sales were up 28% due to significantly increased demand for advanced HD DVR settop. Operating earnings were up 48% from Q3 last year driven primarily by higher sales and operating margin is up sequentially as we continue to come down the cost curve on the 64 12 dual tuner DDR settop box. Excluding the organization expenses operating margin was up a 100 basis point versus Q3. In the quarter we achieved a significant milestones by shipping over 40 million set top units since inception to-date. We began shipping the 3412 HDDVR set top, the newest all digital HD dual tuner DVR supporting open cable standards. Verizone launched itâs TV video service in _____ Texas deploying an end-to-end video network designed built and installed by Motorola which includes state of the art video set top products. We also named the supply of the next generation IPTV set tops for SPCs TV deployment. We also went to the Italian digital TV market for launch of new interactive threshold receiver providing access to interactive services. Our guidance for Q4 is for sales to be flat and operatings to be up versus last year, sequentially from Q3 we expect sales to be somewhat down and only to be up as our North American cable service providers, our customers definitely manage their year-end capital expenditures. We expect this to grow once again in Q1, we expect our V to be up due to the improved mix. Finally I show a slide now for the better of this year. I grade ourselves, I grade the team, I did have to after this great quarter add another check mark for execution, I think they just really did a great job, very proud of the team, the financial performance with stock doesnât get any better and finally I think the organizational efficiency that we announced a year ago in terms of some of the things we are doing around simplifying the company, unifying some of our corporate functions supply chain work we are doing is starting to come into effect, and we are seeing that returned to the bottom line, so lot more to do as you can see from the slide. We had a great September 30th, October 1st in terms of raking up the numbers but the team is back hard at work in getting Q4 we are all looking forward to 2006. With that I will turn it back over to Edward. Edward Zander : Thanks. Now before we take your questions I would like to remind you that in addition to Edward and David we also have Greg Brown, Dan Maloney and Eric here to answer questions. We would like to ask that each of you please limit yourself to one question and to avoid multiple part questions. We only do this to help ensure that in the limited time available as many of you as possible will have an opportunity to ask your questions. Your cooperation is greatly appreciated. Now I would like to ask the moderator of the call to please give you calling instructions. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. 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EarningCall_234035 | Hereâs the entire text of the prepared remarks from Amgenâs (ticker: AMGN) Q3 2005 conference call. The Q&A is in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Arvind Sood - Vice President Investor Relations] Ok, thank you Crystal. Good afternoon everybody. I would like to be the first to welcome you to our Third Quarter 2005 Conference Call. Kevin Shearer, our Chairman and CEO will lead off the call followed by our Chief Financial Officer, Richard Nanula, who will give the additional details on our financial performance during the third quarter. I have also asked George Morrow, who is our EVP of global commercial operations to make some comments on the overall market and the current reimbursement environment. After George, Roger Perlmutter, our EVP of research and development will provide a pipeline update. Before you start, I would like to make the requisite cautionary statement. During our discussion today, we will make certain forward-looking statements and of course actual results could vary materially. So, with that, let me turn the call over to Kevin. Thank you. Good afternoon. Our Third Quarter Financial Performance was strong and gives us real momentum as we look to 2006. This momentum was driven by strong sales of our key products including Aranesp, Neulasta, and Enbrel, the total product sales having appreciated 23% through the first 9 months of this year. George will provide some additional details on our products including the market dynamics in a few minutes. During the third quarter, we received 3 important regulatory approvals to support our commercial goals. The first 2 approvals allowed us to expand our manufacturing capacity to a second plant for Enbrel in Rhode Island and produce commercial bulk material for Neupogen and Neulasta in Puerto Rico. The third approval allows us to now promote Neulasta to a broader patient population at risk for febrile neutropenia. I have asked Roger to provide further background as to label expansion and give a full development update later on in the call. I am very pleased with the productivity of R&D organization. We expect to have additional announcements in the year to come on data relating to key pipeline products. Before I turn the call over to my colleagues, I would like to address several issues. Last week, Ortho Biotech, which is a subsidiary of Johnson & Johnson filed a lawsuit against Amgen alleging anti-trust violations relating to our sales of products to oncology clinics. We have reviewed their complaint and we believe that Orthoâs claim was unmerited. We intend to defend our position aggressively in court. I also wanted to comment on Amgenâs response to the recent natural disasters in the Gold Coast region. In response to Hurricaine Katrina and Hurricane Rita, we mobilized response plan for the patientâs reserve and for Amgenâs staff who were affected. The company and the Amgen Foundation are also contributing significant funds to relief effort with special focus on healthcare. The financial impacts on our business, however, has been negligible, and we will continue to work with suppliers, physicians, and customers to ensure an uninterrupted supply of Amgenâs medicines to patientâs in the Gold Coast region. Finally, my personal thanks to the over 15,000 Amgen staff members worldwide who work so hard to serve our patients and deliver strong performance quarter-after-quarter. Before I turn it over to my colleagues, I want to remind you that we will report our full year 2005 results on January 26, 2006, and on the same day host a meeting in New York for the investment community. In addition, to our full year results, we will also provide guidance for 2006 and give a commercial and R&D update. We will send additional details on the meeting over the next few weeks. Richard if you could now review our financial results. Thank you Kevin. I am pleased to report adjusted earnings per share increased 33% for the third quarter to 85 cents per share. On a GAAP basis, earnings per share was 77 cents in the third quarter whereas was 18 cents in the prior year, the prior year being impacted by the acquisition of Tularik and the $554 million charge for acquired in process R&D. Total product sales grew 19% compared to the third quarter last year reaching $3 billion. Consistent with the first half of the year, we saw a strong growth of Aranesp, Neulasta, and Enbrel. While George will discuss our products in greater detail, I will just highlight year-over-year growth comparisons for our key products. We believe in general year-over-year comparisons are the most meaningful indicator of our growth as sequential quarterly trends can be influenced by factors such as extended holiday periods, for example the 4th of July weekend or buying ahead of price increases. Gross sales of Aranesp rose 38% during the quarter, similar to the strong growth we had in Q1 of 33% and Q2 of 36%. Sales of Neupogen/Neulasta rose 17% during the quarter, which brings the year-to-date growth rate to 21%, higher than the 17% growth what we realized for the first 9 months of 2004. Enbrel sales rose 35% during the quarter, which brings this to 42% for the first 9 months of the year. Epogen sales at $599 million continued to be impacted somewhat by the increased use of Aranesp in the hospital setting, which we expect to stabilize by the middle of next year. Demand in the freestanding dialysis clinics, which account to the vast majority of Epogen sales, remain consistent with patient population growth of around 4% in this setting. Based on a year-to-date product performance, we are confident that our 2005 revenue guidance provided last quarter of mid-to-high teens growth is still applicable. Let me briefly turn to expenses, which I will do on an adjusted basis for both periods. Cost to sales rose 13%, primarily due to higher sales volumes, R&D expenses rose 13% during the quarter mainly due to higher staff-related expenses and increased plunging for clinical trials such as our large phase III program for _____. SG&A expenses rose 3% due to higher Wyeth profit share related to Enbrel sales growth. During the third quarter, we continued to see some leveraging of our 2004 sales and marketing expense. Our total operating expenses grew 9% during the quarter, which is obviously below the 16% growth in total revenue, though as a percentage of sales, operating expenses represented 56% of sales, which is pretty much in line with 58% in Q1 and 57% in Q2. Historically, our operating expenses have increased in the fourth quarter, both in absolute terms and as a percentage of sales due to the timing of major medical meetings and certain other discretionary programs, which occur in the later part of the year. Looking at the past few years, operating expenses as a percentage of total sales during the quarter have been within the range of 65% to 70%. For the fourth quarter of 2005, we expect year-over-year growth in operating expenses to be more aligned with revenue growth. Q4 will include higher SG&A expenses due to consumer advertising for some of our marketed products and contributions to co-pay assisted programs during the fourth quarter as well as increased R&D spending to support products in our pipeline. We expect to see a continued increase in R&D spending in Q4 of â05 and beyond in order to capitalize on the number of attractive opportunities in our pipeline. We expect initiating number of new studies in Q4 this year, entering the planning process for a number of additional studies related to starting the first half of 2006. Many of these studies are substantial in nature, in some instances requiring more than 200 clinical sites to effectively and efficiently execute them in a rapid fashion. In addition, we plan to continue to add staff to our R&D organization to both execute these trials and to grow our early R&D stage capabilities in order to generate additional opportunities. Our adjusted tax rate was 26.3% for the third quarter. For the fourth quarter, we expected the adjusted tax rate to be somewhat lower. For purposes of calculating our adjusted EPS, shares outstanding were $1.249 billion, reflecting our continued share re-purchases and the term modifications in repayments made earlier in the year relating to our convertible notes. During the quarter, we re-purchased roughly 9.5 million shares at a cost of $769 million, which brings the year-to-date total shares re-purchase to 48.5 million shares at a cost of $3.2 billion. Adjusted earnings per share for the third quarter were 85 cents, a 33% increase. As a result of the strong quarter, we are reaffirming our guidance range of $3 and 10 to $3 and 20 cents for 2005 adjusted EPS. Capital expenditures were $199 million in the quarter primarily due to continued construction at our Puerto Rico Facility to relocate our bulk manufacturing capacity. Cash flow from operations totalled 1.4 billion and our cash and marketable securities were $5.6 billion at the end of the third quarter. I would now ask George to make some comments about our business. Thanks Richard. Major headline for the third quarter is that we saw a continuation of the positive performance seen through the first half of the year. Total product sales rose 19% during the third quarter, which brings the total product sales growth through the first 9 months of 2005 to 23%. At the quickest side, some of you may be looking at sequential growth rates for our products in quarter 2 to quarter 3. When we look back over a number of years, we have always seen a seasonal sequential decrease in the growth of our total product sales from the second to the third quarter. As Richard pointed out, sequential quarterly growth rate can be influenced by other factors such as extended holiday periods or buying ahead of price increases. We did see small buying in Q2 related to the 4th of July holiday weekend which if we adjust for leads to slack or popular sequential trend. Okay, that being said, what are the key factors driving product growth? First, sales of Aranesp rose 38% during the third quarter and again this was consistent with the type of growth seen in earlier quarters this year. In US, Aranesp continues to exhibit strength due to both share gain and the growing penetration of erythropoietin, where we saw 14% demand growth in Q3 within the oncology channel. In EU, erythropoietin use grew 6% in the oncology setting and 7% in the Nephrology setting. Aranesp share increased to 45% in oncology and 46% in nephrology. We continued to drive the uptake of extended dosing regimen in both markets, which is important in our preparation for the entrance of FOB following biologic in coming years. Sales of Neupogen and Neulasta increased 17% for the quarter and continued to benefit from the new MTCN guidelines discussing the appropriate first cycle use of colony-stimulating factors or CSFs. The Neulasta package insert was updated in September to include data supporting the use of Neulasta in patients receiving chemotherapy with a 17% or greater risk of febrile neutropenia. In the US, demand for CSFs grew 12% and Neulasta currently has a 70% share. Regarding the label expansion, there are potentially 100,000 new patients undergoing chemo with an FN risk of 70% and greater, who could benefit from Neulasta and our field force is focused on getting this important message to our customers. In EU, we are still actively converting patients over from Neupogen to Neulasta, and Neulastaâs share increased to 42% by the end of the quarter and it is now the market leader. Before I move on, just a few points about the reimbursement environment. First, we are starting to see a gradual stabilization of ASP through our products. Recently, we have taken more frequent price increases but of a smaller magnitude. For example, at the end of September, we increased the price of Aranesp, Neulasta, and Neupogen by 2, 3, and 4% respectively. Second, there continues to be a fair amount of speculation on the likelihood that the oncology demonstration project will be continued in some form in 2006. Just the other day, the US Health Representative passed a resolution urging the CMS to extend a current oncology demonstration project. It remains unclear when CMS will finalize the decision, but we know that Asian Groups and Cancer Societies are working closely with the CMS on the detail. Although the scope of the program is uncertain, in our view, these are positive steps to ensure that this program remains in place for next year. The CMS Hospital Out Patient Payment Final rule or OPPS is expected at the end of the month. You may recall that the proposed rule included AFT plus 6 with a 2% add on to cover pharmacy handling costs. The proposed rule did not recommend an equitable adjustment to the payments rates for Aranesp and is relying instead on a market-based approach. Regarding Epogen, the revised CMS Epogen policy coverage or the HMAPM should be released in the next month or two, but will not likely be implemented until 2006. We do not believe that a revised policy will substantially impact utilization of Epogen. Returning on Epogen, sales declined 12% in Q3 â05 versus Q3 â04. The decline in Epogen sales was impacted by inventory changes and increased Aranesp use in the hospital setting. Aranesp use in the hospital segment is being driven by pricing and a preference to stock a single erythropoietin. However, the vast majority of Epogen business is currently in freestanding dialysis clinics as compared to the hospital-based dialysis clinics. We expect that for the full year of 2005, Aranesp use in dialysis will be approximately $150 to $200 million. We expect the use of Aranesp in dialysis to stabilize by mid 2006. Full-year expectations for growth in freestanding dialysis clinics is roughly 4% reflecting that of patient growth. That is the sense so far, US and European performance continues to meet our expectations with strong growth. We continue to see greater use in patients with CTHs below 440, which we believe is the signal of physicians increased comfort with the drugs. In US, we believe that adoption could further be enhanced through the broader coverage offered to this population through the part B Medicare benefit as this approach is reaching a significant level of sales now, we will disclose the sales beginning in Q1 2006. The last protocol covers Enbrel. Sales remain strong at 35% for Q3. The RA segment grew 28% during the quarter and 76% in the dermatology setting. Enbrel maintains lead market share position in RA at 44% and continues that leading share at the derm market place at 85%. We saw a little flatness in the derm channel this past quarter, most likely related to the pull back of our brand DTC campaign. However, the latest script data show an uptake in demand. We initiated a disease state awareness campaign for psoriasis in August, and over 110,000 patients responded. This should stimulate patient growth going forward. We have also successfully completed discussions with the FDA and now have our Enbrel psoriasis DTC campaign back on the air. In terms of competition, we recognize the changing landscape but continue to be optimistic due to Enbrelâs broad spectrum with indication and long-term safety record. The 2006 part B Medicare provides potential coverage to an additional 15% of patients for Enbrel RA. Somewhat fewer psoriasis patients may be covered due to the younger average age of psoriasis patients. So, before I turn it over to Roger, let me just address one other issue. As Kevin mentioned, J&J has filed a lawsuit against Amgen alleging anti-trust violations related to our sales of products to oncology clinics. We have reviewed their complaint and believe that J&Js claims are without merit. We intend to defend our position aggressively in court. I am sure you will understand we will not be responding to questions about this lawsuit; however, I will say this. On October 1st, Amgen amended the contracts we offered to oncology clinics. These contracts are just part of the discount program that has been in place since the spring of 2004. Both our current discount program and our prior discount program offer greater discounts to customers who buy more Amgen products. This has resulted in increased competition and reduced cost to clinics, patients, and the government. Our customers have the option of either accepting or rejecting those amendments at their discretion. The lawsuit filed by J&J is unfair to customers and patients. It is an effort by J&J to prevent Amgen from offering discounts that benefit clinics and their patients. Amgenâs contracts are lawful, pro-competitive, and in the best interest of customers and their patients. Amgen is pleased that the lawsuit will be handled through a judicial process in an orderly and comprehensive manner. We are confident that our contracts will withstand judicial scrutiny. Thanks George. Substantial progress was made during the third quarter across a range of preclinical and clinical activities. During the third quarter as George mentioned, we received approval from the FDA to update the label for Neulasta, reflecting landmark studies completed last year. Neulasta is now approved for use in first-cycle myelosuppressive chemotherapy associated with at least a 17% risk of febrile neutropenia. This label was based on the key study, which showed that compared to placebo treated patients, patients treated with Neulasta have significantly reduced incidence of febrile neutropenia, hospitalization related to febrile neutropenia, and anti-infective use. We also received a positive opinion from the European Committee from additional products for human use with the introduction of Kepivance to decrease the incidence and duration of severe oral mucositis in patients with hematologic malignancies receiving myelotoxic therapy requiring hematopoietic stem cell support. The European authorization awaits full approval from BNA. Turning now to Aranesp, we have now completed our review of three phase II studies exploring the treatment of anemia in the setting of symptomatic heart failure. I will remind you the heart failure is a grievous illness the leading cause of hospitalization in people over 65 years of age and that treatment for heart failure has been estimated to cost approximately $24 billion per year in the United States alone. In heart failure patientâs, anemia is an independent risk factor for mortality. Of the approximately 5 million Americans diagnosed with heart failure, about 1 million are anemic with hemoglobin levels less than 12 grams/deciliter. Our three Phase II studies involving more than 500 patients tested the ability of Aranesp to safely elevate hemoglobin levels in anemic heart failure patients. The primary concern in these studies as I have indicated before was safety. Particularly, the increase in the red blood cell mass might be stabilized in patients with chronic heart failure. In addition, we collected data on exercise tolerance, quality of life, and heart failure hospitalization. The data showed that Aranesp was well tolerated in anemic heart failure patients. No significant drug-related adverse events were observed. With Aranesp, it was possible to achieve a gentle rate of rise in hemoglobin concentration that ultimately stabilized at approximately 2 grams/deciliter above baseline. Both fixed and weight based dosing yielded similar result. Overall, the Phase II program showed that treating anemia in heart failure patients produced positive trends in mortality, reduced cardiac-related hospitalization, exercise tolerance, and quality of life. These data support further investigation and Amgen has now made the decision to pursue a Phase III program. The Phase III program will be approximately 3 years long and include 3400 heart failure patients of New York Heart Association Classes 2 to 4 having baseline hemoglobin concentrations in the range of 9 to 12 grams/deciliter. This placebo control trial will have all cause mortality or first heart failure hospitalization as the primary composite endpoint. Also on Aranesp, we intend to complete our filing for extended dose duration with the FDA by year end, which will harmonize our US and European labels. Now I am going to highlight some aspects of our major registration-enabling programs. In the third quarter, we gained substantial additional insight into the utility of Kepivance, formerly called AMG 162, our novel therapy for bone resorptive disease. Kepivance acts at the level of the osteoclasts to inhibit bone resorption. This novel mechanism should offer several advantages including a rapid onset of action, a long duration of action, reversibility of the effect, and a very encouraging safety profile. More than 10,000 patients are now enrolled in the Kepivance clinical program. This program includes our pivotal Phase III trial in 7869 women with postmenopausal osteoporosis. The primary endpoint of this trial is reduction in vertebral fractures. It is a 3-year trial that will not be completed until 2008. Also, we are conducting 3 additional Phase III studies in the prevention of osteoporosis and the protection against the reduction in bone mineral density seen in patients undergoing hormone ablative therapy for breast or prostate cancer. During the third quarter, we completed our review of 2-year data from our ongoing Phase II study of Kepivance therapy in patients with postmenopausal osteoporosis. This trial is a randomized placebo control dose ranging study of Kepivance in 412 postmenopausal women with low bone mineral density. The trial also contains an active comparative control alendronate given at 70 mg once weekly. The 2-year data continues to support both the favorable safety profile of Kepivance and its efficacy profile as measured by changes in bone mineral density. A complete analysis of these data will be presented at the next oncology/rheumatology meetings next month. However, I can tell you that Kepivance treatment at 60 mg given once every 6 months by subcutaneous injection versus placebo yielded sustained increases in bone mineral density at all sites. Just as an example, bone mineral density increased by 5.11% in the Kepivance group versus a decline of 1.75% in the placebo-treated subjects in the lumbar spine. Just a few weeks ago, phase II data supporting the ability of Kepivance to suppress pathologic bone turnover in patientâs with metastatic breast cancer became available. This randomized phase II study compared subcutaneous Kepivance to IV bisphosphonate treatment, the latter given once monthly by infusion in bisphosphonate naïve women with breast cancer metastatic to bone. Reviewing the totality of the data, I find the results extremely encouraging. Suppression of bone turnover was very rapid in the Kepivance group and was especially well maintained in patients receiving once monthly therapy. From an efficacy standpoint, although the study was designed as the dose ranging study and was not powered to show relative efficacy, Kepivance appeared to inhibit bone turnover at least as well as did IV bisphosphonate treatment and also yielded favorable trend even at this early interim analysis with respect to skeletal-related events. I would remind you that a substantial body of preclinical data supports the view that Kepivance should prove especially effective at blocking malignancy-induced bone destruction. Finally, the safety profile of Kepivance was excellent at all doses tested. These exciting results provide the underpinning for our registration-enabling studies in oncologic bone disease, which will begin during the first half of 2006. A complete analysis of the phase II data will be submitted to ASCO. Finally on Kepivance, we expect to have the opportunity to review yet another phase II data set, examining the effect of Kepivance treatment on bone lesions and rheumatoid arthritis before the end of the year. New data have also become available for anatumomab, Amgenâs fully human monoclonal antibody directed against the epidermal growth factor receptor, which we were developing in partnership with Abgenix. Because fully human antibodies contain no murine protein, hey may have a lower likelihood of immunogenicity. In clinical trials, severe hypersensitivity reactions have been rare and anatumomab has generally been administered without premedication. In addition, the PK profile of anatumomab should permit dosing once a week, once every 2 weeks, or once every 3 weeks. Just last week, we had the opportunity to review interim data from studies 250 and 167 open label single-arm phase II study, which examined the safety and efficacy of anatumomab administered as monotherapy in subjects with metastatic colorectal cancer, who develop progressive disease or relapse while on or after chloropyrimidine, irinotecan, and oxaliplatin therapy. I remind you that these studies were conducted under special protocol assessment with the FDA and that central adjudication was required both to confirm disease progression and also to confirm disease progression after treatment. Anatumomab is administered at 6 mg IV every other week in these trials, so the primary end points being objective response through week 16 and the duration of response. The 2 studies differ in that patients in the 250 trial have tumors that express low or in many cases undetectable levels of the EGF-receptor targets as judged by immunochemistry. Analysis of these two new studies confirms our prior experience. Anatumomab is active in the setting of third-line colorectal cancer even in heavily pretreated patients with a 10% partial response rate. About one-third treated patients were judged to have partial response or stable disease. Interestingly, the studies demonstrate explicitly that patients with tumors in which EGF-receptor expression cannot be detected can nevertheless respond to anatumomab with similar response rate. The safety profile for anatumomab was acceptable with major on-mechanism skin toxicity as the principle finding. These studies provide support for our VLA filing which we expect to initiate later this year. Results from the pivotal 408 study, which examines progression-free survival in third-line colorectal cancer patients who have failed all prior therapies and who are randomized with anatumomab or best supportive care should be available shortly. The central review process, which is so critical for adjudication of the data has now been completed and you can expect that we will announce the results of the study by mid November. In all our VLA submission, we will include results from more than 1700 patients. We previously announced that the FDA expanded fast track designations with application. Finally, we continued to enroll patients in our phase IIIB trial evaluating anatumomab in first-line treatment of metastatic colorectal cancer. Patients are randomized to treatment with Avastin plus chemotherapy with or without anatumomab. This open-label multicenter study has end points of progression-free survival response rate, overall survival, and safety, and interim analysis of the first patient group is expected by the end of this year. Let me tell you a few things about our other ongoing registration-enabling studies. First for AMG 706, which is a small molecule that entered in several pathways simultaneously including the entire family of VEGF receptors, c-Kit, and EGF receptor continue on track in studies designed to explore the utility of AMG 706 in patients with gastrointestinal stromal tumors who have failed prior therapy with Gleevac. The phase II registration-enabling trials are fully enrolled and we have received fast track designation for this program. Final data on these trials are expected in the first step of 2006. We are also conducting a registration-enabling phase II study in metastatic thyroid cancer, where enrollment is on track. Finally, we are conducting studies of AMG 706 in combination with a variety of other therapeutic regimen including anatumomab. For AMG 531 antibodies, first peptibody in clinical development, we continue on track with our Phase III study, which are now about 50% enrolled. The primary endpoint of these studies in patients with idiopathic thrombocytopenic purpura is a incidence of the durable platelet response, which is defined per protocol as a doubling of the baseline platelet count and greater than 50 x 109 platelets per liter for 6 of the last 8 weekly assessments in a 6-month treatment. The data from these trials will be available on the second half of 2006, and I should note that our phase II studies in ITP show that AMG 531 double platelet counts in 94% of patient and was the effect in even in patients who had undergone splenectomy. AMG 531 continues to be very well tolerated in our studies. I should also mention that we continue to explore the utility of AMG 108, a potent monoclonal antibody that binds to the human I1 receptor, thus inhibiting I1, which is the key mediator of the human inflammatory response. Because of a long half-life associated with this antibody, AMG 108 could accommodate longer dosing intervals and could demonstrate improved efficacy over Kineret in the treatment of inflammatory arthritis. We did initiate a randomized double blind placebo control study of the safety and efficacy of AMG 108 in patients with osteoarthritis. This study involved 146 patients who were analyzed using the Western Ontario Macmaster Pain Score in osteoarthritis. Our analysis of preliminary data at the 6-week primary endpoint indicate that AMG 108 does not ameliorate the pain of osteoarthritis and thus this trial failed at this primary endpoint. We await final analyses to corroborate these preliminary findings. I should say that AMG 108 remains a very viable product candidate for rheumatoid arthritis and for other inflammatory diseases. As we begin the fourth quarter, I am pleased to report there are 6 new molecules entering human trials this year and I expect that we will begin study with 2 additional molecules by yearend. In all cases, these drug candidates explore totally new approaches to the therapy of grievous illness. This productivity testifies to the industry an innovativeness of my colleagues in research and development to whom I am deeply grateful. I would now turn back to Arvind to commence the Q&A session. |
EarningCall_234036 | Hereâs the entire text of the Q&A from Insightful Corporationâs (ticker: IFUL) Q3 2005 conference call. The prepared remarks are here. Thank you. The question-and-answer session will be conducted electronically. If youâd like to ask a question, please do so by pressing the star key followed by the digit one on your touch-tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Weâll proceed in the order that you signal us and take as many questions as time permits. Additionally, please limit yourself to one question and one follow-up question at a time. Again, please limit yourself to one question and one follow-up question at a time. Once again, please press star one if you do have a question. Ashok Ahuja: Hi. A few questions on InFact, follows on to the last question, I guess. Could you help position the product a little bit? Is there something in the market that you would compare it to? And when youâre talking about possible strategic relationships, what kinds of companies would you possibly be looking at as viable partners for InFact? Jeff Coombs: OK. What products would we compare it to? I would say that the closest products in terms of pure technology would come from companies such as Attensity or Clear Forest are traditionally in the area of whatâs called enterprise search. And the idea is that instead of looking for key words you actually try two participle sentences and you try to understand nouns and verbs and you try to extract events, relationships or actions. So, Attensity or Clear Forest might be the closest. Our advantage is that itâs a lot easier with InFact to extract those because we do it in a more automatic and scalable way. In terms of who might be the kinds of strategic relationships, the kinds of companies, that could â that can have a wide range. It can be anyone who provides content to the industry or to the market and are trying to find better, more accurate ways to deliver it. And so, that might be â you might think of lawyers who are trying to look through documents such as LexisNexis and trying to get information that way. It could be any of these companies that are trying to bring books to market via portal and they need a more accurate way to search it than keyword search. So, that can be anybody from a company that provides something like LexisNexis to somebody whoâs developing a portal and trying to digitize any kind of information that comes from books or newspapers. It could be âThe New York Timesâ. It could be the âWall Street Journalâ. Any of those kinds of companies are potential strategic partners. Ashok Ahuja: OK. Then I have a question on outlook. I donât know if I should queue back in or if I should ask it now. Ashok Ahuja: OK. So, the question on outlook, help us understand a little bit about the comment of the variability, if you will, in potential outcomes. Just give us some thinking behind that, if you will. Jeff Coombs: I think one of the drivers of that is that as we move to solutions, as we move away from a focus on desktop sales, individual deals are increasing in order of magnitude. So, any particular deal or set of deals can swing the revenue more broadly than they have in the past. And so, that makes it all more variable. Operator: Once again, please press star one if youâd like to ask a question. The next question is from Steve Chess with Martin Nelson & Company. Short-term investments of $632,000, what is that? And in that youâve gone to short-term investments now does it make sense to take some of that $9.6 million in cash and maybe make some other short-term investments simply to increase the rate of return? The other question â with top line growth â I guess itâs a comment and a question. With top line growth of about 12 percent and some earnings in spite of significant increases in sales and marketing and R&D and G&A expenses, it seems like the companyâs making big strides every quarter. When do you anticipate â and I know that you donât know exactly, but when do you anticipate a general leveling off of these escalating expenses, which of course could add greatly to the bottom line if revenue continues increasing? Richard Barber: OK. On this short-term investments, those represents marketable securities that have an original maturity of greater than 90 days. If they have an original maturity of less than 90 days, theyâre considered cash equivalent. On your question about moving more of it into the short-term investment category, that is something that we look at. We seek to maximize the return that we get on our portfolio. Much of the $9.6 million is in higher yielding marketable securities that are in the under 90 day original maturity range. On your question about revenues and costs, I think if we are going to be a growing company and our top line is going to grow, I think youâre going to see most of our expenses continue to grow. Hopefully G&A will decrease as a percentage of total revenues, so you wouldnât expect it to remain flat as the company grows. So, hopefully that answers your question. When youâre growing revenues, you typically have to hire more salesmen, more consultants, your development efforts increase, so your costs go up. Jeff Coombs: So, weâre in the process of putting together our two, two plus year plan. As revenue grow, sales and marketing will certainly grow with it. We also feel there are still investments that we need to make in the product line, in solutions, in the platform underneath those solutions so that we play at the enterprise level. And the focus will continue to be over that planning horizon for us to focus on making the right investments for growth. And thatâs more important to us at this juncture that is trying to drive profit growth. So, revenue growth over profit growth is the priority. Operator: As a final reminder, please press star one if you do have a question or a follow-up question. Weâll go to Steve Springer with Target Capital. Steve Springer: Yes. Going back to 1996, this company traded at 8 bucks a share. Itâs currently trading at a fraction of that, less than $3 a share. In view of the negligible return, the negative return on for investors over a period of virtually a decade in this company, my â I have two questions. One, what is the cost of being public, of public ownership of this company, estimated to be by management in 2004? And where does that â there was a reference to increasing Sarbanes-Oxley costs in 2007. Where does that go, number one, in terms of ultimate costs that youâre projecting? And number two, what is the reason to stay public when these costs are projected, I believe, to more than offset current net income? Richard Barber: So, weâll start with the costs of being public. Itâs kind of hard to give a number for that. It depends on the year. Weâve publicly announced what our audit fees are. Thatâs â those are in the $100,000. In 2004, it was more than that with some of the issues that the company had. So, Iâm not going to give the exact costs of what it costs us to be public right now. Sarbanes-Oxley where the costs go, those are typically G&A expenses. And they consist of â for most companies theyâve consisted of consultants to come in to help the company deal with the complexities of Sarbanes-Oxley, help them understand what the actual requirements are. And then there are the costs of actually complying with the standard, which means that you might have to hire people to avoid having one person doing the job of more than one person, that the COSO people think should not be doing the same job. Thereâs also IT costs that go along with being Sarbanes-Oxley compliant because there are fairly rigorous standards for IT systems in terms of security and change management. So, there are significant costs to being public, but there are also significant costs to going private. Steve Springer: OK and so, what are the benefits of being â I mean, what are the benefits of being a public company? I mean, you donât use your equity. You donât use the stock. You donât buy back stock. You donât return some of the excess cash thatâs been sitting on the balance sheet to the shareholders by buying back stock. You donât use the stock as a vehicle to acquire other companies or other technologies. Iâm wondering what is the benefit of being public. Jeff Coombs: I think one of the things, Steve, is that the cost of just doing very simple math and the cost of going private for one thing would be very significant. And it would eat up the cost of being public for well more than one year. And thatâs money I prefer to invest in the company at this point. Richard Barber: And Steve, going private requires somebody to essentially buy the company. Someone has to pay for all that outstanding stock. Steve Springer: Well, Iâm not suggesting that the company go private. Thatâs not what Iâm suggesting. What Iâm suggesting is that we, the shareholders, who are the owners of the corporation, are not receiving a benefit from being shareholders in this company. I mean, itâs one thing if youâre an employee of the company and youâre receiving a salary. Itâs another thing if youâre a shareholder and thereâs no dividend and thereâs a negative return. And so, Iâm wondering on this conference call the management declines to give a projection of what the fourth quarter will bring. I can appreciate that. Iâm frankly â I donât think the company should be in the business of providing quarterly guidance. On the other hand, talking about possible variations in revenues as a reason for declining to give guidance of some sort for the following year. I donât understand that on a company with $20 million in sales. General Electric can give guidance. Exxon can give guidance. They do $100 billion a quarter. They can give guidance. And we have a company here that thereâs not a great deal of transparency here, guys. Weâre trying to understand what we have. Itâs difficult to know. The initial question was referred to InFact. And there was a question posted on a bulletin board that referred to the fact that in 2002 the management of Insightful in the â in releasing the â in making a press release about InFact, referred to the fact that it was at least three generations ahead. Jeff Coombs: So, Steve, weâll â Iâll answer any question where the person identifies their name on a public call; on a bulletin board where somebodyâs anonymous I will not respond. Steve Springer: Well, thatâs on â itâs on your Web site. If you go back to April 15, 2002 itâs on your Web site. Steve Springer: Well, Iâm specifically referring to the introduction of Insightful where it says that he product is at least three generations ahead. Itâs on your Web site. Steve, the management â the current management team and the board of directors is committed to providing transparency and people understanding where weâre going, where weâre making investments, what our strategy is, and we are endeavoring to do that. Related to G.E. and Exxon giving guidance, they are very big, incredibly diversified companies. And itâs a lot easier to give guidance when youâre diversified. They donât give guidance on any of their business units that are $20 million. And as to providing value to shareholders, thatâs absolutely what this management team and what this board of directors is absolutely committed to. And over the past couple of years, two plus years, that this management team and the current board has been around, overall â over that period of time, weâve delivered growth, weâve delivered profitability, and our efforts to drive shareholder value over that period of time has been rewarded. And our goal is over the medium and long run to continue to do that. And thatâs what weâll do. Steve Springer: Well, look, Iâm in support of that, but I would simply like to say that there is not one research analyst that follows this stock. Iâve been in this business for 30 years. There is not one research analyst that follows this stock. This is a â youâre in a technology space thatâs supposed to be a relatively high growth space in the U.S. economy. We have a good economy. GDP was up 3.8 percent in the last quarter. In this â the quarter just ended. I mean, thereâs not one guy that follows it. You said that you were going to have an investor relations team brought on or investor relations person brought on. That hasnât been done. I mean, where are we? Thereâs nobody out there thatâs looking at this company and saying, âThis company is a good investment.â These guys â youâve been there for two years. OK. Thereâs nobody out there validating your approach. Thereâs no independent approach. Itâs just you guys saying the same thing. Weâre preparing for future growth. Weâre preparing for future growth. I mean, the big marker this year is that the stock didnât go to $1. Itâs the first time since seven or eight years the stock did not trade at $1. So, I donât understand why you canât get somebody else in the investment community â itâs a public company â to validate your strategy, to talk about it. Jeff Coombs: And so, in response to your last question, it generally is our approach not to buy analysts and their reports. And our experience is that the analysts from the Wall Street firms, especially the large ones, typically donât follow and donât issue reports for micro cap companies with our volume. So, our approach is to continue to grow the company and drive an exciting strategy and, as a result, get better and better. Weâll get a following. And thatâs the best way to get them to follow. And thatâs our approach. Richard Barber: One last thing I wanted to clarify. I will â in the next conference call I will provide an estimate of what our costs were in 2004 as a public company. Theyâre incremental to being a public company â so that everyone has that information. Robert Ellsley: These numbers are very, very strange to me. You spent $2 million in sales and marketing expense to generate $5.4 million worth of sales. According to the numbers that I just printed off your net worth, your stockholders equity went down $1 million. Now, somethingâs wrong in my figures here because something says the cash is nine six five oh, which was the same as 2004. And I think Mr. Barber said that cash was 10 something. Jeff Coombs: And that $2 million that sales and marketing and $5.4 million, Iâm not sure what your question is on that. Those are actually for software companies selling the kinds of software we do. Those are very favorable numbers compared to other companies. Robert Ellsley: Well, let me tell you, you hired in the last number of months a new vice president of sales, a vice president of research, a vice president of marketing. And your profits are down. Your sales are up. You think itâs up a lot, but I think your sales are up marginally. Robert Ellsley: OK. And the last conference call I had, twice as a matter of fact, Jeff, you told me that there will be thousands â when we talked about InFact and I said, âWhatâs the potential?â and you said, âThousands of users. And we will be signing up two new InFact contracts each quarter.â Now, I havenât seen one contract. I mean, Iâve seen research grants. Jeff Coombs: I said specifically that our goal is to sign one or two new customers or contracts, research grants, each quarter. Robert Ellsley: All right. So, whatâs the prognosis now going forward? Do we have customers? Is InFact in any customers as opposed to the government? Jeff Coombs: Yes, it does. We â as Iâve stated before, we have two pharmaceutical companies who are â have purchased the product and we are working with to tailor the product to the pharmaceutical industry, with our goal to explore broad deployments. The initial purchases that they made were not for broad deployment. But, similarly, to the Defense Department, we are looking to deploy broadly to large numbers of customers. We have not done that yet, as Rich pointed out, but thatâs still our goal. Jeff Coombs: It could be anywhere from the low to multiple hundreds of thousands or if itâs a very large deployment it could be bigger. Robert Ellsley: And why â and let me ask you one little quick follow-up. I provided Tom Jones in your conference in London, which went very well. And could you explain to stockholders â and Mr. Springer reflects the mood of a lot of us whoâve held the stock and saw very little return, by the way. How come youâre so successful overseas comparatively with a much less staff than you are in your own country? Jeff Coombs: Iâd say that a good reason for the growth there is that they take more of a solutions approach than we have here. Here, historically where weâve been doing business longer, we sell a lot to individual statisticians and have focused more on that here. In Europe, they take more of a solutions and a professional service consulting approach. So for example, Switzerlandâs done very well and shown good growth. They â weâre foreign because we bought a professional services organization, and so they continued to focus on large customers, large engagements, and were not so focused on the smaller desktop statistician sales. And because of that, because of their strong focus, thatâs what theyâve been successful at. So ⦠Robert Ellsley: And youâre now going to bring that idea â because my friend Tom Jones says you have great product and youâre not marketing to the right people in the United States. I mean, he was the vice â he was the Chief Financial Officer of Citicorp and he knows the market out there. And he says youâre not marketing to the correct people. Jeff Coombs: Well â so, the focus in the United States is to bring that solutions focus. It is to expand our professional services capability, which has been doing better and better. And we have sold clinical reporting here in the United States and to global accounts quite successfully. And weâre attempting in the U.S. to do more of the solutions focus in financial services as well. Absolutely. Richard Barber: And Iâd like to point out one other thing as youâre looking at the leverage we get in Europe. Keep in mind that all of our research and development is performed here in the U.S. and thereâs a much larger G&A component in the U.S. because we have our headquarters here. So, if youâre looking at the headcount disparity and productivity, keep that in mind. Robert Ellsley: No. I appreciate that. I wasnât looking at the headcount. I was looking at the penetration to the kind of market that I think you need here in the United States. Jeff Coombs: And I think itâs easy to show higher percentages in Europe. Itâs a lower number. But, that said, they are doing a good job of moving where we want to go and are setting a good example for us to follow in North America. Aaron Langman: I have a question. You say youâre a leader in statistical analysis and so forth and so on. SPSS is in your space. SAS is in your space. SPSS earned 40 cents last year. Theyâre going to earn 79 cents this year, and theyâre projected to earn $1 next year on around $250 million in revenue. How does that impact you? Iâm not even going to talk about SAS. Itâs a billion dollar corporation and that prints money. Jeff Coombs: So, yes, we do compete with those two organizations. We compete with SAS more than SPSS. SPSS focuses more on data mining and sells a lot to academic institutions. They focus on the manufacturing sector, doing a lot of CRM customer analysis. So for example, look at everybody whoâs got credit cards and figure out the best people to mail to who are likely to buy one of your credit cards. The other kind of analysis you can do is if youâve ever had a purchase rejected when youâre in Italy, for example, because itâs a bad area to be, they have data mining software to do fraud analysis, for example. We do some of that, but we focus more on financial services and on pharmaceuticals, which is more the venue of SAS. So, we compete more head to head and deal to deal with SAS more than we do with SPSS. So, in manufacturing itâs SPSS, financial services and pharma itâs SAS. And actually our goal is for customers as they purchase additional statistical software that we get a higher and higher market share away from both of these players. They are large players. Our software is much more flexible. And as people build new products and want to integrate statistics into their existing business processes, our software is more componentized and more easily embedded, which gives us an advantage. The disadvantages as we go into very large customers sometimes they want to go with a $1.5 billion company of SAS rather than a company of our size. So, thatâs essentially what we see and how we compete with SPSS and SAS. Aaron Langman: And the other question I have is as far as InFact. I was at luncheon in 2002 where the prior CEO made the remark of that InFact was three generations ahead of anything else in the market. Steve â was that the same -- Steve asked all the questions I was going to ask anyway. And Iâm a long-term stockholder and I feel like Steve feels at this point. Why havenât you guys bought back any stock? Why hasnât there been any insider buying at all? I mean, are you guys happy sitting on your options? But bought back stock â I would answer that we have looked at that. Weâve had that question before. And our view on that is the same, and thatâs we believe we would like to keep our stock available so that we can invest it in appropriate things if we see an appropriate investment. Itâs better to have the stock on hand to buy somebody, to be â who knows? But we think itâs better to have it there than have to raise money if we saw something that would fit within our portfolio very well from a technology or other perspective, whether it would be a consulting company, whether it would be a product company, a piece of technology. Weâd like to have the cash available and the flexibility there instead of buying back the stock. Aaron Langman: Well, the only one that ever bought stock as far as insiders are concerned is Mr. Meshberg. And he canât be too happy either because he must be under water. Jeff Coombs: I think you would need to talk to Sam about that. I think the record will show that Sam has repeatedly bought stock over the years, including recently. And my last question is as far as InFact is concerned the whole buzzword is about search, search, search, whether itâs Google, Yahoo, AskJeeves, six other companies, and so on and so forth. It seems to me that InFact is such a hard brow product that it goes â it seems to go over everybodyâs head. Is there any way to extrapolate some of that InFact work to be able to bring it out to a larger audience, to a mass audience? Jeff Coombs: I think thatâs a very good question, Aaron, in that Ronâs focus is not on selling the technology. And I think thatâs what weâve done a lot in the past. Weâve talked about semantics and linguistics and the fact that itâs the best at extracting events and actions and facts. And Ronâs event â Ronâs focus is to figure out what are the best applications for that and then take a solutions approach and to sell that application that just happens to have the technology underneath it. Thatâs a very similar approach that weâre taking on the data analysis side and that the VP of marketing here, Martin DeBono, is focusing on, what are the best markets, financial services, life sciences, what are the solutions weâre selling, and it happens to have some statistics in it. Ron will be taking the same focus and looking to figure out the best markets and the best solutions and start to sell solutions to business problems as opposed to technology. And that will be our focus going forward. Our biggest focus to date has been getting the technology for a couple of very targeted applications, to the point where we think itâs ready for primetime and ready to expand it more. And now thatâs Ronâs job to do that. Aaron Langman: I think youâve been too narrow and over everybodyâs head with the technology. I mean, itâs great for the DOD and intelligence agencies and so on, but I would think that with that kind of talent to be able to produce that kind of product you can certainly produce a commercial product that can be used by â whether itâs AskJeeves or Amazon or your next door neighbor, that 800-pound gorilla thatâs next to you. Jeff Coombs: I think thatâs a good approach. We have been narrowly focused, absolutely. I think focus can lead to success. Itâs also been a division that overall has been running at break-even or better, so itâs been funding itself as a public company where people generally like to see us profitable. I think theyâve done a very good job of getting the technology and the product to where it is today at the same time, not like a typical startup where youâre eating to millions of dollars. Theyâve done it without eating into cash. Aaron Langman: Yes, but thatâs where the money is. I mean, $400,000 in sales, to me, is miniscule. I mean, youâre not even tapping a fraction of the potential that that product has. Jeff Coombs: Four hundred thousand dollars a quarter is not a large amount of revenue. Itâs Ronâs job to escalate that. And weâll keep you appraised of what is the target market and what is our approach, what is our strategy now that ⦠Ashok Ahuja: Jeff, I guess you noticed the frustration in a lot of the investorsâ tone of voice. And Iâm sure that the question about does it make sense to be public and the frustration that goes with it. Iâm sure you sensed it at least as much as any of those investors because Iâm sure itâs got to be frustrating for you to not be able to see the kind of growth that is potential from the â poten, tial from these markets. I guess as you listen to those comments I wonder if â there was a question about does it make sense to take the company private. And I think you guys mentioned that to take something private costs money and somebody has to be willing to pay what it takes. Have you at , all considered the potential of possibly looking for two different buyers for the two aspects of the company, company like an SPS, S as a partner for the statistical side of the house? And last I checked Googleâs market cap had crossed $100 bill, ion. So, thereâs got to be somebody there who can find research â especially if you say the product is ready, which it sounds like it is â who can really leverage that significantly and the value to us shareholders can be significantly higher than it is. I know that only certain things you can say or not say. But just Iâd like to add those to you. Jeff Coombs: Well, I appreciate the comment. As you just said, I canât comment on any particular things weâre doing in those areas. But I will say that the goal is to maximize shareholder value. And thatâs what weâre trying to do. So, that can mean a variety of avenues. And for InFact, for example, weâre going to look at the best way to bring that product to market as a whole product that solves a solution that can involve partnering with other players. And partnering can mean a whole slew of things. So, weâll certainly keep our ears open and look to see what makes sense to maximize shareho, lder value. Thatâs our goal. Tim Westbrook: Hello. I had to step off the call. But about S-PLUS, in the past, Jeff, you said that S-PLUS is the foundation and driver of the companyâs future revenues. And you were optimistic about it. So, have you explained why this recent quarter didnât show the new license business for S-PLUS? I think that we did well in life sciences. We didnât do as well in financial services. We had a pipeline there. We had opportunities there, particularly in service sales. There were a number of larger deals in servers, say, for example, to Wall Street. Those deals are good deals for us to be in. Historically weâve been selling more to desktop software. Now weâre starting to sell more servers to have the opportunity to play a more significant role within some of our customers. Our customers are typically very large companies. Itâs a very good customer base, a customer base to die for basically. And weâre trying to expand our role there. As we try to sell servers based on S-PLUS 7, IT gets involved in these larger deals. They do evaluations, and so some of our deals have taken longer than we expected and didnât close in Q3. Many of them are still in the pipeline for Q4. So, as we move forward, we start to sell larger deals to companies, there are more swing deals that they can bring a quarter up higher or down lower. In this particular case, the ones in finance did not â we did not close as many as we had hoped. And thatâs the primary reason for the flat revenues for financial services. Tim Westbrook: Is it the size of the deals that are still alive and may be closing later, were there specific reasons you lost others? Is it competition? Jeff Coombs: Our â some is still in the pipe. We have lost for a variety of reasons. They â there is not one particular reason that stands out above all others. So, if I go to lost reports â just take North America â we lose sometimes to SAS. We lose to SPSS. We lose to MATLAB one or two a quarter. We lose some just because they slip out. Weâve lost some to internal development. Weâve lost some because of the budget going away. Thereâs a variety of reasons, no one of which dominates. But the good news is as we have progressed over the past quarters the numbers of larger deals that involve these servers has generally been increasing. And thatâs the good news. And in Q3, some of the larger ones that we hoped to close that had significant license components we didnât close as many as we had hoped. And so, you saw flat year over year license revenue. Tim Westbrook: Well, it does. Iâm just trying to get a sense if youâre as optimistic as you were about that side of the business. Jeff Coombs: OK. So, yes, Iâd say that S-PLUS is still absolutely the foundation for the future of the company. Our big data capabilities were an absolutely important and essential step so that we can scale to larger amounts of data. Other steps that weâre taking are to focus on selling that as part of a solution. Weâll continue to invest in that product, to make it more and more enterprise scalable so that IT loves us as much as statisticians. S-PLUS is built to think the way a statistician does so that we do great at prototyping of models and delivering graphics and reports that help people, even non-statisticians, analyze the data to make decisions. As we deliver these solutions and start to be deployed more on servers, the product needs more and more to be deployable, which means youâve got to have fault tolerance, multi-threading, multi-processing ⦠Jeff Coombs: ⦠capability, that kind of thing. So, Iâm still â weâll continue to invest in those areas and Iâm still bullish on S-PLUS as the foundation for the future. Tim Westbrook: I think whatâs a little confusing is that you appear to have â the past couple quarters got some sales momentum and traction for S-PLUS. And typically that continues rather than just abruptly stops. Jeff Coombs: And the momentum has been in delivering of solutions. And so, you saw professional services grow. So, we had very strong professional services group growth and not the license growth we expected. We canât continue to drive our growth just on the desktop business. And so, we need to close a larger number of the deals that are â have the larger server license components. Jeff Coombs: Right. We did explain that. In Q2, we saw a lot of upgrades to enterprise, typically on the desktop. We announced the product in April or mid Q2 and did a lot of marketing, did an international road show around it that did result in Q2 in some good upgrade revenue. It also got us into towards the end of Q2 some of these larger server based opportunities, which we had hoped to close in Q3. And we did not close as many as weâd like in Q3, but we didnât necessarily lose those deals to the competition. Many of them are still in the pipeline, hopefully to be closed going forward. The last point I wanted to make was about InFact. And the comments earlier on the two or three generations ahead of the competition, that, if youâre not aware, was a way that prior management defined InFact when it was first introduced. So, I think people now are looking for your definition. And apparently itâs that itâs a niche product, still in the testing and development stages and customer testing with the biopharmaceutical companies and the government. Is that how youâre defining InFact now rather than just this large product which is three â the technology is three generations ahead of the competition? Jeff Coombs: Generally â thatâs right; I donât refer to it as three generations ahead as far as previous people did. I try to be more explicit in what it means, and I donât necessarily use the word niche. But what Iâve focused on since Iâve been here for two plus years is that itâs a good technology. Weâve been validating it, get it to the point, like I said a couple times previously, where it has sufficient scalability, precision and recall there for accuracy, and a good interactive query language to the point where itâs ready to be the foundation of applications and solutions. And thatâs what weâre focused on now. And Iâm not really going to comment on what previous management called it. Tim Westbrook: Right. Can you perhaps share some of the feedback youâve had from those biopharm customers or the government agencies testing InFact? Jeff Coombs: I think the government agencies are a little more difficult because they donât like to be references, since theyâre typically defense intelligence agencies. And I think weâve got several customers who have re-upped their term licenses or bought perpetual licenses to replace term licenses. So, the fact that they purchased it again is a good sign. The life sciences companies arenât at the point where theyâre deployed and, therefore, ready to do quotes. But I think theyâre very enthused by the ability to look through the pharmaceutical literature in order to find what theyâre looking for. And theyâve found that it does a significantly better job than the competition. And now our goal in working with them is to figure out how to make the product most usable through portals or whatever to a wide array of people. So, weâre focused on figuring out what the applications and the deployment of the technology will be for those customers. So, the core science â people like the core science. They like the core technology. And now weâre focusing on figuring out whatâs the user interface, whatâs the usability going to be for a specific user, so basically delivering a complete solution to the non-technical people. Tim Westbrook: Well, can you â is there some way to â for you to describe the value that it brings to their business, to the biopharmaceutical industry? Jeff Coombs: Sure. Yes. The value is quite simple, is youâre in bio â youâre in the pharmaceutical industry whenever youâre doing research, whenever youâre doing clinical trials. Youâre constantly looking at the literature to find out who else is doing similar things to what youâre doing. And there are millions of pages being added constantly to the literature. So, you just canât read them. And you just canât use keyword search to search them because you get way too many hits and you donât get what youâre actually looking for. So, with the ability inherent in our software, you can look for very specific things and get much more accurate and fewer returns, results. And therefore, you can zero in on getting the answer you want to find out. For example, if a particular compound affects various genes which might kill people, and therefore, you can more quickly find what youâre looking for, whereas keyword search itâs just completely ineffective for doing those kinds of things. So, it makes researchers, it makes clinicians incredibly more effective. And it can mean you donât do a trial or you cut a trial sooner. It can save millions of dollars or it could mean that you get a drug to market faster. Tim Westbrook: Well, youâre making it sound very compelling. So for practical purposes, I would think the biopharmaceutical companies would be very hungry to get this technology up and running. Jeff Coombs: The key is getting it to the point where itâs applied in an application thatâs going to be broadly usable. And the user interface is very intuitive and easy to use and fits in with the way people do business on a day to day basis without a lot of training. Robert Ellsley: I just want to come back because I liked a lot what you said about InFact and expanding it and getting it caught out of the laboratory and so forth. Although this last couple of questions kind of confused me when you kind of mentioned that the S-PLUS business was the foundation of the company and its driver for growth and so forth. As an investor, I would think that if in fact InFact was the product that people are saying and even on your Web site at the conference call the things that it could do, that the potential of revenue from InFact would vastly surpass the S-PLUS revenue. What am I interpreting wrong here? Jeff Coombs: Well, we look at two business units. And we looked at them very separately. And really even looked at two different P&Ls here. And so, we are looking to grow both of them. We see potential in both of them. I donât know that Iâm going to comment on the particular vastness or the potential growth on either one. I think they both have very significant potential for growth. Robert Ellsley: You know, I do appreciate the fact that the company is growing somewhat and is profitable and so forth. But in the search business and in a lot of real technical businesses, if in fact their technology is unique, I can quote you many, many companies that lose a lot of money and their stocks have done very, very well because they have now come out with a product that after a couple of years of work and so forth has a commercial application. Convera is one of them, the European company that eBay just bought, the telephone company, the voice-over, they never made a nickel at the start, but they invested in getting their product out. And it would seem that as I keep reading about what people are saying, your people currently, not management two years ago but the current on your Web site on the user conference, that it can ruffle a portal, it does this, it does that, it has a great advantage over everything else, and we have $400,000 worth of revenue. And those two things â I mean, if it is now ready for primetime, then I would think that the revenue explosion could be quite significant. Jeff Coombs: Well, Converaâs revenues are declining precipitously and theyâre losing lots of money. Thatâs not our goal here. And they claim to have â their stock is up significantly because they ⦠Jeff Coombs: ⦠have invested $4 billion worth â four billion Web pages. So, Iâm not sure whatâs going on there. I really canât comment on that. Our approach is not the same as theirs. We are â if â we are looking for those applications, stack ranking and prioritize them and weâll go after the one that we identified with Ron very aggressively. Weâre not at the point here where weâre looking to significantly lose money, but we are looking to exploit the technology to develop solutions and applications that focus on user interface that is ⦠Robert Ellsley: And I agree with you. Iâm not looking for the company to lose money either. But it seems like the payoff to be successful is being somewhat downplayed by you people. Jeff Coombs: No. Our goal is to drive the stock price up as much as possible. Thatâs how we all make lots of money and you make lots of money. Absolutely, thatâs our goal. No doubt about it. And whatever the end game is, if it drives the stock price up, weâre all for it. Robert Ellsley: OK, I agree with that. See, Iâm not of the school that yells and screams about your options because youâre in the same â you own stock like I own stock. So if the stock goes up, you should only make a lot of money. That means weâll make a lot of money. Richard Barber: Thatâs right. And when we say we want to drive the stock price up we mean through results, through operating results and running the business in the right way. Steve Chess: Yes. When I put in for this question since then a whole bunch of people have been speaking up with a lot of good questions. And, you know, in some ways it seems to us â just so you can understand our perception, it seems to us that maybe youâre holding back something on this InFact because youâre saying this â youâre implying that thereâs very broad applicability to this. Youâre obviously looking to do some business with it. But I guess the real concern among everybody is that what does Google have? Could somebody like Google just leapfrog you in technology and then youâre put out to pasture and youâve got no chance of selling any more product? And maybe the time is right now that youâve got the technology in place, which is what youâre saying, that maybe you ought to shop the technology. And you are saying to a limited extent, yes, you might look for a partner. But I guess thereâs a real risk that you would simply focus on your business exactly, trying to get new customers. In the meantime, you lose it to somebody else. And so, is it possible that you should look very seriously at partnering very soon as opposed to just keeping it as a general idea? Jeff Coombs: We are looking at all opportunities to drive shareholder value here, to find the best path to market quickly, to see how to deploy this technology quickly. You think about holding something back. Weâve developed â weâve been focused on developing the product and the technology, and sometimes applying the technology is a challenge as well. So, now weâre taking on that challenge. Iâm trying to tell you where we are, what weâre trying to do, and not drive the stock price up on something that Iâll do in terms of hype but in terms of developing and delivering those solutions, driving the results, which will drive the stock price up. Thatâs what weâre trying to do. And weâre looking at all possibilities, the best way, the fastest way, the most expeditious way to drive shareholder value, by bringing this technology through solutions to the marketplace. Steve Chess: Do you have any protection on the technology? Do you have patents or anything like that? And also, does Google or anybody else have any other type of technology that theyâre working on that you know of thatâs similar? Jeff Coombs: We absolutely do have patents on the technology. And I donât know what Google has in terms of this area. Google is working on all kinds of things, so I donât know specifically what they have that would be similar to this that theyâve got in their labs. Jeff Coombs: Most â I will say, Steve, though, that most of the people that have similar technology are â seem to be small companies. And I mentioned companies like Attensity, Clear Forest, a few others. The first is that you never answered my question regarding investor relations. The company said either late last year or early this year that in the second half of this year, it would be retaining investor relations people. And I would like to correct something that â a misperception perhaps on your part, Jeff. I donât suggest that you buy a research report. Iâve never suggested that in my entire career. If you have to buy a research report, the company is worth nothing. But letâs be clear about something. There are plenty of investors out there, hedge funds, plenty of reputable investment companies who are looking to invest in micro cap companies. There are analysts who are scouring the landscape for them. So, the idea that you would have to go out and buy a research report is ridiculous. So, thatâs my first question. Iâd like to ask since you said that you were going to hire investor relations people in the second half Iâd like to know if youâre going to follow through on that commitment. Richard Barber: So, let me answer that, Steve. I donât believe we said we were going to hire IR professionals. I think we said we were going to start an IR program. And we have been doing that. We talk to numerous people similar in profile to what you described on a regular basis. So, we are reaching out and we are being reached for. And we talk to these people regularly. Richard Barber: How we decide to do it is â whether we use outside resources or internal resources to do it, I think, is not relevant. Steve Springer: Well, you say that you have hired other â on a project basis or whatever IR people. Why donât you tell people? Why donât you tell us? Richard Barber: So, we hired somebody to help us out with an investor conference and he advises us occasionally on press releases and that type of thing. Steve Springer: Well, what Iâm talking about, guys, is the strategy. Iâm not talking about a one off event. Iâm talking â Iâm asking you about the strategy. Jeff Coombs: The strategy is that we talked to a fair number of micro cap, typically investment, companies. And we have regular discussions with them and we meet with them on conference calls. We meet with them in person. And that generally is the approach. So, itâs a one on one talking to potential investors or current investors. And thatâs the focus of what our IR people, which is mostly Rich and myself, focus on. Steve Springer: Yes. And the other question relates to the comments that are being made not only by me but by almost everyone else that has commented on this call relating to previous remarks or assertions made by the management of this company about the power, to use that word, of InFact about it three generations ahead, whatever. Those are comments that were made by the management of Insightful Corporation. Two years ago, you were brought in, Jeff, to replace a former CEO who was fired. And you were brought in based on your marketing background because the company wanted to get away from technical people and get into the marketing, have a more â a stronger marketing presence. You have since hired â I believe you have an MBA in marketing. You have since hired another guy who I think his title is head of marketing. Is that correct? Steve Springer: Who has an MBA in marketing. So speaking as a shareholder, when the company makes these assertions about the explosiveness of its product â and you bring in these two marketing people, youâve been there for two years. And now weâre on this conference call and the company is still punking along at a $20 million annual rate and the sales are in fact, to put it mildly, disappointing. And the company â you guys are refusing to give us the market size or the market opportunity, the specific where you expect to be with this product. I mean, itâs very difficult to understand this. Thereâs a lot of technical talk about it, but who knows what is the exact â what is the market opportunity that youâve identified? Undoubtedly youâve spent time and money, the corporationâs money, to develop a marketing strategy. You must have identified the marketing opportunity for InFact, but youâre refusing to share it with us. Weâre the shareholders and owners of the corporation. I donât understand that. Jeff Coombs: We are not refusing to share with you the strategy. We have stated exactly what weâve been doing, which is weâre focusing on DOD and the pharmaceutical market to take this core technology, get it to the point where it has â it meets the requirements that Iâve stated, and then the focus is on developing the user interface and the applicability so that it can be more broadly deployed. The first thing in marketing, especially in high tech, is product strategy. You need to work with customers and you need to make sure youâre solving a particular problem with your technology. Thatâs where weâve been focused, getting the core underlying technology to the point where analysts in the defense intelligence area can basically find bad guys by using this interactive query language. The interactive query language has gone over very well with the defense intelligence folks. In the pharmaceutical area, other problems that we need to solve involve much more arcane nomenclature about drugs, proteins, et cetera, so weâve had to solve those problems. And we also find that in order to deploy it more broadly in pharma, you canât use the interactive query language. You need something thatâs more of a portal approach. And so, we have been exploring what that portal needs to look like, what is the user interface. It needs to be something that looks more like a typical portal approach, a Google, a Yahoo!, et cetera. So, we have been working on taking this core technology and looking to apply it to these two specific areas. And now weâre bringing on Ron who will look for additional areas where we can â and additional methods, whether it be channel, partners, whatever it happens to be, to bring this technology to market so that we can show the growth. Would we like the growth to have been much more explosive, in your words, and faster earlier? Absolutely. That would drive shareholder value. Thatâs still our focus. And we have done this with funding thatâs been net zero or better for the company over the last two years. And thatâs a very good thing. And weâre still looking for that â those applications that will drive the growth that youâre looking for. Steve Springer: Well, Jeff, I appreciate that, but what Iâm really talking about is the size â the market size, the market opportunity. Iâm not talking about â youâre referring to these very narrow opportunities in pharma and in defense intelligence. You have a development contract for the defense intelligence agency. Iâm very, very familiar with defense intelligence agencies, who does the buying, who they buy for, how long it takes, et cetera. OK. Youâre identifying two narrow markets. What Iâm talking about is the market size â the entire market size in the various different markets for InFact. Thatâs what Iâm talking about. Jeff Coombs: So, what â I previously discussed those. We think the defense intelligence market is something in the $100 million range. We think that pharmaceuticals is something at a similar range. Those have been the two that we have focused on. The other markets itâs â weâre really too early on in looking a wide â looking at a wide variety of possible uses for the technology. Thatâs what Ron growth is â Ron Faithâs goal is. Thatâs what his objectives are. And itâs too early to list the five, six, seven, eight, nine, 10, 11, 12 different potential directions that we could go and talk about the markets beyond those two that weâve been focusing on explicitly over the last couple of years to get the technology to the point where weâre ready to do this. Steve Springer: Well, in the â if youâve got $100 million market opportunity in both defense intelligence and pharma, thatâs the entire market size for your product, correct? Steve Springer: What do you expect to get â be able to get of that market size? What is a reasonable expectation? I mean, saying that itâs a $100 million market size is interesting. Now we know what the ultimate market is if you had 100 percent of the market. We know youâre not going to get 100 percent of the market because itâs a tiny company with limited resources competing against big people. So, the question is what is a reasonable expectation on the part of our shareholders? We are making decisions about whether to own, buy or sell this stock. We need to know what is a reasonable expectation. We need to be able to hold management responsible and accountable in a reasonable way, not in a critical way, in a supportive but a reasonable way, expecting reasonable results. We need to know what a reasonable expectation is of â in 2006, letâs say, for the defense intelligence business and for the pharma business. Jeff Coombs: Yes. Weâre not saying how large we expect that division to be at this point. Weâre just not doing that, Steve. Itâs still early on. Itâs still a startup within the bigger company, and it has much more variability than the data analysis side. So, weâre not stating growth rates for a year, two, three years for that. Weâre just not in a position to do that right now. Steve Springer: Well, just so you know, you introduced the product three-and-a-half years ago; three-and-a-half years ago. Itâs not some outrageous proposition on behalf of the shareholder to ask you where you can be in the following year, in the fourth year after you introduced the product what kind of sales we can expect from the product. I donât think that thatâs some nutty expectation. Jeff Coombs: Yes. Iâm not going to state when weâll start to give guidance or not. At the point that we are confident about the projections that we can make for a particular year, weâll consider doing that. Weâre not ready to do that. Steve Springer: Well, again, Iâm not asking for a specific projection. What Iâm asking for is what you think is attainable, not what your goal is. We need to have some sort of a guide. Is it 50 bucks? Is it 50 million bucks? Thereâs no â thereâs just â thereâs nowhere in between. Thereâs nothing at all. You guys just say, âWell, we have a product. Weâre going to do our best. Talk to you next quarter.â Jeff Coombs: Steve, I think youâve asked the same question three times and Iâll give the same answer if you ask it 16 more times. Iâm going to give you the same answer. Weâre not answering that question on either guidance or how big we think weâll be with that product in any particular timeframe. Weâre not going to answer that question. Steve Springer: OK. Last thing. I â what I would like you to do is take some of the marketing expertise that you guys have and apply it to shareholders. Apply it to talking to shareholders, being more transparent, trying to meet our needs, trying to meet our concerns. Itâs clear; every single conference call that Iâve been on for the last couple of years thereâs a group of disgruntled people, myself included. And Iâm on a lot of conference calls. Iâm not this way on every conference call, but itâs this company and itâs the results of this company. And I think that the company could do a better job of communicating what theyâre trying to do and how theyâre going to do it. You could be more user friendly. Ashok Ahuja: Jeff, just a comment. I think personally that you handled the conference call very, very well. I think youâve been very open beyond almost any other company Iâve heard. And I can see the frustration in many peopleâs voices. However, I do believe that youâve really handled the conference call very well and have gone â bent over backward to answer every question with ultimate patience. So, congratulations for that. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. 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EarningCall_234037 | Hereâs the entire text of the prepared remarks from Intel's (ticker: INTC) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [[ more ]] Thank you, and welcome to the Intel third quarter earnings conference call. Attending from Intel are CEO, Paul Otellini, and CFO, Andy Bryant. Before we begin, please bear with me a minute while I read our Safe Harbor language. The third quarter earnings report discusses Intel's business outlook and contains forward-looking statements. These particular forward-looking statements, and all other statements that may be made on this call that are not historical facts, are subject to a number of risks and uncertainties, and actual results may differ materially. Please refer to our press release for more information on the risk factors that could cause actual results to differ. The specific forward-looking statements cover expectations for product mix and demand, revenue, gross margin, expenses, tax rate, interest and other income, capital spending, depreciation, and amortization of acquisition-related intangibles and costs. These statements do not reflect the potential impact of any mergers, acquisitions, divestitures, investments, or other business combinations that may be completed after October 17, 2005. Lastly, if during this call we use any non-GAAP financial measure as defined by the SEC and Reg G, you will find on our website, http://www.intc.com/, the required reconciliation to the most directly comparable GAAP financial measure. With that, I will turn it over to Paul. iShares S&P 500 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and taxes, of US large-cap stocks, as represented by the Standard and Poorâs 500 Index. Learn how IVVâs holdings represent a smart way to invest in US large-caps. Compare returns for the iShares S&P 500 Index Fund. iShares is the worldâs largest family of exchange traded funds, or ETFs. With nearly 100 different equity and fixed income funds to choose from (about 4 times the selection of any other ETF family, investors can create an asset allocation plan thatâs precise, tax-effecient, and tailored to your specific needs. Contact iShares for more info. Thanks, Doug. Revenue in the third quarter finished just below $10 billion, and was an all-time record for Intel. 18% year-over-year growth was driven by robust demand for our notebook platforms, and emerging market strength, with records in several countries, including China and India. At the product level, we set new unit records for microprocessors, chipsets, flash memory, wireless LAN connections, and applications processors. We also continue to make excellent progress with our transition to dual-core, with over 1 million units shipped so far this year, and plans to more than double that by year end. Last week, our Digital enterprise group launched our first dual-core products for the server space. These new Xeon processors code-named Paxville are ramping ahead of schedule, with DP system announcements from over 30 OEMs to-date, and MP systems launching later this quarter. These systems provide industry-leading price performance, with a system from Dell breaking the $1 per TPC mark for the first time ever. Our 65-nanometer dual-core Bensley platform remains on-track for production in Q1, and we are already providing seed units to end customers, to help in the rapid adoption of this exciting new platform, which will feature faster memory and IO, plus new virtualization and manageability technologies. I am pleased to announce that Intel is now in commercial production of its 65-nanometer, 300-millimeter process technology, and that we recently shipped our first dual-core Presler processors for revenue, with desktop systems expected in the marketplace early next year. Our overall dual-core ramp is also proceeding very nicely, and we plan to ship millions of dual-core units this quarter across notebook, desktop, and servers. Moving to our Mobility Group, we had an excellent quarter with record shipments of mobile CPUs, chipsets, and wireless LAN components. Notebook demand remains strong in all of our geographies, and we believe notebooks now represent about one-third of the PC market worldwide, with levels well over the 50% mark in the consumer segments, in Japan and Western Europe. Our first dual-core CPU for Mobile, code-named Yonah, remains on-track for revenue shipments later this quarter, with an early first quarter launch with our Napa platform. In Flash, we had an all-time record in unit shipments, and grew our #1 position in NOR. Our application processor business also had record units, and continues to grow rapidly, with units doubling versus last year. In addition, Research In Motion announced plans to use Intel's new cellular processor code named Hermon, in its next-generation BlackBerry device. In the Digital Home Group, we unveiled the new Intel Viiv brand name, for upcoming digital home platforms, that will deliver our best-ever consumer experience, with a variety of online services and software, such as movies, music, photos, and games. Available in the first quarter of 2006, Intel Viiv platforms will come in a variety of shapes and sizes, and will include dual-core processors, chipsets, and platform technologies designed from the ground up, to deliver ease of use in the digital home. We are also developing platforms to power consumer electronics devices, such as digital televisions, set-top boxes, and digital media recorders. We announced the Oplus system-on-a-chip multimedia display processor, for flat panel displays and HDTV monitors. We also announced plans to acquire tuner technologies and capabilities from Zarlink Semiconductor, that will allow our platforms to receive, process, store, and display digital broadcast signals. In summary, the third quarter was a record quarter for Intel in a number of areas. Our 65-nanometer process technology is in production, and on-track to ramp into high volume in 2006. We are executing on our dual-core roadmap, with 15 projects underway, and expect to ship millions of dual-core units in the fourth quarter alone. In 2006, we will aggressively ramp dual-core across all of our platforms, with plans to crossover from the single core in our performance segments by the third quarter of that year. With that, I will turn it over to Andy for more details on the quarter. Thanks, Paul. For several years, we have spoken of three powerful forces shaping our business. Growth in emerging markets, demand for mobility, and advances in manufacturing. The third quarter was another case-in-point, as these forces combined to deliver strong financial results. Revenue, gross margin dollars, and operating income in the third quarter, each achieved year-to-year growth rates in the double digits. In manufacturing, we are ahead on our cost targets. Stock repurchases and cash dividends during the quarter returned approximately $3 billion to stockholders. And average shares outstanding are down 5% from a year ago, and 10% from the peak in 1998. We expect a seasonal second half, our third consecutive year of double digit growth and revenue, our fourth consecutive year of progress in gross profit margins, and our tenth year with cash from operations in excess of $8 billion. Two non-operating items weighed heavily on profits. Accrual of a charge related to an unexpected legal settlement, lowered gross margin percentage by 1.4 points, and earnings per share by approximately $0.02. Estimated taxes related to repatriation of cash, lowered earnings per share by approximately $0.04. Revenue for the third quarter was approximately $10 billion, just over the midpoint for the ranges we forecast in the July earnings release, and the September update. The growth of 8% in the second quarter was slightly higher than we typically see for this period. Revenue grew 18% from the third quarter a year ago. On a geographic basis, as Paul mentioned, the leader in year-to-year growth was Asia-Pacific, where revenue growth of 28% sustained the momentum of the second quarter. Growth in this region was fueled by continuing broad strength in demand for mobile platforms, including strong local consumption in China and India. Japan's growth of 20% marked over 10 quarters of year-to-year growth in quarterly revenues. In Latin America, an economic environment that appears to be more positive and stable is helping business, and government-assisted PC programs are driving revenue growth. Europe's year-to-year growth of 6% was led by European emerging markets. Overall revenues were also 6% higher than a year ago in the Americas region, where seasonal growth and demand was offset by movement of sales and manufacturing to Asia-Pacific. The geography leading sequential growth was Europe, where revenues were up 11% in the second quarter, and set a record for the third quarter. In most markets, overall demand and revenues were above seasonal patterns, offset in some cases by tightness in chipset supplies. Channel revenues were approximately flat with the second quarter, reflecting some movement of sales to direct customers. Gross margin dollars of approximately $5.9 billion reflects the impact of an estimated charge of $140 million related to a legal settlement. This is part of a total of $300 million in payments. The remainder of which we expect to amortize over 10 years. Even so, gross margin dollars grew faster than the sequential and year-to-year growth rates of revenue up 14% in the second quarter, and 26% from a year ago. Including a reduction of 1.4 points for the charge, gross margin percentage was 59.7%. If Intel's results were adjusted for the legal charge announced today, gross margin percentage would have been 61.1%, just over the top of the range we forecast in September. As we anticipated in July, the improvement in margin was driven by higher revenue than in the previous quarter, lower start-up costs relating to the ramp of the 65-nanometer process technology, and lower unit costs of products offset by higher reserves. Sales of microprocessors were a little higher than we expected in September. In a year-to-year comparison, gross margin percentage is 4 points higher than the third quarter of 2004, and includes the reduction of 1.4 points for the legal charge. The improvement was primarily a function of higher revenues and lower unit costs. Spending on R&D, Marketing, and G&A was $2.8 billion, in-line with our previous forecast, and up 12% from the second quarter. The largest part of the increase was in R&D, as we began production on 65-nanometer and transitioned resources to develop development of 45-nanometers. For the year to-date, spending as a percent of revenue is nearly a point lower than the first nine months of 2004. The number of employees rose during the quarter to 96,000 at the end of September. The year-to-year increase of 14% is lower than the year-to-year growth in revenues, and keeping with our goal to keep the growth in annual spending, at or less than annual growth in revenue. Before looking at non-operating income, I will highlight results for Intel's two largest operating segments. About two-thirds of the total revenue came from the Digital Enterprise Group, which achieved growth of 6% from the second quarter, and 9% from a year ago. Microprocessor revenue for the group was at the high end of the seasonal patterns for all microprocessors, and up 7% from the second quarter. The chipsets constrained by tight supply, revenue from chipsets, motherboards, and other, was up 3% sequentially. The Digital Enterprise Group make good progress in operating profit, which was up 8% sequentially, and 20% from a year ago. Revenue in Intel's Mobility Group accounted for one-third of total revenue. Revenue from mobile microprocessors was up 13% from the second quarter, and 48% from a year ago. With the success of mobile platforms, revenue from chipsets and other products was up 82% year-to-year. Our Flash memory business shipped record units with higher ASPs in a competitive market, and revenue was up 8% from the second quarter, although down 10% from a year ago. The Mobility Group also made good progress in operating profit, up to 23% from the second quarter, and 76% from a year ago. And now to non-operating items. Intel's tax rate of 38.5% included accrual of tax expense of approximately $250 million, related to the repatriation of accumulated income earned abroad. Fully diluted earnings per share, which includes potential dilution attributable to employee stock options was $0.32. The charge related to the legal settlement lowered earnings per share by approximately $0.02. On the balance sheet, inventories of $2.8 billion were up slightly from the second quarter. Inventories have been leaner than we would like, and we expect to build to higher levels in the fourth quarter, as we produce more 65-nanometer processors. Total cash investment comprised of cash, short-term investments, and fixed income trading assets ended the quarter at $13.6 billion, a decrease of 900 million from the second quarter, after stock repurchases of $2.5 billion, capital spending of $1.3 billion, and dividend payments of nearly $500 million. As we turn now to the outlook for the fourth quarter, please keep in mind that the forecast data do not include the effects of any new acquisitions, divestitures, investments, or similar transactions that may be completed after October 17. I will use the midpoint of forecast ranges when making comparisons to specific periods. We are planning for revenue in the fourth quarter to be between $10.2 and $10.8 billion. The midpoint of this range would mean sequential growth of 5%, which is less than the 8% five-year average for this period. And year-to-year growth of 9%, which is lower than that in the previous three quarters. The picture is different as you look at the second half overall. Growth in the third quarter was a little better than usual for this time of year, while growth in the fourth quarter is projected to be a little slower. Added together, they point to a second half with revenue that is 10% higher than the first half, and consistent with a five-year average for these periods. While there appears to have been a small inventory build in the range of $100 million among our large OEM customers in the third quarter, demand looks healthy and seasonal. Our expectation for growth margin percentage in the fourth quarter is 63%, plus or minus a couple points. This is approximately 3 points higher than the third quarter including the the legal charge. We anticipate that most of this increase will be a function of the qualification of new dual-core products as we ramp 65-nanometers. legal charge, and 2 points higher excluding Higher revenue will also contribute to better gross margins. Spending, R&D, plus MG&A should be approximately $3 billion, up from $2.8 billion in the third quarter. In addition to revenue and profit-dependant items, the increase includes seasonal marketing programs. Depreciation should be between 1 and $1.1 billion, approximately flat with the third quarter. We expect amortization of acquisition-related intangibles for the fourth quarter to be approximately $20 million. Our estimate for gains and losses from equity investments, and interest and other income is a net gain of $130 million. For the entire year, we continue to target capital spending of $5.9 billion, plus or minus $200 million. The outlook for R&D spending for the year is also unchanged at approximately $5.2 billion. Depreciation forecast remains 4.3 to $4.4 billion. The estimated tax rate for the fourth quarter is expected to be approximately 31%. Our outlook combined with the results for the year-to-date, anticipate a year with revenue in the range of around $39 billion, which would be growth from 2004 of approximately 14% to 15%. The same process points to gross margin percentage for the year in the range of around 60%, up more than 2 points from 2004. Spending for the year is growing roughly in-line with revenues, and we anticipate that spending as a percentage of revenues will be approximately flat for 2004. With cash from operations in the first two quarters of nearly $7 billion, we are on-track for another year of strong cash generation. With that, let me turn it over to Doug for Q&A. Thanks Andy, we will now open the conference call for Q&A, We will attempt to take questions from as many participants as possible. To help in the process, we ask that you please limit yourself to only one question, no more than one follow-up. Thank you. Operator? iShares S&P 500 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and taxes, of US large-cap stocks, as represented by the Standard and Poorâs 500 Index.Learn how IVVâs holdings represent a smart way to invest in US large-caps. Compare returns for the iShares S&P 500 Index Fund. iShares is the worldâs largest family of exchange traded funds, or ETFs. With nearly 100 different equity and fixed income funds to choose from (about 4 times the selection of any other ETF family, investors can create an asset allocation plan thatâs precise, tax-effecient, and tailored to your specific needs. Contact iShares for more info. |
EarningCall_234038 | Hereâs the entire text of the Q&A from Biogen Idecâs (ticker: BIIB) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Hi, thanks for taking my question. I was wondering, Burt, perhaps you can elaborate on what are some of the key issues at this point either from the investigators or the regulatory authorities in regards to restarting the TYSABRI clinical study? I don't think there are any key issues from the investigators. I think there's a tremendous amount of enthusiasm from investigators and patients alike for us to be moving forward in any and all ways to bring the product back to patients. And I don't, we haven't heard anything from regulatory authorities, but I wouldn't anticipate a lot of issues. If we have the confidence to be sending the sBLA back and to be able to reopen conversations with the EMEA about approval for the product to go into the commercial space, I think we have to have confidence that we understand how to use the product in the clinical trial area. So I'm pretty upbeat about all that. Hi. This is actually Robin Karnouskis in for Mark. He's on a plane. Thank for taking my question. I just was wondering if you could clarify, you mentioned on the call that AVONEX sales were a little light because of FX charges and so forth, but what are we, what should we expect going forward? Should we expect growth to be flat or increasing market penetration in the EU? What are your thoughts? Hi, Robin, it's Peter. First of all, we think that we would expect the international side to continue the trend that you would have seen, and, of course, it did have, the international business did grow 15% over prior year in the third quarter, so I just want to highlight that the business is still very strong. It is growing faster than the market in total as well. So it's gaining market share. They've done a great job over there. I think this is just sort of, there was a couple of little differences. One was ForEx as I mentioned. The other was that we changed the structure of our relationship in Italy so it just caused us to for the inventory at that distributor to defer revenue , to change the point where you recognize revenue. So we expect the business to continued to do quite well. We do think also the market continues to be penetrated. Clearly in Europe in particular the position of neutralizing antibody competitively in the marketplace has been very effective, neutralizing antibodies are well understood. Long-term therapy is highly valued. So we think they're going to do very well. The commercial team in Europe and around the world has done a great job developing the business over the last couple of years. Likewise in the U.S. I think the team's done very well. The market share was very steady as we came through the third quarter. The market growth overall, I think, has, in fairness, has slowed a bit in the U.S. And I think that as you go forward to next year, we're looking forward to continuing to hold our strong position with AVONEX but also get back into reintroducing TYSABRI, which we think, if you look back at the launch experience of this year, one thing that you have to conclude is that while the U.S. market had, growth overall had been slowing up to that launch, clearly, there is a lot of unmet need still out in the market. A lot of patients lined and were very interested in getting back into therapy and trying TYSABRI, so we think the penetration in the U.S. market will improve as well with that relaunch. Thanks. I have a question about your guidance on business development expense next year. Will that be likely to be in the R&D line, and why not amortize those expenses so that they won't be so lumpy next year? Thanks. Hi, Joel. I think I'll take that one. So I think in fairness most of those BD costs would be in R&D. I think that's a fair assumption. Secondly, in terms of amortizing them, well, I think that, if we use the word amortize we're really talking about what the accounting treatment for the up front payments and most of these programs are in clinical stage, and so the proper accounting treatment would be for, to be expensing them. There are some instances that we could discuss off-line, perhaps, where you might take a large payment and capitalize and amortize it over the future useful life, but for the most part we're assuming that we're going to be bringing clinical products that we'd be expensing the up front. Thank you. With regard to the TYSABRI filing, could you give us some sort of sense of what kind of rich production you want to put in there, what sort of methodologies you're asking doctors and patients to go through to lower the risk of, or identify early potential PML patients? Yes. I mean, to the extent that I feel comfortable because obviously this is an area of great interest to the FDA and one that they've got their own group with expertise on and we'll get some feedback on our proposal. But first and foremost, the issue is to ensure the drug is used in patients for whom it's indicated, patients with relapsing forms of multiple sclerosis. Second of all is to ensure that physicians and patients understand what the risks are with any and all drugs that act on the immune system with respect to anything from PML to risk for opportunistic infection. So I think ensuring that patients and physicians understand the class of drug they're prescribing, understand who it's indicated for is first and foremost. Then I think is basically to the remind people that the use of drugs that affect the function of the immune system in patients who have recognized disorders of immune function is probably something that people need to be advised about. So you don't want to give the drug to someone with AIDS, probably, and you want to recognize other drug exposures or other historical facts in a given patient that might indicate that they are, that they have an altered immune system. And I think awareness and education and ensuring that that message is delivered is front and center in an effective risk management program. Thank you for taking my question. Just had a quick question on AVONEX inventories and price increases. Were there any changes in inventories and any price increases before the quarter? In Q3 there were, I'm just double checking, there were no price increases in Q3 for AVONEX. The inventories remained the normal range in the channels in the U.S., which is, we always say it's between one and two weeks. So really in general the business is pretty straight forward in the U.S. Internationally we don't really think there was a lot of change in inventories per se. The one thing I did note was in Germany we feel that perhaps in Q2 we did have a price increase in Q2 in Germany, and, but we don't have a lot of visibility because we're selling directly into pharmacies. So perhaps some of the strong sales in Germany in Q2 were driven because of that price increase, but, which might imply a slightly reduced level of inventories in Germany in Q3, but it's hard for us to have visibility of that. Thanks for taking my question. Follow-up question on TYSABRI, there was suggestion that from peripheral blood borne PCR might be a more robust method for following, for early detection of JC viremia in patients developing PML. I'm just wondering if that work has been done on the affected patients, PBMCs, and what the result was? And secondly, have you obtained the samples from the third patient that wasn't presented at the meeting and what were the serum and CSF JC virus finding prior to your clinical presentation and diagnosis in that patient? Thanks. So this is Burt. I'm not going to comment specifically on some of those questions except to say we've been working with Gene Majors who is one of the world's experts on assay methodology for JC virus in the blood, plasma, urine, CSF, tissues. We do use a PCR-based analysis. The trick to good assays is the probe sequence that you use more so than whether you go to lymphocytes, monocytes, etc. So I think we are using state-of-the-art technology and Gene and others involved in this will be discussing these results from this study and others in greater detail at various scientific meetings over the year. With respect to any tests that we may be developing, there are no strategies to develop tests concurrent with the launch of the drug. Testing is a research activity. And with respect to patient number three, I don't think we know anything more than we've already told folks about that patient. Hi, Peter, sorry to turn this into accounting for dummies, but every time I think I understand your guidance and your expense recognition, I'm wrong. So, the one-time expenses associated with the PDLI deal, that 50 million, is it, am I right in believing that your R&D line would have been $50 million lower were it not for that recognition? No, let me just touch that one quickly. The ZEVALIN impairment was split between cost of sales and SG&A. So in the cost of sales line there was $12 million, and in the SG&A line there was 13. And that's simply because some of it was inventory that we now believe based on the revised projections around the shelf dating issues, and then secondly, the remainder is writing off intangibles that related to patents as well as manufacturing technology that we have accessed. So, but they have a short life and so that's why the short-term sales projection is what's critical. Craig, I know that you're not in the world of accounting for dummies, but anyway, I apologize if that was confusing. I hope that helps. Thanks. Maybe a question for you, Peter. You did mention that modeling, you guys are planning on TYSABRI launch in mid next year with a minimal contribution. I'm assuming that you're assuming that the drug is going to be commercially available, or to be sold, and not just on the compassionate use basis? Correct. That's correct. We, obviously, we have to assume something for modeling, so what we're doing right now is just saying, Look. What are our expectations? What's a reasonable thing to work with? And so we have made those assumptions that in fact TYSABRI would be back in the market and sold in the U.S. in mid 2006 and then likewise launched in the European market, and obviously in Europe, obviously you go country by country so take that with a grain of salt, but in the second half of 2006. Quite frankly, we're early in the process, as you know where we are in terms of submitting data to the FDA and we have an ongoing discussion with the EMEA, so, but this is our best estimate at this point, and that's what we felt was appropriate for our guidance. Importantly, as I mentioned, we think that probably TYSABRI would be a modest contributor to revenue next year, and quite frankly, with the development costs that we expect, we don't think it's a big contributor to the bottom line. So even if those dates change a little bit, I'm not sure that would dramatically change our outlook. Good afternoon. Peter, I'm also having a little difficulty understanding the guidance for '06 in terms of expenses. If I just do the exercise of taking out 50 million from R&D and 13 million from SG&A in Q3 '05, and then carry that kind of organic expense rate forward into '06, the assumption that the cost savings at least offsets the in-licensingâs that you're going to see, I'm coming up with dramatically lower expenses and higher earnings than you guided to. So where's my math wrong? Yes, no, that's a fair, very fair question. A couple additional items, though, that I think we've talked about that you should be incorporating into your thinking for expenses next year. First, we will be launching, we're assuming that we're going to be launching in RA for RITUXAN which would be a separate sales force on that side, and we'd be building that up as we finish up this year and going into next year. So that's one additional cost. Secondly, we would be relaunching TYSABRI in the U.S., which is a higher level of marketing and sales activity certainly than what you're seeing in the third quarter, where we're really completely shut down in terms of TYSABRI activity. Additionally, we would be launching and marketing TYSABRI in the European arena, which would be a higher level of activity over there and very exciting activity obviously for those markets who have not even yet seen TYSABRI, so there'd be a lot of communication and information sharing would be critical. Those would be three pieces. And then finally, at this point, as Burt highlighted, we have no clinical trial activity going on for TYSABRI. And so you have to figure that, Okay, right now we're at a pretty low run rate relative to the R&D clinical costs, almost zero probably, for TYSABRI, but yet as we go back and we work with the agencies, clearly there'll be some requirements to continue dosing patients and monitoring them and all the things that you'd normally expect to have as part of the discussion with the agencies and that would increase our clinical costs as we go through next year for TYSABRI. I think those would be the major drivers of why the OpEx would be, I'm sorry, operating expense would be higher than maybe a Q3 trend per se. So perhaps maybe I should have clarified that before, but I think that'll help get to the right outlook. Hi, a question on TYSABRI. When you relaunch the product, assuming it's approved, how will you position it? Because I imagine the risk is higher when it's used in combination with AVONEX, but knowing the risk profile, one would imagine this would be more appropriate for the more advanced patients or breakthrough patients? Hi, May-Kin, it's Burt. I'm not going to speculate at this point on the, exactly what the usage and indication label will say. We have identified some risks associated with TYSABRI that hadn't been anticipated in the original label. But we do have to also say that now that we've completed this very comprehensive evaluation, we haven't discovered any more case of PML or any other unique insight into risks that we didn't know the day March 1 or so that we made the announcement. So issue one is that the risk is out there, but pretty limited in terms of how many cases and how expansive the risk appears to be. Second of all, what we do know is that this remains a remarkably effective drug with tremendous activity both on relapse rate, MRI, and disability progression. So it's an important drug for patients with a life-long disabling serious disease. I believe that the risk benefit profile of this drug still meets the needs of patients of a broad spectrum of patients with multiple sclerosis. In terms of the specific usage statement, I'm just going to wait until we've completed our discussions with the FDA and EMEA. Good afternoon. I have a question about the business development expenses that you're talking about taking next year, the $200 million. Along two lines, one is what kind of expansion in the pipeline do you really see that turning into? And second, how much of that $200 million is going to flow out the door, and how much of that $200 million is basically consumed by what must be sort of heightened due diligence efforts on the part of the staff that is currently employed at Biogen Idec? Alex, let me just first answer part of it. Maybe someone else will jump in as well. But first of all to the question of what we expect the $200 million to be constituted of, it could be a couple things. One is it could be up front payment or it could be if a program was brought in early in the year or mid year it could be the additional sharing of costs in that collaboration as we go through the year, or if it's an in-licensing the cost to actually step up and start carrying the cost of the clinical trial. In terms of, additionally, obviously, you have some due diligence and so forth, but I think that's not really a major cost relative to $200 million. I mean we obviously have very active due diligence efforts as we look at programs but it doesn't add up to that much probably. So it's primarily the additional programs we'll be bringing in, with either up front milestones or new clinical costs that we'd be sharing as soon as we sign the deal and bring it in. In terms of flowing out the door or not, it's a fair point in that once we bring a program in, obviously, we then start participating in the sharing of the cost, but we also start taking on some of the work, most likely, not always, but most likely in some of the programs. And so I'm not sure if that's what you meant by flowing out the door, but obviously, yes. Some of that $200 million will represent additional costs, particularly let's say in Burt's area, or in the research area and manufacturing area as these groups step in and start getting involved in these programs. That's not always the case. I mean, in some cases our partner will be perhaps carrying the load for particular molecule and we may just be sharing the cost. Other cases we may be stepping up and helping with the manufacturing, and the technical development or the clinical activity. It's hard to tell until you actually get there. This is Jim. It's very hard to predict because with each deal it comes in a different shape and form, whether that's an in licensing, a partnership or an acquisition. So it's hard to predict going in. It's likely to be lumpy as it goes through the year because it will flow when the deals get done, and those, they happen when they happen. They take some time to do. And whether it's 200 or more or less, I think remains to be seen. I think the main point around a number like 200 is that is a major statement to make internally to people to say this is one of our core parts of our strategy, and externally that we do have the, we've got the money in terms of cash as well as P&L space to be active and a good partner. Hi. Thanks for taking the question. A question for Burt just on BG12. Could you remind us of the design of the phase II trial? And then, looking forward, what's the bar that's kind of been set to move this into phase III for MS? Well, it's one of our typically well-designed comprehensive phase II dose ranging studies in multiple sclerosis with MRI and relapse rate as the important endpoints. The bar to take this forward into phase III, I really don't want to discuss with you at this point except to say that obviously we understand this space pretty well. I think we can estimate the unique value of an oral agent in this space as long as it has an efficacy and safety profile that we think is, makes it useful to clinicians and patients. So we'll be mixing all of that together along with what we anticipate as rigorous results from a well-constructed phase II trial. Hi. This is actually Kevin Peung filling in for Steve. Two questions, both TYSABRI-related. How much additional commercial infrastructure is needed overseas in Europe for a TYSABRI launch next year? And second if you could provide any clarity surrounding I guess your current plans or current thoughts on filing TYSABRI in Crohn's disease? Okay. Why don't I take the first one, and Burt can take the second one if that's okay, Kevin. So internationally obviously we do have an MS organization sales force, the whole organization established throughout Europe and so forth. So there is obviously some leverage from that and that's clear. Although we haven't really articulated yet to what degree we'd be adding resources, but you very well can expect that we would be adding infrastructure to support a launch of a whole new program like this, just to expand the presence and so forth. So we haven't really broken that out yet. Some of that might depend a little bit on kind of as we develop the strategy right now as we're going into the budget season and so forth, but there will be increases. Perhaps as we get into the year and get closer to that launch point I can give you some breakdowns of that a little more clearly. I think you can relate back to kind of how we launched in the U.S. We did add significantly to the sales force presence in the U.S. We had, in the U.S. it was unique a little bit unique, we had infusion specialist organization as well. That may not be as important going forward, but we will see. And in Europe, obviously, it's a slightly different market, so that may not apply. But there will be a ramp up, and obviously, only part of the cost is the actual sales infrastructure. There's also a lot of communication on a product like this at a launch where you have to make sure that people really do understand the label, the protocols, how to use the drug and obviously in the U.S. we've covered a fair bit of that, but that'll be to be renewed in the U.S. because it's based on the current review of the safety data and the two-year data. But in Europe it'll be new, and so obviously that'll require a lot of communication and does, that can be expensive as well for conference call calls and things. Burt, any comments? Yes. So very quickly on the Crohn's strategy around Crohn's. Obviously we are working closely with our colleagues at Elan to figure out what to do here. But in general I would say we will entertain conversations with regulatory authorities in the U.S. and Europe on the Crohn's data. But what we don't want to do is in any way, shape or form slow down the already active review process for TYSABRI in MS in U.S. and Europe. Yes, hi. Burt, I have a question about TYSABRI and RA. Did I hear you right that you were going to halt the in development in RA, and if so, when are we going to see that data, did you say. Yes, so you heard me correctly. We, our evaluation and our colleagues' at Elan's evaluation of the results from the truncated RA study is that, despite being truncated, we believe that the data are adequate to conclude at this time that activity in RA does not warrant further development. Exactly when those results will be presented or published, I actually don't know. I'm sure sometime within the year. I don't mean between now and the end of '05, but I would say within a year cycle from the announcement of the results. Okay. Thanks. I appreciate everybody attending the conference and holding out for a little over an hour, and we look forward to talking to you in, on the Q4 call and early next year. Thanks. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234039 | Hereâs the entire text of the prepared remarks from Tellabsâ (ticker: TLAB) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Ladies and gentlemen, thank you for standing by and welcome to the Tellabs Investor Relations Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. Thank you, Judith, and good morning, everyone. With me today are Tellabs President and CEO, Krish Prabhu and our Executive Vice President and CFO, Tim Wiggins. If you haven't seen the news release we issued this morning, you can access it at tellabs.com. Before we begin, I will remind you that certain statements made on the call today may be considered forward-looking. I direct you to the risk factors contained in today's news release and in the reports filed by Tellabs with the Securities and Exchange Commission. In addition, as we're in the process of acquiring AFC, I am obliged to say that this communication is not a solicitation of a proxy from any security holder of Advanced Fiber Communications, Inc. Tellabs, Inc. has filed with the Securities and Exchange Commission a registration statement on From S4 which contains a preliminary proxy statement prospectus. Advanced Fiber Communications, Inc. expects to mail the definitive version of the proxy statement prospectus to its stockholders concerning the proposed merger of Advanced Fiber Communications Inc. with a subsidiary of Tellabs Inc. We urge investors and security holders to read the definitive proxy statement prospectus and any other relevant documents to be filed with the SEC because they will contain important information. Investors and security holders will be able to obtain the documents free of charge at the SEC's website, that's www.sec.gov. In addition, documents filed with the SEC by Tellabs, Inc., will be available free of charge from Tellabs Investor Relations at 1415 West Steele Road, Naperville, Illinois, 60563, the telephone is 630-798-8800. Documents filed with the SEC by Advanced Fiber Communications, Inc. will be available free of charge from the Advanced Fiber Communications Inc. investors relations department at 1465 North McDowell Boulevard, Petaluma, California, 94954. The telephone is 707-792-3500. Interest of certain persons in the merger. Tellabs Inc. and its directors and executive offices and other members of its management and employees may be deemed to be participants in the solicitation of proxies from the stockholders of Advanced Fiber Communications Inc. in connection with the merger. Information about the directors and executive officers of Tellabs Inc. and their ownership of Tellabs Inc's stock is set forth in the proxy statement for Tellabs Inc's 2004 annual meeting of stockholders. Investors may obtain additional information regarding the interest to the participants by reading the proxy statement prospectus when it becomes available. Thank you, Tom, good morning, everyone. We announced third quarter results today. Our revenue was below our expectations. We had indicated to you in our last call that revenue would be 300 million, plus or minus 5. We came in at 284 million and the 15 million miss on revenue was largely related to a manufacturing transition issue we had in Europe, and it is all contained in our managed access products line. We were transitioning our outsourced manufacturing from a location in Finland to Estonia. And unfortunately in the transition, we could not ramp up to the bigger need we needed to meet, to fulfill some of the orders we had on hand. It was a lot not a component issue, nor was it an audit issue. We hope to get this problem fixed. We have a team working there round-the-clock and we hope to catch up here in this quarter. Earnings were per expectation at $0.11, though I must clarify and we've done this also in the release, about $0.02 is due to tax refund issue, which Tim Wiggins will elaborate a little bit more. But the difference in the expected earnings of $0.11 versus the operating results of $0.09 is largely related to the margin which we missed because of the revenue miss. Margins were around 54%. Our model for margin is 55 plus or minus 2%, and it is the 2% is mix related. This quarter, we had lower 8100 product. That is in our managed access category. That was part of the 15 million which we could not ship. We had 7100 revenue which is next generation transport platform that we are launching in an ILEC. We shipped quite a bit of that product this quarter and the earliest shipments had more frames and infrastructure rather than modules. And it's those transponder modules that have higher margins. So as traffic goes under this network, we expect that we will recover good margin on that shipped product. And then we also a higher component of service business. Our service business as you know traditionally has smaller margins than our product business. Last quarter, if you're comparing our margins this quarter to last quarter, last quarter the margins were unusually high due to a concentration of wireless products, which we had clarified in the last call. In order to give you some color about the trends in our underlying business, especially we have four moving parts: the transport products, the managed assets products, the voice quality enhancement products and the data products. I will just give you some numbers and then Tim Wiggins will elaborate a little bit more in his presentation. Our transport products year-to-date for the first three quarters have grown 43% between 2003 and 2004 and that is all related, or primarily related, to the wireless activity we had which we've talked about. Last quarter and this quarter, weâve had the two highest wireless shipments that we have had in the history of Tellabs, so we have really benefited from the wireless bulidout. Managed access year-to-date is down 9%, voice quality enhancement year-to-date is up 73% again on the strength of wireless and voice over IP, and data, we are still in a start-up mode and I will talk little bit about some of the trail activity. In the area of managed access, we hope to recover some of the last revenue that we had in the third quarter. We hope to recover in the fourth quarter. Tim Wiggins will give you some guidance as to what we expect in the fourth quarter. In terms of data, we had indicated earlier that we had nearly a 100 customer engagements, we track our data activity in four phases, starting with customer engagement, a committed trial, initial revenue and follow on revenue. We now have three customers with follow on revenue, we have eight customers with initial revenue, we have 18 customers who have committed to our trial and we have 26 customers who are in various stages of a trial. So, all in all we are quite pleased with the market traction, of course as you expect and we expect, we would certainly want more revenue but data plays one that has a longer upfront sales cycle especially since we are very focused in our data activity. The AFC merger activities progressing well, we are working closely with them in the integration planning, we anticipate and look forward to a successful close. And you may have noticed, AFC has announced yesterday that their shareholder approval meeting is set for November 30. I will now ask Tim Wiggins to go over some of this in more detail and I shall come back to answer some of your questions. Great Krish, thanks and good morning everyone. Compared to year ago levels, our third quarter results followed developing pattern, higher revenue, higher margins and lower expenses combined to drive improved profitability. Whole revenue for the quarter was $284 million and while itâs up16% from the third quarter of 2003 as far our expectation on a sequential basis that Iâll discuss shortly. Net income amount of $46 million or $0.11per share on both the GAAP and non-GAAP basis. As Krish mentioned, net income was positively affected by tax benefit of approximately $4 million, which includes an $8.5 million benefit associated with the resolution of a recent federal tax audit. The tax benefit contributed about $0.02 of EPS. While we are discussing EPS, let us talk about GAAP and non-GAAP for a moment. Given the small difference between our GAAP and non-GAAP results this quarter approximately 300,000 in charges, related to previously announced restructuring actions our GAAP and non-GAAP results are basically the same. In last yearâs third quarter, however, our GAAP result included about $48 million in restructurings and other charges. Therefore, the following discussion will include some non-GAAP measures. You will find a reconciliation of these non-GAAP results with our GAAP results in our press release. This quarterâs net income of $46 million or $0.11 per share can be compared with a non-GAAP net loss of $18 million for $0.04 per share in the third quarter of last year, as a $64 million turn around in net income in a space of twelve months. By way of comparison, last quarter we are in $53 million or $0.13 per share on a non-GAAP basis. We generated $84 million of positive net cash from operating activities during the quarter versus a negative $3 million in the third quarter of â03 and a positive $71 million in the second quarter of this year. This quarterâs results show respectable year-over-year growth, total revenue came in below the range of expectations we gave you in July. The difference can be attributed in large part to some transition issues we encountered as our outsourced international manufacturing operation was relocated from its longtime home in Finland to a different facility in Estonia during the third quarter. Overall, we estimate that this transition or these transition issues inhibited our ability to ship approximately $10 to $12 million of 8100 managed access systems and 6300 next-generation SDH products during the quarter. The manufacturing situation is similar to what we experienced last year when our North American manufacturing operation was moved to our outsourced partners' facilities. Issues are being addressed and we expect to ship most, if not all, of the 81 and 6300 products in the December quarter. A lot of income has been spilled over wireless spending in North America this quarter and, like other suppliers, we saw wireless revenue decline sequentially. In all fairness though, this was the second strongest wireless quarter in Tellab's history, exceeded only by the robust prior quarter. Looking forward, it seems that this quarter's results are more in line with where we think the businesses is heading over the near term. We fully expect that wireless will remain a vibrant part of the Tellabs' storybook for the foreseeable future and we look for continuing strength in 2005 as the industry works through its consolidation issues and more wireless carriers begin to build their networks and support increase minutes of use and deliver new data oriented services. On a geographic basis, revenues from customers in North America amounted to 66% of total revenue versus 59% in the year-ago quarter and 70% in the second quarter. Revenue from customers in Europe, Middle East, Africa, Latin America and Asia-Pacific regions was down about 2 million year-over-year and up more than 4 million compared to the second quarter of this year. For the third quarter, transport revenue increased to 138 million, up 31% over the year-ago quarter. Compared with the second quarter, transport sales declined 23 million, primarily as a result of the wireless situation I just described. As a measure of the overall resiliency of the 5500 business, more than 1.4 million T1 equivalents were shipped during the quarter. By way of comparison, we shipped about 800,000 T1 equivalents in the third quarter of 2003 and 1.8 million in the second quarter of this year. We also began to ship our 7100 Metro DWBM system to an ILEC customer for deployment in the next-generation 10-gig backbone network designed to position them for a triple-play service. For the quarter sales of our managed access products, the Tellabs 8100 Managed Access Platform and the 6300 next-generation SBH platform, along with our Tellabs 2300 Access Platform for cable telephony services amounted to 73 million, 10% below the year-ago quarter and about 3 million below last quarter. The overall revenue decline was driven primarily by the manufacturing transition issues I described earlier, offset partially by a year-over-year increase in sales of the 6300 products. For the quarter, our voice quality enhancement products came in at 20 million thatâs up 29% over the year-ago quarter and 4 million below the second quarter level. This product category includes both stand-alone echo cancellers, primarily for wireless applications and echo solutions designed to be integrated into voice switches. We addressed the IPM TLS network opportunity with our broadband data products, the Tellabs 8800 Multiservice Router and our 8600 Managed Edge Service Platform for Ethernet services. For the quarter, revenue for the 8800 Platform amounted to 8 million our best quarter today. Revenue from services and solutions amounted to 45 million in the quarter; that's 6 million better than the third quarter of 2003 and about 4 million better than the prior quarter. Moving to the profitability aspects of our business, gross margins were 54% compared with 46% in the third quarter of '03 and 59% in the second quarter. Product and customer mix shifts caused gross margin to come in at the low-end of our expectations this quarter. When I look at the sequential change, we had about 3.5 points of margin decline related to mix shifts across Tellabs' product lines. Compared with Q2, we sold less high-margin 55 and 8100 products and more lower-margin products, like the 7100 Metro DWDM Platform. The remaining 1.5 points of margin decline was related to customer shifts within products, as for example, we sold our 6300 next-generation SBH product in more price-competitive regions. Moving ahead, I expect gross margin for the fourth quarter to be flat to slightly down, plus or minus a point or two. Any variability will likely be attributable to changes in mix. Turning to operating expenses, actual operating expenses came in at 120 million, in-line with expectations. That compares with 131 million in the year-ago quarter and 122 million last quarter. For the quarter, R&D expenses were down 1 million sequentially to 60 million. That amounts to 21% of sales. By way of comparison, R&D accounted for 28% of sales in the year-ago quarter. As we look forward to the pending acquisition of AFC, we are exploring our ability to reallocate R&D resources in order to address more opportunities in the access space. SG&A expenses were 57 million, flat with the previous quarter. That equates to 20% of sales versus 24% in the third quarter of 2003. Intangible asset amortization at 4 million was flat with the second quarter of this year, and accounted for the balance in spending. We have done a good job this year in holding the line on spending. But as we look forward to the fourth quarter, we are targeting flat to slightly up total FX as we exceed and expect the impact of integration costs associated with the pending acquisition of AFC and normal seasonal factors to affect OpEx. All told, this could increase total OpEx by a couple of million dollars sequentially. Operating income was 33 million positive in the quarter, or 12% of sales versus operating loss of 18.5 million in the third quarter of last year. Other income was 9 million versus 5 million in the second quarter of this year. Our tax provision for the quarter was a benefit of approximately 4 million. During the quarter, we reached an agreement with the IRS on their audit of our tax returns for the years 1998 to 2000. As a result, we recorded a benefit of approximately 8.5 million in the quarter's provision. Excluding this benefit, we would have recorded a tax expense of approximately 4.5 million, resulting in an effective tax rate of approximately 14%. Our GAAP effective tax rate for the past couple of years has been impacted by the valuation allowances that we've maintained against our deferred tax assets. As we have discussed in detail in our recently filed S4 for the AFC acquisition, our tax rate post-acquisition will be significantly impacted by acquisition accounting. Generally speaking, we expect to see our effective tax rate return to a level that more closely approximates the combined federal and state tax rates in the mid to upper 30s range. However, because of our tax loss carryforwards and other deferred tax assets, we anticipate that our cash taxes will continue to be close to zero for our U.S. income until such loss carryforwards are utilized. We encourage you to read our S4 and 2003 annual report for more detail on the accounting implications of our valuation allowances and the potential impact of the pending acquisition of AFC on our future tax rate. Turning to the balance sheet, day sales outstanding was 57 days, up two days sequentially. Inventory turns decreased to 8.7 times versus 10.1 in Q2 and inventory in terms of dollars totaled 64 million, up from the previous quarter. Cash flow from operations was 84 million and CapEx during the quarter was 9 million compared with 11 in Q2. At the end of the quarter, our cash and investment balance increased to $1.343 billion, up 101 million from the second quarter. The actual numbers of shares outstanding was approximately 417 million at the end of the quarter and headcount at the end of the quarter stood at approximately 3000, flat with Q2. For the quarter, book-to-bill was below 1. As I look and take backlog into consideration along with our other internal indicators, we expect fourth quarter revenue to be up sequentially over the third quarter 2004 and range between $300 and $315 million. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234040 | Hereâs the entire text of the Q&A from Sabre Holdingsâ (ticker: TSG) 2006 outlook conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Okay. But that is 50% of your bookings. Then I assume there is a price increase there, if you sort through the value-based pricing? Yes, that is a pretty good assumption, Jim that there is an increase. The exact percentage, probably a little bit lower than the 50% you quoted. Just because we are in individual negotiations with a lot of different carriers. Got it. And Sam, what is the biggest risk, in your opinion, to the '06 plan or the forecast that you have given us? Well, I think, as I look at it, I feel good about what we have laid out for next year. And so I don't see really large risks on any part of the business. I think it is going to be important that we continue to execute as we have. And I think if we do and, in fact, if we, if the airline deals that we are working on come to fruition as we think they will, then we should be in pretty good shape for '06. Well, I think what we said about the forecast is that it is reflective of the types of economics and discussions that we have underway today. And so, we are fairly deep in the negotiation pipeline with a number of airlines. And so what we have projected for next year is reflective of the types of economics that we are talking about with them. If I can get one last question. Jeff, how much of the free cash flow growth in '06 is related to the Lastminute timing issues that you alluded to last October? I thought you had talked about some timing issues in the free cash flow. Yes. Again, I think, let me help you maybe get through that in a simplistic way. And that is that our guidance before we acquired Lastminute was roughly 200 million. Our guidance on the November call for the year after we acquired Lastminute was about 50. So that, 150 So, I would suggest that's a pretty decent estimate of what had to do with the timing of when we acquired Lastminute on a year-over-year basis. Thank you. Can you, you briefly described in qualitatives where you were in terms of the negotiations. And what gives you the feel that you are going to be able to maintain the Travel Network revenues and actually obviously increase the cash flows based on your discussions that are going on now? Obviously, you are not going to tell us what is going on in the discussions. But if you can just give us some color around those discussions, that would be great. Yes, well, we said the rate was going to be slightly down. So if you take that, and then you think about merchandising initiatives, growth in our nonair businesses within TN. So we see good growth in our current hotel business. We saw that this year and we will see that next year. So, merchandising plus revenue growth there. With a slight rate decline for the airline business. It all adds up to where we are at in these deals. We do have transaction growth built into the plan. If you look at nontransaction growth, it's up in the 15% range. So, there are a number of, I appreciate that there are a number of moving parts here that aren't, we don't have total, we are not providing total visibility into. But I think you can expect on the fourth quarter call that we will provide a little bit more insight into that. Now, the other thing I would say is that the team, the Travel Network team has done a fantastic job of focusing in on costs and cost reductions and improving the cost structure of the business. So you don't get to the levels that we've talked about here in terms of earnings without that type of hard work. And they have done a really good job through the process in the last couple months of the year getting ready for '06. Right. And finally, one quick follow-up. And that is on Travelocity, you are talking 2007 beginning to reap the benefits of these synergies. Is there going to be an inflection point sometime later in 2006 where we can begin to see a milepost on Travelocity, so that we can get some, let's call it, a better feel for 2007? At what point in 2006 should we be looking at 2007 based on what you've just told us now? Well, I think in Travelocity, you will see continued or significant improvement year-over-year in operating income, at large. Obviously with Travelocity Europe, we were losing money. We expect to make money in Europe next year. So I think what Sam and Jeff are referring to is, there will still be integration costs dragging down some of that benefit in '06. And that will tend for the most part go away in '07 as the integration costs are done. But you will see progress, and even with the first quarter, you will see a year-over-year improvement in the bottom line picture at Travelocity, Europe, and Lastminute combined. And we will, I think each quarter you will hear from us as to what we are doing in checking the boxes on all the synergy work that we are doing. Reflecting back to the deal model that we put together when we were initially evaluating and then when we closed this deal. And a lot of that stuff we talked about in our last quarter call. So, private labeling aside, consolidating the technology, consolidating some offices. So, we are already hard at work at those synergies that drove the yield model. So, even given the seasonality, we should be seeing some sequential progress in Travelocity on the margins because of these, because of the integration costs going down? Hi, Jeff. First on the cash flow, I think your guidance was 300 million. Can you tell us what percentage of that is from working capital so we can better compare that to Expedia? Well, no, I really can't. Part of it is from working capital growth, both in Travelocity's European operations and domestic operations, But keep in mind a big chunk of it is also just operating cash, operating earnings growth. Obviously principally at Travelocity but maintaining margins and improving on margins and operating earnings slightly in the TN business and then maintaining margins in the AS business as well. I don't want to get, I don't want to sort of delineate between those yet, but it's kind of driven by both things. Okay. And, Sam, can you talk about the timing of the DCA3 agreement to the extent you can. Pretty aggressive guidance relative to expectations into the call for '06. Just thinking of timing. And we'll probably have to start doing our '07 modeling. When do you think those agreements will be, start to come out. I won't, I haven't provided very much specific guidance on timing thus far. Except to say, that we expected to get to agreements, begin to get to agreements with airlines toward the end of this year and early next. And I think that remains my expectation. Okay. Last shot at this. When we think of the year-over-year comps for the Sabre Travel Network business, do you think you will see better comps in the first couple of quarters than the last half of the year? Or can you give us any color on that? Quarterly, you would really like us to break it out quarterly, I think that is probably something, Justin, we ought to do on the February, whatever that was, 4 call. Thank you very much, Mr. Post. Next in queue we go the line of Scott Devitt with Stifel, please go ahead. This is Scott Devitt with Stifel. Two questions. I was wondering how much is remaining on the existing buyback and your thoughts about potentially increasing that possibly after you've figured out the bridge financing? And then separately in Europe, I was wondering if you could just add some color as to the synergy benefit in terms of profitability versus possibly an industry-wide change in the mentality around sales and marketing and potential for scale there as well? Thanks. Okay. I might have to ask you to ask that last part of the question. I can't hear you to well. Let me tackle the first one on stock buyback. Jeff why don't you jump in on the financing piece. You may recall that in May, we received an authorization from our Board for another 100 million in stock repurchase. As is. as was with past implementation of those type of programs, that's left to management discretion. We obviously make buyback decisions based on best use of available cash. We haven't initiated any stock repurchase based on this recent authorization. So, nothing has occurred with tha authorization in light of the Lastminute.com deal. We do have some, we have an automatic purchase program to replenish and satisfy obligations on, to deliver options to employees under the stock option plan, employee stock purchase plan. But we haven't done anything as a part of that authorization. Do you want to talk, Jeff, on the financing piece? Yes, I will give you some thoughts on that, Scott. Principally, as I said in my comments, we are evaluating our refinancing options. At this point in the year I think that we have nine months until the bridge expires. Next point that I suspect you will see some clarity on our actions here will be early in 2006. Once our 2005 numbers are out there, we may well in the near term put in place some kind of interest rate hedge to take advantage of the markets. Particularly the longer term debt markets that are in place today. And other than that, I would just say if you go through the notes to our press release, and I encourage everyone to do that, there is more information there than we gave you on the call. I think you will easily see that we've assumed a debt rate for 2006 in arriving at our projections for 2006 of about 6%. That, again, not indicative of any decisions we will make. But I think it is a pretty reasonable long term debt rate in the market at the moment. And Scott, on the Europe side, there are three things going on to get us from a significant loss to the mid single digits number for operating income that Jeff gave. And that is, of course, significantly ratcheting back the investment we were making in Travelocity Europe. And we started doing that by consolidating front end and technology platforms and ratcheting back on marketing spend and the like. Secondly, the lastminute.com, just native improvement and some of the market changes. We believe we are at a point where we were with Travelocity maybe a year or two ago. Where we can drop a lot of the incremental revenue down to the bottom line as we've made the investments we need to in things like technology and the like. But then finally of course, is the drag next year in some of the integration costs. So, things like getting SarBox compliance and financial systems integrations and the like, which are integration costs that will largely go away by 2007. So, the European improvement in performance is really a function of all three of those things. We haven't given specifics on what component is from each. But it's really all three of those things coming together. If I can just follow-on to that. The sales and marketing piece specifically, do you think that's more related to the benefits of consolidating the two entities? Or do you think there is an industry-wide change occurring in terms of leverage in Europe? Sure. So in Europe in particular, lastminute.com has always been particularly strong in having lower customer acquisition cost vis-a-vis its competitors. And one of the reasons we bought the Company and feel so good about it is the strong identity it has with consumers. And its ability to drive marketing, acquisition in a cost-effective manner. So, we certainly think that is a benefit that is fairly unique to lastminute.com. On the Travelocity Europe side, it's easier, much easier for us to feel good about ratcheting back marketing spends, since lastminute.com will be the lead brand across Europe. So, part of it is just placing our bets wisely country by country and using the lastminute.com as the lead brand. And of course, just like in the U.S. where now in North America, as you know, we grew transaction revenue through the third quarter at more than five times the rate of media advertising growth in North America. Those same kind of scale effects are starting to happen in Europe as well. Thank you. I have a couple of questions also. Could, I think you mentioned that you expect incentives to grow at a slowing rate. Can you give us an idea of how that compared with the rate this year? And also if you'll look at, separate that into small and medium-size agencies compared with large agencies, whether, how those differ? Well, first of all, Michael, we didn't comment on incentive growth in 2006. And I imagine that will be something that we spend a little bit more time on in, again in February on our fourth quarter call. So, we haven't provided any projections on that yet. Of course, I do think that the Travel Network team has been doing a great job of managing incentive growth down, but, and we are not providing any projections as yet. Yes, I would just say on Travelocity side on the, we have said the same thing now consistently on the hotel side, which is we believe that long term healthy margins in the low 20's are sustainable. And that's a combination of standalone and packaging and the like. And we continue to see nothing that has changed our perspective on that. And then in general, we are obviously shifting most of our business to packaging and hotels in general, which tend to have a higher margin. Other than that we haven't made any specific comments on margins by product line. Okay. So, is it fair to assume that you are not much different than others in seeing margins declining in the air business? No. To be clear, our competitors have talked about in past quarters about significant pressure on yield or I think you are using the word "margin" but basically yield between growth and revenue in several product lines. We have not made that comment. We have not seen, I guess we haven't seen as much a pressure as some of our competitors have. And in Europe, I know Price Line has made two hotel acquisitions, which have had huge increases in volume over the last two years. Are you generally seeing this kind of increase in hotels to suggest that you might want to buy more hotel properties? And not so much properties, but to do more agencies that handle hotels? Yes, we never comment on our M&A as you know. Having said that, remember domestically, we have significant increases in our hotels. Even all year organically in our hotel year-over-year in terms of room nights sold. So, I think we still see tons of organic opportunities in front of us. We talked about in Europe on our last call that we were seeing particularly strong hotel bookings in Europe. And we continue to see that as an area opportunity for us across the Company. Travelocity, well Jeff just gave the numbers. We said, North America operating margin including Zuji, which would be a roughly 10 million loss. But including Zuji, expect it to be in the low double digits an adjusted basis. And approach double digits on a GAAP basis. And on the Europe side of Travelocity, operating margin for the European operations is expected to be in the mid single digits. With an operating loss on a GAAP basis. And total operating income for Travelocity is expected to more than triple and approach 10% operating margin on an adjusted basis. The only thing I would add to what Michelle just said; is that EBITDA is expected to be over $150 million. And on the Travel Network side, we said EBITDA greater than 300 million. And we said mid-teens operating margin. But a, both on the margin side and the operating income absolute side, an increase over 2005. Thanks, guys. A couple of questions. Maybe just to follow up on the previous question from Michael. I guess you don't want to talk specifically about incentive trends. But Jeff had said there was a $50,000 cost reduction effective to the Travel Network business. To the extent you can, can you put some more color around where that cost savings will come from? Just to reiterate what I said, which is data processing costs, slowing growth in incentive trends, and a variety of categories. Many, many categories of overhead. Okay. And then it seems increasingly likely that deregulation is possible in Europe in the fairly short to medium term. Have you guys forecast that into your budget at all? And if you haven't, what potential effect would you think it could have on the budget if we do see deregulation in Europe? We don't have any explicit assumptions for Europe. In large part because those processes take a lot longer to actually play out and be affected in the marketplace than you might think. So in reality, post deregulation in the U.S. is starting to have an impact in 2006 earnings really. So, it is several years after the laws were actually changed. Sam, do you want to add anything to that? I think that's right. It is a little too early to say what things are going to look like in Europe. We might expect things to shape up similar to what we have seen in the U.S. market. But, again, we are kind of 18 months after the fact now in the U.S. deregulation. And we are just beginning to see some changes in the way deals are being struck, that type of thing. Okay. Great. And then finally on Travelocity, what do you have in the budget for 2006 in terms of Travelocity's revenues that will come from incentives? One thing I want to clarify on the call. When I talked about stock compensation expense, I am reminded here by my colleagues that I said "with" instead of "without" this adjustment. So my point is that; for 2006, even if you didn't make that particular adjustments, which again we think makes sense because most of our competitors do it. It is a noncash expense. We would meet our financial target of $1.70. One other thing I wanted to point out on this. We happen to have participated in a survey that 400 publicly traded companies all participated in. And somewhere in the range of third to a little bit over half of the Companies who would start to expense both stock compensation for restricted stock and the like and options expect to be providing investors with obviously the GAAP numbers. But additional information from the adjusted numbers to give them a better sense of the true cash flow operating earnings of the company. So that was motivator as well. Good afternoon. I was wondering if you can speak to any underlying raw merchant margin or merchant markup assumptions that might underlie your 2006 expectations? Or just give general some general sense of the markup or lower margin environment for that business? Yes Brian, I won't say more than what I just said earlier. But on the hotel side, we continue to believe that long term sustainable margins for our hotels and merchant are in the low 20's. And we continue to believe that is long term sustainable. We have been saying that for a while now and we just don't see anything to change our views on that. And that of course, also effects our packaging business when you think hotels, the merchant hotel is a chief component of our packaging business as well. So, I would reiterate what I said but we wouldn't go beyond that. Yes. I was hoping could you talk a little bit about your goal for 2007 Travelocity. How much of that might come from revenue synergies versus cost synergies? And also whether it includes particular headcount reduction? No, I would just say though clearly, and we have shown this over the course of this year; that we have hit scale in a lot of the areas. And so we're dropping a lot of our revenue growth. And we have had terrific revenue growth on Travelocity down to the bottom line. But we're going to, and we will obviously do all the things that you would expect us to do to drive much more marketing effectiveness and efficiency. We don't see the need to be adding headcount in ways that we did, obviously that when we were a much younger Company. And so, the improved revenue can have a much better job down to the bottom line than it used to. So, I think that's the, that gives you a bit of a sense. But we certainly haven't gone through and done exercises of specific headcount target reductions. And Europe, of course, is very part and parcel of our deal model and our integration plan to reduce headcount where it makes sense. We talked for instance, back on our Europe call that G&A as a percentage of our total cost structure is significantly higher than where it is for the rest of Travelocity and where we think best practices. So, we see that in Europe in particular as a big opportunity. But we won't go after that until we figure out the right technology and processes to simplify the business. So, we are not driving all that of headcount cost. And that stuff is well under way. You will see G&A improvements for the European business in 2006 over 2005. I think, and Michelle is just emphasizing that there is even further improvement to be made beyond 2006. Okay. And then one other question for Sam. I am not exactly sure, but I was hoping you could maybe help me better understand. If there are any decisions you need to make if down the road, say later in 2006 you feel like the market is no correctly valuing especially the growth here at Travelocity; would there be things along the way that you might have to do differently to give yourself the maximum kind of strategic flexibility? Or do you run the business pretty much the same way and the strategic decision is just kind of potentially addressed at some point down the road? Yes. I think we are open to a lot of different ways to improve shareholder value. I think we feel good about the portfolio business as they exist today. I think we have had some work to do for quite awhile. And we still have a fair amount of work to do in terms of our airline relationships. But certainly we are looking at how can we deliver more shareholder value on a regular basis. But I won't comment any further than that. I'm Sorry, just one extra question on Europe. I was wondering if you could break down that business in terms of growth rate between Travelocity and Lastminute or somehow get us to an organic number? Yes. And that's, Scott, that's real hard. We haven't done that. We will be able to provide a little more clarity on Europe and guidance as we get into our February call. But as you know, it's getting harder and harder for us to look at organic for a couple of reasons. One, is we really think about Europe as the combination of Travelocity Europe and Lastminute. And then within that Lastminute obviously is different businesses, the trade businesses, which are growing slower but high margin and the online assets like lastminute.com, which are growing much faster. So, it's harder for us to kind of give you a pure organic look. But I imagine we will provide a little bit more information as we get into our February call. In general, as we mentioned on our last call, we expect that our online assets will grow at the rate of the market in Europe, that online market is expected to grow at. And our offline assets are more trade businesses like Holiday Autos and the like, will be much lower growth rates but again very healthy margins. And thank you Mr. Devitt. With that, Mr. Gilliland and Ms. Peluso and our host panel, I will turn the call back to you. There are no further questions. Okay. Well, perfect. We will let all of you go then. It is starting to get late in your day on the East Coast. Really appreciative of your joining us today. And look forward to spending more time with you in the coming weeks. And then again as we get together on February 2. Thanks very much. And ladies and gentlemen, your host is making today's conference available for digitized replay for two weeks starting at 7 p.m. Central Standard Time December 12, all the way through 11:59 p.m. December 26. To access AT&T's executive replay service please, dial 800-475-6701. At the voice prompt enter today's conference ID of 804820. Internationally, please feel free to dial in at 320-365-3844, again with the conference ID of 804820. And that does conclude our outlook for 2006. Thank you very much for your participation as well as for using AT&T's executive teleconference service. You may now disconnect. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234041 | Synaptics (ticker: SYNA), maker of touchpad products for PCs and MP3 players, reported fiscal first quarter results that beat analyst estimates, but cautious guidance and investor concern for its diminished Apple iPod business (the iPod Nano and Video do not contain SYNA's product) drove the stock down about 5% since the earnings release. Key data points and excerpts from the SYNA conference call: we respect all competition, and weâre not taking Cypress lightly. But, we really believe in strategy in terms of offering total integrated solutions with all the pieces of the technology together⦠We can confirm that the most recent [iPod] product launches announced do not include Synapticsâ solutions. we certainly have much less visibility this year than we did last year. I think going into the December quarter last year, our backlog was in excess of $39 million as compared to the $19 million we have entering the December quarter of 2005⦠our view of the way the December quarterâs going to, I think, pan out is primarily a reflection of how strong consumers show up in the notebook space. I think on the margin, corporate demand in notebooks could be a net positive. But, we think the overall quarter will depend largely on consumer spending. |
EarningCall_234042 | Good day ladies and gentlemen, and welcome to the Q3 2006 OSI Systems Earnings Conference Call. My name is Tony and Iâll be your coordinator for today. At this time all participants are in listen-only mode and we will conduct a question and answer session towards the end of this conference. (Operator Instructions) Thank you very much and good afternoon. With me on the call today are OSI Systems Chairman and CEO Deepak Chopra, the president of the OSI Security Group, Ajay Mehra, and OSIâs Chief Financial Officer, Anuj Wadhawan. During our presentation this afternoon, we will make forward-looking statements concerning upcoming events and our expectations regarding the Companyâs financial performance. Each time we do, we will try to identify these statements with words such as expect, believe, anticipate, or other words that indicate potential events. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those in the forward-looking statements. Please consider the risk factors contained in todayâs press release and stated during this conference call, as well as the risk factors described in our latest Form 10K filed with the SEC. For a limited time we will make the webcast replay of this presentation available on the investor relations section of our website. Our website address is www.osi-systems.com. Please note that the date of this conference call is May 15, 2006. Any forward-looking statements we make today are based on assumptions that we believe to be reasonable as of today. We undertake no obligations to update these statements as a result of future events. Finally, this conference call is a property of OSI Systems and any recording, reproduction or rebroadcast of this conference call without the express written consent of OSI Systems is prohibited. Iâll turn the call over now to our CEO, Deepak Chopra. Thank you very much Victor. Before I go into the quarter, I want to mention that I am speaking from New York City where Iâm currently participating in our trial with L-3 Communications. The trial has just entered the third week and is expected to last for approximately four weeks. As you can expect, I am unable to comment or answer any questions regarding the progress or potential possible outcome of the trial until its conclusion. For the third quarter of fiscal 2006, the company recorded revenues of $108.1 million with diluted earnings per share of $0.06, after stock-based compensation expense of $1.5 million or $0.09 per diluted share. Anuj Wadhawan, who is currently in Los Angeles, will discuss the financial highlights in further detail at the conclusion of my operational review and then we will open it up to questions. Overall, we are pleased with the operating performance for the company as a whole in all of its three operating segments. We are particularly pleased with the Security segment recording record revenues of $36.7 million and returning to profitability, which we said in our last conference call. We expect this performance to continue into the fourth quarter of this fiscal year. The revenue growth and operating income performance for the Security business was primarily led by the strong performance of our Cargo and Vehicle product line and continued robust revenue stream from our people and parcel scanning conventional business. Year to date, we have announced an excess of $28 million in new Cargo orders from both international and domestic customers. The backlog for the Cargo product stands at approximately $44 million to $43 million at the end of the quarter with the total Security businessâs backlog to be at a very healthy level. We continue to see increased traction for the product line globally, especially Cargo, led by the U.S. Government and strong performance should continue into the fiscal 2007. The Security business will continue to be committed to R&D both for its Cargo product line and the Automated Hold Baggage Screening market, although we did say in the last conference call that the R&D going forward for the Cargo line, is relatively lower and reducing, and the R&D for the Hold Baggage Screening line is increasing. A major focus of our R&D spending will be on the commercialization of the Rapiscan RTT1000 CT system for Automated Hold Baggage inspection. As for before, the system utilizes our proprietary Real Time Tomography technology for the automated inspection of hold baggage. The system is electronics-based without any moving parts that by design will increase baggage throughput from the present machines doing approximately 500 to 600 bags per hour, to increase the throughput to approximately 1500 bags per hour. We believe the system will radically reduce installation and ongoing maintenance cost, which associated with the current systems is the big problem in the market. This quarter we announced a $7 million order with the Manchester Airport Group, which was one of the original groups to go towards CT scanner technology for automatic hold baggage. If all the customer options are exercised, the order could be worth approximately $40 million. We are expecting to deliver the product in fiscal 2008 and we are at present, wrapping up R&D towards what we call scaling it in size and to continue to work out the various sub-systems of the system. Healthcare business. The third quarter of our healthcare business, as we have mentioned, is seasonably weaker when compared to the businesses in theâespecially in the second quarter ending December and the fourth quarter ending June. Despite the seasonal factors, our monitoring and anesthesia business continues to show year-on-year order book growth. For the first nine months of the fiscal year, monitoring order book growth globally has increased by 18%. The growth has been led by the continued strength and strong performance in the U.S. market, which is the biggest market for the monitoring products. The business has and remains focused on recapturing our replacement cycle business. Published industry growth rates show the market growing at approximately 3-5% in the U.S., similar number in Europe and about 10% in Asia-Pacific. Our order book growth clearly indicates that we are achieving our internal goal of recapturing our installed base while also capturing market share from our competitors. Gross margins for the Healthcare business continued to improve and approached 48% versus 46% over the first three quarters as a whole over the fiscal year. The improvement is attributable to the introduction of new products in the patient monitoring line, and the achievement of efficiencies in the manufacturing process in our monitoring and anesthesia product lines, and the growth in our revenue. The business although, is facing a challenge in the U.K. and German markets primarily due to the government spending cycles, a challenge that we are not alone but us and all our competitors are also facing. This quarter, the company also reached a settlement with Masimo regarding our Dolphin ONE digital pulse oximetry products. Under the terms of the settlement, we agreed to discontinue the product line of Dolphin ONE digital pulse oximetry. The financial impact of this is expected to be minimal and immaterial. Take focus of that product line is in our original equipment manufacturing relationships for continuing to make oximetry products for other patient monitoring companies and supplying products under the name Tru-Link or Spacelabs. The Healthcare business is focused on organic growth in all the product lines and we are looking to introduce new technologies and products while also focusing on the introduction of the anesthesia product line into the U.S. market sometime in fiscal 2007. We continue to look at acquisitions; globally it is part of our strategy. We internally have said that we would target the Healthcare business to approach approximately half a billion dollars in revenue over the next two to three fiscal years, combination from acquisitions and from internal organic growth. Any acquisition we look in that product line, we target towards making it accretive to both Spacelabs and OSI in a very short period. The Optoelectronics business continued its great performance in fiscal 2006. The business has benefited not only from the general pick up in the economy but also the improved performance in our Security and Healthcare businesses. This quarter we achieved record inter-company sales of $7.6 million. This has helped in pushing the operating income for the business for the quarter. This quarter we also announced the resignation of Deloitte & Touche as our independent accountants. We had been with Deloitte & Touche for the past 15 years and thank them for their service. We welcome our new auditors, Moss Adams, and looking forward to a long-solid relationship with respect from both sides. The resignation, as we have discussed, of Deloitte & Touche was primarily due to relationship issues and not in any way associated with financial reporting procedures of the company. For the six months ending June 30, 2006, we expect revenues to be between $231 and $236 million, an increase of approximately 18% when compared to $196 million achieved in the second half of fiscal 2005. We will be profitable and expect that operating income will be significantly higher in Q4 when compared to Q3. Overall, we are well-positioned to finish the year on a strong note setting us for a successful growth-oriented 2007. Our revenues for the third quarter of fiscal 2006 increased by $13.9 million or 15% to $108.1 million compared to $94.2 million for the third quarter of last year. Revenues for the first nine months of fiscal 2006 increased by $42.8 million or 15% to $327.1 million from $284.3 million for the first nine months of fiscal 2005. Net income for the third quarter of fiscal 2006 was $1 million compared to a net loss of $2.9 million for the third quarter of last year. Net loss for the nine months of fiscal 2006 was $3.1 million compared to net income of $840,000 for the first nine months of last year. Diluted income per share for the quarter was $0.06 compared to diluted loss per share of $0.18 for the third quarter of last year. Diluted share for the first nine months was $0.20 compared to diluted income per share of $0.05 for the first nine months of last year. Due to the adoption of FASB 123r in the first quarter of fiscal 2006, we recorded stock-based compensation expense of $1.5 million in the third quarter and $4.1 million in the first nine months of fiscal 2006. To give you the breakdown of revenues, on the Security side of our business, revenues increased by $7.4 million or 26% to $36.4 million this quarter compared to $29 million for the last yearâs third quarter. The increase was primarily due to an increase in revenues of $4.8 million or 101% in our Cargo and Vehicle Inspection products and $2.6 million or 11% in our conventional (base) business which comprises of baggage, parcel and people screening products. For the first nine months of fiscal 2006, the Security group revenue increased by $2.8 million or 3% to $93.8 million from $91 million. The increase was primarily due to increase in revenue in our conventional (base) business of $7.2 million or 10% and was partially offset by decrease in revenues of our Cargo and vehicle inspection products. On the Healthcare side of our business, the revenue increased by $1.6 million or 3% to $49.4 million in the quarter compared to $47.8 million in the last yearâs third quarter. For the first nine months of fiscal 2006, revenue increased by $17.2 million or 12% to $161.8 million compared to $144.6 million in the first nine months of fiscal 2005. The increase in revenues in the quarter and nine months was primarily due to increased revenues from our monitoring and anesthesia systems. On the Optoelectronic side of our business, external revenue increased by 28% to $22.2 million in the third quarter compared to $17.3 million in the last yearâs third quarter. External revenues for nine months increased by $22.8 million or 47% to $71.5 million from $48.7 million in the last yearâs nine months. The increase in revenues in the quarter and nine months was primarily due to an increase in revenues of both Commercial Optoelectronics and higher contract manufacturing levels. In addition, during the quarter we recorded an inter-company revenues of $7.5 million compared to $5 million in the third quarter of fiscal 2005 and $5.4 million in the second quarter of fiscal 2006, which got eliminated in the consolidation. Our gross margin for the quarter increased to 39.8% compared to 35.2% in the last yearâs third quarter and 38.5% in the second quarter of fiscal 2006. Our gross margin for the nine months increased to 38.3% compared to 36.4% for the last yearâs nine months. The increase in gross margin was primarily due to favorable change in product mix in all of our three businesses. SG&A for the third quarter was $33.8 million compared to $30.2 million for the last yearâs third quarter and $33.5 million for the second quarter of fiscal 2006. The increase in SG&A in the third quarter, compared to last yearâs third quarter, was primarily due to increased legal fee of approximately $1.9 million associated with the ongoing litigation of L-3 and SAIC, and the inclusion of approximately $1.2 million in stock compensation expense and higher administrative costs to support the growth of our businesses. The increase was partially offset by the impact of an increase in bad debt reserve of $2.5 million in the three months ended March 31, 2005. SG&A for the first nine months of fiscal 2006 was $100.7 million compared to $80.6 million for the last yearâs nine months. The increase in SG&A was primarily due to increased legal and professional fees of $5.2 million, higher administrative cost of $2.2 million, inclusion of stock-based compensation expense of $3.4 million, $2.7 million due to inclusion of full nine months of Blease SG&A, higher sales export cost of $7.2 million to support the growth of our three businesses and foreign currency translation losses. The increase was partially offset by the impact of an increase in bad debt reserve of $2.5 million in the three months ended March 31, 2005. R&D for the third quarter of fiscal 2006 was $8.9 million compared to $7.3 million in the third quarter of last year and $8.7 million for the second quarter of fiscal 2006. R&D for the first nine months of fiscal 2006 was $26.3 million compared to $21 million in the first nine months of fiscal 2005. The increase in R&D spending was due to increased R&D spending by our Healthcare group for the development of next generation products and increased R&D spending for the development of our Automated Hold Baggage Screening and Cargo and Vehicle Inspection Systems by our Security group. We had an income tax benefit of $820,000 for the third quarter of fiscal 2006 compared to a tax benefit of $2 million in the third quarter of fiscal 2005. For the nine months of fiscal 2006, we recorded a tax benefit of $1.8 million compared to a tax benefit of $602,000 for the last yearâs nine months. Our tax rate is dependent on the mix of income from U.S. and foreign location due to tax rate differences. Our effective tax rate has increased due to inclusion of incentive stock option expense in the total stock compensation expense which does not qualify for tax deduction. We expect our tax rate in the fourth quarter will be impacted as we adopt (FAS) 109-2 to repatriate our foreign earnings. We are currently evaluating the impact of this. In the first nine months of fiscal 2006, we used approximately $10 million of cash in operating activities, primarily for working capital to support the growth of our businesses. Our total backlog remains strong at the end of March of approximately $131 million, our Cargo backlog at the end of March was approximately $43 million. We reiterate our revenue guidance for the second half of fiscal 2006 to be in the range of $231 million to $236 million and expect revenues and operating income be higher in the fourth quarter when compared to the third quarter of fiscal 2006. Hi, this is Brian Ruttenbur of Morgan Keegan, I donât get paid like the guys at Morgan Stanley. A couple quick questions for you on the tax rate, you expect it to be up significantly from third quarter levels, or we talking 45-50%, we talking 35%, what range are we talking? If we look at the third quarter we had a benefit, income tax benefit and in the fourth quarter, we (inaudible) but there are various different variables out there and one is the stock compensation expense and repatriation. Tax rate is going to be higher, itâs going to be over 50-70% range. Okay. And then legal fees, you mentioned in the quarter was $1.9 million I believe, itâs what I caught. What kind of legal fees do you anticipate in the quarter weâre currently in, given the trial and everything? Well, let me try to answer that question, cause Iâm in New York. Brian, very difficult for us to come up with a number. We definitely think that the best estimate we can give you, it would be higher than Q3. But at the same time, it will drastically go down by the end of this quarter. By the end of this month. Okay. Thatâs fair. The other outstanding large, I guess, litigation is the only one that I am aware of is SAIC, is that the big one out there? Is there anything else major besides that? No, Brian. Itâs Victor Sze, those really are the two that are sort of the larger part of our legal fees. The others are more minor. Okay. And then, let me just talk about gross margins. You had good gross margins in the period, in the third quarter and thatâs over the last, I guess, six or seven quarters, thatâs your highest gross margin overall. Can you maintain that 40%? Is that the goal? I think that a lot depends on the Security shipments and as we have said that fourth quarter would continue to show growth if compared to Q3. So, there is no reason why the gross margin should not continue to tick upwards approaching the 40% plus number. Okay. On SG&A, just going down through the income statement for the next period. Itâs seasonally very heavily-weighted Q4, I think that because of bonuses and salary increases and everything that takes place in the fourth quarter. Is that the case? I donât know. Maybe, Anuj, you want to take it. I think that the bonus accrual goes all through the whole year and there are no raises or something that come in to fourth quarter. I think itâs more like the hourly people gets reviewed in August and (the rest) gets reviewed in September. So, I donât think so thatâs true. Anuj, you want to add on to it? Yeah. The fourth quarter, another factor kicks in is the professional fee associated with the auxiliary testing on Sarbanes and coming from the auditors. Thatâs another variable coming in to it. And another variable comes with the commission of our internal sales force. As in the Healthcare business, their compensation is based on the revenues. They have their sales targets. As we come to our fiscal year end, and they approach their sales targets, they have commissions on that. Okay. So, seasonally the fourth quarter is much heavier even as a percentage of revenue, thatâs what it has been at least. Is that fair to say this year? If you take it as a percentage of revenue, I donât think itâs going to increase significantly. They all depend on the variable, as legal, as Deepak mentioned, is going to be higher. But if you exclude that, if not, our SG&A is pretty much in the lower (inaudible). Okay. And then, finally, on R&D, it sounds like itâs going to be up in the fourth quarter versus the third quarter, did I hear that right? Ajay, you want to comment on it, because the only area that is up, going to be up, is not Medical but your RTT Automated Baggage Scan. Yeah. I mean, obviously, we are ramping up on the R&D there, Brian. Itâs going to be up, but I would say itâll be up by less than a million dollar quarter to quarter. Okay. And everything else should be down or flat, beyond that, for the rest of the Company. Is that right, Deepak? But just to complete your first sentence on the SG&A, just thinking about it, what Anuj was saying. As a percentage of revenue, I donât think so that your SG&A is going to be higher in Q4 compared to Q3, because if you look at our guidance, Q4 revenue is going to be significantly higher than Q3. Yes. Okay. That makes sense. And then, I guess, last question, Iâve asked way too many, but I just want to understand a little bit more on the Security side. What all is going out there from a macro environment? What is up for bid right now? Where is the big action? Is it in the US, is it Europe, is it Asia? Where are the big, large Cargo and other contract award expected? Yeah. I think on the large Cargo side of things, weâre seeing activity both internationally and domestically. Weâre actively talking to, participating in various government agencies over here. Internationally, again it is very strong, activity is very strong, stronger than what weâve seen it, in fact, ever before. On the financial side, our people and parcel scanning business, we continue to see growth. Anuj mentioned that we were at 10%, 11% higher than previous quarters. We are seeing growth there, we are looking at newer markets that weâre entering overseas. And the Automated Hold Baggage Screening, thatâs just a market that we started. We are obviously looking at customers that have been with us in different airports, and they are the same customers. So we think that weâre going to get some good traction there as weâre going forward. So really, all three areas of our business are looking very strong. Thanks for taking questions. Three questions. In terms of your revenue growth from patient monitors, youâre signaling that growth in the global market or the order intake was at 18%. How long do you think this growth will continue for, given the marketâs growing low single to mid-single digits? And where do you see particular inflection point in terms of new products coming through. Iâll ask the next two questions after you answer this one. Number one, thatâs very true. Our growth, what we have said to you for the last 4, 5, 6 quarters that weâve been talking about, we continue to see double digit growth. Our U.S. business, surprises me, had been very strong in monitoring, order intake, which basically says that not only are we capturing our lost market share, but weâre also taking business away from our competitors. Definitely non-U.S., we have some challenges still as you know that that area was started when the company separated from GE from scratch and we are still building our sales force, we are still building our relationships. In the Asia Pacific, we continue to make progress. We have new products in line, the closest one is the low acuity monitor especially geared up for the low cost fair market to go after the outer clinics and the Asia Pacific area. Our major launch for a whole new platform is not scheduled âtil late 2007, 2008. But the other initiative is, as you know, that we have 510(k) approval for anesthesia machines in U.S., and we are in right now in our final strategic plans of launching the anesthesia product line into U.S. So there is a lot of activity happening in that area. Answer to your question how long can we continue this double digit growth? Weâve said it that for the next foreseeable future, we will continue to see this double digit growth and we donât see any slowdown in the short period. Where it will end up in the inflection point, I think itâs still 4, 6, 8 quarters out. And just on the anesthesia business, do you think that given the strength of that business in the rest of the world, that you could see a pretty confident launch in the U.S.? What are your expectations or preparations for launch of anesthesia products in the U.S.? Well keep in mind that U.S. is the biggest market for the anesthesia products. So, even if itâs huge market, but weâre also coming in. You can appreciate it that Drager Siemens and Datex-Ohmeda GE are there. We plan to launch it but we have always said to you, we are going to get one shot in U.S. So we are very careful, we are doing all our analysis and thatâs why we are very cautious and we are going to take it very carefully when we launch. But when we launch, we are going to launch it very aggressively and we have high hopes for it that we would capture a good share of the market. And for the final question. On the margins, on the Healthcare side hit 48%. Do you think that thereâs a reasonable headroom for further margin expansion in the final quarter and then going into fiscal 2007? Are you able to rationalize some of your costs in your cost centers such as China and India? The answer is yes. Weâve told before that we think that we can cross the 50% mark. We might miss it by a quarter or so but we are on the right path. We believe that as our monitoring business continues to grow, it automatically has a higher margin. We continue to look at manufacturing in other areas to increase our efficiency. So it is absolutely true that we continue to move towards the 50% margin in the near future. Hi. Back to the gross margin, I wanted to ask you, given, I understand you are seeing improving gross margins in all the segments and thatâs obviously having the most predominant effect but I was surprised given the makeshift moving away from Healthcare this quarter sequentially versus the Cargo business that gross margins still went up. So, can you provide a little cover there in terms of, it sounds like the Security gross margin was up particularly strong recently, maybe a little bit of specific commentary on the improvement there? Well Iâll answer the Healthcare side and Ajay can maybe take on the Security. On the Healthcare side, we did mention to you that this is going to be a weaker quarter in revenue wise compared to Q2 but even then, because the monitoring sales especially in U.S. was so strong which inherently has very high margins, Jeff. So that pushed the margin even with the revenue being down and our Optoelectronics business has performed very well in its margin and continues to do well and we think it will continue. Ajay, you want to comment on the Security side? Yes, I think if you look at the Security side, the margins have improved both to look at a growth on the conventional. We said as the sales go up, your related expenses donât necessarily go up the same amount. So weâve been able to leverage our margins as the sales volume has gone up and same thing is happening on the Cargo side. The other thing were doing on the Cargo side is, if you remember, nine months ago or a year ago, we were doing a lot of one-offs as we become more familiar with some of the products. Our margins have improved there as well. Okay. I went through before all the different line items on the P&L, but it sounds like what youâre pointing toward is the operating margin in this fourth quarter that youâve seen it sometime, but thereâs a lot of moving parts here and can you give us a flavor for, do you think you can achieve a mid-single digit operating margin this quarter or how should we get this, it seems like the gross margin should have another nice step-up with the make shifts will be more favorable and obviously thereâs continued leverage there and with good revenue growth youâll see some improvement in operating expenses? So, can you give us a feel for how that turns out in the operating margin line? Well, let me try to answer that youâve (asked) a pretty tough question for us. Our revenue is going to be significantly up in Q4 compared to Q3. We also said Security will continue to be strong and we also said Q4 will be stronger than Q3 in Healthcare. Basically, youâre absolutely right that all these factors lead towards that the gross margins should be up. The problem we have is that we donât know where the legal is going to fall. And like I said, we are in an active lawsuit right now. We have also the moving parts where Anuj mentioned about our tax rate and Sarbanes Ox expenses which start coming up in the Q4. So what we are trying to say is that if you take out some of these one-offs kind of thing that are happening, the operating income line will be significantly higher compared to Q3. But very difficult for us to project beyond that for this quarter. But on the operational side, the revenue is going to be up. All segments would be profitable and the operating income line will be significantly higher than Q3. Anuj, you want to add some more flavor to it? Maybe Iâm (inaudible) in looking at the fourth quarter, but if we look at â07, the legal expenses are much more normal and you got a gross margin thatâs north of 40%. Can we expect you to get back to the 6% operating margin in â04 anyway, or maybe just some sense on what your targets are now that you have had chance to really drive some improvements and get some scale back in the Security business, where do you think we should look to when we look out the next fiscal year? I think that youâve monitored it quite well. If you take out the legal expenses going in to 2007 and as Ajay says, the activity is quite strong and we can do growth in Healthcare, thereâs no reason why we should not return back to overall company margin in the 40% plus or north of it and the return back to at least single digit operating income. Just keeping with one proviso that Ajay is saying that we are increasing on R&D spending in Automated Baggage Scanning business. But your analysis of it is right. Okay. Youâve given us in the past the absolute dollar number of shipments on the Cargo side? Is that the number that, I think youâre just talking in terms of incremental year over year growth. Last quarter I think you said the large Cargo was say, about $5 million, did that improve quarter on quarter? And then, compared to $4.5, $4.7 million in the last yearâs third quarter, and about $4.7 million in the second quarter of fiscal 2006. Okay. Great. And the last question I have was that youâre talking about the kind of double digit growth youâre seeing in the patient monitoring business but the overall Healthcare business was up less. Can you talk about where the business has been weaker in terms of whatâs dragging the overall growth down of the revenue in the Healthcare group? Well, one of the things is that the European sector especially in U.K. and Germany, definitely the challenge for all of us because of their healthcare spending. The other thing is that our medical data on clinical trial business is weak, and that is dragging the growth down. On the other hand, monitoring which inherently has very high margin, continues to be strong. So, overall we are quite happy and you know, keep in mind the Oximetry business, Iâm sure you know, have been in a sort of state of flux with this Masimo, Nellcor, which is part of Tyco, fight going on. It doesnât have any impact on us presently or even in the future. But that definitely, everybody (inaudible) was sitting on the sideline, seeing what these two guys are going to battle it out. We didnât have enough to lose, so we decided to just not even push forward with our digital oximetry business. So once that whole environment gets settled down, we continue to be believer in the rest of the oximetry business to continue. So, I think that to me, when I look at the significant jump that youâre expecting in the fourth quarter sequentially in terms of overall revenue, thereâs not anything unusual, I mean thereâll be a seasonal recovery in Healthcare but thatâs not enough to get you guidance. So youâve got visibility into, I would take it to be a much stronger shipment quarter in terms of Cargo in this June quarter and maybe Ajay can talk about, given the overall lumpiness there, whatâs your comfort level if that happens. Well, let me ask you again, let me answer the Medical side. Definitely Q4, seasonably and we have given guidance, will be stronger than Q3. On the Security side, Ajay you want to comment on it? Yes, Cargo is lumpy, but youâre sitting here today and like weâve said, I do expect Security to be a better part of the fourth quarter than the third quarter. All right. Just to add on to it, Jeff, we did say that Cargo backlog should stand at about $43 million even with shipments of 9 million plus, and we also said that the total Security backlog is quite healthy. Right, and I understand that there is much more than a normal recovery seasonally, so to speak in your numbers. Iâm assuming itâs a real stair step up in the Security business as well. Weâre looking forward to make your guidance. Hi guys. Good quarter. In looking at the backlog, how much of the Manchester order went into the Security backlog? Did you account for any of that? Okay. So from the Manchester order, can I get going forward in the backlog will be $7 million until you start shipping out of the CT? Okay. And then, Iâm just going back to the tax rate. You know, weâve had a little bit of fluctuation here, you talked about repatriation and some of the stuff you have going on with some of the foreign income. Is this something that we expect to continue to fluctuate over the next year? I mean, when is this going to settle down? We see a lot of variables in there. As I mentioned earlier, mix of income, stock compensation expense, ISOs included in there. But if we exclude this repatriation, itâll be somewhere in the neighborhood of 40% â 55%, somewhere in that neighborhood. And Josh, this is Deepak, just to add on to another thing, I just want to make sure what you asked about the Manchester backlog. Manchester backlog would be in the total Security backlog, not in the large Cargo backlog, which is at $43 million. Okay, thatâs a good point. Then on the Dolphin settlement, you said that you didnât expect significant impact there. Is there going to be any impact on the inter-company revenue, so their impact on the margin side? No. Inter-company revenue in that particular product line would be to Spacelab Healthcare for their Tru-Link oximetry product, which has nothing to do with Dolphin ONE or digital oximetry. Okay. All right, and then, I guess finally just going back to the R&D issue again. I understand that youâre going to wrap R&D to get where you need to be on the Hold Baggage side. But youâve talked about Healthcare being sort of flattish maybe a little down, and then the Cargo is obviouslyâis coming back in. So, if you look at the R&D line both from a percentage of revenue and also just from an absolute number, are we going to kind of settle in to the numbers that weâre seeing now? Do you expect this to still come up within that million range that Ajay had said before? I think thereâs been some confusion there. Well, but let me try to answer. I donât think that we ever said that the Healthcare R&D is going to go down. But as the revenues pick up, the percentage is pretty much way ahead right now. In the Security side, yes, the R&D is going to go up in the Automated Checked Baggage business but we also said the R&D in the large Cargo is going to go down. But the net impact is going to be, itâs still a little bit too early. But one of the things that you should look at it is because Q4 is going to be significantly stronger in revenue. As a percentage, I donât think R&D is going to go up, it might even go down. And on the Healthcare, the only (inaudible) thing thatâs happened different is that weâve been a little bit more efficient of the R&D engineering as weâre going in India compared to what we thought weâre going to cost, itâs costing us less. Good afternoon. I apologize in advance, I wasnât able to listen to the early part of the call, but, so some of these are going to be redundant, but what do you expect the tax rate to be in the fourth quarter? Yup. Tim I mentioned earlier, a lot of variables are going to be there. One is a mix of income between our foreign and domestic locations and ISOs included in a stock-based compensation expense, which doesnât qualify for tax reduction. And the fourth quarter, we are expecting that the tax is going to get impacted because of repatriation of foreign earnings. Thatâs currently we are evaluating. Definitely, we will increase our effective tax rate. Combination of all that, I mean itâs a very broad range. Itâll be somewhere between 50-70%. But you also had said, Tim, if you were not there in the early part of the call that this repatriation is a one-off item that we have to do it before June 30th 2006. Yes. The vast majority of that is going to be again itâs going to be within the next 12 months. I mean theyâre obviously weâre shipping some fourth quarter, Q1, Q2 itâs going to be shipping on the next 12 months. New orders we get in take anywhere from four to nine months to ship. Some of the older orders weâre shipping, weâll ship some in Q3, weâll ship some in Q4 and Q1. And can you talk about the pipeline a little bit, Ajay, especially with regards to Cargo screening. And I noticed that thereâs a fair amount of funding in the pending Supplemental Appropriations Bill for containers screen. Is that something that is applicable to OSI? Yes it is. WeâreâI mentioned earlier, if you look at our pipeline, if you look at activity out there, itâs very very strong, stronger than weâve ever seen it both internationally and domestically. Itâs a matter of as you know, what the government, itâs a matter of some of these budgets passing and getting some of the funds appropriated, but we feel very good about what weâre seeing out there right now. Just to add on to it Tim, that as you know, that we did announce some time ago an IDIQ order: Indefinite Quantity Indefinite Delivery. We have multiple products of large Cargo qualified in that program. And as the budget gets finalized and goes into the next year, starting October time period onwards, we definitely think that our products are needed for national security. So, it is your understanding that the $200 million plus of funding for container screening that CBP has would be spent under the IDIQ? I think it will be inappropriate for me to answer that question. All I can tell you is that they have chosen different vendors and we are one of them under the IDIQ. Where they spend that $200 million, whether itâs all in the IDIQ or some of it, thatâs a question you better ask to the U.S. Government. I donât want to answer for them. Well, but maybe Ajay you can give some color relatively on last year, the total number available to them was significantly smaller than what they are trying to put through this year. So, that sort of gives youâthem an indication that if we got some input in our order intake from last year, this year as the number goes significantly up that theyâre asking for, but maybe they will be more available. Right. Yes I like the sound of that. On the margin side, on the operating margin side, I was a little bit surprised in the composition, you touched on this a little bit, but the Heathcare margins were maybe a little bit lower than I would have anticipated granted in a seasonally weaker quarter, but the Opto margins were outstanding. Is there any trade-off between the inter-company work there? Is that all eliminated out? I mean is that all outside business margin that Opto is getting, or is there some kind of trade-off on who gets the saving from in-house manufacturing that the Opto is doing for Healthcare? Let me try to answer that question. We award this practice, arms-length transaction, between the Opto Group in a fair way to the divisions. The external sales are higher. That increases their margin and as they ship more inter-company, they do ship with margin. So when you add the two things together, definitely Optoelectronics Group generates very healthy operating income and weâve said that before. But I wonât go as far as saying, is there some kind of a monitoring that we just divide a little bit here, a little bit there or whatever, thatâs very well thought of arms-length transaction with what the fair pricing is between the manufacturing component group of Optoelectronics and the two divisions; Security and the Healthcare. Victor, Anuj, would you like to take a shot at it, but if you donât, somebody can make a good estimate? And in this quarter, the current quarter, itâs still pretty hard to estimate where your legal cost are going to end up? Well, we did say, I think that you were there in the call or not, that we canât estimate, but we have the best guesstimate. We are in a four week trial as we speak. So we think that Q4, which is June ending, the legal cost will be higher than Q3 which Anuj mentioned, was approximately $2.7 million. Right. Alright. Okay. In other than the legal cost, is there any initiative that might lower SG&A or do you expect SG&A cost to stay relatively flat in fiscal â07, excluding the legal cost? Well, when you really look at it, one of the things that has happened. One, we definitely want to emphasize that we continue to look at our SG&A cost, but the new variable that has entered into it is this compensation expense that wasnât there before, and now itâs in there, and that just having an impact in there and the R&D is up. So I think of it, I know that you continue to ask as a percentage of revenue as the revenue line picks up, the SG&A as a percentage of revenue, it should start coming up. Especially if you take the big element out of the legal effect and even after taking legal out, I think as the revenue line continues to grow, excluding the legal, the percentage SG&A should start coming down. Anuj, you and Ajay want to add something? Okay. I was just looking at excluding stock option expense and excluding legal expense, you need about $30 million in SG&A in the third quarter. What Iâm trying to figure out is can I kind of extrapolate that as a good run-rate that you donât need to grow much in fiscal â07? As your legal cost run off, maybe that would be a good run-rate that we should think about? Okay. Thatâs great. And then the management retention bonus is that, do we have one more quarter of that? Is that done? Okay, and you may have such touched on this, if you have donât repeat yourself please, but can you talk about the situation with the auditor and why there was a severing of the relationship? Well, the issue basically was that, I think the relationship was the major issue, Tim. After 15 years of marriage I think fatigue was showing from both sides. Our biggest complaint had been that we just didnât get their respect or called the priority. We were eight hours late on our year-end, a couple of days late on the quarter, and after Q2 it was pretty obvious that both sides were not being in a happy mode. So we actually had started dialogue even before Deloitte & Touche resigned. Iâve started talking to and interviewing various potential but our plan was to look at a point after the third quarter. But Deloitte & Touche surprised us by resigning eight days to the quarter left. And then we had to actually aggressively go forward, and we had multiple choices. We had even choices in the end between Big 4, and going to a smaller regional firm, those are debated inside the company. We basically get our analysis and said, what really was our biggest complaint was that respect and our ability to be on the front-side of the priority to get the answers. We thought that we would be better served with a regional firm. So it turned out that Moss Adams had their headquarters in Seattle, they had offices in Los Angeles. And basically we are very happy with what we have seen, and you can see that we were very worried about the timing, and in that motion, we can tell you that we have not filed the (Q) yet, but we are timing the (Q) to be any day, and we think itâs in the next couple of days. We think that if we were with a Big 4, this would have been very difficult, we wonât get to this. Itâs been a great four weeks including midnight oil burning from both the auditors and inside. But we are very happy with the service weâre getting. No. When they resigned, there was no item that was opened. Q2 had already been signed out, Q3 they have not even started, so it was in between with no open issues left. I think, Deepak, you can add to it that Deloitte was very helpful and very instrumental in our bringing aboard a new audit firm. They expressed some very positive sentiments about us and did say that (inaudible) business relationship issue and beyond that they had no concerns about us. But just to add on to it that internationally, with our independent offices, I think in Asia Pacific, Anuj, what Malaysia or Singapore or where is it? And, Tim, all the open items which were there not opened but to all the significant deficiencies and material weaknesses, those we had were already disclosed in our eighth day. With that, Iâd like to end it. I want to thank you very much for this late evening, at quarter to seven on the East Coast. We appreciate your time. We believe that we are poised for a good 2007. We continue to look at all our segments and we are very comfortable in saying that in Q4, revenues would be stronger than Q3, operating income will be significantly stronger, and all three segments will be profitable, Security will have a good Q4, better than Q3. Going into 2007, we are looking at a growth and we are looking at a positive movement to get towards profitability. Margins continue to improve and we are looking forward to ending one of the litigation this quarter so that we could go start the New Year with one less litigation. Thank you. |
EarningCall_234043 | Hereâs the entire text of the Q&A from Estee Lauderâs (ticker: EL) Q1 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Hi, while the weakness is pretty-broadbased I wanted to talk about Europe, and the sluggishness there on the top line. Can you talk about how much of that related to distribution center issues, and also on travel retail? What's going on with travel retail? What was the number there, and why was it so weak? Well, Dan is going to address the distribution issues and I will come back to talk to you about some of the top-line consumer issues. Chris, this is Dan. We estimate that between the distribution center in Oevel, in our major distribution point, we lost somewhere between 10 million to $15 million of shipments in the first quarter. Some of that will be recouped with the replenishment of existing basic stock, but a lot of it was promotions that were running during that September period, and they won't come back to us. As far as top-line issues, there are a number different issues. Let me give you the highlights: one of the highlights is our travel retail business, which currently, year-to-date, is tracking on a comp currency basis at 5%. They are projecting their year at 7. But just to give you an example, the month of October is tracking at plus 18% for travel retail. But to give you an idea, overall consumer confidence on continental Europe is not particularly strong. There are a number of reasons for that in the major markets. As well, a significant factor is that after five consecutive years of significant, strong consumer demand and growth in the UK, we are seeing a slowdown in UK demand. UK is still relatively good compared to Continental Europe, but not nearly as strong as it used to be. So I think you are seeing some of the same factors we experienced here in the United States with lack of consumer confidence. We were also experiencing those same issues in Continental Europe also in the major markets. Okay. And then I just wanted to follow-up on the gift-with-purchase issues. I know you didn't really have success on the fall promotions, and I think you mentioned about repositioning the gifts and repackaging them and getting them back out there. What is the longer-term fix there? Obviously not as effective a piece of a business as it was at one point. What is going on in the long term, and how do you get past that? Well, a couple of issues. The specific short-term issue in the Fall this year related to the gift-with-purchase programs, which was more acute is we made a fairly significant bet on a look which is around tweed for the Fall gift programs, and as you know, in August and September, throughout most of the United States, we experienced unusually warm weather, where the consumers were hot and sweaty just looking at tweed, let alone touching it. So those programs were not as attractive to the consumer as we would have liked or hoped. Interestingly now in the month of October which has been significantly cooler throughout North America, these same gift programs that are now running with retailers are much stronger than the same programs were a month ago. As far as the reworking is concerned, both the Estee Lauder and Clinique brands are taking different approaches to how they rework the existing gift inventories to try to recoup their business with different offers that are incentivizing the consumer to focus primarily on the more attractive of Skin Care and Makeup. The longer-term secular issue of gift-with-purchase is not insignificant. We are looking at over three-plus years of general weakness in, or declining return on investment in the gift-with-purchase programs, which is a concern for us. That being said, these programs are still much more efficient than most of the alternatives for the significant investment we might have that stimulates the top line. So while the return on investment is nowhere near where we would like it to be, and what it ought to be, and what it has historically has been, it still seems to be more efficient than alternative uses of these funds. We are looking at strategic alternatives in reallocating amongst the different communications and motivating vehicles for the consumer, but we need to do this in a manner that does not significantly affect our top line, which ultimately helps fund the productivity in a full-year basis. Chris, I would like to follow up with that. That is why we have been so bullish with the Macy's National advertising program because that gives us a vehicle to reinvent gift-with-purchase. We will go to National dates for most of our major stores. You are confident that is the right move to stay with gift-with-purchase and sort of reinvent it, rather than find another way of executing things? Well, part of the reinvention is a different way to execute different promotional vehicles to support it, but as William said it is a large part of the three major brands in the United States business, and we can't walk away from it. We have to reallocate funds to other areas, but we still have to make it successful. Actually Goldman Sachs. In terms of the Belgium logistic problems. You quantified it, and that was great, but can you walk us through what the issues were there. Your confidence in getting this fixed by the end of the second quarter, and I am wondering whether that's the reason, sort of the fact that your longer-term cost reduction programs are taking longer to implement, is the reason that you are stepping up your short-term cost reduction program. I am sorry to make this a long question, but could you also, William, maybe flesh out a little bit more your short-term cost reduction plan? I understood the indirect expense focus. I wasn't sure about the rest of it, and you talked about potentially having to take a charge. I am not sure why there would be a charge associated with that. Sorry that is such a long question. Well, there are multiple parts of that. I will let Dan answer the first part of your question about the Belgian distribution center. Amy, let me give you, it is a two-part issue. Part one our distribution center in Oevel. We went into a new building with a new system, and we did not anticipate the complexity of the start-up problems we had. Our direct shipments to customers in four major markets were impacted tremendously during the August-September period. Compounding the issue we have a major contract with DHL, who supplies all of our facilities and major distribution centers throughout Europe, and got dramatically behind in the August timeframe, and did not recover in time for the quarter. That is being addressed, and we think that will be fixed, and is fixed as we speak. Our Oevel distribution center is fixed, in terms of meeting our everyday shipping needs, it is not running as efficiently as we want, but we are confident by the end of the quarter it will give us the efficiencies that we would expect. As far as the short-term initiatives are concerned Amy, there are a number of different initiatives that we are taking, that we are very aggressively going after a number of the opportunities, and as you may have caught in the text of my message, there is really two main focuses. One is an activity-based approach toward our processes, which looks to rationalize on an economic basis our activities, and make sure that all the activities we are pursuing, are in truth accretive to the needs of the total company, and to eliminate those activities which seem to be perhaps marginal at best, given the new realities of the current business environment around the world. Well, it is not, you know marketing spend comes as a tail which is created by the dog, which is all about program creation and initiatives, and what other forecasted returns on these marketing programs. The general theme that we are emphasizing very emphatically with the brands is spend more on fewer programs, but make each of those programs more impactful. So rather than promoting a dozen programs throughout the season, we are going to ask them to focus on 6 to 8 programs, and make more noise and more impact with those 6 to 8, rather than the 12 different programs. And that manifests itself in an emphasis in the creation of fewer programs, an emphasis on the reduction of the expenses associated with the creation, and instead a reallocation of these funds, towards advertising and promotional vehicles which will drive those fewer programs to greater success. The second part of that is, a more efficient, more focused look at indirect spending and coordinated indirect spending, between and amongst the brands so there isn't any duplicative efforts and perhaps less efficient use of total corporate funds and, again, the focus on improved productivity, and doing more with less for more impact. So William, what's the one-time cost associated with these two programs? Because these seem like they are pretty straightforward, and you just sort of drive them internally through really sitting down and fleshing this out with the different managers. Well, there is a number of different one-time costs that would be associated with that. It may be termination of contracts with suppliers who are not as cost effective as other competitive suppliers, as other divisions as example. It may entail one-time cost with reductions in force in areas that are not as effective or efficient, or return on investments. Those are examples. In addition the most important things about one-time costs is, you are saying, hey, look, we are going to be lowering the absolute levels of spending not this year so it comes back next year. We will be lowering the absolute level of spending this year, and in the following years for good. My first question has to do with the Skin Care business. Would it be fair to say that the promotional issues, would have affected Makeup more than Skin Care. I am wondering why the Skin Care business was so weak, whether it is a market share issue, and how confident you feel about a pickup in that category specifically? Wendy, if you look at it, you are mostly right in what you say, but not entirely right. The Skin Care weakness that we saw in the first quarter was largely related to the weakness in the promotional programming, and also, as you may have heard us say, also related to the sequencing of our shipments, and our focus in programs in Skin Care this year versus last year. So if the weaker gift-with-purchase programs in the first quarter, you saw weaker Skin Care, because total sell-through was weaker because of the gift-with-purchase programming. In addition to that the launch programming associated with that was less skewed to Skin Care this year versus last year. That effects most of the weakness and we expect to recover most of that going forward. Why would the tweed program sounds more like a shade statement or color statement to me. What in there would be Skin Care related? Well, there is nothing specifically Skin Care-related about the gift in and of itself, but one of the major attractive programs of the gift itself is a bag. And unbuyable bag where the consumer gets not only in the gift with purchase a number of products, but the bag it comes in, and the emphasis of that bag was in the tweed program. So it wasn't about a color story per se, it was literally about was the bag itself attractive to the consumer? Good morning. If I could I want to keep this kind of broad here. What do you think about the long-term top and bottom-line growth targets you have set out, 5 to 6% top line growth, the 13 to 13.5% operating margin, and 12 to 15% EPS growth? Well, certainly if you look at it, we need to continue to hit our numbers each year, to be able to achieve our long-term growth. We have confidence in the fundamentals, given what our current visibility is today over the long-term, what we see as opportunities around the world in our key categories. We have confidence not only in our own ability to achieve that, but also in the strength of our brands, very unique and attractive positions within their markets to our consumers and to the retailers, as well as in the abilities of these brands to achieve individually their goals, which means we roll it up to a total company, we believe in our total abilities to invest those objectives. The obvious issues that could be obstacles going forward will be any longer-term secular disruptions, like we have seen in the recent couple of months, that extend on a broader basis for a more sustained period of time. And I wish I had some control over that, but unfortunately those factors, especially the weather, are out of our control. Okay. That's fair. And then just a follow-up. Can you talk a little bit about your SAP implementation, and whether or not you think that the tools you have are forecasting now are, you know, below par, and should we see a marked improvement in that, as you move forward on this system integration? Sure, certainly, Bill. The tools that we have today are nowheres near as good as the tools we will have under SAP. So we are anticipating a much better forecasting capability with the implementation of SAP, which as you know is a couple of years away, but that is one of the driving reasons that we are implementing it, the ability to forecast better, and also the benefits it will bring to the supply chain, and some of the processes and the way we run our business. Thanks. Just had a question again on the gift-with-purchase programs. I guess one of the other negatives would be that that kind of thing could encourage consumer pantry loading. Do you have any method of monitoring that? And what do you think the current consumer inventory levels are of your products? You know, it is very hard to judge about what the consumer inventory levels are. When I visit friends' homes do I not look in their drawers to see how many extra lipsticks and eye shadows they have. My hope is they have lots of them, and they are all our brands, certainly. If I use a proxy for that, as an example last night I was looking on E-Bay of how many items were for sale for our different brands, and you look at 8,000 to 10,000 items offered for sale of the Estee Lauder brand, or the Clinique brand, or some 5,000 to 7,000 for the MAC brand, being offered by consumers on E-Bay, and I use that as a proxy, if you will, a consumer interest, if you will, a different level. Saying there is a lot of product out there, but there is still plenty more for consumer to want to spend money on. Over time, one of the things that we've seen happen is, let's use the Los Angeles Southern California market as an example. 10 years ago, there were five major different retailers who offered our brands in the region. So each season the consumer had, for both the Clinique and Lauder brands five different gift-with-purchase offers in any given season. So ten weeks out of the season, she was being offered from one the retailers a gift-with-purchase from the Estee Lauder or the Clinique brand. Today those five retailers are now two. So she now has a choice, not of five different gift-with-purchase which she could shop for at her favorite brand amongst her different local stores. She now has the choice of two. Does that create a greater incentive for her to pick each one if she was, in fact, a gift shopper, versus a loyal Macy's shopper, or loyal Nordstrom shopper? Perhaps. But I don't believe you are going to see stockpiling in our category of merchandise, much like you would see in other categories, primarily because we don't believe the consumer is extremely price sensitive, one. And two, there is an instant gratification associated with the purchase of our category of merchandise, that may not be associated with others, and I don't believe the consumer buys 3s, 4s and 5s, with one exception, when their favorite color is discontinued for one reason or another, usually their sales associate in the store will tell them, and call them up and say your favorite color is being discontinued. Then the consumer stockpiles it, because she doesn't want to not have her favorite color. Operator Instructions Again, please limit yourself to one question and a related follow-up. We will go next to John Faucher of J.P. Morgan. I would say that is a new pronunciation. I want to just follow up on the guidance issue, which related to the significant sequential improvement you are expecting, can you talk about sort of how we should view discontinued ops in that, versus what we had previously modeled before, and then, you know, as we look at the problems with the distribution center in Belgium, you know, short-term execution probably will remain a bit of a concern, and how comfortable can we feel in the short-term cost saves, given some of the execution issues we have seen over the past couple of quarters. Thanks. Sure. John, regarding discontinued operations, I mean obviously the reason that we are discontinuing operations is we think it benefits us. Not so much on the performance that we in a sense move aside from Stila, but the fact that we now have resources that we can invest into other brands that will give us a better return. Regarding the cost savings initiatives, most of those kick in the second half, obviously it is almost November now, and most of those benefits of those programs that William outlined, are going to benefit our second half. So that's really contributing, if you will, to the sequential improvement that we see for the second half of the year. Regarding the distribution centers, Dan pointed out most of the issues that we have with the distribution centers have been resolved at the moment. It is not running as efficiently as we would like it to be, but it is certainly operating as we would have expected it to operate from the beginning. And by the end of the second quarter, we think we will have all the issues sorted out with that. Rick, are you guys giving a number on the discontinued Ops side, so that we can track that through and plan accordingly? I think it will certainly be part of our Q, so you will see the numbers that and you will see it reported that way. For the year of the benefit, John, I want to state benefit is probably $0.03 or so, $0.02 to $0.03. If we can go back to travel retail for a second. You explained how sales were growing, but why did operating profit decline in the first quarter? There's any number of reasons why operating profits declined in the first quarter, and the relation is not necessarily to travel retail in particular. I will remind you of what we've said before about the travel retail business specifically. Travel retail has a lower gross margin than our standard business model, but a higher operating profit, because of lower operating expenses than our standard business model, but I will remind that you travel retail is reported through our European region, even though this business is dollar denominated on a global basis. Connie, part of it is the timing. You know we do activities related to travel retail. But in general, our operating expenses are lower. We do occasionally some activities as we open new airports, and we do in-airport, if you will, certain activities to help drive longer-term growth, and some of that is affecting our first quarter as well. You are saying there was investment in travel retail that caused its particular operating profit to decline, because the sales are growing faster than the overall average? Could also ask a question on inventory. As inventories have been growing faster than sales for quite a while now, and I was happy to get the breakdown of the different days and their sources, but what is the long-term target here, and how do you get there? Well, longer term, we had talked earlier about the benefits of the improved forecasting systems from SAP are going to bring us, and one of those benefits will be better forecasting so better supply chain production of goods, and better inventory management tools, so that's the end gain is that when we have SAP fully implemented, we will have tools that will allow us to do a much better job of managing our inventory than we have today. Because of the length of our supply chain, when we have a sales result like we had in the first quarter, unfortunately, that leads to driving our inventory numbers up, and that was the, as you said there were 7 days increase versus last year in our inventory numbers, related to unfortunately the flat sales in the first quarter. So longer term, we turn our inventory now twice, a little more than twice a year, and our objective is to get that to closer to 3 times by the time we have SAP implemented. Shorter term, we wanted to get back by the end of this fiscal year to an inventory in terms of days, similar to where we were at the end of fiscal '04. But you know, we announced a program recently about reducing a number of points of distribution going from 50 points of distribution, to down to slightly below 30. That is obviously going to help benefit us as well. So, I mean, we are working on it. It is just, you know, because of the length of supply chain it takes a little longer. It is certainly going to be tougher, no question about it, Connie. That is still our objective. Will we get all the way there by the end of the year, we will see, it is possible we may not, but we are working hard to try to get there by the end of this fiscal year. I have a question in terms of the top-line growth guidance for the first half. It does sound like you look for a sequential pickup between Q1 and Q2 that is fairly significant to get to 3 to 4% constant currency sales growth. I was wondering what was going to really be different in this quarter outside of the promotional problems not reoccurring hopefully again, that would get you there, and also I guess as sort of an auxiliary question to that, on the market share of Clinique and the Estee Lauder brands, is there anything that you are seeing outside of what happened on the promotional problems in the first quarter, that would make you feel like the rate of decline in the shares of those brands have accelerated somehow versus what we have seen in previous years? Well, you know, the gift-with-purchase business represents 35% approximately for both the Clinique and Lauder brands of their total sales. So 35% of your business is weak, obviously you have to strengthen your business the other times. And one of the things we are seeing which gives us some confidence and more than some confidence is that basic business, nonpromotional business is quite strong for these brands. Literally from one day to the next, from a day you are going against the promotion, to a day you are going against the basic business, we are seeing a significant pickup in that business. So we have some confidence from a share point, much of the issues in share erosion are primarily related to the gift-with-purchase programming. And let's not forget that the absolute value related to their total market share, because of the promotional spending is quite significant to the total business that these brands experience, as well as the average productivity per door that they are able to enjoy because of all the promotional spending. Secondly, we do have some confidence in Christmas. We have got stronger Christmas programs. Christmas programs so far that are early in the stores seem to have nicer sell through. We have confidence both in the Tom Ford for the Estee Lauder program. As we mentioned before, we have Sean John launching in the November time period. And we are expecting that Europe will be approximately up 10% or so for the holiday season, because of a number of different programs, as well as some other recoveries. Okay. Then I just had one other question that related to some of the comments you made earlier, and that was really talking about how the newer products were performing pretty well. It is the base business that is suffering. Something that you guys need to do to maybe step up your innovation rate, or pick up the R&D spending. So it is what the customer wants, you can maybe cater to that more? Well, it seems over the long-term, Sandy, what we have seen pretty consistently, is that approximately 30% of our business comes from product launch within the last three years. And 70% of our business continues to come from product launched more than three years ago. And this has been pretty consistent now over the last 10 to 12 years. The difference is that the 70% that is coming in basic, is coming in a less concentrated manner than it has before, which relates to the inventory question, where it is taking more SKUs to make up that 70% of the basic business at three years old, as it did before. If you will, some of the basics of the traditional 80/20 roll, where 80% of your sales were made up of 20% of your SKUs are changing somewhat. The consumer response to the innovation rate and the success of our new product launches, continues to be a pretty consistent basis. The real question is about the new product launches is their sustainability in years 2, 3, and beyond, and the consistent contribution that these new products bring to the table. Hi, good morning. Just so I can understand your guidance better. Can you tell us where on the P&L, the 40 million to $45 million in savings, will show up and how much of that is in cost goods sold, and how much of that is in operating expenses? Probably about 80% of that number will show up in operating expenses. There will be some benefit in cost of sales, but the vast majority will be operating expense related. Okay. And then can you give us an update on what the ratio of advertising to sales is going to look like year-over-year for the year? You know, it's somewhat sensitive as you know. Somewhat sensitive to the level of sales growth that we have overall as the Company. We were forecasting that number to start to come down as a percentage of sales. I still believe that that will in true for the year, but, again, it depends where our sales come within the range of the 3 to 4% guidance that we have given you. Don't forget when you are looking at the advertising ratio, our two largest brands, the Estee Lauder and Clinique brands are the biggest advertisers yet, our fastest-growing brands have significantly lower advertising rates as a total of their sales. So as our mix of business changes, and our faster-growing brands that are not as dependent on advertising for their growth begin to contribute a larger portion of the total, while our actual voices and page rates, and all the other GRP measurement points of advertising voice for the existing brands, Lauder and Clinique in particular don't change, the mix changes on its own, because of the growth in brands that are not as advertising-dependent. Can I ask a question about that for the brands not as advertising intensive, whatever advertising you do, is that intensity going up? In other words, is the ad-to-sales ratio for the smaller brands likely to intensify as they become bigger brands, and more established brands? Well, in actual fact what we are finding is, that these brands are able to stimulate their top line quite effectively, with a very consistent marketing message that is a very different mix, than more traditionally advertising-driven brands. And they are not looking towards increasing their voice to accelerate their growth, because they are finding that the different means and methods to which they accelerate their growth, are not necessarily dependent on advertising. Thank you. If you were unable to join us for the entire call, a playback will be available between 12:00 noon Eastern time today through Wednesday, November 2. To hear a recording of the call, please dial in to 888-203-1112, and reference passcode number 8413888. That concludes todayâs Estee Lauder conference call, I would like to thank you all for your participation, and wish you all a good day. You may now disconnect. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. 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EarningCall_234044 | Hereâs the entire text of the Q&A from BankRate.comâs (ticker: RATE) Q3 2005 conference call. The prepared remarks are in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Operator] Our first question comes from Rich Ingrassia, with Roth Capital Partners. You may proceed. Thanks. Tom, graphic ad CPMs are up in the mid 40% range through nine months. What do you think is a reasonable expectation for growth on those CPMs in '06? I think we are seeing at this point, the demand is up. Sell-through will be improved. I think we can probably look at, sort of, the mid teens, 20 being conservative when we think the CPMs increases will be next year. There is great demand. We really had a dramatic increase this year in CPMs as you know. I don't think we will see that amount of increase continue, but we will see a continuation as they are just greater, there are larger advertisers making larger commitments and there is real, I will call sort of, demand for our inventory. So, we think, sort of being safe, sort of, 15% to 20% increase is reasonable. Okay, thanks. And typically from second quarter to third, you get a sequential decline or at least flat cost as a percent of revenue, but it was up slightly this quarter. Is there anything unusual in the current quarter to speak of? No. That comes from the partner contribution that just comes from sort of the internal technology. We ought to be able to maintain that level going forward. Okay. Good, and you are still growing revenues about double the rate of operating expense growth, so it's not a major concern, but product development was up. Do you think we are normalizing here at 700,000 or does it come back down in 0.5 million range? I think they'll come down a little bit. That was a one-time pop related to all the development work that went into the CPC, some additional equipment, some additional technology that we had to have in order to implement CPC. So, we did it all, we did it, but 90% of on staff. We were using a vendor for fraud, but all the billing tools, all the admin tools, the new payment portal, the new web portal, the new tracking was all developed internally. So, that was the reason for that pop. Okay. Great. And finally, Bob, no cash back to state in the quarter, right? And if not then when do you expect to bank in cash? No cash. We are still amortizing the deferred tax asset and it looks like we should make it through '06. It's hard to predict some of the tax deductions that we will get but on the run rate we are going right now, I would say we are probably looking at one more year. Hi guys, a couple of questions. Your traffic was down 5% sequentially, and I think you talked about how in September it was soft, and it rebounded in October. Can you just elaborate on what happened in September to have caused it? To be perfectly honest, don't know. We were running. If you look at sort of the trend page views in 2004 were 92 million, 92 million, and 91 million page views in the last three quarters. This year it has been 114, 111, 108. September, it was slightly soft. I really have no idea. We didn't go out to spend a lot of money in paid search terms. We were kind of monitoring that and stepped back a little bit, we saw slight decline in partner traffic as some of those guys just had an overall decline in traffic, but we think also there is just a slight softness in the mortgage market. It might have had an impact on September, but having said that, October has bounced back and October looks like the earlier months in the year. September was just a little bit of blip, I honestly don't know. Kind of the Q2, I mean everything this year looks about the same except for September, and I don't know why there was a little bit of a blip. Okay. And on to your plans for the mortgage aggregator business, I thought I heard you say that you're planning on dedicating 10% to 15% of your traffic to LowerMyBills and iHomeowners next year. Have you made the decision that you are going to keep them on? I'm sorry. Let me clarify that. This year, those two aggregators had 40% of our inventory. We are going to devote 10% to 15% to our aggregator strategy, meaning not the other guys. We haven't made any determination. They may compete for some of the ad space with the other graphic advertisers, but what I meant is, we will separate 10% to 15% of that inventory for us to use internally to generate at least for our aggregators strategy. I see, but you have not made a decision yet as to whether you will even have somebody other than yourself or you will definitely have one of the two maybe? We haven't made that determination, we are really looking at what the demand is for other sort of non-aggregators, and it is pretty high so, I doubt that we will have a significant presence from them on the site similar to what we had this year because we think we can get more from other non-aggregator advertisers. Okay. And lastly on the hyperlink revenues, I think you've guided now, you increaseed the potential up tick or uplift to 30% from 20 for Q4. Any help you can give us for next year? How much of an uplift the hyperlink business could see? Yeah, great question. Let me walk you through what we think the impact will be next year for example of CPC and why it was such a critical conversion for us. We will think about rolling into Q1. First of all, Q1 you have got a seasonal increase in traffic and clicks and let's just ballpark that as 10% to 15%. You've got a potential increase in pricing, let's ballpark that at 10%. You have got the additional distribution that we could have through co-brands and affiliates. Then you have the optimization that we are looking at now. You know as I said revamp CPC this quarter with the highest screen you could possibly have for fraud. So, we have been kicking out probably a higher percentage, not kicking out, but not billing advertisers for a higher percentage of clicks than we probably should or could, because we wanted both coming through the first quarter. We wanted to make sure that we didn't have complaints, we wanted to make sure that we didn't have concerns, and we wanted to make it as easy for the advertiser, for the hyperlink advertiser because we really want this to be a long-term initiative that did well for us. So, optimizing additional distribution, increases in pricing and seasonal increases, it could have a very nice impact. We will quantify that as we give 2006 guidance and we'd like to get another 30 days into this quarter and watch CPC before we do that, but all those things will impact. So, we think there is going to be a nice flip in CPC as the result of as I said, the increase in traffic and clicks, the increase in pricing, distribution of co-brands and affiliates and the optimization that we think we'll be able to drive. So, it's a long-winded non-answer, but I hope it's directionally helpful. Hi Tom, hi Bob, Congrats on another great quarter. So, just quickly, can we talk about on the Yahoo! CPC side. Should we consider that to keep running along the lines of 0.5 million a quarter and has there been any change in the CPC rates there, I think it was around $3 in the June quarter? I think what we are going to see with CPC is just a continuing sort of tracking trend, specifically what are you looking for? I am just trying to get a sense on the Yahoo side not ruling out the broader coverage. Just wanted to get a sense if Yahoo is going to be running out at a steady state on the CPC side? We think so too, we also think there's going to be other partners coming in. We've had initial conversation with some other partners and we have got, as you know 80 co-brand partners and as we go not these all, sort of, one by one and start implementing CPC and implementing aggregation opportunities and we think there's going to be kind of a steady build on the CPC side, as we pick up that additional distribution from beyond the Yahoo! folks. And as you learn all these, the additional co-brands, should we expect that click rates will be similar to what we have seen with Yahoo!? Okay. How about on the new channels? Could we get a breakdown on traffic pipe channels, any comments on the college education and the personal Finance Channels? Obviously, the biggest impact and change was the deposit money markets channel. Mortgage was down slightly sort of the high 30s, but the traffic to automotive to home equity to other areas of the calculators and tools really didn't change. We haven't seen a major push yet on college. We've got a couple of things that we're doing from a marketing standpoint that we think are going to improve that going forward, but those are in sort of the sub 5% range still and we hope to improve those through different things that we will do on the site and different ways we will market it outside of Bankrate. How does the lead aggregator inventory drop down in the quarter? How does that relationship work? If there is demand from premium advertisers for their space, can you rotate certain page views away from the aggregators? That's precisely what it is. First of all, if there is more demand from other people, I mean we can cap out the aggregators at a certain amount or we can add to, they're always interested in making incremental buy. Our sort of philosophy has been, nothing against those guys, we like those two partners, but you know there are times when some of the brand guys, some of the bigger guys, some of the financial institutions that we see building more business in Bankrate are more competitive from price standpoint and we are strictly optimizing that, you can say at the expense of some of their incremental page views. So, we can look at that as their pages coming in at 31%, as sort of a sign of the robust premium brand names coming in and taking up your pages, is that fair to say? First question, I wanted to ask a little bit about the lead aggregation work that you are doing for next year. My guess is that you are probably looking at, at least one acquisition to build out your capabilities there. I'm just wondering if you could give us a sense of, sort of the size of an acquisition that you might do and what valuation looks like in that space, would you expect that the Company that you bought in would have sort of similar operating margins in terms of valuations, if you think it would be relatively accretive to the business? And then I guess on a related note just to kind of flip end, I agree with you having such a low percent of your traffic coming from paid sources is a great thing. On the flip side, as you get into lead aggregation, you also have to have, I would assume, some media buying expertise. I was just wondering what your response is to that and maybe that's a capability that you would be looking to buy? You're right about that. The three things that we have said we want with an aggregator capability is media buying, probably the easiest things to find and develop particularly with my background and the background of a number of people in this Company who all come out in media industry. The second thing is the technology platform that can take and process those leads and push them out to a group of lenders who are pre-positioned to buy, and the third is a lender network. So, in Bankrate we will go along, we then helping build out, develop that lender network just by virtue of being able to got to a market and say, `hey a large percent of our lease that we will be generating are coming from great and those are known to be high-quality leads. The biggest thing in that business is the quality of the leads, drives the price, drives the commitment from the lenders, and the quantity drives the revenue. Well, we've got sort of the best of both worlds, we got a high number of leads that we can drive and we have seen evidence of that with the two partners we have been working with for the last nine months. And we know they are exceptionally high-quality. So, we feel we can push that business out pretty aggressively. Now we have talked about, we can license this technology, we can acquire this technology. I think when you go out and acquire -- these companies that are being acquired other than LowerMyBills, which is sort of an anomaly in the business but, a number of the others are going for one-time, one-and-a-halftime sales kind of in that ballpark or somewhere between one and two let's just say, and they do have margins similar to the margins that we have. Now the biggest cost, 50% of their cost at least comes from the media that they buy. Well, with at least the Bankrate part of their business, the cost of media is going to be zero. So, the margins can get even better in that business for the percent of leads in that sort of a lead portfolio that are coming directly from Bankrate not being bought by to your point outside media. The other thing about looking at a co-brander or an affiliate relationship is, if you go out there and rev share, the cost is zero. So, you can drive that lead revenue at again pretty attractive margins, if you are not paying for that space if you're assuring that revenue with the host side. So, we have been working on this for a while, it shouldn't be long before we have something more definitive to tell everybody and then when we do that will put some guidance out there, but we don't feel the need to go out and buy, even if it works, some of the larger guys in the space. What we really need is a platform, we really need the lender network, and we really need to rate at a lesser degree, as I put it third in the priority list, the media buying capability. But, it is the skill sets that we would like to have internally because we think it will make us better at perhaps marketing outside of Bankrate, and buying keywords, and things like that across our platform. I think that is very helpful. If I could ask just one more quick question. If you do the simple math on the 30% year-over-year, in hyperlink it looks like it's roughly flat sequentially, and I know, you mentioned the volumes tend to be lower, but then your pricing is obviously going to go up. So, I was just wondering if you could give us a sense, roughly the mix, what the volumes typically decline from Q3 to Q4 in that business. I assume that is primarily what is driving flattish kind of revenues? It is seasonal and some of it is sort of 15%, 20%, from the seasonal standpoint. And then, you go back and you look at, a big pop in the first quarter. So, it's really why we wanted to get CPC out this quarter as we mentioned. It is the easiest quarter in which to do it. We thought that the risk of a downside if we kind of stubbed our toe or if it wasn't as elegantly launched as it could have been or should have been, or if we had a negative advertiser reaction or if the sign-up was slower than we thought, fourth quarter was the quarter in which we wanted to do it, because we thought the downside risk was minimal. We may be able to do better than what we have indicated. It will all depend upon what traffic and click volume and everything else looks like in November and December but so far, so good. We are really happy with that. I wanted to make one comment on the question that was asked earlier and that was about September. In just sort of looking at a bunch of documents sitting here, the one thing we saw in September was some impact quite possibly from some of the natural disasters that occurred. A couple of hurricanes that hit, and you've got Rita and Katrina and the impact that those had. We did see a decline obviously, in the Gulf state and obviously in Florida at that time, that may have had some impact on traffic. Can't really be specific about that but that could have been the reason, sort of to the previous question about the bulletin in September as I start thinking about it. Hi thanks for taking my call. Just wanted to ask a question about how much made you need regarding what's mortgage lenders pay for leads? The ten-year bond yield had risen 60 basis points in recent months, which points to lower volumes and profits for mortgage lenders in 2006. Why do you think that mortgage participants on your site will pay more of the leads when history has shown that they will earn less from those leads if volumes do indeed go down? Actually history in this business has shown the opposite, but we have been talking to a number of them, we talked to the big guys and I don't want to name any specific names, but you know who the large players are in the business. A quote from one of them says `We now are going to pay more for leads, we now are going to pay more for advertising. We think this is a great time to steal share. We think this is a great time to increase the volume of our business and we are willing to pay more`. They are coming to us looking to make a larger commitment, looking to lock down a deal for positions on our rate tables, an ad by a lead buyer when they get into that business. So, we've worked on the number of them that one of them is the quality of Bankrate, the fact that the conversion rates are so high. We think we will be able to charge more for those. I guess that issue is -- typically larger guys do steal shares from the smaller players and you also have a lot of smaller players who are advertising on your site, and it is those participants that I think my question was directed at? The small guys. The small guys are not buying graphic advertising. We separated it into a couple of buckets. The large guys are the graphic advertisers. The other guys are going to be least impacted and still have the most marketing money and still be the most aggressive. On the cost-per-click model, let's assume, let's just say, if you go today and look at a 30-year fixed Fresno you will see 42 lenders on that table. Okay. 15 of them fall out. So, the average of the customer goes to, this is the beauty of cost-per-click. The customer goes to the table looking for a 30-year fixed Fresno and now sees 30 advertisers, 30 lenders rather than 42. Number one, does he realizes that the 12 guys are gone? I would say no. Can he still find somebody with a rate that will give him a loan he wants to do business. So, I would agree with you 100% in our old model. Our old model and that's why we have gone from 585 to 350 plus lenders on our rate tables in the last two years. Why we went to cost-per-click? Under cost-per-click the number of lenders has almost no impact on us as long as there is enough of a base that we don't have a rate table with only two or three lenders. The fact is, we have got 15 national lenders. So, every table you go through has got at least 15 guys on there. So, we don't have the kind of holes that we would be concerned from the CPC standpoint. Do you not think that shifting to the cost-per-click model is tethering the firm's revenues more closely with the cyclicality of the mortgage business? That stands as is. It's the other 60% that's moving to this new pricing model. Of that 60%, which is meaningful clearly. Does that not tether the revenues of the Company more closely to page views and volumes and things that are more cyclical in nature as opposed to paying monthly fees? The number of lenders going out of business, that is a cyclical issue, had a huge impact on our old model. This does not. So, we think we have mitigated the risk, we think we can grow this business, we think we will have pricing power going forward, we think that we're going to increase distribution and we think we can optimize the model. So, I mean obviously, you have another point of view. And just finally on aggregator business, did you look out to survey the market for acquisitions, there was one publicly traded company Lending Tree that proved through most of the timing of the public, it didn't make money and it made money in the last couple of quarters as I recall when volumes in the industry peaked, or started to peak. What is your history with being able to make money in this business through an up and down cycle? The biggest cost of Lending Tree, first of all, Lending Tree has got a very different model than this because, they have spent a huge amount of money in infrastructure, they spent a huge amount of money on technology, and they also spent a huge amount of money as an advertiser. There is no organic traffic going to Lending Tree. They spent millions of dollars on television, millions of dollars online, millions of dollars on the radio and print. So, it's a very different situation. The other thing is, one thing we know the reason we are getting into this business is, over and over and over and over again from lenders, we are told there is nothing in the industry like the Bankrate quality. So, you take that quality, you take those conversion rates, and you take the fact that we are not paying for the marketing to reach those people, and we think it's going to be a win for us. We don't have the infrastructure that Lending Tree does, we don't have -- it's a very different model. I think Bob covered that. He said that we will run the NOL through, it appears at this point through 2006. At this time ladies and gentlemen, this does conclude our Q&A session. I would now like to turn it over to Mr. Tom Evans for closing remarks. I think we have just heard from a short. Really appreciate you joining us today. Obviously, we feel very good about our business. We are pleased with the quarter we just had, we are pleased with the momentum, we've talked a lot about our initiatives that we have been pushing on, we have got a great sales team in place, we've got real momentum on the graphic advertising side of the business. We're delighted with the early response that we've seen to CPC and we do believe the aggregator initiative is going to pay off for us in 2006. So, we appreciate your interest, we appreciate your time, and I hope you will continue to monitor our business. Thanks everybody and good day. |
EarningCall_234045 | Hereâs the entire text of the Q&A from ConocoPhillips' (ticker: COP) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you Jim. You just to the natural gas agreement in Alaska. Are there any additional details you can provide on that and what it is about that agreement that gives you more confidence and I guess essentially moving forward with the project, maybe what additional steps need to be taken if Exxon and BP have to come to an agreement as well. And is there any better estimate of the time when that might gets start moving forward or even start out. Arjun Thank you. As you know the producing companies have been negotiating and discussing with the State of Alaska for a very, very long time period in way which we can move forward with the development of the Arctic gas resources of North Slope. And we made a lot of progress and which led to the announcement by our company obviously we look forward to ExxonMobil and BP reach an agreement with the State of Alaska here shortly. And we certainly would like to look forward to that. The State of Alaska, the Governor we have to keep the information somewhat confidential at this point of time because I believe the Governor intends to lay out all the details of this to the legislature which ultimately then will be considered by the legislature so I canât really give out any more details that what we have announced because this is in agreement with the Governor and the State and all of us will be made known over the next several weeks for full review and discussion by the legislature and everyone within the State of Alaska, so that really what I can pass on to you. Jim, would it only be the Alaska legislature body that needs to signoff in this or there any Federal approvals at least in terms of the primary agreements that are needed? No the agreements that we are talking about, agreement in principle is between our company and eventually the other producers and the state of Alaska, so itâs really the state of Alaska, not other states or the Federal government. And then just finally, does moving forward possibly with Alaska gas in anyway impact moving forward with Mackenzie gas which I know you did mention in your prepared remarks, you still, would you still also like move forward with Mackenzie gas. Absolutely, we certainly want to move forward with the Mackenzie Delta gas. We would expect that Mackenzie Delta project would come before the Alaska North Slope project because it is further developed. Itâs a large project but somewhat certainly somewhat smaller than the Alaska North Slope gas. So we would expect, we are very interested, we expect Mackenzie Delta to come first. This makes sense for all reasons and we certainly want to not be trying to do both high points at the same time. So the Canadian Mackenzie Delta comes first and then the Alaska North Slope. Good morning Jim, and congratulations on another record result. Your are welcome and in Refining and Marketing U.S. Petroleum product sales were well above that of the year-ago period in 2004 but within then quarter I want to see if there were meaningful differences in consumption growth between the different months meaning where demand trends considerably different in relation to the year-ago period for instance in July, August and September on kind of a comparable outlook basis whether you have in retail or wholesale and also if you guys have any updated consumption trends for October, that would be appreciated as well. Well Doug its somewhat difficult for use to really respond to that, what I will say is obviously as you know, you know even before hurricane the supply demand situation was very, very tight and then with the impact of the hurricanes it has quite an impact with respect to supply and therefore had an impact obviously on the pricing environment. What we have done throughout all the time period of prior years and certainly through 2005 and now after the hurricanes all of efforts are directed and dedicated to getting our facilities up and running and maximizing the availability supply so as to meet the needs of consumers and to modulate the price impact in the environment. So what we see is not really any impact on in terms of how we run our operations, everything that we can make the market certainly wants to see the supply so it does have an impact pricing but in terms, if we donât see anything unusual or strange in terms of demand for what we produce and the different channels by which we sell our refined product. Okay. Great and then on the top of Arctic gas coming, is the development project in Russia is the project where above partners have been announced but there has been some favorable commentary toward your company and few others as it relates that outcome. Can you just give us an update there as well is the working expectation that partners will be announced by the end of this year or 2006 Autumn or is just to know? Well, our company is been named one of five on the shortlist, we working on review of the study and development of Shtokman project, what gas Gazprom?. Gazprom is a very specific good program and time line by once they want go forward with the projects and the expectation is that the partners in this project and it will more than just one company in this project, there will several companies participating because it is a very large technically challenging and all. That will be done more in the March time period as I recall Gazprom has announced. So it wont be the end of the year but the study work continues such that it reaches to selection of the participants in the March 2006 time period. And then there is a quite aggressive program by which to technically and commercially move forward with the Shtokman so as to accelerate the time period in which production can be started and delivered to the North American markets specifically the U.S. can occur. Yeah, same thing Jim and Gary congratulations on a great quarter. I have two questions you know basically the first one Jim is on your debt reduction in respect to the share buybacks. First do you have any targeted debt level on which you will go down to number one and how you are going to balance that out against share repurchases? And the second part of the question, some of your competitors now starting talk about high inflationary pressures. Could you go into any discussion on that and what you are seeing if you can quantify it, it would be great and will it impact your capital spending going into â06 and â07. First with the respect to net debt reduction share repurchase. We are looking at some modest debt reduction as we go through the rest of this year and into â06 and â07. We donât to, itâs not a priority objective for us to accelerate that reduction but we said overtime over the next several years to slowly let the debt come down to I would say that maybe a minimum of about $10 billion makes a lot of sense for us, but we donât have to, cost by debt is very reasonable and so what we will do is slowly like we are this year maybe over the next several years a billion or so a year is what we have in mind. And then we want to be quite aggressive and very competitive on dividends. So with good strong earnings and cash flow we think that good discipline of having annual increases and dividends. And so the remainder then through cash availability really goes towards shares repurchase. Now what I would say though our capital spends for this year. Capital spends on organic growth and investment and all purchasing shares will grow. We are going to be spending in the neighborhood of â05 $10 to $11 billion in this program. If you look at 2006 when we have November Analyst meeting you are going to see a similar amount of capital on investment spending going forward into the next year. So what I really coming to tell you we have as unique situation in our company. Yes we are strong in this environment, strong cash flow but we redeployed a good share of most of our cash flow right back into the growth and development of our businesses and when we talk about our businesses at both E&P and refining and marketing. With respect to the impact of inflation, inflation is having an impact on our cost structure and our capital spend and we intend to pretty thoroughly go through that in each of our businesses when we have our November presentation in New York city with the analyst. It is certainly is having, inflation is having an impact on operating cost and capital spends. But these are incorporated in our operating plans. We will talk about them and they are incorporated into the numbers when I talk about capital spending of $10 to $11 billion a year. Jim, but just going back to debt question, I mean, you quantify a minimum $10 billion but on a net debt basis what is the level that you are willing to go down to I guess as part from a capital efficiency standpoint? I think what weâve really said is the company is done very, very well over the last several years. Its beneficiary of various strong pricing environment, upstream and down stream. But also we have operated well and weâve had the synergies and all of how we do our operations. We initially said we want to get that ratio down to 25% then the 20%. I donât think we want see our debt ratio going below 15% to 20%. If already now almost 21% headed towards 20%. But I think the guidance I would say is we donât want to maintain a hold a lot of cash so what we really see is bringing that debt down slowly towards $10 billion in absolute terms not holding too much cash and so we going to be quite aggressive in terms of capital program but our competitive dividend then will accelerate share repurchases. Just a quick one on U.S. gas. You did have sequential production up even with the hurricanes predominantly onshore is my question? Was it gains? Well we certainly were impacted by the hurricanes, but we do not have a great deal of offshore Gulf of Mexico production. So the impact to us probably relatively to the industry and our profile of gas production in Lower 48 offshore in the Gulf is less than other companies. So that is really why we probably work a little better in terms of our production in the third quarter. Great. One other one, you had spoken downstream is spending an incremental $3 billion downstream and over the next five years or so, given all thatâs happened in the Gulf of Mexico, post hurricanes, do you think the industry will have the capacity to service your needs or will this be more protected? Well. I didnât know exactly where you are going with your question but weâll again share with the financial community and the analyst in November, we are going to spend atleast an additional $3 billion in terms of our enhancing our capacity and capability of our refining system around the world. But definitely in the Lower 48 states because we have good opportunities but furthermore we also recognize the supply demand situation so we are going to be adding capacity. We had this in mind before the hurricanes. We came out and announced that we are going to significantly do whatever everything we could add capacity because we do have the opportunities and we are going to add capacity in many of our refineries we have 12 of them in the United States and weâll share with you at the November Analyst. But we are also increasing our capability by which we can handle the lower quality group feedstockâs, thatâs a good investment return for us, but more importantly also we will make greater proportion of transportation fuels. So it is a win-win to our company in terms of investment opportunities in the downstream but it also win for the country and for the consumers, because weâve recognized several years ago the need for adding capacity and capability in our downstream part of our business. I think your question is concern we have, we are going to be able to do all of these things obviously the availability of contractors and service industries to perform and help us. That is a question for us but a lot of our projects have already been on the drawing board, weâve lined up a lot the capability to help to do these things but no doubt you make a good point. As you go into the subsequent years this is question for us and that is the availability of the construction and service industries to serve what we are doing not only upstream but certainly downstream and because we have to got to make sure that we deliver our projects on schedule and within the cost constraints. But again (3926) is with you when we go through our views on it, they are very thoroughly upstream and downstream in November. Good morning Jim, just a couple of questions. First I havenât seen any repaired cost, or cost associated with hurricane, can you quantify what that mightâve been in the third quarter? In the third quarter it would be very modest because we were in the assessment stage alliance Nicky, and we shutdown our refineries at Sweeney and Lake Charles in advance for the hurricane so they would be more in the nature just operating cost. So we will have the substantial cost that we have will start appearing in the fourth quarter and though we think it is better that we update you on that in the November 16, at the analyst presentations. Secondly as this project Iyambo, may be you could talk on what you anticipate in terms of timing of construction there and potential configuration of the plant? Well. We are actively working with the Saudi Aramco, we are very interested in the project. We have commercial and technical teams working. We know that there are other companies who are quite interested in doing the same. We were encouraged and we also very interested in this investment opportunity because it fits very nicely with what we are trying to do in the downstream part of the business around the world globally. And it fits in quite nicely not only on refining side but fits nicely with our commercial attributes of what we are trying to do in terms of moving refined products both to the North American markets, Europe and Asia. But there is strong competition and I think the plans for the Saudi Aramco is to finalize determination of who in the companyâs side they are going to participate in this as we through right this year and early into the year. But this is an opportunity that we take very, very seriously and we are quite very interested in doing and working with Saudi Aramco. Itâs not right for me to get up and talk about this at this point of time. But I think what I really want to say is our company is obviously working, reviewing working with the Saudi Aramco, we are very, very interested in it, but itâs not yet been determined by Saudi Aramco which companies they are going to select to participate in this project and we expect that to be late this year earlier next year. John do you have something, do you have something more on this? I was only going to just add that precise configuration of the refineries is not yet determined, that is something that, the technical teams are discussing and weâll be determined when they make the selection of the party that is going to help them. The other thing that I would say is it is very important given the current environment that we operate not only in the United States but around the world. When we are looking at adding, refining capacity, certainly we need to and want to do that in the United States and one of best ways of doing that is to add capacity and capability where we already have refineries. We are encouraged by the legislation that is passed, the new energy bill, the legislation passed because that is going encourage not only adding capacity in the refinery but hopefully newer refineries in the United States. But when you look at the opportunity of adding capacity and new refineries in Saudi Arabia while they may not be in the United States, it does provide over time more supply to worldwide market and refined product. Whether that facility is build in the United States or else, we need to do everything we can to add capacity and supply not only in our country, but Europe, Asia and certainly in the Middle East. Hi. Good two questions for you. The first one is really just looking at the jump in natural gas prices in the start of the fourth quarter, could you give us a sense of you mentioned higher utility both in terms of refining possibility, whether the increased cost of hydrogen, what pressures are you seeing in terms of refining profitability in the fourth quarter due to the higher commodity cost. Well obviously, Neil, what you are seeing is important, we do recognize the cost of utilities, the cost of natural gas and all, and that we have all of our operations, not only downstream but upstream, cost of hydrogen, I think that is, I am not really the right one to respond to that, maybe we could do that offline and I know when we are in New York, Jim Nokes and the downstream people can certainly answer that question a lot better than I can. Okay. Just the second question then. It is basically when you see the increase in terms of the LUKOIL investments on your productions profile, what seems to be happening from our numbers atleast is that you are loosing a bit of leverage of higher oil prices, the components of Russian production has got a higher tax rate, a few thoughts or advise going forward in terms of your upstream business, where the role of M&A, or major asset acquisition might sit into your strategy as it doesnât seem that you are replacing reserves from a exploration point of view and areas of lower tax regimes are the fasten up pace to keep your leverage high with the higher oil prices. Well. You made a good point. One of the things we do know is access to new areas of exploration. It is something that is become more and more difficult for our company in our industry and this access is not only around the world but it is also in the United States. A lot of things that obviously we are working on is what we can we do to increase our production, as an industry we need more access. So it is true what you are saying, more and more of the reserves recently have been replaced by companies based on all the exploration acreage that they have been working on apprising and developing, but we need new exploration acreages not only our company but others. So we are looking at business development opportunities where we go in and we know standard gas for LNG projects or there is heavy oil projects potentially in another place in the world but we pick our technology and financial resources and people to help get it up. But you made a good point then, when you look at all other things, exploration, business development, standard gas where we can go in with our capabilities to add reserves and production. We also look at the M&A market. What assets may be available for acquisition. That is very very competitive. As you know it is a pretty much a seller market, not a buyers market. We look at everything, we look for the opportunities but we also have to make sure that when we look at these things as a way of growing and developing the company, it is not in the way of support of what evaluation creation for the shareholder. Libya, I routinely go through Libya, working on the negotiations for reentry, our partners of the Oasis Group Amerada Hess and Marathon, we continue to have very good dialog and discussion with the authorities in Libya and it has taken us quite a bit more time but we are very interested in the opportunities and hopefully over the next several months weâll have something positive to report going back in. Reentry of the Oasis Group in the oil concessions. Thank you and good morning everybody. Jim apologies for initial ratio, I think there was couple of minutes late getting on the call, the domestic gas realizations versus the indicators rising quite a bit, can you just remind us our goal again perhaps why that was? There is nothing unusual about that I am aware of, I think it is a mix, weâve a of course a lot the same on gas production. Weâll have to come back to you, it is that not something that is really talked out to a large degree. Okay. I guess, Jim the only other question I have is a probably a follow-up to one of news, it kind of relates to your exploration and the outlook for 2005 as things have progress so far this year. Our understanding is that youâve had some changes in the exploration team internally and obviously there has not been a great deal of news flows this year, can you give, a kind of fuel for hold, how comfortable you are with the exploration portfolio you have right now, furthermore, do you think you need to take some kind of more significant action to address the I guess a fairly small base of exploration successes and perhaps can you give us a feel for how you feel the exploration, reserve replacements might look this year, in the absence of any major projects? Well when we come back precise, I think weâve addressed some of this in earlier comments. Our company is no different from others, our exploration success could always be better and we are looking to certainly do everything we can to improve it. One of the things that very, very important is access and we do not have access to new acreage and new prospects that weâve had historically over the past decades. And the other is that we do have some nice explorations success that has recently been announced and come forth in Asia, specifically in the Timor Sea of Asia. So I think really the changes we make are just routine changes of personnel from time to time and to different parts of the organization of the company, our exploration success is never good enough, we always can do better and we are emphasizing that, we do need access and we will share with you the successes and where we are going to exploration when we meet in November. No. I donât think your missing anything, you may, what is the common terms of adding reserve and get book this year verses next year. Yeah. I am just trying to get feel for how the reserve replacement, how it might be for the current year? Well I think weâll share that with you in November but it is something premature for us, as we talking about this point of time what the reserve replacement will be this year. Jim and Gary, again congratulations on a great quarter. Jim the freight price continues to or continues to see a lot of negative comments and inflammatory political comments regarding Venezuela, and I guess my question is basically, does this give you pause, given the fact that you do you have a large commitment there in number of future developments on the board that, in the past youâve expressed the desire to pursue. Gene, thank you, yes we are significant investor in Venezuela that comes by our heavy oil projects that we have with Petrozuata, Hamaca as well as the new offshore oil development Corocoro, and we had with partners exploration success. Our relationship with the, we understand following the questions that have come in terms of what you call, relationships in all Venezuela and United States and as we have a base with where we operate around the world. I would say this, that irrespective of the political situation between countries our relationship with Venezuela, Pedevesa that administering the authorities is very, very good. And we continue to do what we really do best. Which is to operate and commercially maximize with our partners, the other international oil companies as well as Pedevesa and the Venezuelan government. Good relationships by which we do we do best, and that is to operate oil and maximize the value of the oil. We also in discussion and work for the opportunities by which we can further enhance the capability and capacity of Petrozuata and Hamaca, with Pedevesa and ministers and with the other partners. So wherever we go, we have these issues and political risks but our investments and our returns have been good experience in Venezuela, we work very very hard, as I said relationships are good and we donât see too much difference than what we said in the past quarters about continuing to work that hard and look for the new opportunities. We are basically more of the same, on the surface, the political stuff in the press, we do characterize that as being worse in reality. No. Gene, I wouldnât, it is not really appropriate for me to make a comment on what the political situation maybe between countries because that is really not our area. What I would I say is not just more of the same in terms of what we do, operationally in investment wise in Venezuela. We have very good operations, acceptable returns, we have additional opportunities, as I said a moment where we can expand and enhance our capabilities and investments there and we continue to work closely in good relationship with the minister and the authorities there that try to make this happen. I just wanted to get a little bit clarity on the Indonesian price impacts on volumes and also what you expect from, that is in the third quarter and the fourth quarter, what do we expect from hurricanes, into the fourth quarter, I am sorry if I missed that earlier in the call? Well, obviously with expect to the hurricanes, the sooner we get our refineries up and running the less impact that has in terms of financial net income to the company and obviously we want to get them up and running for that purpose but also we increased supply thatâs made available to our consumers in the southeast and throughout the country. So that weâll share with you because we do have cost in terms of repair but we also have cost misinterpretation in the refineries. With respect to production levels as I said earlier production in the fourth quarters is going to be higher than the third quarter, you can then average all in, because we say we effectively began, for all of these different reasons be flat â05 compared to â04 in terms of the impact of the higher price structure for crude oil and its impact on production in Indonesia, as we said it does have an impact because the production here in contracts, I donât know maybe Gary may have or John may have the numbers associated with that but if we donât have today on the call, weâll just circle back and give to you later. Yeah thank you Mark. If you look at the supplemental information majority of the change in Indonesia related to the PSC impact from high prices. And because we continue to grow and add new projects by which we can increase production, we do get the impact on the higher prices in November Mark, we plan to give a full year outlook for price reduction for Indonesia. For 2005 and also our product development, there will be some variation in â06. Okay I guess this raps up our discussion on the third quarter results for ConocoPhillips. Once again I thank everybody for your interest in the company. You could find the slides that we went through as well as a transcript of the presentation weâve made this morning on our website conocophillips.com. Hope you all have a good day. Ladies and gentlemen, we thank you for your participation in todayâs conference. This concludes the presentation and you may now disconnect. Have a great day. 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EarningCall_234046 | Good afternoon, ladies and gentlemen, and welcome to Extreme Networksâ Fiscal Second Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Following todayâs presentation instructions will be given for the question and answer session. If anyone should require operator assistance during the conference please press the â*â key followed by the â0â. As a reminder this conference is being recorded today, Tuesday January 24th of 2006. I would now like to turn the conference over to Bill Slakey, Chief Financial Officer with Extreme Networks. Please go ahead, sir. Thank you, operator. Good afternoon, everyone. Thank you for joining us. On the call with me today is Gordon Stitt, President, and CEO of Extreme Networks. This afternoon, we issued a press release announcing our financial results for Q2 FY 2006, copy of which is available on our website at extremenetworks.com. This call is being broadcast live over the Internet today, and it will be posted on our website and available for replay shortly after the conclusion of the call. Let me note that some of the remarks made during this call may contain forward-looking statements about financial and business guidance, product introductions, and customer development. These reflect the Companyâs current judgment on those issues. Because such statements deal with future events, they are subject to risks and uncertainties that could cause the actual results to differ materially. In addition, some factors that may be discussed during this call, important factors that could cause actual results to differ materially are contained in the Companyâs Form 10-Qs and Form 10-Ks, which are on file with the SEC and are available on our website. And with that, let me turn the call over to Gordon. Thanks, Bill, and thanks to everyone joining us this afternoon. Iâll begin this call with a summary of the financial results, review our quarterly highlights, and then turn the call back over to Bill for more detailed discussion on our financials. First of all, let me say that we are pleased with how we are managing many aspects of our business, as we are able to generate sequential net income, increased margins, and increased cash flow. We executed on our stock buyback program and reduced our operating expenses. We achieved our earnings goals even though revenue did not meet our expectations. Net revenue for the quarter was 92.8 million, and net income for the quarter was 5.7 million or $0.05 per diluted share on a GAAP basis. Excluding stock-based compensation expense of 1.6 million, non-GAAP net income for the quarter was 7.2 million or $0.06 per diluted share. This is an increase sequentially from $0.05 per diluted share reported last quarter. We experienced strong growth internationally this past quarter. Both our EMEA and Asia-Pac regions increased revenue. EME had, EMEA, excuse me, had revenue increases both year-over-year and sequentially. And in our Asia-Pac region, we saw very strong quarter, a year-over-year increase of 7.4 million. In Japan, the region that I discussed in detail last quarter continued its recovery and enjoyed an increase in revenue. Our Americas business did not achieve the revenue that we planned. Our challenges were mostly in the US market where some large deals that we anticipated were pushed out beyond quarter end. In addition, I donât believe that we managed our pipeline as well as in previous quarters. Weâve already undertaken steps to address the US market. Weâve made management changes at a variety of levels, and identified actions to better track and increase our sales pipeline. We will aggressively be hiring additional sales and systems engineering teams in the US, and our Vice President of Worldwide Sales, Frank Carlucci, will provide direct attention to the US market working closely with our regional directors. Weâve also added a seasoned sales executive to drive our US federal business. As I mentioned earlier, this quarter resulted in sequential improvements in our gross margins, profitability, and cash generated from operations. These results demonstrate our ability to firmly manage our business and enable us now to focus on increasing revenue going forward. Let me touch on a few more financial details. Last quarter, we announced a $50 million stock repurchase program. During this recent quarter, we began implementing that plan and repurchased $6.8 million in stock. We are executing to our internal plan and will continue to do so going forward. We increased gross margins during this past quarter. This marked eight consecutive quarters in which gross margins have increased on a year-over-year basis. Gross margins for the second quarter on a GAAP basis were 54.7%. Excluding expense for stock based compensation, gross margin was 55%. This is an increase from 53.8% from the same quarter last year. Again, this was the eighth consecutive quarter of gross margin increases. We continued our drive toward efficiency and higher profitability by reducing operating expenses during the quarter. On a GAAP basis, operating expenses were 45.7 million. Excluding stock-based compensation of 1.3 million in the quarter, operating expenses were 44.4 million or 47.8% of sales. This is a reduction of 1.7 million compared to the same quarter a year ago. We generated cash from operations during the quarter of 12.7 million. After 6.8 million for the stock repurchase activities, we ended the quarter at $456.3 million, an increase of 6 million from the first quarter of fiscal 2006. Again, to be clear, we increased cash over and above our stock purchases, and Bill will go into more detail a little later. At this point, I would like to review our strategy going forward. As we have previously stated, our focus is on convergence, security and on the Metro Ethernet market. Now first convergence. As many of you are aware, Extreme has been promoting our customer-oriented strategy for handling the convergence of applications occurring on todayâs networks. Our architecture and vision of open converged networks, places us in a unique position to help enterprises and Metro Ethernet service providers build infrastructure that offer the availability, security, voice quality connections and ease of management required to run voice and video. Our approach allows users to build a network foundation that promotes intelligence, allowing for collaboration between corresponding network devices throughout the network infrastructure. And, our approach permits customers to integrate best-in-class technology for their own customized technology path, not their vendors. We believe this open and focused approach to convergence will allow us to capitalize on the underlying market requirements and grow our revenue in the future. Key piece of technology in our open converged network architecture is our BlackDiamond 8800 switching solution. The first switch to deliver true voice class availability at the edge of the network, the BD 8800 continues to attract new customers. Its combination of our award winning Extreme XOS operating system, convergence ready hardware and excellent price performance makes it an ideal solution for converged networks and the key component of our growth going forward. We talked in the past about the importance of our software, and specifically of our modular operating system XOS. During the quarter, we completed a major new release of XOS that delivers many new capabilities to the market. Development was focused on providing network availability and enhanced security for converged networks. Specifically with the software release, we delivered what is called hitless failover for a BlackDiamond 8800. Hitless failover provides for the continuous operation of the network in cases of certain failures. Our implementation even allows powerful devices such as IP phones to be preserved, allowing no interruption to Voice over IP services. This is very important to keep business quality in Voice over IP conversations going. We also added new security capabilities, including network logon functionality for secure network access control. We made these enhancements because customers expectations are that Voice over IP calls are not interrupted when a change in the network occurs, even with functionality such as network access control turned on. Now, our unique open approach was recently recognized by global growth consulting company Frost & Sullivan. Extreme was the recipient of its 2005 product line strategy award for the enterprise switch market. We were singled out for our innovative approach to provide an integrated software and hardware network solution that helps customers implement Voice over IP and establish network security, as well as integrate wired and wireless infrastructures. An integral part of our strategy for being a leader in open converged networks is our global strategic partnership with Avaya. There are two parts to our relationship strategic reseller arrangement and a joint technology development program. We recently extended our technology development agreement for another year, after having previously extended our strategic resale agreement earlier last year. Together, our two companies continue to attract new enterprise customers seeking to deploy market leading IP telephony applications and our innovative infrastructure to run them. And while the contribution from Avaya was lower this quarter due to seasonality as this was the first quarter of their new fiscal year, this partnership continues to open doors for us and we believe will help to drive growth for us in the large and mid-enterprise market. Now let me take a moment and review some of the many customers that relied on our open approach to converged networks to run their businesses. Extreme Networks is now working with Nike, the worldâs largest, the worldâs leading designer, marketer and distributor of athletic footwear. Nike is implementing the campus extension at its Beaverton, Oregon headquarters in conjunction with MCI, managed service provider, as well as our IP telephony partner Avaya. This customer chose Extreme Networksâ secure and available switching solutions over our leading competitors based on our degree of innovation and performance. Nikeâs new employee facility necessitated network access to their campus LAN. With our quality of service, bandwidth management and power over Ethernet, the network will easily allow Nike to migrate to Voice-over-IP applications in the near future. At CalTech, Extreme Networksâ BlackDiamond switches were part of a record-breaking bandwidth challenge as part of the Supercomputing 2005 event in November where a team of leading scientists and engineers collaborated in a demonstration of high-performance grid computing. The result was a new world record for data transfer over a global network. Using our line rate 10 Gig bandwidth, and our low latency features to aggregate server traffic, the winning team was able to sustain more than 130 gigabits of traffic over an optical network. And in Mexico, the Governmentâs INSP national health services institution, selected Extreme Networks as the underlying network technology for its 17-hospital system. Focused on specialty health areas such cancer, nutrition and cardiology, INSP has in place a master strategy to implement leading-edge health technologies throughout its system, with network infrastructure being the first stage. Our network switching technologies are positioned with our IP telephony partner Avaya to serve as the most reliable converged voice and data solution. For the second driver in enterprise network strategy beyond convergence, is securing the network. At Extreme, we offer the customer a solution addressing the entire infrastructure, not just the perimeter. As we have done in the past, we combined our culture of innovation and different perspective, along with customer feedback to develop our solution. The result is a security solution that makes securing the infrastructure easier to manage and much more robust. We believe this approach to security will be an important part of our growth going forward. We base our solution on a technology that we invented called CLEARFlow. CLEARFlow is a programmable security rules engine that is built into our ASICs. Because CLEARFlow is ASIC based, it operates at full 10 gigabit per second speeds, making it very high performance and suitable for use even in the largest networks. This hardware-centric approach also allows the switches to keep working even while the network itself is under attack. The strategy of enhancing customer security by integrating security into the core of the network is complementary to the current base of primary security solutions commonly in use. Our approach to integrating security into the network provides users with a solution that keeps the network up and running. We frequently hear from IT professionals that this is exactly what they need to secure their networks, and to focus on their businesses. This is a strong differentiator for Extreme, going forward and will be an ongoing area of investment for us. The third business driver for Extreme is the Metro Ethernet market. This market is and always has been a key market to Extreme, generating between 20% and 25% of our revenue. Metro Ethernet sales contributed much of our strong growth in Asia during this past quarter. Since early 2000, Extreme has been a pioneer in this market. From our cries of âSONET is deadâ to Ethernet everywhere, we have helped to build this market and both drive and enable the movement to Ethernet-based metro networks. We have invented and delivered several innovative new technologies, such as our Metro Ring Protocol called EAPS. EAPS, which is an acronym for Ethernet Automatic Protection Switching, delivers high availability and resiliency at carrier-class levels. The strength of this technology and our experience in building large-scale networks with EAPS is a competitive differentiator for us in an expanding market. Our beam end technology that helps segment network traffic to increase network efficiency and scalability also demonstrates our ability to differentiate and redefine the market, which should contribute to our growth. The growing trend of entertainment services over the Internet, signals a need for networking technology that can meet the availability requirement. With our history of delivering carrier-class technology, our XOS software and some upcoming extension, Extreme is firmly positioned to leverage the opportunities in this growing market. In addition, as more and more service providers use Ethernet to offer residential services, the fact that Extreme has a solution that provides a platform that delivers both business and residential services, greatly strengthens our value in this market. I would like to review a few Metro Ethernet customers that are relying on us for emerging Triple Play Application. First, Finlandâs Vaasa Telephone Company is using Extreme Networks for converged Triple Play services. Supporting its Metro Ethernet serving thousands of customers on Finlandâs West Coast, Vaasa delivers voice, video, and data over high-performance 10 gig network between two cities. Vaasa is relying on our BlackDiamond 10K switches for the network core and Summit switches at the network edge. Today the network aggregates more than 30,000 combined fibre-to-the home and DSL connections, carrying broadband traffic for phone calls, internet connections, and video. Also during the quarter, Korea Telecom, one of the worldâs largest telecommunications providers continued to work with Extreme to build out its Ntopia metro network, providing residential Ethernet access. Korea Telecom supports video on demand application as well as VPNâs broadband Internet and Voice over IP services for more than two million subscribers. Our Alpine switch provides the quality of service, bandwidth and Layer 3 services that are essential to these converged services. Again, I would like to emphasis the opportunity we have in the Metro Ethernet space. We have a strong technology base, a number of technology innovations that differentiate us and the experience to help carriers build up the next generation of Ethernet broadband networks. Our investment in this market hopefully will bear fruit this calendar year, as we introduce some new purpose built products for this market. So to quickly summarize the quarter, we are pleased with the ability, with our ability to manage certain aspects of our business. We are focused on growing revenue and we are optimistic that we can capitalize on the growth drivers, convergent security and particularly Metro Ethernet going forward. Now with that, Iâd like to turn things back over to Bill for a detailed financial review. Bill? Thank you Gordon. As always I am going to briefly review our financial results for the quarter and then update our expectations for future performance. This was a good quarter for profitability and improvements in our base operating model, and we did meet or exceed many of our financial goals for the quarter. Gross margins as a percentage of sales expanded again. Operating expenses were down notably in dollar terms. Profitability in earnings per share were improved on a sequential basis despite lower revenues. Cash generation was very good as well with 12.7 million in cash from operations and the repurchase of 6.8 million in stock. We believe this use of our cash is both a very direct step to take to increase the value of our shareholdersâ investment in our Company. Itâs also a tangible evidence of our commitment to improving shareholder value at Extreme over time. This was also a good quarter for revenue growth outside the US, with international revenues up 15% sequentially and 7% year-over-year. Our performance in the US was weak however, and impacted our overall growth rate. Gordon has taken you through some of the steps we are taking to address this going forward. Revenue for the quarter was 92.8 million consisting of 77 million in product revenue and 15.8 million in service revenue. Our book-to-bill was slightly above one, service revenue were up 9%, compared to the year ago quarter and down 1% sequentially. Product revenue decreased 6% sequentially and 10% year-over-year. Shipment of modular products represented 45% of sales with stackable products representing 55%. The split of enterprise sales and service provider sales was 74% to 26%, similar to Q1 and generally consistent with our typical mix. XOS-based products continue to help drive revenue growth and gross margin expansion for us. All told, sales of XOS-based products represented more than 25% of total product bookings during the quarter. We saw solid contributions from the BD 8800, and our XOS-based stackables. Sales of some of our older chassis products declined consistent with the shift towards newer products. New bookings for PoE ports were also up sequentially. We saw a solid increase in the sales of PoE blade for the BD 8800. New bookings of PoE ports represented more than 10% of our total port bookings. We expect PoE ports to continue on a growth trajectory driven by demand for IP telephony and wireless. Bookings through our Avaya channels, both direct and Avaya resellers, were down sequentially in what is a seasonally slow December quarter for Avaya sales. Avaya-related revenues and bookings were up strongly compared to Q2 a year ago. Avaya represented between 5% and 10% of total Company revenues in the quarter. Looking at revenues geographically. In EMEA, our European operations, which include the Mid-East and Africa, our revenues were 31.4 million for the quarter, up 5% compared with the same quarter a year ago, and up 4% sequentially. During the quarter, we saw strong growth in Germany and Eastern Europe in particular. Revenues in Japan were $11 million, up 2% sequentially compared to the September quarter. This is a good outcome for us, the second consecutive quarter of flat to up revenues after a period of sequential declines in quarterly revenue in Japan. Revenues in Japan were helped this quarter by one of our largest wireless wins to date. Looking at Asia outside of Japan, revenues were 16.6 million, up 45% from the September quarter and up 80% from the second quarter a year ago. Revenue from Asia can be lumpy for us as a result of a high contribution from service provider business, but this was a very solid result and our strongest quarter in Asia Pacific in over three years. Our international revenue growth of 7% versus Q2 a year ago was a good result and in line with our goals for the quarter. In the US however, revenues were weak. Revenues in the US were 31.9 million, down 27% compared to the second quarter a year ago, and down 29% sequentially. Revenues were particularly soft in the month of December. It is certainly fair to say that we did a poor job of forecasting our pipeline; both deal timing and closure rates. Gordon is taking you through the steps we are taking to address our revenue growth in the US, and as result of these steps and the number of deals deferred into the current quarter, we do expect that US revenues will be up in March, despite typical seasonal trend. Turning now to cost and expenses, the cost of goods and operating expense comparisons I will be discussing do not include stock-based compensation expenses. These expenses added 1.6 million to our total cost for the quarter. For those of you who want to note it in your model, the breakout of these expenses by P&L line item in the quarter was as follows. A 196,000 increase to product cost, $92,000 increase to service cost, $594,000 increase to sales and marketing expense, $442,000 increase to R&D expense, and 250,000 increase to G&A expense. This breakout is also included in table form in our press release. Looking at gross margins, not including stock-based compensation, total gross margin as a percentage was 55%, up from 54% sequentially and 53.8%, a year in the same quarter a year ago, both product and service gross margins were up sequentially and year-over-year. Excluding stock-based compensation, product gross margins were 56.7% compared to 56.4% in the September quarter and 55.7% in the year ago quarter. Service gross margins, excluding stock-based compensation, were 46.8% compared to 46.3% in September and 42.3% in the same period a year ago. Gross margins were up sequentially despite lower volumes, primarily as a result of more favorable product mix, lower overhead rates and reductions in per unit product costs. At 55% total gross margin, we are operating in the target range for gross margins that we have previously laid out for investors. We do believe that gross margins on both product and services can continue to improve over time through a combination of higher revenue, operational improvements and new product sales. That said, given the number of pricing, mix, cost, and volume variables involved, we do not expect the gross margins will improve lockstep each and every quarter. Turning to operating expenses sales and marketing, R&D, and G&A expenses for the quarter were $44.4 million, not including stock-based compensation. This was down from 47.8 million sequentially, and from 46.1 million in Q2 a year ago. Sales and marketing expenses declined by 1.7 million sequentially as a result of lower variable cost and less spending on product introduction. G&A spending decreased 1.1 million in part as a result of lower legal expenses in the quarter. R&D expenses declined $0.5 million sequentially to $15.2 million. Our expenses, overall, particularly G&A and R&D, also benefited from holiday shutdowns in some groups. Of note, headcount at quarter end stood at 835 up from 795 at the end of September. The bulk of the increase in headcount was in engineering, primarily in our new facility in Chennai, India. It actually has resulted in cost savings as a result of bringing in-house previously outsourced work. Sales headcount was also up sequentially. Looking at net income in Q2, on GAAP basis, we reported operating profits of 5.1 million, adding in 1.4 million in net other income results in profit before tax of 6.5 million and after tax of 5.7 million or $0.05 per share on a diluted EPS basis. On a non-GAAP basis, excluding stock-based compensation, operating profitability was 6.7 million or 7.2% of sales, up from 5.9% in September, despite lower revenues. Profit after tax was 7.2 million or $0.06 per share on a diluted basis. Compared to Q2 of last year, profitability is down from 10 million or $0.08 per share, a reminder our results last year included $3.9 million or $0.03 per diluted share for a consumption tax refund received in Japan. The tax rate for the quarter was 13%. Total shares used to calculate EPS in the current quarter was 124.8 million total shares outstanding at quarter end were 122.3 million, down 900,000 shares from the end of September. Cash and cash equivalents, short-term investments, and marketable securities totaled 456.3 million, up $6 million sequentially. Cash from operations was 12.7. Net inventory at quarter end was 21.9 million, up slightly from 21.4 at the end of Q1. Inventory turns stood at eight for the quarter, in line with September quarter. Accounts receivable were 33.6 million, up 3.5 million sequentially. DSOs at quarter end stood at 33 days, up from 28 days at the end of Q1. Accounts payable were 22 million, up 4.4 million sequentially. During the quarter, we used 6.8 million to repurchase shares, reflecting a pace that was generally in line with our previously stated goal of completing our $50 million share repurchase program within 12 months. You will note on the balance sheet that our $200 million convertible note has been reclassified to short-term liabilities, reflecting the fact that it is due in the coming December. Currently our plan is to pay down the debt when due. Some other items to note depreciation and amortization for the quarter was 3.7 million and capital expenditure for the quarter was 1.6 million. Turning now to guidance, for revenue in the March quarter, we currently anticipate that our revenues will be in the range of $90 to $95 million. We do expect to see seasonally lower revenues outside the US, but we expect that revenues in the US will be up from an unusually low result in December. On gross margins, our expectations for the March quarter is that gross margin as a percentage of sales will likely be flat to down somewhat from this quarterâs 55%, not including stock-based compensation. As ever, our gross margins are sensitive to volumes, pricing on large competitive deals, and on the precise mix of products and channels. In addition, we are beginning to incur some costs related to new environmental regulations, in Europe in particular. On operating expenses in Q3, we expect our total operating expenses will be in a range of 44 to 46 million, not including stock-based expenses. This is down notably from our previous guidance of 47 to 48 million. And other items for your model, we expect net interest income of approximately 1.2 to 1.4 million a quarter. We anticipate a corporate tax rate of 10 to 15% throughout the remainder of fiscal â06, and we anticipate that stock-based compensation will continue to run at a quarterly expense rate of $1.6 to $2 million approximately. As for the impact of our share repurchase program on cash balances, interest income, and share count, we will make no particular further forecast on this other than to note it is our expectation to complete the $50 million program over the course of the next nine months. As always, I will note that there are risks associated with our expectations. Investors should note that our quarters are backend loaded with approximately 50% of our business done in the last month of the quarter. And so, it is fair to say our visibility can be limited. There is also a case where one or two large deals a quarter can make the difference between sequentially up or sequentially down revenue. And before I turn the call over to Gordon, I would like to note that Extreme will be holding an analyst meeting in New York on March 2nd, which is few weeks later than we have in the past. Invitations will be going out shortly. With that let me turn the call back over to Gordon. Thanks, Bill. To conclude I just wanted to thank our team here for their hard work in improving our business model and for their focus on increasing margins, lowering costs and for providing stronger leverage to our business model. With that, I would like to open the call to questions. Operator? Thank you. Ladies and gentlemen at this time we will begin the question and answer session. If you have a question please press the â*â key followed by the â1youâre your touchtone phone. If you would like to decline from the following process please press the â*â key followed by the â2â. You will hear a beep tone prompt acknowledging your selection. Please ask one question and one follow up and re-queue for additional question. If you are using the speaker equipment you will need to lift the handset before pressing the numbers, one moment please for the first question. I think Extreme has missed three out of their last four December quarters, but you have always managed to grow revenue sequentially in every single June quarter. Is it a sales force incentives issue or is it something else? And what component of the miss in the US was end market weakness, or was it execution? And did you see some CapEx rush at the end of the quarter? There is a number of questions in there, Mark. Iâll address the last one in terms of was it market weakness or internal execution. As we stated, I donât think we did a great job of pipeline management, although I can certainly put my finger on a number of large deals that we did anticipate we would ship within the quarter that were delayed beyond the quarter boundary. Any thought just on how you can change your incentives so that you can have sequential growth moving forward at a December quarter versus having very strong June quarters? Well, I donât have good answer to that, Mark. I am not sure that a sales incentive program is at the root of this problem. Well, so June quarter you guys had a major debacle in Japan and you were waiting for that to roll off here in the March quarter so you can get back to the growth trajectory and now you are busted in the US. How should we be thinking about this companyâs growth prospects over time, when you canât seem to put together more than two or three quarters without missing, having a serious debacle in your operations, which looks like from everything we can tell, was more company specific than end-market specific? Yeah Alex, this is Gordon. Like I said in the last answer, we do accept that there were operational issues in the US, but we also did see some behavior of delays, just delays in terms of business that we have won, but that was not delivered. We are very focused on the US operations. It is our largest market. But I do want to comment that the other markets in terms of Europe and Asia did have very, very strong quarters. So if I can follow up, the, certainly the guidance here is below anybodyâs forecast for the March quarter. So weâre still, even with business being delayed out of the quarter, it would still look like you are well off the growth curve that anybody had anticipated coming into this earnings release. Either the Street is missing something or your execution has got some more serious problems to it. What is it specifically in the environment thatâs causing a periodic miss, one geography at a time, the way youâve seen over the last year? To be blunt about it, you still havenât grandfathered the problem in Japan yet. Well, again there is a couple of questions in there, Alex. In looking at Japan, we had, Japan used to be a very high percentage of our business, in the high teens and low 20s. As the carrier build-outs there have been lumpy, we saw that drop to a lower level, but that has grown over the last couple of quarters. Although we havenât seen high level of growth there yet, weâve put in place, I believe, the right infrastructure to head that direction. Specifically on Japan. Thanks. If I could take another shot at, just what happened in the US, are you suggesting that some of the delays in deal closing that you saw were market phenomenons? And just, can you talk about overall activity, was it end of the quarter deals didnât close, which did it affect your linearity? Yes, Subu, this is Gordon. The decline came, as Bill mentioned, largely in the month of December. We did see business delay from both new and existing customers. So, I donât believe this was a situation where we were looking for big budget flushes. We had a pipeline there and we had expectations for revenue coming in and this deferral came literally during the last several weeks of the quarter, and it did catch us by surprise. Itâs hard, itâs hard to break out whether it was specifically related to Avaya or to frankly a particular channel. But at these levels of revenue, we do have some very large customers, and particularly in the large enterprise space. When you look at a $1 million deal or a larger deal that moves across a quarter boundary that can have a very significant impact on our overall sales level, clearly. That said, we are proud of the fact that even given that drop and those deferrals, that we were able to maintain our profitability at a very high level, relatively high level. Good afternoon. A few small questions, but a number of them. First, what was linearity for the quarter if itâs normally 20, 30, 50, what was it this time around? Well Sam, it was slightly better than that, but that was a result of coming in with the hole in the revenue in the last week or two of the quarter. Got it, okay. And how about US Federal business in particular. Did you notice anything where was it, mainly, US enterprise was the problem? Got it. And then lastly, a few other questions. First, book-to-bill slightly above one, but you had deals push out at the end of the quarter. Does that mean the deals in fact have not been booked yet? Yes, thatâs what we mean by deal having them pushed out, it was not signed, not booked; itâs not in the backlog. Got it. And lastly, why is accounts receivable up quarter-on-quarter if, at the end of the quarter, you had a revenue fall off? I mean, a lot of that should have been through the billing cycle and usually you would see DSOs go down in those cases. Yes, it was the function of particular channels and mix we were doing our business in some of our larger reseller type more favorable terms than others. Thank you. Could you tell us how much, exactly Avaya was down sequentially in the quarter? And also, on some of the new products, can you give us a sense of their contribution and sort of the wireless LAN and the security areas? Christin, we donât break out Avaya sales directly quarter-to-quarter. But it was down a few million dollars enough to impact things. As it relates to new products, XOS-based products and new product revenues, they were up as a percentage of revenue; in some cases up in dollar terms sequentially. But in other cases down in dollar term sequentially primarily as a result of what was happening in the US. Thank you. And then in your OpEx, you are making good progress and bringing the OpEx down to the 44 million to 46 million. How are you driving your OpEx down there in terms of either employee headcount or sales and marketing and R&D by the major expense category? Yes. In some cases we are, we recently opened up our facility in Chennai and what that has allowed us to do is bring in-house functions, we were preciously doing outsourced. Actually in doing that, weâve had a very positive effect on R&D, among other things. On the sales and marketing side, the revenues, excuse me, operating expenses are coming down with revenues. In some case little bit more focus on where weâre investing dollars particularly in the recent quarters as it relates to product intros and such. On the G&A side, having worked through some of the previous legal issues thatâs helping us on those operating expenses there. Weâll continue to work this and I think the $44 to $46 million a quarter range is a range you can use for a few quarters yet. Thank you. A few questions here. Back to the margins side having the similar type of operating margins on a lower revenue base. Iâm just curious, since the miss was very late in the quarter, surprised you were able to swing your OpEx that much of your manufacturing absorption. Should we assume that had that revenue not missed or pushed out that you were managing the business for 10% plus operating margins? Or is there something else Iâm missing there? Second question, when you talk about the US market being up sequentially, I think Gordon also mentioned some management changes that are occurring. Could you talk about any potential impact that that, those management changes may have on your near-term business? That seems like that could be a risk there. And then third, if you could just talk about the new sales hired for Federal or whatâs your sense of timing for a little more traction in that business because there needs to be more certifications to get into some of the larger programs? Okay, so a lot of questions there. Let me try and handle the operating margin question. We previously laid out a goal of getting our operating margins to a 9% to 14% range sometime during this fiscal year. So you can assume that we are trying to run the business to get into that range and weâre doing so for the current quarter. And yes, you might infer that had we, run at higher revenue rates, certainly operating profits would have been higher. Some of the ability to turn expenses on short notice included things like holiday shutdowns, et cetera, which could be implemented. As far as the Federal, new changes in Federal, Gordon I will turn that one to you⦠Yes, Tim, let me address some of the organizational changes. I want to be clear that these changes have already happened in terms of the organization. We are ramping the headcount in the US, and given that percentage decline, I do believe that there is upside ahead of us in that market. In the Federal, we did bring on a new leader of that business during the December quarter. And as you suggest, there is a long tail some of those deals. But we do have installed customer base there, and we do expect to see revenue from that customer base as well an aggressive workforce toward winning some new business there. You asked about certifications and the answer, the short answer is, yes, we do have the certifications. There is a long list, and weâd certainly be happy through that with you offline. Thanks. Iâll stick with one follow-up and one question. The follow-up is for the deals pushed out to March, I was wondering could you talk about how many of them are, if any of them or half of them have been closed, have been booked? And Iâll ask a question later. Yes, this is Gordon. I think that, given where we are in the quarter very early on, I donât have a good answer for that yet. Okay, fair enough. Could I have, Iâll leave a longer-term question for you. If you look at the space, enterprise LAN switching space, it seems like over the last seven or eight years, the number of players in the space has been increasing, but lot of the products increase in a somewhat commoditized. The long talk about the industry consolidation hasnât happened, so I was wondering, could you talk about what are your view on this space? And if the industry starts to consolidate, where Extreme stands? So, there is a, again there is a couple of questions in that. Let me address, Jiong, the question of commoditization. And I think one thing that is difficult today is that a lot of the market research firms have bunched a lot of products together. For example, taking Layer 3 products and Layer 2 products; the lines blurred and so theyâve grouped all those products together. If I look at some segments of that market, and letâs say for example, this small and medium business segment I would tend to agree that that is commoditizing. And the functionality is pretty high in a lot of companiesâ product and certainly sufficient for a small business to build a network. And we all see that in the networks we built at home in terms of the cost of products. I think when you come to the large enterprise market, and more particularly, to the Metro Ethernet market which are the two markets in which we participate; that itâs far from commoditization. The skills, both in terms of the support skills or systems engineering skills, and the products and technology thatâs necessary to build a 10,000 or 20,000, or 30,000 node network is significant. Although I would agree with you that there are more players in the overall switching business than there were eight years ago, there arenât more players in the large enterprise space, in that a lot of the new entrants have approached it from the very low cost segment and addressing the small and medium business. So, I hope that answers your question. Yes, hi, good afternoon. A couple questions very nice sequential growth in Asia-Pac. Just wondering, was this concentrated, was this growth concentrated in one to two carriers, or it was more spread out? Also you mentioned that growth was driven by project-related upgrades. Can you tell me how long will such upgrade projects typically last, before the spending turn down? Yeah, this is Gordon. The second question again, in terms of when you look at upgrades, it depends very much on the particular customer. So I hesitate to make any generalizations. We have seen in some parts of the world a network upgrade where we have won the next generation network. Weâve seen that upgrade being installed over the course of many quarters; six to eight quarters. There is other cases in some other regions where we see an upgrade go through pretty quickly and sometimes within a single quarter or bridged over two quarters. So, thatâs something thatâs very difficult to predict, again, as the carriers operate. That business does tend to be lumpy. And as far as where the revenue came from, it was spread across multiple carriers and in fact, multiple countries in Asia-Pac. For several quarters, the mix, the percentage of modular switching continues to decline. You have said that you expect the mix from modular switching to eventually recover to above 50%. Now, is that, are you still expecting that to happen sometime during the year or you think itâs going to be pushed out to next year⦠Well the catalyst for it to become more a 50, 50 mix would be stronger sales in the US. It is just the nature of our business that outside the US we have a higher mix of stackables generally in the revenue stream, and inside the US itâs a slightly higher mix of modulars. So the fact that US revenues were unexpectedly low this quarter also affected the mix of stackable/modular. As the US recovers and becomes a more traditional part of our total revenue stream, I would expect stackable and modular to shift around. Okay. Are you going to pay off the $200 million convertible debt by year-end? And you are going to continue to carry out this share buyback program. What kind of net cash level are you comfortable with on the balance sheet? Yes. I think that the right sort of net cash balance for a company like us to carry is something around 50% of revenues. At a balance plus or minus that number, I think we are at the right balance. It is certainly more than enough to run the business day-to-day; gives you a little flexibility to be opportunistic on things and gives customers comfort. Hence the thinking on the use of cash to both repurchase shares and pay back the note. With that, let me move on the next question. Good afternoon. Can you talk a little bit more about the US? Youâve said that youâve experienced some deal push outs and also some pipeline management issues. Can you explain if thereâs, or talk about if there is any turnover that is effecting execution here? Okay. But there has been some management changes instituted. I mean there, there seems to be at least, you do here regionally that, there is certainly some sales turnover in North America beyond, maybe some forced management changes. Yes, again let me directly address your question and say that, yes, there has been turnover in the sales force and certainly that impacts results. Okay, and then on to Japan. Obviously it looks like we did have a little sequential improvement here for the quarter. Can you talk about the expectations that you have as we go into 2006 year. I think you have laid the groundwork in terms of distribution and may be trying to get into the enterprise. But you see some opportunity for carrier upgrades in that region? Or just what are you thinking along the lines of Japan? Okay. I want to be clear and say, you asked about the question about the calendar year and so my comments are about the calendar year and not any particular quarter. We do see significant opportunities in Japan during calendar year 2006. We have a large install base of Metro Ethernet within the Japan market across many, many customers. Some of those networks are again a little long in the tooth; have been installed for three to five years, and we do expect there to be upgrades there. Given our strong position in that market and in our install base, we expect that that will contribute significantly to Japan in this calendar year. Hi guys. I want to focus not on the results, but rather on the bigger picture and I want to go back to the question that Alex asked at the beginning of the conference call. It seems like youâre trying harder and harder and harder in the same area of switching, while Cisco has been gaining share if you look at the market share data over the last two years. And you would argue that you have a better solution, scalable, carrier-class, whatever. What are your steps, or what are the expected steps that youâre taking in order to reverse the trend, and I am referring here more to your product strategy, long-term focus? Thank you. Look Tal, first of all in comparison to Cisco, we participate really, in two segments, that is, call one segment be the mid-size and large enterprise segment and the Metro Ethernet space. Ciscoâs market approach is considerably broader than that in that they have been seeing strong growth in their small and medium business segment, which is not an area that we participate in at all. Itâs hard, I mean I look at that on a customer-by-customer basis, and we beat Cisco a lot. Itâs sometimes tough to capture an account from them, but we certainly have done it during not only this past quarter, but in previous quarters. I donât know of any good tracking for the, that breaks out specifically by market segment in terms of looking at large enterprise. So itâs really hard to determine what the share changes there are. I would say though that, again, in looking at this marketplace, that there is a part of the market that not only is open to buying a non-Cisco solution that is the part of the market that doesnât want to buy from the market share leader. But, I would say that there is a part that wonât buy from them for whatever reason. Whether itâs because of the size of the company and difficult to get a response or because they want a leading edge solution thatâs technology based. So, I think you get to a point where, frankly, for them it becomes very difficult to grow market share in a particular segment. I think you can see that in terms of looking at their overall corporate strategy and diversifying into new market areas. I think they are having tougher time gaining share, again, in the particular segments that we play in. So, if I use my follow-up question also on the same issue, so, Gordon, wouldnât you think that you would need maybe to expand into other areas? You see your competitor foundry going into routers, going into Layer 4-7. You, yourself said that Cisco is successful because they are going into SMB, and the, subsequent question would be, so why wouldnât you try and go into other areas? So the question is bigger, so what is the future direction of the company? Are you just going to try and do more of the same or are you are going to try and diversify into other sections, other areas? I think the answer is pretty clear. Weâve made investment in the security space over the last, the investment has been over the last 18 months, but we are just starting to see the benefits from a revenue perspective. We made a significant investment there, not only in our core technology that is the ability to build security within the switch, but also in security appliances. You can expect to see more from us in that area both from a software perspective, from products, and from partnerships. We see the security space as an adjacent space. Itâs also an opportunity to be best-of-breed and to have a market leading solution. I think we have a unique opportunity given our switch architecture to embed that in and to not have a perimeter security solution, but a core security solution. So thatâs one area where weâve made some visible steps. I think you will see some future steps from us in that area. So, I would say we are not just going to build Layer 3 switches, but we will build and emphasize areas that are a key part of the network infrastructure. Again, just one comment over the, whether itâs a switch or a router, the line between a Layer 3 switch and a router is, from a product perspective, is blurring. We tend, well, we do call our products switches largely because thatâs what weâve called them in the past, a Layer 3 switch by definition does routing. Many of our products are very effective routers and are used in the network as routers. It just happens that we classify them as Layer 3 switches. So I think when you look at that and you look at an enterprise router or an enterprise switch, they are really one and the same in todayâs market. Thanks. This is actually Priya Parasuraman for Bill. Just going back quickly on that US businesses, the order push outs, were they related to XOS-based products or were they more legacy products? This is Gordon. Not sure the answer to that. It would vary on a deal-by-deal basis, but I suspect that there was a lot of XOS product in there, given those are our newer products and are focused on our largest customers. But we would expect that on a sequential basis from here, Avaya is a growth through the year and than weâll get to next December and weâll see where the sequential pattern is there. Iâd be disappointed if we didnât see a sequential improvement in Avaya revenues here in March. Yes, hi. Itâs actually Matt Schnaub for Wojtek. I have a question about your APAC revenues; can you clarify for me? This is, I think largest revenues in a few years, and so what are you seeing? Are you seeing a few carriers buy a lot of equipment and now they are going to deploy it over the next 2, 3 quarters? Or are you seeing these carriers just buying what they need quarter-by-quarter and you expect this to continue for 2 or 3 quarters at this rate? Hi, Matt, this Gordon. So, our business in Asia-Pac is a mix of enterprise and carrier, and we won some, just some terrific enterprise deals in that part of the world. So, I donât want to put too much emphasis on the carrier business. That said, the carrier business in Asia-Pac has been a great one for us. We have a number of leading customers. I mentioned on the formal part of the call Korea Telecom has been a customer of ours for quite a few years. In terms of buying practices, itâs of course hard for us to tell, but in general, carriers buy and then deploy that equipment fairly quickly, they donât let it sit around. The pattern of buying and network expansion is really based upon their demand level and the take-up level they have of new services. So in some cases if itâs a brand new service, for instance, they will buy a modest amount and then over the next couple of quarters as service take-up comes, they will continue to buy. If itâs an existing service, that may be just a standard order from them every quarter or more or less frequently, again, depending upon the customer, very difficult to predict. Thatâs why weâre always are careful to say that is a lumpy business. Again, Asia-Pac was very strong as you suggest, the highest level in quite a few years, and good balance in that market and very good execution by our team. Are you willing to clarify there how much of the growth was driven by service provider versus enterprise that might be a little more sustainable? I am not willing to break it down by markets. Youâve seen the percentage of the carrier business. If you look at our overall numbers, being at the, in the 20 to 25% range; been pretty consistent. Bill, this quarter it was? Towards the high end. I think you could surmise by the US being down and the US, as weâve said being a largely large enterprise that, there was pretty strong growth in the Metro Ethernet segment. I think there is a lot of underlying growth just overall in Metro Ethernet that we hope to capitalize on. Understood. And quickly on the XOS transition, you mentioned it was greater than 25% of your revenues this quarter. Last quarter I think you said it was greater than 20. And actually it seems a little bit like a slow transition. Do you have thoughts on that and how you would expect it to continue to play out? We do expect that XOS will continue to increase as a percentage. All of our new chassis systems are based on XOS. We do have some older systems that continue to be used and deployed by customers and continue to be competitive in the markets that are ExtremeWare-based. We donât have any plans to convert those systems to XOS. So, it isnât an instantaneous change over, but you will see XOS revenue grew as a percentage. Also, many of our new Summit switches are stackable switches; are XOS based, where today there is only one segment of our product line thatâs XOS based. So you will see that pickup here during the calendar year. Okay and just, the weakness in North America, do you think, are you seeing any sort of product transition from the XOS software versus ExtremeWare? Is there any sort of hesitation on the part of your customers to wait? Thereâs, again, this varies customer-by-customer. We have a lot of customers that have a mix of ExtremeWare and XOS. To be very clear, there is no inter-operability issues, many people have networks that are mixed XOS and ExtremeWare. In fact, certainly any customer thatâs been a customer for several years has a mix on their network. Okay great. And just back to the 10 gig, I mean, is it more than 5% now, or can you not even not do you not want to tell us that? Thank you ladies and gentlemen. That does conclude todayâs teleconference. If you would like to listen to replay of todayâs conference, you may dial in at 303-590-3000 or 1-800-405-2236 followed by the access code of 11050009 and then followed by the # sign. Once again those numbers are 303-590-3000 or 1800-405-2236 followed by the access code of 110500099 and followed by # sign. Once again, thank you for your participation in todayâs conference and at this time you may disconnect. |
EarningCall_234047 | Good morning and welcome to the Verizon Fourth Quarter 2005 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the floor will be open for questions following the presentation. Operator Instructions. It is now my pleasure to turn the call over to your host, Mr. Ron Lataille, Senior Vice President, Investor Relations of Verizon. Good morning, everyone. Welcome to our Fourth Quarter 2005 Earnings Conference Call. Thanks for joining us this morning. I'm Ron Lataille. With me this morning are Ivan Seidenberg, our Chairman and CEO and Doreen Toben, our Chief Financial Officer. Before we get started, let me remind you that our earnings release, financial statements, the investor quarterly publication and the presentation slides are on the Investor Relations website. This call is being webcast. If you would like to listen to a replay, you can do so from our website. I would also like to draw your attention to our Safe Harbor statement. Information in this presentation contains statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. Discussion of factors that may affect future results is contained within this presentation and is also contained in our SEC filings, which are on our website. This presentation also contains certain non-GAAP financial measures as defined under the SEC rules. As required by these rules, we have provided reconciliations of these non-GAAP measures to the most directly-comparable GAAP measures on the same web page as our presentation slides. As you know, we closed our merger transaction with MCI on January 6, 2006. As such, the results we will be discussing today are of those of the Verizon stand-alone business for the fourth quarter and full year 2005. Before turning the call over to Doreen, I would like to direct you to some information on our reported and adjusted earnings. Adjusted earnings per diluted share for the fourth quarter were $0.64. On a reported basis, EPS was $0.59. For full year 2005, adjusted EPS was $2.56, representing 2% growth over $2.51 of adjusted EPS in 2004. Reported EPS was $2.65 in 2005 and $2.79 in 2004. The special items that make up the differences between reported and adjusted EPS are discussed in the earnings release and provided in reconciliation tables within our financial statements. For the fourth quarter of 2005, these items principally related to previously announced changes to management benefit plans, severance and relocation costs. With that, I will now turn the call over to Doreen. Thanks, Ron and good morning to everyone. Verizon delivered another quarter of strong operational and financial performance. Our strong fourth quarter capped the year in which we achieved some major strategic goals and strengthened our position in key growth markets. Our strategies are really starting to take hold and you can see it in our financial and operating results this quarter. As a result, we enter 2006 with excellent momentum and a business that is performing extremely well across the board. I'll take you through the details of our fourth quarter results but here are the headlines. Customers are responding very strongly to our products. In fact, we set industry records in both wireless and broadband net adds. More new customers than any other wireless company, Telco or cable company has posted in a single quarter. We accelerated our revenue growth at 6.7%. We made important progress in creating the growth markets of the future with our EV-DO and FiOS initiatives, which are both gaining scale and customers. We also prepared for our merger with MCI, which positions us for growth in the large business market. And we showed, once again, that we can invest in growth and still generate solid cash flows, margin and earnings growth. All in all, we are pleased with the strong finish to the year with great momentum going into a very exciting 2006. Now, let's take a closer look at our consolidated results, starting with revenues. On chart four, you can see our steady growth trajectory. Quarterly revenues increased by 1.2 billion or 6.7% and annual revenues grew 4.2 billion or 6%. Full year revenues were just shy of 75 billion, representing more than a 9 billion increase in three years. Our key growth areas are becoming an increasingly larger piece of our total revenues and compose nearly 60% of our fourth quarter total. The next chart shows the components of our revenue stream and clearly demonstrates the increasing diversification of our revenue profile. We have three network businesses, Wireless, wireline, serving residential and business customers. Wireline also includes a large and very healthy wholesale business and an enterprise business. As you know, earlier this month, we completed our acquisition of MCI, which will increase our presence in the large business market. Our growth initiatives are diversifying our revenue profile and helping to mitigate our competitive risk. We are also gaining momentum with these initiatives across the entire business. You can see for yourself on this slide. Customer connections, the combination of switched access lines, broadband connections and wireless subscribers, up 5.7%, wireless data revenue, now a 2.2 billion annual revenue stream, up more than 100%. Wholesale data traffic volumes with double-digit growth. And an increasing appeal among residential customers for some kind of bundle or package of products from us. Another key point here is that we are seeing increasing demand for our services across the board. Turning to margins, we delivered our fourth straight quarter of margin growth, even as we're continuing to invest today for better growth tomorrow. Adjusted operating income margins, excluding pension and OPEB costs were 22.1% in the fourth quarter, an increase of 90 basis points sequentially and 190 basis points year-over-year. And as you know, growth initiatives initially create downward pressure on margins. Since we are committed to margin stability and ultimately to margin expansion, it is mission critical to drive other costs out of the business by increasing efficiencies and productivity throughout the entire organization. And I can assure you we never lose sight of that fact. We view driving down costs as a critical matter of financial execution, especially as we expect to continue to grow our customer base or have existing customers take multiple products and services from us. This is extremely important as we remain committed to capturing the growth opportunities that will drive future revenue and earnings growth. During 2005, we maintained fairly consistent quarterly earnings performance, as you can see on the top of slide seven. For the year, adjusted EPS was $2.56, representing 2% growth over 2004. While this is modest growth, I believe it demonstrates our capacity to manage cost-effectively and offset the initially dilutive effects of growth initiatives. Final solutions for the full year 2005 was worth $0.15 as compared to the $0.04 in 2004. In addition, I would point out that the net pension and OPEB expense had a $0.30 negative impact on EPS in 2005, compared to a $0.21 in 2004. So, from a bottom line perspective, we were able to preserve earnings stability, even as we made significant investments in network platforms that will fuel future revenue and earnings growth. Let's take a look at slide 8. 2005 was another year of strong cash generation and our balance sheet is stronger than ever, something that I'm particularly proud of. CFFO, which totaled 22 billion for the year, was strong in both the wireline and wireless business. Our 2005 capital spending was on target with previous guidance. The increase over 2004 spending reflects our focus on growth opportunities. In fact, 69% of our capital spending in 2005 was related to growth initiatives. Total debt levels were maintained in spite of the increase in capital spending and wireless spectrum purchases. Our credit metrics are the strongest they've ever been. For example, our net cash flow to debt ratios finished the year at over 50%, our best ever. Let's begin our segment review with wireless. Simply put, these are the best wireless quarterly results from any carrier ever. If you take a look at any of the metrics from growth through profitability to loyalty, Verizon Wireless has equaled or surpassed its own industry record results. And we continue to demonstrate that the growth engine we have built just keeps getting better with time. Net adds for the quarter were an industry record 2.05 million. Retail post-paid net adds were 1.76 million for the quarter. Total customers now stand at 51.3 million, which is 17.2% higher than last year. For the full year, we added 7.5 million customers. I think that's a number that bears repeating. We added 7.5 million customers during the year. 7.1million of whom were retail post-paid. Our success is the result of capitalizing on opportunities and leveraging our strong fundamentals and networks to capture market share. And with our commitment to quality, we are seeing very strong customer loyalty. Our customer base is about 96% retail. Total churn of 1.22% tied our previous record and our retail post-paid churn of 1.02% was also near all-time lows. These results show that it really is the network and our award-winning service that attracts and retains customers. Slide 10 shows our very strong revenue growth trends over the past five quarters. Total revenues grew 18.3%, reflecting the phenomenal growth that we had this quarter. Quarterly revenues have increased over $1.3 billion in just one year, which is incredible. As a matter of fact, I suggest there are very few 30 billion plus businesses that are growing revenues at this kind of pace. Service revenue was up 963 million or almost 15% compared with fourth quarter last year, driven by data usage and the good customer profile of new adds. Service ARPU was $49.36, down 1.9% year-over-year, representing about 100 basis point improvement in the year-over-year run rates from the second and third quarter. This improvement is attributable to increasing data usage as well as strong customer mix. Wireless data is an increasingly big part of the Verizon Wireless story. At 731 million, data revenue accounted for almost 10% of fourth quarter service revenues. Data contributed $4.85 of ARPU, up from $4.23 last quarter very strong sequential growth. Almost half of our retail customers are data users, up significantly from this time a year ago. And we're seeing strong uptake on Broadband Access cards and PDAs from corporate customers, thanks to our extensive EV-DO network. The key to our success in wireless data is our commitment to investing in the network. The result is a first-mover advantage, which has really separated us from our competition in terms of coverage and experience in delivering broadband services. Our EV-DO network gives us, by far, the most pervasive wireless broadband coverage of any carrier in the marketplace. We now offer 24 different EV-DO broadband devices, the most of any carrier. We have six PC cards, eight PDAs and 10 handsets in the market today. We have partnerships with Dell, HP and Lenovo to embed EV-DO chips in their laptops. We also recently launched the Windows Mobile Treo device. Customers are snapping up these products because of the growing set of multimedia applications that can be delivered to a mobile device. Verizon Wireless is leading this wave, as well. We continue to see strong growth in V CAST and our just-launched V CAST music service has gotten rave reviews. V CAST music is unique. It is the most comprehensive mobile music service in the world. You can download full songs over-the-air to your handset and your Windows PC and you can transfer your existing collection of music downloads and CDs to your phone. The exciting thing is that we're really just at the beginning of the wireless broadband revolution. And we have the network and the products to really take advantage of this growth trend. Of course, growth is only part of the Verizon Wireless story. We focus on profits and growth, not one or the other, but both. And you can see on slide 12 that's what we delivered in had the fourth quarter. We continue to grow with increasing profitability as our operating income margin expanded to a record 25.8% for the quarter. Quarterly EBITDA margins were 46.8%, up 36% year-on-year with a run rate of over 3 billion in each of the last three quarters. This is the best in the industry. Our already-low cash expense per subscriber hit its lowest level ever. And all of this, while we increased retail gross adds, very impressive. Our low cost structure is the result of many efficiencies in the business, as well as our very balanced distribution mix. As you can see on slide 13, we have excellent cost metrics across the board. One key element is our superior distribution network, which saw 69% of our retail post-paid gross adds coming in through our direct channels in the quarter. Acquisition cost declined by 18.6%. Network costs continued to decline. Expenses per minute of use are down nearly 18%. We continue to drive customers to the most efficient means of doing business with us. The number of self-service transactions increased nearly 48% over the past year. Employee productivity increased by almost 5% as our focus on efficiency and quality in our call centers is paying off. When you're able to increase quality and decrease costs at the same time, you have the ingredients for a winning business model. Let me wrap up wireless by saying this was another record-breaking quarter in which we expect that Verizon Wireless has increased its lead as a top carrier in the industry. Verizon Wireless has size and scale and a superb management team and organization that is executing its business model. This model is built upon the fundamentals of the best network, excellent customer service and innovative products and services. As you can see from our results, the Verizon Wireless machine is hitting on all cylinders. We have built significant momentum and are generating growth and profitability. We have an extremely loyal customer base, very low churn and a very high percentage of our customers on one or two-year contracts and we've introduced lots of new products and services. We also enter this year with a significantly enhanced spectrum position. And we have a business culture that is driven to deliver continuous improvement quarter-after-quarter, year-after-year. Our consistent investment has created the platform for innovations that will drive our growth. Let's move to wireline, where we are seeing continued customer growth across the broadband, enterprise and wholesale markets. The big news is in broadband, where we now have 5.1 million customers, an increase of 1.7 million customers for the year, we added 613,000 in the fourth quarter alone. Our bundle penetration ended the year at 65%, up from 55% a year ago. And Freedom for Business packages have passed the 1 million mark, up 38% since last year. Almost half of these customers are on an annual contract. In wholesale, we also saw strong demand for DS1s and DS3s, which grew by 12.5% year-over-year. All in all, we have seen steady increases in growth product penetration and we expect to see more of the same in 2006 which will help drive revenue growth in future quarters. Our emphasis on growth products is transforming the revenue mix in the consumer market. As we have said before, this makes the traditional access line metric much less important as a gauge of revenue growth than it used to be. As you see on slide 16, growth in revenue generating units, RGUs, which we introduced last quarter, track much more closely with revenue performance than do access lines. We did lose 426,000 retail access lines in the quarter, which is an improvement over the last two quarters and from the fourth quarter of last year. We believe that the increase in broadband subscribers, the introduction of Freedom Essentials and other marketing activities help retain and win back customers. As a matter of fact, the fourth quarter marks the first time that our broadband net adds exceeded the decline in retail residential access lines. With regard to retail business line losses, we continue to see improvements over last year, especially when we exclude dial-up port disconnects as these contracts expire. Total wholesale voice connections, both UNE-P and retail declined by 323,000 during the quarter. So, overall, the increasing use of broadband connections by our customer base is redefining the traditional view of the wireline business and creating new opportunities. Looking at wireline revenue trends, we did see increasing competition and technology substitution in 2005. We are responding in the marketplace with our broadband initiatives, new products and services, increased use of bundling and some pricing changes. As you can see, we were able to maintain a stable revenue base of about 9.4 billion each quarter. Although revenues were essentially flat on a sequential basis, fourth quarter revenues were down 1.8% year-on-year and full-year revenues were down 1.1%. Among the reasons, which contributed to the fourth quarter and full year decline are the loss of revenues from discontinued activities. In the fourth quarter of 2005, this amounted to 127 million decrease over fourth quarter a year ago. For the full year, this represented a decline of 269 million. A large part of this decrease is from the termination of a large logistics management contract this past summer. You can expect about 80 to 100 million unfavorable effect in each of the next two quarters as a result of this issue. Another factor adversely affecting the fourth quarter comparison were revenues from our CPE business, which were lower than last year. In previous years, we saw CPE sales spike up in the fourth quarter but that did not occur this year. In the consumer market, fourth quarter revenues were down on a sequential basis and 1.1% year-over-year. For the full year, consumer revenues, which totaled 15.2 billion in 2005, were down only .4%. As I said earlier, this shows that we are mitigating the loss of revenue from access lines, with broadband, long distance and other services. In the fourth quarter, average monthly revenue per customer was $51.50, up 3.9% year-over-year. Wholesale revenues increased by 33 million or 1.6% on a year-over-year basis. Sequentially, revenues were essentially flat. This market includes switched access, local wholesale products like UNE-P and retail. It also includes high speed, high capacity growth products, which are driving data growth in this market. I would mention that we now have 92% of our base of UNE-P customers on commercial agreements. We are scheduled to see some UNE-P price increases in 2006, which should provide an incremental margin opportunity. Looking at business, revenues in the business market were 2.75 billion, down slightly on a sequential basis and down 126 million or 4.4% versus fourth quarter last year. As I mentioned before, our CPE business was part of the reason for this decline. In the highly-competitive small and medium-size business market, we have had success in retaining customers and have been actively marketing our Verizon Freedom for Business as well as DSL. Within the enterprise space, we are obviously looking forward to the upside opportunities now that the MCI merger has closed. More on this in a few minutes. Quarterly data revenues continue to grow, increasing 9% year-over-year, driven by strong demand for high capacity and broadband products. Data transport drove most of the quarterly growth with 9.7% higher revenue than last year. For the full year, data revenues totaled 8.5 billion, an increase of 10.5%. Importantly, data is also becoming a more significant percentage of our overall wireline revenues, now standing at 23.4%. Between our data products for business and the growing popularity of our consumer broadband products, we are well-positioned to benefit from the ongoing expansion of the market for high-speed, high-capacity services. Now let's move to FiOS. We continue to see a strong and growing customer response to our FiOS data and video product offerings. Looking at the penetration rates for FiOS data, we are ahead of plan. We are seeing good customer acceptance and consistent monthly penetration gains. Last quarter, we told you that in the 35 markets where we have been actively marketing in for six months or more, average penetration was 12.4%. I want to give you an update, but in a slightly different and better way to look at our progress. In markets where we have been selling FiOS data for at least six months, the average penetration at the six-month mark for each was 9.2%. At this point, this includes more than 90 central offices. In markets where we have been selling FiOS data for at least nine months, the average penetration at the nine-month mark for each was 14%. At this point, this includes more than 35 central offices. These markets are spread throughout our footprint and compete with all the major cable players. These early penetration rates indicate that we are well on our way to achieving our goal of 30% penetration in five years. In video, we are seeing great initial acceptance by customers. In Keller, Texas, our first video market, we have already achieved 21% penetration in only four months. Within the last few months, we also began selling FiOS TV in some other Texas markets as well as Temple Terrace in Florida and Herndon, Virginia. While it's a bit early to give you penetration rates, we are very pleased with our initial sales and just this week, we launched video in Massapequa Park, New York and Woburn, Mass. We will also be selling services in a California market very shortly. As we move forward, we expect to continually enhance our video product and differentiate it even more with converged capabilities. So, we're off to a strong start. From a deployment standpoint, by the end of 2006, we expect to have passed a cumulative total of 6 million premises or about 20% of our households. Going forward, we expect to pass about 3 million per year. As we gain scale and connections, we will also be able to drive more costs out of the business and we also expect that technology improvement will further drive down our network costs, as well. Moving to our wireline margin, operating income margin, excluding pension and OPEB was 16.1% for 2005. In fact, we're targeting about a 16% margin for 2006. Of course, we normally see some variability in operating margins on a quarterly basis. The fourth quarter difference was largely driven by our very high growth in DSL and FiOS deployment. I would mention that as we gain scale in DSL, we have turned the corner on EBITDA profitability, which should continue to improve and help margins going forward. Quarterly cash expenses were up 2.6% year-over-year. We continue to see significant opportunities for additional cost savings. We have many new cost initiatives, which I'll discuss in a minute, which will help stabilize telecom margin performance. As you would expect, we continue to be focused on improving the wireline cost base. We closely manage our force levels, balancing them with our work volumes, shifting manpower whenever possible to support the fiber initiative. Our overall wireline head count ended the year at 141,000. We are also replicating the success achieved by our Partner Solutions Group, which significantly automated wholesale orders and reduced head count and costs. Over time with higher in the fourth quarter on both a sequential and year-over-year basis. This was a result of us having to shift manpower to deal with the inordinately high damage and repair caused by the heavy rains, mainly in the month of October. Online bill payments are up 16% as we continue to drive customers to more efficient transaction-based services and we see further opportunities for savings in the areas of real estate and call center management. So to sum up wireline, we are rapidly transforming this business around the customer's growing demand for broadband. We are investing in broadband capacity in our access network, developing differentiated broadband products across all segments of the market and creating new revenue opportunities in markets such as video. You see this strategy taking hold in the fourth quarter with our record-setting performance in DSL, strong performance in data and our earlier success with FiOS. In the meantime, we're holding our ground with steady revenues, stable margins and a relentless focus on costs. We're confident in our strong wireline business model. And our network will give us an unsurpassed strategic and product platform for growth in the broadband era. I want to spend a few minutes sharing some information about our new business unit called Verizon Business, created by the acquisition of MCI. We believe this acquisition provides us with a great opportunity to further strengthen the power of the unified Verizon brand, particularly now that we can add wireless services to the product portfolio. We have an experienced management team in place with great leaders from wireline, Verizon Wireless and MCI. We have challenged these seasoned professionals with some very aggressive integration plans and some aggressive financial targets. We have a lot of experience in mergers and acquisitions, both wireless and wireline, and I'm very confident in our ability to achieve the synergies. On slide 24, you see these synergy targets by year. These run rates are about 10% higher than we originally announced, primarily from realizing these savings earlier than originally forecast. The net present value of the synergies has increased from 7 to 8 billion. Network savings represent nearly half of the total, with workforce reductions and IT savings each representing about 20% of the totals we estimate at this time. One significant area for savings in the network category is third party access savings, that is, bringing more traffic on net. These savings will be realized through a combination of moving more Verizon Wireless traffic on net as well as moving our out of footprint access and long haul LD traffic to the former MCI network. In 2006, we expect these savings across Verizon to be well over 200 million. In the area of workforce reductions, we anticipate achieving a workforce reduction of about 7,000 people within a three-year period. More than half of this reduction will be from eliminating duplicate corporate staff and from the mass market business area. In the IT and systems integration area, we also see significant opportunities. As far as the transition costs needed to capture these synergies, you can see our estimated annual spread of these costs on the slides. In total, we expect to spend about 1 billion over the next three years. Integration capital spending is estimated to be between 1.6 and 1.9 billion over the same three-year period. We estimate about 550 million of that will be spent in 2006. We have an aggressive go-to-market plan that will introduce the new Verizon Business to the marketplace. We hope to immediately enhance the customer experience with a more integrated approach to the sale of our wireless products. You can expect us to build upon Verizon and MCI's reputation for excellent service by transforming the service experience for our customers. We have a unique approach to business service delivery, called "Customer Service Surround". Our unique brand sales office structure places our account teams closer to our customers. Similarly, the Verizon Business Customer portal will put online service and account management tools at our customer's fingertips. From at your side support to online self-service and all points in between, our objective is to deliver an unmatched customer experience, geared to a customer's personal preferences. This will be a major element of the Verizon Business difference. And I want to emphasize that we see huge opportunities for margin improvement Verizon Business. As we look across all three network businesses, we continue to see significant cost savings opportunities over the next several years. Verizon Services, our recently created organization to provide back office and support services across our businesses, is an example of how we intend to increase efficiencies through economies of scale and reduce duplication of efforts. We are also conducting an extensive review of our expansive real estate portfolio. We are convinced that we can capture savings and unlock value through this portfolio rationalization. Web-based customer self-service applications are also examples of ways we can increase the efficiency of our business. Our network investments are intended to grow revenues and significantly reduce maintenance and operating costs. Our fiber build is a perfect example of this. Our innovative and competitively priced products and services are increasing customer retention and helping to reduce the cost of churn. As we strive to stimulate revenue growth in all of our businesses, you can expect us to continue our relentless focus on reducing our cost structure. Let me give you a couple of thoughts about how we're looking at 2006. As I said at the beginning of today's discussion, we are entering 2006 with excellent momentum. Our strategies are taking hold and customers are responding to our wireless and broadband products and services at record-setting levels, helping to diversify our revenue profile. These customer successes will continue to drive revenue growth in 2006. Our capital investments also enable growth. The investments in our network will result in market share gains and revenue growth. In addition, the resulting increase scale helps improve margins, earnings and return on invested capital. We previously stated that capital spending in 2006, excluding MCI, would be between 15.4 and 15.7 billion. With MCI, all-in capital spending is expected to be between 17 billion and 17.4 billion. The 1.6 billion to 1.7 billion incremental spending as a result of MCI, includes about 550 million of integration capital in 2006. With the MCI merger now complete, more experience with fiber and our EV-DO plans on track, we have a high degree of confidence in the stability of our 2006 capital program. From a total telecom capital spending perspective, we see 2006 as the peak expenditure level. We are very focused on maintaining stability in our margin as we grow the business. This morning, I have shared with you some of the cost-saving opportunities we see. Related to 2006 costs, let me give you a sense for net pension and OPEB expenses. As I noted earlier, net pension OPEB costs resulted in an unfavorable EPS impact of $0.30 in 2005. In 2006, we expect this total to be about $0.04 to $0.06 worse or $0.34 to $ 0.36 in total. As you know, we've taken steps to control future post-employment costs through changes in our management plan. As far as CFFO, we see improving cash flows, which will fund future investments in our networks and return value to shareowners. We have set specific goals and targets for our three network businesses. All of these are focused on growth, both top and bottom line, and creating value for shareowners. Lastly, this past December, we announced our plans to divest our Verizon Information Services Directories business. We are moving full steam ahead with our bankers. We are well along in developing the necessary planning to successfully accomplish this disposition in 2006. We will provide you more information on this value-creating transaction when our exact plans become more definitive. Thanks, Ron and I will turn it back to you. Hey, guys, good morning. Congrats on the quarter. Just wanted to ask a couple of questions on a couple of topics, first on the wireless side obviously and typically what's usually a lower margin fourth quarter, there was a big step down in CPGA, a big step down in cash costs per user. If we look ahead in '06, I was wondering if you could address some of those sustainability issues on those forces as we kind of look for where margins might wind up in the coming year. The second issue would be on the FiOS metrics that are coming out. Could you talk a little bit about whether those are being driven by conversions of existing subscribers in DSL or competitive winbacks? And then maybe the last issue would be on the directory spin. You know, whatever, how it happens, there's going to be probably incremental borrowing capacity or cash coming into the parent company. Any early thoughts on what the intentions are to do with that incremental flexibility? Thanks a lot. Hey, David thanks. If I start with, I guess the first question on wireless margins. I guess what I would say is we target wireless margins in the, you know, sort of mid to low 40s. That would be normal. To the extent that you didn't have the kind of growth, you know, you might actually kick it up a little bit. But I would think about the fact that we think there's lots more opportunity out there, there's a lot more at only 70% penetration, we think there's a lot more opportunity to grow, but the target sort of, you know, mid to low 40s. On your the metrics, I guess, for fiber, I guess the, the conversion rate from DSL is around 35%. Was there more with the DSL? That was it for DSL. Okay. And then Ivan, do you want to do the⦠Yeah, David, on the question of use of cash with the directory divestiture, the way we think about this is, as Doreen pointed out in her opening remarks, we feel pretty good about the visibility of our -- of our spending this year, where we're going to put our capital. So, we don't see the issue of the use of cash from the directory as impacting the run rate of what we would do with organic investments in the, in all three businesses, Wireless and Verizon Business as well as the Telco. Now, once we get a little further along into the year and we look at the form of the actual divestiture, our first focus there is to try to figure out a way to return value to shareholders using that cash. And as Doreen has talked about in the past, there are options to do lots of things, which is balance sheet improvement, reduce debt, buyback shares. So we'll, as this unfolds during the year, we'll -- we'll take a careful look at that. Hi. A couple of questions, first on the wireline margins, you had said in the past that FiOS would, would create dilution of about $0.14 in '05. Can you update us on that, on how that, how that turned out here in the fourth quarter? And then looking out into, into '06, we got the 16% EBIT premargin or prepension margin guidance. What kind of dilution from FiOS and potentially from the, you know, video rollouts are included in that number? And then just real quick follow-up on the DSL growth, is this kind of you know similar to David's question on wireless, is this a sustainable number? Is it being driven by the $15 plan? And how much, you know, if you can maybe in round numbers, are you getting a nice kick from FiOS, as well? Okay, I think on the FiOS question, it was $0.04 in the third quarter, it kicked up to $0.05 in the, in the fourth quarter. So, that was the incremental dilution. I think I did say, you know, in the text, that in '06, we sort of expect a $0.10 to, you know, $0.15 additional dilution on top of that. A lot of it based on success base, so that's sort of why the range. Yeah, that would be already built into the 16% target that we're, that we've talked about. On the DSL, I think, you know, about 50% of the net adds are coming from you know, from the 1495. However, very, very, very low migration, which is, which is something that's good. The people are really staying with their existing higher speeds. And as far as the ability to kick up, I mean the penetration of broadband is still very low, you know, in the country at 35%. So, we do think that there's a lot more opportunity, you know, we still have all the dialup guys converting, that's a lot of what's happening with the 1495. So, we think that there is still a lot more opportunity on broadband into '06. Yes, good morning, everybody. Thank you very much. Just looking at the dilution from media products, just following in from John's comment, how should we think about programming cost as well as subscriber position costs in 2006? You've launched a number of media markets this year and you're going to launch further as we go through 2006. What kind of operational expenses should we reporting into our models? And how media expenses and SAK are going to be amortized through the P&L? Thank you. Okay, hi, Viktor. Let's make sure I understand your question. The $0.10 to $0.15 obviously has the video piece in it. I would suggest that it probably ramps during the year, you know, as you start to have more success base, if you're thinking about how it spreads, right, you're going to, you're going to ramp it up through the end of the year. And on, as far as the, you're asking like what we're capitalizing and what we're expensing piece of it? On the video piece, I guess it's really mostly capital. Okay, thanks very much. Good morning. Ivan, there's been a lot of talk out of Europe about Vodafone being pressured to sell their stake in Verizon Wireless. Can you just talk about whether that's something you would still like to do and whether do you think there might be some more opportunity this year? And secondly, can you talk about the regulatory environment around video franchising? Any sort of movement in Washington or in the states, to try to get that moving along more quickly? Thanks. Yeah, on the Vodafone question, like everyone else, we were very interested in what we read and heard about the, the Vodafone earnings call. Our position has pretty much been the same all along and maybe I, and there, I take a moment to clarify where we are in this. First of all, we've had no direct indication from Vodafone that they've changed their position. So, we're as anxious as anyone else is to see how the, the conversation that started the other day materializes. To the extent, however, that there is a change of a view coming from Vodafone, we clearly would be interested in increasing ownership of Verizon Wireless, whether in stages or actually acquiring 100% of it. I would add that we also recognize that the put option is not the preferred vehicle for Vodafone to facilitate any transaction. That was exactly the issue we had when they were considering the purchase of AWE. So, so, Simon, we are very open and willing to consider negotiation around that to make sure that it's efficient for both sides and it's, we can maximize value for both parties. You know, when you think about it, Verizon Wireless has gone through an extraordinary run here. It's, it's created a lot of value for both sides. And that I think that it's a good time to think about this and so we would stand ready to work on that. One other point that, that I would make is that, as we think about this, just so that Verizon shareholders would understand how we think about this, Doreen and I have, have talked about this, and our view is to the extent possible, we would try to do anything here if it was, if it was given to us by Vodafone, with as much cash as possible. And so, for example, like everybody understands, the Omnitel ownership, perhaps the, the divestiture of VIS would all be, be part of how we would think about funding, funding the whole operation. So, I think we need to give Vodafone some room to think through what they want to do. But our position, Simon, has been what it's always been. If the opportunity came to be, we would be, we would stand ready to work with them. Yeah, on that we feel that we're making good progress here. We got a few more franchises working. Weâve got plans for several hundred more to file. There've been a couple of breakthroughs in several states, in which legislatures have taken votes on it. We even have one state, believe it or not, where the, where the local cable association has taken a positive position on, on where we are. So, I think, Simon, the way we see this, is we're going to continue the, the sort of community by community approach that we've started. But we feel we are getting traction in several states. We're taking a look at the broader picture. I'm sure you know that next week there's a hearing in Washington on this subject. So, I think there's a lot of momentum building, and we're taking the position we're going to do this step by step, but also look for the sort of broader policy opportunity and we feel that the, the stars are lining up for public officials to take a more aggressive stance on this over the next several months. Good morning, guys. Ivan, if I could just follow up, two questions, if I could follow up on your answer to Simon's question just now. I was wondering if you have any sense of what the difference in timing looks like between a state level approval process for franchising versus a municipal, municipality by municipality one? And then, Doreen, is there any way you can give us a similar kind of update as you did last quarter on where we are on things like operating expense savings and capital savings that you're seeing in markets that have had FiOS for six or nine months or longer? Yes, quickly, I don't think there's a big issue associated with timing. I don't think there's, by the way, any story there. I think that the law is the law. I think we have to go out and get, and get franchise approvals and we're doing that and we're doing it aggressively. And we're queued up. We don't feel that there's any impediment to our rolling out FiOS during the year, 2006. Admittedly as we go into two seven and '08, we'll need to be more aggressive because we'll be in more communities. But by that time, I'm sure we will have so much success with, with the early deployment, that the whole political environment starts to, to change as we go forward. We've already seen that. And as I, we've said before, every place where we, we instigate a vote, the vote usually comes out, you know, let's, let's create competition in this, in this marketplace. So, we do have some, some things in the regulatory process we need to work through, but I don't think there's any, any timing issue that we have to face anytime in 2006. Okay, and Jeff, on the operation, operation savings or on the capitol savings, I think at this point, the scale, the amount of how homes that we really have connected, it's really to small to have, you know, to have a lot of data. What we get is antidotal at this point. So, it is, it is, we do track, say when there's weather-related, you can see that the trouble reports from those, those homes, you know, don't vary at all. But as far as, you know, being able to say it's "X" amount of dollars at this point, I think we need, you know, some more time and some more scale before we can really get our hands on that definitively. Good morning. Doreen, you had talked about workforce and, of course, with, with MCI you'll have about 250,000 employees, and you had mentioned 7,000 over, over a three-year period. Can you comment a bit on, on the overall strategy of, of head count management? In all well, in the different units if I starting like with wireless, in wireless, I think what we've seen is, you know, you'll see increases because of its growth, plus we've had different strategies in wireless, where we're actually putting people in stores. So, to the extent that you're actually putting a store within a store, you're actually growing your head count. If I move over to the Telco, they will have, you know, some reduction level this year and part of it will be, you know, a straight reduction. The other piece is, you know, they're going to move some people really on to the FiOS plan. So, they have a fairly significant number that they're going down. But some of it is, in fact, a shift from the base into capital. And the 7,000 that we talked about, a lot of it, very heavily front-end loaded of that 7,000 over the first two years. So, you'll see a substantial number going down, a lot in the mass markets initially. Okay? Okay, just a couple of thoughts here. Hopefully as, as investors and owners look at our Company this quarter, there's a couple of things that, that we would like you to consider as you do your analysis and you look out into the future about us. First of all, hopefully you see that, or as Doreen said, our strategies are taking root, we're gaining some momentum. There is a greater shift of our overall top line focused on the growth markets. You can see that in all of the markets that we have significant opportunities. Our Telco is gaining customers. We recognize we need to convert the investments in FiOS and DSL and LD into bottom line results and we're anxious to, to prove that. The VZ Business to us, that is a bottom line story of getting synergies out and generating improvements in, in cash year-over-year. The wireless story speaks for itself. It's both the top and the bottom line story and it's one of raising the bar and widening the lead. But while that's happening, hopefully that, that everyone sees that wireless looks at the market as having more unlimited opportunities, rather than a closing, a ceiling on it. There's plenty of growth available for us, and with the kind of engine that our team has built, we're in good shape. There's always a lot of discussion about returning value to shareholders. The only comment that I would like to make on that is, that as we finish 2005, we took steps with our pension for management. We, we just took a step, last month, to increase our share buyback capability from 80 million to 100 million shares. We have focused on the divestiture of VIS and the quick go-to-market for the MCI combination. So, we feel we're in a better position, as we move into 2006, by executing on our plan, showing that we have good solid results and good, good operating focus. But at the same time, the Company will have increased flexibility to deal with how we return value to shareholders during the year. The, the new starter this week, as we were preparing for this call, obviously the new interest and perhaps acquiring a greater ownership share in Vodafone. While there's still a lot of work to be done and we have to be sure we, we know where Vodafone comes out, that's another opportunity that, if it came to us, we would be more than delighted to, to go forward. So, with that, we feel like we had a good quarter. And that we're poised to continue the momentum into 2006. Thanks. |
EarningCall_234048 | Hereâs the entire text of the prepared remarks from Medimmuneâs (ticker: MEDI) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Ladies and Gentleman and welcome to the MedImmune 3rd Quarter Earnings Conference Call. My name is Ann Marina I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a Question and Answer sessions after the presentation of todayâs conference. If any time during the call require any assistance please â*â followed by â0â and a coordinator will be happy to assist you. I would now like to turn the presentation over to Mr. Peter Vozzo, Director of Investor Relations. You may proceed. Good morning and welcome to MedImmuneâs Quarterly Conference Call of Investors. This call is being electronically recorded and the copyrighted by MedImmune. No reproductions, transmissions or copies of this conference call may be made without written permission of MedImmune. In this call, members of our senior management will discuss MedImmuneâs financial results for third quarter of 2005, as-well-as the Companyâs business outlook going forward. Please note that any statements for the Companyâs prospects or future expectations are forward-looking statements. As you know forward-looking statements involve, substantial risks and uncertainties and actual results may differ a materially from expectations. Please refer to the press release issued earlier today that is related to this call and to our filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ. Todayâs press release describing our third quarter 2005 results, may be found at our website at www.medimmune.com in the box marked news, or with the archived press releases on investor relations page. And now, I will handle the call over to the David Mott, MedImmuneâs President and Chief Executive Officer. Good morning everyone, thanks for joining us again. Let me begin by just remarking, what a quarter! The past quarter and frankly, the entire first nine months of 2005 have been a period of tremendous accomplishment and productivity across all areas of our business, commercial product development, operations, and corporate development. I actually have our entire Executive Committee here with me for the call today, and I must say this is the team I am proud to be part of. We have James Young, President and Research and Development, Armando Anido, head of Sales and Marketing, Edward Connor, Chief Medical Officer, Lota Zoth, Chief Financial Officer and I specifically asked Ed Mathers, who runs our corporate development function to join us this morning to take a figurative bow, because his group has really been bringing home the bacon for us during 2005. After Lota and I review the details of the quarter in our usual fashion for you, the whole team would be available for any questions you might have. During the quarter, we continued to make progress on many fronts toward our 2009 goals of generating approximately $2 billion in revenues and $2.0 of earnings per share before stock option expense. Worldwide sales of Synagis in the 2005 third quarter increased 66%, from the third quarter of 2004, due to a significant increase in Ex-US inventory stocking by Abbott international in anticipation of the season of strong growth. Domestic sales of Synagis increased, modestly during the same period as our US distributors built their inventories for the coming RSV season. We entered into an agreement Abbott, to buy them out of their US co-promotion rights for Synagis following the 2005, 2006 RSV seasons. This transaction provides us with substantial strategic operational and financial benefits in the future. We received regulatory approval in Japan for the use of the Synagis in children with hemodynamically significant congenital heart disease, at 8:00 o clock in the morning. We submitted a supplemental biological license application with the US Food and Drug Administration for approval to use our refrigerator stable formulation of FluMist, known as CAIV-T, in preventing influenza in healthy individual 5 to 49 years of age and we submitted an application for a new bulk manufacturing facility in the United Kingdom. We formalized a cooperative research and development agreement with the NIH, the development investigational pandemic influenza vaccines. Worldwide sales of Ethyol in the 2005 third quarter grew 15% over the same period a year ago. We announced the acquisition of Cellective Therapeutics, a privately held company that will provide MedImmune with three preclinical antibody programs targeting the B-cell antigens CD19, CD20 and CD22, this acquisition will significantly strengthen our growing capabilities in the area of B-cell biology. As you may have noted from our public announcements we closed this acquisition last week. The licensed worldwide rights from Glaxo SmithKline to develop anti-staphylococcal molecule antibodies of which the lead antibodies in phase II clinical development for the prevention of serious blood stream infections caused by Staphylococcus in low birth weighed infants. We signed a new collaborative agreement with VasGene Therapeutics and in-license technology from Georgetown University, to develop cancer focus molecule antibodies targeting different tyrosine kinases further building on the expanding expertise we have developed in this area with our FA-2 and FA-4 research programs. We filed in an investigation on new drug application to begin clinical studies of our antibody targeting interferon-alpha, focusing on lupus, which for your record keeping we referred to this product candidate as Medi-545 and as you noticed in our press release issued this morning just after we issued the earnings release, we entered into yet a another licensing in collaboration agreement this time with the company called Avidia to develop anticancer products targeting CMET a receptor tyrosine kinase and develop two additional target using a Avidiaâs Avimer technology. Letâs now, dig a bit deeper in the several of the items that I just highlighted above, starting with a few more details on a product sales during the quarter. For the third quarter 2005 worldwide sales of Synagis increase 66% to a $101 million as Abbott international began to build inventory in preparation for the current RSV season. You will recall the last year AI began to stock ex-US inventory in the second quarter, but waited until the third quarter this year to begin the seasonal bill. Sales to AI were $58 million in the third quarter of this year compared to $19 million last yearâs quarter. In the US sales of Synagis for the 2005 third quarter were $43 million up 2% compared to the third quarter of 2004. As most of you already know sales of Synagis occur primarily during the winter months in the 4th and the 1st quarters when RSV is most prevalent in Northern Hemispheres. As such in the second and the third quarters, when we have relatively low sales of Synagis, our reported results can be unusually impacted by year-over-year variations in the international product shipments and US inventory fluctuations. Through September 30th of this year, our nine-month results include world wide reported sales of Synagis that increased 16% to $624 million compared to $539 million in the same period last year. This growth rate has been driven by the strong ex-US sales to AI that have grown 46% to $98 million and solid US sales that were up 11% to $526 million. To continue to increase the support Synagis and further enhance pediatrician awareness of the benefits of FluMist, we added 50 new biotech sales professionals to our sales organization over the summer. We now have a total of almost 300 sales professionals focused on pediatrics. This year we expect to introduce the liquid formulation of Synagis by November, after depleting the existing inventory of the lifeline product. The liquid formulation is the product improvement over the current freeze derived formulation that we believe will enhance the convenience for physicians in administering the drug, and as such has the potential to reduce the amount of time young patients will need to wait in doctorâs offices to get their doses of Synagis, which in turn could help produce their exposure to sick children in physician waiting rooms. And with the help of Abbott international, our distribution partner outside the US we received approval this week from Japanâs Pharmaceutical and Medical Devices Agency for the use of Synagis as a prevention in pediatric patients with hemodynamically significant congenital heart disease. This further expands the label and opportunity for Synagis in our second largest market. Longer term, we continue to focus intensely on building the value of our RSV franchise. As I mentioned in my opening remarks, we recently amended our US co promotion agreement with Abbott for Synagis. I believe this transaction has tremendous strategic and financial value for MedImmune. First MedImmune will take full responsibility for sales of Synagis in the United States starting in the 2006, 2007 RSV season. We planned to expand our pediatric sales in marketing organization by approximately 125 professionals in advance of the 2006, 2007 RSV season to replace Abbottâs co promotion efforts, which will provide us with strategic and operational advantages, as we prepare for the continued growth of the pediatric infectious disease component of our business. Key opportunities in this area include the potential launch of CAIV-T our next generation intranasal influenza of vaccine in the fall of 2007, the potential fall 2008 launch of Numax and the recently announce anti-staphylococcal antibody program we acquired some GSK, currently in phase II development. Abbott will continue to co-promote Synagis in US during the 2005, 2006 RSV season and will in fact have been greater direct financial incentives prior to achievement of our common sales goals for the 2005, â06 season that Medimmune prior to the amendment. They will continue to be directly compensated based on our US sales of Synagis throughout 2006 to ensure our interest continue to be aligned, with anticipated launch of Numax in 2008 it is MedImmuneâs intent to replace Synagis in the market place with Numax, assuming Numax is approved by the FDA, given that Abbott does not have a commercial or financial interest that product in the US. This accelerated termination of Abbott co promotion of Synagis, avoid the divergent of our interest as the launch of Numax gets closer. Finally the transaction with Abbott get substantially accrued to MedImmune earnings beginning in 2007, driven by the elimination of the co promotion commissions, we pay to Abbott, which over the last 12 months already exceeded $200 million per year. Importantly while we continue to be very optimistic about the prospects of the Numax, we are now positioned to achieve our 2009 earnings per share goal of $2.0 before stock option expense, whether we were selling Synagis, Numax, or both. Currently we are conducting several trials with Numax, our third generation anti RSV antibiotic. In our Pivotal phase III trial for this drug in which we are comparing at Synagis, our goal is to show that, Numax is at least safe and effective as Synagis in reducing RSV hospitalization in high-risk infants. We completed dosing 2,695 patients in the first Northern hemisphere portion of the trial earlier this year, enrolled 605 additional patients in the Southern hemisphere component of the trial in the second quarter and started enrolling the balance of our overall target of 5,750 infants this week. We expect to have results from the trial available in the second half of 2006. If all things continue to go well and the FDA approves the drug, we continue to believe that we could be in a position to introduce Numax to the market for the 2008, 2009 RSV season. Now let me turn to the update on other trials with Numax. We initiated dosing by 136 children in a phase II study being conducted in the Southern hemisphere, evaluating the safety of re-dosing children with Numax for a second season and anticipate completing dosing by the end of this month. We are planning to start enrolment of the safety trial on the Northern Hemisphere this month, in which Numax will compared to Synagis for the first time in approximately 600 children with hemodynamically significant congenital heart disease. And finally, we were initiating dosing for the second year of another late stage trial of Numax that we initiated last November, focused on assessing whether Numax can help produce the incidence of RSV hospitalization in full-term native American infants. We enrolled 329 children during the past RSV season and planned to continue enrolment over the next three to four seasons. In addition the measuring the reduction in RSV hospitalization, the studies designed to measure the incidents of wheezing episodes at three years of age, if an impact on really wheezing is absorbed and evaluation of pulmonary function at age 5, will be assessed. Synagis has been very successful drug and its ability to help reduce serous RSV disease in infants. If the pharmacy we see with Numax in preclinical studies holds true in children. It may be even better than the Synagis in helping to protect the lower respiratory tract and preventing RSV hospitalization. In addition Numax may be able to protect the upper respiratory tract and decrease the incidents and severity of upper respiratory tract infections such as otitis media. However as usual, we will remind you again that we cannot rule out problems could arise at any time as we advance for Numax program. Next in our RSV franchise is our combination vaccine against RSV imperial influenza of virus type III. As of the end of September we had fully enrolled the 120 patients targeted in double blind Placebo controlled phase I trails to evaluate the safety, tolerability and immunogenicity of our lead candidate vaccine in healthy adults. Data from a pre-clinical study have showed that our vaccine candidate may induce the protective immune response against both viruses. Letâs now switch to FluMist and CAIV-T and review our long-term strategy regarding this product and recap some of the recent events. First Iâd like to emphasize again that as I have on previous investor calls, that the current situation for the flu supplying, for this season and in the future years is complex and very difficult to predict. Our long-term plans for FluMist are to establish it as a better influenza vaccine preferred by pediatricians. To get there we must first show that refrigerator-stable CAIV-T is biologically equivalent to the currently approved frozen formulation. To that end we successfully demonstrated equivalent immunogenicity of CAIV-T and FluMist in our Bridging Study. And we recently submitted a supplemental biologic license application with the FDA for approval to use CAIV-T in preventing influenza in healthy individuals 5 to 49 years of age. If we obtain FDA approval we can then eliminate the difficult storage conditions that currently hampered the handling of FluMist after it is shipped to customers. We believe that this will provide greater accesses to the product in a currently approves age range of healthy people between 5 and 49. In addition in August we submitted an application to the FDA for a new state of the art bulk vaccine manufacturing facility in the United Kingdom. This facility, which incorporate several improvements to the manufacturing process, will have a capacity of upto 15 million trivalent bulk doses per month, with approximately 90 million trivalent doses per influenza manufacturing season. Construction and validation were substantially completed in Spring 2005 and the FDA actually completed itâs site inspection this week. Until regulatory approval of this new bulk facility is obtained, MedImmune will continue bulk production and FluMist in nearby leased facility. The Companyâs existing blend/fill/finish vaccine production facility in Pennsylvania has undergone improvements and modifications to increase finished product capacity to approximately 35 million trivalent doses for the influence disease. Any decision to further increase blend/fill/finish capacity will be driven by feature product demand. Next we must expand the label, to include children under the age of 5 and to show that our product is better helping to reduce influenza illness in young children. If the clinical data that support CAIV-T, is better than the shot, pediatricians weâve spoken with tell us that they would likely recommend the use of the intranasal vaccine, for most of their patients. Towards this goal, we continue to expect unblind our Pivotal phase III study this quarter. This study is designed to compare the safety in efficacy of CAIV-T directly to the injectable flu shot in nearly 8,500 children, between the ages of 6 months and 59 months. We do know that we have documented more than 600 cases of culture confirmed flu in the overall study population. Once weâve unblinded the study, we expect to share with you at least top line results, sometimes soon thereafter as we get data ready for submission to the FDA, which we still target to be in the second quarter of 2006. What we are hoping to show from the study is that CAIV-T is a differentiated flu vaccine, one that would be perceived as better by pediatricians and top(ph) leaders, they are preventing influenza then the traditional injectable vaccine particularly in children. We will look at efficacy against vaccine matched and mismatched strains and balance that against the safety profile of the product, to determine with the recommending bodies in pediatricians would consider better. If it is not a differentiated product, we would not consider it good fit with our portfolio and would evaluate our alternatives, such as out licensing it or selling it. In addition to our two primary goals of FluMist and CAIV-T we are also strategically planning for the expansion of the label to include adults 50 years of age and older and to collect additional safety data in certain high risks populations, that will hopefully show that the live attenuated influenza vaccine is safe for use and immune compromised individuals and other healthy people beyond the healthy population. Thus far 42 FluMist and CAIV-T trails involving 64,000 subjects have been completed in children down to 6 weeks of age and adults up to 98 years of age and we have seven clinical trials underway involving nearly 70,000 additional subjects. Ongoing clinical trials include a large multiple season safety surveillance trial being conducted in the Kaiser system. A shedding and immunogenicity trial on the individual ages 5 to 49 years old, a trial designed to study the impact of vaccinating large numbers of school age children, and the affected areas on the community, and a herd immunity trial designed to look at the effectiveness of immunizing large numbers of children to community based mass vaccination outreach efforts. Our commercial focus of FluMist continues to be and trying to expand the usage of the current formulation of the vaccine during the development cycle of CAIV-T, which we hope to deliver to the market in 2007. We then fine tuned our efforts to built top leaders and public policy support and invested in medical education, addressing the scientific rationale for a live attenuated intranasal vaccine, including the vaccines safety in efficacy as well as potential protection against drifted strains. We believe significant progresses has been made, for example new recommendations from the Centers for Disease Control and Prevention Advisory Committee on immunization practices help and encourage the use of FluMist last season among healthcare workers, allowing it be used in more than 900 hospitals across the US. In this season, the ACIP has included in its priority influenza immunization recommendations, that FluMist may be administered at any time for vaccination of non-pregnant healthy persons, age 5 to 49 years including most healthcare personal. Other persons in close contact with groups at high-risks, for influenza related complications and others desiring protection against influenza. FluMist is therefore not subject to the cheer recommendations for prior use of trivalent inactivated influenza vaccine prior to October 24th. Another aspect of our commercial focus, is to increase the use of FluMist among school age children by expanding the number of pediatric practices utilizing FluMist. Towards this end a few things are new for the 2005, 2006 influenza season. First FluMist has been included in the federal governments of vaccines with children program. For healthy children aged 5 to 18 years who lack sufficient healthcare coverage. Second, as the part of FluMist for schools, public health initiatives, MedImmune is providing the vaccine to several school districts across the country. And thirdly, at least one state, New Jersey has seen the importance associated with vaccinating all school age kids, with its recently issued public health recommendations, that all children in this age range should be protected against the flu. We began shipping FluMist in the August, actual I think it was August 31st and sold approximately 800,000 doses during the 2005, third quarter resulting in revenues of about $10 million. As you may recall we did not begin shipping FluMist last year until the beginning of the 4th quarter. I mentioned earlier that the Flu business is full of complicities that seemingly change with each new season. At the beginning of this year, we gave guidance that we would expect a modesty increase in product sales for 2005 has comparative to 2004 product sales of $48 million. Our forecast was based on Chiron not being a factor in the market place, assuming that if they back it all, they would be back late in the year and with a relatively small amount of product. But, we donât know right how Chironâs recent announcements will impact over all flu vaccines supply or demand for FluMist, we do have 2.5 to 3 million doses of available for commercial supply of this season. Now let me briefly mentioned, our recently finalized agreement with the National Institute of Health to develop pandemic influenza vaccines and the intellectual property we had assembled around reverse genetics. As we announced in September, under a cooperative research and development agreement we will work together with the leading researches of the NIH to produce and test versions of MedImmuneâs attenuated live intranasal influenza vaccine for use against different types of potential pandemic influenzza of strains, including one based on H5 and 1. In fact, an initial clinical trial with our vaccine technology has already been conducted with the vaccine against another Avian Flu strain H9 and 2 and results are currently been analyzed. We will use our propriety reverse genetic technology to develop the pandemic vaccines. This technology allows us to alter potentially harmful portions of influenza viruses, such as the hemoglobin protein of the H5 and 1 virus strain and rapidly produce attenuated vaccines strains, thereby accelerating the vaccine production. In the interest of public health, weâve offered licenses for reverse genetic technology to US and international health authorities and other vaccine manufactures, developing pandemic influenza vaccines. It is important to note that MedImmune owns an exclusively licenses certain patterns and technology in the field of common influenza production and reverse genetics. Lets move to Ethyol. In the third quarter of 2005, worldwide sales Ethyol were $25 million up 15% compared to $21 million reported in the third quarter of 2004. Wholesaler and distributor inventory levels at the end of the third quarter 2005, were down 42% compared to the year ago period and we continue to anticipate that sales would be returning to growth consistent with underlying demand. As I mentioned on previous conference calls, a number of market conditions and disruptions negatively impacted sales of Ethyol in 2004, both in the US and the rest of world. We continue to build on our efforts started last year and we are still anticipating returning to an annual growth pattern in 2005. On the clinical development front for Ethyol, we are progressing on two clinical studies that possible expand which gives a new indication. The first is the phase II trial evaluating Ethyolâs ability to help reduces esophagitis in patients with non-small cell lung cancer. Weâve enrolled 127 patients in this study and expecting annualized data from the first 100 patients shortly. If the data demonstrate positive trends in absence of any safety issues, we planned to expand enrolments to approximately 300 patients. The second study is a phase I, II trial of evaluating Ethyolâs effectiveness in reducing toxicities to certain increase chemotherapy regiments on patientâs with acute myelogenous leukemia in order to improve tumor outcomes. Switching over to Bitoxin (ph) I would like to update you on our progress in our studies and melanoma and prostate cancer patients. During the third quarter we were due to the full one year data from a 112 patient melanoma trial with our oncology advisory board, as well as the ongoing analysis from additional preclinical and biomarket studies with Biotoxin. The advisory board concluded that while there is evidence of biological activity, it is uncertain whether these results can be confirmed in phase III trial. Further weâve also tried to balance the cost of the large phase II trial in melanoma against what we view is a relatively small market opportunity for this particular cancer. Therefore we have decided to wait for the final data from the phase II pro-state cancer trial and completion of bio market study in melanoma to make a more informed decision regarding further studies in melanoma patients. We completed enrollment in 126 patients phase II prostate cancer study in April under the amended protocol and anticipate annualizing the primary end point data from the study by the second quarter of 2006. Before I turn the call of the Lota I would like to briefly mention a few other projects in our pipeline. During the third quarter of 2005, we continued to enroll patientâs in second phase I study with subcutaneous administration with our anti IO-9 antibody, that we hope to develop that as an asthma therapy. We completed a phase I safety in pharmacokinetic study with this antibody intravenously administered the healthy adult volunteers earlier this year. We recently announced that, we closed in the fourth quarter the acquisition of Cellective Therapeutics, this transaction provide us with pre clinical antibody program is targeting important B-cell antigens and expands our capability in B-cell biology an area we expect to generate significant new therapeutic opportunities in the future. During the third quarter, we announced that we license worldwide rise from GSK to develop certain staphylococci molecule antibodies. The lead antibodies in phase II clinical development for the prevention of serious blood stream infection cause by staphylococcus in low birth weight infants. In addition we in-licensed technology from George Town University for the development of molecular antibodies targeting, anaplastic lymphoma kinase, a member of the insulin receptor family of tyrosine kinases, we initiated the collaborated agreement with VasGene Therapeutics that developed cancer progress antibodies targeting in normal member of the subfamily of receptor tyrosine kinases FB-4, as well as Ligand F, B2. And we announced this morning that we entered into a licensing and collaboration agreement with the Avidia to develop anticancer products targeting cMET a receptor, tyrosine kinesis and to develop additional targets using a Avidiaâs Avimer technology. Last week we filed an investigational new drug application to begin clinical studies for MEDI 545 or fully human antibody targeting interferon-alpha. Preclinical data indicate that levels of interferon-alpha are elevated in many patients with active systemic lupus and other autoimmune disorders and may be associated with disease activity. And finally we are excited to about the results that Merck presented at the Infectious Disease Societies of America annual meeting earlier this month, from their ongoing phase III study with their HP candidate vaccine showing 100% success against cervical pre cancers and noninvase of cervical cancers. We believe those results along with the results from GKSs program validity the research that was conducted at MedImmune in the mid to late 1990âs. We look forward to LA filings from both Merck and GKS for the HPV vaccine candidates in 2005 and 2006. And expect these important new vaccines begin to contribute to a significant stream of royalty and milestone income MedImmune in the future. This time I will hand over the call to Lota for more detail discussion of our financial results. [Lota Zoth, Chief Financial Officer] Thank you David and good morning to all. Now at the time in our call today to discuss the financial results for the company, for the third quarter of ended September 30th. As usual David will take you through the highlights of our product sales, so let just recap couple of points. Our worldwide sales of Synagis were $101 million in the third quarter of 2005, compared to $61 million in the third quarter of 2004. As David mentioned, with relatively low seasonal sales for the quarter, the underlined trends were impacted, by the timing of the international product shipment. Reported sales of Abbott international were $58 million in the quarter up from $19 million in the last yearâs quarter. Sales of Synagis in the US increased 2% in the quarter to $43 million. As we mentioned before last years preseason inventory bill in resulting international sales to AI occurred principally in the second quarter while this yearâs stocking occurred largely in the third quarter. I would also I like to point out that other revenues of $8 million in the third quarter of 2005 included revenue from AI in consideration for the ex-US Numax distribution rights under the terms of our amended distribution agreement. I would now like to briefly comment on our bottom line results. Our third quarter 2005 net loss was $ 64 million or $0.26 per share. This is comparable to last yearâs reported third quarter results, which was a net loss of $65 million or $0.26 per share. We recently exclude the charges taken in both years associated with the termination of the Voice agreement, as described in our press release issued earlier today, the net loss for the 2005 third quarter, will be $61 million or $0.25 per share, compare to a net loss of $55 million or $0.22 per share in the 2004 third quarter. I do admit if I did not remind you that historically our quarterly results to reflect the seasonality of Synagis, with the first quarter being the most profitable quarter. Further our quarterly spreads of earnings per share are also impacted by the timing of R&D expenses, and the impact of FluMist on overall gross margin. Iâll now walk you through our expenses for the third quarter of this year. Letâs begin with gross margin, as the press release today describes, our overall gross margins on product sales for the third quarter was 67%, compare to 56% in the third quarter of 2004. Excluding the impact of FluMist gross margin of 72% in the 2005 third quarter were higher than gross margin of 69% in the 2004 third quarter, primarily due to the impact of higher international sale of Synagis in 2005. Also aiding margins in the third quarter was the impact of reducing approximately $5 million in past royalty overpayment on Synagis. And while FluMist is currently continuing to exert downward pressure on overall gross margins, the impact was lessened for the 2005 third quarter due primarily to reduce production cost and our expectations for being able to utilize bulk inventory produced this season for next yearâs production. For the first nine months of 2005, gross margin excluding FluMist was 75%, compared to 74% for the first nine months of 2004. Letâs move on to the Research and Development. R&D expenses for the third quarter of 2005 increased to $119 million up 63% compare to the third quarter of 2004 and driving year-to-date R&D expense to $266 million. Thatâs for this year-to-date R&D stand is approximately 36% of year-to-date product sale. The growth in R&D expenses, in this yearâs third quarter compare to last year is due to a higher level of activity from both new and ongoing collaboration agreement and clinical and pre-clinical research and process development activities. Included in the third quarter of this year, were up fronties and milestone payments under licensing agreement and research collaborations totaling approximately $36 million. Compared to up frontiers and milestone payments, of approximately $1 million in last yearâs third quarter. The 2005 third quarter, includes collaboration for GSK for the Antisep antibody and VasGene Therapeutics for the EphB4 and EphrinB2. In addition we had ongoing expenses related to the continuation of several later stage Numax studies including the Pivotal Phase III studies David had discussed earlier. SG&A expenses for the third quarter of 2005 increased $81 million from $68 million in the third quarter of 2004, primarily due to higher selling cost largely driven by the expansion of the pediatric commercial organization. Income taxes for MedImmune are a complex area, given our tremendous growth including acquisition and the seasonality of our business. That complexity was clearly demonstrated in the effective tax rate in the third quarter and for the nine-month period. Let us start with the quarter. The effective tax rate used to calculate the benefits from income taxes on the pre-tax laws reported for the third quarter of 2005 was 29%, compared to 37% in last year third quarter. As outlined in our press release today, the Company identified and made a correction to the prior accounting for the reversal of valuation allowances that occurred in relatively small amount since 2002. The total amount of the correction was $5 million. Tax related evaluation allowances are reversed, if it is determined that they are no longer needed, as this was the case when we were able to utilize, certain income tax carry forwards acquired from Aviron in 2002 to offset taxable income in the companyâs tax return. The proper treatment for the reversal of these particular evaluation allowances would have been to reduce goodwill, rather than to reduce income tax expense. Therefore the $5 million correction made during the third quarter, had the impact of lowering the effective tax rate for the quarter and also reducing goodwill. Remember that while we had a taxable loss for the third quarter, the seasonality of our results are such that for the nine months ended September 30th we had comparatively lower amount taxable income, reflecting a strong first quarter of earnings followed by seasonal losses in both the second and third quarters. As such, the $5 million correction actually had a more significant impact on the effective rate for the nine-month period driving it up to 65%, compared to 34% last year. We ended the third quarter 2005 with cash and marketable securities at $1.4 billion, compared to $1.7 billion at December 31st 2004. Itâs important to know that the third quarter is the seasonal low point in cash balances, prior to the ramp up of correction related to Synagis and FluMist. This decreases also due to payment related the average to the amended Abbott agreement up front payments related to collaboration activities and the purchase of approximately $106 million of our common stock including 1.4 million shares purchased at the cost of $38 million in the third quarter. To the end of the third quarter 2005, weâve repurchased $366 million of common stock under our $500 million share repurchase program that was authorized in July of 2003. I would also like to point out that our fitness disclosures in the press release, we issued this morning has information related to the amended US co-promotion agreement with Abbott for Synagis. In connection with its transaction the company recorded an intangible asset of $360 million, which represents the estimated fare value of the co-promotion rights as determined by the sum of probable additional payments to be made under the amended agreement. The intangible asset will be amortized into SG&A proportionally with Synagis sale, while active sales and marketing programs continue Synagis in the United States, intangible anticipated launch of Numax. Included in SG&A for the 2005 third quarter, is amortization expenses of approximately $4 million associated with the intangible assets. In the third quarter MedImmune made cash payments totaling $70 million to Abbott. As we enter into the fourth quarter, let me comment a bit on our full year guidance. As a remainder on February 3rd 2005 MedImmune provided its overall financial guidance for 2005. On August 31st the company reduced its earnings per share guidance by $0.10 to $0.11 to a range of $0.24 to $0.30 based upon the revised co-promotion agreement with Abbott that had the impact in 2005 of primarily increasing SG&A cost. On September 14th 2005 the Company further updated its earnings per share guidance with the acquisition of Cellective Therapeutics. This transaction, which closed last Friday will result in a one time non-detectable IPR&D charge in the fourth quarter that is expected to reduce, our 2005 diluted earnings per share by approximately $0.20 to range of $0.4 to $0.10. The effective tax rate for the year is expected to be approximately 94%. So, while we see to exclude the impact of the non-detectable IPR&D charge for Cellective the effective rate would be approximately 43%. Today MedImmune is reconfirming the guidance given in February 2005 for revenues, gross margin and R&D expenses and reconfirms the revised guidance given in September 2005 for earnings per share. Let me mention the couple of other items that had the potential to negatively impact our outlook for the remainder of the year. The first is, that we are continuing our aggressive business development efforts, which may result in upfront payment as we seek ordnance or own internal capabilities with external investments in our pipeline for the goal of bringing Numax, CAIV-T and two additional products to market over the five-year planning horizon through 2010. Secondly to reiterate a point David made earlier the current Flu environment makes it difficult to estimate demand and predict with certainty the financial impact of FluMist sales in the fourth quarter, with that Iâll turn the call back to David for his closing comments. I would like to close by emphasizing that weâve had an extraordinarily productive quarter and year thus far in 2005. Weâve made substantial progress toward achieving our long-term goals. The buyout of Abbott, US co-promotion rights for Synagis, the increased economics we receive to our expanded Ex-US distribution agreement with Abbott and the out-licensing of our HPV vaccine technology to both Merck and GSK, together have the potential to substantially drive the growth in our financial results over the next several years. The maturation of our late stage R&D pipeline and the substantial expansion of our overall R&D portfolio, promises to drive our long return growth. And we are clearly making the investments required to build a solid foundation for year business, as evidence by the recruitment more than 30 new Directors and Vice Presidents over the past 12-months, the construction of the new pilot lab and a new bulk vaccine manufacturing facility and the implementation of new technology initiatives, such as the corporate wide electronic document management system and a web based performance management system. We are intensely focused on building a world-class biotechnology company and I am pleased to report to you that, thus far in 2005 we are succeeding. I would like to thank our employees for their dedication and excellence and thank our shareholders for their continued support, now we will be happy to field your questions, please limit yourselves to one question each out of courtesy for those in the queue behind you, operator. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234049 | Hereâs the entire text of the Q&A from Exxon Mobilâs (ticker: XOM) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you, Mr. Hubble the Q&A session will be conducted electronically if you would like to ask a question please do so by pressing the â*â key followed by the digit â1â on your touchtone telephone. We request that you limit your number of questions to two so that as many may have the opportunity to participate as possible. If you are using a speakerphone please make sure the mute function is turned off to signal to reach our equipment. Once again that is * 1 if you do have a question. We will go first to Doug Terreson of Morgan Stanley. Good morning Henry and congratulations on a record third quarter result. My question involves a downstream and specifically a petroleum product sales and refining and specifically with your global positioning that you guys have, you obviously have insights into fundamental trends and lots of different markets for petroleum and so I want to see if you could provide an update on the trends that you guys have experienced in the past quarter or not only in North America but in Europe and Asia as well. And while I realize that you provide petroleum product sales in the release they are often unusual effect but you talked about the day related to strategic actions and whether and what had you so I want to see if you could review the trends that you guys are seeing and if you have apples to apples on a comparable basis that will be appreciated. I guess if you look at the volumes that we had in the third quarter year-on-year we were about flat. And in fact we were actually up 1 % in the U.S. Now that reflected the fact we were offsetting hurricane impacts by importing product basically to meet the demands there. In Europe we were down some but really that reflected the export of products. Basically we were using our facilities to relocate products from the European markets so although weâd see underlying we do have the divestments in and activities going on there, but overall I have not really seen a basic decline in demand. Okay. Let me ask you this question. I donât know if you had this data or not but do you have same store sales in retail for instance for North America. No I donât. If step back from all of this and you look at what our global demand has been for the year, we are up about 1.3% year-to-date versus last year. And we really and the effects you see in our numbers, it will show some down in Latin America area, Middle East Africa but again thatâs more restructuring activities not something really seen as underlying demand. Okay. And let shift gears on you. And you guys obviously had significant gain on the transfers of Gasunie position and so I would suspect that you are also going to have lower profits in the future and if memory serves me correct your net profits from that position was $30-40 million per year, isnât that the ballpark or can you provide more updated estimate. We havenât really had disclosed that. But I donât see where you are going with the lower earnings. I mean this restructuring itâs that gas in the Gasunie basically it is domestic gas, if you look at the longer-term trends in Europe. They are going to need imports so this gas it is going to be base loaded. And so we are not seeing that as an ongoing impact. Hey Henry. Great quarter. I wanted you to do me a favor as far as whatâs going on in the cost contained area you do guys do an obviously job there. You guys do obviously an exceptional job there you really donât have any significant cost overruns, can you try and tell us what it is reflected in your returns so can you tell us basically what type of underlying inflation rate you are seeing and how you are mitigating that, that would be my first question and then a second question just on the EMP side - number of new project have come on stream, youâve got some more coming on later this year. PSEâs are impacting you, assets sales, but can you give us just some type of color on what mixture will look like in light of those two factor also the assets sales and PSE on your volumes? First letâs start on the APEX side of things. I guess if you look at underlying inflation itâs still in terms of our overall APEX itâs pretty low. You are seeing more pressure in the project areas where rig rates and services and that kind of thing. But even so in our project as you see from the results, I mean we have been able to offset those, mitigate an awful lot of them. Basically through the contracting strategies, the approaches that we have, but if you step back and you look at it on an industry level, lot of those areas, the rig rates have gone up fairly substantially, but it just makes it more important that you focus on how you utilizing the effectiveness of utilizing those rigs. The success of wells, the development plans that we put in place all of these things that reduce the amount of real time that we have, the number of feet we get per day of drilling, all these are critical and managing those costs and mitigating those costs and thatâs really where we are putting our focus, so that when we look ahead, we actually see this kind of environment as expanding out the differentiation that we had in the past. I guess the other question that you had was around⦠Well on your production, I mean if you take out, if you look at asset sales this year and PSE impacts and also the hurricane. Basically if you take that out, your production is going to be essentially flat this year. What I am asking you is going into 2006, you are still going to have some impacts from PCSs, do you expect the same level of asset sales, I mean what type of guidance or color can you provide? I mean the things, as you know we update this once a year, our whole profile and we are going through the planning process right now what weâve been doing that. So that will be coming later, but you know, its all going to depend. I mean the internal impacts are going to depend where prices and that going to reflect back itâs in reverse if they go down, go up if they go up. I mean itâs going to depend on the prices. The asset sales that we made you know are going to continue through. I mean those assets are gone, so you are not going to see them in our profile for next year. And whether there are additional assets sales, I wouldnât expect anything out of the ordinary at this point. Henry, is it possible for you to split out the out-of-pocket cost expenses from the hurricanes on your refining and chemical operations, not to mention the volume impact which you provided but, what sort of cleanup cost and other cost effects you had from the hurricane? Well I mean the costs in our press release we indicated were about $45 million of cost in the third quarter. And that really the relatively small and that was associated with the response clean up activities and also there was a fair contribution to community efforts, over $13 million. Well, when you look at impacts going forward because the bulk of the actual repairs will occur in the fourth quarter from after refineries and so on. But thatâs the bulk of the cost that will be there, there will up some but still under a $100 million after tax. Thatâs great and then secondly Henry, Conoco Philips early this week announced an agreement with the State of Alaska of some sort regarding natural gas from the North Slope. Can you comment on where you all stand in terms of negotiating with the State of Alaska and how you are thinking about that project? Well, we are in active discussions with the Alaskan government on fiscal terms and progress is being made and we are encouraged by that. But there are still something that have get resolved before we have this finalized. Henry, I wonder if you could help my modeling shortcomings on the international upstream. Obviously the volumes were down at bit. You mentioned there were some maintenance impacts there. Can you really quantify the sequential change in the production as a result of maintenance and perhaps give us some color on how that impacted unit cost in the quarter? Well, the impact in the maintenance area if you look at you taking in the sequential comparison. Really the bulk of that was associate with European maintenance. And just looking here if I have-- Well the schedule downtime was associated with fine maintenance and then we also have some, we had some continuing downtime associated with Shearwater. That was the biggest unscheduled piece. Okay. If I look at these sequential changes in volumes on the realization changes, if I was coming up a little bit short in terms of the earnings you actually reported a little bit higher value you can note but below what I was looking for. So Iâm wondering if there were any specific cost issues in that part of the business that you could identify. Ok. I have another. I guess my other question I have on, you give us some rundown on the sequential changes again on refining and marketing, between the refining and marketing, I missed some of those number, can you just maybe run through those again for me? Ah, yes. The marketing piece is. All right if you are looking at margins, its about $1.1 billion up in refining and down to 250 in marketing. Hey, Henry. Two questions, I think that you give some impact about the entitlement to asset sales, Katrina and all that related to what's causing the year-to-date down of the production. Can you breakdown by individual item, I mean year-to-date you were down by about 4.5%, about 189,000 BOE per day. Can you break down, say, what's the impact from the PSE, what's the impact from other sales and what's the impact from the downtime, other than Katrina and Rita? What I've got, basically if you look at year-to-date numbers, year on year, it's about right around a percent each for entitlement, about a percent for the divestments and the hurricane impacts were about a percent. That was the major piece of our downtime. Okay. Great. If I could, can you also let us know if thereâs any major impact on the price finalization for your downstream and also any Capex gains or loss in the different divisions comparing to the second quarter? Yeah. Price finalization impact in the third quarter versus in the third quarter and were very smaller under 50 and that if you look at the sequential is but 100. It was really very small all the way around. They were not be much in the way of currency changes during the quarter. If I can just sneak in one side question, did you loose money in retail in the third quarter in U.S? Yes thatâs bringing on the Kizomba B project and it ramped up very rapidly and weâve got that its been performing very well. Hi, Yes. I have one question on CapEx. Last quarter I think you were guiding to about $17 billion of capital expenditure? I know you mentioned it briefly but could you tell us what the increase to $18 billion is about. Is it phasing or is it new activity or cost increase? Well the biggest piece is associated with OBO project execution. And thatâs the largest chunk and the other piece is associated with accelerating some Qatar projects, basically our Qatar gas, to train 5 and RasGas train 7, so we are moving those ahead but again the biggest piece is the OBO project execution. Right. Now I know you, I am going to ask you, but you wonât answer it, but should expect CapEx to be running about this level going forward I mean that was always the understanding I think in the previous guidance. Our past guidance was we were projecting something about 18 billion â07 ââ10 we havenât really updated that at this point and that will reflect you know whatever addition or issues that are coming into this plan. Maybe Iâll just have one more, which is you mentioned on the call continuing the incremental investments in refining capacity additions- Any thoughts of any more slightly more major projects there, or anything along the lines of you were saying from other companies of some large expansion? Well, I mean itâs interesting, if you look at, we invest if you look at the US as an example $3.5 billion over those last five years. But the real issue is not how much you are investing, itâs what you are getting out of that assessment and our focus is on lower cost kind of bottlenecks and if you look at our performance over a ten year time frame weâve grown our capacity 2% per year well above the demand rate which has been 1.5% and when you apply it across the kind of capacity that we have that ends up delivering us you know the equivalent of a new refinery every three years. So we see that as a continuing, the way we will continue to invest in a business. You know that not to say there is other parts of the world where you may go with you know where grassroots investments maybe necessary and we have our efforts in Bugan as you know. Hi, just again two questions. The first one real on chemicals, I think in the past what weâve seen is that youâve really benefited from the integration with the refining assets that you have and the close proximity of your chemical assets. This time it doesnât seem to have really helped or held up your chemical earnings especially versus some competitors, just wondering if you could walk through some of the issues associated with the chemical earnings in this quarter and why maybe some of those synergies have not come through and then Iâve got a follow-up question. Yeah. Alright. The kind of synergies you are talking about really donât change in the environment. They continue to benefit us. The issue that we are really have in the chemical side was the short time squeeze associated with margins as feed stocks rose basically we saw a squeeze in the margins. There has been a lot of upward movement in prices, demand is strong our capacity is fully utilized and so you know there is really nothing there that I would point to say hey there is something is changes versus base. Is there any particular region where you noticed this was a particular problem in terms of the feed stock cost running up and not being able to pass that through to the customer? Well, certainly in the US, because of the hurricane impacts, you had capacity down and just as we saw in some of the product run-ups you saw the same thing in the feed stocks so it was particularly acute there. And when you look at the margin squeeze this quarter versus last year third quarter, Intermax has been hit pretty hard and that was one of the big drop offs. Well Asia volumes have been holding up reasonably well, In fact, well and donât really you have margin pressure though, kind of through out the world. Just a the second question was really on the decline rates and the mature basins, I just wonder as we go through the time if it is a continues thing that we continue to take guidance from your March strategy presentations where you see production growth going on throughout the years, Yet it never seems to quite get there due to various factors that keep happening, such as PSA effects and other events and I'm just wondering how much of the strategy in the upstream division going forward is to do with divestments, because it does seem that you are divesting as a constant rate and I just wonder if that is going to pick up over time so maybe those longer term growth rates need to be somewhat dampened to take into account maybe your active divestment program going forward? Oh, I would, if you, if you look at our, you know, what the impacts have been versus our outlook, the outlook that we put out at the beginning of the year, I mean entitlements clearly have impacted and as we talked earlier, about 1%. But that's a straight reflection of the price increases that we've seen in the marketplace and so nothing it just improves the returns associated with those projects and then the asset sales as we've talked before, in a high-price environment, we're constantly looking at our mature assets and those assets and evaluating how much those assets are worth to us and how much they're worth in the marketplace and so we're constantly testing that and in this environment we've sold some properties and we feel very good about the values that we've achieved. That really is our focus, is trying to get return. Now, how is that going to play out going forward? You have to tell me the price forecast before we can be able to really even guess at that. Well, maybe I could do -- if I have my own price forecast, as everyone else does, if I read into that should if I've got higher oil prices in my forecasting forward than yourselves, should I be fitting in a higher divestment rate than you may have indicated in the past Henry weâre very worried about windfall tax and what is going on in DC potential in that area, could you remind us as a financial community what your responses to this idea if you like, and any other comments youâd have to make on the subject that perhaps you could be criticized for making too much money in this environment? Well, the thing, when you look at our business you have to think of it over a longer term and if you look at that the current issues that are facing the industry, and what a lot of this seems to be in response to is if any thing, a tightness of supply versus demand. And frankly if you are trying to encourage supply growth it seems odd to put in place disincentives and what we think is the best approach is to let the markets work and we are focused on getting additional supply. I know with the incentives out there others in the industry are going to be focused on getting additional supplies and that has proven to be the most effective way to respond to these things in the past. Sure. Very specifically on U.S downstream, it is noticeable that your CapEx is continuing to fall in that area and remains below DD&A. How would you feel about pressure on you to increase CapEx in the U.S. down streams specifically? Well, I mean we are, as I said where I mentioned earlier we are growing our capacity and weâll stand on our record there if you look at the capacity growth weâre growing faster then the market demand is grown. You go over a long period of time, weâve done that. We do it cost effectively and the most efficient way to do it is through capacity creep low cost at bottlenecks, the reliability improvements, all these things applying technology that is how we really deliver that growth, to say you need to invest more to do it, thatâs not the answer, you do it as cost effectively as you can. So I understand Henry. To change subject somewhat perhaps related to the declines, the Asian gas looks weak is that primarily Arune related or Bastrate, what is the driver there? As you know those are, it is Arune and thatâs mature fields that are in decline and basically no surprises there. And it is consistent with our overall guidance, that weâve been providing on the portfolio which is about a 4% to 6% decline rate. Is the current rate of change in Asian gas likely to continue in terms of decline or can we expect that to flatten out? Is this is a particularly bad quarter for instance, or is that a trend that we should look for? I donât really have a forward projection on that, that is mature area, it is going to continue to decline whether the rate of decline is flattening out, I canât really comment on field by field basis. Oh yeah. When you look at I mean look at overall gas business its growing and will grow, in the later part of the decade as we bring all of this Qatar production and all those projects that weâve got under way Henry Good morning. I had a couple of things, first isnât it time to perhaps update your corporate guidance a little bit I wonder if you might be so kind as to do that? Yeah. I mean the numbers that you used from a guidance standpoint in the past, I mean, I think we could all agree you kind of anachronistic, arenât they? Okay. Secondly I thinking a little bit ahead toward, the end of the year trying to conceptually understand and identify potential sources of reserve bookings for 2005. And I was thinking back in terms of the number of project that have been sanctioned over the course of 2005, that could be candidates for booking. And I guess my memory is not serving me all too well because I am not coming up with a long list. Can you perhaps refresh my memory has to recent and in significant project sanctions that could provide a bit of an inventory for year-end â05 reserve bookings? Well, overall I just expect from the top, overall weâve long demonstrated an ability to over 100% versus our production and we donât see anything that is in the way of doing that for this year and so we are going to update that in the first quarter and youâll see it at that point in time. Le me try one other one. Was there a big working capital liquidation in the third quarter that contributed to the $15.7 billion cash from operations, I am guessing, it was probably $3.5 billion or more. I mean if you look at, if you look at our cash you are looking of the 16.5? Iâm trying to figure out how to come up with that. Yeah, I may, well the Gasunie is in those numbers. It was equity restructuring and it is basically distributed through dividends and shows up in that 15.7. Okay and then you have working capital effects associated with higher crude payables and higher tax accruals, before the earnings and thatâs the impacts. Thanks. Iâve got two questions first on the Chalmette refinery, you mentioned that restart would be imminent. Just wondering if you can give some more color around that and when you expect to be a full runs there and secondly on the share buybacks should we assume that this quartets pace will continue looking out the next couple of quarters? Well. On the share buyback, we donât give forward guidance on that but you can look back at our practices, weâve been more consistent than most in our share buyback and weâre basically that you can use that for kind of guidance and then when you look at the Chalmette refinery, it is going to be phased startup and when I say a imminent, I mean they are in the process of bringing power and boilers up this point and then it will, it will basically phase through but it will take some period of time. But, before the end of year, itâs up full rates and I donât know really have detailed schedule in terms of when it is anticipated to be up to full rates before that. Yeah, thank you Henry. Two quick ones with European gas you mentioned, mentioned and demand loss, could you give us a split in terms of the drop sequentially from second quarter? Yeah if you look at the demand side of it, that was the biggest piece and basically itâs about our 3%. Okay thanks. Then with the U.S upstream youâve been doing some more partnering with Independence in North America whether itâs Canada, south Texas, whatever. Should we expect to see more of that. Well. Its we have approached, weâre going to look at how to best develop these resources, and you may be referring to some of the things weâve done in Pyons and other areas but basically weâre going to look at the especially we will have larger resources like that and look at the areas that weâre going to develop ourselves weâll farm out, but weâll have a mix of things and basically doing whatever is makes sense to manage the risk and deliver the best value to the shareholders, so thatâs really the focus. Let me just say. First Iâd like to thank everybody for joining me this morning and before I end the call Iâd like to leave you with just a couple of key points. First although the hurricanes created difficult conditions, weâre working hard to support the communities we serve and responded rapidly. We maximized supply to the U.S to minimize the immediate hurricane impacts on our customers and weâre focused on restoring the remaining operations as safely and quickly as possible. Secondly our upstream projects are being completed without delays and adding the volumes that we expected at costs on budget or below and thirdly our results reflect the same business model and disciplined investment process that we have had and will continue to have for years. We look through volatility of the commodity cycles, we consistently focus on delivering superior results to meet energy challenges of this quarter and beyond. Iâd like to thank you for your time. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234050 | Hereâs the entire text of the Q&A from Citrixâs (ticker: CTXS) Q3 2005 conference call. The prepared remarks are in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. You may want to read the prepared remarks before reading the Q&A. [Q]: Yes good afternoon. You got a number of interesting products in the pipeline could you talk about how you are thinking of positing your constellation, Kevlar , IRIS, are these capabilities that are going to folded into existing suite, or sold as discrete products? [A]: Thanks for the question, the answer is all of the above and we have not made productization decisions yet. Remember that these technologies have been in development, most of them are designed for the Longhorn server environment although we are developing some of them to be backward compatible to Windows Server 2003. We will release some as products; some of them will become features of existing and new products so we will actually do kind of all those things from a packaging perspective. But I think the way to look at all of those project code names and some of the other suites showed at iForum like Blade Runner and so forth. What we are doing with constellation is really applying the vary vast technological base in platform that we have around application virtualization and turning up the velocity and heat and building more products to meet very specific customer segments like customers that use for example very graphic intensive applications like product line management some healthcare type of applications. GIS stock prices apps so that will be a space that we go after with some of the technology as well as obviously expanding the Presentation Server and in addition creating some additional management kind of tools and products as well. So really itâs turning up the velocity and heat in app virtualization to extend our leadership even further. [Q]: And just a question on channels with, 800 partners reselling the Access Gateway, could you talk about how much overlap there is with your existing Presentation Server channel you know how much of these 800 are new maybe securing brand bar and just touch a little bit on your progress in where your plant were rolling introducing NetScaler to existing channel partner. [A]: These are been your question about Gateways. The overlap is significant although we have recruited some new integration partners as a result of having the Access Gateway specifically from the security space players that had been selling first generation SSL VPN and as well as IP 6 VPN so this product really distinguish itself when compared to those two categories. But I think the majority of these Access Gateways growth is coming from Citrix channel partners that have been Presentation Server partners and what they are doing is they are going back to Citrix Presentation Server customers and showing how they can turn off the secured gateway feature of Presentation Server and turn on the Accesses Gateway as a more secured more robust and more flexible solution that has a better user experience and that also support all kinds of other application access including web application, connections including made-of-connections to E-mail file services as well as you know a connecting to soft phones IP PBX etc. This is one of the if not the only product that is out there that actually has all those capabilities. Thatâs were we are getting into traction channel wise with the Access Gateway and by the way that number of around 800 or so, itâs growing everyday and because we havenât completed the worldwide geographic rollout of the Access Gateway. so thatâs still underway. Then it is a good segway to answering your question about our application networking products because we think that many of these same integration partners have not only the skill set, but also have the interest and vision to step up to our application networking products. Because they understand security, they understand application delivery, and they understand how to integrate products within networking infrastructure and all those skills are important for selling and servicing our application networking products. Having set that we will continue to recruit integration partners that have been selling these types of products whether they are first generation so the point product in the space whether itâs a load balancer, a firewall something like that we will up level them to a relay this next generation that is technologies and products. So we will be going after them as well to both single and two tier distribution. [Q] Hi guys, great quarter, just three quick questions. first just from the NetScaler perspective,. wondering if you comment on what it contributed during Q3 and then also when you start look at Q4 and Q1 as far as moving NetScaler into some of those channel partners. may be you could touch on this sort of what your plan is as far as training. [A]: Well I will take the first part of that question then turn it over to Mark,. market as far as the part of the ANG performance in the third quarter contributed roughly $6 million in total revenue and remember that it was split about 75% in license and 25% in the services line. On a net dilution basis and a little bit less diluted than we had originally anticipated the deal closed slightly latter in the quarter so it is just under two pennies diluted to the bottom line. [A]: Phil great question. Training is absolutely essential on new products and so I think most of you know that we have our worldwide summit week in January and every year the focus of that meeting is training. This year imagine we will have probably close to 3000 to 3500 attendees. All of the Citirx employees that customer facing as well as key partners on a worldwide basis probably one third, two third in terms of attendees one third Citirx employees two third partners. The training on our application networking products will absolutely be key and for that event. We have really turned up the velocity on the training materials I mentioned that in some of the prepared comments, we are ready to do this in a more, more repeatable scaleable way and gain plan is to then feather these training programs into our Calx, Citirx authorized learning center. We have over 300 worldwide and weâll look to have them provides certifications for not only configuring and managing NetScaler products but also selling them. So thatâs will our game plan for training, really sort of starting with a focus on the top end our customer facing people and partners and as we go into a sort of mid to back end of the year really having a scaleable repeatable process that partners can advantage of through our Calx. [Q] Great, there is one last question and you guys great to leverage this quarter. I was just wondering sort of if you comment on your plans as far as whether you would be head count on the sales or R&D side or just more this given up an revenue look at 2006. [A]: Well I think as we look into a really into Q4 and to next year and weâll certainly be adding head count in the places that are almost strategic for the business. And in the field it will be not only places where we can drive synergies across the various product groups. But also to expand geo coverage in the places that make sense in each market. Certainly be working in the channel organization, customer care to help drive mail or remove of the subscription advantage program and other support business. But we are certainly focused on the leverage thatâs why you seen our head counts grow certainly moderate a lot over the past couple of quarters as we really look to drive return from all the investments we have been making. So imbedded essentially in the operating expense guidance is a modest head count grows and really all off areas of the business in Q4. [Q]: Hi good afternoon and good quarter, a couple of questions on the margins, in the quarter you exceed our expectations and I was wondering if you found that NetScaler was slightly less diluted than you thought, with the margin outside came from the core Citrix business and along that line talk about what the contribution is at this point in the online business. [A]: Let me take that a couple of seconds. I just answered the question a couple of minutes ago regarding the dilution of the NetScaler business it came between 1 and 2 pennies and slightly less than we had anticipated just because of the close date being slightly lower than we anticipated. So that had minimal effect on it, overall the corporate functional groups as well as the Access management group have been adding a lot of heads throughout the year. Weâve been keeping that growth pretty much in check. So excluding the NetScale business core expenses actually declined just slightly on a sequential basis. The online group posted about 20 to 22% in a standalone profitability so pretty much consistent with what we saw last quarter. I think we are just seeing good success across all areas of the business this quarter. And like I said while we go into business we continued to be focused on driving leverage to the bottom line. [Q - Adam Holt]: And just two questions if you will on the revenue side. If I took your comments correctly on the contribution for NetScaler and the Access Gateway in the quarter it looks like the combination of Access Suite and Presentation Server grew about 1% year on year. What do you think is the right growth rate for the combination of those two product areas. As we continue to get further into the four hour cycle and the channel continues to ramp. [A]: I think in Davidâs comments he mentioned that it was the one area that we saw growth but it really was under what we wanted. And strictly around the activity we saw in EMEA around the Access Suite and having some deals pushed pretty consistent with what we have seen for now three quarter in a row. So I think with that under sort of more normal economic environment in that part of our market because it is a big piece of our business over there. We think we should be able to grow the Presentation Server and Access Suites in the mid single digit. Sort of range and that will be our focus to do that. [Q]: Just one more question on the services business. Have you starting to pick up now that you are in the online business for a bit a while any kind of seasonality in that business in terms of sequential trajectory and any comments on what we should expect going into next year there. [A]: Specific to the online business, no real seasonality there its growth rate fluctuate a bit quarter to quarter, but you are seeing that in business is continuing to grow around 65%. So itâs really one of our fastest growing business. If you look at the other lines in the service, really the other components of the services line you did see pretty healthy growth sequentially and year over year. That was driven by better utilization our consulting teams increasing demand for education are in the release, especially in North America and some other things. So weâve added to consulting capacity around the world. We need to help get customer successful and drive that standardization so I think that it will move around a bit but it will continue to grow in this range over the next year. [Q]: My congratulations on the quarter as well. I just wanted to get a clarification on Philâs question, I though when you said $6 million contribution with about 75% in license but thatâs was just networking group NetScaler acquisition did not include the Access Gateway is that correct. [Q]: And may be you can give us a little color on the revenue contribution, the earnings that have Access Gateway business. [A]: That was a lot tougher because itâs been pretty well integrated into the rest of the field promotion over time, weâve actually integrated the end to end product into the Gateway. So we are looking at it less in terms of a standalone group. So overall the business continues on a standalone however continues to do very very well. As Mark mentioned in up about 50% sequentially still running at a negative overall contributed margin , that we talked about in so many forecasts for the several quarters. [A]: If I would add just one other things, so David that we do look at it as standalone business because so the market that it addresses one of the markets that it addresses that we just donât spend a lot of time talking about, is the voice over IP market, where our application gateway is the number one product for driving applications to IP screen phones. And that product seeing some very nice growth via our partnerships with Cisco with Avaya and Nortel as a mater of fact during our conference in Las Vegas I went over with a couple of other of our team to see the implementation at Caesarâs Palace and they have this incredible color IP screen phones in the new tower and are 1500 rooms with the advertising , theatre tickets, bell services, room service right on this screen and they are very excited about it, weâve only sort of scratched the surface, we have lot of bids out for this kind of implementation, weâve the done at the Wind hotel there, so this group is also driving that part of the business and we unfortunately have so many products that, feature every one of them in our prepared comments. So we are seeing go traction there as well. [Q]: David a question, on the tax rate was 21% in the recent period, the outlook for the full year of fourth quarter, can you also comment on either one of those. [A]: For the fourth quarter, I expected similar tax rate, I think we are somewhere around 21%, as you know the tax rate does move around just based on what geo, a lot of revenue and profitability is being generated from at this point of time I would expect somewhere around 21% to 22% in the fourth quarter, I did mention that into 2006, We expect this tax rate to move up, 2 to 3% points and thatâs just because the application networking business gateways online continue to improve and show more and more profitability. We are just having move revenue coming in domestic sources. So those are somewhat upward pressure on the way till next year. [Q]: Thanks good. I wanted to just get clarity on a Access Gateway presentation server throughout this year again, I think the matter looks 5% growth so we had this on the earlier mentioned 1%, so I wanted to be clear on that but on doing the math right it should be around d$4.5 million to NetScaler, less of that we think about 5% growth for the organic. [A]: Let me answer in couple of different ways, I mean there is a distinction that I am hearing a lot between organic and acquired businesses. And the one point that I would make is that organic business when we think about the Gateways, it was essentially zero revenue at the time of the acquisition so all of that is basically organic business at this time. And we are talking about online, we running at a level roughly one third of where we are right now. And also new products like Go To Meeting being organically delivered revenue in business. So as we go forward we are trying to ge t reasonable granularity into components like the application networking business etc., Itâs just harder and harder to break it out, as we integrate the sales promotion of the product etc., We will be focused on selling whatever makes sense to our customers whether itâs an accessories to gateway etc.,, So take it back to your original question, the license revenue contribution from the application networking group was $4 to $4.5 million quarter and the rest in the services business. The Gateways revenue if you were trying to break it out as a standalone will be a few million dollars with modest growth in the accessories presentation side of the business. [Q]: Okay great. And on the tax rate, can you give more color on why that would go up to 2% to 3% next year? [A]: Itâs got more revenue. If you look at where the majority of the revenue is coming from, from the online group the Gateways organizations and the applications networking team. Most of that in the US, we do pay close to 40% taxes in the US and a much lower rate for resources coming from outside the US. So as our businesses become much more profitable it just puts pressure on the aggregated rate. So obviously we will be looking to drive incremental revenue outside the US in new markets which is really just new opportunity for those businesses. [Q]: Great and then Mark there was announcement out of IBM about the work that you guys are doing with them around virtualized host and client infrastructure, I just like to know press release that on, how does that blend in, where do you see that driving revenue and which of these new guidance will play into? [A]: See we actually demonstrated this in the lab in iForm, we didnât give it much, well we didnât any keynote visibility at all, the project thatâs called Blade Runner 2 and actually have been working with IBM for over a year and we are excited about it because we think it gives more choices when it comes to virtual machines. And we are all about making the connections between virtual machine devices whether they are servers and desktops that are physical or there are servers and desktops that are virtual. So this announcement is a very interesting one that we partnered with IBM in sort of early market developments in IBM GS, we will have some service offerings around it. If you went to lab during the iForm and looked at Blade Runner you could see sort of public version of it. The private version is even more exciting and we think virtual devices are just one more sort of piece of the infrastructure that we need to connect us to. So that means for customer is that they will end up with more options when it comes to sort of the desktop side, and the server side and for us it means more opportunity because we really cater to making these more heterogeneous and more complex kind of environments driven by more access and application scenarios, we can simply of the delivery of all of it. So itâs good stuff. [Q]: Great and lastly can you comment on the conducive environment around NetScaler as there has been a lot of talk about _____ do in that market. [A]: Yeah. We feel really good about our market position, on both the technical front as well as the customer satisfaction and service front and are focus on customers. We are regularly beating the other players in the technology shootouts that happen all the time. So we are feeling really good about that and we are not standing still, we released some exciting new compression technology during the quarter that moved the acceleration and performance up significantly and we have lots more in store there so it is again an exciting market place, the fact that the matter is, the big opportunity is the not competitive front , it is the not share, it is the growing the primary market place. So that what we are trying to is actually use our partner network to communicate with our customers and really explain to them in simple terms where the sweet spot is for using the NetScaler application delivery system around driving TCO driving performance, driving security in terms they understand that I think is a much bigger opportunity then just trying to steal business from one of these other players. [Q]: Good afternoon everyone, Mark I wanted to get your comment when you are ready for the 64 bit version presentation server, I think now you are looking at about somewhere between 50 to 80 users per server. And I think you said that could triple with your 64 bit release and is that actually Vista phenomenon or what could we expect around that? [A]: Okay so the high speed version is not Vista okay. We are talking about the product thatâs available today, that runs on the Windows Server 2003 X64 edition, okay, you are talking about 64 bit. So itâs really notwithstanding Vista long formats. Itâs now. So there are two things here John, there is what the operating system does in the 64 bit environment that opens up 64 bit addressable memory space which is classically been the limiting factor in most of these percolations projects that weâve done for many years. So thatâs one piece. And then the second piece is a number of technologies that we released in PS4 have been moved forward in the 64 bit world that actually drives the platform in a way that allows to create even more users per server than standard terminal servers. So weâve broken some boundaries there and thatâs part of the value lab that we provide that gives customers instant order line. Even related to sort of basic terminal services capabilities. [Q]: Just a clarification , is the number that you said, I proposed it was 50 to 80 per server today, and you could actually triple that meaning 150 to 200 let us say. Is that really the type of magnitude you are looking at or we are going off pace here. [A]: We have customers I can tell you that are running a 150 plus users per server today. Okay and thatâs not on PS4 okay, in a 32 bit environment and thatâs because that the applications that they are running in that environment and then you have them, that would be in the sort of 80 to 100 range as well. So either case sort of apples to apples they are going to get approximately 3X which if you think about it, when you think about the economic dynamics here, itâs fundamentally changes those and the sort of the cost model around application virtualization in a way that we think will allow customer to move from, using this technology for only remote access or for limited number of apps to a broader set of points over style applications and a broad number of users no matter where they happen to be accessing the application from. [Q]: Okay. Perfect. Mark with the Access Gateway and NetScaler you have a different product line, you are going through your indirect with these guys obviously supporting it with your internal people as well facing customers, wondering if you could articulate for us the strategy behind that to keep these products not only to leverage half of your existing presentation server obviously for a new deal that is packaged in it as a part of the presentation server for new proposals. But also in a standalone environment. Is your existing channel is the right distribution mechanism to do that would you have to add channel partners, do you have to beef up your internal customized baking organization. [A]: Okay. So let us see, so it was always tough when you characterize in our channel in one term, to ask whether they are right. They are not. They are not a single person, sort of a range of people and personalities from the local organization and maybe a small town to IBM Global Services. And remember the way we work with partners is sort of two fundamental ways. One is on domain account, we have a little over 400 domain accounts where we accept the responsibility for coordinating the relationship and bringing the right partners and even Citrix specialist to the table to make sure that the customer gets the kind of solution that they need across the product areas. So thatâs one piece and in that piece we have great partners and we have the need for more partners that are capable of working more of a enterprise far from multi national type customer. And weâve continued to develop that kind of partner community, the second sort of way we work with partners is we do a lot to stimulate demand both indirectly and directly and work with them and support them in fulfilling that demand in terms of value selling as well as the fulfillment. In those we are trying to make sure our partners get trained in all the new product areas that they wish to represent us in and if they donât get trained they donât handle those products. Where we have gaps in a particular geography with a particular product area we look to recruit partners like that to work with that can driver those markets with us. And so thatâs the other part of business so let me now map those to John our application networking and our access gateway products. So first of all the application networking product line is pretty sophisticated, pretty complex and historically has been sold in this more domains account type of manner. And so there is shift there, they brought some new channel partnership to the table because we didnât have a 100% overlap who would work there, at the same time, next year we just announced NetScaler standard edition product for smaller and midrange type customer and thatâs the kind of product because if you look at that product itâs much easier to configure much easier to sell, itâs got the right price point, itâs got a number of characteristic that are really suited towards a larger scale channel that can actually take that product in an proactive basis with our support again , support with training , support with demand generation and support on a transaction level. So thatâ how the application networking products, the inverse for the Access Gateway products, I say that the Access Gateway products have really gained traction through our broad based channel really getting exciting about the product, taking it into existing customers as well as customer that they have sold prior, let us an IT VPN or even a first generation, FSL VPN, and the opportunity there now is when you see that some of the analysis weâve made last week around our advance Access control capabilities and some of the things we are going to be doing in combination with some of the NetScaler technology to really take the Access Gateway product line up market and make it suitable for the domain account in the larger scale type customer in that kind of sale promotion. So itâs a long explanation but these products donât come prebuilt for specific, for the broad market place, they come with focus so we are accepting that focus trying to amplify it and extend it using our have confidence in. [Q]: Okay. Just following up a little bit on Johns question, so in terms of getting things into the hands of channel partners you mentioned things like getting certified to sell Access Essentials or since that is relatively similar to the core products, what is involved in getting certified , thatâs just technology training or is that just getting onboard with the marketing message? [A]: Brent itâs both. And you are right itâs pretty straight forward, itâs not complex right. But we do ask partners to put some skin in the game and show their interest with some real activity upfront and then we try to reward that on supporting them and then remember all these products benefit from our advisory rewards program that I think has been very successful in stimulating the relationship with our channel partners and stimulating them the value sell, to get out there and sell the products in a solution kind of format, whether itâs the simple product like Access Essential or upcoming more sophisticated product like our application networking product line. [Q]: So in terms of the actual mechanics which tends to sounds like itâs a little harder than cutting this thing off the bark so serial, itâs time to getting your cab to midnight member card but not as much as getting started for the first time for your guys. Itâs like two days of training per person or? [A]: I think with the case of Access Essential itâs not that complex, most of these programs you can actually do online,. Through online training we seen some great performance from our online training offerings. And you can take the test online, you get certified online actually in many of these areas. And we look for that scalability and offering that through our authorized learning centers [Q]: Hey guys, sorry, I think you have answered your question already, but your voice kind of faded on my line, but through such a fact that Gateway, what was the license revenue. [Q]: $3 million okay, and moving on to Access Essentials did you have any plans to kind of replicate that model in terms of bundling into Microsoft cow, kind of on the enterprise side? [A]: Dino, not at this time, enterprise customers have select agreements with Microsoft and they are on subscription with Microsoft and there really isnât much in the way of economic nor simplicity value for them. Incase of the small customer, there is both an economic as well as simplicity of installation, getting the product up and running, sort of need, so we fill that need with these they bundle up the cow. [Q - Jason Craft]: The switches online margin is 20 22% pretty same as last quarter, which is like 22% whatâs your expectation there as far as how much more room there is run, could it be as high as 30% or is this pretty where we should be modeling the (010009) Citrix online going forward. [A]: Well I think Jason for the short term itâs where we would like to see it, I mean there is really clear trade off that we make, each quarter we are doing plan between growth and profitability in this business. And we think that the market opportunity is still so big that I did rather not run it at a higher profitability that means cutting back our ability to grow top line. So for the foreseeable future, I think kind of in the low 20s is really the place where it would be optimal for us. But it certainly has potential to generate higher margin on a contribution basis. As we do things to integrate more of the back office functions, and they are really easy savings. We will be working on throughout 2006. [A]: Jason the thing that I would add as I think the team, Dave has done a tremendous job in gaining more and more leverage within the business. And if you look at whether itâs sales cycles, selling cost on a contract and agreement basis, that âs where we are getting a lot of the list in the operating margins and so we want to continue to see that very carefully as David mentioned to get the right balance because we are seeing great success from that team and we want feed it. [Q]: For Q4 with the NetScaler been in there for the first full quarter, whatâs your expectation for the blended networking gross margins. [A]: Well, I mean , we talked about this little bit in our strategy day few months back for the various components before the A&G business obviously, has the standalone may be running in the lower 70s , A&G with the Gatewayâs products running in the mid upper 80s. honestly though we are really not modeling the business that way, we are modeling it more on a combined looking at revenue in the aggregate and I think that looking at a 94% 95% is the range that to must really comfortable with going into the fourth quarter. [Q]: Okay great. Final question on the guidance give some color on the margins for 2006, given some of the comments earlier by Mark on what kind of expectation for presentation or access suite going forward any status what we should be thinking about for 2006 revenue growth range guidance. [A]: Not yet, not at this time, we are just starting the fourth quarter, I think that on the January call we will get much more granularity in terms of not only Q1 but also what to expect for the later part of 2006. [Q Scott Kessler]: Thanks a lot. Two quick questions. One is give me a give a question but may be your responses maybe longer. I guess If you could provide more details around constellation, I was trying to followup obviously a lot of the information that you provided on the call, in conjunction with some of the slides but wasnât able to catch up as quickly as I would have liked. Some additional background underlying that would be super and the second question is when do you think we could start seeing some products enhancements from Citrix that include what NetScaler offers. Thanks a lot. [A]: Okay Scott let us see, I think probably for today, we are not prepared to get into deep conversation around constellation technologies although we would be happy to do that with any of you that are on the call that would like to know more, weâll certainly talk more about these during our financial analyst meeting, in â06. Remember this project is really designed to really intersect with the availability of Longhorn server which is, about two years away. Having said that based on some of the other comments made earlier regarding constellations technology, you will start to see some of these capabilities as perhaps features in some products that we would be releasing in the next 12 months let us say. And again as I mentioned to Ed when you asked. We havenât made the final productization decision, we are working hard on the technology themselves making sure that they are flexible enough to be able to integrate into some of the products that we are looking after as we do it, I think a much better in the future of segmenting the market place in terms of customer needs and really matching products to very simple and clear customer needs and we saw some of that in our, in the excitement at our iForm conference last week. [A]: Good question., you should describe constellation as set of technologies that represent the next generation of application virtualization capabilities designed specifically for the Longhorn server platform. Thatâs the way you should describe them. Okay. So as we go into Longhorn server, the Longhorn server platform will have additional capabilities in the terminal services area that we are going to be able to embrace and extend and some of these technologies reflect our intention to embrace and extend those specific new capabilities of the Longhorn server. [A]: Well, there will be a few things that maybe you just want to take away. So first of all none of these technologies will allow us in the Longhorn server, timeframe to make sure that our enterprise application virtualization franchise continues to grow and our brand in that area when it comes to meeting the large scale enterprise requirements is unassailable so thatâs the first piece. The second piece is that a number of these technologies will allow us to actually build special purpose ad virtualization product for narrowly defying the market segments. Like the (010720) project that we demonstrated, both on stage and in the lab which we demonstrated virtualizing open GL specifically with Rick Mudder talking about the Boeing 787 project and what we are doing there with their systems environments, so there will be more products like that, coming from these technologies and the Longhorn server platform. And there is the number of areas that we need to do more working around the fundamental Access management not only application virtualization but across the platform that some of these technologies that were demonstrated in the lab under the constellation banner will allow us to address, so really it is a pretty broad answer, and represents lot of opportunities and strategy for the future. [Q]: Yeah thatâs really exciting, my other question involves when we could start seeing NetScaler functionality in some of the Citrix offering. [A]: Again another good question. And an interesting one even internally, itâs awfully hard to ask a team that has got a huge runway and such a huge growth rate, ahead of them, focused on sort of the delivery and web applications and optimizing web application delivery to peal off some technology to support another part of the company. And so itâs interest to date, we do have a group that have advanced products and technologies group that actually works in this area and I think the answer to your question is not in the near future probably a longer term more of a 12 to 18 months time frame. And we will look to make sure that the NetScaler product family is a really good member of the overall access platform so we wonât do it at the expense of slowing that product line down because there is such a vast opportunity there. [Q]: Good afternoon just one quick question for you Mark. You kind of mentioned that Europe may be live up to your expectations and there was a couple of push outs and maybe thatâs been hanging around for a while, is there something you need to try to fix that or how are you looking at that business. [A]: Yeah. Honestly weâve been studying it as a team every single quarter that we see this occur. And weâve done a lot of things in market, I think that historically I think you all know that historically one of our strongest team for our execution in the world, so they are dealing with some significant localized kind of economic issues that are in the macro environment doing their best, but I donât that there is a lot more that we can do to change that. And so we are working through it like many many enterprise infrastructure companies are in that specific market. [Q]: Good afternoon, nice quarter guys, Rob just lead me to the punch but an extension to that question with respect to North America as you look at Q4 are you seeing any signs or any push backs from customers given some of the macro concerns that are in the market right now. Or is your expectations based on the pipeline both here and the state as well as in Europe that we are likely to see some phenomenal fourth quarter seasonality. [A]: Okay Israel I think everyone should be concerned about the macro environment that we are .looking at, I donât need to repeat all of that, so from a general perspective we are not seeing any of that in the pipeline or in the business at this point in time. But I can tell you as we look into â06, really do our planning into â06, we are going to really do a very carefully in context to the macro environment that could start to change after Q4 and so we got a great Q4 plan as the guidance suggests. And a huge pipeline, great excitement in our customers and partner community and our customer facing people, so itâs all there and if the general environment doesnât work against us we are going to have a great run here. [Operator]: Ladies and gentlemen we have reach the end of the allotted time for questions and answers. I will now turn the call back over to the management for closing remarks. [Q]: Well we are going to close really quickly.. Once again thank you for joining the call for the excellent questions and for your ongoing support as we continue to grow the business and really execute our strategy to be the number player in Access infrastructure. Thank you and weâll see in three months. |
EarningCall_234051 | With us today we have Mr. (Dennis Pence), Chairman and Chief Executive Officer, President and Chief Merchandising Officer, Ms. (Georgia Shunk Simmons), Mr. (Mel Dick), Executive Vice President and Chief Financial Officer and Mr. David Gunter, Divisional Vice President Corporate Communications and Investor Relations. If you have not received a copy of the release distributed this afternoon, please contact our office at 208-265-3977 and we will send one out to you immediately. During the course of this conference call we may make forward-looking statements regarding future events or performance of the company including forward-looking statements and projections about our operating results, business initiatives, growth opportunities and prospects. I want to emphasize that any projection involves judgment and that individual judgments may vary. Any projections we make today are based on information available to us now which is subject to change as the quarter progresses. Actual results may differ substantially from what we say today and no one should assume later in the quarter that the comments we provide today are still valid. More over, we are not undertaking any obligation to provide updates in the future. The documents the company files from time to time with the Securities and Exchange Commission including our most recent Form 10-K and Form 10-Q contain and identify important factors including the risks and uncertainties described under risk factors. That could cause actual results to differ materially from those contained in any forward-looking statements. A replay of this conference call will be available immediately after the call today until midnight on November 29th. The number to call for the replay is 719-457-0820 and the pass code is 9614479. The web cast of this call will also be available on the investor relations page of our web site until November 29th after which the transcript of this conference call will be posted. To access that information, visit www.coldwatercreek.com and select investor relations. I am pleased to report that better than anticipated sales and profits in the third quarter resulted in an increase in market share for both our retail and direct segments. In addition, we have seen momentum building over the last four weeks as we move toward the all important holiday season. The continued successful execution of our retail store roll out increased our store count by 27 stores in the third quarter, the largest number of stores we have ever opened in a single quarter. We will open the last store we have planned for 2005 tomorrow which will take us to our goal of having 174 locations in place for the holiday selling season. Based on the effectiveness of our retail expansion this year, we have announced that we now plan to increase our roll out for 2006. As previously reported, we currently plan to open 65 stores next year, up from our original plan of 60. Additionally, we have increased our average store size for the coming year by approximately 500 square feet, a 10 percent increase. We believe this additional space will allow us to more fully represent the brand in the retail setting and increase overall revenue on a per store basis. The Coldwater Creek catalog has proven to be an effective store traffic driver and we plan to further leverage this successful marketing tool by expanding this initiative next year. We'll have more information on this during (George's) comments. Our national magazine ads continue to generate positive results as a brand building initiative in the third quarter. Based on favorable customer response, we expanded our advertising program to include an eight page advertising insert in major women's magazines for the holiday season. Also adding to our brand awareness is the recognition we received last week from the National Retail Federation which named Coldwater Creek the number one specialty apparel retailer for customer service in the United States and number two in customer service for all retail companies overall. This award was based on survey results for more than 8,500 consumers across the country. Providing excellent service has always been a hallmark of the brand in our catalog and Internet channels and we're especially pleased to have earned this recognition for the service we provide in our retail stores. Once again, this past quarter Internet growth was stellar with our Internet site traffic exceeding 12.9 million visits during the third quarter, an increase of 72 percent compared with a year ago. Including the new names added during the recent quarter, we now have nearly 2.6 million active email addresses. More than 66 percent of the customers on our email list now live within 30 miles of a Coldwater Creek retail store. We continue to leverage both our growing email list and catalog mailings to drive retail store traffic and promote special events. Turning now to a brief overview of our third quarter financial performance, the data is as follows. Net income increased 37 percent to $12.4 million resulting in earnings of 20 cents per share compared with 15 last year. Operating margin for the quarter was 10.3 percent. Improved merchandise margins and leveraging of our full line retail store occupancy costs resulted in a 220 basis point improvement in the gross profit rate. Net sales increased 26 percent due to solid response to our fall merchandise collection. We ended the quarter with a cash position of $104 million, working capital of 125 million and zero debt. In regards to the retail segment, net sales from the retail segment increased 44 percent to 115 million in the third quarter. Retail stores represented nearly 61 percent of our total net sales for the third quarter compared with approximately 53 percent a year ago. In regards to the direct segment, our overall direct segment net sales increased seven percent due to continued growth in the Internet channel. Internet sales increased 21 percent in the third quarter compared with the prior year. Internet sales represented nearly 63 percent of our direct segment net sales for the period. Catalog sales decreased 11 percent in the third quarter as we continued to use catalogs as our primary print advertising medium to shift more customers to the Internet and drive traffic to our retail stores. In summary, strong sales performance at the beginning and end of the third quarter more than offset the negative impact of Katrina and its aftermath which was contained to the first three weeks of September. Ongoing execution of our retail store expansion strategy remains a top priority for the company and we now plan to open 65 stores in '06. We plan to open the last store in our 2005 retail expansion tomorrow which will give us a total of 174 stores supporting the brand as we enter the holiday selling season. We believe the positive impact of an expanding national store base, ongoing growth in our Internet channel and effective brand building initiatives continue to increase our market share while taking us another step closer to the goal of establishing Coldwater Creek as one of the premiere specialty retailers in the United States. Net income for the third quarter was 12.4 million or 20 cents per share. This represents an increase of 37 percent over the net income of 9.1 million or 15 cents per share we reported in the third quarter last year. Our consolidated net sales for the third quarter increased 26 percent to 190.1 million from 150.5 million in the comparable period last year. This increase was a result of strong customer response to our fall merchandise in August and October and an increase of 56 retail stores compared with the prior year. Net sales from our retail segment increased 44 percent to 115.2 million for the fiscal 2005 third quarter from 80.1 million in the prior year period. Our retail segment net sales represented 60.6 percent of the company's total net sales in the most recent quarter compared with 53.2 percent a year ago. We had 163 full line stores in operation at the end of the third quarter compared with 107 full line stores in the prior year period. Currently we have 173 full line stores in operation with the addition of 10 locations that have opened so far in the fourth quarter. We are scheduled to open our final store of the year tomorrow, successfully completing our plan to open 60 stores in fiscal 2005. Net sales from our direct segment increased seven percent to 74.9 million for the third quarter compared with 70.4 million in the 2004 period. Our direct segment net sales represented 39.4 percent of the company's total net sales in the most recent quarter compared with 46.8 percent in the prior year. Internet sales increased 21 percent to 47 million in the third quarter compared with 39 million last year. Internet net sales represented 62.7 percent of the company's direct segment net sales in the third quarter compared with 55.4 percent in the fiscal 2004 period. Catalog net sales decreased 11 percent to 27.9 million for the quarter compared with 31.4 million a year ago. This decrease was primarily due to customers from the catalogs continuing to shift to our retail and Internet channels. Catalog net sales represented 37.3 percent of the direct segment net sales for the period compared with 44.6 percent in the prior year third quarter. Gross profit for the third quarter was 90.8 million or 47.8 percent of net sales compared with 68.6 million or 45.6 percent of net sales for the same period last year. This 220 basis point increase in gross profit rate was primarily due to improved merchandise sales margins in the direct segment and to a lesser extent, improved leveraging at the company's full line retail store occupancy cost. Selling, general and administrative expenses for the fiscal 2005 third quarter were 71.1 million or 37.4 percent of net sales compared with 53.4 million or 35.5 percent of net sales for the third quarter of 2004. The increased in selling, general and administrative expenses expressed as a percentage of net sales was primarily due to increased personnel costs associated with our retail store expansion and to a lesser extent, increased national magazine advertising. For the recent quarter, income from operations increased 4.5 million or 30 percent to 19.7 million or 10.3 percent of net sales. This compares with 15.2 million or 10.1 percent of net sales in the prior year period. Turning to the balance sheet, we closed the quarter with 113 million in inventory, an increase of 21.9 million compared with the end of the third quarter last year. This increase in inventory was primarily due to the addition of 56 retail stores since the third quarter of last year. The 24 percent increase in inventory came during a period when we had 52.3 percent increase in store count and a 45 percent increase in retail square footage compared to the third quarter of 2004. At the end of the third quarter, we had no short or long term debt and a cash position of 104.7 million. At the same time, the company's working capital increased to 125.6 million at the end of the period from 111.2 million in the comparable period a year ago. In regards to our Coldwater Creek co-branded credit card program, we had more than 60,000 activated cards during the third quarter which resulted in credit card revenues of more than 4.5 million for the period. This represents a substantial increase over the credit card revenues of just under 1.7 million in the second quarter of this fiscal year when we introduced the program. As of the end of the third quarter we had a total of more than 81,000 activated cards and we continue to see growth in this program. Finally, updating the status of our distribution center expansion in West Virginia, we are planning to add approximately 350,000 square feet to the existing facility which will bring our total space there to almost one million square feet. Construction is expected to start later this year. We plan to take possession of the new space in the second half of fiscal 2006 and believe that with this expansion our single distribution facility will be sufficient to fulfill up to 450 to 500 retail locations going forward. In summary, our merchandising and marketing initiatives for fall resulted in positive customer response across all channels which contributed to an increase in net sales and net income for the quarter. I will now turn the call over to (Georgia) for a discussion of our merchandise results for fall and a look at what's in store for the holiday. Once again in this recent quarter, customers responded very well to our iconic novelty jacket and top assortment but new for us has been the excellent response to our pattern and prints skirts. We had a higher degree of confidence in our merchandising strategy going into the fourth quarter and based on positive early response, we remain enthusiastic about the holiday selling season. As always, holiday at Coldwater Creek is about items and gift giving. We approach the season with a warm and cozy traditional feeling and of course some innovative twists. Everything about our holiday collection was carefully designed and all of our categories this year emphasize multiple gifting. For instance, we have novelty tops and sweaters with many dyed to match accessories and colorful suede jackets with matching suede gloves. Along with items like these, we are featuring an assortment of fun merchandise including stocking stuffers. That puts a focus on the gift giving that's so important to us. We believe that we have a distinct strategic advantage this time of the year because of the categories we offer. We dress her, our customer, for 10 months out of the year and although we continue to dress her throughout the holiday season, we really become her gift destination as we get closer to Christmas. The way we merchandise gifts and hard goods with our apparel continues to set us apart from the competition and it becomes an even bigger differentiating factor in the all important gift giving season. For early holiday, we have seen particular strengths again in our novelty jackets, knit tops and great fun accessories. Our current gift with purchase promotion has proven to be an exciting addition to this successful program. Customers are responding extremely well to our amethyst earring and necklace set. The gift with purchase strategy is one that works well for us driving traffic to our stores while it gives the customer an attractive incentive to spend $100 or more to receive their gift. Another very successful initiative has been our Coldwater Creek catalog, a title which features mostly store specific merchandise from all of our catalog titles under one cover. Based on positive response to this store traffic driver which by the way also performs very well in the direct segment, we are increasing circulation for this book next year and in 2006 we will have six mailings of the Coldwater Creek catalog, up from five mailings this year. As (Dennis) mentioned, our national magazine advertising campaign has become an effective brand building tool and we are reaching out to a greater number of customers this holiday season with an eight page insert in high circulation titles such as Oprah, Better Homes and Gardens, More, Country Living and Good Housekeeping. In November and December, our total page count will exceed one half billion pages of Coldwater Creek brand messaging. I'm also pleased to report that our inventory position came in under planned for the third quarter even with the addition of 56 new stores compared to the prior year. In addition, our inventory is more current than in the past due to the effectiveness of our well managed virtual inventory and our single distribution center. Retail inventory increased approximately 15 percent on a square foot basis to $70 per square foot compared to 61 in the prior year. This increase was primarily due to our merchandise built up and the preparation for the holiday season. Turning to our global sourcing initiatives, we are on track to achieve our goal of having 15 percent of our volume direct source this year and remain confident that we can meet or exceed our goal of 50 to 100 basis points improvement in gross margins associated with direct sourcing. Next year we plan to increase that amount of merchandise sourced directly to approximately 30 percent. We also plan to open our Hong Kong office in January which will play an important role in our ability to increase the level of direct importing going forward. In closing, overall we were pleased with the response to our merchandise in the third quarter thanks to good sales in August and October. We continue to see customer response to our retail store expansion as very positive as well as strong growth in our Internet channel which had a 21 percent increase in net sales compared to last year and now represents nearly 63 percent of our direct segment net sales. Our brand building initiatives, the national magazine advertising and the Coldwater Creek catalog traffic drivers continue to perform well for us driving sales in both the retail and direct segments. Inventory levels are below plan at the end of the period and our inventory is more current than in the past. At the same time, we added 56 stores that increased retail square footage by 45 percent compared with the same period last year and although it's still early, we are seeing very positive response to our holiday assortments in all three selling channels and we are very enthusiastic about the balance of this important selling season. Before we open up the lines for your questions, I'd like to update you on our guidance for the remainder of this fiscal year. Based on the positive early response to our holiday assortment and what we see as potential upside for this selling season, we are increasing our fourth quarter and full year net sales and EPS guidance to reflect the following: fourth quarter net sales in the range of 245 to $250 million and EPS of 24 to 25 cents. That makes the full year an increase in guidance to reflect net sales in the range of 745 to $750 million and an EPS of 69 to 70 cents. The question and answer session will be conducted electronically today. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touch-tone telephone. If you are using a speakerphone, please remember to make sure your mute function is turned off to allow your signal to reach our equipment. Again, that's star one if you would like to ask a question and we'll pause for a moment to assemble our queue. Hello. (Georgia) I just was wondering as gift cards have become more important in the holiday season, have you adjusted your inventory flow for December and January? Will the stores receive more full priced goods during this time than they have in the past or are you doing anything different to address this? Gift cards have become an ever growing part of the holiday season and the business and so there are â that's already baked into our plan for us to be able to not only sell them but of course redeem in January and February. Yes absolutely. Even though January becomes the sale period and the big sale period, we always have full capsules and full price spring merchandise coming in again to give the customer some newness. OK. And then I guess regarding sale, it appeared that the clearance sale in the retail sales lasted a little longer this year than last year before the goods were moved to the outlets and the Internet and I just was wondering was this planned and is this something we can expect to see as the retail store base continues to grow at a greater rate than the outlets? And then also in the past you continued to have solid full price sales during your clearance events and was this also the case in the third quarter? Let me answer that. The first question about the sale lasting longer, in prior year, in 2004 we stopped the sale a week before the end of October and brought holiday goods in prior to Halloween. Strategically this was not a good move for us so we decided that again the consumer, especially our customer, is not ready to even think about holiday until after Halloween is over so we added an extra week at the end of October to clear fall goods and not bring holiday in too early. So that was a strategic plan and we'll continue that next year. I just was wondering are you still seeing that you have strong or full priced business during while your clearance events are going on as well? Yes we have continued to see all year and including in October that every time that we bring full price merchandise in and the front of the store in (capfuls of newness) that the customer responds exceptionally well. OK. And then just one last question, can you comment how the expanded petite offering is doing and have you received you know good feedback on that and do you see this as a growth opportunity going forward? I would say that we have seen very positive response to the petite offering being expanded. We are continuing to look at into it and this will be â we'll keep the expansion going forward and looking into other areas. A question on the marketing initiatives in the third and fourth quarter, the increase in media advertising or print media, you had talked about this as sort of an interesting test in the third and fourth quarter. I'd like to know what you learned in the third quarter, what kind of measurable results you've seen either in new email or catalog customers and then if you could comment on the deferred marketing expense in this quarter and the sudden build up in that. I'll take the first one Richard and (Mel) might wish to talk to the second one here in just a second. We saw very clearly that we had a remarkable competency a year ago in terms of what I'll call print media advertising that really we'd previously defined as our catalog channel and we saw a very good way to refocus that into magazine advertising so that we could now begin to attract a customer who was not a catalog customer to the brand and move them into the stores and we're seeing a fairly high percentage, about one out of four customers who are responding to these magazine ads have never heard of Coldwater Creek, have never purchased from Coldwater Creek before and it is really providing some great incremental new business for the company across the three channels but primarily of course going into the retail stores and secondarily into the Internet site. Based on what we seen the success of it, it does two things. It really leverages the beginning of creating a brand umbrella over the entire company's portfolio of offerings across all the channels and I think as for us at this stage Richard it's a much more cost effective way to do that than for television and second, it certainly drives traffic immediately right to the stores and we did see that opportunity and we are seeing it as we speak. Richard regarding the question on pre-paid advertising increasing, there's really two components of that. one is some increase in our bringing in catalog paper early because of an opportunity to bring it in at the prices we wanted to and then also the national advertising campaign we have the ability to tie those sales to those particular offers so there is some pre-paid advertising costs related to the magazines that would be in home in November and December and it's those two components that caused that increase between years. I guess you've talked about seven million in additional advertising in the fourth quarter. Should we assume that some of that was paid for in the third quarter? Some of that might have early â yes actually some of that would have been paid for and would have been â some of those magazines would have been in home right around the end of the third quarter, the beginning of the fourth quarter. The number that we actually are spending I think is roughly $6 million for the quarter. Well a majority of those dollars are setting in the pre-paid advertising cost at the end of the quarter or some portion of them are and then we'll be spending some for the December ads that will go in home or are currently on the newsstands. Cash flow adjustment is made immediately and then as the catalog gets mailed or as the ads run you'd take the expense. Right. Richard if there is a â there is a coupon attached to these ads with an offer code so from an accounting perspective we can track the sales curve of the ads, that the ads are responsible for by the redemption code on the coupon that the consumer redeems so it's different than just the normal ad that is designed to increase awareness but has no coupon with a code that you can track and that's why you have to defer it and then amortize it over the life of the sales. Now you anticipated my next question. What's the response on a percentage basis to your ads? Would you say you know Home and Garden is a million book distribution and you know do you get 100,000 responses to that or can you â have you tried to quantify it in that way? We can quantify it. I can assure you it wouldn't be anywhere near 10 percent. It is a small percentage but as a I say, so many are new to file that it seems to be very positive for us. I was wondering could you detail just this quarter how many catalogs you mailed out and then what the expected number of catalogs you're expecting to mail out next quarter? Yes in Q3 we mailed out approximately the same amount of catalogs as we did in Q3 of '04 which is in the â it's in the area of about 43 million. For the fourth â for the fourth quarter again we will be very close to what we mailed last at about 109 million. OK. And then jumping just onto the SG&A line, when you commented in the press release that you opened an extraordinary amount of stores this quarter, what was the impact on it from a basis standpoint on the margin? Basis standpoint on the margin, it'd be easier to look at it from a standpoint of opening up 27 stores and that probably had an impact of roughly a penny and a half or a million and a half dollars of pre-opening costs. Hi thank you. A couple of questions; can you talk about the improvement in gross margin, how much of that was related to your direct sourcing initiative? Our improvement in gross margin really there's two major components of it. A little over 100 basis points was related to the merchandise margins improving and of that I would say probably half or so was related to direct sourcing. The other improvement was from leveraging our total occupancy cost related to our retail stores and that improved the margin about 100 basis points as well. OK. Thanks. And then just again in terms of SG&A, in your guidance for Q4 of 24, 25 cents, can you just give us a sense of the SG&A dollar growth that that's embedded in there because I know it's been up considerably and I assume without the store openings it should be a little bit less going forward. Yes, I don't have a specific dollar growth that's embedded in there but it'll be â the growth rate will be approximately the same as the third quarter. There would be some leverage in Q4 because we wouldn't have the number of new store field operation people coming on. However, we do have the significant national advertising campaign going on. Great. Thanks and let me add my congratulations. Just going back to the SG&A piece for a second, can you break down the increase in advertising expense and I know you've outlined some numbers for Q4 but what we should expect to see in 2006. Well on 2004 or 2005 here, there really are two components to the growth in the SG&A. As I mentioned, one was the increase in store people â store operating personnel and then the second was on our national advertising campaign. I don't think I have the percentages at my fingertips that you asked for Amy. Certainly qualitatively we are seeing first of all the print advertising, magazine advertising we are going to continue and selectively expand. That is based on the individual magazine. We'll be trying some new magazines as well outside of the some of the traditional shelter magazines number one and number two as (Georgia) eluded to, the Coldwater Creek catalog which is particularly determined to drive retail traffic will be expanding and adding an additional drop so we will see our SG&A rise on an absolute dollar rate due to those two initiatives. I think very important to recognize it is a wonderful opportunity while we have such great residents with the customers right now in this age group is to solidify our reputation with new customers as new competitors potentially come into this sector. We really do want to prudently increase our brand advertising over the next couple of years. OK. And just a couple more questions, maybe if you could talk a little bit about the timing of new store openings within the quarter, how it progressed and then last on inventories, I believe (Georgia) mentioned they were up 15 percent at retail due to some early receipts for holiday. What do you think is the ongoing increase during the quarter as we head into Q4 and where do you expect to end the fourth quarter? I'll take the question on the store openings. We really built up the stores. There was 27 stores in the third quarter and the majority of those stores were opened in the last two months of the third quarter. OK. And then talking about the inventory, we will end the inventory year at about $46 per square foot. That includes the (DC) and that's very, very similar to last year. So it should come down nicely. I was wondering if, I know it's early but will you â are you willing to share for next year the timing of your new stores by quarter? Yes, we would anticipate that we will do that but I don't have that right now. We'll be doing that later. I would say the break out in the stores this year I think we had five stores in the first quarter, 11 in the second I believe, 27 in the third and then 11 in the fourth. I think I'm off a little bit on the second quarter but the ratio will probably be approximately the same for the 65 next year. OK. Great. And then can you describe the margin differential, the product margin differential between your non-apparel items versus your you know more of the gifting and accessory items? Yes absolutely. All of our â first of all just we do about you know 86 percent of our business in apparel. That is our largest IMU because we design all of our own products and in jewelry and accessories the IMU is also high. Where we have lower IMUs happens to be in the gift and hard goods and somewhat in footwear because again we're not doing as much product development. So the â and that's really â the 86 percent really is annualized and actually in the fourth quarter we usually do about 75 percent in apparel and pick up the rest in gifts, accessories and jewelry. Hi everyone. Congratulations. A lot of questions have been asked so just a few; (Mel) when do you expect to hit 15 percent as an operating margin? What year? That's going to be in the 2008 time frame. At the point â there's really two keys to meeting that for us. One is the continued build out of the stores and being able to leverage the store operating costs and the purchasing volumes from the stores and we would expect to see some leverage from our stores on an SG&A basis starting in 2007 when we hit probably 225 to 250 at stores and then the other major component is the direct sourcing initiative that (Georgia) spoke to. When we hit about 70 percent direct sourcing which will be in 2008, we would then expect the combination of those two items to give us the opportunity to have a 15 percent operating margin. OK. So then from here we'd be looking for you to increase the operating margin about two percent per year. I'm assuming roughly nine, nine and a half percent this year. The increase â we'll still have some increase in SG&A next year so I think we see the leverage really beginning in '07. We'll start to leverage near the end of '06 when we have 225 or so stores in place by the end of next holiday. OK. Also the merchandise margins in retail, I know you mentioned them in the direct segment but in the retail segment was there any differential or . . . No actually because the merchandise really is all the same so you're looking pretty much at the â at the same elements. OK. And also just quickly on the balance sheet, am I reading this right that the it looks like the inventory on a per store basis was down and that the accounts receivable have jumped ahead of the growth in sales? Yes there's three â you're correct on the inventory. The receivables though have a couple of different components in there. There's really three major pieces. One just in general sales were up year over year because of the increased stores so the credit card receivables were up. Secondly the credit card fees that Coldwater Creek receives on our co-branded program was up. That was something that we didn't have a year ago and then lastly with the addition of 27 stores plus 11 in the fourth quarter, our tenant allowance receivables are up substantially year over year as well. OK. And I'm sorry on the per store inventory it looks like it's actually down relative to the number of stores you've added on a year over year basis. On a per square footage though basis though I think (Georgia) mentioned it was up roughly 15 percent the total inventory available to the retail stores. Actually the 15 percent is actually under plan and the reality is we will be back at the end of the year to where we were last year at approximately $46 a square foot including the (DC). OK. So then going into holiday though I mean I realize this is a static number at the end of the quarter of the 15 percent being below plan but does that mean that going into holiday you'll be where you want to be? Questions for you (Georgia), last quarter you talked about adding more accessories to the mix. Can you just give me an update as to where that stands? Yes absolutely. When we â we've been continuing to add more (substance) to the mix and certainly we do as we get into the gift giving season. So strategically not only did we add more we actually did a lot of our own product development and really added as I said in my remarks the addition of which I think is great is the multiple gifting. So you don't just buy the sweater. You buy the sweater and the hat or the sweater and the gloves or scarves or hand bags that go and have actually been designed to go together so it makes it very easy for our customer to purchase gifts and they make a really wonderful presentation besides great quality merchandise as you open up the box. So yes we have increased it. Excellent. And a question in terms of the hurricanes, can you give me a sense of what the store closures were like and any negative impact it might have caused? We really didn't see heavy store closures. We didn't have any stores in New Orleans at all but we did see nationwide for that first two weeks after the hurricane a reduction in store traffic and we also saw that our North Country catalog that dropped the same weekend that the hurricane hit the coast did have very poor sales associated with it. we did see this effect clear but it certainly seems that the clearing almost was inverse relationship of the amount of publicity, the TV coverage, all the sadness and bad news and it seemed like our customers responded to that very much and certainly I think the good news from the point of view of the investors on the call is we saw then in October the vibrancy of the business return to exactly where it was in August which was very strong so it certainly seems as though it was a highly unusual event and luckily it was over very quickly. We're lucky that there weren't additional disasters that occurred subsequent to that. Absolutely. And then (Mel) one question for you, when I look at accounts receivable at a percentage of sales it looks like it's up on a year over year basis. Is that the same issue of tenant allowances that you had last quarter? Yes it's a combination of tenant allowances with the more stores opening up year over year and also the fees that we received from our co-branded credit card. There's a delay in when we actually receive those fees so that you see this year. We didn't have that program last year. Do you have any plans to reinvest any of your sourcing savings by going direct and upgrading piece goods quality thereby creating better value â a better value proposition to drive store traffic? I know you mentioned at the analyst meeting that you didn't expect to raise prices so are you going to in any way change the price value equation? No actually I think maybe the better way that I can answer this is we worked very early on the type of piece goods that we use. They are tested rigidly to make sure that they will provide the customer with comfort and also quality so at this point what I look at is getting the best value for this customer and we actually price things by looking at them. You know what is this really worth in the consumer's mind and our mind and â but we do intend to remain competitive but I think we offer actually a really nice product for the value. So that's what I want to continue to maintain and again execute that on a continuous basis. So you have no â at the moment you have no intention of â for example I saw cashmere sweaters in Kohl's. You have no intention of replacing polyester acrylic fabric with a natural fiber? Well actually we run quite a bit of natural fiber. The problem with cashmere is that everybody is in cashmere including Wal-Mart so it's very difficult to compete in it and we find that our customer prefers to be able to wash and wear and so that's why our faux cashmere has been so successful for us. Well I didn't mean to focus on cashmere but cotton as opposed to polyester or a polyester blend as opposed to 100 percent polyester. We do carry â we do carry natural fibers and we carry both natural fibers all 100 percent but we also do carry blended fibers today and one of the reasons that we do is actually the technology in both yarn and in piece goods has gotten to the point that actually the wearability and the quality is much better. (Tencel) is still around but what happened was is that there are again because of technology there are fibers that actually react and really make a stronger and better piece goods that are less expensive. (Tencel) still tends to be because it's wood based a very expensive piece of goods and we run (tencel) jackets constantly because our customers do like them so it's still around but not what it was before. And just going back to one of the changes you guys seem to be making is on the store size. You've done a great job of kind of tweaking that model over the years and really getting a great return out of it and it seems like some of the stores you're opening going forward are going to be a little bit bigger. Can you just kind of walk through what you're seeing there? Sure (Kevin). This has been really an organic process over the last three years and it's kind of a Goldilocks phenomenon, you know too big, too small, just right and we originally built stores just a very small quantity of them that were too large and then as an initiative we reduced the size and as they initiative a couple of years ago we looked at stores quite small relative to where we had been and as we analyzed the sales per square foot, we saw that we did not see any higher sales per square foot in the smaller footprint stores than we were seeing out of stores that were 20 percent or 25 percent larger and this was true across geographical areas whether it was a mall or a lifestyle center and so it became really obvious that we were leaving money on the table and given the breath of the merchandise assortment it was not a better proposition from an earnings perspective to all of our shareholders to build these stores that small and at the same time we remain highly focused on an efficient store model so it looked like and we think we are now just about at the most efficient place with this about 5500 square foot average. Now some will be 4500. Some will be 6500 depending on the market and the number of customers in that market but it was really a result of the analysis of the sales per square foot of the very small stores and the recognition we were leaving money on the table. Can you â can you at all comment on kind of the competitive situation? Are you seeing as over the last year â have you been able to quantify how many of your customers have kind of come away from the (Jill) brand and come to the Coldwater Creek brand because they've kind of strayed away from their core customer? Well yes, I'm happy to comment on the question and really and this is something â I talk about it internally a lot, really if you look at where our customers the majority of the customers in this population segment continue to shop it's department stores and the department stores make up more women's apparel over the age of 35 than the specialty people and the big box people put together substantially more and even though the department store share keep shrinking, they still are getting a huge percentage of the business. Now our customers don't like shopping there as much as they used to and we honestly believe that that's where we're picking up share more than anywhere else and the amount of total volume done by all the specialty apparel peers put together is not really significant compared to the department store so our focus is on finding ways to attract these customers to our brand and take this business as aggressively as we can from these department stores. OK. Great. And when can we expect â are we thinking the first quarter or the first half of the year roughly in terms of starting to report the great same store sales that you guys are generating? We expect that when we have 100 stores in the comp base for a full quarter we'll start reporting and so when we report second quarter earnings of 2006 is when we would start that reporting. Hi thanks. (Georgia), a couple of questions for you and then I'll move onto (Mel). Can you give us an update on sport and then dresses as well? OK. In sport we continue to have especially in the sport sets we really continue to have great success. So we will be going forward for spring with our sport book. Also dresses, dresses are very interesting. As you well know, for our retail stores, they're really more sportswear oriented but quite frankly the dress business in direct both catalog and the web has been on fire and so we're really, really pleased with our dress business and we will continue to do the dress business which you know represents a large portion of the direct business. Right. And then (Georgia), have you commented on your plans for (sirk) for '06 and then if you do one incremental Coldwater Creek titled catalog for '06 does that mean anything for the frequency of spirit or north country? OK. Great. And then (Mel) you know sourcing is already contributing it appears on that gross margins but what's happening on the cost side of that business? You know I think people are trying to get at you know the SG&A number here in the quarter and I'm just wondering if there were some additional costs from sourcing that you saw in Q3 this year or has it been fairly linear with what you've seen earlier in the year? Well partly the SG&A on a rate basis, certainly we had two weeks in September where we would have liked to seen a little bit better revenue. And it appears there are no other questions in the queue at this time. I'd like to turn the conference back over to you Mr. Gunter for any final remarks. |
EarningCall_234052 | Good day and welcome to today's Colgate-Palmolive Co. fourth quarter and year end 2005 earnings conference call. Today's call is being recorded and is being simulcast live at www.Colgate.com. Just as a reminder there may be a slight delay for the question-and-answer session begins due to the Web simulcast. At this time for opening remarks I would like to turn the call over to the Vice President of Investor Relations, Ms. Bina Thompson. Please go ahead. Good morning. Welcome to our fourth-quarter and year end conference call. With me this morning are Reuben Mark, Chairman and CEO; Ian Cook, President and Chief Operating Officer; Javier Teruel, Vice Chairman, Stephen Patrick, CFO, Dennis Hickey, Corporate Controller, and Ed Filusch, Treasurer. Our remarks this morning on the fourth quarter will refer to our results excluding the following items, a 32.9 million after-tax gain on the sale of our Southeast Asian detergent business, a 41.9 million after-tax charge for restructuring and 10.4 million after-tax for other charges. Each of these items was included in the as reported numbers contained in this morning's press release and accompanying financial statements. The reported GAAP results with reconciliation to the results excluding these items are included in the press release and posted on the Investor Relations page of our Website at www.Colgate.com. During the Q&A we will answer any specific questions including or excluding these items as you may wish. We are delighted with this quarters results, which show a strong finish to the year and set the stage for another good year in 2006. It is a strong P&L with all the ratios moving in the right direction. Our financial strategy, with which you are very familiar, is back on track. Soft line sales in unit volume are up, gross margin increased strongly, overhead expenses are down. This has allowed meaningful increases in worldwide advertising while operating margin, net income and earnings per share have grown. Our businesses and marketshares are strong around the world. Also in the quarter we announced the sale of our Asian detergent business consistent with our focus on the higher margin categories of oral care, personal care and pet nutrition. So let's focus first on the worldwide P&L. Excluding divestitures, sales increased 5.5% and volume increased 4.5% on top of a 10% sales and 9% volume growth in the fourth quarter of last year. Pricing increased 2%, was up in all geographic division except Europe. This is very encouraging and is a good indication that our global focus on more efficient trade spending is beginning to bear fruit. Foreign exchange was negative 1%. Gross profit margin increased 100 basis points. As Rubin said in the press release, above our expectations. This excellent performance is particularly notable in light of the commodity cost increases which all companies experienced in 2005 and which escalated in the second half. Gross margins benefited from five factors. One, our ongoing funding the growth program. Two, savings from the 2004 restructuring. Three, improving product mix. Four, favorable pricing. And five, our newest element the increasing savings coming from our improving efficiency in promotion spending. These factors helped to offset the sharp rise and will impact material costs. And we expect this good gross profit momentum to continue into 2006 and we budgeted and fully expect to achieve further meaningful gross margin increases this year. Looking at SG&A on an absolute basis, SG&A increased slightly and since sales were up SG&A was down 100 basis points as a percent of sales. Very importantly to us the overhead component of SG&A went down very nicely while the advertising component increased 6% to 10.5% of sales, up 20 basis points from the year-ago quarter. As we go through the divisions you'll hear how this continued focus on increased spending in advertising has helped both volume and market share. As I said overhead expenses were down as a percent of sales reflecting our ongoing emphasis on cost containment and driving efficiencies around the world. Operating profit decreased 10% in absolute terms and increase as a percentage of sales by a 110 basis points. Our tax rate was 31.1%. This brings us to 31.7% for the full year, toward the high end of our announced target of 31 to 32%, and reflects increased benefits from the European business of realignment we have previously discussed with you as well as other global tax savings initiatives. Net income increased 14% from 11.9% of sales in the fourth quarter of last year to 13.1% of sales this year. And diluted EPS increased 17% to a record $0.69. Cash flow and balance sheet are solid as well. Our working capital is at a record low of 1.7% to sales down from 2.4% last year with both inventory and receivable days down nicely. So we feel it is a very good finish to the year which gets us firmly on track and positions us well as we enter 2006. Before I turn to the divisions, effective January 1, 2006 the Company as required will adopt the statement of financial accounting standards 123R share-based payments. The new accounting for stock-based compensation will result in incremental expense which for the full year 2006 is currently estimated to be in the range of $0.0 to $0.10 per share. However, as most of the Company's equity awards are generally granted in the first and third quarters this charge will not be spread evenly throughout the year. The projected incremental impact to the first quarter of this year is approximately $0.03 per share. So let's turn to the divisions starting with North America. Excluding divestitures volume in North America increased 6% in the quarter driven by even stronger volume growth in the United States portion of the division. The U.S. was up 7.5% in volume and 10% in sales. For North America as a whole pricing increased 2% and exchange added 0.5% resulting in a total sales growth of 8.5%. As you know we are undertaking a worldwide initiative to increase the efficiency of our trade spending. The pilot program for this is here in the U.S. and in Mexico, and our positive pricing momentum reflects the early successes we are achieving. Advertising increased both absolutely and as a percent of sales and operating profit increased just under 10% and up on a percentage of sales basis as well. Our very healthy volume growth is reflected in good market share performance here in the U.S. Our national shares as measured by Nielsen are up year-over-year in toothpaste, toothbrushes, dishwashing liquid, fabric conditioners and bar soap with an all-time high level being reached in all but the dishwashing category. In the toothpaste category our share was up almost half a point year-over-year. New products such as Colgate Max Fresh and Luminous continue to perform well as does Colgate Total. Total's full year share was 14% with sales increasing 14% year-over-year. Our domestic manual toothbrush share was up over a full point. Colgate's 360-degree toothbrush launched early in the year has been a significant driver to the marketshare gain as it has in other markets as well. In bar soap our share is up over half a point and essentially tied for the number one positioning in the deodorant bar soap category. Our latest entry, Irish Spring MicroClean, helped build share and we expect some more new news in the Irish Spring line later this year. Looking ahead we expect volume in North America ex divestitures to be up at least mid-single digits in the first quarter and full year. Operating profit should be up high-single digit in the quarter and year. Turning to Europe, excluding divestitures volume in Europe increased 2.5%. Pricing was down 1.5% which while the only negative pricing number in the whole Colgate world is a sequential improvement from the third quarter. Currency was -6.5% all resulting in a sales decline of 5.5%. Advertising was down slightly in the quarter as a result of timing of new products and more importantly as compared to a record fourth quarter in 2004 when advertising was up 45% from the prior year. On a full-year basis our European advertising was up both absolutely and as a percent of sales. Operating profit declined 7.6% largely due to currency. Unit volume was down in Western Europe while Central and Eastern Europe posted strong double-digit growth. As has been the case for most of 2005 macroeconomic conditions in Western Europe have been very challenging particularly in countries such as Germany, France and Italy. However, more recent economic data are beginning to show some signs of economic improvement. The third-quarter GDP growth rate was the highest since the first quarter of 2004. Inflation is expected to decline in December and the unemployment rate has also come down somewhat. So as a consequence consumer confidence in our key markets improved significantly in December which should bode well for 2006. And we are seeing some better volume trends in Western Europe more recently. Two new products in the toothpaste category have just been launched in Western Europe which should rollout across the region over the next year. Building on the success of Colgate Sensitive toothpaste we have introduced Colgate Sensitive Multi-protection toothpaste, this has a dual action formula which provides not only unbeatable sensitivity relief but also protects teeth and gums, thanks to a clinically proven bacteria fighting system. In addition, we have introduced Colgate Time Control toothpaste with active vitamin E. This new product is targeted to the aging population that tends to experience receding gums. Receding gums are one of the main causes of root cavities and can lead to further problems. Colgate Time Control's clinically proven formula protects the exposed root area against cavities and contains a gum protection system with active vitamin E which helps invigorate gum tissues and prevents them from receding further. Our GABA business had an excellent fourth quarter capping off a very good year. GABA's volume grew double-digit. You may recall that our expansion strategy with GABA is to work with dental professionals and academics to build brand awareness and recommendations and to enter a new market first in the pharmacy channels to build market share. We have done this very successfully in Italy where our share in the pharmacy channels is in the high teens and we are the most recommended brand. As mentioned in the press release, our market shares across Central and Eastern Europe are establishing new records. Our shares are up in seven of ten categories with over a 3 point gain in toothpaste and over a 2 point gain in toothbrushes. In the bar soap and shower gels categories we have maintained our number one position across the region. And further new product activity in 2006 should maintain these excellent results. So looking ahead unit volume in Europe excluding divestments should be up low to mid-single digit for the first quarter and at least that for the full year. Operating profit is expected to be up modestly for the first quarter and up mid-single digit for the full year. Turning then to Latin America. Latin American volume increased 5%, pricing increased 5.5% and currency added 6% resulting in a sales growth of 16.5%. Advertising was up very strongly, up absolutely and as a percent to sales. Operating profit increased 16%. Business is strong across the region and marketshares reflect this. In Mexico our most recent toothpaste share is back over 81% despite intense competitive activity. The launch of Colgate Max Fresh has contributed to the excellent performance and in addition, a recent program called Red Storm designed to strengthen our presence with our exclusive distributors has delivered good results. New products in the personal care category, Palmolive's Nutri-Milk bar soap has also met with success. This is a premium product, our first entry into the moisturizing segment. In Mexico it already has almost a two share and has been incremental to the franchise. Our Mexican shampoo business is also doing well. Palmolive's Optim has been the first brand to launch a shampoo, conditioner and treatment line to enhance the color of natural or tinted hair. The line comes in four variance for different hair colors and was launched in September with complete media and in-store support. Initial acceptance was excellent. It appears this will be largely incremental to our existing business. Our Brazilian business is also very strong. Marketshares are up in seven of nine categories including toothpaste, toothbrushes and mouthwash. Our Colgate brand reached record share levels. Contributing to this good performance is our relaunch of Colgate Total, Total 12. As in other parts of the world this has been accompanied by very powerful testimonial advertising. In Brazil the share of Total toothpaste has doubled since the relaunch. In the liquid soap category we also achieved outstanding results in Brazil. Strong growth from Palmolive's Aroma Therapy, Protex and Palmolive's Natural resulted in Colgate obtaining leadership in this segment with a 23.6% share up almost 7 points from the year ago period. Across the region our toothbrush business is doing very well driven by market share growth in key markets such as Brazil, Mexico, Colombia and Venezuela. Colgate is now the number one brand. Our Colgate 360-degree toothbrush will be throughout the region in 2006. As you know it has been extremely successful in markets where it is already introduced, so this bodes well for the continued growth of our toothbrush business in Latin America. Looking ahead volume in Latin America is expected to be up at least mid-single digit for the first quarter and full year, and operating profit is expected to be up double-digit for both the first quarter and full year. Asia/Africa; volume in Asia/Africa increased 6%. Pricing was positive half a percent, while exchange was negative at 1.5%, resulting in a sales increase of 5%. Advertising increased double-digit up absolutely and as a percent of sales and operating profit increased 13%. And as elsewhere new products played a critical role in the solid performance in the region and this is reflected in good market share performance. In India, Colgate sustained its leadership position in toothpaste with 47.5% share in December. For the full year our share increased to 47.4%, a growth of 80 basis points versus last year. A new product, Colgate Active Salt toothpaste achieved very strong share results, 2% in just the fourth month of launch which was supported with a nationwide 360 program including a very successful advertising campaign which achieved good recall and has helped to grow the Colgate equity image. In the Indian toothbrush market Colgate strengthened its leadership with a 32.9% share in December reaching record high share for the second consecutive readings. Across the country great progress has been made in further expanding our rural distribution offering, further opportunities for growth. In China, we increased our toothpaste leadership with our full-year share at 32.8%, up half a point from the year ago. This strong performance was led by the premium segments and the launch of Colgate Max Fresh accompanied by a regional 360-degree program which included advertising. In the personal care category we have achieved excellent results in the Philippines with the relaunch of Palmolive's Natural shampoo. Palmolive now has the highest share in the last ten years, almost 22%. Part of our success was driven by using small sachets which has resulted in much better distribution across the many small stores in this country. Our business in the more developed country of Australia is also strong. Our toothpaste share is up a full point, 65.4%. Colgate Total itself grew to the number one toothpaste sub brand with a 22% share, up 2.5 points. In toothbrushes the launch of Colgate 360-degree toothbrush resulted in a share gain of 5.6 share points bringing our manual brush market share to 40.1% on a full-year basis. Looking ahead volume in Asia/Africa is expected to be up mid-single digit for the first quarter and the full year. Operating profit is expected to be up modestly in the first quarter and should be up high-single digit the full year. Finally, Hill's. Hill's volume increased 5% with good growth both domestically and overseas. Pricing increased 2.5% offset by a comparable decrease in resulting in a 5% sales increase. Advertising increased maintaining it's high-level as a percent of sales and operating profit increased 5%. As for the Colgate business new products played an important role in the quarter for Hill's. One of the most successful ones is our Prescription Diet j/d, a diet which helps dogs with arthritis. In the U.S. our volume shipments of j/d exceeded our estimate by 50% and we were able to roll it out globally in less than six months. Similar results are being achieved overseas. Two other new products, Prescription Diet d/d and z/d for dogs and cats were also launched. D/d addresses all types of inflammatory skin conditions and z/d is now considered the gold standard in diets which helps with adverse food reactions. Here in the U.S. we have expanded our very successful shelter program. This program provides ongoing nutrition training for the staff of not-for-profit animal shelters, as well as informative e-mails with nutrition topics and helpful retail merchandising tips and a variety of in shelter signage. The objective of this activity is to stress the importance of clinical nutrition to pet owners at a key time in their decision-making process while encouraging trial of Hill's products. In addition, specific programs from the pet channel have driven consumption and it looks as though that momentum is continuing into this year and several of our large accounts are off to a good start. Our international business continues to grow especially in the higher growth markets which are sustaining strong double-digit volume increases. Looking ahead volume at Hill's is expected to be up mid-single digit for the first quarter and full year. Operating profit is expected to be up high-single digit for the first quarter and full year. So in summary we are delighted with the strong finish to 2005 and are excited about the prospects for 2006. As you know, gross margin increases are a key element of our financial strategy and our ability to deliver good consistent results. It is very encouraging that all the programs we have in place to increase gross margin are delivering good results and also offer further potential. In particular, our worldwide effort to increase our commercial spending efficiency shows great promise. In our pilot countries such as the U.S. we are already seeing excellent results as evidenced by a solid increase in pricing, but this is just the beginning. As we roll this program out globally we should see further savings around the world. So we look forward to sharing our results with you as we go throughout the year. My first question has to do with Europe and the profit margins you are seeing there. It doesn't look like you're looking for much expansion next year, but if I'm not mistaken that has been where the lion's share of your restructuring initiatives have been. Can you comment on whether you're just reinvesting more money or whether there is a mix shift there? What is driving the lack of margin expansion in that region? I don't think, Wendy, that the majority of the restructuring efforts is really in Europe. We have a very major effort in this country and elsewhere; you may recall we announced the closure within the last six months at one of them in the last two months of our two biggest plants in the United States. But looking specifically at Europe the expectation for next year is that it will be a plus volume year as this was. As you know our volume was up about 6.5%. In terms of operating profit, operating profit was up this year overall in Europe and is expected to be up more next year. We believe starting in the first quarter. As I think Bina mentioned in her write up that the volume trends in Western Europe which were I think for everybody are not as robust as one would want, have most recently picked up a bit and they have started off the year it would appear quite well with Eastern Europe continuing there very strongly. I thought and I may be mistaken but I thought looking at the 10-Qs last year that the lion's share of the charges you had taken at least through the first nine months, were related to the Western European operation that you were shutting plants there. Is that not right? That is right; but again it continues to move through. Don't forget this year, late this year we took the charge for our Jeffersonville plant which is the biggest plant in the United States, and that process is literally going on now, we just got union agreement and so on. And I think you will see more of the same. My second question has to do with that plant closure in the U.S. Where are you going to move the oral care manufacturing? And if you end up moving some of that to Mexico, is there hope that some of the pressure you have seen on the Mexican margins from all of the competitive activity, you have got light at the end of the tunnel because there is going to be more volume in that market or what is the thinking there? First, there is an elaborate process as you would imagine to determine whether we open up the new greenfield site in the State of Indiana or in other states, and we have been engaged in that process for a number of months. I don't know if the announcement has, the announcement has in fact been made and amazingly it is going to be, we have a big plant in Morristown, New Jersey. This is going to be in Morristown, Tennessee and everybody knows I got a nice letter from the Governor of Indiana yesterday where we saw the big Hill's plant of course. But it is going to be, the bulk of the production is going to be moved to Tennessee with some very significant onetime and ongoing savings. And the production in Mexico will not be obviously for Mexico, it will be for some areas outside of Mexico. But when you say the margin pressure in Latin America, my sense is that our EBIT in Mexico on an ongoing basis is 7 or 8 points, i.e. 800 basis points higher than our total company, that is about 30% and we are budgeting at 31% makes year. So I don't think again, you may know more or different than I do, Wendy, but we do have a very good margin in Mexico on an operative profit level. I'm sorry, you said operating margin and I'm done, sorry, the operating margin in Mexico is budgeted for 31 in '06? Is that what you said? 30% to sales which as you know our total company is 20, 21, 22. So it is 800 basis points better and as budgeted up, on a percentage basis slightly and more significantly, on an absolute basis. I'm not sure that, Wendy, I was trying to say something. One of the notes out this morning talked about Colgate as a defensive situation, and I just wanted you to know that that A) that is really true, and B) all you have to do is say something critical and you will see how defensive I will be. First of all you guys sound much more excited about this reduction in trade promotion strategy than I have heard you since you first discussed this last December, December of '04. Number one, am I reading that right? And number two, are you ready yet to quantify what that opportunity may be now that you have a couple of quarters of this under your belt and you're actually starting to see it flowthrough in the P&L? You are reading it correctly. We are probably not ready to quantify it although I have been saying and I think I may have said in the last conference call, that as we are getting a better look at it, it looks like it conceivably could have the magnitude of the value we are going to get out of the restructuring or even more. I checked this morning with both the chief financial officer of the company and the chief legal officer of the company, because I told them what I was going to say and that from what we have seen so far my strong belief is that we have got a tiger by the tail on this half, and we will be seeing over the next several years some very exciting stuff coming out. That is great. Just turning to the restructuring, can you just walk us through what the savings were in '05, what you expect them to be in '06 and what you expect them to be in '07? Because I believe last we spoke some of those numbers had moved around from your original expectations a bit. They are the same as we talked about last time; that is they have not moved since we talked about them last time. In 2005, Amy, we took a charge of $145 million in total, and generated savings of about $35 million. The expectation in 2006 is that we will have charges of about 228 million, with savings of 70 plus million. 2007, a little further out, 90 million in the savings and 110 in charge. You understand, Amy, that those sound precise, but of course as those projects are actually put into effect, some of them cost more or cost less and the savings are more or less as I am sure you are familiar with that. Right, but I think originally the savings in '06 was going to be 100 million so is it fair to say that the savings are more backend loaded because of the point you just made which is timing of projects? Slightly. The overall savings we expect are slightly higher. The charges are somewhat less and there is that, what we view is relatively small difference in timing because of some changes required in the scheduling of some closings. However, I have to say from my own perspective relative to the conversation we just had about other areas of margin growth, gross margin growth within the Company, I am more comfortable than I have been. Okay, great. Last but not least a quick one, is there any way that you could give us volume guidance on a reported basis in addition to the numbers that Bina gave by region excluding divestitures? Because I think that might help us when you guys ultimately report your numbers? I don't have that, but I do have, Amy, for each quarter of next year what the sales as reported and sales ex divested are, and there is more or less a starting off the year, a 200 basis point difference, declining obviously somewhat as the year goes through to less than 100 basis points difference in the fourth quarter. And I'm looking at the financial people but basically you could transfer that pretty clearly to volume. That is as much as I can give you because we haven't worked it out on that basis. It was clear. I just was hoping for a little bit more specificity but I will just do it off-line because I have asked enough questions. No, that is okay. We are expecting, as you know our targets are normally 4 to 7% volume and this year, or total year we had 6.3, last year we had about the same. We are expecting the first half of next year to be more or less in line with that range. Good solid volume. We would hope some positive price, in fact we are planning on it, and good gross margin growth. So in other words you would expect volume excluding divestitures in that 4 to 7% range in the first half but more like 2 to 5 on a reported basis? If we could go through the puts and takes to gross margin, I know Bina listed what the benefits were but if we just could quantify it. Sure. And again, for everyone we go through this normally each quarter. As you know in the quarter the gross profit was up 100 basis points. In that we got plus 70 from pricing and going back to Amy's question this may give you a little bit of guidance of how potentially potent this promotional SAP enabled promotional ROI kind of thing is. About 50 basis points of the 70 in pricing came from actual price increases around the world and 20 points came from gross to net reductions, i.e. promotional efficiency. And we only have the program really going in the United States and Mexico. Continuing, Lauren, restructuring gave us 50 basis points. Our funding the growth savings which are our whole panel fee of internal savings programs including our capital expense budget and all the other programs we have gave us 130 basis points which is very good and gives us a very strong year in that savings area. Material prices was a -200 and then all other mix changes and so on were .5, 50 basis points up. So you add those all up together that comes up to 100 basis points. Just as an aside, as those of you who follow Colgate for sometime know that historically we have looked for and gotten in a range of 50 to 100 basis points a year. And that has even with sales level, some years that were modest, that has allowed us to, that combined with a drop in overhead, has allowed us to increase advertising and deliver double-digit profit. For the last couple of years what has happened is the increased promotional spending in the market, plus largely loyal driven raw packing material cost price increases have not allowed us actually or anybody else to get that. We are very encouraged to the point that we can say that we think that going forward, we will still be able to again be able to get on a regular basis 50 to 100 basis points. Because number one, our business is becoming less and less dependent on any oil source; as you know our most oil intensive business was detergents and as you see we are exiting those businesses. And secondly, our own cost savings combined with these promotional costs savings will allow us to shoot for that 50 to 100 basis points range. What you have this quarter is of course two aspects. Hang on one second. I have prepared something on that. In North American, the North American business on a full-year basis was $170 million or so; just interestingly again it makes the point about mix change and about what businesses do we want to be in and so on. The margin was 34% as compared to the total U.S. company including detergents at about 20 points, 2000 basis points higher. Operating profit was 13.5% with operating profit of the division including the detergent number, about 1000, 10 percentage points higher. In 2004 it represented about 6% of the division sales, this year 3.3 and next year zero. Similar, and as you know, we announced the Asia/Africa more recently the numbers are virtuallyâ¦. Okay. And then with the impact bigger though in the fourth quarter than it was in the third, because it certainly was on the top line. I'm just trying to understand how big of a driver of gross margin was that? Next year we would expect our gross margin worldwide to be improved by the existing sales of detergent, that is to say a couple of quarters or however many it is of the U.S., and basically four quarters of Asia will be between we would hope between 30 and 40 basis points. Then one more thing was trying to pick which one I want to ask. On Latin America seeing pricing and currency both up so strongly and moving in the same direction, I know we have seen it one or two quarters before, but I just wanted to go into a little bit more detail on why and basically how that is possible. I mean to be raising prices when currency is also a positive and is that a dynamic we should expect to continue? Yes, in Latin America my recollection is that the breakdown of the pricing is like, let me give you that, the total change in pricing as you see from the chart you have before you, was 550 basis points, 5.5%. Of that lower promotion, largely in Mexico but throughout the division as well, was 2.3%, 230 basis points and the price increases per se were 3.1. That is not a typical, a 3% price increase is not atypical for Latin America and clearly it has to be handled on a category-by-category basis. But some of the competitive threats in some of our categories that were really quite excellent a year or two ago have receded somewhat. Who knows? We went back over 81% of the toothpaste market in Mexico, Venezuela about the same and so on and so forth. And our division wide toothpaste share is at an all-time high, so that allows a bit more flexibility. But as always we will be very cautious. Our expectations going forward for Latin America are interesting. We expect volume in the mid to high single digits throughout next year with probably Brazil and Venezuela leading the way, Mexico slightly behind those, but still they're quite positive. So volume looks to be a lot of spending in there. We had a lot of spending this year and yet operating profit is expected up next year double-digit, it was a double-digit this year as well. This year advertising spending was, even though sales were up 16%, our advertising spending was ahead of that primarily in media, and next year it is budgeted ahead of sales. I was wondering if you guys can talk a little bit about the difference in the U.S. and growth between the Wal-Marts and club stores of the world and the track channel. Because obviously the U.S. growth is huge and the IRI data, which again we know is limited, is showing somewhat of a different story and the diversion seems to be bigger than ever. Is there any color you can give to that? The color I can give you is what I believe are the facts, but you have to decide that for yourself. We periodically, when asked, give how our top ten accounts, which are obviously Wal-Mart, Target, Sam's, Kroger, Costco, Dollar General, Family Swiss and so on, compare with the rest of the country. And for the quarter the top ten were up 10% in volume and about the same, slightly more in sales, or up actually 11% in sales and the other was up 3 or 4% in volume. So that's how we get the total 7% volume increase, case increase and volume increase in the United States. I think Bina mentioned in her write up that actually our volume, as shown there, excluding there, in the United States portion of North America, the higher end is up, as I recall, 8% or so versus say a 10% quarter last year. So good volume. Inventories haven't changed either, so it looks quite good. And then I also wanted to dig into that a little bit. Obviously you're doing a lot of things with more efficient gross to net and just marketing in general looks better, advertising is up. But is there a way to think about that in the context of the new product pipeline? And do you view, is new product vitality in the U.S. much better than it was say a year ago or a year and a half ago? Or is it really sort of similar and you're just marketing your new products better than you were before? I don't know that there's any difference. Again, we focus, everybody is going to yell at me when I say this, but we focus less on, we launch a lot of new products around the year and each of the product groups in our creative innovation centers, the acronym is CIC and I never remember what it stands for, but they are creative innovation centers, really are doing a very good job and the pipeline is full. But again, volume is a function of everything going on, a lot of new products around the world, a lot of new products in the United States. Our marketshares are generally quite good. We're ahead in toothpaste, we're ahead in fabric softener, we're ahead in toothbrushes and so on and so forth, which I think Bina told you. I don't think anything is different being done except that we have more money to spend, number one, because of the increases in gross margin. And number two, as you remember a couple years ago we, and again, I took the responsibility for it, we chased Simply White whitening gel a bit and took some money away from the big guys and that's beenâ¦.. And then just on Latin America, I think in Bina's prepared comments you described heavy competition there and then I guess Red Storm which is I guess your promotional program. Can you talk about that a little bit more? Yes, I think each divisional president and marketing director came up with wonderful names to describe and they're always dynamic and robust as that is. But Colgate toothpaste around the world, to the people who have been in the Company a long time it's known as Big Red. So this is the Big Red Storm and actually it has been quite successful in getting our share, as I said, in Mexico back to 81. Latin American shares are quite strong, for example, and volume, overall. I can read you in 2003 our overall Latin American share, and I think its 16 countries, was 72% of the market. 2004 when there was a slight erosion in Mexico and we were down to 72, we were-- our year-to-date is 72.9 and the latest share was 73.4 throughout Latin America. So it's a good trend and whatever name they put behind, Red Storm or Purple Tempest, it seems to be working. A question on the gross margin outlook for '06. You gave us the 30 to 40 basis point contribution from the divestiture. What are you budgeting on the raw material, pricing the other components of that in terms of that long-term 50 to 100 basis point improvement? Okay. To reprise the information we've been giving you, just to bring it up to date, this year we budgeted a cost increase which was basically an increase, a substantial increase in the Colgate part of the business and a decrease in the agricultural commodities. But taking them all together we budgeted a 1.7% increase in all packing materials. The way it's turning out or has turned out, because the year is done obviously, it was 3.8%, so 200 basis points more than we expected and, as we told you, the mix changed the volume and the gross profit savings more than offset that which we're quite proud of. Next year the budgeted number, equivalent to the 3.8, is 2.5% and that assumes that Hill's turns around a bit, instead of their costs going down they're going to go up slightly, but that the consumer products, the Colgate area is only going to go up between 2.5 and 3 as compared to 5 this year. That's our expectation. Who knows? We are less dependent on oil than most, but any movement in oil, obviously either way, helps or hurts us at least slightly. And then overall you'd expect the gross margin up on the higher end of the 50 to 100 because of the 30 to 40 basis points from the divestiture benefit? Financial people are nodding, yes, but my sense is I would rather be conservative. We will be in the 50 to 100 basis points. Since the operating people are in the room, I would be very disappointed if it was not on the high-end. But, yes. And also if you can comment on the competitive environment. You had mentioned some of the competitive threats in Latin America had receded a bit. Anything elsewhere in the world including North America where, again, we have that limited view of the measure channels where we saw increased promotions from the competition, anywhere else in the world that you're seeing that? I guess you have to get competitive data from the competition. But for example, in the United States there, as you saw, in effect by more efficient promotion spending the price went up slightly and very affectively and yet we didn't lose any market share as a result of it. So that would indicate that we remain competitive. It's tough to say. A, it's tough to say it and, B, all you have to do is say that hey, it's diminishing in country X or country Y and they may dial it up just to prove you wrong. But at any rate, as always our job is to take our own destiny in our own hands and the whole concept underlying with what we call the Colgate business plan, CB, another acronym, CBP, which is the SAP-enabled promotional efficiency improvement, plus a lot of other things, the concept there is to find ways to build market share while still getting more efficient with our spending. And then just finally, on the U.S. innovation pipeline, the release didn't mention anything in oral care in terms of products. Are you still planning Colgate Oxygen in the U.S. and, if not, are there other products in the oral care pipeline for the U.S. in '06? There are certainly other products, perhaps including that one, in the pipeline. But you would know, Bill, that we could not tell you if they have not yet been announced to the trade. Our oral care business in the United States and around the world is healthy. I usually give a U.S. questioner or if somebody else asks the question of how our core businesses have done, and in the quarter our oral care business is up 8% worldwide in volume and personal care is up 4% and home care is up a percent or whatever, 1%, just exactly the way you would prioritize them, and Hill's of course is up about 5% as well. So the priorities that we have talked to you about are indeed working. And on an oral care basis we have a budget that's quite healthy and with the spending to support it for 2006. Can you just comment on what your FX assumptions are for the year? The reason I asked the question is that I think in the press release you blamed a lot of the profit decline in Europe, which is obviously correct, on the currency decline. But how much of the Latin American profit enhancement was from currency as well and then just kind of some of the assumptions for next year? Okay. I don't know that we blamed it, it was in local currency, it was what it was and then translated it's a fact of life. Our assumptions for next year versus today's spot are that on a Europe basis, let's take a euro, that we are assuming that our budget is $1.23 per euro and this morning it was $1.227. Again, there's a lot of things that can happen between now and the end of the year, but that's in Europe we're at least on currently. We are assuming in Latin America appreciation in the currencies. Mexico versus the current rate of 10.50 we're assuming 11.30 which is down 6% for, Venezuela has held up at fairly rigid. Brazil we're assuming 11%, Columbia down, and so on. So that has been factored into our calculations. Whether or not it happens we shall see. If it's worse than that we'll have to find a way to cover it, if it's better than that, which so far it is, that will give us a little extra tailwind. And then this is my last question. How far along are you on moving the supply chain from a regional supply chain to a global one? I know there's a pretty tremendous profit opportunity there and I just want to try to understand how far along you are on that process? I think the restructuring is one part of that and that is moving along well and it is expected to be completed by 2008. So you could take that as a guidepost. But the savings come in not precisely on a linear basis as we talked earlier in response to Amy's question. But there are a lot of other things that are going on and some of them will be very quick and some of them will be a little longer. Interestingly enough since this Colgate business, as an SAP enabled Colgate business planning, an important element of which is promotion efficiency, has other supply chain implications which are going to be working themselves out over the next several years. It has a lot of cascading effect. Just get an update on this, the way I understand it there are seven different instances of SAP at Colgate and you are trying to combine that into one, unified global SAP platform. Is that done yet or is that still work in progress? Javier just said that we have seven variations of SAP which can be run together I understand. Those are going to be cut; everybody, essentially everybody will and is on SAP and they are interchangeable and but those variations are going to be cut to four. We are linked without question universally, I mean literally Ian and Javier are sitting in the room, and if they want to dial up what our sales were this morning in whatever division they can do that, get a consolidation, get a by sub analysis and everything else. That exists today and will continue. And that is one of the things that allows us to expand this model that is being developed in the United States and Mexico on the promotional efficiency. You should know that there is a fully dedicated group with salespeople, finance people, IT people and whatever else and distribution people working on this and it is led by Seamus McBride who is a very experienced executive who is also president of our U.S. company, since they basically pioneered it. He is leading it around the world. And we have a whole schedule of rollout and everything else. Each quarter we will be reporting to you on that. Maybe I missed this but did you give some information about the next regions or countries where the trade efficiency program will be rolled out? I didn't and that is a little premature because people are basically landing in airplanes now to take them through it. There was a trip that Seamus made to Asia, the Far East actually with Ian, and I was just coincidentally talking to him last night and he was delighted with the reception. He took a team out there and they made presentations to several more countries. His response was when you are in New York you get people, well, how about this and is this good or is this not good. And then you get out in the subsidiaries and they really, really want to grab hold of it. We are going to have to do it I think as it goes rather than in advance. But I would guess that by the end of this year we will have, I would say 40% of our business at least beginning the program. Then over the next year or so it will be completed. Okay. And one more thing. You had mentioned some higher costs for Hill's in '06. What are those, are those the corn related costs? No, I think it was simply this. It was that as you know agricultural commodities in 2004 skyrocket. This year they came down a little, they came down substantially off those historic highs, and now they are going back to their normal levels. It simply means that the normal kind of cost increase for agricultural prices, so you won't get that onetime benefit. However, Hill's has a lot of gross margin stuff going on and their gross margin so you, I will tell you what the impact of that is. Their gross profit this year, whereas the total Company all being said, was up 10 or 20 basis points. Hill's was up almost 100 basis points and is expecting it to go up again next year, despite the couple percent increase in cost. They had some price increases this year which will get the full year effect next year. That wasn't me, Reuben. Can you maybe give us a little more color, you are talking about a tiger on the tail on this promotional spending; how once you roll it out into a market, maybe some of the learnings you have had, in the initial markets and how it becomes a sustainable multiyear reduction in costs? First of all there is some proprietary aspects do it. A lot of proprietary aspects to it, and I think that as we go along we will be doing that. I don't think we can do it now I was just joking earlier because I perceived several presentations on both the concept and the execution, and I am not particularly dumb and I still don't fully understand it. So it would be difficult for me to pass along. But nonetheless it is a quite interesting, complicated mechanism. I don't mean to be mysterious, seriously Justin, but we're just at the early stages. We have some surprisingly strong results back and we think that will continue. Now don't forget we're coming off a period where everyone escalated their promotion spending quite dramatically so it is coming off a high-level. Of all times that is the great time to be implementing this. I think we are able to do it because with our kind of focus we are not in any new businesses, we have a pretty tight focus and once, all the history of Colgate says, once there is an effective model developed and it goes out into each country it grinds away and really generates results over time. This is going to be an ongoing story and we will tell you a lot about it. The key thing though it is just not a, you just don't roll it out in a market and then it works for a year and then the growth stops? One would hope not. It is designed basically to in a sophisticated way to supplement our original and continuing strategy which was we have to find ways to put more money into media advertising and sampling, by driving margin up and driving overhead down. That was eroded by the period when promotion spending went up just a cost of doing business. Now whether or not competition does anything or not we are going to try to find a way worldwide to spend less money but get at least the same effect. It may sound like alchemy and maybe it turns out to be but I really don't think so. Can you comment on your market share gaps in oral care versus your main competitor in China, Brazil, India? Or should we do that off-line? India our market share is 49%. And touching 50 in toothpaste and about 70 as I recall in powder. The nearest competitor which is a worldwide competitor has in the 20s. Nearest competitor has just over 30. Brazil, my recollection is we have a 62 share and the nearest competitor in China we are the, we have 33 and I think Procter & Gamble has, got to get it from them, but our nearest competitor has in the mid-20s. I'm not exactly sure what you mean byâ¦.. They are in certain countries, and it is China is obviously a continuing battle. Russia our gap we actually took over the number one position during this last quarter and that I think gap will widen. The gap in Europe is widening, as a result of our own share gains in GABA. We haven't talked about GABA but GABA is doing extremely well with market share gains in each of their countries. And as you know they dominate the pharmacy channel, so our lead is widening in Latin America. In Europe, India, Australia again we can do it off-line, but I can give you a country by country analysis. Don't forget and actually, Joe, I learned earlier today, being a Swedish Italian and she said I didn't realize I thought from Spanish I thought Altobello means meant tall bell, but it really means tall and handsome. Indeed. Little ironic though. But as you know in countries and I believe it is true in Latin America and I am looking, Ian, tell me, that we have a list price which is very much above the actual set, what we actually sell it for with a series of discounts so that if a price freeze comes along we can basically remove one or more of those if we so choose. But as yet our business in Argentina is actually quite good and Argentina, someone just wrote a note to me, Argentina price actually was up 130 basis points in the quarter. As you know Joe, this is Ian, as you know the European discount scene is split between the hard discounters like the Audi's and Needle's and the soft discounters like Padillos and Mettos. We are quite well-established with the soft discounters and have begun in certain markets, beginning with Germany discussion with the hard discounters who now on a selective basis appear more open to branded goods. Okay. And finally on the stock buyback you guys I guess bought back about 800 million in '05, should we expect a similar number in '06? We budgeted $600 million of buyback versus the 774 this year, 2005. Yes, 774 but my sense it may be more than that. I will give you five bucks if you can tell me what my name means in French. So it certainly doesn't mean tall and handsome I can tell you that. Was wondering if you can give us an idea just on a run rate basis, now that we have gone through a year of significant reinvestments from a marketing standpoint on the advertising and media lines, how do you feel about that basin and what do you think is the appropriate run rate going forward from that standpoint after the big increases we have seen over the past year? Fortunately at least in the budget we have sufficient aspirations in the gross profit area and the containment of overhead and the various savings programs, that we are able to look at and increase a further increase in total advertising especially in media. For example, our advertising as it appears in the annual report grew in 2004 10% weighted heavily towards the second half as you remember. This year that is 2005, it grew 12.5 or thereabouts and next year in the budget we have a further growth a bit higher than the 12% and yet still delivering the double-digit EPS growth. Now that depends obviously on our making the savings goals, making the promotion savings goals, getting the gross margin, so one and so forth but that looks quite good. What we found is we are getting good mileage out of that money, especially as we spend it more efficiently and it is working. Actually it demonstrates the efficiency we sent out for and got it. What was I saying? Oh, yes, so that if everything goes as planned we will be able to keep increasing advertising, at least reasonably so and that hopefully should lead to more market share gains. That after all is the strategy of dominance that we believe in. That is how we get there. Don't forget, John, that we long ago said that we are trying to change the ratios of the business so that again gross profit gets up to the '60s, overhead keeps going down as a percentage of sales, and the advertising line specifically, the media keeps growing driving topline again. It is reasonably consistent with what we have always done. Just wanted to circle around on the gross margin outlook and more on the longer-term thought process behind it. When you announced the restructuring over a year ago I think you were suggesting that the longer-term trend would migrate from the 50 to 100 basis point increase to the 75 to 125 basis point increase benefiting from that restructuring program. So I wanted to circle back to that because I don't hear that 75 to 125 talked about as much anymore and just wanted to get a sense on that from you? It is a good question but that is inadvertent. I think that the 75 to 125 was after the second or third year of the restructuring when all those savings took hold. I would reiterate that that is a problem. If you really want to know the truth which is not a great If actual budget for gross profit for next year is in the 75 to 150 range, not the 50 to 100 range but again that was why I was saying that everybody was nodding and I was being cautious. I would be again very surprised if we're not in that range next year. Just trying to look at this from the components that you guys lay out every quarter, materials cost increases, savings programs, funding the growth, the restructuring program, pricing, the program you have got going, I mean even if you assume material cost increases about 100 basis points negative to gross margin, you still are looking at some significant increases over the next few years. Is there something else offsetting that that would keep it, I mean frankly less than 150 basis points a year for the next couple of years? I am putting the numbers together of funding the growth that is 100 to 150 basis points a year, restructuring of 50 plus a year, pricing that is probably on the order of 25 to 50 a year if you have got high raw material cost. The program sounds like it is 25 to 50 a year; so you put all of those together we are talking at least 150 basis points a year gross margin expansion. And obviously I am missing something because you seem to be suggesting less than that. Yes, you have been around a long time Alec as I have been and many people sitting around this table and other tables that are listening. We may very well get more than that, but you know that if we say 150 basis points and it comes out 148 we are in trouble. And that we're running this on a systematic basis over time to increase the gross margin we pay for advertising. I am more, when we started the whole thing with a 39% margin, I am more optimistic now with a 56% margin that we can go up the next 500 basis points than I was originally. Simply because we have tapped into some very interesting far more sophisticated kinds of programs. Maybe we are being conservative but as you would expect as a shareholder that that is a desirable thing. Historically we have been. Okay, fair enough. Just quickly CapEx, 390 for '05, I thought it was going to be ticking up faster than that with the restructuring program which has pushed off a little bit, so I am just wondering and looking for '06 CapEx guidance? '06 including the restructuring the budget is 524 which is higher than virtually any year on there. Without the restructuring it is 382 which at 3.2% sales which is about online with history. That includes the savings programs, which again as you know we do this in some detail. The savings projects about slightly more than half of the 382 is for in a regular program are savings projects. And the average after-tax rate of return on the figures says 43 7, is about what it has been as your remember about 40% historically. So by '09 when the restructuring program is over, we revert back to kind of this 382 run rate as a percent of sales? Yes, except that tying back to an earlier question about the global sourcing almost by definition when you have more limited number of plants, the percentage to sales doesn't have to hold because you get more efficiencies out of one or two big plants than seven little plants. But, yes, we have historically for many years run between 3 and 4% usually on the low side of 3, 1.3, 2.3, 3, 4, of sales and that on an ongoing basis I would expect to continue. In the budget, yes. A couple hundred million dollars less than this year but or $150 million less but what history says is that we generate more cash than we budget and we use that opportunistically to buy back shares. And given your enthusiasm for this restructuring program, the gross margin outlook, your Robie program and the eventual rollover and the CapEx levels, why wouldn't you lever up a little bit and buy back more shares now for the potential payoff down the road? We prize our AA rating but maybe that is a good idea, and certainly as always when we examine that on a regular basis with our Board, we will talk about that. Just a question on Europe please. I was wondering if you could elaborate a little bit more on what you are seeing in that market because this was the one area of the business where pricing was still negative. Could you talk a bit about the competitive dynamics in your key categories and perhaps whether you see opportunities for pricing going forward? In terms of our key categories in Europe, interestingly we had in the fourth quarter good volume growth in oral care. We had an 8% volume growth in oral care and everything else was a little bit lighter which led to the 2.5% volume that you saw earlier. They are budgeting a continuation of that simply because it is a market share increase which generates it. The markets are difficult. Ian mentioned the both the hard and soft discounter. Pricing is difficult and economic conditions are difficult. Although in preparing for this call I didn't notice that the big three or four countries France, Germany and Italy are prophesying somewhat better GDP growth this year than last and we are seeing as I say a slight uptick in our business momentum. There is no doubt that Europe is a difficult market for everyone. We are pleased that on the year our operating profit was up and our volume was up essentially. Western Europe is of course booming and Eastern Europe is of course booming and we balance between them. I don't have it broken down that way but I would guess on a calculated basis it would be because GABA grew very well faster than the rest of the business even though the rest of the business grew nicely, and that on a mix basis would probably push the price up. Great, that is very helpful. Just one final clarification question; I am sorry to come back to this because you did go through it earlier, could you just confirm that the restructuring savings that you mentioned earlier on the call, that the figures that you quoted referred to the incremental progression annually and not to absolute figures? My question is back on this promotional efficiencies, I know you are really excited about it and they are coming in better than expected, but still it is sort of nebulous as to what the efficient are. Can you give me an example of how you're doing things differently with promotions that is working so well? We can go from very simple to very complex. Because what happens is coming into the SAP system are all the measurements from both the syndicated services, the accounts and our own data. So that I'm looking around, there is actually some people in the room who know a lot about this so I am really on ice here, but, nonetheless, and so that essentially you take a promotion, X, Y, Z, whatever it is and you are able to determine how much, first of all what the takeaway is, how much repeat business you get out of it, what the cost of that repeat business was, what the rate of return is, whether or not you want to do it again, with what frequency, do you want to and so on. That is a very simplified example but that multiplied many, many, many fold and the development of best practice for that particular marketplace then becomes the guideline for the future. I have heard you talk about this before I mean three years ago getting more efficient in terms of promotional spending. Why is it suddenly accelerating and getting a lot better, just better systems? Number one is that the whole line itself got much, much bigger in the competitive battle over the last few years so it is a far bigger target. Number two, 3 years ago we weren't united by SAP; we were just getting to the worldwide footprint that we now have. And three we were fighting other battles and we have now focused on this for the last I would say, year, and it is exciting as you say. My one other toped is dog food. Clearly you keep growing nicely; can you give us overall data on I guess the volume growth of the dog food market in America; it's growing faster than the population I guess? It is, the pet food market, the dog and cat food market is growing faster than the population and there has been a bit of a resurgence because it moved away from pet stores couple of years ago and now it is moving back. We are looking for volume next year which parallels the market growth of about 5% domestically and generally I think I have the actual numbers here. This says the market growth in the specialty market which is where we compete is 5.3% internationally and in North America 5. The total pet food market is much smaller growth, 0.8%, that includes all of the supermarket brands and everything domestically 0.8, and internationally 0.3. If you take the market in which we compete it is about 5% in the United States and somewhat higher overseas. Our consumption for 2005 was actually slightly more than that internationally and about the same domestically. Thank you everybody. I appreciate the interest and the time and we will continue to do our best to live up to your expectations. |
EarningCall_234053 | I would like to welcome everyone to the Southern Company fourth quarter and year ending 2005 earnings call. Operator Instructions I would now like the turn the call over to David Ratcliffe, Chairman and Chief Executive Officer. Thank all of you for joining us. I'm pleased to be with you for our fourth quarter earnings call. Joining me today is Tom Fanning, our Chief Financial Officer. Let me remind you that we will make forward-looking statements today in addition to providing historical information. There are various important factors that could cause actual results to differ materially from those indicated in the forward-looking statements, including those discussed in our Form 10-K and subsequent SEC filings. As you can see from the materials we released this morning, we had a good quarter and a very strong year. It's clear that our strategy is benefiting our investors as well as our customers. Our generation planning results and a lower priced fuel mix with coal, nuclear, and hydro comprising 90% of the fuels we utilize. We are continuing to make capital investments to help ensure reliable supply of electricity. And third, we continually focus on customer service and satisfaction. These are the three components of our business model. Investing in our infrastructure, keeping prices below the national average, and taking care of customers, all of which help maintain a constructive regulatory environment. We certainly had our share of challenges last year. For us, 2005 will always be remembered as the year of the hurricane. In the days following the storm, the Southern Company family came to the aid of our customers on the Gulf Coast with an unprecedented response and restored electricity within 12 days. As we turn over 2005 on the calendar, the efforts of our employees and those who assisted us from other parts of the United States will never be forgotten. I'm pleased to note that the electric utility industry took note of our response to these storms. Four of our operating companies recently received awards from the Edison Electric Institute. In addition to these awards, we received national recognition in the news media for our efforts on behalf of our customers. In addition to hurricane Katrina, there were other noteworthy events that occurred last year. In our regulated businesses, we completed fuel recovery cases in Alabama, Georgia, and Mississippi. Storm cost recovery plans were also implemented at Gulf Power and at Alabama Power. Gulf Power and Mississippi Power are working with their commissions on storm recovery costs, and we expect a constructive outcome in these discussions. I believe the successful outcome of these proceedings reflects the constructive regulatory environment that currently exists in all of our jurisdictions. We never take this working relationship for granted. In an environment of increasing costs, such as exists in the United States today, we must be diligent in controlling expenses as we continue to provide affordable and reliable service. A competitive generation business also completed a very successful 2005. We added to our generation assets in the state of Florida last year through the purchase of the Oleander facility and extended major contracts with Florida Power and Light and Progress Energy Florida. In addition, the contracts we signed last year with the Piedmont Municipal Power Authority in South Carolina are now being implemented. The progress we've made in the wholesale business should help us meet the goal of achieving $300 million in net income from this business by 2007. While our primary business continues to be that of a traditional electric utility, our vision of the future is anything but ordinary. Last year Southern continued its leadership position in the nation's development of clean coal technologies. Our integrated gas combined cycle project, or IGCC is on schedule for commercial operation in the summer of 2010. Southern Company, along with our partners at the Department of Energy, the Orlando Utilities Commission, and Kellogg, Brown & Root, will construct a 285 megawatt facility in central Florida that will utilize coal in a cost efficient and environmentally compatible manner. We're also moving forward to develop the next generation of nuclear plants. We've notified the NRC of our intent to apply for an early site permit this year and a combined construction and operating license in 2008. Work is currently underway to meet the schedule for both of these applications. 2005 was indeed a memorable year. Now to review the financial performance for 2005 and to provide earnings guidance for 2006, I'll turn the call over to Tom Fanning, our Chief Financial Officer. Thank you, David. As you mentioned, we had a solid quarter and an outstanding year. I'll discuss the specific reasons why in a moment, but first, let's review our numbers compared to the prior year. In the fourth quarter of 2005 we reported $0.21 a share. That's a decrease of $0.06 per share from the fourth quarter of 2004. However, in the fourth quarter of 2004, we had a positive $0.03 per share of one-time items stemming from tax related matters. With the exclusion of these one-time items, our earnings in the fourth quarter of 2005 were actually only $0.03 a share below the fourth quarter of 2004. And as we told you in our third quarter earnings call, we were able to catch up on some of our operations and maintenance initiatives. For the full year, we earned $2.14 a share. That's an increase of $0.07 a share over the prior year. Again, our net income for 2004 included the positive impact of $0.03 a share in one-time tax items. Excluding the impact of these one-time items, our results for 2005 exceeded the prior year by $0.10 a share, or $2.14 a share in 2005 compared with $2.04 a share in 2004. Now let's turn to the major factors that drove our numbers for the full year compared with 2004. First, I'll cover the negative factors. Here's the breakdown. Non fuel O&M in the retail business decreased our earnings by $0.14 a share in 2005 compared with the prior year. This is due primarily to increased spending to meet continued growth in the southeast as well as the completion of certain O&M projects that were carried forward from 2004. Errant company and other expenses reduced our earnings by $0.03 a share. This reduction was due primarily to storm-related costs and other corporate items. So, total negative factors reduced our earnings by $0.17 a share in 2005. Now let's turn to the positive factors that drove our earnings. Continued customer growth, increased consumption among residential and commercial customers, and market-driven revenue increases in the industrial segment added $0.16 a share to our earnings. Marginally warmer weather in 2005 compared with the prior year added $0.03 a share to our earnings. The weather in 2005 was normal while the weather in 2004 was milder than normal. Including with our retail business, the net impact of regulatory changes in Georgia added $0.01 a share to our earnings for the year. Our competitive generation business added $0.06 a share to our earnings for 2005. This increase is due largely to new contracts with Electric Member Cooperatives in the southeast, starting from the Oleander facility we purchased in 2005, and excellent performance from our asset optimization effort. Net income from competitive generation totaled $270 million in 2005. Finally, our syn fuels business added $0.01 to our earnings. So overall, our year came in at $2.14, on increase of $0.10 a share over 2004, excluding the $0.03 of one time items. Before we turn to guidance for 2006 I would like to update you on several key business and financial issues. As I indicated earlier, strong demand for electricity and sustained economic growth in the southeast continued to be major contributors to our earnings. On the industrial side, automobile manufacturing, steel, lumber, and paper were the major drivers of economic growth in the fourth quarter. One of our largest industrial customers, the Chevron refinery near Pascagoula, Mississippi is now back to pre-hurricane production levels and expects to build a liquefied natural gas terminal next to the refinery. Personal income growth in the region is nearly 3.6% compared with 2.5% for the U.S., which helps drive the purchase and use of new appliances and other household items. In addition, we're seeing continued growth in building permits, counter to the national trend of a slowdown in housing. Employment increases in both Alabama and Georgia continue to be strong. Georgia added more than 67,000 jobs last year while employment in Alabama is close to its previous peak set in 2000. The influx of new residents to our service territory is the highest since 1998. For example, nearly 80,000 new residents moved to Georgia last year. Finally, the Mississippi Gulf Coast is showing a strong recovery. It is now projected that a majority of casinos in Gulfport/Biloxi area will be reopened at least in a temporary condition by the end of this summer. The recovery along the Mississippi Gulf Coast is well underway. As you may have seen in the business outlook section of the earnings package, we have released an updated capital budget for 2006 through 2008. Our largest capital area continues to be transmission and distribution with a projected expenditure of 3.3 billion for the three-year period. And our CapEx related to environmental is now projected to grow significantly over the next three years. We are entering a period of significant capital investments in scrubbers, SCRs, and baghouses at our larger coal fired plant. During the three-year period through 2008 we are planning to invest approximately 3.1 billion in these environmental upgrades. This investment, which is expected to peak in 2007, should enable us to continue utilizing our coal-fired fleet, helping keep prices below the national average and minimizing the impact on the environment. Turning now to regulatory issues, I want to update you on some matters we have pending at the Federal Energy Regulatory Commission. The first item concerns the market power case which is currently before FERC. Our objective in this hearing is to present analyses that will enable FERC to make a reasoned decision on the question of whether we have generation market power in our control area. We think we have a strong case because so much of our generation is committed to serving our retail and wholesale native load customers. FERC staff and one intervenor have taken initial positions to the contrary. The case is currently pending before an administrative law judge, and it will probably be late this year or early next year before the judge issues her decision. The other matter before FERC concerns the inter-company interchange contract. We are currently engaged in constructive discussions with the staff. As a result of these discussions, FERC has suspended the hearings while granting all parties in the case additional time to work toward a settlement. We are hopeful that this case can be settled without a formal proceeding at the commission. Let's turn now to our earnings guidance for 2006. As you may recall last May in our analyst meeting we presented a financial plan outlining a 5% annual growth in our earnings range for 2005, 2006, and 2007. Our plan assumes a return on equity of 13.5% for the retail regulated business and continued progress in our net income goal of 300 million for the competitive generation business. In 2005, we made 13.8% and 270 million respectively from these businesses. An excellent result. For 2006 and 7, we will continue to target a corporate return on equity of 13.5% for the retail regulated business. With the contract we currently have in place in our competitive generation business and with about 10 million in initiatives at Southern Power we expect to earn approximately $285 million in this business in 2006. So the plan we outlined last May to get 5% earnings per share growth remains the same. On average, we still forecast approximately 3.4% earnings per share growth from our retail regulated business with the remaining 1.6% driven by growth in our competitive generation business. With earnings per share growth of 5%, our plan is to grow the dividend at approximately 4%. As our payout ratio declines and accounting for the expiration of syn fuel earnings we'll continue to evaluate whether to recommend to the Board increasing the rate of growth and dividends per share to match the long-term rate of growth in our earnings per share. For 2005, we provided a guidance range with and without syn fuel earnings. For 2005, our range was $1.93 to $1.98 a share without syn fuel. Then, after adding $0.11 a share for syn fuel earnings, the range we provided for 2005 was $2.04 to $2.09 per share. For 2006 we are starting with the range without syn fuel of $1.93 to $1.98 a share and adding an EPS growth target of 5%. This calculation results in an earnings range for 2006 of $2.03 to $2.08 without accounting for syn fuel earning. Then, adding $0.12 a share for the full value of syn fuel, our estimate for 2006 is $2.15 to $2.20 a share. Again, that range for 2006 is $2.15 to $2.20 a share, including the full value of projected syn fuel earnings. So to emphasize our earnings guidance for 2006 is consistent with the 5% growth plan we showed you last spring. Without syn fuel we project earnings per share to be between $2.03 and $2.08 per share. Including syn fuel earnings this range is projected to be between $2.15 and $2.20 per share. Finally, to complete our discussion of earnings for this year, our estimate for the first quarter of 2006, including syn fuel, is $0.38 per share. Now, this estimate is lower than what you might have expected. However, we will expense stock options in the first quarter this year, which will decrease our earnings by approximately $0.02 a share during the quarter this is the first time we will have expensed stock options, so this will be an ongoing item with most of the impact seen in the first quarter. At this point I will turn it back to David for his closing remarks. Thanks, Tom. As you've just heard our businesses are performing very well. The population and the economy here in the southeast continue to expand, and as a result we look forward to another excellent year. Our main priority this year is to continue successful execution of our business strategy. On the retail side we have no major base rate case actions scheduled for 2006. We will move forward with the merger of Savannah Electric into Georgia Power which we expect to complete by July. Also in Georgia, we will have a fuel filing in March, and in Mississippi we expect to complete certain other rate matters. On the competitive generation side of our business we have demonstrated our ability to grow this business and meet our financial targets. Our goal is to extend our track record in this area. In conclusion, our focus will continue to be on reliability, price, and customer satisfaction, while at the same time providing our shareholders with attractive risk adjusted returns. I'm confident that we have the team in place to deliver these goals. At this point Tom and I will be happy to take any questions you might have. We'll now take the first question. Good afternoon. Just wanted to ask you, has there been any estimate on the type of synergies you will be expecting from the merger? Because I would assume that there will be some economies of scale that you could get. Hey. We've already assumed the fact that synergies will account for, really between now and next year will account for all of the transition costs that we will incur. We are not giving any of our companies, particularly Georgia Power in this case, any relief from its target of a 13.5% ROE objective. So in essence, we're assuming that we're going to make up for any transition costs with synergies. Yes, but we're going to basically, yes, we're going to account for them over two years, but in fact, Georgia is going to seek to achieve its return objectives even accounting for any transition cost they incur this year. I think the other thing, Danielle, is to remember that in the Georgia jurisdiction, Georgia will file a case under the current accounting order in 2007, so they will plan to file in July of 2007. That determination will be made by the end of 2007 with the outcome implemented in 2008. So what they will be filing will be the combined Georgia and Savannah numbers. I see. You are anticipating 1.1 billion of long-term capital expenditures in the competitive area. How much of that is maintenance, and how much is new projects? When you look at it, between '06 and '08, you should expect kind of normal CapEx associated with maintenance for the plants. They have to be somewhere around, I don't know, $30 million a year, something like that. So that leaves about 975 of place holders. I might add that you may be aware that we're interested in thinking about at least investing in some renewables. We have included in that kind of 975 number about 250 million of place holders for those kinds of investments. But in essence, as we've said before, those are, in fact, place holders, and whether we invest them or not depends on whether we get projects that meet our rather conservative and disciplined financial criteria. Could you remind me of your recovery mechanisms? And I'm not sure which jurisdictions, if that's mostly allocated to Georgia and Alabama? You bet. Glad to do it. We have three of our states, Alabama, Mississippi, and Florida, all have provisions and rates for recovery of environmental expenditures. Alabama just put theirs in place last year. I might add that Georgia, as a practical matter, contemplates a forward spend on environmental when it sets its three-year accounting orders every three years. So in essence, all of our companies have either an accounting order or a mechanism in place currently that allows for contemplated recovery of environmental. Now, with respect of what share of environmental is born by what company, over the three-year period 2006 to 2008, we look at about 3.1 billion. Alabama is about 1.1 billion, Georgia is about 1.6, Gulf about 300 million, and the balance taken up at the rest of the Company. And then industrial demand, I saw that it was down in the quarter. I'm not sure if that was because of hurricane-related issues, perhaps with Chevron's refinery or if that was indicative of any other sort ofâ¦.. You got it. That's it. In fact, if you adjust for the hurricanes, industrial sales probably would have been up about 0.8%, something like that. So it would have been right on our target, had the hurricanes not existed. And you may know that we're pretty happy with the recovery of the industrial sector, particularly along the Mississippi Gulf Coast. We mentioned Chevron, we mentioned the fact that they're adding an LNG terminal, and I guess the last customer to turn on is probably going to turn on in the first quarter here, I guess that would be DuPont. So we feel very positive about the recovery of industrial loads in that area. You were very careful in explicitly delineating that your earnings guidance includes the full benefit of syn fuel. Can you talk with us about how we deal with the fact that oil prices are where they are and whether or not that impacts your decision to run the business, to curtail production, how those earnings might or might not phase out and impact that guidance? Yes, beautiful. I guess the first issue that we're kind of hopeful about is that we believe in one of the reconciliation bills, it's kind of moving through Congress, is there is a possibility of including essentially a look-back provision on the oil price that will determine the extent to which you are entitled to receive tax credits, right? We believe that the, if, in fact, that is passed that we'll have certainty, we think, for 2006, which would provide for a full recovery, or full entitlement to syn fuel tax credits for this year. With gas, with oil prices being where they are now, they're frankly fairly close to our break even rate for the year. And so we're watching that very closely, and certainly working with our partners should we feel that it's prudent for us to stop production we will do that. So something we're looking at. Okay. So if we assumed that the market froze at the current oil price and just stayed at that price for the rest of the year, and you didn't get a change in the tax code, you would, there would be an economic decision to not run? Okay. All we do is present value, the value of tax credits. So what's left, there's not a lot. I wanted to make sure I understood what was in your guidance and how you're thinking about that. That's right. Just to give you a little more granularity there, I think what we see is something like, is it $67 currently right now, and 69 is kind of our break even point. So that's kind of where we are there. And our own calculations, it's somewhere less than $0.20 a share on whatever it is now, about $0.35, $0.30 or something share price. The second question was CapEx, should we just assume 3.2 billion a year over the next three years or is it back end loaded? Can you give us an annual CapEx forecast? Because you've given us '06 to '08 numbers. Sure. Let's see. They're a little back end loaded. If I were to give you year by year, it kind of looks like 2.8 billion in '06, 3.6 billion in '07, that's the peak of our environmental spend we project right now, and then about 3.1, 3.2 in '08. So when we look at the roll-ins or the rates, for the CapEx that you actually, in these jurisdictions, that will start ramping into revenues and earnings in the back half of '07 and into '08? Is that the right way to think about it? Yes. Alabama's mechanism that includes environmental spend is a forward looking mechanism. So there should be minimal lag there. But, yes, you're right. So why, so 5% growth, I mean, I know you guys have stuck to that number for a long time. There's an economic tailwind here, and you've got a tailwind from all this rate-based growth. So is there, would there be reason for us to believe there's potentially in the short run, although not systematically, bias to the upside on that earnings growth rate? Well, I guess there's, we like to structure our financials in a conservative manner. We have since I've been around. We'd rather have more upside than downside. We still think, however, that 5%, when you think about the way it's structured, is a pretty aggressive objective for us to fulfill. I mean, for the retail regulated business to earn 13.5% these days is a pretty good accomplishment, from the competitive gen business, I think you can see that in 2005 we earned $270 million. So that's good. We think a lot of that performance was driven by high gas prices. Remember that, there again, we budget relatively conservatively, and we have upside structured in case we have high gas prices or we have other circumstances that work to our benefit. So we still believe the 5% objective is a good objective for '06. Yes, good afternoon. Listen, a couple of very quick minor questions but things I was interested in. First of all, your small C&I reclassification that you mention in your release, what kind of growth in small C&I quantity sales do you see now that it's been reclassified going forward? Well, that really just involved, I think it was in the, as a result of the last rate case in Georgia, people moving from one set of rates to another. Let me see about, hang on a sec. Let me see what difference that makes. Bear with me just a sec. I am guessing that we should look to see about, in line with our demand growth, about a 2% forward growth rate. And you did give us a number on the effect of weather for the full year but do you by any chance have the effect on it for the quarter? Yes. Then lastly, you point out that you expect to spend 3.1 billion from the period '06 to '08 for environmental expenditures. How much of that do you have tax exempt financing for, or do you plan to get tax exempt financing for? That's an issue we're working through right now. I can't give you an answer on that but it's something we're considering. Good afternoon. A question I had, Georgia on the sharing arrangement, my back of the envelope numbers looks like the financial ROE was actually higher in '05 than '04, and I know the ROEs were set a little bit lower and the sharing bracket as well. Did you get into the sharing range, and if so, how much? We're still working all that out. There will be a filing to be made later this spring, but we're right on the edge of that. And one of the things that benefited Georgia's ROE, remember when we think about competitive generation on, some of that is embedded, that is attributable to the retail regulated companies and some of that is attributable to Southern Power. Georgia Power benefited from some good wholesale sales. Good afternoon, everyone. Just a quick question on page number 5. I just noticed something. You provide your funds from operations of 10.4 billion, and if I look at the third quarter release for the years 2005 to 2007, it's about $1 billion less. Now, I realize there's some drop-off of lower earnings in '05, and a pickup in '08, but $1 billion is quite a big swing. Could you just give me an idea of what's driving that change? Yes, and I guess the other piece is storm related. In fact, I could probably get that for you in total. Hold on just a sec. Just a sec. We have, we have, let's see, about 1.6 in total between the two. On fuel it's a little over 1 billion at year end. Most of that at Georgia Power. Okay. And that fuel recovery increase has been put in place, so that should be coming back relatively shortly, should it not? Well, let's think about it. As of December Georgia Power had 750 million. Somewhere around 500 million of that was already spoken for in their fuel filing last year. The balance of that continues to grow. In other words, the fuel filing we made, prices continued to go up. Georgia anticipates probably another fuel filing later this year, probably in March. So we'll work to get that. The agreement that was struck in Georgia was a recovery over a four-year period. Okay. Fair enough. Thank you very much on that. Just on your competitive generation, it looks like it's gone up a couple hundred million dollars. I know you had some potential ideas, things in 2008 that might come on. Is that something new, or is that primarily some of the coal plants that you're building down in Florida, et cetera? Yes, the IGCC that you're referring to in Orlando is really due to come on between 2010 and 2011. What we're really looking for in project development in the southeast continues to be in the high attractiveness areas of the Carolinas and in Florida, and for the most part in the near term is probably driven by combined cycle gas-fire technology. So that's where we continue to see our growth. It may be, we had a real good asset optimization year in '05. We may get some of our numbers there. We may pursue some acquisitions, as we did with the Oleander deal last year. Is that $200 million increase in your, and again, that's a three-year period, so I understand it could be spread over several years, but is that $200 million accounted for on things that you've already discussed, or is it to be discussed in the future? Pretty much to be discussed in the future. Okay. Fair enough. Just on competitive generation, could you just go through your optimization and how much you made from that portion of the business? Sure. Delighted to do that. Our budget for 2005 was around $38 million. We had a good year. We ended up making $59 million. Let me split that up for you a bit. Embedded, the part associated with the retail regulated businesses, we budgeted 18 and made 23, Southern Power we budgeted 18 made 36. So if you look at this kind of $21 million delta between budget and actual, it was really comprised of kind of two major areas. So that for us is about $0.03 a share. About $0.01 a share is associated with opportunity sales. Shouldn't surprise anyone that the margins available in the wholesale markets this year actually increased over 2004, if you just kind of want some round numbers there, remember that our energy mix is 90% driven by relatively inexpensive fuel sources. 70% coal, 16% nuclear, and 4 to 5% hydro with the balance being natural gas. When you think about the wholesale margins that clear in the southeast, that's largely combined cycle, natural gas driven. So once we satisfy the native retail load requirements in the southeast, if there's anything left over with that fuel mix, we can sell it profitably and the margins in 2004 were around $12.40 or so per megawatt hour. In 2005 they increased about 50% to $18.60 in round numbers. So an increase of 50% of the margin. When you think about your ability to hit that margin, our generating fleet performed admirably during the year. You know that our E-4 rates have been just terrific compared to national averages in the past, and, in fact, we had another excellent year where if you adjust for hurricanes, our equivalent forced outage rate for hydro was around 2.3%. So when you think about total production numbers, we actually were able to generate another 7 million megawatt hours out of our coal fleet. So our ability to run coal well translated into profitability from an opportunity sales standpoint. So that really helped us. I guess the other piece of our asset optimization floor was related to kind of unit performance bonuses that would relate to heat rate bonuses and availability bonuses. Just a follow-on to that forced outage rate, which was probably one of the best that I've seen so far, but just with regard to implementing your environmental spend on these coal plants, how do you see that playing out over time, and is there opportunity to, I guess, not only sustain that but to get that down even lower? Probably as we go forward with the process of installing additional equipment on the back end of the unit, you shouldn't expect the reliability to increase any on these units. I think we will be challenged to maintain the kind of forced outage rates that you see at this point in time. They are, to your point, very, very attractive and lead the industry, but you've got to believe that as you add more stuff on the back end, that's a considerable challenge going forward. Yes, to the extent you have to have an outage to install your equipment, yes, but we'll try to make that a part of the planned maintenance schedule that we would do anyway. Coal supplies are fine. We certainly have had, as I guess everybody around the United States has had some disruptions in delivery or production, but we feel that we're in good shape, and we'll be back to our kind of normal inventories by the beginning of the peak season, which is 30 days. So we're doing fine. Hi, Tom, David. Just a question about this FERC's review of market power. It has been taking so long, so do you read into anything into that review? Or how do you feel about it? And does that prevent you from doing any further industry transaction or so? If I had to characterize the process, Vic, I guess I'm encouraged by how it's going. You may know that the last couple of weeks, Calpine gave notice of its intent to withdraw from the case. So in light of this development, Southern and FERC has filed a joint request to revise the schedule so that the staff could kind of supplement its testimony that otherwise would have been spoken for by Calpine. So what will happen as a result of these various filings, someone else may step in, we don't know, but at this juncture it's just kind of hard to tell. We've scheduled a pre-hearing to address everybody's arguments, in that regard, be around the end of this month. And in the meantime, a request by us for a two-week extension has been granted. So this allows some time for the judge to consider competing arguments and decide who is going to provide what testimony, but overall, I think our sense is that everyone is working in a constructive manner, and we look forward to the outcome. Remember, Vic, we said I think in our prepared remarks that what we've been trying to convince FERC of since we began this process is that because of the tremendous amount of commitment we had to retail native load and wholesale commitments, that has to be taken into account when you're calculating whatever form of market power determination you intend to use. So we've been trying to convince FERC that there's a better way to look at this. I think that's beginning to settle in, so we're optimistic about our ability to move through these two proceedings. David, on the bigger question, do you see Southern becomes active in margin consolidation on a general basis, without commenting anything specific? With one slight modification, we are where we were, and that is, let me just review for everyone that may not know. We have relatively conservative criteria, I suppose, and that is we want to, anything we do has got to accrete to shareholder value. That's the beginning point. And therefore, the way we translate that is we want to contribute positively to our 5% growth objective. We want to be accretive in a matter of months, not years. We think our stock trades as much on its low risk profile as it does its attractive return, and therefore we want to be credit neutral, and then we want to be faithful to our strategy. Now, we have said in the past our super southeast strategy. Let me assure everyone that we remain focused on the southeast, but I think we just want to make that slight refinement just to give recognition to the fact that the repeal of the 35 Act causes us to at least look a little further. We have looked at this stuff, we continue to look at it, but I think we'll be exceedingly disciplined. Let me just add one more comment about geography. It's always a challenge when you consider M&A to achieve synergies in order to pay for the premiums of the acquired company. Certainly it is our belief that companies in close proximity from a geographic standpoint enhances your ability to obtain those synergies. But please understand that we still believe in the synergy likelihood of geographically proximate companies. But we are willing to expand our reach just a bit further, expand our look. We still believe we've got the scale we need. We don't feel compelled to move, so I hope that answers your question. Anything else you want to cover there? Doing well, thank you. Just had a quick question about your dividends. You mentioned that you're going to continue to grow at essentially 4%. Does that include, with or without any impact to syn fuel? That's the idea, yes. It is the same profile that we suggested last May. When we looked over what we would say about guidance, what we would say about dividend policy, and everything else, we essentially are just confirming what we told everyone last May. So we're right on that trajectory, right on that plan. Okay. And that, because I remember the payout, you had that 70% payout ratio target. I guess that doesn't really apply in this case any more. Well, if you follow, if you let me just do the math we showed last May. If you grow earnings at 5%, and you grow the dividend at 4%, and then you reach a period kind of, I guess this is in 2008, where you don't have syn fuel, you could probably find yourself in a position where the payout ratio, if you increase to 5%, would be about 72.5. We think that's a reasonable range. I wanted to follow up on Greg and Paul's question on the syn fuels. The reconciliation bill, could you just elaborate a little bit more about this look-back provision and how that actually works? Which is designed to basically act as a proxy for determining the need for incenting the development of syn fuel products. Okay? The way it works is, essentially that number is calculated for '05 you won't know it until about the spring of '06. What the provision in the proposed legislation would do is essentially use that number that's calculated in the spring of '06 now, not just for '05, but also for '06. So you have certainty within the calendar year with respect to whether you're going to be able to earn the syn fuel credit. We'll see what happens there. In case that doesn't happen, though, we have the issue of what the actual cost of the tax credits is in case you, if you guys are planning on producing with the current price year, although it sounds okay, because the break-even is around 69, with the way it's sort of set up, if the price goes tremendously higher in the later part of the year and you guys have produced this, there's a possibility that you guys would actually have a loss that wouldn't be covered by the syn fuel tax credit benefit, correct? Sure. The way I think about it, at least for Southern Company is this. Remember the economic censure said that generally speaking you have an operating loss, and so you essentially earn credits, part of the credits essentially account for earning back the operating loss, and then whatever is left over after the operating loss goes to the bottom line as net income. Right. What is the actual operating loss though? If you didn't have any of the credits, if for some reason they were to go away what is the cost of operating these plants without the credit? What's the impact in that case? What we would do is essentially this. We would monitor where the breakeven is. And if we get very close to the breakeven rate, we would probably recommend stopping production and kind of stopping the loss, if you will. So if I were just to project a number, if we stopped right now, that number might be around $8 million or something like that. In other words, if you didn't have any tax credits available, and you had an operating loss like right now, it would be about $8 million. If we did it at the end of the first quarter, for example, in other words, we continued producing through the end of the first quarter, and at the end of the day we got no tax credit, the operating loss would be about $29.5 million. Okay. That's very helpful. Okay. And then, so that's how you guys, you guys are just going to monitor it, assuming that this reconciliation bill doesn't include this language, you guys will just monitor it, and obviously, and make your decision as time goes on, but with the reconciliation bill you don't even have this risk and you would be able to produce as much as you want. And then finally on the parent expense, you mentioned $0.03 associated with the storm impact on the parent, the increase in parent expense but it looks like there was a bit more there. Could you elaborate on what you guys expect that to do in 2006 and what's causing it? Well, one of them, we made a donation to the Southern Company foundation and it equaled about $0.01. Probably the other $0.01 was associated with interest costs, things like that. Okay. And then in 2006, I guess, other than the $0.03 associated with the storm impact, your 2006 guidance would have what, if we were back out that $0.03 it would pretty much stay flat? Is that the idea? Yes, I guess the only thing I would caution you is what would happen if interest rates between now and the end of the year. That would be the only swing. You're right, I mean, theoretically, if we don't have any more hurricanes, and therefore no hits on our captive insurance policy, and we didn't make a foundation contribution, then you wouldn't have those $0.02 there. Okay. Then just finally on Leslie's question, just a follow-up and make sure I understood your answer to it, it sounds like you guys feel that hurricane, at least from the industrial perspective, you guys are pretty much back on line. What would you say, I mean, in terms of the recovery from the hurricane? Should we expect pretty much, you guys be pretty much okay? The impact of the hurricane to be pretty much not there in 2006? In terms of lost revenues or whatever. Yes, let's kind of go through that, because it's an interesting question, and something we really are looking hard at. First of all, let me just handle the cost recovery standpoint. We have proceedings already contemplated, Mississippi and Gulf and we think we're through our constructive relationship I think we're going to get treated well there. I think we're going to be treated fairly. Now let's go to kind of the ongoing economic impact. We've said before in Mississippi that we lost about 20,000 customers. I suggested at the last earnings call that from a, one of the things we like to look at is here is where are FEMA checks being sent. And what was suggested back then is that 80% of the FEMA checks associated with the loss of customers in Mississippi, 80% of them are to the same zip code in Mississippi. So that suggests that if people are displaced, they're still in Mississippi. They may be living in rental housing, relatives, FEMA, temporary housing, what have you. I have another statistic prepared for this earnings call. It's just an interesting number. When you look at the total number of applicants, actually people receiving FEMA assistance, if you add up all the zip codes in the Southern territory, you get something like 360,000 people receiving FEMA aid. Now, of course, some of those people are already in our territory, and so I don't know what the right number is in terms of what that suggests about the influx of people that have been displaced not only by Katrina in Mississippi, but also by the floods in Louisiana, Rita, and a variety of other things. But it does suggest that perhaps we're seeing net addition of people in our territory than before the storms hit. And I think we're gratified to see that even with this influx of people, our unemployment rates remain low, our economy seems to be able to assimilate this influx of people. So I don't know how long these people will stay, whether they will make it permanent, or whether they will move back, but it's an interesting outcome to contemplate. I notice that this big increase in competitive income brought you to $270 million. Now you did have the benefit of the Oleander addition, and as you mentioned, conditions were particularly favorable for your selling power this year with the good, with good productivity of your plant, et cetera, but it seems to me, I mean this is a $50 million increase. You're looking for 300 million by 2008. Might that be conservative? Well, we'll see. With the asset optimization side, you know that we like to maintain a conservative projection there. We just always have. We think it has more upside than downside, but that's the way we'd rather cast our financial plan. We don't believe in surprising our investors negatively. So if there is a bias, there's a little bit of a bias there. In terms of contracts, we're assuming for the year the full year of Oleander. We've had another major contract that helped us through '05 was the EMC-30 deal in Georgia. And in order to hit the numbers that we're looking at in kind of this $285 million number, assuming a relatively conservative budget for asset optimization, it looks like another 10 million of initiatives somewhere. That could be through the acquisition of another plant like Oleander, or something else. So that's kind of the construction of the estimate. And remember, and I just want to point out for everybody, remember I spent some time at the analyst conference last May, and I probably talked about it some on these earnings call since then. When we look at what do we need in order to hit 5% growth, I suggested that we didn't need 300 that we needed really somewhere around 275. That assumed that we had kind of this historical split between Southern Power andâ¦â¦. And retail, right. The embedded side. What you saw in 2005 was a little more allocated toward the embedded side. So I think we're on our track this 285 number is a good number for us to hit for 5% returns this year. Good afternoon. I have just a general question. David or Tom if you could address, people are starting with the nuclear construction, people have started thinking of sites, and people have started approaching legislatures in terms of trying to get bills in to try to get a recovery up-front. Before the, going for a rate case once the plant is built in. Could you just tell us where you are on this future nuclear option, whether you have started approaching legislature or how does this play out for Southern in the next couple of years? Sure. I will be grad to talk about that a little bit. We've been pretty open about our efforts with regard to the new start consortium, and you know we're part of that. In addition to that, one of the things we did last year internally was to put together an internal team to look very specifically at the process of adding additional capacity at our planned Vogel site since we think that would be first jurisdiction, the Georgia jurisdiction would be the first place where we would actually need base load capacity out in the, somewhere in the 12 to 15 time frame. So and everybody who is talking about adding nuclear plants is looking at adding into existing sites because that seems to be the easiest from a permitting standpoint. So we had a team that spent a lot of time putting a strategic plan in place. You will remember that in the Georgia jurisdiction, there is a very well established process with the Public Service Commission of looking at, through what's called an integrated resource planning process, very formal and public where we file with the commission to look at future needs and get certification of needs and then in a subsequent filing we actually go to the marketplace and solicit bids for that capacity. We would plan in the next couple of years, as we step through both of those processes, to find a way with the Georgia Public Service Commission to engage in a discussion about the merits of nuclear power as a part of that bid process, and exactly how they would like to approach that from a public policy standpoint. So we're, we think we are well positioned. We're also moving forward with discussions with Westinghouse about potential technology commitments, and we think those discussions are moving forward well. I think we're still looking at it. I think we're making progress, but we'll fill a report sometime in August this year. So not much to say until then. Hi, it's actually Terran Miller. Just going back to Paul Patterson's question, the $29.5 million potential loss, how is that embedded in your guidance? Okay. So what would you do, I'm sorry. I see what you're saying. You're right, you're right. That's exactly right. The $0.12 assumes syn fuel earning. You take the $0.12 you're $2.03 to $2.08 and the $0.29 would be there. Can you, first of all is that 29.5 after tax, and then could we get a follow-up or an update on where the Mirant lawsuit stands? Yes, sure, it is after tax. And Mirant. There hasn't been a whole lot of developments, although one of the developments has been that the case has been moved out of the Bankruptcy Court in Texas into the U.S. District Court of northern Texas. So it's sitting there, and we'll see what happens from here on out. But otherwise, there hasn't been a whole lot of development. |
EarningCall_234054 | Hereâs the entire text of the prepared remarks from Comcastâs (ticker: CMCSA) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good morning, ladies and gentlemen, and welcome to the Third Quarter 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. Operator Instructions Please note that this conference is being recorded. I would now like to turn the call over to Executive Vice President and Co-CFO, Mr. John Alchin. Please go ahead, sir. Thank you, operator, and welcome everybody to our third quarter conference call. First of all, I'd like to refer everybody to slide 2 which contains our Safe Harbor disclaimer and remind you that this conference call may include forward-looking statements subject to certain risks and uncertainties. Additionally in this call we will refer to certain non-GAAP financial measures. Please refer to our Investor Relations website for reconciliation of non-GAAP financial measures to GAAP. Good morning. We are pleased to report another strong quarter in the third quarter. We had 9.8% revenue growth in cable and operating cash flow growth of 13.9%, approximately 14%, consistent with the first two quarters of the year. We are once again having strong results across the board. This quarter allowed us to invest more than $1 billion in our common stock. We had no major other investment activity, and we were able to significantly increase our share buyback purchasing more than 25 million shares for $750 million. In effect, we invested all of the free cash flow, $723 million that we generated in the third quarter, into buying back our stock. In addition, we settled another $250 million of Comcast exchangeable debt. So since December 2003 when the Board first authorized post-AT&T our stock repurchase program, we have repurchased 2.7 billion, or 93 million shares, plus we have redeemed for cash 1.4 billion of debt, that was exchangeable into Comcast common stock, effectively removing another 47 million shares of float, bringing the total amount of recent repurchases to 4.1 billion. With more than 1.2 billion of remaining authorization we expect to review all possible uses of capital with our Board early next year as we continue to balance reinvestment opportunities with return of capital to shareholders while maintaining a strong investment grade balance sheet. The acquisition of 70% of Susquehanna cable that we didn't previously own is another clear example of finding compelling investment opportunities in cable. With identifiable tax benefits and synergies primarily in programming and overhead, we will effectively be gaining control of 225,000 subscribers for less than 6.4 times operating cash flow. On the business side, everything we are working on, whether in cable or content, is about improving and differentiating our products, extending our competitive advantage and increasing the value of our assets. We are really focused on innovation and differentiation as I have said before. And yesterday's transaction that was announced with Sprint, Time Warner-Cox, and Advance/Newhouse is another example of a transaction that helps to drive innovation, this time, of course, in the wireless space to deliver to all of our customers unprecedented opportunities of real-time high-speed mobility and access to content all in a single package. So let me quickly review the Sprint transaction, not to be repetitive but to point out certain key attributes. We have for a long time said that wireless is a potentially important fourth product line that we would like to explore. The agreement with Sprint is not just a wholesale or reseller arrangement. The initial phase will allow us to offer wireless phones as part of our bundle, and that's nice, but in my opinion, the power of this news is the coming together of both -- the many, many U.S. cable companies in America, and hopefully room for others, so that we have the makings of a national platform, unlike the set-top box business where we have differing standards from the beginning of going into wireless, if we could have a national platform we think that that could drive innovation. Coupled with partnering with a company with the technical capability of Sprint Nextel, six weeks after their merger, is a great statement of their focus on innovation with the cable industry and with Comcast for new products that will work on a wireless network. And yesterday we demonstrated some of the initial ideas of the products that might be available starting in 2006, and they range from communications products to entertainment products. And so on the communications front you can imagine integrated voice mail between your CDV, your Comcast digital voice, and your wireless phone. You can imagine bringing a smartphone home and having it use your Wi-Fi network in the house so you have great cellular coverage in your house but you don't actually go over the cellular network, giving great benefits to both the consumer and the cellular minutes that you wouldn't use and to the cellular company for reception, and at the same time, the beginning of application of entertainment products such as being able to look at programs from your digital video recorder, as we secure the digital rights, to programming your DVR potentially to actually having television right on a third screen. And I think it's the ability to innovate to this platform that will be a 20-year arrangement, a long-term journey, but a complete focus for our innovation plans to have a bundle and to have a partner that knows wireless, doesn't force us to go into a new business line, and at the same time, they're looking for us to be the entertainment and in-home communications piece, and I think it's a wonderful, natural alliance. So we also pick up the retail marketing between both parties and Radio Shack said yesterday that they are supportive of this, and we believe all of Sprint's retail locations will be demonstrating in Comcast areas, Comcast high-speed Internet, Comcast cable, digital cable, high definition, and Comcast voice. We will do the billing for our customers in the first year customer service, Sprint will own the wireless customers, and the cable company will own the cable and video and high-speed data and telephone part of the relationship. Why is that important? Well, I think it's very clear up-front, as we've done many, many partnerships, to try to come up -- and I think we -- I'm very, very pleased with the innovation in this deal structure and our deal department did a super job -- in allowing for a structure that there's not a new co-created that will create tension with its two partners. Instead, the new co here is really about driving the product roadmap, the innovation, and the marketing ideas, both one on one with each local cable company, and potentially national marketing as you develop national products. So we believe this is going to offer great growth in the future and we can talk about it over the months and years to come. Thanks a lot, Brian. I would remind our listeners that we do have slides on our IR website, and would refer you to those if you're not already there. And I'm just about to speak to the consolidated results, which is slide number 5 of the presentation for the quarter. Consolidated revenue for the quarter grew 9.4% to $5.6 billion, while consolidated operating cash flow grew 12.9% to $2.1 billion. Cable had a great quarter with revenue up 9.8% to $5.3 billion, while cash flow increased 13.9%. I'll review the drivers of cable results in just a moment. Looking at content, revenue increased 14.8% while content cash flow increased 19.3% to $74 million. These results were driven by growth at E! Networks, Golf Channel, and OLN, with increases in distribution and advertising revenue across all networks. Third quarter was the highest rated quarter ever for both OLN and style. OLN's ratings were led by a strong Tour de France showing and also with the addition of Survivor. We're revising guidance for consolidated operating cash flow for the year for approximately 13% from previous guidance of 14 to 15%. This revision is driven by increased investments in our content brands. Our recently announced deal with the NHL along with certain other initiatives will result in approximately a 50% decline in the fourth quarter content operating cash flow. But I would remind and emphasize to our listeners that 2005 cable operating cash flow is still expected to be approximately 14% for the year excluding whatever hurricane-related costs we incur in the fourth quarter, which it's still too early to estimate what they may be. In the third quarter we reported corporate and other revenue of $22 million, and operating cash flow loss of $91 million, compared to revenue of 47 million and cash flow of 60 million in the third quarter of last year. The increased operating cash flow loss includes one-time charges related to termination of player contracts at Comcast-Spectacor. Consolidated operating income was up 28.6%, up from $686 million last year, driven by an increase in the cable operating cash flow of 258 million. The Company reported consolidated net income of $222 million, or $0.10 cents a share, basically unchanged from the third quarter of last year. Net income and EPS were negatively affected this quarter by an investment loss of $104 million, or $0.05 a share on a pretax basis. The investment loss primarily reflects the change in value of the derivative component of our ZONE set as a result of the Sprint/Nextel merger. Excluding the investment loss EPS would have been $0.13 a share. Moving on to the next slide, number 6, where we detail cable revenue, cable had as I said before a strong quarter with unit growth and near double-digit revenue growth of 9.8%. We added a total of 710,000 RGUs in the quarter, and so far year to date we've added 1.8 million RGUs. We're on track to achieve full-year 2005 guidance of adding about 2.5 million RGUs for the year. Total video revenue increased $184 million, or 5.7%. Growth was driven by higher monthly revenue per basic subscriber and a 12.4% increase in the number of digital customers. We're having tremendous success in moving customers to our digital services. We added 307,000 new digital customers in the quarter to end with 9.4 million digital subscribers, or 44% digital penetration up from 39% a year ago. And our digital sell-in rate continues to increase. It was 62% in the quarter, up from 60% in the second quarter and 59% a year ago. Digital customers are taking as many as 1.75 digital boxes per customer on average reflecting strong demand for both the hi-definition and DVR services that we're rolling out. And that number is up from 1.63 a year ago. In the quarter we deployed 326,000 advanced set-top boxes with hi-def and/or DVR capability. This is the equivalent of 60% of the boxes that we deployed having those advanced capabilities, up from 40% a year ago. We ended the quarter with 2.3 million advanced set-top boxes in service. This is the equivalent of 22% of our digital customers having advanced set-top boxes up from 10% a year ago when we had a million fewer digital customers. High-speed data business delivered more than $1 billion of revenue this quarter as we continued to add units while maintaining strong average revenue per subscriber. For the quarter, we're reporting average revenue per subscriber of $42.88, essentially unchanged from a year ago. We ended the quarter with more than 8.1 million high-speed data customers adding 437 in the quarter. Record adds of 549,000 in the third quarter last year were driven by the successful launch of our video e-mail and photo show features. We've added many, many products and enhancements during the past year, including increasing the speed to 6 meg and 8 meg, adding free McAfee Internet Security Solutions, adding NHL on line, photo show deluxe, and lots more, but there was no special feature launch in the third quarter this year, but still we report strong additions of 437,000 for the quarter. High-speed data penetration is now 20% of available homes, up from 17% a year ago, and the sell-in rate continues to increase up to 43% from 38.5% a year ago. Our Comcast digital voice rollout is progressing on plan. We added 46,000 digital voice customers in the quarter, digital voice additions are offset by the roll-off of circuit switch phone customers as we transition to our CDV product that Steve will have a lot more to say about in his commentary. Advertising revenue for the quarter grew 4.5% to 333 million with 2.9% growth in local advertising and 11.8% growth in regional and national advertising. Advertising revenue growth was impacted by a decline in political advertising when compared to the 2004 election year. The increase in other revenue of 36% reflects the growth in our regional sports channels because of a launch of Chicago Sports Net, which occurred on October 1, of last year. Moving on to the next cash flow slide, as I mentioned, cash flow grew 13.9%. Third quarter margins increased 140 basis points to just shy of 40%. Increased year-over-year margins and operating cash flow result from higher top-line growth of 9.8% as well as continued reductions in the rate of growth of expenses offset by the impact of two hurricanes in the third quarter, which impacted cash flow to the extent of about $12 million, or 0.5 point of cash flow growth. We expect that hurricane Wilma will have an impact on fourth quarter results, but it's too early to estimate what that impact will be at this time. Moving on to the next slide, where we highlight capital expenditures, slide 8, capital expenditures for the quarter were 899 million compared to 871 last year, reflecting the strong demand for our digital services and continued rapid deployment of high-speed data and DVRs. In addition, the increase in CapEx also reflects higher cost of phone readiness and CDV deployment. The composition of capital is now predominantly about 75% variable and revenue-driven. While we're increasing CapEx guidance for the year to approximately 3.5 billion to reflect this increased advanced set-top box deployment and CDV readiness for our phone rollout, you can see on the slide that CapEx per revenue generating unit has declined 26% over the last three years from 115 to $85 per RGU. CapEx per sub is also declining and is now at $164 per sub. Table 5 in the press release also reflects this trend as you look at year-over-year capital investment, the increase year to date in variable capital of $615 (Indiscernible) million more than offset the decline in upgrade capital of $518 million. We really believe that we have a winning strategy and are committed to continued product differentiation and innovation. Our industry leading VOD platform in conjunction with our advanced set-top boxes with hi-def and DVR functions and our recently introduced enhanced cable, all-digital service, offers our customers more choice, convenience, and value. So to maximize this competitive advantage we're aggressively deploying digital boxes and rapidly rolling out Comcast digital voice. This strategy will result in slightly higher capital expenditures than we'd previously anticipated, as we now project guidance of 3.5 billion. And the specific factors contributing to that are greater deployment of the higher priced advanced set-top boxes, higher phone launch costs than originally budgeted, and more certified but not marketed CDV footprint. Moving on to free cash flow, we generated 723 million for the quarter of consolidated free cash flow, up 34% from the $540 million that we reported a year ago. The increase is driven by increased operating cash flow and offset by higher capital expenditures and taxes. Year to date free cash flow of 1.9 billion is nearly 30% above the 1.4 billion that we reported a year ago. We now expect consolidated free cash flow growth of 30% for the year, reflecting both the increased, or the new consolidated operating cash flow guidance and higher cash flow, or higher CapEx. Moving on to the next slide, number 10, talking about our focused capital deployment, as Brian mentioned, we significantly accelerated the pace of our share buyback in the third quarter where we invested more than the free cash flow that we generated for the quarter and repurchased over 25 million shares. So when you include the stock that we have bought back since inception, plus the debt instruments that are exchangeable into Comcast common shares, we have repurchased, or effectively removed from the number of shares outstanding, 140 million shares, for a total buyback for the program of $4.1 billion. And we'll continue to balance share repurchases with investments in the business that are key to our growth while maintaining a strong investment grade rating. Moving on to the last slide that I want to review, the Susquehanna acquisition, on October 31, we announced a definitive agreement to acquire cable assets of Susquehanna communications for total consideration of approximately 2800 per sub, or 6.4 times 2006 operating cash flow. This is effectively converting a passive investment into an operating cash flow generating asset. We're adding 225,000 subscribers primarily in the central Pennsylvania area, and after we've done the Adelphia acquisition, 80% of these acquired subscribers will be adjacent to current Comcast systems. These are great systems to be acquiring, fully upgraded with solid basic penetration of 63% with upside opportunity, with digital penetration in the acquired properties only 27% versus 44% in Comcast, with upside in average revenue per subscriber which is only 69% in Susquehanna, while it's almost $83 in Comcast. So we have a real opportunity here to build on an already strong business by accelerating the deployment of our advanced services such as Comcast ON DEMAND and digital voice. Thanks, John. It's been almost three years to the day since we closed the AT&T Broadband deal. And it seems like a good time to take stock of where we are and where we're headed. Financially, we've made a lot of progress with 40% margins and OCF per subscriber, per year, which we think is probably the best index of how we're doing on an operational basis, of $395 for 2005, which is almost double the $208 in OCF per sub we had in 2002 when the deal closed. And even before we step on the gas with phone, the Company is growing RGUs at over 2.5 million units this year, or about 7% unit growth for the Company as a whole. Our video business is getting stronger. Today only 8.9 million of our customers are analog-only cable customers, which is down from 9.7 million a year ago, and we think headed down even further in 2006 as we continue to roll out high-speed data, phone, and digital products. These analog-only customers have the highest churn, so it's important to reduce this base over time, which is happening exactly according to plan. During the quarter, the third quarter this year, we lost about 46,000 basic subscribers. About half of these subscribers were life line customers who pay us about $15 a month. This loss of subscribers doesn't concern us too much because during the quarter we added over 700,000 high-speed data and digital customers who, on average, pay us well over $40 per month. So when you net those two out financially, it's a very, very good trade. We also continue to make our VOD product better during the quarter, and in October hit 1 billion streams for the year. We said we'd do that by the end of the year and we actually did it half-way -- or nine or ten months into the year. We've also recently added over 250 new free movies, so we think VOD will continue to increase in the future. Our high-speed data business continues to grow nicely. We think there are three key metrics that you should keep your eye on in this business. Unit growth, average revenue per user, and share of new broadband customers. Adjusted for our footprint, our net adds are comparable to the big bell's, so we think our share of net-adds is okay. In terms of units, we think whenever someone tells you what their high-speed units are, the next question you should have is what's your ARPU? And in that category we're doing very well. Our ARPU is essentially flat versus last year despite a lot of discounting in the industry. So when you're seeing unit growth of 24%, it's actually converting to revenue growth of 26%. With all of this as a foundation, we've now turned our focus this year to starting to accelerate our phone deployment. I think we made significant progress on the digital phone front in the last quarter. Today we're launched in 21 markets ahead of our goal of having 20 markets launched by year end. Comcast digital voice is being marketed today to over 12 million homes, and we will be marketing to over 15 million homes by year end. By year end, our plant will be certified to over 20 million homes, or roughly half our footprint. Now, what we try to do is be very clear about where we're actually marketing. So when we say we're certified to 20 million homes, what that means is our footprint in 20 million homes is capable of launching phone and has capital deployed, and we're ready to go. The difference between certified and marketable largely stems from apartment complexes where we do not have the permission to go in and market. So by the end of the year we anticipate having 15 million homes that we can actually market to but the capital and the readiness will be there for about 20 million homes, which is about half of our plan. Our marketing approach has been to introduce phone on a node by node basis. And so far the results have been very encouraging. It's clear to us demand will not be an issue any time in the near future. Some of our initial market are coming up on one year since launch, Indianapolis and Springfield, and we're approaching 5% penetration. We're currently experimenting with three product bundles, and we're seeing the same kind of results as Time Warner cable and Cablevision and getting more and more excited about what CDV can do as a growth engine but as importantly what CDV can do for our high-speed data and basic subscriber businesses. We think we're in good shape, as we told you before, to hit 200,000 to 250,000 CDV unit net adds in 2005, and in addition, we think we're very well positioned to meet or exceed 1 million units of CDV net adds in 2006. I think in summary there's been a lot of hard work over the last six months getting the company ready for phone, literally thousands of people have been trained. We spent a lot of capital to where we are today, and we really look forward to starting to reap the benefits in the months ahead. John? THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234055 | Welcome to TSYS Fourth Quarter and Year-to-Date Earnings Conference Call. At this time all participants have been placed on a listen-only mode, and we will open this floor for your questions and comments following the presentation. It is now pleasure to turn the floor over to your host Phil Tomlinson. Sir the floor is yours. Thank you, Michelle. Before I get started, I wanted to go ahead and cover the safe harbor statement. I want to call your attention to the fact that we will be making forward-looking statements about the future operating results of TSYS. They involve -- that may involve risks and uncertainties. Some of these factors could cause TSYSâs actual results to differ materially from the forward-looking statements that are set forth in the TSYS reports filed with the SEC. As all of you know and we appreciate you joining this morning, 2005 was somewhat of roller-coaster year, full of great achievements in new markets and certainly some well-publicized disappointments. We had really exceptional financial performance that is exceeded our expectations we had great expense control by our people. We had historic market share gains. We entered into some of the very fast growing markets including China, and certainly the Vital acquisition had to be a real half point. We had very strong growth in our fundamental business, and the last few months as far as e-business have been some of the best in the Companyâs history. And I believe we are very close to announcing some other good news this time as we move forward into 2006. As you know recently we have announced the Capital One agreement weâve announced Toronto-Dominion up in Tronoto, and one is really exciting to ask is the CUP Data deal in Shanghai, China. There is no doubt, weâve been terribly disappointed by the Bank of Americaâs decision to take that consumer portfolio in-house. There is still a really large client of ours and frankly we are hopeful that we will do even more business with them in the future. I donât think that decision in anyway diminishes our reputation for providing the highest level of service and the gold standard in technology in this industry. This is not the exactly new ground for us, losing our largest customer. If you recall back in 1998 AT&T was sold to City and we lost that business in the year 2000. I firmly believe that we have the most experienced management team in the industry, and I am totally confident that we are going to manage our way through this given the up coming challenges. We will discuss more of the impact of this later in our presentation. Right now I want to turn it over to Jim Lipham, our Chief Financial Officer who is going to go through the financial details with you. Jimmy? Thank you, Phil. And we are pleased announce this morning as Phil said that we finished â05 slightly ahead of our upper-end of our, target range of 28% as net income came in with the growth of 29% thatâs the earnings per share of $0.99 versus the consensus out there $0.98. As Phil mentioned we had a lot of good things happen in our core business, as well as the acquisition of Vital back in March that contributed to this great year. And as we go through the P&L this included in the press release, Iâll bring a few of those things to life. First of all in the electronic payment processing revenue line if you look at the quarter we were up 12.8% to 224 million in year-to-date up 14.5 to 870 million, some great growth there in both quarter and year. BoA and Chase obviously continued to be the leader -- real drivers behind the quarter as well as year-to-date. For the quarter BoA had the course of positive effects from the fleet conversion that came about in the first part of â05. And they also had another 100% billing, which is about the third one that theyâve had this year. They had that in October, which contributed greatly to our increase. Chase continued to add other services and growth ahead of forecast during the fourth quarter and continue for the year. If you look at the increase for the year of 110 million, Chase accounted for about 27 % of this increase, and Bank of America accounted for about 18% of that increase. Europe had good growth representing about 11%, and is mainly attributable to middle Bank of Ireland was converted in the second quarter of â04 as well as ABN AMRO came home in March of â05. Our process services area has been a pleasant surprise all year, the revenues there represented about 13% of our increase. TSYS Prepaid as you know, we acquired August of â04 and they accounted for about 12% of our revenue increase since they were here for full 12 months of â05. The other services area which have value-added accounted for the remaining 18% growth and also note that during the year I cancelled 5, they grew at 22% and finished the year at 438 million. When we look at our authorization that builds, they grew 15.7% for the quarter and 16% for the year. As a total, authorizations were 4.7 billion for the year, which is outstanding growth. Transactions deal they grew at 16% for the quarter as well as 16.7 for the year. The transaction numbers for the year are 5.2 billion. When we look at our revenue make up of growth of 15%, we canât break it down into internal growth of around 12%, new clients added another 9%, and then to bring that 21% total down to the 15, it was a combination of things with lost services and clients as well as pricing concessions associated with contract extensions. We will drop down to the merchant service line, obviously this is a growth process and related to Vital as well as the majority owned subsidiary in Japan GPNet. When we look at merchant services for the quarter was 67 million compared to 6 million for the same period last year. For the year merchant services at 237 million compared to 26 million. This increase in both quarter and year-to-date is mainly attributable to Vital's results. Vital is experiencing continued volume growth of over around 46% in their VirtualNet products. As well as continued good expense control. Vitalâs operating profit margin before reimbursables for â05 was 21.6, which is continued to show a raise over the last few years. We look for margin improvement in â06 of another 1% to 2% as we go forward. Sequentially merchant revenue is down from the third quarter and it is due to a one time termination fee around 2 million in the third quarter, as well as a re-class of around 2 million of contract revenues that we recorded as expense reduction, instead of -- as a revenue reduction during the third quarter. We drive down the other services line, you will see flat revenues for the quarter and on a sequential basis the other revenues they increase 1.8 million as a result of bankruptcy services growth at TDM as well as loyalty services at ESC. For the year ESC had revenue of 27.1 million, which was up 26% from â04 and accounted for 6 million of our increase in other service line. Reimbursable items again they include money that weâve received from my clients for out of pocket expenses, and obviously the largest reimbursement item here is for postage which represents 50% of our year-to-date reimbursables and the card association fees represent another 22%. The increase in reimbursable items year-over-year is the impact of the acquisition of Vital and TSYS Prepaid, $39 million is attributable to those two for the year-to-date increase. When you look at on revenues for the four quarter up 37%, or 114 million for the year 35%, or 416 million, excluding reimbursables we experienced fundamental growth in revenues of 34.5 for the quarter, and 34.8 for the year. The increase in revenues for â05 includes the decrease of approximately 2.9 million for the quarter. And a decrease of 1.2 million year-to-date related to the effects of the currency translation of our foreign based subsidiaries. But all-in-all we had a very strong very solid quarter in year-to-date in revenue growth. When we look at the operating expenses, our employment expense for the quarter grew 39.2% to $128 million and for the year at 27.8% to 462 million. Vital contributed 48% of the increase for the quarter and 55% increase for the year-to-date. And the remainder of increases came from of core salaries and benefits when compared to â04. We had around 6700 employees at year-end compared to 5700 last year. Vital added 800 employees of the increase and during the fourth quarter we saw over 176 new employees at TDM, which is our subsidiary line that we've added in the call center business. If you go down to occupancy and equipment expense grew 26.2%, or 71 -- up to 71 million in the fourth quarter and 18% up to 284 million for the year-to-date. We continue to add least equivalent and software expense necessary to add capacity for the new conversations prior to Cap One in the line, also the results of the 2005 include a full-year expenses associated with our new data center in Europe which began live production in August of â04. Other expenses they grew 51% for the fourth quarter and 68% for the year. Vital was a predominant reason for the 22 million quarterly and year-to-date increase. Vital as you know had a lot of their fees in other expense which have to do with their telecommunications and all their infrastructure accounts. During the fourth quarter we also had an additional one time charge of a 2.2 million, which was a charge-off of professional fees and other cost associated with our decision to abandon our plans for western data center at this time. If you go down to our income tax for the quarter it increased slightly as a result of increased foreign earnings, effective tax rate for the quarter was 33.8 versus 33.7 for the year, our last year, excuse me. For the year, our effective rate was up and almost a full point at 34.9 compared to 34.1 last year. The equity income line, joint venture is down for both quarter and year-to-date as a result to consolidate the results of Vital obviously in March of â05. This kind of, this will continue to be down in until the anniversary of the acquisition of Vital in â06. Iâll note, Phil mentioned during the quarter we did acquire a 34% equity interest in CUP Data for around 37 million. We did have a positive pick up there in their earnings and look forward to a good contribution from them in â06. Net income for the quarter has increased 15.7% or $6.7 million, our basic earnings per share includes $0.25 compared to $0.22 last year. For the year net income up 29% or 44 million, and as I mentioned before our earnings per share was $0.99 compared to $0.76 per share last year. In conclusion, for the financials we are extremely pleased with our performance for â05 and are looking forward to a good â06. As uplift to the segments phases there are few comments there, as they are three categories and again during the domestic based support services international and merchant. When you look at the domestic based, it includes the results of the entities based in the U.S. that have to support the core process and business. Revenues for our domestic based services increased to 11.8% for the quarter and for the year-to-date. Excluding the reimbursable items revenues grew 9.7%, and 11.5% for the year-to-date. Depreciation and amortization increased as we mentioned before as a result of the mainframe operating systems and the growth that we have experienced in MIPS and software expense. And the segment expenses represent various transactions between all segments including management -- certain management fees. The management fees between the segments are cost at the international based support services and merchant processing segments, rely on the domestic based support services to combine and this portion of the base tend to fluctuate between periods as our requirements change. Domestic based support services operating income increased on a sequentially basis and this is mainly due to more management fees during the segments. International base support services include the financial results of our foreign based introducing branches. Total segment revenues increased 18.9% for the quarter compared to the same period last year of 27.8% increase for the year. Also impacts in these revenues of the international base segment are the impacts associated with the effects of the currency transaction adjustments and were negative that I mentioned earlier. During the fourth quarter TSYS Europe reimbursable item increased and this was a result of the third party call center service provided to our new client and excluding the reimbursable item segment revenues for the quarter increased 5% and 14% for year-to-date, mainly the result of the increased process in volumes of the TSYS Europe Company Segment operating income decreased sequentially as a result of the inter company management charges previously discussed. In the merchant processing segment includes the financial results of Vital, sequentially total revenues are down 6.7 million as a result of a termination fee received in the third quarter and also less revenue from the terminal business at BTMS, segment operating income decrease sequentially as result of the decrease in revenues. If you look at the balance sheet next sheet over the acquisition of Vital has greatly affected the comparison ofâ05 to â04. We had cash at the end of â05 at 238 million, it was an increase of 5.8 million in â04 most significant, it is really more significant when you consider that cash outlays of Vital at 95.8 million CUP data 37 million. We had an outstanding year in growing our cash balance. And as you could see going down the balance sheet we continue to make investments in the Computer Software and Property and Equipment. On the cash flow in the next page, you will note cash provided operating activities of 239 million for the year compared to 333 (ph) for last year, an affected 41 million in property and equipment, this is mainly the acquisition of computer equipment and another 36 million was invested in software, 13 million had been purchased and 23 were developed. But the majority of the developed software related to Vitalâs work on some of their software Vital Express, MS2 and then ESC and Atlanta developed a new system which they call TOP in their business. Our CapEx of â06 is expected to be between 75 to 100 million and with the Banc of America announcement of taking that consumer processing in-house, we have decided to indefinitely halt the construction on our Western datacenter as I mentioned before. Our free cash flow for â05 was 144.6 million and continues to show good strength. With that Phil Iâll turn back over to you. Thank you Jim and I appreciate it. On, I donât know the business I want to make sure I had some questions last night, you saw in the press release where the board appointed me as a new Chairman and Rick Ussery stepping down. I did retain the CEO title, I am happy to tell you this morning, so I did have some people to question that last night, now I just want to make sure you are clear of that. Rickâs have had a wonderful career and I know he is looking forward to his retirement. He is going to remain our Director and he is not going very far. He lives right down the street to me. As Jimmy said we started off the year with projections between 19% and 22% and we wound up reporting growth at 29.2%. In April if you recall we raised our forecast from 20% to 25%, then in July we raise the forecast to 25% to 28%. The drivers of those changes including, included, certainly included the conversion of Chase, strong performance of Vital, value added services that we talk about a lot in here and the fact that our customers using our systems and services more and more as jimmy talked about our product systems that have become very, very popular. We also installed a project management system that has allowed us to track projects and get fully reimbursed dry up its there. If you also we doubled our cash dividend back in April when we talk about cash flow. Our core businesses really continued to perform exceptional well is evidence by 12% growth in organic revenue growth. Some times I get the feeling that our core business gets a little under appreciated and I think it is important to say that in 2005 we added over 40 million accounts organically, none of that customers based added that. And then you add all that to conversion work that we did. I think weâve had historic market share gains and really about the only journal or trade that we can refer to is the Nelson report and, in, in 2003 we were felt like, we were processing about 20% of the branded Visa and Master Card market. We will reach a peak this year of 49% which is about as close to half as we can get. During 2005 we converted the Fifth Third Bancorp in Cincinnati, ABN AMRO in Amsterdam, FleetBoston and Chase. Those were the big ones. We also renewed contracts with a number of customers that represented over a, over a half of billion dollars over the life of that relationship and thatâs Navy Federal out of Washington which is the largest Credit Union in the world, AmSouth out of Birmingham, Vancouver City Savings, Credit Union out of Vancouver, Canada, Trustmark Bank out of Jackson, Mississippi, Juniper Bank which as you know has been acquired by Barclays out of Juniperâs in Wilmington, Allied Irish Bans in Dublin, CNS Podesto (ph) in Mexico and Metavante in upper Wisconsin, Metavante has been a customer of ours, since 1978 and I think that if my memory serves me right, Trustmark is about the same age they both are very, very old customers and we are proud to have them. I think one of most exciting thing that we have going on is we have a convergent pipeline it is the largest in the history of TSYS. We have over 75 million accounts lined up in that convergent pipeline. It is stand as; itâs in the process of being converted over to TSYS. We will, we of course Toronto-Dominion that will be coming on July, CUP Data will be coming on in three stages August, October and February, and I think all of those are progressing very nicely. We also think, an interesting has happened with the, as a result of the Banc of America and MBNA Merger or acquisition where we had some pretty good enquiries from aged banks of MBNA that that frankly are just kind of exploring as to whether they have, whether they want to get back in the business or not. So thatâs a little bit encouraging and so we will keep you at plugged in on how thatâs going as time goes back. I want to take just a second and talk about international expansion. We still have less than 10% of the global market. Our international revenues make up about 19% of our total revenues and I firmly believe that over the next 5 years international should be in the 30%, 35% range as far as revenues. There is a tremendous amount of geographic and product expansion through Europe. We see good opportunity there over the next 18 to 24 months, particularly in the UK as a lot of issuers will be forced to make system conversions to other platforms. There is also another in house issue that are waiting there a bit, our key strategy is in options. We are having conversations with, I think some, one of the really neat things that we did was the Bank of Ireland Post Office Deal. I donât know how familiar are you with the post office in UK, but itâs, they are huge merchant and they, Bank of Ireland has launched a new credit card that allows customers to treat some transactions like installment loans and some of the same credit card. That relationship for the UK post office will wined up offering a really board range of services that may attract a tremendous amount of traffic. ABN-AMRO is a big win for us 2005. And itâs really like getting the good house keeping seal of approval in Europe. We are continuing to see success in the Dutch market and we believe that certainly there is going to be much more opportunities there as result of the ABN AMRO deal. Toronto-Dominion is, we loved doing business in Canada. They have approximate about 5 million accounts according to Nelson with the conversion of Toronto-Dominion we will have 3 of top 5 banks in Canada, plus several large retailers including Canadian Entire which is the largest retailer. We believe that our market share today, well after Toronto-Dominion deal is done will be in 43% range. We think there is still lots and lots of opportunities in Canada with other banks and retailers and I can assure we are working hard on. We will convert as I said earlier Toronto-Dominion in mid â06. CUP Data, we made the announcement in the CUP Data in December, I believe its, I believe long term its going to be the most significant international announcement we have made. The biggest we have ever made was Royal Bank of Scotland, as you know we purchased a 34% equity stake in China UnionPay. And we will increase that ownership up to 45% here in the near future. I am confident we'll have it done no later than in end of the first quarter. Weâve been working with CUP Data over the past several years to get this deal put together and CUP is sanctioned by the China Union Pay sanctioned by Peoples Bank of China, which is there equivalent to the Federal Reserve of China Central Bank. And it has quickly one of the worldâs largest and fastest growing payment networks. The PBOC, the Peopleâs Bank of China has mandated that all banks must adapt the CUP brand for domestic transactions. Thatâs good for CUP Data. CUP today has a 166 member banks and they are responsible for operating the only national bank card network that accepts bank cards in China. So you can imagine the feeling that we have, as best we can tell according to our G2 there are about 875 million general purposes cards that carry the CUP brand today in China. Only 35 million of those cards are credit cards. Our best estimates are that about 2008 that 35 million will go up to about 200 million. You have heard a lot about bank card penetration in U.S, itâs the 2.9 cards per person in the U.S. Itâs about a half a card in China. The nationwide retail consumption on bank cards is only about 5% in China. We have had people ask us why we didnât, why we partnered up with some one and you heard me say for the last couple years, when we go to China we feel like we have to go with a right partner. Itâs a, we found that the business is very relationship driven. The government has strong influence in this very complex process. And we feel, I say we will be very happy that a notable cause going in. I donât think there is any doubt that they are clearly the best partner in the market place. They could currently provide transaction processing, the last recovery for other banks and bank card issues in China including debit processing. To-date in 18 months they have signed, they have miscued contracts with 23 banks in 18 months of operation. We have about 5 more lined up. We believe itâs a great strategic fit that we would certainly have some long term impact on TSYS and absolutely I think it could be the next Vital or really even bigger Vital over the next 3 to 5 years. I described with our people everybody that is in this business try to do this deal with CUP Data and a lot of people that were not in this business and I think its like hitting a home run in the bottom of the seventh to win the world series, I mean it is a, it is a big, big deal and we are thrilled about it. Switching over to the prepaid market, 2005 was a year of trying to build some momentum in the prepaid market on a global basis. We have received strong traction with our prepaid services and this segment is important to TSYS because it positions us to capture a broader retail finance market. And it serves as a wonderful bridge to new geographic markets and product segments. The prepaid cards are getting probably as much a more attention in Europe than they are in the U.S and I believe this is going to be a great platform to help us expand in the European market. For a lot of the international customers this is, prepaid is really the first step in outsourcing and we are absolutely one of the first movers in the industry and we have established ourselves as a market leader. By the end of 2006 we would be processing 13 million prepaid cards in 14 different countries with numerous issuing partners. Some of the deals that we announced in 2005 with a Zoomcard and the Answers Etc. card through KeyBank and this is primarily for the un-banked market, the un-banked population in the US. We announced a deal with Royal Bank of Scotland with HMV, which is the largest seller of music, and CDs and all of that in the UK. We did a deal direct with Sonae Distribuicão, a large Portuguese retail chain and then we did a deal straight, direct with Hunkemoller, which is a leading Dutch specialty store. We also, I think showed some great leadership, we took the initiative to create a Branded Prepaid Card Trade Association, and the purpose of that association was to establish industry standards, and create greater awareness in this -- in this business. We also see prepaid as an access to a broad range of other payment applications at the point of sale and we are confident that the healthcare industry will be an early adopter of this technology. I think that the healthcare industry has a problem desperately looking for solution and frankly we thought that we would have a good announcement by this call, but we believe weâre very close to, closing some business in this area. Our products offer unique multiple plus capabilities that allow a provider to integrate HSAs, FSAs eligibility add debit cards, and on separate loan of credit, all on the same cards. So, we think thatâs a strong area for future growth. I couldnât let the day go by without talking a little bit about Vital. They just have performed magnificently. They have renewed contracts this year with 3 of their top 10 clients, including a long-term contract with Banc of America. They had strong organic growth, coupled with the pipelines that continue to add new products and services. And, I think that I am confident that Vital will be a consistent growth engine for TSYS. We are in the process of introducing two new products, a gift card solution for a smaller to medium merchant segments, that has some enhanced reporting capabilities. We have brought Orlando Vital express, which is a single point of entry, for when you go out and you sign a merchants, and do maintenance on merchants, and its had successful data launch, and weâve already signed up two more customers after the data for Vital express, which we do charge forth. Another interesting area, we start to look around and saw that we had 4 or 5 different call centers, and everybody was sort of doing their own thing, and what weâve done is developed a new division called Managed Services. And weâve restructured our call centers to create a strategic business here with more than 1,250 agents in 7 contact centers around, across three countries. It will have a more efficient operating structure and a dedicated sales and support team. We think that we are positioned to deliver customized half quality support in these centers, for things like receivables, management merchant technical support, provide a risk management in just general services. -- Over the next couple of years, our leadership team believes that they can generate over $50 million of new revenues from this group. Certainly, there is no doubt that we had some setbacks, and we were certainly disappointed with the Banc of America decision, I will tell it was a terrible way to end the year. And I will say this, if you would ask me the list of the top 100 problems that we had on January 1, of 2005 Banc of America wouldnât been on that list. There are a happy customers, they, we got a great relationship with them and as you know we converted the fleet business in March of â05 and renewed the Banc of America contract out to 2014. As we talked about when they de-convert the significant termination fee that would certainly impact our financials and basically itâs a moving target which is based on a number of months remaining in the contract and they have said that they going to leave in October and so thatâs what we are planning on. Itâs our, in expectation that we will use this cash to invest in the business. We may use it for some acquisitions. We are looking several right now. But certainly we can put to good use. This cash we have, frankly was we, we would never get that pay out. We do have a plan to manage our expenses. As you know itâs sort of a cliff issue when you talk about expenses with credit cards. We have to service these accounts until the very last day that they are here and they are gone and the next day we have to start getting, start reducing those expenses that we have. For 2006, we have a zero growth rate in our team member base, so we donât go and add any net people in 2006. We have about 90 team members working solely on the Banc of America business. We loose about 30, 35 professionals every month and a total of about 80 team members through just normal attrition. In over the course of the year we are going to redeploy those team members to fill other jobs and certainly we have a need for that through out the company. We are also going to have to lean heavily on our hardware and software vendors to restructure our capacity. If you look at TSYS in 2005, the people and equipment are 57% of our expense base. We also have some new clients coming on that will observe some of the capacity. I think itâs a tragedy that all of the accomplishments and momentum that we build in 2005 seemed to be getting over shadowed by the BoA decision. I hope that you realize that from my comments that there is no one silver bullet that can replace the Banc of Americaâs consumer business. It was a huge piece of business for, for us. They were an anchor client. They have been here for 25 years and they are going to be hard to replace, but we do have a lot of different pillars of growth if you will and we are encouraged by a long-term prospects. Our fundamental business is, is still very strong. We continue to have 8% to 10% organic growth and thatâs what we think we will have in 2006. Our value added products as you know the industry continues to get more sophisticated, we will continue to roll out new products every year. Value added is about 14% of our revenue. The loyalty business is, is one that I am really excited about. I believe that the acquisition of ESC loyalty is going to be one of those great events in our history of long term. As, as Jimmy said we built this new product TOP and its really becoming a must have in this business and I think you are going to be surprised long-term with the results that we post on ESC. We are very, very encouraged by that. When you, when you talk about Europe, the European banks are getting more comfortable with outsourcing before we get there, I donât think that they have really thought much about that. There is, there is going to be more consolidation in banking and itâs going to leave a lot of European processors with multiple technology providers. The other thing is there are over 80 processors in Europe, mostly owned by banks, very similar to what we had in US 25 years ago. And of course any time we have regulatory and compliance changes. It causes insurers to reconsider their in-house solutions and may be somebody else can do it better. In China, we absolutely are convinced that CUP Data is the right entry into the Chinese market and I think it would do; see some right things out there. Vital gives us good growth and diversification. We have a very aggressive anti-strategy and expense control plan put together, but certainly when you loose a customer like BoA it forces you to look at every efficiency and so we are evaluating everything. We want to move in to new technologies that can reduce our costs structure. I want to take just a few minutes and talk about our forecast for 2006. There is no question, 2006 will be a good year, given the challenges that we face. Certainly, the timing and the decision on the Banc of America conversion will have an impact. We had not expected them to pick the October date. But provided that Banc of America leaves in October, we believe that our total revenue growth will increase in the 5% to 7% range. Our revenue before reimbursables growth will be in the 9% to 11% range. And -- and that includes the termination fee, and the fact that as a result of them leaving, that we will have to accelerate $7 million in contract acquisition cost that we had been advertising over the, after the 2014. Our earnings per share will be in the 21% to 23% range. We fully expect to close out the year at 395 million to 405 million accounts on file. And, as a part of our assumptions for 2006, we are deferring the revenue and cost associated with the Cap One contract. That contract has got some multiple components, and there are some outstanding questions around the timing of the revenue and expense recognition. So, when you extract the BoA termination fee, and try to normalize the numbers, both revenue before reimbursables, and EPS would be a 4.6%. I think itâs right incredible when you think about losing 131 million accounts. I think itâs pretty impressive that we could have any grows. So, with that Michelle I will open the floor up for questions, and we will go from there. Thank you. Ladies and gentlemen, the floor is open for questions. If you have any questions or comments please press the number 1 followed by * in your touch tone phone at this time. Pressing one for a second time when we remove you from the queue after question may please pick your handset listening on speaker phone for optimum sound quality. Please, hold yourself for questions. Yes, hi Lehman Brothers and this is actually Alex Brown for Roger. How are you? All right, all right. First question on the BoA, you talked about the de-conversion not affecting the commercial and small business card programs and can you remind us little bit how big those programs are and what do you think the risks are about loosing that perhaps as well? Well, we will give a specific numbers on clients, but I can tell you they are absolutely in our top 5 customers. I donât think that there is high risk of loosing that business. We, itâs a very specialized business in the U.S. We tend to dominate that business. We have got close to a 90% market share. We also process in MBNA commercial and small business accounts and I would say probably at sometime they will merge those two businesses together. I donât have any details on that, but thatâs a business decision for them. But we have been advising that business in good shape and we feel good about our long-term prospects there. Okay thank you, itâs helpful. And then on Vital, it looks after you pack up these one time items I think thatâs $4 million that was in it, it looks like there was a 5% sequential decline in revenues and is that what we can expect going forward in terms of seasonality, do you think that it was basically thatâs the seasonality that we can see next year? No, thatâs not seasonal; I mean that was more inline with the one time things that happened in the third quarter. We also had some accounting entries and dealing with Banc of America contract that was finalized. So you will see the third quarter was little abnormal. And the third quarter and thatâs the reason we are down from the fuller in the fourth quarter. Great and then lastly I guess I donât know if I missed that but did you give tax rate guidance for next year? Yes, we did. We should been in the same neighborhood of 34% to 35%. I think we have some audit years that will be closed now then; we could have a little favorable impact there. So we might be able to bring it back down to 34 ranges. Hi guys this is actually Craig Ellis calling for Tony Wible. I just hope you can go over couple of quick things, one is translate your comments regarding, your desire to cut back on expenses subsequent to the BoA de-conversion that you guys actually are looking actually to keep some of those expenses on, in anticipation of some further wins. Can you just give me a little bit more flavor for that? I will try, I mean, obviously we have a plan for those expenses. The key thing probably is we are not going to add new people. We are going to redeploy. As I mentioned earlier, we lose about 80 people a month for various reasons. We estimate that 30 or 35 of those would be the professionals, IE programmers. So, we have the BoA and secret business fallen off, and we have dedicated people, very strong people dedicated to those two accounts. And, as these new businesses come on, Toronto-Dominion and Cap One and others, we hope to be able, where we will hope we will be able to move those people around and assign them to strong slots. What we are trying to avoid frankly is a layoff. And we, we prefer not do that. We have got a lot of good business coming on, as I said we have got a 75 million account Q; that is very strong, it is the largest Q we have ever had in our history. -- There, we think we have planned as best we can to be able to get these, these myths out the door. As Iâve said earlier, almost 60% of our expenses, our people and equipment. We have, we have delayed the building of the western data center until all these settles down. Now, I said delayed, we still believe that we need a western data center, but, you know when you go back to, to what Iâve said earlier, if we would have had, if you ask me to list a 100 worst problems we have loose BoA would not have been on the list. And so, we are working our way through that. We think we have a good plan. We think we are going to do well, but the problem is with these expenses you just canât cut them off the same time that the customer leaves. You have leases to deal with, and you have people issues, but I think we are going to be pretty efficient with that. And just, maybe just talk about from an absolute dollar point, dollar value standpoint, as you guys are exiting maybe out of â06, do you expect that the absolute dollar amounts as compared to 4Q of this year, for both dollars and personal, and that occupancy in equipment will be lower than that are exiting this year? I donât, I donât think there will be low but I would expect them to be in the same range now, in our forecast we are optimistic and I am somewhat optimistic that is going to be better than what we put out there in the news release, but our folks are here temper me a bit but I, deep down in my heart I have this feeling that we will be better than that. Itâs a, in this forecast we do have, we do have full benefits in there we, we, we believe that we can pay those benefits. That would be the one big thing that might reduce theâ05 expenses versus theâ06 because that can be a big number based on the year that we have, but I think the key is we have stop hiring, we are not hiring anybody. We are replacing some people. And thatâs going to be the, thatâs going to be our aim until further notice, now we, do we have some business on the horizon I think so, I think you can always depend on us to have some good business on horizon. We got a lot a lot of unique and niche opportunities out there that I think next quarter we will be talking about and you are going to be impressed with. All right and just make sure I got this straight on the one time fee net of the amortization, big flourish in amortization, thatâs being taken into account within the guidance correct? And by the way just said you known this that termination fee we will not pay that will be a one time event, we will not pay any bonuses or profit share based on collecting that fee. We think collecting that fee is a negative. Good morning itâs Paul Bartolai, Credit Suisse. First just a follow up on that question is the one time fee going to be in revenues? Okay, I am, and then just back on Vital, I was just trying to understand what is going on here I mean, so you have $4 million in one time type of stuff in 3Q? So then is that a normal seasonality that it would have been down 5% in the 4Q is that the normal seasonality or may be if you could give us what the kind of the pro forma year-to-year revenue growth would have been in Vital if you can give a sense of what was going on in that business? I think, if you look at the third quarter too, we had a, we closed the San Diego office a Vital merchant services with sales organization. That was probably around the $1 million worth of revenue in the fourth quarter that disappeared. And I think that will something going forward as we will continue to see a little less revenues coming from. I think year-over-year Vital is going to continue to grow in the higher single digit in their revenue growth and as Phil mentioned they continue to have a pipeline that continues to help our opportunities from⦠Well the main process and volume as your VirtualNet products and I mentioned in there that they were up 46% and as you know the dial is, dial goes down and VirtualNet goes up, VirtualNet is the most profitable piece they have and thatâs good growth form. I think year-over-year they were in the 16% to 17% growth range total. The problem with that maybe to give you, my simple answer is going forward you should expect the fourth quarter in Vital would be higher than the third quarter. Okay thatâs helpful, and then just on the guidance, can you give us any indication of the, what you expect by revenue line item in the Vital segments. Well we havenât really ever disclose that and how the Vital Merchant pieces is new to us this year. I think we still want to stick with our consolidated number this time. Hi, Merrill Lynch. Just on the revenue on the, you guys mentioned the revenue guidance before reimbursed bills, I want to verify that you said 9% to 11% growth and that does include the termination fee is that correct? Okay and then the, just the timing on the DFAD conversion I spent some prior skepticism about this October deadline I mean is that still operationally realistic at this point? Well, Greg they believe it is, so I think we have to go with what they believe, they are having to do all of the heavy lifting and I think that certainly between Banc of America and MBNA they are large enough and have enough resources to where they can do about anything they want to do. So I think we are on count on October. I think they are going to, they going to have a difficult time, is a hard conversion but, but they get it done. Okay, so there is no big dating items on your hand preventing you from meeting that goal in anyway share performed? Hi, Fox-Pitt Kelton and I just want to go for this Vital again, as I want to reconcile back between your 225 to 235 annual revenue before the investments and then is that really against the merchant services on the consolidated income statement rather than the merchant processing services on the segment reporting and just how should we think about that, those two, the difference between those two numbers? You know I think that when you look at Vital as far the merchant services and we floated in 235 and thatâs pretty much where they ended the year. So if you look at it going forward you can count on the, few more months next year but though they started a little late bit but they would be up, get 10 months at 235, so you can count the figure where it be. Okay, and that you, then but when we look back at the segment numbers it looks like that numbers closer to 220 there, does Vital has some revenue in the other segment lines as well then? Great so far. And then we should we think about return on investment as some kind of contribution in the near term? I donât think I would initially are with -- I would initially, if you can -- there was -- this is a, -- we planted the seeds for the future here, and I just think it is going to be a while longer before we would be thinking about a lot of that I think at some in point you ought to be thinking that. Thank you. Michelle the time is getting late the market is before my watch is opening so we will take just take one more question. Hi, JMP Securities thank you. Two things, one can you give us a little more color, really as we looking over the next may be 3, 4 years with the domestic versus international mix, it sounds like card account is going to look like and then now that you, one, Capital One and two JP Morgan Chase, Bank One, and BoA in-house. There donât appear to be any real big 800 pound realism in the domestic front. If we had to forecast three years from now and where the growth is coming from and what the mix is going to look like what do you think international revenues as a percentage of the total might look like in few years? Well, I said over the next 3 to 5 years I think I said over the next 3 years be in the 35% range. No, no not really. All the years consultants have moved to Europe and they -- we have our own set of rules that we play with and so they, theyâve succeeded in reducing that premium down. I think what happens is, we talked about earlier we have this, this huge capability and as people move on to, to Total Systems they, they tend to buy more and more product and we talked about the value-added products in the differ margins on those products and, and so as we get into a deal several years it really becomes more sweeter for us. So, there would be good growth in Europe, as far Europe, internationally there would be good growth. We are excited about that, you know, I keep saying 3 to 5 years in China because thatâs really new ground for us. We -- I would like to think it could -- it could be faster than that. We have the Olympics coming to China in 2008. The government has mandated that the last majority of merchants must accept credit cards. But there is a corporal issue there, were they are used to debit cards and a part of that is, is happening, same thing is happening in Japan. And some to degree in Europe, I mean, there is much more debit cards, and many more debit cards in Europe than there are credit cards. So we are, we think they are great opportunities, you add on top of that some of these new businesses we've added, I mean, we still think we will be very successful in prepaid business. We know we are going to be very successful in the loyalty business. And so we are very bullish over our long-term capabilities, now that we have some other things that we are working on, absolutely. I think that you will see some good things out of us in 2006. So from is, all of this as a pretty long-term sales cycle that we are bullish on it. And we are encouraged as we believe the card industry is very dynamic and particularly when you at look the transaction growth, and the product evaluation at the point of sale, so we are very excited about it, but international has got to be part of our long-term growth plan. Got you, and lastly, you obviously will have more of an imposing the cash balance in Wall Chest (ph) after the termination fee. As you look the acquisitions I know you have put a lot of different processing in merchant oriented platforms. But your value-added products have grown considerably, and I trusted a lot of those are products that you host for other vendors. For example fair highway products and so forth. Would you be interested in acquiring a lot of those types of technologies for yourself instead of relying on vendors and perhaps, you know, capturing more of the economics of that or would be focused on acquiring still more process and oriented business? Well, I wouldnât want to limit anything, but absolutely we are looking at several key areas right now. I mean the one area that we talked a lot about over the year -- past several years has been debit processing. Frankly we may have missed the window there and there is a huge price war going on that business anyway data analytics we talked about before. Weâve got some issues that we want to got to deal with in the, in the merchant in you know in with vital in the merchant business we think there is some, some gateway if you saw we would like to go deal with the some new products so we have got pretty to deal with to try and go deal with and I think, we are building up a good â just and but the fact the matter is its got a fit we are, as you know we are, we are not the kind of folks who just buy just to buy --. And some, some, some people would think that may be we are little too particular but as you can is evidence matter financial we are conservative and now see that change in any time soon, so I donât mean to ramble with you Roger but we are, we are really looking at a lot of different segments that they might make some sense for us we a got a, a full time team doing that. I more I more try to close it out I donât know if Steve Stout is out there with UBS but I would like to say to him he is a Texas Longhornâ congratulate him on university Texas winning the national championship, things like that are always important. We believe that, that the card industry is still very dynamic, we believe that we have the goal standard we have a varied client centric service model we have proven capabilities and we think so more advantages in the market place I am convinced that we will continue to win and with lot of the gossip in the industry news going around in this business today I think it, its very helpful to us we are clearly committed and focused on this business and, and we feel its going to continue to grow. As always a I really want to thank you for your support over the past year and, and hopefully in the 2006 and thank you for your encouragement and friendship ph and we will be talking to you thank you a lot bye, bye. Thank you, ladies and gentlemen this thus concludes todayâs conference call you may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation. |
EarningCall_234056 | Flash memory-maker Sandisk (ticker: SNDK) reported very strong 3Q05 earnings yesterday - income was up almost 100% from 3Q04 and came in well above analyst estimates. Key data points and quotes from the SNDK conference call: In 2007, mobile phones may eclipse both digital cameras and MP3 players in their usage of flash storage⦠On the horizon, we begin to see flash in video applications, and in a few years, we expect to see flash used extensively in hybrid combinations of flash memory and disk drives in notebook PCs. In the third quarter Sony Ericsson launched a Walkman phone with a 512 Megabyte Memory Stick PRO Duo card supplied by us. Motorola introduced the iPod ROKR phone with a 512 Megabyte microSD bundle card supplied by us. Nokia announced their music-centric phone that will use, for the first time, a microSD card. And Samsung Mobile announced a support for our TrustedFlash cards in many of their content-centric handsets. Nine out of the top-10 handset OEMs have announced, or are expected to soon announce, models that support the microSD card, which is a TransFlash that we introduced and which is rapidly being adopted as the new de facto standard for removable cards in handsets. Music is turning out to be the major trend in new mid- to high-end mobile phone, fueling the use of higher capacity cards. |
EarningCall_234057 | Good day and welcome to the Apple Computer's First Quarter Financial Results Conference Call. Todayâs call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Ms. Nancy Paxton, Senior Director, Investor Relations and Corporate Finance. Please go ahead Ms. Paxton. Good afternoon. Thanks for everyone for joining us. Speaking today is Appleâs CFO Peter Oppenheimer and he will be joined by Appleâs COO Timothy (Tim) Cook and corporate treasurer Gary Whistler for Q&A session with analyst. Please note that some of the information you will here during this call consists of forward looking statements regarding revenue gross margin, operating expenses, other income and expense, taxes earnings per share, Appleâs retail initiative, iPod shipments, future products including Intel based Mac, component prepayments and non-cash stock based compensation expense. Actual results and trends could differ materially from our forecast. For more information please refer to the risk factors contained in the companyâs Form 10-K for 2005. Please also note that any non-GAAP financial measures included in todayâs call should be viewed in addition to and not in lue of Appleâs GAAP results. A reconciliation of any GAAP and non-GAAP measures discussed will be posted on Appleâs website at www.apple.com/investor. I would like to remind you that the second quarter of Appleâs fiscal 2006 will end on April 1st and will span 13 weeks rather the 14 weeks spanned by the first fiscal quarter. In connection with SEC rules on corporate disclosure Apple is making this analyst call open to the media and general public by broadcasting the call live over the internet. With that i would like to turn the call over to Peter Oppenheimer for introductory remarks. Thank for joining us. We are extremely proud to report a tremendous first quarter for Apple. Revenue of $5.75 billion increased over $2 billion from last quarterâs record revenue and was up 65% year-over-year. This quarterly results also exceeded Appleâs revenue for all of fiscal 2002. The quarterâs revenue was fueled by record shattering iPod sales, solid Mac sales and 14th week of business during the quarter. Quarterly net income nearly doubled on a year-over-year basis and also widely eclipsed the previous record established in the September quarter. Based on an unusually strong operating margin of 13% net income was $565 million or $0.65 per diluted share on a GAAP basis. Excluding the impact of non-cash stock based compensation operating margin was 13.8%, net income was $595 million and diluted earnings per shares was $0.68. I will now provide highlights of our two businesses, Mac and Music. Our Mac business generated 41% of total revenue which was up 12% from the year-ago quarter. Mac shipments increased 20% year-over-year to $1.254 million the highest quarterly total in six years. We continued to experience strong portable system sales. We shipped the combined total of 587,000 iBooks and PowerBooks representing 39% year-over-year growth. We shipped 667,000 Desktops systems representing 7% year-over-year growth. Mac unit sales exceeded our internal expectations despite of what we believe was a positive sale associated with the Intel transition. Reflecting on the September and December quarters, we were pleased with the lower than expected impact at the Intel transition on sales and with the moment of our Mac business. Our ending channel inventory remain below our target of 4-5 weeks as planned due to our Intel based Macintosh announced at Mac World. Our Music business generated 59% of total Apple revenue in the quarter and was up 145% compared to the year-ago quarter. We sold over 14 million iPods during the quarter, more than three times the number we sold in the year-ago quarter and more than double the previous record number of iPods we sold in the September quarter. We are particularly proud of our execution given that we replaced two of our three iPod lines including the highest volume iPod Mini line as we entered the holiday season. Customer reactions about the iPod Nano and the 5th generation iPod. IPod channel inventories were lower than we would have liked during the quarter. At the end of the quarter including units in transit our channel inventory levels were within our 4-6 weeks target range based on our current US demand for the seasonally lower March quarter. It was a landmark quarter for the iTunes music store with the addition of television, music video and short term content to the storeâs vast and growing library of music and audio books. The iTunes music store continues to be the worldâs leading online music service and currently operates in 21 countries that represent over 90% of the global music market. We have sold over 850 million songs and 8 million videos to date. And according to Nielsen Sound Scan Apple accounted for 83% share of the US market of legally purchased and downloaded music during the month of December. The Apple Retail stores reached a significant new milestone in the December quarter by generating $1.072 billion in revenue compared to $561 million in the year-ago quarter. We opened 11 new stores during the quarter exiting with a 135. With an average of 129 stores opened during the quarter average quarterly revenue per store was $8.3 million up 41% from the year-ago quarter. Retail segments profits grew sharply to $90 million from $45 million in the year-ago quarter. And associated manufacturing margin not reflected in retail segment profit with a $199 million up from $99 million in the year-ago quarter. We are particularly proud of the moment we have realized in our stores. With fiscal 2004 after 3 years of operation we generated $1.185 billion in annual revenue through the stores. In fiscal 2005 we nearly doubled that number $2.35 billion. Now in a single quarter we have surpassed $1 billion in revenue. We will continue to add new stores at a measured pace and expect to open a total of 40 new stores during fiscal of â06. In terms of geographic results including sales from our retail stores quarterly revenue in Japan, the Americas and Europe was up year-over-year by 92%, 70% and 51% respectively. Gross margin was 27.2% on a GAAP basis and included $5 million in expense related to non-cash stock based compensation. Without this expense non-GAAP gross margin would have been 27.3%. GAAP operating expenses were $814 million including $39 million in expense related to stock based compensation. Non-GAAP Opex was $775 million $55 million higher than our guidance primarily due to variable expenses associated with the higher revenue level, a greater than expected mix of direct sales and investments we made in our business. OYME (ph) was $81 million and the tax rate was 32%. Cash grew by $446 million during the quarter to $8.707 billion. We made prepayment of $750 million related to previously announced agreements for future supply of NAND Flash memory components. Without these prepayments cash would have increased by about $1.2 billion. The cash generation was primarily a function of strong earnings, excellent working capital management and employee stock option exercises. Cash flow from operations during the quarter was about $283 million which includes the impact of a $750 million prepayments. Capital expenditures in the quarter were $82 million including $40 million for our retail initiative. Looking ahead for the March quarter i would like to review our outlook which includes the types of forward-looking information that Nancy referred to at the beginning of the call. Quarter-to-quarter which will span a fiscal 13 rather than 14 weeks we are targeting the second best quarter in the companyâs history second only to the last quarter with revenues of about $4.3 billion. This target represents 33% year-over-year growth and an increase of over $1 billion year-over-year. We are factoring into our guidance a seasonal decline in iPods in the beginning of our transition of Intel based Mac. We expect the total quarterly cost of non-cash stock based compensation to be approximately $49 million. We expect GAAP gross margins to be about 27.8% reflecting approximately $5 million related to stock based compensation expense. Without that expense we expect non-GAAP gross margins to be about 27.9%. We expect GAAP Opex to be about $774 million including about $44 million related to stock based compensation. We expect non-GAAP Opex to be about $730 million. We expect OYME (ph) to be $72 million and we expect the tax rate to be 32%. We expect to generate GAAP EPS of about $0.38 which includes an anticipated $0.4 per share related to non-cash share based compensation expense. We expect non-GAAP EPS to be about $0.42. During the March quarter, we expect to pay the remaining the $500 million of the $1.25 billion NAND Flash repayment. We just completed the best quarter in Appleâs history, and fiscal â06 is off to a great start. Our new Intel based Mac announced at Mac World has been very well received. We remain extremely enthusiastic about our innovative product pipeline and we are confident in our strategy. With that I would like to open the call for questions. A couple of things, Peter do you â are you able to quantify the impact of the extra week, I believe last year you did not have the week after Christmas, this year you did, and so was this yearâs extra week extra big or is it really hard to say and then I just wanted to ask more about your guidance, so it would be great if you can just answer. Let me answer your first question. Yes, the 14th week this year, did span between Christmas day and New Yearâs day and that is traditionally and it is was year, a very strong shopping week, and our earnings expenses and revenue were all higher as a result. Okay. I mean is it possible to say like it added a million or 2 million iPods or is it just too hard to say? Then with regard to your outlook, I mean can you just tell us a little more about what you are expecting with the Intel transition, I mean, you are coming off a quarter where you guided 4.7, you are coming in at 5.75, I mean, now you are at 4.3, shouldnât we assume, why are being so conservative, a little more detail on this exact Intel transition issue, would be helpful, may be even if you can go back to the weeks of inventory and what you might expect further drain or anything else. Let me, Iâll let Tim address, our channel inventory. But let me just speak to you in a little broader term about our guidance. We factored a number of considerations into developing our guidance. Our first, then, this really was your first question, Q1 spanned 14 weeks, and Q2 will span a normal 13 weeks. And again the 14th week that we had this quarter was the week between Christmas and New Year which is a very strong, sharp shopping week. Second, for our Mac business, we have factored in the very strong response that weâve received for the new Intel-based Mac that we announced at Mac World, the limited number of shipping weeks that we will have on the MacBook Pro and the positives that we saw in customer demand for Q1. For the iPods we have factored the extraordinary demand in Q1 which was fueled by iPods being one of the top holiday gifts of the season, some channel fill that we had and the seasonal drop in demand as we go from holiday quarter to the March quarter. On iPod channel inventory, as it has been widely reported in number places, our channel inventories were lower than we would have liked, for most of the quarter. Shipments did improve on iPod across the quarter, in particular in the second half of December, the shipments were very strong. With the strong shipments, the total channel inventory which included a significant amount of inventory that was in transit at the end of the quarter increased by approximately 550,000 units as compared to the channel inventory at the beginning of the quarter. Despite that the ending channel inventory was still below the target range of 4-6 weeks based December sales. However we believe that the channel inventory is within our targeted range of 4-6 weeks, based on our current view of demand for the seasonally lower March quarter. In terms of the Mac channel inventory, we began the quarter below the targeted range of 4-5 weeks, and as we had planned we ended the quarter below the targeted range in preparation for the Mac World announcements that we made last week. Okay. Tim, i am going speed it for one more, the â just, i see a situation where you still may have some lower than expected channel inventory but, may be now are you seeing anything out there that is giving you any pause in the economy or in the consumer markets other than some of these Apple related events that you are talking about? What we are seeing is, we had extraordinary response last week to our announcements at Mac World, we are thrilled with the reactions that weâve got including the bookings on the new iMac and the PowerBook, our MacBook Pro, the last quarter we did see a pause as some customers began to speculate about the upcoming announcements at Mac World however, the Mac beat our internal expectations as Peter just said, we obviously factored some level of pause into our guidance and we were able to beat that number and we are happy with that and the overall moment of the Mac business. Just kindly of looking at the Opex guidance, it is now basically inline with your sales guidance, i know you donât give a target model anymore but historically you used to try to keep that tracking at about 50% of the growth of sales, how should we be thinking about that, do you need to be spending this much if top line growth is going to be slowing like this? We, as I said we are very confident in our business, in our strategy and we are continuing to invest for long term growth, both in revenue and in earnings. Iâve provided very strong guidance for the March quarter with revenue growing at 33% and double digit operating margin. I guess one follow up on the Mac question. Obviously you have had a strong response for the new product, does this mean you are very scared about iBook and PowerBook sales really deteriorating until those two new products are launched as well? We did see a pause quarter as Peter has said we have factored what we saw last quarter, end of the quarters guidance, we are thrilled with the response that we got last week and as we said we started shipments of the iMac already and given that weâve got an entire to ship it, we believe we can, we are hopeful that we can meet the demand on the iMac. But also as we announced last week, the MacBook Pro will begin shipping in February and therefore has a limited number of weeks to ship during the quarter, given that and the very strong response that we saw, we may not be able to meet the demand on the MacBook Pro. Obviously phenomenal quarter, just wanted to dig down a little bit more on the CPU side of the equation, you have reported several times the fact that you saw a pause, since that was the one area where some people could say, they were disappointed on the December results. Can you just provide a little bit more specificity in terms of what you saw that gives you a confident that this is purely a pause in front of the product cycle as compared to any disconnect on the âHalo Effect�? that many people have? Let me make some comments. First of all the Mac business grew 20% year-over-year and it did exceed our internal expectations which had factored again at a level upon. We did see a pause, weâve received reports from a number of customer from different markets that they were postponing purchases tending Mac World announcements, however in our results last week that we saw in the reaction last week is extraordinary and that gives us tremendous optimism about the customer reaction and on the Intel based Macintosh. It is very difficult to predict how customers will react this quarter. And so obviously factored in a that kind of thinking into our guidance. A year ago we had a situation as you recall the comparison of the quarter where we had, a significant shortage of G5 chip in the September quarter and then we began to fill the channel and serve the pent-up demand as we entered the December quarter. And so the comparison frankly is also a difficult comparison. That has to be taken to consideration as well and looking at the year-over-year results. You specifically like to talk about specific products anymore but would you atleast confirm that more of the slowdown happened on the professional side of the equation as opposed to the consumer side of the equation? Or is there another trend that you saw? We had some level of reports from customers in different markets, i wouldnât want to pin it on one market above the other. First of all, on your website you are still offering the iMac G5, obviously the PowerMac G4. They are at the same price as the new Intel based Mac, that you highlighted at Mac World. Can you give us an idea of how much inventory you are still need to work through for the legacy products and also help us understand how you work through that inventory without discounting? We donât Bill, talk about future products or future pricing but we certainly factored our thinking into our guidance and we will continue to ship the iMac G5 and the PowerBook 15 inch wealth of iBook. Okay. Just a clarification on the in-transit inventory that you included in your channel inventory number, that is not recognized as revenue yet. You donât recognize until it actually arrived at the retailer or is that incorrect? Sure. As you know i donât want to be, for competitive reasons specific in what we want to talk about, specific iPod sales, but i will tell you that the iPod gross margins in the December quarter were above 20%. Charlie, as i have indicated in Billâs question, we donât want to talk about iPod sales by model or geography. I can tell you that with 14 million sold last quarter, we were thrilled with that result and there were points in the quarter where we were too low in our many of our channels. Okay. Let me ask the final question then. At the Mac World keynote last week, Steve indicated that music downloads were running at 3 million per week, i believe, i assume that that level was reached through a lot of redemptionâs of gift certificates, is that a reasonable assumption? Yes. In the december quarter we sold a lot of iTunes Music gift cards and certificates over the store but we were also having people purchase directly as well, and we couldnât have been happier with the sales of iTunes in the December quarter. Can you give us an idea in terms of availability of components from Intel and specifically is that leading to any delays in terms of getting the MacBook Pro out? Just specifics, you said February, it is earlier rather than later in the month? Let me answer the question broadly about the supply of the iMac and the MacBook Pro. Weâve begin to ship the iMac, we are very happy with how the production ramp is going. We are extremely happy with the response we had last week as iâve said before, and we are hopeful that we could meet the demand for the quarter. On the MacBook Pro as planned we are beginning to ship that in February and given the number of weeks that would remain in the quarter to ship and the extraordinary response that weâve seen with our customers we may not be able to meet demand on that product. And with regard to any product constraints in the last quarter, any thoughts on air freighting, any incremental cost that were associated with any shortages? In the current quarter, that factored into our guidance we would be airfreighting the Intel based iMac in order to get those into customers hands very quickly. We are also in the results in our Q1 that has Peter has talked to airfreighted some number of iMacs as we had rose the multiple line up in October. Two part question, if i could. 1) is there any chance the new iMac and the PowerBook have better gross margins given the scale of the Intel Eco system for other parts of the component. 2) is it accurate of the impact of any price protection that you may have incorporated for plan discounts of the legacy G5 and G4 Mac, with that already be incorporated in the December quarter and hence that would negatively impact this March quarter and finally i just wanted to be clear, are you saying that with your comments on the inventory that the supply and demand are now in balance for all of the iPods includes the NANO 4gig? Let is answer your first two questions and Tim can address your third. As regards the Intel based Mac gross margins we donât to provide specific gross margins for any of our products, i have given you pretty detailed guidance for the December quarter. And i am sorry what was your second question? As i had earlier mentioned we are not going to talk about product plans or pricing actions that we have not already have announced but i can tell you that any price protection that would effect our channel inventory that contemplate, we provided for in our December quarter and in future action beyond that, would not affect the channel inventory but March quarter is down in, we have factored into our guidance for the March quarter. Relative to the channel inventory on iPod on an aggregate basis, we believe that we are within our targeted range of 4-6 weeks based on our current of view of demand for the quarter however, there are stock out in different places on different models and also some countries are leaner than others. We are working very very hard right now, to alleviate this situation. Just in terms of the big picture here, conceptually where you are going with the market share plan here, do you see yourself being a little bit more aggressive 2006, in terms of your efforts to gain market share, maybe just in terms of breadth of distribution and other ways that you could gain market share? A - Timothy CookWe are very confident that we have selected the right course where the future of the Macintosh, we reviewed the roadmap, from many different sources, we believe Intel has the best one by far. Weâve got the launch underway, we were happy that we were able to do that 5 or 6 months before the expectations doing it, and we will have the transition completed much earlier than the market anticipated by pulling again until the end of 2006. And so we are very very optimistic about the future of the Mac and the way we are headed. But there are also just of couple of, doing the product side which i would say is they are important but there is also, the distribution side and the pricing side, and you guys can probably have an opportunity to really put the hammer down in terms of picking up market share in 2006. So just conceptually, obviously you guys like to talk about pricing, but conceptually do you see Apple being more aggressive, trying to gain market share in 2006 or kind of continue to the status quo of creating the best products, happen âto be more selective in terms of distribution, more selective in terms of price. We are going to continue to make the best products on the face of the earth, that is reason that we are here. On a distribution basis, we continue to open stores, we also continue to look at different alternatives to the channel, and when responding that we like and we would obviously view that, they are beneficial, i wouldnât want to comment on the price question. And just last question is, outside of the extra week in the December quarter, and outside of people postponing their purchases in anticipation of the Intel based, is there any reason to think that the seasonality between December March should be any different than previous years? Yes. There is a reason to think that seasonality of the total company would be different because the music business with a much higher percentage of our business in the December quarter than it had previously been and so obviously the iPod would have a different seasonal curve than the Macintosh to have. I just wanted to repeat this but, three questions, seasonality on the guidance, you are assuming this similar, i have seen a stronger seasonal decline in the resent systems, is that impromptu to comment? The impact of the Timâs response to the prior question was, effectively that you are assuming a larger seasonal decline in music business than the Mac business? What i am saying specifically is that if you look at previous years for Apple, and the Q1 results, and just look at the total revenue, we would not expect the total revenue to look the same sequentially that had in the past, because we were operating at a much higher music content in the Q1 in the holiday period. If i can follow on the second question, you kept, as you said, the old product pricing is unchanged, can i fundamentally ask why, just that you assume users perceive the things, your performance for what they need. Could you comment on that? We are selling the iMac G5 and the PowerBook G4 15H product while supplies last. And we factored our thinking into our guidance. So effectively you are saying, so you see no need to reduce prices, in spite of the perceived difference in value? I am saying that anything that we are planning on doing we factored into our guidance. And that we are only selling these while supplies last. And finally, if upon rough calculations on the implied music and video downloads are revenue streams, are correct, excluding that downloads at iPod, the remainder of the music revenue streams look like they are non-iPod non-download music revenues increased dramatically Q4 to Q1 and could you comment on that and comment on the seasonality and dynamic associated with that business. Richard this is Peter. There are now over 2000 different accessories that you can buy with your iPod and fundamentally those are the revenue streams that i think that you are referring to. We did very well with our sales with these in the quarter, both the Apple branded and our third party developers that we sold directly. We expect to have a good quarter in March and honestly we are going to learn more about the seasonality of this part of the business because it is bigger, it is growing, i have said this before and believe it to be the case that many people will buy and iPod and then later come back to add accessories to it. And this seems to be a part of our business that has more of a recurring revenue stream, much like the iTunes music stores and we are very pleased with what we are seeing and we are learning more about it. Tim, i was hoping if you could just give us standard pitch on component pricing and availability during the first and second fiscal quarters for the major commodities that you buy and then also i was hoping if you could give us the mix of web direct sales in the quarter please. On a component basis, Rich what we saw last quarter was that the, we have a favorable component environment, both in terms of LCDs and memory, both of those were most stabilize than we had predicted, as we enter into this quarter, we continue to see the LCDs being a favorable environment, because supply is greater than demand, we do expect the DRAM market stabilizes on as more of the manufacturing capacity is converted to NAND Flash. Hard drive prices continue to decline but they are declining at a lower than attributable rate due to some underlying components. I would tell not to continue to expect price reductions in the flash area as more and more and people convert their DRAM capacity to NAND in short term, but overall as you can tell by the amount of prepay that weâve elected to do, we view that particular market as not having as many down turns as some of the other commodity markets then, we believe that it is very important to lock supplies for the long term. Rich, i will add with overall our direct sales which include the web sales that Tim referred to, sales through our retail stores, and direct sales to US education and enterprise and music stores comprised of 49% of total Apple revenue and that was up from 44% in the year ago quarter. And then may be Peter, just one more simple one for you. Can you talk about the location of the 14 new store openings that you talked about fiscal 2006. How many of those are domestic versus international? We expect most of those to be domestically but we will continue to open stores in Canada, the UK and Japan as well. In terms of the seasonality of the iPod, it seems which you are baking into your guidance, in terms of my model, at least so much of your earnings power for the quarter and for the year for that matter, depends upon what assumptions one makes for seasonality in the March quarter end, looks like your guiding, if i am doing it quickly, it perhaps not accurate, looks about 45% sequential decline in iPod, it looks may be bacon in that kind of a decline to get to the numbers that you guiding to, i think first of all, i am in the ballpark with that and secondly if you donât comment on the iPod things specifically, how do you think about the broader CE market in terms of the typical March seasonality. Steve, it is Peter, Iâll address that. I am not going to provide specific product level guidance, to think you thought i would, but let me make some comments what was last year and related little bit to this year. Last year we did see a seasonal drop off, in the combination of our iPod and the iPod Mini line which was more than offset by the introduction of the iPod shuffle. And as was widely reported and weâve commented, the iPod was one of the top holiday gifts this season and it is natural to think that they will be decrease in demand in the March quarter from this exceptional holiday result which again included a 14th week. And you can go out get some primary research on what you would see for various CE products. And then, in terms of okay, Iâll leave that alone and then go on to my last question, can you walk through, Tim commented on what you expect for component in the March quarter, go through, because of the kind of puts and stakes that you factored into your gross margin guidance? Two questions if i could. Tim i just wanted to clarify, i think what you said was you started the quarter with some low inventory in the CPU side and you ended a bit low too, so it didnât sound like inventory played a big role in the December quarter in the CPU side can you just clarify that if i could for the first question? We started below our range, we ended below our range, and we had planned that Keith because of the announcements that we made at Mac World. The second questions, is there anyway to conceptually think about your CPU business may split in terms of the units at all between the Intel side and the Mac side in this quarter, is there any kind of general plan that you could think since there is the vast majority of the platform is still on the IBM processor side or the G processor side. Is that 80-20 or any kind of color you could give us there? We are producing the best Macintosh that has ever been produced and there are great products that have Power PC processors in them and incredible products that have Intel processors in them and we just have to see how the customers vote in terms of the percentage of each. Well let me ask the software part of the question and Tim, At least at Mac World, the Cox coming natively, and then the Apple software suite is running natively in sounds like Rezatto and emulation is still, going to be a part of the software side of the equation, so you still have the emulation. Do you think that is going to cause people to pause it off in terms of the performance that you didnât get? What we are seeing is that Rezatto runs very well with products like Microsoft Office as an example and as you commented we have already reported the iLight suite and it is shifting on the new iMac, new MacBook Pro. Weâve already ported iWare. Obviously the OS is native and all of the applications embedded in the OS that is just mail, iChat etc., are also ported. Weâve also announced as you refer, that our, the bulk of our Pro application will be available in March natively. It is just includes final product and logic and aperture expenses. There are a lot of things that are already native and in fact as weâve announced last week, the website has recorded over 200 native ads already, and well over 1500 witches. And so we are seeing great moment for our developer community and i think by making the announcement, obviously people are even more anxious than they already were to complete the work and we are very confident that weâll continue to see great momentum in that area. I think that is a question for them, however, we worked closely with Microsoft with running Rezatto and if you, i would invite you to try that yourself and we certainly believe that users will be very satisfied with that experience. You mentioned that iPod margins were about above 20% in the quarter, is that from lower component cost, or a better mix and how sustainable is that? David, i donât want to be specific any of those parts of your question and just we said that they were above 20% in the quarter, and i will report to you in April what they were for the March quarter. Okay. Let me try something on the Mac side. Do you expect to end the March quarter within your targeted channel inventory range. And if so how much build you think you will have in the quarter, how much you have included in your target? Yes. Two questions. Europe looked like there was very very strong, just wanted if you could give more color in terms of what happened there in terms of i guess the Mac business versus the music business and then the second question R&D, looks like it took a big of spike in terms of the absolute dollars, but certainly not so on the percentage of the revenue, just wondering how should we think of R&D spending, should we think remaining at these levels, or could it turn down? Shaw, let me address your R&D question and Tim can talk a bit about Europe. As i mentioned earlier we are very confident in our business and we are investing in the business for long term growth and both revenue and earnings and a big part of that is our investment in engineering and you have seen it go up, each quarter for the last many quarters and just expect it continue to invest not only in engineering but in opening more retail stores and more advertising and marketing program to grow the business. Shaw, on the Europe side the Mac shipments were up 49% sequentially from September, but as you probably know that the September quarter in Europe is the traditionally weak quarter because the summer vacation that happen across most of Europe. In terms of revenue Europe with retail stores was up over 50% and frankly there were many countries in Europe that had more relatively more iPods constraints so that revenue number was held down iPods a bit more than some of the other geographies. I was hoping first with regards to iPod if you kind of outline how you see the opportunity for the iPod in terms of units or other market comparisons and on the total opportunity available and also with regards to creative professional can you comment with regards to the health of that market both from a video perspective as well as publishing? On your second question, on the creative professional we saw good growth in the video market on a year-over-year basis, we were very pleased with it, DNP was weak and if it is as you know the DNP market itself is not a hugely growing market, it is just that not out of our expectation though by any means. In terms of opportunities on the iPod, we see iPod as the absolute best player in the market. We only recently announced the iPod Nano and the iPod, there is more video content on the way with the iPod and so i think there continues to be significant opportunity for the iPod in the overall music business. Good afternoon again and couple of things, just caught me a little off guard, it was pretty quick. With regards to other music at 491 much better than expected. I am just wondering, was there anything in there, that that particularly helpful meaning you are seeing a lot of extra shells now iPod accessories in many retailers, maybe if you are able to kind of talk to how much iPod accessories were in that number and what is going on with the iPod Eco system going forward so that we can model that line a little better. Ben, the two largest component of the other music related products and services are first the iTunes music store and then the iPod accessories, both the Apple branded that we sell both directly and indirectly and the developer iPod accessories that we sell through the Apple online and retail stores. Both had significant growth year-over-year and sequentially the music store, we couldnât be happier with itâs performance as indicated earlier, we are serving customers in 21 countries, where over 90% of music is purchased. And we saw just strong growth both year-over-year and sequentially not only in music but with the addition of video and we look forward to bringing more content both here in the United States and in other places before too long. The accessories business continues to grow for us both in terms of the Apple branded and our developers support. We are now have over 2000 accessories that you can buy with your iPod, the vast majority that Apple doesnât make. And as i said we are beginning to see a bit more of a recurring revenue stream there where people are coming and adding back, that next accessory to their iPod family. We are very pleased with the response on it Ben, and we are working very hard to get units out. We are currently not meeting demand but we are working really hard to try to do it. I am not projecting whether we can or not, for the full quarter at this point. I mean, is that like million of units, tracking type of device in the future, that kind of subset of iPod sales, is that the potential where we are looking at. Like a higher attach rate? Okay. Thanks. Gene and thanks to everyone for joining us. A recording of todayâs call will be available for replay via telephone for seven days beginning at 5:00 PM pacific time today. The number for the replay is 719-457-0820 and the confirmation code is 1699046. A replay of the audio webcast of this call also will be available beginning at approximately 5:00 PM pacific time today at www.apple.com/investor. Members of the press with additional questions can contact Steve Dowling at 408-974-1896. Financial analysts can contact John Hoover or me with additional questions, Dowling is at 408-974-4570 and i am at 408-974-5420. Thanks again. |
EarningCall_234058 | Hereâs the entire text of the Q&A from eBayâs (ticker: EBAY) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Operator: Thank you. At this time, if you would like to ask a question, or have a comment, please press star one on your touch-tone telephone. If you are using a speaker phone today, please remember to turn your mute function off to allow your signal to reach us. Once again if have you a question or a comment, please press * 1 now. Q: Thanks. Two questions. One around the core business, and then Skype. The first question regarding the relationship between core listings, gross merchandise value, and revenue, last quarter, I think the growth of those three metrics year-over-year was 32, 36, and 40%, and this quarter, it was 32, 30, and 37. So the spread between listings and revenue actually tightened. I was wondering if that was just generally ASPâs converging or something else? And then secondly on Skype, wondering if the opportunity with that product to actually further improve your competitive position in China, and possibly maybe even re-enter Japan with the core business, and maybe finally, wondering if the percentage of Skype accounts that actually are funded with PayPal currently today? Thanks. A - Rajiv Dutta: Okay. So let me take the first of all those questions, which relates to the relative relationship between the growth rates of listings and GMVs and revenue. So you know, when you look at the overall revenue growth that we saw accelerating particularly in the U.S. business, this is, just to be very clear, driven by volume. It is driven by listings. We had more users come to eBay and more of these users listed more items, which in fact is what really drove the revenue acceleration. But you are correct, we had seen increases in average selling prices actually now for a number of quarters and we saw that again in Q3, and we have also seen some very robust conversion rates. You know, typically in Q3, we would expect to see that to drop a little bit. And we actual saw robust conversion rates in the quarter in the U.S. business. So that is what is accounting for the slightly shifting relationships between these relative metrics. A - Meg Whitman: With regard to Skype, Scott, in China, we actually think that the combination of eBay, PayPal, GG, and Skype gives us a tremendous set of assets with which to really grow our business in China. And as you know, Skype, one of Skype's strongest marks is in fact China, so we do think that there is going to be some very interesting integration points, and with all of our businesses. As you know you may know that Skype has a joint venture in China with Tom online, a very powerful mobile port in China. So there are very interesting opportunities there. And stay tuned with more details there. With regard to re-entering Japan, you know, Japan is a tough market for us, but Japan is again a very strong market for Skype, and it may provide actually a nearer term opportunity for PayPal, because if we fulfill the vision of every Skype account that comes with a PayPal account, that's a great way for PayPal to enter Japan. So there might be an opportunity to enter with, you know, a new marketplace model that's more on a lead generation basis than a transaction revenue model, but that's probably a little bit longer term. With regard to the percentage of Skype accounts that are funded by PayPal, it is about 25% of the of Skype accounts, mostly in the U.K., that are in fact funded by PayPal. But again, it is not a wallet. It is that they top up their Skype account by paying with PayPal. And the vision of course is actually to have a wallet so that due need any more top-up, you simply draw down out of your PayPal account as you pay for the Skype fees. Q: Thanks. Good afternoon. Before I ask my questions, first of all, Rajiv Dutta, I want to wish you luck in your new position. And I think whoever fills your shoes is going to have some big shoes to fill. So you might be with us for a while. My questions are I have two questions. One is, on store listings, economics, store listings have been growing significantly faster than the auction listings, and the fixed price listing, you buy it is now listing, but the economics per list having been improving for the last couple of quarters. So can you give us a sense of what is happening with the economics of the store listings? Is the velocity increasing? Is the ASP increasing? Is the success rating improving on those? A - Rajiv Dutta: Thank you. And first of all thank you for your comments and just to be clear, Mark, I am going to be here for a while, so you won't be getting rid of me that quickly. You know, to your point about what is happening with store's inventory listing, what we call listing, stores inventory format, you're correct they have been growing much faster than the auction listings on eBay. And the economics, as you recall, we changed some of the pricing with regard to stores inventory format, earlier this year, and part of the reason for doing that was to balance the relative economics between stores and the rest of the auction format. So as a result of, you know, some of the changes we made, and then what buyers and sellers have been experiencing, is infact very, very good conversion rates and good ASPs. And that has absolutely been impacting the overall economics as far as listings, not just for our sellers but then also by consequence for eBay. So it remains a very successful product integration, much like many years ago, this is really driving incremental growth and so we're really pleased with the overall trend lines for this listings. It is clearly driving a significant part of the growth in the U.S. business. A - Meg Whitman: And I say these two formats really work together what we know is, our sellers to combine core eBay listings with a store actually do more business on eBay. Their repeat business is stronger and they are able to increase their ticker price if you will, if buy camera, you get a camera case and so from a marketing perspective I think we are seeing the power of these two formats work together to the advantages of market place to the advantage of our sellers and then directly upwards to the advantage of eBay. Q: So itâs the ASP and the success rates, though, that are improving and not necessarily the velocity of those listings? A - Rajiv Dutta: You know, the velocity of the listings are improving, but what is you know, the velocity is a slightly tougher measure to capture because most of these listings are either good till cancelled, they're on a 30-day cycle, so it is very difficult to keep track of exactly whether the same items are being re-listed or are they new items but when you look at the overall listing, there is no question that ASPs and conversion rates are driving some of the improvement. Q: Okay. And then Meg, you said that the U.S. and Germany both accelerated in the quarter. Is there anything specifically that you're doing that has caused those rates to accelerate, or are the markets just improving, the economy is improving, at all? Are they external factors and something you're doing something specifically? A - Meg Whitman: No the result of the improvements in Germany and the U.S. is very specifically driven by actions that are taken by the team in these markets. And let me categorize them for you, because they're quite similar, I think, between the U.S. and Germany. The first, I think, is that first of all we are capitalizing on the great franchises in both markets. But we are actually improving the efficiency of our marking efforts, including natural search optimization as well as more of our Internet marketing. Secondarily, some of the product features and functionality that we have introduced, we just talked about some of it in terms of stores and store inventory format is also increasing the value proposition for both our buyers, for our sellers, and therefore, they're bringing more "good goods to the market for buyers. And also trust and safety, particularly in Germany, we have actually just introduced pay with PayPal and you're covered. And we believe that is actually having a really nice effect on buyerâs confidence on buying on the German marketplace. So what we're seeing is accelerating bids, and accelerating average weekly unique visitors. The GMV per active user grew $16 in the U.S. and we're seeing improved average selling prices and improved conversion rates. So it is directly a result of the actions that we've taken. And I think what it underscores for us is these are very young businesses, they are very responsive, when one takes deliberate action, and goes deep in customer insight, that you can actually move the needle here pretty fast. And I think particularly in Germany, the renewed growth has happened faster than we anticipated. Q: Hi, couple of questions. First just housekeeping. Rajiv Dutta, does the guidance next year include or exclude the 100 million from Verisign? Q: Perfect. Wasn't clear on that. Second we've seen some deceleration in the U.K. in our own listing accounts and I was wonder if you could comment on that more specifically, and whether you could portend a similar sort of deceleration in Southern Germany, put your thoughts there, and then finally, just on Skype, my understanding is that you do not have paper call capability today. Would you have a preference to buy or build that as you try to build out that functionality next year? Thanks. A - Meg Whitman: So, let me take the question with regard to the U.K. You know, one of the interesting things is that obviously growth remains very strong, but we are a learning organization and the lessons that have been learned in the U.S. and Germany are already being applied to the U.K. And we have I think the best ever sort of cross-functional and cross-business unit teams that we've ever had. So rest assured that the learningâs from the U.K. and Germany are rapidly being applied to the U.K., so we hope you know, we hope to mitigate what would obviously be a more natural decline in that marketplace. With regard to pay per call, our instinct is to build that functional inhouse. You know, we have some plans under way in that regard. And so that will be part of the Skype effort over the next bit of time. Q: Is that included in the 200-million revenue next year? Or is it going to be a longer-term development than that? A - Rajiv Dutta: It would be 200 million largely in Skype revenues and there is a very small component of pay per call. We see there as a longer term buildout, which is particular as that reflects the revenues. Q: Thank you very much. First of all Rajiv Dutta congratulations. Well deserved. My questions really revolve around the holiday season and the sort of business trends that you see coming into the third quarter. First, Meg, I was wondering if you could comment specifically on what you do differently this year going into the holiday season based on lessons learned from last year? And then if you could incorporate into that any benefits from integrating the structured search technology from shopping.com, where are you in that process? And then Rajiv, the second question relates to the sequential growth. I think if I back out all the anomalies of acquisition, etc, the original fourth quarter versus third quarter growth rate was around 13 to 14% in your old guidance and now it looks like to be around 9 to 10% which seems very conservative to me, U.S. accelerated and Germany accelerated and what is going on with PayPal so I was wondering if something is going on differently or if you're being conservative and I figured I would give you a hard time since this is probably your last time doing this. Thanks. A - Meg Whitman: Good for you, Anthony. Let me talk a word bit about what we have planned of the holidays for a couple of our biggest markets. Let me start with the United States. We are really excited about the new brand campaign. It is a fully integrated marketing campaign that covers TV, print, Internet marketing, direct marking, and on-site. And simply put, we want people to check eBay first no matter what you're looking for and the message is reinforced in the official tag line, whatever it is, you can get it on eBay. And the ads break tomorrow, or the next day, and you can actually go to the Investor Relations section of the eBay Web site and see the ads right now before they actually go live. And we're really pretty excited about it. I think it is a more inclusive message than last year. There is more of a call to action than there was last year. So we're pretty excited about it. With regard to Germany, they are also embarking on an integrated marketing campaign that will in fact include it will be the third year of 321 nines, and we're really excited about it. I think that they're off to a very good start there, and again, build on the leadership position in Germany. The U.K. also has a great holiday campaign under way. They had very good results this year. They've got a great marketing team there. So we have good deal of confidence there. And actually, a fun one is going to be in China. We are actually going on television, in print, outdoor, and in a major marketing push for China in Q4. The commercials go live in seven days. And we're really looking forward to a great holiday season in China. So I think we've got it right this year. The proof will be in the pudding. But we feel real good about the campaigns in our four largest markets. A - Rajiv Dutta: And Anthony, with respect to the second follow-up question, I appreciate the consistency of the question. So I would say that, you know, when you look at the Q4, this is a very robust year-over-year growth. You know, and we are excited about the momentum in the business. And you know, what I would say to you is the same thing I've said before, which is this is a transparent business. Are you going to view how it progresses, just as we do, and as we look out on Q4, from this vantage point, we are expecting a strong Q4, which is reflected in our guidance. A - Meg Whitman: Anthony, I forgot your question about shopping.com. Whether eBay will benefit directly this holiday shopping season from the catalog capabilities since shopping.com. As you know before we bought shopping .com, we were improving the find ability on eBay around the world and that will continue, I think the find ability will be the best ever in Q4. There was some value add from shopping.com technology, but you recall it only closed on August 30. So we will not see the full benefit of that. Separately, we expect shopping.com to have a good holiday season as well. So I think that was the answer to your shopping.com question. Q: Great. Thank you. I was wondering, with the introduction of reserve pricing, and the auto business in Germany, back in May, have you seen any reaction there, in that business, since the introduction there? And also, if you could just talk a little bit, Rajiv Dutta, you may have said this during the numbers, but can you talk about to what level the acquisitions contributed in Q3 and so are you looking at this on a year-over-year basis, trying to get to kind of an organic number, is there a way to get to that? A - Meg Whitman: So let me answer the question about Germany autos. Reserve pricing absolutely had the desired effect in the German auto business. Before reserve pricing we saw a very low average selling price for used cars, and that has continued to actually improve because people can now set a floor by which they don't want to sell below, so that was completely the right strategic move. The other really fun thing about the auto business in Germany is the synergy between mobile DE and the eBay Germany motors business, that has been really a really nice synergy. Today, when you go on mobile, if you don't find what you're looking for, you see Germany, eBay Germany auto listings and vice versa, as a result the conversion rate is up and the GMV rate is up in the autos business. I think there is a lot more running room in autos in Germany. It was an under penetrated under exploited category that I think findings, of unlocking the secret sauce there. So I think you can look for continued growth in the German auto business, in the auction format as well as the classified format. A - Rajiv Dutta: And with respect to the second part of your question and let me answer both piece, for Germany, there really is no acquisition in the year-ago comparison that would impact the year on year growth rates because mobile as you recall was a quiet Q2 of 2004, so when you look at the numbers, you know that business accelerated on an organic basis. And again, to reiterate a point I made earlier, this is volume acceleration. This is primarily driven by listings. Many of the other metrics, the fundamental metrics improved very strongly, but the primary driver has been volume, both the U.S. and Germany. And with respect to sort of eBay overall, in my prepared remarks, that actually talked about excluding the acquisitions from the year-over-year comparison, and the acquisitions that fall under the sort of less than 12-month sort of mark are market plus in the Netherlands, rent .com and shopping.com. And if you exclude all of these, year-over-year growth on an overall eBay basis, with 33%. Q: A question about PayPal. You took a more conservative effort to managing the business last December, you focused more on eBay or PayPal off of eBay, Meg, you talked a little bit about some of the wins of eBay vendors you had this quarter. Can you give us a sense of how we should think about the PayPal milestones for the next three, six, nine months? How we should think about more large vendors coming on as PayPal customers, how we should think about the growth in digital content? Thanks. A - Meg Whitman: So you're right, we actually put a concerted effort against the merchant services business. You remember year one after acquisition with eBay .com and eBay international and 2005 was our first year of really focused effort around merchant services. So we're pleased with the results. We have targeted, you know, the top merchants on the net to go after. Some of these sales cycles are quite long, so we are well in process with many, many of these very large merchants. The next milestone will be obviously, we want to get more than our fair share of those. The next thing we've got to do is of course integrate Verisign. The key aspect of the Verisign payment gateway business is to capture all of these thousands of merchants and make sure that they have an opportunity to purchase the entire suite of payments products from PayPal. It is still going to be a small business focus with them but as I said, we're still also focused on the large merchants. Digital still needs to emerge. We are, you know, ready with payments, we are talking to a number of different players in the marketplace, and we are all over it. We do have a very nice micro payment solve that is ready to be brought to market. Q: Good afternoon. A couple of questions, Meg, you talked about some impressive wins, new merchant wins on the PayPal platform, could you give us a sense of the adoption rate of PayPal as a payment mechanism among those merchants? You seem to have some new data now. And second, could you talk about some time lines that we should be considering over the next 12 to 24 months in which we could see integration of shopping .com, rent .com, and Pay-Per-Call from Skype, within the eBay platform? Thanks. A - Meg Whitman: Sure. Let me talk about the adoption rate. Usually in the first, you know, three to six months when we go live with a site like pet co or pet smart or the ones I mentioned, you will see anywhere from a 3 to 8% penetration in terms of the number of payments that go through PayPal in a merchant like that. And then in the second year, we don't have a lot of experience yet in the second year you begin to see that pick up. Obviously, when we are the sole source provider for on SMV, 100% goes through PayPal. So that is usually the starting point, the 3 to 8% penetration rate. A - Rajiv Dutta: With respect to your question of shopping, rent and now Skype in terms of the Pay-Per-Call, you know this is these acquisitions, particularly shopping has just closed. Skype has closed literally two days ago. So work is continuing as we speak. You know, we will be absolutely working on shopping .com and the way we are going to look at this is what are quick things that we can do and try to get them done as soon as possible. You know, things like Pay-Per-Call will take more time. Pay-Per-Call is something that we had indicated when we acquired Skype. It is something that will be built out over the next several quarters, and so, you know, sometime next year is when you should start seeing some of that rollout. Q: Thank you. Just a couple of questions. First, can you tell us how much was the organic growth, if any, was in the international revenue? And then looking at the PayPal metrics for I guess transaction loss rate, you know, it seems to me as those kind of move back to a normal rate from abnormally low last quarter, but I'm wondering if you think this is an appropriate rate to use for modeling going forward? A - Rajiv Dutta: Let me give you a little bit of input to both of those. So I think with regards to your first question, as far as the international business is going, yes, it is growing very fast and it is absolutely contributing to the overall growth rate of the business, but then so is PayPal, and so is the U.S. business. So if you look at the overall organic growth rate in the business, which as I pointed out is about 33% in response to an earlier question, you know, the sort of main components of this business are the marketplace business, including the U.S., which by the way is the single largest marketplace business that we have, followed closely by Germany. You know, between the U.S. and Germany, these are the two largest businesses in the marketplace. PayPal is a very big component of that, and obviously the largest business that PayPal has is in fact the U.S. business, and then third is the international. So each of them contributing, all of them growing very, very well. A - Meg Whitman: And I would actually say the organic growth rate for international as a percentage of the total is actually higher, because virtually none of the acquisitions were international in nature this year. Each net is over a year old so that would be included in the international that would be included in the organic growth rate. Shopping.com is largely domestic, rent .com is largely domestic, so virtually all of the international growth was organic. A - Rajiv Dutta: Yes. And with respect to the loss rate at PayPal, you know, what we mentioned the last time is, you know, PayPal is really very, very advanced in its fraud capability, in terms of its modeling and its understanding. And frankly, prevention of that behavior, which results in loss reserve and so that number has been coming down pretty significantly. And in June, we had seen, as you correctly pointed out, very low rate of the loss reserves that we had accrued for. In Q3, what we had pointed out last quarter is that we were substantially upping the purchase protection that we were offering. Not just in the United States but also in other places such as Germany, and so part of what has what you see over here is in fact the effect of that increased purchase protection that we're now offering, you know, to our buyers in multiple sites around the world. A - Meg Whitman: And I think the other thing to know about that loss rate, Steve, is while we want to keep that number, you know, down low, there is the objective is not to drive it to zero, because if you drive it to zero, you actually drive trial away from PayPal. So it is a finely tuned number that moves with decisions we make about buyer protection and about the number of new users and the ease with which they can get a PayPal account. So I think this is probably a decent number to model going forward, but I will tell you could be up or down based on what we decide to do around the screens of letting people in, and the buyer protection levels that we deploy in countries around the world. Q: Yes, hi, a couple of questions. First, I was wondering if you could talk, what is your foreign country impact sequentially and eBay international business, and secondly, I was wondering, Meg, if you could talk about a couple of concerns that investors have in terms of Skype acquisitions that your planned revenue per minute will decline, and as the number of _____ users in Skype increases, it will decrease usage level. So I was wondering if those are true, if that is true, how do you try to drive the revenue growth, and if it is not true, why do you think it is not true? Thanks. A - Rajiv Dutta: So let me take the foreign country impact first. We have actually you know, this is a number that we keep a close eye on. On a year-over-year basis, foreign countries really didn't have much of an effect this time around. But on a foreign country basis, if you look it, for sequentially, it impacted our revenues by 15.5 million, on the revenue line, it negatively impacted us. And on the bottom line, it impacted us by about $10 million. A - Meg Whitman: With regard to Skype, let me make a couple of comments. One is, it is very clear that voice communications is moving on to the Internet. And the marginal cost of voice transmission of the Internet actually is zero, which I believe means that in the end, the price that anyone can provide for voice transmission on the net will trend towards zero. Now, by the way I don't think that is going to happen in the next year or two years or even three years, but I do believe that your statement that actually the revenue per minute will go down over time. And of course, as the P to P usage, Skype users to Skype users go up, the percentage of users that you can actually charge for will actually go down so I actually agree with that and we understood that when we looked at Skype. Our belief is that the winner in this space will be those that have the largest ecosystem, and what I mean by that is, the largest number of registered users, the largest number of voice minutes, the largest number of developers who develop against the platform, the best product, and the best array of value-added services that users of a certain network are willing and want to pay for. And we think that this that the way ultimately four or five, six years from now, maybe it will be a little sooner is, that the value-added services will be the way that Skype and many other of these providers are monetized. And we think we have a huge lead in that regard. One of the things we understand now better than ever is how far ahead Skype is in users, in usage minutes, and in the product capability that Skype brings to market, and the size of the ecosystem. The hardware ecosystem, the developer ecosystem, the build out of the APIs. So we subscribe to your thesis. I don't think it is this year or next year, but I believe the ultimate monetization method of voice communications on the net changes from a revenue per minute to, you know, based on the size of the ecosystem. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234059 | Welcome to Gen-Probe's First Quarter 2006 Earnings Conference Call. At this time all participants are in a listen-only mode. Operator Instructions. Now, I will turn the meeting over to Mr. Mike Watts. Sir, you may begin. Thank you Rosie and good afternoon everyone. On behalf of Hank Nordhoff, Gen-Probe's Chairman, President and CEO; and Herm Rosenman, our Vice President of Finance and CFO, as well as the rest of the Gen-Probe team, I am pleased to welcome you to this conference call to discuss our first quarter 2006 financial results. The press release announcing our results was issued today just after 4 P.M. Eastern Time, if you haven't seen it, it's posted on our website at http://www.gen-probe.com/. In our call today, Hank will first provide an overview of our top-line performance in the quarter and discuss progress we've made on future growth drivers. Herm will then review our detailed results and updated 2006 guidance, then we will take your questions. Before we begin, let me first review our Safe Harbor policy. Forward-looking guidance, financial or otherwise is only provided on conference calls or in our press releases. Any statements in this conference call about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. These statements are often but not always made by the use of words and phrases such as âbelieveâ, âwillâ, âexpectâ, âanticipateâ, âestimateâ, âintendâ, âplanâ and âwouldâ. For example, statements concerning 2006 financial guidance, financial conditions, regulatory approvals and timelines, possible or assumed future results of operations, growth opportunities, industry rankings, plans and objectives of management are all forward-looking statements. Forward-looking statements are not guarantees of performance, they involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied. Factors that might cause such differences include but are not limited to those discussed in our SEC filings including our report on Form 10-K for the year ended December 31, 2005, as well as all subsequent periodic reports. Copies are available on our website at http://www.sec.gov/ and on request from our IR department. Gen-Probe assumes no obligation and expressly disclaims any duty to update any forward-looking statements reflect events or circumstances after the date of this call or to reflect the occurrence of unanticipated events. With that administrative detail out of the way, I will turn the call over to Hank Nordhoff, Gen-Probe's CEO. Thank you Mike, and good afternoon everyone. As described in our press release, Gen-Probe is off to a strong start in 2006 with a very solid first quarter that once again established a new record for product sales. At the same time, we made important progress on certain short, medium and long term growth drivers. For example, we executed our blood screening regulatory strategy well by submitting an amended EOA for the PROCLEIX ULTRIO assay and a Form 10-K to use of TIGRIS system to screen blood for West Nile virus. We made excellent development progress in our industrial collaborations with GE and Millipore as well as in our prostate cancer and HPV programs. Since we talked a paramount of our blood screening and industrial initiatives last quarter, I would like to focus more on prostate cancer and HPV today. But first let me review our top-line results for the first quarter. Product sales were 78.5 million in the quarter, 32% higher than last year. This extends an impressive track record of consistent organic growth. Of the 15 quarters since our spin-off, this is the 14th time we have established a new sequential record in product sales. The strong growth in product sales help drive total revenues in the first quarter to $86.3 million, up 25% compared to last year. Our first quarter results illustrate that Gen-Probe is not only growing but also growing profitably. Excluding the effects of share-based compensation under FAS 123R., non-GAAP earnings per share were $0.33, an increase of 27% versus the first quarter of 2005. Even on a GAAP basis earnings per share were $0.27 in the first quarter, up slightly versus the prior year period despite the added compensation charge. If we dig a bit deeper into the performance of our base businesses of clinical diagnostics and blood screening, our first quarter results demonstrate that the fundamentals of both are strong and vibrant. Clinical diagnostic sales established a new record of $40.2 million in the first quarter of 2006, up 18% compared to the prior year period. And what has become a familiar and pleasing trend clinical diagnostic sales once again benefited from market share gains of APTIMA Combo 2, our amplified assay that simultaneously detects chlamydia and gonorrhea both on our semi-automated equipment and on our TIGRIS system. PACE, our non-amplified tests for chlamydia and gonorrhea declined by about 13% versus the prior year period as expected to actually increase slightly on a sequential basis compared to the fourth quarter of 2005. This continues to demonstrate that much of the APTIMA adoption on TIGRIS is coming not from the cannibalization of PACE but rather from competitive market share gains. It's worth mentioning however that we view the sequential uptick in PACE as a temporary increase that was driven in part by favorable ordering patterns that we do not expect to recur this year. Similarly, even our non-STD diagnostics business, which historically has been relatively flat showed exceptional growth in the first quarter to its highest level in recent memory. While this increase was obviously a nice surprise, we believe it was a one-time event due primarily to the timing of some large orders and not to an enduring increase in underlying demand. Now, let me move on to blood screening. First quarter sales were $38.4 million, a healthy increase of 51% versus the prior year period. Blood screening sales benefited from three main factors. First, sales of our PROCLEIX ULTRIO assay, which simultaneously detects HIV, hepatitis C, and hepatitis B continue to grow outside the United States. Second, and obviously connected to the full factor we had our biggest quarter ever in terms of TIGRIS related sales to Chiron with $5.3 million of TIGRIS unit sales and spare parts. As you know under our contract with Chiron, we sell TIGRIS instruments to our partner at cost. TIGRIS sales therefore diminish our gross profit margin in the quarter when they occur but are a necessary precursor to higher margin assay sales. As a side note, I should mention that we expect Chiron to be buying their spare parts directly from our third-party supplier in the second half of the year mainly for ease of administration and logistics. While this will reduce our top-line slightly, it will have minimal effect on profits given the way our contract with Chiron is structured. The third factor that benefited blood screening sales in the first quarter is equally important. Following FDA approval in December, we began shipping commercial supplies of our West Nile virus assay to Chiron in March. As a reminder, we reported blood screening revenue in two trenches. First, when we ship assays to Chiron, and second, when the product is actually used to screen blood. We record the first portion of revenue based on a contractual transfer price and a second portion at the eventual commercial price, which includes more margin. So, the $3.7 million of West Nile revenue that we mentioned in our press release represents our initial shipment revenue to Chiron, say to another way, this revenue is Chiron's initial stocking order of commercial products which is mainly because assays that were shipped as investigational before approval cannot be used (inaudible). As a side note, I should also mention that commercial West Nile testing also began in April, so we should begin to see a small amount of what we call true-up revenue trickle into our income statement around the end of the second quarter since we record this revenue two months after Chiron does. Let me remind you however that in the second quarter and beyond, we will continue to collect cost recovery revenue on West Nile testing done on the TIGRIS until TIGRIS is cleared for marketing by the FDA. Even though the FDA has granted our request for a higher cost recovery price, let me caution you that we will still likely record far less West Nile product sales in the second quarter than we did in the first. This is because of $3.7 million that we recorded in the first quarter was essentially pulled forward from the second, at least relative to most street expectations. To wrap up my discussion on the top-line, we are very pleased with the performance of our key product franchises in the quarter, and we believe we are on track to meet our goals for the year. Now, let me give you an update on the progress we are making in the two lead programs of our oncology initiative: prostate cancer and human papillomavirus, both of which have us excited about the future. Much has transpired in the past few months in our prostate cancer program. Our market development partner: Molecular Profiling, has independently validated our Analyte Specific Reagents or ASRs for PCA3 and we expect them to begin commercial testing this quarter resulting in a very small amount of revenue to Gen-Probe. We believe the ASR and related efforts of our lab partners will play an important role in indicating the marketplace especially urologist about the role our innovative assay can play in prostate cancer diagnosis. In addition, we began our European market development efforts for PCA3 by presenting updated research at the April meeting of the European Association of Urology in Paris. We notice that attendees showed a high level of interests in our data, which confirmed the promise shown in earlier studies. Specifically, in more than 200 men who had at least one previous negative biopsy, our investigational PCA3 assay showed specificity of 74% versus only 17% for PSA. In other words, our test had significant value in a patient population where PSA has poor utility. While we remain optimistic about the potential of PCA3, we have always said that we intended to move aggressively to gain access to other markers that would help us build a true franchise in prostate cancer. Our previous deals with Corixa and the Center for Prostate Disease Research are a reflection of this strategy. And just yesterday we announced another collaboration that we think represents a major advance for the company. We have license from the University of Michigan the exclusive worldwide rights to develop assays based on newly discovered genetic translocations that are highly specific for prostate cancer. Translocations, which have been implicated in other blood born cancers like chronic myelogenous leukemia, our fusions have two sections of DNA in an abnormal fashion. As for Michigan researchers published a paper in the prestigious peer-review Journal Science, which showed that 23 of 29 prostate tumors contain the translocations. Perhaps more importantly researchers at four laboratories have since studied about 300 samples, have yet to find the translocations in healthy tissue. They strongly suggest that if you have the translocations, you have prostate cancer. In other words, the provocative working hypothesis is that these translocations could be a prostate cancer. Given these early findings we are excited about using our core technologies to develop a molecular test for the translocations. At the same time, we recognize that these particular translocations are not found in all prostate cancers. This has two important implications. First, we will be funding research at Michigan over the next few years that we hope results in the discovery of additional translocations that could increase the sensitivity of our assays. And second, we believe that testing for PCA3 or other markers in addition to the translocations could significantly increase clinical sensitivity and specificity. This is consistent with our long held belief that in the future, the accuracy of cancer diagnosis will be maximized by detecting a panel of biomarkers. So, all in all, we are very pleased with the steady maturation of our prostate cancer initiatives. We believe our pipeline especially with the addition of the Michigan collaboration is one of the most robust in the field of prostate cancer diagnostics. Now, let me give you a brief update on the development project we have not yet talked much about our HPV program. As you probably know, persistent infection with high risk subtypes of HPV can cause cervical cancer. Our HPV program is picking up speed on a number of fronts. We are very close to finalizing the formulation for assay, which can be run from liquid Pap specimens on the TIGRIS system or on a semi-automated platform. We have designed our assay to target messenger RNA from the E6 and E7 genes of 14 high risk HPV subtypes. These are known oncogenes that have been shown to contribute directly to HPV progression. We presented data on our prototype assays for the first time at the just completed Urology meeting in Paris. We demonstrated very good analytical sensitivity and specificity as well as very competitive clinical sensitivity and specificity versus the only HPV test approved in the United States. I should point out however that these clinical data were generated from less than 400 samples. We are making plans now for additional larger studies and at the same time, we are beginning to develop our manufacturing protocols and processes. To support this effort, we expect to make our next purchase of oligonucleotides from Roche in the third quarter. As you may recall, under our supply and purchase agreement, we buy these oligos from Roche then incorporate them into an APTIMA format assays. Next, oligo purchase will therefore contribute to a significant increase in our R&D spending in the third quarter. HPV will also be a significant driver of R&D spending in 2007, keeping the percentage of revenue that we spend on R&D relatively flat. So, while we are still early in the game on HPV, we believe we are making good progress and remain enthusiastic about the ultimate opportunity. We believe a highly accurate APTIMA HPV test using liquid Pap samples on the fully automated TIGRIS system will represent a winning value proposition especially when coupled with our already strong STD franchise. Before I turn the call over to Herm, let me summarize by saying that we are very pleased with our first quarter performance. We executed well in our base business and clinical diagnostics and blood screening, resulting in record product sales. At the same time, we took important steps to advance and even add to our rich pipeline of oncology projects. With that preface, Herm will review our first quarter results and updated guidance in more detail. Thank you Hank, and good afternoon everyone. As described in our press release, Gen-Probe had a strong first quarter. Product sales improved remarkably over the same period in 2005 and also increased on a sequential basis, establishing a new quarterly record. And total revenues and earnings per share grew solidly as well. Hank already covered the dynamics of product sales. Let me start by discussing collaborative research revenues which were $6.9 million for the first quarter of 2006, an increase of 10% compared to the prior year period. This increase resulted primarily from reimbursement from Millipore for certain development expenses in our industrial business. The largest component of collaborative research revenues in the first quarter like in recent periods was cost recovery revenue associated with use of our West Nile virus assay under IND, which totaled $4.5 million. While our West Nile assay is now approved on the eSAS system, we expect to continue receiving cost recovery pricing for those tests going on the TIGRIS system until that platform is cleared for this assay by the FDA's Center for Biologics Evaluation and Research. Along these lines, the higher cost recovery price that Hank mentioned is likely to begin hitting our income around mid-year. Royalty and license revenues were 800,000 in the first quarter, much lower than in the prior year period, in which we recorded license revenue from bioMerieux based on their exercising an option to pursue certain disease targets using our patented technologies. For the next two quarters, we expect royalty and license revenue to remain fairly flat before potentially increasing in the fourth quarter based on bioMerieux next and final option exercise. The amount of revenue we recognize will depend on how many targets bioMerieux intends to explore. Now, let me turn to gross margin on product sales, which was 67% in the first quarter of 2006, both on a GAAP and a non-GAAP basis compared to 74% in the prior year period. The gross margin percentage was once again negatively affected by the sale of TIGRIS instruments and spare parts to Chiron, which totaled a record $5.3 million. As Hank mentioned, we expect Chiron to begin buying spare parts directly from KMC in the second half of the year, mainly for administrative convenience. Based on our recent run rate, we expect this will reduce quarterly product sales by $1.5 million to $2 million but will have no affect on profits since we sell spares essentially at cost today. The margin percentage was also negatively affected by shipments of blood screening products primarily our West Nile virus assay at transfer prices. As reflected in our updated guidance, we expect our gross profit margin percentage to improve in the second half of 2006 as commercial pricing for West Nile and increased operational leverage outweigh the negative effects of TIGRIS instrument sales and increased share-based compensation charges. Research and development expenses for the first quarter of 2006 were 19.3 million on a GAAP basis and 17.4 million on a non-GAAP basis compared to 18.7 million in the prior year period. Obviously, share-based compensation added approximately 1.9 million to R&D spending. On a non-GAAP basis, R&D expenses were less than the prior year period due to the timing of development lot production and due to clinical trial and regulatory expenses associated with our investigation of blood screening products last year. Based on how we now see projects unfolding throughout 2006, we do anticipate a fair amount of lumpiness in R&D spending this year. Specifically, we expect R&D to increase in the second quarter based in part on a $500,000 upfront payment associated with the Michigan prostate cancer deal, as well as the timing of several other projects. We then foresee R&D spending peaking in the third quarter based primarily on the next purchase of HPV oligos, which Hank discussed. Marketing and sales expenses for the first quarter of 2006 were 8.9 million on a GAAP basis and 8.1 million on a non-GAAP basis compared to 7.4 million in the prior year period. Share-based compensation therefore added about 800,000 to marketing and sales expenses. On a non-GAAP basis, marketing and sales expenses increased versus the prior year period based on costs associated with the continued rollout of the TIGRIS instrument and assessing new markets such as prostate cancer, HPV and others. General and administrative expenses for the first quarter of 2006 were 10.7 million on a GAAP basis and 8.8 million on a non-GAAP basis, compared to 7.2 million in the prior year period. Share-based compensation added 1.9 million to G&A expenses. On a non-GAAP basis G&A costs increased based primarily on a higher legal costs associated with the company's two patent infringement lawsuits against Bayer. All this nets out to first quarter fully diluted earnings per share of $0.27 on a GAAP basis and $0.33 on a non-GAAP basis compared to $0.26 in the prior year period. All in all, we had another strong quarter marked by impressive profitable growth. Now, let me turn to our updated 2006 guidance. As we said, our first quarter financials have us off to an excellent start in 2006. We are raising our guidance for total revenues and now expect total revenues of $335 million to $340 million this year, based on continued growth in both clinical diagnostics and blood screening product sales led by the APTIMA Combo 2 and PROCLEIX ULTRIO assay. Total revenues are expected to decline sequentially in the second quarter primarily because we recorded our first big tranche of West Nile virus revenues in the first quarter. Our total revenue guidance includes collaborative research revenues of $14 million to $15 million, and royalty and license revenue of $7 million to $8 million. Collaborative research revenues are expected to decline slightly on a sequential basis in the second quarter before falling off more significantly in the second half of the year as blood centers transition to commercial pricing on the eSAS system. Royalty and license revenues are expected to peak in the fourth quarter. Turning to product gross margins, we expect them to be between 68% and 70% of product sales on a GAAP basis, or between 70% and 71% on a non-GAAP basis. We anticipate R&D expenses of between 25% and 26% of total revenues on a GAAP basis, or between 23% and 24% of revenues on a non-GAAP basis. As previously discussed, we anticipate R&D expenses to increase sequentially in the second quarter based on the Michigan deal and other factors and peak in the third quarter based primarily on the timing of key projects such as HPV. We expect marketing and sales expenses to range from 10% to 11% of total revenues on a GAAP basis or from 9% to 10% on a non-GAAP basis. Finally, we anticipate G&A expenses of 12% to 13% of revenues on a GAAP basis or 9% to 10% on a non-GAAP basis. All this leads us to increase our earnings per share guidance to between $0.98 and $1.08 on a fully diluted GAAP basis while our non-GAAP guidance remains $1.30 to $1.35. Most of the increase in our GAAP guidance therefore results from a reduction in the anticipated expense under FAS 123R. Specifically, we now expect share-based compensation charges to be between $0.27 and $0.32 per share, which implies that these charges will increase from first quarter levels throughout the year especially in cost of goods sold. In terms of quarterly earnings per share, it's likely that earnings would decline on a sequential basis in the second quarter based primarily on the West Nile revenue that we recorded in the first quarter, and on a higher R&D expenses. Our earnings per share guidance for 2006 is based on a fully diluted share count of 53.5 million for the year and a tax rate of approximately 37% on a GAAP and non-GAAP basis. We expect our GAAP tax rate to be higher than our previous guidance principally due to an increase in taxable interest income. So, in summary Gen-Probe is off to a good start in 2006 with continued strength in clinical diagnostics and blood screening product sales, enabling us to invest heavily in future growth opportunities. We are adjusting our full year guidance including raising our forecasts for GAAP earnings per share and total revenues. This concludes the financial section of our conference call, which I will now turn back over to Mike. Thanks, Herm. We are happy to take your questions now. For Q&A, we are joined by Bill Bowen, Vice President and General Counsel; Glen Freiberg, Vice President of Regulatory Quality and Government Affairs; Dane Kacian, Executive Vice President and Chief Scientist; Steve Kondor, Vice President of Sales and marketing; Lynda Merrill, Vice President of Investor Relationships; and Harry Rittenhouse, Senior Director of Cancer Research. Larry Mimms is our Executive Vice President of R&D is offsite today and on the call. In order to ensure broad participation in the Q&A session please be courteous and limit your questions to one plus a follow-up, then jump back into the queue. Operator, we are ready to take the first question. Hi, thanks very much. I had a question about the increase in the revenue guidance, just on so that we understand here with the loss in the spare parts sales, should we think about it in net increase here more in the $8 million to $10 million range? And if so where is that coming from, is that a change in your outlook on clinical diagnostics or blood testing? And is that related to equipment sales for blood testing? Well, you got several parts here Tom, this is Herm hi. It's kind of all the above, we've got continued strength in APTIMA Combo 2, both on TIGRIS and on eSAS, we've had development in West Nile virus with increased cost recovery pricing, which is positive. We see continued strength in ULTRIO and we see continued sales of the TIGRIS instrument. Yeah, thanks, good afternoon. Just a follow-up on Thomasâs question, I guess just kind of thinking about the increase of revenue guidance, obviously no change to the bottom line, I guess we would think that that's presumably the increase in the top-line can be weighed towards lower margin products, say TIGRIS sales, Chiron, I guess, is there something else that from an expense side of things guys that we are missing here, had you not been planning on purchasing the Oligos from Roche and thatâs kind of offsetting some incremental profitability that would have come from increased revenue guidance, can you just help us think a little bit about that? I think the West Nile shipment in the first quarter has a lot to do with it, in escorting out the shipment revenue. So that in and of itself is roughly very good margin there. Okay from the sounds of it, from the expense side of things, things haven't changed, it's just that the increase in the revenue guidance is going to be more geared toward lower margin products? Bill, we also have a point in the one point difference in taxes, right? And that's primarily a shift in our portfolio from almost essentially all non-taxable instruments to taxable quite a bit of taxable instruments as well as now focusing on the effects of the R&D tax credit, which weâre not taking into account the reinstatement is at just yet. So, presumably if that gets reinstated, Herm we could see the tax rate see a catch-up adjustment perhaps in the third quarter? Good afternoon, couple of quick questions here. And this first one doesn't count against me if you want to answer it so I canât hold against â but any increased color on the pricing for West Nile given that we are about a month or two away from commercialization? David, we can definitely hold that against you. You got Mike standing up and leaning over the table before the speaker. Okay, how about couple of another question. In terms of this mix between what's going to be run on TIGRIS versus what's not going to be run on TIGRIS, can you give us a sense just very broadly how that would track into the second, third and fourth quarter? Are we talking about a 50-50 mix, are we talking about a 75-25 mix? Is it going to be very customer driven? I think it varies during the year but I think it's probably going to be about 30, maybe a third on TIGRIS, it's just a rough estimate. Okay. Perfect. And then a little bit of kind of strategic question, now that your APTIMA and base businesses are doing better than expected, given the increasing HPV vaccine marketing, a lot of Pap smear direct-to-consumer marketing, are any of your lot customers reporting that they are expecting a slight increase in Pap testing and maybe downstream gonorrhea and chlamydia testing because of the aggressive expense we've been seeing in the last six weeks? Yeah, we do expect the - we are seeing in fact with the launch of the LTT claim, we are seeing an increase in chlamydia testing, we are seeing that STD market growing as a consequence of that. HPV will only bolster that opportunity again for more STD testing coming out of the same path essentially. Okay then last quick question, then I will be back in the queue. Just on the collaborative research the Millipore came in this quarter, should we consider that to be constant payments throughout the year or was that more one-time in nature up in the collaborative research? Yeah, I think, David, you can consider it pretty much constant payments. We haven't disclosed the amount and it's not necessarily going to be the same amount each quarter. Yeah, but there will be consistent payments in collaborative research from Millipore somewhat offsetting the West Nile losses in the back half part of the year but probably not really offsetting it because of the magnitude of West Nile? Just wanted to ask about the conversionary APTIMA combo 2, where that's been in the U.S. and internationally, and what your targets are for the full year, just an update? Lee, this is Steve Kondor, about a third of our growth is coming from existing APTIMA combo 2 customers, about a third from phase conversions, and about a third from consider the takeaways and we expect the phase declines to be on the order of 12% to 15% for the year. To phase down 12 to 15 but as a percentage of total sales -- put better way the inverse of that, the present conversion to APTIMA combo 2, again, can you give me a rough estimate for that, that target for yearend? Super, and then similarly, could you give me where you are with the ULTRIO in terms of the international conversion and if you are going to reiterate the target for the full year conversion? They said last they were about at 60%, it's a little over that now but Iâll say just a little plus 60%. Okay and then lastly the percentage of stock comps flowing into COGS, that is to say when you take the gross up and net income impact to the operating impact and then allocate that stock compensation among COGS, R&D and SG&A, it was only about 3% here. I assume that's because of your comments that's going to increase, it was 2.8%, to be precise. But what percentage of that is or where do you see that percentage going, I guess, for the remainder of the year? As you know we didn't say but you're right, the percentage that was capitalized into inventory in the first quarter far exceeds the amount that went into COGS. Exactly. And why was that so low? I mean I was expecting something at least five times that magnitude in terms of the allocation. Because of the production. Just because of the number of units produced allocating what would have gone into the first quarter, of course all the other expense lines get 100% but that particular one based on production, a vast majority went into inventory. And that's why we made the statement and in future quarters, it will go up. Okay and one last question, I apologize, just I realize that you're not going to sell TIGRIS and spare parts beginning in the second half but is there an assumption for the first half total sales? Both spare parts/TIGRIS, so in aggregate the number if you would add what you did in Q1 here which I think was 5.3 million, what are you looking for the full first half before it switches to going to a third party? Weâve said before we won't tell you the exact numbers on the TIGRIS instruments because it's not a real good indication of how we are doing but Herm I think can give you some color on the spare parts. The quarterly guidance we gave on this call and the script and the press release so we really don't go further than that, Lee. Okay, I am sorry, I must have just missed it then, I'm not asking to split it out but in addition to the 5.3 that you put in the press release in Q1, are you looking for something similar to that, I guess, in Q2, put it another way? Lee, this is Mike, just to clarify a little bit, the 5.3 number was an aggregate number, we didn't break out what the spare parts number was in this particular quarter but as you know it's been in the neighborhood of 1.5 million to 2 million per quarter. And for further clarification what we intend starting in the second half is for Chiron to purchase their spare parts only direct from KMC. We will continue to have the TIGRIS instruments pass through our P&L if you will albeit at no margin. No, we did not. If you are talking about the virtual warehouse, what we did is we just booked the international shipments through and all domestic revenue that was in the virtual warehouse which was contained in the deferred revenue account happened at the end of the year. And then just so I'm clear on the West Nile Virus in the quarter, the 3.7 million, is that, I mean is it fair for us to assume that that is basically a, I guess a quarterâs worth of stocking or is that not a fair assumption? Okay. And then, I want to be clear on what I think I heard you say, in terms of the REO inventory, I mean, you guys are going to basically eat through that, arenât you thereâs not a write-down that's going to happen there, is there? Okay. I wasn't clear on that, and then lastly, I know we all want to know, I guess some sort of color on the strength on the clinical side, you guys are still booking some Hep C in that business, are you? Are there revenues associated with the Hep C test on the clinical side or is that all â or that's not in the numbers? Okay. And, when you think about APTIMA and I guess trying to get a sense for CTGC sales and conversions and what not, do you know currently, I think I probably asked this question before but looking at the whole business, how much of the revenue stream on the STD side, do you think is coming out of the vile, if you will, today? Bruce, this is Steve Kondor. That is a very difficult answer to give. It's really because we, the LPT transport not really generate the revenue, so, it's difficult for us to track through our customers how much of the APTIMA increase comes directly as a result of the LPT. Well, I think as weâve said in the past we are not going to give updates on specific customers any longer however, I'd say that Quest is an important customer for us, not only on the STD side but as well on the non-STD side of our business. And they are going to continue to be a important customer for us and we have a very good relationship with them. Thanks for taking my questions. Just couple of quick questions. On the clinical diagnostic side, you mentioned that about those of you APTIMA revenue is due to the share, taking share away from your competitors, I'm just curious kind of how we should think about that trend over time, is it accelerating, is it steadily growing, how could you describe that right now? Well, I would say we are quiet pleased with the results thus far regarding our growth from APTIMA coming from competitive gains. How that will continue? We certainly hope so. We are doing a good job thus far. I think TIGRIS is a good part of that as well as our strong IP and differentiation as a result of our technology. Okay. And then on the, so you are continuing to ship TIGRIS to Chiron and just over the next few quarters, how should we think about the revenue with the actual tests being shipped? How should we think about that phenomena overtime, the switch from the low margin product and instruments to the higher margin assays, can you give any color on that? I think it's probably fair to say that the number of TIGRIS shipped in subsequent quarters this year will probably be less than the quantity shipped in the first quarter. Okay. And then in terms of the assays, how, is there any additional details on how that, the assay built up would take place? I think we expect continued growth in terms of the number of assays shipped. We are getting great growth overseas and, of course, while the number of West Nile Virus assays will not increase a lot, the value will. Right. Right. And then just final quick question, any update on Chiron merger with Novartis in terms of blood screen business, is there any update on that, this status quo or are there going to be any different signals other than that? We â the status quo was that the acquisition went through, we think it's a plus. We think that Novartis is better situated in countries overseas with their own people and their own infrastructure and we expect that the tempo of geographic expansion will increase now that Novartis is running the business, and we expect the-- basically business is usual. The personnel, we do not expect will change and the good relationship we enjoy with those incumbents should continue. Hi guys, thanks for taking the question. First, I guess that here on the HPV, thanks for the detail there, but can you just walk me through I guess the different sub types that you guys have available in the IP you licensed from Roche, if there's any kind of changes that is going on in the IP landscape with a couple of decisions that I think have been made internationally in the last couple of months? And also you didn't give a timing for that. Is there a timing set up for HPV? The patent situation has not changed substantially in our view, we believe that we acquired the necessary rights to practice HPV as a result of our deal with Roche, and we are confident that we can go forward and introduce our tests. This is Glen, in regard to the question about the subtypes, we followed our fairly standard procedure of seeking and recognizing customer input, and we have included all of the high risk subtypes that the customers are demanding in our assay. Great, I guess shifting over, I mean you talked about TIGRIS a lot of then - we don't necessarily know that it's going to be called Panther but Panther is an instrument you guys are get to used one time in a slideshow but as we look forward even beyond that, if it falls an agreement in GE, what kind of R&D can be put together for what would be some type a patient bedside or handheld type instrument, is it specs lined up for that, is that kind of an R&D issue that overlaps and what can be the timeline and progress we can expect there? Thank you. You're welcome, Frank. We do have an instrument we call it the closed unit dose assay that is being developed primarily and initially for the industrial business, it's small, it can be carried on rooftops to check water and cooling towers. It does not have a very high throughput but would lend itself to point of care testing. It's closed. It's real time quantitative, so it has an awful lot of capability for use in the diagnostics arena. Hi gentlemen, thank you for taking my question. Recently we've been seeing some consolidation in the market specifically Siemens announcing the acquisition of Diagnostic Products Corporation, I'm wondering if you could comment on your view of consolidation in the marketplace and possible role that Gen-Probe might take? Well, do you see this perhaps as a beginning of more consolidation that's going to take place or do you think this is a beginning of a trend? And if it is a trend, do you foresee Gen-Probe playing in that area? Well, I had a statistics professor in graduate school, he said that one event, a trend does not make. So, I mean it may very well happen, Jason, I have heard that some of the imaging companies like Philips and like GE maybe similar to Siemens want to spend a little more of their capital into diagnostics, this is part of diagnostics. Whether other companies will follow that I can't say, there are an awful lot of sharp investment bankers around who would probably be delighted to comment on that. They were interested in both nosocomial infections and resistant MRSA and VRE and we think that's a logical outgrowth of what we do know. I think it's a growing area. Hi, thank you and thanks for the update on the long-term pipeline. If I could follow-up with the question on PCA3, Hank, you mentioned that some of the initial data that you showed in Europe was in negative biopsy patients and I just was wondering if you could confirm that that was indeed the patient population that you guys were looking at for this test initially? And in terms of clinical trials, what's the latest thinking in terms of when youâd possibly initiate clinical trials with the products that you have today? Thanks. You're welcome, Sara. That is correct. We had envisioned the initial usage of PCA3 in biopsy negative patients with the idea of eliminating needless biopsies going forward. We are still planning â the planning is moving along nicely for our first clinical trial with PCA3, we are looking to get a CE mark by the end of the year in Europe. I think we are in pretty good shape to start the clinical studies. The question we have, we have so many markers that look so good, itâs exact combination of marker CUs. And clearly PCA3 will be one of them. We are doing validation on the other markers we have both from the government, from the center of prostate and disease research as well as from Corixa and those validation studies are ongoing but we are looking at them in isolation and it's going to take a genius like Harry Rittenhouse to pause at the best combination. Harry, do you have any comments on that, now that I've set you up? This is Harry Rittenhouse and I do feel set up. But we are making some very encouraging progress, for example, Hammacher, is one of the key genes that we acquired from Corixa and we done studies in Jack Schalkenâs lab in the Netherlands, this is a Gen-Probe technology with Gen-Probe's scientists at that location and the preliminary studies indicate a increase in clinical sensitivity of about 15% and also detecting cancers with high-grade. So, I think these studies are definitely pointing the way to a next-generation assay that's going to be even better and as Hank mentioned PCA3 test right now is quite good and it's targeted for the negative biopsy population which is a very large number of men today that are in a dilemma because they don't know when to have the next biopsy and there's no good test for them at this point. Just in terms of, I think, Hank was talking about the specificity of that PCA3 in that small study of something like 74%, I mean, is that good enough? And I know it's a significant improvement over negative biopsy but, it's still as far as from a specificity that would give you a really definitive answer just in terms of the clinical utility of that, can you just comment on? We think you're right, Sarah. I mean, it is a tremendous improvement over PSA but it's not good enough, we think we can do better. I will just add that there is really no definitive test, and the definitive test so to speak if biopsy but 75% specificity is extraordinary, and especially in this population where PSA does absolutely nothing so, it's really extraordinarily good. Okay thatâs helpful and then, Hank, I know you probably purposely didn't comment on the industrial but at least if you could just talk about in terms of confirming some of the things that you said last time, and I think that was Millipore, you guys had left out some initial products and they were moving into customer validation this summer? And then on the GE, I think you were just about entering kind of the stage where you were setting out some products. So I wonder if you could kind of confirm that the stuff is still on track and itâs anyâ¦? I can confirm that we are really pleased with the progress we've set up, some aggressive timelines and we are tracking them very well. Not so aggressive is to have Alpha testing this summer. Okay. And in terms of visibility when we are going to get some improved visibility either from you guys or some of the partners on, what exactly the tests are that you guys are developing and the interim platforms on which you go to market with and when can we expect to see some additional visibility there? Thanks. I think as we move forward and get closer to a commercial reality, we can talk more about it. Obviously, some of our partners are concerned about competitive information and want to keep the products fairly quite. Mike, you want to add something? Yes, Sara, just to clarify for everybody's benefit what we said previously, the Alpha test we would hope through Millipore would be in customersâ hands by the end of this year and then the first revenue likely in the back part of 2007. And that's consistent with what we've said previously. And hopefully as we get closer to that Alpha testing, we can provide a little bit more color on what those opportunities look like. Thanks for taking the follow-up. I just wanted to go back to the actual quarter numbers here and understand a little bit better the guidance that you've laid out. If we end up looking at your blood testing revenue and stripping out the West Nile virus shipment, stripping out the sales of instruments and spare parts and also stripping out deferred revenue recognition last quarter, if I do that math, and I think if I'm doing it correctly we would have seen your blood testing revenue decline from 33 million in the fourth quarter to 29 million in the first. Am I missing something there? And if that's the right math, can you help us understand why there might have been such a big sequential decline in blood testing? Well, your math is not accurate but it's in the right direction, don't forget we did if you are comparing quarter over quarter, we did have a reduction in phase, we talked about I think 13%. So that would take most or at least a good portion of your number. And we also said - patients who are within the band of 5% in donations were down in the quarter for us, and so you're right, it did dip a little bit in the first quarter. So, your math is in the right direction, Thomas. And when you look at your guidance on a go forward basis, are you assuming that testings recovered there and does your guidance also account for TIGRIS approval this year for West Nile virus and the positive revenue impact that would ensue from that? Let me take the second half first. As you know, we are not predicting approvals any more, we are not in that business anymore, we only tell you when we file. But you can probably figure that one out for yourself, just based on the normal action dates. And the first part of it was, again, first part of your question? Actually I think you are pretty much answered that part. And then just really quickly, you had mentioned non-STD clinical diagnostic sales were very high this quarter, can you quantify that for us, maybe what it was in the fourth quarter and in the first quarter? It was up, our non-STD, which of course is (indiscernible) and stuff like that, was up about a little more than half a million dollars in the quarter, which we said we don't expect to occur. And then very quickly on going back to this full donation rate issue, did that recover as you look forward into the second quarter? Yeah, I am not going to state whether or not we expect to recover, what I will tell you is that our blood screening forecast for the year and therefore, our guidance is based on what Chiron gives us. We might think a little bit based on things we know that they might not but it is based on a solid forecast starting within. Well, thank you all for your questions. To wrap up, Gen-Probe had a strong first quarter and is off to a good start in 2006. We continue to generate profitable growth from all of our clinical diagnostics and blood screening businesses led by APTIMA Combo 2 for PROCLEIX ULTRIO and TIGRIS. First quarter product sales grew by a robust 32% over the prior year and established a new record for the 14th time in 15 quarters. As a result, total revenues grew 25% and non-GAAP EPS increased a very strong 27%. Not only did we execute well on our current businesses, we made important progress in our blood screening industrial prostate cancer and HPV programs, which we believe will lead to future long-term growth. Thank you for your time and attention today, and please contact us if you have any follow-up questions. |
EarningCall_234060 | Hereâs the entire text of the Q&A from Millennium Pharmaceuticalsâ (ticker: MLNM) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you. Ladies and gentlemen, if you have questions please press *1 followed by â4â in you touch phone and you would put into the queue. If you would like to answer to your question please press 1 followed by 3. Once again if you have the question please press 1 followed by 4 and answer to your request please press 1 followed by 3. And our first question comes from the line of David Witzke at Banc of America Securities. Good morning. A question for Deborah. In 2004 I think the R&D was 403 million. Can you break out what percent was R versus D, and then looking forward to 2006, how will that split look as you reduce that by 30% to I guess, 282 million or so? Dave, this is Kyle. Thanks for asking the question this morning. Iâm actually going to turn the call over to Marsha, whoâs going to start off the question and then Deborah might add some comments. So Dave, historically the division between R&D has been roughly 30, 35% for discovery. And as a result of this refinement we would expect that to be closer to the 25% of the total expenditures. What we have said about the expense reductions is that they would be 30% across R&D and SG&A, and at this point in time we havenât been more specific about providing guidance on the division of SG&A versus R&D, because as we finish our planning a cycle and continue with some of the clinical trial program plans for next year we really need the flexibility to be thinking about the investment profile across those areas. Thanks. I guess the higher level question, after these reductions, is this a good run rate for R&D and SG&A going forward or do you think, I guess, specifically for research infrastructure will that need further revisiting? Dave, this expense profile is one that has been constructed in view of a conservative outlook for the revenue profile of the Company, and therefore we expect this to be the profile that we continue forward with in the future. I think we always do really need to have the latitude to think about the relative SG&A and R&D spend in order to reflect the investments we want to make in both the commercial and the clinical side, but certainly in total that profile is the profile we expect going forward. I think that itâs important to also think about, Dave, in that discovery weâll be strengthening in oncology so actually adding resources there. And we believe that we will be at a level that we can continue building a leadership profile in oncology discovery. So, you know, a lot of the development spending is going to depend on how the molecules move through development. And the more successful we are and the more weâll be moving molecules into later stage trials. So the investment profile will change as the pipeline advances also. Thanks. Thatâs helpful. And a final question, if I may, on the collaborative revenue line. What percent was a one-time payment this quarter? I guess the 71 million out of the 105. Really, the question is what is the right run rate going forward for collaborative revenue? Thatâs a tough one to answer because we have so much variability quarter-to-quarter depending on when milestone payments occur and when certain R&D reimbursement occurs, but certainly in this quarter what we had said was that about $10 million was really one-time payments and reconciliationâs as a result of the Integrilin transaction restructure largely, as well as the 71 million in the inventory purchase. So you know, roughly 80 of the 105 million were non-recurring events. Thank you for taking my question. Could you give us a break down of the headcount reduction as to how it flows through the different selling, discovery and development? So Sapna, at the beginning of the year we were at roughly 1500 positions. By the end of the year, weâll be at about 1100 positions. Roughly 200 of those were a consequence of the Schering-Plough agreement restructuring, and the vast majority of those were on the commercial side coming from sales and marketing. With regard to the other positions, the other roughly 200 positions, probably two-thirds of those are R&D related, and the other third are overhead related positions, G&A related positions. Thank you. And just also second question on the discovery projects that you have discontinued in inflammation et cetera, are you going to try to monetize those assets by trying to partner them elsewhere? Hi, Sapna yeah. Certainly as we said on the call, that some of the more mature assets in discovery will be moving into development as part of our sanofi-aventis collaboration. The earlier assets that we have at Millennium will be ones that we would consider out licensing to other partners depending upon their level of maturity. Importantly, and I think this is something weâve always mentioned, there is cross-talk between inflammation and oncology, and we will also continue to work on a couple of the molecules weâve spent a lot effort on in our oncology discovery group as they have direct applications for cancer therapies. And just a last question, when you say you is going to strengthen your discovery in oncology, what areas are you expanding into? Again, weâre very comfortable with the current level of molecular and cellular biology and people who are specialized in cancer biology. The areas we feel we need to put more effort on, because of the number of targets that weâre now prosecuting, is in chemistry, particularly medicinal chemistry, and also in pharmacology. Again, these are necessary to really continue to move the pipeline forward. So we will see some internal movement of chemists from our former inflammation discovery effort that will be moving into the oncology area, and weâll be recruiting a small number of additional scientists, particularly pharmacologists, to really increase that area. Okay. The second question is that Merck recently signed an agreement on an antibody to PSCA and it seemed like they are putting quite a bit of financial commitment to it. Can you discuss how PSMA is different than PSCA and what are the potential advantages? Well itâs a different target as you know, May-Kin. I think many people are convinced that PSMA remains one of the best, if not the best target in terms of targeting advanced prostate cancer because of its high level of expression and its increasing expression in the metastatic setting. The other advantage, of course, is that we know, based on our current studies that we have biological activity with our particular antibody and with the particular target. So, this is not to discount that PSCA might be an important target as well, I just think itâs much earlier in terms of the validation. Good morning. Thanks for taking the question. Just a few on Velcade, I think historically you guys have given market shares in first, second, and third line. Wonder if you can provide that today, and as well as any comments on potential maintenance use? I think weâve seen growth in the Velcade frontline share up to 9% this quarter from 5% last quarter. So weâve got compendia listing now in nine states, at reimbursement in nine states based on the compendia listing. Weâve got 39 states who are considering the review of the frontline data now, and we anticipate, because the data is strong, and there is such a need in myeloma, that further states will reimburse. Obviously people will choose to use it as they see fit. Itâs not something that Millennium can promote. And looking at the maintenance setting, and Iâm going to have Bob comment on that. Just a couple of things, just to go back for a second for the frontline. I would encourage you to try to attend some of the sessions at ASH where we will be updating some of the frontline data from the investigator studies. Of course, not from our Phase III studies yet. But I think that will be important data for to you see and, you know, we hope that that will increase, continue to convince people of the importance of the drug in the frontline setting. As Deborah mentioned, I want to also remind you that we do have a re-treatment study underway where we are looking at the ability of Velcade to induce a second response in patients who have already received a good response to Velcade in the past but then have relapsed in the interim. And this is based on the fact that both in the laboratory and in the clinical setting, we have not seen overt drug resistance develop to Velcade, and we have certainly seen in the clinical setting anecdotally the ability to induce good responses, again, in patients who have been treated with Velcade for a second time. Yeah, I think that theyâve been more or less flat. Second quarter was a little bit under a week, and weâre pretty much back to the regular week now. Iâve got a question about MLN518, I think probably appropriate for Bob. The evolving kind of landscape of competitive agents in AML is the question and how you see the approval strategy going forward potentially for in AML for 518? Iâd like Nancy to comment, because as I mentioned in the call, our strategy, based on the biological activity we saw in relapse patients, but the inability to achieve a significant number of complete responses as a single agent prompted to us move to the frontline setting where, you know, where weâre excited about the fact of having a new biologically active agent to combine with standard induction therapy MI. I might ask Nancy just to talk a little bit about that trial. Weâre pretty excited about the 518 molecule. You mentioned there is a lot of competition out there, which we certainly know about and are following closely. We think based on the data that we have with our molecule and what we know about competitor molecules to date, that we have a more favorable profile. One of the problems of some of the other molecules have been problems on the PK side, and we donât seem to have similar such problems. So weâre clearly keeping abreast of those. We are moving aggressively forward based on the input from our advisors and, you know, in addition to the work that weâll be doing in AML, we are also going to be doing trials with CTEP based on the anti-PDGF activity and that would be in glioma and prostate and renal cancer. So we think it has broad applications and we think we have a good molecule and weâre going to aggressively pursue it. Hi. Thanks for taking the question. Maybe back to Velcade. Can you maybe talk about where things stand right now in terms of the average number of cycles a patient will get Velcade? Chris, one of the things that we know is a growth opportunity for us is having the number of cycles increase. I think that with our APEX data one of the things that is exciting in that trial which demonstrated the survival advantages that among the responders they were getting a median of eight cycles or greater. So we also know that Velcade, although itâs a very powerful agent, not everybody responds immediately that you do get an increasing response over time. And so we have seen some lower cycle usage among some physicians, and particularly physicians who havenât been heavily detailed to date. As you know, weâve had a relatively small sales force and so my belief is our voice in the marketplace really hasnât been as strong as we need it to be which is why weâre expanding now, because where we have been able to detail the physicians with an appropriate reach in frequency we are getting more cycles used. So thatâs why I really believe this is a potential growth opportunity for us. Thatâs great. Thanks. So you said that APEX, youâve seen eight cycles or greater. Where are we in the market? Do you have any sort of sense? Okay. And can you maybe comment, I know you mentioned that part of your plan is to increase your sales presence. Can you give us some idea on a percentile basis where the sales force might be after youâve completed that expansion? A couple questions on Velcade. Velcade was approved in Europe for over a year. Can you give us an update on sales uptake there and also can you remind me of the Roche repayment rate from J & J for ex-U. S? Han, you know, J & J sales are not something that we comment on, so thatâs something youâd have to really discuss with them. Weâre very satisfied with our partnership with them; theyâve been very enthusiastic about Velcade and have done a very good job. And the royalty rate? Han, we have not disclosed the royalty rate with the Johnson & Johnson collaboration except to say that it is significant double digits. Okay. And also, I understand that you will give a pipeline update at your analyst meeting next week. But can you give us a preview what should we expect at URTC and ASH meeting? I think that as we said at ASH this year weâre going to have over 50 abstracts and six oral presentations. Weâre going to be providing updated survival data from the APEX trial and youâll see also frontline data from investigator initiated studies updates two studies, and beyond that we really arenât going to comment any more at this point in time in terms of that. Han, we donât expect there to be significant data really to point you to. There may be some early studies, but as you know, Millennium typically presents its data at the bigger conferences, ASCO and ASH. Good morning. Thanks for taking my questions. First on Velcade, given the recent compendia listing have you guys seen any traction for mantel cell lymphoma use? Maneesh, we are seeing some with the compendia listing, and we anticipate as the data matures and itâs spoken about more that weâll see that pick up. It is a small cancer, and, of course, we canât promote it, so you know, the uptake will be slow. Sure. Can you actually give us a flavor for off-label use of Velcade in general, where you might be seeing more use and where you think you might be seeing more use going forward? Considering that our label is in relapsed myeloma the majority, first of all, off-label use is not a massive component of Velcade sales. We have said weâve got about 9% use in frontline, which is off-label, but obviously in the same disease area, and then the majority of other off-label uses coming in the lymphomas. Thereâs a very small amount in lung cancer right now. Bob, would you. No, I think thatâs exactly right. Weâve certainly heard anecdotally more over the year usage in lymphoma as weâve spoken to oncologists at a variety of meetings and other settings. So, again, I think based on some of the data youâll hear at analyst day and then at ASH, hopefully the messages will continue to get out. Then one final question on Velcade. The first line strategy, when do you think we might be seeing some data from the Millennium-run trials? So as you know, we initiated three Phase III frontline trials this year, a randomized control trial, two in the transplant setting and one in the non-transplant setting. Weâre very excited about the breadth of these programs. And currently they are enrolling based on the targets that we have set. The earliest Iâd expect to see data from those trials would be some interim data from one of the transplant settings at the end of â06. Good morning. Thanks for taking my question. My first is on the restructuring charges that you have yet to recognize. Could you give us an idea of when those might be recognized on a quarterly basis and what component will be cash versus non-cash for each quarter? Itâs a little tough to give you the quarter-by-quarter unfolding of that, though, because a lot of this really depends on some facility planning that weâre still engaged in right now in terms of when we can exit and really make things happen without disrupting activity. However, the majority of the remaining charges of 60 to 90 million are expected to happen over the end of this year and over 2006. With regard to the non-cash/cash distribution, what we had discussed with the 2003 restructuring charges was that that was roughly two-thirds/one-third, cash/non-cash. And with the more recent announcement itâs a bit more of a fourth of those charges are non-cash. So on a blended basis going forward about 30% is non-cash of the remaining charges of 60 to 90 million. Okay. My second question is more of an accounting question. It seems, at least in this quarter, for your non-GAAP results you excluded the restructuring charges but you kept in the restructuring-based revenue. What would your non-GAAP EPS look like if you actually excluded both components, the restructuring revenues as well as the charges? And how can you keep one in and exclude the other? Thanks. The restructuring related revenues in the quarter, once again, Phil, thatâs a little bit of a tough question to address because a fair amount of the bulk of that number in the quarter is really just a movement of inventory from us to Schering-Plough. And so it really wouldnât seem appropriate to remove that from the revenue consideration, and itâs offset by the cost of sales line. And so in a sense itâs really a neutral event from a P&L perspective. And beyond that, the only thing associated with the relationship that wouldnât have occurred in the normal course of business is the amortization of the up-front payment, which is 35.5 million over several calendar years. So itâs a pretty small number, and then, of course, the royalty is really just a substitute for the prior arrangement. So in terms of things that would be kind of really one-time and drop to the bottom line, it would really only be a small portion of that up-front payment. The rest of it is really the ongoing business. So would it be safe to assume that your non-GAAP EPS would be the same whether you excluded or included those revenues? Thank you. Good morning. My question has to do with the overall trajectory that you announced here last night, in that the prior guidance had been that the Company would be breakevenish in 2006 and so relative to the trajectory that you found when you came into office, how much is this plan that youâve sketched out here changing that? I think, Alex, thanks for the question. What weâve tried to do is put ourselves on a very firm footing to be able to deliver on the goal of non-GAAP profitability in 2006 without building in additional large partnering revenue, and so I think weâre in a very solid position. Thatâs not to say that partnering isnât a key tenant for Millennium. It has been and will continue to be, but it puts us in a position that we can deliver on the â06 breakeven, if you like, without something that we havenât foreseen yet, and then we can continue to look at how do we partner strategically to help us fund R&D and gain the global commercialization of the product outside the U.S. So I think itâs a solid foundation. Thatâs helpful. My second question relates to Velcade. Obviously there are an awful lot of clinical trials ongoing, many of them from Millennium. Is part of this a streamlining of what youâre doing with Velcade, or are you sort of continuing full bore with the Velcade program as it had been sort of previously sketched out? I think you can count on us continuing to drive Velcade to fully optimize that product. Itâs got a lot of growth left in it. And weâve got some significant investments in it, you know, approximately 2,000 people being treated in frontline myeloma registration trials. Weâve got trials in other different combinations, trials in lymphoma, and trials in lung cancer, so I think you see this Company investing for the future in Velcade. Alex, youâre going to hear an update on the trials for Velcade at our analyst day, so I ask you to either join us there that day or listen to the Web cast. Thanks very much. The average, just another question on Velcade. The average number of cycles that you talked about being five, the doctors that have been heavily detailed, what number of cycles are they using, and can you also just break down the number of cycles in the various groups of patients in terms of first line, second line, third line? To answer the second part first, I donât think we have the data by line of therapy. But where physicians have really recognized that Velcade can change the outcome for patients with a survival advantage, they are using, you know, between six and eight and sometimes well beyond that, number of cycles. We do have some physicians who have really taken on Velcade even using it in maintenance, and, of course, thatâs their privilege and right. We canât promote that. But the more that physicians in general, the oncology community, the goal has generally been in all cancers to try and go for survival. The issue with myeloma has been that there hadnât been an agent that could really deliver that until Velcade. So once oncologists understand that message the natural tendency is to go after that survival advantage. We need to help them understand thatâs achieved with more cycles of therapy. The other thing it results in is people using powerful agents up-front, because the one thing that all oncologists and hematologists know is that nailing the tumor early is the right answer in trying to give your patients the best chance. So as our frontline data matures, as people understand the survival advantage of Velcade really do see this as the backbone of therapy, and the fact that itâs combinable with other agents, and wherever it has been combined, it adds significantly to the complete response rate, the overall response rate, will make it ideal for combination with agencies in frontline now and new agents that will come. And so just so I understand, in terms of the math here, when we think about, you know, we have a hypers I guess more educated physicians using six to eight cycles but the average is around five so that means that a lot of physicians are using maybe three cycles, somewhere around that just giving up very early. Is that consistent with your market research? The other question is, you had previously talked about Velcade in ovarian and prostate. It looks like the GOG ovarian study was suspended. Should we think of that as just not being a fruitful area or an important area of research for you anymore? The GOG study has just completed enrollment, and the data, we need to follow all those lapped patients in the trial and the data need to be collected. So we donât yet have the results of the GOG study, but it certainly has completed enrollment but weâre waiting the results. Well, you know, itâs a cooperative group and so we donât have complete control, nor do we necessarily know definitively from them when theyâre going to have data, but I think the good news is that enrollment has been completed and so Iâd imagine sometime next year weâll see the data from that. Okay. And then just one last question on the mantel cell opportunity. Iâm a little bit surprised that you expect that opportunity to, I guess just the sales turn out to be relatively slow going just based off of the strength of the data. Is there anything else you can do, or I guess why do you think that that will be so slow? I think, Rachel, the data is one thing, making sure patients can get it reimbursed is another. And thatâs the process that we work on as we ensure that the product is compendia listed, which it has been, in the relapse setting. And then working with individual physicians, working with insurers to make sure that patient can get it reimbursed. So, you know, over time, that builds, and certainly the data will mean that physicians are prepared to go through the challenge of dealing with the insurance company on a patient-by-patient basis. I think thatâs the normal course of events for something that isnât an approved agent. It takes time for the reimbursement to come through. Rachel, just wanted to add quickly that we do remain enthusiastic about the data. And again, we, but you can attend the analyst meeting next week. We will be presenting an update. Ladies and gentlemen, unfortunately, due to time constraints weâre not able to take any further questions, so Iâll turn the conference back to you, Dr. Dunsire. Itâs actually going to be me, Claudine. I just want to thank everybody for joining us today and to once again invite everybody to join us for our analyst day in New York next week on November 2nd. Thanks again for your ongoing participation and support of Millennium. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Thank you, and have a great day, everyone. 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EarningCall_234061 | Welcome to the PortalPlayer, Inc. fourth quarter and year-end 2005 earnings call. Operator Instructions At this time, for opening remarks and introductions I would like to turn the call over to Kristine Mozes, Investor Relations for PortalPlayer. Please go ahead, ma'am. Thank you. And thank you for joining us today. In addition to this call being recalled by phone replay it's being broadcast live via the Investor Relations page of PortalPlayer's web site at www.PortalPlayer.com. Earlier today, we issued our earnings press release and filed it with the SEC. The press release is also available on PortalPlayer's web site. That press release contains certain non-GAAP financial measures, which we will discuss during today's call, together with the most directly comparable financial measures calculated in accordance with GAAP and reconciliations of the differences between these measures. With me today is Gary Johnson, President and CEO of PortalPlayer, and Olav Carlsen, PortalPlayer's Chief Financial Officer. I will begin this call by reading our Safe Harbor statement. The statements on today's call, which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements include, but are not limited to, statements as to our future plans and growth, development efforts, features, benefits and introductions of products and technology, entrance into new markets, our plans to hire additional resources, our and our customers' market positions, our revenue growth, including revenue from the Flash market and timing thereof, market trends and demands for high capacity players and anticipated growth of this market, market trends and demand for differentiated notebooks and anticipated growth of this market, availability of Microsoft Vista side show technology, market trends and demand for products with wireless connectivity and anticipated growth of this market, potential acquisitions, demands for our product and future financial results, GAAP, and non-GAAP, including revenue, net income, expenses, gross margins, ASPs, stock-based compensation charges, tax rates, cash flow, weighted average shares outstanding, and operating expenses included but not limited to future R&D spending and selling, general and administrative expenses. These forward-looking statements are subject to a number of risks and uncertainties that can cause actual results to differ materially from those discussed in these forward-looking statements. Please refer to today's earnings release, our Form 10-K for the year ended December 31 2004, and our Form 10-Q for the quarter ended September 30th, 2005, as filed with the SEC, and from time to time in our other SEC reports. For information on risk factors that can cause actual results to differ materially from those discussed in these forward-looking statements. These forward-looking statements speak only as of the date hereof, PortalPlayer disclaims any intent or obligation to update these forward-looking statements. Additionally, this conference call is the property of PortalPlayer, and may not be recorded or rebroadcast without specific written permission from the company. Now, I would like to turn the call over to Gary for his introductory remarks. Gary? Thank you and welcome, everyone. 2005 was certainly an outstanding year for PortalPlayer. On the financial side, we grew our annual revenue from $93 million in 2004, to $225 million in 2005. We also increased our profitability significantly year-over-year, and have impressive shipment activities throughout the entire quarter, including the last three weeks, which we recognize as deferred revenue. We are very proud of these results and believe that there's significant opportunity for growth in our current market of personal media players. And that we also have many opportunities ahead of us to leverage our technology to other fast-growing portable multimedia markets. We are really looking forward to the future. To help support this growth in 2005, we organized the business into three product divisions: Each focusing on a different market opportunity, personal media players, personal media displays, and personal wireless entertainment. In the personal media space, we achieved very impressive results this year. We introduced innovative new technologies, such as our PP 5022 family which tripled the battery life of media players and features our MPEG 4 and motion JPEG capabilities, and our 5024, which is our first device to integrate the media processor along with the audio power management and battery charging features in a single package. In September the iPod Nano, the first Flash-based media player using our technology was introduced into the market with great success. As a result, we extended our leadership position in the personal media player market to include Flash and hard drive-based storage. We also worked very aggressively on new technologies in 2005, we can't share details of all the projects we are focusing on just yet, but one result of our hard work was the successful launch at CES of our new PortalPlayer Preface technology. The implementation of which, garnered much attention and media attention during the show. We believe the new technology will expand into a major market segment, personal media displays, a new, exciting feature for notebook computers in 2006 and beyond. We'll talk more about that market in a few minutes. In addition to working on these new opportunities, we are also looking at ways we can incorporate wireless connectivity into new multimedia devices. We were proud to see the Sirius Satellite Radio, the first wireless customer shipping the revolutionary Sirius S50, a CES Innovation 2006 Award honoree in the portable audio category. In addition, our newly created personal wireless entertainment division has been working very hard on next generation wireless technologies. In a few minutes I will go into more detail on each of these initiatives but first I will turn the all over to Olav would will take you through the details of our fourth quarter and year-end financials. Thank you, Gary and welcome, everyone. This fourth quarter of '05 was again another record quarter in many ways. We proud to announce that revenue was a record $78.2 million which is a 75% increase from the $44.7 million in the same period a year ago. And 35% higher than the revenue of $57.9 million we recorded in the third quarter of 2005. This is above our guidance range of 65 to $75 million due to the fact that we met stronger than expected demand, especially in the second half of the quarter. As Gary mentioned earlier, we had a very high level of shipping activity throughout the entire quarter. Our Q1 guidance of $70 to $80 million reflects the strong late quarter activity, as well as some expected seasonal decline for Q1, but less of a decline that you would expect after a very strong holiday quarter. Revenue from our largest customer represented about 95% of our total revenue, as market share shifted again in favor of this customer's very popular new model, which features innovative form factors and revolutionary capabilities. Having said that, in Q4, revenue from our other customers increased to about $3.9 million, and we're certainly are very proud about our new design wins at Sirius Satellite Radio, Phillips and SanDisk and more about this in a few moments. Our fourth quarter gross margin of 46.2% continued to be above our operating target margin of 41 to 44%, and I want to remind everyone again, that our financial forecast is based on a 41 to 44% growth margin range. Net income for the fourth quarter was $23.8 million, compared with a net income of $10.5 million in the same period a year ago. This fourth quarter 2005 net income resulted in an income of $0.92 per diluted share, based on $25.8 million weighted average shares outstanding, compared to a net income of $0.50 per diluted share based on approximately $21.1 million weighted average shares outstanding in the same quarter a year ago. The significant difference in share count between these two quarters is, of course, due to the fact that we went public in the middle of the fourth quarter a year ago, and the newly issued IPO shares were partially included in last Q4's share count, using the required weighted average method. Net income in the third quarter of 2005 was $10.3 million or $0.40 per diluted share, based on 25.5 million weighted average shares. In terms of taxes, we saw a one-time benefit this quarter, which impacted our results by $8.6 million or $0.33 per diluted share. Based on our recent strong financial performance in our financial forecast, we evaluated our deferred tax asset position and adjusted our valuation allowances accordingly. In doing this, we anticipated in the fourth quarter the favorable effect of some remaining tax NOLs. Now that we have used in 2005 most of the favorable effects from our pre-IPO losses, our effective tax rate for Q1 is expected to be at 35%, which is about the same as we had predicted in the past. When comparing year-over-year results in the future, it will be important to keep the difference in tax rates between '05 and 2006 in mind. Now, excluding stock-based compensation charges of $664,000, and the one-time tax benefit non-GAAP net income for the fourth quarter of '05 was $15.9 million or $0.62 per diluted share. This, compared with a non-GAAP net income in the fourth quarter of '04, of approximately $11.2 million, or $0.53 per diluted share and non-GAAP net income for the third quarter of '05 was $11 million or $0.43 per diluted share. We provided the detailed reconciliation between GAAP numbers and the non-GAAP numbers, which detailed the stock compensation charges for each quarter, as well as the one-time tax adjustment. Now here's some other details on this quarter's P&L. In Q4, our ASPs and costs were in line with our expectations, since we began shipping our 5022 family about a year ago, ASPs for the SKU have decreased by 20% which is the low end of our financial forecast, of an ASP decline of 20 to 25% on individual SKU basis. Operating expenses were about $18.8 million for R&D, and SG&A in the fourth quarter, $1.8 million above our guidance, and as we experienced strong revenue growth, we increased our spending level accordingly, with our financial operating model in mind and so operating expenses again, like in previous quarters came in at our target level of about 24% of our revenues. $12.7million of this, or 16.3% of our revenue was allocated to our R&D activities as we continue to successfully accelerate some of our important R&D milestones. We were able, again, to attract many strategically important new employees, mostly in engineering areas here in the U.S. and in India. Going forward, in Q1, we expect to continue to manage our R&D spending to about 17% of our revenues, or about $13 million. SG&A expenses in the fourth quarter were $6 million, which is a $2 million increase from the previous quarter, and is within our long-term operating model. This increase is mostly driven by additional costs associated with our Sarbanes-Oxley compliance and one-time expenses related to the filing of our S-1 in October of 2005. In Q1 we expect SG&A to remain within our long-term operating model n of about 7% of revenue, or about $5.2 million, $800,000 below our Q4 spending level. Our stock-based compensation charge of $664,000 included, as always, elements of amortization of deferred compensation, some variable charges, and a charge for amortizing the expense of restricted share grants that we began issuing in 2005. Going forward, we will record stock-based compensation in accordance with FAS 123-R, and will find the elements of these charges in the gross margin, and R&D and SG&A operating expenses, as well as the benefit from these expenses in our tax provision. For Q1, we expect our total compensation charge under FAS 123R to be about $2.4 million or about $1.8 million net of certain tax effects. Now let's turn to the balance sheet. Our inventory balance at December 31st was $7.2 million, most of which is finished goods. This represents 10 to 11 days of inventory, once again, below our targeted goal of 30 days, reflecting the very strong activity level we saw at the end of the quarter. And accordingly, I will defer to income position, which represents the gross margin for shipments in the last three weeks of the quarter, was again at a very high level of $10.9 million. Head count at the end of the quarter was about 284, during the fourth quarter we added 34 very talented employees to our ranks, most of them in R&D. For the full year, we added a total of 103 new employees. As in previous quarters approximately 80% of our overall head count was focused on our current or strategic R&D activities and, again, about half of our overall head count was based in Hyderabad, in India. And now turning briefly from the fourth quarter to fiscal 2005 results, net revenue for fiscal 2005 was $225.2 million, up 143% from the $92.6 million in revenue for fiscal 2004. Net income for the year was $48.2 million or an income of $1.90 per diluted share based on 25.4 million weighted average shares outstanding. This compares with a net income of $10.4 million, or $0.57 per diluted share based on about 18.1 million weighted average shares outstanding in 2004. Non-GAAP net income for fiscal 2005 was $41.8 million, or $1.65 per diluted share, which excludes the fourth quarter tax benefit, and non-cash compensation charges. This compared with a non-GAAP net income of $16.2 million, or $0.89 per diluted share in fiscal 2004, excluding non-cash compensation charges. And before I turn the call back over to Gary, let me summarize our guidance for the first quarter. Revenue is expected to come in between 70 and $80 million, total OpEx before stock charges is expected to be about 24% of revenue or about $18.2 million, stock-based compensation charges are expected to come in at $1.8 million, net of tax, GAAP net income per diluted share is expected to be between $0.28 and $0.38 based on approximately 26.5 million weighted average shares outstanding, and excluding the net effect of our stock compensation charges, non-GAAP net income per diluted share is expected to be between $0.35 and $0.45. Thank you, Olav. Thank you. All around another great quarter, and a great year for PortalPlayer, Financially, operationally, and technically. I would like to thank the entire PortalPlayer team here in the U.S., in India, Taiwan, Korea and Japan for continuing to execute impeccably on business plan, follow our road map and in supporting our world-class customers. As I mentioned earlier, we organized the business into three product divisions last year focusing on personal media players, personal media displays and personal wireless entertainment. First, let's talk about our personal media player division. In the fourth quarter, we focused a lot of our attention on our operational execution. Supporting our customers as they significantly ramp their newly introduced products in the holiday season and getting new customers ready to introduce their products. Our largest customer had an excellent quarter, as for other customers, we recently announced that our technology is in the new SanDisk sensor, E200 series of mp3 players and the Phillips Go Gear HDD 6330 and 1630 personal media players. SanDisk E200 series, which features music playback, photo and video capabilities, is the first media player to use our 5024 device, and it comes in two, four and six gigabyte Flash models. SanDisk just introduced these players at CES few weeks ago and they already received rave reviews. The Phillips go models offer customers access to music, photos, FM radio, and voice recordings with an intuitive sensory touch pad and are available in 30 gig and 6 gigabytes HDD models. Phillips is one of the world's most recognizable customer brands and we are proud to be working again with them on these new personal media players. These new models, together with Apple's iPod, and iPod Nano, are examples of products in which we call, in what we call the feature rich segment of the personal media player market. Products in this feature rich segment include color displays, sophisticated features such as photo, video and gaming capabilities, in addition to playing music and large storage capabilities. In the future, we believe that this feature rich segment of the personal media player market will see very strong growth rates. We estimate that this portion of the market will almost double from about 35 million units in 2005, to about 64 million units in 2006. We intend to continue to be the leader in this segment. In contrast to the feature rich segment, personal media players that have no display or simple or single or double line displays, limited storage capacity, and only play music, we call the value portion of the market. These products are typically characterized by little opportunity for product differentiation, and low barriers to entry. We want to lead in the space where features, functionality and innovation are key. We believe that there are several significant drivers that are going to fuel demand for higher capacity media players, with additional functionality. Including the availability of video content, satellite radio services, PBR capabilities, subscription services, podcasts and wireless connectivity. Now let's talk about our personal media display division. This new product division leverages our current leadership in the personal media player market into other markets That can benefit from low power multimedia displays. The first new market addressed by this division is the secondary displays for notebook computers. These displays, an anticipated new feature in notebooks will be located on the outsides of the lid of the notebook, and allow the consumers to access key data, application, music, photos, and video content without having to turn on and boot up the notebook. In order to enable the best customer experience for this new feature, it should be tightly integrated with the operating system and applications on the notebook. With this in mind the personal media display division has been working very closely with Microsoft, to enable this capability in Microsoft's slide show technology, which is part of the Microsoft Vista operating system. We recently launched our solutions to in market under the name Preface and in a book, the preface is the first thing you read and from this case the Preface-enabled display is the first thing you will look at on your notebook. In addition to eliminating the need to boot the computer to access the notebook content, a process that can take between two and four minutes, the low-powered nature of the Preface technology platform can enable up to 500 hours of music playback on the notebook. The low powered capabilities of the Preface platform also enabled access to certain notebook content for tens of hours, even if the battery is depleted to the point where the notebook can no longer boot up. Initially notebooks that incorporate this technology will have access to data such as music, picture slide shows, Outlook calendar, e-mail, contact information, alarms, clocks, battery meters, and so forth. In addition, Microsoft is making this an open platform so third-party developers will be able to write their own applications, known as gadgets, allowing users access to many kinds of data stored on the notebook. In addition to Microsoft, we have also been working with partners such as Altura, Authentec, and Symantec to offer a variety of interfaces for these personal media displays. According to Gartner, notebooks are the fastest growing segment in the PC market and we believe that manufacturers are looking for ways to differentiate their products. The PortalPlayer Preface technology enables visible differentiation to the design and the use of notebooks, which really have not changed since they were first introduced in the 1990s. We expect notebooks and secondary displays using Windows Vista to begin shipping in the second half of 2006. This year, we believe that total available market for this technology could be as high as 6 million units, growing to 16 million units next year and about 48 million units or almost half of the entire notebook market by 2008. Our targeted customers to Preface will be the top 10 OEM and ODM notebook manufacturers. In fact at CES we showed prototype designs from Quanta, and Asustec, which together make up a substantial portion of entire notebook market. Our sales and promotion efforts for the preface platform were kicked off earlier this month at the Consumer Electronics Show in Las Vegas, where we were able to show the Preface technology to a wide variety of press, analysts and potential notebook OEM customers. The response from the wide ranging audience was enthusiastic interest in the technology, and interest for the notebook OEMs to incorporate the technology in the 2006 and the 2007 models. And also an energetic display of the preface technology Walt Mossberg on CNBC. We are very excited about this market and the opportunity gives us in leveraging our existing technology into an entirely new space, targeting a new customer base. Revenue from this new major market could potentially reach 10% of our overall revenue in 2006. Our personal wireless entertainment product division has also been hard at work, behind the scenes here at PortalPlayer. The group is focused both on the technology aspects of wireless, as well as understanding the ecosystem required to deliver compelling user experience on wirelessly connected devices. In addition, they are exploring opportunities to address the shortcomings in battery life and usability seen in many of the wireless devices already in the market today. Looking forward into 2006, we will continue efforts in the wireless space, by working with strategic customers, wireless technology partners, as well as considerating strategic wireless acquisitions as they make sense. In summary, we are extremely pleased with our accomplishment in 2005, and believe that 2006 will be even more exciting. We believe that the feature rich segment of the personal media player market could almost double year-over-year in 2006, offering us a great opportunity for continued growth in our core market. With the expected emergence of the personal media display market in the latter half of the year, this will allow us to further increase the market opportunities available to us, and diversify our customer and revenue base as well. We continue to invest in wireless technology, as we believe that this wireless connectivity will become an integral part of the overall consumer electronics landscape. We are now happy to open up the call to take your questions about our business. I want to remind everyone that it is our policy not to comment on specific customer products or road map. Operator, we are ready for questions. Thank you, sir. Operator Instructions. We'll pause for just a moment to assemble our roster. We'll take our first question from Randy Abrams with Credit Suisse First Boston. Yes, Thanks a lot. I wanted to start off, you mentioned the Phillips and SanDisk products and maybe talk about your outlook for diversification over the next couple of quarters, even more in the media division, as three customers ramp up. Well, as you know, Randy, CES is a very busy time for us, for us to bring new designs and to bring new life to our potential customers. The designs that analysts and other folks saw at CES are a good preview for the first half, but I as I said, the ones we've announced so far are focused on the Phillips and SanDisk devices. The SanDisk device, I think brings some new innovations to the market, the capacity of the device is very nice, the user interface, but beyond, beyond the SanDisk and Phillips devices we will not disclose new customer wins until our customers announce them. Okay. And Olav, I want to see if you could clarify, the ASP a unit year-over-year trends. I think you mentioned that 20%, was that a total company ASP for year-over-year? Well, it almost turned into total company because we shipped, most of our product we shipped basically, especially in the last three quarters of the year were the 5022 and so I only referenced the ASP decline for the 5022, which was a 20% year-over-year decline. Okay. And then turning over to Preface, could you talk about, I think you mentioned that displays is the first application. Maybe talk about some of the other applications where this technology starts to make sense. Yes, the, the other applications again reinvolvele around multimedia displays and what Mossberg got excited about on CNBC, we had example prototypes at CES that showed this in intelligent remote controls, the ability to have rich display with lots of content on the remote controls, also, for example, front panels, for example, in media centers as media center PCs become more intelligent, you could well see a more intelligent user interface and panel for that market. Longer term, this type of application, I can see this moving to many markets, including automotive, but I would say, beyond notebooks, remote controls and media center PCs are that we have already demonstrated at CES. Okay. And maybe one final question, just on the gross margin. Maybe talk about the trends that drove the upside in gross margins and then as you move into the notebook application, is there any prospect with that mix shift that it will carry a higher margin? So the second part of your question, I don't believe that there's a shift. I think we feel very comfortable in the 41 to 44% target model that we are operating in longer term. So I see with the diversification of our business in the second half of the year, I don't see that margin model change. The, the first part of your question was about the trends or the uptrend to the 46, or about 46% gross margin in Q4, again, I need to remind you, our long-term model is 41 to 44%. That's our target model. If because of customer mix, or cost developments specifically the development on the cost side, if we can have a specific quarter or even two quarters we are happy about that. Hi, this is Peter Kirzres (ph) with Glen Yeung. I wanted to ask going forward into the first quarter, your guidance is better than normal, seasonal decline. If we get a feel for how much of that would be coming from new customers, versus how much of that is coming from your existing customers, or, I guess your largest customer. And also if there's any benefit in pricing, as well. So, Peter we don't break out our revenue guidance by customer, it's a matter of policy. We do give you data on past quarters but not in terms of guidance. We are very proud of the designs that are shipping from Phillips and Sirius and we are excited about SanDisk. Ultimately consumers will decide how much they like the products. They are certainly cool products out there. It's too early to break it up at this time. Can you remind me of the second part of your question? That actually takes care of it. But I will ask you this then, on a separate subject, for wireless, as you are working through your wireless division, have you zeroed in or do you have any more clarity on what type of assets you might need to take in to, as you bring the products to market? Or before you bring products to market? Well, yes, we have honed in on the type of assets but they are not for discussion at this point. The technologies that obviously interest us most are technologies that can really add to our portfolio of low power technologies. When we look at wireless, in terms of a hand held device, we really want to focus around applications that will start to push you both in multimedia aspect and the low power aspects. So, we could use acquisitions as part of the methodology to acquire technology, and expertise there but we also, as you indicated have had a very active in internal development now during 2005. The short answer is it's too early to tip our hat, but we are narrowing in on what we think will be very important capabilities on the next generation platforms. Just to touch on the guidance, again, I guess looking at the deferred income line. It looks I can you have a third of your revenue guidance, I guess in the deferred income line heading into the quarter. What type of seasonality or linearity are you expecting in the quarter? Is it typically a back-end loaded quarter, maybe some color as far as that? I don't think that the first quarter is a back-end loaded quarter. Number one, our guidance reflects everything that we know at this time, and most current business inputs. And to your question on the deferred revenue, yes, we have extremely busy three weeks activity there in the last three weeks. It is right that as a central portion of the revenue that we guide to, is already in that deferred portion. So that we realize in the Q1, it's certainly, we have to do some math and I can help with you that, how much of the deferred revenue is already sold through our customers in the fourth quarter and how much of that is going to be sold through by our customers in the first quarter. All right. Okay. And then just again on the gross margin. I think your guidance, or you are implying that you would fall back within that 41 to 44% range in Q1. Can you talk about what the drivers of that would be, perhaps more pricing or maybe just a level of conservatism? It's just a matter of consistency. This is our target model, 41 to 44. This is the model around which we model a very highly successful company of in financial terms so we would like to remind everyone about it. What could drive, the gross margin from 46 back to 44, 43, pricing and cost? And as new products will be introduced throughout the year, as costs, the manufacturers cost shed, it's easy to get a 2% change in your gross margin up and down, so we like to remind everyone about that target model of 41 to 44%. Okay. And then last question, just circling back on a missed opportunity. When you look into the design window, can you just talk generally about where you stand today as far as your interaction with customers? Have you locked in any design wins yet, just kind of talk about what gives you confidence in kind of your 10% revenue target by year end. Let me describe, let me set the landscape, first of all. As you know, a good deal of the features and the benefits come in lock stead with Vista. And so we, when we look, that clearly looks towards a policy and second half opportunity for us. The notebook OEMs and ODMs all have different cycles. There are some OEMs and ODMs, for example, that already have plastics and cases designed into the, you know the earlier '07 time period, but there are many others who have cycles throughout the year, and they are the ones that will be targeting as we look at the second half '06 opportunity. Again, we will be relying on the VISTA rollouts, but, again, by having the technology and having the technology demonstrated, frankly with two leaders at CES we believe the platform is stable, and it's now ready to be incorporated by the notebook OEMs and ODMs and we feel very encouraged by the feedback we are getting. You reorganized now into three divisions. I'm just kind of wondering looking forward maybe in '07, I mean is this something you think over time you start to report revenue by division, just to give us a flavor as to what was the traditional personal media player, what was Preface or personal media displays and PWE on a good forward basis? Again that might not make sense until later this year. Do you envision going in that direction when talking about revenues. We have not made that decision yet. It's sort of premature but, you know, we'll certainly take input in that makes sense, we'll certainly look at that That but we have made no decisions on that at this point. And then following up on Jason's question about the timing of the launch. It seems the Computex trade show in early June is one big trade show where you see a lot of the second half systems. Would you think that you have at least prototype systems or your customers might have prototype systems on the show floor sort of for display, in that time frame? I don't want to be that specific, frankly, in tying down sort of future design wins, that level of granularity. You are absolutely right, Computex is an important time of the year, and we, frankly, are, from an investment point of view, investing quite significant resources now in our Taiwan office in terms of development expertise. So we are very focused on that. As you pointed out, that would be, an important time of year for us but I don't want to go any further, in preannouncing customer design wins. As you know, the style base, we do that for all of our customers and we let our customers announce first and then generally we announce post their announcements. You are absolutely right, Computex will be a busy time. Okay. Maybe one for Olav, I know you haven't introduced, formally introduced the new silicon platform, as you look at, you talked about a 20 to 25% sort of per SKU price decline, what do you have on the road map in terms of process technology shrinks, either down to say, 0.11 or 90-nanometer is that something that we can expect to help you further reduce costs either on existing platforms or new platforms? There's nothing that we can talk about today in terms of reducing it to 90-nanometer or anything. I think it's pretty logical that over time, you will look at this, we are an engineering and fab company so we have people look at this all the time and it's not just for not starting today only. So will it help us on costs? Absolutely. These reductions when you get over the first hump, maybe the first quarter or two and as you ram in significant production, yes, you should see a benefit at a time when you move from 0.13 to 90 nanometer, as we have experienced when we moved from 0.18 to 0.13. Having said all of this, you know, we haven't made any announcements at this time. We want to remind you of that. I want to add a little color of that. A good part of our business, it's still one where innovation counts and it's the speed of innovation and bringing out new product cycles as we are doing and adding new features. In general as you said, as you implied you can have the cost reduction cycles. At the moment this market is adding features at such a rate that we are generally focusing much more on the next cycle of innovation, that necessarily focusing on a cost reduction path. We have lots of new technology to integrate in. It's likely having some type of process technology shrink, but, you haven't announced the details yet. Just last question on the personal wireless entertainment, is the Sirius design win is that grouped into that division, or is that still part of the traditional PNP business? That really came out of the 2005 efforts, the formation of this business unit came as we transitioned from '05 to '06 and as you said, it could be viewed in sort of either case. What was probably and frankly more important than where it all sits in the business is the learnings we got in being an applications processor, certainly is applicable to that division's work and we've got some, again that with other significant efforts going on is building, we think, some good internal mention on our own technology capability. With respect to the gross margin, your guidance does seem to indicate or imply about 41% or so coming down from the 46% range. Can you give us any view, is that a shift due to maybe from the 5022 to the 5024? Okay. Don't take what I said as a guidance. For any particular part. I would just like to remind you that what our long-term model is and I, we do not guide to the next quarter's margin. So having said that I mean, is there then another question that is, anything else that you, Well, I guess what I was trying to get at is it does appear as Q1 comes down to the bottom end of that 41 to 44% range, is that something we can expect to come back up in Q2? So as I haven't guided to the bottom range or the upper range, you know I can't answer your question, really, and bringing, just taking, I constantly remind everyone of the 41 to 44, this is not new. I have done this in the past fourth quarter. We present the 41 to 44% gross margin model everywhere and so it hasn't changed. This is not new. This is consistent with the past. Don't take that as a specific guidance for the first quarter. Back to wireless connectivity I know you have been beating around the bush on this. People have been talking about PNPs having wireless LAN and Bluetooth built in. Can you give us some better view as to what that group could look at? Well, one way of giving it some color on that is actually CES where you have a technology demonstration there, where, for example, we were starting to point towards the capabilities, for example, of Wi-Fi. That is now pervasive enough that you've got hot spots. You have home networks. You have office networks. You've got streaming. But Wi-Fi is prevalent. That certainly could be a useful addition to a pnp capability. In the area of Bluetooth, we think that's more likely to be signed, for example to work on wireless headsets and frankly, we demonstrated that a year before last at CES So you are right, in that the wireless technologies typically take longer to rollout. They have to have an infrastructure in place. You have to really generate, good insertability, but Wi-Fi, for one, does look an attractive solution, now that we have, you know, access points everywhere, you have got low-cost o r no-cost services. So we feel quite bullish on Wi-Fi. One last question. With respect to the cell phone market, there's, there has been some debate as to whether the MP3 capability will be run off the base then or there will be a multimedia processor and that would put you in direct competition against a TIs, or others. How are you seeing that market and is that a market you can expect to play in, in maybe late '06 or if not '07/08? You are right, there's various architectures being proposed and emerging in the cell phone space. The simple low cost coprocessor to give you sort of simple polyphonic tones and MP3 playback have gone as the first generation of phones in that they haven't really got, they haven't got great user acceptance. They are in the phones but that simple co-processor is not one that's particularly attractive to us. But moving forward, though as you describe the co-processor has proved to be a popular business model for adding new multimedia features to the phone. And so that clearly would offer interest to us as we look at focusing really on the features and the battery life and performance as differentiation. So that the co-processor model has proved itself to be popular and that could be a vehicle we could use to bring, you know, high quality, low power multimedia type features to that type of market. Well, as we talk about for all of our product lines, we won't be disclosing design wins or customer wins ahead of time. We have been very active with work in that space now for a period of time, but these cycles , typically the wireless space, are more extended than you would have in a traditional market, solidification cycles, working with these platforms, do take longer. So there's nothing that we would announce at this time. Yes, good evening. Thank you for taking the call. A couple, if I might. First, Olav your R&D spending, it fell a bit below your 17% target. So will your spending or your hiring in the quarter allow you to catch up to your target during the, during the first quarter or into the second? And then on your inventory level, being at 10 to 11 days, did you expect to be able to get into your target range over the course of the first quarter as well? And then just last question, on Java ME can you talk about that what that does to margins of a given platform, are you able to pass through the royalty of software costs on top of platform per unit, or do you actually get a little bit of upside on margin on Java and the ME enabled platforms? All right, the answer to the first two, it's simple, it's both yes. So even though R&D was below the 17%, we have increased it significantly as you see quarter over quarter and as revenue increased, even faster, we're below the 17%, but slightly, right, 16.3%. We are targeting and we keep targeting that is building to our very fleflible spending model of 17% R&D and the guidance that we have given is very clearly We are again hiring about $13 million of R&D for the first quarter. We will be hiring. We will be successful as we were in the last quarter. I have no doubt that we can attract very talented engineers to our group, with our new divisions. We have a lot of, you know with have a lot to sell here to these people. They are very interested in what we are doing. I have no doubt that we can be a successful R&D spending company in Q1, within the target model. Inventory, 10 to 11 days that's kind of like what you have seen in the past. And, you know, when you calculate the inventory days you get a balance sheet snapshot. You don't see what we have during a quarter and when we have the high level of activity that certainly looks at the balance sheet. With doe have a 30-day goal. I would like to remind you, it's not just us holding inventory we have a powerful supply chain with our intermediaries. It is very easy for us to pull inventory out of the supply chain. We don't have to have it on the balance sheet. I'm very happy with the 10 to 11 days. I would like to see a little more inventory, but a balance sheet snap, but balance sheet snapshot, during the quarter might be different things sometimes. So I have no concern about our inventory level whatsoever. I will pass it on to Gary on your Java question. Yeah, on the Java question, as with any of the new technologies that we are adding, for example, at CS, we were able to show the addition of things like gaming, the video, and of other advanced features. They generally offer us an opportunity, as you point out to do an upsale in terms of ASP price points. Not always the case but sometimes strategically we don't necessarily do that. For example in video, we purposefully have what we call a, one part of our strategy is what we call video-for-ree and C.S we showed MPEG 4 on our existing chip set and make video part of the main stream for that market for a zero uplift. But you're right in, general, when there's other licensed software we do aim to have an ASP uplift. Well, the, we wouldn't have been, we wouldn't have made that investment and shown it at C.S, if we thought it was a zero sum game. We have significant interest from different times of customers that are interested in that. Again, it's, it's preannounced design wins but it is an important technology and one that actually can be applied, you know across different segments of our product divisions, as you think about it. So we think Java is an important extension technology for us, as well as we'll hope we turn into additional business this year. A couple questions. One, on the, on your relationship with your manufacturing partner, are there any plans to change that? In the foreseeable future or do all things remain rosy on that front? Well, the, I would say all things remain rosy. We enjoy I think very positive relationships, as you would expect in a growing business. I think the vector is clearly in the right direction for everyone as part of the bigger economy here. So in general, I think we're very happy with both intermediaries we used. So, no immediate changes on the horizon. Have any of your customers complained about margins stacking or driving costs down further or it's not an issue at this point? Our customers constantly complain about pricing, and it's part of their pricing negotiation discussion we typically have two or three times a year. Nothing that's out of the ordinary. Of course, customers find various reasons to complain about pricing, but as I said, we've had a very consistent 41 to 44% model that we've been working towards. We bring a great deal of value to our customers solutions, so, but, of course, customers find any reason to complain, but our 41 to 44% puts us in a good balance, and the right sweet spot we think with the value to our biggest customers. Okay. With respect to the depressive engagement, can you talk about the competitive situation there? Who else do you know of is gunning for those sockets and potentially, do you know if they are as far along in their software development efforts as you are or whether or not your head start was exclusive with Microsoft? We believe we have a very significant head start. We haven't seen other folks talking about this type of solution in the market. So we do, I think we do characterize it as having a significant lead in the market. Part of that, frankly, comes in developing this, working very closely with Microsoft, there was an enormous amount of work that went into this for the second half of '05. We do expect to see competitors emerge, but at the moment, from certainly the very strong response we are getting from the, the notebook OEM and ODMs, I think we have an opportunity to establish a real foothold here in the market as we go. Well, of course, I would like a very large market share there, but, no, we are not going to make a public prediction of market share for this type of segment. We have been very fortunate working with leaders in the personal media class space and we have advantage in personal media displays and we hope to turn that into a long term relationship. To your point, we are playing this for long term, we think that '06 will give us really good momentum, but we really have to build and really keep our eye focused on the potential market of 16 million and 48 million units in the subsequent years. So time will tell, but we have a fresh move to start. One more and then I will drop off. Can you give us maybe who are your top two competitors in that market segment? Good afternoon. When does OpEx cease to become a fixed percentage of sales for PortalPlayer? And I ask this, you know, because of the universe of fab companies so much of the earnings growth is derived from leverage off ever operating expenses. Well, not in the foreseeable future and when I say that, I don't plan to change the model over the next couple of quarters, but, yeah, you have a point. If at some point, this becomes a huge revenue company den aim I'm not pointing to this, I'm just theoretically discussing I'm pretty sure at some point in time, you will see the leverage and especially on our SG&A side, you will see some leverage, with 24% target model will not be 24 or 22 or something below. But I think it's too early to discuss at the time. We're fast ramping in not just one division anymore. We have like, two interesting divisions now. We are targeting business and customer diversification, which is very important for us, and for our investors, you, investors with, you know, the successful launch of our PMD division, the personal media division and the wireless is our next step. So we have, I think, you know, good incentive to keep spending at a certain level and limit it to that level so that you guys have an opportunity to look at our financials for the future and to model us for 2006. I give you the point that at some time later, develop to maybe look at that model again but not for the foreseeable future. Okay. That's helpful. Thank you. And for Gary, you know, considering your extensive experience within the MP3 player industry, can you help us understand, you know, the significance relative underperformance of higher capacity window-based MP3 players as compared to the obvious alternative? I mean this cam subpoena certainly a very large, camp is certainly a very large opportunity for PortalPlayer and when does it take off in your estimation? Well, the, I'm not sure I have any particular insight other than it's obvious in the market. The present market leader is just firing on all cylinders across a broad range of strengths in both services and content and devices. They are doing everything right. So I, for the other camp, is it an asset or marketing dollars or features? What will get that other camp moving? I think to get the other camp moving, it is, there's going to have to be a maturity in the technology, the technology has progressed over the last two generations. That needs to be, I think, a shift maybe in the Tyne of business model in the way that the people want to enjoy content. The model from Microsoft, you know, starts to really focus in more on a subscription type of model, a more adaptable, purchase or view for 30 days or enjoy for 30 days model. And so, really, I think it may come down to, do people, well a segment of the population latch on to subscription services. And without that, you are right,-- the difference becomes very unclear. Hopefully two quick questions. One on the Preface product, that it's based on the 5024 platform. Going forward if you try to diversify, should we expect, these other product verticals that you need to be also based on the same chip platform that you are using in your core market. Not necessarily. We took an opportunity for speed and also the actual factor that the display drove, display lid drove, which is a small physical size. 5024 was a perfect fit. But to your point in other verticals, we will develop, you know, specific leading edge solutions for those verticals, but, again, if we can leverage the technology and maintain the chip technology it's a great ROI for us. So the answer is that was probably an example of good adoption technology across the space, in general, as you know, we have previously discussed having three development teams and we certainly have the ability to develop specialized silicon for different market opportunities. Okay. And then you talked about the feature rich MP3 market in terms of the unit volumes. I'm curious if you looked, to see how that will evolve this year. How much of that market could be addressed with the capabilities of the 5022 product today? Certainly with the addition recently of the from CES, the capability of video, as you looked into '06, we think a lion's share of that market is available to that class of product. It really does address, you know, the audio, the photo, the video, and the gaming capabilities. So I think a lion's share of that market is developed for that class of product. And the video spec on the 5022 that you were showing, I mean it was a little reduced from what's out there in the market. But, you know, do you think that is enough at least this year to, you know, most of the market out there? Well, certainly the feedback that we got from our customers was not quite as negative as you first sort of posed it there? I didn't mean it to be negative. No, that's fine. The example on the key metric that everyone, I think was impressed with was the 30 frames per second MPEG 4 functionality on the smaller screen. That technology, i.e. video for free, will not be on the larger display devices but for the main stream devices where the cost of the display is paramount, we think that could be a very compelling solution and, again, it's hard to be free. Great. Great quarter, guys. Thanks. Thank you very much for joining us today. We plan to meet with investors on February 8th in San Francisco at the Thomas Weisel Partners technology conference. We look forward to seeing many of you there, and with that, we'll conclude this conference call. Thank you. |
EarningCall_234062 | Hereâs the entire text of the Q&A from Lam Research's (ticker: LRCX) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you sir. Ladies and gentlemen at this time we will begin the question and answer session. If you have a question, please press the â*â followed by â1â on your telephone keypad. _____ process may press the â*â followed by the â2â. So, we have two-tone prompt to acknowledge your selection and your questions will hold in the order they are received. Please limit your questions to one question and a follow up. For any additional questions please re-queue using the â*ââ1â feature. (static). Our first questions come from Bill Ong with American Technology Research. Please go ahead. Q: Yeah congratulations on a nice quarter. I would just like to get some update upon what percentage your product line is now fully outsourced to Selectron and maybe what areas of manufacturing are being done at contract manufacture verses done in-house, in your system built? Thanks. A: Okay good. We have about 75% to 80% of our value of the product that is outsourced, primarily the activity the we do it in our factory here is a final integration for some customers who want to see the product in a final integration state prior to shipment. For most customers, we have the major modules shipped from our suppliers and then we rerouted and just packaged together for shipment to our customers and the only think we do here is a certain amount of high IP related technology component parts in the chamber that we want to maintain high control of so we do that assembly work here and the base majority the product is outsourced and shipped either directly from the outsourced provider or merely routed through the factory here. AI think that we are continuing the process to work with our outsourced providers on strategies that involve year over year continuous cost reduction and our strategy as it relates to going to low cost manufacturing regions has been built around going with our suppliers and having them utilize their networks and their organizations that exist overseas. There is potential and we are certainly pursuing it that we are bringing some new suppliers into our activity. These suppliers are ones that have a larger set of operations and experience base already existing in whether it is Korea, Taiwan, China or Singapore and we are working with them to get our products built in lower cost regions and I expect that to contribute to opportunities for us to have margin improvement, as we go forward in conjunction with increased volumes that output from the factory. Q: Hi, Actually I had one and then I have a quick followup. If I look at your foundry orders, you were guiding the orders roughly flat sequentially and they actually came in down a little bit. Am I misreading that or was there kind of a change there and I have a quick follow up. A: No. Tim you are not misreading it, we had said that we thought that there was a situation as it related to the foundries which for us was very strong in the June quarter but we expected them to be flat, but we had a number of situations were what the foundries are going to do in the order environment was really sitting on a September, October time frame, and as it turned out some of the orders that we thought were likely to occur in the September quarter, actually will go down in the December quarter, and when you look at the amount of business on a systems basis, itâs only really three systems or so, but because of the ASPs of the system and the low overall volume kind of percentage wise they look greater than the actual numbers are. Q: Understood, thanks Steve and then just a really quickly if I look at your guidance that you gave back in July you gave kind of six month forward guidance back then, you gave both revenue and you gave shipment guidance out six months, and if I look at what you are saying now, what you are going to do in December for shipment and revenue, both of them are about between $20 and $25 million higher than what you though back in July, where is that pull-incoming from, is it memory getting incrementally better, or where is that coming from? A: Itâs coming from actually memory and there are some logically related pull-ins, we are seeing a general uptrend, I should say in bookings activity and as the function of the short lead times and typical customer behavior with short lead times, is they wait and they wait and then they order and they also want short delivery. So, we have been able to incremental up our December output plan greater than the 15% to 20% that I had talked about last quarter and that has resulted in the second half of â05 being down versus the first half of â05 in shipments by only 6% as opposed to the 15% that we had expected but the pull-ins are occurring primarily in memory, but in other segments as well. Q: Thanks. Steve wouldnât your customers have a fair idea of how the next yearâs CapEx would be based on, wouldnât they being seeing that in your activity, can you share some of those thoughts with us. A: Well, most of the customers today are in the process of working on what their CapEx is going to be for â06 and what the lead times in the whole supply chains being as short as they are, the reality is that if you can think about or look at the business in six months increments thatâs where you could have a degree of accuracy, and so we are sitting at the October time frame and wanting to know whatâs the second half of â06 going to look like and there is so much that can occur between now and then, that the ability to predict that is really limited. In the past, lead times were long enough and when demand got way out in front of supply then people would basically be committing to order environments and delivery environments that extended out to nine months. Today all the cycles are so short and the whole industry is far more consumer dependent that itâs really not a situation where anything other than macro analysis can tell you whatâs going to go on in â06. So our perspective if we look at whatâs going on is, we are clearly seeing an uptake in bookings in December. Our expectations would be that has we look forward that we ought to expect that things would remain positive in the March quarter and when we look at the fact that we are upping our shipments 30% then we would expect that we are going to be able to output more in the March quarter because our bookings will be up in the December quarter. Q: Hey guys, good job here in terms of gross margins in the quarter but I am wondering about your clean chamber and your clean product and as you start the RAM shipments in Q4, how is that going to impact margins out in â06? I have a quick follow up. A: So you want to know how our clean product may affect our margins in the December quarter, is that the question A: Well first off let me try to put the clean product into context because I think its important that while we created recognition of the activity thatâs going on there, one of the things I commented on last call was that we did not expect that there would be any revenue being reported by the company until the June time frame at the earliest. The second thing I think that is important is the product is primarily being targeted as a technical solution to some cleaning application challenges at 45 nm and the potential for some 65 nm activity, that it may be a needed solution or it may be a preferred solution provided the product brings enough reliability and cost of ownership and production worthiness to the party. We are in the process right now going through evaluation of number of customers where increasing our beta shipments in the December quarter and in the March quarter, none of those will end up hitting the P&L for revenue, and we are expensing most of the cost for those as part of the expense increased structure that we talked about in R&D, and we will be better able to answer the specific questions on the products margin activity when we better understand the value it delivers, the pricing we will able to achieve relative to the cost to produce the product. Q: Okay and a quick follow up for Martin, as you look out in â06, I know you gave guidance as to the financial model in â05, could you care to give some details on kind of the top stones for the model for â06 say around 1.6 billion or 1.7 billion? A; There really is a good reason why we only give guidance of that level for one quarter so I am going to decline to give any specific commentary on that. Q: Hi good afternoon, just from your general talk about the memory being 60% or so I think of orders of what you said, so I assume that you got the boundary uptake or meaningful uptake in your March quarter assumption, would that be accurate? A: One of the things I talked about is that I expect in the next three to six months that the foundries are gonna need to come into the marketplace with higher order levels. The reality is that is not necessarily visible in a significantly meaningful way. What we are seeing is each quarter there is always foundry activity and its currently being invested as I said at a level that is resulting in a CapEx spending of 34% less in calendar year â05 than in â04. So at some point time whether itâs the March quarter or June quarter, my expectation is that the foundries are going to come in at higher levels than we see, but currently right now based on what they are saying and what they are telling as they want to do, the foundry activity is going to be causing bookings to be in the similar area in the December quarter as they were in the September quarter. So I am just forecasting from a general perspective that when I look at the foundry business as a whole, I think it is need to increase its spending, but that has not yet become visible. Q: Hello I guess a sort of a similar question when you prepared for March you talked about uncertainly in terms of planning a foundry yet, your confidence levels in bookings guidance appears to be rather high, so I am wondering what gives you the visibility to such strength in December? A: Well when we look at the current quarter that we are in, we have a couple of things, one was essentially in two to three weeks into this quarter. Customer activity in a stable demand environment and one that is not in the bottom of the downturn or on the sharp rise of an upturn can be very predictable or at least relatively predictable in the kind of circumstances that we are at. So we had been in discussions with customers for a long time and we calibrate and look at which customers are saying they are going to place orders in what time frame, which of those customers are on the bubble between a December placement and a January placements and we look at all of those things and we factor in where we are in the cycle and that results in a situation where when we place our guidance, we feel that there is a strong likelihood that we can deliver the bookings in the range that we set. But there are certain times in a semiconductor industry cycle where it becomes more difficult to project with a high degree of accuracy what the customersâ bookings behaviors are going to be, but I think we are in one of those more stable times right now. Q: Yeah hi good afternoon. You guys had a pretty nice pickup in bookings in the US in the September quarter and you also talked about some share gains in the quarter, are those two things related, is any of the order pickup in the September quarter coming from many customers? A: Yes there is some correlation to share gains that I talked about as it relates to North America and it is also just that the activity level in North America did pick up in terms of three relatively large customers ended up placing orders and again in comparison to the prior quarter, it really was not that North America was exceptionally strong in the September quarter. They were slightly weak in the June quarter, so when you combine those two you can end up with the kind of percentage changes that we saw, but it is a result of increased customer activity and some market share wins. Q: Good afternoon thank so much. Steve good question about Lam specifically and then I will followup on the industry. I know Lam is gaining shares, we hear that from all the checks that everyone does, can you help me reconcile that the fact that your year-over-year revenue growth is kind of flattish, which is sort of consisting with the over all CapEx budget from, is that a reflection of customer exposure this year as is it just coming off from the higher base because we really all do believe you are gaining share, it did not show up on your revenue numbers? A: I a.m. glad you asked that question because actually I think CapEx is going to be down 7% to 8% with wafer fab equipment spending being down slightly more at around 12% and I think Etch is going to down closer to 15%. We wen back because I made these comment in the last conference call that in downturns Etch tends to fall further and in upturns tends to grow faster and we went back and looked tonsillectomy and adenoidectomy the last four downturns and going back to 1997 and not only is what I said true for Etch, it is also true for other processing equipment segments in the front end. And so when we go back and look at the 1999 upturn, wafer fab equipment grew 22%, Etch market grew 28%. If we go back to 2004, the wafer fab equipment grew 69% and the Etch market grew 96%. And just to kind of reinforce it in the downturn environment, the downturn that occurred in â98, the market dropped 28% and Etch dropped 36%, the downturn in 2002, the wafer fab equipment dropped 32%, the Etch market dropped 40%, So we believe wafer fab equipment is down 12%, Etch is down 15%, therefore the fact that our revenue between â04 and â05 is flat, that represents a market share gain of 4 to 5 market share points. Q: Thatâs a very helpful analysis, thank you. If I could just ask a question on the memory side of the equation relative to your comments about 60% of the orders, can you help us break that down between DRAM and NAND and then relative to the DRAM orders some of the companies are profitable, some of them arenât, do you think the DRAM industry has to be profitable to keep ordering equipment or do you think there are scenarios where some of the customer can continue to lose money, but still make some orders? Thanks so much. A: I will try to give you a little perspective on what we see in the memory market and some of the breakdowns between Flash and DRAM that have occurred that we can understand. We think that DRAM represents around 66% of the total memory spending and Flash about 33%. There are mixed lines out there, but there are lines that are now being put up that are dedicated to DRAM or dedicated to Flash, and a lot of that has to do with the fact that you end up in a mixed model, that you will have about a 10% loss in capacity output depending upon whether you set it up for DRAM and then you run Flash you will get 10% less out, if you set it up for Flash and you run DRAM you get 10% less out, and it has do with the need for more dielectric steps in DRAM and more Gate and silicon application steps for Flash. Having said that, I think that clearly in a market like memory, itâs a part of the business that they is very cost driven and the players in this industry need to be able to continue to provide their customers with product almost independent of whatâs happening to the pricing environment, and the memory market has the tendency when there is too much memory out there to result in price drops and that triggers increased memory being placed in the various products that use memory. When memory supply falls behind demand and prices go up the end user customers just cut back on how much memory they are putting in there so there is multiple regulator types of environments in the memory business and so if a customer is losing money in the short term, they are still are going to continue to invest, if they are going to play in this business, because if they stop investing they stop having the ability to continue to output to the device unit growth demands that are present every year or they will lose market share and they will make their problems go from difficult to worse very quickly. So I think that the players that are in memory, given the consolidation that weâve seen, have a high degree of commitment, but having said that that doesnât mean that management teams at some of these companies arenât necessarily looking at what they want to do, with their lines and how much goes into DRAM, how much goes into Flash and whether they are considering looking at diversifying into other semiconductor activities as a function of cost competitiveness, technology capability etc., Q: yes. Just two very quick questions, given kind of the decline in bookings in Japan, would you expect the revenue in that country to grow again sequentially and if my math is right when you gave us the order guidance for December and gave a 60% in memory, I think that implies basically all the DRAM orders are up nicely and the other sectors would be down, could you just clarify that to make sure my math is right. A: I think that in Japan, the spending continues to remain strong, and again that when we look at the percentages we really talking in many cases here, sometimes two systems, sometimes three or four systems, that both along the quarter donât put the net, and that create a change in Japan being 28% in June and 22% in September. And then on a going forward basis, we can be plus or minus that number by 5% point and it really doesnât necessarily constitute a trend. You are correct about memory in the December quarter, being a higher percentage, there is clearly memory companies around the world in Korea, in Taiwan, in the United States that are making investments in memory, we have very good market share, in memory, we have at the leading memory companies around the world we have a higher market share, with them, itâs a higher market share has been our global average market share so when memory spends itâs beneficial to us as a function of our market position. Q: One follow up the 4% to 5% increase in market share that I guess you are siding for calendar â05, what geographic region was the biggest contributors for that. A: we had a very good year in Japan, one that weâve been investing in for really for a long time but we are successful in making some significant in roads last year, that has accelerated to the point where Japan 2 to 3 years ago was really a drag on our overall global market share, we are now booking business in Japan at the same market share that we have on a global average. Q: Alright, good afternoon you guys, Steve just a quick question back from the DRAM and Flash memory segment and recognizing that some of the lines and mix. Could you just sort of compare Lamâs competitive position in DRAM and Flash memory and are you guys seeing any differences between those two in terms of the pricing environment? Thank you. A: We took a look at our position in DRAM, as well as our position in the NAND Flash lines, in the DRAM segment our market share is just slightly below 50% and the NAND segment itâs above 50%. So clearly with NAND being the fastest growing segment, we are pleased that we have an even stronger market share position in that segment and overall our market share in memory as a total is like I said higher than our global average market share. Can you repeat the second question. Q: Did you see in the pricing environment between those two segments, we have highlighted some of the challenges in DRAM pricing, we have highlighted NAND Flash being the faster growing segment, so I would assume that there is some difference that you see in the pricing environment. A: Yeah. When you talk about, you are talking whether there is equipment pricing differences between NAND and DRAM and there are. The competitive environment that exists out there in the market place whether it is foundry whether it is logic whether itâs NAND, Flash or DRAM. Itâs is not significantly different in anyway. A: I will take that real quick, yeah we did. We spent a sum of $79 million repurchasing 2.6 million shares at an average price of $29.76 and that brings our year to date activity against the Board approvals to $246 million. So since we began repurchasing stock weâve spent $246 million, we repurchased in the range of 8.5 million shares. So against the original Board approval weâve $4 million available and obviously we have everything available in the latest half of billion approval that the Board gave us. Q: And then the just on the gross margin guidance here, if you look back to your March quarter when you had a similar revenue level, you were doing from up 50% gross margin, so I am just a little concerned here, wondering why you are not getting the similar type of leverage. A: I am glad you asked that question because we took a look at that too, and the answer is a couple of things â one, in the march quarter we did not have any equity based compensation and those numbers and so thatâs a half of margin point degradation contributor. The other aspect is that the product mix that we are shipping is different and so too is the customer mix that we are shipping to, but most importantly itâs the product mix issue, and what we have been doing in the last two quarters and certainly accelerating in the December quarter is increasing the shipments of our 65 nm capable products are Versys Kiyo, silicon based product, which has been out in the marketplace since December of 2004, and has greater than 150 chambers that will have shipped by the end of the calendar year. Our new next generation products have a tendency to have a higher material cost and slightly installation and warranty costs as a function of the first fab and their characterization activities. In addition to the Kiyo 65 nm capable product, we have begun shipping Kiyo 45 which is the next generation beyond that and that is in our product mix and margin mix in the December quarter. In the dielectric arena we have been shipping the Exelan Flex, which is a 65 nm capable chamber configuration, we have been shipping that since the June frame of 2004 with over 400 chambers so that product will have been shipped by the end of the calendar year, but we have begun since June of â05 to ship our next generation product of Flex 45, which is a 45 nm and below capable dielectric Etcher and it is in our product mix and it is in our margin mix and has the same introduction types of cost structures associated with it that i mentioned earlier. So my expectation is that there is a bit of margin pressure as a function of the new products in terms of the material cost, in terms of their installation and warranty support cost as we work with our customers on the very challenging aspects of what is takes to get them successful yield of 65 nm, what I expect that we will work through all of those issues, our material cost will improve, we will clearly establish the value in the product which will enable us to maintain or even potentially improve our average selling price and that I would expect that our field based cost to work through the 65 nm solution with our customer will improve as well as we go into the â06 period. Q: Hi. Thanks Steve for the detailed analysis. Two questions I have is first of all, is you penetration of the two large Flash suppliers about the same or are you more biased towards one to the other, and the second question is it is pretty clear that you are negating a concern here, talking about up orders in the December quarter, following a little bit of up in September and possibly again in march, can you give a sense as to what the potential magnitude or duration of this cycle could be? A: If I could do that I did probably doing pretty well in some other business making a lot of money, I think it is not very hard to fiscal term when you, when your bookings come up the bottom and they are up 3% and your revenue at the bottom then goes up. I think your question is a $64 million question and the reality is that we just donât know and we are in the process right now of working through our forecasting activities for calendar â06, I will have comment on what I think the â06 looks like on the next conference call, I want to let the current environment play itself out a little bit, see how the consumer with the post hurricane activity and I think that will give us a little better feel and there will be little higher confidence that we are going to able to find the right vicinity for â06. As it relates to our market share in the big Flash players, we are doing very well at both of those Flash players, I am not going to break out the specifics between the one or the other, but we have a greater than 50% market share on both of those players and I think thatâs the relevant point. Q: I have a question on the dielectric Etch and how it applies to particularly on the logic side and it seems like you folks have the whopping lead in terms of performance that and that might be somewhat bridging particularly on wafer performance, but could but could you tell us are you still beating costs on the cost of ownership side or what other areas you still have quite a lead on that side? A: You know logic we were talking about the critical application to get everybodyâs tension is proper dual _____ , Etching and via entrenches and the ability to do both via entrench all in one including a strip application and what we have found is well everybody in the industry continues to improve their products that we still possess an ability from a production worthiness, from a predictability, from a defect control standpoint to deliver to our costumers not only a very technically advanced result on the wafer, but one that brings a production worthy predictability and a yield benefit that most customers are still finding compellingly differentiated, so we continue to have an opportunity to take that install based position to run just thousands and thousands of wafers through these chambers, and our technical team are very busy incorporating all of learning into next generation design modifications that are going to satisfy to 65 nm needs for our customers and so the more wafers you can run, the faster you can learn, and the faster you can learn, and we are benefiting from that and its helping us win the additional new application market share gains that I mentioned in my opening comments. Q: Thanks a lot, congratulations, also. Two part questions, first on the bookings outlook and then on the market share, on the bookings front in terms of your outlook, is that 5% to 10% range would you say that the foundry are still the swing factor and on the market share question are the opportunities for gains coming from new customer winds or they be driven by as you mentioned expansions with customers that are putting it towards new applications. A: Okay. When I talk about a bookings guidance of 5% to 10%, 10% above where we are is $30 million, if a foundry customer in our forecast were to not order, that certainly going to affect whether we come in are flat or 10%,. But at the same time, if a memory customer should decide to delay, that can affect to an equal extent and so what we try to do is look at the totality of whatâs going on out there, put probabilities and expectations and give our best estimates of whatâs going on recognizing that somebody may fall out, but we may also have somebody come in that wasnât in the forecast so I donâtâ think It would be right to say that only a foundry is really the swing factor, I think that any one customer can be a swing factor. Certainly we have foundry in that forecast, we are expecting that those foundry orders will come through, but they are not the only factors as to whether we achieve that 5% to 10% upside in orders. A: On market share, itâs both, we look at market share obviously at the end of the day, itâs about revenue percentage versus all the money thatâs been spent. But we look at application whence we look at increasing our market share at existing customer where we improve our market share position and we also have been successful at penetrating customers where we had no dielectric business or no silicon business and in some cases we have penetrated customers where we had essentially no business and so it is a combination of both of those but we continue to win new applications at customers where we have significant market share because they have gained increased confidence as a function of the business that they gave us over the last few years, and they want to increase that level of business with us on different applications. Q: Just two quick ones. First on the interest in the strength of this quarter, where there any one time items and how you expect that the trend next quarter, and second when you look at the lot of discussions done on market share today, where do you think ultimately your overall industry market share can go before the customers at some point, say âHey, weâve got have some balance so that we can have more than one supplier or what notâ Steve, what do you think the natural peak of that might be? A: I will take the other income and expense question first. This is real kind of plain vanilla P&L which may explain the frequency of the questions that I am getting today, but there are really only two components to the item, one is interest income, and as itâs common for most people with the type of investment portfolio that we have which is very conservative, a 3% yield is a pretty good yield, we have $850 million of cash on an average during the quarter so the interest income and the net interest income for the company is going to range around $6 million. The only other item in their, if it is significant this quarter is foreign currency, and as I articulated in some detailed last quarter, that number to a large extent is naturally hedged by the fact that more than 80% of our revenues and more than 80% of our costs are US denominations. The only significant exposure we have to that is the Yen denominated revenues and we have contracts in place from order placement through cash collections to manage that risk. So foreign currency for us ends up just being kind of plus or minus 2 to $3 million that is kind of there as a function of the asset and liability positions of the company, and currencies have been reasonably volatile but for us itâs actually being defined around the weakening of the Taiwan Dollar on a liability position so you really got kind of two things, one is interest income $6 million the other is gain on foreign currency mostly Taiwan Dollar clearly in terms of outlook, the only real certainty is the cash position of the company and the interest income affects largely self managed, but our guidance seems zero gains zero loss on foreign currency. A: Okay, on your question about how high market share can go, well, certainly there are companies and products out there with 70% type market share, so I would have say that on a theoretical basis itâs possible, but in our segment I think itâs highly unlikely. We have four major players three of whom have about 90% of the market, and what is takes to get market share in the 40% to 50% plus type ranges Is a combination both of our excellence in terms of technologically differential capability that our competitors cannot achieve, and at the end of the day that really has to do with whether we can create a yield benefit that the economics becomes so over powering that the customer is not concerned about whether or not you have too much share, they really are going to go your direction because the economics of yield dominate everything. And so if we look at whatâs going on today, if we look at the market share wins that we are continuing to generate this year, we stated that our objective for the next upturn, whenever it is or however long it lasts, that we were targeting a 45% market share position, I believe that when I look at the competitive landscape today that, that potential is still readily available, I think if we can execute to the opportunities, if we can continue to be seen by our customers as the fastest to their solution needs, that they will reward us with that kind of market share. So the potential is there, the execution is really up to us. And we have a plan, we have a roadmap and we have ways in which we are attempting to get to that position and we will keep you informed as we go. Q: Good afternoon thank you, just a follow on Steve to the market share discussion here, with higher market share that you have in memory, how much of that is metal etch and how could that change for Lam as memory transitions to _____ ? A: Well, metal is not very large, itâs about 10% of total Etch market, and over time thatâs going to trend down, but even as the memory guys move more toward getting out of metal, there is typically one level of metal thatâs still remains and I think that metal hard mask is a new application that âs actually come into the market place, and so what you see is that metal has been hanging in there around that 10% range for quite a while and I think we are going to see metal remain in the memory device structures for the next couple of generations and I think we actually may see that there is some small increase in metal depending upon the adoption rates for metal hard mask, so I donât think what you just talked about represents a concern. Q: Good afternoon guys, couple of questions, Steve first can you talk about the clean market, you sort of characterized it as niche tech application and used the necessary versus preferred solution, I am wondering if you can give us an understanding of how big a market we should be thinking about NAND addressing with the clean application, then I have a follow up. A: Okay. I donât recall saying niche market, but we are certainly targeting a need for a new technology solution as it relates to certainly primarily logic cleaning activities around copper bias. the product is designed initially to address certain issues in that area, and the market that we are talking about in the first couple of years, is a 2 to 300,000 million market and within 3 years from the time frame that we are talking about is looking more additional applications and a $500 million market. To what degree we can address effectively the markets that I just mentioned and to what degree we can expand those markets, are certainly within our potential and what we want to do right now is to get the product understood, itâs performance established and we will talk more about the markets and the sizes and what we think the challenges and issues are, some times in the early part of â06, when we are going to have the more information and I think we will be able to provide you with a clear picture of what we are trying to do, I just donât want to say too much about that product at this point in time because I think that itâs too early in the process. Q: Great, secondly you said you donât want to talk about 2006 CapEx but in your prepared comments, you kind of went through and analysis that argued that foundries would need to increase at least 20% to 25% next year. Foundries have been running about 20% to 25% of the business so that incremental sort of 4 to 6 on the overall incremental growth of about 4 to 6% so the overall business which is good, itâs just not that exciting, I am just kind of curious at the end of the day when you look at the other two big segments, memory and logic, is your buy is directionally flat down or up for â06 CapEx. A: Let me talk specifically about the foundry numbers that we just talked about, because foundry in â05 is really going to closer to about 15% of the total CapEx and back in â04 it was 21% but if you go back to â03 it was actually around 14% or 15%. So foundry if I average â04 and â05 is really in the 17.5% 0- 18% of total CapEx, and what I am suggesting is that if itâs going to in that vicinity in â06 and as a function of that if they are 15% today, and they go and become 18% of a CapEx number in â06, thatâs essentially the same, the total CapEx, they are going to up 20% to 25% to go from 15% to 18% type of range and then it might be 25%, if itâs also includes the fact that overall CapEx is up a little bit, so I donât think their percentage as a function of total CapEx is the size what you were talking about. Q: Hi. Just a follow up on the foundry situation, two question there, number one, what do you expect the foundry to spend in terms of technology nodes, is that 60 or 90 nm, and the second question is that in one of the answers to an earlier question you mentioned that Lam has had market share gains in certain products, you have a better position per dollar on memory versus foundry. Can you quantify what the difference is between memory versus foundry. Thank you. A: When you talk about the 90 and 65 spending in the foundries, the foundries are spending and booking orders to date for 90 nm expansions and most of the equipment is 65 nm capable, and the 65 nm buys are more along the lines of earlier pilot type of activity so the volume is 90 nm and I would expect that over the course of â06, we will see a switch in the amount of equipment that is ordered for 90, it will go down and 65 will become more prevalent, the exact timing of that, itâs too early to tell.. When we talk about market share for memory, we talk about market share for foundry, I think the comment that I will make is, Iâve already said that our market share in memory is higher than our global average, our market share in foundry is also higher than the global average, which obviously leads to the fact that our market share is logic is below the global average and I think everybody knows that, thatâs primarily driven by the fact that a couple of key spenders in the logic arena, we donâtâ have a position and so I do think that our position in foundry and our position in memory are very good indicators of the competitiveness and the capability of our products and our service teams. We definitely have time for one more question, our final question comes from Vineesh Goyal with CREF Investments, please go ahead. Okay, Well in that case we would like to thank you for joining us today to discuss the results for the September quarter, we appreciate your interest in the company. Okay. This concludes the Lam Research September Quarter 2005 financial results conference. Thank you again for your participation on todayâs conference, you may now disconnect. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234063 | Hereâs the entire text of the prepared remarks from the Apollo Group's (ticker: APOL) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good morning ladies and gentleman and welcome to the Apollo Group Incorporated Fourth Quarter and Fiscal 2005 Year End Earnings Conference Call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will follow at that time. Please refrain from entering into the queue until those instructions are given. If anyone should require assistance during the call please press â*â 0 on your touchtone telephone. And as a remainder ladies and gentleman this conference is being recorded today October 12, 2005 and may not be reproduced in whole or in part without permission from the company. There will be a replay of this call available till October 21st 2005, approximately two hours after we conclude today. The replay is 800-642-1687 or 706-645-9291 internationally. The conference ID for the replay is 1132957. Additionally, this call will be broadcast over the internet and can be accessed via the companyâs website at www.apollogrp.edu. I would also like to remind you that this conference call contains certain forward looking statements with respect to the future performance of Apollo Group that involve risks and uncertainties. Various factors could cause the actual results to the company to be materially different from any future results expressed or implied on such forward looking statements. These factors are discussed in the companyâs 10 K report filed with the Securities and Exchange Commission. I would now like to turn the call over to Mr Todd Nelson, Chairman and CEO of Apollo Group. Thank You. We appreciate you joining us this morning. I have just a couple of brief comments and then we are going to turn sometime over to Kenda Gonzales who will give you a little more detail. As mentioned in the press release we are pleased to announce that the quarter is $0.65 versus our revised guidance of $0.64. Also, $2.46 for the year as compared to the original guidance back a year ago $2.40. We are also pleased to mention that our board authorized an additional $300 million for stock buyback, which I believe takes the total now Kenda to⦠Todd Nelson: So we are again very pleased with that, and with that I am going to turn sometime over to Kenda. Thanks Todd. We have had a few questions this morning as to why we did not include the business outlook in our release. We issued the outlook for the first quarter of fiscal 2006 and all of fiscal 2006 on September 19th. Our guidance is based on detailed budget prepared at the campus and department level for the company and those budgets have not changed in the last three weeks. At this time I would like to reiterate that we expect revenue for the quarter ending November 30th 2005 to be between $635 million and $640 million and to be between $2.685 billion and $2.705 billion for fiscal 2006. Excluding the estimated impact of stock option expensing, diluted earnings per share are expected to be $0.72 for the quarter ending November 30th 2005 and to be $3.2 for fiscal 2006. Including the estimated impact of stock option expensing diluted earnings per share are expected to be $0.70 for the quarter ending November 30th 2005 and to be $2.92 for fiscal 2006. Revenue related to students enrolled in degree programs increased 20.3% for the fourth quarter of fiscal 2005 to $550.7 million compared to $457.9 million for the fourth quarter of fiscal 2004. Discounts for the quarter were $29.4 million or 4.7% of gross revenue. During the fourth fiscal quarter we were able to leverage instructional cost and services as a result of the Department of Education Settlement reported in the first quarter of fiscal 2004, partially offset by an increase in our provision for uncollectable account and an increase in faculty pay. Selling and promotional costs decreased as a percentage of revenue in the quarter ending August 31st 2005, primarily as a result of a decrease in advertising. University of Phoenix currently has 63 local campus locations of which 33 are less than five years old, 20 of these local campus locations are two years old or less with 15 of these locations not yet at breakeven for fiscal 2005. During the fourth fiscal quarter of 2005 general and administrative expenses decreased as a percentage of revenue due primarily to decreased employee compensation and related expenses. Our operating margin excluding non-cash expenses associated with the conversion in August 2004 of the tracking stock and the Department of Education Settlement increased to 31.9% for the fourth quarter of fiscal 2005 compared to 31.2% for the fourth quarter of fiscal 2004. Net income for the fourth quarter of fiscal 2005 excluding the items previously mentioned increased 18.4% to $118.2 million compared to $99.8 million for the fourth quarter of fiscal 2004. Turning to the balance sheet, cash and marketable securities were $693 million at August 31st 2005. Net receivables were $201.6 million, which equates to 33 day sales outstanding. At August 31st 2005 we had reserved 21.8 million against our receivable balance and during the fourth quarter of fiscal 2005 we wrote off $11.4 million of Ju9%ne receivable. Although we consistently provide the detail of the student deposits and current portion of third revenue in the notes to our public filings, it appears there is some confusion regarding this balance sheet item. As indicated in the description this item is made up of student deposits 64% of the total and differed revenue 34% of the total with differed application fees making up the balance. The current portion of differed revenue increased 29.3% to $132 million. Student deposits increased 17.9% to $249.7 million. The deceleration in the increase in student deposits is the result of more students managing their own financial aid. Depreciation and amortization expenses were $15.9 million for the fourth quarter of fiscal 2005 compared to $12.2 million for the fourth quarter of fiscal 2004. Capital expenditures for the three months ended August 31st 2005 were $23 million compared to $21.6 million during the quarter ended August 31st 2004. Cash flow from operations for the fourth quarter of fiscal 2005 was a $123.1 million compared to $125.9 million for the fourth quarter of fiscal 2004. During the fourth quarter we determined that the most appropriate presentation of restricted cash to avoid some of the confusion with re-classes etc., is in the investing activity section of the statement of cash flow. During the fourth quarter of fiscal 2005 we purchased 1,483,000 shares of stock. At the end of the quarter including the $300 million additional authorization that Todd mentioned earlier, we have $351 million remaining of the amount authorized by our Board of Directors for stock buybacks. Great. Thanks Kenda. So again I was asked the question this morning about are we still feeling good about our guidance for the first quarter â06 and the year, and thank you Kenda for reconfirming that. Just one another point I would like to make, as we begin this new year we are also encouraged by lead flow and conversion rates going into the quarter so again we are very optimistic of this upcoming year. So, with that I would be happy to open it up for questions. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234064 | Good day, everyone and welcome to this VeriSign, Inc. conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Tom McCallum, Director of Investor Relations. Please go ahead, sir. Thank you, operator. Good afternoon, everyone. Thank you for joining VeriSign's fourth quarter and full year 2005 results call. I'm here today with Stratton Sclavos, Chairman and CEO of VeriSign, Dana Evan, our CFO, and Steven Gatloff, our VP of Finance and Treasurer. In a moment, Stratton will review Q4 2005 results. And will provide some insights into the performance of our businesses. Dana will then follow with a detailed review of our Q4 and 2005 financial results. She will then provide a forward-looking financial guidance. We will then open up the call for your questions. We anticipate the call will end at approximately 3 p.m. We'd like to remind everyone that other than the historical financial data today's discussion may include forward-looking statements in the subject of risks and uncertainties described in our annual report and other reports with the SEC. Our financial results released today on the news wires after the market closed. The press release, the related financial information discussed on the call and a reconciliation of GAAP to nonGAAP financial information can all be found at our website at www.verisign.com, under the Investor Relations tab. This call is being webcast live, both on our website and at StreetEvents.com. Before I turn the call over to Stratton I'd like to remind everyone we set the date for our 2006 Analyst Day. This year's Analyst Day will be held at our Mountain View headquarters on May 25. With that, I'd like to turn it over to Stratton. Tucows Inc. (AMEX: TCX) is the largest Internet services provider for hosting companies and ISPs. Through 7,000 partners globally we provide millions of email boxes and manage over five million domains. Tucows remains one of the most popular download sites on the Internet. Tucows Inc. makes the Internet easier and more effective by reducing business complexity for our B2B and B2C customers as they acquire and deliver services to millions of Internet users around the world. Thanks, Tom, and good afternoon, everyone. Let me add my welcome to all of you attending today's call. As our results indicate Q4 2005 kept a solid finish to a strong year for Verisign with year-over-year growth in revenue coming in at 42%, while operating income grew over 50%. From a strategic perspective, we also saw many of our businesses hit new milestones in terms of installed base, customer penetration, and international contribution. Collectively, these strong financial and business results allowed us to make significant investments in new technologies and infrastructure that will fuel incremental opportunities for us in 2006 and beyond. While the mobile content business posed several challenges in the second half of the year, we still believe we're in the early stages of the move to mobile and broadband entertainment and that our technology assets and expanding customer base have us well positioned to ultimately succeed. All in all, we feel we focused the company on a simple mission. To enable and protect all the world's network based interaction. We believe our accomplishments in 2005 have allowed us to create the world-class portfolio of intelligent infrastructure services needed to execute on that strategy. With that, let me dive into the Q4 and year-end highlights for the business units before giving you an overview of our outlook for 2006. Let's begin with the Communications Services Group. As you know, given the focus on the mobile content business in 2005, we have been reporting the CSG group revenues in two categories. Core communications in commerce and content. The communications and commerce line of business includes the Legacy Network Connectivity, database, and pre and post paid billing services. While the content line of business includes Jamba! and Jamster, LightSurf and our SMS and MMS interoperability services. The strategy in CSG is the same as in the Internet Services Group. Take our leadership position in delivering critical services to carriers and leverage those assets and customer relationships to move into adjacent service areas that show strong growth potential and enable new revenue streams for our customers. Clearly in the communications market this strategy embodies helping our carrier and service provider customers transition from a voice dominated circuit based world to an IP based world where voice, data and content coexist and converge. For Q4 the communications and commerce line of business achieved $105 million in revenue, consistent with Q3's strong showing. In terms of business metric we delivered over 15.9 billion data base queries in Q4, up 10% sequentially and 24% year-over-year. We also processed billing and payment services for approximately 7.8 million wireless users, up 8% sequentially and 20% year-over-year. While we continue to see some pressure on the course signaling and database businesses due to consolidation and customer renewals, we are finding significant interest in our new billing, messaging, and IP connect offering In fact, our two largest billing customers have already committed to our next generation platform, and both are planning new market roll-outs in the first half of this year. Additionally, we are seeing strong demand for our messaging services from both traditional carriers and Internet service providers. We've recently won several new contracts in this space, and we'll be making joint announcements with those customers before the end of the current quarter. We also have several new IP connect services in development that we belive can provide for the democratization of the IP voice world in terms of access and interoperability. We are expecting to introduce these services in the second half of 2006. Expanding our communications and commerce footprint internationally has also been a key objective over the last 12 months. I'm pleased to say that we had significant competitive wins for our clearing and messaging services in both Asia and Latin America during Q4, and would expect to see significant growth in both regions over the course of 2006. Now let's move to the content line of business. Overall we achieved revenues of 114 million during the quarter, down 13% sequentially, but up nearly 21% year-over-year. LightSurf and our SMS, MMS interoperability services accounted for approximately 13 million during the quarter, Jamba! and Jamster accounted for the remaining 101 million in the content group. Slightly better than the earlier guidance due to a one-time revenue item that Dana will discuss. . On the LightSurf and MMS front we saw good growth in the picture messaging business during the quarter and delivered a new client platform to our key customer. We are also well into the development of our next generation messaging platform which will combine all of our messaging capabilities into a common unified offering for carries and internet portals. We expect to launch the new services in the second half of 2006, and have already begun prebriefing with our key customer and prospects. All in all, we believe the assets that we have in the LightSurf platform and our strong and growing carrier relationships have established VeriSign as the clear leader in the multi media messaging space. Now let's move onto Jamba! and Jamster. While the Jamba! and Jamster revenues were roughly on target for Q4, we are still seeing erosion in the base in several key markets. Several factors are influencing the current market demand including continued changes in marketing restrictions in certain countries, as well as our own brand relaunch, which is attempting to simplify our offering. As we said last quarter, we expect the base to stabilize in the first half of the year as we refine our marketing programs, add additional carriers and country, and create a more compelling long-term value proposition for our customers. That being said, we would still expect to see a decline in the B2C content revenues sequentially as we see the effects of the eroding base and the reduction in marketing expenditures. While short-term trends will continue to be hard to forecast we still fully believe in the long-term opportunity in mobile content and in our ability to capitalize on our position as the leading global platform for these services. As we mentioned last quarter, we have several initiatives underway to diversify the revenue contribution in the content business by expanding our B2B offering. Our target customers include traditional wireless carriers, as well as broad based media companies and internet portals. In late breaking news I'm pleased to announce that in the last 30 days we assigned two new B2B contracts to provide a full range of mobile content services. One with a global media company and the other with a leading Internet services company. We would expect both customers to launch these branded services before the end of this quarter. So in summing up the Communications Services Group, I think it's fair to say that the remaining challenges in the B2C content business will have an impact in our ability to get out of the gate quickly in 2006. That being said, we are very optimistic about the growth opportunities that exist across the portfolio, including messaging, international clearing, billing and B2B services. Now let's move on to the Internet Services Group. The ISG group contains our newly remained information services business unit and our security services business unit. Our information services unit is the new name for what was our naming and directory services business. We believe the new name more accurately characterizes the expanded focus of the business, which is to provide relevant, realtime information that enables intelligent network interactions. In 2005 the acquisitions of Arcor Global Systems and Retail Solutions International allowed us to broaden the business into intelligent supply chain services. While the acquisitions of Moreover and Weblog launched VeriSign into realtime publishing services. Of course, while these new businesses have exciting potential, the main driver in VIS continues to be the naming business for dot com and dot net. 2005 was a record year in naming in almost every way imaginable. Increased overall demand, deeper international penetration, and new product traction combined to drive new units and renewal volumes throughout the year, leading to a very strong Q4 and great momentum heading into 2006. During Q4 alone, we processed approximately 5.3 million new registrations for dot com and dot net domain names. We also saw another 6.4 million names renewed or extended adding up to 11.7 domain name transactions in the quarter. VeriSign's adjusted base of that at the end of the period stood at an all-time high of 50 million up 7% sequentially and 30% year-over-year. Our intelligent supply chain services also began to demonstrate important traction as our existing electronic product codes directory services, coupled with our new consulting services from R4 and our point of sale data from RSI have allowed us to build out a set of end-to-end solutions targeted packaged goods and pharmaceutical application. As a case in point, we received contracts in Q4 to deliver ePedigree services for two of the largest pharmaceutical distributors in North America. We expect to begin delivering these services in Q2 and are seeing a growing pipeline for our other supply chain offerings. We expect to see strong growth in this area over the next 12 to 24 months. In the second half of 2005, the VIS group also began to execute its realtime web strategy that we laid out at our Analyst Day in May. Our internal development of a global PING server infrastructure coupled with the acquisitions of Weblogs and Moreover, have positioned VeriSign as the leader in realtime information services for publishers, bloggers, websites and enterprises. We believe we are now touching 75% of all global PING traffic serving over 3 million feeds per day. This traffic volume is up 100% in the last 90 days alone. We are also serving over 100 million aggregate news articles on a daily basis. By the end of this quarter we expect to be harvesting news from over 20,000 sources and providing access to over 4 million blogs in our access fees. As the realtime web continues to flourish, we will look to become the authoritative source of intelligence for enterprises, web portals, and media companies. Moving to our security services unit, we were pleased to see the momentum we had experienced throughout 2005 continue in Q4. Culminating in a record bookings quarter in the security business. We sold over 139,000 at the certificates during the quarter, up 14% sequentially and 20% year-over-year. This brings our active installed base to a record 489,000. Demand here is being driven by an increasing number of transactions at existing websites, coupled with continued international expansion. On the enterprise side of security we talked significant customer wins in the quarter including Scottish Power, Citigroup, G-Mack, Hyatt International, American Express, Honeywell and. As you will recall, one of our key objectives for 2005 was to both deepen and broaden the penetration of our services into major accounts. The security services group executed on this strategy extremely well, as Up-sell Cross-sell rate into our top 25 enterprise accounts reached new levels in Q4. We believe we have become the provider of choice and a strategic partner in these accounts for critical security services. We expect this trend to continue as malicious continue to rise in both complexity and frequency, and as new compliance and reporting mandates take hold. Demand for our Managed Security and Consulting services, as an example, remains strong and we continue to believe we are winning the majority of large account deals in the state. In fact, Gardner recently released its quarterly update on managed security service providers and VeriSign was once again placed in the leaders quadrant in this highly influential report. Strong operational execution, and expanding portfolio of services and value-added intelligence from our global infrastructure helped the MMS business grow over 50% last year. We're also seeing an increasing amount of interest in our unified authentication platform and tokens. Of course, the big news in the second half of the year was our alliance with eBay and PayPal to deploy strong authentication technology to their active user bases. With a firm commitment to deploy a million tokens and a comprehensive game plan to provide incentives for adoption and use, we believe PayPal and eBay represent the ultimate anchor tenants for our unified authentication platform and for a push into second factor authentication for consumers. As we come into 2006, we are looking to accelerate these plans. You should expect the significant announcement regarding our next move in consumer authentication before the end of this quarter as we also begin planning for PayPal and eBay's first deployments in Q2. As we look into 2006, we are very bullish on the Internet Services Group as a whole. We believe our information services and securities services businesses are excellent proof points of the VeriSign intelligent infrastructure strategy. In essence, we have used our unique technology and global infrastructure to build a leadership position in a critical service area where we act as the trusted and authoritative source for enabling and protecting network-based interactions. Our DNS and SSL offerings are perfect examples. Once established, we then move into adjacent markets leveraging our technology, infrastructure, customer relationships and premium brand. In the information services area, we're moving aggressively to build our intelligent publisher and supply chain offerings. While in the security area we have taken the SSL franchise and expanded our offerings into network and end-user security. Strong execution on this strategy in 2005 gives us confidence that the ISG group will grow by 20% or more again in 2006. Let me now say a few words about Q1 and our outlook for 2006 as a whole. Overall, we believed the end market demand for our intelligent infrastructure services is continuing to accelerate as the world continues its migration from physical to digital interactions. With these trends in mind, we are expecting a strong showing in the Internet Services Group in 2006, as our services continue to enable and benefit from the global growth in network based communications and commerce. Meanwhile, our strategy in the communications business is to continue to gain market share with our core offerings as we attempt to ramp new services such as interactive messaging, voice over IP interconnect and B2B content for both mobile and broadband. We also believe there is still a significant opportunity to increase our global share across all of our businesses. As it relates to Jamba! and Jamster, there will be a tough year-over-year comparisons in Q1 and Q2. We'll continue to manage our marketing expenditures carefully as we look to reposition the offering and support the B2B rollouts during the course of the year. Putting this all together, and remembering that we're heading into a year without the payment business, means that Q1 will be sequentially down from Q4. We do expect, however, to be able to grow revenues and earnings sequentially throughout the remainder of 2006, as ISG grows at a 20% clip, and CSGC's new product revenue streams kick in. With that, I want to thank you for your attention. And now I'll turn the call over to Dana. Thanks, Stratton. And thank you, everyone, for joining us this afternoon. As you can see, our results for the fourth quarter cap off what was a strong year for VeriSign. We delivered annual revenue of $1.66 billion, up approximately 40% year-over-year, operating income of $362 million, up 52% over for 2004 levels. And we drove annual earnings growth of more than 53%. In addition to generating solid financial results, we also strengthened our balance sheet throughout the year with record annual operating cash flow of $480 million, and free cash flow of nearly $340 million for 2005. This strong cash generation afforded us the ability to aggressively repurchase nearly 23 million shares of our common stock throughout the year. While still making significant investments in operations and focused acquisitions to support future growth areas such as supply chain, realtime publishing, multimedia messaging, and enhanced security services. We also saw strong balanced performance across our core businesses. Not only in the fourth quarter but throughout 2005. As Stratton just mentioned, however, we certainly saw some challenges in the second half of the year in our mobile content business, where we continue to focus on stabilization and discipline spending. Before we begin with the Q4 results, let me spend a few minutes on the sale of our Payment Gateway business to eBay, which closed mid way through the fourth quarter. The partial quarter sub period for that business generated approximately 8 million of revenues, and 4 million of operating income, which is included in our nonGAAP results for the quarter. On a GAAP basis this transaction has been treated as a discontinued operation, and has been reflected as such in the financial statements released this afternoon. In addition to the income statement impact of the sale, we also saw a 12 million of deferred revenue come off our balance sheet with the closing of the transaction. Lastly, for those of you who have not taken the Payment Gateway business out of your models for 2006, it would have been forecasted at approximately 75 million of revenue, and 50% operating margins for the current year. So with that, let's turn to the detailed financial results for the quarter starting with the top line. On a consolidated basis, VeriSign reported fourth quarter revenue of $401 million, representing a 13% increase year-over-year, and a 3% decrease over Q3. Looking at the detailed revenue by reporting unit, the Internet Services Group delivered approximately $182 million of revenue for the quarter, up 19% over Q4 of the previous year, and up from 177 million in Q3. For the year, ISG revenue came in at $686 million, up 22% over 2004. The year-over-year revenue growth was driven by consistent strong performance of SSL in managed security services, both in the U.S., as well as an Amia and Asia pack and solid growth in the global sale of domain names. Our Communications Services Group reported $219 million of revenue for Q4. Up from 204 million in the same quarter last year, but down from the 238 million we reported in Q3. For the year, revenue in CSG came in at 976 million, up 62% over 2004. This was driven primarily by growth in our core signaling and connectivity and multi-media picture messaging services throughout the year. While in our Jamba! Jamster business we saw solid revenues in the first half of the year, which weakened significantly during the second half. Within this reporting group, Q4 revenues from the core Communications and Commerce line of business were relatively flat, and in line with our guidance. While the mobile content line of business delivered $114 million of revenue. Note that this includes $101 million from the Jamba! Jamster services ahead of our guidance of 90 to 95 million, due to 5 million of one-time revenue events in the quarter. Moving to our international operation, the percentage of revenue driven from international customers, affiliates, and subsidiaries was approximately 32% for Q4, relatively flat from Q3. For 2005 international revenue represented 36% of annual revenues, as compared to 28% in 2004. While the content business is obviously a big contributor to this number on an absolute dollar basis, in our Internet Services Group, international revenues were approximately 38% of total revenues for the year as well. Looking at cost of revenues and gross margin, our cost of revenue for the fourth quarter was relatively flat from Q3 at 129 million. This translates into a 67.7% growth margin for the fourth quarter, down from 68.9% reported in Q3 but better than previously guided to due to the higher than projected mobile content revenue. Total operating expenses for Q4 were $181 million, down from $189 million in Q3. The majority of that occurred in the marketing area, and is attributable to controlled marketing spend in our mobile content business. Offsetting the decrease in marketing spend our additional G&A expenses incurred in this quarter, primarily for increased Sarbanes-Oxley and audit-related activity. With that said, pro forma operating income came in at $91 million. This translates into a 22.6% operating margin, a slight decline over Q3 after factoring in the lost operating income from the sale of the Payment Gateway business. As it relates to employee head count, we ended the year with a total employee base of a little more than 4,000 people, up from 3200 at the end of 2004. VeriSign reported nonGAAP pretax income for the fourth quarter of $94 million, down from $102 million in Q3. Year-over-year nonGAAP pretax income grew a healthy 57%. NonGAAP earnings per share for Q4 was $0.26, which is at the high end of the 25 to $0.26 range we gave in November, after the close of the Payments transaction. This earnings per share calculation uses a diluted weighted average shares outstanding number of approximately 257 million shares for Q4, consistent with our guidance. Moving on to the balance sheet and cash flow items, cash balances increased by $107 million in Q4, translating into cash equivalents in short-term investments totaling $906 million at year end. This sequential increase in cash was the result of strong operating cash flow in the quarter, and 370 million in cash proceeds from the sale of our Payments Gateway business. We used $290 million of cash during Q4 to repurchase approximately 13 million shares of VeriSign common stock. And over the course of 2005, we repurchased a total of approximately 23 million shares of VeriSign stock for $550 million, or nearly 9% of total shares outstanding. We're pleased that cash balances for the year increased over $100 million, even after these significant stock repurchases, 140 million of capital expenditures and 176 million spent on strategic acquisitions. As it relates to accounts receivable, net DSO for the fourth quarter came in at 51 days, which is consistent with the previous quarter. Net of the much higher DSOs we see in the content business, DSOs from our core businesses remain below 40 days. Total deferred revenue on the balance sheet was $496 million at the end of Q4, as compared to $481 million in the previous quarter, after factoring in discontinued operations. This balance reflects the reduction of deferred revenue from the sale of the payments business, which was more than offset by continued bookings growth from the domain name registry and businesses. On a year-over-year basis, deferred revenue grew 23%. Operating cash flow for Q4 was in excess of $140 million, fueled by solid operating income and favorable working capital for the quarter, bringing us to our record total cash flow for 2005 of approximately $480 million. Capital expenditures for the fourth quarter were $67 million. For the year, capital expenditures came in just over $140 million, 25 million above our original forecast for the year, due to three main factors. One, approximately 12 million spent throughout the year on capital for the newly acquired companies Two, additional investments in our next generation BCS billing and payment platform. And three, the initiation of the build out of the new data center on the East Coast. The annual capital expenditure distribution was relatively consistent with 2004, and breaks down as follows. Communications Services Group, 47%, corporate and infrastructure services, 34%, and Internet Services Group, 19%. And that completes the financial review. So let me now turn to some guidance for Q1 and our outlook for 2006. As it relates to Q1, we would look for revenues to be in a range of 370 to $375 million. This revenue guidance reflects the expectation that the Internet Services Group will represent approximately 49% of revenue, and Communications Services Group approximately 51%. Additionally, this guidance anticipates consistent growth in ISG, and in CSG a flat quarter in core communications, Jamba! Jamster revenue in the mid-$70 million range, and continued double-digit growth in our SMS and MMS services. As it relates to margins for Q1, we would expect gross margins to decline and be in the 65 to 66% range, due to the anticipated decline in Jamba! and Jamster revenue and the sale of the very high margin payment system. In terms of operating expenses, we will continue to execute on our plan for investing in the next generation services, while remaining focused on expense management in all areas. This would suggest a modest increase in Q1 for R&D expenses, and for operations and infrastructure costs included in G&A. Given the revenue decline and modestly increasing investments, we would expect operating margins to be in the 20% range. As it relates to share count, we would forecast a diluted share count of approximately 250 million shares for Q1. So taking into account the anticipated Q1 revenue, our planned increase in spending and the margin guidance I just gave as well as the loss of two pennies of EPS from the sale of the payments business, we are guiding to earnings per share for Q1 of $0.21 to $0.22 on a fully tax basis, using a 30% effective tax rate. Looking at operating cash flow, we would expect to generate cash flow in Q1 of approximately $50 million. While this forecast is obviously well below the Q4 cash flow we just delivered, Q1 historically is a light cash flow quarter for us. This is the result of cash to be paid out for annual bonuses, and the significant capital assets purchased late in Q4, both of which are accrued in accounts payable at year end. Our outlook for capital spending for the year anticipates total capital expenditures of approximately $140 million. We would expect approximately 50% of that annual budget to be spent in the first half of the year. And lastly, as we look out to the rest of the year, given the continuing difficulty in forecasting the trends in the mobile content business, we will not be providing full-year guidance at this time. With that said we would like to reiterate the growth expectations for our core businesses. Specifically, in the Internet Services Group we continue to look for both the security and information services businesses to grow revenue at least 20% year-over-year. And in the Communications Services Group, we would anticipate the core VCS business to grow in the mid-single digits. The emerging SMS and MMS business are also expected to deliver solid growth for the year. Operating margins from these core businesses are expected to increase throughout the year as well, and that should drive EPS improvement each quarter. As we begin the new year, we expect to continue to face an uncertain landscape in the Jamba! Jamster business, but nonetheless, we are well positioned through continued momentum in our core businesses in 2006. We're also excited about our opportunities in the new growth areas and are looking for our strong balance sheet to continue to fuel further expansion and growth. So with that, I'd like to open the call for your questions. Operator, may we have the first question, please? Hey, guys. Two questions for you. First on Jamba!. Can you give us an indication in terms of the branded business versus the B2B business. What was B2B as a percentage of revenue this quarter? That breakout in Q3, Todd, was about, only about 5% B2B. We haven't turned on these two new customers that I just mentioned, so it was probably roughly the same in Q4. Okay. And if you just look at the branded capabilities. You guys have slowly been managing the marketing of expense. But is this something that you managed marketing expense that never stabilizes? I mean, how do you see it beginning to grow again on the branded side? Well, I think there's just a lot of things in flux there. Obviously, we're just 60 days into the relaunch on the brand. And it's only in the, the hardest country, the UK and then the U.S. So we'll be continuing to roll out new branding programs and new packaging in the over the course of the next 60 to 90 days, including in Germany, we're continuing to try different types of marketing spend. And different ways in which we promote the value proposition of the offering. So there's just a lot more work to be done. I think it's too early to tell. Meanwhile, what you're seeing us do is really devote a lot more resource in the selling proposition and the support proposition around the B2B side to help bring that revenue number up as we get further into the year. If you look at your three largest markets, UK, Germany, and the U.S. would you expect all three to be down sequentially from Q4 to in to Q1? I would expect the UK and the U.S. could be down a little bit sequentially, I'm not clear on Germany yet. Okay. And then just one quick question on the ISG side. Very aggressive or nice guidance, at 20% plus. What are your expectations on the domain name side. How sustainable is the growth on domain names? Well, in 2004 the domain base grew 26%, which we thought was a pretty healthy clip. It grew 30% in 2005. And we would have expected some level of leveling off there. As it's turned out, so far in January it's actually accelerated a little bit again. So it's just hard to know. We are continuing to see good fundamental growth driven by all those factors, including the PPC market and the PPC markets not increasing dramatically as a percentage of the name. So the raw pure demand is still there. So it's looking pretty good and renewal rates continue to be in the 73, 74% range. So obviously it's, it's been strong and it seems to be getting a little bit stronger. Yes, good afternoon, guys. Maybe you can give us an update on some of the domestic tier 1 carriers that you're been targeting are either in soft launch or supposedly right around the corner. And in light of your guidance of the U.S. being down sequentially. And we continue to leverage that platform. Not at full volume yet. But at a good reasonable clip. No new news on Verizon. We continue to be waiting for their go ahead to bring more off portal providers on board. And we would expect to still be in the first rush of those as they do it. It's a function of churn. And it's really related to the run rates as you still saw the UK diminish in Q4. Obviously, as you come into January you have the smaller base that you're starting to count from. So it's really mostly related to churn, not in pricing. Okay. And then some of the new businesses I think you've been trialing over in Europe, like prepaid phone cards, full music downloads and then I've seen also eBay auctions. Any update there on any early traction you're getting or what the opportunity is? Probably too early to make any overall statements on it. We do have a lot of things that we're working on. Some are showing really interesting dynamics. Others are, we're kind of quickly eliminating. So I think the team last count I saw had something on the order of two dozen or so different initiatives that they are working in the German market in particular, and starting to do in the UK as well. All of which we are measuring on a daily basis and obviously those that work we'll pour more resource into and those don't we'll kind of shuffle, or shut down quickly. I would doubt it. I think what we're looking to do really is obviously get the B2B side ramped. You'll see those announcements later this quarter. You'll begin to see us focus kind of marketing efforts really in the main countries here and so we've done a little bit less new country ramp-up here in the last 60 days. And we'll probably do, hold that as well here in Q1. Just really want to get that base stabilized. And as we get to stabilization, I think we'll be more broad based in our discussion of the dynamics. On the communications side. Starting first with the Jamba!. Dana, I'm assuming that $5 million one-time event was related to Sprint turning on? No, actually, it wasn't. It was a, we had had a rev-share dispute with one of the carriers that we had settled up on in the quarter. Okay. And then as far as when you do, I know you're not giving full-year guidance but when you start to think about seasonality in this business, typically there's been a lag effect to handset shipments. You're at Q1 you're guiding down. When you start to look at the summer months how should we start to think about just those generally speaking? Well, I think last year was probably a unique year. In that you had a lot of the one-hit wonder with the Crazy Frog coming in Q1 and Q2. And then you saw, I think a real backlash because of the marketing restrictions in Europe. So it's really unclear to us what the steady state dynamics are going to look like, right? Generally, we would expect Q1 and Q2 to be stronger, Q3 and Q4 to be weaker. Given what happens with handset sales and what happens with summertime in various regions that we're in. But, again, I just don't think we've had a normalized year yet. And then also, just looking at, can you contrast, I guess, just the business models there as far as your percentage share of the dollar business and how the gross in operating margins sort of differ between those two. The B2B deals as you'd expect with organizations of the five that we're doing them with tend to be custom right whether we're doing website hosting, linking to other properties, different number of languages, and the rest so, I don't know that there is a common framework yet for B2B deal. In general, though, we will take much less of the revenue share, however, we will have zero of the marketing cost. So on the margin structure, I would think long-term they'll end up being about the same. It's just how, where in the gross margin line you see it. And then finally, just last on the B2B side. When you look at your global footprint, who else do you see out there as a competitor, not just from a U.S. offering, but actually does have that global support. Well, I think it would be fair so say that one of the reasons that we won these last two accounts was because of our global reach. The fact that we could turn on in multiple country, in multiple language with multiple currencies and with dozens of carriers so I think it is showing that at least for the large brands that want to have that kind of a presence, there really isn't a strong competitor who can match us. In local markets if you're a local carrier or a local portal in a market and you're really only concerned with your geography, then there are point providers in each of those markets. Clearly here in the U.S. you've got smaller companies like InfoSpace and Motricity. In Europe you've got companies like ZET and others, but I think from a global perspective, we're probably one of the only ones that can do that. Great. Thanks very much. Stratton, you've mentioned the eBay deal, the PayPal-type of sale. How was the traction date on the token arrangement? I know you have a contractual minimum that will be rolling up next couple of years. Has that started yet or is that later in '06? We've been in detailed planning with them on a roll-out as you would expect. In their market place, with the number of users they have, they're being diligent about mapping this infrastructure into their existing user name and log-in system. And then in to the various properties across PayPal and eBay. So we had always planned for Q2 roll-outs in some limited geographies and that is on track and on schedule and we have worked with them on the, both the infrastructure integration as well as the tokens that they've chosen to use for their first roll-out. So it's actually proceeding very well, very pleased with the level of dialog and engagement we've got on their side. And they will be part of the bigger announcements we'll be making here shortly. Okay. And then just on the naming directory side of the house or not, I guess as you're calling it. How is your feelings for the pricing environment heading into '06? Is there some leverage there at all in single digit-type land? Or is there pricing pressure? What's some of the general feedback on that? Well, we're still in settlement discussions or we've proposed a settlement to ICan and it's board and they're still evaluating that. If that goes through as it's currently written, we would have the opportunity starting in'07 to raise prices. We've made no decisions whether we would do that or not but at least the flexibility will be there. And as well in the new .net contract we currently do have that flexibility starting, I belive in 2007 as well. So there is some opportunity for pricing flexibility in the future. Whether we'll choose to exercise that as soon as we can or not, we hven't made those decisions yet. Hi, just a couple of questions. I guess you mentioned certs were up year-over-year about 7% in terms of account and the revenue. I guess I'd gather probably is in the 20% range growth because that group was in that range. Stratton, could you just tell us sort of what's going on there? I know you've been at the high end of the market for a while. Just trying to get sense of are you turning off the low-end stuff and ASP's going up? Or where is, where is that big discrepancy coming? Yes. A couple of things. One, we have been the premium price brand in this space for a long time. And through the course of 2004 and 2005 had taken prices up for both new units as well as renewals and we had been upselling customers into higher strength, broader-based packages. So in essence our ASP's have been going up over the last two years and obviously on a recurring revenue customer base that over time continues to build your revenue better than your unit growth is going to show. At the same time, we've also seen a shift a little bit from our thought brand into our VeriSign brand. So you're getting the higher price items at retail as well. So all in all, we're just seeing the pricing dynamics work out in our favor over the last 24 months and that's showing up in the growth rates on the business. Okay. Great. And then just on the mobile consent side. Is it your plan that Q1 would be the bottom in terms of margins on that mobile content business? And they would pick up in the second, third and first quarter or do you have to continue to invest and take those margins down to drive the B2B stuff? I think it would be our goal that that is the way it turns out. I think we have been snake bit on that a couple times here in the last 6 to 9 months. So we're going to watch it carefully. I think because that marketing expense is variable we continue to have that leverage to be able to use over time. But we also don't want to starve the business and stunt it's recovery because we're not going in for customer acquisitions. So I think it's a balancing line we're going to walk. And our hope is that Q1 is where that turns. Thanks a lot. Dana, you provide guidance for Q1 for $0.21 to $0.22. I was wondering if that included stock option expense? No, that's a pro forma EPS number. On a GAAP basis, there will be about 12 million of stock option expense in Q1. Okay. The second question I have is you guys announced a $500 million buyback in August. I was wondering how much capacity is left in that buyback, and what kind of activity you've gaged in Q4? There's about 120 million of capacity left in that plan right now. And as I said, we did buyback quite a bit of a stock within the quarter, partially part of that plan and completing our old plan that we had in place. Yes. Question about the signaling and data base businesses. You've commented on some pricing pressures there. Can you talk about what's at play there. Whether you have any large contract coming up for renewal and what other services there you, you have most confidence in seeing offset that? We have generally Q4, end of Q4 and heading into Q1 is when our signaling database contracts typically come up. This year looks like we have one relatively large size tier 2 provider coming up, that'll cost us a few million. I think it is important to point out we do expect the Q1 revenue in the communications group to be flat with Q4. That'll be the first time in three years that that's actually happened. So we're not losing a significant post-pay billing customer. We're not seeing a dramatic number of renegotiations on price. So being able to come out of Q1 flat from Q4 and then grow it from there, we think is a partial victory that we'd like to see obviously continue to better growth rates heading out into the second quarter. Okay. And not to beat a dead horse, but on the geographic distribution of the Jamba! revenues, were there any regions where the deterioration or the churn was actually worse than you anticipated or better? And just your thoughts about you've expanded into several countries over the last few months. And just wondering whether you may just continue on a delivered customer acquisition course, or whether you're really looking to pull back most of that? Yes. So, we, again obviously the most important country is Germany and I would say the decline there was less than we had planned. The UK continues to see significant drops and I think the marketing restrictions there plus the publicity in the market has just got the pendulum over to the far right there and we'll have to wait for that to come back. And we'll ease off on our marketing expenditures there for awhile. In the U.S. market, while there was a climb in Q2, I'm sorry, in Q4, most of that was self-imposed in that we went through with the carriers and have eliminated from the base it, folks who, on the prepay side or the post-paid side we did not see billable collections from. So we did one relatively large clean-up in Q4. Other than that the U.S. is declining at a relatively modest rate. And as spring kicks in fully and Verizon comes on, hopefully in the late first quarter early second quarter we'd expect to turn that around. I think we're also trying, Ed, a ton of different marketing techniques right now to make sure we're establishing the value proposition of the subscription. One of our findings in Europe has been through some focus groups that people would just as soon pay $5.99 to get the single ring tone and then cancel, and so they're not seeing the value in the option of having that $5.99 there to allow them to get multiple products, so we've got quite a bit of marketing programs underway to test various combinations in the advertising to make sure that the propositions coming through. We're hopeful that's going to extend the lifetime of these customers as well. And just a final question on some of your realtime web services. Could you provide just a little bit of color in terms of how you expect to monetize the opportunity from Moreover and Weblogs. Sure. There's some short-term and then obviously longer-term ideas there. So in the short-term we really aren't making any financial return off of the Weblog PING infrastructure on our own. We're really providing that as a community-based service. We're now handling about 75% of the traffic. As I said, it grew 100% in the last 90 days. But on top of that, we're now building the feed management and aggregation services for Moreover. We charge enterprises and search engines and portals a monthly fee for the service there to get the data streams, if you will. And the, and then longer term we'll look to do add insertion and content metatagging to provide personalized more relevant, if you will, feed management. So all of those will enable an advertising model longer term that, as we said last quarter, we'll talk about as we're ready to turn it on. I just want to go back briefly to Stratton, your comments on the ability to raise prices in the registry in the domain name side. What sort of levels of price hikes could you put in right now in .net. Where you have a contract in place. What are you offering as an icon on the.com side? Sarah, I believe the .net got finalized with a 10% per year increase capability. A sealing of 10% raises. And that is finalized and done. Again, that would allow us to start, I believe, in 2007. .com has a 7% number in there. And that's currently, as I said, being evaluated by the ICan board. Okay, great. And then on the intelligent supply chain offerings, you talked about your, you feel that that could be a good business for you in 2006. What sort of size are we talking about? Is it kind of, 10, 20 million. Is it bigger than that? Just wondering if you could help us scope that out. Yes. Supply, intelligent supply chains is looking like it'll be over 25 million of revenue this year. So we're pleased with that ramp, that's probably coming off about a 10 million, less than 10 million this year. And then just to note on the realtime web, we expect in its first year it'll probably do somewhere north of 10 million. And obviously have very high growth rates quarter-over-quarter. That's what, as I have said earlier, the way we like to think about those businesses is that you can build them off the existing infrastructures but then begin them to see them ramp to 50 to 100% growth each year as the markets emerge. Got it. And on the supply chain side, is that some monthly consulting revenue or is there real product, are people actually using the registry or the registry piece that you things like RFID. It will probably be about a third consulting, a third of the directory services, the traditional EPC. And then a third will be coming from new contracts that we're launching, like the ePedigree services with the two pharmaceutical distributors. As well as some of our retail point of sale services that RSI has. Got it, okay. And then just a final question. A little bit more of just a bigger picture. Because you have a lot of moving price in your business. What's the goal? Over time that you see synergies on the revenue side between ISG and CSG? Or is it more that there's synergies on the back end and leveraging the infrastructure and that's kind of why you keep the two pieces together? That's all right. So let's talk about the infrastructure side. There's definitely over the long-term infrastructure synergy. Several of the CSG services run inside us are broad-run facilities that operate .com and .net in the security businesses. And are on platforms that team has been building for them, including some use of the atlas technology, in fact the VoIP services use a full-blown atlas implementation. On the distribution side obviously the sales force is, we had our, ran our first combined sales meeting a few weeks ago. And the sales forces are now working across major accounts trying to go in and provide kind of end-to-end communications and security services. And then lastly on the engineering side, for example, something like our ePedigree solution would use the supply chain EPC services around directory and RFID tracking along with digital certificate and digital signing technology from the security business to create audible transaction records as the pharmaceuticals move across the supply chain. I think we are. I think it's early in those days. I think it's most accomplished on the infrastructure side, which obviously you can't see from the outside. It's beginning to work in product planning around next gen services like ePedigree, the VoIP offering will also have a security component and an atlas component. And then in the distributing side it's likely we would probably look to do more consolidation and combination of the sales force as we head into 2007. Okay. Thanks very much. Hi, guys. Just a couple questions. In terms of the CSG business or the core CSG business. I guess the guidance went down maybe slightly from that mid-to-high single digit range previously. Just wondering if that's the result of any forecasting changes perhaps in the signaling and database business or just kind of more for just the CSG business on a larger or broader perspective? Yes I would say no, no signaling going on there. We're just, mid signal digits is a reasonable number to walk into the year with. Okay. Good. And then just secondly, looking at MMS and SMS revenues I think went up slightly Q4. Is it possible at this point, Stratton, I know it's early on to see any discernible acceleration as a result of the enhanced MMS interoperability? Gregg, that business is going to show double-digit revenue growth in the Q1 guidance. And it's actually going to grow over 100% this year, year-over-year. Now granted it was off the small base but it's seeing significant traction. See, she wasn't going to let me answer that. She wanted to give you that. We are seeing both very good uptake in the existing accounts. And we've got a whole lot of proposals out on new stuff there. So like you would expect, several years into the MMS phenomena it's starting to get traction. I think Sprint now says that they've exchanged over 400 million pictures using our picture messaging service. And with the interoperability I think you're going to start to see that traffic patterns grow like SMS did once interoperability came in. Good afternoon, just a couple housekeeping items. Dana, when you look at the mobile business and the $5 million one-time event. Should we be using kind of 109 going forward to think about being down sequentially or should we use the 114? The Jamba!, that 5 million was in the Jamba! Jamster business. And we said that was 101. So your run rate net of that would be 96. Okay. Great. And then on the balance sheet I think you talked in your prepared remarks, accounts payable went up. What was that due? I think it increased like 80 million? So we had significant year-end capital spending of over $60 million. Which is the biggest piece. And then traditional year-end spending that always drives accounts payable up as well. Yes. One of the big pieces in there that we really haven't talked much about so I'll kind of start the discussion now is we are, we have committed to building a new state of the art data center on the eastern seaboard here. And probably a good chunk of capital extension in Q4 to the first down payments on that facility and equipment. We'd expect that data center to be up and running in the second half of the year, towards more the end of the year. It will be VeriSign's most comprehensive data center yet. And is there really to allow us to increase our service levels to 100% in some services, and so the 5-9 in others. So we're, we do believe in this world that's moving to software and, managed servi, software as a service and managed services for network, that he who has the best service level agreement will win and that investment in that data center is started now. Hi. Most of my questions have been answered but in terms of the authentication business, Stratton, have you seen any reaction in the marketplace following the directive issued by FFIEC? And also maybe you could give us an update on the status of your anti phishing business? Thanks. Sure. Lots of incoming phone calls, lots of meetings. I think all the financial institutions are trying to get a sense of what's available in the market. What could they deploy easily, what are the benefits of deploying second factor authentication versus using fraud management tools, versus using something else. So I would say that what we've seen since the directive came out, is a ton of discussions with just about everybody. And my expectation is all the vendors are getting the same phone call. We would expect to start seeing some activity there in terms of deployment probably in the second, third quarter as people are testing out these new services. I think you're also going to see this consumer push that we've talked about dove tail with that and you'll see not just traditional financial institutions, but other, if you will, Internet lifestyle companies. Whether they be portals, or healthcare or market place companies begin to look at this as well. So we're pretty excited about it although I think right now it's in a lot of tire kicking. Our anti phishing business is good. We have a good consulting business there, we work with several of the major banks, if you will, most targeted sites. I think phishing, is however, while it was kind of a focus topic several quarters ago, it's really now one of five or six different things people are worried about, including these new terms that's farming attacks. And these key stroke bloggers and all the Spyware. So our customers are being inundated with this stuff. And I think that's why the security business is seeing the demand it's seeing is they just can't keep up. It's different by market place, in Europe you tend to still see a lot more polyphonic tones than you do here in the U.S. I would say in Europe we're probably 30 to 35% real tones and the rest poly tones and graphics. Here in the U.S. real tones are probably 60% already of the offering, and I think that has to do with the handsets bought here. The market evolved here later and, therefore, the hand sets we're targeting are the more sophisticated ones. The data plans are cheaper, and I think that the genre, if you will, is really focused on those real tones from the real artists. And you might have already mentioned this but, in the U.S. does Sprint contribute as much as you expected it to? I would say it probably did in the Q4 period. You know, hard to gauge. I mean, they were immediately out of the gate were the largest carrier in terms of new sign-ups. But that's because they had pent up demand from those subscribers for not having been available prior in the year. So I think we won't now steady state here until this quarter or next. Well, I think we're very excited about this messaging area and we believe interactive messaging both in the tech side as well as in the multimedia side are going to be very big growth opportunities. So we've looking at expansion internationally and new types of services there. There's always a build or buy discussion. I think we're also looking into the broadband side around content distribution and content delivery. These are things we've talked about over the course of the last few quarters and I think those still remain the most interesting spaces for it. And then on the Internet services side, it's really now just building out the franchise that we've got with things like iDefense that was a very successful acquisition for us last year. Where we're bringing more intelligence to the security information and our customers are obviously clamoring for that. Okay. And last question, now that Sprint merged with Nextel, I mean, is there any update regarding the MMS deal you guys have going on there? We've just delivered a brand new client to Sprint for the picture messaging service. It's one of their most profitable and successful product lines so we don't have an update there. I know there are others in the industry talking about that but our expectation is that they will be a long-term and successful customer with us in the MMS area. Hey, most of my questions have been answered but with regards to authentication service you did allude to a near-term announcement. Could you clarify whether that's an announcement around an additional customer or some type of additional offering? Okay. And then just with regards to VoIP, you're mentioning VoIP. Any update on mobile VoIP initiatives? I know you guys had a couple of roll-outs at universities late last year, particularly around timing, or anticipated timing of that. I think that we are continuing to see good interest in that service. That is a new ecosystem that has to get developed because you're dealing with Wi-Fi to cellular roaming, you're dealing with handsets that have to have dual mode capability, you're dealing with carrier hand-offs and Wi-Fi hot spots, billing and clearing facilities so those are big projects. What I would tell you is we did sign another customer for trialing the wireless service here in Q4. It's one of the new brands that's going to be coming out with very advanced phones, including Wi-Fi land capability. But my expectation is that the hand sets are going to be the long pole in that whole market as you just don't have, if you will, the appropriately packaged and priced and available hand sets right now. So our expectation is those pilots will run through the first half of the year. We'll learn a lot. And it's likely in the second half of the year there'll be some new fancy hand sets that can take advantage of all of this. At this time I'd like to turn conference back over to our speaker's for any additional or closing comments they may have. Thank you everyone for your time today. As always we look forward to talking to you, answering any additional questions you may have. Thank you and good evening. And once again, everyone, this will conclude this VeriSign, Inc. conference call. Thank you all for joining us today. You may now disconnect the line. Tucows Inc. (AMEX: TCX) is the largest Internet services provider for hosting companies and ISPs. Through 7,000 partners globally we provide millions of email boxes and manage over five million domains. Tucows remains one of the most popular download sites on the Internet. Tucows Inc. makes the Internet easier and more effective by reducing business complexity for our B2B and B2C customers as they acquire and deliver services to millions of Internet users around the world. |
EarningCall_234065 | Hereâs the entire text of the prepared remarks from Sinaâs (ticker: SINA) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good day, ladies and gentlemen. Welcome to the Sina Third Quarter 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will, however, be facilitating a question and answer session towards the end of the conference. I would now like to turn the presentation over to your host for today's conference, Ms. Chen Fu, Investor Relations Manager. Please go ahead, ma'am. Thank you. Good morning. Welcome to Sina's earnings release for the third quarter 2005. Joining me today are CEO Wang Yan, our President and CFO, Charles Chao, and our COO, Hurst Lin. This conference call is also being broadcast on the Internet and is available through the Investor Relations section of the Sina Website. Before the management presentation, I would like to read you the Safe Harbor statement in connection with today's conference call. During the course of this conference call, we may make forward-looking statements, statements that are not historical fact, including statements about our beliefs and expectations. Forward-looking statements involve certain risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Potential risks and uncertainties include, but are not limited to, Sina's historical losses, its limited operating history, the uncertain regulatory landscape in the People's Republic of China, the effect of the notice issued by the Chinese State Administration of Radio, Film and Television in late January 2005, on the Company's revenues from usage-based SMS products promoted via direct advertisement on radio and television, the Company's ability to develop and market other usage-based SMS products, fluctuations in quarterly operating results, the Company's reliance on mobile value-added services and online advertising sales for the majority of its revenues, the Company's reliance on mobile operators in China to provide mobile value-added services, the change in January 2005 by China Mobile to its billing process for undelivered MMS services and the effect of those changes on the Company's MMS revenues, the migration by China Mobile of MMS onto MISC platforms and the effect of such migration on the Company's MMS revenues, any failure to successfully develop and introduce new products, and failure to successfully integrate acquired businesses. Further information regarding these and other risks is included in Sina's Annual Report on Form 10-K for the period ended December 31, 2004 and its quarterly report on form 10-Q for the quarter ended June 30, 2005, as well as in its other filings with the Securities and Exchange Commission. Additionally, the non-GAAP and comparable GAAP information are contained in our earnings release, which can be found on our corporate website at http://corp.sina.com. Following management's prepared results, we will open the lines for a brief Q&A session. Now let me turn the call over to the CEO, Wang Yan. Hello. Good morning to those of you in Asia and good evening to those of you in the U.S., and a warm welcome to all of you to our September quarter 2005 earnings conference call. September has been both a rewarding and a challenging quarter. We reached our revenue target of $49.6 million, which was an increase of 8% over the previous quarter. This performance was achieved mainly by the fact that our core advertising business continuing to perform strongly. The advertising revenue of the September quarter was $23 million, which is a 24% increase over the same period last year and a 13% increase over last quarter. Advertising revenue now represents 46% of our total revenue, compared with last quarter's 44%. On the Mobile front, unfortunately we had to make some difficult decisions regarding the usage of television advertising for a few of our key SMS monthly subscription products. Due to this marketing decision, we ended up spending much higher advertising dollars than what we had originally anticipated. While this may have caused a temporary setback in Sina's profitability, I personally believe that this decision should bring future benefits to our Wireless business. I will now turn it over to Charles to give you more colors regarding the impact from the advertising decision that we made regarding our Wireless business. Thank you, Wang Yan, and good morning, everyone. As Wang just said, we have closed a rewarding and challenging third quarter. At the beginning of the quarter, we told investors that we cautiously believed that we would have some modest growth in our Wireless business, primarily because we had seen some encouraging results from our TV campaign starting from the end of the second quarter, for a couple of our newly introduced monthly subscription based SMS products. We carried out an extensive TV campaign throughout the third quarter. Our total advertising expenses relating to this campaign amounted to $6.7 million in the third quarter, significantly higher than the $1.2 million similar expenses we had incurred in the second quarter. We acquired many new subscribers for our new monthly subscription based SMS product service through the TV campaigns during the third quarter. And each subscriber paid approximately 10 IOV which translates into about $1.25 per month for the subscription. As a result, our SMS revenues for the third quarter increased by 11% from the second quarter, to $17.4 million. During the third quarter, however, we faced a tough decision as to whether to continually invest in direct advertising activities, since we put even more costs in advertising than the revenue benefit we would receive within a quarter. We have maintained a sophisticated live monitoring system on the effectiveness of the TV campaign and we are confident that over the latter period of the subscriptions for the part users we will generate positive returns. Our experience has been that a subscriber on average will continue a subscription for a few months. As a result, we decided to continue to increase our TV advertising spending as long as the spend will generate reasonable returns over the long term, and we ended up spending $6.7 million in TV campaign in the third quarter. This amount was obviously higher than our original projection at the beginning of the quarter. This was a tough decision as we could have cut back advertising to include the bottom line for the current quarter, but we believe that our decision makes sense from the business point of view. We generated approximately $5.5 million revenues from these advertisings in the third quarter. In October, 2.5 million of monthly subscribers we acquired from the TV campaign in the third quarter should remain Sina customers, and we certainly believe that these subscribers will generate more revenues in the future period. Hence the amount of TV advertising expenses for subscription based MMS products became so material for the third quarter, and the nature of these advertising expenses was such, the nature of these advertising expenses was acquiring subscribers and the probable future revenue benefit from these subscribers acquired, the Company is required to consider the Statement of Position 93-7 or SOP 93-7 on how you report advertising costs to determine whether such advertising costs meet the requirements to be treated as direct response advertising under SOP 93-7. If we determine this is direct response advertising and meets the specific requirements under SOP 93-7, then according to this pronouncement we should capitalize a portion of the $6.7 million and defer the expense provision to future periods, when we receive the benefit for these costs. We estimate that between $3 million to $4 million of the $6.7 million should be deferred to future periods, if we meet the requirement for capitalization. If that happens, our operating expenses for the third quarter will be decreased by the same amount and our net income for the quarter will be increased. Unfortunately, the requirements under SOP 93-7 for capitalization of advertising costs are very complex. Not only does it require companies to prove there is a direct linkage between advertising costs incurred with revenue received, it also requires the Company to have reliable historical data to accurately estimate the future revenues that will be generated from the initial advertising costs incurred. The specific guidance for the SOP 93-7 actually gets more complicated and requires significant investment. As a result the amount of work involved to demonstrate the Board's conclusion is very time consuming. Based on the work so far, we are not able to reach a conclusion as to whether we can capitalize advertising costs incurred in the third quarter and we are not certain when we can reach that conclusion. As we're approaching our 10-Q filing date for the quarter, and given that we are not sure when we can reach the conclusion, and given that the issues involved only relate to the timing of the recognition of these advertising expenses but not impacting the overall economic benefits over the longer term, it has been explained to the investors that we have chosen to announce our preliminary third quarter results assuming we will not be able to meet the requirement for capitalization under SOP 93-7. We certainly hope that we can reach a conclusion before our 10-Q filing date on November 9, but there is no guarantee that we can do that. I guess we have talked enough about this topic. Coming back to the business, since we'll receive recurring revenues from users we acquired in the third quarter, our SMS revenues was 80 in the fourth quarter, although the growth could be modest in single digits. Our MMS revenue decreased by 37% from the second quarter to $1.3 million. This was primarily due to the continuing impact from the billing platform transition that began at the end of the first quarter. We do not expect that we can grow our MMS revenue in the future quarters, as we are not seeing a pick-up in MMS usage in the market. Our revenues for our WAT service grew $1.4 million, up 10% from the previous quarter. We saw some relatively strong pick-up in WAT revenues in the months of September and October, so we are expecting meaningful growth in WAT revenues in the fourth quarter. Revenues from IVR were about $1.9m and revenues from Ring Back Tone were about $1.3 million for the third quarter. Both on track from the previous quarter. We believe we'll see some growth in revenues in the fourth quarter, as we begin to offer IVR service on more platforms, such as fixed line platforms. But our impact on revenues in the fourth quarter will realize the impact from the third quarter. Our revenues from Sina Games jumped more than 100% in the third quarter from second quarter, to $800,000, due to the introduction of more games. While we continue to see growth in games in Q4, the growth rate will come down significantly. Now let me turn to our online advertising business. During this past quarter, our online advertising which included mainly brand advertising such as Bennet Equine (ph) and rich media, but excluding pay search listings, totaled $23 million for the quarter representing a 24% increase from $18.5 million reported in the same period in 2004 and a 13% increase from $20.4 million reported in the previous quarter. Advertising revenues now accounted for 46% of our total revenues, as compared to 44% in the previous quarter and 35% in the third quarter last year. This strong growth came off an increasingly high advertising revenue base and in an increasingly competitive online advertising market in China. This again confirms that we are continuing to maintain our leadership position in China internet product space. Total number of advertisers has reached 571 in the third quarter as compared to 515 in the second quarter. Spending for advertising also increased slightly, from $39,600 in the second quarter to $39,900 in the third quarter. During the third quarter we saw continuing strong demand in the factors like webhosting, webcast and IT industry. And these three factors continue to be the three largest contributors of our advertising revenues in the third quarter. Combined, these three accounted for 47% of our total compound revenues for this quarter, as compared to 50% in the previous quarter. In addition, we saw more revenues contribution from vertical websites such as our own channel including our payment company, as we began to receive full quarter benefits from multiple year contract from China HR and eLong. Revenues from advertisers of fast-moving consumer goods, or FMCG, continue to grow, although we intend our out through dollar amount it is do not material to the total recovering revenues. During the quarter, Coca-Cola and the Pepsi started a rich media fighting advertising war on our website, which was widely reported on Chinese press as advertising war between red and blue and green. We believe that this kind of media attention has evicted growing interest from other FMCG customers, with a very good foundation for the take-up of large-scale media trends in the Internet by FMCG customers next year. Despite increased competition in online advertising market in China, we are not seeing a slowdown in demand for this advertising business. And in fact we have adjusted the rate popup, starting in the fourth quarter, for some of our product inventory, without probably much negative impact on demand. Overall, our general sense is that the Internet is taking market share away from traditional media, especially newspapers, for certain advertising categories in China and we believe this trend will continue. We launched a few new products in the third quarter. In August we successfully launched our Blog 2.0 version and have since attracted over 1 million users to our new fast service. We intend two Blog versions, one for Chinaâs elite group, such as famous writers and celebrities, and one for ordinary net users. Each day we have approximately 9,000 new Blog ads and estimate good growth. By that standard, we believe that weâre already one of the largest Blog service in China. First is Search. During the third quarter we continued to improve our search offering. In addition to a traditional webpage search engine, we add a global search with detailed maps for ten of the top cities in China. We also add a mobile search to allow users to search on their cell phone through WAP. Lastly, our knowledge base community search has been, has begun to attract corporate sponsors, such as Hewlett Packard, who use this platform to provide extra answers to users regarding IT products. Looking ahead to this quarter, weâre again ready for another major upgrade to our search, with a much more expanded document library and improved user interface. Another major product, instant messaging. Our UC brand instant messaging has made major progress in the September quarter by achieving 500,000 max daily concurrent users, up on 300,000 in June quarter. As this is a major project for SINA, in the upcoming quarters we will continue to invest to capitalize on the progress that we have made so far during this quarter. On the Online Game front, we experienced a summer peak of close to 700,000 active users during the quarter for iGame and weâll continue to develop upgrades to digital casual games to make the experience ever richer, even richer for our game players. On the SINA front managed to continue to suffer from user based erosion. The average concurrent users for September quarter was roughly 50,000, down from 70,000 recorded in the June quarter, with roughly $110,000 of loss from our shares in a joint venture with NCSoft during the quarter. Regarding our option platform, 1pai, as many of you know, in August Yahoo announced its investment in Alibaba. As part of this investment, Yahoo intended to transfer its shares in 1pai to Alibaba. SINA owns 33% of this joint venture and weâre in negotiations with Yahoo and Alibaba as to the settlement of our investment in the joint venture, but as yet no agreement has been reached. In summary, during this quarter we continue to focus our energy on our core business in Internet, with both telephony product launches and product upgrades. Looking ahead, we plan to continue to invest in key areas such as Search, Blog, as Charles mentioned, and broadband streaming to further cement our position as the number one portal in China. Okay. Thanks, Hurst. We have already talked about revenues in detail, so Iâll just talk on a few more financial items briefly, then weâll switch to Q&A. First, let me talk about gross margins. Our advertising gross margin remained flat at 68% in the third quarter compared to the second quarter, despite an increase in advertising revenues. This is largely due to an increase in our content costs, especially in the content costs for the video content and our bandwidth costs. We expect that our gross margin will remain the same in Q4 for general. Our gross margin for Wireless business was approximately 56% in the third quarter, down from 57% in the previous quarter. That means another 2 percentage point drop in Wireless gross margin in the fourth quarter, as we continue to increase our content costs and transmission costs for our Wireless business. Our accounts receivable balance at September 30 was $32.9 million, slightly increased from $32.4 million at June 30. This was mainly due to an increase in revenues, offset by our head paper collection in the receivables for the advertising revenues. Our DSO for the quarter is 61 days for the third quarter, improved from 64 days in the second quarter. During the third quarter, we accrued a loss of approximately $708,000 on auction joint venture with Yahoo. As Hurst just mentioned, because Alibaba subsidiary is also involved in online auctions in China, weâre in negotiation with Yahoo and Alibaba concerning our shareholding in this joint venture and we think we can reach an agreement in the fourth quarter. We also recorded a heavy loss by our games joint venture with NCSoft. The amount of loss was approximately $110,000. We expect to incur similar or slightly higher losses from JD in the fourth quarter. During the quarter we also reported a gain in the amount of $1.5 million for the sale of Fortune Trip to eLong. And this is offset by a similar loss for the other investment in Tidetime Sun, previously known as Sue Media Group, for the same amount. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234066 | Thank you, Operator, and good morning. Welcome to Great Plains Energy' s third quarter 2005 earnings conference call. Joining me on the call today are Mike Chesser, Chairman and CEO of Great Plains Energy, who will provide a strategic ov erview of the company; Bill Downey, President and COO of Great Plains Energy and President and COO of KCP&L, who will provide details on the performance of the utility; and Terry Bassham, Executive Vice President and CFO of Great Plains Energy will be pr oviding financial high lights and details on 20 05 earnings guidance. Shahid Malik, Strategic Energy CEO will also provide an update on our competitive supply business. I wanted to take a moment to let investors know that we will be presenting at the Edison Electric Institute's 40th Annual Financial Conference on Nove mber 8th. We look forward to this upcoming opportunity to spend time directly with our investors. Since some of our remarks will be forward- looking, I must remind you of the uncertainties inherent in such comments. The second slide included in this webcast as well as the disclosure in our SEC filings contains a list of some of the factors that coul d cause future results to di ffer materially from our expectations. Thanks, Todd, and good morning, everyone. This truly has been an interesting time in the energy business -- record natural gas pr ices; unseasonably high wholesal e prices, in our markets, at least, are double those of last year; and high anxiety among energy customers. In fact, I'd venture to say that we are in a new age for the energy industry, and this new age is characterized by a number of trends. First, volatility in natural gas and power prices that have become more the rule than th e exception; second, increased regulatory reactions are being seen in response to higher prices. These reactions affect both the regulated and the competitive states. On the regulated side examples range from exam ination of natural ga s purchasing strategies, closer examination of G&A in states like Michigan, a nd fuel clause recovery scrutiny such as what we've seen in Arkansas. On the unregulated side, we are seeing many different proposals for the evolution of deregulation in Illinois and proposals for tem porary restraints to high prices in places like Texas. The third trend is that there is clearly an increased interest by customers in efficiency and demand response programs. And, finally, there is heightened interest in renewable energy strategies. The good news in all this is that Great Plains Energy's strategic plan positions us to capitalize on this new environment. KCP&L's current supply portfolio is right for the times. KCP&L is a coal and nuclear-based utility . Over 95% of our megawatt hours in 2004 cam e from these low-cost fuels. Our fleet is extrem ely competitive. We start from a strong position that provides a hedge against th e difficult issues faced by utilities th at are heavily reliant on natural gas as a fuel source. Our scenario planning has also helped. During last year's strategic planning effort, we identified multiple scenarios against which to stress-test our strategy. One of the scenarios which we call "natural gas chaos" provides a stress test similar to the current environment we find ourselves in. Our comprehensive energy plan fits very well, because it emphasizes a balanced approach on a number of fronts. First, it balances the need for energy that is afford able and energy that is environmentally responsible. Coal, we all kn ow, is low-cost and in abundant supply. By increasing coal generation, we can deliver afford able, more predictably priced energy for years to come. At the same time, by investing in modern technology and environm ental upgrades in our plants, we can significantly improve air quality in the Kansas City region. Second, the plan also balances th e need for renewable energy with the need to be practical. The addition of wind in our portfolio hedges us agai nst some environmental risk but not at the expense of reliability or cost. Third, the plan balanc es actions we can take to reduce custom ers' costs with actions that customers themselves can take to reduce their own costs. This includ es valuable new customer programs for energy efficiency and demand response as well as affordability programs. Implementing this plan in the near term, we are in the final stages of planning our investments in 100 megawatts of wind generation. The wind project is on schedul e to be completed during the third quarter of 2006, which will en able us to include the investment in KCP&L's rate case and begin earning a return on that investment in 2007. Also, over the next two years, we will be rolling out a nu mber of demand-side management efficiency and affordability programs that we also will be able to earn a return on. In competitive supply, current market conditions clearly are not optimal but, over time, as energy prices decline as it's being project for mid next year, and utility rates move up to reflect market prices for fuel, Strategic Energy is strongly positioned to capitalize on the growth opportunity in competitive electricity markets. During this year we continue to increase sales of new flexible products that have been designed to help customers address the current high-price environment. These new products leverage our competitive advantage of being a valued cons ultant to cu stomers and further strengthen our brand. For instance, the new index-based products accounted for 57% of new sales year-to-date. We are also aggressively managing our operating costs across Great Pl ains Energy. At KCP&L our internal production costs per megawatt hour are tier 1 today and, in fact, are am ong the lowest in the region. Initiatives underway in non-fuel O&M are anticipated that move us close to tier 1 next y ear as we ll. We also are targeting efficiencies in our delivery business that leads to tier 1 O&M costs in 2006. At SEL, we have achieved reductions of G&A cost s in 2005, and as new state-of-the-art retail pricing and transaction management system s come onl ine in 2006, we expect further productivity gains. Additionally, during 2005, we have completed a talent assessm ent proc ess with the goal of identifying top performers and matching individual skills w ith jobs wh ere they can be most productive. This will increase our effectiveness and improve our cost structure. Overall, we continue to believe that Great Plai ns Energy is well positioned to benefit from the solid growth of our regulated ut ility, which we expect will expe rience nearly 60% growth in its rate base under the Comprehensive Energy Plan and produce 2% to 3% average annual earnings growth. The utility is complemented by our low-risk competitive supply busin ess, which can take advantage of customers' needs for advice and competitive products. The 2% to 4% combined growth in these two businesses, along with our attractive dividend yield, which is currently north of 5%, provides a strong total return to our shareholders for years to come. Looking at the third quarter for a second, KCP& L benefited from weather that was 15% warmer than normal, and wholesale power prices that were double the levels seen la st year. Strong retail sales and increased wholesale prices help to offset the failure of the main transformer at our 565- megawatt Hawthorne 5 coal unit. The 32-day outage drew higher fuel a nd purchase power costs during the quarter, which offset a number of positives including favorable weather, strong power prices, the benefits from regulatory treatment of pension expens es, and tax benefits recorded during the quarter. The difficulties experienced by railroad deliveries of coal for the Powder River Basin resulted in a decision that managed coal burn more closel y. With the outage at Hawthorne 5, however, our coal inventory levels have im proved, which will allow us to operate at highe r levels than originally anticipated for the remainder of 2005. We are also encouraged by the third quarter trends at Strategic Energy. While we have seen a shift toward shorter-term products that has reduced future back log, quarterly de liveries, which we consider to be a critical m easure for this business, have remained relatively constant year- over-year and, importantly, strong customer loyalty continues to provide a foundation for future growth. Beginning this quarter, we will disc uss core earnings to provide investors a useful indication of Great Plains Energy's results that are comparable among periods. Core earnings is a non-GAAP financial measure that excludes the effects of discontinued operations, unusual or nonrecurring items, and mark-to-market gains and losses on energy contracts. In past presentations, we discussed ongoing earn ings results, which included mark-to-market gains and losses on energy contracts. We have stated in the past that our ongoing earnings guidance did not include mark-to-market gains and losses on energy contracts. As a result, core earnings results will be consistent with our earnings guidance. In the third quarter of 2005, Great Plains' revenues were $783 m illion, an increase of more than 9% compared to last year driven by warm weather and the KCP&L service territory and higher power prices at Strategic Energy. These power revenues were offset by higher fuel and purchased power costs due to th e Hawthorne 5 outage and slightly lower margins at Strategic Energy. Earnings for the third quarter were just over $90 million compared to $75.5 million last year, and core earnings were $78 million, up from $65 million in the third quarter of 2004. Earnings in the third quarter benefited from the regulatory accounting treatment of pension expense that allowed Great Plains to establish a regulatory asset retroactive to January 1, 2005, for annual pension cost in excess of $22 million. Earnings also benefited during the quarter from income taxes that were $17.9 million lower than last y ear due prim arily to a lower com posite tax rate, which reduced KCP&L's deferred tax liabilities by $11.7 million and lower taxable income. Earnings this quarter were significantly impacted by a $10.7 million after-tax net mark-to-market gain on energy contracts at Strategic Energ y. These mark-to-market gains are driven by increasing power prices and are ex pected to reverse, ov er tim e, as the energy is delivered to customers. These gains could also reverse if power prices drop prior to delivery. The other category was breakeven during the quarter compared to a loss of $10.8 million in the third quarter last year. Results were impacted in this year's quarter by the release of tax reserves and, while not affecting Great Plains Energy' s consolidated earnings, the other category in 2004 was impacted by changes in parent company tax allocations. Year-to-date revenues at Great Plains Energy were $2 billion, up about $90 million from last year. Earnings were just under $132 million and core earnin gs were $11 8 million, both down from the year-ago period. In add ition to th e items that af fected the th ird qua rter, year-to-date earnings were impacted by higher operating expenses at KCP&L and scheduled and forced plant outages that reduced megawatts available to sell in the wholesale market. These items more than offset the favorable weather and higher wholes ale prices ex perienced at KCP&L. Also, Great Plains Energy's year-to-date core earnings were negatively impacted by reduced core earnings at Strategic Energy compared to last year due primarily to nine months of Seams Elimination Cost Adjustment, or SECA charges, as well as lower retail gross margins excluding the impact of net mark-to-market gains on energy contracts. At KCP&L third quarter revenue was $353 million compared to $323 million in the third quarter last year. Earnings were $69 m illion or 8% higher than third quarter 2004. Retail revenu es increased by nearly $3 2 m illion, or $310 m illion compared to th e same quarter last year, primarily due to weather that was significantly warmer than last year. Higher retail usage, the 32-day Hawthorne 5 outage, and coal cons ervation measures led to third quarter wholesale volumes which were 37% lower than last year. However, wholesale revenues were roughly flat at $39 million, down just $1 million from last year as the decrease in wholesale volume was largely offset by wholesale prices that were almost double last year's level. Fuel costs during the third quarter were $21.7 milli on higher than last year, prim arily due to an unfavorable fuel mix driven by the Hawthorne 5 outage, higher natural gas prices, and m odest increases in the cost of coal and coal transp ortation. Purchased power costs also increased $14.3 million during the quarter due primarily to higher prices and more megawatt hours purchased during the Hawthorne 5 outage. As we alerted you last quarter, income taxes in the third quarter were $16.2 m illion lower than last year. This was due prim arily to a lower composite ta x ra te as a resu lt of su stained audit positions, in cluding the effect of th e lower co mposite tax rate of deferred tax ba lances that I discussed earlier, and lower taxable income. Third quarter earnings also reflect lower pensio n expenses of $7.1 m illion primarily due to the establishment of a regulatory asset for a portion of the company' s pension costs, including $5.6 million relating to the first six months of 2005. Year-to-date, KCP&L revenue was $858 m illion compared to $844.5 m illion last year, and earnings were $109 million compared to $118.4 million in the same period last year. During the first nine months, retail revenues increased $43 million yea r-over-year due prim arily to warm weather. Higher retail revenues were partially offset by a $28 million decrease in wholesale revenues due to scheduled and forced plant outages and coal conservation that reduced megawatt hours available for wholesale in the first nine months. The effect on earnings of the lower megawatt hours available for wholesale was partially offset by higher average wholesale prices. The lower year-to-date earnings also reflect a $38 million increase in fuel and purchased power expenses due to higher natural ga s prices and scheduled and for ced outages, which resulted in unfavorable fuel mix. KCP&L's other operating expenses year-to-date we re $15.3 million higher than last year due to several items, including a year-over-year outage -driven increase in plan t op erations an d maintenance costs, a $4 .9 m illion increas e in storm expenses, a $4.5 m illion in property and other general taxes, a $3.9 m illion increase in em ployee-related costs, $2.6 m illion in higher legal reserv es, and th e absence of last year's $1.5 m illion benefit from a reversal in environmental reserves. Higher operating expenses were partially offset by a $3.9 million reduction due to the application of the regulatory treatment of pension expense and a $4.6 m illion year-over-year reduction in transmission service cost. Year-to-date, interest expense was $4 m illion lower than last year, and income tax expense was $32 million lower than last year due primarily to the previously mentioned tax benefit reported in the third quarter and lower taxable income. Strategic Energy reported third quarter revenue of $430 million, up 10% from last year due to the higher pow er prices. While deliv ered retail megawatt h ours decreased by 5% to 5.4 m illion megawatt hours. Third quarter earn ings were $18.1 million compared to $13.4 m illion last year. Results for this qu arter were sign ificantly impacted by $10.7 million in af ter-tax net mark-to- market gains. Core earnings, which exclude mark-to-market gains were $7.4 million compared to $10.9 million in the same period last year. Third quarter retail gross margin per megawatt hour was $7.85, which includes $3.36 per megawatt hour due to mark-to-market gain s. This compares to a reta il gross margin pe r megawatt hour of 5.50 last year, which included $0.77 due to the mark-to-market gains. During the quarter retail gross margin also benefited from portfolio optimization strategies that are a normal part of actively managing our hedg e positions. The hurricane -induced volatility in the power markets provided optimization opportunities that were larger than normal. During the first nine m onths of 2005, Strategic Energy's revenue increased 7.5% to $1.1 billion while earnings were $34 .6 million, up from $32 m illion last year. Year-to-date 2005 earnings were negatively im pacted to $4.7 m illion af ter-tax by SE CA and positiv ely im pacted $15.1 million after-tax for net mark-to-market gains on energy contracts. Co re earnings were $19.5 million year-to-date compared to $29.8 million last year. Year-to-date megawatt hours delivered were flat compared to last year. Our retail gross margins per megawatt hour were $6.30, which included the $1.71 due to net mark-to-market gain on energy contracts, $0.08 due to a reversal of ta x reserve, and a reduction of $0.54 pe r megawatt hour due to SECA. This compares to $6.00 in 2004, which included $0.25 due to net mark-to- market gain on energy contracts. During the third quarter, the tim ing of tax cr edits and a ccounting reductions of affordable housing investments resulted in earnings of $1.9 million from KLT investments. Year-to-date earnings from the KLT investments were $2.4 million. We continue to anticipate $0.07 per share for the full year. The other category was breakeven during the quarter compared to loss of $10.8 m illion in the third quarter last year. Results were impacted in this year's quarter by the release of tax reserves, while the third quarter of 2004 included the loss due to changes in parent company tax allocations to subsidiaries. KLT Gas discontinued operations in the quarter reflect $1.8 million of earnings due to the partial reversal of a legal reserve established last quarter. Based on Great Plains Energy's results year-to-date and the company's expectations for the fourth quarter, we are increasing 2005 co re earnings guidance to a range of $2.15 to $2.30 per share. The driver for this increase in core earnings gu idance is the anticipation that average gas prices should range from $12 to $13 per mcf during th e fourth quarter, which is expected to positiv ely impact KCP&L's fourth quarter wholesale revenues. Strategic Energy's results have also improved in the quarter, a nd we have m oved their range up modestly. Finally, we expect to provide 2006 core earnings guidance in mid-December as we complete our budgeting and planning processes. Thank you, Terry. As you heard from Terry, KCP&L had a solid quarter, even though we were substantially impacted by the failure of a five-year-old main transformer at our 565-megawatt Hawthorne coal-fired station. The failure resu lted in a 32-day outage during the quarter. The backup transformer size limits the unit' s capability to 500 megawatts until a new transformer is installed. We anticipate the changeout to occu r in June 2006. As a result of the Hawthorne outage, much of our coal conservation originally planned for the fourth quarter was shifted into September. We anticipate to be able to r un Hawthorne at 500-megawatt capab ility until we install the new transformer. Given the doubling of power prices compared to the same period last year, we project increased wholesale revenues in the fourth quarter should more than offset the 2005 financial impact of the outage. The Hawthorne outage and m odest am ounts of coal conserva tion negatively impacted our baseload coal fleets equivalence availability, and capacity factors during the quarter. Availability and capacity were 82% and 76%, respectively, compared to 91% and 85% in the third quarter of 2004. Last year's third quarter, by the way, was a record for availability and nearly a record for capacity factor. The slig htly wider spread between availability and capacity in the third quarter of 2005 reflects our coal conservation efforts. As a result of the higher retail usage due to wa rm weather, the Hawthorne 5 outage and coal conservation measures during the quarter, whol esale volum es declined to just over 900,000 megawatt hours in the third quarter. This represents a drop of 37% compared to the same period last year. The lower volumes were largely offset by wholesale prices that were almost double last year's level, nearly $51 per megawatt hour compared to roughly $25.50 last year. The net result of lower wholesale volum es and higher wholes ale prices produced wholesale revenues which were nearly flat compared to last year. We were also gratified to have received a recent ruling from the FERC that KCP&L successfully rebutted a presumption of market power in our control area. KCP&L's successful rebuttal was based on a detailed economic analysis that took into account the obligatio n we have to serve our native load. This was th e first time FERC had accep ted a rebuttal of the pr esumption of market power under its revised market-based rate program. The FERC's action removes the potential of KCP&L being required to refund a portion of its market-based wholesale sales. In addition, the company can continue to make wholesale sales at market-based prices in the control area. Favorable weather was also a sign ificant driver in the third quarter. Cooling degree days were 54% higher than the thir d quarter last year, and 15% higher than normal. This unusually warm weather was the primary driver behind the 11% increase in retail revenue experienced during the quarter. September, in fact, was the warmest on r ecord in Kansas City's history. Unfortunately, the Hawthorne outage did not allow us to take full advantage of the favorable weather. Weather-adjusted retail megawatt hour sales growth was just unde r 2% on a year-t o-date basis. Kansas City Power & Light's first generation proj ect in the Comprehensive Energy Plan is the addition of 100 megawatts of wind. In August RFPs were issued. We expect to complete our selection of proposed sites and developers during the current quarter. We remain on schedule for completion of the wind project in the third quarter of 2006. This will enable us to include the wind generation in our 2006 rate case and begin ear ning a return on this investment when new rates are effective in 2007. The RFP processes for environmental and coal projects currently are underway. We anticipate awarding contracts for the La Cygne 1 SCR project this quarter, and we should begin awarding contracts fo r Iatan 2 and the Iatan 1 envir onmental retrofits in the first half of next year. Permitting for Iatan 2 remains on track for completion by early 2006. The process we implemented to gain approval of our comprehensive energy plan was highly collaborative and included workshops with cust omers and regulators. Since then a number of customer programs suggested during the works hops have been adopted. These program s would allow KCP&L to work with customers to reduce expensive peak demand and increase energy efficiency of their hom es and bus inesses. The programs, treated as regulatory assets, will allow customers to manage their energy costs proactively. Within three years we expect to shif t approximately 100 megawatts of peak load to ours, where power is less expensive. We see almost 15% of our custom ers taking advantage of load management, as well as energy efficiency and a ffordability programs over the next three years. Our strategy is to engage customers in an interactive relationship. This strategy has worked well in our Web-enabled self-service. Platts Research in this year's survey of utility websites rated the KCP&L site as the second-best in the nation overall for features and functionality. Our penetration rates for these services as well as paperless billing are two to three times the industry average. This customer acceptance allows us to hold down servicing costs. Mo re importantly, these capabilities allow us to transform our relationship with customers. As Mike mentioned, with the recent natural gas price increases, customers have expressed an interest in accelerating the implementation of these programs. We are working with regulators to move these program s ahead quickly. Now I' d like to introdu ce Shahid Malik, who will discuss the operations of Strategic Energy. Shahid Malik - Strategic Energy CEO Thank you, Bill. Good morning, everyone. Let me start with a review of the competitive environment. We are finding that custom ers are no longer paralyzed by higher prices, but high natural gas and power pr ices do co ntinue to affect customers' purchasing decisions. We see a strong preference for shorter-dur ation products, including our inde x-based products that contain both fixed and floating com ponents and m onth-to-month renewals in which customers remain with Strategic but accept floating prices and thus assume commodity price risk, anticipating th at prices will fall. This preference for shorter-term products has redu ced future year committed backlog relative to prior periods. However, as we will discuss in a moment, our quarterly deliveries have remained relatively constant. The custom ers on th ese s horter-term, m onth-to-month, and index-based products feel the financial sting of rising pri ces quickly, and we continue to believe that customers prefer price certainty. So while cust omers have gravitated to short-term product in response to high prices, we s ee considerable pent-up demand for long-term price certainty amongst our customers. We are quite confident that we will renew a signif icant number of these customers to longer-term contracts when the prices dip. Indeed, the current forecast of na tural gas indicates that prices should decline after the winter period, and some customers may see such a price de cline as an opportunity to lock into longer- term contracts. Customers today are looking for advice, education, and information, and we believe that this is an area where Strategic Energy' s em ployees have sign ificant va lue. Ou r whole approach to marketing to these customers is very much focused on a consultative sale, which is highly valued by our customers. In this environment, we are finding that sales are most robust in markets where pricing is dynamic, and where pow er prices can quickly adjust to changes in the market price, including Texas, New York, Pennsylvania, and Massachusetts. Strategic Energy remains on track for 2005 deliveries of over 19 m illion megawatt hours with 4.1 million megawatt hours in back log for the fourth quarter. This is well within our previous guidance of 17.5 to 21 m illion megawatt hours. However, the im pact of our customers' current preference shorter-term contracts can be clearly seen in the size of our committed backlog for future years. As our product m ix has shifted toward shorter-term contracts, backlog is significantly diminished, and the backlog for futu re y ears tends to become a less meaningful measurement of our business volumes. As such, if you exam ine the bar chart on the ri ght of Slide 25, you can see a period-to-period comparison of megawatt hours delivered. Since our run rate has remained comparable to last year when taking seasonality into consideration, customers are remaining with us, as you can see in our quarterly deliveries. They don' t show up in backlog due to the ve ry short-term contract that they currently prefer due to the current high energy prices. Strategic Energy also continues to see strong customer loyalty, even as customers are moving to shorter-term, m onth-to-month renewals. Retent ion, excluding m onth-to-month custom ers, was 39% during the third quarter compared to 82% last year. However, when you include those month-to-month customers that are staying with us, Strategic En ergy retains approximately 80% of customer load year-to-date compared to 86% a year ago. Excluding customers that have opted for m onth-to-month renewal, the cont ract duration of new business year-to-date has been 14 months, down just slightly from 15 m onths last year, and average retail gross margin per megawatt hour on new custom ers rose in the quarter to $3.53 compared to just under $3.00 last quarter. This was largely driven by a continued increase in smaller, higher-m argin custom ers. This segment represents ju st 4% of sales year-to-date bu t 12% of total sales in the third quarter. We are continuing to execute several strategic operational steps to improve the business and adapt to the current market environment. I call them the four Ps -- positioning, procurem ent, product, and productivity. The first is positioning -- we ar e focusing our resources on aligning the G&A stru cture of our business to the dynamic markets that have attr active headroom to sell. We are also finding customers increasingly valuing the consultative advice that's inherent in our sales and custom er service approach. In addition, we are sharpening our marketing and sales efforts with a particular emphasis on the sm all business cu stomer that has increased to 12% of sales in Q3 compared to less than 1% last year. The second P is for procurement -- we are working on aggregation strategies to try and buy more effectively for our custom ers, especially in the renewal area with the opp ortunity to bundle load and to buy more effectively. We have added new talent to our team with a new vice president of supply that's helping us to im prove that portfolio optim ization strategy to more effectively manage our portfolio. We are al so implementing new system s, as Mike mentioned, to help us better measure and manage our risk. These pricing improvements have helped us to improve our competitive position this year, particularly in our key markets in Texas and New York. The third step is new products -- as we have described, our new index-based products, our month-to-month renewals, and our new products marketed especially to the smaller customers are increas ing new sales and also driv ing slightly higher margins in the busin ess. These improvements are also producing results with 57% of new sales from our new index-based product and, as mentioned, a strong increase in that smaller customer segment. And, finally, we're focused on our fourth P -- productivity. New systems that we're implementing are anticipated to im prove scalability. Focusing on attractive markets should allow us to rea lign G&A costs, and we also believe th at there is significant sales pr oductivity potential to be gained once prices declin e and customers b ecome motivated again to sign long er-term contracts. We would then have fewer customer touches and more opportunity to pursue new business. Thank you for your attention, and that concludes our remarks. I'd now like to pass the baton back to Todd and open up the call for questions. Just a question -- you did mention that there was some portfolio optimization at Strategi c in the third quarter that was abnormally positive due to the volatility from the hurricane. Can you quantify or , in any sense, crudely, what -- how much of that was due to abnormally benefits and whether th at explains, essentially, all of the increase in guidance at Strategic for the year? Good question. We started taki ng a much more active role managing our portfolio. As we buy the power, equally im portantly, once we've bought it, and it' s in our portfolio. But with respect to the activity that we took, it was relatively sm all. Specifically what it was, we have tr ied, in the past, no t to ac tively manage our purchased contracts, but with the recent volatility and with the increased attention of our supply team, we're paying close attention to low-risk opportunities to manage that optionality that's in our book. For example, in this case we've made a sign ificant sale in Pennsylvania some time ago, and we've purchased power for delivery to a nearby liquid hub, and on closer exam ination of our book, we determined that we could actually swap out that transmission part, actually in PJM, of one for another one, which allowed us to take a dvantage of the fact th at we now had a more valuable opportunity. In this way, we reduced our risk and took over $2 million in pretax income earnings to the bottom line. So relatively small, I would say it' s about $0.01 to $0.015 net income. But, Doug, not all of that was recognized in the quarter. We probably had less than $0.5 million that was recognized in the quarter. Okay, thank you, and then ho w much was the SECA charge in the third quarter? I mean, I think you gave the nine months, but unless I missed it, I didn' t see the three- month SECA charge. This is Terry -- the three-month charge was minimal for the quarter because there was an offset for some of our collection activities we started. So the actual SECA charge was the same as it had been on a quarterly basis, but we ac tually began the process of billing some customers as well, so net-net, given that offset, there wasn't a material impact. We're beginning the process, that's correct. The charge itself was still there, but we also had a pickup from the initiation of that process with customers. I was wondering if you could tell me how the siting process is going at KCP&L. You guys were talking originally about getting siting sometime this fall, and I was wondering how that was moving along? Well, of course, I think we're m oving along very constructively. Everything seems to be on target. We have -- I think you're referring to the perm its, key perm its that are anticipated, and we still remain confident that, in the first quarter of next year, we will be able to obtain those key permits. Great. And I was wondering, at Strategic, two questions -- first of all, you mentioned that you' re looking at sm aller, highe r-margin customers. Could you talk a little bit about the dem ographics of what that group lo oks like? A nd, secondly, how big is the SECA charge on an annual basis, and how long is that incurred? I know it' s transition area, but I don't know how many years that cost will be passed onto you. Let me address the SECA charge first, Kathleen. It was roughly about $1 million, $1.1 million, per month for 16 months, which works out to about $16 million in charge. As Terry mentioned, we are in the process of doing three things with the SECA charge. Firstly, we are filing regulatory appeals with various agencies, both FERC and various stat es. We believe that the charges are unjust and unr easonable and goes against the established doctrine of no retroactive ratemaking. So at FERC we're planning testimony. We've also started an intervention to pursue a shif t in th e cost of the shipper, and we've also filed a write of mandamus in federal court. So all those things are ongoing right now. With respect to the charge, it was $16 m illion for the period from Ja nuary 1st of this year through March of 2006, so about $1 million a mont h. Our expectation is that we will recover some of that through charges to our customers and hopefully a good chunk of it as well back to the shippers who supplied us the power in the first place. You're welcome. With respect to the smaller customers, we've been quite active in trying to segm ent our business in a much more thoughtful way than we have in the past, and we've been very, very conscious of the customers that we haven't served in the past -- the larger customers and the sm aller customers. We believe that the sm aller customers represent a good opportunity for us. We've principally focused on them in our core states in Texas and New York, but we believe that we have a significant leve rage opportunity through our sales channel and, therefore, that's where most of our customers currently are. Total size -- those customers tend to be peak load of 150 kilowatts or less at any on e time. So a sm aller demographic than we've had in the past. But so far it's been quite a successful plan. I wanted to ask you just to clarify the pension and tax impact once again. The pension im pact for the quarter was how much? And how much of that is sustainable, I guess? This is Terry. Remember that the pension impact is related to th e regulatory agreement and basically what it amounted to wa s a reversal of the charge we had taken throughout the year that we couldn't really consid er until the regulatory orders were final. So what happened is when the final orders were a pproved in both states, we were ab le, th en, to reverse back the amounts over that $22 million cap that's in the agreements, and that's a one-time reversal of those first amounts. So it's certainly sustainable. It will be the am ount for the rest of the year. Okay, and then the tax impact -- I'm sorry, but I wasn't completely clear on what -- I mean -- there's a reversal there and what have you -- how normalized is that, I guess? On a year-over-year basis, we did have a sim ilar size tax adjustment last year. So from that perspective, I would say it' s normalized year-over-year. We will continue to work, as we always do, on opportunities to reduce taxes. That single adjustment of $10 m illion-ish is certainly larger than we normally find on a regular basis, but we have been able to find that now in two different areas over the last two years, and we'll continue to look for opportunities. Okay, so the $10 m illion is kind of an un usual item, but you guy s think you might be able to do that again, going forward, is that the idea? Or something in that neighborhood? Well, I'm not sure I would say we could tell you today we'd do that at that level. We certainly would continue to look for opportunities, but to say today I wouldn't know we could do that level next year would probably be a little be yond what I would be comfortable with. Okay, and then the invested tax credit of $0.07 that you plan on having in 2005, is that going to be continuing as well? We're going to talk a little bit more about that when we give guidance in December, but we are going to have benefits th at con tinue for the next couple of years in invested tax credits. Okay, and then, just briefly, on Strategic Energy, it sounds like the SECA charges are now able to pass that through to cu stomers to some degree. So I'm wondering if everything -- let' s say even if you're not successf ul with respect to th e SECA charge and your legal challenge, it soun ds like there was rea lly no impact associated with it financially and th at you were able to pass it through to custom ers. If we go into 2006, should we expect that $7.2 million -- or $4.7 million after-tax -- that you' ve incurred in the last nine months, to basically go away? Would that make sense? Well, it would be great if that would happen. In reality, we are likely to only see a portion of that SECA charge come back to us . For competitive reasons, we clearly cannot talk on the full cost of that SECA charge to our cust omers, but we hope that with a combination of what we are passing onto our customers in these ar eas, as well as the potential sh ift back to th e shipper, that we can recover somewhere approaching a third to half of our charge. We' ll see. Our expectation is that for a good attempt of that. Okay, and then, finally, with the new business margin that you guys were talking about, it obviously looks like it' s come up a bit, obviously, than the previous quarter, and that's because you're focusing on smaller customers, if I understood that correctly. But you also -- I'm wondering if there are other char ges, or other costs that are associated with having sm aller customers -- administrative or what have you -- that might lower the actual earnings impact of getting those smaller customers, a, and then, b, you're looking at lowering G&A in 2006. I was wondering -- I saw that in the slide -- I was wondering if you could quantify that a little bit. Yeah, a good question, Paul. Firstly, with respect to the cost of customers, we are seeing some incremental costs, which are relatively small because we're using existing channels and mostly existing channels of sale. W ith respect to the administrative load as a result of these higher sales, our scalability should increase once we implement these new systems. So long-term I'm not looking for a significant increase in cost s, and it's more than well covered by the incremental margin -- the net-net is a positive. Okay, so the G&A -- net-net -- everything -- with the in itiatives that you' re taking place and this focus on smaller customers, should we expect that to go down in 2006? With respect to G&A, you should see an increase in productivity. That will mean a combination of realigning our G&A, a combination of increasing our scalability and just being more effective in how we go to market. Okay, so the to tal G&A number would -- producti vity-wise, it would im prove, but from a total number, would it probably go up? Just wondering if you could give us an update on when you'll file in Missouri in 2006. I think you had spoken to filing in early '06. Any way we could get any additional color on that? This is Bill Downey, Erica. Our antic ipation is that we will f ile in February of 2006 and expect a decision for January of 2007. We would file not only in Missouri but also in Kansas at the same time. Okay, and then second questi on, just kind of following up on what Paul was asking regarding the G&A im provements and some of the im provements in the cost structure that Mike spoke to in the beginning of the call. Is that expected -- the savings expected to drop to the bottom line next year? Is there any possibility that we would see some significant benefit to earnings next year from savings associated with some of those initiatives? I think there are savings that will go to the bottom line. I'm not sure that I would call them largely significant, but I think it will help us in our goals next y ear. Next year, as you know, is going to be a challenging year for us, b ecause th e first half we' ll still see high gas prices, high wholesale prices, and next year will also be our final year before we get our rate increase in 2007 on the utility side. So it's very important that we do everything we can to realize these kinds of savings to keep the year being a solid year. A quick question -- following up again on something Paul touched on. I understand taxes are -- even with that, your tax rate looks lower than it has been historically, and I'm just wondering if you can comment on what you expect for a tax rate, going forward, this year and next year? This is Terry again. For next year, no reason to believe it shouldn' t be more normalized in the 38 to 39%. Anothe r couple of things th at affected it are not on ly the sing le adjustment we discussed, but we also had a release of a reserve related to some tax reserves that had a connection to or potential for capital treatment. Recall that we've been selling SO2 credits, which provided some capital gains, so we were comf ortable that if our treatment of a particular reserve was capital, it would be offs et, and so we released that as well. So there are a couple of things that affected it, but, going forward, again, we'll be looking for opportunities, but I couldn't give you any specifics right now fo r next year that would change a normalized tax rate for next year. Okay, so even with that, you think there's enough opportunity? I guess I'm just trying to distinguish, as Paul was, the core earnings versus what you'd previous had is ongoing under GAAP earnings. Eric, the only difference between the core earnings and the ongoing earnings is just the removal of mark-to-market. Otherwise, the two measures are the same. Okay, so then it really -- even though something like a reversal could be thought of as one time, although you've done it for two years now where you could find reversal. You feel comfortable with that. It's kind of been a repetitive earnings load? Yeah, obviously, what we're trying to do is provide a measure that's transparent and repeatable, and so we want to protect against considering t oo many things one-tim e. If it's truly one-time, we'd certainly do that. We want to explain the pieces of it as well. But, go ing forward, the purpose of our core earnings descrip tion is, we were giving guidance without mark- to-market but yet calling it ongoing, so it's effectively the same measure we've used, but we think a little more clear and consistent with our guidance, and then, again, there are moving pieces that will go up and down different periods, obviously, and within core earnings, what we've described is very accurate. Okay, one last question -- could you just give us a little color on the index- based products such as the true floating product that market on a m onthly or daily basis -- how that pricing works? The index-based products are tw o-fold. One is our m onth-to-month products, which has increased in size during the quarter as a result of custom ers really deferring decisions. We fully expect those to convert to longer-term, fixed-price sales. The ne west suite of products that we've introduced, which we call "por tfolio suite," which are different by customer class and by region that we operate in -- those are consultative sales, which are relatively low-risk for us in that the customer takes on most of the risk and that we help work with them so that we can lock in power at prices that m eet their budgets, and therefore, from a risk standpoint, and risk is transferred from us to the custom er, and they ar e able to buy according to when they feel most comfortable with the prices. We are, of course, holding their hand throughout this process. So that's what we m ean by index portfolio type product. They have the ability to either float or to partially float at any time they wish. This is Terry. We don't have a set tim ing, obviously. We've talked about the possibility of an equity issuance next year. We continue to mon itor that and watch that from a timing and a size perspective. We'll be looking at the rate case process, and be giving you a little more specificity, if you will, as we head into next year. So that's kind of -- we still have the plan on the table. Not a lot has changed yet, but that's about as specific I could be today, I think. I think you had previously talk ed about 15% volume growth at Strategic, kind of as a long-term target. Does that change at all given the new focus on the smaller customers? Philson, that's a question that we are planning to address as we get to ou r planning process for the end of the year. What we are seeing, however, is year-over-year, we are seeing an increase in volum es, 2005 compared to 2004, and we do expect that trend to continue, moving into ' 06 and ' 07. Whether it's 15% or 20% or 10%, we can't get a good handle on that right now. My question is -- your ability to partially to cover the SECA charge now, is that one of the factors of today's guidance at Strategic Energy? I would say it' s one of the factors. Again, as Todd mentioned earlier, we're starting the process, and it' s not all impacting th e particular quarter or year, but it's one of the several factors that we're looking at as well as improved operations that we've talked about in Shahid's initial comments. Let me just add to what Terry said -- yes, we are asking a little bit of recovery in the SECA charge. We're also seeing productivity gains as we manage our costs more effectively. We're being quite aggressive abou t those, and in addition to that , we ar e seeing some of these smaller high-margin customers fall into our four th quarter period. So the combination of those things is proving to be a better turn of events for us than we anticipated a quarter ago. I just mentioned earlier on that we expect somewhere between a third to a half of the total charge for this period of time. Now, it may not come all in 2006. We'd love to see it as soon as possible, but we have a long process to get through to recover over that. I was just trying -- can you tell us, as we try to forecast the business, what kind of ROE the regulated bus iness will end up based on the forecas ted ' 05 results? Or if you could give us th e rate base the other way -- what the rate base would be at the end of the year, whichever is -- I don't know if you have any of the data. Mike Chesser We can get you the rate base information -- projected rate base. I'm not sure we have that right here, but the ROE is obviously going to be a product of the discussions in the case. We do feel like we have a strong case for a good ROE. As you know, interest rates are beginning to go up. Some commission rulings -- recent comm ission rulings , support a pretty favorable ROE, and we're going to be doing ev erything we can to put on the best possible argument. But I think it would be wrong at this point to forecast that. This is Bill Downey. I would also suggest if you look back at the stip ulation and what we agreed to, this is a long-term agreement with a number of factors that will be brought to the attention, particularly around credit quality of th e company. So I think there is significant discussion that will be based on that and the fact that we have a major building program going on in the state that is unique. As you know, in the stipulation we do have assurances that they' ll provide sufficient cash flow that we'll be able to maintain our credit quality, and I think that's also going to be an important element of the case. Well, technically, from an ROE perspective, of course, we don' t have a regulatorily approved ROE. We haven't been in a rate cas e for many, many years. I think the returns based on our guidance that we've given are going to be similar to returns last year. But in terms of an approved ROE from the regulator, we really don' t have one at this point -- the process that Bill and Mike were talking about starting to for next year. Let me just indicate -- in that ROE, there are a num ber of one-time benefits, including the tax benefits we were talking about, so from a regulator's eyes, that ROE would be lower than the actual accounting ROE. But Mike and Bill, Westar decision is expected in December. They ha ve the same wholesale. Can we use the Westar decision in December and, of course, yours is going to be a year later, so I understand the interest rates could be totally different at th at period of time, but can we use the Westar decision as a guide to you r decision in Kansas? Or are they going to look at you in a totally different light than, say, Westar? I don't think you can use their decision as an indicator for ours. They don't have a stipulation, they don't have a building program like we have. There's more risk inherent, in some ways, in our building program. So I think we're in different places at this point in tim e, and I would suggest you use the past -- our past su ccess in dealing with the Kansas and Missouri commissions as an indication of the fact that we'll be treated fairly in the future. Okay, and then if I could end up with -- Shahid, could you break -- is there a breakdown in the quarter versus how much of the volum e that you did in the quarter was based on the old contracts, you know, a y ear or two years old versus new contracts? Is there a breakup between old contracts and new contracts in megawatt hours in the third quarter? I mean the California, the higher-pr iced contracts that roll off -- I guess they roll off by next year, am I correct? That's correct. You know, I don't have -- we can probably get you that information, but I don't have that to hand. What I can tell you, though, is that with respect to the segments that we're serving, and margins vary by those different segments, we are seeing 30% of our business right now that we are contracting fo r for the future is new business, and about 70% is current customers. So our new custom ers that we're bringing on board will have an im pact in the future. I'm still just a bit confused on a tax item here. I've heard a couple of different numbers. I just want to make sure I'm straight. The tax adjustment, I heard a $17.9 million number up front in your monologue? I'm sorry, we ha d an adjustment last year go the other way as well of about -- I think it was about $4 m illion. I can get th at number, that final number for you, but -- so we had the adjustments I talked about for this year, and last year was s lightly less. Over all, year-over- year, the difference was $17.9. $11.7 was the one related to the adjustment to deferred taxes because of the composite tax rate, and then we also had lower taxable income. Could you talk a little bit about what that adjustment for the deferred tax rate is? How does that come about? Sure. If you recall, we had a similar sized adjustment last year, an d what ha d happened is we had an allocation methodology that Missouri state law provided for, and there were various ways of choosing your allo cation methodology. The S upreme Court ruled, I believe, it was last year, maybe late the year before, that allocation methodology could be changed, and you were allowed to alter your choice. In other words, by prior rule, if you made an allocation choice, you had to stick with it. Th e Suprem e Court allowed companies to make changes to that allocation methodology. We did that last year an d received a benefit as a result. We also had several things happen this year that affected that same type allocation. Ou r receivables program that we put in place, and the receivables factoring reduced the revenue or numbers for the ut ility, and so we were able to again allocate under a more favorable factor. We had made those adjustments in our filings and our tax filings, but we had not been through the audit process yet, and what happened in the third quarter as we finalized our audit work with the state taxing authority, and we're comfortable now that those adjustments are appropriate. The one last year did. The one for this quarter is more cu rrent. The effect, though, was to change deferred taxes, which is obviously a cumulative effect over a period. Okay, and just to clarify, I think I got this right, but that is not adjusted out for your core earnings, and so that is included in core earnings for the quarter and for your guidance? That number, and you've made statements about the sustainability of that, again, longer-term is what -- now in terms of repeatability or not? Well, again, recall that we had the same type of adjustment about the same size last year, so we did have it last year, do have it this year. Certainly, going forward, I can't tell you that we will have a sim ilar adjustment again that would have that im pact related to these particular taxes. We do have othe r tax work and other work we do that we believe we'll be able to accomplish some of this. But to tell you that we have this kind of adjustment of this magnitude happening again next year, no, I couldn't tell you that. Again, fr om a core earnings perspective, we want to be consistent and transparent abou t what's included and not, but we don' t want to exclude things that aren't clearly one-time. Does that make sense? I just had a quick question -- one of the things you mentioned on the call was that there was potentially pent-up demand for fixed price contracts and -- Yeah, I had you guys on a headse t. I guess one of the things you mentioned earlier on the call was the potential for some pent-up demand on the strategic side for fixed price contracts, given how high gas prices have been and the fact that people haven' t been buying them. I was wondering, given your di scussions with customers and your own view, if there is a way to think about what sort of dip might make people comfortable w ith signing fixed price contracts, whether that -- if you could give an ab solute number, I'd be very interested, but if you can't, if there's a way to think about it, if you c ould maybe give us some insight into where you think your customers might start to uptick their fixed-price contract signing. Well, I think we had a very good indication in th e May-June tim eframe of this year. I think prices came down by a couple of bucks , our gas prices, and we had a pretty healthy signing rate during those two m onths, and, of course, they went back up to the teens again. So if the share fo recasts and other forecasts are right, that we're looking at $6 to $8 gas towards the middle of next year, we think it' s reasonable to expect that we could have a similar kind of signing success. Shahid, do you have anything to add to that. You know, it' s a very hard question to answer, and I wish I had that answer. It would help me in my planning pro cess. But we clearly be lieve th at th e market will fall. We believe that customers will sign up. We've looked at three scenarios of low price, gas and power environment, and mid-price and a high price. We are planning for every single contingency, just so you know. We're developing products, and we're developing segments so that we can attack each of those three, regardless of the price. My expectation, though, is that you would see, if prices get to the mid case or base case, you'd expect to see a pretty he althy surge in sales for not just for Strategic but also for the industry. In addition to that, you'd also see contract terms becoming longer as well. The combination of those two hold out great optimism for us. It sounds like you thi nk if there's a -- roughly speaking -- if it's a fall below the double-digit numbers, then customers might get more comfortable with signing longer-term contracts. We think they would, and the other point that I hope you heard in Shahid's comments is that he and his management team ha ve prepared for that. They have the market segmentation, the supply management, the processi ng systems in place, so I think they're well prepared to capitalize on it. Okay, well thank you all very much. Just to reiterate, we believe that, with the regulatory plan that is moving ahead on schedule, and with the Strategic Energy business strategy in place, we think we are well positioned to create long-term shareholder value. We very much look forward to talking more in detail w ith you at the upcoming conference in Florida and have a great day. |
EarningCall_234067 | Good afternoon. My name is Eduardo, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the DreamWorks Animation earnings conference call. (Operator Instructions). It is now my pleasure to turn the floor over to Rich Sullivan from DreamWorks Animation Investor Relations Group. Sir, you may begin your conference. Thank you. Good afternoon, everyone, and welcome to DreamWorks Animation fourth quarter earnings conference call. I'm joined on today's call by our Chief Executive Officer, Jeffrey Katzenberg; our President, Lew Coleman; and our Chief Financial Officer, Kris Leslie. Today's call will begin with some brief discussion of our financial results, followed by an opportunity for you to ask some questions. I would like to remind everyone that today's release is available on the Company website at www.DreamWorksAnimation.com. Before we begin, I would like to remind everyone that certain statements made on this call may constitute forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties, which may cause them to vary materially from actual results. A description of these risks and other factors are contained in the Company's annual and quarterly report and in other SEC filings. The Company undertakes no obligation to update any of its forward-looking statements. With that, I would like to now hand the call over to our Chief Financial Officer, Kris Leslie. Kris. Thanks, Rich, and good afternoon, everyone. In the fourth quarter, the Company reported net income of approximately $63.2 million or $0.61 per share on a fully diluted basis, bringing our reported earnings for the full year 2005 to $104.6 million or $1.01 per share. There were two offsetting items that impacted the fourth quarter EPS, including a $0.27 per share increase for the recognition of a tax benefit on two film projects that were previously written off for book purposes in 2003; as well as an incremental write-off for Wallace & Gromit, which resulted in approximately a $0.15 reduction to the fourth quarter EPS. I will discuss both of these items in more detail in a moment. Excluding these items, results for the quarter were primarily driven by the home video performance of Madagascar. Of the $172.9 million of revenue for the quarter, Madagascar contributed approximately 88% or $152.3 million. By year end, we recorded approximately 14.2 million units on a worldwide basis, which reflects the first seven weeks of the title's initial release. Shark Tale, which contributed $5.7 million of revenue in the quarter, has now sold approximately 17.3 million home video units on a worldwide basis through the end of the year. While this performance demonstrates the strength of our product in this very competitive environment, we remain cautious in our assessment of the home video market, especially as titles move into catalog. We're monitoring closely the impact of limited shelf space and the increasing pricing pressure on catalog titles. This is something that could have an impact on our titles going forward, but it is too early to conclude any long-term impact to our business. The remaining $14.9 million of revenue in the quarter was generated by our library and other titles. Our latest release, Wallace & Gromit, has reached approximately $184 million in worldwide box office to date. The film has been released in most major territories with the exception of Japan, which is scheduled for release later this month. As anticipated, we did not see any revenue for this film in 2005, as our distributor did not recoup its marketing and distribution costs by the end of the fourth quarter. However, due to the film's lower than expected home video performance to date, we have lowered the film ultimate, resulting in an incremental write-off of approximately $25.1 million, which is reflected in the fourth quarter's cost of revenue. Although the film was released on home video in the first quarter of 2006, the accounting rules dictate that we assess our inventory balances prior to filing our fourth quarter results. Accordingly, we have recorded the charge as part of cost of revenue in both our fourth quarter and year end 2005 results. As indicated by the write downs taken this year, we do not anticipate seeing any significant earnings from this film in the future. Despite concerns with the home video market, we believe that the performance of Wallace & Gromit was more of a title-specific issue than an indication of an industry trend, as it did not achieve the consumer awareness we hoped for in the market. Moving on to the remainder of the income statement, SG&A was approximately $15.7 million, which included approximately $2.6 million in stock compensation expense, reflecting a downward adjustment to awards that have performance criteria. SG&A also included costs for Sarbanes-Oxley compliance and legal fees related to the pending securities litigation. Looking at the tax expense for the quarter, we recorded a non-recurring tax benefit associated with two previously-discontinued film projects. Both Tortoise and the Hare and Tusker were written off for book purposes in 2003. Because we plan to abandon the rights to these films in 2006, we recorded the associated tax benefit, resulting in an increase to net income of approximately $28 million in the quarter or $0.27 per share. So in total, the net income for the fourth quarter was $63.2 million, including $12.4 million related to the tax benefit and incremental write-off for Wallace & Gromit. Looking at the year end balance sheet, the Company finished the year with a strong cash balance of $403.8 million and debt of approximately $194.5 million. As previously announced, the $75 million signing bonus received in the first quarter of 2006 as part of the new agreement with Paramount has been used to lower that debt obligation. Looking forward to 2006, the Company's primary source of revenue and earnings will come from the performance of Over the Hedge, expected to be released in theaters on May 19. Because the success of our films is ultimately dependent upon consumer acceptance, it is extremely difficult to predict how they will perform prior to their theatrical and home video release. As a result, we have made the decision not to provide EPS guidance. With that said, I would like to provide some general comments about 2006. While we will be releasing two CG animated films this year into theaters, unlike the first half of 2005 which benefited from the home video release of Shark Tale, we will not have a similar driver of earnings in the first half of 2006 due to the write-off of Wallace & Gromit. As a result, we do not expect to have any significant earnings in the first half of the year. I would also like to remind everyone that while Over the Hedge will be released in the second quarter of 2006, we do not expect to recognize any revenue for this film until after our distributor has recovered their costs. As a result, it is possible that depending on box office, we will not recognize any significant amount of revenue or earnings until Over the Hedge is released in the home video market in the fourth quarter. Our second film, Flushed Away, is scheduled for release in November of 2006. As is typical with our fall releases, we would not expect our distributor to be recouped by year end and therefore do not expect to see any significant revenue from this film in 2006. I'd just like to close by updating you on our new distribution deal with Paramount, which became effective on January 31st. As we stated at the time of the announcement, we think it was a great opportunity for the Company to secure a long-term distribution deal under similar economic terms, while also providing access to new assets like Nickelodeon. We have already started transitioning the distribution of our future films over to Paramount, with Over the Hedge being the first of our films to be distributed under the new agreement. In terms of our past titles, Universal remains committed to servicing our current releases through a transition period, which goes to the end of the second quarter of 2006. After that time, Paramount will take responsibility for all DreamWorks Animation titles. We will continue to work closely with Paramount to minimize any potential short-term issues that can arise when transitioning to a new distribution partner. In terms of shared services with Paramount, DreamWorks Animation will absorb some of the corporate functions that were previously provided by DreamWorks Studios under a services agreement. The costs associated with these activities, as well as the costs associated with additional executive management added at the end of last year, will likely result in approximately a 15% increase in SG&A over the $76.5 million reported for 2005. As part of the Paramount deal however, Paramount has agreed to reimburse us a predetermined cash amount on an annual basis, intended to offset any incremental costs as a result of the new distribution agreement. While the accounting treatment for this payment has yet to be determined, it is intended to keep us economically whole for these added costs on a free cash flow basis. In 2006, we will receive approximately $11 million in cash for cost reimbursement. Thanks, Kris. That concludes our formal remarks today. I would like to welcome our Chief Executive Officer, Jeffrey Katzenberg, and our President, Lew Coleman, to join us for the Q&A portion of the call. I would also like the Operator to please once again repeat the procedures for logging in a question. Thank you very much. Actually, I had two questions for Jeffrey and Kris. The first question is, you had mentioned on the call that you are cautious about the home video market. I was wondering if you could elaborate specifically on what you are seeing that keeps that caution very much at the forefront. Secondly, you also mentioned that you are not ready at this point in time to change your film ultimates based on what you are seeing because you don't know what the long run outlook would imply because you haven't gotten through that time period. What types of things are you looking for before doing that, to justify if you don't need to or to actually lower the ultimate profits per film? Thanks. I'm going to take the second part of your question first, Anthony. It's not exactly accurate to say we haven't made any changes to our film ultimates. Obviously, the ultimates for released films reflect our current view of the state of the market, which includes some of these pressures that I mentioned, particularly as the titles move into catalog. Clearly there's been a flood of product in the market; that creates shelf space issues and some pricing pressures, which we are reflecting in our release to ultimates. I think the comment I made was, it's too early to tell whether that's going to be a permanent change to the business model, and we will wait and see what happens with Madagascar as it moves into catalog. We need to get a few more data points. Remember we have just a very limited number of titles in the market at any point in time. So, for us to draw a conclusion as to whether something is permanent or not, we are just not there yet. Anthony, with regard to the first question, I don't think there's anything new from what we discussed last time with you. We continue to watch an influx of catalog and television product into the market in all the same regards that Kris just mentioned -- shelf space, you know pricing all of these things in it. It is still a market that is adjusting to this. Nothing has changed remarkably one way or another from last time we discussed it. Kris, you know I probably didn't phrase the question correctly, but you did hit on what I was looking for in terms of the permanent changes to your film ultimates as opposed to the film ultimates for the product that's already come out. So, if I heard you correctly, and please correct me if I'm wrong, you're waiting to see what happens as Madagascar plays itself out before making that permanent change. Then, based on that, you'll make a decision, it sounds like. If you're asking me about Madagascar in particular, let me step back one second Anthony. Currently given everything we know about the market, including our caution, Madagascar still fits within that overall generic business model that we laid out for you guys. I will add to that however, remember it did have performance, international box office versus domestic box office, in a higher ratio than what we have typically seen historically. But, all in, in general, it still fits within that business model. Now, when it comes out in catalog, we will assess how it performs. If there is a change warranted at that point, obviously we will make the change. Even given everything we know today, we're still within that model. Thank you very much. A couple of questions as well. First, could you maybe give us some specific examples of what kind of distribution changes we might see as the films start to move through the Paramount arm and what you might be able to do differently that might be additive to what you were doing previously? Second, on Madagascar home video, maybe kind of what you're seeing in terms of pricing. It looks from the revenue you reported for Madagascar, the units it seems like probably not a lot of major changes. I'm sorry if I missed this, if you broke out domestic and international units. Then lastly, your balance sheet strategy. Obviously, you've been holding a relatively full cash position and I'm wondering what your plans with your cash are going forward. On the first one, Michael, in terms of Paramount, we are in a transitional mode right now; with that I think are both the challenges of getting the organizations integrated and working with one another. So far, they have gone smoothly. There's a lot of strong organizational support there. As to new opportunities, I think those are things that we are just exploring and I think it's premature for us to try and quantify or qualify them. Michael, on the pricing issue, as you know we don't get into specific pricing on any of our titles. But you've got the revenue and the units, so I think you've got at least some information. Can you repeat your last question on the balance sheet? I'm sorry. Sure, before that though, did I miss -- did you provide a breakdown on the 14 million units? Did you provide a breakdown between domestic and international? Michael, it's Lew Coleman. I'll just comment broadly. Our belief is obviously that if this business gets extremely successful, it is a big cash generator. We would like, as a matter of practice, to keep about two movies' worth of cash around, obviously invested in short-term. If we have nothing better to do with the remaining cash, we will return it appropriately to the shareholders. Thanks. Question is for you, Kris. With respect to how 2006 is going to play out, in addition to the DVDs that you mentioned and the movie releases, are there any other smaller revenues or events that we should be thinking about, in terms of things that are coming into the broadcast window, for example, or anything of that ilk? Then second, when you say that we shouldn't expect earnings for it sounds like the first three quarters of 2006, does that potentially mean negative earnings? Or are you talking about basically breakeven? Thanks. Let me take the first part first, which is other sources of revenue. I don't want to go through the films specifically, but let me give you a couple rules of thumb in terms of TV revenue and expected timing, because I think this may be helpful as you look at all the films. For domestic pay television, typically we recognize that revenue about 12 months after domestic theatrical release. For domestic network television, it's typically about two-and-a-half years after domestic theatrical release. International pay television begins about 18 months after domestic theatrical release and international free television about two-and-a-half years after domestic theatrical release. In the domestic pay and domestic network, we typically recognize virtually all of the license fee immediately when it hits that window. In the international markets, obviously it's on a country-by-country basis, so those can flow out over several months from the point at which we start recognizing. So, hopefully that will be helpful in terms of the TV side. Then the second part of your question -- I am sorry; can you repeat it one more time, Kathy? I'm sorry. You basically said not to expect any earnings for the first three quarters of the year. I'm just wondering whether you are suggesting that it's going to be breakeven or potentially even negative earnings. Thanks. Kathy, as I said, we're not giving any specific EPS guidance. I think we're just trying to give you some guidelines that help you to understand where the majority of the earnings are coming and what will drive them. Good afternoon, a couple of questions. Kris, I just wanted to make sure I have my math correct on the organic EPS number. Excluding the tax benefit and excluding the incremental Wallace & Gromit write-down, I have $0.49. If you could just confirm that for us that would be great. Jeffrey, I was curious how much of Over the Hedge you will be showing next week at the ShoWest Convention in Vegas, whether or not you'll be showing the whole film or whether or not you'll just be showing select clips. Thanks very much. David, I will take your first part. We only give GAAP EPS numbers. However, we've given you the components of the two non-recurring charges. So, the tax benefit again is $0.27 positive, and the Wallace & Gromit write-off is about a $0.15 charge. David, to the question of Over the Hedge, it will screen next Thursday in Las Vegas. We're showing the entire film. However, 80% of it is in color and the balance of the 20% is completely animated but not in color yet. It is a work in progress, and it's not fully dubbed, and various other things that still make it a work in progress. Thanks, good afternoon. A couple of questions. Kris, I think you talked about Wallace & Gromit being a title-specific issue that really led to the write-downs on the film. I'm wondering if Jeffrey, you want to address this a little bit. But talk a little more about in your post-mortem, what you think didn't work about that film? In the context of that, what your general outlook -- I know you're not going to give specifics, but -- how should we think about the potential size of both Over the Hedge and Flushed Away as we head into those two releases? Kris, just one accounting question. The $75 million, what will the accounting treatment of that be? I think that trying to do a post-mortem on these things is a challenge because what you're doing is trying to gauge consumer appetite, which is obviously something difficult to predict. Wallace & Gromit was critically about as well-received a movie as one could hope for, and in certain places around the world performed sensationally well. In other places, particularly here in the U.S., was disappointing. I don't think that there's anything to be taken more or less as -- I think it is a unique product. It's a stop motion film. Really, I'm not sure that there's any way to relate it to any of our past or future films coming at this point. On the $75 million, I'm sorry; I should have mentioned that earlier. That along with the cost reimbursements, we're still working through the accounting treatment. So, we will let you know in a subsequent call when we get that firmed up. Jeff, I don't know if you wanted to make any comments about your thoughts on these two films that you'll be releasing this year? Could you just give us a sense, Jeffrey, of the progress on the Bee Movie, how that movie is beginning to come together in terms of timetable? Then also, just comment on a financial type, Kris, on the cost structure of that film relative to what you're putting out during 2006 as well as your other film in 2007, in Shrek 3? I will be happy to do that if I want only because Rich is sort of sticking a piece of paper in front of me here. Just to clarify for everyone the fact that Over the Hedge is at the stage that I just mentioned to you -- 80% in color, 20% of black and white-- it's exactly on schedule for its delivery on this. So I think Rich was nervous that maybe it sounded as though we were not going to hit the finish line on time here. So, he now just calmed down. On to the Bee Movie. It's again on schedule and I think has been moving through the process well. Jerry Seinfeld has been engaged in every step along the way with it. Again, I think the picture looks fine. From the cost standpoint, we've talked a lot about the costs in the past. Typically, we say that films are about $130 million from a production cost standpoint. On top of that, we will have contingent compensation and we've talked about sequel versus original. I think what I would say about the Bee Movie is that given the people associated with the movie, the contingent compensation will be similar to a sequel versus an original. I think what we have said in the past is that can be somewhere in the range of 10% to 14% of worldwide box office. Contractually, do you have to spend anymore on marketing, or do you have any base that you have to spend given Seinfeld's involvement? Jeff, perhaps a question for you. There has been a lot of discussions in analyst conferences recently about distribution windows, perhaps an HD window or a VOD window 60 days after theatrical, shrinking the pay-per-view window. You have such a high-profile product, might your distribution of those products be a little different than say the average studio that has 20 plus films a year to have out in the marketplace? Jeff, I don't think there's anything that's presented itself to date that changes our distribution strategy or our approach to the existing windows. We think that we are getting full value for our product, given the structures that exist in the marketplace today. It just seems unbelievable that any of the studios -- including you -- want to take customers, who have paid you two or three times for a product and turned them into somebody that pays you only once. Is that an accurate assessment of how we can look at distribution windows? No, I think you would have to say it depends on what they are paying you and what your margins are when they pay you. So, I think there are couple of more elements that would go into that equation. Thank you. Jeff, have you made any progress on the TV side of the Viacom agreement? Could you just talk about what you hope to get out of this over the next few years? Well, we're just at the beginning stages of it, Jessica. We have had a number of creative meetings with Nickelodeon and they continue. We've got some more scheduled over the next few weeks. So there's nothing really concrete yet, other than there seems to be great interest on their part in finding ways of moving some elements of our properties onto the Nickelodeon channel. As to when or what the impact of that is, I think it's just too early for us to speculate on that. Thanks, Jessica. That concludes today's earnings conference. I would like to remind everyone that a replay of this afternoon's call will be available shortly and accessible on our website. That address again, www.DreamWorksAnimation.com. If you have any follow-up questions, please feel free to contact DreamWorks Animation Investor Relations. Thank you very much for participating and have a great afternoon. |
EarningCall_234068 | Hereâs the entire text of the Q&A from Broadcom's (ticker: BRCM) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you, we will now begin the Question and Answer session. if you have a question, please press â*â followed by the â1â on your touchtone phone if you wish to removed from the queue please press the â&â sign or the â#â key. If you are using a speaker phone you may need to pick up the handset first before pressing the numbers. Once again for a question, please press â*â followed by the â1â on your touchtone phone, one moment please. The first question comes from Seogju Lee from Goldman Sachs, please go ahead. Hi, very strong quarter, I am wondering bill, if you could give a little details behind the guidance for next quarter just picks the what is it for the various product segments, what areas it might be growing little bit stronger and what areas would be out performing and what areas might be more sort of inline or tracking a little bit lower. Thanks. In safe with our normal policy, Seogju we donât give a lot of granularity on that, we did say that we expect it to be broad based. I did highlight a number of areas we are particularly strong in the quarter that just ended. And in particularly we made the comment its on or more consumer driven business tend to get some pretty high water marks near the end of the year and particularly some of those business were include Bluetooth, Mobile Multimedia and Wireless LAN. But beyond that there is really not a lot of additional granularity, another one it is a good thing about, within first time I have to making the point on our diversification and the fact that we arenât always able to predict it exactly which business is going to be how strong infact that we have enough of them going on, in different areas that we have confident that the entire business will be up 10% to 12%. And just clarification on the outlook for Q1 Bill. You said that it would be down versus Q4 or would it, are you looking the growth rate. What I said that it would be prudent to expect that it might be down a little bit, if you look at the semiconductor industry as a whole typically it is down a little bit on Q1 versus Q4. We are by no means exclusively a consumer products company so we wouldnât have that kind of real steep fall off. We donât expect, however there is some of the business that most likely will have a slower first quarter then going forward, and that will offset by others of commercial businesses that would be expected to remain strong through the first quarter. Hi guys congrats on a great quarter. Obviously a lot of things are going well, one thing that I didnât hear form you and may be so many other things doing better but was on the ITTV front, clearly you are involved in a number of ways on the ADSL2 and DSL rollouts but we really havenât seen you guys talk about ITTV to date, is that because you guys earn position there or is it just may be the scalper we are looking at right now. Well I donâtâ guess we are very bullish on the ITTV market overall and in long term we think it is going to be very important market and we are involved in a lot of the players who were deploying that, itâs just not much of the revenue story to talk about yet because we are still missing a lot of content on the ITTV space so there is nothing holding any of that from a technology point of view but we havenât seen the content deals develop that will enable users to want to buy the boxes. And so we donât see a lot of revenue in that space in the near term although long term we are very bullish on it and do participate. So there is nothing from a technological standpoint that would be privilege from more concern with Microsoft, if the market is developed quicker than what we are seeing today. Hey guys great numbers again, two questions first on the wireless Lan phase, is the strength you are seeing from notebook or for modems or I guess nick cards, where is that coming from and then second question on the set top box phase, are there been a couple of weaker data points in the supply chain out of EMF and then I think thatâs Thomson Street announced, did you have any concerns about may be the satellite or cable set top boxes that you could help with it. First on your Wireless Lan question, we are seeing pretty broad pick up for the processors so itâs not certain point to any one space, it is the general pick up which is very encouraging. On the set top box phase, we have noticed some of those data points, but we donâtâ strictly see any issues there, we are seeing stuff sell grew, there were some rumors in inventory but we are just not seeing that, we have done channel checks and we have talked with our customers and in general we believe that we got good sale through and no reason not to except the continued growth as we outlined. Just to amplify and that also one of the things that is happening in set top box is now there we have heard some slowdowns in the standard def boxes and so due to this turn in the standard def boxes those tend to be recycled. And the new boxes that ship are the high definition and the ones that include TDR and thatâs the major strength that we have so our trends in set top boxes somewhere quite the same the market in general. I see that very helpful. And that eventual one more, now that your comments about the Q4 slowdown turned out to be too conservative, can you just help us identify which areas you were concerned about that you might have been shipping in too much that it turned not to be so. As we had indicated the consumer oriented businesses is relatively new for us so some of the things like Bluetooth, Mobile Multimedia processors and Wireless Lan, this all came in stronger than what we had expected them to do. I have question about Bluetooth certainly that seems to be a rocket chip rocking use that term what do you think the penetrate rate can get to in cell phones versus where it is today and I have a couple of follow-ups please. This is Peter, you did take a quick look at some of the inside data that just came out with the brand new report if you look at fiscal year 2005, they are expecting that penetration within cell phone alone will be 35% in â05 going to 42% in â06 and up about 50% in â07. Thank you Peter. On follow up about both Mobile Multimedia and handset, I think you talked about a handset based and growing in Q4, could you talk a little bit, is there is customer change that has occurred. Or can you top line design in there and Mobile multimedia, are we talking about anybody beyond northern Californian company. Well on your first question, we are unable to announce our 3G customers at this point and in general and that base we are not allowed to talk about until they ship but we will certainly fill your way, as we are able to do so. But as I said we feel like we are on track with that, and all the guidance we have given as is still true and we made progress on the IOT, we are at the final stages of the IOT in 3G which is quite an achievement. So we are feeling very comfortable with that. On your comment on the mobile multimedia we have certainly got presence not only in the handset space and Samsung has announced using our mobile multimedia for some of their phones. We have also received design wins in some of the new reshipping products from other companies that ship in the MP3 space. And youâll probably some teared down reports that indicate we do a customer in northern California. Of course thatâs going to depend a lot on what happens on the share price but we are internally remodeling it to may be increase by somewhere in the 10 to 12 million share range. Okay thanks, and couple of follow-ups, one on If I understand correctly correct if I do not, WCDMA or 3G shipments were supposed to start this year, when you say you are on track does it mean you will be shipping 3G baseband by fourth quarter. Weâve said in the past that we would have some initial shipments at the end of this year, which is fairly small but we are on track for that, yes indeed but we expect it to ramp more signification next year. And then final Bluetooth you have given us quarter over quarter numbers for the last quarter, how much did that segment go again this quarter. Thank you. We are not going to break that out every quarter, amazingly it grew even more than it did last quarter, it âs an explosively growing market, it did extremely well. This is Peter, also just another data point we havenât seen all our peers in the Bluetooth market announced results yet, but based upon the guidance that a number of them has given, we expect to either maintain and or increase the market share. Yes. Once again itâs being primarily driven by handsets but we also had sequential growth in the PC as well as the headsets markets as well. Thank you just a question on, 802.11n, and as the market moves into new standard do you see any foreseeing any changes in a compettive landscape and what is your strategy, any more market share in that space. Liang I think the two questions you asked are related because 802.11n is a much more sophisticated and difficult to do technology than some of itâs predecessors, the multiple-in and multiple-out technology is quite difficult so I think lot of the peole who were able to participate in the B&G rounds will find that itâs just too difficult for them to go forward, so I expect the number of players will drop out of the market at that technology node which is good for us as it narrows the total number of players, we also expect the present traditional Silicon that will give us an ASP increase on our products and so that will help us fair, so we see both a chance for market share increase as well as an ASP increase in 802 11n going forward. Also remember one of the key differentiates is that Broadcom has an additional 801.equipment that we can pull out. Is that we also have all the platforms which are going to integrating the Wireless Lan into them such as DSL modems, cable modems, set top boxes, cellular handsets etc., So in terms of the adoption I assumed the retail segment will be the first to adopt the new technology do you agree with that or any other segments that seeing the adoption first. Yes I will agree with that. I think generally the retail is very rapid to market and many of the retail customers are less concerned with compatibility and doing a very broad range of testing. So it will hit there first and then you will see more widespread adoption with the PC LOM. The PC LOM generally wants the extensive testing and confident that it works with all together systems they have out in the market, just could bit been want to have Bill quotes. And in terms of the product introduction I havenât seen a formal product announcement and is that forthcoming for you guys in this area and when do you expect to ship in volumes. As we said in the earlier notes we expect to see volume more next year, we havenât made an announcement yet in terms of the specific product shipment and we will do that just shortly before we ship. Thanks guys, great quarter. With respect to last quarter when you had given guidance regarding Q3 and then a little bit conservative on Q4, can you talk a little bit, is that a little bit of what you are doing today with regard to Q1 of â06 because you are talking a little about the consumer but the way I look at your business is, there are a ton of consumer oriented applications that you got there , obviously Bluetooth has grown significantly but outside of that in cell phones, what would be the seasonality that would be so dramatic in Q1 that we would see. First of all when we give any kind of guidance itâs very unusual for team to look also a quarter ahead, we are trying to do that too because we believe that this consumer business and the volume of the consumer business is relatively new for us and if you note that mobile and wireless which is the severely consumer driven of our business groups have by far the strongest growth this last quarter is up 47%. Itâs is now 27% of our total business. So we do have the right substantial amount of business in that area. I would always rather be proven too conservative and forecast. We tried to give these estimates in good paces as closely as we can. Thank you, hi Bill. Question for you on the share count, you said 13 million of the increase came from options, just wondering where the rest of the increase came from? What I said was 13 million came from the treasury stock methods. That means those are un exercised options. Most of the balance actually came from options that had been exercised during the quarter. Okay. Any plans to change your increase your share buyback going forward or are you happy with the $250 million that you laid out already? The $250 million was a one year program, we will be reexamining that at the end of that one year, we did repurchase over million shares during the quarter. Okay great. And then just looking into Q1, it appears there was a question on this but do you have visibility to tell us that in a kind of a(37:54)just basing it on the fact that you have consumer exposure and it could be seasonally weak. Itâs seasonally weak and then weak is an adjective that I have a hard time using given the numbers the strength of our business in general, I think it is more of a seasonal pattern as opposed to a weakness because we are not projecting that any of the markets we are in consumer, or enterprise are weak as such, itâs just that the consumer driven spikes, that happen around the end, around the holiday selling season, are pretty formidable and as we said that its fairly new for us. We are still trying to understand exactly how thatâs all going to work out. I would rather have investors be pleasantly surprised on the upside than on the downside of course. So I think itâs is, and if we didnât believe that there was some risk the business might be down, some in Q1 we wouldnât have said anything. Okay. And just quick question on the Apex, the increase in R&D clearly you have been growing pretty rapidly in the last three quarters but the R&D increase we saw last quarter was very significant, are you adding or entering new markets here, or is it just the existing program. Could you give us a little bit color as to where you are investing these orders? We are always entering new markets. In addition to the headcount issues and of course might be in an acquisition we have the extra expenses as a fact in the quarter, we have been doing a lot more prototyping in this most recent quarter and some of our indirect expenses in support of us some of the new programs have increased so that there is not outside consulting expenses and design expenses, that sort of things. One of the things we said earlier in the year, in some earlier conference call was that we were investing R&D because we saw very high likelihood wins for us and great opportunities or in some cases where we had won the designers as a matter of staffing to make sure that we could deliver on it and I think some of multimedia designs you are seeing right now are examples of investments we made earlier in the year that we eluded to and now you are seeing a very quick payback on those designs coming within the same year, we made the R&D investments. So those are very attractive for us and when we see those as a management team, we believe those are very good investments and we do pursue them. Okay. One last question on the new markets part as you look into 2006, you have storage, 3G and digital TV, could you give us some idea and why do think, these new markets, what kind of revenues or when do you think they will become meaningful as far. One for the things about our business is we have quite a few businesses so thatâs why we didnât talk about every single one of them but I think to give you a little color on some of those storage, we are very encouraged by and we have won a number of design wins that we think will come into play on the server side especially with some of the new Intel cycles coming next year. So we do expect to see a ramp there. Digital television, we are still excited by that, we do have number of design wins with top tier vendors across both Asia and other parts of the world,. And so we are very encouraged by that and digital TV those are going to be more of a ramp up the latter half of next year so I think thatâs a second half of 2006 revenue driver not so much in the first half. There is some now , there is some this year, thatâs a little bit more in the first half of next. But second half as well, I think the big kick is going to be on digital TV. 3G we said thatâs going to ramp over the course of next year. It will depend a little bit on the model acceptance for some of our customers; itâs a little harder to predict a priority how successful all the models are going to be. But we have secured not only initial models with these customers but also follow on models so we believe that that will ramp over the course of next year, but at this point it is a little hard to estimate exactly how thatâs. Okay. Two questions on the operations side of things, gross margins for the last few quarters have been running hope high-level space, in part I think on lower wafer cost. In terms of the upside on the gross margins how much do you think of that is due to wafer cost versus mix? You know thatâs really hard to tell Jeremy and we tried to analyze that as best as we can, each quarter but there is so many dynamics going on, we have first is the pricing sided equation and then there is the cost side and then there is the fact that we are constantly coming out with new products and we are constantly negotiating better pricing on the products so how much of the changes because the new product came out as the next generation as cost improve versus just the wafer cost itself went down. So there is not a good clean answer for you on that, it is dependent both on mix and on what kind pricing environment is and where we are in the product cycle. As weâve said before when we first started shipping a new product thatâs often not the best margins on a product, because it has been cost optimize here by the time it gets to the next generation and the volume ramps that tends to be the sweet spot of the market. Very good okay thank you, one last question here, you are obviously higher strongly on the tail of strong revenue growth, but you continue to dive to operating margins of 22%, do you foresee sometime that guidance on the high end of the operating margin as you go up. With the guidance at 20% to 22% announced since 1998, one of the great things about this business in the markets that we are in, is there is always more good development opportunities than we have funding to spend on them, so we tend to reinvest that to the extent that we start returning it to the high end of our model, we would probably be more inclined to reinvest that to try and spur even greater growth in Q3. We have a great relationship with AMD and we do products to help their servers be as fast as they are and I think they are getting wide acceptances in the market place, I saw a report that says, they are gaining some market share and some of that is due to the chip sets that we deliver and they are super fast. As we think about your leverage longer term can you help us sort of if I think about your IP that you develop, your R&D and SG&A your spending, how much of that is going for very specific products and how much of that is going for basically all of the products or multiple products? It is a little hard for us to give you an exact percentage on that, the sense we have, we have a central engineering group, itâs task is to deliver the technology that we use across our products so that has to do with a lot of basic cells and analogs block things like that, so that tends to be reused . We are also finding more and more we are able to use technology developed in one group to help another and a great example of that is Voice Over IP and Aero-2 and 11 technology where that was developed in one group and is now being used in another and share so when we get into triple play solutions in the cable market, we share a technology with a mobile and wireless group you will see now mobile multimedia, moving to much greater capabilities and we expect that has a long way to go in terms of new capabilities there and thatâs converging with our broadband market and the lot of the technology we develop for them. And so we have a lot of joint projects now between our groups, so I would say that over time our reuse of technology is increasing so I say we are getting more effectiveness out of our R&D cell. So sustainably over time, your revenue growth should be whole the way up strip your operating growth may be with a bigger delta, is that possible. Now I think we are all fine with seasonality but I donât think we want to avoid is hyper seasonality, a lot of these products are going into release some other ones driving Q4 growth. Anyway in the consumer side effects we get a feel, to make sure you are not shipping well above what actual consumption is going to be heading into the first quarter. I think we are pretty cautious on that we work very carefully with our customers and it is not in our interest to stuff in the one quarter and then pay the penalty in the next quarter so we aim for working closely with them to minimize any excess build up and we believe weâve been successful doing that, going back to the diversity issue I think the breadth of design wings we have in the consumer space helps a lot and you see for example we have new product introductions like multimedia and other things, that are going to ramp in the face of others that might decline a little bit. So we are trying to aim for a steady business since we have agree absolutely we are not interested in hyper seasonality and we donât think we will fall into that trap. I guess along that line inventory up 20-% sequentially obviously have a big ramp ahead of you. But is that looking forward below that more as the mixture, what is driving that big of a number. Our model is to be at about eight inventory trends, we have 7.9 of this last quarter so we are not concerned about that and some of that, was built up in anticipation, clearly I notice we already have it on our books. And is there any concern at all about capacity and is that effecting at all the way you want to mention, inventories for the couple of quarters. First of all on the foundry capacity it has been in pretty good shape but still then a little more of the squeeze at the backend, the assembly and test although thatâs capacity that you see to bring online with a shorter lead time. That is probably a bigger bottle neck currently than foundry But having said that are any of the numbers that we plan we certainly have the capacities available to us to be able to deliver that. Do you feel like you need any more buffer heading into that, just even in terms of guidance,and getting some package product. We buffered so that if we see higher numbers than weâve expected we could hit those, so we naturally plan for upside and the capacity to deliver to that but also we see the backend manufacturing problem thatâs right now, itâs relatively short-lived. Thank you. Michael had asked most of the questions in regards inventory, Bill just above said, that inventory was up about 21%, with most of that initiatives or with that mostly grim. So in terms of end products it is pretty big safety cushion again that things you imagine (49:47) though, you have been satisfied with your guidance, is that more for potential rollouts in the first half of the year, than they get pulled in from your customers that is. Let us just put it this way, our total record earnings throughout history on having obsolete inventories, is probably as good as anybody , probably better than just anybody in the industry so typically if we have the inventory on hand, but we donât sell in the current quarter it sells in the next quarter but we tried to stay tuned as best we can to meet the current quarter demand and be prepared to get into the next quarter. And Scott, going back to your some of your â06 drivers particularly within storage indicated several intel cycles that would help to fuel that, that has taken most of your efforts have been mostly within the serialized and not to much serial EPA. But you tell into little more detail, is that going through the server market, can we look for server chips within the general market or are you targeting any particular Intel platforms as well? We primarily target the larger OEMâs, server OEMâs and both with FAT OEM, the iSCSI so I think you will see a broad base availability of that, we also target some of the white box makers if thatâs what you are looking to. Yes. part of that and certainly within Intel CSCD group, white box and iSCSI and so we expect to see another round of championships that has been target more for the Intel platform in addition to your AMD. As a reminder for any questions please press â*â then â1â on your touchtone phone. The next question comes from David Wu from Global Crown Capital. Please go ahead. Hi this is Hung Lee for David Wu, I noticed that there are quite a bit of fraud in the interest and other income, could you please give some guidance on that. Yes we have a lot more cash than we did and we are getting lots of order rate some we were. It is quite really simple there is nothing unusual going on there, our cash balance now is $1.7 billion. Thatâs a very substantially what it was this time a year ago. And instead of getting interest rates to start with a one, we are getting interests start with a three. Nice job for all guys, just a couple of quick questions if I could, first, starting of at your end as you look at the voice enablement on the modem side, ramping up during Q4, you had enough by itself to allow that broadband division to accelerate after the third quarter growth rate that you saw. Well I have to think about that because we certainly do expect some broad based growth in the fourth quarter so we did expect that group to grow, it is hard to think about whether that alone would do it, hard to say, we have a hard time, breaking that up specifically. Okay. And then it is so assumed that with the growth we saw in blue tooth but that is now a I am assuming itâs probably your biggest division bigger than wireless lan. And just last one. Congrats on the success of 3G, and I know that you got some questions that how quickly it ramps but would you expect that the 3G baseband business would surpass that of the GSM, GPRS business next year or is that taken till 2007? It could catch next year, I think it would depend a little fast, depend on how quickly some of those models ramp up. It is capable of passing the others, but it depends because if the GPRS models, blow the doors off on demand then no, and if the 3G stuff sales really well then yes. So we are looking forward to that race. Thanks, Bill I know earlier you asked about mix versus input prices and you are going to get to too specific, but it sounded though foundry capacity wasnât the big issue and maybe backend was becoming a little easier, what are your expectations for input prices going forward? To be clear what I had said was, the foundry capacity seems to be getting a little bit more available than it had been but the back end is tighter not easier. Then we could expect to see those input prices continue to put a little bit of pressure, do we run into problems that have been extending in the next year, or do you expect that to be a little easier this year? Let me clarify that a little bit, the front-end generally is extremely capital intensive and can take anywhere between 6 months and 18 months to bring under new capacity in a fab were as the backend, the wire bonders and for some of the test equipment generally comes online in a channel one and half month, and so thatâs why we believe that itâs a relatively short term issue in the backend and that will resolve between now and the end of this quarter. We believe we have the capacity we need in order to hit the numbers we have described so, we donât expect that thatâs going to be off the revenue blockage for us. Then if things does improve that at least in the backend by the beginning of next year, if the mix starts to shift back for those that are little less seasonably sensitive, more less and less consumer oriented is that been help your overall margin trends for the first quarter, may be while you see revenue decline. You could see margins same way. I can only tell you the two word answer in that but you donât like it. It depends. It depends on what those consumer products are versus what the enterprise products are just because itâs consumer driven doesnât necessarily mean itâs poor margins. It depends on the level of integration standard thatâs is level of innovation of within the product, and the same thing on the enterprise products, some of the older products have margins that arenât so good, and some of the more advanced ones have very strong margin. So you canât necessarily draw a conclusion from that. Yes. . Just wanted a little more color with in terms to your wireless business, we talk a lot about strength like four areas Bluetooth, WiFi, Multimedia and Voice Over IP, just wanted you getting more color on your wireless baseband business. Thanks. Yeah. Not really under them what weâve said, we do see our largest customer Sony Ericcson trending up in terms of revenues because of some of their new models out there. So positive sign there, I think the big mover in that market is going to be when we start rolling out 3G and that will be a little bit this quarter and then most of next year. Yes thank you. I noted that you answered a lot of questions on the satellite front you did mention that LG has begun the ship with a new unit for direct TV, what is your rate of penetration there at the high end right now or how far into that ramp are we, is just beginning the turning on in earnest this quarter or do we have to wait more until next year? Alex thatâs just beginning to ramp, so we see that as something thatâs growth driver for us going forward as we get further into satellite and we will continue to pursue all the aspects of the direct TV business through the variety of different box providers there. But to date LG is the only one announced. Okay. If you could may be characterize whatâs going on with on a blended basis maybe, high end average selling prices, your opportunity cable satellite and then also the normal non-DVR non-HD and perhaps if you could on IPTV. Whatâs the real ASP type, material type of opportunity for you. Well there is good news for Broadcom, this is Peter, is that the ASPâs remain relatively constant between the different end markets, so you intend to take a ST box whether it is satellite cable or IPTV it tends to be priced around the $15 range and then as you go up and as features such has HD TVR, dual screen TVR, Broadcom is able to getup at another upto about $45 per set top box. Good thing now is we are just now starting to see the upgrade cycle in the satellite space sensex forum. Just on the base level, that would add an incremental $10 to the box that Broadcom is able to derive. Now how does this compare with whatâs going on in terms of what type of boxes are being dreamed up or designed for IPTV. I would say you should assume the IPTV stuff roughly had the same silicon content and it is the other boxes. I donâtâ think then need, the amount of silicon that deals with the (59:47) bioelectric is relatively small versus all of the video processing and other things which make up the bulk of the chip. And then in terms of the digital television opportunity you mentioned might start ramping in earnest more in the second half of 2006, what kind of content are we looking at there I know there is a wide range of models out there, but is it also similar to the set top box market at this point, so if you can tell. In terms of the opportunity you are finding there, because I know you market in a number of technology, at this point are you basically just getting, the modulator winds or you coupling in multituner winds, have you actually started targeting PVR winds as well as those designs that are out there. What is your thought on your kind of mix in the second half of â06 because I know that they are being designed now. Well we certainly get some of the PVR business as a result of the set top box explosion we have. The digital TV we are referring to the mainstream consumer digital TV products out there. And these are for single chip TVs so we have integrated all of the TV functionality on a singe chip, and those products are sampling and available now that 36.50 and others and so that is single chip TV solution for mid range of high end digital TV. Thanks guys, like everybody else congratulations and a lot of questions so just a couple left that I can see, in the 3G side of things, as you look at your 2006 design winds today, it was generally lean more towards, just the base end, just the multimedia processor or more of a bundled approach to date. A - Scott McGregor: We are seeing design winds in a variety of areas, I think a lot of our customers are independently making design decisions on Bluetooth versus multimedia versus Aero-2, 11 versus day stand, so we donât see so much bundling today, but we expect that to increase going forward as we begin to integrate more of a platform approach in filling the other pieces so we will definitely see more platform going forward. So when you refer to design winds in 3G pretty youâre pretty much just talking about baseband is it right now. Well yes, but it doesnât mean we donâtâ have the other pieces as well. So in some of those models for example we do have Bluetooth, but we have Bluetooth in quite a few phones these days. As most of the first year vendors we have Bluetooth designed in. So we want Bluetooth in lot of those high-end phones, multimedia in an increasing number and baseband so there is a high correlation if we win one we win the other. But I just donât want to leave you with the impression that we sold it as a package. They are independently decided by the customers today. Okay and then a separate product line and the transition to VDSL and VDSL 2â¦can you just talk a little bit about how you are positions there and when you expect to have that market ramped. Currently it is ramping mostly in Asia and we are beginning to see that market ramped faster and faster and we are now starting to see some interest in Europe as well. And we think the World Cup soccer is going to drive a lot of the growth in that phase, so we do expect to see Europe kick in as well. Thank you. I would like to ask a bit more about gross margins from a longer term perspective, you talked about what they are going to do next quarter, on mix and some of the input prices, but could you may be update us on where you think longer term gross margins are going to be, are they kind of be where theyâve been for the company exactly, say around the range you got choose for December or will the mix affect things longer term just like to give you kind of a long term model view. It is one of the those things that is difficult to predict, every year we start out looking what our margins are going to be for the next year and now it looks like they are going to be falling off the cliff by the end of the year, they never do. The long term guidance weâve given has been that we expect to be in the 50% to 52% range and we havenât anything basically to change that, now this year weâve been above that for most of the year. And so what is that going to be, the new range or not , we really canât predict it this time. Is there any more detail you could provide on whatâs affecting the mix, is it primarily confined to consumer products, I mean most specifically Bluetooth or is that acharacteristic of concentrated customer base or is there any kind of channnelizations you can make about mix. As I said it is generally is more dependent on where we are in a particular product cycle on a particular product than it is what the end user market is. Okay. And then a second question if I could, it sounds like cable modems were stronger for you in terms of growth in the quarter as compared to cable set top box. Can you talk about what the, what your pricing differential is say compared to those two opportunities within broadband. A data only cable modem has a lower price than a lower end set top box. A cable modem thatâs voice enabled has a higher price in the low end set top box. And a lower price in the full feature set top box I would like to thank everyone for joining us today, I hope weâve been able to answer your questions and give you the information you needed, we believe we had a great quarter and we see a good quarter going forward, we have a lot of comfort in the business and looking forward to seeing you next quarter thanks. Thank you for participating in Broadcomâs third quarter fiscal year 2005 earnings conference call. This concludes the conference for today. You may all disconnect at this time. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. 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EarningCall_234069 | Hereâs the entire text of the Q&A from 1-800Flowers.comâs (ticker: FLWS) Q1 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you if you would like to ask a question, please do so by pressing the â*â key followed by the digit â1â on your touchtone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow to your signal to reach our equipment. Once again â*â â1â if you have a question, for pause for just a moment together we give everyone an opportunity to signal. We will go first to Jeffrey Stein with Key Banc Capital Markets. I got a couple of questions on your b2b initiative. Over the course of the last six months, you guys have done a pretty good job of signing up new florist to become members of your network and I am just kind of wondering what the time line is for actually adding and selling products and services to the florist that youâve recently added? As we looked at the range of different products and services that we can offer to our Bloomnet florist we prioritize both based on the need of the florist on the network and our ability to package deliver those. Our collection of products and services that we will be introducing two or three more of this fiscal years and then probably half a dozen or more new products and services in the next fiscal year beyond. So we arenât in a position that we want to lay out a timeline for issue those products and services but it is a combination of our ability to package and deliver in our analysis of the florist needs that will determine how and when we need to introduce our services. And Jeff there is evidence of that, we do have our first directory released in the first quarter and now weâve had successful sales effort for the second directory that will go out at the end of this, the latter part of this quarter. Okay terrific. And Bill a question for you. You guys have kind of bumped your service charge by a buck and under normal conditions it would seem the most of that would drop to the bottom line but I am wondering incrementally with the increase weâve seen in shipping charges, how much of that dollar increase in shipping charges do you think you be able to capture this year? Jeff, weâve been testing different price initiatives, the dollar bump in service charge some shipping charges etc., that all to help kind a what said as we have other cost from third party carries and others, so we are using it right now that what said that and as we implement other operating efficiencies we hope that helps contribute to our gross margin increase this year. But we did reaffirm our gross margin targets for this year so we think the combination is different efficiencies we are achieving, different pricing schemes we are experimenting with different systems we are providing to our florist as well as partners will mitigate those obliviously increase in cost so that we can reaffirm our guidance for the year. Great thank you very much. Could you just talk about the underlying unit growth in consumer floral business, I asked that just looking at some of the other companies in the space for the last couple of quarters looks like there has been actually a year over year decline in consumer floral orders. Is there anyway you could comment on what kind of growth you have seen calendar year-to-date and what do you expect going forwards? Thank you. Well what weâve said is that we did expect for the full year that we see double digit revenue growth in our floral business I think we are certainly on pace with that as a result of first quarter. So we are not seeing it. I frankly think that we are not seeing a decline in quarter growth in the category. I think itâs increasing atleast as concerns that those companies that report public. As we look at it certainly we are very pleased with the growth in consumer business consumer floral that we are experiencing as we look at what we see from our competitors we believe where we are outpacing the growth of our competitors on the consumer side. Great thank you. If you could just talk a little bit more about the sales and marketing expenditure as we saw as a percentage revenue looks like it had the highest level weâve seen since 2001. How much of that is an increase in the amount of advertising that your doing verses the price you are having to pay for particularly the online advertising and search based advertising that your are doing? As we mentioned last of January and we reiterated on our call in August that we are going to continue to invest in, step up our marketing spend there but we are also seeing in that sales and marketing line, the other fact the lions share of the stock based compensation charge hits that line item, so thatâs a new year-over-year item. All you going to do that our people get, as we said last year when we stepped up our efforts in that line, come this next January when that increase start to anniversary you will see that normalize itself, to the question of cost versus, particularly increased cost of the advertising/marketing versus stepped up impressions etc., most of it is in stepped up impressions, while we are seeing cost rise in the online world especially in portals as an example we also seen our efficiency in portals decrease and thatâs been causing us to migrate our advertising to other areas, whether the other areas online or as we stated in the past couple of quarters more offline spending there and getting as the effectiveness. So overall what that equals to is more marketing impressions that we were gaining, not simply increasing cost marketing. Yeah additionally because the seasonality of our business in the acquisition that we made in the first quarter, the operating expenses as a percentage revenue would be up as a result of that as well, those businesses have the lions share of their profitability in the quarter that we are in now. Thank you, very much. Good morning Gentlemen. Jim I was wondering if you could talk about the b2b business, a little bit more detail, you expect to see up tick in development expense that can acceleration year-over-year build out that network and can you comment on the types of fees that you are getting there. And then second question relates to the acceleration year-over-year growth in the online retail business, the Cheryl & Company or Winetasting contribute more to the top line than you originally anticipated and if so what would have been the drivers. Thanks. I will answer the second part first Anthony. Winetasting Network and Cheryl & Company are very, very small contributors during this quarter. Their expenses obliviously impact our operating results for this quarter which contributed about half of the increase in our EPS most of the quarter because our fourth quarter business, so yes weâve the expenses associated with those businesses, no they are getting contributed more into top line than we anticipated but yes we expect in the contribute, during this current second fiscal quarter of the holiday quarter. As regards to Bloomnet, I donât think we see an increase in expense rate for example, the one program of service we introduced during this fiscal first quarter, we mailed our first directory. 100% of the expenses related to that were at a loss because there was no revenue to offset the printing of that book, the mailing of that book, the personnel in this system that you develop, it was one of the more expensive efforts in terms of product and service that you might see us introduce because of those factors. But we anticipate that will be atleast a breakeven probably a profitable contributor beginning in the first calendar quarter or the third fiscal quarter because weâll mail that now at the end of this quarter, there is revenue from advertising that book, vis-Ã -vis, by design nil revenue from advertising this quarter. So I think that the answer is no, you wouldnât expect a ratcheted up in our development expense for those product and services. We anticipate that the director would be among them most expensive and we now already going to turn in profitable in that effort. Understand, last year across the e-commerce world my understanding was that the ramp in demand had started a little bit later slower than everyone had anticipated, it sound like a lot of companies that are going into the holidays season that are focused on any form of gifting, or are doing something a little bit differently about their marketing plans to make sure that they combat it if that happens again, could you comment little bit on what you are seeing in the ramp of demand this year versus last year and what you are doing differently on the marketing front. Sure Anthony, this Chris, I will take that one, yes I think we all continue to see that demand come later and later in need to the holiday season, I think we saw that in this currency with Halloween. I think weâre well positioned as a company to take care of that because of our delivery capabilities and the tight delivery networks that we have and the flexibility that we have. So it is always nerve racking issue, we are well positioned to take advantage of it. From the marketing point of view yes, weâve adjusted in different areas several about different brand of mailing away the catalogue we are doing some of our online advertising a little bit later to make sure that we are fishing where the fish are. So we are adjusting to the consumer demands and again while its nerve racking, we think we are well positioned to take advantage of it. And Anthony with Christmas falling on a Sunday this year and Autumn falling December 26th which is after the Christmas holiday there is, we do feel that there is going to be an awful lot of consumers that wake up on Monday before Christmas that weekend because they have that whole week to care of things and there is going to be a greater push that last week of holiday season. But anecdotally we will tell you, Anthony, this is Jim. It seems to me that every year for the 30 years that weâve been florist, it is hard to imagine but I think it only seems that way. Hi thanks, if I could I am going to lob three questions at you, I have got some background noise here, and I donât want to be very disruptive on the call if I can. Everything is okay done here. But weâve gone back to the stoneage. Weâve got generators and limited phone and what not, so itâs quite fun. Thank you. First if you could give us an update on, youâve mentioned couple of times that the catalogue, could you give us a sense for perhaps the penetration of florist that are now advertising in the next drop that will happen in this quarter. Because we are trying to get a sense for obviously how receptive florist are to being an member and being an active member in Bloomnet versus Teleflower, FT or potentially additive. And then the second question and the third question are more on the financial side. Second question is on the inventory, obviously is up as you mentioned in your prepared comments and that you are comfortable with that, but could you describe why is there more significant increased this year than last year and what new acquisition might be contributing to that. And then the third question on stock based compensation I believe your guidance had been for a run rate of about 3.5 million for fiscal year â06 and I think you may if you running a little bit ahead of that if assuming that guidance was pre tax number. Is that 3.5 still the target or is, or has it changed a little bit? Stock compensation is basically $900,000 gross and grows and $700,000 net so if that were to straight line it would be 3.6 and about 3 million. So I think its inline with the guidance that we gave which is $3 to $4 million from that point with regard to inventory, it is up and we expect to be up, it does show the increase in seasonality of the business the acquisitions that we made that have inventory or some of the changes that we made as we are looking to enhance our gross margins. We have changed them to sourcing we are importing more about products from overseas, that has longer lead times so we are taking on some inventory with respect, all those contribute to let all as he turns back to cash in Q2. I will ask to handle the Bloomnet question, but just a follow up on the on the inventory, each time that we looked at inventory decision we were always asking ourselves the question. Does the increased exposure to inventory, which is still for us a company very lighted around 4% of our sales with our peak inventory period. So we still have good returns in inventory. So while we have fulfilled the question, will the increased inventory exposure been more than offset by the enhanced margin opportunity in an two instances that Bill spoke about, our increased Asian sources which gives us improved margin opportunity and the increased range of products and services with prior gross margins, particularly in the Cheryl & Company and WT and acquisitions, both more than offset recovering cause to be risks cause associated with inventory by the gross margin improvement. Chris, if you handle a lit the question on Bloomnet. In regard with Bloomnet, as we look at Bloomnet service basis, I donât think it is suddenly getting into breaking it out, specific metrics within Bloomnet while it is in the early stages from the recent activity point of view, I think we can look at the numbers on the macro basis and see that we are continuing to get to the membership numbers that we want we continue to be able to enhance the product and service offerings now as spoke about, our directory moving into the second piece of it. To sell through that weâve had has been a little bit above what our expectations were again in the early stages, but now look into the rocket fuel here, in the first two directory that we get out there but we are pleased with the acceptance rate that we are getting for that, as well as other products and services that we sell into our purchase net. People buying the product that we are looking for them to buy and support the 1-800Flowers business and they will always accept Bloomnet is very encouraging. Good morning, couple of things. One is your estimate for capital spending for the current fiscal year, I donât know if you gave it or not. What is it looking like? I just want to make sure you get the right definition. Can you talk about in terms of the b2b network here and any object you have in terms of size to grow with by the end of this year. What do you think the existing florist are taking advantage of third or second provider or knocking someone else, I guess that sort of color you might be able to talk about? And Glen this is Jim, we are not going to give a lot of color on it and we havenât it all and we said in this first year we wouldnât. What we said is that the we planned on increasing our membership network from the 3000 or so that to start the year with, we did gradually introduce products and services like we began with our credit card clearing up with our directory efforts, so we are not going to give the specific cost ranges in terms of the anecdotal information or a little bit better anecdotal information will give you. I think weâve a pretty good proposition for the small number of florist that weâve chosen to work with, that is weâve good directable orders and weâve good product and services that will help down. It is no secret of florist under some pressure in the greater market place in U.S or all of North America frankly weâve seen a number of shops come down pretty dramatically according to the Society of American florist over the last 5 to 6 years frankly I think that trend is continuing, which speaks well to that fact weâve a good product offerings and good profitable relationship to offer to a subset of florist that exist in this country out there. So we are very pleased with the reception weâve done as to whether or not they are choosing us being over another wireless service or they are choosing Bloomnet to enhance themselves. I think the evidence is that they are choosing Bloomnet as an additional service in the early stages. Okay I will stop on that and Plowandhearth, new management there how do you access it at this point, how they are doing? Weâve tuned the management over the past year and half there by a couple of additions and couple of changes there, the newest ingredient there is a gentleman we brought into a to lead just Plowandhearth brand in the last week and I think he had a good day on Tuesday, had a have long lunch on Wednesday and so far he is looking pretty. He is a most recently at a Garden of Eden before that he was at Edibower. And he was sound regarding Britannica. Well he is just one of the several additions we have made there in the last year and he is a fellow we are very pleased has joined us. Glen, as we have spoken about on previous calls as well as where we saw Plowandhearth had comp negative in the first quarter last year, down 6% then we saw it seems to turn as we had implemented a number the initiatives that we had plus 2% to 3% in Q2, plus 7% in Q3 last year, plus 13% in Q4 and now this year plus 10% in Q1 of this year. We are pleased with the progress and turn around that we had. So clearly the management team that we had in place and we had it enhanced over last year are those that are initiated, so we were pleased the job theyâve done. And then lastly on Cheryl, how is the integration going there in terms of the web offering for a holiday product etc? Glen, we think that this integration is going very well, we have a good product offering under 1-800flowers.com brand of the Cheryl & Company product line as well as our marketing efforts by utilizing some of our assets such as our customer base our international marketing team is integrating well from an operational point of view all the call center platforms are intergraded into so many distribution aspects of our integrated well, our corporate sales efforts are integrated servicing, we moved their website into our they havenât made any changes to their website which has moved into our infrastructure. So we can provide increased capacity for functional design changes will come later. But So far we are very please of being overall integration to it. Technically, I donât have the number but it was, if you remember the share price throughout the quarter probably averaged 200,000 shares in the quarter. Could you give me a fill in the four non-core mix for the quarter, I am sorry , I may have missed this? Let us talk a little about wine, last year you sold for Christmas, you had wine to wine.com now you are doing as to Winetasting your own network, what you are going to be offering in terms of Christmas, in terms of volumes or pieces for integrating wine. Last year was our first test step, even our first test is a ramped test effort as it was on prior years, and we were able to introduce several thousand gift baskets during the early part of the holiday selling season, frankly we donât have the volume capacities that we would like to have this year. Because some of our vendors whom we had cooperated with last year donât have the capacities available to them this year. Even that they had last year. So while we have a lot more of our gift basket offerings featuring wine this year, it wonât be the number that we think the potentialities are so we are a step above last year, but where we like to be. And it is a combination of, we will use Winetasting our internal resources to fulfill and speak that we can fill in and we will continue to use wine.com until another â That hasnât changed. The retailers can still only ship to about 16 states direct shipment. More states have opened up for wine, or used to send directly to consumer, the next step at most states have legislations in place, but trying to move forward, the next step is to open up for interstate wine retailers to send directly to consumers. The legal argument is pretty clear, if it is discriminatory to exclude to out of state wineries clearly it is discriminatory to exclude out of state retailers as well. But you do have to fight that regulatory battle in each and every state that prohibits It and that is ongoing. What is the tax expense for the year? I guess there is one without the options or with the options? What is the tax without the option expense there? Well this is actually Kaisy sitting in for Robert. I have a question on your Bloomnet, if you taking members from FDD or Telefore or are they just an incremental increase? We donât have specific hard evidence about what is happening with other providers or services in the category. That would be information that they would give and I am not currently familiar with what their numbers are but I would say that our proposition isnât dependent upon them, being a member or not being a member of another service provider or in this case would you call a wire service. So we donât know whether or not any of those lots are choosing to be members of us and not them, we only know that they were choosing to be members of our services. And as we reported we are very pleased with the membership increase that weâve experienced, we want to do it at a steady pace, we clearly have no intention of becoming a 20,000 plus member network, we donât think that there are that many florist qualified enough to be into our network, so it is material though whether or not they belong to another provider. Our success is independent of another provides lack of success. And so it is doesnât matter to us whether are not they belong to another network in this case all that matters is if with the right florist, choose to be compatible with work. Okay. Great, thank you. And then in regards to mailing your first directory in September, what is the general frequency of you sending directories, any charge to that? James Mc Cann Thanks for taking my question. I just wanted to follow up again on the buyback. You got $8 million outstanding, only about $2 million, is that due to volume constraints? There are number of factors that would influence our buyback here, one is cash availability versus operational needs of cash, another would be borrowing capacity whether or not we choose to be involved in borrowing for that purpose, another is black out periods in windows, and we are kind of restricted windows for us to be in the market place, all of those contribute to our decisions and we consult with our board regularly on, how aggressively they will allow us to be, in terms of the repurchasing of our stock. And then Ryan, volumes descriptions would have to the biggest impact on us during the first quarter when typically historically, our trading volumes are significantly lower than they are in the year around. Okay. You are in light of what Jim just said. In the next quarter if you guys get more volumes are you going to have the ability to purchase more or you are going to hamstrung by the other considerations. Okay. And I have a couple other questions, can you talk a little bit more about your vendor issues on the wine side that are not going to allow you to fulfill in a timely passion, is this from the wine sounds there, what speaks typically is what you are talking about. What I was talking about was the wine gift basket, they have to consecutive, they have to have the physical local for those and we have the combination of our own facilities to that, as well as third party contract facilities. Some of those third party contract facilities that we started to use last year, donât have the same capacities available this year. Because of their own internal issues, so that when we talk about our abilities or for the volume of baskets that we like to offer this year. Okay. And have you talked at all about kind of what you expect from the wine and Cheryl & Company on the revenue side and gift baskets, have you talked about that, what do you expect in the next quarter? Only on full year basis, we donât break our individual, on a full year basis, we believe that we will generate, weâve said that a number of times and it is in our written pieces at the food, wine and gift basket category for this year, will generate something in excess of $100 million in sales which clearly positions us as a leading player in that category. Well , we have been making those changes, the management team there, two years ago, when we first saw, less than stellar performance from that category, we did an reflective analysis, on what the contributing factors where, so as a result of that there had been some changes in the management there, that we made evolutionary over the year long time period, plus the leader of the division who lead those changes and diagnosed the issues, Peter Rise, who started the company has been with us now for six years after the acquisition, had delayed his retirement at my request, two or three times. Especially to see you through this change period where we diagnosed issues and identified the changes we have we need to make, so we asked them to go for one more period with us. That has expired in June, and then we asked him to stay through the holiday season because we though the plan was solid we wanted him to see it through which he is agreed to do. And after that he will retire. So five years after his stated intent to retire at 55, he is now going to a part time status with us, at 60 he is done terrific job, he is terrifically with us, and executed all of the changes in the personnel changes that we have seen take place there. And now with the new leadership we brought in there, and the transition gone so successfully in the last several weeks and thanks to Peter and thanks to Mike. And Mike has a very heavy background on merchandising which was the core of the issues, that we saw that needed enhancement and change in Plowandhearth, that already have been effectuated. So anything Mike will be able to bring to the table in terms of his expertise in merchandising, should be added if there is changes we have already made. So the reality is that the people who fixed the previous problem are still there, they are going to around to transition. And Peter who lead those changes will still be involved with the company on a part time basis, not just in Plowandhearth but in variety of other things we are doing across the company, he is a talent we do not want to loose. Yeah. It is, Do you mean between G&A, sales marketing and technology? It is probably, 50% Plus on the G&A line, 10- 15% on the tech and development line and the rest in sales and marketing. The acquisitions year-over-year if Cheryl & Company and Winetasting Network, their revenues in Q1 a year ago, how does that split between the consumer line and retail line? Yeah. Really if you are talking about in Q1 a year ago, we did not own Cheryl & Company at that time. I appreciate it, but the revenues were a year ago, where do you think the revenues in the current quarter? I am just trying to get to organic. Well I think from a perspective of what they are contributing this quarter, we would still like to know, low double digit organic growth this quarter, and the rest of it was 2 or 3 for Cheryl & Company When we acquired Cheryl & Company they either came with eight retail stores, so that will go on to that one. So again itâs like couple of million bucks. And that is all in that line? Okay. It looks like you planned $277 million in revenue in Q2 is a ballpark? We are constantly investing in the infrastructure capabilities and the sulfur capabilities, in the data mining capabilities, so it would be across the enterprise and some of the technology and most of the non-technology will be on the performing side of our capabilities. And we have no further questions at this time, Mr. Pititto, I would like to turn the conference back over to you for any closing remarks. I will take from Joe and I am Jim, but thanks for your questions and your interest today, and if you have any additional questions please donât hesitate to contact us. In the meantime Halloween is just a few days away but it is not too late to send a perfect trick or treat, with an emphasis on treats ofcourse. From our Boo, Boo fun pale from the popcorn factory complete with loads fun flavored with popcorn candy which just had from Cheryl & Company. It is a great collection of iced pumpkin cookies that Cheryl is famous for. We also elegant flower mesh from James Carole and happy jack bouquet with itâs unique jack-o-lantern vase. We have everything you need to help make Halloween for ghost and goblins of all ages. Send now second, now it is time to start planning for the holiday season, business gifting needs. Our business gifts services team will help you find the perfect gifts to help you enhance your professional relationship, everything from delicious towers of cookies and cakes from Cheryl & Company to decorated tins of popcorns from the popcorn factory emblazoned with your corporate logo. And a tremendous collection of gift baskets and gourmet trees and even wine. You can reach our business gift services group at 1-888-755-7474. So this holiday season call if you would like to come in to one of our stores to see all the great ways that we can help you connect and celebrate with all the important people in your lives. Thank you and have a great Halloween. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. 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EarningCall_234070 | Hereâs the entire text of the Q&A from Fiserv's (ticker: FISV) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Have you guys been able to sort of better quantify the potential impact from the hurricanes on the flood processing business? You know, at this stage, the answer is no. We do expect a pickup in flood processing claims in the fourth quarter, and if it follows the -- and I would caution you, too, that the fourth quarter of last year had a lot of flood processing claims in it, too, so it will not make a material difference in our organic growth, but we would expect if it follows the same pattern of the last wave of hurricanes to see our fourth quarter pickup stay strong in the first quarter of next year and then start tapering off in the second and third quarters of next year but we do expect an up-lift there. Okay. Great. And then switching gears to the healthcare business, you know, you talk in the press release about it getting a little more competitive. Are there any kind of longer term strategic initiatives you're looking at such as an acquisition to help kind of bolster your position there? How should we think about that? Strategically we've talked about changing or not changing but continuing to concentrate on the middle market and on specialized companies as opposed to going head to head with the big guys who own the PPOs. We also, if you remember in this last quarter, added a PPO, Aetna, to higher capability. So we can now go into companies with a network selling Aetna's network, which is a little bit of a change in strategy. You also see us concentrating on business process outsourcing in the health business and that lines up with what we did with EDS, signing the contract with EDS to use their software capability and our business processing outsourcing capability. So we've done a lot of things I think to recheck(ph) our strategy in that area. At the same time, the pharmacy part of that business continues to grow very nicely. So overall, we still think that's a good business. We will continue to fine-tune our strategy, and we think thereâs a good prospect. We would also add that it also brings a tremendous capability when you start talking about health savings accounts and the whole redefinition of the health payment system in this country. We think that will not only help us on the health side, but help us on the electronic payment side back in our bank area. Not only is at good group overall, it's going to be complimentary to what we do on the bank side. Okay. Great. And then just lastly on the new Fiserv Global Services initiative will that be based out of India? And then is this more focused on sort of internal initiatives or more on external for selling product rather than internal development? Greg, when we bought a company last year it had an Indian operation in it, it had about 35 people. We're now up to about 80 or 90 people in India, primarily in the development area. We have taken that part of our Indian operation and added to what Arun is doing. So initially it will be aimed at development so we're not outsourcing as much of our off shore development to other companies, but doing it ourselves. Over the long haul, however, it will look at other opportunities to participate in off shoring in the BPO area and now we think it's a major move in the globalization of Fiserv as a company, and it will bring advantages not only to our companies but to our clients over time. Could you walk through some of the drivers of margin compression in financial institution outsourcing in the quarter? To what extent was that pressure from the new Australian check processing contract? David, it's Tom. I think in our press release on page 11 we kind of talked about the factors from the second quarter, and as we indicated previously, we had higher software license sales in the first half of the year and our margin there in the second quarter in the financial segment was about 25%, and then the third quarter it decreased to about 23%. And again it was decreased software license sales. We had some increased product development costs in our lending group. The Australian contract, as you indicated David, also contributed to that, the ramping up of that, and we did have a slightly reduced termination fees from the second quarter. So all of those factors kind of contributed to a lower margin, but in the first six months we have had historically high margins in that financial segment. Can you drill down a little bit on the Australian check-processing contract? That has been a driver of improved internal growth what is the margin trajectory on that look like? As we indicated when we announced that contract, that contract in the first year would be diluted by 1 to 2%. Long term in the first year, and we would continue to have ramp up expenses in the first year of that contract. And but longer term, upper singles, lower double digits is the planned margins on those larger type contracts, and in this one case Australia. Okay. Then on the free cash flow it's down about 20% year to date. What are your thoughts for the balance of the year? David, I think it will pick up for the balance of the year. The first quarter, it was about $102 million. The second quarter was $78 million. Third quarter here it's a $100 million. We've been hurt in part, because of our internal growth; it's been so strong, that that's generated more receivables than we have in the past when internal growth is less, but we'd rather have the internal growth. In addition to that, our tax situation has had a, somewhat of a weird phenomena in that because we sold our securities business, the way you estimate taxes means that we end up having a tax hit of something like $50 to $60 million because we accelerate our tax payments relative to what we've done in the past. That's again because we had this gain that caused our first quarter to have a higher tax bill. We had a very strong third quarter in the FIO business, and if you look at where we are to quarter we are just about on, slightly below but just about on quota. One of the things I would add, we obviously set quota for our sales professionals because it's a way to motivate sales professionals and track and drive growth, but what we really look at more today, as we should, is the organic growth rate, and that's one of the contributors to organic growth rate. And overall our organic growth rate in that segment, as you know, is improving. If you compare us year-over-year in sales, we're ahead of where we were last year in sales. So overall we started slow and we talked about that in some of the earlier quarters. We had a very strong third quarter and our pipeline is excellent as we go into the fourth quarter. So I would expect a strong fourth quarter as well. We feel good about the sales performance in that especially in the financial segment. My first question is back on the global business. Does that incorporate, will that business incorporate at all the sales that you have of, I believe it's the CVS product, or will that remain a separate division? It may get, it will remain totally separate from a division standpoint. Arun is running an operating group. He sits on the management committee, which is now nine operating groups completely separate from CVS. Okay. And then could you give us a sense of, there's certainly been a lot written about the replace, the opportunities for replacement of core systems, outside the U.S. Could you talk to us a little bit about how you might see that opportunity? Well, we think a good opportunity there as well. Our ICVS product is very competitive in that market and is having a strong year. The pipeline there is good as well. Over the past two or three years we've signed some very big deals with ICVS products most notably the one in China in conjunction with IBM. So we think there's good opportunity there for us in the coming quarters. Okay. Thanks. Then just finally on the health business, is profitability or any ability to get operating margin improvements there going to come really with top-line growth, and, understanding that the mix obviously with prescription has a big impact but how do you see margins I guess trending in that unit? I would see the margins trending up. We're doing some consolidation in operation efficiency work there that will help margins next year. Okay. And I guess, Ken, if you coulgive us a sense, if it tens(ph) of basis points, or more than that? How significant are some of these cost opportunities? Les, I wanted to go back, you said that you had a quota and if you could just maybe give a time frame as to when you meet quota and when those sales hit revenue, what's usually the timing? I guess the timing of the backlog. In the business we're in were, a large part of the sales are service bureau sales. It takes a conversion to get the revenue on. So it can be anywhere from 90 to 180 days or longer if it's a very large client. So it's not years but it can stretch out over months. And what I did say is that we are right about on to slightly below quota through three-quarters with a very strong pipeline going into the fourth quarter and a very strong third quarter in the sales area. And so if you look at margins on the financial outsourcing business for the fourth quarter you said fourth quarter of last year also included flood claims, this year should also include flood claims. They obviously have good margin. Would you anticipate year-over-year margins to be somewhat similar in the fourth quarter or should they improve? Yes. I would say that we're at the fourth quarter last year in the financial segment was around 23%, but I would also hesitate to say that there are a lot of things that go on in the business that's difficult to predict but I think 23% coming off 23% in the third quarter, that's a reasonable trend line going into the fourth quarter. And I'd just stress our margins do jump around in that area. For example, last year it went from 24 to 24 to 25 to 23. So they will jump. A lot of its got to do with you mentioned flood insurance is one of the factors. Software sale is another one, the level of software sales. Termination fees is another one which will vary quarter by quarter. So there are a lot of factors in there. When our margins move 23, 24, 25, back to 23, it's not a material event because of the nature of that line of our business. It's just the way the business moves. And then one final question. One of the things you indicated as far as margins being lower in the financial outsourcing this quarter was lower software sales,. Jack Henry yesterday also indicated they had a little bit lower software sales. Is this just something that's happened, or do you think there's a shift in type of services that banks are looking for, or is this one of those things that just happens and it's a coincidence?. I think it's just a coincidence. I don't think there's any trend of slowing down of software licenses. We're a little bit better protected than Jack Henry because the volume we have of service bureau business doesn't impact us as much percentage wise, but it is just I don't think it's a trend? Sure. Hi, guys. Real quickly can you talk about the components in the other operating expenses the sequential increase and what's sort captured in that line item, expense item. Then also D&A it looked like it decreased sequentially I just want to understand how the D & A line actually went down this quarter? Julio, it's Tom. I think regarding the depreciation and amortization it's fairly close to where we were last quarter, maybe down $800,000 on a base of about $45 million so I think the number is fairly consistent with where we were in the prior quarter. Regarding the other operating expenses, as we indicated in our margin analysis, we have a few things going on there. One, we have increased revenue associated with our lending systems and settlement services businesses versus software license revenues in the second quarter. That business have a higher proportion of other operating expenses, which tends to increase that line item when we have revenue growth in that particular division. They're sort of outside services that we have, either outside appraisers or outside consultants that we have in that particular line of business. And the other thing we had had is we indicated in our press release, increased product development costs in the lending group. We have invested a lot more and that's some outside development type efforts, and our Australian item-processing contract as I indicated also had a higher proportion of other operating expenses, and those are the primary drivers of that particular caption. Great. Thank you. Just real quickly on the global services business, the operation itself, just to make sure I understand, is going to be mostly an internal resource for development purposes in the initial phases? Okay. And then over time do you guys see that as being a resource pool that you could use to, say, compete against some of the other sort of global software companies that are out there, I'm thinking of like Pinnacle or I-Flex, some of the guys that we see pop up out of India that have financial services software packages, is that this sort of a defensive move to eventually compete with those guys, or how do you guys sort of (indiscernible) 19:33 To some degree it is. It's also just building a capability to do some business process type outsourcing work offshore. There's a lot of reason to look to the offshore capability from a cost performance standpoint, and that is certainly one of them. I think it is just a major move of Fiserv towards the globalization of our business, and it's going to touch us in a lot of ways and should touch us in a lot of ways in the coming year if we're going to stay competitive. We've certainly seen the whole phenomena take hold here. Related to that, then, the only question I guess I have is with regards to pricing. Have you guys seen any sort of shift as the global services model continues to take hold in your ability to actually get pricing leverage, and is this an opportunity to sort of help yourselves out with that regard? We haven't really seen any pricing pressures at this point ,but as you see this off shoring continue to develop, we feel like we've got to stay ahead of it because we could see price pressures down the road the more people use that capability, so I think what this is more of a positioning for the future than any kind of defense of what we're seeing right now. Great. And then my last question is just related to the Bill Matrix acquisition. The expense associated for that, I think it was reported, apologize, was it $359 for the current quarter in the acquisition expense? Thanks. Good morning. You mentioned in a previous question about the flood claims processing margins being pretty strong. Is there any way we could quantify that a little bit more or at least get some sense of the degree that those margins are above the FIO average? Okay. Fair enough. When you talked about your guidance for Q4 you mentioned termination fees, the large one is not in there. Should we assume other termination fees and the flood claims boost you may get is included in the guidance? It's just one large termination fee that we did not include and we mentioned in the second quarter and that's the only thing that's not in our guidance for the fourth quarter. Right. Okay. Then just the last question, curious if you could talk a little bit about the competitive environment especially in light of the Fidelity strategy announcement in the core bank market? We haven't seen nor do we anticipate any immediate competitive environment change because of that. Certainly they plan as we've all read a lot of synergies between those two organizations and they will accept to watch that over time, but there have been acquisitions in this business over the past ten years and we do some and they do some and we all weather the storm and move forward. Thank you. Good morning. Two questions, first, Les, could you give us any kind of update on the search for your successor? Is there any note worthy developments along that time line?. At this stage I'd just tell you that our Board is doing a very diligent job, as they should, and we hope to have a decision soon. Right now they're interviewing both internal and external candidates, some very good internal and some very good external candidates and we'll have a decision soon, we hope, but I appreciate the effort that our Board is putting in on the and picking my successor. Makes me feel good I must be hard to replace. Second question is on internal growth. First part is, when you give an internal growth calculation historically and then talk about forward guidance, that does include termination fees, is that correct? Okay. The math that I'm doing, I just curious if this is along the right train of thought, if we exclude the grow-over you had on termination fees this quarter, since there are about $8 million lower, it would actually look like internal growth, actual your termination fees, was probably about 7% this quarter, and actually looks like it's been moving up sequentially throughout the year. Is that the correct train of thought? Does that sound correct? I would just say that in the third quarter as we indicated in on our press release on page 11, that's correct. If you look at the termination fee decrease that we had, it adds about 1% to the financial segment internal growth rate we reported 5%, and if you excluded the decrease we had there that would add another percent. So it would be around 6%. I'm not sure what that would have been on a trend in terms of the previous quarters, quarter over quarter. We'd have to go back and look at it. I calculated it and it looks like you're short of 5% in 1Q, 6% in Q2, and I'm calculating 7% in the third quarter, but maybe it's 6, as Tom articulated. Definitely looks like things haven't, persuade dropped off. And maybe marginally this improved over the course of the year. I think that there are lot of things going on in the organic growth initiatives that we've got going that are gaining traction and we're doing better. Thanks Les, one of you just give us some color surrounding the Bill Matrix transaction. First, sort of talk about your thinking, in terms of evaluation looks like a little bit outside your normal evaluation parameters and also just talk about it strategically and what kind of growth prospect and margin prospects you see for it? The reason it was a little outside of our parameters on acquisition is because it's in a very fast growing area, the fast growing market. We feel like it's one that will continue to grow. It has a nice strategic fit with the other things that we do, Bill Matrix was beginning to move into looking at clients in the mortgage area and insurance area and auto finance area, all that we have clients in already. We think we can leverage that. They also have a technology, this real-time technology where they access the billers(ph) accounts receivable directly. Has a nice tieback to our bill payment capability on the bank side. So it's in a rapidly growing area and a high-margin business, and it was worthy of a higher multiple on the acquisition side. We also think we've picked up an excellent management team there who is very creative and can continue the, to move into this electronic area with us. You may have disclosed this before, but could you just refresh us on what the revenue magnitude was on the margins for it? There's been some issue or some push-back that I've heard on the, quote,(ph)convenience fee that they are receiving, whether it's going to be ultimately some pricing pressure there. How do you see that? They don't see that as a major threat. It's obvious something we looked at during the acquisition process. This fee that is paid is quite often paid by the individual paying the bills, sometimes part or all of it is paid by the biller(ph) themselves but it's a mix, and it's we believe obviously that it's sustainable at a nice level. Les, I just want to clarify, the impact the flood claims is going to have next quarter, is it just going to offset the 4Q of '04 strange or do we expect a little boost in revenue growth and margin as a result of higher flood? Okay. That's helpful. And then in 2005 in some of your comments in the release, you mentioned 2005 had a little bit better organic growth. Part of it is increased volumes and new clients in the lending division. Do you think that can carry on in '06, the increased volumes in new clients, or is that something that will become a tougher comp year-over-year? I mean the last year and we see no reason for that to slow down materially as we move into '06. We think the lending area will continue to expand and grow not only in number of clients, but in volume from existing clients. We've got a very nice business there. As we talked about earlier, we're continuing to invest in that business, and we have some nice software, new software that is being worked on for releases in the coming months and years. Okay. Just looking at the organic growth in financial, obviously I think it's up 5% in the quarter but if I look at operating income year-over-year in the financial, it's down 2%. I understand some of that is due to the termination fees. But even if I add back the $7.9 million, operating income only grew 3.5% year-over-year. And I know we talked about some reasons, software and flood quarter- over- quarter, why the decline in margin, but I guess I'm curious to know year-over-year what else is impacting margins. Year-over-year I would say, Bryan, when we go back to the third quarter of '04, just to begin with, I think our operating income there was about $174 million. If you go back to the second quarter or the fourth quarter '04, rough around 160. So we had an extremely strong third quarter of 2004 that we're comparing to. Regarding the margin impact again I think we've hit on them. We've had the contract termination fees, as you know, $8 million, which is a large item that has very high incremental profit, as you know which was a big factor. We had a little change in the mix of our business, but a little bit more in the lending services area, and those increased product development costs along with the Australian check processing contract, which is another big piece of that, and so a combination of those factors is really where we're at. We are at still a very strong margin at 23%. We'll continue to see that going forward. And in our overall operating margins on a year-to-date basis in the financial segment, they're 25%. Last year they were 24%. So, again, what we look at on a year-over-year basis we're up nicely as far as our profits go. We should be able to maintain that as we go walk forward. That's helpful. Thanks for the color, Tom. Then just Finally, Ken, on the free cash flow, I know we discussed that a little bit, but do we get back to equal levels of last year by the end of the year for free cash, or there should be a little bit decline because of the tax and the receivable issue and the working cap? I think you'll see more of a pickup next year because of the tax phenomena that I mentioned will go away, so you'll get a pick up from that. And I would expect the fourth quarter you'll get some pick up, but as long as we continue to have strong internal growth, you're not going to have accountS receivable working against you. (indiscernible) 32:02. Wondering if you guys could kind of update us on your acquisition focus in terms of tuck-ins. Are you still going to, are you going to focus on the payments area, on flood insurance claims, on health processing?. Strategically we will be doing in a couple comments then I'll throw it over to Ken. Our eight, now nine, group presidents really kind of go out and search for acquisitions to aid in the business that they're growing. So we don't really focus on one over the other. Where the focus comes in is based on what's available and how they're priced and how they fit. So we will look at them individually but I can assure you that the thrust is pretty much across all of our product lines. Ken, can you add to that? We do look at everything across the lines. Right now we have more in the payments and insurance area than some of the other areas, but that will probably change in another two months. In the payments area, what are some of the areas that are a good focus for you, and would it be more on kind of augmenting your product portfolio or building kind of your scale in your existing. Okay. Sure. And just in terms of, use of cash or need for cash, do you guys anticipate, doing it through cash flow from operations or maybe going to the market and re-capitalizing your balance sheet? Yeah, just in terms of funding future acquisitions or maybe some of these initiatives like global services, etc, just in terms of funding it. When you get down to the global services and initiatives like that it's purely free cash flow. In terms of acquisitions it totally depends on the size of the acquisition, if the acquisition was large we'd probably go back to the debt markets and increase our debt. Okay. And just finally, apologize if you may have already covered it, but in terms of your Capex and D&A guidance for the full year of '05 and then kind of looking into '06 in terms of, where it would roughly be as a percent of revenues. I think our Capex is around $110 million with our cap software and that's been increasing roughly around $30 million, in that range. We're not going to give exact numbers but we're probably going to be on point last year in that $140 to $150 type range for the current year and we'll be covering our '06 estimates in our year-end conference call, but I anticipate no significant increase in the Capex and cap software. May be 8 to 10%. But we'll give you more guidance on that in our January call. Thanks. On a broader scale If you look back in the last five years, you guys have done an exceptional job as far as compounded growth rate and earnings by about 20%. Les, as you sit out, and I know your departure is in the middle part of next year but as you sit out and look at the environment kind of where you are today, based on your organic growth and what you've got on your plate as far as acquisitions, would you see that changing over the next five years, or is that kind of how we need to think about Fiserv? As far as our growth rate goes, we look at earnings per share growth rate, which is probably what you focus on as well, and we've historically been in the 18, 20%, although over the past year we started giving guidance down from that. I think, our last guidance was 14 to 17 or 14 to 16%, somewhere in that range. As we get bigger obviously our percentage growth is going to come down by size. The beauty of the business is with the percent of recurring revenue and recurring earnings that we have, significant drop-offs just aren't in the cards, but size, the law of large numbers are going to start to bring that number down gradually over time. Okay. And as it relates to the floods, I believe last year's hurricanes really helped kind of the first quarter and second quarter. Obviously with the scale of these hurricanes, I would think that that's also going to flow into the first and second quarter of next year. Is my thinking there right? That's correct. It will start impacting us in the fourth, then go into the first and start tapering off as we get into the second and third. We project it out into the fourth quarter which was 38.4% and we will be updating that on our year-end conference call. Okay. Then maybe a more bigger picture question. The status of your middleware integration initiative, how's that going? How are clients receiving that, and is that saving you guys integration costs? Yes. That's an area that we're very pleased with. It is going extremely well. We just had a technology meeting in Chicago this past week with 170 developers. And not only are they embracing the middleware technology, they are now, as a team, coming up with better ways to improve on it and more things we can do with it. It is saving us integration dollars. It is aiding our clients in what they can deliver and how they can deliver product to their customers. It is so far been everything we expected it to be. It certainly has a lot more growth in the coming years. So we're very pleased with progress there. I haven't got the foggiest idea in the world. I mean, I really can't. Overall we track how we cross-sell, and we know we're doing better and better on that. Obviously some of itâs got to be impacted but to pin it down is just very difficult to do. Thanks a lot. Can you talk a little bit about what you were describing on the call as I guess a one-time tax related benefit that accounted for up-lift of $0.03 per share for the quarter? The other question I had involved the press release you put out two days ago related to revenue opportunities in China. If you could detail those a little bit and just give us a sense as to the types of revenue opportunities that are possible, what you guys are pursuing, when they could become material, is it as soon as next year. Thanks a lot. I think, the press release that went out this is Tom, I think it was one of our top people, Mark Seawright who gave a presentation in China about how the opportunity is for banks to generate revenue, and he looked at it from an opportunity of how banks and how well they could do in China as far as growing their non-interest income. And regarding China, we continue through our ICPS product to continue to look at that marketplace and it continues to expand we've had had some wins there also, so long term I think it's a good opportunity for Fiserv also. Regarding the first part of your question, on the income taxes as we indicated in the press release it was a $0.03 one-time benefit in the third quarter, primarily related to a number of different things, as we indicated. Tax law changes, some tax audits closing and just a finalization of various tax returns. So it was a combination of those items that led to the one-time benefit of $0.03 per share. If I could follow up on the China question, is it fair to say that some of the opportunities described in the press release and obviously talked about in a more general sense could possibly accrue to you even as early as next year? I mean, when do you really see the opportunity becoming material in terms of revenue for Fiserv?. I would say it is a longer term. As you know, our business today is, you know, 5% of our business is internationally. I would say over the next three to five years we're going to continue to try to expand that growth through the things we're doing, Fiserv global services and general expansion. So when I look at next year do I think it's a major impact on the company? No, but I do think over next few years you're going to continue to see us expand our growth internationally. Fiserv is going to become more and more globally oriented, and you've seen that with our move into Australia. We have had had some very nice wins in China. We are partnering with other companies like IBM in some of those initiatives. We see this as an opportunity to continue to grow, and Tom is correct in cautioning you that we're still only talking about 5% of the company's revenue today. I would be surprised if over the next five years that percentage doesn't continue to move up, because of the initiatives we've got going on. Not the least of which is this new operating group that we just started. One last question, if I may. You obviously acquired Bill Matrix and I think reading the tea leaves it's pretty obvious to me that at some point in the not so distant future, that company's capabilities are going to be increasingly used to enable Fiserv to offer on-line bill payment capabilities to its banks, and I was just wondering if you could detail your plans related to that in a specific or general way. When should we start seeing perhaps Bill Matrix being sold perhaps alongside what Fiserv is already selling? Is this a couple of months? Is this further out than that? Thanks a lot. You are right in that that's the general direction of initiatives we've got going on to be more active in the bill payment area for our bank clients, but to give you a time frame other than to say it's more like a 12 to 18-month window before you'll start seeing any activity I think it's unfair. I can tell you right now we're looking at ways to develop that and to develop it faster but it's going to be over time. Hi Good morning. I was just wondering with the lumpiness of the Australian contract coming on can you quantify at all how much that helped organic growth in the third quarter in financial services? In the third quarter? We said like $25 million this year, and in the fourth quarter we were expecting $8 to $10 million. Okay. And I guess just a general question on, I come up with the same calculation of organic growth having improved in the third quarter. How would you look at the improvement in terms of your efforts over the last couple of years on the cross-selling front? How much of this improvement is cross-selling as opposed to new customer wins?. To quantify it exactly is very difficult. I would tell that you certainly is we've had continued new sales. We've had the lending area turn back around. We've had the international market, which was giving us trouble a year or so ago, start to stabilize and look good. At the same time, our cross-sell initiatives are ongoing. The use of this middle ware product to allow to us integrate and sell multiple products at the same time has been a plus. So when we really started pushing and concentrating on the organic growth of top-line organic growth, which is something that we really concentrated on over the past couple of years, we've had a lot of initiatives going on that have contributed and certainly cross sales is one of them. Okay. And I guess just one other question. On your stock buy backs, you were obviously very active again this quarter, and it looks like you're taking a view that you will lever up a bit to buy back stock because debt levels went up. Obviously that was influenced in part by the acquisition. But I'm just curious as to what your view longer term on stock buy backs is. I mean would you continue giving lower interest rate environment using debt to buy the stock back? Thanks. I wanted to ask a follow-up on the global services initiatives, Les. Would you characterize this as kind of move slow or go fast in terms of what you want to do there? And how agressive or how big is your appetite for acquisitions to help you build those capabilities? I would say we're going to be fairly aggressive. We're looking at that as an opportunity to grow. We think we've hired a very good leader of that. We're encouraging Arum to look at acquisitions that might help him grow in that market so that's certainly going to be part of the plan. We would like to see ourselves go up significantly obviously from the 100 employees we have over there and to get ourselves to 500 employees and 1,000 employees in a very short period of time is something that we've challenged Arum to do. So look for a lot of activity. It's not going to be a sleepy area of Fiserv in the coming months. Weâve got to go down the list on the questions printed out here. Wonder if you can give us a little bit of color regarding the two different markets within credit union markets and also then your core banking market as well. Has there been any changes in kind of spending as we've gone along through the third quarter of 2005 and, has the spending patterns kind of materialized to what you guys thought, the beginning of the year? Early part of the year we talked about the strength of the credit union business and we also talked about the fact that our bank presidents were starting, and our banks in general were starting to show a positive sign in spending money on technology. And I would say that certainly in the first and second quarter and into the third quarter have not disappointed us. We still see optimism in the bank area. So we would consider, we would think that our growth in that area would continue. I would go back, though, to mention credit union. Credit union business has been extremely strong for the past several years. We've done some acquisitions in that area but they've also had some nice growth. Competitive area but one that we compete very well in and we continue to see credit unions do well. And then when you kind of look at the pricing environment, you said that you don't see maybe it's no changes in pricing, but as far as with the bank base and the credit union base that you have to keep that business at the incumbent side, what would you characterize the pricing of keeping incumbent business? Do you find that that's going to become more challenging? It does in spots and in certain geographic areas and with certain competitors where we'll have to be a little bit more aggressive but I don't think materially different from how it's been over the past ten years. We've always had competitors in certain geographies that will come in and low ball, bottom fish, as we call it. Most of those guys over time will get themselves in trouble. You can't compete, especially on the service bureau side of the business, price-wise, over the long haul. So no material change. But it's still there a little bit. Shifting gears to the acquisition side, Fiserv has always had a pretty strict kind of criteria of what prices they're going to pay for an acquisition. It looks like the Bill Matrix was outside of those parameters. Is that what we're going to see to find growth opportunities? Are we going to see those kind of multiples paid? If we can find another exceptional company like Bill Matrix, yes. But in general, that's an exceptional company, so in general I would say that you won't find those kind of multiples in the future. High-margin growth areas, we'll pay up for it. The normal business that is just moving along as we as a company do, we're not going to change the discipline that we have in place. Is it so much an exceptional company, or is it just you were so behind the curve as for as bill payment, et cetera? As far as the, no, it's not from, I don't think it it's specifically from Bill Matrix. You mean on the cash flow? No, on the asset side, your AR went up about $40 million, and your accrued expenses went up about $50 million sequentially. Well, the accrued expenses I think generally have headed up over as we go through year, mainly because we have a lot of other payments that we make in the first and second quarter. But as for as the AR goes, that continues to increase. Did the acquisitions contribute to that increase? Absolutely. And we did have a number of those but it also is reflective of the cash flow statement. It's up $40 million compared to 13 in the prior year. It always bounces all around. In fact, I saw someplace that some people speculated that it was our prescription business that caused it. Actually, our prescription business had a decrease in receivables. Okay. And then, Les, if, not that we want to see you go, but if you look at the management expected change, it seems like it's delayed, and now we're talking about external and internal prospects. Can you shed some color on what's going on the management front? I would just tell you, looking at the outside is not new. The Board has been looking at inside and outside candidates all along. And to go any deeper into what's going on obviously at a board level is just something we can't do. Does it concern me that it's taking this long? I would say, overall, no. I'm more pleased with the job that they're doing than I am concerned about the delay. Would I have rather had it done six months ago? Sure, we all would. But we're going to come out with an outstanding leader for this company and obviously we'd like to see it sooner rather than later and I think we will. The safest thing for me to say is, I've learned over the past six months, they will announce it when they announce it. This concludes the Q and A session. I would like to turn the call back over to Mr. Muma for closing statements. We thank you for your interest. I notice that a couple of other callers popped into the queue. I would encourage to you call us directly. We'd be happy to answer your questions individually. Thanks again for your interest in the Company and the questions this morning. Have a good day. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234071 | Thank you for standing by. And welcome to the Lexmark International First Quarter 2006 Earnings Conference Call. (Operator Instructions). I would now like to turn the call over to John Morgan, Lexmarkâs Director of Investor Relations. Please go ahead, John. Okay. Good morning and thank you for joining us today for Lexmarkâs first quarter 2006 earnings conference call. With me today are Lexmarkâs Chairman and CEO, Paul Curlander and Lexmarkâs CFO, John Gamble. After Paulâs and Johnâs prepared remarks, we will open the call for your questions as time permits. Following the conclusion of this conference call, a complete replay will be made available from our investor relations website located http://investor.lexmark.com. Currently, on the upper right hand corner of this website, you can access a supplemental information slide that we hope you all find helpful. And as a reminder, any of todayâs remarks that are not statements of historical facts are forward-looking statements and involves certain risks and uncertainties that are disclosed in the Safe Harbor section of our earnings releases and SEC filings. Actual results may differ materially from such statements and Lexmark undertakes no obligation to update any forward-looking statements. With that, I will turn it over to Paul. Thank you John. Well today, we are announcing first quarter results, that exceeded our expectations despite the year-to-year decline in revenue. Given the circumstances, this was a good quarter for the Lexmark. In the first quarter, we executed good expense control reduction. We made good progress with our planned restructuring initiatives. We had solid unit sales performance in our key branded segments and we continue to make progress on our core strategic initiatives. First quarter revenue of $1.275 billion was down 6% year-to-year but exceeded our guidance due to stronger than expected supply sales. Overall, supplies revenue for the quarter grew 3% year-to-year compared to the flat results we were expecting as sales of both inkjet and laser supplies were above expectation. Overall, hardware revenue for the quarter was down 18% year-to-year as a decline in inkjet unit shipments year-to-year price declines and a mix shift to low-end lasers were only partially offset by increased unit shipments of laser hardware. Earnings per share of $0.78 significantly exceeded our expectations. On an operational basis, excluding the $0.31 in restructuring related charges and the $0.06 pension curtailment benefit, earnings per share would have been a first quarter record of $1.03. Earnings per share were better than expected due to the higher gross profit driven by stronger supply sales and a more benign consumer pricing environment and lower operating expenses. Lexmarkâs financial position continues to be strong. Net cash from operating activities in the first quarter was $220 million. For the quarter, supplies revenue grew 3% as laser supplies grew faster than this and inkjet supplies were about flat year-to-year. Our estimates indicate that negative impacts from year-to-year channel inventory changes were less than expected in the quarter. Overall, we believe end-user demand for laser supplies were about inline with our expectations. For inkjet supplies, we believe end-user demand came in slightly above our expectations. However, as we look ahead through 2006, we see the potential for some erosion in inkjet and user supplies demand due to the softer OEM sales weâre experiencing and the reduction in the inkjet volume due to our walk in the way from the low profitability business as we discussed in January. Currently for the second for the second quarter of 2006, we expect supplies revenue year-to-year to be flat to low single digit growth. Now in the consumer segment, in the first quarter, revenue was $587 million down 7% year-to-year. Consumer segment operating income was 65 million. Excluding restructuring related charges and the pension curtailment benefit, consumer segment operating income in the first quarter would have been $96 million, up 22% year-to-year. Now for the quarter, inkjet unit shipments were down 18% year-to-year with growth in all-in-ones is being more than offset by declines in branded single function and OEM sales. However, our branded sales were down much less than 18% indicating that we are seeing good growth in the more profitable segments, such as three-in-one, all-in-ones and four-in-one inkjet that we are trying to penetrate. Now for the quarter, hardware price declines were fairly modest sequentially. However, year-to-year price declines continue to be significant. In the consumer segment, we are also working on a hardware component storage that potentially could impact second half results. We are actively working to improve this and itâs such, itâs difficult to estimate right now what if any impact it could have. In the business market segment, revenue was $688 million, down 5% year-to-year. Business market segment operating income was $148 million. On excluding restructuring related charges and pension curtailment benefits, business segment operating income would have been $155 million, down 13% year-to-year as the business market segment was negatively impacted by price declines and exchanges. During the quarter, laser unit shipments were up 7% year-to-year, a strong growth in branded low-end mono lasers, branded color lasers and branded workgroup MFPs being partially offset by declines in both OEM sales and branded mono workgroup printers. Now during the quarter, we continue to make progress in our core strategic initiatives. Our investments in product development are evident in our new product announcements that are strengthening our presence in key growth segments as well as winning industry awards. For example, during the first quarter our new family of workgroup mono laser MFPs, were recognized with Editorâs Choice Awards as industry leading devices by Better Buys for Business. Now although just announced in the first quarter of 2006, we are already seeing strong demand for these multifunction products in the segment that is growing rapidly but where we have had little presence. Although in mono lasers the E240, E340 and E342n, won Editorâs Choice Awards during the first quarter from Better Buys for Business. Our C522 and entry color laser which has been a strong addition to our color laser line won PC magazine Editorsâ Choice award. Our X8350 four-in-one would significantly strengthens our offerings in this key integral segment was recognized by Better Buys for Business within Editorsâ Choice Award. During the first quarter of 2006, we announced the Lexmark E120n mono laser which is our smallest monochrome laser in both size and price and this product strengthens our current award winning low-end mono line within entry level model. Now today, we are introducing three new inkjet all-in-ones that deliver industry leading value and ease-of-use for the home printing market. And overall, our strategy continues to be centered on three core strategic initiatives: first, to expand the number in penetration of product segments in which we participate including low-end mono lasers and color lasers, laser MFPâs for our inkjet all-in-ones and inkjet four-in-ones, secondly, to expand our penetration in the key market segments including enterprise solutions and services, small and medium business and part of the retail channel where we are under represented. And third, we want to continue to build Lexmarkâs brand awareness and brand position. Now, as we look forward to the second quarter, we expect revenue to decline in the low to mid-single digit range as we continue to be impacted by significant year-to-year price declines and reductions in inkjet unit sales. We expect earnings per share to be in the range of $0.70 to $0.80, excluding the impact of restructuring related charges and sequentially, we expect second quarter earnings per share to be lower due to slower inkjet supply sales and increased operating expenses primarily in R&D and brand development. Now as we look to the longer term, the distributed output market is growing, and represents Lexmark with a number of attractive growth opportunities in segments where we are currently under represented. We have unique strength in this market and continue to strengthen our competitive positions to investments in R&D and branding and we have a strong financial position with a strong balance sheet and good cash flow. Now these things coupled with the strength in our recent product introductions, the pipeline of the products on the way, the steps we are taking to focus on more profitable opportunities in inkjet and to restructure our operations makes us optimistic about the longer term. Now with that, I will turn the call over to John Gamble, for his more detailed remarks on the financials. Thanks Paul, and good morning. Consistent with previous calls, I will first discuss our results of the first quarter relative to the prior year, then relative to the fourth quarter of 2005. I will also discuss selected changes on the balance sheet and certain items of cash flow. Finally, I will finish with more detail regarding our guidance for the second quarter. Our first quarter 2006, results include pretax restructuring charges and expenses of $50 million and pension curtailment benefit of $10 million both of which we discussed with you on the January earnings call. This met $40 million expense increased cost of sales by $19 million and our operating expenses by $21 million. Iâll call out the impact of these items separately as we walk through the P&L. Please note; in the supplemental slide deck posted to our website we have included details on the income statement line items impacted by the two items referenced above as well as the 9.7 million of FAS 123R stock based compensation expense incurred in the quarter. Now let me start with the P&L. Total revenue for the quarter was $1.275 billion, down 6% from last year and down 7% sequentially from 4Q. This quarterâs revenue was higher than expected primarily due to greater than anticipated supply sales. Geographically for the first quarter, US revenue of 574 million declined 8% year-to-year, revenue in EMEA of $465 million declined 9% year-to-year, the remaining geographies were up 6% versus a year ago with particularly strong performance in Latin America. Laser and inkjet printer revenue in the first quarter was down 18% from 2005, as Paul indicated earlier inkjet hardware shipments declined 18% and laser unit shipments were up 7% year-to-year in the first quarter. Inkjet hardware average unit revenue was about flat year-to-year reflecting price reductions offset by a favorable mix to more AIOs. Laser hardware AUR was down about 25% reflecting the impact of pricing and unfavorable mix. Laser and inkjet supply revenues in the first quarter was up 3% from 2005. Business segment revenue for the quarter was $688 million down 5% from 2005 and down 1% sequentially from 4Q. The year-over-year decline was driven by lower hardware revenue. Consumer segment revenue for the quarter was $587 million down 7% compared to a year ago and down 13% sequentially. The year-over-year decline was due primarily to lower hardware revenue. The sequential decline was also driven by lower hardware revenue. Gross profit margin for 1Q was 31.7%, excluding the impact of $19 million of restructuring cost gross profit was 33.1% approximately flat from 2005 then up 480 basis points sequentially. The flat margin versus last year is principally due to 380 basis point improvement mix, mostly from a decrease in the percentage of inkjet hardware offset by hardware margin declines in both inkjet and lasers. The 480 basis point sequential improvement was principally driven by an 820 basis point improvement in mix, mostly from a decrease in the percentage of inkjet hardware offset by product margin erosion. Cost of sales included $1 million of FAS 123R expense in the quarter. In the quarter, there were no new products transition to supply our managed inventory agreements. Operating expense for the quarter was $283 million, restructuring expense and curtailment gains of $21 million impacted operating expense this quarter. Excluding this impact, operating expense was $262 million, a decrease of $24 million year-to-year. SG&A was a $175 million, a decrease of $28 million from 2005 and R&D was $87 million, an increase of $5 million from 2005. This yearâs operating expense also includes $9 million of FAS 123R stock based compensation expense with $2 million and $7 million impacting R&D and SG&A expense respectively. The SG&A reduction of $28 million reflects lower marketing spend restructuring savings and last yearâs adjustments for Spain, partially offset by the FAS 123R expense referenced above. Sequentially, operating expense excluding restructuring cost and curtailment gains decreased $9 million versus the fourth quarter due to $13 million reduction in SG&A expense. The SG&A reduction reflects reduced marketing spend partially offset by $9 million of FAS 123R expense referenced earlier. The operating expense to revenue ratio in 1Q was 22.2%, excluding the restructuring cost and pension curtailment benefit, the operating expense ratio was 20.6%, a decline of 40 basis points from 2005 and an increase of 70 basis points sequentially. As mentioned earlier, the decrease from prior year was driven by reductions in SG&A, offset by our continued investment in Research and Development. Sequentially, the 70 basis point increases due to the addition of equity based compensation expense in â06. Operating income was $120.5 million, excluding the net restructuring expenses and pension curtailment benefit of $40 million operating income was $160.3 million flat from 2005 and up $45 million sequentially. Compared to 2005, the business segment operating income of $155 million was down $22 million versus last year while the consumer segment operating income of $96 million was up $17 million versus last year. Please note: all FAS 123R expense of $9.7 million is recorded in other expenses and does not impact business or consumer segment reported results. Other expenses consisting primarily of cost related to centralize supply chain, IT and other operating expenses primarily G&A were $91 million, a decrease of 4 million from 2005. Operating income margin was 9.5%. Excluding the restructuring expenses and pension curtailment benefit, our operating income margin was 12.6%, an improvement of 70 basis points from first quarter 2005 and an improvement of 420 basis points sequentially. The improvement from prior year was primarily attributable to our improvement in operating expense. The increase sequentially was primarily attributable to gross profit improvement due to lower sales of inkjet printers. Concerning financing and non-operating costs, the interest in other was a net income of $5.5 million, an increase of $1.8 million from 2005 and an increase of $1 million sequentially from 4Q. The tax rate for 1Q was 31.6%, higher than the 29% expected, reflecting the expiration of the US Research and Experimentation Credit that has not been extended by Congress to-date. Our 29% expected tax rate for 2006 assumes that these are in credits, will be extended for 2006. The tax rate in 1Qâ05 was 25% which included a one-time benefit of approximately 2 points. Net income for the quarter was $86 million. Without after-tax restructuring costs and pension curtailment gains of $27 million, net income was $113 million, down $10 million from last year. Net income in 2005 was $124 million. GAAP earnings per share for the quarter were $0.78. GAAP EPS in 1Qâ05 was $0.96. Excluding the restructuring expenses and pension curtailment, the 1Qâ06 expense was $1.03, up from $0.96 last year and significantly stronger than the $0.60 to $0.70 range we indicated in the January earnings call. This improvement was primarily due to higher gross profits, due to strong supply sales and more benign consumer hardware pricing environment and lower operating expenses. Now moving to the balance sheet, cash flow from operations for the quarter was quite strong at $220 million, a sequential increase of $7 million. Accounts receivable decreased 67 million from December, inventory decreased 10 million in the quarter, accounts payable decreased 19 million since the end of December and accrued liabilities increased 9 million since the end of December. For the quarter, capital spending was $47 million, depreciation was $62 million and currency of the euro was accounted for, at $1.20 compared to $1.31 in 1Qâ05. Cash and marketable securities at the end of 1Q was $0.8 billion, down $123 million since December. Cash decreased due to share repurchases of $300 million that occurred in the quarter. In 1Q, we repurchased 6.4 million shares at an average price of $47.22. At quarter end, we had $1.03 billion of share repurchase authority outstanding. The restructuring actions that we announced in January are proceeding according to plan. We still expect the total implementation cost to be $130 million or $80 million in cash costs and again we expect to incur all of this in 2006 with $50 million impact in cost of sales and $80 million impact in operating expense. We still anticipate $15 million in savings in 2006 and an annual, and on an annual basis going forward in 2007 and beyond, we expect approximately $80 million annually in savings, approximately 70% of which will benefit cost of sales and 30% operating expense. In the first quarter, as indicated previously, we incurred $50 million in pretax restructuring costs and related expenses and $10 million in curtailment gains. Savings in the quarter from restructuring including their curtailment gain were approximately $15 million. In the second quarter, approximately 40 million of the 130 million total cost of the restructuring will be incurred. Approximately 15 million will be in cost of sales with the remaining estimated $25 million, impacting operating expenses. The second quarter savings is estimated to be approximately $10 million. Now for my forward-looking comments concerning 2Q. Before getting into our detailed guidance, I would like briefly address the sequential trend in our earnings in 2Q. As Paul mentioned, we expect EPS in the second quarter to be $0.70 to $0.80 excluding the impact of restructuring charges. This reflects reduced supply sales sequentially and increases in operating expenses in 2Q, primarily in the business segment reflecting both increased R&D as we continue to increase our focus on both color and multifunction product and increase marketing and sales expense. Now for our detailed guidance. We expect second quarter revenue to be down on a percentage basis in the low to mid-single digits versus both 2Q 2005 and 1Qâ06. We expect EPS to be in the range of $0.70 to $0.80 per share excluding the $0.26 per share impact of the cost of the restructuring. GAAP EPS which includes these restructuring expenses is expected to be $0.44 to $0.54. Included in our guidance, is the FAS 123R expense estimated at $9 million with $0.05 per share impact. GAAP EPS in the second quarter of 2005 was $0.64 or $1.06 excluding at $0.42 charge for approvals repatriate $684 million under the American Jobs Creation Act. In the second quarter, we expect the gross profit margin percentage, excluding the impact of the restructuring costs discussed earlier, to be lower than last yearâs 34.6% due to product margin erosion and slightly lower sequentially than the 33.1% we achieved in 1Q. The operating expense to revenue ratio, excluding restructuring expense in the second quarter is expected to be slightly higher than last yearâs 29.9% as our SG&A reductions mostly offset the impact of higher development spending and option expenses. Versus the first quarter of 2006, operating expense to revenue ratio, excluding the restructuring expense will be higher than the 20.6% as I discussed earlier. Operating income margin in the second quarter, excluding the cost of the restructuring actions is expected to be down from last yearâs 13.7%. Versus the first quarter of 2006, operating margin excluding the cost of the restructuring actions is also expected to be down from the 12.6% we achieved this quarter. Despite our strong 1Q operating margin, we still believe that our operating margin once we have completed our restructuring will be in the range of 8% to 10%. The effective tax rate in 2Q â06 is expected to be 31.7%, and for the full year of 2006 is expected to 29%. Capital spending for 2006 is expected to be approximately $230 million. And depreciation is expected to be approximately $160 million. For the full year, we still expect the pretax impact of FAS 123R to be approximately $37 million. With that, we will go ahead and open it up for questions. Okay great thanks. Some clarification on the guidance, I appreciate all the details. But if I go back and look historically over the last 9 years, every year in the second quarter gross margin has been up year, quarter-to-quarter; Op margin has been up quarter-to-quarter with the exception of one year. And as I look at your sales commentary or margin commentary, and look at all the plusses and minuses that, the down sequential gross margin, the down sequential Op margin just looks extremely conservative and not all that realistic, given the business model, and, what we are seeing historically, so is there something in there thatâs causing you a guide down that would be different from what weâve seen historically or different from your sales commentary? Well Rebecca I think, as we look at the second quarter, what we are seeing is compared to the first quarter; we are expecting to see less inkjet supply sales. And we are expecting to see step up in operating expense. Other than that, things look fairly similar to us between the quarters. I think historically, we have seen a lot of things similar between the quarters. So thatâs the difficulty we have as we look at the, at the second quarter we realize the $0.70 to $0.80 is quite a bit under a $1.03, we understand that is not necessarily historical trend weâve seen, but as we look it where we sit right now today, we are seeing less inkjet supply sales in the second quarter and we are seeing greater operating expense which is bridging that gap between the $1.03 and $0.70 to $0.80. So on the OpEx side, it sounds like a lot of the variance quarter-to-quarter has to do with the, relatively large pull back in marketing expenses during the first quarter and then commentary about, revisiting brand development in the second quarter, could you quantify that in a manner whatsoever and just talk to what your strategy is on brand development going forward? Well basically what we are looking at as we go sequentially from the first quarter to second quarter is, we are looking at, at the ongoing investments that weâve talked about really over the last 12 months in R&D and brand development. Whatâs going on in R&D is, we are consistently stepping up over spending, weâre focusing on these key growth segments where we want to improve our position and those growth segments havenât changed from what weâve talked about before. And, so you are going to consistently see that step up as we go quarter-to quarter, some quarters would be more than others just depending on whatâs happening specifically and we are seeing that projected step up first to second quarter. In terms of brand development, we intend to continue to spend, a little bit whatâs happening to us here in 2006 is the quarterly mix is little bit different than what we saw in 2005. So, in first quarter of 2005, we spend a lot more than what we did in, in â06 and that helped us year-to-year in operating expense. And I think converse to here in the second quarter, we intend to spend more in 2006 than we did in 2005, so weâre kind of seeing a year-to-year impact as well as the sequential impact in that area. But we intend to continue to spend on both these initiatives and our intent has not changed on that in the last 12 months. Yeah, good morning, thanks. Two questions, Paul, can you clarify with regard to your inkjet supply comments sequentially, are you seeing orders go down right now sequentially or you just, is your model and your internal planning saying it should be down, are you seeing it fall off dramatically right now to cause that guidance? Well, we have always seen, historically between the first and second quarter some reductions in inkjet supply sales Ben and actually what we are projecting this year is very similar to the reduction we saw in inkjet supplies from first to second quarter in 2005. So, I think this is really is just a little bit of a seasonal effect. Okay and then with regard to laser printers and also inkjet, when do you think that OEM decline stop being a drag on revenue, do you have any ideas we look out throughout the year maybe without being as per, you donât have to be completely precise than I donât like to comment on this, but is there certain quarter out there where it stops being dragging and actually be benign or even contribute to grow? You know Ben, I donât have the answer; itâs very hard to project what OEM sales are going to be because we donât drive those sales; our OEM customers drive those sales. The only, only, I think, I could point out you is that, it was the fourth quarter of â05 where we saw OEMs decline on a year-to-year basis, but other than that, its hard to project. What I would tell you is that we are focused on driving the branded side of the business and we have a pretty good quarter, in the first quarter all things considered certainly on the laser side, we had a good first quarter in branded, low-end mono, color, laser, all-in-ones is a very good story for us. On the inkjet side, things were tougher because we are walking away from business. But even there, we saw growth in all-in-ones and we felt like weâre doing pretty well. But on the OEM side, itâs really hard to give any guidance on that. Hi, yes thank you, I have a couple of questions. Paul, I wanted to revisit the guidance question, your gross margin guidance is, tends to be down only slightly sequentially implying that the OpEx is going to be the significant delta, given that you are going to get at least 5 million in incremental restructuring saving sequentially, it implies that your OpEx might be going up 20 million or 25 million which seems like an enormous boost actually maybe even a bit more because your share count is coming down so dramatically, is that really the kind of OpEx investments that you are looking to be making and given that R&D stepped up this quarter, my senses to that really is an SG&A statement, and does that really the order of magnitude and does that consistent with the kind of cost control that you are trying to put in place in the company? Well I am not sure how you interpreted this slightly down on gross margin, but I would tell you that the, of the factors the inkjet supplies is a bigger factor in our outlook than the operating expense. So the numbers you are quoting there on OpEx are little bit bigger than what we were thinking about. Okay, in terms of the supplies growth you have mentioned that there was less of an impact on supplies due to channel inventory adjustments this quarter, can you clarify those comments where, was there, from your perspective, any drive down in channel inventory this quarter or was there any bills in channel inventory this quarter, overall, and supplies are in either side of the business? Let me, let me start my response with that by qualification, Tony, as you know, we donât know what the channel inventory is, we have estimates but we donât know, we get, we get reporting out of the first tier another 100%, we donât get any reporting out of the second tier, so its hard for us to know but we do, we do estimates. With that qualification, relative to our estimates, we saw last year-to-year impact than what we thought, we currently thought that we would see more year-to-year impact which is why we project a flat supplies year-to-year and we didnât see that in fact, we saw quite a bit less than that. So thatâs really the main reason why we popped up from flat to the plus 3%. On the laser side, that was pretty much all a bit on the inkjet side, we came in little bit, our estimate is, we came a little bit better on the end-user demand from what weâve thought, so thatâs kind of what we saw. Yes thank you. First of all, you touched on a hardware component shortage or some kind in second half, can you discuss that forward in more full, in fuller terms. Secondly, can you give us the factors again that would close the gap between operating margins that you just reported and the operating margins that you are talking about, the 8% to 10% operating margins, that you are talking about in the future was the very, very sizable difference. So what, in some kind of priority order, are the things that you think would be the contributive to that. Let me start with the second one first and let me ask John Gamble also to give us his thoughts. Relative to the margin, as we, as we look at the 12.6%, I would probably make a couple of comments on it, about the quarter thatâs a little bit unusual and may not necessarily be sustainable on the long-term. First thing is, weâre walking away form a lot inkjet business and as we walk away from inkjet business that obviously helps us in the near term in terms of profitability. Thatâs not our long-term goal, our long-term goal is not to be down 18% year-to-year weâd like to be up 18% year-to-year. And so, when you look into â06 that kind of fuses some away that I think is not representive of where we are thinking about long-term. Second, the second thing we saw in the quarter was really a surprisingly benign price environment; it was very different than what we saw, certainly off through 2005, different than what we expect to see even we look forward in 2006. So I think those two things were somewhat, somewhat unusual you know as⦠Did you mean that you put those things in order, yes, you are walking away form lot of inkjet business but by your own choice, a lot of that inkjet business is coming in an area that you really donât want to be as involved and whereas the inkjet business that you are proportionally more involved in, is more of a contributor on the consumable side. So again, I donât quite understand sort of the disconnect, the size of the disconnect between the longer term goals and the just reported numbers? Well I think, I think where the, the one thing to think about in the inkjet side is that the business that we walk away from, its a profitability over a life discussion a lot of that has to do with the consumables usage we expect to get. So thatâs not necessary to say that the, that the margin on the business is any better or worse than the business we continue, itâs a statement about the profit over life not being as good for the consumables usage, maybe not being as good. So these are the factors, as we look at the financials, these are the factors. The other thing that we have to look as we go forward in time is we do expect prices to come down. And as prices come down, we have to get cost down, it depends on the rate of prices coming down, the rates that we can get cost out. This is also a risk as to what we see in the operating income as, and when we roll these things together, we still think 8% to 10% is the right margin range that people should be thinking about for Lexmark right now, certainly in the foreseeable future. Fairly, we did much better than that in the first quarter, but Iâve given you my thought just to why I think thatâs not necessarily sustainable, and the fact I think we are not going to see that in the second quarter but John do you think itâs going to go? All right, I think the only thing I can really add is again, as we talk about the second quarter, we are expecting to see operating margins to move back toward that range. So given, given that, thatâs the case, right the things that are driving that as we indicated earlier with the, with the lower supply sales and the increased operating expenses and the increased investments. So again, thatâs whatâs driving is their in the near-term and as Paul said thatâs what people should be thinking about us in the near-term. All right and of course, we are committed to continue our investment. Relative to the hardware components shortage a question were, first let me be clear that we do not expect that to be an impact in the second quarter, weâre, we donât have a lot more say about than what Iâve already said, we do have a component shortage that could potentially impact the second half, we are actively working on that component, itâs a hardware component, so itâs not a supplies issue, itâs the hardware issue. And, as such, itâs hard for us to predict what impact if any of thatâs going to have. We intend to put a statement to that effect in our 10-Q. So, I brought it up today because we donât want anybody to be surprised if thatâs going to show. But we are actively working on that. So, the timing isnât really right to know what that impact is and our intent would be to update everyone when we do the second quarter earnings release in July. Thank you, over the last couple of quarter, youâve been really reevaluating demand for supplies more on the ink side than the toner, but really on both and wanted to come back and revisit, now that its been a little better than expected, is there been any change to your model whatâs youâve been updating every quarter? Well, I think that our view of the inkjet supplies has moved pretty dramatically over the last 12 months. And certainly the growth rates that we are seeing have moved pretty dramatically over the last 12 months, what we saw in the first quarter was essentially inkjet supplies flat year-to-year, that I think is given that, we didnât have a lot of year-over-year change in channel inventory, I think is fairly representive of what we believe is the end-user situation in terms of demand, even though it came in above, a little bit above of what we expect and thatâs not too far off. As we look forward in time, if you see the potential for more erosion there, because currently our OEM sales are softening, in fact down, year-to-year in the fourth quarter, down year-to-year in the first quarter and we are walking away from business which in the near-term will have a supplies, end-user supplies demand effect. So, thatâs kind of how we see the inkjet supply end-user demand situation right now. When you look at the ink sales, there is about 20% of that, you know, you did last year, you wonât be repeating that you are walking away from and also basically youâd met, mentioned OEM, have you got a sense for how much supplies demand is driven by, say branded versus OEM, how much might have been driven if any by the business you walked away from. Or was that just to manage to sell an inkjet cartridge when the printer went out the door? No, I mean we have estimates certainly on branded versus OEM and what I would tell you is that that the fact that we are at minus 18% with branded declines much less than minus 80% is really a very positive statement. Because what that says is, in the segment that we are focusing on the segment that we want to grow strategically, we are getting growth there. And so as longer coming in below that, the hurdle rate of what we are walking away from on the average thatâs the good thing for us, and we saw that. On the, relative to the near-term impact of walking away from some of the business we knew that when we decided to do it, but we did for the long-term benefit and once we get to the transition period which we will experience pretty much through 2006, what we then would expect to see is growth in these focus segment the three-in-ones, the four-in-ones which should drive a good usage for us. And this is what we need to do, to start to, to get those units up and growing and get that supplies moving back in the positive direction. Similarly over on the laser side, the growth rate certainly is better than what we are seeing on the inkjet side, but that weâd like it to be much better. And the key there is we got to get the hardware units up and moving particularly in color laser which will drive a lot of supply particularly in things like laser all-in-one, the products we announced in the first quarter. These will consume a lot of supplies and so long term this is the game plan and to go drive that those segments, that have usage and really see that if we can turn supplies situation around. Okay, thank you very much. Couple of questions, first of all, in past quarters, Paul youâve made reference to weaker than expected corporate laser demand, I think especially in Europe. And was just hoping you could give us an update on how you see demand in that particular segment. And then secondly, I was hoping that you could just give us, now your read on channel inventory levels for both hardware and supplies and both year-over-year on sequential trends, for that inventory level? Thank you. Richie let me, let me just say a few words about channel inventory levels, obviously we donât know what those channel inventory levels are we have estimates and as such it really is typical for us to give any comment on whatâs going on with this channel inventory levels. Relative to laser demand, what I would say is that in Europe, I think the demand is okay. I think there is opportunity there for us in Europe. As we look forward we see, we see some good deals, we see some good demand, weâve had a tremendous response in Europe on our new laser multifunction devices, which is great because overall workgroup mono lasers has been a pretty week category in the market around the world and to the extent that we can drive more all-in-ones that will just drive more usage and would be a tremendous help to us going forward. What I would also tell you in the first quarters, you probably saw some weak demand in US maybe weaker than we had expected there, as we look at the sellout from our distributors in the US, the total market not just the Lexmarkâs statement, the total market mono was certainly weaker than what we had expected to see overall color was up but not as strong as certainly what we have seen to the quarters in 2005. So, I would say demand in Europe was looking okay, theyâre pretty good, Iâd say demand in US was little weak in the first quarters certainly we hope the market will do a little bit better as we go forward through the year and we currently expect that. Paul you mentioned earlier that, you thought that inkjet supplies inventory levels were pretty flat year-over-year, can you just give us maybe a more qualitative assessment of what you think inventory levels are doing? What I said about to the inkjet, what I said about the channel inventory levels overall, that year-to-year, we didnât see a great change in our, from an estimate standpoint, we didnât see a great change in the first quarter, its very difficult to talk directionally about whatâs going to happen with channel inventory levels, currently we thought in the first quarter that there would be significant negative impact to us, we didnât see a significant negative impact to us, so my conclusion is, its just very hard for us to call exactly how these things are going to move. So, I think as we look forward in time, we always have the risk to be making channel inventory movements, but the reality is that as we indicated in the near-term, we are expecting supplies revenue growth to be flat to low single digit. All right thanks, I just want to follow up on that, so youâve seen that the supplies growth are flat to low single digits for the remainder of this year is going to, I guess, Iâm hearing that, I was wondering if you can comment then on the hardware side, when you might expect to actually get back to seeing some year-over-year growth, and then I have a follow up. Okay, Kevin I am, I didnât mean to imply anything beyond the second quarter, what I meant, when I said flat to low single digit was just the second quarter, weâve not given any guidance for supplies beyond the second quarter. Relative to hardware, we obviously had growth in laser units that we certainly would hope and except to have growth in laser units as we go forward through the year. On the inkjet side, it is going to be tough and weâre walking away from about 20% of the business thatâs going to be present in every quarter of this year. So, I think the key thing to look for there is on the branded side to the extent that branded is coming in with decline less than that 20% and in the first quarter we certainly did that. Thatâs the positive thing that indicates growth in the strategic segment that we want to focus on, once we get through this transition. But on the inkjet side overall, we could expect to see some negative unit numbers year-to-year certainly throughout all four quarters of 2006. Okay then, my follow up is you kind of indicated at the beginning that you are happy with this quarterâs performance. But the order what are you kind of saying is that these are sort of, perhaps one-time exercised benefits that rolls this quarter. I mean, can you maybe summarize if you are happy with the outlook based on what you did this quarter? Yeah I think, I think this was the good quarter for us and when I say that Iâm certainly not focused on any one-time transitional thing that occurred during the quarter, the fact that Iâm focused on the fundamental that occurred during the quarter. The things that I point to, that I think very significant are that we have been investing in segments such as low-end mono laser, color laser, laser all-in-one, inkjet three-in-ones and four-in-ones. And in this quarter, in the first quarter, we saw strong growth in low-end mono lasers, strong growth in color lasers, strong growth in laser all-in-ones. We saw good growth in inkjet all-in-ones. And this is due to the investments we have made to the products we have announced and the performance of those products in the marketplace. The other thing I would point out to here in the first quarter, relative to the first four months of the year, is that we are doing, selling very significant in terms of our product development our product announcements. We are filling in gaps in the product line, in gross segments where we have not had products before. The laser all-in-one announcement is a very significant for us. And some of the awards we won on that, I think they are indicative to the strength of the products that weâd launched there and we are seeing strong demand on those products just from the moment that we have announced them. Weâve also pointed out new products that are very recent in the product line, things like the E120, the entry mono laser; weâve not had an entry mono laser in the product line before thatâs a strong growth segment thatâs an opportunity for us. The X8350, weâve not had a strong entry in the inkjet four-in-one market which is strong growth market. Thatâs a very strong product force. Thatâs winning awards. So, these are the things that I point to, I feel very good about in terms of the quarter, clearly, we also feel very good that we are executing the restructuring plan, that we laid out, I mean, we got a lot of things going on, a lot of things we are trying to do, and thatâs executing pretty much according to schedule. We feel very good about the cash flow. That went on; I mean we are working very hard in our cash cycle on working on, basically receivables and on payables and these are things that we are seeing some impact, and these are strategic things that we are working on. So, as we look at this we feel very good about the quarter from those aspects, obviously, we are not happy about overall revenue being down year-to-year, we are not happy about the inkjet units being down 18% year-to-year, these are things, we are working to correct as we go forward and obviously supplies growth of 3% is in where we would like to be in long-term. Hi, thanks for the question. I have a couple ones if I could, I want to go back to the long-term margin description that you gave Paul, is the impact to get back to or go lower, I should say to 8% to 10% versus what you did this quarter. Is that more coming from gross margins or OpEx if you could give some colors on whatâs the greater impact in any characterization I have some follow ups please? Well, as we look at the sequential movement of margin or certain sequential movement of operating income we are going to see an impact in gross profit because of the reduce sales of inkjet supplies that we are expecting between first and second quarter and we are going to see an impact from the operating expense because of the step up in R&D and in the brand spend that we are going to do in the second quarter, I would say the bigger of those two factors is on the gross profit side than on the OpEx side. Okay, Paul in the same commentary youâve suggested that inkjet hardware units being down 20% this quarter, I think youâve said that would continue for the year. Doesnât that suggest though that you are going to get a margin, positive margin impact through the year? Well, remember what we are trying to do, we are walking away from 20% of the inkjet unit. So basically, if you walk away from 20% and the other 80% were just flat year-to-year then we would expect to see, kind of a minus 20% every quarter it would vary a little bit by quarter, but on the average it will be minus 20%. So, what we are trying to do is we are trying to grow that other 80%. So we can grow the other 80%, if we could grow letâs say 10%, then overall we would be seeing a minus 10% on inkjet units year-to-year we would view that to be a great result, and clearly that would not necessarily be favorable, as favorable every quarter as what we saw in the first quarter. So, we are trying to drive that inkjet decline to be less, then what it is by focusing on the segments that we want to grow, and in the near-term thatâs a negative, thatâs negative versus what we saw in the first quarter. A question for you in terms of the year-over-year 18% decline in inkjet hardware, Iâm curious youâd said youâre in a walk away from 20, do you think thatâs pretty much encompasses what you wanted to walk away from, or is there a big chunk there thatâs OEM and therefore there is more to go on your side. Well, in the 20% there was branded as well as OEM that we would like to discontinue. As we take a look at the minus 18% branded was stronger than that OEM was, was weaker than that. So, I think the way to interpret that is on the branded side, since we are pretty crisp about the business we didnât want to do again that the business we do want to do is getting more growth than just being flat year-to-year, weâre also getting growth in those segment and we saw a growth in all-in-ones in the first quarter. On the OEM side, in aggregate, right, we have more than one OEM partner, in aggregate, thatâs coming down more than 18% which sales we are not seeing all the growth weâd like to see in the segments that we would like to grow. Thatâs, thatâs basically how I think you should interpret that. Okay and then when we look at the revenue growth by geography, can you just talk a little bit about profitability by geography, in terms of gross profit and operating margin or operating income contribution, if International is growing in emerging markets, or those the same level of profit dollars that you see out of the US and Europe, given the more of, I guess emerging market potentially lower, I guess, level of products that they would purchase? Okay and then my last question is in terms of maybe in, I think Paul you mentioned, you were looking at moving more into retail or different segments of retail that you are not in right now. Is that trying to regain shelf space that maybe you, youâve lost or moved away from over the past couple of years or can you be any more specific, in terms of were you are targeting? Yeah, I mean, clearly weâre not, weâre not happy with where we are shelf space certainly in the US; let me just focus US for a moment. As we, as we moved away from, from the bundles here in the first part of the first quarter, we end up loosing little bit shelf space and we had expected that, I think the good news is we did retain some shelf space certainly with those customers and that where weâve been doing the bundles. We would like to get some of that shelf space back as we go forward in time, we are obviously not happy with that shelf space in the OSS channel, we are not that happy with our shelf space in the club channel, right now, so these are all places where we would like to do better than we are in terms of inkjet shelf space. Yes good morning. Quick question for you on the effect of supplier manage inventory benefit here in the first quarter or what you would perceive in the second quarter. Was there any benefit, can you qualify it? Again, we didnât have any, any new product transition, so this is specific SMI benefit would not have been material in the period. Okay and then also a follow up on the component question is it laser or inkjet component and is it an industry wide or is it most Lexmark specific particular to a, particular product design or design that you guys have? Yeah, Bill itâs an inkjet product and I havenât done a lot of research to understand how much might be industry wide. But I can certainly say Lexmark has this issue. Thanks couple of questions for you guys. Can you provide some color on percentage of inkjets sold in the quarter that were single function versus multifunction, and that similar type of question for supply sales in the quarter? Well, I am not sure we can break out supplies between single function and multifunction. But, relative to the hardware, what we could say is that, for the quarter, the units were down 18% year-to-year single function units were down year-to-year, all-in-one units were up year-to-year. And thatâs the level of detail we give. Okay and following up on the strategy that accepts the low-end single function segment, when do you expect the full grant of the follow through on supplies to impact the P&L? Is that a second half event or do you think 2Q will be the worse of it? Chris, let me clarify that we are not looking to accept the low end single function segment. There is certain business that we were doing which didnât dry up the hurdle level profitability over the life of the product that we were looking for, certainly a lot of that was in bundles that utilize single function printers. But standalone single function sales at the low-end are very profitable for us. So, we are not looking to exit that segment or walk away from that. Relative to the supplies impact itâs a little hard to predict how you will see that roll over, over time obviously to the extent that this business is coming down about 20%. Weâve expect to see impacts in every quarter from that relative to the near-term supplies. Okay great thanks. In terms of pricing you said during the quarter, can you tell us was that, largely due to your own conservative actions or is that certainly that industry-wide phenomenon that shows more rational behavior throughout the quarter. I mean, then second, I thought to keep asking about the component shortage, but can you tell us that is it a new product or an existing product? Bill, relative to the components, sure, itâs really isnât much more we can say than what weâve said and we will look to give an update in the next earnings release in July. Relative to pricing; let me clarify one thing on pricing. Even though we are focused on exiting some business doesnât give the return that we are looking for overtime. We are not the giant from the marketplace and we are very active and we are very aggressive in the market, and we would intend to be very aggressive and certainly would react anybodyâs pricing moves that we would see in the market, if we think thatâs the right thing for Lexmark to do. So, we continue to be as focused as we were doing during 2005 and being competitive in the marketplace. So we talked about pricing, that really was a market phenomenon, I mean, obviously to the extent that Lexmark has indicated that weâve seen pricing impacts and that we would drive into some business, who knows what impact that has in the thinking of our competition, hard for us to say, but I would say across the board that the pricing in the market was pretty benign in the quarter, but we donât have to show, expect that to continue to as we go forward in time. Thank you, Paul I apologize for asking you to clarify follow up on a question that you have touched upon in a couple of different instances, all right, do you think there is an aspect for the question that you have not answered directly, specifically with supplies channel inventory, I heard you say, you saw last year-over-year impact than what youâve expected, but sequentially either in terms of weeks or in terms of absolute dollars or in terms of impact on sequential growth, what was the change in supplies channel inventory up, down or flat for laser supplies and inkjet supplies in the channel? Yeah, Richard we havenât quantified that and we donât intend to quantify that and again these are estimates we have inside Lexmark, as indicated, we donât have the fact this is not data Lexmark has, we have partial reporting from the first tier, we have no reporting from the second tier, we have estimates and I really donât think, as a company we should begin enough quantifications from things that are, is not data inside the company. So I can just tell you that, that we saw less impact in our estimates, than what we had expected to see, hopefully thatâs fairly accurate directionally, but beyond that, I think we can only talk about the supplies we actually solved which were up 3% year-to-year, which was better than the flat which is what we are expecting. The, historically, I think the perception that we have is at the business model for laser is a little bit less backend loaded than in ink, youâve commented that AUR user down 25% on laser this quarter due to mix in price, I wonder if you could comment on whether those are the changes that were offset by laser hardware comps these on declines or whether they are structural model changes that are going on in the business model for laser. Yeah Richard I think, I think that there are some structural things and weâve talked about some of these before but let me, let me kind of revisit them, the reality is that the extend that we see a transition from mono to color, color laser pricing is very, very aggressive. Color laser is much closer to an inkjet model than to the historic laser model, currently in terms of upfront hardware margins and recovering in supplies over time. So part of what we are seeing is that to the extent that we grow color, you are seeing the shift in the business from mono and laser from what it has been historically. The other thing, I think we are seeing is that historically Lexmark has been more heavily loaded to work replaces then other people in the market and to extent that starts to even out more towards low-end lasers, we also see a little bit of a shift currently in that business model also. So, I think that there are something that are changing there that are contributing to the 25% and that is both price and pricing has been very aggressive in color laser year-to-year. Itâs been very aggressive in work replaces year-to-year and also in low-end mono lasers. So thatâs there, but then the mix shift that we are seeing from the high-end to low-end mono lasers is some thing thatâs also impacting us and you can see that in the results weâre reporting. Is it due to, to improve from that that laser gross margins on a hardware side are eroding where the inkjet margins were relatively, relatively stable, on hardware, albeit a lot? I would necessarily assume that. I think on laser side, certainly I think weâre seeing impact on inkjet side on a year-to-year basis, weâre also seeing impact on the margins. You canât bring down prices 25% to 30%, you canât get that much cost out. So youâre going to see, youâre going to see an impact and with the pricing that went on in 2005 and obviously we are looking at same profitable year versus the first quarter of last year then thatâs what you are seeing. |
EarningCall_234072 | Ladies and gentlemen thank you for standing by. Welcome to the Lucent Technologies Investor Relations Conference Call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the call, please press â*â followed by â0â. As a reminder this conference is been recorded. I would now like to turn the conference over to your host John Debono, Vice President of Investor Relation. Please go ahead. Good morning everyone. With me today are Patricia Russo Lucentâs Chairman and CEO and Frank A. DâAmelio, Chief Operating Officer and Chief Financial Officer. We will begin with Pat and Frank providing an overview of Lucentâs results for the quarter and fiscal, and then weâll open the call up for your questions. Any one has not yet seen a copy of our earnings release it is available on Lucentâs website. Now, before we begin let me remind everyone that this conference call is open to the media and we are providing a simultaneous webcast of the call for the public. The replay of the call will be available on the companyâs website this afternoon; it will run through January 31st. The PDF version of the slide that of a video streaming, along with this call was preposted to our website for your reference. I also want to remind you that todayâs remarks also includes some forward looking statements about our plans and our expectations for future performance. The actual results could differ materially from those suggested by our statements today. Additional information about our forward-looking statements and factors that could affect future results, is described in our recent SEC filing including our 10-K, 10-Qs and 8-Ks. Now at this point of I will turn the call the call over to Pat. Thanks John. Good morning everyone thanks for joining us. As we announced earlier today, Lucent reported revenues of 2.05 billion for the first quarter of fiscal 2006 and this compares with 2.43 billion in the previous quarter and 2.34B in the year-ago quarter. Despite this disappointing drop in revenue, we were able to maintain a solid gross margin performance of 42%, due primarily to our continued focus on simplifying our operations and diligently managing our cost structure. On the bottom line, we reported a net loss of 104 million or $0.02 per share for the quarter and this loss includes the charge of 278 million or about $0.06 per share due to the previously disclosed judgment in the Winstar case. Frank will provide more details on our financial results in just a few minutes, but first, Iâd like to provide some context to the revised guidance we issued 11 days ago as well as a little color around what weâre seeing in the market and in our business. As you know, on January 13th, we announced that while we had previously anticipated annual revenues for fiscal 2006 to increase on a percentage basis in the mid single digits, we now expect annual revenues to be essentially flat or increase in the low single digits for the year. While we are clearly disappointed by having to change our guidance, we do consider this to be a temporary setback to the progress weâve made and we are confident that our performance will be much stronger for the remainder of the year. Why do I say that? Despite our Q1 revenues, we continue to be encouraged by the opportunities weâre working in the opportunities weâre involved in across our portfolio and around the world and these are opportunities that align with our strengths and the investments weâve been making. From a product and services perspective, letâs take a look at them. In wireless, we expect some of our large North American CDMA wireless customers to continue adding network capacity throughout 2006 and as high speed wireless data communications emerges as the key differentiation tool for mobile operators, to start migrating toward EV-DO Rev A later in the year. We also expect several of our other wireless customers in North America to be building out new markets and weâve announced some of those contracts previously. We expect significant revenue growth in UMTS during second half of the fiscal year as we accelerate our rollout and grow our market share. In Services, the transformation from legacy to IP networks is driving significant demand for Lucent Worldwide Services as a network integrator. Our strategy of investing in and enhancing our multivendor skills is helping us to capitalize on these opportunities even with customers who donât have Lucent products in their existing networks. Weâre seeing a lot of activity in the Lucent Worldwide Services sales pipeline around network transformation services, which plays to our strengths in transcending traditional outsourcing and managed services. This will enable Lucent to capture more services dollars by offering not just OpEx and CapEx reductions but also quicker to market revenue generating services. In fact, weâve made significant progress with several yet-to-be-announced customers who will soon launch new revenue generating services that Lucent will host via our global network operation center. Weâre continuing to build an annuity of services contracts built upon these transformation capabilities. Just last week, we announced a multiyear agreement to operate and manage the U.S. based network facilities of Pacific Crossing, which owns and operates the trans-Pacific fiber optic cable. And we are engaged in additional annuity opportunities in new services growth markets similar to the nine-year $187 million contract we signed with Capgemini and TXU last year. In wireline, we continued to see increased interest in our Ethernet services, especially in metropolitan applications and thatâs really across all of our customer segments. Weâre seeing customers deploy our integrated optical and data solutions to provide the optical transport, Ethernet aggregation and Ethernet switching for the next-generation video distribution applications that are linked to our IPTV solution, converged Ethernet solutions, IMS, and wireless backlog solutions, and in the access space, we expect to see increased IPTV sales to some of our North American customers in second half of the year. In addition to these opportunities, which Iâve characterized more along the product and services segment, we see additional, encouraging signs around the world; youâve heard me reference several opportunities in North America, letâs look at some of the other regions In the Caribbean and Latin American region, we expect continued growth across our portfolio of products and services, with both existing and new customers, in particular, weâre encouraged with the progress weâre making with IPTV in that region In Europe, weâll see revenue growth from recent contract wins, some of which are announced, some of which are not, and new customers building next-generation networks. Weâre also making progress in growing our professional services and network integration business in that region as these and other services capabilities serve as an excellent entry into customers where we have little to no installed base. In Asia, we expect revenue in Korea, Japan, and India to be stronger in the second half 2006 than in first half and this is based on opportunities we have with both existing and new customers and they are primarily driven by our wireless applications and service offerings. Looking further ahead, we expect to continue to see our customers invest in the next-generation of networks based on IMS, which play to our leadership position in that space. To date, weâve announced 7 customers for our IMS portfolio, which we believe is more than anyone in the industry, and we have continue to expand our list of IMS trials with fixed, mobile, and converged customers. In all, we currently have 77 trials underway with now 16 customers. This includes Verizon, which is currently conducting an extensive lab trial of a wide range of elements from our IMS portfolio Under evaluation in Verizonâs lab are several Lucent offerings, including: Our Session Manager, Our Active PhoneBook, Our MiLife solution, SurePay, Feature Server, Network Gateway, And our VitalSuite Network Performance Management software. Obviously, this represents a considerable opportunity for us and we believe the depth and breadth of our IMS offers, our unique Bell Labs technologies, and the multivendor integration skills and expertise offered by our Services business position us well to help them meet this emerging market need. As we said this the past, IMS is more of a longer-term play in terms of revenue but our early leadership in this space has positioned us well for when we expect revenues to ramp in 2007. Before I turn it over to Frank, let me close by sharing a few thoughts on his new position. As you know, we recently announced that Frank has been appointed Lucentâs Chief Operating Officer. With our industry undergoing a significant transformation as the boundaries between telecom, media and the Internet worlds continue to blur, I concluded the time was right for us to once again have a Chief Operating Officer responsible for driving growth, operational excellence, and flawless execution across the business. As COO, Frank will be responsible for leading the operations of the business, including sales and product groups, the Services business, the supply chain, IT operations, and labor relations. This will allow me to increase my focus and attention on both Lucentâs longer-term strategic issues and strategic growth opportunities and as well to continue to spend more time with customers As you know Frankâs leadership as CFO has been vital to Lucentâs turnaround. He has played a significant role in helping guide Lucent through one of the most difficult periods in our industryâs history - named, which I am working as aggressively as possible, and as such, he will now provide details on our first quarter results. Frank? Thanks, - always, the charts I will be reviewing today are included in our webcast. With that, let me get to our financials. Today, we reported revenues for first quarter of fiscal 2006, 2.05 billion, a decrease of 16% sequentially and a decrease of 12% compared to the year-ago quarter Sequentially, revenues in the U.S. decreased 11% to 1.34 billion while international revenues decreased 23% to 704million. This resulted in a geographic mix of 66% in the U.S. and 34% outside the U.S. We reported a net loss of 104million or $0.02 per share. These results compare with net income of 372 million or $0.07 per diluted share in fourth quarter fiscal 2005. The first quarterâs loss included a charge of 278 million or about $0.06 per share due to a Bankruptcy Court judgment relating to litigation between Lucent and the trustee for Winstar Communications. This judgment is being appealed to the U.S. District Court for the District of Delaware. Youâll note that the basic and diluted share count as of December 31st was the same, and about at about 4.5 billion shares. Since we reported a net loss, there was no dilutive effect of stock options, warrants, and convertible securities on our share count. The gross margin rate for first quarter was 42% of revenues compared to 46% in fourth quarter. The sequential decrease was due largely for lower volume as fixed costs were spread over a lower revenue base. The fiscal 2006, we continue to expect to generate an annual gross margin rate of 41 to 43%. Operating expenses for first quarter fiscal 2006 were 940 million, an increase of 130 million sequentially. Before getting into details on operating expenses, let me point out the following. Our net pension and postretirement benefit credit for first quarter was 104 million, down $81 million compared to the prior quarter. The net credit includes a gross pension benefit of 167 million and a cost of 63 million for postretirement benefits, which is primarily retiree healthcare. Consistent with prior periods, about two-thirds of this amount is reflected in operating expenses and the remainder impacts our gross margin. We continue to expect our annual net pension and postretirement benefit credit to decrease by approximately $300 million during fiscal â06 from the 718 million in fiscal year 2005. In addition, other income in first quarter of fiscal 2006 included a $33 million minority interest credit related to a reduction in the profit from one of our joint ventures. And in first quarter, we recognized $16 million of income taxes, primarily attributed to non-U.S. earnings. U.S. deferred income taxes were not recognized during the quarter due to the U.S. pre-tax loss, resulting primarily from the Winstar charge. We continue to expect to recognize tax expense of approximately $170 million in FY 2006 with approximately 100 million for U.S. deferred taxes, most of that expense is now expected to be recognized in second half the fiscal year. Now back to operating expenses. The first quarterâs operating expenses included litigation charges of $283 million, related almost exclusively to the Winstar charge. The fourth quarter results included 71 million of charges resulting from the settlement of several litigation matters. Sequentially, all other SG&A decreased by 43 million to 380 million, due largely to lower accruals from employee incentive awards and cost control efforts across the business. R&D of 280 million, $283 million reflects a 36 million sequential decline related largely to lower mobility trial expenses, lower accruals from employee incentive awards, and deficiencies gained as a result of actions taken across the business. The SG&A and R&D expense declines more than offset the sequential decline in the net pension credit. In first quarter, we recognized 24 million in stock compensation expense compared to 5 million in the prior quarter. The sequential increase was due to the inclusion of stock option expense in accordance with FAS 123(R); 21 million was reflected in operating expense and remaining 3 million was reflected in cost. We continue to expect stock compensation expense to be about $100 million for fiscal 2006. Including the $278-million Winstar charge mentioned earlier, we now expect fiscal 2006 operating expenses as a percentage of revenue for E to R to be about 33% Now, Iâll make some comments on our segment performance. As I mentioned on last quarterâs earnings call, effective with first quarter of fiscal 2006, we are reporting under a new segment structure. Revised historical segment results are available on our website The prior period segment results were revised to conform to the new reporting structure and to reflect some other changes including the elimination of certain revenue sharing arrangements, the internal transfer of certain organizations, and revised internal allocations of employee benefit rates. Mobility Access and Applications Solutions, which includes CDMA, UMTS. WiMax, and applications, revenues for first quarter were 945 million, a decrease of 139 million or 13% sequentially U.S. revenues declined by 6%, driven primarily by lower sales of application products, Non-U.S. revenues decreased by 33%, due primarily to lower CDMA sales in China, and delay of 3G license awards in China could continue to have a negative impact on future network deployments in that country. Segment income for first quarter of 317 million decreased $90 million decrease was $90 primarily to a lower gross margin, which was partially offset by lower expenses. The lower gross margin was due primarily to lower sales volume and the favorable impact in the prior quarter of revised estimates to long-term contracts. The lower expenses were due in large part to the inclusion in the prior quarter of higher R&D expenses related to product trials and continuing efforts to reduce spending. Going forward, we now expect fiscal 2006 annual revenues for the Mobility Access and Applications Solutions segment to be essentially flat for the year First quarter revenues for Multimedia Network Solutions, which includes optical, data, and access networking, were 395 million, a decrease of 75 million or 16% sequentially. U.S. and non-U.S. revenues decreased 17 and 15% respectively compared to fourth quarter. The declines were due primarily to $60-million decline in optical sales, which were particularly strong in fourth quarter. Segment income of 45 million decreased by 48 million sequentially, driven primarily by a lower gross margin which was offset somewhat by a slight decrease in expenses. The lower gross margin was due primarily to lower volume and an unfavorable product mix. For Converged Core Solutions, which includes both legacy voice and next-gen next-generation IMS/VoIP core products, revenues for first quarter were 145 million145 million, a sequential decrease of 91 million or 39%. U.S. revenues decreased 37%, due largely to a decline of sales of legacy voice products. Non-U.S. revenues decreased 40%, due primarily to lower sales of PHS products in China. Circuit switching and PHS revenues in first quarter declined 72 million sequentially and accounted for approximately 50 and 20% of total Converged Core revenues respectively. Segment income decreased by 16 million sequentially, resulting in a breakeven performance. The decline was due primarily to a lower gross margin, which more than offset slight decrease in expenses. The lower gross margin was due primarily to considerably lower volume. For fiscal 2006, we now expect annual revenues for the combined Multimedia Network and Converged Core segments to be down somewhat y-over-year. For the Services segment, which includes maintenance, deployment, and network transformation services such as professional and managed services as well as network operations software, revenues were 540 million in first quarter, a decrease of 53 million or 9% sequentially. The sequential decrease was driven primarily by a decline in revenue related to professional and maintenance services, which offset an increase in deployment services revenue related to a large U.S. network deployment. On a sequential basis, U.S. revenues decreased 6% to 322 million and non-U.S. revenues decreased 13% to 218 million. Sequentially, segment income of 89 million decreased by 15 million, due primarily to a lower gross margin, which offset a decrease in expenses. The lower gross margin was due largely to lower volume and an unfavorable services mix. The expense decrease was driven primarily by efficiencies related to the integration of the network operations software business. Going forward, for fiscal year 2006, we now expect revenues for the Services segment to grow at or slightly below 10% year-over-year. During Q4, we used 523 million in cash for operating activities, due primarily to the payment of fiscal 2005 employee incentive awards into a lesser extent an increase in working capital. Cash generated from operating activities in the prior quarter was approximately $1 billion, including a 902 million federal income tax refund. Capital spending, which includes internally user software, decreased by 46 million to 30 million in first quarter. We continue to expect capital spending to fiscal 2006 to remain relatively consistent with the fiscal 2005 level. During Q1, we funded approximately 59 million in retiree healthcare and other postretirement benefits out of operating cash. Going forward, for fiscal 2006, we expect operating cash funding requirements for retiree healthcare and other postretirement benefits to be about $250 million. The U.S. pension plans meet the requirements of ERISAâs funding rules, and we do not expect to make any contributions to the qualified U.S. pension plans through fiscal 2007. In addition, in January â06 we will use about 300 million in cash to collateralize a financial instrument to be issued in connection with the Winstar judgment. Now, some details on working capital. Inventory turns decreased from 7.2 to 6.2. DSOs increased from 52 to 63 days. Going forward, we continue to expect a normalized level for DSOs of about 60 days, and our headcount at December 31st, 2005, was approximately 30,200, a decline of about 300 from September 30th, 2005. This reflects a decline of almost 600 in the U.S. and adds of almost 300 in non-U.S. regions. Now to the balance sheet As of December 31st, 2005, Lucent had cash and marketable securities of about 4.4 billion compared with about 4.9 billion on September the 30th, 2005. The sequential decrease was driven largely by cash used in operating activities. Total debt and convertible securities remained relatively flat in first quarter at 5.4 billion, and our net debt position increased by 533 million to approximately $1 billion. From a maturity perspective, our debt portfolio continues to remain relatively long dated. As of December the 31st, 2005, about 80% of our public debt, convertible securities mature in or after 2010 assuming the 8% convertible security is put back to us. Now I will turn I back to John DeBono We are now ready to begin the Q&A session. In order to allow us to respond to many questions as we can during our call, we ask that you limit yourself to one single part question. As soon as youâve finished asking the question, youâll be removed from the queue. Ladies and gentlemen, if you wish to ask a question, please press â*â â1â on your touchtone phone, you may remove yourself from queue at anytime by pressing the â*â â2â key. If you are using a speaker phone, please pickup the handset before pressing the numbers. Good morning. If we look in a bit to the Mobility numbers, noted that the US application sales were is, are EV-DO upgrades, largely application definitions that you laid out or is it more specific, software, thing like push to talk or e-billing or whatever? The second piece of that, is in the numbers, have you now begun recognizing revenue from the Cingular, and would you expect aftermath in that customer revenue stream in future quarters? Paul, this is Frank, by the way, you were fading in and out, but I think I heard the questions, so let me answer them and hopefully I heard them correctly. So first in terms of, you mentioned applications with mobility. In my comments, I said that in the US mobility revenues were down quarter over quarter, sequentially by 6%, and essentially all of that was a decline in application product sales, not mobility product sales, and internationally mobility was down 33% quarter over quarter and that really was due to the decline in CDMA sales in China. Now to your specific questions, when we talk about applications and then relate that to EV-DO sales, the EV-DO sales are really mobility product sales, they really donât have a material impact at all on the application numbers. So I think that was your first question. And I believe your second question was âFrank, are you guys beginning to book revenue on the Cingular contract?â, we typically donât call out revenues by individual customer or contract or product. However, we did book revenues to that contract this quarter, and we do expect as a company our UMTS revenues to increase significantly in second half of the year. So a couple of questions on your guidance there, when you talked about the weakness in China, can you give us some sense of whether youâre further pushing out your assumptions on the timing of the Chinese licenses impacting your business further out into the back half of the year, and what your thoughts are in terms of the timing of that? And then the second one is, given the steepness of the decline here in revenues in first quarter, what is it thatâs giving you the confidence in that rebounding quickly enough to get you back to a flat to up slightly revenue guidance. I am not sure I followed, the timeline there very clearly? Okay. Let me do this. Let me hit the second question first in terms of a Frank, given the absolute revenue number in Q1, why do you guys feel confident about the remainder of the fiscal year and the guidance we provided? And then we will come back to, because thatâs the bigger question, then we will come back to the timing issue around China with the licenses. So we see lots of encouraging signs right now in our business, across our product portfolio and across our regions. So let me just kind of rip through some of them, give you, for some of the things weâre seeing, not to be, theyâre not meant to be all inclusive but theyâll give you kind of a flavor to the various things we see. So first in an area like wireless, we see our large US CDMA customers continuing to add network capacity throughout fiscal year 2006. So thatâs one thing. We see our other US wireless customers continuing to build out new cities. As I mentioned in my comments to Paul, we expect our UMTS revenues to increase significantly in second half of the year. If you look at an area like services, right now weâre seeing substantial activity in our sales pipeline there. Now obviously our job is to convert that into contract wins, we see substantial activity there. Weâre seeing lots of opportunities for annuity service business similar to the nine-year $187 million contract we announced last fiscal year with Capgemini Energy-TXU, and In fact recently we announced a managed service deal with Pacific Crossing to operate and manage their network. If you look at optical, we are seeing lots of increased interest in Ethernet over optical services particularly in metropolitan applications and once again our job is to take those opportunities and convert them into contract awards. Weâre seeing increased interest in IPTV and weâre seeing lots of opportunities across all of our regions, whether itâs CALA, EMEA, Asia. So itâs based on all those things and all the things we always talk to you all about, right? Looking at our sales model, talking to our customers, understanding their CapEx spend, itâs all of those things in combination that really we take into account before we make the statements we may including the statement around our confidence remainder of the fiscal year. So thatâs the answer to your second question. In terms of the question on China, we are not assuming, Iâll call it any positive material impact, on our revenues in fiscal year 2006 resulting from the issuance of those new licenses. So thatâs how I would answer the question. If I can, my question is to dig a little bit deeper into the revenue and the gross margin, because the gross margin actually was quite impressive I thought given the revenue shortfall. If I can clarify from that previous question it sounded like the revenue, your confidence going forward is coming more from the revenue opportunities youâre seeing as opposed to recovering the revenue shortfall from this quarter. So I just want to first of all confirm that what happened this quarter was not necessarily revenue recognition issue with percent of completion but more had to do with simply lost share, lost revenue, lost opportunity that you expect to make up going forward in new opportunities as opposed to recovering this. And my, that was a confirmation, but my real question has more to do with the gross margin. It seems like that it didnât fall as much as I thought it would have, and it sounds like you, or it looks as though you have a very nice control on the variable cost structure on your revenue now so that itâs not a fixed cost structure, does that have something to do with percent of completion and the fact that more of your contracts are now under percent of completion from the change you made and the accounting change last year and so therefore can we see a more stable gross margin going forward because of that? I understand the questions. So let me comment on each one. First on the revenue, let me see if I can come at this. In terms of the revenue, I think what happened is we clearly thought we were going to have a bigger Q1 revenue number, we clearly thought the number would be higher. But remember the rhythm of our revenues in the business, right. Most of our revenue is recorded in the last month of a quarter, and then most of that revenue is recorded in the last 2 weeks of a quarter. So clearly the revenue we recorded in the last month and last 2 weeks was lower than we expected, kind of point one. And so you say well why, Frank? Why was it lower than we expected? And there is a couple things. One is we didnât see some of the calendar yearend spend from our customers that weâve seen in the past, in fact in certain instances we actually saw it pull back. Right. So there was no, we saw no capital flush and in fact actually saw a tightening up very late in December. So we didnât see any of that which really from my perspective, once you donât see that at the end of the calendar well then those CapEx budgets are gone, right the calendar year for our customer ends, those CapEx budgets are now completed and then we go into a new calendar year from a customer perspective with new budgets. So those are dollars that basically werenât spent or we didnât get and therefore you donât get them back because those budgets are gone. And so now what we are doing is we are working into the New Yearâs calendar budgets, calendar CapEx budgets for our customers. Then in terms of POC, POC by the way today is give or take about 25% of our revenues, but no, I would not be, use that as kind of an explanation for what happened with the gross margin quarter-to-quarter. Let me talk about what happened with the margin quarter-to-quarter. And Iâll talk about some of the commentary specific to the margin being in the low 40s, despite the decline in revenue. What really happened quarter-over-quarter with the decline was primarily a volume issue, which I alluded to? We are down 4 points quarter over quarter, most of that the majority of that is really driven by the lower volume. Thereâs some onesies here and there, some other onesies in terms of a plus point or minus a point but the big attribution quarter-over-quarter is really driven by the lower volume level. And then in terms of the margin itself, remember, early, when we had our Analyst Day back in the fall, we have a lot coming at us this year in terms of earnings, right? Weâve got the pension credits down 300 million, weâve got tax, weâve got compensation expense per FAS 123(R) of another 100 million, we have got the U.S deferred taxes that we called out of 100 million. So weâve been all over all of our spending, COGS, expense, all of it. Quite frankly, weâre always all over it but weâve been acutely all over it since the fall, knowing weâve had these issues coming at us and I think what weâre seeing in the quarter is really much of the benefit of the work weâve been doing in those areas, thatâs showing through in the results. So thatâs how Iâd answer the question, it isnât from my perspective, the POC accounting. Good morning, thank you. I have a question on profitability both near-term and long-term. As you look out over the rest of this year, you gave us I think some good points on your revenue growth, gross margin. As Services and Mobility trade positions in terms of leading growth, what do you expect for profitability trends over the next, over the rest of this year? And then second, Pat, to go to your comment on IMS growth taking off in 2007, whatâs your expected impact on the business model as IMS and applications grow from a margin and expense standpoint? So Iâll hit the profitability trends question. So Scott, in terms of profitability trends, I think the way Iâll answer that is based on the guidance that I provided for the year, because we donât get into quarterly guidance numbers. What I said is we continue to expect our annual gross margin rate to be 41 to 43%. And I said given the $278 million legal charge we recorded this quarter, we now expect annual operating expenses as a percentage of revenue to be about 33%. So you can work the 41 to 43 less, the about 33% for ER and that gives you kind of an operating margin range from a profitability perspective. Yeah. And Scott, with respect to IMS, couple of things I would just point out. We believe weâll start to see a ramp of revenues associated with the IMS contracts with the portfolio, as customers really start to deploy these new services on these new platforms. From a margin and a profitability standpoint, there are many elements underneath this umbrella of IMS, right? Youâve got gateways, youâve got elements that are strictly software, youâve got application servers where thereâs a software element, so I would say, I would answer your question in the following way. Number one, weâre very comfortable with the, with the aggregate margin of the IMS portfolio when you take the entire mix and believe that we will be able to continue to be in the range of the margin guidance we have provided as that really starts to ramp. So, we feel pretty good about the margin potential in the IMS space. Good morning Frank, good morning Pat. I wasnât sure on Donâs comment about the multi-part, do they have to be related to each other on the questions? So much for my humor, A couple of questions for you. Itâs all right, my wife doesnât understand it either. Pat, if I may, your Verizon IMS comment, Iâm not sure I understood, is Verizon, have you already signed up for IMS, or is that in trials? Your Services comment on the guidance. Can you refresh my memory what the guidance was for Services previously? And finally, on your Rev A timing comment. I think Len Lauer yesterday or last week at a conference made the statement that theyâre projecting Rev A in â07, â08 timeframe, so I just wanted to reconcile your comment about the Rev A rollouts with what I thought I understood to be his comment, and finally why no budget flush? Okay. So letâs go to the, letâs see, the first, let me comment on your first question. I got them all down here. Number one, what we said with respect to Verizon was that we are in trials with Verizon, okay. And so as you all know, the process here is a process of you get into trials, things get tested, customers evaluate, they then decide, etcetera. So the stage we are in and what we said with respect to Verizon is they are trialing many elements of our IMS portfolio, weâre very pleased with that, and we consider that to be a very important opportunity. With respect to, the second question was regarding Services, go ahead Frank. Yeah, Paul, the previous guidance we gave on Services was that the revenue would grow at or slightly above a 10% growth rate. This time we said the revenue would grow at or slightly below a 10% growth rate. And thatâs a year-over-year growth rate, so â06 to â05. With respect to the capital flush, Paul, Iâm not sure I can answer why, because youâd have to almost go customer by customer. But as Frank noted, we often see at the end of the calendar year some capital flush roll through, and in this particular quarter, we didnât really see that anywhere, and in fact in a number of cases actually saw a pulling back very late in the quarter with respect to business moving through, and therefore, in some cases obviously that spending not occurring, and in other cases some moving into this quarter. With respect to EV-DO Rev A, what weâve said is we expect the availability of Rev A late in â06, and we expect to see some of that fall into our business, but we havenât commented on a customer by customer basis. So thereâs not necessarily an inconsistency in what you heard and our view of the opportunity late in the year for Rev A to have some positive impact on the business. Hey Frank. Listen I was wondering if you could give us a little, some more comments on your second half year confidence and how much are you counting on it to come from new wins versus existing business thatâs been won. One of the things that this quarterâs miss highlighted is that youâve got, you already have a high-level of customer concentration, fairly close relationships with these guys and it was a pretty big miss that we didnât see coming. So, as we look out into SECOND HALF, kind of what gives you confidence and how much is that going to be on new wins? Because you highlighted a lot of new opportunities, I just want to know kind of what weâre betting on thatâs still on the come. So I think the way Iâll answer this is as always itâs a combination, right? I mean itâs clearly a combination of business to be won and existing business. And Iâm going to elaborate a little bit. But for example, we make a statement around we expect UMTS revenues to increase significantly in second half of the year. Thatâs really for the most part existing business and then expanding on that existing business. So, weâve lots of opportunities to expand existing business with existing customers, point one. Point two, remember in our business, even when you win contracts, you then have to get the orders to fill on those contracts and book revenue. And then, when you do POC accounting just because you do POC accounting doesnât automatically mean you book revenue, right? Youâve got to get orders, youâve got to ship, youâve got to meet operational milestones, you have to get acceptance and then after you do those kinds of things, youâre able to book revenue. So we have lots of opportunities in the business going forward for the remainder of the year where Iâll call it what existing customers, existing business, significant opportunities to grow that revenue for the remainder of the fiscal year and then obviously we want to add to that, supplement that with new business, new awards, so, to help with the financial performance. Remember, this is an industry, though, where sales cycles are fairly long. So, youâre not, once you get into January, almost February, you arenât going to win a whole lot of what Iâll call new business, new customers and see that impact the fiscal year results, in any real material way when you look at the annual numbers. Most of the business has to come from existing customers, and then existing and new contracts. I think thatâs how I would answer it. Pat, do you want to? Yeah. No, I think the categories Frank described is right, we have some announced wins where we havenât really recorded much revenue at all yet and weâve got orders, and we know itâs going to flow as we move through the year. Frank mentioned an example, there are other examples of contracts we have announced. There are contracts, there is business we have won that we have not yet announced, simply because we havenât finalized a few things and the customers havenât been ready and therefore we know from a demand standpoint that there will be a requirement for us to deliver and therefore weâll book revenue in â06. And so thereâs those kinds of categories, and then thirdly, things that we are expecting that are on a shorter sales cycle and itâs a matter of factoring your sales funnel and your opportunity funnel and your win rate and your expectations about what you believe youâre going to deliver, which is contributed to by the product unit views and the sales teamâs views. So itâs really those categories, when you put it all together that cause us to say what we say about what we think is going to happen for the rest of the year. Good morning, thanks, two quick ones if I could. First, if you could just talk a little bit about India. I think that was one of the areas where Pat had talked about some better growth in second half. Obviously, thatâs been a market where itâs been a little tougher pricing environment. Just give us your thoughts on pricing there and whether or not with the, now that weâre much into follow on contracts rather than initial contracts, if weâre seeing any better pricing or margin performance on those contracts? And then secondly, the WCDMA share gain comment, I think this might have been asked some way, share gains in second half, and over the next year, are we talking mostly Cingular there to drive those share gains, or are we talking some potential other contracts and where geographically might we look for some of those other WCDMA wins? Yeah, so, let me answer the second question first, on the CDMA question, I think the way Iâll answer that is the statement around revenues in second half of the year being increasing significantly, thatâs with existing customers. Thatâs the assumption underneath those revenues. And then obviously, weâre working on other opportunities. But that statement is based on existing customers. And then in terms of India, we still see the pricing environment there as extremely challenging. And what weâre trying to do is win business, but win business in, I call it, the right way. And so weâre being prudent in terms of what weâre doing there, weâre trying to win business weâre trying to win it the right way and what weâre not going to do is sign business with big contract losses. And we havenât done that. That clearly by the way, can have an adverse impact on revenue. But a positive impact on profitability and cash flow and our bias is profitability and cash flow. So where thereâs really difficult pricing challenging pricing weâre walking away from that business. Good morning, Frank. Thank you very much. I have a quick clarification first and a question. Frank, I think you mentioned a 33% OpEx as percentage of the revenue. I want to make sure, is that for the entire year or thatâs a number we should look at when you exit fiscal year 2006. And my question is a follow up question on WCDMA, I know other than Cingular and you have in the past talked about E access in Japan. I was wondering do you have any other trials you can talk about give us a little bit more color in terms of your position in the WCDMA for the next couple of years? Yeah, so the 33%, by the way, you heard that absolutely correctly. Thatâs the fiscal year â06 guidance statement. So thatâs annual operating expenses as a percentage of revenue will be about 33%, and remember that includes $278 million charge we reported this quarter for the Winstar case. In terms of some other UMTS/W-CDMA trials we could talk about, one we always mention is kind of what weâve got going on with the Chinese Ministry of Information Industries, we are conducting a trial now with China Netcom in Shanghai on our UMTS capability. So thatâs clearly a trial weâre working on weâre working with field testing and thatâs clearly a major area of opportunity for us going forward. And I would just add to that, we also have a couple of trials of our base station router which plays into the UMTS network that weâre working as well. And obviously when it relates to Wideband CDMA weâre also participating in bidding on opportunities for the core network and the IMS network. So, thereâs the RAN, thereâs the RAN piece of Wideband CDMA and then thereâs other aspects of the Wideband CDMA networks which weâre also focused on, as we seek to try to enter into these networks where we were not participating in the first round, in addition to what Frank said. On the, on the accruals for the incentives, I believe last year the company paid $350 million in year-end incentives that were accrued throughout the year and paid this quarter. Given the new guidance that you have which is lower than when you entered the year, these incentive accruals are already showing up in your OpEx being lower, if you hit your guidance, Frank, what do you think these employee incentive payments would be? So that would be the first question. And then the second question very quickly on the CapEx budget flush was your comments there US specific or more global in nature that you didnât see the year-end budget flush you normally see? All right, Iâll let Pat, Pat will handle the budget flush question. Let me handle the accrual question. So, first, Nikos, in terms, in terms of the accounting and then the cash youâve got it spot on right. So what we do is every quarter, we book a compensation accrual during the fiscal year and then we pay it out in the first fiscal quarter of the following year. So for example for fiscal year â05 weâve booked accruals in each quarter and based on achievement of an internal plan. And then the cash was paid in December of 2005. So in the first fiscal quarter of the following year which is first Q1 of fiscal year â06, this past December we paid out all in 450 million, in employee incentive awards it was our short-term awards plus our long-term awards so it was all in 450 million and thatâs really for example what drove the cash used in operating activities. It was 523; the bulk of it was that item. And thatâs number one. In terms of the accruals, and relating that to operating expense, our comp accruals this quarter were lower than our comp accruals last quarter. So you know if you look at our OpEx quarter-to-quarter, on a GAAP basis it was 940 million this quarter it was 810 million last quarter and then I called out litigation charges that were included in each of those numbers, right? It was give or take about 70 million in Q4, and this quarter 280 million just around the numbers if you were to subtract those numbers from the GAAP numbers you get 740 for last quarter and about 660 for this quarter and give or take about half of that, half of that, is a result of the lower compensation accruals, which is what I think youâre asking me. In terms of our employees and what could they expect for the year, clearly we need to complete the fiscal year determine what our performance is versus our internal plan and thatâs what will drive the accounting. But based on first quarter, the payouts will clearly be lower than they were in fiscal year â05. Thatâs how I would answer the accrual question. Pat? Yeah. Nikos, regarding the budget flush, obviously capital budget availability late in the year has tended to be more present and visible to us obviously in North America simply because of the mix of the business. But I would answer your question in a way that says we really didnât see any budget flush anywhere and certainly did not see that in the US, in the customer stats that make up our business. So I didnât see anything dramatically different, globally from the US, but obviously given the amount of business we do in the US, thatâs where weâve tended to see the impact of what happens when thereâs a capital flush at the end of the year, and we just didnât, we just flat out didnât see it. Good morning, just a follow-up on the budget flush question, do you think that the lack of a budget flush this quarter typically I mean there is, people set a budget, CFO sets a budget, the engineers spend all they can towards the end, do you think this implies anything for CapEx targets? I know Verizon said some things but a lot of people havenât actually come out with formal CapEx and CapEx guidance? Do you think this implies anything for 2006, the 2006 market, in terms of CapEx? Yeah. Paras, Iâll just give you my opinion and I think each of the large operators always shares what their capital expectations are. No, I wouldnât take from what we saw or didnât see last quarter as an indicator of what the capital plans will look like customer by customer. So my answer to your question is no. Not based on anything Iâve heard, not based on any conversations Iâve had, I think it was just simply, what we said, and I wish I had a, a more textured explanation. But there are some years where you see an availability of capital late in the year; this wasnât, this wasnât one of them. Yeah at least not for us by the way, I canât, obviously I canât speak for others. But for us in the markets where we are, we just didnât see it Good morning. Is your new Multimedia Access Platform commercially available today? And if so, you mentioned earlier your IPTV, how many trials are you in? So in terms of the Multimedia Access Platform, our MMAP, let me just spend a minute or two on the product and then Iâll talk about the availability of it and then I think Pat will talk about IPTV. In terms of the MMA, itâs, it supports DSL, fiber to the home or premise and WiMAX, and it supports all of it in a single frame. So kind of a very integrated, very dense network element that we think has the potential to be very successful in the marketplace. We expect to do some Iâll call it trialing and controlled introduction of that later on second half of the fiscal year, with general availability early in fiscal year â07. So thatâs kind of the timeline for that product. Yeah, our participation in IPTV shows up in a couple of ways and obviously some of these weâve announced and talked about publicly like with Bell Canada and with Telefonica, and others we havenât. So we are participating in IPTV rollout utilizing our Access Platform and doing the integration work for customers in some cases. We are participating in some areas, especially in Latin America, as the network integrator for IPTV rollouts but not necessarily utilizing the Lucent Access Platform. So we continue to see good opportunities there, even where weâre not participating in the product, on the product side of the access front. And we have some trials underway; I would say a handful that we have not announced for our IPTV solution as well in North America and in the Caribbean-Latin American region. Good morning Frank. Thank you. I wanted to ask a question to look at the issue of revenue recognition policy. I will ask it very explicitly and hopefully youâll give us as much detail as you can. But I guess what Iâm looking for specifically is, is there a change or difference in your revenue recognition in the Cingular UMTS project versus the Verizon work. My assumption has been that Verizon, youâre recognizing revenue of shipments of base stations and equipment, and Cingular, thereâs some other terms and conditions. So if you could speak to that point. Yeah. So we donât comment, I donât comment on individual revenue recognition by contract. But I think the way Iâll answer the question and it should get at your question is in two ways. First, we have not had any, Iâll call it, revenue recognition changes in the quarter that in any way would have changed the rhythm of the numbers. I think that would be the first thing and then the second thing, in terms of specific POC accounting, we did not have any POC accounting changes within the quarter, once again, that werenât expected or, we didnât have any changes, so therefore, there wasnât anything that wasnât expected and that didnât have any impact on the revenue numbers one way or the other. I think thatâs how Iâll answer the question. Yeah. A couple questions for you. One, Pat, can you quantify what an IMS contract would look like and give us an idea what the size of one of these contracts would be? And then secondly, can you talk about the number of UMTS trials that you have ongoing or how many UMTS opportunities you see this year, like, can you perhaps talk about eAccess company youâve talked about in the past? How are things going with that company? So first on the IMS contracts today in the trials, the way I describe this, Brian, is today there are, Iâll call it, smaller opportunities. Theyâre tens of millions, theyâre not big, three-digit contracts. From my perspective, what weâre seeing now is almost an appetizer and then the entrees are to come. So thereâs a lot of dabbling still going on. Itâs still very much in the learning curve mode. Itâs clearly a critical element to next-generation networks service enabling, leveraging tunes and gaming and music and content and all those kinds of things, but today the contracts are relatively small. But I, but that would, whatâs good about that is the big contracts are to come. And the rhythm of it is very consistent with what weâve seen in new introductions of this magnitude in the past where the contracts initially are smaller and then they get bigger as we go along. Yeah, the other thing I would add to that is when you think about IMS contracts, there are, there is the hardware and software elements of those as Frank points out in tens of millions. And then thereâs the whole integration services opportunity set, which is much larger than our traditional service opportunity associated with any hardware sales. So itâs a very different construct of opportunity for us. That is why we always say you canât just look at gateways in an applications server, but you have to look at what does being in an IMS network for your customers bring you with respect to other applications and services that connect to it and as well the services element. So as Frank noted, most of these deals are at, are defined as what I call the early stages as customers start to deploy the service and then we are working with them on migrating. I mean, their goal by the way is to get out of their legacy networks on to all-IP networks and they wonât be finished until theyâre totally off the legacy and on to the IP. So these contracts we expect form the, as Frank called it, the appetizer but itâs a foundation for growth as the transition from legacy to IP occurs, as the services get proved in, and we see not only the hardware and software opportunity but we see lots of services opportunity with it. Okay. And then, Brian, your second question was on the UMTS trials or opportunities we currently see. Right now, we are working opportunities in several places; I mentioned China earlier on the call, other places in Asia and Europe, Western and Eastern Europe relative to opportunities weâre currently working. And the other thing we need to do is where we do have business we want to expand. And we want to delight our customers and expand our existing business. So those are the things we are working on. Good afternoon Frank. Just a quick one really, you effectively seemed to have moved your Services guidance down a little bit. I was wondering if you could talk to why youâve changed that guidance because we are generally under the impression that Services was the engine of growth this year. Yeah. So one, youâre absolutely right. The guidance does move down slightly but still a healthy growth rate. If you look at what we said, we expect Services to grow at or slightly below 10% so a healthy growth rate. And in terms of why we changed our overall guidance including Services, quite frankly it was the low Q1 number. If you look at Q1 number, we would, 2.05 billion, Services was 540 million. It was down 9% sequentially and so when we looked at the overall picture, looked the at the elements of the pictures, we thought it was prudent to, based on everything we currently see for the remainder of the fiscal year, to make the revisions that we made to our guidance statements including the Services guidance. And I would just add for Richard and everyone, it obviously does not, itâs not intended to imply that we are not aggressively pursuing opportunities to do better than that obviously. But I think Frankâs answer is right on and he will now have the opportunity in his new role to go execute against all of this and I have every expectation he will. Thanks John. Despite the decline in revenue in the first quarter, we are confident that our performance will be much stronger for the remainder of the year. We expect annual revenues for fiscal â06 on a percentage basis to be essentially flat will increase in the low single digits for the year. Revenues in the second half of the fiscal year are expected to be significantly higher than the first half of the year. We achieve the gross margin rate of 42% for the first quarter and we continue to expect to achieve an annual gross margin rate of 41% to 43%. Our quarterly gross margin rate maybe saw such quarterly fluctuation towards the potential positive or negative impact changes its sales volume levels, products services and geographic mix and competitive pricing pressures and our ability to continue to realize cost reduction. We continue to highly mange expenses including the 278 Winstar charge recorded in the first quarter. We now expect annual operating expenses as a percentage of revenues to be about 33%. And thatâs always our focus remains on continually improving performance and creating shareholder value. Thanks for your time and interest today. And thanks to all of you for listening in with us this morning. As always if you have follow up question, please un-hesitate call any member of the Lucent Investor Relations team. Have a good day. Ladies and Gentlemen, this conference will be available for replay, starting today at 12.00 PM and running through midnight on January 31. You may access the replay by dialing 1-800-642-1687, international participants may dial 1-706-645-9291, the access code is 3057136. Thatâs concludes your conference for today thank you for your participation. |
EarningCall_234073 | Good afternoon. I'm Don Flick, the Director of Investor Relations at Eastman Kodak. I'd like to welcome you all to our meeting here this afternoon and I would also like to extend a greeting to those who are joining us via our webcast and teleconference. And as per my custom I would take this moment to invite you all to take your cell phones and other electronic devices and either turn them off or set them on mute if you wouldn't mind. And then just a few housekeeping details to dispense with. Of course, we are making forward-looking statements in the course of today's meeting and these are subject to important risk factors. These are detailed on the Safe Harbor statement that's included in your handout package and of course in the webcast that's being put out today. And in the same sense we also use some non-GAAP metrics in the course of the conversation. Because these are important metrics by which management operates the business, but in each and every case the non-GAAP metric is reconciled to its closest GAAP equivalent and that's done both in the material attached at the end of the presentation deck today and on the website for those of you who are following via the webcast this morning. So now, I would like to introduce Antonio Perez, Kodak's Chairman and CEO. Thank you, Don, and good morning. So I will introduce the meeting and give you my thoughts about 2005. I will get Bob Brust here and we will go through the results of the Q4 and the full year and then as well our forecast, our outlook for 2006. I'll come back and I'll give you my own perspective about next year and then we will go into Q&A. Now, if you look at the overall company in 2005, you look at the results and you look at the positioning of the Company, by any measure that I can find, 2005 was an extraordinary year for Kodak and in my view we make phenomenal progress in our transition. I'm especially pleased with the last four months of the year. The last four months of the year was crucial for several reasons. Among them represented 40% of our digital revenue and more than 100% of our digital earnings and the Company deliver on those. In going further than that, for me the Q4 was the most significant of the four quarters of the year because the Q4 is the first time that I have been able to have the structure in the company and the management team the way it is going to be run in 2006. We had GCG completed, we had the new restructure of the consumer groups into digital and traditional and we have recovered from some of the issues that we had in health at the beginning of the year. So that is the Company that we going to run in 2006 and the fourth quarter was an excellent quarter, a phenomenal quarter in any sense, and that is the Company that we going to run in 2006. And it was excellent both in digital revenue as well as in digital earnings. So in fact in the fourth quarter we grew ourselves in digital by 45% versus last year. Our digital earnings were $161 million. They compare on the same terms with 63 million the year before. A very significant increase. And we exceeded our cash goal. On top of that, we completed the acquisition of GCG and it was very well received by the market. I had a test of that by talking to customers. Obviously about as well, looking at the orders that we got in the fourth quarter. It was a difficult year for the health group and I will talk about this morning in a minute but the second part of the year was much better in the digital side of the business than the first half. In Q4, was another good recovery from the bad first and second quarter that we had in health. In fact, when you look at the digital earnings of the health group, the second half of the year was 22% higher than the first half of the year. Then I'll talk more about that in a minute. Now for the consumer groups we had for the digital part of our consumer business we had an incredible Christmas. And every single category where we are participating I will give you numbers later. In the consumer, traditional business is finally is running the managed per cash business to perfection. I'm very proud of that team. It's very hard to manage a business that's in decline. They doing a superb job dealing with the risk structuring and at the same time managing that valuable business for cash. Overall the whole company, if you look at this company today and you look at this company a year ago, the operational discipline of the Company has changed dramatically. When you look through the numbers, the basic operations of this company and you look at the way we managed inventory, we managed account receivables you will see that it is a phenomenal difference from last year and then obviously the cash performance was excellent and as you know that was the first goal, the most important goal we had for the year. So if that was the quarter, for the year for me 2005 was a pivotal year and actually a year that marks an inflection in our transition. Not only this is the first year in the history of the Company when you take the whole year that the digital revenue was larger than the traditional revenue, but we have positioned the Company for very strong success in 2006, and I will make my case for that during the next slides. Starting right now. We have a group of $3 billion in GCG that we didn't have a year ago and this group is going to return immediate and sustainable profit growth from now on. They already performed very well in the fourth quarter and you will see them performing very well during next year, starting in the first quarter slowly and getting later in the year with very high performance. We achieved a critical mass, a market power, a market position in the key categories of our consumer business. Let me give you numbers. The digital cameras grew 30% in a year where the industry was slowing down so we grew a lot of market share. We don't have the numbers but I'm sure we grew share. The home printers we grew 57% year-over-year. Within that 57%, the print docks actually grew 92 or 95%, I'm not sure about the number. I think it's 95%. Kiosk continue with a growth, 37% year-over-year and the Kodak Gallery grew 45% in revenue year-over-year. For me what this means is that installed base of the whole system grew very significantly this year and for me this means money. Money coming to us soon. Because the more Kodak digital cameras you have in the market, the more files that you have that will end up being printed in a larger number of printers in a larger number of Kiosks that we have all over the world. And the more cameras we have in the installed base, the more subscribers we are going to have to our Kodak gallery. The more cameras we have, the more CMOS sensors we are going to sell, so on and so forth. We look at this as a system and I think the system has reached a critical mass that is going to set us in a great position to be profitable for the first time this year. The consumer digital group which has been losing money in this company up until now will start 2006 as the first year where they are going to be making money and this is exponential. Now obviously I'm not happy with the results of the health group. So let me take you through that. First of all, our digital, our operational digital earnings in fact that would have achieved the goal that we had at the beginning of the year if it wasn't for the bad year we had in health, in the year it started badly in the first quarter, you probably remember we have some quality issues with CR. We've solved those issues in the second quarter and then we recover in the third and the fourth. But this is a very important P&L. We have very high margins with CR. And that very bad three, four, five months set us back for the year. DR, which we introduced in the fourth quarter had excellent results but in the fourth quarter and as you remember, too, probably, I did say that we were late for about three months introducing DR, and that as well did not help us. Then on top of that, HCIS, HCIS started out slowly. We had a very bad six months as you probably recall. We took action and we had actually a very strong second half of the year, but the combination of those three P&Ls not doing what we were hoping for them to do didn't allow us to compensate for the decline and the DryView laser printer business, which declined as expected and is part of our digital revenues and profits. Now when you look at end of the year you will see that actually digital capture which is a combination of CR and DR actually ended up doing relatively well for the year. They grew 15%, which is excellent but it wasn't as good as we had it planned for the year. And HCIS was a very strong performance in the latter part of the year, actually grew 39% as well they recovered somehow but it was not the plan that we had in mind when we started the year. Now the action that we took after the, in the middle of the second quarter was look at the root cause of what happened in the health group, we decided to reorganize the group and organize the group in verticals the way it has been working in the fourth quarter with the intention of giving more responsibility to the right people and as well increase the visibility of this issue so they can be dealt with earlier. One of the problems we had is that it took us too long to react to those things. Now moving to the direction of business, the managed for cash business model, as I said before, is starting to work beautifully well now. It took us a while to organize that, this was a company that was not managing like that for many years for obviously very good reasons and it took us time to organize the team and put the processes in place so worldwide we can take advantage of a very valuable business that is in decline, but if it is managed, the way it's been managed in the last six months of this year will still produce a lot of cash for us in the years to come which is the objective that we have. And in fact, halfway through the year we decided to spend $140 million more in restructuring, more than we had planned at the beginning of the year because we saw the possibilities that we had in cash generation for the year. We thought that we could cover out that 140 more than the plan and still beat the number that we had for the year. Bob will take you through these numbers later. Which bring me to the liquidity question. We closed our debt agreements as you know and we build up a very strong cash position for the year. Stronger than we actually had in plan for the year. So for me overall this is an excellent year. I think it's an excellent year for the Company and especially because what we have done in the second half and in the fourth quarter which gives me a lot of confidence for 2006. So the results are there. First half soft, second half strong. The summary is we build a very strong digital company, large at this point of time. That has the size and the structure and the market position to be ready to exploit the digital business model including everything, including our instruments, including our services, including our consumables, to increase the operating margins starting this year, which is going to be the topic of the second part of my presentation after you listen to Bob. Bob? Thank you, Antonio. And good to see everybody again and thanks for coming and we will try to run by, a little discussion on the metrics for this year, talk a little bit about the '05 results, a little more color on it and the '06 plan, and some key messages. Early this time last year we said we were going to go and concentrate on three metrics, digital revenue growth, digital earnings, and cash and we still think they are the right things to focus on as we go through maybe another four to six quarters with heavy restructuring going on in the Company and very hard to get clean results because of all of this restructuring and valuation allowances and all the stuff you heard about this year from us. We did have some good progress last year in '05. We will talk about that and we are off with good momentum in '06. In the middle of the year, we accelerated the transformation and the restructuring of the Company and we discontinued guidance and we said we were going to a GAAP only basis which we will only be reporting GAAP measures going forward. But in '05 we had some of both and our objectives were based on operationally and ended up on GAAP so I'm going to try to transit that for you as we go through '05 and then in '06 we will just be talking about GAAP. So last year we said we would, digital revenue growth the target was 36% growth. EFO on an operating basis was 275 to 325 and we were going to try to get investable cash flow of 4 to $600 million. Remember, this investable cash flow we, our cash flow, our earnings, and our restructuring cash outflow are not too far apart. We have to work a lot of ways to get cash flow into the Company. On a revenue basis, digital revenue, it grew 40% through the year. For the year the old DFIS business, which has since been split grew about 29% and that was driven by digital capture, home printing, and Kiosk. Our GCG business was up 131% and that obviously was driven by the acquisitions of Creo and the consolidation of KPG the first of April and Creo June 13. And our health business as Antonio said was, did not have a great year. Had a pretty sharp decline in digital output. Just barely offset by our IT business, digital capture, and services. The earnings goal for the year, we had a midpoint of 300 million in the 257 and 325. We ended up about 202 on that basis off about 100 million. Virtually all in health. As Antonio said, we reported a GAAP number of 118 and to get from the 202 to 118 are some one timer that normally wouldn't be in operating income. Purchase accounting for both Creo and KPG, the in-process R&D write-offs, we had some allocation changes as you brought those companies into the Company and the asset we shortened the asset useful lives to in the second two quarters of the year as you know. So on that same kind of basis we missed it by about $100 million and again, that was all in health. Cash we started out the year saying 4 to 600 million of investable cash. When we met you in September we knew we were going to spend 140, 150 million more in restructuring and we also knew there was a little bit of pressure on earnings and so we lowered that number from 4 to 600 million to 450. We said in there was a couple 2 or $300 million from sales of properties and IP and stuff, and all of that happened and the other thing was everything happened well. It's one of those, the old, for you older folks, the old A team, it's great to see a plan come together but virtually everything worked. And so our goal was to take inventories down 500 million, we took them down 510 million. Receivables, bringing all these companies in we beat that by $85 million. We constrained our restructuring by about 25 instead of 625 it was 600 and we didn't delay stuff, we just made it more efficient. We sold more real estate than we thought by $20 million as we restructure the traditional businesses. It's for sale. We don't need those assets, we will sell them as quickly as we can. We did accelerate our depreciation by shortening useful lives. We did spend a little more on CapEx than we thought. When we got comfortable with this there was a couple of projects that we put in that was mostly equipment for revenue this year. So we let that go and then we had about ten other things that was in the other category so we ended up with 728 million, which I thought was pretty good. Another way of looking at this, the Company covered restructuring, if you take the restructuring back out we really only would have generated about $1.3 billion of cash, pay 600 million for the restructuring and end up with 728. The Company my conclusion is good access to liquidity. It's important for a noninvestment grade company, we can't get commercial paper now and with the high seasonality of the Company, this is a very back end loaded company, being a digital company and we will talk about that a little bit more again, in the earning's. We needed good liquidity so we started this year with a cash balance of $1.7 billion on the books. We have a $1 billion undrawn line of credit that we negotiated in the fall. And we have a $500 million delayed draw option which expires June 15, which we're not going to use now because of the good cash balances, because we are planning to draw down debt this year and we have some small lines of credit around the world that are uncommitted. So we're in good shape liquidity-wise. I keep pushing these buttons the wrong way. If you look at the whole year, our revenue grew from $13.5 billion to $14.3 billion, which was 6%. In 20004 our digital businesses grew 39%. We had some acquisitions back then. Heidelberg, we had NexPress and we had Versamark. This year we grew 40%. Digital business is now 54% of the Company last year and will be much higher this year. Our traditional business declined 11% in '04, declined 18% in '05, and it continues to rapidly shrink, it is now 46% of the Company. Almost 40% of where revenue occurred in the last four months as Antonio said we have become very back end loaded and the revenues did grow about 6%. In the fourth quarter report you read this morning revenues were about $4.2 billion, up 12%. There is a big gap now as we go through this restructuring, a lot of the, all of the depreciation, accelerated depreciation and asset write-up, a lot of it ends up in COGS, in GAAP and gross profit. So we had a 2% drop in gross profit. Part of that is selling more digital equipment, which has lower margins than the film it's replacing but a lot of it is the accelerated depreciation and asset write-offs. The low EFO was worse, last year in '04 we booked the Sun settlement which was 92 million positive and that's most of the 105 that we dropped there and so EPS was about flat both years. The restructuring was a little less in the fourth quarter, that varies by quarter. For the year it was about $1.1 billion. The total year was up about 6%, we just went through that, $14.3 billion. Again, gross profit was off sharply. We booked 1.1 billion in restructuring and about 700 million shows here and the rest of it is up in there and that's why that's off so much. We had a big loss last year and we will talk about that in a minute of $4.76. And that all occurred in the third quarter. It was a $1 billion valuation write-off that you all saw us do in the third quarter. And it was evaluating the deferred taxes that's down, they're not gone, we just put a valuation allowance. So we ended up about $0.50 off the first two quarters, $0.20 negative here and it was a big thing from that valuation allowance. Probably, that won't reoccur this year we hope. But as we go through this restructuring that's part of the volatility of all this heavy restructuring. That is the restructuring totals. We spent 900 million in 2004. 1.1 billion in 2005. I know a lot of your models we said it would be about 3 billion for the period but it's going to be higher than that. I would expect 1.2, 1.3 billion this year of restructuring as we keep understanding more and more what we are doing as we move ahead in this. The cash payments last year was 460 million and was exactly 600 million in '05. I'm expecting around 650 this year for cash payments for restructuring. Last year at this time I remember leaning against the podium over there and talking about we were going to have to report two material weaknesses, I think we were one of the first major companies to report that and then during this summer we had an error anda restructuring over in the U.K. which was because of the very low materiality we now have because we are not earning much money, was another material weakness. We are in the process of remediating all of those. There is no indication right now that those remediation plans aren't on track. We won't know the final outcome until February, late in February and we will put the results of that in our 10-K but right now the plan seem to be on track. Going to 2006, the transformation is going to continue to progress. We have a lot of work to do this year. I would say there's four to six heavy quarters that are going on this thing. And we will show you a little bit about that in a few minutes. During, when we were here in September we told you we are changing the DFIS business and splitting between the consumer digital and the traditional and Antonio talked about that and we will show you that in a minute. We decided to discontinue accounting for LIFO. Some of you younger folks might not realize when that was put in years and years ago and the inflation thing and becoming more and more meaningless for Kodak. Many of our new businesses are not on LIFO and as we shrink the old manufacturing business, LIFO is not material so we are discontinuing that as of '06. And we, the new subsidiaries we purchased last year, Creo and KPG we now put those into the parent company and so they are picking up more of the corporate allocation and that will lower the digital earnings as reported as we do a pro forma going forward. The new segment structure, FPG is our film and photo finishing group and that has all those old traditional consumer businesses in it, entertainment imaging, aerial imaging, consumer output, pro output, and film, and photo processing. PDG is the new consumer digital business. Digital capture, home printing, HS systems, sensor solutions, the gallery, and our Kiosk businesses is all in that business. The health business hasn't changed. That's kind of virtually unchanged from where we used to report it and GCG now is all, that's the conglomeration of the acquisitions now as Antonio said in the fourth quarter this whole business is up and operating. This is how we are going to report operations starting in April as we move through and we will report digital earnings on these segments beginning with the first quarter. Again, we have to go through the pro forma accounting. The 118 of digital earnings that we ended the year with, we add a little bit for the structural changes. LIFO goes away which is recast through operations for several years and that takes 12 million out. And then our digital earnings will be hurt by 27 million because we will pick up more of the Corporates assesses so that just increases traditional earnings, no change for the Company. So as we look at the 2006 plan. This our key measurement, we expect revenue to increase by 16 to 22% over this year and we will show you that by little segments in a minute. Digital earnings 350 to 450. Consider that thing as several things going on in here. In the 86 we talked about we absorbed a lot of things that won't recur this year. A lot of the things in consolidating GCG. In GCG they are working on 70 or $80 million of integration savings this year, which helped that. We will talk about the growth in the different segments in a minute. In investable cash flow. Again, a target of 4 to $600 million. This year looks very much like last year did. Our earnings will be by and large taken up by the restructuring cash outflows. So we will be working hard on the, much the same things we did this year and we think we can get 4 to 600 million in investable cash flow. This should be the last year of that. Next year the restructuring should be beyond the decline and the earnings should be going up. Again, we have a small change with our structural changes in digital revenue. We recorded 7.7 on a pro forma basis it would go back to 7.4. So as we look at the segments '05 to '06, our consumer digital business we're forecasting a growth of 16 to 17% and our health group 9 to 11% as the IT work and the digital, and the DR start to offset some of the decline and DO and GCG still getting helped by the acquisition, a very strong 28 to 30% growth this year. One of the things that is becoming apparent as we put this digital company together is it's very seasonal. It's very back end loaded. And last year as you look at our earnings, our digital earnings on a GAAP basis were 118, 161 of that was earned in the fourth quarter. So we are back loaded. And it's heavily the consumer digital business, the last four months of the year, September to December, is where a lot of that output goes, it's Christmas oriented, holiday oriented and that probably won't change much. Our health business is more or less distributed a little bit back end loaded but more or less flattish during the year first half, second half. And our graphic communications business, which is rapidly becoming a big part of the Company is also back end loaded. Things like scanners and stuff like that tend to go out at the end of the year, plus they're doing all of their integration this year now that they have those businesses all together and there is $80 million of integration savings we think are going to occur this year and they will grow as the year goes on. So we are going to have another, I think year not quite as back end loaded as last year because the acquisitions are here, but it's going to be heavily back end loaded. So you should look for that same kind of thing, a very slow start and a very strong finish as we move through this year. This is the consumer digital, the consumer digital imaging group. The EFO this year on a pro forma basis still had a loss in it. Pretty good loss and we expect it to become profitable on a full year basis on GAAP, we think there is going to be very strong leveraging of the cost structure, the platforms, we're going to continue to go after royalties and the infrastructure as we find the go to market models and that business now has the scale and the size to start getting some real cost reduction out of platforms and infrastructure. We had a lot of, we should get much more of the media, paper and stuff like that because the output was strong. Sold a lot kiosks and printers and stuff this year. So this growth is about half of our EF growth, not quite, but about half of the EF growth. From '05 to '06. The health group, Antonio talked about that. We had a large decline in our digital output business. HCIS got very strong near the end of the year. It was much later than we envisioned. We thought it would be much more helpful last year but it looks like it's going to be in much better shape this year and our digital capture margins are improving. That's a very, very modest improvement. The downturn should be arrested and we are expecting a very modest improvement here. Most of the rest of the improvement is GCG. The integration is going well. Everything we see that's a very big success. If you were here in September you remember Jeff Jacobson got up and talked about the integration he is in charge of that, the 70 to 80 million. That looks like that's in very good shape. So we expect a strong performance from this group during this year and about half of that earnings growth comes out of GCG. Little bit on cost, we have been doing a lot of this manufacturing downsizing in the traditional business. It's going to be a big year this year, but most of that should be done in '07. We are working that down. In September I told you about a 3 or $4 billion business we think that will be kind of stable for a few years. In that stable business would be entertainment imaging, x-ray films for health imaging, and color paper. And some films, regular films that are left over. But we were pulling that infrastructure down under $1 billion asset value and that's where we are heading toward, to be able to approve this kind of a product which we think will be stable for a few years and when it goes away we will continue to downsize that. But that's where we were aiming. Each of the businesses now is doing a segment go to market models. We had this big huge go to market model for the old traditional business and now we are customizing that for consumer digital, for GCG, and all of these other businesses and that's going to be complete by the end of this year and we will take out SG&A costs as we get that finished and you will see the full impact of that next year. We continue to work on our corporate cost. We have been pulling those down. We are going to wrap that corporate service part around it, whatever those four businesses end up on their segment. And that should be completed by the middle of next year. So when we look at our SG&A costs, they were 18.6% last year. We think they will go down by 1 to 2 points the next few years as we move toward our ultimate digital model that we showed you before. I would say about a percentage will come out this year and that will accelerate as we go forward and continue to do those things which I talked about up there. Investable cash. Again, I think coming into this year feels much like coming into last year. Got a lot of work to do. We do have the opportunity in working capital still. We took $500 million out of inventory last year and it's got to be at least 2 or 300 million more or maybe more than that we can get this year. Our receivable. We brought in some components that are not as efficient at receivable collections as we are, have higher past dues. We got some of that in the last part of last year, we should be able to get some pretty good work out of the receivables. We will be monetizing assets. As soon as we restructure something it becomes available and is ready to sell, we will sell it. Any assets we do not need will be monetized. Those end up being pluses and minuses on the income statement but it's cash we are after. So even if it's going to take a loss to sell it, we will sell it to get the cash. We will just book the lost. Restructuring this year around $615 million on the cash. About a 1.2 billion or 1.3 billion in total and the rest being non-cash items. We watch that very carefully. We look at that every week and we make sure that we are not spending $1 inefficiently on that large number. We are going to start pulling debt down this year. Our plan is, I will show you a debt schedule in a minute. To reduce debt by about $800 million and become a, draw that back down as our financial health continues to improve. We have no significant acquisitions are planned obviously and there's no change in our dividend policy. This is our debt repayment schedule. We have $819 million of debt due this year. It's our intention to pay that. And then after we get through this year the debt certainly is not a burden and we may accelerate repaying that depending on our future financial condition. But in '07, there is virtually nothing, $7 million and then there is a little bit in '08. And so we just get through this year, our debt is in good shape and again, we may try to pull some of that forward. We started this year with a 1.7 billion in cash. It's actually 1.665 billion. We are going to try to generate investable cash of about 500 million this year. We are going to repay debt of about 800 million and so I would have guessed the cash balance at the end of this year somewhere between 1.3 billion and 1.5 billion. Our goal is to keep that cash balance above $1 billion. Well, we don't have access to commercial paper to go through the seasonality of the business. As you know, when we negotiated the new lines of credit and new debt in October, we were put under covenants for the first time because we are not investment grade and a lot of people were worried about how we were doing in those covenants at the end of the year. One covenant is debt to EBITDA and we had to have, it had to be less than 475 and it ended up 280. So way below the covenant there and the other covenant is EBITDA to interest which had to be greater than 3 and it ends up being 640. So we will watch this closely. We will watch this every month. We will make absolutely sure we aren't getting close to violating those covenants. But as you can see there is adequate headroom under those and we don't look at that as any big danger and we'll continue to report to you how we are doing on that. Some other things on looking ahead below EFO, interest costs will go up this year. We have higher debt. If we repay it down because of our noninvestment grade we have little bit higher interest rate so interest costs will go up. As we monetize and sell the assets, it's hard to determine when this is going to happen. Because they have a for sale sign on them and two, whether we're going to get a gain or a loss. Again, we are only after the cash there, below EFO, we are going to record whether it's a gain or a loss and we will just tell you what that is every quarter. Tax rate. With everything that's going on in the Company with all of this restructuring, tax rate is almost impossible to calculate. With the valuation allowance last year. Our GAAP effective tax rate was minus 92% last year. So we are going to have something like that this year and it's, we will keep telling you every quarter as we go through what it is but it is not meaningful to forecast it because we can't get all this restructuring exactly lined up how it's going to happen. So kind of the key messages from me is much of the transition will be complete this year. We will really be close to the end, maybe a quarter or two more. And we will have this thing pretty well stabilized. The EFO growth from digital is accelerating and at 400 million is starting to become a sizable number. As you go into '07 and restructuring starts to fall away we can now generate cash the old fashioned way by those earnings. Our cash position should be stable. It is stable. I don't see a changing much between now and the end of the year. Even if paying off $800 million of debt and the debt reduction will begin now and we hope to be long term debt repayers than incurring any more debt. So that's all I had to say on this thing. I'm going to turn it back over to Antonio. Thank you, Bob. So I'm assuming that we have some credibility as far as cash generation and probably significant credibility, I hope in digital revenue growth. So I'm going to spend most of the time in this part of the presentation talking about digital earnings and why we put that number on that chart of 350 to 450. First of all, the focus is moving for very good reasons and I will take you through that through our logic, and through our rationale. From share of market to share of profit, when we say that we want to be number one and number two in any particular market, we want to be number one or number two of the share of profit that we can extract from that segment. Not necessarily only share of market in units. This is the purpose. Now, of course, you cannot get to a share of profit without a decent share of market as far as units is concerned. And because of that, during the first two years of this four year transformation, the goals were set in that particular order. Number one was cash. Most important theme for this transition as you can imagine with all of these payments, all these expenses that we have to go through, through the transformation. Number two was to building, build a digital business of enough size. And we did have to sacrifice in many cases the earnings in order to get the size and the market share that we needed to get. Now we have built a very significant business now in the digital business. I took you through the growth during last year and the year before. Now what's going to happen in the second two years is first are going to grow out the cash the same way. Cash continues to be the number one, it's the most important thing during this transition. Probably ever anyway, but certainly in this transition we will continue to do that and we know how to do that. The second we are going to subordinate digital revenue growth to digital earnings growth. Don't get me wrong. We are still going to go for a growth of 16 to 22% in revenue growth and this is the opportunity to go for earnings growth. Let me take you through the case. The size of the digital business influences tremendously your ability to generate earnings with that business. Let me give you example. The size of DCG helps to drive not only revenue but it helps to lower the cost of the business. The R&D investment which is large. This leverage is across a lot of businesses. And that larger cost per dollar of sales. Your influence with your customers is a lot better, your influence with your suppliers is a lot better. You can get better deals with your suppliers, you can get better deals with your customers, with your distributors, with your partners. A good example, I talked to you about the revenue growth successes that we had both in some cases in health, digital capture and HCIS as well as the consumer digital group. Let me give you some examples on GCG. NexPress grew this year 82% in revenue. Better than we thought. I can assure you the sum of that was because of the synergy created and the influence that we have obtained by building this big organization called GCG. In fact, because of that growth, 82% we expect a lot of consumables coming from that business next year and because of that last number of consumables that was more than we expected in the past we are actually planning to end up the year with a round rate of breaking even, or of positive for the business which is earlier than we ever thought when we bought the Company. A lot of that has happened because of the influence of a larger, more powerful, more compelling, organization called GCG. Same thing in the consumer business except that even bigger. I took you before through some of the effects in our P&L of having a large number of cameras out there. And I get this question from you very often. Why are you in the digital camera business? That's not a good business. Nobody makes money on that business. I get that question often. First of all we are not in the digital camera business. We are in the digital capture business. The way we define that business is that includes our CMOS sensors. This an initiative we started two years ago. We came with the first two sensors a few months ago. We are right at the beginning of that business. Includes CMOS sensors, includes image science. Includes royalties from our IP deals and includes digital cameras and all the devices that will become digital capture devices. You have to put all those things together to look at the, at our ability to make money with the digital capture business. By the way, the investment in R&D that we've done in the last 50 years affects each one of those elements. You can't really separate those. The same IP that goes into image science is supplied to the CMOS sensors, is supplied to the IP royalties, is applied to the digital cameras, et cetera, et cetera. And again, I am going to go back to the same notion that I told you before. The number of cameras in the market share of cameras and the shelf space that we have helps with a lot of things. First, with the number of CMOS sensors that we are going to sell into our own cameras. And that we are planning to sell to any of the cameras that are interested in buying good CMOS sensors that we are going to produce. Of course, because we produce digital sensors to our own cameras which is a large number of cameras is going to allow us to create a low cost image sensor that then we can sell into many other devices such as the cell phones and that is why we are in interrupting the deal with Motorola which we are going to try to supply to them for ten years to come with a lot of CMOS sensors. You have to link all those things together. Royalties. Because we have a large number of cameras out there a ability to negotiate IP deals is much stronger than it would be if we wouldn't have any camera in the market. So on and so forth. So when you look at all, then something else. When you have a large business in cameras, which we didn't have few years ago, three or four years ago, at that time we used to design product. That's all you can do. You only going to sell so few so you have to design product. Last year we had been working and I talked to you about this two years ago. We've been starting to design platforms. If you look into our cameras today you will find that some of the key elements of the camera, long lived components, the expensive components they becoming similar in a large number of cameras. That allows us to get a better price for those components, to lower the risk of that inventory, to lower the risk of distribution. And by the way, because they are designed in platforms allows you to come with products a lot faster with hardly any cost. With very little cost. All of that comes from the fact that we have been able to create a large digital business. In many ways time to volume here is time to money. You have to get to that point to be able to exploit the business case. To the point when you combine all of these elements, both in GCG and in the consumer business, they are going to give us two things. One, a great improvement in earnings GCG from year to year which is very obvious. We didn't have the $3 billion business last year and this way it would allow us to go positive in earnings for the first time for the Company in the consumer business next year. Another way to look at it, is where are you going to get those earnings from? What part of the P&L is going to show improvement? Actually it is going to be about 1 point or a little more than 1 point on each one of the three lines. First the gross profit. We are going to move from 28 to 29. Somewhere around 29. Why? This is a mix issue. We have more revenue coming from commercial products that have higher gross margins. They are going to help us with that move. At the same time we have created a lot of consumable business by selling a lot of printers, a lot of presses. More consumables means higher margins, too. The combination of those two things and a little selectivity in how much you go for growth in consumer digital is going to move us at least that 1 point to a 1.5 point there after. The R&D, we know the chance of the number in R&D will be around the $900 million. But because the revenue has grown so fast, obviously as a percentage of revenue will be going down. In the SEMA, we have now some upward pressure because we have included in the Company companies such as KPG and Creo that come with higher SG&A percentage but we are working in those synergy. Bob mentioned some of those and as well we will have our own problems with the rest of the Company. By the way, year to year without acquisitions our SG&A went down by 8% year to year. We will keep working in AGA reductions and more productivity from our people and reducing the cost of our corporate center that Bob mentioned. A combination of those three will get us going from 1, 1.5 to 4 to 5 EFO as a percentage of revenue. Another way to look at this is where are you going to get the money from? We are going to have, we used to have not very long ago only one business that was making money in digital with digital revenue. That was the health group. This year for the first time we are going to have three businesses that are going to contribute to digital earnings. Let's go through each one of them once more. Graphic communications is a $3 billion business. We can argue how much we are going to make out of this and it is going to be different, the beginning of the year to the end of the year. But we should aim at having at least a 4% year for us, a percentage of revenue for the business. Lower at the beginning, then getting percentages and the volumes higher at the end of the year. It very much will then actually lower than the industry we should be able to get that. And in order to get that, don't forget that we have 70 to $85 million in integration savings that will help to get that number. I'm not saying that the integration is already done. I know that we have work to do with our integration still. You don't put six companies together in six months. We understand that. We have work to do with systems and people and processes. But things are going very well. And the least we can expect from this business is to go around those numbers. So that will be one of the key components of this 350 to 450. Don't forget either that the NexPress installed base has grown significantly last year. That means a lot more consumables, that is going to help with that. In this case, the prepress consumables are moving rapidly from monologue to digital. Guess what, in this case the margins in prepress consumables in digitals are higher. I am going to say it again. Are higher than the margins in the old analog business so that is helping this business, too. And then Versamark continues to grow, they grew 18%. They are going to have more media and more ink that we will be selling this year. The combination of those three things, those four things allow us to put this forecast with a significant year-over-year digital earnings growth. Obviously, it will be very significant because we didn't have the business last year. But nonetheless it will be a key part of that 350 to $400 million to $450 million that Bob put on the chart. Now the health group. We are going to forecast essentially flat year-over-year earnings. Slightly vary digital earnings but flat overall, about flat. Why? Because we need to continue to invest in digital. We made, I told you before that the second half of the year went well for us in digital. We recovered somehow most of the losses, if not all that we had in the first half. We have a better plan, better people, better prospects both for digital capture, CR, especially for DR which has been very successful and a much better success with the implementation of installation of HCIS. But as well, we are going to work and the cost of digital and dental we have a great business there. We haven't been paying enough attention to the cost. We are going to work on cost. The combination of all those things will give us a good compensating effect for the fact that x-ray will continue to go down very much as planned. And DO the DryView place of business will continue with, to go down as planned. So overall, year-over-year similar. Slightly better in digital earnings from year to year which should not be that difficult given the bad beginning of the year that we had in 2005. Then finally the consumer digital imaging group. I don't want to repeat myself here very much but we were planning a substantial year-over-year earning. This is one of those business that it is exponential. That there is a point in which your COGS start to reduce significantly because of the volumes and the platforms and the deals that you are making. The number of consumer, the revenue that comes from consumables increases enough to compensate for the lower margin of your hard work. And then together with that, your cost in inventory goes down, your distribution goes down. The whole system gets much more effective and this is the plan that we have for the year. Together with that, we are going to see the beginning of the CMOS business. The CMOS, we have a lot of faith in that business. Phenomenal technology, phenomenal IP, and as you know a ten year deal and hopefully many others that will come and that business basically is time to volume. So semiconductor business is bank to volume. When you think about digital sensors, don't think about just the semiconductor. Our plan obviously is to include a very valuable technology that we have in image science that will be obviously embedded in those semiconductors. Not only the value in the IP and the know how of the software but as well our brand will be very valuable to sell that. So strong focus in expanding our earnings. Our operating earnings based on all these ratios that I gave you, we think this is the right time. This is the right size of the Company, the right moment to do that. We have the basis to be able to do this. We will continue to restructure the Company as fast as we can. We are going to finish with this by 2007. And we are going to continue to manage for cash the traditional business as we have been doing in the last year and a half. And we will continue to do extreme effort in reducing the cost of the Company to get to the target model that we want and that will be working in SG&A and working in the Corporate center costs. In my summary, as we've come a very long way in a very short time and a very difficult transformation. We have proven the ability to succeed in digital markets. And I will say that market share shows that, digital earning improvements as showed by Bob, show that. Our customer satisfaction rating shows that. JD Power's awards. Innovation awards. CES awards. And our brand and our IP finally have been recognized in this industry. Significantly and has allowed us to make very significant partnerships. IBM, Motorola, and more to come. Those partnerships are fundamental for us. And the digital business model do have to partner to give the total solution. You can't do that by yourself like we used to do in the past in our old business. It's fundamental that we establish those relationships. They are coming along and they are coming along very powerfully and they are not a one shot deal. Those are long time relationships with a lot of very good implications for us in the bottom line and in the top line. And finally the strong momentum that we had in Q4. As I described to you the last four months, specifically the last quarter when I felt that I had the Company just the way it was going to be run in 2006 gives me a lot of confidence for the 2006. Thank you very much. We are going to go now to questions. If we could bring the house lights up as far high as we can. Okay, and as for the normal course, as I recognize you and you get the microphone, if you'd please take and state your name and the name of your business that would be great. We'll start with Matt Troy. Thanks, Don. Antonio, wanted to drill down to one of the bright spots of the quarter, the graphics communications groups results certainly ahead of my expectations. As I understood it, fourth quarter you were going to ramp up in terms of product rationalization also in terms of sales force integration. As we look forward to 2006, what are the one or two key metrics you are looking at to monitor progress in that business and integration, what should we be looking for in terms of roadmap? And a follow-up. I guess three things, although you probably few more, but I will be looking first of all to get the 70 to 85, hopefully $100 million in cost synergies. Those synergies, we have to get them early or you don't get them. There is a way which the organization, they kind of settle. So it's critical that we get there, we get them this year. We did a good job in the first four months of the year. We got more than we thought we were going to get. I expect, my desire will be to do the same and overperform that number, that's number one. I think the second is look for the synergies in revenue, too. We haven't talked much about synergies in revenue. We had mentioned a few things now. I've seen some of that. I didn't expect to grow NexPress by 82% year-over-year. I mean, this is magnificent. It's really phenomenal. And it's the fact that it's going to get, that's going to give us a lot of consumables next year. So now my goal will be to be break even or better soon during the year with NexPress which will be a great help. And then finally we have very ambitious plans for new technologies that we had in Kodak and they have to go through GCG. I will be looking at Jim Langley and ask him to expedite the transition of that technology from the labs into the products. The follow-up then is on the consumer side and I hate to focus on one product in such a large company with so many moving parts and pieces but it does come up in terms of investor conversations and interest and that's the ink jet strategy. I was wondering, on the consumer side could you just give us an update. You had originally talked about back to school special, finish line and then also with HP soon to put their skin in the game in terms of an ink jet strategy at retail, is there an opportunity potentially for Kodak to use that technology and put it into that distribution channel? Thanks. We have a great ink jet strategy. We do have, we understand who we are going to be competing with. We haven't changed any plans of what we have said before. We are trying to disclose what we are going to do as late as possible, simply because we think it's better for us. We have several options on how we are going to go about it. We still have several options that we can do and we will pick the one that we think is better for us at the right time. We understand the business very well and we think it's a great opportunity and I'm sorry to be dancing around the topic but it doesn't help me if you knew more than you should. Hi, Shannon Cross. Curious on the royalty payments and your strategies on that going forward. It looks like there is 60 millionish based on what Motorola said in the quarter. Curious if there were other cell phone providers? Where you stand with Nokia? How we should think about timing on that? And then also, with the success of the royalty in this quarter, what your thoughts with regard to maybe just licensing your inkjet IP as opposed to actually manufacturing it yourselves. Second part of the questions wouldn't work. A lots of the companies that work in inkjet, they have cross license across them and the cross license do not allow you to pass technology around. So that, I don't see that working. I can imagine a consultant with my work in certain areas but I don't think it will be a large and stable business. The first time we invested for more than 15 years a lot of money in R&D. We kept building a lot of IP portfolio and know how and then we come in with products, but IP royalties and IP relationships have been part of the program from the very beginning. They are not a one-shot deal. We aren't trying to just get a bunch of money and get out of here. We are trying to build relationships that will continue to bring revenue and profits to the Company with time to come. Because we need to build these partnerships. We can't succeed in this market if we don't have these partners. They control business channels, they control products and other technologies that we need too. So we will continue to make relationships that are valuable for both companies. And the plan with those partnerships is to disclose as much as we can from both, we want to disclose as much as we can until the point in where we are starting to hurt our competitiveness. Both from IBM and us, Motorola and us, or whoever we have a partnership with. So we will continue to try to use our brand and our IP portfolio to build partnerships, partnerships that are revenue generating and profit generating and they have a longer term with much more interest in that than in short of cash tomorrow and we aren't looking for that. We can deal with our cash. We are in good shape with cash. More cash would always be better, but we are in fine shape. We are looking for building a sustainable business. Okay. And a follow-up. Bob, looking at the traditional business, I think you said something, it seemed to calculate out to about the $300 million EFO this year for 2006. Is that sort of in the ballpark when you look at the fact that you had the 900 to a $1 billion worth of GAAP losses and then you've got 1.2 billion in charges. Is that the best way to think about it in terms of profitability and traditional? Yes, Shannon we're not, we've decided not to disclose traditional. That's where we book all the restructuring charges and some of the restructuring charges are GAAP, some are non-GAAP, some are useful life and everything so I mean the traditional business is still valuable. We always said it would run in the, we said before it would run in the 10% range before the useful life. So it's probably somewhere around where you said. It's not wrong. It's just the accounting is so complex that not going to forecast. The analysis, about that, maybe a little more. Two questions, both related to your consumer business. What do you see Antonio as the major risk to that growth forecast overall for the consumer business, particularly in light of the maturation of the consumer digital camera market? Secondly, just to delve into the EFO forecast a little bit more, if you take the midpoint of your '06, EFO number that's, let's say 400 million which is well over $0.250 billion more than what you did in 2005, half of that increment is in your consumer business, or let's call it 125, 150 million incremental profitability this year in consumer which seems to be a pretty high proportion of your incremental revenue assumption for the year for consumers. So I know you think about this as an exponentially leverageable business, but maybe give us the components of where you really see that magnitude of incremental dollars coming from, particularly going back to the first part of the question as to any market risks with respect to consumer revenue. And a follow-on. Well, we are aiming at, it is exponential. That's all I can say. The risk will be that people will stop printing. People will stop printing and then I have a problem. If people continue to print then they are going to deliver numbers that we have there. And we, obviously we took a plus or minus for all those things, so some people print more and some people will print less. The other risk, we didn't, we are not, we are looking at very low growth in digital cameras for next year. Within the markets. And we are moving up in digital cameras. You probably noticed that we just introduced the first ever dual sensor digital camera in the whole world. Since you asked me I am going to brag a little bit. If you allow me to just for a few seconds. Actually, we got comments that it was really cool that the ultimate film company in the world, Kodak, will be the one that actually tells the world that the analog workload that is used right now with the personal digital camera is no longer going to be valid for the future and they are coming with the first one to break that model. We have a lot of innovation and you will see it coming. And you will see our cameras going steadily up in the price range. You will see CMOS getting to our cameras. The question is when they are going to come into the camera. That is a risk. When. When they are coming will make a difference. Could we sell immediately to other camera manufacturers or not? Or to other devices sooner or later? That could be another risk. The growth that we had around 16 to, what is the growth in CDG as well. 16%?. 16 to 18 is, we will soon have a very good growth in kiosk in front of us. We will still have a very good growth of home printers. We have consumables growth. Very low growth we've put in those numbers for the cameras. Those are the risks associated with the business. But we have been very aggressive gaining share as you can imagine. And I explained why. You may or may not disagree with that theory. But that, we executed what we thought was what we needed to do. And now we are going to execute on this strategy, that is subordinate the digital growth. You can always buy share in this market if you really want to. So those are the risks. Just a follow-up on GCG. In response to an early question, you highlighted revenue synergies, which you and Jim have talked about earlier in prior presentations. You saw some of that at print '05 in terms of your booking commensurate to the show. Is that the preponderant part of your growth assumption for '06 and beyond? Is this really the heart of the strategy? No, we took, this is our first year with GCG. We want to have a good year. His main concentration has kept the business running. It's give the consumables capacity. We don't have enough capacity for consumables at this point of time. We are running at the edge. We have to ramp fast and get capacity. Integrate those systems, get the natural revenue synergies they are going to come by having all these products with you. Get the cost. That's the biggest thing for the year. I have two separate questions. The first one is on China, can you give us update on China, you had some problems there last year. Could you just tell us what's going on now? And then the second was on the gallery. Do you have any data that you can give us on how many customers you had at the end of the year? And then also a lot of your revenues at the gallery come from people who aren't buying 4 by 6 prints. It's the coasters and the aprons and the T-shirts and all that. Can you sort of break down the growth rates of those two buckets and where those buckets are starting or whatever this year? Yes. China is moving to digital fast. I guess that's the best answer that I can give you. We did underestimated that at the beginning of last year. We learned. We learned our lesson. We are dealing with the fact that that's the way it is. So we are moving field more and more into the second tier and third tier cities and we are going for market share in, in cameras and printers. What we are doing as well is we are taking the phenomenal distribution system that we have, which is the Kodak Express stores. We have more than 9000 Kodak Express stores with independent owners. But the work with us and stores are called Kodak Express and we are helping them to move to digital. Yes, some of them, they have kiosks. Some of them they have kiosks. No. Second and third tier they don't have the, they don't have enough money to pay for that, no. But we are, so we are building first in the coastal cities, it's very large. There is a lot of cities, a lot of people, a lot of stores. So still a lot of work to do and one of those cities is like a country in Europe. So it's a big, we have a lot to do yet in the coastal cities. So that's what we are doing in China. I don't know if we will disclose the rest for the color gallery. We have never put a big splitting apart or parsing apart of all those details. The only thing we've talked about directionally, of course is to acknowledge that we've had a lot of growth in photo books and the other higher value added. It's a competitive issue we have three or four guys and another 15 coming into that market and we don't want to tell them what sells and what doesn't sell much. But we are selling all those things. And then just finally, you talked at one time or another over the last couple of years about starting to charge for different levels of service or storage at the gallery. Is there anything new on that? You can choose now premium services. Why don't you go into the website and you will have your answer there, right there. And please sign up. Thank you. JP Morgan. I have a couple of questions for you. First, is one, based on the cost structure that we had in the fourth quarter ignoring any changes in lease structuring from now, what is the time to market between the print and photo finishing group and the consumer digital group? How long will it take to get to market and what is the product mix that needs to change to get there in terms of devices with the consumables. If I understand your question right, Sam, the film growth, the parity in margins close to never. I mean, that was a very high margin product. As long as it has reasonable sales and we can continue those facilities, we are down to a couple players left in the world and we, and it's going towards good margins. If we can pull that down fast enough which we are doing, if you just read the restructuring, like you said, if we could pull it down fast enough it will be in a high margin product for a long time and it depends on what part of the digital products you are talking about. If you are talking about cameras, I don't think they'll ever hit. But if you are talking about the consumables and you are talking about papers and stuff like that, maybe, but it's been awhile. Let's say the metric would be return on capital. You can't look at the film and look at the gross margins, forgetting that we invested billions and billions of dollars per year to create that. I don't know if that is, it wouldn't help me to know, obviously the margins and the gross margin and the consumer digital group, it will never be higher than, I don't know, 30%. If we will do really well, 32, if we have a great year. If the CMOS sensors are a lot bigger number than the rest, we will go higher. But it will never compare to 65 or 70% margin. But, of the metrics because it's a completely different business. It's going from a chemical business to a mechanical business. And it's a, the investment intensity is not even comparable. CRIC gets close to them but not the actual margins. Can you give us a sense of the Corporate expense of advertising and other corporate overhead, how is that allocated currently between consumer digital and the other segments? One of the things that I agree with your report, maybe one of the few, no I agree with more. We have too expensive corporate center and I think we have to work in our advertising expense. So good point. We are working on it. Thanks. Just two questions. The first one sticking with consumer digital. It looks like you are looking for that business to earn 150 million in EBIT next year. Is that mostly going to come from output or if you were going to look at that break down of 150 million what are the big sources behind that? The system. It's the system. We, first we are not going go down into splitting that. Second we never said the 150. That's yours and that was the second time that appeared. You two apparently said it the same number. But it's a combination of getting, doing a lot better with cameras, doing something with CMOS, doing better with printers, doing better with Kiosk, doing more consumables, and a combination of those. And that's as much as I will go. No. Which is better, by the way. We know, we are not looking for a miracle will happen. Something that will, we're looking for something that will happen naturally. This is not, we are not mavericks and we aren't expecting a miracle. This has been done through innovation and a lot of hard work, that's why I think it is going to happen. And then looking at cash flow for next year, two questions around that. Is it going to be as seasonal as this year with pretty much all of it coming in the fourth quarter? Is it going to be more even? Then if you look at the 4 to 600 million next year versus the 720 something this year, what are, it looks like earnings and the restructuring are going to be similar in '06 versus '05. What are going to be the other big variables that might not come in as big this year in '06 or might come in, whether it's asset sales or so on? Yes, I think seasonality I hope it's not as late. That was finger biter, but we had a lot of our asset sales currently in the year. We started that process much earlier now and we are deeper into the restructuring so the assets available for sale have been identified. Last year they were being identified during the year and we went out and saw them. Now we have identified them and we're working on them. So some of that will come earlier. We have a much more sophisticated supply chain in digital now. Last year we weren't as efficient during the year at accumulating equipment as we will be this year now because we have got a better way of bringing those to market and more close to the point of sale rather than building a lot of digital equipment up. We built it up and pulled it down. This year I hope we don't, so that will pull the cash a little forward. The earnings, and a lot of that depends on the timing of the restructuring cash outflows which is generally people. So it will be a little more seasonally front. It's a little lower, you are right. The earnings and the cash outflow from restructuring aren't that far part so most of this has to be done by working capital improvements, selling assets, all that stuff we talked about. So if everything works, it will be higher. So I'm trying to give a number that we can run the Company on which is around 500 million. The same things seasonality though is going to be, it should be seeing a little better this year but similar to this year. We can't change that this year. Next year we will be, we are getting increasingly better. But first quarter should be low. That's the way. And we don't like it like that either. In fact, we have been being considering, we haven't decided this, but we have been considering would it be better for our investor, for our fiscal year will be different. We'll have a better handle of the year rather than have such a big chunk of things to have to happen in the last four months of the year and so much at stake. We haven't made any decision there. But it would get better with time. But slowly. Thank you. Luke Williams, Bertco Advisors. Could you give us the, a discussion of the competitive landscape and the commercial graphics group and what type of profit margins do your key competitors have, please? I don't know what they report, but that industry is an industry that should be able to produce anything from 8 to 12% EFO. Some companies they are more dedicated to digital printers and presses. Others have more software so it's hard to make comparisons. But our goal is to end up with something like that in that business. Could you though, tell us the main companies with whom you compete and your market share versus theirs? How you plan to change it? We aren't going to change them. They are going to keep competing with us. But depending on what area and we have a unique value proposition that we have announced that we thought that the, talking to many customers for many years we figured out that the most valuable thing for the presence of customers is how can we help them to move from the analog world to the digital world and make money while they are doing this. And we looked at the key elements that will contribute to make the addition a reality and that's why we created the Company that we have created including KPG and Creo and NexPress and Versamark that we have. The industry really is not organized like that today. We spend a lot more money and a lot more effort and workflow than many of the companies that we compete with. We have production printers vary at which most of the other people don't have. So it's hard for me to compare. I mean, you have to go company by company and look at the difference. We are slightly different than the majority of the industry competitors. Joan Lappin, Gramercy Capital. I have two questions. One is the impact of this tax, the tax court decision that added considerably to your fourth quarter earnings had on all of these reported results. I'm sorry, I don't have the notes here to look and see what you did with that and if it affected any of these groups. And my other question is on the health group. You're forecasting flat year on year earnings and the question is that's a group, that's a business you have been in for 100 years. And yet you're competing there with GE, with huge companies that are also offering doctors and clinics and whatever of these document systems and whatever and they are going around saying why do you want to buy Kodak for? They may not be there to support it. You are saying you've made some changes to address some issues. I don't know if those are the issues you are addressing or what. But I would appreciate more as we say on Wall Street these days, color. No, but I have a son-in-law who happens to run a very large radiology group here in New York and they just opened a new clinic, your folks came in, he decided not go with you and that was the line he was given and he fell for it. And he is a very smart guy. So I just figured he's, and he frankly was at GE for many years. He knows, well, he was selling against you and so, you know. I really don't know what to tell you about your friend. I haven't heard from, I see a lot of these customers myself. Nobody has said that we are going to, that we are going to disappear. This is the first time that I hear this. They did say that GE is larger. Which has some good things, some very bad things, too. That's what they say. So we have our specialties that GE doesn't have, by the way, we have a great relationship with GE. We sell them a lot of our, all of the laser printers that they sell or most of them they come from us. We are happy that GE is very successful in that business, because every time they sell one of those systems, they sell one of ours. But you're saying here, flat year on year earnings so something isn't quite right in an area that you have been functioning in for decades and yet you are still not able to grow there. I'm really asking why? I think, I tried to explain it before. What I tried to do is that we needed to invest more in digital. Our digital business had a bad beginning of the year last year. We needed more investment and we needed to do a few other things such as reorganize ourselves. We did that. That's why we are taking this year, we said though, I said that we have grown ACIS more than 30%, 39% for the year. Digital capture devices that include CR. They are growing very fast, too. We had a bad year in health, yes we had a bad year in health, so we trying to recover this year by putting more investment in health. We compete very well with those people, by the way. In our own specialty they are very strong in other areas where we are not participating. The health market is enormous and GE and all the others participate in many other things that we are not participating on. So when you look into the areas in which we are participating like the x-ray, x-ray department, and the radiology we are actually extremely strong in those departments when it comes to x-ray. We are the only company that has the full proposition for x-rays out there. And the strongest proposition. So we aren't trying to be a GE. We don't need to be a GE. We aren't trying to be like them. God bless them. They are a very good company. We are our own and we are going to keep our footprint. Yes. I think the tax issue you are referring to is the settlement of a 1994 thing which was the sale of the Sterling drug company and we settled with the IRS on that. Just one of those long time things that go on. The proceeds of the settlement were booked against discontinued operations and the interest that they owed us on the, it went against interest income. That's where you would ordinarily expect that kind of stuff to go, so it's discontinued ops. Thank you. Hank Wines. Yankon Securities. I have two questions. The first, I would like to get to know what your feel is with the relationship you have with the Lexar Corporations and the sale of digital film. Secondly, I would like to know your reaction to the Minolta and Konica decision to exit the photography business and Nikon's decision to exit the film photography business? I'll start with the second. Minolta, we were expecting that to happen in the business that is going down the ways we're going down now unless you have very large critical mass like we do or Fuji does, it's very hard to sustain. These are very large installations and very expensive machinery. If you have that machinery idle for a few hours, you can't make any money any more. So I wasn't surprised. I was surprised by how long it took them to do this. The same with Acfa I didn't quite understand why they kept going at it. So what's going to happen with that decision to us? I don't know exactly but I'm sure it's not going to hurt. I think it's going to, I know it's going to be positive and I don't know how positive yet. We have to watch and see what happens. I feel the same about Nokia. And I think it was an expected thing in the industry. I think as well is no, not going to hurt us. In any case, if anything, it might help us. Lexar we have, we put our brand and they do the product and they do the distribution. We don't cover any inventory, that's what we do. We are making some money. I want to make more, but making some money. Ulysses Yannas, Buckman, Buckman & Reid. How long do you expect yourselves to continue making single use in 35-millimeter cameras? Or when are you going to decide to outsource them. We already outsource them. We use a company in India, a company in China, I cannot remember any more. They buy the film, they make the cameras by themselves, we sell them with our name and with our film. Oh, no. Single use, we still do it. It's a pretty complex process for the single use camera. We have the very highly developed. The lowest cost in the industry for single use cameras. So as long as the volumes remain and going down, but as long as we have enough of a volume to run those operations, we are concentrating in the operations though. We used to have three factories, we haveâ¦â¦ Actually, not. Actually not. Because you are going to end up with the fact that most of the uses for single use cameras are not in China, are in the U.S. So whatever you see from manufacturing there you are going to lose that and more bringing it here so we can't do that. Another question, if I may, you were asked before about the gallery, and the programs you started last September with premium service. Can you give us some idea what percentage of the people in the gallery have been signing on? Very good. Very good. You got me. Small number. We won't say, but this is a small number. This location process is going to take time. For anybody. I mean, you have seen, our competitors are trying to do something similar with videos and things. This is a location process. By and large, consumers out there think that whatever's on the web should be free. That's why people keep going to the web. I noticed that with Yahoo! and some of the guys now starting to offer and getting paid for some of the services. We are all trying the same thing. Or similar things, I mean the same idea behind different services it's a small number. But we knew it was going to be small. But it's moving but it's small. And then can you also give us some ideas to what percentage of the gain in kiosks related volume was media? I think last time I disclosed this and I think I said something like 2.5 times so close to 3 times of the revenue comes from media. So it's big time. Okay, we have time for one last question and we will go to the back there to the gentleman on your right as you go up. I want to give you the right number, Ulysses. Could you check that Don? We will get that number. But it's about that. Thanks. Adam Camorra and Chess Capital. What's your current outlook for the theatrical film business. Does this business segment generate approximately 300 million or so of EBITDA. It's a good business. It's a great business. It has grown this year. I know that everybody says that it's going to go away. They tell me all the time wherever I go, they tell me the business, actually it has been going away for the last two or three years and we see them growing year after year. I don't know what to say any more. I don't want to get into a technology discussion. I know very well, as well as anybody else in the world how easy it will be to do that with digital projection. I understand it perfectly well. I could lecture. I could lecture on it. The problem is the business model doesn't work very well. And that is helping to keep the business the way it is. The businesses still grew this year. Do we expect it to grow, do we expect that business to grow in the future? No, we always think it is going to be kind of flattish. Maybe going down a little bit for next year. But we haven't seen significant signs to make us believe they are in decline. I mean, actually we've seen the contrary signs. And we don't disclose what the individual numbers of that business make. For a good reason. First, competitively will be an issue that there are not many suppliers in that business so we don't want to disclose that. Second, because the same machinery that we use, we have four big related assets in the world and one of them is dedicated to this business, but some other the things to and if you were to disclose individually the number that you ask me, you will have to do all sorts of, activation allocations of these very large assets is not very valuable for us. So that's why we are putting within the natural business of which it is. We, the processes business, the best single rolls that they go independent on the cameras we use the same machines or we use as well to do aim films and other films, so we put it all together. That's the best way to do the accounting. But in terms of your long-term forecast, it sounds like you are anticipating that this business stays flat as you look out one years, three years, five years? Or can we eventually, is there a time frame where you think something might change in this business? I think it is going to last, I think it's going to last for a significant amount of time. But I said as well publicly that as far as the need from this company to use the cash generated from the business to survive which is sometimes why they ask me this question. They ask me this question and then if I say, well, I feel for the next two years is not very significant changes I keep saying. I don't want to get into the forecasting business how long it's going to be. I think it's going to be a lot more than two years for many reasons. Many technical reasons and many business model reasons. But what I have been saying is that as long as we last, we need that business at a good level for the next two years because we still have a lot of restructuring to do. After that I said that we love the business, but it won't be a necessary business for us to have to be able to deal with the, for the transformation. But I believe it is going to last a lot more than two years. Okay, thank you very much. We are out of time. I would like to thank you all for coming and have a very good day. |
EarningCall_234074 | Good afternoon. My name is Jodi, and I will be your conference operator today. At this time I would like to welcome everyone to the Wendy's International and Tim Hortons first quarter results conference call. (Operator Instructions) Thank you. I would now like the turn the conference over to Mr. John Barker. Please go ahead, sir. Thanks. Good afternoon, everyone. The purpose of our investor call and the webcast today is to discuss our first quarter business results for both Wendy's International and Tim Hortons Inc. and to update some of the key initiatives at both Companies. Wendy's and Tim Hortons published their first quarter results earlier today. The news releases and accompanying financial statements as well as other information you might find helpful are available on the various websites for Wendy's. It is www.wendys-invest.com and for Tim Hortons, www.timhortons-invest.com. The agenda for today's conference call will begin with remarks from Wendy's interim Chief Executive Officer and President Kerrii Anderson, who was appointed to her role last week. As you know by now, Kerrii's appointment follows the decision of Jack Schuessler to retire from Wendy's after a 30-year career with the Company. On behalf of the Board and all the management and franchisees of Wendy's. we all wish Jack well in the future. Jim Pickett, our new Chairman, has expressed his support for Kerrii in her new role. As many of you know, Kerrii has managed many areas of the Company in serving as our Executive Vice President and Chief Financial Officer as well as a board member of Wendy's International since the year 2000. Now following Kerrii's commentary about Wendy's' corporate results today will Tim Hortons CEO and President, Paul House; along with Executive Vice President and CFO, Cynthia Devine. Paul and Cynthia will discuss their first quarter results, their first quarter as a public Company. All of their reference to say currency will be in Canadian dollars. After those remarks we'll open up the call for questions. Looking ahead, let me remind you that both Wendy's and Tim Hortons will release second quarter sales on Friday, July 7th and second quarter earnings on Thursday, July 27th. For future reference please note that our key disclosure dates are listed on the websites for both Companies. I'd now like to refer you for a moment to the Safe Harbor Statement that is attached to this morning's news releases. Certain information that we may discuss today regarding future performance such as financial goals, plans, and development is forward-looking. Various factors can affect the Company's results and cause those results to differ materially from those expressed in our forward-looking statements. Some of those factors are set forth in the Safe Harbor Statements that are attached to the earnings releases. Finally, some of our comments today may reference non-GAAP financial measures. In the event that we reference any non-GAAP information we would post a reconciliation to the most directly comparable GAAP financial measure on our websites as mandated by Regulation G. Now, let me turn it over to Kerrii. Well thanks, John, and good afternoon. Earlier this morning we held our annual meeting of shareholders here in Dublin, Ohio and all five of our directors who were on the slate were elected. In addition, PriceWaterhouse Cooper was also approve as our independent registered public accounting firm for the current year. We also announced our first quarter financial results which I'd like to review. Our financial highlights are that revenues hit $931.5 million, up about 4.2%. Our same store sales, as you know we reported a few weeks ago, Wendy's U.S. Company down 4.8%, Wendy's U.S. franchise down 5.2%, Tim Hortons in Canada, meanwhile continued to be very strong at a positive 8.7% and Tim's in the U.S. positive at 9.8%. Baja was down about 3.7%. Our net income for the quarter was basically flat, and that's a result of lower than expected operating income, but a benefit on the tax line. Overall EPS was $0.44 a share compared to $0.45 in this same period for us a year ago. We did open 57 new restaurants system-wide during the quarter. That consisted of 29 Wendy's, which about nine were Company and 20 were franchise; 27 Tim Hortons and one Baja. The factors that impacted the quarter included certainly stronger than expected sales at Tim Hortons and lower than expected sales at both Wendy's and Baja. During the first quarter we did spend about $15 million in incremental pre-tax advertising expense, which is on the operating expense line, to aggressively defend our competitive advantage with our spicy chicken sandwich. We expect to spend the balance of the previously announced $25 million during the second quarter. We are happy to report that we have not seen any erosion in spicy chicken mix of our sales since McDonald's introduced their version at the end of January. In fact, our sales have actually on spicy chicken increased slightly. Both Wendy's and Tim's picked up significant benefit in the quarter from a lower effective tax rate which resulted from two significant items. Due to the higher than expected proceeds from the IPO resulting from the price increase as well as the exercise of the over-allotment option, combined with the execution of financing for Tim Hortons third-party debt, we reversed a deferred tax accrual for $5 million in Canadian withholding taxes which we had previously expected to pay. We also picked up about a $3.8 million benefit for the permanent book and tax differences on certain hedge transactions that we had put in place. As noted in the release we do not expect to realize benefits of a similar nature in future periods. Other factors affecting the quarter were certainly a stronger Canadian currency. We experienced $1.155 versus $1.23 in 2005's first quarter. This benefited our pre-tax income by approximately $4.2 million compared to 2005. We also had the loss of approximately $4 million in rental income due to the fact that we sold a number of Wendy's properties, as you know, in the last quarter of 2005. We also lost 17.25% of the net income contribution from Tim's for one week following the IPO which resulted in a year-over-year reduction of approximately $700,000 of pre-tax income. We picked up a slight benefit in the quarter from lower prices of the fresh ground beef which averaged $1.38 per pound in the first quarter of this year versus $1.42 in the first quarter a year ago. This benefited pre-tax income by about $700,000 compared to 2005. And our outlook for beef prices in the second quarter is $1.425, and that's compared to $1.52 in last year's second quarter. So now let's talk about the operating segment. The enterprise operating margin was 7.2%, and that was compared with the prior year's 10%. The decrease is primarily the result of lower year-over-year contribution from Wendy's as well as certain IPO costs and consulting fees. Wendy's segment operating income was about $11.8 million, and that compared to $43.9 million a year ago. Operating margins were 2.1% compared to 7.5% a year ago. Clearly, the factors driving the decrease were the incremental $15 million in advertising contributions and a 5.1% decline in same-store sales. Partially offsetting this were some gains we talked about from the sale of properties. Segment operating income at Tim's was $76 million, and that compared to $62.5 million a year ago. The increase primarily resulted from a strong top line performance driven by exceptional same-store sales, new restaurant development, and some currency impact. Now let's take a closer look at some of the key lines on the first quarter income statement. Cost of sales was $505.8 million, and 67.1% of retail sales. This compares with $477.9 million and 66% of retail sales last year. Again, the factors driving the increase are attributed mostly to the increased cost of sales for Tim Hortons resulting from many additional restaurant openings, higher sales per restaurant, and the stronger Canadian dollar. These factors were partially offset by lower food costs at Wendy's. Company restaurant operating costs were about $175.7 million, and that's about 23.3% of retail sales. This compares with roughly $169 million last year which is also about 23.4%. Operating costs were $60.4 million, and that's compared to 36.2% in the first quarter of last year. The increase is primarily driven by the $15 million of incremental contribution to the Wendy's advertising fund. Factors related primarily to Tim Hortons include the start-up costs for the new frozen distribution center and a stronger Canadian dollar, as well as the growth in the number of properties being leased and subleased in addition to the higher percentage rent due to higher sales. Depreciation was basically flat with the year ago, and general administrative expenses were $82.5 million or 8.9% of revenue compared with $75.8 million or 8.5% of revenue in the first quarter last year. The increase as a percentage of revenues is really driven by lower same-store sales at Wendy's U.S. This line does also include the impact of the stronger Canadian dollar, higher consulting fees and certain IPO expenses substantially offset by a reduction in the accrual for performance based incentive compensation primarily at Wendy's. On the other income line, we produced $8.6 million in income compared to $4 million a year ago. Again, the other income expense line typically includes such items as income from Tim Hortons joint venture, Par Baking Plant with Cuisine du France, currency adjustments and other non-operating items not related to our primary business. This year's increase primarily reflects net gains on the property sold during the first quarter of 2006. From a balance sheet perspective, we ended the quarter with $1.3 billion in cash compared to $393 million at year end. This of course reflects the proceeds from the IPO of Tim Hortons and the issuance of the debt by Tim's. From a dividend perspective, the Board did approve our 113th consecutive quarterly dividend which will be paid on May 22nd, and the quarterly payment will be $0.17 per share. This is our third dividend paid since our July announcement of a 25% increase in the annual dividend rate from $0.54 to $0.68. As we think about the balance of the year and really think about guidance, we realize that many of you on this call are interested in more insight into the Wendy's stand alone financials and our outlook for the remainder of 2006. We will certainly provide more insight into our standalone financials once we have a definitive timeline for the full spend of Tim Hortons. We do not feel at this point we are in a position to give detailed guidance regarding the balance of the year due to the lack of visibility regarding several key items which include the timing of the spin-off of the remaining 82.75% of Tim Hortons. We have committed that will occur by year end, and that's our current position. Also the use of proceeds from the IPO, as well as the method and the timing of actions to return cash to our shareholders. We also have expenses and restructuring charges that we expect will be related to our $100 million savings that we discussed in release this morning. We will provide updated guidance for the rest of 2006 when we have more insight regarding those items. In the meantime, I would like to share with you the priorities we as a management team are focused on. The first is to implement our previously announced strategic initiative. We have now successfully completed the IPO offering for the 17.25% of Tim Hortons, and we expect to spin off the remainder by the end of this year. We are analyzing various methods for the spin. They could be a spin, a split or a combination thereof. Our focus is with a total that we also achieve a tax-free transaction. We are also pursuing strategic initiatives for Baja Fresh and we have obtained Goldman Sachs to assist us in that process. Finally, we are focused on the best way to utilize our strong balance sheet and this cash position of more than $1 billion. Our board has formed two new committees, finance and strategy, which will help advise our management team in implementing these initiatives. Our second priority is to execute the Wendy's combo plan and energize the Wendy's business. The initial stage of our next chapter project, which is to reduce costs, improve the Company's profitability and prepare the organization to operate as a standalone Company after the spin of Tim's is under way. As you saw in the release, we have increased our target for cost savings to $100 million from our previous range of $40 million to $60 million. We have made this decision after working with our management team and consulting group of Booz Allen who has helped us define the opportunities to proper size the Company after the expected spin-off of Tim's. Booz has helped us to identify additional process improvements as well as validated the major cost reduction opportunities. Most of the cost reductions and downsize will occur at the corporate office and field offices. And no job reductions will occur at our restaurants as part of this process. We intend to significantly improve our operations and service, specifically to our franchisees as well as our customers. Cutting costs really is only part of the plan. We must drive sales and profits by improving operations and by launching new products. This is already underway with the roll out of Frescata deli sandwiches in April. We also plan to reenergize our late night business with national media campaigns; launched the three-tier combo program and promote our kid's meal choices, featuring nutritious new sandwiches. Our third priority is to energize and strengthen this Wendy's system with the objective primarily to focus on operations by working with our franchisees and our Company operators. In support of this goal, I was excited to be able to name Dave Near to the position of Chief Operations Officer earlier this week. Dave is a superior operator who has demonstrated the ability to produce exceptional sales and profits in his restaurants for more than a decade as a Wendy's franchisee. I am happy to report that this announcement has been well received within our franchise community, and I look forward to working with Dave and our franchisees to improve the results at the Wendy's restaurants system-wide. We acknowledge that we have lagged many of our competitors recently, but consumers continue to recognize Wendy's industry leadership as a superior brand on many key attributes. Our goal is to leverage this leadership and recapture the momentum that we had less than two years ago. These priorities will be our primary focus for the immediate future, and we will update you on our progress throughout the year beginning with our second quarter call in July. In summary, I'd like to wrap up the Wendy's portion of the call and then turn it over to Paul and Cynthia so they can discuss their first quarter as a public company. As you know, we achieved our goal of the late March IPO as Tim Hortons began trading on the New York and Toronto exchanges on March 24th. It certainly was a very complicated transaction with lots of complexities and some challenges, but by all measures it was a tremendous success, and we were able to accomplish this because the spirit of the teamwork and cooperation between our Companies and our management teams. In many ways the IPO symbolizes a great relationship we have enjoyed with Tim Hortons over the past 10 years, and we are extremely proud to see Tim's begin operating as a public Company. As you can see from the results they released today, they are more than ready for the challenge. Here to give you more details on the topic is Paul House. Thanks, Kerrii. As Kerrii said, we have enjoyed a great relationship with Wendy's over the past 10 years and we appreciate the support that they have provided for us as we have grown during that time period, with this IPO being the latest example of this. Now as far as the IPO goes, we've had a very successful outcome as we raised $833 million Canadian dollars in net proceeds. This amount included pricing on March 24th of $27 per share, up from our original range of $21 to $23 per share as well as the deal turned out to be 25X over-subscribed institutionally, 49X over-subscribed from a retail standpoint. These proceeds enabled us to pay back the $622 million note outstanding to Wendy's in April. Because the offering was in such high demand, one of our biggest challenges was working with the underwriters to allocate the shares. Despite speculation in the media, more than 50% of the shares went to Canadian investors. In addition, the allotment of shares to retail investors was at the high end recent comparable restaurant IPOs. We were happy to be able to meet the overwhelming demand for shares from our franchisees and employees. These group of investors have had the most to do with the building of Tim Hortons into the brand that it is today. So we consider this allocation to be the best outcome we could have hoped for. While the offering was successful, even more important is that we continue to deliver strong results, and I am happy to report in our first quarter earnings surpassed our expectations, $0.79 per share. Highlights from the quarter included system sales that exceeded our expectations, driven by a strong promotional activity and great operational execution by our store owners. It was also aided by favorable retail pricing impact as well as unseasonable mild weather during the quarter. Our promotional activity included our annual Roll Up The Rim to Win Contest in April, coffee-specific advertising during the Olympics and our chicken noodle soup and turkey bacon club combo to name a few. Other key accomplishments during the quarter were new store development that is on track, the successful launch of our new hot breakfast sandwich in the United States, and the opening of our new distribution center in Guelph, Ontario. We began shipping dry goods from the Guelph facility in the first quarter and will start distributing frozen products in the second quarter. Finally, I'd like to mention that we're welcoming three new board members during this first quarter. Michael Endres, Randy Lewis, and Wayne Sales. In addition we are happy to appoint Jim Pickett Chairman of the Board. Now let me tell you a bit about each of these individuals. Michael Endres is a principle of Stonehenge Financial Holdings Inc. He was formerly Vice Chairman of Bank One Capital Holdings Corporation and Chairman of Bank One Capital Partners. He also serves on the Board of Directors for Huntington Bank Shares Incorporated, Pro Century Corporation and Worthington Industries among others. Randy Lewis is a Senior Vice President of Distribution and Logistics for the Walgreen Company, the nation's largest drug store. He's also a member of the Board of Directors of Wendy's International Inc. Wayne Sales is President and Chief Executive Officer of Canadian Tire. He has helped grow Canadian Tire's business into a top quartile performer among North American retailers, total return to shareholders. Canadian Tire's retail sales have increased nearly $2 billion since he became CEO in 2000 and now surpass $8 billion. Jim Pickett will serve as the Chairman of our Board as Chairman of the Pickett Realty Advisors Inc. here in Dublin, Ohio. He is also currently Chairman at Wendy's International Inc. where he has served on the Board of Directors since 1982. With that overview, I will now turn it over to Cynthia who will provide more detail on the quarter. Cynthia? Thank you, Paul, and good afternoon, everyone. Before I get started let me remind you that all amounts I will reference in these comments are in Canadian dollars. As Paul mentioned we started the year with a strong first quarter. We exceeded our net income expectations due almost entirely to two factors: one operational, and one non-operational. The operational factor was very strong same store sales growth of 8.7% in Canada and 9.8% in the United States. Paul mentioned some of the key marketing and operational factors that drove this performance as well as price increases that we implemented in Ontario during February and some of the Western and Atlantic regions during the fourth quarter of 2005. In addition, we did benefit from the shift of Easter from March in 2005 to April in 2006. The non-operational factor is a tax benefit that Kerrii described in her comments. As Kerrii mentioned, both Wendy's consolidated and Tim Hortons Inc. benefited from a lower effective tax rate. Canadian equivalent to the U.S. dollar amounts that Kerrii provided are $5.8 million for the deferred tax reversal of previously accrued Canadian withholding taxes and $4.3 million for book tax differences relating to certain hedge transactions. We do not expect to realize benefits of a similar nature in subsequent periods. As far as our operating margins go, our operating income was $83.1 million compared to $72.5 million a year ago. And our operating margins were 22.3% compared to 22.4% in the prior year. As Kerrii mentioned, this operating income increase of approximately $10 million was primarily resulted from our very strong top line performance driven by exceptional same store sales and our new restaurant development. Our operating margins are slightly lower than prior year due to the start-up costs of our new distribution center in Guelph as Paul mentioned. We have incurred incremental costs especially with our new distribution center in the first quarter, but we did not begin distributing frozen product until the second quarter. Therefore we have not recorded any revenues to offset these costs. Now let me review in more detail some of the key line items of our income statement. Our total revenue increased 15.2% to $372.8 million. Primarily the result of Easter sales growth, as I mentioned earlier, and new restaurant development. We opened 27 new restaurants in the quarter compared to 23 in the first quarter of 2005. Our cost of sales was $213.9 million. This compares to $183.1 million, a 16.8% increase over 2005. This is consistent with sales growth of 15.2% which resulted from additional restaurant openings and higher sales per restaurant. Cost of sales also includes the start-up costs associated with our new distribution center. Operating expenses were $43 million compared to $38.2 million in the first quarter last year, a 12.6% increase. This line item consists primarily of our rent expense and other property-related costs related to our real estate. Most of the increase is attributable to a higher number of properties being leased and subleased in addition to higher percentage rents due to higher sales on certain properties where we pay percentage rent. These are primarily our non-standard stores. Franchise fee costs were up 15.6% due to a higher number of store openings compared to the first quarter of 2005. General and administrative expenses were $28.3 million, or 7.6% of revenues, compared to $25.5 million or 7.9% of revenue in the first quarter of 2005. This line item includes the impact of certain IPO expenses and other costs related to becoming a standalone public company as well as incremental restricted stock expense. Excluding the IPO costs our G&A dollar increase was up just 4.4% versus the first quarter of 2005. Equity income was $8.5 million compared to $7.6 million in the first quarter of 2005. This line includes the impact of our equity investment in joint ventures and other minority investments. Increase relates to improved performance in both the Maidstone Bakery joint venture and the combo units we share with Wendy's. These items benefited from our improved sales performance in the first quarter. Other income was $1 million compared to 100,000 in the first quarter of 2005. The change is primarily due to currency gains in the first quarter of 2006. The last line item I'd like to discuss is our interest expense which contains some noteworthy year-over-year changes. Net interest expense in the first quarter of 2006 was $8.5 million compared to $1.9 million in the first quarter of 2005. The 2006 first quarter amount includes interest expense incurred under our new third party debt, as well as $6.8 million in net affiliated interest expense that reflects our net borrowings by Tim Hortons from Wendy's. To give you a better understanding of the interest expense line both in the first quarter and going forward, let's now move to the balance sheet. During the first quarter we entered into third party debt of $500million. This consisted of a $300 million five-year term loan and a $200 million bridge facility. Due to our strong cash position of nearly $1 billion due to the IPO proceeds and our solid first quarter results we expect to repay $200 million in bridge facility in its entirety and we have repaid our remaining note to Wendy's during the second quarter. Other components of our credit facilities consist of $100 million revolver, U.S. $100 million revolver and $200 million Canadian dollar revolver. These facilities are both currently undrawn. One final note regarding guidance. Many of you have asked for insight into our outlook for the remainder of 2006. Due to the many complicating factors regarding the impact of the Wendy's distribution of its remaining ownership stake in Tim Hortons, we are not providing P&L guidance for 2006 at this point. We will continue to benchmark current best practices and consider the needs of various constituents as we evaluate our position on guidance going forward. During the second quarter we do however plan to provide quarterly income statements for 2005. This will give you more insight into our historical performance and show the comps that we will be facing for the rest of the year. With that I'd like to now turn it back to John Barker for the q-and-a session. Okay. Thanks, Cynthia. Because this is our first combined conference call with Wendy's and Tim Hortons we'd like to try to keep this somewhat orderly. So we'd like to request you cooperate with us on this q-and-a session. I'd ask as you queue up for questions and the operator pushes you through to preface your questions by letting me know if the question is specifically for Wendy's or for Tim Hortons. Also, we'd like to make sure everybody gets an opportunity to ask questions. So if you could limit it to one question per caller, then we'd let you queue back up for additional ones. We know we have many, many people on the line today. One more thing, please keep in mind that the answers that we will give for the q-and-a for Wendy's will be in U.S. dollars, for Wendy's international Inc. results and just as a reminder Tim's will be in Canadian dollars. Operator, we'd now like to have queue up for questions. Thanks. This is for Wendy's or the overall enterprise and hopefully it's simple. Kerrii, can you break out the consulting and IPO costs in the first quarter and if it's possible are there some that are borne by Tim's and not Wendy's? If there is an allocation issue, if you could let us know that as well? The consulting was around $2 million, John, and IPO costs were about $1.5 million, and of course most of the IPO costs would therefore go to Tim's. These were the expense items. We may have other IPO costs that of course would offset the proceeds of the offering. Right. Well, anything offsetting the proceeds of the offering get recorded in the equity section. Except the $1.5 million in IPO costs were in the G&A line. Hi. Kerrii, this question is on Wendy's. I wanted just to dig into the cost savings and how it might flow through the income statement. I know that the release said it will come primarily from corporate and field overhead, and that no job reductions would occur at the restaurants. However that doesn't necessarily mean that all of it will come out of G&A. I was wondering roughly what portion of the savings will be to G&A and what benefit might be accrued to Company restaurant margins? Secondly, how might it break down in terms of Wendy's segment versus corporate unallocated or even the developing brands? Thanks very much. From a cost savings perspective, David, certainly primarily most of the savings is going to occur on the G&A line, probably about 80% of it. There will be other savings that would occur in what we call Company restaurant operating costs. As and as you know I shared with the analysts in New York that you have certain costs at CROC and certain costs in G&A. It's primarily in the corporate line. As far as how it effects exactly restaurant operating margins, the piece that comes out of CROC certainly improves the operating margins at the restaurant. As far as corporate, as to your next question about allocation, I think between developing brands and Wendy's. That's not a part of the number at this point. The focus is on Wendy's. So if Baja Fresh is spun off, there may be additional savings either from discontinuing an operating loss and/or additional corporate overhead savings? Yes, hi. Could you go over again the reconciliation of the Wendy's operating income, $32 million down, $15 million of that's the ad spend I'm assuming. Is the entire rest of it the same-store sales decline? Effect on operating income? Yes, it sure is, Scott. We need positive same-store sales in the 3% to 4% range in order to maintain, and with a negative 5%, that's basically the impact on operating beyond the $15 million of investment in advertising. On your statements of the cash, how much is that all at Wendy's or is part of that at Tim's and part of it at Wendy's? The cash balances, is the 1.3, is that all at Wendy's or part of it at Wendy's and part of it Tim? Yes, good afternoon. This question is for Wendy's. Just in terms of if you look at your stock buyback increases obviously you have a pretty healthy dividend increase. Now obviously with the Tim Hortons spin off; and now today across the news wire a possible special cash dividend and what you talked about on today's call as well. Where do bondholders stand in terms of your targeted credit quality? You obviously were once a BAA1, BBB+ credit, obviously coming down pretty quickly from there. It seems likely that you're going to go below investment grade. Do you have a targeted debt rating or credit ratio that you're trying to get to? Is it mid double B, is it high double B? Are you willing to go to single B? What is the expectation in terms of a pro forma Wendy's and where do bondholders stand? Thank you. Yes, thanks. Well certainly our preference is we don't have a target, but our preference is to maintain the investment grade rating. But I will be candid with you and tell you that we cannot control all the factors involved in that, including decisions that the rating agencies might make. I believe that the most critical element that the rating agencies consider is the performance of our core brand of Wendy's, and that's where our focus is because I think that's going to have the greatest influence on their decisions about our ratings going forward. Right. But with the spin of Tim's completely off by the end of '06, would you look at -- today at your shareholders meeting and on this call you mentioned the possible one-time or special cash dividend using the $1 billion plus. Clearly that would be in your control as to whether or not you decide to impair your balance sheet any further. Obviously the Wendy's business is critical to your ratings today, but in terms of how you allocate capital going forward is going to have an impact on your ratings. Would the Company not give a dividend if it meant going to below investment grade or is that sort of insignificant in your mind in terms of making that decision? I believe that with respect to the rating agencies, the bigger impact to their decisions about our credit ratings is not the cash on our balance sheet but the performance of our core brand. Right. Okay. Liquidity is absolutely one of the considerations when they look at the credit metrics of a company. It's obviously operational, but also a critical element is how your balance sheet is shaped up, et cetera. Maybe I'm not asking the question correctly, but understanding that you're trying to improve the Wendy's operation, bondholders will now lose access to all the Tim Hortons assets. When you look at you balance sheet, there's no specific targeted metric in terms of debt to EBITDA or net debt to EBITDA when you look at the liquidity that that extra cash provides you? Great. Thanks. Question for Cynthia. You mentioned Easter shift and price increases impacting comps. Was wondering if you could just give a little bit more color around that? The one in Ontario was approximately, again it's hard to measure it because it varies with the mix of your products, but it was approximately 3% to 3.5%. And the ones in the West and in the Atlantic vary from about 3% to 4%. Hi. A question for Tim Hortons. As far as new store openings, it looks as though net/net you're only up about 18 stores. Do you still think you will maintain the target of 180 to 200 openings in '06? Yes we do believe that we're still on track for that target. Our store openings are typically a lot lighter in the first quarter than they are in the balance of the year. Typically the third and fourth quarter are very strong for us in terms of store development. Hi. Question for Kerrii, and I apologize if you covered this. At the beginning of the call we had trouble getting on. Just update plans on returning cash to shareholders? Hi, Joe. Our position at this point is that we are continuing to go evaluate the best use of the $1 billion. I will tell you from our discussions this morning at the annual meeting, our first priority in thinking about how to invest this cash is in the core business of Wendy's. Of course we've done a little bit with the $25 million of incremental advertising. We also continue to try to find ways to facilitate things like the installation of double-sided grills with our franchisees, and really reinvest back into the current facilities we have both from Company and incentivize our franchisees to do so. So our first priority will be that. Secondly, of course, returning cash to the shareholders, whether it be in the form of an increased dividend, a special dividend or share repurchases. And we did not articulate, Joe, specifically what we will do today. We're continuing to analyze that in light of all other strategic initiatives. The timing of that decision I would say, would probably be closer to we said the end of the second quarter we would talk about the spin and the timing, and I would expect us to have an update on our position on the $1 billion of cash at that time also. Hi. This question for Wendy's. Hi, Kerrii. My question is it seems like to certain investors that's interested in just investing in Wendy's standalone, and the way to do it right now is you need to borrow shares from Tim Hortons and then sell short that. It seems like there's a market for it to lend out these shares. I think currently people are getting charged 9% to 10% on annualized interest to borrow your shares. Have you considered maybe lending out these shares to make some extra money for the Company? Considered lending out these shares you have in Tim Hortons to the Street so it can earn the 9% to 10% on the interest that you are lending out the shares on? Good afternoon. This is a question for Kerrii. Kerrii, with same-store sales at the core Wendy's business continuing to trend downward at least through the first quarter, I'm wondering if and when a decision will be made as to incremental advertising spending going toward? Is this $25 million just a one-time shot or is there the potential that going into the second half of this year and potentially into next year that you do some incremental advertising spending as well? Well, certainly at this point in time the $25 million that's been announced is all that we have currently on the table. I think as we talk about our $1 billion in cash and how we might best really energize the core brand we will consider all alternatives. About when does that planning takes place? Is that through the summer months or what sort of time frame would that decision be made? Hi. Could you tell me on Wendy's what the cash and debt will be after Tim makes final payment on the note to Wendy's? Also, could you tell me depreciation for Tim's in the first quarter? Okay. The cash and debt on Wendy's is currently today we have $525 million of debt on Wendy's books, and the first payment of debt right now is 2011. Any debt that we owe as far as payments go. Today the cash on our balance sheet at the end of the quarter today because we have now received payment from Tim's is $1 billion. As far as depreciation goes, Cynthia will answer that in Canadian dollars. Hi. Thank you for taking my call. This is for Wendy's. Just back to Eric Miller's question, I would have to totally disagree with you in terms of what the rating agencies are looking for you to do. In talking to them, they are concerned about the performance of core Wendy's, but one of their big issues is also what the ultimate capital structure of Wendy's is post the spin-off of Tim Hortons at the end of year. Now this is in your control, and you decide the fate of whether or not you keep investment grade ratings or not. So really, what is your plans to bondholders, and if you really want to keep investment grade ratings, it's really up to you. So, can you give bondholders some sort of feeling as to how important is it for you to be investment grade rated? Because if you do go to high yield, any new debt issuance you do issue will have covenants, restricted payments and will require a road show. It's quite a hassle actually. So can you just give us more clarification on your plans from a ratings perspective? Thank you. Well, to kind of reiterate what I have really said before, and that is our preference certainly is to maintain investment grade rating, but I would tell you that I would have to beg to disagree with your statement. We have had conversations with the rating agencies, and they are very clear about what influences, certainly, a big part of their ratings thoughts. I would tell you that it is the performance of the Wendy's core business. Correct, but it's the performance -- if you were to spin off Tim Hortons today you guys are not invest grade. Your credit metrics are not investment grade rated based on the amount of debt have you on your balance sheet. You could take out one or two debt issues and keep one outstanding, and that's moved your credit metrics back into the investment grade land while you turn around the performance of core Wendy's? Would you agree with that statement? I would not agree with that statement. We have had those conversations with the rating agencies, and I would not agree with your statement about first of all we can't prepay the debt, that is something that's very clear in the terms. I understand we could. But I still do not think that that would be the total influence on the rating agency. Hey, Kerrii, in the release there was some positive comments made about the Frescata and mentioning it was the most exciting product to launch in years. I'm wondering if you might be willing to say that you've gotten to positive same-store sales and whether you're kind of watching that hoping to see some repeat before you go any further with it. Could you give us some indication there? Well, David, I have to give you credit. That's a pretty nice try. As you know as a matter of practice we don't give out specific information about our monthly sales trends in the current quarter, but I will tell you that the Frescata roll out was in late March, and the marketing really just started mid-April, right after the Easter holiday, and we are very encouraged by what we've seen so far both Company and franchise and that's about the best I can do for you. Well, we talked about having one store here in Columbus, Ohio. We have a couple of stores that we are preliminary testing even in Raleigh, North Carolina, and then we are prepared to roll out the test more in the fall in a controlled situation. Hi. Thank you very much. I'm wondering if you can give me a breakdown of the profitability, this is for Tim Hortons in Canada and the U.S. and also maybe give us indication of your marketing spend in the quarter relative to what it's been in the past? Sure. With respect to the breakdown of our earnings between the U.S. and Canada, my preference is to wait until the financial results are finalized and that would be in the Q. Again, I'd like to wait until the Q comes out and talk about it at that time, but we did have very favorable same-store sales results in the U.S. and we feel good about the progress that we're making in the U.S. business. It would be up slightly just based on the fact that our sales last year increased, and so our budget grew accordingly, and so there would be a bit more money to spend in the first quarter versus last year, but not of major significance. David, this is John. We're going to get back to you. I know you had a call into us. We were a little busy the last day or so. We will get back to you and get back on some of the questions you had. Hi. I was actually hoping for clarification on a couple of numbers on Wendy's, Kerrii. First is, if I heard you correct you said of the $100 million cost savings, approximately $80 million are going to be allocated to G&A, and our back of the envelope suggests Wendy's run rate G&A is about $225 million, so that would imply about a 35% reduction in G&A for Wendy's in the context of enhancing your service to franchisees and customers. Does that allocation sound reasonable? I will say that it is, Peter. It's a little less than 35%. It might be on the lower end of the 30%. But, yes. Okay. And then for the quarter, I realize it is seasonal, but the Wendy's business posted operating income of $12 million which included the benefit of the real estate gain. So taking into consideration the income from the franchising side of the business, that would imply that Wendy's Company operated margins were negative during the quarter. Does that sound reasonable to you also? Well, I think you have to remember that we did lose the $4 million in rental income compared to a year ago in the same quarter because we've now sold those properties. The gains on the sales of the properties were basically offset to that. Right. So the operating income for both Company and franchise units was just $12 million for the quarter, and obviously the franchise business really didn't have a huge change in cost structure? Thanks. Kerrii, just a question I'm just getting in the mind set of the franchisees, there's been changes in the Chief Operating Officer over the past six to twelve months a couple of times. I am just trying to understand comps continue to lag. You spend more money on advertising in the first quarter and I'm not exactly sure of the timing of that. But, it didn't seem as though it provided a lift at least for the whole quarter. Could you just describe kind of conversations you've had with franchisees and kind of where they're at right now from a mindset standpoint? Well, I'd like to first respond to your question about the incremental advertising. It was more in March and nothing is immediate. It does take time for the message to resonate with customers, and you generally see a lag impact. I will tell you while we made the incremental investment I did share with you that we actually, with McDonalds coming out with spicy chicken sandwich, did not see erosion of our spicy chicken. So I that's actually is a positive in our mind. So that's from that perspective. I have spent quite a bit of time over the last couple of weeks talking to franchisees. I would say generally, franchisees are very much focused on their business. They were certainly concerned about the negative comps, concerned about where we are with respect to effective marketing campaigns as well as new product introduction. Our conversations have really come around wanting to have leadership in the operations role, and quite honestly that was part of making the appointment of Dave Near. I think we have not had anyone in that role of key role of operations since Tom Mueller, as you pointed out left last September/October, So from that perspective I think that is a key factor to meeting the needs of the franchisees and for all of us to be focusing on what is happening in the operations of our both franchise and Company business. I'd tell you in general, everybody is focused, we now have new products, the Frescata and some of the salads we rolled at the end of March were the first new products we had rolled in almost 18 months. So I think we're having new news. We have a strong calendar going forward. As you know, we're continuing to make a $10 million investment here in the second quarter which is the rest of the $25 million. So I think we have a number of very positive initiatives, and as a management team we are focused on driving this business in a positive way, and really strengthening our relationship with our franchisees. They are our partners. If they are successful, we will be successful. But we will not get there without them. So we are focused on making sure that we're working together. Okay. And just one follow-up on the G&A question earlier. I know you talked about the different line items that's going to flow through in the P&L. Did you talk about the timing with which we can expect to realize this $100 million? The timing really is the first quarter of 2007. That is our objective. That is what we shared this morning that we would want to be on a run rate by the beginning of '07 to realize the $100 million. Yes, good afternoon. Christine, I wanted to ask you about the tax rate. If I add the $8.8 million that you had in gains that you had this quarter, I come up to about $15.5 million on the taxes which is a much lower effective tax rate than you normally run. Can you kind of flush out the effective tax rate and what we can expect going forward? We are not going to talk about the forward-looking tax rate at this time. I mean I think what we talked about on the road show was 34% was the long-term rate for the Company, but at this point in time because of things related to the spin and the distribution of Wendy's remaining interest in Tim Hortons, there are certain areas where it could impact the tax line and we want to make sure that we are watching that as that unfolds. First quarter I think we talked about it, but there were really two items in the first quarter, and they were $5.8 million and $4.3 million. The $5.8 million was a release of a deferred tax on a Canadian withholding tax, and the $4.3 million was a tax loss on some hedge transactions that we had in place. Hi. I have a question with respect to the IPO of Tim's and the future full spin. Have you guys taken any time to look at the entirety clause? Within the indenture of what the 2011 and the 2014 maturities are given that Tim Hortons generates over 50% of the operating income and that now trades at a much higher multiple relative to Wendy's. Do you think there's anything there with respect to that covenant? I'll be honest and tell you that the answer we believe is no, the call does refer to transfer of substantially all assets, and the fact that Tim's comprises more than half of our net income has no bearing on the covenant. What about the fair market value of assets given that since Tim's has since been IPO'd we can kind of derive the full value of what Tim's is relative to Wendy's and what the market is implying those values are? The fair value of assets, not the book value of assets. Today accounting is based off the assets as reported and not fair value. So we would say it does not have an impact on the covenant. Hi, Kerrii, back over to Wendy's for a second, the February 6 press release where you detailed the combo plan had three components being increasing comps, improving restaurant margin 500 bips and then the $50 million of cost saves. The cost saves you updated that component. Are you still comfortable with the framework of the other two and how you're getting there? I will say we are absolutely. I mean we are focused on growing sales as well as a number of margin improvements. This morning at the annual meeting I talked about a number of key initiatives that we're working on to improve margins that aren't related specifically to just growing sales or reducing costs, and I think we are making significant progress on that. Just to make sure the 500 basis points of restaurant margin you're targeting are independent of that $100 million that we're talking about or the $20 million is part of that? Thanks. Just sort following up on that; part of the original program was to refranchise the U.S. It sounds like you slowed down or halted the program. So I guess can you update us on how you think about refranchising? Do you have to first realize the cost savings before you go after that or might we still see some of that later this year? You are exactly right, John from the standpoint of our focus right now is to get the cost out with the current restaurants we have at Company-owned today. Certainly we still think it's important to refranchise some of our restaurants, but not at the current levels that we are producing margins today. We do not think it would be reflective of the value of those assets, so as a result we have slowed down that process until we improve our operating margins at the store level. This is a follow-up to Mike Notaro's question as far as the conveyance covenant goes. I'm assuming that when you did the spin you guys obtained opinion of counsel, internal and external, that this wouldn't violate the covenants and you're very comfortable that you can do this without tripping that off? If I said that, that would be correct, right? Okay. Thank you very much. We want to thank everyone for joining the call. You can follow up with Dave Poplar or myself later today and tomorrow. We'll talk to you all later. Thank you. |
EarningCall_234075 | Hereâs the entire text of the Q&A from Intel's (ticker: INTC) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Q: Thank you. Essentially Andy for the September quarter, if you did not have the chipset constraint, how much more revenues could there be? A: Well, it is difficult to estimate. If we had not had the chipset constraint, it would certainly cause us to round to the next higher, if not a little bit more. Q: Great. And I am terms of the inventory build, with the end customer, essentially is this, I mean are you seeing this across the board or is it more specific? And where do you think it comes from. A: I don't want to point out any specific customer but there is not a lot of them. We saw the inventory build. And what happened, I think, is we have been in a period of tightness. Our customers do want to make sure they have respond to a fourth quarter upside and in reality it is perfectly natural if you can get a few extra part, you get a few extra parts. A : China is about to become, or if it hasn't already, the second largest consumption market in the world for PC's after the U.S. It is about to pass Japan. So it is in that range. A: China, what we called out specifically, because it is a big enough percentage of revenue, so you will see that. India is much smaller at this point. Clearly just getting under way as a growth market. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Mr. Chris Caso of Friedman Billings Ramsey. Please proceed. Q: Yes, hi, thank you. I wonder if you could just give some more color on the gross margins and, specifically the increase for the fourth quarter, if you can kind of break down for us where the sequential increase comes from, perhaps, break it out by the different components? A : By far, the vast majority of the increase in large percentage for the fourth quarter will be in the qualification of the products in 65-nanometer production. You always get a little bit of benefit when have you increasing revenue, particularly in a quarter when you make processors the biggest driver, so to a small amount, we have the product mix. By far, the biggest explanation will be adding the qualification for the 65-nanometer product. Q: Okay. And as a follow-up, if you can just,, address, obviously, a lot has been discussed about the capacity constraints that you're under right now. How do you see that playing out perhaps into Q4 and into Q1. Which areas do you still expect to be tight as you exit the year and go into Q1? A : Clearly, the chip set constraint will continue into the fourth quarter. We are producing more chip sets ourselves. We do have relationships now with a couple of other suppliers who will be providing chip sets for the low end desk top. It takes a while for that competitor to come online. I still think you will hear a fair amount of noise in the third quarter. We are hopeful that as we get to the end of the quarter we will start to get some relief from the constraints we have been seeing. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Christopher Danely with JP Morgan. Please proceed. Q: Thanks, guys. Just a quick clarification and then on to the questions. So, Andy, you said that the reason that the Q4 sales guidance is a little less than seasonal is basically because Q3 was better than seasonal and there is a little bit of an inventory build out there? Is that where we're going? A : That's correct. I said that I thought there was about $100 million of inventory build in the third quarter, which means if you look at quote normal consumption, it would have put us back more towards the midpoint of the third quarter season. If you recall last year, we had a situation like that, and we over forecast the following quarter, and not allowing the inventory to be used by a customer, so what we see is seasonal consumption, and we see about $100 million inventory swing for us between the third and fourth quarter. A : Well, you saw inventory up under $100 million, all essentially good for the third quarter, which was a pleasant surprise, to be honest. And I do think as we qualify the product for the 65-nanometer, that then does put some spending into inventory and I would expect to see the increase in inventory levels in the hundreds of millions, above 200, less than 400, something like that. Thank you very much. And again, ladies and gentlemen, we do have a question, please key * 1. Our next question comes from the line of Michael Masdea of Credit Suisse First Boston. Please proceed. Q: Thanks a lot. Continuing on the gross margin side, one of the major concerns out there is that we may be at or around peak gross margin for Intel. Can you talk to us about the dynamics that are playing out in '06 that go into making a decision like that or a call like that? What are the moving parts and cogs that we should think about next year assuming that demand is alright and ASPs don't surprise us in a big way. A: You took away all other factors. The biggest factor of gross margin next year will be demand, will be the worldwide economic health and our factories stay full, our margins will remain fine. I think that our product is getting stronger and stronger as the year goes on. I like our product lineup at this point and what it comes down to, can I keep my factories full, and if I can, we're in pretty good shape and continue to make our cost targets and continue to have a decent year. I'm not going to make that call until January. January, we will give you an estimation as to how we think the year will unfold. A : The answer is no. But, I'm not going to tell you, if you go back through our entire history, it doesn't get much better than it does in the fourth quarter. There are ways it could be margins could be higher but it is a complex mix that has to be how successful your chip set business arch the flash business and the mixers involved and different types of processors involved, and a lot of moving parts. It can be higher, and quite frankly it can be lower. Again, why don't you wait until January and I will try to give you a little bit more insight. Q: A quick follow up on the chip outset I'm trying to recall Intel has been capacity restraint consistently for a year and is there something else going on here that is driving this on the transition of 300-millimeter or anything else that is factoring in here? A: The factories are helping, no issue there. The chip sets are on the 8-inch network. We're transitioning to the 12-inch network next year, which will certainly give us a lot of relief. I would say we're gearing toward a decision to try not to grow the 8-inch network. We want to invest in the 12-inch, which is our future. Demand spiked on us and as a result we got tighter than we would like. The investment goes forward these days. Thank you very much, sir. Ladies and gentlemen, our next question comes from the line of Mr. John Lau of Jefferies & Company. Please proceed. Q: Thank you. Andy, circling back to the inventory comments, I think most people are concerned about. That so specifically, do you believe that this inventory is prudent given the current tightness? And if so, and if you take a look at the PC demand, if that remains seasonal throughout the year, seasonally normal throughout the rest of the year, will that inventory sell through without any excess by year end? Thank you. A: I clearly believe the inventory that we have in the third quarter is prudent. In fact if I could have it today, I would take it today. And it is in a time when we have been constrained, we're doing all we can to try to make sure we have the parts available. We've learned many times again, which you see over this last year, Intel is always better to have parts available ready for an upturn and not constrained like we have been. So yes, inventory is prudent. Under normal business conditions we will not have excess inventory. It is a very controlled normal environment. The only thing that is going to cause me a problem will be if there is a worldwide economic problem. And demand drops more than you would see in the first and second quarter. Q: And those comments, I was also relating not only to your own inventory, but the inventory that you had commented with regards to your major customers. Is that correct? A: Absolutely. Again, $100 million in the worldwide PC networks is very small. We still are in a situation today where we have customers in channels we would like to actually have more products. So we have outlets if we would have inventory right now. Q: Okay. And just, I know I'm beating this again on you, but assuming a normal PC seasonal demand out there this shouldn't be an issue by year-end then? A: Oh, absolutely not. By year-end '04, as I said earlier, I still think I'm going to be struggling to meet the chipset demand. I think the nanoprocessors is gone. Thank you very much, sir. Ladies and gentlemen, the next question comes from the line of Mr. Adam Parker of Sanford Bernstein. Please proceed. Q: Yes, could you give a little more color about Q4, your guidance in revenue in particular? Do you think it is indicative of a slowing PC market, a sense that maybe your blended ASPs are going to be down? I think you said they're flat sequentially. Or is it continued share loss to AMD who has guided to more like 10% growth that is making you,, coming into I guess it is several points below normal seasonality? A: So I will choose the fourth, and say none of the above. What I believe is happening is there is a bit of inventory build in the third quarter, that inventory will be sold out in the fourth quarter, and quote, the extra inventory won't be replenished but as a result it will appear to be an above seasonal third quarter for us, and a below seasonal fourth quarter consumption in PCs, and PC-type products will be perfectly cease seasonal for the third quarter and the fourth quarter. Q: I mean if you add 100 million to your midpoint, which is the number you're throwing out there, and it is still, it doesn't get you to even the lower end of normal seasonality over the last five years so it just seems like, maybe we're splitting hairs on a couple hundred million dollars, I'm just trying to figure out do you think that anything else is going on? A: I agree. You also subtract 100 out of the third quarter. And if you take 100 out of the third quarter, you have a seasonal third quarter and if you add 110 to the fourth quarter number from the third quarter number, you are back to your seasonal fourth quarter. Q: It is close enough. All right. The other question is, you talked about, trying to keep your revenue growth above your operating expense growth, and are you looking at a year where SG&A growth is going to be about 20% plus or minus above your revenue growth. It is there something that you can point to in terms of why that is really had to come up a lot in the last year? Is it competitive positioning or new initiatives with dual core? And how should I think about, the SG&A growth in particular going forward? Are we in a new environment where that is going to have to be still pretty high or how should I think about that? A: If you look at we will take R&D and SG&A and look at it as a combined investment spending. Year-over-year, the increase in that bucket will be the same as the increase in revenue for '05 versus '04. The difference you're seeing is the front half of the year we grew spending at a much lower rate, as we have in some prior years. And the second half of the year spending more quickly. We have every intention now to trail off the spending growth to match revenue growth next year. So we think where we're at for the year right now is a pretty comfortable place to be. Q: So I'm kind of confused. Why do I have to think about it as combined SG&A and R&D? I guess dumb Wall Street guys sort of think R&D going toward technology and the SG&A going toward marketing. Is that too simplistic? A: We think of them as both investments. For example, we have to choose between whether you're going to do a new version of a processor versus a marketing program like Centrino. Or _____ you get a return on each of those. And what we have to do, under the guise of trying to make sure spending in total matches revenue growth, it depends, figure out which of those we think we will get the best return on and allocate spending appropriately. We don't separate the two buckets. We make investment choices in total. Q: Got you. So bottom line is long term there is no operating leverage? I mean in terms there is no operating expense A: Our intent right now long term would be to have revenue and spending grow pretty much in line with each other. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Tim Luke of Lehman Brothers. Please proceed. Q: Thanks. And I was wondering in your guidance of midpoint, could you give us any sense of after the quarter and third quarter digital enterprise was up around and mobility under around 12 or 13, whether one would continue to expect the mobility to exceed the digital enterprise growth or talk about maybe some of the factors, influencing the differentiated growth rates of the two areas? A: We certainly expect to see mobility to be a driver of growth. It is now a year ago, we would sit and talk about it, and talk about the U.S., and is not a worldwide phenomenon. It is going to continue, we're seeing the price points of those products hit in the places around the world where many, many more people are choosing to have the ability to have a laptop to be mobile. And American business, you see it almost exclusively, being what is being bought, same thing in Western Europe. I don't see it changing. The capabilities of those machines are such that they will continue to be the growth driver. A: I don't want to get pinned down to giving growth rate percentages off of baseline inventories. We don't provide it to being with. I would just say, you can look at (36.19) has been, it is going to continue for a while. We don't think we've begun to hit the equilibrium point yet. A: It would be well, I will say in the Intel architecture product line. I would say it is not flash or communications stuff. A: I don't want to define it any more than that. It is in the Intel architecture, so think logic, and silicon, and as my friend Paul is pointing out to me, $100 million equals about two days worth of shipments, so it is a small number. Q: And lastly, as we look at the beginning of next year, if we assume normal seasonality, just if you could give us any flavor of the factors that may influence the gross margin from this very high 63% level, as you end this calendar year? A: No, I'm going to, I have got new back one, I will hold off answering '06 margin questions until '06. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Joe Osha from Merrill Lynch. Please proceed. Q: Hi, folks. Two questions. First, just back of the envelope math, in terms of your silicon acreage next year, if you will, would indicate to me that your capacity growth for 2006 is going to be higher than 2005. Is that a reasonable statement? Q: Okay. Second question, you bought back now $7.5 billion worth of stock this year a lot of it at higher levels than where the stock is now. You got a market multiple basically, your dividend yield is half the Dow, so I guess my question is, since the market obviously isn't necessarily being all that impressed by these buybacks, why is the dividend yield on this stock not twice what it is? A: That's a decision made by the Board. It is a decision that gets debated throughout the time frame and those discussions are under way, and if they decided to change the dividend yield, we will certainly let you know within 24 hours. Q: Well, I mean you're a smart guy. What's your impression of why it is the Street is not rewarding this massive stock buyback? A: Actually, that is a hard debate for us to get into. If we hadn't done matching buyback, the price would be the same. Anyway, I don't really actually I'm not going to go there. We will continue to look at ways to return cash to shareholders, and I'm sure we will look at whether we should increase the dividend and do more of that versus buybacks. Q: And just back to the first question. Is it fair to say that the incremental just confirming your incremental capacity comes from bringing the conversion of Chandler back up, and then also continuing to ramp the second phase of Ireland? Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Michael McConnell of Pacific Crest Securities. Please proceed. Q: Hi. Thank you. A question for Paul. Paul, with the Bensley right around the horizon, what should we expect in terms of the server market, with the competition there? Are you expecting to regain some share with Bensley, or do you have a higher degree of confidence that if we look into the summer with the new architecture on the micro server time, should that be the time we think about share reversals in the server market? A: I think that I'm not going to give you a specific number, Michael, but we've got three events all of which are very positive in our server line. One is the tax bill launch for DP a dual processor, and then MP, which is coming later this quarter, which are already having an impact in our volumes. The second is the Bensley platform launch in Q1 that you referenced which I think will give us another pop. Implicit also in Q1 is our first very low power blade for servers, Soccer man will be shipping, and then mid year, you're right, we have the next generation 65-nanometer products woodcrest platform shipping. All three of those events happening over a kind of a quarter a piece, over the next year, really give us much more competitive road map in '06 than we have today even. And I would expect to be able to exploit it. Q: In terms of though, an inflection, should we think about it being more gradual? I'm just trying to get a sense of your perm confidence and when we can A: We're going to ship the heck out of them when we get them. At that point it just becomes how our customer does. A: They're all very excited, and the feedback about pulling the product line in is very, we're very well received. Our customers, as you've already seen, are able to exploit it with a dollar per TPC number that Dell put out, giving them industry leadership on that platform. Q: Okay. And then one last question, just on the chip set side, on the low-end desk topside, there's been some speculation that Intel is going to be exiting that segment. Should we look at that as being strained or is this a matter of you being constrained right now as we go into Q1 you start to ramp the chip sets at 90-nanometer, are you expecting some of the third party arrangements that have you right now to work their way back down, and then you start to obviously ship what you want to within that particular market segment? A: We backed off on the low-end desktop volumes this year, because of the capacity constraints. And we didn't get out entirely. We backed down some. And you will see us as we get capacity over the course of the next year, re-enter that part of the market again. It is our intention to be a broad-based supplier of chipsets. It is intrinsic to our platform strategy. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Tom Thornhill of UBS. Pease proceed. Q: Thank you. Question for Andy in gross margins. You laid out a unit cost program at analyst meeting about a year ago, Q4 '04 to Q4 '06, down 25%. Q: Where are we on that plan? How much progress have we made? How much progress is there yet to go? A: Today, I'm a little ahead on that plan. And if my factories can stay full next year, I'm pretty comfortable with that plan. What it comes down to, today, Tom, quite frankly it is also a give me, because the fact I'm building everything I can build. If we have normal loadings next year with the company on track to make it, today with loading, I'm ahead of where I thought I would be. A: Boy, I don't want to wing it. Sorry, I don't know the specific number we had for this particular time. A: There certainly is more to go next year. You get the benefits of 65-nanometer coming across the product line. You get more 300 millimeter near the product line. You get, non-processor products fitting into the 300-millimeter factories. So there is the technology is bringing more benefit through next year. Q: In '05, gross margins were impacted by 65-nanometer start-up costs and I understand that their start-up costs continually on new process, but there are ramps and sort of tidal surges in those. What has in '06, is there something similar in the offering that we had in '05 or not? A: Not the same level of tidal surge. As you get towards the end of next year, you will begin to start seeing the beginning efforts of getting ready for the next manufacturing process. But it is to back in the last year and it will be much smaller than we saw in '05. Q: Okay. Paul, a question about enterprise. Revenue growth quarter to quarter, can you differentiate at all between desktop and server? I mean it is clear that mobility had good growth, because we can see that, the way you report, but between server and desktop, was there a difference in the growth rates? A: There was a no difference. They were both positive. That's about as much granularity as I can give you Tom. We grew units in both desktops and processors this quarter. Q: Given that your servers were up, and since we know what your competitor has already reported about their sequential growth, they are clearly the rate of share change slowed, what were the key factors in that, in the first quarter? That carry into Q4? A: Again, a new platforms shipping, we've been doing actually better than we expected internally this year because our product line has been able to be pulled in over the course of the year. Bits and pieces and that along with our customers being pretty aggressive, you've seen bell be aggressive, you've seen HP be aggressive, IBM with the hurricane platform has done very well with Intel based XEON products. All of those combined have given us pretty solid year-end servers. Better than I had expected coming into the year. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Ambrish Srivastava with Harris Nesbitt. Please proceed. Q: Hi Andy just trying to considering your comments on channel business, you mentioned it was flat Q-over-Q. And then you talk about growth in emerging markets. And what am I missing here? Is there something going on, IE, some market share shifts or how should we be looking at it going forward? A: The emerging markets are served more than just by the channel. You have big local OEMs like novo and Dell establishing presence and you have HP being active and what tends to happen this quarter is we saw the large OEMs being more successful in all markets, emerging markets particularly, versus the channel, but not the management. Like I said, the channel is flat, so the growth happening in the OEMs happens around the world. A: It hangs around the 30%, plus or minus a couple of point force the last decade so I wouldn't see it moving out of that range. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Hans Mosesmann of Moors & Cabot. Please proceed. A: Well, we're not allowed to give out TPC numbers until they're in volume but we're comfortable that this will be a very competitive platform and it is not just in TPCs, it is as I said earlier, we've got other platform features in terms of manage ability and virtualization that will be released with that platform that we think have nice value-add for our customers. Q: Okay and a quick follow up 65-nanometer, when do you expect the crossover to consider in '06, if it does occur in '06. Thank you very much, sir. Ladies and gentlemen, your next question comes in from the line of Cody Acree of Legg Mason. Please proceed. Q: Thanks. Paul, following up on the server side, not being able to give specific jumps in performance, but it does sound like Woodcrest is going to be a real step function in capability. Do you run into an issue, maybe where there is such an anticipation in the step functioning capability that we see some delayed purchases during the first half of next year, waiting on this new architecture to come out next year? A: I have never seen that yet in my history of this industry. So it would be remarkable for that to happen. And I don't think so. I think people tend to buy from their existing vendors, when they need the product, and they look at the road maps, they have to vault them, and the one difference is when they see the need for a new blade server that may have a lower power envelope into an existing data system, that is something that might actually be something that people wait for and you have seen us launching the product early in Q1. Q: Okay. And then just secondly, last year, you guys ran into an issue in excess supply, partially at 90-nanometer yields came up faster than you anticipated. 65 sounds like it is coming on pretty quickly here. As you run into next year and you start to look at a little inventory building here internally, not knowing exactly where demand is going to fall next year, but yet it looks as though yields are progressing well, what are you doing to make sure we don't see some repeat of that upward yield surprise last year? A: Well, the difference this time is 90-nanometer factories will be a pressure relief valve for our chipset business, which as Andy indicated, are essentially built-on our eight-inch network today and therefore constrained at the upper end of their volumes. By having the processors move to 65-nanometers, we free up capacity for chip sets. And that allows us to move on to the next generation, more capability, lower cost, and ultimately take the eight-inch either offline or retrofit that. Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Mr. Ben Lynch of Deutsche Bank. Please proceed. Q: Hi there. First question I had was, Andy, you guys have stuck to this sort of typical $600 million revenue range guidance for Q4. Given that your capacity constrained, I would think that you might have a tighter view on attainable revenues. Sort of removed one degree of freedom. I'm just wondering how much is their revenues attainable sensitive to capacity constraints? And somebody asked specific to Q3, what did you, you think the dollars left on the table were, and you didn't want to get pinned down. Could you maybe comment on that for Q4, please? A: Sure. The, there is a reasonable probability it could show up in the upper end of that range. Remember we are building the inventory. If demand is strong enough to consume that inventory, we do have upside to the current range. So I don't think I'm capacity limbed at this point. We do make sure we have chip sets available, that customers do have a little bit more juggling than they normally do, but I'm pretty comfortable with the inventory build I have planned, that if demand is strong, that we can find a way to meet higher levels in the midpoint we've given. A: In terms of whether Q4 will be constrained. It is tough to predict. At this time, I don't think I see chip sets con straining the business, other than the chip set business, and it's hard to know today exactly how much that will be. It is hard to even know looking backwards how much it is con strained to prior quarters. So I think there will be some constraint. I think there will be some lost revenue opportunity in the chip set space. And I think the rest of the business will be about okay. Q: Okay. And you're not sort of factoring in the possibility as just product availability for a tight for chipsets that you ship a bit later in the quarter than you normally would? A: It certainly is a possibility but again the customer base is pretty resourceful in finding ways to meet demand if demand is now. So I think we will continue to see people scrambling, we will continue to see people doing all they can to meet customer's demands because they're concerned of a loss shipment a delayed shipment is a lost shipment. Q: And the other phenomenon that you have is we're launching the Napa platform and the Viiv platform in Q1. So I think people will take product later in the quarter in anticipation of the launches in the January timeframe. Q: Okay. And then the second question I have is then for you Paul, directly was I think in September, according to current analytic, one of the houses out there, they say that AMD for the first time ever over took you in U.S. retail desk top for a full month. Can you take a bit about this in terms of, to you think the data is sort of representative of what happened? It doesn't really matter? It is due to chip set shortages? You guys are focusing on notebooks? Just sort of give your perspective on that, please. A: Well it is about of all three of those. I did see the data just briefly and I haven't analyzed it yet, but the first approximation, I can't argue with. It the U.S. retail phenomena, though, have you to remember is no longer reflective of the U.S. consumer market. Because it excludes the direct business. For example Dell is not in there and Dell is the largest consumer vendor in the United States. So you need to really add Dell's numbers into that to get a snapshot of the U.S. consumer numbers. Number two, as we were constrained on low end desktop chip set, much of those were retail oriented and for companies like Hewlett Packard, and the results are what you saw as a result in U.S. retail. On a worldwide basis, the numbers don't look anywhere near like that. Q: Thanks. Hopefully not beating a dead horse, Andy but in terms of the last comment, when you said that the delayed shipment is potentially a lost shipment, in terms of stock-out, when you take a look at the 100 million in the inventory, was that essentially due to a constraint? And did some of your lower guidance for fourth quarter, based on an assumption that some of that 100 million, or what was constrained in the third quarter won't materialize in the fourth quarter? Q: The 100 million build that occurred at some of the larger OEMs, I assume was due to constraints and the inability of some of those OEMs being able to ship? A: I don't think so. I think it was the OEMs wanting to make sure they're prepared for an up Q4 and have inventory in place when they had a chance to have it. I don't think it was lost orders for them. Q: Maybe looked at it a different way, you answered earlier that you did believe that some that there was some upside that could have been realized in the third quarter. And what I'm looking for is whether or not we are still somewhat tight in the fourth quarter. Could that spill over into the first quarter as you like to bend people are still scrambling and make sure a delayed shipment does not become an outright stock out and a lost shipment? A: It is possible if we're con strained in the first couple of months, some revenues lost that could have been had. I think I was talking about our revenue, and I'm not speaking for our customers. You need to get their input, their data from them. And in our case, we believe if we had more chip sets, we could have shipped more chip sets. Q: Andy, one other question, just in terms of the shift going on right now. I noticed your tax rate actually coming up a little bit, even with the other issues. And yet, your shipments to Asia are well over 50%, and seem to continue to grow fairly well. Can you give some sort of idea as far as is there a shift going on right now, or some of the stall-outs, and Paul, to that idea, the ESPD group, in terms of the server side, included with the OEMs or within channel group? Just for a little more clarity. A: Our tax rate, I will do the tax rate one first. Our tax rate is essentially a function of mostly where the fabrication takes place. As more is done in the United States and Arizona, and in the development Fab out in Oregon, you see a higher percentage of the revenue and less effectively a higher tax environment. A: Your question on the service, all of the server revenue is reported in the DEG or Enterprise Revenue Group, whether it is shipped through the channel or through the OEMs. Q: Okay I think when were you talking about flat channel, any progress in terms of that ESPD group as far as enabling now particularly toward the i campaigns? Operator: Thank you very much, sir. And ladies and gentlemen, our last question this evening comes from the line of Glenn young of Citigroup Investment Research. Please proceed. Q: Thank you. I guess either for Andy or Paul. If I were to look at, let's say your guidance plays out for the fourth quarter. Can you compare where your utilization would look like exiting Q4 of this year compared to how it looked exiting Q4 of last year? A: Exiting Q4 of this year would probably be a little higher than exiting Q4 of last year. If you recall last year in the fourth quarter, we had the 12-inch factories full by the end of the fourth quarter. We had wafers start in 8-inch factory full. However, we started though in the middle of the quarter that the lead time to get through the factories. At this point, everything is full. Beginning in the first quarter, first part of the quarter. So in effect, have you a little higher utilization but not dramatically. In both cases, you see three or pretty full factors. Q: And one of the elements of this year's first quarter was 65-nanometer start- up charges looking better than you had anticipated. And I think you answered this already but just to be clear, you don't have anything like that in the first quarter of next year where it could play a factor in the way gross margins could proceed? A: Again, I'm trying to stay away from next year's margin questions but there is, to my knowledge now, actually no big surprises in the first quarter, no. Q: And then early in the year, you had talked about ASP pressure in servers in particular. And I wonder if we looked out into 2006, at Bensley, both with Dempsey and Woodcrest, middle of the year, whether you would anticipate the pricing pressure next year would not be as intense as it was earlier this year? A: I do think our products are getting stronger versus competition but I really can't talk about pricing for next year. It is way too soon. Q: And the last question, just to absolutely clarify this, when you look out at your guidance for the fourth quarter, recognize can that the combination between Q3 and Q4 is normally seasonal, has there in fact been any change from your customers' perspective in term what was they're telling in terms of what demand will look like in either quarter? |
EarningCall_234076 | Hereâs the entire text of the prepared remarks from XM Satellite Radio's (ticker: XMSR) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.[[ more ]] Good morning, my name is Jamie and I will be your conference facilitator. At this time, I would like to welcome everyone to the XM Radio Third Quarter 2005 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. [Operator Instructions] I will now turn the call over to Joe Titlebaum, Chief Counsel. Thank you, Mr. Titlebaum. You may begin your conference. [Joe Titlebaum, EVP, General Counsel and Secretary] Hello everyone. This is Joe Titlebaum, General Counsel of XM Satellite Radio. Before we begin our prepared remarks, I would like to remind everyone that certain information on this call may contain forward-looking statements. Due to a number of factors, our actual results may differ materially from those projected in such forward-looking statements. Those factors include future demand for the Company's service, the Company's dependence on technology and third-party vendors and the potential need for additional financing, as well as other risks described in XM Satellite Radio Holdings, Inc.'s Form 8-K filed with the Securities and Exchange Commission on August 5, 2005. Copies of this filing are available online and upon request from XM Radio's investor relations department. I will now turn the call over to Hugh Panero, President and CEO of XM Satellite Radio. [Hugh Panero, President and CEO] Good morning and thank you for joining us. On the call with me are Gary Parsons, Chairman, Joe Euteneuer, Chief Financial Officer, Steve Cook, Executive Vice President of Sales and Marketing, and Joe Titlebaum, whom you just heard from. This morning we will review XM's results for the third quarter 2005, a quarter that exemplified what I'd characterize as the smart subscriber growth the Company has demonstrated quarter after quarter and year after year since we started service in November of 2001. We will focus on XM's strong subscriber additions this quarter, including a close look at our positions in both the automotive and retail distribution channels. We will highlight some programming initiatives designed to appeal to new subscribers while ensuring that our current subscribers remain dedicated listeners. Further, we will discuss recent product releases as well as provide an update on our strategic partnerships. Finally, Joe Euteneuer will summarize XM's financial performance, illustrating how we maintain our market leadership while building a sound business model. The third quarter again demonstrated XM's ability to deliver dramatically-increasing subscriber and revenue growth with the lowest subscriber acquisition cost, or SAC, in the industry. From a strategic standpoint, XM has built a powerful economic engine with both the automotive and retail cylinders hitting in parallel. Our long-term value is in the integrated business elements we have executed, which include advanced products, great brand image, broad cost-effective distribution, lasting partnerships and outstanding content. First and foremost during the quarter, XM surpassed the 5 million subscriber milestone in September. It took nearly two years for XM to capture its first million subscribers, which was in itself a record surpassing the early adoption rates of cable TV, the Internet, CD players, and other mass media. Now we are going to add that many subscribers in the current quarter alone. During the third quarter, XM added 617,152 net new subscribers, ending with a total of 5,034,642 subscribers. Our growth during the third quarter represents 48% more net new subscribers than the 415,671 subscribers added in the third quarter of 2004, and slightly fewer subscribers compared to the 647,226 added in the second quarter of 2005. Our significant third-quarter subscriber growth occurred in the face of a new rate structure instituted in the prior quarter and a softer market for new car sales. XM's subscriber growth rate is reflected in the Company's rapidly increasing revenue, reaching a record 153 million in the third quarter of 2005 with subscription revenue of 140 million. Third-quarter revenue more than doubled to 65 million in revenue reported in the third quarter of 2004, and is 22% more than the 125 million recorded in the second quarter of this year. The secret to XM's smart subscriber growth rather than growth at any cost is the ability to control marketing and product expenses while rapidly growing subscribers. This quarter, XM kept its fully loaded per-unit costs of capturing a new subscriber, or CPGA, constant at $89 -- the same CPGA we reported in the third quarter last year. These results provide us the flexibility to aggressively advertise and market our service in the fourth quarter. And in fact, that is what we are doing, implementing a comprehensive media campaign comprised of advertisements, rebates and other promotional techniques to fully exploit the holiday selling season again this year. XM is clearly the dominant leader in the satellite radio industry with over twice as many subscribers as our competitor. Our subscriber growth continues to set records, even relative to other subscriber businesses because of our healthy positions in both the automotive and retail distribution channels. As in the prior quarter, each distribution channel contributed approximately half of the third quarter's net subscriber growth. Let's first turn to the exciting automotive OEM channel, where XM is far and away the satellite radio market leader, as the third quarter 2005 demonstrated, when XM added more than 300,000 net new OEM subscribers. Success in the OEM channel requires carefully-developed long-term relationships with the largest automobile manufacturers, and factory installation of satellite radios is the key to adding large volumes of subscribers. XM's OEM partners represent 61% of the U.S. auto market. Currently, the majority of XM's OEM subscribers come to us through General Motors and Honda. General Motors has proven to be an outstanding partner of XM. In September, GM announced that it had produced its 3 millionth vehicle with factory-installed XM Satellite Radios. In 2006, GM is planning production of 1.55 million vehicles with XM factory-installed, a 150,000 more GM vehicles than currently expected for 2005 and a third more vehicles than 2004. American Honda Motor Company, another of the world's most successful car companies, recently announced it will equip over 550,000 of its 2006 model year vehicles with XM Radio. XM is now factory installed as a feature on the 2006 Honda Civic, one of the best-selling models in the U.S., as well as in the 2006 Honda Pilot, Accord, Odyssey, Element, and Ridgeline. XM will also be an option on the all-new 2006 Honda Civic Hybrid and a standard feature on the Honda Accord Hybrid. On four Acura models, XM is a standard factory-installed feature. While we have benefited greatly from our partnership with General Motors and Honda, we also have been building a lasting foundation in the OEM channel with numerous other leading automakers that will drive our factory installation program beyond 2 million vehicles. Hyundai is the first automaker planning to launch XM as a standard factory-installed equipment across its entire model lineup. By year-end 2006, over 70% of Hyundai vehicles built will be XM equipped, with the remaining models following quickly thereafter, totaling well over 500,000 units by 2007. Nissan currently offers XM radio as a factory-installed option on 19 Nissan and Infiniti models. Today, XM is available as a dealer-installed option on 13 Toyota, Lexus and Sia models, with this number increasing to 20 models in the first quarter of 2006, including the popular hybrid models such as the Prius and the Lexus GS. Toyota selected XM as its factory installation satellite radio partner and will commence factory installs in the 2007 model year cars. Audi, Volkswagen, and Porsche are also active XM partners, offering factory-installed equipment. And Suzuki began offering XM as a dealer-installed option in the fall of this year. As a result of our strategic building of the OEM channel, we have captured more than 80% of all OEM satellite radio subscribers to date and expect to maintain a dominant leadership position throughout 2006 and beyond in the OEM category. Let's turn to the retail distribution channel, where XM continues to lead the industry by adding more then 300,000 net new retail subscribers in the third quarter. All indicators are that we have outperformed our competitor in this third quarter. All the numbers for retail distribution should be in shortly. As you know, both companies have already pre-reported overall net subscriber additions, and XM achieved a 63% market share for the third quarter 2005, which is essentially unchanged from 64% in the prior two periods. Now let's look at XM's plan for the retail market for the fourth quarter, when we expect this channel to drive the preponderance of our growth as interest in satellite radio peaks during the Christmas season. Going into the holiday season, XM has the best and most balanced programming with the right radios at the right price, along with a new media campaign designed to attract the next million XM subscribers. XM is offering a broad range of radios, including two new products, the Audiovox XM Xpress and the Delphi XM RoadyXT. For consumers wanting a five-line display screen, the Xpress, a plug and play receiver, is the smallest satellite radio in the category. The RoadyXT, weighing only 2.8 ounces, is the thinnest satellite radio at an attractive $79 price point. In consumer electronics, size does matter and the smaller, thinner, the better. Consumers can also select from many other XM radios such as the SKYFi2 and the Roady2 plug-and-play radios. We continue to offer the entry-level Roady2 at a $49 price point that puts XM in the sweet spot of the consumer electronics mass market at the low end. Meanwhile, consumers shopping for XM radio home entertainment systems this holiday season will find an array of products from Yamaha, Pioneer, Denon, Onkyo, and GPX, as well as Eton's Porsche-design radios. And of course, our portfolio of XM to go portable radios are readily available, including the Pioneer AirWare, Delphi MyFi and the Tao, all priced at $199 after rebate. XM is the only provider of a truly portable satellite radio that goes where you go and receives the live satellite feed along with memory functionality. Beyond this holiday season, XM recently announced XM MP3 integrated players will be available at retail in significant quantities during the first quarter of 2006. We have ensured through a strong inventory planning and management system that retail outlets will be well-stocked across the fourth quarter. Some questions have been raised about Delphi's recent voluntary, Chapter 11, bankruptcy filing and its effects on XM. All Delphi aftermarket radios are manufactured overseas and outside of the current union issues, and Delphi has advised us that it expects no disruption in the continued supply of XM radios. With hardware inventories flowing and distribution channels broadening, we have also significantly enhanced XM's leadership position in offering the best sports, talk and music programming. During the upcoming year, XM will provide over 5000 live sporting events, the most in satellite radio. XM's popular broadcast of Major League Baseball featured innovative play-by-play coverage of the League Championship Series to the World Series, featuring the Chicago White Sox and the Houston Astros. For the World Series, XM subscribers were given the option of listening to the home or visiting team radio coverage, the national play-by-play coverage, or the games broadcast in Spanish. Last weekend, XM sponsored one of the biggest branding and awareness promotions in the history of the World Series, which was widely covered by the press. 40,000 fans attending game 1 in Chicago of the White Sox/Astros matchup received a voucher for a free RoadyXT with a six-month subscription commitment. You may have also noted XM's logo on the left-field fence during the games in Chicago which White Sox hitters seemed to use as a bulls eye. XM's leadership in live sports programming was reinforced in the third quarter when the National Hockey League announced a 10-year agreement making XM the exclusive satellite radio network of the NHL beginning with the 2007/2008 season. On October 5, XM launched play-by-play NHL coverage and will carry 90% of the games across six dedicated channels. Our partner, Canadian Satellite Radio, is funding a significant portion of the NHL agreement and NHL play-by-play coverage will be available in English and French. In the third quarter, XM carried the U.S. Open for tennis fans and the PGA events for golf enthusiasts. In August it premiered XM Deportivo, its 24-hour coast-to-coast Spanish-language sports channel, which will be the exclusive satellite radio home for the World Cup Soccer Tournament beginning in June of 2006. XM has recently enhanced its college sports coverage, which includes football and basketball games from the Big 10, PAC 10 and the ACC, with one of college basketball's great coaching icons, Duke University's Mike Krzyzewski, who was just recently named the Olympic coach for the 2008 Olympics. He is hosting a weekly talk show called Basketball and Beyond with Coach K. Yesterday we announced that NASCAR superstar Jimmy Johnson will host his own weekly show to debut in February on XM's NASCAR radio channel. In the area of talk radio, XM has also made significant strides. Earlier this month, we launched Take Five, a channel dedicated to women featuring Ellen Degeneres, Tyra Banks, the Satellite Sisters, and other talk talent, along with content from the Food Network and Home and Garden Television. And XM recently announced that the Fox News Talk Channel will be available in January featuring Fox News personalities Bill O'Reilly, Tony Snow, John Gibson and Alan Colmes, among many others, balancing out our exclusive carriage of Al Franken and Air America. On the music front, XM continued its critically-acclaimed Artist Confidential interview and performance series with some of the biggest names in the music industry, including Clint Black, Joan Baez, Herbie Hancock, and being taped tomorrow at Jazz Lincoln Center, Santana. Plus, we announced the multiplatinum artist Ludacris will host a weekly show on Raw, XM's uncut hip-hop channel, beginning in January. On the broader community service front, XM is a good citizen and has dedicated national programming to a variety of relief efforts. After Hurricane Katrina devastated homes along our southern coast, XM responded by joining forces with the American Red Cross to launch Red Cross Radio. The 24-hour nationwide XM channel provided help and information to disaster victims, Red Cross staff and volunteers. XM also donated radios to the Red Cross relief workers and aid stations. On our emergency alert channel, XM aired extensive coverage of Hurricane Wilma's impact on the Southeast. Clearly, we provide a valuable service during national disasters and other emergencies when traditional radio and other media may not be available. In our last quarterly conference call we outlined many of XM's strategic partnerships. Let's update you briefly on them. In September, our partner Canadian Satellite Radio, which I mentioned earlier, won approval from the Canadian Federal Cabinet to offer XM Canada Satellite Radio. XM Canada has made significant progress assembling the key elements of its business, leveraging XM's experience and existing relationships. XM Canada has hired a seasoned radio and marketing management team, begun developing broadcast studios in Toronto and Montreal, is constructing a repeater network throughout major cities across the country, and establishing key distribution arrangements with GM and national consumer electronics retailers such as Best Buy, Future Shop and The Source by Circuit City. XM Canada is a promising future source of value and revenue for XM. Turning to our strategic online relationship with AOL, we launched the co-branded AOL Radio featuring XM on AOL's music home page, offering the best of both XM and AOL programming. Furthermore, beginning in mid-November all of DirecTV's approximately 15 million customers will enjoy a selection of XM's quality music, talk and sports programming, providing XM a great opportunity to further build awareness during the holiday selling season and beyond. Soon we will be launching the XM+Napster service, allowing XM subscribers to discover music on XM, mark their favorites, then purchase the music online through Napster and store them on XM MP3 devices. So, in summary, the third quarter 2005 represents another quarter of XM market leadership and smart subscriber growth. XM's leadership in the OEM and retail channels resulted in it ending the quarter with more than twice as many subscribers as its competitor, our revenue rapidly increased, cost-effective programming additions broadened our appeal, new products are in flow, and strategic partnerships are on track. We strengthened our foundation for a spectacular fourth quarter when we will exceed 6 million subscribers and for an exceptional 2006 and beyond. I will now turn the call over to Joe Euteneuer for a detailed discussion of XM's financial performance during the third quarter of 2005. [Joe Euteneuer, EVP and Chief Financial Officer] Thanks, Hugh. In the third quarter we continued to perform against its financial and operational metrics. As you know, the primary driver of revenue is subscriber growth. We added more than 617,000 subscribers and surpassed the 5 million subscriber milestone during the quarter. Churn remained at a low rate of 1.4%, unchanged from the previous two quarters. Subscriber additions were slightly lower than the second quarter's 647,000 net new subscribers; however, this is consistent with seasonal patterns we have seen in previous years, and specifically for this year, was impacted by XM shifting some marketing resources to the critical upcoming holiday season, as Hugh mentioned earlier. First I'd like to comment on the makeup of XM's subscriber universe, and I refer you to the detailed financial attachment to our third quarter 2005 press release. The end of the quarter total of more than 5 million subscribers included 4.4 million self-paying subscribers, 625,000 OEM prepaid promotional subscribers, and 42,000 rental car subscribers under the Avis, Zipcar, National and Alamo brand names. Please note that the level of rental car subscriptions typically fluctuates in the third and fourth quarters as rental car companies adjust their fleets with the new car models. The conversion rate of our new OEM prepaid promotional subscribers to self-paying subscribers upon conclusion of the promotional period continues to be nearly six out of 10, or 56% of new car buyers. Of our total subscriber base, the self-paying subscribers were 87%, the OEM prepaid promotional subscribers were 12%, and the rental car subscribers were 1%. These percentages were essentially unchanged from the second quarter. Now let's move to revenue. Total revenue increased 134% to 153 million for the third quarter of 2005, from 65 million reported in the third quarter of 2004. Recurring subscription revenue of 140 million for the third quarter of 2005 increased 135%, from 60 million in the third quarter 2004. Compared to the second quarter 2005, subscription revenue was up 23%, reflecting the continued significant growth in our subscriber base as well as the higher ARPU I will now discuss. Average subscription revenue per user, or ARPU, climbed to $9.78 in the quarter, up $0.43 or about 5% from the second quarter, and up $1.14 or 13% from a year ago. As you might expect, the primary reason for the improvement in ARPU is the steadily increasing proportion of existing subscribers migrating to the new rate from our April increase, as well as new subscribers signing up at the new rate. ARPU continues to reflect the popularity of discounted annual and multiyear prepayment plans, as well as the impact of discounted family plan subscriptions, all of which are our most loyal customers. The family plan program grew by 2 percentage points to 17% of ending subscribers from the second quarter, and the annual and multiyear prepayment plans grew slightly to 41% from 40% in the previous quarter. Deferred revenues grew in the third quarter by 15 million to 303 million, following the 66 million increase in the second quarter, which was attributable to the large number of subscribers who opted into the annual and multiyear prepayment plans at the time of our rate increase. At the end of the quarter, subscribers had prepaid their subscriptions by an average of 9.2 months, up from the 6.8 months in the third quarter of 2004 and down slightly from the second quarter 2005. I will now spend some time discussing the quarter's expenses. As you know, we look at expenses in three categories, variable operating expenses, fixed operating expenses, and sales and marketing expenses. Variable expenses, which include the cost of merchandise, revenue share and royalties, customer care and billing and ad sales, were 54 million in the third quarter 2005, up from 25 million in the third quarter 2004 and up from 49 million in the second quarter 2005. Changes in variable expenses result directly from the growth in revenue. The important metric, the contribution margin of our subscriber business, which equals subscription revenue minus revenue share, royalties, customer care and billing costs, increased to 69% of revenue in the third quarter 2005 from 65% in both the third quarter 2004 and the second quarter 2005. The primary contributor to this improved margin is the rate increase. Consistent with seasonal patterns, however, subscription margin in the fourth quarter will be lower, as more subscribers sign up for service in the last few weeks of December along with the additional temporary holiday staffing which affects variable customer service costs. Fixed expenses, which include satellite and terrestrial, broadcast and operations, programming content, research and development, general and administrative, and marketing retention and support, were 77 million for the third quarter 2005, compared to 41 million for the third quarter 2004 and 68 million for the second quarter 2005. This expected increase was due primarily to new programming initiatives and other operational expenses. XM's targeted and efficient sales and marketing efforts have enabled us to continue to demonstrate cost-effective subscriber growth, both in the direct cost to gain a subscriber, or SAC, and the fully-loaded total cost, including discretionary advertising and marketing costs, to gain a subscriber, or CPGA. XM's SAC for the third quarter was a modest $53 per gross addition, a decline of $4, or 7%, from the $57 per gross addition in the third quarter 2004. CPGA for the third quarter 2005 was $89 per gross addition, unchanged from the third quarter 2004 and down from the $98 in the second quarter 2005. Similar to past trends, we expect fourth quarter SAC and CPGA to increase due to greater media and promotional activities during the upcoming holiday selling season. XM's EBITDA loss for the third quarter of 2005 was 74 million, versus an EBITDA loss of 63 million in the third quarter 2004 and 90 million in the second quarter of 2005. The third quarter 2005 EBITDA loss included the cost of adding 201,000 more next new subscribers than we added in the third quarter of 2004. The overall liquidity position of XM at the end of the third quarter 2005 was approximately 890 million, including cash and short-term investments of 754 million and undrawn facilities from GM of 135 million. As part of our strategy to strengthen XM's balance sheet and reduce interest expense, as opportunities present themselves, XM reduced its debt in the third quarter by retiring 15 million of our 12% senior secured notes due 2010. In addition, we announced the redemption of all of the outstanding 14% senior secured notes due 2010. In October, we completed this transaction by paying noteholders $24.8 million. For the third quarter 2005, XM's net cash flow from operations was a -91 million versus a positive cash flow of 6 million from the second quarter 2005, as deferred revenue returned to a more seasonal run rate following our second quarter rate increase. The third-quarter cash flow also includes semi-annual payments to Major League Baseball and General Motors. In summary, the strong progress we've made in the third quarter enables me to reaffirm the 2005 guidance that we had previously given. XM expects to report 500 million in subscription revenue and EBITDA loss of 395 million for 2005, while ending the year with over 6 million subscribers. In addition, XM still expects to achieve operational cash flow breakeven by the end of 2006. We will issue our next subscriber update in the first week in January. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234077 | Hereâs the entire text of the prepared remarks from InfoSpace's (ticker: INSP) Q3 2005 conference call. The Q&A is in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Executives: Mark May, Needham and Company Sasa Zorovic, Oppenheimer & Co. Stewart Barry, Thinkequity Partners Gordon Hodge, Thomas Weisel Partners Scott Sutherland, Webbush Morgan Securities - Analysts Safa Rashtchy, Piper Jaffary Jason Wylie, Morgan Cabot Derek Newman, J.P. Morgan Good afternoon and welcome to our third quarter call. With me on the call today is David Rostov, Chief Financial Officer. Before we get started I would like to remind you of two things. First, this is an investor conference call. Accordingly, we will only be taking questions from the investment community. Standard Disclaimer Omitted. Now, I'll turn the call over to David. Following his comments we will open up the call to your questions. Thanks, Nancy and welcome to the call today, everyone. I wanted to start by giving you an update on our CEO Jim Voelker. As we announced, Jim underwent coronary bypass surgery earlier this month. His surgery was successful and he is now home recuperating. His recovery is going well and we are looking forward to his return to work in the coming weeks. Overall, we are pleased with our results for the third quarter. Revenues were up 24% year-over-year and in line with the second quarter. This was driven in part by sequential growth in mobile media downloads. In terms of highlights, we are particularly encouraged with the progress we've made in hiring on the mobile side. Over the last couple of months we've added significant media and entertainment expertise to the team. We hired Steve Davis as our new President of mobile media. Steve will be responsible for managing our mobile entertainment business worldwide including content licensing and production, marketing, public relations, promotions, sales, and product development. Previously, Steve was President of Grenada America, the U.S. based development and production division of ITV, one of Europe's largest media companies. Prior to joining Grenada America, Steve was President and CEO of Carlton America. A leading distribution, video, and book publishing company. Steve's experience in content management and production will be invaluable to the company as we build on our leadership position in mobile. We look forward to his contributions. As we continue to increase our focus on mobile media, we are also pleased to welcome Jules Haimovitz to our Board of Directors. Jules is a seasoned entertainment executive whose media and content expertise and relationships will be a tremendous asset to our company. Jules is currently the Vice Chairman and managing partner of Dick Clark productions. Prior to Dick Clark Productions, Jules he held the position of President of MGM networks. Switching to the product side, we continue to leverage our search and directory capabilities into the mobile arena. Most recently, we introduced an innovative new mobile local search product, which allows subscribers to easily and quickly find everything from nearby restaurants and movie times to maps and driving directions. InfoSpace's mobile local search product leverages our knowledge in the online space and ability to design location based mobile products. For example, a user wanting to catch a movie can look up nearby theaters, choose a film, pick a time, and get directions to the theater, all from one application. Finally, during the quarter we continued to strengthen our metasearch offering. We added Microsoft's MSN search, becoming the only search provider to combine results from the leading search sites including Google, Yahoo!, MSN and Ask Jeeves. As the only provider to have relationships with the most popular engines, we are able to offer a search solution uniquely designed to provide users with the most relevant results. Now, on to the financial results and outlook. Our revenues for the third quarter were $83.2 million, an increase of $16.1 million or 24% from third quarter '04. We had another strong quarter of profits, generating net income of $11.3 million or $0.32 cents per share. Weighted average fully diluted shares was $34.8 million for the third quarter of 2005. For the third quarter, adjusted EBITDA was $14 million, a decrease of $3.1 million or 18% year-over-year. The adjusted EBITDA margin for the quarter was 17%. And as of September 30 of this year, we had approximately 600 employees. Now, let me turn to our segments. In the third quarter of '05 search and directory revenues were $44.2 million, up $2.2 million or 5% from the third quarter of '04. As we expected, relative to second quarter, revenues were down mainly due to the loss of the Verizon Yellow Pages subscription business. This is partially offset by a full quarter of revenue from yellowpages.com. On a positive note, in the quarter we added Yellow Book merchants to our Yellow Page listings. During the quarter total paid searches in North America for both, search and directory, were approximately $182 million. Average revenue per-page search was approximately $0.20, an increase of 18% over the prior year third quarter. Segment income was $16.5 million and the segment margin was 37%. As we discussed on last quarter's call, we expected the margin to be in the 35% to 40% range due to the loss of the Verizon Yellow Pages revenue, as well as greater spending on marketing. As we had planned, we increased our marketing spend over the prior quarter. Although we had good success driving more users to our site, we did not see the impact we had hoped for on the revenue side. As such, in the fourth quarter we have scaled back our marketing spend to a level similar to earlier periods. In the third quarter, search distribution revenues in North America continued to account for over 60% of the portion of search and directory revenue coming from search. Now, turning to the mobile business. Revenues for the third quarter were $39 million, an increase of $13.9 million or 55% from the third quarter of '04. Relative to second quarter, revenues were up $1.9 million or 5%. We saw favorable increase in our mobile downloads relative to the second quarter. Mobile segment income totaled $6.8 million for the quarter, down $300,000 or 4% from the same period last year, and the segment margin was 18%. In line with our guidance our margin was impacted by continued shift to label tones and continued investment in next generation products and services. Regarding the balance sheet, the company ended the quarter with approximately $362 million in cash and marketable investments. During the quarter we repurchased 2 million shares for approximately $51 million. Since we initiated the $100 million repurchase program in the second quarter, we have repurchased a total of 2.3 million shares at a total cost of $62 million. Excluding the stock repurchases in the quarter, our cash would have increased by over $6 million sequentially. Now, let me turn to our fourth quarter outlook. On the mobile front we are pleased with the pickup in media downloads and expect additional growth in volumes in the fourth quarter, due to a seasonally stronger period for handset sales, music sales, and greater promotional activity by the carriers. On the search and directory side, revenues will be down sequentially due to continued efforts on our part to improve the quality of our distribution traffic network. On the margin side, we expect segment margin percentages to be in the same range as we discussed in the prior earnings call, 15% to 20% on the mobile side and 30% to 40% on the search and directory side. As a result of these factors and for the fourth quarter, we expect revenues to be between $84 and $86 million. We expect adjusted EBITDA to be between $13 and $14 million and net income to be between $9 and $10 million. On a fully diluted basis, earnings per share is expected to be between $0.25 and $0.28 cents. This assumes our effective tax rate in the fourth quarter remains in the low single digits. In the prior outlook, we had assumed a 38% effective tax rate in the fourth quarter. For the full year 2005, we expect revenues to be between $337 and $339 million. We expect adjusted EBITDA to be between $68 and $69 million. And net income to be between $53 million and $54 million. On a fully diluted basis, earnings per share is expected to be between $1.46 and $1.49. This guidance excludes the gain from the first quarter litigation settlement. It also assumes that the company maintains its current effective tax rate in the fourth quarter. Looking at 2006, and consistent with our comments last quarter, I would encourage you to assume a full tax rate of 38% in your models for 2006. Of course, given our significant NOL, our cash taxes in 2006 will be very modest. In conclusion, it is important to keep focused on the tremendous opportunity before us. Mobile devices and high speed networks are combining to form a new global media network. Today's personalization and entertainment services will continue to evolve and broaden. As the industry continues to develop, it will expand into local information, commerce and advertising services similar to what we have seen on the internet. We intend to capitalize on this growing opportunity by continuing to invest in the next generation of products and services. Our goal is to improve the mobile experience and help our partners solve critical problems. With our strong cash flow and balance sheet search expertise, critical partner relationships, extensive content catalog, and experienced team we are uniquely positioned to exploit the convergence of mobility, search, information and entertainment. This concludes our prepared remarks. I will now turn the call over to the Operator and I'll be happy to take your questions. |
EarningCall_234078 | Good morning and welcome ladies and gentlemen to the First Quarter 2006 Earnings Call. At this time, I would like to inform that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation. Thank you. Good morning and thank you for dialing into Fairchild Semiconductor's first quarter 2006 financial results conference call. With me today is Mark Thompson, President and CEO; Mark Frey, our new Executive Vice President and CFO; Bob Conrad, our Senior Vice President and General Manager of the Analog Products Group; and Izak Bencuya, our Executive Vice President and General Manager of the Functional Power Group. First I would like to highlight some upcoming investor conferences that we will be attending. On May 2, we will be attending the CSFB Semiconductor and Semiconductor Capital Equipment Conference in New York. We'll attend the Piper Jaffray Hardware & Communication Conference on May 10 in New York, and then the Robert W. Baird Growth Stock Conference in Chicago on May 11. We'll also address the JP Morgan Technology Conference in San Francisco on May 23, and the Citigroup Semiconductor Conference in Boston on June 1. Finally, we'll present that the Bear Stearns Technology Conference in New York on June 13. We will be calling our Annual Analyst Day on June 28 at the Computer History Museum in Mountain View, California. And this is the first time we held the event on the West Coast and we look forward to seeing our large shareholders in the West in that area as well as all the sell-side analysts that cover us. So please mark the calendar for June 28 to join our executive management team for a morning of presentations and discussions about the future of Fairchild. This call is being simultaneously webcast from the Investor Relations session of our website at fairchildsemi.com. The replay for this call will be publicly available for approximately 30 days. I also want to note that we plan to publish our mid-quarter press release to update our business outlook on June 7 before the market opens. Now I will start today's call with a review of our quarterly and annual -- quarterly results. Mark Thompson will discuss the results in more detail and then Bob will provide some additional color on our strong analog performance as well as update us on design wins and end markets. Mark Frey will wrap up with financial highlights and discuss our full guidance for the second quarter of 2006. Fairchild Semiconductor today announced results for the first quarter ended April 2, 2006. Fairchild reported first quarter sales of $409.5 million, 10% increase from the prior quarter and 13% more than the first quarter of 2005. Fairchild's first quarter of 2006 included 14 weeks instead of the normal 13 weeks fiscal quarter. Fairchild reported first quarter net income of $26.6 million or $0.21 per diluted share compared to a net loss of $4.7 million or $0.04 per share in the prior quarter and a net loss of $10.4 million or $0.09 per share in the first quarter of 2005. Gross margin was 29.9%, 570 basis points higher sequentially and 680 basis points higher than in the first quarter of 2005. Included in the first quarter results are $5.3 million in total stock-based compensation in accordance with Statement of Financial Accounting Standards Number 123R, $3.2 million net gain on the sale of LED lamps and displays product line and a $3.5 million in net tax benefits related to certain finalized tax filings and audit outcomes. Fairchild reported first quarter pro forma net income of $25.6 million or $0.21 per diluted share, significantly better than the pro forma net income of $13.6 million or $0.11 per diluted share in the prior quarter and the pro forma net income of $12.5 million or $0.10 per diluted share in the first quarter of 2005. Pro forma net income excludes amortization of acquisition related intangibles, restructuring and impairments, gains from the sale of the LED lamps and displays product line, certain net tax benefits, litigation settlement proceeds, charges for potential settlement losses, impact of tax repatriation and other items. Pro forma results include stock-based compensation expense. Fairchild management will be making forward-looking statements in this conference call. These statements including all statements about future results and performance are made based on assumptions, estimates that involve risk and uncertainty. Many factors could cause actual results to differ materially from those expressed in forward-looking statements. A discussion of these risk factors is provided in the quarterly and annual reports we file with the SEC. In addition, during this call we may refer to pro forma or other financial measures that are not prepared according to generally accepted accounting principles. We use non-GAAP measures because we believe they provide useful information about operating performance of our businesses that should be considered by investors in conjunction with GAAP measures that we also provide. You can find a reconciliation of non-GAAP to comparable GAAP measures at the Investor Relations section of our website at fairchildsemi.com. Website also contains 2006 first quarter fact sheet and updated financial sections with updated unaudited financial highlights including detailed breakout of segment and retail revenues, gross margins, EBIT and EBITDA. Thanks, Dan. Good morning and thank you for joining us. As many of you know, we set some aggressive operational and financial performance goals in the middle of last year and I am pleased to report that Fairchild delivered impressive first quarter results ahead of our expectations. In the next few minutes I will update you on progress including my thoughts about our sales and gross margin growth, analog performance, channel management and inventory control. Let's start with top-line performance. We grew first quarter sales by more than 10% sequentially above our initial expectations. Keep in mind we had an extra week in the first quarter that explains 7% to 8% of sequential sales increase which was partially offset by 2% reduction in sales related to the divestiture of our LED lamps and displays product line at the beginning of the quarter. Netting this out results in a 4% to 5% apples-to-apples sales increase compared to Q4 2005, well above our typical first quarter results of down 2% to 3%. After spending most of last year reducing inventories and improving our channel management processes we were able to resume shipping in line with end market consumption in the first quarter which drove most of our above seasonal sales growth. We also believe that we have gained market share in both our analog and high value power discrete businesses, based on the latest WSTS data. Our goal has been to grow our analog and power discrete business at/above the market rate while becoming increasingly selective in our lower margins standard products business and this is exactly the profile performance we delivered in Q1. We grew our analog sales a strong 18%, power discrete nearly 13%, while reducing standard products revenue by 1% from the previous quarter. The increase in sales helped to improve our utilization rates to our target levels, typically in the low to mid 90s which coupled with a modest improvement in product mix enabled us to significantly increase gross margins 570 basis points sequentially, to effectively achieve our immediate goal of 30% in 2006. Clearly we have made faster progress improving our gross margins than anticipated. We expect to make steady progress toward our next objective of mid 30% gross margins by delivering more new products, while mixing out lower value products to better optimize the margin mix running in our factories. In this way, we believe we can show continued gross margin leverage even as we maintain our target utilization. I am particularly pleased with our improvement in the analog gross margin, now above 40%, which is the highest level we have recorded since the year 2000. This is also beginning to reflect the investments we made in product development and field application support to build a higher value product portfolio. We are making solid progress toward our goals to build our analog business to the $500 million sales level at 45% to 50% gross margins in the next three years. Bob will discuss our analog progress in more detail a little later in this call. Our bookings were even greater than sales allowing us to build backlog during the quarter and position us very well for Q2. We are monitoring our backlogs very closely for signs of excess order rate. We are managing lead times more effectively on analog and high power discrete which we believe reduces the potential for excessive order rates. We have actually reduced blended lead times during the second half of the first quarter to about 10 weeks with lead times for our analog and power discrete products generally below this level are roughly half of what they were during the last up cycle of 2004. We are also working closely with our small distributors in Asia to ensure that their order rates are in line with the end market demand, using paper performance incentives to drive better management, which leads me to the distribution channel. We are keenly focused on managing our distribution channel to closely map our shipments for the channel sell-through. In the first quarter channel resales were seasonably lower in Asia due to the lunar New Year holiday but sequentially higher in other regions resulted in worldwide resales being about 3% lower than the prior quarter. We responded by adjusting our shipments into our distributors to achieve about 1% reduction of inventory dollar, while we held weeks in supply roughly flat to the prior quarter. We are of to a great start in 2006 and look forward to building on this momentum during the rest of the year. We are still early in the process of mixing out lower margin business to improve our gross margins. Our new product pipeline continues to improve, as we build our technical capabilities to better sell and support high value products in the field. We are managing lead times more effectively on analog and high power discrete products to better meet our customer requirements and to minimize the potential for excessive order rate, and we are watching inventories like a hawk to stay in our target range. I believe the impressive results we delivered in the first quarter offer just a glimpse of the improvement possible for Fairchild as we continue our transition to higher product value portfolio in the fast growing analog and power management market. I would like to take a minute to welcome Mark Frey, our new CFO, who will discuss our financials in just a few minutes. I have known Mark for years, worked closely with him in [tasked roles] and delighted to have him on the team. You will find Mark to be a great person to be work with, articulate, credible and with highest level of integrity. Now, Bob will review the analog results for more details as well as our progress in new products, design wins and end-market dynamics. Thanks Mark. We delivered impressive analog financial performance in the first quarter which is more indicative of the results possible with our higher value product mix and stable inventories. With sales of $82.1 million, up 18% sequentially and gross margins of slightly more than 40%, our analog business reached an important turning point in Q1. I want to take a few minutes to explain some of the reasons for this turnaround followed by a review of our end-market. We have been joined Fairchild more than two year ago, we have been focusing our analog team on opportunities where we can provide leadership products offering unique value to our customers. When Mark took over as CEO, he challenged us to accelerate the transition of our analog business to become a clear leader in our chosen market. To meet this goal, we've increased our design effort by adding more design teams and design centers while building a stronger field applications team. While these investments are for our long-term goals, we are already seeing the impact on our product portfolio. One metric that we track to measure our new product success is a percent of total backlog that is comprised of new products, which we define as those released within the last three years. This metric has been rising steadily over the last two years and has been in the range of 55% to 60% of the backlog for analog business during the last three quarters up from the mid 40% range a year ago. Margins on our new products are higher than our average indicating the potential for continued gross margin expansion. Looking at some examples with the types of new products that are driving these improvements. We won designs with a variety of our leading power conversion products, including our highly energy efficient FPS power switches and power factor correction solutions that help to drive significant sequential increase in the first quarter of power conversion sales at record margins. These products serve a wide variety of end markets including consumer electronics and all supportable to lighting and high power industrial motors. Our analog switch products continue to win important designs in handset and computing applications enabling us to us achieve record sales again this quarter while building a very strong backlog position. We are expanding our strength in audio switches to new USB switch solution targeting high growth handset and computing application. We recorded strong sales and bookings growth of our signal path analog business led by a high margin µSerDes interface products and our highly integrated analog video filters, drivers and amplifiers. We continue to expand our design win base and expect to steadily ramp revenue in this line across 2006, as more of these designs go into production. And our system power business we believe we have gained share with our VRD 10-compliant system regulators and expect to continue this momentum with our new generation of VRD 11 compliant solutions. We are also winning new designs with system regulators for the memory graphics and other sub systems in the computing and storage end market. In our functional power products we won a number of new designs with a highly integrated SPM line of power module in a variety of air conditioner and industrial motor applications enabling us to achieve record sales for these products in the first quarter. We are also winning designs and gaining market share with our advanced low power MOSFET products targeted for LCD television and we expect this market to continue growing at well above average rate. Our new product execution continues to improve making the foundation for higher sales at better margins in the future. Turning now to our end markets, sales continued to be solid in all of the end markets with particular strengths in product supporting industrial, handset and computing applications. Bookings grew steadily during the quarter resulting in continued backlog growth even as we maintained stable lead times. Order rates were at or about fourth quarter 2005 levels in virtually all end markets while demand was strong as power products servicing the power supply, battery charger and desktop PC segments. Thanks Bob. Let me start with financial highlights. We delivered excellent financial performance in virtually all aspects of our business led by our significant improvement in margins. Our strong sales growth improved product mix coupled with better utilization and operational performance enabled us to increase gross margins to 29.9%. We effectively managed total pro forma operating expense to remain within our guidance increasing $90 million sequentially due to bonus accruals, stock-based compensation expense, and the greater number of days in the quarter. Our stock-based compensation expense was higher than our regional guidance because our better than expected financial performance resulted in higher performance share expense. In addition, the expense amortization of these performance shares is front end loaded. Our underlying effective pro forma tax rate was 15.8% in the first quarter and reflects the benefits of generating profits in low tax jurisdictions, as well as the usage of a portion of the US deferred tax assets that were reserved in 2005. These combined factors enabled us to record more than an 88% sequential increase in our pro forma earnings and EPS in the first quarter. During the first quarter, we generated 3 million in cash flow from operation resulting in cash and marketable investments of $535.6 million. Internal inventories remained lean and well within our target range given our higher sales level. My past experiences have made it clear to me the importance of maintaining tight controls of inventory and spending in general, and I plan to focus intensely of staying within our target ranges. Our $23 million in capital spending for the quarter keeps us within our annual budget of 6% to 8% of sales. Cash flow was negatively impacted by the payment of nearly $20 million of accrued liabilities for our fourth quarter tax repatriation and the settlement of certain liability claims. Turning now to our forward guidance, we expect second quarter revenues to be flat to down 3% sequentially as we return to a 13-week second quarter from the 14-week first quarter of 2006. We entered the second quarter with a stronger backlog position than a quarter ago, which coupled with continuing capacity additions should allow us to sequentially increase our daily ship rates from less than 4.2 million per day in the first quarter to more than 4.4 million per day in the second quarter of 2006. This represents about 6% sequential increase in our daily ship rates. We forecast gross margins to increase about 50 to 100 basis points sequentially, due to expected improvements in our product mix and slightly better utilization. Looking forward to the rest of 2006 and 2007, we expect to continue growing sales for our analog and power discrete products at/above the market rate while maintaining our tight control of general and internal inventories. We believe the combination of profitable sale growth and improved product mix through more new products and less low margin commodity business will allow us to make continued steady progress toward our next goal of mid 30% gross margins. We expect operating expenses to remain flat with the first quarter as we selectively fund new product development opportunities while rigorously controlling infrastructure costs. Our underlying effective tax rate for 2006 is expected to remain at approximately the same level as the first quarter of 2006. It is important to note that effective tax rates can vary as the regional distribution of income shifts during the year. We are forecasting our stock-based compensation expense to be in the $6 million to $7 million per quarter range for the rest of 2006. Our strong first quarter results and guidance for sequentially higher daily shipments and gross margin for the second quarter provide more evidence of the progress Fairchild is making at improving the quality of our business. I am personally excited to be part of this great team and to help lead the powerful transformation thatâs underway at Fairchild. Thank you. I will turn the call now back over to Dan. Great, thanks Mark. We will now open the call to questions. I would ask that in order to allow more of you to ask questions, we would limit each person to one question and one follow-up. Thanks and let's take the first question please. Thanks and congratulations on a strong quarter. Just wanted to look in to your guidance on both the top line and the gross margin, if you could break that down a little bit by the three basic segments that you have the power analog, the discrete and the standard products, that would be helpful? Sure, while we have guided the sales flat to down 3% and as you could see in the profile for Q1 our analog sales grew the most and I think that's going to be a scene that we should be seeing playing out for '06 that our analog business should be growing the fastest, our discrete business is going to be growing at a very healthy clip, both either at/above market and then on the standard product side, like you saw, we are going continue to run that in a very selective mode and I would expect to see the least growth there. As for the gross margins, we would get some leverage out of the increased daily shipped rates, plus we continue to have a positive mix out of reduced low margin commodity products and additional higher margin analog products. Okay. And I guess is the follow-up, given your new target as the mid thirties and the gross margin. Can you just explain a couple of the leverage that you get there and then any general timeframe that we could expect that goal to be achieved? Well, Mark here, let me answer you question backwards. First is we are in the middle of re-running our financial models and we are not done with that yet. So, one our plans come analyst day is to provide a refresh of our improvement schedule at that time and so I would like to differed the answer to that for the analysts day discussion and in terms of the mechanisms to improve margin are heavily increasingly orient toward new product development, new application development and making space in the factories for those product by reducing the commodity end of the business and that will be a consistent team most aggressively worked in analog but will be managed across the business that way. Thank you. Good morning everybody and congratulations on the strong quarter. Just to clarify the strength in the quarter versus the mid quarter update, how much of the basic 1.4% incremental revenue growth came from either a better end-market performance, maybe better execution on the part of field application engineers through your internal supply chain or alternatively just new product expenses that you haven quite picked in? Well it's very difficult to partition those because they are really part of the machine that we have been working very hard on and so, certainly they all contributed, we commented during, if you recall during Q4 that we fell that our revamp supply chain organization had done a very good job of delivering on short lead opportunities and that continued to trend into Q1 and the performance of that team continues to improve. We continue to see a very good residence between the new products that the analog and the high power MOSFETs teams are launching. So really it's a -- there is no single element that's driving the performances of the business. It's -- the system is working bit better each quarter and I think that what's driving the results. Okay. And then may be a strategy question for you, Mark, you have that LED divestiture in the first quarter. You are getting great momentum on the analog types of business, can you talk about how you look at organic growth within the analog segment versus the potential for some selective acquisitions that augment the core that you have there? Yeah. Obviously, even with -- taken out the 14 week of this quarter, we grew quite strongly and so we are doing clearly double-digit well above market rate for this year, and in Mark's commentary he described they are trying to get into the $450 million to $500 million analog business size out in 2008, we have been at that run rate some point through the year. And we feel like we are on pace to that and can do that without acquisitions. So we are always looking at acquisitions to both -- obviously refine our own strategic view as well as look for opportunities to accelerate that. But we are working at that same on track to get to that range of business in 2008. And this year we are at or ahead of that pace that we had actually kind of outlined last fall. Well, let me add a quick comment in addition to Bob's about acquisition, so one of the structural changes that we made last year was we took one of our officers, Pete Groth and had him worked full time on acquisition analysis and really developing a framework for both deal flow and also getting very disciplined about things that we buy and sell. And so Pete managed the process for the LED divestiture, for example, that went very smoothly. We are looking very hard at lots of things that we could acquire that would accelerate the trajectory of our strategy, but we will be very disciplined about what we buy and in the event that we do acquire, it will clearly line up with one of our key strategic goals and will quantify deliverables at that time. Great. And then lastly for Mark Frey. Mark first welcome on board, and secondly, how should we think about where you'd like internal inventories to be as exit second quarter? Well, we are targeting to be flat as we exit second quarter. As a general comment, as you know I have come from Lam Research where we kept setting the bar lower and lower below even theoretical models of what was achievable and the results are very impressive. So I am a hawk on inventories and I have only just gotten started here, but I will be looking and challenging all aspects of the channel of inventories including external inventories to make sure that we can optimize the [mark] because I think it is one of those underlying things that drives other benefits offer to the company whether it's cycle time whether it's more leverage over pricing et cetera. Great. Thanks for taking my question. How should we think about the 18% sales growth in analog? I mean, even if I strip out the 7% to 8% contribution from the extra week it seems a lot faster than consumption, and you guys are not building inventories, help us think about the contribution from market share gains? Well, obviously. Yes, we are out growing the market. Yes we do not achieve that by building inventory in the distribution channels, consistent with the overall company performance on that front as well. The computing segment was up strongly for us this quarter in both CPU power management VRD 10 as well as system regulators. The signal path business, which is our switches, our µSerDes was in our first full quarter of production, it was up well into the double digits quarter-on-quarter as well. And then over in our AC-DC, where our Green FPS or sub-1-W standby power product family was up again nearly 20% quarter-on-quarter. So we are seeing just a lot of growth from each of the product strategies in actually widely varied market. So overall market share in the analog segment were still a relatively small player, but we probably gained couple of sensible points quarter-on-quarter overall. And we are doing it in segments that we are already in, so it has obviously increased share as opposed to trying to be broader than we were a year ago. Okay. And could you just clarify the comment that lead times contracted in the second half of the quarter, was that that you guys just actively trying to be more responsive on orders or did you start to see customers make some cuts on some of the longer lead time products, in standard products for example? Well a couple of things, first is that the longest lead times in general are in standard products, so consistent with the best -- the most important strategic business gets the first shot at capacity, the lead times I believe are longest in logic for example. So, its part of the continued process and in fact the only -- the order rate is very, very strong. The only orders that were taken of the books were taken off as a result of our collaboration with end customers in concluding together that there was no demonstrated end market for what they -- particularly in case of distribution, what people wanted to put on the book and we took multiple tens of millions of dollars off the books as a results of that and it was always a collaborative discussion with the distributor. So, there is -- thatâs a bit of the process and so Robin Goodwin and the supply chain team continued to improve their process and active dialog with the end customers for what's the key timings for things are and managing a process that allows us to move the mean lead times down by moving something's in and something's out. The only other thing I would add to that Romit, as you know, we take lead time units very seriously here. We think thatâs a big element in preventing excessive order rates which has marked the cycles in the past. In the analog area in particular, we have also circled the added capacity, because we know on the analog side in particular having our lead times to be less than 10 weeks is really crucial to that market and we are really trying to manage that way. Well Mark, I mean what's your view, just in general on distributor inventories, I mean at 10 weeks do you think they should be carrying more, I mean just given the bookings strength and the better than seasonal growth you guys are saying? Well that's one of the debates we are having right now and I tend to -- at the end of the day come out pretty lined with Mark Frey on this one which is I don't see any evidence that we need to raise our inventory levels. We will continue to look at our end service levels carefully, our share levels and continue to align the inventory with high resale velocities, so we will continue to be thoughtful about it but we have seen no evidence that suggest we should be increasing our weeks of inventory in the channel. Thanks and could you -- I don't know if you have said what the book-to-bill was because you did talk about backlog, was that above one this quarter and what's your turns requirement for the coming quarter guidance? It is above one, we don't normally talk about book-to-bill, but we did comment that bookings were greater than sales, so you could infer from that the book-to-bill was favorable. And our stole requirement is very small -- somewhere in the order of less than 10%. Okay and based on that discussion around lead times, are you expecting that lead times will hold set in the coming quarter, can you try to expand just some thoughts on where it's going to come out? Well if you look, I think that in Q1 they were banded by 10 and 12 weeks approximately, if you looked at how they moved around through the quarter. Certainly we would be happy if we could get it underneath the ten week band, given the strength of demand, I think that is unlikely but we will continue to make sure it doesnât go above the upper control limit of 12. Well, so two things as demand is strong, pricing pressure tends to be less and we are certainly observing that. I would comment however that our margin goals donât assume favorable pricing interjectory. So, that cushion is built into the view. Thanks a lot. The analog, Bob, the gross margin is phenomena, I donât think I have ever seen in my life I guess 1860 basis points expansion in the quarter. Can you help us just with the pieces of that? It seems like, is that all product driven, mix driven, how much was just the revenue piece and help us with that? Well I can explain a couple of the biggest chunks, Indiana market jumped in as well, roughly a third of that was driven by mix flash pricing, and I wouldnât really drive that pricing is being the major factor there. One of the things as we said, we are focused on mixing out lower margin business. So, that obviously generates an ASP improvement as well. And then other two-thirds was the combination obviously of factory utilization benefits, but that was the smaller piece of it. As we had talked about last year, we had spend a lot of time cleaning up a number of things in terms of end of the life processes and programs, which mostly came to fruition in fourth quarter as well as the supporting reducing distribution inventory. And a lot of that weighed heavily on fourth quarter and basically was at a normal low level in Q1, which was one of the big -- was one of the big improvements in margins quarter-on-quarter. Okay. Great. Thanks. And I guess, as we are listening to all this commentary about the store earlier, but it seems interesting that your commentary about lead times coming in, in just the tad, which is partially it sounds like something they are trying to do. OEM is seeing more than distributors, and distributors not allowing to build inventory. It seems a little different than what we are hearing out there, is there any reason why you think your seeing something a little different in aggregate than what we've been hearing somewhat from the other companies with the caveat that is still early in earnings? Well, it always difficult to analyze competitive commentary. So I think in this case we'll leave that to the expert switch with you guys, and stick to the commentary on our business side. I mean, we've hit the key themes that we believe in which is to really focus to supply chain on getting the most important and valuable products to our customers and creating a process and a mechanism that put those first in line. And so I think we are seeing that starting to work pretty well for us. So that may be a source of some differences versus some others, but I'll not speculate for you. I mean, the only comment that I was really on -- Mike is that, if you look at higher value companies you'll find that generally their lead times don't vary as much. I think that's part of the transition that you are hearing and we recognize that and hence how we are tying to manage the business. Okay. Thank you. I was hoping if you could comment a little bit on the tax rate, you mentioned in your guidance that would be similar to Q1. So is that -- by that you mean the 15.8% throughout '06? Yes. Plus or minus let's say three points. As you know, we reserved 195 million last year for our NOLs in the US, and so as we book income in the US until we recapture those reserves, the effective tax rate is zero. And then we have income in Korea, which if you read our 10-K, we have a partial tax holiday that still has several years to go there. And so that profile will support that level of ETR going forward. Okay. This is a follow-up, if you could -- does that then continue into 2007 and just if I could, your [strict] comment on how much of sales will drop off relative to the LED sale going forward and how much going in sort of [foundry tax]? I'll do the first half of that question, we are not commenting on 2007, but the underlying profiles, I donât expect to change a great deal, and obviously the calculation in terms of the US and how much income is generated between now and 2007. Steve, if you go and look at the 10-K and you figure out how big the NOL was you will realize that if we burn through that in 2006 we are going to have huge year. So I think it will last several years out there. It is going to be there for a while. The LED revenue has gone, we didnât -- we virtually reported no LED revenue in first quarter. And then one thing to keep in mind, in Korea, we have a partial tax holiday and that will begin to phase out over the next four years. So next year's tax rate will be slightly higher than this year's tax rate in a location like that. Good morning. Looking at your disty sales or sale in which was about in line with -- and resale that could assume a double-digit increase in sales to OEMs, is that a correct assumption and could you may be explain what was driving that? Is it new products specifically? Certainly, I donât have the breakout in front of me of our growth in the OEM segment. I donât think we break that out. But certainly one of these strong areas of focus has been with our alignment with our tier one OEM. We have made a lot of progress on that recently and see that continuing to accelerate, and that is heavily concentrated on new leadership products. Yeah. I will give you a little bit more color on that Tristan. Our sales into disty were up because remember we were under shipping the channel's consumption levels last quarter. So we were up strong both in OEM and disty, but the key in the disty side was that we ultimately match which we shipped into, what shipments sold through. Well, I hope I am consistent with when we answered that a few minutes ago. What we have seen is a moderation of price reductions. We saw that in Q4, we see that continue into Q1, however, our forward guidance does not assume that. We assume a fully competitive market when we make our gross margin analysis. Okay, so I guess it is fair to assume, maybe lowest single digit very slightly down, if you can get to that level of detail? We say, Tristan, that we typically run in the down 2% to 4% per quarter, quarter-per-quarter range and we have been saying the last quarter, so that we have been on the low end of that and I think given what Mark had stated that, we are clearly in the low end of that range probably even a little bit below that range right now, going into Q2 where our backlog positions are very similar, the margin on the backlog, we are kind of still in that very favorable range of pricing. But as Mark said, we don't really count on big pricing swings to help us in the gross margin side. If its there, it's great but it's not a big part of the calculation for us. Thank you. Looking at the strength in desktop PCs, we have obviously heard some what different trends coming from some much larger companies. Can you tell about your comfort level with that trend that seems to be obviously a little bit different and then secondly looking at the tax rate for a clarification of that, that would be a pro forma tax rate, is that the assumption? Okay well, Mark A will take the market share one and Mark B will take the tax rate piece of that. So, we commented that we believe we took share in a couple of key places, we have said that overall in computing and Bob commented on some of the VRD10 compliant regulators and such. So, we do believe that we have taken share in those spaces and so I think that's the tie-off to our analysis and yours, and we clearly grew faster than the market in those spaces. As to the tax rate, there is really only about a one point difference between our GAAP underlying tax rate and our pro forma and that's because there is very little tax expense associated with the intangible depreciation that we add back in for our pro forma purposes. But the guidance we gave you was pro forma. Would it be fair to say then that the next lever then to been more mixed driven for the gross margin lines I suppose, are we kind of done with utilizations being the incremental driver of the gross margins? So that is -- so we can just -- so mix is what we have looking forward then to drive that gross margin line? What I am trying to get, we had two levers for your gross margins going forward, we had obviously higher utilization rate and we had improving product mix. So, can we take the utilization rate now out of that equation looking forward to your gross margin lines? Well I wouldn't say you take it out, I think itâs a very small component. Certainly we don't plan to increase loadings beyond their current state. And so what we will continue to do is as we will be expanding capacity in places where we have very good margin, so that will improve that margin profile and we are targeting our product development at obviously at a high margin component and as that comes online it will squeeze out the low margin component where we are constraining capacity, and so it's a complex mix process, but those are basically the two component drivers. Okay and if can speak one last one and I will be quick, just a remark, the company is obviously running right now in kind of sell-through mode operationally in terms of how you are handling your distributors now. When are we going start to see revenue recognition now move from sell-in to sell-through is that on the table now that we have (inaudible)? It's always on the table to analyze but if I am comfortable that we are managing the company on a sell-through basis I donât see any reason why I would go to all of the confusion that would result from doing an accounting change. Number of very high quality companies that we compete with, recognize revenue on a sell-in basis and there is no problem understanding what the results are. So, well we keep looking at that carefully and is very essential to our operational management of the company but unless that profile changes I donât necessarily see the need to make the accounting change. Hi just wanted to follow up on sort of the capacity editions, it's sound like the plan is to sort of moderately, or modestly add capacity in strategic areas and also to grab some incremental capacities just through the ramp down of older standard product. So sort of mix shift gives you some sort of capacity in your new products, and then you also have limited capacity additions. So we are not going to see your wafer starts or sort of data run rate on the [fabless inside] jump significantly in '06. Okay. And then so on the incremental, usually what you guys are going from, say, the mid 70s to where you are now in capacity utilization, you get fairly high incremental gross margin on each dollar of revenue, each higher dollar of revenue. Now that you are kind of at your fairly loaded utilization rate, where do you think margin would be on an incremental basis on a go forward, is that still in the 50% range? Do you think it's lower or is it really just a function of mix shift so kind of hard to call? Well. It's interesting, if you think about it because if it's something where we are adding capacity right, just like if we were just using more subcon, obviously, we'd have a lot less incremental fall through. If it's a mix shift there is a lot of fall through because you are basically, you haven't seen cost structure but you are just getting a lot more for the product that you are making. So you've got this range there and as we've just said, we are going to be, as you characterized, very actively Quinn, we are going to be modestly adding capacity, because remember we are only going to spend 6% to 8% of our sales on capital, roughly half what we've spent the last up cycle year that we had in 2004. So we are going to have constraints about how much we can add, and then on the other side, we are going to have strong product mix enhancements going forward, which have great fall through. So that's one of the central element, I think, that is different about the story now, and I hope that people will comprehend us as we go forward in future quarters results that they did in the past. When we started to cap out on utilization, people would say, utilization leverage is over, the gross margin improvement may be much less now. The story we think going forward is with the modest increases in capacity coupled with the product mixes, we can keep extending the gross margin leverage for some time to come. Good morning. This is actually Jim Schneider for Craig. I think most of my questions have been answered, but if you could comment on overall OpEx guidance for the year that will be helpful? We expect OpEx to remain roughly flat with Q1. The current run rate of our bonus accrual is expected to stand about where it is now because it's sort of in the max range for the program that we have defined. Equity comp will increase to an area between 6 and 7 million, and that's for two reasons. One is, one of our performance programs was actually granted half way through the first quarter, and we only have one half of a quarter's worth of run rate. In future quarters we will get full quarter run rate, which will add about $600,000. The other is in the adoption of the new accounting. We have about $1.5 million that are expensed above the line in gross margins for our equity comp. We capitalized about 800,000 of that into inventory that sort of a one-time thing. And so going forward, we would be incurring about $1.5 million per period above the line. And so that sign, sort of, was a headwind but we are going to focus on finding other areas where we can continuously decrease the cost of our infrastructure activities to keep that in check. Let me just add one more embellishment to Mark's comment, so while our goal is to maintain our OpEx flat, we are continuing to focus on shifting its mix toward R&D and away from G&A. We have picked up two first class design teams in the last quarter on the analog side, Bob continues to scrub the world for high quality teams as we find those, we are picking them up and adding them in product capability areas, we think represent growth opportunities and we are finding the budget out of G&A. So you will -- we have talked before about shifting the mix on that, our OpEx and we will continue to drive that process. Okay, thanks. And one follow-up, can you comment on the backend and suddenly some of your competitors have noted tightness there. What do you see, and is it rolling over? Certainly there are some constraints in the backend, I think probably, if I were to look at some of the commentary I have seen in other parts of the industry, it's probably less of an issue for us than it is for some others. I think, we have probably more in-house capability and some control over that, so again we are just like at the front-end at the backend we are able to compromise the low value business and shift the capacity toward the high-end business. And so we have worked that process effectively for us and so I think thatâs been less of an issue for us. Jim, the other thing I would notice, if you look at what we have given you guys for guidance, we are taking our daily ship rates up about 6%. So clearly we are going to find more capacity in the backend, either some just bear utilization as well as some selective capacity ads that we have been doing. The tightness is clearly more of the chip-scale package type product that is where we have been adding capacity and that is where we will probably continue to invest. We have given ranges in the past. It really varies depending on the products. Our analog products for the most part are in sourced, some of our discrete products we have got lot of outsourcing, so it is a mix. So, we can range anywhere from very little to maybe 60%, 70%. Okay, well thank you all for joining us. We look forward to seeing you all on June 28th, at our analyst day in Mountain View. Thanks a lot for joining us today. |
EarningCall_234079 | Hereâs the entire text of the Q&A from the Apollo Group's (ticker: APOL) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you ladies and gentleman. At this time we will be opening up the call for question and answer session. Please press the â*â and the number 1 on your touchtone phone if you would like to ask a question. If your question has been answered and you wish to withdraw your request you may do so by pressing â*â and then the number 2. If you are on a speakerphone please pick up your telephone handset before entering your request. Q - Mark: My question relates to the provision for bad debt and I am wondering if you can give us a little more color as to why that was up in the quarter? A - Todd: Well. Yeah, Kenda will comment specifically to the numbers, but again as we said before there were a couple of changes that took place regarding, well basically management changes and in particular a campus was not applying the policies that we have normally regarding bad debt, and receivables and as a result there was a slight increase now. Since then weâve corrected that and going forward as I said in our guidance call, we feel very comfortable that that will come back to the levels that it was at before. That may take several quarters but again the guidance that we have given for the fiscal year includes that as far as Iâve seen that get back to normal, but again we are looking for that to occur over several quarters not that it will have to occur in the first quarter, to create any change in the guidance. Q - Mark: Thanks for the color Todd and then regarding your comment on lead flow and conversion rates being in check. I am wondering if you can give us some additional color on W16%IU online on those two points and then to add to that if you could just also comment on attrition within WIU online and then I will turn it over. Thanks. A - Todd: Sure, weâve been very encouraged by what we have seen as far as just lead flow in general, in particular if you look at some of the statistics and studies that are being done today and the population shift as far as from the baby boomers to the eco boom and the profile of a student and the type degree program that appeals to the student and that particular profile of a student, this is a program that is designed very much to help meet their educational needs, as well as structured in such a way that their personal financial situation and other thing that it is applicable. And as a result again when we originally designed that program I donât think that was necessarily what we had in mind, so we found that there is overwhelmingly positive demand for that. And because of the academic structure, the credit hour cost for that program it is very appealing to students and as a result we do feel that is affecting the conversion rate in a positive way. So, going forward, I mean as we talked about it, it did have a slight impact on our revenue per student this last year, but going forward itâs going to allow us as an organization to better provide programs for the potential market thatâs out there. And I think you then use that same approach and look at things on an international basis as we all know, there are very few countries that have the spending power that the United States has and the ability to design programs in such a way that you are able to deliver them in a more cost effective way and more affordable for the students. I really think it does position us extremely well going forward. Q - Mark: And Todd or Kenda did you describe or release the year-over-year growth in bricks and mortar and online? I donât know if I caught that. A â Todd: In fact, I am glad you asked that question because I was asked that a couple of times this morning and I just differed to say that I am sure the question would come up here. One of the things that, as a company, as things change, as the business is changing, we struggle internally how to present the data in a way that presents the most accurate picture of whatâs going on. Just to follow the process over here a little bit, because I think it will help you understand. In the past when a student wants to find out about the programs, they may call one of many different numbers and that would make sense especially in the past because you were doing advertising in local market, television, radio, print, and then as it migrated more into direct now and then from there to now we are the majority, the vast majority of your leads are in the area of the internet. And so what happens is you now have the ability to more accurately assess those leads and then send them to the more appropriate campus. But, unfortunately one of the weaknesses that weâve had internally is that, that was not happening very well. Infact I believe one of the questions that we had on our last guidance call was, I think a person said they had called a campus and wanted to talk about an online program and the enrollment counselor there was not as helpful as they could be in directing them into that program. That is a fallout of this system that has served us very effectively in the past, but now again because of the majority of the leads being generated in this particular way, we need to change that process. So, what I am leading up to is what I have talked about before but can shed a little more light on that. The best way to service students and in return have a more positive conversion rate and lower your acquisition cost is to make sure that the student is getting what it is he wants and so the process that we are working towards right now is that when a call comes in, it will be centralized through a call center that will basically be a screening center to then direct that lead to the appropriate enrollment counselor so that the student can again be served the most appropriately. Now what that means, let me just give you an example. In the past the student would say call campus A and then they want to be interested in a collect net program or an online program but the enrollment counselor there may not feel prepared to be able to do that so they would probably try and have the student attend in campus. What we want to have happened now and we are starting that process is that when a call comes in, an assessment will be done for that particular student and then direct that lead to the more appropriate campus. That is a long way to lead into this, but what that does is that it does change how you look at the enrollment count. For example I assume, if you were to say in Southern California they have been growing at 8% to 9% a year, and when they are put on this new process you would then see potentially that enrollment rate go as high as 12% or 13% or low as 5% or 6%. In reality they are still converting the same students at, we will hope a little percentage because it is a little more efficient process but the numbers for that particular campus will look a little obscured and so as we have started to do this, you do see the numbers all over the place except on a consolidated basis you see them very consistent. And so back to your question⦠when we look at this we were struggling with a way to try and present that data and so the most appropriate number especially as we are now just starting this process is an overall number, an overall enrollment number. The second number that is helpful is just the online enrolment growth number, and so the plan is as we said in our last call is to look at an overall number which is what we presented in that press release which is this quarter just over 20% consolidated growth, online within the high 30s, on ground was in the mid to upper single digit range, and going forward I think we are going to see that continue to fluctuate a little bit, but the consolidated number will be very consistent and if anything we feel very good about the guidance that we have of a consolidated growth rate of 20% and an online growth rate of earlier in the year over 30% and then start to get down close to the actual 30% range as the year continues. Q â Howard: Thank you operator. Good morning Todd and Kenda. Kenda you mentioned in the explanation around the selling and promotion growth in the quarter that there was actually a decrease in advertising, did you actually mean literally a decrease or a year-over-year just deceleration in the growth and advertising? Q - Howard: Okay. And then also the discounts in the quarter year-over-year change in the margin on that, was far less in this quarter books than the prior few quarters, I was just wondering if that is sort of setting a new ways to consider for discounting through â06 or was there any one time in the fourth quarter? A â Kenda: Well. Actually the one time thing came in the second and third quarter which was the 4 for 3 promotion that online had offered where students took three consecutive classes and received fourth class free and we discounted that fourth class off in the second and third quarters. Just to give you a little color, the largest item within our discount is our military discount as we are serving the military students. So that is the largest portion of that, and that has stabilized somewhat over the last couple of quarters. Q - Howard: Okay and then in terms of the discussion on differed revenue and student deposits, you said that most students are managing their own financial aid. Is that actually more aid that is title for percentage or justâ¦? A - Kenda: No. The way it works Howard is that when a student takes out student loan, their bank forwards the money to us. The student has the choice we cannot require them to leave those moneyâs on deposits as student deposits. The students have their choice as to whether or not they want to manage it themselves or leave it on deposits. So thatâs why we have seen the increase per student deposit decline as more students are choosing to have us forward the money for them to manage and then they pay off. Q - Howard: Okay and then in terms of the University of Phoenix accounted for 86% of the tuition revenues in this quarter and I think it was in the 96% a year ago in the same quarter. Can you just help us sort of think about the lower percentage in the University of Phoenix and whatâs that telling us about WIUâs contribution and so forth? A - Todd: Sure. I guess if we look at it as a company and as I was saying earlier the best way for the long term success of Apollo Group is to make sure that the students are being matched with where they can be most academically successful. And as I was trying to explain earlier is this new program at WIU is a very, whether the program was UOP or WIU, itâs not that relevant to us as the design of the program is really matched more to the particular student and the student right now where your largest demand is coming from is this student who is a little bit younger and has fewer college credits from other institutions. And because of that, that program is extremely popular right now and just a little history of Apollo Group, thatâs not unusual for us in that, there have been times when our graduate programs were more popular or some of our bachelors programs were more popular than others. When, at one time the University of Phoenix had a credit hour requirement that required you to have 60 credit hours to get into the program. We changed that over the years and as we did that those became our more popular programs as well. The ones where you didnât have a number credit hours required and so we are seeing that same thing happen now and the thing that I think internally why we are very excited about it, is that we look at just the statistics of the population in general in the United States and then when you go outside of the US as well, this is really where the demand for education is going to be coming, itâs also where there is the shortest supply of seats. And I know you have heard me talk about this earlier but there was the study in California where they said the community college system is going to be short almost 400,000 seats. There was another study that showed the number of students growing in California to literally 8 million potential students. All these things and when you look at whatâs making up this growth it is this particular part of the market. And so our ability to serve them adequately will have huge amount to do with Apolloâs ability to continue to grow in future. So again we are very excited about most importantly the academic outcome of this program, we are secondly very encouraged by the amount of retention, again it is designed around that so the program is again not only academically but financially conducive to that type of student and to the profile of that student. So, although as I said it was hit to revenue the past year because again when you are charging less for that credit hours you are going to expect that but going forward we now have had a year to kind of model that more successfully and so as I said, as we start our next budget year, we are already very pleased with how September turned out as for as our ability to model it and the retention of those students. Right now we are very encouraged by what we are seeing. Q - Howard: Okay. I am sorry, just to wrap up on this as quickly as I can, that decrease in the percentage though, I think it translates into roughly about $15 million in terms of the change. So I guess, Kenda is that increase there? Is that the WIU Associates Degree Axia Students that we are talking about? Q - Howard: Okay. So if those students, if you hadnât put those students in that program then at least theoretically perhaps you could have described higher revenue per student number to those people in which case. Q - Chris: Kenda I wanted to follow up on your comments on margins, first to the gross margin, I guess if you back out the settlement charges in the fourth quarter of last year with proper litigation that the gross margin on a comfortable basis is down 150 basic points year-over-year. I have done that correctly. And I am wondering if that is the function of the make shift WIU online or just less leverage with a bit of decelerating top line or some other factor? Q - Kenda: Well. Sure I am happy to talk about it. I mean, itâs really a combination with the WIU program because of the less revenue. That resulted in a little bit less gross margin on outlined items for the WIU online student, but it is also the increase in the _____ expense which I mentioned and then also with WIU part of the reason that the faculty pay is queued a little bit and why thatâs increased is because of that WIU online program thatâ where we are just starting the roll it out. Q - Chris: Okay. Not that any kind of specific guidance, but the application going forward then it will still see moderate gross margin expansion or given these factors has gross margin speaks for the medium term? A -Todd: No I think that as we extend before I do feel comfortable that we do expect a slight marginal increase, not a stabilization or decrease. A - Kenda: And we tend to talk to the operating margin line Chris, not just we donât provide guidance on the individual line item detail. Q - Chris: Yeah fair enough. And then primarily looking down the G&A specifically, I think you mentioned a lower compensation cost, would it just to say lower bonus accrual or was actually reversal of a prior accrual? A - Kenda: Right. There was lower bonus accrual and obviously the prior year was paid out during the current year. Q - Chris: And would it be perfect as soon as the very low level here in the fourth quarter of â05 was understandably low and going forward it will happen more normalized accrual? A - Kenda: So it was just a little overall lower for the year and we did not have as much bonus accrued in the fourth quarter of this year as we did in the previous year. Q - Greg: I would like to just go back to the enrollment breakout for a little bit. I just wanted to be clear on that, so you are in the process of putting in this new screening system, is it already actually rolled out throughout the whole systems so there is one number where you call into and then can you give us any more specifics and actually if youâve been testing it, what youâve seen on the front of the conversation rates, is it helping, is it doing anything? A - Todd: Sure. It is now just in the process of getting started the expectation will be that we almost have it fully implemented by the end of the half. So that gives you an idea of where we are with that. We have had, over the past we have done basically a couple of pilot programs where we have looked at the ability where there is cross-selling going on and the result is overwhelmingly positive. The combined conversion rate goes up significantly, the cost related or the cost of acquisition obviously then comes down. But what has been more exciting is the retention of those students goes up significantly. So if you start to, and if we donât want to get ahead of ourselves, if you start to make certain assumptions that, that would continue through the entire systems as it takes place, it does have a significant decrease in our acquisition cost and an increase in our conversion rate. So, both of those things work very well you know for us going forward should we experience the same results. A - Todd: It does not Greg. We did not, based on last year, even though we are still $0.6 over our original guidance, for us thatâs actually not a very good year. We tend to like to be beyond that and so this year we were much more conservative on how we budgeted and we did not put any of these effects in the guidance going forward. Q - Greg: Okay and just on that same note, that I think just to understand your explanation. Is it more difficult for you because of that actually give projections on both the online and off-line, were you just not certain when those enrollments are going to be coming in? A - Todd: I appreciate you asking that question because that is exactly what we are concerned about. Because using my example from earlier, there was a great amount of consistency in the past where say a 100 leads going to particular number and in enrollment counsel was working that set of leads. You would expect consistent patterns year over year. But now whatâs going to happen is you are introducing a new person into that whole process whose going to again end at look at the student and again by what they are saying and their background may be direct that in a different way and so we would expect that there wouldnât be the consistency. Now having said that, that consistency should come back within four quarters because you then have had a year to do that and our expectation is that we would continue to do that the same way. So thatâs where as I said that I think the benefit will come and if people will be patient in the short term with the amount of data thatâs available. Going forward our hope would be that we would able to give much more data as it relates to that relates to that but there is this period of time of inconsistency. Another factor that you have to bring into play and although it has not happened yet is that as we continue to explore some of our international opportunities, there you will also have to look at those students in a different way because again they are not the same type of student here in a sense that you got a revenue for student that in many cases itâs a fourth or fifth of what it is here. You are also not going to have a history of retention as well but, thatâs why itsâ so important I think in this point of time that as we would be appropriately have a number that reflects whatâs going on inside the business verses just trying to stay consistent with the truth which is a process that is not going to be consistent at least through this transition. Q - Greg: Okay you gave ranges on the numbers. I am assuming from upper 30s are you basically saying around sort of a 36% to 37% online and then somewhere around 8% offline is it fair? Q - Greg: And then, are we actually going to get the exact total enrollment numbers from you guys at some point? A - Todd: Well that is again, as we go through this process that is the goal to get to Greg. Absolutely, I think that we have to have that number but again till we go through the process of again learning how these students are, where they are going to go whether itâs online or on-ground. Q - Greg: Todd, I just meant the combined total on these, you said over 20%, is there going be a total enrollment number given, because this is just a percentage, and I might have missed it, it was just a percentage? A - Todd: Oh I havenât answered your question yet, in fact I will have Kenda as we go through it, weâll make sure we find out the exact number for you. Q - Greg: Okay just one more quick one. Kenda on the free cash, you know what you said about the student appraisal and also the higher details for the next however many quarters, are you still thinking $550 million or above for the year in the free cash? Q âMark: Thank you very much. I was just wondering if you could talk more on the philosophy on why you are easing back on advertising, itâs certainly good for this quarter, it almost seems like a deliberate effort to slow growth a little bit is there something you are seeing in the market that makes you a little more hesitant to spend money? A-Todd: I think it is a very good question to ask because the truth is really it is not that at all. What happens is that you still need a certain number of leads based on the number of enrollment counselors and the conversion rate thatâs out there, but as your ability to buy those leads in a more efficient way so lower cost per lead or the type of lead you are getting is a better lead that is more a reflection of the end result versus the fact that you are just getting less leads. So I think that the really important answer here that you are asking is are you just getting less leads and the answer is no. If a particular source of lead, if that were to drop it would be only because the quality of the lead has increased therefore basically you donât need as many to get the same number of new students. But yet we donât know, you are not seeing less advertising going on thatâs for sure. A - Todd: Well again the last thing we want to do is to get more leads in our enrollments counselors hands than they are able to add quickly work with and so I think that is the reason, one reason not to go push that too much. The second is retention, if you are not retaining those students then why get them in the process but we certainly would have the possibility if we decided to do that of just certainly spending a lot more money getting more leads and getting more starts. But I donât think that would be a good thing to do for the company right now because I think still our main focus is to make sure that we are putting the students in the right program and providing the right service to the student so that they will be successful in completing the program. Q - Mark: Right, understood. How about the impact of energy prices, GAAP prices, have you got any feedback from students whether that has an effect on your campus enrollments attrition matter. A - Todd: Yeah I am glad you are asking that question. There are two parts there, first I believe that there has been a slight impact on us because obviously especially on-ground students have to had to deal with that but if I think somebody we are looking at the value of education continues to increase domestically, internationally and I think everybody would agree with that. Second thing, is that we all know that the supply of education is not despite some of the noise it got there about some of the more people getting into full profit area. The total number of seats in the area that we see which we reserve is not increasing that significantly so here you have the value increasing the supply not really growing to meet this increased demand. And now you got this issue of energy cost. The one school system, in our opinion that has the ability to be the least impacted by the shortage in energy cost is Apollo Group. We do that because of several reasons, one lets go to the on-ground, which is the most difficult. We donât have a particular large campus where people have to drive large distances infact if anything we as you know try and get small locations out as close to the students as possible. So, if they are going to have to drive we are certainly the most appropriate alternative. Second is online, I mean that is the absolute solution to any kind of problem when you are talking about increased transportation or energy cost. Third, we have introduced a new program that instead of going up 8% to 10%, which is more than national average _____ increase we have introduced a program thatâs less expensive. So, again I would love to say that we were doing those things because we were prophetic in what we saw coming, but that was not the case. It just is the fact that weâve been fortunate in that our programs are the most well positioned for the population trends as well as some of the as you pointed out here in economic trend that exists right now. So we are not feeling the impact of it right now to the extent as others are and early indications of the year are what the rest of the year will be like and we are very optimistic. Q â Gary: Hi guys, couple of questions, one of the things that I think people have been interested in and pretty focused on is the lower price at WIU, could you give us the big picture sense of your pricing strategy there and in particular I understand that most of these kids are coming in with very few credits, as they move through the system and maybe get past the 60 credit mark. So that itâs more comparable to the UOP student, does the pricing ratch it up, or are you planning to move that so that it will indeed be closer to what you are charging through your University of Phoenix? A - Todd: Yeah. Well I think that the program is actually an associate level program which only goes through the Freshman and Sophomore year and so when they become a University of Phoenix student and become part of the bachelors program and then whatever that tuition rate is, it would obviously apply there and yes it is higher. Q - Gary: So is that the plan right now that these students will have the option to matriculate into University of Phoenix once they have done their two years? A -Todd: Yeah in fact the majority of the students that are in and the vast majority of the students that are in Axia right now are students who were interested in the University of Phoenix. Then again the student is given the option obviously of the two different programs with obviously a certain amount of information as to why maybe one program will be more appropriate for them and as a result they ended up in Axia and I know Brian sitting here, I would say over 90% you are planning on a Bachelorâs degree through the University of Phoenix. So that gives you a pretty good indication that they will end up at the University of Phoenix and complete their bachelorâs degree there. Q - Gary: Okay. Next question it looks likes you opened seven new campuses this year and I thought that the plan had been more like 8 to 10. You didnât enter Connecticut, which I think you got an approval for last quarter and we thought you might. Any comment on that and what did your first half look like? A - Todd: Sure in fact just to give you an idea we had expected Mexico to be opened in the fourth quarter and that did not happen so that would have taken us to 8 which is what you referred to. We were also thinking that we would have possibly one other campus in Indiana as well and no slip into the first quarter of this fiscal year so instead of 8, or 9 last year we ended up with 7 but as you will see from the information we are giving now, where those play out. In â06 we are planning on 9 possibly 10 but in that 3 of those will be opened in the first quarter and those are _____ Indianapolis, Northwest of Indiana, and then Northwest area of Arkansas so again couple of them were bumped to the fourth due to just some operational issues ended up being in Q1. Q2 there is planed campuses in Nebraska, South Carolina, two more in that area in the second quarter including Washington DC 3rd quarter. And then Quarter 3 Madison and Harrisburg and then with just a little bit hope, we do believe that the possibilities of Connecticut and New York will also enter into that as well. Q - Gary: Okay. Any sense where we are, I know you are still probably working on these number in the 10 K but where we are in terms of corporate reimbursement, it seemed like a couple of years ago, it was somewhere between 35% to 40% your total revenues and my sense is that they are dramatic growth volume has come in a little bit. But is that still somewhere around the third, a large part of revenue? A -Todd: What we look at is we donât look at the percentage of revenue as we do as a percentage of students because, itâs not a 100% accurate whether the student is giving a dollar amount say 2 or $3,000 a year or 100% reimbursement. But what has happened is that most recent count of the percentage of students that are getting reimbursement is still above 40%. A - Kenda: Yeah. It was 50% last year and I donât have the number yet for this year okay? But it was 50% last year. Q - Gary: And then just one last question. I think on a call a month ago you commented that 3 or 400 of your 5000 admission reps were actively allowing and helping students choose what of the two online programs on the campus would be the best option for them, I understand you are pointing to roll that out further across the company. I guess two questions come out of that. Number one can you give any sense of timing as to how quickly you are going to allow all or more of your reps to do that? And number two, if we do continue to see a big mixture of course online can you give any sense to possibly shrinking the physical footprint that you have and maybe not number of campuses but actual space reset campuses to try to take advantage of the students continued preference for online. A - Todd: Sure, to answer your first question, the thought on that as I said earlier is to roll out this process of having a centralized call center by the end of our first half and so that it although wonât be completely through the system many of the calls will be going through that and so thatâs the timing as far as the roll out. Now and then your second question was⦠on the space? Yeah. I mean, the nice thing there is that and thank heavens unlike some schools and other universities where they own their facilities, we lease all of ours and itâs because I think we do know that it is an evolving process that is out there. And so going forward I think you will see less space. We actually are taking less space now just because of Flexnet we are on your instructional part of the space cost, that could potentially be reduced to as much as 60%. So what that amounts to is you are going to see us leasing less space in the future but not necessarily eliminating or closing down any thing that we currently have. Q - Bob: Hi Todd, what do you envision ultimately as the University of Phoenix role in the younger, less experienced student market, I take it from the centralized call center that seems to facilitate the ultimate integration of Axia into the University of Phoenix is that the right way to look at it? A - Todd: I think thatâs a good way to look at it, Iâd say that itâs a little early in the process to say thatâs exactly what would happen but I think that it certainly has that potential and again I think it has to come back to really the kind of guiding principles for us, which is what is it that the student wants? And if again the University of Phoenix has stronger band for them, helps them in their ability, the proceed quality of that is something that helps them in their ability to get jobs and promotions and raises and things like that, then absolutely and I think that obviously this makes that a much easier segway, should that decision be made. I should not say that is the way to look at it but it is certainly a good way we look at. Q -Bob: And how aggressively is the WIU Axia program being marketed, I mean what percentage of leads are coming in via WIU Axia versus University of Phoenix right now? A - Todd: Very, in fact very, very little. I talked with Brian a couple of weeks ago, so I maybe a little outdated on a that. But no real direct advertising is being done for that at all. These were again leads that were being generated mostly through the University of Phoenix and through the old database and so really not aggressively at all. I think that there is a potential to do that going forward but again I think if you getting the leads that you need and you see the conversion rate up, you are hitting your budget as far as new enrollments, there is no need to be too aggressive in that area. Q - Bob: Todd, you commented on that earlier, but is there any quantification, you can give so far WIU students persistence rates in the program, obviously way too early for completion rates? But in terms of persistence and/or your expectations of the migration rate of those students, you did mention a lot of those students are coming in to the rest of the bachelors programs to begin with. A â Todd: I will qualify that I canât give you exact information on either but early indications are that they are staying in longer. As you know we talked about this looking forward the big reasons that students drop out of not just the University of Phoenix but other universities as well as, they donât have the funding to complete a yearâs program and one of the things there is very appealing about Axia is that, that issue is not as big an issue because itâs less expensive and get through their own personal funding or through financial aid access. Itâs not as big an issue so therefore the retention so far, looks much better. As far as quantifying it, that still is the moving target, I had said earlier 5% to 7% I believe is the number I used higher and certainly our feeling is that number is similar if not better, and as time goes on thatâs when you really will start to see I think better retention. Q - Bob: Last one Todd, what was the average tuition price increases in your programs in â05 and what do you plan on doing in that regard in â06? A - Todd: Absolutely, our average is just over 4% and those of you who follow this know thatâs about half of what the national average is and going forward we donât see really any plan change in that. Q - : Thanks. Just wanted to get back to the enrollment numbers, if I remember correctly on your call in September you said, you are going to disclose two separate numbers for historical enrollments, weâve only gotten one as of August 31st, I was wondering if you give us the online enrollment for August 31st A - Todd: Yeah. I donât have an exact number just because of the fact that we are starting the segway) but I would definitely say it is in the mid to upper 30 range percent. Q - : Okay and just moving back to the SG&A line item, what kind of I guess normalized SG&A should we be looking at in fiscal year â06, I know it has kind of bounced around a little bit for the past few quarter? A - Kenda: You know for the year G&A was 4.4% of revenue and thatâs down from 4.9% I mean I would not anticipate that we are going to be able to get a significant amount of leverage of a number thatâs already pretty low. Q - : Okay and then since you brought selling and promotional, can we talk about that as well? I just wanted to know in terms of what the normalized numbers we should be looking⦠A - Kenda: Well, we are at 21.5 % of revenue for the year and I would anticipate that it will be somewhere it will bounce on the quarters because our advertising is not as consistent as perhaps you guys would like but itâs the way we run the business and so you could probably in any given quarter see that slightly North of 22%, although frankly when I am looking at the budgets I am not quite expecting it to get that high, so lets just say 22% and it could be as low as 20%. Q - : And then in terms of the number for the year, would it be down as a percentage of revenue in â06 versus â05 based on your guidance? A- Todd : Yeah and again we are in the process of doing that now. Several campuses have already started that the goal as I mentioned earlier, we are hoping that you are able that do obviously more effectively in your larger campuses, but going forward we are planning to have every campus being able to offer that certainly by the end of this fiscal year, but with a little bit of luck most of them done by the end of the half as well. Q - Sarah: And in terms of pricing do you plan to price the on-ground program similar to the online associate degree program or would it be priced more comparably to the traditionally URP program? A- Todd : Actually in the middle and reason for that is that it is a little different model itâs not exactly the same as the online model. Just to maybe give you some average numbers if you are talking about say under $300 a credit hour for an Axia on the online program the lower credit hour program and say the regular on ground program of being say $350 a credit hour this would be more in the neighborhood of an average of $325. So you can see itâs right in the middle. Q - Sarah: So in theory the pressure on average revenue per student that we saw for the end of this year probably going in to next year. When you are modeling are you assuming continued pressure on that given the roll out of the ongoing program as well. A- Todd : And so again let me just put a little color on that, we donât want to have what happened in the last couple of quarters in the last fiscal year, where because of the popularity of that program it made our revenue models not as accurate as they have been in the past and so this year what we did is, we took the conservative view of that and so therefore again we donât expect that same type of situation to occur. Q - Sarah : Okay is it fair to assume that the average revenue per student is probably going to be down in the first half of the year but then flapped up in the second half. Is that what you are assuming? A - Todd : I would think itâs a little early to tell. Yes simply because the real numbers of that new program started to fall into place in the third and fourth quarter. Q - Sarah : Okay, and then the last quick questions could you give us an update on the Flexnet programs and any sense of how many students are currently enrolled in it and how itâs going? Q - Jennifer: Hi. Todd could you clarify what youâve experienced thus far in terms of the operating margin for the WIU online students. I think there has been some confusion about expectation versus what you have seen thus far. A - Todd : I think the main, if you are going forward as a large percentage of these students are in place and a lot of your development that was going has also been spread out over more students. The margin for that student will be growing faster than the expected margin growth in the University of Phoenix student and in the early stages they were less profitable since because again you had fewer students and they have now become significantly more profitable than what they were. But going forward our feeling is very strong that they will have be higher margin of students and there are couple of things that I know, infact I have read somebody speech this morning commenting on this but then yes as you have a larger class size again because the academic model is structured differently, there is more contact hours with the faculty member and so therefore you can accommodate a larger class size, you would expect your margins to be a little bit better. A - Todd : Today, I would say again itâs hard to measure it accurately but the margin is a little bit more larger than a regular University of Phoenix student. A - Todd : Sure. Infact I also read another little matrix on that this morning, that if you look at just across the Board we have the Director of New Orleans, all of our Louisiana campuses in and we also had a regional VP. But right now of the three campuses that are located specifically in Louisiana, two of them are operating, the third one is not open yet and we are not sure when that will be operational. What weâve tried to do is those students who can, we try to get them into the other learning centers or the other campuses in Louisiana and those in New Orleans that we can reach to get into an online program if they would like to do that. The building itself in New Orleans is in relatively good shape. And going forward as I said before we built about $21 million revenue reduction for the impact of the on-ground effective, on-ground students and from Katrina and our hope is that obviously it wonât have to be as much of that. Because going forward Bob just gave a note that their feeling is that they are hoping by the second half of the fiscal year that it will be up and running. There is a lot of obvious things that would have happened by then. As far as the impact indirectly, and this is the one I think there was some confusion from the one that was mentioned before. Itâs hard to quantify the impact on online students and although yes they canât physically attend the campus, there were many students who were affected that did not have access to any kind of telecommunication and the ability to access the program online. Now those students obviously will come back sooner but the things still affecting their personal lives are having an influence and impact on that. Also those whose decisions are whether to go to school or not to go to school right now probably not the most important thing on their mind. So thatâs why we put what we felt was a reasonable number in there, penny and quarter and then as I said as mentioned on the revenue side of that, our feeling is that itâs more than adequate and in the second half of the year there maybe a little bit of cushion built in there for us but again, I felt it was the most responsible thing to do to put a penny and quarter for that A - Todd : Just a minute, let me look at the notes here, I would say probably we have been able to get back into the system about 50% of those students to dateâ¦.a little bit higher.. so maybe in the neighborhood of about 30% of the students will get back in the program. Q - Trace: Hey, you kind of touched on this call but I just wanted to try to clarify this if I could. I think last call, you endorsed a number for Axia that was how it was actually in the 30,000 range and I suspected some people then looked at that and grew concerned at the underlying growth in the University of Phoenix online program was may be less than what they had anticipated. Is it fair to think of it that way or is it in fact a case that you did have those low credit hour students in University of Phoenix online a year ago, and now you are directing them to you what you think will be a more effective program? A - Todd: Thatâs exactly right. What happened is as I said this with Brian earlier that well over 90% of the students that we are getting now are people who were interested in the University of Phoenix, they didnât come to us because of their interest necessarily in Axia and so the assumption is that a large percentage, not all of them obviously, but a large percentage of those would have been in the University of Phoenix, so if we were saying that all of a sudden lead flow at University of Phoenix fell off, no thatâs not the case at all, these werenât University of Phoenix leads. Q - Trace : Right, okay I thought that was the case, I just wanted to put a fine point on it. Kenda, just one more question for you, itâs looks as though the cash conversion of earning as dipped a little bit over the course of this year versus prior years, and itâs seems as though one of the drivers of that is kind of an increase in your restricted cash. I wonder if you could comment on that whatâs driving that trend and what we could expect going forward? A - Kenda: Restricted cash is a calculation based again on when studentâs financial aid money comes in, but as I mentioned we moved that to investing so that it would not queue the operating cash flow numbers in the future, so we have made that move down, I think some of the confusion came within the second quarter where we were required to break out option rates securities, we restricted down into inventing so we had a portion of the restricted cash in operating and a portion in investing so now we have moved it all to investing. Q - Trace: Okay, so, the increase is thereon a function of sort of mix of programs, so the growth of Axia or anything like that. A - Todd: Thanks, operator we probably have time for just two more questions we are already over an hour so, go ahead. Q - Fray: Thank you guys, I just got one quick one question in here. Whenever you look at the question about energy and you said that you lease most of your buildings, so is it safe to assume that from a budgeting standpoint, you guys arenât really impacted by the higher energy cost that will becoming through this winter? A - Todd: Yeah, very, very little impact by that, and not only do we lease just some of our building, we lease all of our buildings. We even know that we have bought the land and built the building we do sell these back again it is a safer operating model and it is also consistent just philosophically that we are not in the real estate business, we are in the business making a convenient for our students when it comes to where their classroom is. So, yeah, I think very little impact there. Q - Fray: Great, and then whenever I look at the average revenue per student in the fourth quarter I know there is some volatility in that number just due to seasonality and what not but it appears like I would have thought that it would have degraded more than it did actually and can you speak for that, is there an anomaly there, or I am just to doing bad math? A - Todd: No I think that the potential is there but I think it is just goes to the strengthen our model, that as far as back to this point as far as value of education and the demand continues to increase. The downside is that if you look at it again, I am looking at macro trends in education, I think they are missing the course for the trees here, that the educational model which will be successful are the ones that can deliver the education in an economic way and still maintain the higher level of quality and customer service. And they have to be independent of technology development as well as economic issues like the energy crisis and so on and the cost of energy and we are just better positioned to deal with that and I think whether its luck or what, it just so happens that I think we are better positioned to take advantage of that, now whether we do or not will depend on our ability to execute but certainly the opportunity is there and it is probably from our point of view it is probably more promising than it has ever been. Q - Fray: Okay and then just one final question, on the student to teacher ratio, did you provide that for the fourth quarter? A - Todd: I did not, but I can just give you as general number. For on-ground it is still in the 15 to 1 range and it is coming up slightly, online is going up more significantly, we are in the neighborhood of about 13 to just under well⦠Kenda is telling me just under 13 .. so 12.5 to one on the online basis. Q - Richard: Great, Todd, I just wondering if you could just talk a little bit about may be the time for students coming to from a lead to a conversion, I know last year you spent about 5 million extra I think it was in the second quarter. Did you get any benefit from that in the most recent quarter and is that the reason may be the growth in selling and promotional is decreased or decelerated I should say? A - Todd : I think thatâs had a little impact on it. I mean when you are talking about the size of the company, and the amount of money we spend, you are talking about may be to benefit of couple of million dollars may be $1.5 million in this particular quarter but nothing overly significant. But we may then because of that be spending in the fourth quarter of this year that we just finished for the first and second quarters of this coming year. So it is hard to⦠as Kenda mentioned earlier, I thought she put it well, when itâs very difficult to tie each of the quarters specifically when it comes to advertising spending because it doesnât lineup with your quarters. You do what you can and make sure you have enough quality leads to produce the start that you need but I would say it is a safe assumption to make obviously we were feeling some of that impact not a lot just because of the shear size anyway but certainly some in that percentage this quarter, this past quarter which is reported. A - Todd: Right now it is the little shorter for Axia and again that, that would be consistent with introducing any new program, there is a little bit of a build up demand there. Todd: Okay well again just a couple of wrap up comments. We appreciate you joining us, I know we are looking forward to a very good year we are seeing out of the blocks, a little bit of conversion rates, our retention is a little higher, we have good things happening within just operationally with this migration to our call center and some of our new programs and so we are looking forward to a very good year and hope to have you join us in a few months from now. Thank you very much. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234080 | Hereâs the entire text of the Q&A from Hecla Miningâs (ticker: HL) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. QUESTIONS AND ANSWERS Hi. To put things into perspective, for 2006 would you be able to give us a rough idea by property which properties will be producing more, which ones less, which ones about the same as what you expect to produce in 2005? Sure. I can do that roughly. We are in the budgeting process, so we're not yet prepared to put out estimates. But I think you'll see Greens Creek to be about the same. You'll see Lucky Friday increase. You'll see La Camorra unit increase. Okay. With regard to exploration, do you believe that the Hugh Zone is the underground feeder system at the San Sebastian property? I think it is a little early to say that definitively, but it is pretty likely that it is. And the nature of the sulfide minerals, the zinc, the copper is implying that it has a -- a intrusive nature to it. So I think that is a good assumption. I have a question. Based on the nine months actual results in 2005 guidance, it appears to be looking for Venezuela to show a sharp decline in gold cash costs in Q4 '05 for the [inaudible]. Can you explain why there is going to be such a large decline in cash costs? Yes, I mean it's essentially a function of bringing material up the shaft. It is a function of the improved productivity that we have already seen in October and into November. It is a function of even more material coming out of Mina Isadora. So you put all of those factors together and you'll see a dramatic increase in -- decrease in the cash cost. And because we're going to have more ounces coming out. It is not the cost of the inputs. Those, you know, are projected to be very similar to what we've had over the last nine months. It is productivity. It is number of ounces coming out of the ground. Yes, a question probably for Ron here. With respect to Lucky Friday, recoveries for zinc are at 45%. Where can you get that to, because unlike most operations, that one seems awfully low, relative to what I would have expected? Yes, consistently we have not paid a lot of attention to the zinc. It's been a pretty small player here. The -- one of the things that has happened in the gold hunter is that zinc has become more prevalent and a bigger player in the game. I can't remember exactly what -- what we're projecting there, but to expect something in the 50 to 55% range would be fairly common out there for this type of flow circuit. Right. Okay. Then, Phil, you didn't come out and say this but, you know, I would say that you indirectly did. You implied that you would put more investment into Venezuela. Do you think that's the right thing to be doing at this point in time? Well, I mean, we're doing it selectively, Barry, things that we see as being very, very perspective. And then, frankly, if we're going to do something more significant, we're looking for ways to increase everyone's comfort that it's well spent. The bottom line, though, Barry, is that we do not feel that Venezuela is really materially changed what it is looking to -- for foreign investment to do in that region. So we think what we do, how we're operating -- well, they told us. They said you guys are the poster child of investment in the mining sector in Venezuela. And we want others to come in and invest in the same way and conduct themselves in the same way this you guys have done. So we think that -- once everything settles out, we think that because of our history there and the country that there's going to be opportunities for us. I mean, there's ground we've been interested taking advantage of and exploring or producing from that, frankly, the title issues have been so difficult we haven't been able to do anything. Well, with this change in their structure there, their scheme, there might be the opportunity to do things on that ground. We're going to be -- we're going to be cautious. We understand the markets, the unsettled feeling the market has toward Venezuela. and we've got to respect that. Okay. So just basically, if I were to paraphrase it, you're a lot more comfortable with it than what the market seems to be worried about at this point in time? [OPERATOR INSTRUCTIONS] At this time, I'm showing no questions. I'll turn the call back over to the presenters for closing remarks. Well, thank you all. This has been the Hecla Mining Company third quarter 2005 conference call. If anyone has any further questions, please feel free to call me, Vicki Veltkamp. My number is 208-769-4144. So thanks to call of you for joining us today and have a good day. Operator Ladies and gentlemen, thank you for joining us on the call. You may now disconnect your phone lines. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234081 | Good afternoon and welcome to Deutsche Telekom's Full Year 2005 Results Conference Call. On our customer's request, this conference will be recorded. This presentation contains forward-looking statements that reflect the current views of Deutsche Telekom management with respect to future events. They include statements as to market potential and the planned T-Online merger and the "Outlook 2006" statements at the end of this presentation. Forward-looking statements are based on current plans, estimates and projections. You should consider them with caution. Such statements are subject to risks and uncertainties, most of which are difficult to predict and are generally beyond Deutsche Telekom's control, including those described in the sections "Forward-Looking Statements" and "Risk Factors" of the company's Form 20-F report filed with the US Securities and Exchange Commission. Among the relevant factors are the progress of Deutsche Telekom's workforce reduction initiative and the impact of other significant strategic or business initiatives, including acquisitions, dispositions and business combinations. In addition, stronger than expected competition, technological change, litigation and regulatory developments among other factors may have material adverse effects on costs and revenue development. If these or other risks and uncertainties materialize, or if the assumptions underlying any of these statements prove incorrect, Deutsche Telekom's actual results may be materially different from those expressed or implied by such statements. Deutsche Telekom can offer no assurance that its estimates or targets will be achieved. Deutsche Telekom does not assume any obligation to update forward-looking statements to take new information or future events into account or otherwise. In addition to figures prepared in accordance with IAS/IFRS, Deutsche Telekom presents so-called non-GAAP financial performance measures, e.g. EBITDA, EBITDA margin, adjusted EBITDA, adjusted EBITDA margin, adjusted EBT, adjusted net income, special influences, free cash flow, free cash flow before purchase of network assets and spectrum in the US, leverage, net debt, net debt adjusted, EBITDA and the adjusted figures on the page titled "FY 2005 Net Income". These non-GAAP measures should be considered in addition to, but not as a substitute for the information prepared in accordance with IAS/IFRS. Non-GAAP financial performance measures are not subject to IAS/IFRS or any other generally accepted accounting principles. Other companies may define these terms in different ways. For an explanation of some of these terms, please refer to "Reconciliation to pro-forma figures" under the "Publications" heading on Deutsche Telekom's Investor Relations webpage at: www.deutschetelekom.com. Now please listen to the reports of Kai-Uwe Ricke and Dr. Karl-Gerhard Eick. Afterwards you are welcome to ask your questions. May I now hand you over to Mr. Thilo Kusch. Thank you, Thilo. Hello everybody. As you will have seen from this morning's announcement, the results for 2005 are very satisfactory and we have met all the financial targets that we set ourselves at the beginning of the year. Revenues have risen by nearly 4%, just under â¬60 billion, with an increase of 5.4% in the fourth quarter. Adjusted EBITDA increased by 5.7% to â¬20.7 billion, and free cash flow of nearly â¬8 billion represents a free cash flow yield of 14%. This results in net income for the year of â¬5.6 billion, which on an adjusted basis equals â¬4.7 billion. This excellent bottom line performance means that we will be recommending to the AGM that a dividend of â¬0.72 per share be paid in 2006 for the year 2005, an increase of 16% over last year. It is Deutsche Telekom's excellent financial position, the strongest it has ever been, that allows us to recommend the highest dividend payment in our history. Let me just highlight some of the business areas that have contributed to this strong performance, and also give you an update on our top ten targets that are part of our excellence program. In Broadband/Fixed Networks we have been very successful in stabilizing the minute loyalty through our tariff reforms, and we have secured the IPTV football rights for our triple play platform, to be launched later this year. The Mobile business successfully implemented its mobile data strategy with 400,000 web'n'walk devices sold during the year. The objective of providing seamless services to our customers saw the introduction at the beginning of this year of T-Mobile@home, and preparations are in hand for the launch of the customer relationship management database in April. Within the Business Customer division, we acquired the Gedas Systemhaus business from Volkswagen in December last year, for which we got EU approval on Tuesday. This acquisition is in line with our strategy to grow ICT solutions. At Group level, we announced back in November the objective of reducing personnel numbers in Germany by a total of 32,000 over the next three years. Let me just stress that the implementation of this program is not dependent on any accord with the trade union as it is based upon voluntary agreement with the individuals concerned. I will go into a little bit more detail now about the results for the three divisions in turn, but I will keep my remarks to a minimum, as you will have the opportunity to hear more about each of these from their respective management teams at our Investor Day at CeBIT in a couple of weeks. Starting with Broadband/Fixed Networks, you can see how broadband growth is accelerating. During the course of the year there were more than 2.1 million DSL net adds in Germany alone. The fourth quarter developed especially well with 660,000 DSL net adds. This is the highest annual and quarterly increase seen to date, and we expect the strong growth to continue for the foreseeable future, particularly as there is still a lot of potential in the German market. We currently have nearly 8 million domestic DSL customers, and of these Deutsche Telekom's retail share stands at around 80%. In addition, the development in Central and Eastern Europe is progressing very well with total DSL subscribers more than doubling to around half a million. We are also seeing similar, very positive developments in Mobile in Central and Eastern Europe. Within T-Com specifically, total revenues for the full year declined by 3.5%, that is around â¬1 billion. Of these â¬1 billion, â¬0.2 billion were internal revenues driven by reduced prices and volumes in its relationship with T-Online and T-System. External revenues in the fourth quarter fell year-on-year by nearly 5%. This is due in part to a loss of narrowband access lines, but mainly it is because of the deliberate policy of proactively defending our customer base through the introduction at the beginning of last March of a new optional tariff structure which led to a stabilization of our minute market share, and the focusing of DSL sales and marketing in T-Online alone. As part of the broadband strategy, and in order to maintain its competitiveness, T-Online twice reduced its flat-rate tariff during the year. In 2006, we will be introducing the new triple play products into the market, and we will be giving you more details about this at CeBIT. Moving now to the Mobile division, you can see clearly how Mobile revenue growth has progressively accelerated during the course of 2005. This is true for both total revenues and service revenues in all the key markets of Germany, the US and the UK. The service revenue growth in Europe was driven by a 5% increase in minutes of use of the network as SIM-card penetration grew, which over-compensated for the slight expected decline in ARPU per SIM-card. Total Mobile customers numbers increased by 9 million to nearly 87 million. The impact of the Safe for Growth program is clearly evident in the fact that despite this very significant rise, total subscriber acquisition costs did not increase, remaining stable at below 3 billion, while Save for Growth had decreased by 14% year-on-year. The US Mobile operations have enjoyed another spectacular year. Customers increased by more than a quarter to nearly 22 million; revenues grew by 28% to almost $15 billion, and adjusted EBITDA by 60% to over $4 billion. T-Mobile USA has been, and continues to be a key contributor to revenue and EBITDA growth within the Mobile segment, and Deutsche Telekom as a whole. In 2005, T-Mobile USA contributed 40% of the total mobile revenues, compared to 31% in 2003. The adjusted EBITDA contribution increased to 34% in 2005 from just 18% in 2003. At T-Mobile UK, we saw a turnaround in the customer growth and revenue development in the fourth quarter. Compared to the fourth quarter of 2004, revenues grew by almost 10% to â¬1.1 billion. Clearly, this turnaround is partly due to the fact that the year-on-year development was no longer impacted by the termination rate cuts; however, the strong revenue growth is also a reflection of the operation improvement of T-Mobile UK, which is also evident in the strong customer growth of 845,000 in the fourth quarter. As you will have noticed, we also took a write-down in the goodwill of T-Mobile UK of â¬1.9 billion. This re-evaluation as part of the annual impairment test, which is obviously a non-cash item, is a consequence of the valuation of O2 following Telefonica's takeover bid. This is quite different to the reasons that led Vodafone to its recent write-down. Karl will return to this later. If I turn now to Business Customers, the focus has been and will continue to be on the opportunities of leveraging the Group's expertise and scale in cross-selling IT solutions to the small, medium and large customers. Although this program was only introduced during the course of the year, the impact is already clearly visible and the increase of nearly 30% in IT revenues from this customer group to over â¬400 million. Thank you Kai. From a financial perspective I can only underline Kai's remark that we generated excellent results. We delivered on all our financial targets; revenue at â¬59.6 billion came in above the low end of the guidance range due to strong growth in Mobile in particular. Adjusted EBITDA with â¬20.7 billion was precisely in line with guidance. CapEx, excluding the acquisition of network assets and spectrum in the US, at â¬7.2 billion came in slightly below the low end of our guidance range. We are pleased with the free cash flow performance. For the year we achieved a free cash flow of â¬7.8 billion, despite significantly higher cash taxes and an adverse development in working capital and accruals. With a net debt to adjusted EBITDA ratio of 1.9, we improved our leverage further, compared to our guidance of no further improvement of this ratio. The net debt to adjusted EBITDA ratio is actually slightly below our target range of 2 to 3. Our yearend 2005 gearing of 0.8 is at the low end of the target range of 0.8 to 1.2. Finally, our equity ratio of 38.8% is back to the historical high in 2001, and above our target range of 30% to 35%. Reported net income increased by almost â¬4 billion to â¬5.6 billion, while adjusted net income improved by 26.7% to ⬠4.7 billion. This strong bottom line performance allowed us to increase the dividend per share by 16% to â¬0.72 per share, which is our proposal for the AGM in May. You will recall that we said that the dividend was dependent on the profitability development. Looking at the divisions, Broadband/Fixed Network continued to experience top line pressure in 2005. Both revenues and adjusted EBITDA came in at the low end of the guidance ranges in each case. Revenue at T-Com Germany decreased by 4%. This was partially offset by stable revenues at T-Com Eastern Europe and at 3.8% revenue growth at T-Online. Despite a revenue decrease of â¬0.9 billion, T-Com's adjusted EBITDA nearly stabilized at â¬9.6 billion, after â¬9.7 billion the year before, continuing its strong record in terms of improving cost efficiency. This strong adjusted EBITDA performance at T-Com was partially offset by the development at T-Online, where adjusted EBITDA decreased by more than 30% in 2005. This is a reflection of the intense competition in the ISP market, and T-Online's successful attempts to stabilize its market share. However, even including T-Online, Broadband/Fixed Network's overall adjusted EBITDA decreased only by â¬0.3 billion year-on-year compared to the revenue decrease of â¬1 billion. Mobile had great results in almost every aspect; revenue grew by 11% to â¬29.5 million, and exceeded our guidance from November of â¬29.3 billion. Adjusted EBITDA came even at the high end of the guidance range with â¬9.8 billion. The customer base grew by 9 million customers to almost 87 million internationally. Almost half or 4.4 million of these new customers came from the US, with Germany contributing 2.1 billion and the UK 1.4 million new customers. T-Mobile US contributed almost 90% of the absolute growth in revenues, underscoring the importance of the US for the overall growth of Deutsche Telekom. Encouragingly service revenues grew in all mobile companies with the exception of the UK. Even in UK the trend is starting to look a lot more positive. Fourth quarter service revenues in the UK increased by 5.6% year-on-year. Total revenues increased by 9.7% due to strong handset sales as already said by Kai. Adjusted EBITDA for the mobile segment increased by 16.3% to â¬9.8 billion, even faster than the 11% revenue growth. As a result, the adjusted EBITDA margin improved by 1.5 percentage points to 33.2%. Germany and the UK posted essentially stable adjusted EBITDA margin for the year with 41.8% and 31.4% respectively. T-Mobile US improved its adjusted EBITDA margin by an impressive 5.5 percentage points to 27.7%. Compared to our guidance from November T-Systems delivered excellent results, revenues came in at the high end of the guidance range with â¬12.9 billion. Adjusted EBITDA exceeded the guidance range with â¬1.6 billion. While this is encouraging we still saw some revenue weakness at small, medium and large enterprises for the year, which was not completely offset by the revenue strength in the top 60 customer segment. However, we are encouraged by the initial success of our initiative to grow the IT revenues within the small, medium and large enterprise segment as already highlighted by Kai. We are very pleased by our continued strong cash generation; with a free cash flow of â¬7.8 billion, we've fully met our target range of â¬7.5 billion to â¬8 billion. We managed to achieve this stronger side despite the adverse change in working capital and goals, significantly higher cash taxes and significantly higher cash CapEx. We benefited both from a very strong underlying cash flow of almost â¬20 billion and a significant reduction in net interest payments due to the lower debt level. In 2005 the change in working capital and accruals had an impact of â¬0.7 billion on the cash generated from operations. Working capital increased by â¬0.5 billion, due in particular to higher account receivables driven by revenue growth. Accruals decreased by â¬0.2 billion, while associated payments increased. These apply in particular to the restructuring of the civil servants' health insurance fund. In this context, let me say a few words about CapEx; CapEx amounted to â¬7.2 billion excluding â¬2.1 billion for the Cingular network in California and Nevada in US spectrum. Compared to 2004 with CapEx of â¬6.4 billion, CapEx increased in '05 due to higher investment imports and fixed network and mobile, still CapEx came in slightly below our guidance range of â¬7.5 to â¬8 billion. We are also very pleased with the developments of the bottom line, net income more than tripled to â¬5.6 billion, while adjusted net income increased by almost â¬1 billion to â¬4.7 billion. Looking first at adjusted net income, EBITDA and net financial expense improved by â¬1.1 billion and â¬1.4 billion respectively. The improvement in net financial expense was due in particular to a lower net interest expense driven by the reduction in gross debt, and the impact of the improved rating on the bonds with step up clauses. This more than offset the increase in D&A and income taxes. The increase in adjusted D&A by â¬1.2 billion was driven primarily by higher amortization of intangible assets which in turn was driven by significantly higher amortization of UM test licenses, due to the IFRS rules that licenses can only be amortized from the date of the launch of service. You certainly will remember that in 2004 we have only written off our UM test licenses for half a year whereas in '05, we had the full year effect of the UM test license amortization. Adjusted income taxes increased by â¬0.5 billion to â¬2.6 billion. In terms of reported net income let me highlight the biggest special influences in the fourth quarter. In the fourth quarter reported costs including D&A, excluding D&A amounted to â¬12.4 billion. Adjusted for special influences costs were â¬11.1 billion, by far the biggest special influences where personal restructuring charges amounting to a total of â¬1.2 billion before taxes. Personnel related restructuring charges at Broadband/Fixed Network contributed about half of this amount, with the remainder coming from primarily from Business Customers and GHS, including the rental. These restructuring charges were made in connection with our program to reduce personnel by 32,000 employees over the next three years. Other operating income was boosted by â¬0.8 billion gain from the release of accruals due to restructuring of the health insurance systems of the civil servants. In terms of D&A, essentially the entire special influence came from the --already by Kai -- mentioned â¬1.9 billion unscheduled write-down on the goodwill of T-Mobile UK. This write-down resulted from the regular annual impairment test that we had already selected in the third quarter interim report. The bid by Telefonica for O2 provided a comparable valuation that we were required to apply for the valuation of T-Mobile UK, which then led to the required valuation adjustment of â¬1.9 billion. This was not caused by any change in the outlook for the business, and let me stress that the write-down is obviously a non-cash item. Just for clarification, this situation is clearly quite different to that of Vodafone. Vodafone had more than â¬120 billion of goodwill, following the international acquisition. We on the other hand, have only a small amount of goodwill in our balance sheet left, out of the total of â¬18.4 billion of goodwill, only â¬11.3 billion are in our international mobile businesses, and in any case as you will recall, we made some write-downs in the year 2002. Returning to the special influences, taxes were positively impacted by a â¬2.2 billion non-cash income tax benefit related to the net operating loss carry forward for T-Mobile USA. This loss carry forward represents an asset to T-Mobile US to the extent that they can be utilized to reduce future cash income tax payments. By maintaining evaluation allowance against deferred tax assets related to these loss carry forwards, T-Mobile US had not recognized them as assets in accordance with accounting rules requiring evidence of its ability to utilize them in the future. In the fourth quarter of '05 T-Mobile US determined that its financial performance strengths were sufficiently positive to support a â¬2.2 billion reduction in the valuation allowance against its deferred tax assets related to its tax loss carry forwards. This then resulted in the gain we see here. Despite significantly higher cash outlays we continued to improve our balance sheet, which is now I would say in excellent shape. Shareholders' equity improved by almost â¬4 billion to â¬49.6 billion, while net debt at yearend 2005 stood at â¬38.6 billion or â¬1.3 billion lower than at the end of the year before. As a result of these developments, all key graded metrics continued to improve as I described in my introductory statement. Let me remind you in this context that we have nearly halved our net debt since its peak in mid 2001 by more than â¬35 billion. Our 2005 yearend net debt of â¬38.6 billion compares to an estimated net debt of approximately â¬74 billion under IFRS as of June 30, 2001. This achievement has also been recognized by the rating agencies where we now have a stable Single A long-term rating from all three major agencies. Back to Kai. Thank you, Karl. Let me conclude by summarizing the revenue and EBITDA targets that we announced in November for 2006 and 2007. For revenues we are targeting between â¬62.1 billion and â¬62.7 billion in 2006 and for adjusted EBITDA the guidance is to deliver between â¬20.2 billion and â¬20.7 billion in 2006. The targets for 2007 remain unchanged as well. As I said before we look at 2006 as a year of investment, similar growth and to enhance our long-term profitability. This level of investment in the business is reflected in the CapEx expenditure. We would expect CapEx to increase to around â¬10 billion in 2006 driven in particular by the fiber investments in Germany and increased investments at T-Mobile UK, T-Mobile Germany and T-Systems. This of course does not include any option of next generation rollout costs in the US AWS option where we expect to fully participate. This is going to be a very important step in the development of T-Mobile US. With the spectrum acquired in this auction we intend to rollout the next generation network with the objective of enhancing further the capacity of our network for both fixed to mobile substitution and mobile data and of driving cost benefits. But, as in the past, we will take a very discipline approach to the auction and we will not overspend. As you are probably aware, the SEC has set June 29 as the start date for the auction in its recent public notice. Finally, let me just take this opportunity to update you on the other outstanding issues. First the online; here we do now appear to be moving forward. Last month the appeals court in Frankfurt approved the accelerated registration of the merger but did grant leave to appeal to the Bundesgericht, our federal court of justice, which is Germany's highest appeals court. The Bundesgericht has yet to determine whether it will allow an appeal. If it were to do so, then we would have to wait for a final decision which would be some time later this year. Second, we are waiting for the revision to the Germany telecommunications act to provide us with the regulatory certainty that we require in order to continue our investment in fiber-optic network. We remain confident that this will be finalized in the not too distant future. And third, you will have seen that there have been some points of detail raised by Brussels regarding the acquisition of tailoring; however we see no reason why these cannot be resolved and expect to be completed by May. And as you will have seen yesterday our agreement with Ortel has been extended until the middle of May. As I have said before, future dividend development will be dependent on the profitability of the business and we remain very confident about this. In addition, let me just reiterate that Deutsche Telekom is committed to providing attractive returns for our shareholders. Thank you. Hello, yes if I could just ask a couple of questions firstly. Just on the movements in T-Com revenue, the overall revenue is down 1% but it looks like network communications as you mention was down about 8% this quarter year-on-year. Could you maybe explain a little bit more in depth what happened to the network communications revenue line? And also wholesale was strongly up. So is it possible for you to explain why it was so strongly up given the comp in the fourth quarter was so weak? And the second question. Could you maybe mention on dividend -- could you explain a bit more about what you mean by profitability of the business exactly? You've not set a floor this year for the dividend payment but it looks with the spending at the EBITDA line as if your net income -- there's a possibility it could be flat or even down. Could you just explain to us what you mean about profitability and what you're linking the dividend to exactly? Thank you. Well let me try to answer your first question at a glance. It reflects the developments in the business customers area. Until Q3 2005, the overall trend was increasing external revenues and slightly decreasing internal revenues. Q4 2005 saw an extraordinary change in internal to external revenue development, 1) the decreasing external revenues compared to Q4 2004 due to very strong Q4 2004 which was toll collect. And the weakness in systems integration whereas there were increasing internal revenues, and the main driver was the Windows XP rollout at Deutsche Telekom which could be completed in Q4 2005. I hope that address your question, I'm not sure whether it really was your question. Second, dividend. I'd like to stick to what I said. We have always said that the development of the dividend will depend on the development of the profitability and that we want to pay an attractive dividend. So no change to that, and we always said that. That still remains true. And I would like to add that it is our strong intention, it's the intention of the management to increase the profitability of the business. And when it comes to the dividend for 2006, we will decide it in 2007. Probably to add to the first point, you're probably looking into the backup where you have the T-Com domestic split but the explanation we have given in the presentation, on the T-Com total revenue decline of about â¬300 million explains exactly what is happening in the fourth quarter. And probably to the wholesale revenues in T-Com, the increase mainly was borne out of the fact that if you look at the 2004 numbers, we had a very unusually low number in Q4 so it looks as if there's a huge increase year on year but that basically is borne out of an accounting treatment of the year 2004 where we had very low wholesale revenue in 2004. I hope that was it, let's move onto the next question. Yes I was just looking at the T-Mobile numbers and seeing that both T-Mobile Germany and T-Mobile UK have swung back into positive revenue growth territory. I was just wondering how sustainable that is going forward given various profit warnings elsewhere in the sector? I was also wondering whether you were surprised by Vodafone's downgrade of its outlook earlier this week? Whereas I do not want to comment on Vodafone and any other outlooks, let me dive a little bit into the German and the UK performance. Yes, you are right; what you see is, and that is where we are very proud of, a decent growth in service revenues, not only in Germany, but also in the UK. And thatâs very specifically in the fourth quarter, which is, and I'd like to stress that, a direct result of our strategy which we started some time in 2004, as I recall it, to âSave for Growthâ. Saving for growth meant that as for today, although we are growing the business like hell, the EBITDA margin look very satisfactory for the 2.3% in Germany, and decent 28.7% in the UK whereas strong customer intake -- intakes also grant some more movements for revenues for the quarters to come. And this is exactly the strategy we are following. So I'm optimistic, not over-optimistic, but I'm very optimistic that our strategy is going to work. Thanks good afternoon. I guess linked to the previous question, on the regulatory side, what could be the impact of the potential roaming cuts on your German mobile revenue growth in 2006? And then secondly, what are you assuming on mobile termination particularly around timing? Thanks. Well when it comes to the roaming cuts, it is definitely too early; there are all scenarios thinkable. What you should take from us, and I know that Rene also was very outspoken in Barcelona about that, that we are -- we are about to proactively move and that we are a net payer in that scenario. This is all I can say right now. Sure that you will have more discussions then on CeBIT about the issue. When it comes to the mobile termination rate cuts, everything has been said for 2006, as you know, there is an agreement in 2005, for 2006 with the regulator. You all read, you all heard that the regulator wants us to cut termination rates further in 2007. We donât know any details; we need to talk to the regulator; it is really too early. Just note please that when it comes to the -- to the argumentation of the regulator, he wants us to be on the European average. Please also note that we are already â¬0.02 below the European average here in Germany. Yes if I could ask two questions. First of all on content that you're going to be using on your wonderful VDSL network. Youâve got the football rights; in theory they start in four to five months' time. Can you give us a little bit more detail on what you're doing on the content side? Are you working at it through T-Online, are you trying to do it with independent production companies? The second one is in relation to the job cuts program. Can you update us where we are in terms of the government changing the civil service law? Where are we on that one? And given that youâve been able to take this provision in your accounts, what element of the 3.3 billion costs has now been allowed in the program? I know you havenât reached an agreement with the Verdi union, but what element of the 3.3 billion that you outlined before should we expect to come through in 2006? Let me start to answer the content question and then maybe Karl, you could step in and explain where we are on the personnel cuts including the discussions which we have with the government. Content; yes you are right, it's a wonderful network. What you need is content, but this is our strategy, you donât necessarily need to own content. Exception? Content where you donât want that others have it exclusive or where you think that you can and need rights to have a USP in front of the customer, which is the football rights. So, our strategy is to avoid all complications when it comes to German media law, but to do what we are doing, and we always did with T-Online, securing rights, giving access to our networks to third parties, which means to the broadcasters of this world, and at the same time, find or cooperate with independent producers, as you said, when it comes to how do we do the broadcasting around our own rights, like the Bundesliga rights. So there is more to come on CeBIT, more details; we are in full swing and we are very positive that the new world also will be a success. Let me go shortly into job cuts. We are also in intensive discussions in this respect with the German government. We are in discussions with the government not only about this issue, but also about this one. What we do want to achieve and supported by the government is an early retirement program for civil servants. This is certainly not an easy one, but we are optimistic that in our intensive discussions we are going to be successful soon or later. You know that I have outlined that we have covered out of the 3.3 billion extraordinary expenses we have covered 1.2 billion before taxes in '05 already. This leaves â¬2.1 billion remaining, I would hope that we can cover a major part of this 2.1 billion costs in this year, but the decision about this one is dependent on the acceptance of the individuals of the programs. So it is unfortunately too early this today to make a precise forecast for '06, but I hope that we can cover another significant part of this one in this year. Okay, let's move on. We have a long list of questions so I think we're going well, so if you restrict your question to one or two that would be great, thanks. Yes, thank you. Two questions then if I may? The first one is regarding the European mobile prospect. To my understanding it was said in Barcelona that you would be happy with achieving flat rate new growth in your European mobile units in 2006, but as we have seen you're moving into the year with positive revenue momentum. So if you could clarify that, I donât know, official guidance or comments from Barcelona would be helpful. Also, did I understand you correctly earlier that you were ruling out further cuts or voluntary cuts in the mobile termination rate in 2006, let's say before mid December? Hannes, yes I donât have any evidence that there will be further mobile termination cuts in 2006 as per today. When it comes to Thomas' remarks in Barcelona, let me clarify that. From my perspective there is positive revenue movement, as just said, from 2005. Yes we all know that the competitive environment in Germany remains tough, but we have no reason to revise the guidance given to you in November. Good afternoon, could I ask two questions? One on -- both on the US; one is on the net operating loss writebacks, does that reflect any change in your view of the business plan over the next few years? Are you any more optimistic than you were previously when you were last at the assessment? And then in the past I guess there was a target for the US cash cost per users and I think the aim was to get it down to the sort of low $20 level. Is there a target and do you expect further reductions in that next year, this year? I'll take the first one, which is the future perspective of our business in the US. I think our future perspective is more or less unchanged. I think what we have seen is an earlier net profit than expected and this was exactly the reason why we had now to capitalize this tax loss carry-forward. And some quarters earlier than originally expected, i.e. to a certain extent in our actual developments I think we have seen an even stronger development than we have predicted but in general I would say our future perspective of the US operation is strong but unchanged. When it comes to your cash cost question. Yes it was me who I think two years ago invented the 20 bucks per customer as a target because I strongly believed and still believe in the scale of facts. In the meantime there have been quite a lot of changes for example the 9/11 costs, there are some taxes, which had to be taken into account still. So I am not aware where the costs are right now on a cost per user basis. Still from my perspective given the fact that there are 21.7 million customers that is a quite significant customer base. There is potential -- further potential for scale, for reducing the cost but I can't now comment and give you a detailed number. Thank you, two questions, first in terms of your 2006 revenue and EBITDA targets, is there sensitivity to those targets if the Appeals Court does hear the T-Online case and it gets delayed even further, let's say to end of 2006? And second question, given you highlight that your net debt to EBITDA is now below the two times to three times range and that you have the convertible or the mandatory convertible coming due in June, would you consider buying back some of those shares given the strong balance sheet and also the comments you made in the past about buying back the shares from the T-Online merger to avoid dilution? Thank you. Well let me take the first one, which is a very tricky one because we still are in good hope that we get this deal done. And when it comes to the question about the mandatory convertibles, in the context of our 1.9 net debt to EBITDA ratio. First I would like to say in general this 1.9 does not put us under any pressure to do anything, not in terms of acquisitions nor in terms of share buybacks. There is no reason of getting nervous about this 1.9. And the decision about the mandatory convertible is not to be made today, that's the only thing what I would like to say about it today. Yes, good afternoon gentlemen. Just one follow-up question on dividends. When you suggest you're striking a measure of profitability on your dividend outlook, are we assuming that that's on your adjusted profitability numbers? And on a second question, Kai, you kindly sort of answered I think probably a different question than Stuart actually asked a moment ago on whether your guidance would change if T-Online was delayed until sort of 2007. I'm just wondering whether you could confirm whether you still assume in your business plan whether that is the case? And also in your business plan can we assume that the Gedas deal that you announced pre-Christmas was deemed in the normal course of business and therefore already included in your guidance? Thank you. Let me start with one remark about the merger of T-Online. I think from my perspective, the likelihood that it is going to be delayed until '07 is not too high. We are optimistic that we get it done finally somewhere in the middle of '06, and Kai certainly will afterwards address the question whether any for delay would address our guidance. But before I hand -- I am going to hand over back to him, let me also go into this dividend question. First in general as we have always said we think it's not right to make it dependent on a matching number. This was true for the past, this was true for last year and this is also going to be true for next year and the years to come. I think what one has to have in mind in order to really better understand what we think when we talk about profitability is, how much is the total dividend payout, how much is the dividend yields, how much is the payout ratio in terms of free cash flow? How much is the payout ratio in terms of net income but also in terms of adjusted net income and how much is also this kind of payment in relation to our EBITDA performance? All this I think has to be put into perspective and all this other has to be put into perspective with our credit metric tools, which we have in place. And last but not least we have always made it clear that we also do want to be seen as an attractive dividend payer in a competitive environment. And then I think it is unfortunately not as simple to make it dependant on a certain matching number but I think we had proven with our dividend developments over the last two years that we are heading in the right direction in the interests of our shareholders. Well back to the question around T-Online. Assuming that we get that done in the second quarter and, meant by give and take a month or so. But assuming that we get it done in the second quarter I do not see any reason why we should change our guidance for the T-Com, the BBFN and sorry the total revenues for the fixed line, which already were foreseen to go down, and just remember here, foreseen to go down in 2006. I think in the region of minus 0.5 to â¬0.6 million -- right, sorry billion, billion Euros. So that is as clear as I can be on that issue and still we hope that we get it done in the course of the first half 2006. And yes just briefly on Gedas, I mean Gedas is one of, we basically count as one of the big deals T-Systems is aiming to complete to basically grow as particular its enterprise services part of the business. Next question? Yes thanks. Two questions, two quick ones please. The first one on the subscriber acquisition costs of T-Mobile Germany, I've seen that they've quite significantly decreased in the fourth quarter. Is that a level that we can now assume also for 2006 or can you give us any guidance on the SAC trend of T-Mobile Germany in the current year? And the second question relates to depreciation, they have, even on an adjusted basis, they have raised significantly compared to the first nine months of this year, there also if there are any, are there any other special effects in there? And accordingly should we expect depreciation to return to the â¬2.5 billion level in the first quarter again? Thanks. Why, well everybody's now digging into the depreciation issue here. I'd like to be careful because I'm really not deep into it when it comes to the SAC level on the fourth quarter you are right, so an exceptionally low SAC level. But I'd like you to save this question for the guys when we're meeting on CeBIT the week after next week. Just to be on the safe side here because it looks exceptionally low, it is from my point of view. You have an answer on the depreciation? Now we've switched it off, are we still here? We just have to change microphone button sorry. No when it comes to D&A and the development which we have seen in the fourth quarter, there was another old point, two exceptional ones for another small item, I think it was more in the real estate field, that's something which was more a one-timer and I think we should go back to the normal level we have seen over the first nine months. Hello everybody, I have a last question remaining and this is on the CapEx. You gave a guidance of increased CapEx to 10 billion, you previously said that you want to achieve a return requirement of 8%. Given that the increased CapEx is not primarily invested obviously in the US but rather in your slow-growing areas in Germany and UK in the fixed line, can you give us an idea how you can ensure that this 8% return requirement is met and in which timeframe do you expect your divisions to meet this target? First let me be more specific in where the CapEx comes from so that we talk from one base. First of all it's very easy to remember, it is 4-4-1-1, for the 10 billion it's round about 4 billion reserved for the Broadband/Fixed line business, another 4 billion reserved for the Mobile business, another 1 billion reserved for the Business Customers, the T-Systems, and another 1 billion reserved for central head offices, and let me give you some more insight then. On the fixed line side, on the BBFN side, CapEx has been as I recall it around 2.5 billion in 2005, so there is some more to come and we already earlier said that roundabout 1.2 billion is reserved, and I explicitly mean it when I say it's reserved, for the triple play, for the further to the curb investments. Which does not necessarily mean that we are going to spend that, that depends on further development, also the regulatory issues. When it comes to Mobile we have had roundabout 3.5 billion as I recall it in 2005, and we now have reserved another 200 million, roundabout 200 million for what we call an accelerated rollout of the 3G networks because by the way, we also see things happening, I mean if you look into the revenues, into data revenues, Iâd like to remind you that the data revenue without SMS is now up to 900 million. So 3G, and another 200 million, roundabout 200 million for the accelerated rollout of the 2G networks, specifically in the Central and Eastern European areas, brings me to Business Customers where it had been about 0.8, and there is a accretion of reserve now of another couple of hundred million, as I said, 1 billion more or less is the target. Four things like Gedas, working on big deals we call it, and then there is another investment planned for the GIS which -- and that's where Thilo you'll have to help me again, we were talking about some electricity and whatsoever issues. Yes, no sorry, it's just some upgrades in the general electricity supplies and air conditions for mainly the fixed and mobile network which is as you know the tower company and the real estates are located in the headquarters, that's the increase there. But the question then was, how do we make sure that the 8% -- on average the 8% are met. Well by being very outspoken when it comes to the business cases because everybody has to then submit a business case finally to our CFO, who then has a lot of fun in judging the respective processes. Yes, I've got two questions. First of all, do you think there is a different model to European mobile where you could take prices down quite a lot further, but also take quite a lot subsidy out of the market, and is that an approach that you'd be willing to look at or do you think your profit pool would be too vulnerable from that? And secondly, just wanted to understand your medium term gearing targets, I mean do you see that two to three times leverage is the right longer term or medium term target, I mean leaving aside the current pending acquisitions in US spectrum and so on, or do you think you will delever from two to three times in the medium term? When it comes to your subsidy versus tariff question, our avenue â our approach is to test the price elasticity curve, and not to just jump on it and then take the bet, so I know from a couple of discussions I had with the Mobile guys, detailed discussions because as you know our strategy on the mobile set is to go for fixed mobile substitution, that we want to test it, we want to take it in steps and that is exactly the path we are following. And when it comes to our gearing targets now we do not intend to change them because these are mid to long term targets which I would like to shortly repeat, it's a two to three time net debt to EBITDA, it's an 0.1 to 1.2 gearing, it's a 30 to 35% equity ratio and it is an 8% ROI. And are we getting nervous if we are doing better now? We are not getting nervous. Does this put us under pressure to do anything now? It does not put us under pressure to do anything. It is long-term targets where we do want to be in, and if we're doing better I'm fine. Thanks. I just wanted to ask you about the tax first, maybe I got it wrong, but I thought your tax guidance for '05 was 2 to 2.5 and your accrued tax seemed to be slightly higher than that, is there any guidance for the -- where the accrued tax rate is going, are you seeing basically a higher underlying tax accrual going forward than you originally thought? And then secondly, the CapEx in the UK in Q4 seemed sort of double versus Q3, is that just seasonality or should we be taking that as the run rate for CapEx in the UK over '06 per quarter? Let me take the CapEx question because I already implicitly mentioned it when I explained the total CapEx of the Group. Well I do not have in hand now what the CapEx figure in the UK was in the fourth quarter, but what I said was that we are ready to invest another roundabout 200 million beyond what we have invested in Western Europe for 3G, where a lot of it will be invested in the UK, because when it comes to the UMTS networks we are very well advanced in Germany, we are not that well advanced in the UK, and since we really take it into the next round in the UK, there will be further investments, CapEx investments in the UK, but they cannot beyond the 200 million which is the figure I gave to you for a total of Western Europe. And when it comes to the Texas, this unfortunately is getting more and more complicated, also as a consequence of adopting international accounting standards; let me be a little bit more specific about it for the last year. First, we had tax expenses without the special effect in the US of 2.6 billion, and also affected by some tax loss carry-forwards in other markets such as France especially, which we had not predicted, including the special effect of this especially in the US, we had in '05 a tax expense of O2. And last but not least cash taxes in last year amounted to 1.2, which is the third number in order to further make it complicated and complex. And the same situation I think we will face in '06. Tax expenses without special effects I think are going to be somewhere between 2.0 and 2.5. Cash taxes could somewhere be around 1.5 to 2 and dependant on the profitability in the US, we also could see in '06 if the profitability development continues to be as strong as it was in '05, special effects on the tax side could be another 2 billion which then would bring down our tax expenses including special effects again quite nicely. I hope this gives you some explanation. Yes hello I've got two questions. On the US side, in your press release you mentioned that you now have 50% increase of coverage with some new roaming agreements. Can you update as far as what percent of your handsets in the US can utilize the cellular frequency? And is this an important concept to compete for net adds against companies like Leap or Metro that are doing unlimited fixed to mobile substitution? The second question is with the auctions coming up, Sprint yesterday said they will not work with Direct TV or Echostar. Are you looking at potential partners or MVNO agreements with your thoughts about what the auctions and the future networks might be in the US? Well to take your first question -- your second question first, please understand that I do not want to comment on anything when it comes to the spectrum auctions and the preparation to T-Mobile US for the spectrum auctions. When it comes to the roaming agreement, you are referring to what we did on the 850 side. We have now a substantial part of our base already for 850 of the handset base, but forgive me I forgot the number, but it was substantially high. We would come back via Thilo who doesnât know it now by heart. But it is less directed against the Leap guys, it is more to be competitive when it comes to compete with the other three national carriers. We are, by the way, when you look on the map, T-Mobile US over the last 12 months has made huge progress when you compare Verizon's network to T-Mobile US network; it really looks great from a T-Mobile point of view. Yes thank you. Two things. First of all, could you comment a little bit on what your expectations are with the new tariff plans in the UK in terms of ARPU going forward and what sort of response you expect from your competitors over the next six months or so? Secondly, going back to T-Mobile USA, I don't want you to comment on the auction but assuming you get something reasonable that you're looking for in terms of spectrum in the auction, can you give us some sense of both the timescale before you expect to be able to rollout true 3G services after that auction is completed? And also roughly what you think the initial CapEx for the first couple of years would be for that special rollout? We will be very fast in rolling out but no other data we want to give. When it comes to -- and again why are we so strict here? Because we don't want to give any indication to competition on what it is, what we are doing. The first question was -- sorry I missed it again. Yes, the new tariffs, they look very promising. Again I don't know it by heart now how promising but they look very promising usage wise and ARPU wise. And specifically on the prepaid side, the rates tariffs, they work and I'd like to ask you to keep that question on CeBIT because people will then give you the precise numbers. But it looks promising. Hello, Iâm sorry, hello, I've got two questions. One is, I guess looking out at 2007 and 8, do you see any reason why CapEx would fall below the â¬10 billion level that you've currently guided to? And secondly, I guess a factual question. In the previous quarters you broke out the fixed line revenue between access broadband and you no longer do that. Could you provide those two figures? Well, let me start with the CapEx number. Well certainly CapEx is always very much dependant on the strategy but also it is dependant on the cause of the business. I think as long as we continue our strategy to grow the business, and this is supported by our strong profitability and the free cash flow performance, I think 10 billion could be a good number also for '07 and '08. But as proven, if there would be reason to reduce it, we also I think would be in a position to reduce it. It goes back to what Frank Rothauge's question was. I mean the question was how do you manage CapEx. And as long as you manage it according to the business plans which have to grant you on average the WACC of 8%, then it is not a question of how much money you invest, yes it is in reason, I look into the eyes of Mr. Eick sitting in front of me. But it is more the question of the rate of return you can for, and as long as we are finding areas to invest, and I'm talking about the organic areas, we will do that. And on the split in revenue, well we have decided is that we are basically following the rebalancing path and basically incentivising people more and more to pay a monthly fee for our services. We have stopped providing that split but I don't know what you want to achieve in terms of analysis, let's take that also after the call if I can help you in any other way. Yes, I have two questions please. The first one was going back to a point made at the very beginning of the presentation regarding narrowband line loss in your fixed business, which is now running I think down about 4% per annum. I was wondering how you saw that developing going forward please, especially if the cable operators start to get a bit more aggressive. And the second question was regarding ARPU in your US Mobile business which just in the last few quarters seems to have slipped a little bit. I was wondering whether that was a one-time effect or whether there was something more structural going on? Thank you. Let's talk about the line losses first. Let me just give you the detailed figures for the quarter again so that we have a base we're talking from. In Q2 -- sorry I'll start with Q2 '05 we had a loss of 430,000 lines. In Q3 we had 350,000 lines losses, and in Q4 we had 373,000 losses, which is high compared to the US. Not as high in the US but it is high. Which is on a level where we are fighting it and when you look into revenue development, I earlier said that we took actions in March 2005 to really fight it by lowering the prices and betting on the customer loyalty. So actions work and when it comes to T-Online and the T-Com merger, one of the benefits is that we can be more bundled because as you know the PSTN is still bundled with the DSL business here in Germany, so that's where we see positive activities to be even better during the next couple of quarters. Yes on the negative side you have growing competition. You referred to the cable guys when it comes to the cable guys I think they will need a couple of quarters more to really compete. So it is very difficult for me to judge on when and how the cable guys and really will make a big difference in the marketplace. Okay, and I think you ask about ARPU in the US, if I understood that right? If you look in the split between blended, sorry post-pay and pre-pay and that explains part of it. As we are approaching about 70% of penetration in the US, we have launched a very attractive pre-pay product, and are successful in that i.e. again selling more pre-pay which means if you look at the mix you have a slight decline in ARPU. But still these pre-pay customer bring in about $25 a month of ARPU; obviously a very profitable business for us as well. Let's move on to the next question. Thank you very much, a very good afternoon to you. Two questions if I may? Firstly I would be very keen to get a bit more color on the 700 million of EBITDA you plan to invest in mobile. Basically my concern is that once you start competing more aggressively you won't be able to sort of pull back if you want to. So is it possible to chat about the areas where you would be looking to invest this EBITDA? And then separately, completely different subject; I note what you're doing about T-Mobile@home and the CRM database, but in the context of the pretty radical mergers happening with Telecom Italia and Cesky of their fixed and mobile businesses, what's your assessment of the pros and cons of this strategy with regard to Deutsche Telekom, and are there any specific company specific reasons that would prevent you, if you wished to follow suit? Okay, when it comes to the 0.7 billion, let me reiterate what we said earlier and what weâre doing. When you look into what the guys are doing, it's exactly what we already said in November. Investing in customer growth, but not necessarily increase the SAC and we just talked about the low SAC in Germany. Mobile broadband go for HSTPA, invest in the handset in the respective terminals and do what we have to do, not only to advertise, but also to proactively tariff the pieces. Other mobile data topic, Web 'n' Walk, push it, we have 400,000 we have 400,000, want to go for a million Web 'n' Walk devices, not necessarily something you want to go back, you want to push it; stimulate the migration to a next generation, thatâs what we're doing, you know go into Mates tariff; go into U-Fix tariff; be more intelligent on the tariff side; give the benefit to the customer so that the customer comes. Go to the brand; invest into the brand, not only in the UK, but also in Germany. If you now look into newspapers, the world is pink with T-Mobile@home. By the way huge success, a lot of customers we're taking. Back to your question; you should not be too much afraid that we repeat all the experiences we made since the beginning of the mobile businesses. And the guys who are running it, they really know what they're doing, they are professionals. The second question was again -- Well, no when it comes to our structure let me be very outspoken here because we had those discussions and I had those discussions each and every year, each and every month, fixed mobile convergence et cetera. When it comes to our structure, there is no other reason than that it is the right structure. Why we have the structure? It is that T-Mobile is going to focus on fixed mobile substitution plus mobile data. And they compete with the Vodafone guys of this world. And then there is T-Com focusing on the residential market, broadband, fixed line and they go the homes. And then thereâs the systems for the business segment. When it comes to the convergent products, we looked into it in very much detail. We believe in some products, I know them all, I know the roadmap, but you do not mingle everything, you donât create the dinosaur or the elephant here, you need to be focused and do it too. When it comes then, and that was the product side, when it then comes to the synergies, for IT budgets, for network, cost benefits, then you have to manage it and thatâs what we call intelligent integration. So we do it our way. And let me add from my perspective some more general remarks about the questions which are now raised quite often about OpEx and CapEx flexibility. Because I hear the concern from some of you that we are now increasing our investments into the markets, and we are also increasing our investments in our network infrastructure, and as a consequence of that, we would no more be in a position to reduce it. I only can say, this is the wrong impression. First, I think we have proven in the past that we have enough flexibility to reduce this if we want to reduce this and reduce it, and it was our conscious decision to invest into growth to do more in infrastructure investment. We are committed to grow our revenues; this voluntarily leads to a reduction of margins. Our reduction, our margin reduction is not accidentally, this is not caused by anybody, but only by ourselves as a consequence of a conscious strategy decision. This can be easily reversed if we do want to. Nobody can hinder us, we bringing down our OpEx down and our CapEx down. I think this is really important to understand as a differentiate in criteria to some of our peers. Thank you. One small accounting question. What kind of period, I mean how many years of projection for T-Mobile users do you use to create the tax asset? First question. Second question, when we look at the targets set for T-Online in France the 15%, which is by the way the lower part of the target, it means more or less have a 30% market share on net add each year. We are far away from that many quarters after that. Are there still realistic assumptions? And one last question if I may, the number of lines you publish exclude fully unbundling lines? Thank you. France, the 15% they referred to by far lower market projections. Again I do not have the detailed numbers in place. But what I know, and I know it, very much in detail, is that when it comes to our net adds in France they are higher than what we projected originally, but the market, the market size, also is higher than projected originally. Then you had the question of the unbundled lines? Yes, you're right, this is not including the unbundled lines exactly. Karl, there was a technical question. The first question was about the accounting period for the capitalized carried forwards. Precise answer to a precise question, it is exactly three years which is now capitalized. Yes I lucked out. There's more than one way to grow, you can grow organically or you can grow through acquisitions. We've seen several of other companies growing through acquisitions, could you please state what your feeling is on acquisitions particularly in light of your capital investment and your investment in Spectrum in the US? Thank you. Before we talk inorganically, again let me reiterate that we are investing organically and let me reiterate what Karl said; we have an asset base where we can create revenue growth organically. And the US is a perfect example for that. When it comes to inorganic growth, again it is what I said earlier. It is that our acquisition policy, weâll remain highly disciplined; we will continue to evaluate any opportunities which arise within our existing footprint, thatâs what I said earlier and thatâs what we're sticking to, and which then finally also meet our rigorous return on investment criteria. Okay well thank you very much. Let's actually you're throwing in one answer to Rick's question I think on the 850 megahertz capable handset in the US, and it's actually more than 50% of handsets of the base are capable of 850 megahertz roaming. With that saying, thank you very much for your time and if you have any more questions, do give us a call at the IR department. With that I say goodbye and have a nice day. |
EarningCall_234082 | Good morning. My name is Tiffany and I will be your conference operator today. At this time, Iâd like to welcome everyone to the first quarter earnings conference call. (Operator Instructions) Thank you and welcome to Genzyme Corporation's first-quarter 2006 earnings conference call. I would like to remind everyone that the earnings release and the call today are available on the investor page of our website, at www.genzyme.com. Today we will discuss Genzyme's business outlook on the call. Forward-looking statements about our projected future financial results and all other statements made on this call that are not historical facts are subject to a number of risks and uncertainties. Our actual results may differ materially. Please refer to our 2005 annual report on Form 10-K on file with the SEC. Forward-looking statements include expectations regarding 2006 earnings, revenues, product sales, expected drivers of future growth, the timing of our regulatory filings and actions, the timing of clinical trial data and financial trends. If during the call we use any non-GAAP financial measure as defined by the SEC in reg G, you'll find on our website a reconciliation to the most comparable -- directly comparable GAAP financial measure. I would like to remind everyone that our second-quarter earnings conference call will take place on July 12th at 11:00 a.m. Eastern. In addition, our analyst and investor day will be web cast live on Friday, May 12th, beginning at 8:00 a.m. Eastern. You can access the live web cast from our website. Thank you, Sally, and thank you everybody for participating this morning. We have quite a few things to go through here, so bare with me. You know, 2006, it has to be said that in February when we talked about the guidance call is really in the first half as we started to see in the fourth quarter a year of significant investments. These investments are extremely strategic and very, very important for the future of the Company, and I am enormously gratified that we are making tremendous progress. The two new manufacturing operations, one in Belgium and one in Ireland, have now started up. We have had visits from the FDA and other regulatory authorities, at least in the Waterford fill/finish facility, and weâre looking forward to these manufacturing operations to start to produce commercial product. In the case of Ireland, that will be still within this year. We started a number of late stage trials late in the year last year, and that's started to shape the picture in terms of the expense side of the equation. These trials are continuing. They are expanding and some other trials are still in the queue to be started up, like the MS/MS trial, and we are enormously pleased with the progress that we're making in terms of enrollment. The tolevamer trial made tremendous progress during the first quarter in terms of enrollment. We enrolled in absolute record time a 90-patient, placebo-controlled trial for Myozyme in late onset patients. That is now fully enrolled. And we now have most of these programs, which are all quite strategic for the future of the company, running very, very well. The other thing that was very important in this quarter, expensive but important, was the whole preparation around Myozyme and the introduction of Myozyme. We're very happy indeed that in Europe we got the broad label approval signed up by the commission now and we are in the final stages of starting to ship our first commercial product. We are expecting that the FDA will act on Myozyme at the PDUFA date, which is April 28th. I will not make any particular predictions what that action will be. We look forward with some confidence, given the importance of the product. It has been a product that has been very expensive to develop. It is still quite expensive, given the trials are still ongoing and the manufacturing scale-up issues around it. This will start to turn into a very important economic driver for the company going forward increasingly through this year, but it will be more visible in the economics next year. Sales during the quarter were generally on track. We had very, very gratifying results around Renagel. With me here is John Butler, President of the Renal division, and he will go into some more detail during the Q&A session, but Renagel, which was relatively stable in terms of revenues in the later three quarters of last year, really started to pick up very, very nicely indeed, more as a result of D-COR and the results that were strong late last year, and possibly the early results around the Medicare Part D benefits that started to work earlier this year. We had three programs that were somewhat below our expectations. In the one case of Hectorol, also part of the Renal division, and that was somewhat influenced in terms of an allowance that we had to take during this quarter. We are quite confident, given the scripts around this product in terms of the remainder of the year. It fits extremely well within the picture of the Renal division and it has significantly changed our ability to reach a very much broader market with a greater sales force. Synvisc is the other product that was a little less than what we had expected, so year-to-year very nicely up 21%, but this program is actually more seasonal than we had in our projections. We still are getting some experience here. We only took over the sales and marketing in the United States in the beginning of last year. We are quite confident. We see the effect in terms of current run rates in April that the seasonality will show that the second quarter and the third quarter in particular are significantly better quarters than the first quarter. So we feel quite confident about the remainder of the year for this very important program. Fabrazyme did also produce less of a result. It was up 15% year-to-year. We had expected growth between the fourth quarter and the first quarter. On analysis, it shows that accruals in the fourth quarter took [inaudible] place in the early part of that quarter. Maybe the holiday season was cause for accruals to be less than the later part of the fourth quarter. And then the first-quarter accruals took place towards the end of the first quarter, so also here we are expecting this picture to pick up quite significantly in the remainder of the year starting in the second quarter. So we understand what happened with these three particular areas. All the other areas did perform very well to our plan. For that reason, we feel quite confident indeed that we will be able to meet our financial goals for this year, which is revenues of $3.1 billion to $3.3 billion. The most important things, as on the financial performance, where we take financial performance enormously serious. We are very much geared to that and we will influence the expense curve and further investments depending on what we can actually afford in order to make sure that we do meet the financial goals. But the most important thing really is are we making progress to making the new programs for the future work. Myozyme I spoke about -- clearly a very important program in our future. Tolevamer -- very, very important program indeed for C. Difficile Colitis. I spoke for years at these kinds of calls, a lot about Pompe disease and Myozyme. We now are delivering on that work and you will hear us speak a great deal in the next year or so about the Tolevamer work that weâre doing. This is a very important program clinically. C. Difficile Colitis is a very, very expensive problem in the hospital systems both here and in Europe. If we can bring a non-antibiotic approach to this clinical problem, expensive clinical problem, it will be a tremendous breakthrough and economically I think very important as well. The expansion of Renagel beyond end stage renal disease towards CKD as sort of development of sevelamer carbonate -- again, a very important program making very good progress. A number of different clinical trials are ongoing, including a trial that develops the possibility to bring a powder to the market, the same powder to the market that we hope will protect [inaudible] on the compliance. Synvisc II and Hilastin, which were follow-on programs from Synvisc, which tried to decrease the number of injections necessary for pain relief in osteoarthritis. These trials are in full strength right now. Synvisc II is totally enrolled. We will see results this year. Both very, very exciting programs, quite strategic in areas where we have a great deal of experience. Campath MS, here we expect that we will start a trial later this year. During the Q&A session, Mark Enyedy, who is the President of the Oncology division, will make some comments on the progress there. We are enormously excited about the possibilities of Campath MS. In the summer -- late summer â weâll see the results of progression, two-year results of the current Phase II trial and we look forward to communicating with you on that. So all in all, first-quarter tracked very strongly in terms of the kinds of things we have set out for ourselves to get done this year. Two or three programs that I mentioned were below our expectations. We know the reasons why they were below our expectations and we fully expect them to correct through the remainder of the year. So we stay very confident indeed that this year will deliver to the financial goals that weâve set, while at the same time we feel quite confident to be able to execute on the kinds of things that are going to be quite important for us to continue our growth in the future. So at this moment, let me hand over to Michael Wyzga, our Chief Financial Officer. Thank you, Henri. Good morning, everyone. As you can see from our press release, the revenue for this quarter increased by over $100 million from last year, and that represents about a 16% year-on-year increase. Our diluted GAAP earnings per share is about $0.37. This quarter, we changed our GAAP to non-GAAP crosswalk a little bit to incorporate the impact of stock option expensing. During the first quarter, the impact of stock option expense is approximately $22 million, or about $0.08 a share. The crosswalk that we attached details of the impact of the stock option expense by functional area. Amortization for the quarter increased to about $53 million. Our non-GAAP earnings exclude the impact of convertible debt on diluted EPS as the stock price did not exceed the conversion strike price. The EPS impact of this is about $0.01. The net income for the quarter prior to these events and amortization was $157 million or $0.59 per diluted share. Our non-GAAP net income increased 19% on a year-on-year basis. Now, as Henri mentioned, the first-quarter results were affected in a number of key areas, and let me kind of walk through those a little bit. The revenue line was generally solid but was impacted by several factors, which include the timing of the patient accruals for Fabrazyme, the seasonal shifts that we experienced in Synvisc and a one-time chargeback associated with Hectorol discounts. This quarter, if you measure on a year-to-year basis, was also reflective of the year-to-year fluctuations of the foreign exchange rate. Our SG&A expenses increased to reflect the Myozyme pre-launch costs, increased Synvisc sales expense and incremental sales associated with the Bone Care acquisition. Our revenue growth from last year was fairly solid. Cerezyme, which increased by 6%, was driven largely by additional international patients. Fabrazyme revenue was $81 million and, as Henri mentioned, that represents about a 15% year-to-year increase. Within the Renal division, the revenue increased by 38% over Q1 of last year. Renagel increased 19% year-to-year, and while itâs a little too early to tell whether the impact was Part D pricing, itâs pretty fair to say that we're seeing a lot of positive trends within Renagel. Hectorol revenue was slightly down versus Q4 at $19 million, and during the quarter, as we mentioned, contractual allowances were adjusted by $3 million for a non-reoccurring chargeback. Synvisc revenue was $53 million. Now, as a reminder, there is significant seasonality associated with Synvisc. Historically, Q2 and Q3 are the biggest volume quarters, with Q1 usually slower. Transplant revenue was $34 million for the quarter, and as we've seen in the past, transplant revenue also tends to be a bit cyclical, with the first quarter representing the lowest revenue quarter. The negative impact of foreign exchange on our revenue line was about $18 million. The largest year-to-year fluctuation that we saw was on the Euro. Now recall the Euro fell from $1.31 in Q1 of 2005, to the current rate of $1.20, with most of the revenue impact being felt in Cerezyme, Renagel and Fabrazyme product areas. Now, while our global manufacturing and commercialized infrastructure dampened some of the impacts of our bottom line, our operating margin was still adversely impacted on a year-to-year basis due to the [FX] rate. Our gross margin was 77% of revenue. The gross margin was impacted by a write-off of about $4 million of Myozyme work in process. Turning to our expenses, our Q1 non-GAAP R&D expenses were $137 million, which is an increase of about 19% of revenue. This should be compared against $110 million, or 18% of revenue last year. And as we indicated in our guidance call, we have a number of late stage clinical trials ongoing. The major components of our R&D expense this quarter were the Myozyme late onset trial, the Tolevamer Phase III trial, the Sevelamer Carbonate trial for CKD patients, and the first of three Phase III Clolar carbonation trials. Our non-GAAP SG&A expense came in at $211 million, or 29% of revenue, which is the same percentage as last year. The major drivers here were the sales investment that we did with Synvisc, increased costs associated with the Myozyme pre-launch activities, and the headcount in marketing programs related to the acquisition of Bone Care. Within our equity line, we saw solid growth within the Aldurazyme revenue. Aldurazyme revenue came in for the quarter at $21 million. Now, we're starting to see some of the favorable impact of our facility in Ireland, but this benefit was offset in this quarter by the impact of lower organ drug credits on a much larger profit before tax base. Our share count increased to 267 million shares outstanding on a diluted basis prior to the impact of contingent convertible dilution. Our capital expenditure for the quarter totaled about $64 million, with most of the investment focused on Ireland, Belgium and the new Framingham science facility. As Henri mentioned, we are reconfirming our full-year EPS guidance, our GAAP guidances of $1.78 to $1.88, and on non-GAAP basis, the guidance is $2.65 to $2.75. And as we discussed in our first conference call this year, our first half earnings will be impacted by the product launches in the manufacturing investments, as well as the late stage trials that we're doing. We expect our second half will reflect a more rapid EPS increase. Before turning it back to Henri, I'd like to remind you that you can find the line-item detailed reconciliation attached to our press releases or on any of our websites. With that, let me stop and turn it back to Henri and open it up for question and answers. At this time, if youâd like to ask a question, press star, then the number 1 on your telephone keypad. Press star, then the number 1 on your telephone keypad. Weâll pause for just a moment to compile the Q&A roster. Thank you for taking my question. I just wanted to get your thoughts on the evolving competitive landscape for Fabry's and Gaucher's disease. Particularly, if you could just comment on the Amicus product and how you see that fitting in relative to your portfolio? Yeah, itâs always difficult to project on something that is not really yet in clinical trials. There are -- we don't expect the competitive landscape around, in terms of enzyme replacement therapy or small molecules, to change for the next three to four years. Thatâs the earliest, if everything goes well with current enzyme replacement therapies that are being tried, and the potential of still extremely untried technology in terms of the chaperone technology and things like that, that we are very, very familiar with. Itâs impossible to project what these technologies really will do, whether they will be competitive or whether they will work for so few patients that it is difficult to really see what the impact will be. But in the way we project our programs, we are specifically not to think about these more speculative technologies. We're thinking about enzyme replacement therapy technologies that we know work, and thus we don't expect, in the case of Gaucherâs disease for the next three to four years, while for Fabrazyme it may be longer because there is a product in Europe on the market and the rest of the world called Replagal that is currently completed. I don't know whether David Meeker, our President of the division, wants to make any other comments on these technologies, [new] technologies. No. I think thatâs right, Henri. I think with regard to the chaperone technology as most people are aware, the issue there is the individual nature of that product and that each mutation would need to be, or we believe will probably need to be, tested to confirm that it does respond. It is targeted as the missense type of mutations and, as Henri said, we have done a lot of work in this area and itâs clear that not all missense mutations are created equal. So the importance of the individual testing is certainly there. So I think in everything else we said, we covered it. Yeah, hi, good morning, Henri, good morning everybody else. I had a quick question on Myozyme. Henri, is there any way you can just discuss with us what the pricing is in Europe of Myozyme? And then, you mentioned, you know, for two or three years ongoing now the incredible investment in this program and there's about 200 or 300 patients right now in clinical studies. You know, from what I understand, it's up to maybe 1,000, maybe 1,500 patients out there. As of now, can you just give us a sense, you know, as to how do you justify this? I think itâs been more than $500 million youâve spent so far. Pricing wise, how would you be able to capture that investment back? Thanks. Yeah, we have not disclosed pricing around the European programs because theyâre not yet in the introductory phase. We generally want to wait until we have the final labels, and weâre waiting for the final label in the U.S. Itâs kind of pretty soon that we will have that. But what I have said over quite a while now is that the pricing of this program will be in the same range as the pricing that we currently have, which is something that people are used to, like the reimbursement agencies around the world are familiar with. Itâs pricing that we currently have for Gaucherâs disease, Fabryâs disease and for MPS 1. So theyâll be in that same range. In the initial phase, we would expect that smaller patients will be treated, eventually larger patients will be treat, but it will be on average within that same experience that we have for Gaucherâs disease. The question, do you get a return, given that the cost of developing programs for these types of diseases is quite enormous, and I do agree with you. That is a very, very important question. To get a return on a very small patient population does result in a very high per-patient yearly cost. Thereâs really no way around it. Additionally, we are providing products free of charge when thereâs no coverage for a patient in a particular geography or country, which we see as part of the responsibility that we have. We have found tremendous support for the treatment of these [ultra-organ] diseases around the world, including the United States. And I guess that support comes because of the importance of these treatments for these diseases. These are, in clinical terms, quite efficacious products. It changes the life of these patients in a very significant way, and a there are a very limited number of patients out there. So the justification really is one of balancing the tremendous cost and health-care burden, clinical burden, life burden that these patients have in a responsible way, in cooperation with the people that are treating patients and the reimbursement authorities around the world, making sure that patients do get access in all cases, regardless of their financial conditions, but also making sure that the program that we provide is sustainable and that we can reinvest into the next program. Itâs a long answer of an excellent question, and one where we now have experience since 1991, and we are confident that we will continue to [portray] positive experiences around Pompe disease. If I could just follow up with a question for David, could you just talk about your ceramide inhibitor, the JNZ112638, and what gives you confidence in the [synthicity] of this enzyme inhibitor as opposed to the previous substrate inhibitors? Sure. So that program, for those who are not aware of it, is a, as you said, a substrate inhibitor. It differs from whatâs currently on the market in that it is ceramide as opposed to the glucose analogs. So it blocks the same enzyme but in a slightly different way. Our confidence comes from the fact that, or our high level of interest, perhaps I should say, and confidence comes from the fact that in vitro, comparing the different available substrate inhibitors, this is quite a bit more potent, 100 to a 1000-fold more potent than the available alternatives. Another major limitation of the existing therapies is the lack of specificity, which is associated with some of the side effects that you see with those drugs. So our goal, given the availability of a very effective, very safe treatment in the case of Cerezyme is we would bring this forward only to the extent that it truly address an unmet medical need and offered something incremental to the Gaucher community. I think the profile that we're entering clinical trials with is one that has that potential, and the test will tell us whether that optimism is justified. So we're looking to start clinical trials in the second quarter and weâll go from there. Thanks for taking the question. Just a quick clarification on Myozyme. I noticed you mentioned that you are gearing up for production to ship soon, and I know you're probably adverse to talking about price, but what are you prepared to do in the case that there is a delay in the U.S. approval? Will you launch in Europe and price it accordingly? How will you reconcile, for example, what might or might not happen in the U.S. in terms of the label? Yeah, itâs tough to speculate too much on what might or might not happen. We are only two weeks away from knowing. But we are introducing in Europe. Patients need this product. We are, like we have with other products, we have gone to global prices. There's going to be very little difference between European cost for therapy versus U.S. cost for the therapy. We are moving forward. Thereâs no way back now. We are talking, have started to talk with different countries in terms of the normal pricing discussions. And like weâve done with Fabrazyme, like we've done for Renagel, like weâve done for Cerezyme, like we've done for Aldurazyme, we will use a global pricing strategy. Thereâs two separate factors involved in the impact to the gross margin. The first one is a write-off of about $4 million of Myozyme material that was in a work-in-process. We took that hit this quarter and did not carve that as a one-timer. The second is the impact of the new facilities coming on board, particularly in Ireland. We have some capacity that was generated there, and so that was taken through the cost of goods sold as well. Okay, so then for the balance of the year, is it still in aggregates on the 8% or just going forward, it is 78%? Good morning, thanks for taking my questions. First question is a follow-up I guess to what you just said on Myozyme. How much Myozyme inventory has been expensed? When would we start to actually see the cost of goods for Myozyme flow through the P&L once that productâs commercially launched? And then second is a follow-up to I think Ian's question where he was asking about the competing drug and development for Fabry's. To my understanding, that drugâs enrolling patients into its trial who have 3% residual enzyme activity. Could you give us some idea of what percent of patients with Fabry's disease have 3% residual enzyme activity? Thank you. Yeah, I mean, Iâll confirm that we don't know, but I think itâs not so much a function of how much residual enzyme activity. Itâs really a function of whether the mutation that individual patient has is amendable to the chaperone approach. So you may have more or less enzyme to be eligible. The more enzyme you have may increase the likelihood that you have a mutation that might be responsive, so I think thatâs the way to look at it. But the key here is really which mutations do you have. On the cost of goods sold, thereâs only two methodologies to capture non-approved product at this point. What some companies do is theyâll expense it entirely at 100% through their P&L as part of the R&D expenses. What we do is we truncate that and start inventorying when it becomes what we call an approvable product. Thatâs usually based upon the last infusion of the patient group for clinical trials. So in fact we have been manufacturing there at risk as it were in inventorying those costs already. So you'll come out with a more normal, what I would call a more normal cost of goods sold and more normal gross margin rather than everything being expensed and capturing it at 100% margin upon shipment. Thanks very much. Good morning, everyone. Two questions on the products. First, could you give us an idea in terms of the Fabrazyme being a little bit light, was that global or is that U.S. or Europe? And secondly, along those lines, you mentioned that you saw patient numbers pick up. Could you maybe elaborate on that a little bit more? And then, unrelated, Synvisc, any chance that you can elaborate on the direct-to-consumer campaign that youâve initiated, and how much pull through you might expect in Q2, Q3? Thanks. Thanks, Meg. David, the first question you can answer and the second question is for Ann Merrifield, the President of Genzyme Biosurgery. Meg, so with regard to the nature of the softness around the Fabry numbers, is it global or is it more regional, I think it is more global, and I think again thatâs why, to Henri's point, I wouldn't put so much store in a specific quarter-to-quarter analysis of this market. There were, as he noted, a few smaller number of patient accruals in the fourth quarter this year. When we look back, it was a similar pattern last year. And that actually is pretty much where we are, reminding you that we launched this product in 2003. So we're just beginning to get some experience with the seasonality around this. There may be a little bit of seasonality in the Fabry world. So U.S., Europe and Japan were all a little bit light from what we had expected. With regard to the pick up in the first quarter, again both most prominently in the U.S. and Europe. There is a significantly higher, I would say approximately double the number of patients accrued in the first quarter as compared to what we had accrued in the fourth quarter. Its those numbers that drive, of course, the run rate for the subsequent quarters. So weâll see. I mean, to be tested, but I think we are quite optimistic, as Henri said, that this is not a long-term trend evolving here. Hi. Yes, our DTC campaign began rolling out in February with a new branded television commercial. We're also doing online work, as well as new print advertising targeting a younger audience, driving males as well as females, and learning from the program that we put in place last year, where we had 275,000 leads and, by our calculation, a 14% conversion rate. So in the story of continuous improvement, we're learning from that and have the program in place. I wouldnât want to forecast our revenue next quarter, but Iâm willing to say our guidance is there for you to look at. And the seasonal trends that Henri referenced, if you go back five years in terms of U.S. shipments year after year, first quarter was lower than fourth, and year after year second quarter showed a substantial boost over first. So we are hoping that trend continues and have every confidence that we will get that yield, if it's there to be had. Hi, thanks for taking the questions. A question for you, Mike, on the SG&A expense. I thought you indicated in your remarks that there was some increased expense there attributable to the startup costs for the various plants, and I know you guys aren't really going through line by line in terms of guidance today, but if you could sort of break out what that is. Then it looks like, to come in line with guidance, this is going to be kind of the high watermark in terms of SG&A expense for the year, and then I actually had a real quick follow-up for John please. Sure. Within the SG&A, again, when you bring a plant online, there are two separate costs. There's the cost that goes with the cost of goods sold, which is more period expenses, but then you have what we call overcapacity or under-capacity costs. As you have under-capacity, capacity that is not utilized in the plant, it goes through an unabsorbed page. That unabsorbed page rolls up through our SG&A costs, particularly the G&A portion of it. So when I talk about the capacity costs, again, you need to think of it in two separate realms -- the startup costs, which are more period in nature, and then the under-capacity, underutilization, which shows up on our G&A. So then in terms of looking at this quarter specifically, I mean, I don't know if you can break that out or is it, I mean, assuming that thereâs really been no change to the SG&A guidance, again it looks like this might be the high watermark for the year in terms of expense? Well, I can address the trends, I mean, as you consume that capacity, that capacity will utilized for inventoriable product, which we placed on the balance sheet, so that will show up through your cost of goods sold. Generally, the guidance that we gave in February was that the startup of these two manufacturing facilities will have some impact on costs during this year and specifically higher as a great step function in the earlier part of the year or late last year, something that we didn't experience before and now we've started to experience. We fully expected this and we fully planned it into the numbers as we gave you the earnings guidance for the year. There are no surprises here, but itâs something we just have to work our way through and get to the point where we produce commercial product and benefit from the actual efficiencies as we now do so fantastically in Austin. Good morning. Thanks for taking my questions. Just a few quick ones for you, Mike. Just R&D and amortization were much higher than I expected based on your guidance for the full year. Can you update us on that or should I just -- are you sticking with your full-year guidance on those, and therefore should we expect those to drop down in the next few quarters? Within the R&D, we already addressed that. I think with the number of clinical trials that are going on, obviously weâll stick with our guidance there. With regard to the amortization, there was a change in the amortization because of the Synvisc marketing rights. As you recall, when we did the Synvisc deal, when we bought back the rights -- or purchased the rights, rather, from Wyeth -- Synvisc marketing rights were amortized over the percentage of current year incremental revenue over the total revenue that was realized from the deal structure. The incremental revenue increased in 2006, so the amortization was adjusted. As part of our carve-out, weâll continue to carve that out as a crosswalk, but that explains the increase from Q4 to Q1. Okay, thanks. Maybe just a few other points. You went a little fast for me in your introduction. Was Fabrazyme also impacted by foreign currency? Yes, the three major areas that were impacted by foreign currency particularly were the ones that, not surprising to anyone, are the ones that basically go through Europe more heavier than, let's say genetics and Synvisc area, in almost rank order, where Cerezyme was the biggest impact, Renagel was second, and then Fabrazyme was third. And my last question, again, I didn't quite catch what you said about Hectorol. You said that you had some contractual obligations, [could introduce] some extra charges. Was that reflected in the revenues reported for Hectorol? That was indeed reflected in the revenue for Hectorol. There is a $3 million decrease for the accrual of chargebacks. Bone Care historically accrued for chargebacks when they processed it, rather than when the invoice sent out. This resulted in an under-accrual for the reserve, which we adjusted in Q1. The method has now changed to accrue when invoiced rather than when processed. I think that we are continuing the accrual on [EDMC] as we have said. The number of patients which are getting in the study is continuing to increase, and we are still very much looking forward for being able to finish the study sometime before the end of this year. Thanks, just a real quick question for John. I understand that obviously you guys are getting inundated with questions regarding the emerging competition. I would think that nobody knows Gaucher better than you guys, and I think we all understand that the genetic mutations are pretty broad in terms of, or thereâs a lot that is going on in Gaucher patients that may be different from one patient or another. I guess it would be helpful if you were to put brackets around some of these things, as you pointed out, would probably not be amenable to chaperone technology. I would think that you guys would have some inkling as to what percentage of patients. If you could bracket that or maybe point us in the direction of any kind of literature that would support the breadth or the narrowness of this approach. Yes, this is very early stage technology thatâs not yet in the clinic for Gaucher disease. These are a number of hypotheses and they need to be tried, as so many things are in the biotechnology industry, that may or may not amount to something so many years from now. This is not technology that you will be able to just see overnight and identify precisely how to do either the clinical trial or identify precisely the patients. There is stuff to be done. Itâs great that itâs being done. We are extremely familiar with what is being done, but it is way too early to say it will have an âxâ amount of impact. It is extremely speculative at this early stage. Actually, I think that is the scientific response. I won't elaborate much on that. I think a lot of the work, of course, to date has been in vitro type of systems, and of course they generate hypotheses. But until we get into patients I think it is going to be very hard to know. I will stick to what I said earlier, which is I think this is going to be very much on a mutation by mutation, patient by patient testing basis. Once we get some data, weâll be able to react to that. Maybe I'll discuss a little bit more on analyst day, but I think thatâs going to be where we're going to come out until we, like the rest of the world, see some more data. Well, internally we have a scientific group which is obviously extremely knowledgeable on Gaucher, so we look at all kinds of approaches to the disease whether itâs a gene therapy approach, whether itâs substrate inhibition, whether it's trying to understand how a chaperone technology might work, or whether exploring ways to modify our Cerezyme to make it better. So thatâs part of our usual staying current with the field, being contributors to the field. In that context, we haven't learned anything thatâs different from what I told you at the start of this call. Itâs very mutation specific and all missense mutations are not created equal. The biggest problem that technology that deals with a subset of an ultra, ultra orphan disease, that is a very problematic approach. There are so few patients, and to tie it up to yet fewer patients and to do a clinical trial on yet fewer patients, thatâs a problematic approach. Thatâs why the subset approach that David explained earlier, that may work for all Gaucher patients. That may provide an oral approach. And a highly specific safe way for all Gaucher patients is in the interim until we get to a gene therapy approach, possibly a step forward for Gaucher patients who are today treated obviously very well with enzyme replacement therapy. So this is a field that itâs very encouraging indeed, that people are really focusing on trying to do the very best science can do for these diseases. Itâs a tough area and to jump to conclusion on the basis of in vitro data, as may be done from time to time -- is not unusual in biotechnology -- but it is not something that necessarily defocuses the work that we are doing to make sure that we do the absolute very best thatâs possible for Gaucher disease. Thanks for taking my follow-up. Henri, can you maybe just talk a little bit about, you know, one of the things that you've been interested in doing is acquisitions. You know, when you look across all your different therapeutic categories and your different businesses, which one do you think you'll be interested in boosting up? We are not discriminatory in that sense. We really are developing these business units, these businesses and maximizing as we are developing them, the connecting points, the synergies, you know, the same way as we did the transaction around the renal area last year. It was Hectorol that was very, very supportive of that area. We also did, earlier in the year, a transaction around biosurgery with a company in Europe that supports the Carticel development. We are in these businesses. The year before we did Impasse in terms of genetic testing for oncology. We are in these businesses to build them and to the maximum extent possible. We run them in a way that they are self-supporting. Now we are clearly choosing R&D investments, as everybody does, where the opportunities are. Sometimes they fall outside of these businesses, like Tolevamer in the case of C. Difficile Colitis, which gets us into hospital [infections]. And that by itself could also increase our interest in that whole point and how we can fortify that. Potentially, a transaction could make sense in that area, but thereâs no need to be done in that area. We think the product has a tremendous identity by itself. So we very much run the businesses as businesses, maximize the synergies as we get into these businesses and look for opportunities across the businesses that we have. Okay, excellent. I just have a couple of housekeeping questions. Can you tell us, are you able to quantify exactly what the FX impact was on Fabrazyme and on Synvisc and on Renagel? Can you give us the ex U.S. number? Sure. As I mentioned before, the most impactful one was for Cerezyme, which is approximately $8.5 million of impact on a year-to-year basis. The second was Renagel, it was about $3 million. And the other one was Fabrazyme at about $3 million as well. Those are the predominant ones that were impacted by the UFX rate in Europe. There were some changes in shifts that took place within other countries, but those are the major ones. Yeah, itâs again within a 9.5% price increase at the very end of last year, and as weâve always said, that bleeds in over the course of the quarter, depending on the Medicaid population, our contracted rates, etc. So we will recognize that over the course of the year. Again, as we said before, the Phase III trial we do expect to complete early 2007, the beginning of 2007 and file obviously subsequent to that as quickly as possible and launch in the U.S. and Europe end of 2008, or mid to end of 2008. Certainly thereâs different levels of awareness of the disease. If you look at Canada, for instance, where they've had tremendous outbreaks, the U.K. as well, there's a very, very high awareness of it. Other markets, we're just starting to understand what the awareness levels are and helping to influence that prior to launch. But you're seeing more and more publications in the lay press as well as in scientific journals that are bringing people's awareness to higher levels. So we think that by the time we're launching we can have a significant impact on that. And as Henri mentioned, the non-antibiotic option here we think will give us a very significant place in the market. Right. This is very much a hospital sell. Obviously this is a disease that's been associated with the use of antibiotics in the hospital. A very, very accessible call point, very much in line with what Genzyme does well. We're already in the hospital in a number of different business units, and we think we can build out that capacity to fully launch this product in each market. Not to dwell on this, but a quick follow-up on the LSD business. Can you talk a little bit about your small molecule in development for Gaucherâs mechanistically? We made a few comments about it earlier which you may have missed. David, do you want to make a comment on where we stand and what kind of the approach is? Just to reinforce, so the mechanistic part, which I think was your question, so it's a ceramide analog as opposed to a glucose analog, and so that's what differentiates it. And then the rest of what we've observed is that, you know, the greater potency and the greater specificity, at least in our in vitro and animal models. So weâll now go in and test this in humans. Although weâve already -- let me back up. Weâve done Phase I testing, so it's already been through the normal volunteer pathway and looks fine in that group. So we're now entering into our Phase II, which is the Gaucher population. Hi. Could you provide a geographic breakout of the Fabrazyme sales -- U.S., Europe and Japan? And if you have an assessment of your market share in Europe, that would be great, and any comments on any changes in the competitive dynamics with Shire now marketing your product, if there have been any. You asked for more details than weâll be able to provide you, but we can give you some of the details that youâre asking for. David, we have been providing international sales and European sales. We haven't broken out Japan. Historically, I think we should stay to that and any comments you can make with regards to market share. I think your question about the market share in Europe, again, our insight into that is sort of our feeling on the ground and then, of course, what is reported and we don't have all those numbers, as you know. I think the general feeling on the ground is that we continue to feel very good about the receptivity to the issue of dosing and the recognition in the market that dose is a critical issue. I think there will be some important information that will come out at the end of this year. Again, weâre waiting for those results as with everybody else, but the AMC trial, which is the only direct comparison of the 0.2 milligram Fabrazyme and 0.2 milligram Replagal study that is ongoing. Our best understanding is that will be reported at some point later in this year, and I think that could be important to helping people understand this. So again, just to summarize, I think we feel still quite bullish about what the data is saying and what investigators and treaters are saying in terms of understanding the importance of that difference. And maybe since everyone seems interested in some of the small molecule, other mechanism drug candidates for LSDâs, perhaps you could answer a regulatory question. What do you think the regulatory hurdle is for those candidates that have mechanisms other than enzyme replacement therapy? You know, because obviously there are adverse event risks, for example, that you wouldn't have with enzyme replacement therapy. I think, you know, I'll make a general comment just about developing any drug in this area, and I think Henri said it at the beginning â itâs difficult. We don't expect certainly any easier regulatory pathway. And to your point, will we need more safety data than we did with the enzyme replacement therapy? I suppose thatâs possible. I think the whole enzyme replacement therapy regulatory pathway has evolved, or is evolving significantly, from when we first launched back in 1991. It was a very different world then. Hi, thanks for taking my call. Henri, I wonder if you could give us a little more color on some of the specific advantages of sevelamer carbonate relative to Renagel, the size of the market that may open up, and what the IP looks like? Iâm going to delegate that question to John Butler. It's a good question and it's an important program for us. John. As weâve said in the past, the desire to do sevelamer carbonate allows us to go into the CKD market, the pre-dialysis patient market. The number of patients who are available there who need phosphate binded therapy, again, when you break down stage three, stage four, stage five not on dialysis, as you get closer and closer to dialysis, your phosphorus levels do increase. So we do know that today, we get a significant portion of Renagel sales from those patients and again, the ability to promote the product in those patient numbers will allow us to continue to increase sales. Additionally, remember that all the other benefits of sevelamer therapy -- the LDL lowering, the CRP lowering, the toxin binding -- all of those things we think will be able to play out much more significantly in that CKD market. So if you think only in terms of those patients who have an elevated phosphorus level, our thought is, particularly with the powder formulation thatâs easier for patients to use, we can drive physician use earlier in the treatment of CKD before you see a markedly elevated phosphorus level. So exactly what those patient numbers are, you know, weâre still working through that in the clinical studies. The results of those studies will help us to define that as well. Thanks for taking my follow-up. A question for Henri, and I'd love to get Mike's feedback as well. What would trigger or what would lead for you to get a little bit more active managing the dilution you're seeing related to the stock options, as well as the [inaudible]? Well, it's a philosophical question. We obviously, like every company in this area, have discussed this whole field of stock option expensing over years now. In the building of Genzyme, stock options have been a very important ingredient, and the cost to shareholders in terms of other vehicles, it is very similar. It doesn't provide any particular benefit for shareholders that we feel is compelling. I do think that aligning all the [inaudible], now more than 8,000, with the interest of the shareholders, has proven to be a very, very strong approach for the Corporation, and it will completely prove itself in that direction in the future. So we feel very good about the power of stock options and the benefits that shareholders have as a result of that. The [analogy] that [large] to develop in a very large group of people, trying to build and move things forward. So thatâs where we are at at this stage, not for lack of studying numerous other ways to do this, numerous gimmicks that have been suggested by all the different consultants that are trying to figure out gimmicks. In the end, we like the simplicity of the stock option approach and we will make sure that we do it in a very responsible way. We have been decreasing the yearly dilutive impact of that over a number of years now, and we will continue to be very frugal in that sense, very diligent in that sense. But we like to think that stock options really provide a tremendous vehicle for the shareholders, for shareholder value creation. Mike, any other comment? No, I think what heâs also commenting on is the number of biotechs that are doing convertible notes, or large notes to do stock repurchase. I think as the industry matures, youâll see a number of companies going down that path. Yeah, I think it becomes not as interesting for Genzyme as you go down the path of just doing a note for the purchase of a repurchase of stock. We tend to be opportunistic and I think if we were to do any sort of financing, itâs certainly around potential acquisitions or reaffirming our balance sheet. So I think the repurchase of stock in and of itself is less interesting because you do get a one-time blip when you do buy back the stock. It does change the outstanding shares, but then you kind of right yourself back to the [mandate] of the business. Hi, I was just wondering on Synvisc, why were you surprised by the seasonality here? There mustâve been something going on with demand too, I think. And number two, can you comment on the HCPCSâ recent proposal to lump potentially -- non-final proposal -- to potentially lump Synvisc in with the other AJ derivatives and 1J code? Thanks. I guess we werenât surprised by seasonality â the degree of seasonality was maybe a little larger than we had anticipated in our plans. We always were aware of seasonality, just a matter of degree. Surely. We were not surprised the HCPCS working group came out with two options for consideration by CMS, one that the status quo be maintained; the second that all products be put in the same code. Itâs a process of review and appeal between now and final ruling in November. Weâre preparing for that dialog and we feel we have a pretty compelling case, both on the scientific differentiation of our products, the ghosting differentiation of our product, and the fact that innovation in this class is all about reducing the number of injections, increasing efficacy, and punctual equivalence doesnât allow for innovation and doesnât allow for patient benefit to be created [inaudible]. Weâre pretty confident weâll prevail in our argument. Thank you very much everyone for participating. We will look forward to seeing many of you at analyst day, coming up May the 12th, and then we will have, of course, the second quarter call in July, at which time we will have quite a bit of progress to go through, such as the Myozyme PDUFA date and what came off of that, and of course the quarterly results itself. Thank you very much for your participation. |
EarningCall_234083 | Certainly. Ladies and gentlemen, if youâd like to ask a question, you may do so at this time by pressing the star key followed by the digit one on your touch-tone telephone. If youâre using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Weâll proceed in the order that you signal us, and weâll take as many questions as time permits. Once again, ladies and gentlemen, star one for questions. And weâll take our first question from Victor Miller with Bear Stearns. Two questions. One, in 2004 and into the first quarter of 2005, expense growth was running in the high single digit, almost low double digit range for the TV business, for example, and the radio business. Third quarter TV is up about 5%. Radioâs down â is less than 1%. And youâve got the $50 million of cost savings going into â06. How have you been looking at the expense side and how do we look at core expenses and what youâre trying to accomplish there? And, secondly, is it true basically that when you look at the Upfront, the Upfront gains you have, the 50% of that gain really shows up in the calendar year, 50% shows up in the broadcast year? And if thatâs true, then given the guidance you provided, what does that say about the strength of the scatter market? And given what youâre seeing in soccer, what does that mean for the growth going into â06? Thanks. We have seen a decelerating of our expense growth over the year in our television business, particularly if you look at the expenses excluding the variable programming license fee. Itâs important to exclude the variable programming license fee because starting in June it reflects Puerto Rico, which wasnât included in the prior year. But our operating expenses excluding the programming license fee in the first quarter were up 15% in TV, 2.5% in the second quarter, and 2.7% in the third quarter. So, we have historically been managing our expenses to lower [growth] rates, reflecting lower revenue growth. The reduction in force and the cost reduction charge that we announced reflects a focus on driving efficiencies in our business, and since most of that effect is in the TV business, I think as we go into 2006 you will see modest growth rates in [expenses in] the TV business, putting aside the World Cup, which is a unique situation. As it relates to the revenue gains as we go forward ... ... and the scatter market, the fourth quarter increase in revenue growth is driven by the television business, with the stations and the network expected to grow similar percentages. We think that the implied growth rates of high single digit for the business reflects, as you said, a portion of last yearâs Upfront and a portion of this yearâs Upfront, which on the last call we said, excluding World Cup, was up low double digits. The scatter market remains good and really thereâs been no difference over the past few months. Hi. Good afternoon. Can you talk, maybe this is a question for Ray, a little bit about the impact of the local people meters and maybe talk specifically about how thatâs impacting the TV station ratings rather than the network ratings that youâve given us a lot of detail on? And then the second question is on the $50 million in cost savings, when do you expect to realize that? Do you get a portion in the fourth quarter and you get all $50 million by â06? Or, if you can just give us some color on the timetable. Thanks. Yes. On the local people meters, I know we didnât detail it, but the ratings at the local stations are at all-time highs, as you know, we had a period of time where we were discussing with Nielsen better samples and so forth. From the local standpoint we still have a ways to go, but weâre #1 among all stations including the English stations in many, many of our markets. Our local news are #1 in many of the local markets, so, the ratings continue to be strong not only on a national level but on a local level. And as far as the $50 million, thatâs an annual estimate of the annual savings so, itâs a year worth of savings. The $50 million is the annualized effect of the reduction in force plus non-headcount related changes that weâre making in our business. Hi. Good afternoon. Andy, on the last quarterâs conference call you had mentioned that there had been returns from a major music industry wholesaler, which slowed sales in that quarter to the tune of about $5 million. What, if anything, did you do differently this quarter? The music numbers look great, by the way. What, if anything, did you do differently to solve that problem? And do you still expect to exercise your option on the other 50% of Disa by the end of next year? Thanks. As it relates to Disa, it is our intention to exercise that option, I believe around June 30th of 2006. As it relates to the returns experienced in the music industry, generally we are continuing to experience higher levels of returns than we have experienced historically. We believe it is a result of the big box retailers reducing their inventory levels of recorded music and other boxed home entertainment product. So, I think that once inventory levels stabilize at [their] new lower level, the returns experience is expected to return to our historic normal average. And weâre watching it very, very carefully. David Miller Hi. I have a few questions. I was wondering, first, if you can comment on the auto category. A lot of your general interest peers are suffering in that category. I wanted to see if youâre seeing some strength. And I also wanted to know â ABC has started dubbing some of their programs in Spanish. Does this impact you at all either now or in the long-term? And finally, when do you start becoming a full cash taxpayer? Thanks. The auto category has continued to show strength for us. In the third quarter it was up high single digits, and going into the fourth quarter it is pacing a similar rate ahead. Itâs two â cash taxes â excuse me, Ray, Iâm sorry. Ray Rodriguez We are pretty much a full cash taxpayer now, but we do have these very long-term deferred tax assets relating to some very large purchases that we had done historically on an asset basis, primarily the USA stations and radio stations that the old Hispanic Broadcasting Corporation purchased. Ray Rodriguez As far as the dubbing, we really believe that language is not what makes a program attractive to our demo. Itâs really the content. Itâs not the actual language. We donât believe that this is going to have an impact on our ratings. However, I think itâs a very good sign that people want to get into this growing market. We just donât believe that dubbing is the way to get any audience. Thanks. I just wanted to hone in a little bit more on the World Cup. With the announcement today, you said the revenues so far [are] $180 million, which is way greater than we expected. How much inventory is left? And is all of the $180 million at the network? And could you outline what do you think the station benefit will be? And then finally, how much of the World Cup buying will benefit â07? Donât most of the advertisers have to commit to periods beyond the World Cup? Thanks. Andrew Hobson The $180 million that was announced in our World Cup press release this morning is gross revenues, incidentally. It reflects both network and station inventory. The inventory split is roughly 80-20, so those revenues are roughly split 80-20. Sellouts, since weâre still selling, Jessica, and it is competitive, I donât think we care to comment specifically on that. I believe on an intellectually honest basis, though, if you assume approximately two-thirds of the World Cup revenues are incremental it is profitable at the $180 million sales level. And I donât know, Jessica, how many dollars were carried into 2007. But you can say, when you sell the World Cup you sell it as part of a package, donât you? Andrew Hobson Thereâs also the effect that weâve always felt years after a World Cup. One of the great benefits to us of the World Cup is that the budgets grow. So, we normally have very good years after World Cup. A lot of that money that comes in for the first time stays. And we do have other sports properties, and so forth, that we put people in. So, it does have a very beneficial effect, not only in the year that you play but the years that follow. Jessica Reif-Cohen And then just one follow-up on the TV stations. Andy, I just want to make sure I understood what you said. In the guidance it sounds like the stations growth is in line with the network growth of high single digits. Just want to make sure I understood that. And could you comment on radio pacings into the fourth quarter, please? Thatâs correct, Jessica. I said that the stations and the networks are expected to have similar growth rates in the fourth quarter. Radio pacings are less than TV pacings right now. Thank you. Good afternoon. A couple of questions. First, starting with the Internet business, you have the most popular Latin American website destination in the U.S., and itâs certainly made some improvements in terms of profitability. The last big thing we heard was the Google affiliate deal that you announced during the summer. What do you think your goals are for 2006 in terms of monetizing that platform and getting more active on the entertainment side of the world? And the second thing is, Andy, Iâm sorry to make you repeat this, but in the third quarter, could you just repeat the revenue growth in TV between network stations and Galavision? I think you said it already. Iâm sorry, I missed it. Well, that continues to be a growing business, and weâre happy with the continued growth in viewing. We have been starting to monetize that, and we expect that to accelerate as we go forward. David Bank What do you want to do with the portal? I mean, what is your goal for 2006? What kind of initiatives are you thinking about to â specifically, what do you want to do with the portal? Ray Rodriguez Well, this is the same way, to a certain degree, that weâve grown the television business which is to concentrate on the content to get more and more people to come in, and then the revenues follow, as has been the case so far. Weâre happy that weâre breaking even, and we have a lot of potential there going forward. We do cross promote heavily on television and on radio, Internet, so we expect it to continue to grow, and as more page views and so forth, the money will follow. Yes. Just a quick question with respect to the share repurchase program announced. In the light of the maybe slightly more aggressive repurchase activity, could you maybe just articulate what the current leverage targets are for the firm? And a related question, I think previously the guidance was that you would look to repay your maturity in â06 out of cash on hand, implying a permanent reduction in debt. Just want to make sure that that was still the plan. Andrew Hobson Our capital policy is to maintain leverage ratios which are consistent with maintaining and deserving BBB flat or the Moodyâs equivalent Baa2 credit ratings. And in your mind, what are those ratios? Because when you talk to the agencies, it seems to be a moving and tightening threshold. Andrew Hobson I think money is fungible, and I believe we will probably refinance it if we are purchasing more than $250 million of common stock during 2006, as we expect to. Good afternoon, gentlemen. A couple questions, some are follow-ups. First, Andy, in calculating that rough profitability figure for the World Cup, is it right to assume around a $90 million cost on the World Cup for next year? And then, whatâs the difference between net and gross on that $180 million revenue figure that you posted thus far? And then, on the Upfront, if you can give us some color as to the number of advertisers that youâve got into the Upfront once it had closed and the progress you made in getting additional brands on the air for advertisers who were returning. Finally just in terms of the cost cuts, can you give any split as to what the breakout is between the headcount versus the non-headcount related portions of those and then any possible breakout as to how much is going to the network versus the stations on the TV side? OK. The profitability of the World Cup assumes agency commissions of 15%, which is the difference between gross and net sales, and the incremental costs of the World Cup are high $90s millions of dollars. The absolute cost is $100 million of rights fees and $8 million or so of production costs, but we are displacing several hundred hours of programming, which has a savings associated with it. So, I use the high $90s million incremental number. James Dix The Upfront, frankly, I donât think weâve ever released the number of advertisers, so I donât think weâre going to. We had 20 new corporate advertisers in the Upfront though. Weâve had recently significant additional brand activity coming out of Procter & Gamble, Unilever and Pfizer, for example. The [breakout of] costs between headcount and non-headcount, I donât have it in front of me so Iâll have to call you back. Hi. Good afternoon. A couple questions. One, just on the World Cup, Ray, youâve mentioned that youâre hoping to see about a 43% increase in audience this year. Iâm wondering, would that be comparable to the sort of rating guarantees that you are offering as you sell World Cup inventory? And then weâve got the Latin Grammys, I think, tomorrow night. Is that anticipated to be a meaningful revenue contributor this year? And would that be excluded from the Televisa program license agreements? And then the last question is, Andy, in the past youâve sometimes talked about pricing versus volume on the network and the stations. Just wondering if you had that data this time. Thanks. Gordon, on the World Cup we are estimating that our total audience is going to be about 50 million, but that audience includes some English, and we donât sell on that. Our guarantees are consistent with our audience growth. And remember that this World Cup is being played in Europe. So, that means that thereâs going to be better time periods, and that is one of the reasons why weâre increasing our estimate, consistent with what we believe will be not only [that] the popularity of the sport is growing in the United States but also the better time periods. As far as the Latin Grammys, it is a very exciting event. Relative to all our big specials, itâs in that level, and because it is a special, we do not pay [Televisa and Venevision] license fees on that. Gordon Hodge Good afternoon. Just two questions here. The first one â with your agreement with Nielsen, should we look perhaps for potential timelines that the Univision Network will be included in the traditional NTI Index? And perhaps you can give us some thoughts, Ray, on what that potential might be from an advertising side. Secondly, just if you can give us a little color on the September filing. I believe it allowed for the separation [of] CEO and president roles. Thanks. Ray Rodriguez Jonathan, we are looking very closely at the NTI, and weâve been tracking their sample and tracking the results of NTI versus NHTI, which gives us our audience, Hispanic audience. And NTI, as you know, is the total national audience. We want to make sure that the NTI gives us as much audience as the NHTI, which is all Hispanics, itâs a bigger sample, etc. We believe that that is getting closer and closer. At the time that we feel that NTI is giving us the total fair count, we will switch to NTI. We believe itâs going to happen this year coming up. We believe itâll be very significant to our business because, as you know, some of the buyers go off of NTI and donât pay attention to NHTI and [in] some of the computer models they use for buying, the NHTI is not in there. So, we donât even exist as far as many buyers are concerned. Once we enter we believe thereâs great opportunity there. Does that answer that question? Jonathan Jacoby Absolutely. If you could just expand on the September filing. I believe the September filing was just a technical change of the bylaws to allow for separation of certain titles. And thatâs all it was. Hi. Thanks. Just two quick questions. First, with a strong presence in Miami in both your TV and radio stations, can you help us get a better understanding of what you think the impact from Hurricane Wilma will be? And can I assume that this is already factored into your guidance? And, second, can you tell us how many different World Cup advertisers you currently have lined up, and what portion of them are new advertisers for you? Thanks a lot. Andrew Hobson OK. As it relates to Miami, we have factored into our guidance revenue that has been lost and it is uncertain whether weâll be able to re-express it as well as some costs related to the repairs or damage we incurred. We expect in our guidance that [the impact] is approximately less than 1% of revenue and approximately 1.5 to 2% of EBITDA. Eileen Furukawa There is between 20 and 25 advertisers on the network. And the stations would have a much greater number of advertisers who not necessarily bought all stations. I do not know the number of new advertisers. Iâll have to calculate that. Hi. This is Tuna from Standard & Poorâs Equity Group. A couple of questions. The first one would be, Andy, as you look at your balance sheet, it seems that the case could be made for maybe taking up the leverage a little bit more in order to perhaps finance a more aggressive return of capital, such as a special dividend. And I know youâve just announced another $500 [million] share buyback, but I guess it seems like youâre being a little bit more conservative than you can be, even within the leverage targets that you had outlined earlier on the call, which are the high 2âs to 3 times. And, secondly, on the long distance telco issue that adversely impacted the last quarter, the prior quarter, how much of that is still a factor for the fourth quarter? And if you can comment on political as well. And finally how much less commercial units are you running on the radio and the TV side compared to English language? And if you can comment on what your CPMs are today on the radio and TV as well, compared to English, that would be helpful. Thank you. Andrew Hobson OK. Hopefully I got all those down. On the long distance telco and political in the fourth quarter of last year, we [had] about $10.6 million of net revenue, which would be nonrecurring. Keep in mind that in the fourth quarter this year we have received a little bit of long distance, so Iâve netted those against each other. On the balance sheet and leverage, Tuna, I guess itâs a philosophical issue. Weâve [undertaken] a $500 million program before. I believe the boardâs view is that thatâs an adequate number to progress â or adequate rate to progress at. If we complete that program before the end of â06 the board will reconsider whether we should ask for more. We donât think itâs necessary to throw a big number out there just as window dressing. Weâd rather put a number out there that we expect to complete in the timeframe that we say. Our board has decided for the time being that the appropriate way to return capital to shareholders is through managed stock repurchase programs. CPMs and CPPs vary by business unit and day part and demo, but generally speaking we are above parity with English-language cost per points and CPMs during daytime. We are at parity in most other day parts, with the exception of primetime, where weâre at a discount ranging from 20 to 30% depending on the business unit. And those are all kind of rough. Thatâs TV, yes. Radio varies a lot by market. We have many markets where our cost per points are significantly higher than English-language cost per points. And thereâs other markets where theyâre significantly lower. One point on radio that I want to go back to , I think it was Jessicaâs question, where we talked about the radio pacings, people should keep in mind that in the fourth quarter of 2004 political made up about 4% of radio billings. So, we did expect to have lower pacings in the fourth quarter for radio vis-a-vis TV. Did I get all of your questions, Tuna? Tuna Amobi Commercial units are standard load and television is 10 minutes per hour. Radio [varies] by format. With the non-talk news talk formats being 10 to 12 minutes, and since commercials are part of the format in news talk, they are much higher. Tuna Amobi Good afternoon. I wanted to follow-up a little bit on the discussion of reduction in headcount by about 6%. I wonder if you can flesh out a bit more about what types of employees [are] involved. Are we talking about automation of processes or reduction in sales force of lower performers? It sounds almost like not a restructuring but a kind of thing where it is a certain change in processes and operations. So could you elaborate? Andrew Hobson That is correct. The changes that have been made in the administrative support function reflect a review of the processes that we undertake, the work that we do, streamlining those processes, and eliminating some of the work that previously had been done. Philip Remek Thank you, gentlemen. Good afternoon. My questions are in two areas, one on cable networks, and the other is going back to actually FIFA and the World Cup for 2010, 2014, the new contract. Andy, the question really is, if one was to look at Mas Musica getting a potential purchase over at CBS and also the cable operators in New York, L.A., and especially Miami lowering price for Latino packages, does that change in any way more recently your thinking lately about development of the cable networks or the potential for that as a competitive scenario later on in the decade? And then on the FIFA new contract, understanding that there are a great deal more events that take place in the new FIFA contract out to 2014, the first one is, Womenâs World Cup 2007. How will you be amortizing the $325 million contract through the life of it? What should we be assuming for 2007, in other words for the Womenâs Cup? Well, Lee, on the amortization weâre going to do that as required, which, as you know, is based on revenues. Until we have an estimate of what the revenues are in each of the games, we wonât be able to give you the allocation, but as you know, itâll be done on a flow of sales or flow of cash basis. And it goes through 2014, so weâll make our best estimate, and once we have that on the sales, weâll divide the cost accordingly. Ray Rodriguez And as far as the cable networks, we currently, as you know, we have Galavision, which is by far the #1 cable network in the U.S., we do have a joint venture with 5 additional channels that are being distributed throughout the U.S. through our TuTV joint venture, and more than that at this point, we donât think is going to be profitable. Going forward, who knows? At this point we think, with what we have, weâre going to do very well. Lee Westerfield Thanks. Just one question. Given how strong your ratings have been over the last few years and the pressure that has really faced [the] overall broadcast TV as far as pricing, whether or not you disagree with it, I think itâs probably fair to say that you run into pressure pricing where advertisers want to pay less on unit price increases than your audiences, and itâs your goal to try to get them to pay up as much as possible. In years back when you were bringing in more advertisers, that put pressure on inventory. So, my question is, given that some of your largest ad categories have matured and youâre trying to focus on bringing up some of the other ad categories, does some of the expense reduction flow back into increased investments in sales? Thanks. Well, part of the answer is yes on the cost reductions. We are going to focus more energy, more resources on sales and marketing. As far as the strong ratings, we have a situation where we have plenty of inventory. And we manage our pricing not based on the inventory that we have available, but based on the value of the units versus whatâs being sold in the broadcast networks and at the stations locally. So, the inventory issue is not really an issue for us as far as pricing. Of course, we get the same pressure that everybody else does. Weâre in a unique position where our ratings and our audiences are growing very quickly. So, I believe itâs a little easier for us than for some of the folks that have decreasing audiences. Jason Helfstein Good afternoon. Two questions. Can you give us an update on Televisaâs litigation, if possible? And, second, just to clarify on the headcount reduction, we should not expect a reduction in other businesses. Is this accurate? There is, I believe, a hearing, if thatâs the technical term, on some motions on November 21st, and thatâs about as much as weâre going to comment on the lawsuit. Gerardo Soto Thank you. Out of the 20 new advertisers youâve gotten Upfront, how many of those would you characterize as being top 300 type advertisers? The second question is, in Puerto Rico typically the commission structure has been higher than in the U.S., so margins have been a little weaker industry-wide. Do you see any change on the horizon there? Well, our commission structure in Puerto Rico is a bit different than everybody elseâs. We pay a little less commission than the rest. It is higher, however, than it is in the United States. And as far as the Upfront, Andy, do you have that? Yes, Iâm looking at the list. Iâm just trying to find the list of new advertisers. I got it. Certainly 18 of the 20 would be top 300 advertisers. The other two may be, but Iâm not familiar with them, so that would be a guess. But 18 clearly are top 300 advertisers. Thanks. Andy, just to go back on political Q4 and maybe â06 outlook, given the campaigns in New York and New Jersey and the issues in California, are you starting to see the benefit of the dollars? Thereâs a lot of money being spent here. And could you also discuss expectations for next year? Andrew Hobson We can never predict political. So, I donât even want to speculate. We have received money primarily in television in the California stations and, to a lesser extent, in New York. My guess is itâll end up being 40-ish percent of what we did last year in aggregate. And that does conclude our question-and-answer session for today. Iâd like to turn the conference back over to Mr. Rodriguez for any additional or closing comments. Thank you, operator. Iâd like to thank you again for having joined us today. Have a nice evening. Operator: Once again, that does conclude todayâs teleconference. We thank you for your participation, and you may disconnect at this time. |
EarningCall_234084 | Hereâs the entire text of the prepared remarks from Halliburtonâs (ticker: HAL) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Ms. Evelyn Angelle. Please go ahead. Good morning, and welcome to Halliburton's third quarter 2005 earnings release conference call. Today's call is being webcast and a replay will be available on our website for seven days. Joining me today are Dave Lesar, Chairman, President, and CEO; Chris Gaut, Executive Vice President and CFO; and Andy Lane, Executive Vice President and COO. The press release announcing our third quarter results is available on our website at www.halliburton.com. It estimates the impact the Gulf of Mexico hurricanes had on different parts of our business. Overall the hurricanes negatively impacted our third quarter net income by $0.05 per diluted share. We have tentatively scheduled our 2005 fourth quarter earnings release conference call, Friday, January 27, 2006, at 9:00 a.m. central standard time. In today's call, Dave will provide opening remarks. Chris will discuss our overall operating performance and financial results followed by Andy covering strategy and our business outlook. We will welcome questions after we complete our prepared remarks. Before turning the call over to Dave, I would like to remind our audience that some of today's comments may include forward-looking statements, reflecting the Company's view about future events and their potential impact on our performance. These matters involve risks and uncertainties that could impact the Company's operations and financial results and cause our actual results to differ from our forward-looking statements. These risks are discussed in Halliburton's Form 10-K for the year ended December 31, 2004, Form 10-Q for the period ended June 30, 2005, and recent current reports on Forms 8-K. Thank you, Evelyn, and good morning everyone. I'm pleased to record another quarter of solid financial performance at Halliburton. Despite the Gulf of Mexico's pretax impact from the hurricanes of proximately $33 million, we achieved record consolidated operating income of $690 million. While the situation in the Gulf has claimed everyone's attention, in reality the hurricanes are only a small part of the news we will share with you this morning. First of all, regardless of what you may read in the papers, we did not do any work for FEMA. In fact, as of today, KBR's hurricane-related work is less than $200 million and is being done under the competitively bid CONCAP contract. In the ESG, I'm happy to report that not only did we achieve record revenues in operating income, but we also posted an operating income margin of 21.8%. Part of this is attributable to the price increases we have implemented in the past. I also announced in September additional price increases beginning this month. These will range from 6 to 18% depending on the product line and Andy will give you more details on those in a moment. We also continue to benefit from our strong focus on return on capital. This is being demonstrated by our fixed or exit strategy, where we are focusing our attention on our lowest performing areas in order to continue driving up our margins and returns by getting better terms from our customers or by exiting the market and taking that equipment to areas where we see higher returns. This has a short-term impact on a region's revenue and cost as we demobilize and remobilize that equipment, but I believe that it is in ESG's best interest in the long run and Andy will give you more details on that in a moment. At KBR, revenue is strong, margins have improved and we have landed some exciting new contracts, including new awards for LNG, and gas-to-liquid products that are strengthening our backlog and portfolio. This quarter also, as expected, we had successful resolution of some of our fuel issues under the Rio contracts. We have settled six of the ten task orders under review with no decrease in the amount of costs we will be reimbursed by the government. We have also monetized an investment we had in a toll road we constructed a number of years ago. Our only disappointment this quarter at KBR were some losses incurred in our E&C operations in Algeria. You will hear more about those in a moment. I would also like to mention that we have and continue to make, strategic investments in the U.S. to take advantage of this strong market, just as we said we would. This has strengthened our returns and is helping us build for growth in the rest of the world. It now seems even the skeptics have changed their view of the continued strength of the North American market. Thanks, Dave and good morning. I will comment on the overall company and individual segment results. I will summarize the change in revenue and then operating income for each of our six segments and then discuss our liquidity and other financial matters. In my remarks, I will be comparing third quarter of 2005 results sequentially to the second quarter of 2005. Halliburton Company revenue was $5.1 billion in Q3, essentially flat from the prior quarter. Energy service group revenue was up $126 million, or 5% sequentially with three of the four ESG divisions setting new revenue records. KBR revenue went down 7% sequentially primarily due to reduced activity on the competitively bid LogCAP contract in Iraq. On a consolidated basis, international revenue was 72% of the total. Halliburton achieved record operating income of $690 million for the third quarter. Overall, ESG operating income increased by $44 million reflecting a 70 basis point operating margin increase. This was driven by higher natural gas drilling activity and continued pricing strength for our services, particularly in North America, where the market continues to be exceptionally strong. KBR operating income increased 23% in the third quarter to $150 million, operating margins rose by 150 basis points to 6%, with the sale of an interest in the U.S. toll road contributing $85 million to operating income, partially offset by losses and project joint ventures in Algeria. Now, I will highlight the ESG segment results. Beginning with production optimization, where revenues increased $61 million or 6% compared to the second quarter of 2005. Production enhancement led the segment with a 14% increase due to high demand in U.S. land for stimulation services and a strong rebound in Canada. Completion tools revenue decreased 10% due to effects of the hurricanes in the Gulf of Mexico, the large second quarter sales into Asia, and the completion of a large project in Mortania last quarter. Production optimization operating income increased sequentially 7% or $18 million with a 40 basis point improvement in margins. In production enhancement, operating income grew 22% and margins continued to benefit from improved pricing and increased equipment utilization in the U.S. and Canada and lower cost due to a change in mix in Algeria. However, completion tools operating income decreased 26%, largely reflecting the negative impact of the hurricanes and lower sales for the quarter. In the fluid systems segment, revenue increased $32 million or 5% over the second quarter of 2005. Cementing revenue increased 4% primarily driven by better pricing in the U.S., land, and strengthened activity in Canada. Third quarter results were negatively impacted by the hurricanes in the Gulf Coast, and decreased activity in Mexico. Baroid revenue increase by 5% reflecting activity and pricing increases in Western Africa and in the U.S. In addition, the rebound from the Canadian spring breakup contributed to Baroid revenue improvement. The hurricanes damaged or temporarily halted operations at several of our cementing and Baroid facilities in Louisiana many of which have already come back online. Fluid systems operating income was up $4 million or 3% sequentially with continued margin strength. Cementing services operating income increased 3% and Baroid operating income increased 2% due to the same factors that drove revenue. Our drilling information evaluation segment had a revenue increase of $22 million or 4% sequentially of which 59% came from international operations. Sperry Drilling Services grew revenue by 7% due to a robust Canadian market and strong activity in the U.S., the Middle East, and the North Sea. Security DBS increased revenue 13%, driven primarily by Canada, the U.S. and the North Sea. The logging services revenue declined sequentially due to higher direct sales in Asia in the prior quarter. Partially offsetting this decline was increased activity in the U.S., and Latin America in logging. Drilling information evaluation operating income increased $3 million or 2% over the second quarter. Sperry Drilling Services operating income increased 6% mainly due to increased activity in Canada, the U.S., and the Middle East. Security DBS drill bits operating income increased 46%, driven by the strength in rig count in Canada, as well as increased activity in the U.S. and Europe/Africa. Logging operating income decreased 16% due to the decline in direct sales in Asia. Drilling information evaluation margins remained essentially flat from the prior quarter despite the impact of the hurricanes which halted or delayed activity in operations and manufacturing facilities along the Gulf Coast. Digital and consulting solutions segment revenue was up 7% compared to the second quarter of 2005, primarily due to sales in North Africa. Digital and consulting solutions operating income increased $19 million or 119% compared to the second quarter of 2005. The second quarter included a $15 million charge for the integrated solutions projects in Mexico. Now let's turn to the two KBR segments. Government and infrastructure revenue for the third quarter of 2005 was $1.9 billion, compared to 2 billion in the second quarter. The decrease resulted from lower activities and the LogCAP contract and at the DML shipyard in the UK. Government infrastructures operating income for the third quarter was $149 million, up $76 million or 104% over the second quarter. The increase is primarily the result of $85 million in operating income on the sale of our interest in the toll road we built in the '90s outside Washington D.C. As part of our plans to develop various projects, we occasionally take an ownership interest in the constructed asset, such as a toll road or a railroad. Our strategy is to monetize that ownership interest once the operation matures and the asset increases in value and this is what happened in the case of this toll road. This quarter, KBR revenue related to Iraq activities was $1.9 billion, operating income was $45 million resulting in an operating margin of 3.7%. We recognized $24 million in income related to the favorable settlement of various Iraq-related audit issues, particularly fuel. The second quarter included $29 million in Iraq-related award fees granted on definitized past quarters. Nonetheless our cumulative operating margin on the Iraq-related activities over the past two and a half years is less than 2% of revenue. In the energy and chemical segment, revenue for the third quarter of 2005 was $614 million, compared to $653 million for the second quarter. Operating income for the third quarter of 2005 was $1 million versus $49 million in the second quarter. Operating income declined primarily as a result of a total of $70 million in losses on various projects in Algeria. Approximately $47 million related to charges we took on an unconsolidated Algerian joint venture. About half of this amount related to project losses and the other half was a write-down of our carrying value of the venture. Separately, from this joint venture we recognized 23 million in additional losses on a gas project in Algeria. Outside of Algeria, E&C continued to have very strong results with the commencement of the new LNG and GTL projects, continued good performance on reimbursable oil gas production facilities and the completion of our work scope on the Belanak FPSO project in Indonesia. Now let's review other financial items. General corporate expenses were 26 million in the third quarter, compared to 37 million in the second quarter of 2005. The decrease was mainly due to reduced outside professional fees. Our effective tax rate this quarter was 20% which is lower than the 28% estimate we provided you last quarter. The reason for the decline is similar to what we have seen during the first and second quarters of this year, the improving profitability of our domestic operations is causing our estimates of U.S. taxable income for 2005 to increase. This allows us to use more of our tax losses and foreign tax credits than we previously estimated. Utilization of these tax benefits has a direct positive impact on our cash flow. We are now estimating a 26% effective tax rate for 2005, compared to our estimate of 29% last quarter. We had to adjust our third quarter tax rate down to get to a 26% tax rate for the nine month results. And we expect about a 26% rate for the fourth quarter. However, this may change as we now are in our budgeting and planning process for future years. If as a result of this process, our estimate of U.S. taxable income for future years increases significantly, we may record a large one-time favorable adjustment to our valuation allowance during the fourth quarter of 2005 which could result in a large reversal of income tax expense and a large positive income contribution. Essentially this would be recognized in the tax deductions for the asbestos settlement that we were not able to benefit previously. In 2006, and thereafter, we continue to believe our effective tax rate will be back at our normal range of 36 to 38%. I would also like to point out that our diluted weighted average shares outstanding increased to 525 million shares this quarter. This caused additional dilution to our EPS of approximately $0.02. The dilution was attributable to the significant increase of our stock price in the third quarter, the impact this had on our convertible notes, and employee stock options in the diluted EPS calculation. Generally, at this level, a $5 increase in our quarterly average stock price results in 1.6 million additional diluted shares. As you know, we plan to adopt a new accounting standard on expensing employee stock options effective January 1 of 2006. We expect this will result in $0.02 of additional ongoing quarterly expense starting next year. Now, let's turn to liquidity. Cash and marketable securities were $2.1 billion at September 30, which is an increase of approximately $550 million from June 30, 2005. Our debt-to-total capitalization ratio was 39% as of September 30, and last week we paid off the $300 million variable rate senior notes that matures this month. Our September 30, 2005, debt-to-total capitalization ratio would have been 37%, including this debt reduction in October. We also had further improvement to our return on capital employed during Q3, which is now running at an annual rate of 25.3%, and that's a 260 basis point improvement from last quarter, and that includes 70 basis points related to income from the toll road sale. We calculate return on capital employed differently from some other companies as we do not deduct our significant cash balance from capital employed. During Q3 our capital spending increased to meet the higher level of activity due to our customers' increase in E&P spending up about 25% versus the run rate in the first half. We expect our CapEx to be in its higher range of 180 to $200 million per quarter into next year. We are confident that we have planned for the appropriate level investment in 2006. Before turning it over to Andy, I will give you an update about the separation of KBR; as we announced in January, we believe it is necessary for KBR to deliver solid operating performance for a number of quarters to build KBR's backlog and to reduce uncertainty around the various disputes and investigations under way in order to maximize KBR's value for our shareholders. We have made progress in these areas but no time line has been set for a separation of KBR. In pursuing the potential operation of KBR, we will consider an initial public offering of KBR as well as private transactions. Thanks, Chris. Good morning, everyone. ESG turned in another record-setting quarter. reflecting continued robust activity in the market. The management team we have in place at the ESG is doing an excellent job in capitalizing on the current opportunities. Our employees are working very hard and we continue to add direct resources to meet the improved demand. If you look at the first nine months of 2005, compared to this same period in 2004, we've had top line growth of over $1.4 billion, or 24%, and we've improved the operating income by over $700 million. Our September ESG year-to-date margins were 22%. We are proud of our management and our dedicated hard-working employees who delivered these great results. I will talk about each region in a moment but first I wanted to describe how the hurricanes in the Gulf of Mexico prevented us from having an even greater quarter. Halliburton was relatively fortunate; nevertheless, we sustained heavy damages to both our Baroid and cementing Louisiana facilities in Cameron, Bennett and Intercoastal City. We have shifted our activity to other facilities while those are being repaired and we are now ready to continue operations at the pre hurricane levels. As you know, some of our customers' platforms and rigs were damaged or lost and it will take them a while to reestablish pre hurricane activity levels. We do expect customers to resume the activities that were curtailed by the storms throughout the end of the year, and into the first half of 2006. Our Gulf of Mexico activity is about 70% of pre hurricane levels. Meanwhile, we have deployed a number of our Gulf of Mexico personnel to higher utilization areas until activity levels resume. The third quarter ESG hurricane impact of $0.04 per share is based on a mix of lower operational activity and temporary declines in manufacturing productivity. Looking forward to the fourth quarter of 2005, we expect a similar financial impact as seen in the third quarter, primarily due to lower operational activities, and the number of offshore rigs that are out of service. I would like to thank all of our employees on the Gulf Coast to helping to secure our facilities, ensure the safety of our workers, and return our business to normal operations. I also appreciate our employees worldwide who very generously helped take care of people who were displaced by the storms, by contributing to a Halliburton matching assistance fund. A positive contributor to this quarter's performance was improved pricing. Since May of 2004, we have had three U.S. price book increases ranging from 8 to 15%. We have announced an additional price increase effective October 15, in three divisions. The increases are as follows: Production optimization 15%, in fluid systems, 10 to 18%, and in drilling and formation evaluation, 6 to 15%. Our price increase in digital and consulting solutions will become effective January 1, 2006, and will be 5 to 9%. Beyond the U.S., we continue to improve our prices. We are pushing for and have been successful with increases in new and existing contracts through direct negotiations and tendered opportunities. We believe additional pricing opportunities exist in every region. Over the last six quarters, on average, our revenues have grown 8% per quarter in North America, and 5% per quarter in the rest of the world. In North America, revenues increased 12% and operating income increased 20%. We continue to focus on pricing improvements, disciplined capital deployment, control of operating costs, and efficient use of our existing capital base while maintaining our leadership position in the U.S. land. This substantial improvement in our productivity reflects improved pricing and better utilization of our equipment. For example, our revenue for U.S. crack crew has grown 65% in the last six quarters. These efforts mitigated the effects of the Gulf of Mexico. Canada experienced strong growth sequentially as activity levels improved from weather-related slowdowns in the second quarter. In Latin America, margins improved in Mexico, where we improved our operational performance on our integrated drilling projects for Pemex. We are encouraged that recent performance gains will be carried through the remainder of the project which we expect to conclude in April of 2006. We continue to focus on improved results in certain areas of Latin America to meet our performance expectations. In our Middle East and Asia region, revenue was down 5% and operating income was down 12%, partly as a result of lower direct sales to certain countries, and the deployment of resources to growing markets. In the third quarter, we mobilized additional service equipment and personnel to meet the overall rig and E&P investment we are experiencing in the Middle East. We are well positioned to capitalize on this opportunity. We expect to see improved results in this area in 2006, led by Saudi Arabia, Oman, and Malaysia. In our Europe/Africa CIS region, revenues were up 4% and operating income was down 4%. We saw improved probability in the rapidly growing Russia and Caspian markets. This demonstrates our commitment to growing in these markets while maximizing our return on investments. Activity picked up in Northern Africa where our revenues were up as we broaden our customer base. West Africa is another growth area in the deep water market and our well dynamics joint venture won several intelligent well contracts in Angola, expanding our strong position in completions in West Africa. We continue efforts to meet local content goals in Nigeria, which should help to improve our margins there. We are also focused on our fix it or exit strategy for improving financial performance in operations throughout Europe and Africa. In the North Sea, profitabilities declined because of product mix and rig scheduling. So overall for ESG in the third quarter I'm very pleased with our results, again. For the fourth quarter, notwithstanding the seasonal impact and the continued effects of the Gulf of Mexico, we remain positive. Now, let's turn to KBR. Looking at the first nine months, revenue is down $1.5 billion, or 16%, primarily due to the completion of the Rio contract and the ramp down of LogCAP work in Iraq, as well as the completion of certain E&C products. The KBR operating income for the same nine-month period has increased by over $700 million, a significant improvement. But we still have work to do. We continue to focus on profitability, the quality of backlogs, and resolving outstanding issues regarding government contracts, and investigations. KBR's total backlog at the end of September was 14.3 billion. With our G&I, within our G&I segment, we expect the volume of work on the LogCAP 3 contract to continue to decline into 2006. As our customer scales back the amount of services that KBR provides. We are pleased with our progress we have made in resolving over $1 billion in issues related to fuel services under the Rio contract. We have favorably settled the majority of the task orders affected by this issue and have forecast orders still under negotiation of which three are fuel related. Fuel was our second major dispute to resolve. As you will remember, we settled facilities in the second quarter. The G&I backlog at the end of the quarter was $3.6 billion in firm orders, an additional $3.9 billion in government orders are firm, but are not yet funded or the letters of intent or contracts have been awarded but not yet signed. In E&C, we've had significant gas monetization wins this quarter. A major contract award was from Yemen LNG Company Limited for the first LNG plant in Yemen.. Another important new contract is for a payout of lump sum turnkey price for an LNG facility to be located in Peru. This grass roots facility will be Latin America's first LNG export plant. And finally we were awarded the project management work for Qatar Shell GTL Limited Pearl project in Qatar. It will be the largest gas to liquids plant in the world. This is our second major GTL project win in 2005 and positioned us well in this emerging market. Our E&C backlog at the end of the third quarter was 6.8 billion. Approximately half of this is from our industry leading gas monetization projects. We are actively pursuing 11 new LNG liquefaction plants for 2006 and 2007 awards. We are disappointed in Algerian losses in E&C. To address these issues we will be more selective about what kind of work we take on in Algeria in the future. For example, some of the losses the unconsolidated venture has experienced are related to infrastructure projects such as hospitals and government buildings. So we don't plan to participate in those type of projects in Algeria in the future. The second major loss was with a gas plant that will be completed in May of 2006. This is a plant where we have filed a major site relocation claim and it's currently going through arbitration. In conclusion, let me say a few words about our industry outlook and the roles I think ESG and KBR will play. This quarter the hurricanes in the Gulf of Mexico had a dramatic impact on activities, and among other things focused attention on America's shortage of refining capacity. During the quarter, we began discussing the first significant refinery expansion in the U.S. in the last 20 years. If and when refineries are built, KBR will be in good position to compete for this business. Similarly if more LNG regasification terminals are to be built in the U.S, KBR is the engineering industry leader in designing these terminals, we'll be well positioned in that market as well. KBR is involved in nearly all aspects of the LNG value chain from onshore and offshore gas production facilities to liquefaction plants and regasification terminals. We are optimistic about KBR's continued growth and success in future gas developments, LNG and GTL projects. For the ESG none of the events of this quarter have changed our positive view of the future. Oil and gas prices will fluctuate but all the evidence indicates higher E&P spending by our customers around the world through next year. Therefore the demand for our energy services will continue to be robust, particularly those services that reduce drilling time and increase production rates. We believe E&C spending will remain strong due to increased demand for energy. The positive industry outlook will not cause us to change our strategy of cost containment, capital discipline, and a focus on profits. Thank you, Andy. You can see we remain very bullish and optimistic about where the industry is, and the future in terms of customer spending. Our company has obviously endured a lot of challenges in the past year, including resolving asbestos, getting the election behind us, and our learning experience on Barricuda. But that's behind us now. Today we're going about our daily business of focusing on higher profits and returns for our shareholders. And we are moving forward with quarter after quarter of financial improvements. I think that the management team feels good to get back to some semblance of life being normal. 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EarningCall_234085 | Ladies and gentlemen thank you for your patience, and welcome to the third quarter 2006 Palm, Inc. Earnings Conference Call. My name is Bill and Iâll be your conference coordinator today. At this time, all participants are in a listen-only mode; however, we will be facilitating a question and answer session toward the end of todayâs conference. If at any time during the conference you require assistance, please key â*â followed by â0â and an audio coordinator will be happy to assist you. As a reminder, todayâs conference is being recorded for replay purposes. I would now like to turn the conference over to your host for todayâs presentation, Ms. Sandy OâHalloran, Senior Director of Investor Relations. Please proceed mam. Thank you and good afternoon everyone. Iâd like to welcome you to Palmâs third quarter of Fiscal Year 2006 Financial Results Conference call. On the call today are Ed Colligan, CEO and President, and Andy Brown, Chief Financial Officer. Todayâs call is being recorded and will be available for replay on the investor relations web page at www.palm.com. Iâd like to remind everyone that todayâs comments including the question and answer session will include forward-looking statements including but not limited to a forecast of future revenue and earnings and other financial and business activities. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. These risks and uncertainties are detailed in Palmâs filings with the Securities and Exchange Commission including its Quarterly Report on Form 10-Q for the fiscal quarter ended December 2, 2005, and an Annual Report on Form 10-K for the fiscal year ended June 3, 2005. Palm undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after this call. Todayâs results reflect a two-for-one stock split effective in the form of a stock dividend for stockholders of record after close of business on February 28, 2006. The stock dividend was distributed to stockholders of record on March 14, 2006. Also, please note that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, Palm routinely reports certain non-GAAP financial results to help you better understand our business. Non-GAAP financial results are not meant to be considered an isolation or as a substitute for or superior to GAAP results. You should be aware that non-GAAP measures have inherent limitations and should be used only in conjunction with Palmâs consolidated financial statements prepared in accordance with GAAP. Our non-GAAP operating information excludes amortization of intangible assets and deferred stock compensation. In addition, our non-GAAP earnings for diluted share assumed a 40% effective tax rate. The non-GAAP measures together with the corresponding GAAP numbers and our reconciliation to GAAP are contained in our earnings press release and are posted on our website. We encourage listeners to review these items. Iâd like to now turn the call over to Ed Colligan. Thank you Sandy, good afternoon everyone. We executed very well this quarter on the large and growing smartphone opportunity. We continue to scale our companyâs capabilities to meet the growing demand for our Treo Smartphone with the continuing goal of bringing delightful products to our customers, expanding our business worldwide, and delivering shareholder value. Also today with the corporate objectives, Iâve asked our company to focus on, so you can track our direction and progress. We are satisfied with these objectives to provide the discipline necessary for our increasing success. Our objectives are to: 1) deliver consistent profitable growth, 2) invest in and strengthen our product engine, 3) sharpen our attention on the customer experience, 4) expand geographically, and 5) collaborate with partners to reach new margins. Iâll start with our just reported results and our first objective -- to deliver consistent profitable growth. In our third quarter of fiscal year 2006 we reported our ninth consecutive quarter of double digit year-over-year revenue growth. Revenue totaled $388.5 million for the quarter, up more than 36% from the year-ago period, reflecting strong and balanced sell-in and sell-through of our Treo Smartphone. In fact sell-through Treo Smartphones to end-user customers reached a record 559,000 units this quarter, up 102% year over year. Both the Treo 650 which operates on the PalmOS and the Treo 700w which operates on Windows Mobile OS are highly differentiated from other smartphones in the market reflecting Palmâs hallmark of excellent design, software customization, and ease of use. Customer interests in both smartphone products remain high. We continue to deliver healthy profit. Income before income taxes for the quarter was $32.2 million, up more than 400% when compared with the $6.3 million a year ago, with handheld computers and smartphones both contributing to profitability. The mix shift in favor of smartphones reaching 74% of revenue was a key driver in boosting growth margins to 33.6% of revenue. Other factors included lower manufacturing cost and higher average selling prices on newly introduced products. Iâm proud of the discipline weâve demonstrated in shifting our product net, all while delivering revenue growth and profitability. Consider for example that in the year ago quarter smartphones were 46% of our revenue, and in the third quarter two years ago smartphones were only 28% of revenue. Turning to cash, we generated $99 million in cash and short-term investments during the quarter, which will allow us to further build our business. We believe we are well positioned for continued growth and profitability. In calendar year 2005, the US-converged smartphone PDA market grew 56% in units. We grew 111%. We concluded the year with 30% marketshare of this category domestically versus 22% last year according to Canalys. Our dedicated focus and unmatched expertise in mobile computing positions us to earn a larger slice of the growing global market for smartphones. Weâre still in the early phase of this market and weâre still working to grow awareness of the roles smartphones can play in improving personal and professional lives. Today, for example, less than 2% of business e-mail boxes are accessed on the go with devices like Treo, so the opportunity is clear. Ongoing market growth will come from customers who replace feature phones, those that handle simple text messages with more robust and capable devices such as the Treo. Itâs a natural evolution of the market as carriers deploy higher bandwidth network capable of significantly enhanced data transfer rates and as customers look for more productivity and flexibility in their devices. We believe this market will be won by companies that not only provide an excellent phone and e-mail experience but that add significant value at an excellent customer experience beyond those applications. Treo Smartphones do just that. One major networking company, for example, deployed more than 2000 Treos with GoodLink from Good Technology. In a study of 1000 of those users, this customer found substantial advantages. Respondents roughly saved about three hours of work each week on average, and those who worked away from the office at least half of the time reported saving more than four and a half hours per week. The ROI results were so pronounced the company placed an additional order for 5000 Treos. Look to us to continue to deliver profitable growth as we launch additional smartphones this year on two platforms, Windows Mobile and Palm OS and introduce products designed to accelerate our smartphone expansion in international markets. Moving to our second objective -- strengthening our product engine, we continue to invest significant in R&D during the quarter. Our engineering and operations organizations are creating and delivering differentiated Treo smartphones at an accelerated pace, and weâre applying profits from our dominant position in handheld computing lines to help fund our smartphone development where the real growth opportunity lies. We made a lot of progress during the quarter. Among our accomplishments, we hired Ron Rhodes as our Senior Vice President of Global Operations. Ron has 30 years experience in supply chain operations with significant expertise in telephone handset manufacturing, ODM management, and scaling for fast growing marketplaces. We built our talent in our new Dublin, Ireland engineering organization, which is working with European carriers to develop custom software applications for Treo Smartphones. We invested in time-to-market advantages and IT ownership in audio, radio frequency, and network testing, and we further diversified our ODM partners to help us deliver more smartphones faster. In our conference call last quarter, I shared with you that Palm would introduce four new smartphones in calendar year 2006. When I say new smartphones, I am referring to a combination of operating systems, new hardware design, new radio technology or other significant advancements. Itâs worth noting that with a new radio technology such as the EVDO weâre able to leverage the investment with multiple new and existing carriers to expand Treoâs presence worldwide. The first of our four new smartphones, the Treo 700w on the Verizon Wireless EVDO network, went on sale on time in early January. Reviewers praised the advent of the Palm experience on top of Windows. Youâll see additional differentiation on Windows mobile products yet to be announced. We look forward to further collaboration with Microsoft to bring more Windows mobiles based Treos to market here and abroad and continue to refine the Palm experience on this platform favored by business. In delivering our three additional smartphones this calendar year, youâll see us continue to deliver on our open platform strategy offering customers a choice of operating system, Palm OS and Windows Mobile as well as choices among radio technologies and industry-leading e-mail applications. This strategy expands our addressable market to embrace more users at a wider range of price points. On the third objective, which is sharpened attention to the customer experience from pre-sales through customer support, we plan to attract new customers by delivering on our brand promise, âsimple mobile computing.â We invested significantly to improve the quality of the pre-sales and the sales experience at carrier and traditional retail locations during the quarter. We trained more than 5700 carrier reps and 2200 retail reps. We also increased our sales engineering support for enterprise accounts received-to-sale cycle and assist in deployment strategies. Once our customers take our products home, they appreciate our improved getting started guide and on-device tutorials. Treo 700w customers, for example, love having T-applications such as Google web search on the todayâs screen, and they report a smooth corporate e-mail setup with Microsoft Exchange 2003. Those factors among others help explain why customers favor our Treos over other devices. In one study of more than 530 US IT managers, Treos were preferred by 43% of the respondents, well more than any competitor. The preference for Treo is so strong that 29% of our registered Treo 650 customers surveyed said they switched carriers just to get it. Our early Treo 700w buyer also had a strong preference for phone. More than 90% of the early buyers knew exactly which phone they wanted before making the purchase and 50% were first-time smartphone buyers, which means weâre drawing new customers into the category. Our products are known for the best ease of use in the industry, but weâre not satisfied. We have much, much yet to do to make our products more inviting for new customers and we are committed to doing just that. Now, Iâll try turn to our fourth objective, which is expanding our geographic reach. We have had great success where we focused first, the Americas, and weâre working to replicate that success in other regions. Europe is the next major target region. Last month at the 3GSM World Congress in Barcelona we shared our plans with carriers, and we were gratified to see that our roadmap aligns well with their interest. On the operational front, we consolidated and strengthened our European distribution activity by signing up two strong partners during the quarter. Vanguard will serve as master distributor for the Nordic and Eastern European markets and as a complementary distributor in Italy. Vanguard also will deliver services, marketing support, and customer support. A second new distribution partner is Dextra Solutions Limited, which will sell accessories across the region. We look forward to announcing new carrier relationships later this year triggered by product offerings tuned to global demand and supported by our newly established European engineering center and realigned sales team. The fifth and last objective is to collaborate more extensively with key partners, with the goal of reaching and expanding into new markets. Our highest profile partnership is within Microsoft, the result of enterprise demand for a palm experience on the Windows platform. We are early in the enterprise sale cycle and itâs clear that a lot of new doors are open to us. I am confident we will increase our enterprise business significantly as a result of this new product line. Weâre especially eager to deliver a Microsoft Messaging Software update and a Security Feature Pack, which will enable direct Push technology on the Treo 700w. Also, among the capabilities in this software release, are global address lookups for a companyâs entire employee population and a âkill pillâ that an IT department could dispense for lost devices. We expect enterprise deployment to accelerate when this update is available soon. Among businesses large and small we saw continued success with our partner Good Technology contributing to growing penetration of Treos in the enterprise. Good counted a total of approximately 10,000 company domains that have deployed the combination of GoodLink, Push e-mail solution, and our Treo 650s. In the second quarter of fiscal year 2006, we estimated about 8000 companies who have deployed the combination. In partnership with Research in Motion we completed the core client software for BlackBerry Connect on the Treo 650. Interested carriers are now in the process of certification tests. Companies see the wisdom and flexibility in our open-platform approach, which gives them choices on e-mail solutions including Microsoft Exchange Accessing, Good technologyâs GoodLink, and pending carrier certification BlackBerry Connect on our Treo 650s. Companies also are seeing reduced hardware costs because for many the Treo completely and largely replaces their need for laptops, 12-key cellphones, and handheld computers. Beyond e-mail, the power of open platforms and a robust developer community enable us to reach a wide range of other business customers with specific application needs. As more and more powerful solutions are developed by both Palm OS and Windows Mobile, we see these applications driving an increasing range of new business deployments. Looking ahead, you can measure our progress against our fifth objective by the results of our world class partnerships and our collaboration with carriers and other go-to-market associates. We are tightly aligned to accelerate our sales into the business market serving independent agents, small and medium-sized companies, and global enterprises. Our progress on meeting the five objectives makes us an even stronger, more competitive company that helps us take advantage of the incredible opportunity for Treo Smartphone. I look forward to reporting our continued progress in future quarters. As I do each quarter, Iâd like to thank our employees who are committed to seeing Palm accomplish its objectives and who work so hard to deliver on our vision that the future of personal computing is mobile computing. I will now turn the call over to Andy. Thanks Ed and good afternoon everyone. We are very pleased with the results of our third quarter of fiscal year 2006. Revenues were $388.5 million, an increase of 36% from the year-ago period. Smartphone demand remains strong with the introduction of the Treo 700w on the Verizon Wireless network during the third quarter and strengthening of sell-through for the Treo 650. Gross margin of 33.6% was above our expectations and a healthy increase from 31% in the year-ago quarter. This is a result of greater revenue contribution from Smartphones coupled with manufacturing cost reductions and a new product introduction. Operating expenses on a GAAP basis were $101.9 million and on a non-GAAP basis $101.1 million. As expected R&D spending increased from the last quarter as we continue to invest in our product roadmap. The decline in G&A expenses during the quarter was mainly from a $2 million reduction in our bad deck reserve, the result of lower overall accounts receivable balances. On a GAAP basis, operating income was 7.4% of revenues and earnings per diluted share were $0.28. On a non-GAAP basis, our operating income was 7.6% of revenues and earnings per diluted share were $0.19. Revenue mix for the quarter was 74% smartphones and 26% handhelds. This compares with 46% smartphones and 54% handhelds for the year-ago period and 61% smartphones and 39% handhelds in the second quarter of fiscal year 2006. We have achieved this dramatic shift in revenue mix and a related change in resource deployment while growing revenues and profitability over the last two fiscal years. As results, we devote relatively few resources to the handheld portion of our business, which continues to produce positive bottomline results. Smartphone revenue of $288.5 million in the third quarter of fiscal year 2006 increased 120% year over year. We shipped 564,000 smartphones during the third quarter. Smartphone ASPs increased during the quarter and we began shipping the Treo 700w. The newest member of the Treo smartphone family commands a higher price due to its EVDO, broadband radio, and its increased functionality. The impact of the higher Treo 700w ASPs was slightly offset by price reductions on the Treo 650 as carriers continued to achieve higher volume, lower pricing tiers. Treo sell-through, as reported by our carrier partners, was 569,000 units, up a significant 102% year over year. We saw strong demand for the Treo 700w at introduction in early January. In addition, sell-through for the Treo 650 was extremely robust resulting in lower than ideal inventories of the Treo 650 at several carriers as we exited the quarter. Carry inventories at the end of the third quarter of fiscal year 2006 were close to the same overall level exiting the second quarter. They were lower, however, relative to the increased velocity of sell-through we experienced during the third quarter. Handheld revenues for the quarter were $100 million, down 35% from the year ago period. We shipped 510,000 handheld units with sell-through at 765,000 units. We experienced a higher percentage of lower ASP handheld unit shipments during the quarter and we reduced channel inventory to 7.2 weeks, down from 8.4 weeks in the prior quarter. We continue to focus on the sweet spot of the handheld market, which we believe is in the $99-299 range. Geographic revenue mix for the third quarter of fiscal year 2006 continued to see strong US demand. The revenue mix was 80% US and 20% for rest of the world. International expansion continues to be a key priority for our company, and we expect growth to accelerate in Europe in the second half of this calendar year. Looking at the balance sheet, cash, cash-equivalents, and short-term investments grew to $536 million by the end of the third quarter. Cash flow from operations in the quarter was an impressive $91.2 million. The cash increase was driven by strong collections of accounts receivable due to the improved linearity of shipments during the quarter. This resulted in net accounts receivable of $119.1 million. DSOs at 28 days were lower than the 40-45 days we would expect longer term. Inventories increased during the quarter to $51.1 million with inventory turns at 25. This level of inventory is more representative of levels we would like to see versus the 36 turns we experienced in second quarter of fiscal year 2006. Looking at the fourth quarter of our fiscal year 2006, we expect revenues to be in the range of $400-405 million. We believe smartphone revenues will be greater than 75% of our overall revenue mix as demand continues to grow for our Treo Smartphones. Gross margins should be at or slightly higher than those achieved in the third quarter, as the revenue mix of our product continues to be more heavily weighted towards smartphones. We anticipate operating expenses should remain in the range of $100 and $103 million on a GAAP basis and between $100 million and $102 million on a non-GAAP basis. We anticipate minimal declines in R&D and marketing and sales spending from third quarter, which will be offset by increases in G&A as we do not anticipate further reductions in the accounts receivable reserves in the magnitude of the $2 million we benefitted from in third quarter. We expect our tax rate in fourth quarter to be positively impacted as it was in third quarter from the reversal of the remainder of evaluation allowance against our deferred tax assets. We believe our go-forward tax rate will be approximately 40%. Our guidance for non-GAAP earnings per diluted share is based on this 40% tax rate. Based on this guidance, we expect our fourth quarter fiscal year 2006 earnings per diluted share to be between $0.33 and $0.34 on a GAAP basis and between $0.22 and $0.23 on a non-GAAP basis. At this time, I would like to turn the call over to the operator for your questions. Thank you very much sir. Ladies and gentlemen, if you do have a question please press â* and 1â at this time, and if your question has been answered or you wish to withdraw your question at any time, please key â* and 2.â Questions will be taken in the order they received. Please key â* and 1â now to begin, and our first question comes from the line of Paul Coster of JP Morgan, please proceed sir. Yes, thank you very much. Andy, if I can just dwell upon the guidance for a second, can you give us any clues as to the volume of Treos on the go-forward basis and perhaps comment on the ASPs. The ASPs were just excellent this quarter and can we expect them to continue to increase or hold back at that $510 level? Paul, a couple of things, we donât specifically give volume guidance but you can expect that shipments of Treos will continue to increase as we move into fourth quarter as I mentioned earlier. Weâre seeing fairly robust demand for both products. With respect to the ASP that really is more function of mix between the products and depending on the mix of the higher band radio products versus the, for example, the Treo 650, that may have a function, but I do believe ASPs will certainly not go to the level that we saw prior to introducing the higher band radio devices. You know, the Treo 700w is only at one carrier at this point in time and weâve got the Treo 650 at many carriers, close to 70 carriers I believe, so I donât think 50% is likely at least in the short term, and we certainly donât give those splits. Paul this is Ed. We donât comment on product introductions as you know. Well, weâre going to do our best to continue to drive our product engine and roll out new products, but weâre not thinking of any specific dates. Thank you very much sir. Ladies and gentlemen you next question comes from the line of Susan Kalla of Caris & Co., Inc., please proceed. Yes, hello. I wondered if you could give us some of your views on the competitive outlook, especially with Research in Motion and the recent settlement of the litigation with FDP and with Apple, and their plans as a smartphone? Well, when I look at the Research in Motion settlement I think itâs good for the industry and we expected that to happen. Weâve been driving our business focus on competing in the marketplace. We think our solutions stand up well for competitive offering and much of the growth you see in our business is really related to our solutions and our team executing well against the opportunity and less related to whatever is happening at RIM. I can't speculate about an Apple product. Those are rumors in the press and we donât speculate on that, but I feel like this category has an enormous growth opportunity. Weâre focused on our execution here and our ability to deliver against the opportunity in front of us, and we canât speculate too much on the competition. We just donât comment on future product releases. We obviously want to roll out Windows mobile products out to as many partners as we can as fast as possible, but we canât give you a date at this point. Thank you very much mam. Ladies and gentlemen your next question comes from the line of Charlie Wolf of Needham & Co. Yes, I just wanted to follow up on that question, Ed. Presumably, Motorola will be introducing the queue at some point in the future and Nokia has their E series. I was just wondering how you did the competitive landscape with regard those entries. The second question is, what was the sell-through of Treos in the second quarter, I forgot that number. And thirdly, Andy, the drop in accounts receivable is astonishing and I thought you might be able to address that. Firstly, sell-through of Treos in the second quarter was 435.000 units. The competitive landscape, we obviously see the Motorola queue and the Nokia product coming, our focus is total and complete in this category. Weâre really becoming a completely smartphone company, thatâs what weâre really focussed on, is executing against those opportunities. So, we think we cannot complete effectively because of the complexities of these devices, the software applications involved, and the work that we do really well around this particular category. That being said, I believe this category is really poised for quite a bit of growth and large companies like Motorola and Nokia coming into the category and legitimizing products with small form factor keyboards and trying to push people into this category I believe will benefit us because I think when people go to try those products and use them against ours, theyâre going to walk out of the store with the Treo. So, we canât worry too much about the competition. Weâre certainly respectful of it, but weâre focussed on executing against our opportunity thatâs front of us. And Charley on the DSOs that I mentioned earlier, Iâd like to say that we do a great job of collecting, which I think we do, but a big part of that is really the linearity that weâre seeing in the business and part of that is being in the smartphone business. It becomes more linear during the quarters and now that weâre approaching three quarters of our business being smartphones, youâre really seeing that kind of impact â itâs just primarily linearity. Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Jeff Kvaal of Lehman Brothers, please proceed. Thanks very much for taking the question. Andy, I have a couple of questions that maybe headed your direction. The first is Iâm wondering if you could clarify on the Treo ASPs. It sounded as though you were suggesting that the primary determinant of your ASPs in the next quarter or two will be the mix between the two lines and Iâm wondering to what extent there might be volume step-downs particularly in the 700 or are we through that? So Jeff, I mean the volume stepdown that youâre talking about that weâre seeing with all of the parts that weâve introduced, as carriers take more products they get different pricing, that will continue to occur with the 700 just like it did with the 600 and the 650. So, that will continue. However, what we are seeing from an ASP standpoint is that when youâre delivering the broadband radios with most features and functionality like the Treo 700w, they command a higher price and to the extent we deliver more of those versus, for example, the Treo 650, that will have an impact on the ASPs. So, you are correct in the sense that we will start to see that tearing, but in general the broadband capability Treos will be at a higher price. Okay, great. And then Andy, it sounds as though the 650 sales were actually up sequentially quarter over quarter, is this by a significant amount or a sort of flat out or could you give some sense of that? Yeah, weâre not going to get into breaking out the different Treos at this point, but I think itâs fair to say that we saw strong demands for the Treo 650. Like I said earlier, we actually exited the quarter with several carriers that were leaner than ideal inventory positions, so the strength of the Treo 650 continues. Okay, great. And now just shifting gears to the PDA side for a second. Traditionally, May tends to be up modestly over the February quarter, is that a pattern that we should expect to continue or any reason for that to be different? At this point in time, I wouldnât expect it to be up like youâve seen in the past. I would call it basically flattish to what we saw over the past quarter. Okay, wonderful. Very impressive sell-through. Thanks for taking the question. Operator Thank you very much. Ladies and gentlemen, your next question comes from the line of Darrell Armstrong of Citigroup, please proceed. Thank you very much. I have a couple of questions. The first one, in terms of the gross margin guidance, given the fact that smartphones are becoming a larger part and clearly the volume of the 700w will also ramp on the quarter-to-quarter basis, why wouldnât your growth margins be a little bit higher? Is that just conservatism or is there another factor implied? No, thereâs nothing there. I think Iâd mentioned earlier that in fact we anticipate that the gross margins will be at or slightly higher than where they were last quarter, and we talk about smartphones being greater than 75%, they were 74% last quarter. So, thereâs no other news on the gross margin front. Okay. And then in terms of the mix in your business, you talked about the vast deployment at one enterprise customer during the quarter and some of the momentum that youâve with your technology, could you give me a sense in terms of what the mix was between enterprise relationship and what is the post membership this quarter and how does that change from last quarter? I think weâve seen the mix shift some. I think the biggest thing weâre seeing right now, Darrel, is huge number of trials going on both of Microsoft Exchange ActiveSync solution and of Good deployment, but the Microsoft Exchange solution came out last quarter, so we saw a lot of new trials, a lot of enterprise interests there, and I think weâll see some additional shifting in our business. Iâd say quarter-over-quarter it probably shifted from being letâs say 30% of the business to closer to 35. And then finally, there was some speculation today that Tim Worth left the company. Iâm not sure if thatâs true or not. If so, could you tell me if you have a candidate to replace him? Tim did leave the company and so that is true, and we do intend to replace him. One of the things weâre focussing on is bringing in a new product marketing leader thatâs focussed on product marketing. Our business has become quite a bit more complex in the range of platforms were supporting and in the range of products were supporting and in the range of carriers were supporting, and so weâre going to focus around two areas, one is product marketing directly and the other is marketing communications and marketing programs which will be headed up by a gentleman named Page Murray who is here today. Heâs doing an excellent job on that and weâre pleased to have him join my staff at this point. So, we will be recruiting for a new leader in the product marketing group. In the meantime, I certainly have an enormous amount of experience in that area and I will be leading the charge there. Thank you very much for answering the question. Operator Thank you very much Sir. Ladies and gentlemen your next question comes from the line of Travis McCourt, Morgan Keegan, please proceed. Hi guys, a couple of questions. First on the operating spins guidance, it looked basically flat. It looks like sales and marketing are down for, I guess, the second straight quarter. Are you just experiencing more operating leverage in the business or was there a big ramp up earlier this year that kind of gives you guys the freedom not to have to grow as much in the back half of the year, just trying to get a sense ofâ¦weâre at a stage now where we may seem more operating margin expansion than weâve seen in the past or is this something more near term in nature? I think the flat guidance on the operating expenses is really more around the engineering portion of the income statement. As you may recall from last quarter, we actually bumped up engineering fairly significantly with prototype materials and things like that for the new products that we plan on introducing this year. That got bumped up last year and youâre more likely to see more of a reduction in the R&D side of things than you are actually in sales and marketing. We do have some specific programs that we drove in sales and marketing last quarter that may not likely to occur this quarter but the majority of the decrease is going to be around R&D and obviously offset by what I mentioned earlier when we took a very large credit for the accounts receivable in G&A. But overall, we do expect over time that we will get more leverage, weâve been seeing that over the last fiscal year. We drove 7% operating profit last year, weâre in the neighborhood of 8% this year, and weâll continue to drive it. Great, and then in terms of use of the cash and I guess a little over $5 share on the balance sheet, how should shareholders think about the strategic use of the cash and what you guys are looking at this point? When we look at our past position, weâre pleased with it, and we really believe that the $500 million is a good operating capital for a company of our scale. It does allow us a lot of flexibility to look at some strategic opportunities and we will look at those types of investments to try to build our product portfolio, our software portfolio, our IT position, and those are the kind of things weâll be focussed on trying to invest in. Great, and I donât want to be the dead horse on the 650 sell-through, obviously it was up sequentially, do you guys get any visibility on whether that was through enterprise channel solely or whether there was strength there in the consumer channels as well above and beyond November? Oh, I think there was a significant strength across the board. We had strong consumer sell-through in retail. We had strong enterprise pickup as I said, combination of GoodLink and Good Technology. So, itâs a product thatâs got a lot of legs, itâs a great product, people love it, and weâre continuing to sell it. Thank you very much sir. Ladies and gentlemen your next question comes from the line of Pablo Perez, Sagio Investments, please proceed. Hello guys, very excellent quarter. The first question has to do with the Treo 650 sell-through and what that implies for new products coming down the line. We did our check and it says that, as you indicated and you confirmed it, the 650 sell-through was excellent. There doesnât seem to be much pressure there. Is this going to affect your decision when exactly to release subsequent Palm OS products or are you thinking about the possibility of selling a new Palm OS product in conjunction with the 650 at the same time? We would never delay new products introduction when the marketplace is selling well. We want to continue to bring out new products. We will drive those to market. That being said, there are various carriers who maybe excited to continue to sell 650, because youâve seen some of the pricing has come down to as low as $99 with some of our carrier partners. Thatâs an outstanding value. Iâm sure thatâs making an impact on sell-through. So, we can expand the line even more with new introduction, but Iâll tell you I feel like itâs a winning product and against the competition thatâs out there and coming, Iâd be proud to introduce the 650 today. So, weâll continue to sell it as long as thereâs customer demand. Excellent, another question has to do withâ¦I guess I have this one and one moreâ¦the channel inventory. I mean your sell-through was fantastic. We did our computations and I know you guys took about a week, but we have a significant decline in channel inventory weeks from last quarter to this quarter which matches your comment about some carriers not having ideal inventory levels. This should be higher. Even when we look at our model and put in additional shipment next quarter and low sell-through growth, it looks like channel will be laying out at next quarter. Are carriers actually asking you to potentially increase orders right now beyond what youâre guiding us, because the channel doesnât look like itâs going to be very high at the end of next quarter either? I donât have your computations Pablo, obviously, but what we did is we did lean inventories with several carriers on the 650, as I said. Inventories were basically flat. Therefore, your calculation is correct and that is yes; I mean from an overall velocity standpoint, the velocity of the business is a relative side if the inventory is down. Weâve taken that into account in our guides and thatâs what weâre guiding to at this date. Okay, final question. The customer operations look fantastic, you also are going to at some point going to receive the $70 million in cash from the land that you just sold, when will you receive the $70 million, next quarter August? Now, thatâs actually somewhat difficult to project at this point, but we are under contract for the land as youâre aware. If everything goes as scheduled âand they donât always go as scheduled, so I need to put that caveat in there â and if the contract goes through, it should be sometime, I would estimate, between August and October is when thatâ¦if the sale goes through could land on our balance sheet. Thank you very much sir. Again, ladies and gentlemen, if you have a question please key â* and 1â at this time.â And your next question comes from the line of Scott Coleman of Credence Capital, please proceed. Hi guys, great quarter. Thank you for taking my question. It seemed as though these past few months had a nice opportunity for you guys to really make some breakthroughs in the enterprise market. You guys own the prosumer and consumer and it seems as though the enterprise market would be a very nice market for you guys to start to take share. So, Iâm wondering if you guys could just go over what youâre doing as far as sales and what your sales force is doing to try and breakthrough the enterprise market and also what youâre doing in combination with GoodLink as a package sale. Thank you. We got a lot of effort there. We significantly increased our direct selling effort by increasing our team to focus on that. They work closely in conjunction with GoodLink. Weâre also working closely in conjunction with Microsoft and Verizon on selling solutions into the enterprise. Theyâre very excited about that opportunity with the Treo 700w. Our real emphasis is on trying to extend the business market, not to necessarily replace RIM and take share, because we believe a very small percentage of the overall knowledge workers are actually hitting e-mail on devices like Treo. So, we think thereâs a big opportunity for market expansion. We think Microsoft in partnership with Verizon and us can help do that, we think Good can do that, we think we can make an impact in the enterprise where Blackberry is already in by delivering our Blackberry Connect solutions. So, weâve really tried to take a very open-platform approach to bring in many solutions as possible to the market, and we were doubling down on the sales effort and also really leveraging as much as possible the carrier enterprise sales teams. So, weâve been doing a lot of training out in the field working with them. All those things we think will result in continuing to expand our footprint in the enterprise and weâre confident that business will forth. So, we could see a sales call with your sales and somebody from Verizon and somebody from GoodLink all walking into the CTOâs office? It can happen. Usually one of those in first and then if they need some expertise in one of the other areas, they would call on us. If itâs a significant enough opportunity, we would deliver someone to that account and make sure that we put our best foot forward. Thatâs what I talk about leverage with the carriers. They have many, many more direct sales people going into the account. Microsoft has many, many more direct sales people going into the account than we do. So, we try to leverage those relationships to get our products in the door. Thank you very much sir. And ladies and gentlemen, your next question comes as a followup from Darrell Armstrong from Citigroup, please proceed. Thank you very much. I just wanted to clarify one of the things you talked about Blackberry Connect solution and of your inroads on the enterprise side. If you think about the entire solution, would you expect that on average the price point that you have in December to the price point that we currently see on Blackberry devices, would it be at a premium or at a discount? And then I have one last followup. With Blackberry Connect as part of the solutionâ¦the Treo pricing wouldnât really be any different and we donât really control pricing to the end-user account. The carrier is usually delivering those products and they are setting the price with the IT Department, the functional department in that business. We will not charge any incremental amount for the Blackberry solution. Darrell Armstrong, Citigroup And then second of all, in terms of new product introductions, one thing that youâve talked about is reducing the return ratios for new product s. You put a lot of processes in place to accomplish that, could you talk about what the return that you would like for the 700w compared to may be some of return ratios from some previous new product launches. Darrell, while we expect the return rates on the Treo 700 to be improved over prior products, itâs relatively too early to tell at this point. The productâs only been in the marketplace 9 or 10 weeks. So, we donât have a lot of data on that at this point, but we are very confident of the quality of the 700w. Thank you very much sir. And ladies and gentlemen that concludes our Q&A session for today. Iâd like to turn the call back over to Mr. Ed Colligan for closing remarks. Thank you everyone. We appreciate your participation in our conference call today and hope you share our confidence in Palmsâ future. We are committed to delivering profitable growth through outstanding products and service and by delighting customers around the world. Thank you very much for your time today. Thank you very much ladies and gentlemen for your participation in todayâs conference call. This concludes your presentation and you may now disconnect. Have a good day. |
EarningCall_234086 | Hereâs the entire text of the Q&A from Microsoftâs (ticker: MSFT) fiscal Q1 2006 conference call. The prepared remarks are in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Operator Instructions] Our first question comes from Charles Di Bona with Sanford Bernstein. Quickly, one housekeeping question. The accelerated repurchases is that built into your guidance here, or is that we had a much lower repurchase plan that got us to the prior guidance. Is that reflected here? Yes, it is. The new guidance is in there, and clearly, we had some expectations of what our prior shape was going to look like in our previous guidance in there. We've got some expectations of what our new shape would be in the new one, but you're correct; it's built in. Okay could we also just drill down a little bit on MSN here? You're up 20% year-over-year. It looks like Ad revenue probably declined sequentially from the fourth quarter. Is that correct? The three components, as you know, to MSN. On the narrowband side, that did decline. On the display advertising, that was up. And you are correct on the search side, on the advertising quarter-on-quarter; it was down. Can you give a little color of what is happening there? Your competitors in the space are up. Google is up 14% sequentially, Yahoo is up 6% sequentially. You guys are down. Are you losing share dramatically here, or is pricing weaker for you guys? Could you give us some color on what's going on? It's not a volume issue from our perspective. As far as we can see, our volumes are in line. Our market share remains probably where it was over the last few quarters. So it's a monetization issue, and that is something that we are clearly going to have to address in the future. It's something that we intend to address through the introduction of our Ad Center platform over in the future, which, as Scott mentioned in his remarks, we are testing in Singapore and France at the moment and also starting to test here in the US. So we are conscious of that, and it's certainly something we're going to address in the future. [A - Colleen Healy] Hi, thank you. I actually had a follow-up on Charlie's question about the buyback, and then one other one. It seems as if you are front-end loading product launch costs; you referenced that in your comments. But then, what does that imply for when we will see some EPS leverage from the accelerated revenue growth that you're seeing? Should we assume that you are front-end loading a lot of the Vista costs and Office 12 costs, that we actually have to wait until fiscal year '07 until we see that? Sure. You are correct; the Xbox expenditure does tend to be more concentrated around the launch. So we've certainly seen the impact of that in the last quarter and in this quarter. In terms of the expenditure from a marketing perspective on Office 12 and Vista, that is a more gradual spend, but it has started. So we are already spending money in those areas. And in the Office side, we're also ramping up on the sales people side, as well. So you are seeing an impact of that from the beginning of the fiscal year. We talked a little bit about that at our last call, but you will see that through the course of this year, going into the launch period at the beginning of next fiscal year. Because then it would seem as if you didn't raise your buyback assumptions, that we would actually be facing lower EPS than what you originally guided to, based on the higher product launch costs. I just wanted to make sure I'm thinking about that correctly. Yes, you are. We didn't decrease, when you look at the operating income, that's probably the easiest way to see it here, though. We haven't changed that number. So all of the marketing spend and the costs associated with the launch are above that. So, to the extent that we kept that the same, we haven't changed our expectations. And then, the follow-up is just really on Client revenue growth. And I know you walked through this in detail in your comments, but I guess I'm still having a hard time getting to the fact that PC shipments were up as much as they were, but you just don't seem to be as correlated to PC unit growth going forward. And I guess, as PC shipments start to decline, how should we think about the correlation your business would have in that type of environment? Let me walk through the math again. And there are a number of steps, so I'll go through each of them in turn. If you start with overall PC unit growth of, let's say, 17% or thereabouts for the quarter, OEM unit actually grew slightly ahead of that, and we made some positive progress, we believe, on the unlicensed side. So OEM units, from our perspective, were up around 18%. But from that number, there is a couple of impacts. Firstly, the impact of large OEM sales versus small system builder sales, so we had a mix change toward the larger OEMs, where we tend to have smaller prices. And also, the mix in the premium segment was higher towards Media Center than towards Pro sales. And again, that's a lower-margin product. So the combination of those impacts takes us from an 18% unit growth to a 13% revenue growth. That's 80% of our business. On the other 20% of our business, which is the retail and commercial side, we saw a 19% decrease. And Scott mentioned that in his comments; there's a number of reasons for that. On the commercial side, we believe people are tending to buy, from a commercial point of view, more through the OEM channel. And on the retail side, there was a high comparable last year with the SP2 sales. And also, we think that is influenced by people waiting for the Windows Vista launch next year. So, when you take 80% of our business growing at 13% and 20% of the business declining at 19, you take the weighted average, and you get the 7% that we showed. Now, in terms of how that will go forward, we don't expect that same negative impact going forward, the 19%. To a large extent, most of the decline was through the course of last year, and on a quarter-by-quarter basis going forward, we think in absolute dollar terms, that side of our business will be reasonably flat, and hence the year-on-year comparables will be not as negative as they were. Though we will still probably get a mix change between OEM units and OEM revenue, but that will tend to be more representative of our Client growth. Just a follow-up to Charlie's earlier, more clarification, I guess. Clarity in advertising wasn't that also a factor in your revenues? Or what was the impact of that on your MSN revenues? It was an impact. On the positive side, we think it has been important, in terms of our search volumes and in terms of the customer feedback we're getting, which is generally positive. On the negative side, it did have some revenue impact. But I would not overstate that; it was a factor, but not a significant one. And then, a follow-up to Heather's question. If the guidance for the year is unchanged in revenue, which it is, and the operating margins, effectively the operating income is essentially the same and EPS is up $0.01, because you beat by $0.01, excluding the $0.02 charge this quarter, I'm not sure how the math works, as far as baking in already the benefit you get from a lower share count from the repurchase. You're telling us it's already the benefit is in there, yet it would seem to me the math would suggest that it's not in there, because operating income is the same as we had before, earnings the same as we had before. I'm not sure how to reconcile those two. We have been buying, certainly in the last couple of quarters, slightly ahead of the four-year pro rata amount. So you will have seen in the last quarter we bought just over $3 billion worth of shares. In our original forecast, we were assuming that we were going to continue to buy at a reasonably healthy rate this year. So the only benefit we get is the differential between the rate that we were previously assuming that we were going to be buying and the rate that we will now be buying. And when you spread that over two quarters because we're halfway through the quarter already, so we won't start buying at the increased rate, obviously, until after this earnings call and spread that over that period and then take it over the course of a full year. It doesn't have a dramatic impact in this year. It will have a more significant impact when we get the full-year impact next year. And if you would like, all of the program will be completed against only part of the program. And then, on Xbox, if I count those two previous as follow-ups, the question would be on Xbox unit shipments for the December quarter. Some of us are saying it should be we're hearing from the channel maybe 1.5 million units, and it had been 2 to 2.5 or so. Can you give us any clarity on where that number might come out or, if you don't want to give a precise number, maybe what we are expecting, in terms of supply constraints? Because it sounds like IBM and Chartered were saying the game processors were meeting their commitments. So I'm not real sure why you wouldn't be shipping more units. If you could give us some clarity there? Sure. We will be giving more guidance closer to the launch. We are not intending to do that for this quarter, on this call. But we will be giving the first 90 days' guidance closer to the launch. So, sorry; you'll have to wait until then. In terms of the shape of the year, it's very much shaping up the way that we had originally foreseen. I know, because we didn't give you guidance for this quarter on the original call that it's difficult for you to estimate how that would come through. But from our point of view, production and sales are, broadly speaking, in line with how we expected for the year. And they're going to ramp relatively steadily from launch all the way through until the end of the fiscal year. So, we will give you some more information in the next few weeks, but no more on this quarter, at this stage. You had some management changes in the quarter. We certainly know, I think, why they were done from a strategic standpoint. But can you give us some color, Chris, on how you think about them from the CFO seat and obviously, there's some confusion about I think you clarified it on the PC unit growth versus revenue growth issues. But can you give us an update of what you're seeing from a pricing standpoint, both on the Client side and the Information Worker side, in the emerging markets? Okay, sure, just take the first one. From a CFO point of view, my perspective, seeing Kevin and Jeff and Robbie with a greater presence is positive, from my point of view. Certainly, they are very close to the business. We will see them making a lot more decisions and Steve delegating some responsibility to them. I think, from a general speed-of-decision-making point of view, I'm very happy with that. And also, I'm working with them clearly, again just on the overall cost profile. And with Kevin Turner coming in and his experience with a Wal-Mart background, I'm obviously looking forward to working with him in terms of the overall operations for the business. So overall, I'm very happy from a management point of view. It gives me some more people to partner with, if you like. And it's a great chance for them to work more directly with the businesses. We are also seeing Ray Ozzie taking more of a presence. I know he's talking next week, but it's great to see him also taking more of a presence. And all of those people I've formed a good relationship with and have a lot of confidence with. So positive messages from my point of view. In terms of pricing overall, in the mature markets, I don't believe we've had any significant pricing changes, so to speak. Some mix change, as I mentioned, but the underlying products, I believe, generally speaking, in line with previous quarters. In terms of the emerging markets, again, I don't think there's any significant changes. We have, obviously, a different product range in those emerging markets. But quarter-on-quarter, the pricing looks similar. My question will be related to database and specifically database demand. With the 1Q 15% year-over-year in SQL Server, especially in front of the launch, should we expect to see perhaps more linearity in the server line item over the next couple of quarters, rather than perhaps traditional kind of lumpiness? What we're seeing in that market is that buying patterns are much more driven around, if you like, commercial needs rather than the launch as such. And that's one of the reasons, probably, the revenue shape is different than perhaps what you were expecting. So we're seeing a much more gradual ramp through the course of the fiscal year, and also a ramp in the second half driven around when some of our contracts mature, which tends to be more in the second half than the first half. So you will still see, if you like, different patterns on a quarter-by-quarter basis, driven around contracts when businesses decide to spend their underlying budgets and so forth. So it won't be influenced as heavily as might be expected from the launch, but will be driven by those other factors. And just a follow-up relative to some of the commentary from the analyst day, on the Linux Win back program. Any update there? We're seeing a really good value proposition relative to Linux, which as we shared with you at financial analysts day, has just increasingly become more commercialized. And we just feel like our value proposition on the server side is demonstrated by the continued strength that you're seeing overall in that segment, including from Windows Server. It continues to do really well, and we're seeing good progress when we go head-to-head against Linux. Business looks good. And then, just finally, on the decision to accelerate the buyback or increase the buyback, what were some of the thoughts around that versus perhaps a change to the dividend policy? I see those decisions as different. We continue to look at our dividend policy and will make decisions about that independently. In terms of the buyback, from my perspective, I'm positive and we are positive about the Company's future and, in particular, the next couple of years. And good capital position obviously our cash flows, since we originally announced the buyback, have been strong. And so, from my perspective, it was a good opportunity to accelerate. But I see it as an independent decision from dividend policy. I've got two follow-ups, first on the Xbox. Do you have any comments on what you think volumes of the soon-to-be old console will be? And to the extent that you're supply constrained, do you anticipate ongoing demand for that? Any specific numbers for the fiscal year? Yes. We don't have a specific number that we're going to give out, but the general guidance is we continue to believe sales will be good for that. As Scott mentioned, they were a little soft in the first quarter. But overall, we continue to see it. From our point of view, it's really a different target audience, different price point, obviously, altogether, and a different target audience. But overall, we think that there is a good market for that particular product, and we intend to continue to sell it through the rest of the fiscal year. And then, just a follow-up on the server platform comments. I guess I can understand why the launch might not have an immediate positive effect on growth, but why is it that you're anticipating that growth will actually be softer in the December quarter than it has been over the last several quarters? There's no particular factor. It's a reasonably high comparable on the previous year. There may be a little bit of softness going into the launch, last month and this month, just people holding back a little in anticipation of next year. So I don't want to overstate it; it's still around double digits. And from our point of view, there's no particular message you should take from that, just a pattern of the year. No. We are still sticking with 11 to 13% for the year, good double-digit growth for the year. And if anything, we see a strong second half for the business for the year. I have two quick questions. One is a follow-up on Rick's question. Just returning to the guidance, the revenue guidance, operating income and EPS and recognizing that the share count will go down, however linear you do the buyback, is there a change in the investment income projections that you guys have that offsets any of the accretion that we would ordinarily expect from the share buyback? Clearly, as we spend faster, then we will have less to invest. So there is a decrease in the investment income associated with that. So that's an iterative calculation, if you like. And we have built that in. And just on the Xbox 360, I think you said that it would ramp steadily. Did you mean by that that March would be a bigger quarter, in terms of unit volume, than December and that June would be bigger than March? Or how do we think about that progressively? I don't want to provide too much detail in particular, foreshadow what the launch volumes would be. We are certainly happy to give more detail out, in due course. Clearly, the launch itself will be in the Christmas season, all other things being equal, with a spike. I guess I'm just foreshadowing a constant level of demand. And, from our point of view, we're trying to constantly supply the retail channel so we don't get peaks and troughs through the course of next year. Yeah, it's great. Following up on Heather's question earlier, on PC unit demand versus Microsoft, when would you expect those to come in closer? In other words, if you look out later in the year and next year, would you expect a closing of the gap there between unit and dollar volume? Yes, we would. And in fact, for the year, we are guiding 9 to 11% on the PC unit demand and 6 to 7% for our revenue. So, for the rest of the year, as we don't have that strong retail and commercial impact, we would expect those two numbers to come close to each other. It's a little early to be sort of given guidance, but conceptually, we would see them running in line. Again, the retail and commercial has got to what we consider to be a steady state. And clearly, with Windows Vista coming up, there may be, if anything, some upside there. Can you also talk a little bit about small-business accounting, real quickly, and your sort of goals or expectations there? And I realize this is not a big season for it, but just generally what you're seeing so far? On the Office side, we really see those coming from a few different sources, both in terms of continuing to improve and innovate on our Office product, which we feel we are doing really well there. We also look to new Office versions and categories, of which you're mentioning one there in the small-business space. We think that small businesses have unique needs that this product offers. And we are really looking forward to being able to tap a new category of users in a deeper way. The other thing I'll add to that is the general response we have had from customers has been very positive. So it's very early days. It was just released in September, but the overall response from a product characteristic point of view has been very good. Thank you. Actually, on the Microsoft Business Solutions, you showed some pretty good growth, I think, up 18%, and mentioned both strength in ERP and CRM. Can you talk a little bit about where those customers are coming from? Are you getting anything from any of the components that Oracle has purchased or about to purchase, or are they coming from any other vendors? It's a very desegregated market, as you know. And there tend to be a large number of very small customers. So I'm not sure I can do a correlation between this customer coming from Oracle and coming to us. The overall comment I'll make is that we are just very happy with the progress we have made there. We do think we are making good strides, and the product range is being well accepted. So I'm sorry; I can't give you sort of a where are we taking share or where we are making benefits, but overall a large number of small customers and doing, generally speaking, well, in particular, in terms of the re-licensing. Is there any way to characterize it as competitive replacements versus customers that maybe, historically, didn't have a solution at all? I don't have any data on that. I am happy to follow up, if we can find it. But we don't tend to stratify the market that way. And I do think the point Chris is making, in terms of the market being fragmented with small businesses sort of being generated every day there's just a lot of in and out of that market, and we did well there this quarter, which was nice. But when we look at other competitors for example, SAP they were up a similar amount, I believe. So there is probably, to your point, some category growth going on there. But we don't measure it that way. |
EarningCall_234087 | Hereâs the entire text of the Q&A from New York Timesâ (ticker: NYT) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Debra Schwartz (CSFB)]: Hi, thanks. It's Debra Schwartz on for Bill. I was wondering if you see any impact from The Weekend Journal and if there's been any change since The Weekend Journal launch versus the past few weeks. [Debra Schwartz]: Thanks. Could you just comment on rising fuel costs and if you're seeing any impact on your cost line now or heading into 2006? [Len Forman]: It's too early to tell. I mean, we expect to clearly have increased costs as a result of fuel increases but it's not a huge component of our overall cost base. So we would expect it to be relatively small. [Brian Shipman (UBS)]: Thanks. Wondering if you guys could talk about your thoughts for how much higher newsprint prices could go in light of the recent October 1st price hike. Are you budgeting for the price hikes into early part of 2006? A second question, you mentioned, Janet, that at The Times you're expecting in the ABC audit, both daily and Sunday to be up. I was wondering if you could give us a breakdown between the DMN and national edition for both daily and Sunday. Thank you. [Len Forman]: You've got a very peculiar situation right now with the two-tier pricing system, as you know and it is causing a little bit of confusion in the marketplace. Folks who watch the industry think that if the price and when the price, hits currently $650 or so, it'll probably stabilize. Hard to know whether, indeed, that will be the case because the suppliers have been very good at managing supply. But we don't expect the kind of escalation in '06 and '07 that weâve seen in the last 12 to 18 months. [Scott Heekin-Canedy]: We've filed the numbers with ABC that show small gains for the September ABC period similar to the gains we've seen for the past three or four ABC reports and I've not seen the exact breakdown yet on the New York NDM market versus the rest of the country. But based on the trends, the split will be similar to what it has been for the past couple years with growth in the national market offsetting decline in the New York market. [Brian Shipman]: Do you see anything on the horizon that would lead you to believe that the declines locally might abate anytime soon? [Scott Heekin-Canedy]: The market fundamentals, which we described in the past are very strong but we have a number of initiatives in place that are showing positive results. First of all, we continue to expand our single-copy availability and delivery through secondary wholesalers. This has proved very helpful over the past couple years. We've been piloting earlier delivery in some areas of the New York marketplace and we've seen very good results, improving both acquisition rates as well as retention rates and for the past six months we've had a fairly intensive marketing pilot on Long Island, which concentrates our tactical and strategic promotion efforts as well as our direct marketing efforts and single-copy availability, all with good results. So we're in the process of rolling out those programs across the New York marketplace. Bottom line is we believe that we can have a positive impact on what those trends have been. We're also continuing to see very good results in the next gen market â schools and colleges â growth in particular in the college-university marketplace. [Len Forman]: I Just have one point on newsprint, which I think is worth pointing out. Even with the rapid escalation in prices, newsprintâs about 10 percent or less of our costs, because we've done a pretty good job at figuring out how to reduce tonnage per copy. So you know in the old days it used to be 18, 19 percent. [Len Forman]: Sure. We've looked at web width reduction. We're continuing to study it. Obviously with The Journal going to a lower web width, that eases our concerns on the competitive side. We've got a bit of a challenge in doing it because we've got multiple print sites across the country. But we think that in fact that's a benefit for us because they're already at 50 web just in their own papers. [John Janedis (Bank of America Securities)]: Good morning. Can you talk about the Marketplace publication? How are you selling the advertising there? What kind of advertiser overlap and take rate is there from The Times? [Scott Heekin-Canedy]: We're having a very good experience. It's about, I guess, in the marketplace about four months so far. We upsell classified ads into Marketplace and we've been placing display ads as well. The display ads are advertisers who run in The Times as well and this is incremental advertising. [John Janedis]: Are you seeing any advertisers out there only going to the Marketplace and not to The Times? You're not cannibalizing The Times to an extent, are you? [Scott Heekin-Canedy]: No, this is an add-on. It's a low-cost add-on that works well for us and it improves the response rate to the ads that are placed overall. [John Janedis]: Okay. And, Janet, can you clarify your comments for October? I think in the release you suggested that business accelerated somewhat in late September, but October looks like September. I don't want to split hairs but does that mean that you've seen somewhat of a slowdown here in October or are you just trying to be conservative. [Janet Robinson]: No. What we did see is a slower start in September with the late Labor Day, but the last two weeks in September accelerated very nicely. We are continuing to see that nice acceleration in the first two weeks of October with some of the categories performing very nicely for us, John. [Michael Kupinski (A.G. Edwards)]: Fourth quarter, I was just wondering if you can talk about how retail's looking like heading into the holidays and also if you can talk a little bit more about the national advertising category. I know that you mentioned about entertainment being a little stronger. I was wondering if you have any other particular categories that you might shed some light on. Then finally I was wondering: the television revenues, I know it's a small component of the overall company, but television revenues were actually a little bit better than what we thought and was wondering if you can give us any outlook in terms of what you're seeing in terms of pacings on television even though you face a little bit of a difficult comp there as well. [Janet Robinson]: Yes, the pacings in October are in the height of single digit, but the fourth quarter is probably down the mid-single digits right now. They are performing better even though they are up against those tough comps of political and Olympics. Very aggressive pursuit of automotive business in particular is helping them do better than we expected as well. [Scott Heekin-Canedy]: Retail is looking strong, as it has been throughout the year. The luxury high end of the market is expected at this stage to perform well through the fourth quarter helped by the continuing strong performance of the magazine, the Thursday Style section, the Sunday Style section as well as other products. If I can put your question about studios in some context, year to date our overall advertising base, which as you know is a portfolio of almost three dozen categories, 60 percent of that base is growing at approximately 5 percent. There have been three or four categories that have offset that growth. We've talked about it all year long: technology, telecom, travel, the agate categories, studios have been flat to slightly down year to date. Janet talked about the release lineup for the fourth quarter, which so far it seems to be performing very strong. We've learned over the last two years that studios are very much have become week to week, the decision makers on their advertising. Based on what we know about the releases for the fourth quarter and the way those decisions have been made so far into October, we're expecting studios to be in the mid-single-digit growth rate for the fourth quarter. So in terms of that overall performance, that 60 percent 40 percent split that I described, I would expect that the studio performance to favorably impact overall performance. Telecom, we're going to start to cycle past the AT&T Wireless comps that have been so difficult for us all year. That'll happen in the mid to late part of November. Technology will continue to be very uneven, we think, into the end of the year for all the reasons it's been uneven so far this year. Travel, we're seeing some positive signs. Hotels, which were down very dramatically in the first three or four months of the year, started to show some signs of growth through the summer, are going to perform very well for us we think through the fourth quarter. And the transportation part of the travel category is starting to show some signs of ameliorating the clients if not even a little bit of growth. So there are categories that have been offsetting the overall fundamental growth in our base advertising I think are we are going to swing toward the positive side for us in the fourth quarter. [Michael Kupinski]: Can you tell me, if you can remind me, what the entertainment category might be in terms of total revenues in the third quarter from The Times? [Craig Huber (Lehman Brothers)]: Yes, good morning. Janet, could you please just go through the percent changes for your seven largest advertising categories at your flagship paper here in the third quarter? And in your Worcester paper up by Boston, I've noticed for a while here you've been charging for Internet access to that newspaper up there. Are you just sort of using that up there as a test market to see how well it does as a charge model versus a free model? If it does well I assume you may roll it out to some other markets? Thanks. [Janet Robinson]: I'll have Scott give you the rundown in regard to the categories and the performances on a percentage basis. Could you repeat the second question though, Craig? We couldn't hear you. [Craig Huber]: I was just asking about your Worcester paper up by Boston, you've been charging for a while there for access to your newspaper Web site. I was just wondering if you're using that as a test market to see if it really shuts down the eyeballs too much and it offsets the advertising or it's actually a good model going forward and you might roll it out to some other markets: charging for Internet access? [Martin Nisenholtz]: This is Martin. The answer to the question about Worcester is no. This was not viewed as a test market. It was simply a decision that was made locally for the publisher to do. I mean that it's a small market and they decided that they wanted to pursue that as a model. I think the model that we're pursuing and is proving out to be a better test market is the TimesSelect model. As Janet said, it's early days but our initial view on this is very, very positive. We're seeing incredible conversion rates off of our free trial, very high: 90 plus percent conversion rates. And we're also seeing terrific cooperation from our columnists, including a new entry â Maureen Dowd will be doing a special email. So you know this kind of highly differentiated specialized tiering approach is, I think, the approach not only that we'll be taking over the next several months and years, but we think that the newspaper industry in general will, as they did in our registration fee, follow us in this regard as well. Because I think we've hit on a model that is well-balanced to provide advertising revenue increases in the way that we've seen them over the past several years, against a new very robust and diversified revenue stream on the pay side. [Janet Robinson]: There has also been very positive comments in regards to the packaging. Not only are they getting unique content from the columnists, the access to the archives is also a very substantial part of this package that is greatly appreciated by not only the people who are paying for this service but also by the subscribers who are receiving it as a free as part of their package. It's interesting to note in the days of TimesSelect that last Wednesday Maureen Dowd's column was the most e-mailed column on TimesSelect, which we were very pleased to see. [Craig Huber]: Back to Worcester for a second, please, how would you categorize how the new model up there is working for paying for access to the newspaper Web site? It's my understanding just a few thousand people have signed and are paying for access to that site. [Martin Nisenholtz]: We haven't, obviously, released any numbers, but I think you would expect to see in a small newspaper market that has a full gate over its Web site you know several thousand people signing up to pay. I don't think that we would view the Worcester model as anything indicative for NYTimes.com or Boston.com. I just want to add a point to Janet's point about the archive, which I think is very important, the usage patterns on the archive are such that we don't believe that there will be any significant overlap or competition in our business-to-business markets, which is a very important market for our digital business as well. You know we syndicate our content to Lexis-Nexis, Factiva, ProQuest, and there was some concern from the community that this would begin to overlap, but we're not seeing that at all. That's very good news for us. We're seeing a distinct consumer usage pattern emerge as opposed to a B-to-B pattern. [Scott Heekin-Canedy]: This is Scott. I'll give you the third-quarter performance for the top five categories. Studio entertainment I've already addressed: down to flat to slightly down. Telecom: down in double digits. Live entertainment is flat to slightly up. Transportation: down in double digits. Real estate is growing, both parts of it â display and agate â overall composite, high-single digits. And help wanted is, both combined, display and agate, is growing slightly. [Alexia Quadrani (Bear Stearns)]: Thank you, on The Boston Globe, when do you cycle against your efforts to reduce the other paid circulation, and if you could maybe give us some color on what you're doing to improve circulation growth there? Still on that topic, do you think your ability to raise ad rate the same level as last year will be impacted by the circulation declines this year at that paper? [Janet Robinson]: We really started the look at paid, at bulk circulation early very late fourth quarter last year, very early this year. So it will be probably the turn of the year that we will be cycling up against that. The efforts are very pronounced in regard to increasing the footprint of The Boston Globe outside of Boston proper and we're seeing some very strong results in southern New England and western New England in regard to that kind of effort as well. There also is a strong promotion campaign that's going on in regard to the increase of readership, both single copy and home delivery. With the introduction of Sidekick, which has been a very interesting quick read that has spurred on single copy, we've seen some very nice results in circulation growth there as well. [Alexia Quadrani]: In terms of your ability to raise ad rates the same rates as this year given the circulation decline, do you think that's going to be impacted at all? [Janet Robinson]: We are always very cognizant of evaluating our increases appropriately, Alexia, and we, with The Boston Globe in particular, feather in the increases during the course of the year. For example, retail increases are at a different time in classified and national. But we are going to be careful in regard to what those increases are going to be, and we are also going to make our advertisers well aware of the readership numbers that are extremely important in regard to how people are evaluating newspapers now. As I think you well know, there is a very strong industry effort in place in regard to something that was announced just a few weeks ago called NADBase, which is being given to media buyers that really does show total readership of all newspapers in the top hundred markets. Certainly The Boston Globe benefits from that, in regard to the increased readership on readers per copy, as does The Times and every other newspaper in that marketplace. [Alexia Quadrani]: Given the weakness in the stock price, do you think itâs an allocate more of your cash flow to share buybacks in the fourth quarter? [Len Forman]: Our cash position is used for pretty much what we've said all along for investment purposes, dividends and stock for purchase. We are cognizant of the opportunity, but we're also cognizant of the balancing that goes on with how we use our cash. So we have stepped up our purchases to the extent that our purchases are greater than the amount of options that have been issued, which was our plan all along, so that we've seen a net reduction in stock out there, so you'll probably see that kind of pattern continuing. [Alexia Quadrani]: Thank you. [Fred Searby (J.P. Morgan)]: Yes, thanks. Couple of questions. One is if you could give us an update on the impact you see from Federated/May and the retail category, what your thoughts are heading into the fourth quarter and 2006, and just to clarify what your expectations and our expectations should be for the November ABC on the circulation side? Thank you. [Scott Heekin-Canedy]: The impact of the Federated-May merger for The New York Times is overall positive. The question mark that we're waiting to get an answer on is the future of Lord & Taylor, which could significantly change that outcome. But overall we're seeing increased spending, and the national presence of the Macy's chain of stores works very well in The New York Times. We understand that they're shifting dollars from local television into newspapers, and we expect that to benefit us as well. [Janet Robinson]: What we are seeing in Boston, Fred, in regard to the Globe is that we are not seeing the significant cutbacks in the fall from Filene's. They have not materialized as we had thought they may. That said, we will see certain reductions next year in 2006. One of the interesting things however in regards is the fact that the Filene's location will be sold to a retailer we believe, that could provide us with upside in regard to retail money coming into the marketplace. In addition we have seen three stores really increase their store coverage in that market. IKEA is in that market now with one store, Cohoes is in that market with three new stores, and Modell's is in that market with 12 new stores. So we are seeing, on the plus side, new retailers entering the market, even though we are predicting that we will experience declines certainly with Filene's leaving the market in the new year. As far as the ABC period for the Globe, we are going to see continued declines we believe in the ABC statement for both daily and Sunday. It should be about 35,000 on the daily and about 50,000 on Sunday. At The Times we are seeing increases both on daily and Sunday â the exact numbers, Scott. [Scott Heekin-Canedy]: The numbers we've filed with ABC show growth, daily growth of about 5,000 and Sunday growth of a little over 2,000. [Lauren Fine (Merrill Lynch)]: Thank you. A couple of quick questions. One, I'm wondering if you could help us understand the, first of all just in a way I might understand it, what was the increase in wages and benefits year-over-year, excluding the unusual items? Secondly, could you discuss why you're willing to incur the higher distribution and printing costs? Are you getting a good return on that National Edition expansion? Then if you could discuss whether you think your pension expense could go up materially or much at all in 2006? [Len Forman]: The last question really is dependent on what happens overall with interest rates, but we don't expect it to go up materially. It's been, as you know, the way pension works, it's amortized over a period of a couple of years and we've been seeing pension expense increases the last couple of years because of the way it's feathered in. But we don't expect big, big numbers in pension expense. Sort of where we are in the current year. We've got a $45 t-$55-million contribution, which has a positive impact on expenses. [Scott Heekin-Canedy]: With regard to your circulation, national expansion circulation question, in almost all cases we justify expansion through print-side expansion and market ZIP code distribution expansion on a circulation profitability basis alone, without even factoring the leverage it gives us in the advertising side of the business. We continue to have unmet demand throughout the country. At any given time we have 40,000 to 50,000 subscription orders that we can't fulfill for distribution reasons. So it continues to be a positive opportunity for us financially and from an overall copy and advertising perspective. I would remind you, I guess, of the high price of the circulation, which enables us to make this justification on the circulation economics alone. [Janet Robinson]: The profitability of those copies, Lauren, is a very important point to remember. That's one of the, you know, the tenets of the national expansion in regard to the growth and profitability of national copy. [Len Forman]: Lauren, I think you also asked a question about wage increases. They're up, on an apple-to-apple basis, about 3 percent. [Lauren Fine]: Great, thank you. One last question. On the equity line, it feels like if the momentum continues that you could beat your guidance. Could you just give us any sense of what's going on there or if things are exceeding your expectations? [Len Forman]: Sure. Part of that is seasonal. We're doing well with NESN but clearly there's no baseball played in the fourth quarter. Discovery came in better than expected. We're likely to be at the high end of the range and it's possible we could beat it a bit. So we're certainly at the high end of the range, based on performance over the last couple of months. [Douglas Arthur (Morgan Stanley)]: Yes, Len, I know you haven't finished your budget for '06 yet, but there's a lot of moving parts here on the newspaper costs, which, if you take out all the noise in the third quarter, were still quite high. With the staff reductions, your comments on newsprint, any ball park sense for what kind of the non-newsprint costs trends could be in '06 at this point? [Len Forman]: Itâs too early to comment on '06. But we clearly, as I said in my opening remarks, it's our intention to grow revenues greater than expenses. That's our goal in '06. So we'll be looking to drive expense growth down. But at the same time, Doug, we are getting benefits from both the staff reductions and the productivity initiatives, and we will use some of those expenses to drive investments in product and elsewhere. So it would be easy to drive costs down to a much lower limit, but we're also looking to drive revenue growth over the long term, so it's a balancing act. [Doug Arthur]: Well, what inning â I know you've given your release schedule of these new print sites, but what inning in the ramp-up of expenses related to new print sites are you in at this point going through '06, '07, and the spike in promotion expenses, is that likely to continue in '06? [Scott Heekin-Canedy]: Toronto's coming on as a new print site in November and Houston in January. So there will be the full-year effect of incremental costs associated with that, and the promotion distribution expenses will probably continue to grow at a similar rate next year. But to Len's point, we're managing our overall expense picture to achieve the results that he's described. [Len Forman]: We're taking 700 folks out of our staffing, which will have a very positive benefit on our overall costs next year, Doug. [Janet Robinson]: As Scott said earlier, too, Doug, on a continuing basis we constantly evaluate before putting a site on in regard to the return that we will be getting on that. As he said, Toronto and Houston will have the full effect next year. But we are evaluating what we will roll out in 2006 in regard to other sites that will be added, making sure, of course, that strong ROI is there. [Christa Quarles (Thomas Weisel Partners)]: Two questions just about ad rates. First, I was wondering if you could highlight what the overall ad rate realization was for The New York Times and what you expect, perhaps, for 2006. Then on an ad rate question as it relates to About.com, I know the revenue there splits between sort of CPM and search-based, and A, can you give us that breakdown, but, B, is a lot of the increase due to more aggressive maybe CPM increases now that you guys have your hands on it? Thanks. [Martin Nisenholtz]: Just so we all understand the terms of our business model, it's basically somewhat like the newspaper business. It's rate times volume, and volume has to do with number of uniques times the visits times the pages per visit. Those numbers, the good news is that all of those numbers are up at About. Page views are up 21 percent, September '04 to '05; unique visitors are up 31 percent from 19,500,000 to 25,500,000. So the volume numbers at About are driving the business results in large part. In addition to that, we knew when we bought the company that it was under leveraged with respect to rates. And so we have pushed very hard on the rate side. Our rates are up September over September 81 percent. So we have increased rates, but we think there's more to do. I mean we're not done yet optimizing our rate structure at About.com. We had a lot of leverage in the system and we're pushing that leverage now in order to get these increases. So we're pushing both sides of the business model, volume and rate, to get the kind of number that you saw us report for the quarter up 67 percent, which is well above anything you've probably seen elsewhere. [Martin Nisenholtz]: We haven't broken it down to date, but let's just say the model is very even. In other words, we have a display line that is roughly equal to the CPC or cost per click line. We have smaller revenue streams in e-commerce and in other revenue, but the two drivers are display advertising and CPC, and both of them are growing, you know, at significant rates. So we're much more diversified in direct response or CPC advertising than most other content sites because of our strength in search and our targetability. In other words, the About.com model is highly verticalized, so when consumers come to a page, they're typically interested very much in the content on that page and therefore are response driven back to the advertising. So the model is very robust on the direct response side, which, of course, is a very fast-growing part of the Internet advertising business. [Scott Heekin-Canedy]: Without getting into the specifics of rate yield, we are very fully realizing our rate increases across all major categories, retail, national, classified and especially on color, which helps us in overall achieve that yield. [Steven Barlow (Prudential Equity Group)]: Thank you. Len, what are your bonus accruals year-to-date this year versus last? And, Janet, can you talk a little bit about the International Herald Tribune? Thank you. [Len Forman]: Steve, we don't go down that level on bonus accruals. It's not the kind of detail that we give out and we've clearly underperformed our own expectations, so we'll have some benefit on expenses going forward. But that's not something we generally go public with. [Janet Robinson]: We are seeing some very nice pickup in the International Herald Tribune's advertising. In fact in the third quarter they were up 30 percent in regard to their ad revenue number. Because of the investments that we've made, the improvement in the product over the last two years, they are beginning to see the kind of advertiser response that we had expected when, indeed, you invest in a strong product. They're also monitoring their circulation very, very carefully to make sure that they monetize their investments and promotion. So I think we're seeing some nice movement in regard to what the IHT can really contribute to the organization. [Len Forman]: Just one clarification: bonuses and other forms of compensation, Steve, are included in our wage numbers, and so we're in a roughly 3 percent increase for the year. So all of that is imbedded in there. [Steve Barlow]: Okay. Can those new plants that you've put on now in Toronto and Houston, can they go down to the 48-inch web width? [Scott Heekin-Canedy]: I don't know the answer to that question. I believe it's yes, but we can look into that and get back to you. [Steve Barlow]: Thanks. [William Byrd (Citigroup)]: I was wondering if the color capacity came on late in the quarter, and would you expect this to have more impact in Q4? Also on costs, I was just wondering if you see any additional material structural cost reduction opportunities? Thanks? [Len Forman]: I'll take the latter question. The answer is, the short answer is yes. As you know, we appointed our corporate comptroller to head up a company-wide effort on process mapping, and that really is accelerating and building steam. We estimated roughly in the $20-million-to-$25-million range in savings this year. We see that growing next year, and we continue to see that grow out into the future because it's the kind of effort where you have to continually go back at it every few years and recycle, as business changes. So we built this into our own structure of how we manage the business so we expect to see continued benefit to this going forward. [Scott Heekin-Canedy]: The incremental color capacity that we've been installing was scheduled to come online in the first week of November, but it's going to start early. As of Sunday night, the Sunday night for Monday newspaper, we'll have this extra color capacity, and we've already been in the marketplace selling it. [Peter Appert (Goldman Sachs)]: Couple questions for Martin. Did the incremental traffic you're seeing at About, do you attribute that to the combination with NYT Digital? Is there some cross-marketing, cross-promotion that's driving that? Number two, can you talk a little bit more about what you've done with Indeed? Is that going to be a platform for growth for New York Times Digital over the next couple of years? Does that become a national help wanted offering that could conceivably compete with Career Builder? [Martin Nisenholtz]: Let me take the About question first. The increases in traffic at About are largely driven, at this stage, by our expertise and continuing leverage of search engine optimization techniques. For example, these techniques, as they are applying to Yahoo! are now driving an additional 200,000 users a day over the results of last year. So we are becoming better and better at indexing our content and making it available to users through what is the primary gateway to Internet content these days, which is search. So this is a competency that we now have not only at About, but that we are now exporting to The Times on the Web and Boston.com, as well as our other properties. I might add that although About's results sort of shine on their own, The Times on the Web has also increased its traffic dramatically. As Janet alluded to in her report, we had a record month, over 21,500,000 unique users around the world at The Times on the Web just for the month of September. That's a very large number for a news Web site. So one of the reasons for the About acquisition was to take this capability that these guys are, in our view, the best in the world at and extend it across our digital network so that all of the properties benefit from this. So the principal driver at About is SEO at this stage, but we also continue to see more and more content created. We're creating 3,000 original content pieces a week at About. This goes into a database of over 1.1 million articles. We have the largest content trove on the Web right now. As that content gets added, mostly evergreen content, as it gets added to the archives, it gets indexed, so you continue to see better and better answers off of search and more and more volume to the Web site. That's, again, the business model that we acquired there. [Martin Nisenholtz]: Indeed, just so everyone is clear, is a meta search engine. In other words, it spiders all of the job listings on the Internet and it produces results regardless of whether it's from a job board or a company Web site, and it provides a comprehensive view of the job market. If you go to About.com and you look at the job and careers path, you will see that Indeed is the job site for About. So the strategic synergy between About and Indeed is already clear. We invested â we owned 14 percent of this company, we invested in it and now we're helping it grow through this incredible engine that we have at About. We don't know what's going to happen to this meta search model. Part of the reason we acquired equity in the company and announced it on the board is to is to learn and to be a part of this, what we believe to be a very important trend, not only for jobs listing but for other agate or classified or listings â listings in general. So this trend is taking place across the Internet, in jobs, in real estate, etc., and we are participating it in actively now and driving traffic to this, and looking at additional opportunities in meta search as well. So we think it's an exciting trend and we think that it could be a game-changing trend over time. [Peter Appert]: Do you have an option to take your ownership stake higher? [Martin Nisenholtz]: No, we don't have an option to take the ownership stake higher, but we obviously have language in the agreement that would allow us to negotiate in a favorable way if we were to want to pursue a greater [Len Forman]: Peter, the size of the investment isn't what's critical here. It's first mover entry into this market and having the ability to integrate with what we're doing and have a seat on the board so that we can help drive the direction they go in. That's really what's critical. [Edward Atorino (Benchmark)]: Good morning. Probably a tough question to answer, but in looking at the buyout schedule, I presume it's not going to be one-third, one-third, one-third. Would it be a little front-loaded, back-loaded? [Len Forman]: Way too early, Edward. We said in our announcement it would take place over six to nine months and it's too early to make that call in terms of how many people are going to take it right away. But certainly within six months we expect it to be done. [Paul Ginocchio (Deutsche Bank)]: Yes, thank you. Just a couple questions about Boston. First, do you think the Boston Herald, with new investors, will be a tougher competitor? There was a nice article in the Globe this morning about that chance. Second, Boston help wanted looks pretty weak. Can you talk about what's going on print versus online and the relative sizes of your print revenue versus your online revenue in the relative growth rates. Finally, in TimesSelect, Martin, I think you're quoted somewhere online that you're looking for 1.5 to 2 million subscribers and I know you've significantly increased your Web ad impressions to get there. I'm just wondering how that's going and is that what's also driving the cost of your promotions? Thanks. [Martin Nisenholtz]: I'm not sure where the 1.5 to 2 million came from? I've never suggested anything along those lines. What I said is that over the very long term we expect this to be, you know, a significant revenue driver for us. Maybe somebody extrapolated that number from those statements, but we've not put a number out there deliberately because it's still early, and what we've suggested is that it's ahead of plan and going well. But we certainly have never said anything in that range. [Janet Robinson]: Help wanted in the third quarter print was down in the high- single digits, and online was up in the low teens. It was a softer third quarter. They're expecting the fourth quarter to be stronger. They are still very pleased, though, with what they are seeing with Boston Works. In regard to The Herald, I think that we always feel it's important to have a strong competitor in the market, and we certainly want The Herald to have more investment and certainly to continue to be a strong competitor. I'm going to ask Jim Lessersohn to give you a little bit more color on that. [Jim Lessersohn]: The way we are looking at it, we just see it as more or less a continuation of the consolidation that's going on in the Boston market, and we ourselves have been very active in terms of making investments in Boston, adding new products in Boston. That's simply to make sure that we remain as competitive as we need to be, to face however many competitors we see in Boston, however strong they become. [Paul Ginocchio]: Let's just follow up on the print versus online and help wanted. What's the relative size of the two revenue buckets? [Janet Robinson]: We're just taking a look right now, Paul. Obviously, the classifieds in the print is much, much larger. It's probably about four times as large as the online in terms of dollars. [Paul Ginocchio]: The number of Web ad impressions online, I think, in September was significantly ahead. I think you're one of the biggest Web advertisers, particularly regarding TimesSelect, and print circulation for The New York Times, is that something that will be maintained? Is that what's driving your increased promotion costs? Thanks. [Martin Nisenholtz]: Yes, we did buy a significant amount of impressions online in order to launch the product, and we'll continue to support the product. But I don't think you would call that expenditure significant, no. [Janet Robinson]: A lot of our promotion for TimesSelect, in fact, was done in paper, Paul, and online in regard to NYTimes.com to increase the visibility of what we were offering with that. It's also important to note in regard to the competitive situation in Boston. Boston not only has done a wonderful job of really doing a great deal of redesign, new product development, they also have developed kind of a one-stop shopping mechanism for advertisers in Boston. Because of Globe specialty products, because of the regional section, because of the magazine, because of their pre-print targeted ZIP coding down to the ZIP code, they now have become really a one-stop shopping mecca for many of the advertisers in there. Those capabilities have rarely increased over particularly the past year that we think will be a good, strong move in the competitive environment. [Jeff Sweat (UBS)]: Two questions. One is the financial status on the new building. Two, a follow-up on a previous question asked, and that is how much of a pension cost increase could be comfortably absorbed at this point, considering the difficult environment. [Len Forman]: I'll take the pension question first. Our big increase in pensions really occurred between '03 and '04. We don't expect to have a significant increase in pension and it's going to be, certainly, in the area where we could comfortably absorb it. So that's not a major issue for us. That's why we are putting in the $45 to $55 million, in order to get a benefit on the expense side. Again, we're doing that to both maintain our 90-percent funding ratio in order to avoid any insurance premiums, as well as take advantage of the expense benefit we get for doing that. So pension, while cost increases are always something to be concerned about, pension expense is well within the realm of what we can do. On the building, your question, what specifically are you looking for on the building? [Len Forman]: We are up on building. We have steel going up. Nothing has really changed in terms of our forecast with regard to building expense. Occasionally there might be some slippage into '06 from '05 just simply because of timing. But we still plan to be in the building in '07 and the bulk of our capital will be in '06 and early '07. [John Janedis (Bank of America Securities)]: Just a quick one. Understanding that quality is an issue on the movie front, how much does the average wide-release movie spend at The Times versus a year or two ago? [Scott Heekin-Canedy]: We don't talk at that level of detail about the performance. I'll just reiterate what I said before is that in the last couple of years we've seen the studios manage their advertising more on a week-to-week basis than we had previously seen, based on how the product performs in the marketplace. We try to develop â we work very closely with them. We have very good working relations with them and we try to help them develop advertising approaches that best position their product in the marketplace. For example, we are doing a lot of sneak preview placements with them, as well as out-of-environment placement of ads. [John Janedis]: Those types of things, I'm assuming they're at the standard type of rate card numbers, they're not at a discount? [Catherine Mathis]: Are there any more questions? Thank you, every one, for joining us today. If you have any other questions, please give a call. Bye now. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234088 | Good day and welcome to The New York Times quarter one 2006 earnings conference call. Today's call is being recorded. (Operator Instructions) For opening remarks and introductions, I would like to turn the conference over Ms. Catherine Mathis. Please go ahead. Thank you and good morning, everyone. Welcome to our earnings conference call. We have several members of our senior management team here today to discuss our results with you. They include Janet Robinson our President and CEO; Len Forman, our Executive Vice President and Chief Financial Officer; Scott Heekin-Canedy, President and General Manager of The New York Times. Martin Nisenholtz our Senior Vice President of Digital Operations couldn't be here today so we have Scott Meyer who is the CEO of About.com; Karen Messineo who is the CFO of NYTimes.com; and John Cantarella, the Group Director of Marketing and Operations from NYTimes.com. We also have Jim Lessersohn our Vice President of Finance, and Corporate Development; Stu Stoller, Vice President of Process Engineering and Corporate Controller; and Tony Benten, our Vice President and Treasurer. Our discussion today will include forward-looking statements and our actual results may differ from those predicted and the factors that may cause them to differ are outlined in our 2005 10-K. Our presentation today will include non-GAAP financial measures and in our press release, we provided reconciliations to the most comparable GAAP measures. Our press release is available on nytco.com. This conference call is being webcast and an archive will also be available on our website, as will a transcript. An audio replay will also be available and the directions to access that are in our earnings press release. For the first time, you can also download our conference call to your MP3 player, so we are truly becoming multi-platform. With that, let me turn the conference over to Janet Robinson. Thank you, Catherine and good morning, everyone. Today we reported first quarter earnings per share of $0.24 based on GAAP compared with $0.76 in the same period in 2005. In the current quarter we had a charge of $0.04 per share related to staff reductions we announced in September, while last year's EPS included $0.46 from the sale of property. Our GAAP earnings came in at the high end of the range we provided in March. Advertising revenues at the news media group varied significantly from property to property. Overall advertising revenues rose 2% at The New York Times Media Group. Strong categories included residential real estate, where advertising increased as a result of greater inventories of homes to sell. Telecommunications, where we have stifled the effects of AT&T/Cingular merger and advertising for voice over Internet protocol technology is increasing rapidly; and hotels, where we have seen increased business from some of the major chains as well as tourist destinations. Advertising was soft in entertainment, which declined as a result of weak box office and fewer dollars being spent for Oscar-nominated and winning films. Media, which declined as networks reduced advertising during the Winter Olympics and classified automotive which was soft at our other properties as well. New products continue to increase ad revenues at The Times. One example is Play, The New York Times sports magazine which debuted Super Bowl Sunday and was a hit with national advertisers as well as sports participants and enthusiasts. It will appear three more times this year, with the next issue appearing during the World Cup in June. Another example is our special real estate themed Sunday Magazine. Based on it's strong success we plan an additional issue in the fall. At the International Herald Tribune advertising revenues grew 18% in the quarter as advertising rose in a broad array of categories. Recently the IHT announced its third consecutive year of circulation growth, with average daily sales up by about 1,300 copies to more than 242,000 copies, mainly because of increased sales in Europe and key Asian markets. The New England Media Group had a challenging quarter. It's regional economy has struggled, job growth is slow, as is population growth. In addition, this is a high tech savvy region, with one of the highest penetrations of household with broadband connection. While Boston.com benefits from this, it does adversely affect the print products. Advertising decreased 7% in the quarter as key categories such as automotive, travel, telecommunications, entertainment, and department store advertising declined. The group continues to be affected by the consolidation of two of the largest retail customers, Macy's and Filene's. Several significant retailers have announced plans to enter the Boston marketplace, including Nordstrom's, which is said to have plans to open three stores in 2007. Consolidation among advertisers and telecommunications and airlines has also affected Boston's results. Product development is key to increasing revenues in New England. We have developed a variety of new platforms, including the introduction of niche publications, new zoned weekly publications, enhanced direct marketing capabilities, new merchandising and retail opportunities, and new Internet sites that meet the needs of our web audience. In early April, the Globe launched mybuyline.com offering books, DVD's, music, and other merchandise related to reviews written by Globe critics. This week we began testing a new zoned product in the western suburbs that targets non-subscribers. A new zoned real estate product debuts April 20. New classified advertising self-transaction capabilities are up and running and more are planned. These capabilities improve productivity and reduce credits for errors, resulting in savings for us. We've increased our commercial printing revenues by printing Metro Boston at the Worcester Telegram & Gazette plant and The New York Daily News at The Globe. This is the main reason other revenues at the New England Media Group increased 17%. In addition, the first and very successful Boston Globe Travel Show was held in March and added to other revenues and earnings. At the same time we have made several key shifts in our New England management team. In December, we announced a new President and General Manager for the Globe as well as the leader of the newly-created Boston Globe Media, charged with developing new products for the New England Media Group. In March we announced the promotion of key executives with digital marketing and data mining experience within our advertising, circulation, and marketing departments. Our regional media group's advertising revenues rose about 5% in the quarter like The Times and New England Media Group, real estate advertising was particularly strong. New products such as weekly newspapers, magazines, direct marketing, and local Internet products contributed significantly to the improvement. The Company's overall circulation revenues were up slightly in the quarter. Circulation revenues improved by nearly 2% at The Times Media Group as a result of home delivery price increases we initiated in February and improved sales of the daily paper. At the New England Media Group, circulation revenues decreased 6%. Circulation revenues increased 1.5% at the Regional Media Group due to subscription rate increases. The websites in our News Media Group had very strong growth in advertising revenues, up 23% in the quarter -- a particularly good showing, given the large revenue base for this increase compared to others in our industry. At the beginning of April, NYTimes.com introduced a redesigned home page and section front pages, new ways for readers to personalize the site, enhanced search capability, an expanded set of easy-to-use navigation tools and more original video, something that advertisers covet. Feedback from both readers and advertisers has been very positive, and we think readers will be particularly pleased with My Times which will enable readers to personalize pages with RSS feeds from The Times and other websites. This differentiating feature is expected to be available before the end of the month. Last month marked the one year anniversary of our acquisition of About.com. It continues to exceed our expectations. It is consistently among the 10 most visited content sites in the United States, and in March About reached 55 million unique visitors worldwide, up 40% from last year. The improvement in visitors has translated into revenues. In the quarter, we estimate that About.com's revenues were up 98%. All three of its revenue streams -- display advertising, cost per click advertising, and e-commerce -- showed strong growth because of higher rates and increased spending from blue chip advertisers. This year we plan to add 100 new guides which will result in more topics for our users and more advertising space. About.com continues to drive traffic to NYTimes.com, Boston.com, and our other websites. It also continues to cross-market our sites, further promoting our brands and extending our reach into reader's homes and offices. With About.com, NYTimes.com, and Boston.com we are now able to offer over 1 billion monthly page views to the marketplace. In terms of unique visitors, we have the tenth largest presence on the Internet, a very important selling point with advertisers. In total, our digital businesses generated revenues of $62 million in the first quarter, accounting for 7.5% of the Company's total revenues compared with 4.5% in the same quarter last year. This includes About.com, NYtimes.com, Boston.com, the websites of our Regional and Broadcast Media Groups, and our digital archives. Revenues at our Broadcast Media Group increased 2% in the first quarter, mainly because of the additional revenues from KAU TV which we acquired last November. Excluding KAU TV, revenues decreased 2% mainly because of lower automotive advertising and network compensation, partially offset by higher Olympic advertising. As we look forward, we are well aware of the challenges confronting our industry and our Company, but we are very positive about our long-term prospects. We are moving aggressively to improve our business on both the revenue and cost sides in order to maximize value for our shareholders. We are doing so by continuing to improve our existing products and to introduce new products that serve our audiences and advertisers in print, online, and through broadcast media. On the cost side, we are benefiting from the changes we made to our expense structure in 2005 and remain very disciplined on managing our costs. We believe that growth in costs, excluding those for staff reductions and the extra week in our fiscal calendar, will be lower in the remaining quarters of 2006 and for the year as a whole than it was in the first quarter. We are committed to improving our margins by achieving higher revenue growth than growth for these costs for the full year. Now I'll turn the call over to Len for more commentary on the quarter. Thanks, Janet. Total cost increased 6% in the quarter. Much of the increase came from staff reduction expenses and the acquisition of About.com, which we owned for only nine days in the first quarter of 2005. Excluding those two items, total costs rose 3.2%, driven primarily by higher distribution and outside printing expense, higher raw material expense, and increased promotion expense in support of our circulation initiatives. Newsprint expense rose 5.9% with 8.2% of the increase resulting from higher prices, which was partially offset by a 2.3% decrease from lower consumption. We continue to look for ways to conserve newsprint. In addition to the annual savings of approximately $4 million that we have achieved as a result of process improvements such as the use of lighter weight newsprint and waste reduction, earlier this month we changed the stock tables in the print version of The New York Times. As a result, we expect to save approximately $3 million in newsprint in 2006, and $4 million on an annualized basis from this action. We also introduced new tools on NYTimes.com to help people better manage their investment portfolios, as the Internet becomes the place where people look for financial information. Rigorous expense management remains a priority. We are achieving it with our efforts to improve efficiency in our operations and to redeploy our resources more effectively. Excluding staff reduction charges, About.com, raw materials, and D&A, non-raw material cash costs rose 2.4% in the quarter. To our various process mapping initiatives, we expect to achieve both revenue gains and cost reductions. As Janet said we are committed to improving our margins. This process of systematically reviewing all of our operations that we began in late 2004 is now fully integrated into our management systems. We expect to save approximately $45 million in 2006 as a result of these efforts. Slightly less than a third of this is related to the two staff reduction programs we announced last year. At the end of 2005, our head count was down 3.6% excluding acquisitions. On the same basis, we project another 1% decline by year end. After the completion of the staff reduction programs, we estimate total annualized savings from them of $50 million to $70 million by 2007. The actual savings will depend on the final mix of seniority of the affected employees. Since 2001 we've reduced overall staff 17% excluding acquisitions and divestitures, while actually adding staff in critical areas. Turning to CapEx, under GAAP the total amount of capital expenditures for our new headquarters for both the Company and our development partner must be included on a consolidated basis in our financial statements. In the quarter, total capital expenditures were $70 million. Of this amount, our development partner's responsibly was $20 million. The balance of $50 million was the Company's responsibility, including $28 million for our portion of the cost of our new headquarters. We expect the building will be completed in the second quarter of next year which has been our timetable since construction began and we forecasted that we'll be under budget. At that time, we will consider alternatives for recapitalization to determine what would be in our best interest and those of our shareholders in both the short and long term. This will be determined by economic and market conditions at that time. As part of our ongoing efforts to examine the value of our assets and their continuing fit with our strategies, on April 8th we exercised our right to require Discovery Communications to purchase the Company's 50% investment in the Discovery Time's channel, a digital cable channel. As part of our initial investment in this channel, this right was exercisable following the fourth anniversary of the investment. By contract, the sales price was determined by a formula with a floor of $80 million and a ceiling of $135 million as calculated by the independent appraiser. The parties have not yet chosen the independent appraiser. Our investment balance in the channel was approximately $104 million at the end of the first quarter. Based on the sale price, which results from the independent appraisal, we will record a gain or loss depending on whether price is higher or lower than our investment balance. We have been very pleased with the performance of the channel. We've learned a great deal and Discovery has been a good partner. But over time, our strategy has shifted. We believe that shorter form pieces such as the video we are currently producing on NYTimes.com serve us well with broadband penetration increasing, video has proven popular with both users and advertisers. Increasingly this is where we'll focus or efforts. Given the partnership we have had with Discovery, we would certainly be very receptive to discussing opportunities with them going forward. In closing, I would like echo Janet's statements on our business. These are challenging times. While we operate in a mature industry, the pessimism that I hear and read is unwarranted. As we analyze the expected future cash flows from our traditional businesses, we believe the market is seriously undervaluing them. We continue to introduce innovative new products both in print and online that address our audience and our advertiser's needs. We're building our Internet businesses and at the same time we're finding ways to creatively bring our costs into line while executing against our long-term strategy. So while we expect revenue growth to be modest in our traditional businesses, we're managing those businesses to achieve margin improvement over time. Coupled with our digital growth strategy, we are optimistic about our economic future. With that we'd be happy to answer your questions. Thanks, good morning. Just wondering if you could reflect a bit on the success of Times Select. Give us an update on how many subs you stand at there; what percentage of your subscribers to Times Select are paying? In other words, subscribers to the print addition obviously get it free. Also, I think you're giving away a 50% discount to university students or just students in general. What percentage are full paying subscribers? Thank you. We are very pleased with our Times Select efforts. We currently have 465,000 subscribers, about 62% of those are home delivery subscribers. The remaining is paid subscribers, which of course is creating a brand new revenue stream for NYTimes.com. We do offer a 50% discount to college students for Times Select that has been very well received in the marketplace as well. Full price. It's $49.95 in regard to that 38%. The Times Select university which is the 50%, has just started. So the results of those are still coming in. The 38%, Brian, really reflects the $49.95. I think that's very hard to say. We are continuing to promote this. We are continuing to put new programs around the content that is available. You are seeing more video. You are seeing more podcasting. You are certainly seeing more opportunities for the columnists to do more with the Times Select offering. To put an exact number in regard to how large we think this is going to be, I think would not necessarily be in keeping with what our plan would be, but from a perspective of how we are looking at the initial effort, really, only six, seven months into it we are extremely pleased with what we have seen. In fact, we are constantly asked by our peers in regard to how well Times Select is doing. Thank you. I just have a few questions. On the newspaper side just broadly, we know online was up over 20%, but were print ad revenues down in the quarter? If so, by how much? Then I'm wondering if you could give us a better sense of April trends on the newspaper side? Lauren, they were down slightly, but they were up at The Times and they were up markedly at the regionals as well. Okay. We'll give you both. It's very early in the month and it's important to remember that this is a five-week month, so giving a prediction certainly wouldn't be appropriate. But what we are seeing are similar patterns to what we saw in March, and we are still coping with challenges, needless to say, as I've noted in Boston but at The Times and the regionals I think we're seeing a pattern similar to what we have seen in March. I guess the follow-up is, if you could help us quantify in the Boston market, the Macy's/Filene change. How big of an impact has that been? Can you quantify it either in dollars or what percent of the decline is it causing? It has a very large impact on the Globe's revenues, as you can understand. I think it's important for me to put some information around the Boston situation. It's very clear that large metropolitan newspapers are more challenged than the mid and small market newspapers and we certainly are recognizing the factors that are contributing to the weakness in Boston. You all know we're dealing with the consolidation of many categories there, department stores being one of them. But airlines, telecom, banking, we're dealing with a migration to the Internet in very key categories, such as help wanted in automotive. We're dealing with exceptionally heavy penetration in broadband connection in that market which contributes very nicely to Internet growth, but it does hurt our print product and as I said earlier, there is slow population growth and a very weak economy there. Recognizing these factors are one thing, taking action to drive performance is certainly another. That's exactly what we're doing. As I noted earlier, there have been several senior leadership changes in Boston within the first quarter. There's a new President of The Globe, there's a new President of Boston Globe Media. There's new leadership at Boston.com. There are new senior advertising executives, new senior circulation executives, and through a retirement at the end of this month we have a new publisher of Worcester Telegram & Gazette. In fact, it is a publisher coming up from one of our Florida papers in our Regional Group. In that market we're also looking at a very strong cross platform sell that we just announced in the first quarter called Boston Globe Media, which really is a complete portfolio of products that we have there, including online, print, events, to mention just a few. This reaches 70% of the Boston market. A very strong drive towards productivity and efficiency in that market, very strong drive towards new product and service development and new revenue streams such as commercial printing, and a strong focus on acquisitions -- needless to say -- with the contributions that [Nesa] makes and Metro. It's important to note that we are having a pronounced discipline in effect in Boston for rigorous expense control and extensive revenue generation. The sizing of our cost structure there I think will certainly improve performance as the days go on. You have experienced some pretty dramatic increases and I think a lot of those are due to pricing, given that it hadn't been fully monetized as well. Do those begin to mitigate as you cycle over some of those price increases? Also, can you remind us what percent of the traffic that goes to About.com is generated from search engine optimization? Thanks. Sure, I'll start there. 80% of the search comes in through search engines. In terms of revenue growth when we look at the quarter it has been about evenly divided between rate, volume and new products that we've introduced that we didn't offer a year ago. Hi, good morning. It sounds like you are moving toward maybe somewhat of an alternative distribution platform for content given the Discovery Times announcement. Does that mean you are considering selling the TV segment given that it is less targeted than cable networks? If not, why? We do not comment on acquisitions or divestitures. I think that as Len noted in his remarks, we're very, very pleased with the relationship with Discovery. They were excellent partners, very similar values in regard to their commitment to quality journalism and quality programming. At this time we are focusing on short form video programming that indeed feeds the web. As I noted earlier, John, there is a very strong demand for video streaming on our websites. We're seeing more and more and more of that, advertisers are really coveting that, and in light of that, we are going to put a strong emphasize on that development. In fact when we announced our research and development team early this year, it was for the major purpose to look at ways in which we can extend content across the portfolio. That meant leveraging content in mobile, leveraging it in video as well. So the reason for that exercise of the put was primarily focusing on why indeed we wanted to put more emphasis in regard to video streaming. It's important to note that our broadcast business is very well managed and there are healthy margins and strong cash flow. Because of their focus on local news, they are very compatible with our regional newspapers. The tax basis on these properties is so low that if we did sell them, a considerable portion of the proceeds would go to the government. Okay. Thanks. What kind of impact, if any, related to the release of the customer information in New England have on circulation or advertising? There was a strong effect on the decline in home delivery. We were starting to see, in fact some very nice gains, John, at the very beginning of the year until this happened. It did have a substantial effect, but I will tell you that we are right now in the market in the last two weeks with a very strong win-back program that we're starting to see some very nice return on. As the year goes on, we expect that we are going to get most of those subscribers, if not all of them back. We took great care in regard to how we handled the response to the credit card situation. We were commended by the Attorney General's office in the way we handled it. We have received very positive response from our subscribers who were affected in regard to how we have treated them during this difficult situation. Thank you. How is your TV pacing is looking for the second quarter? The other question is, can you give us a preview of your March circulation volume numbers for the ABC for both The Times and Globe? Can you just quantify your non-newsprint cash costs in the newspaper division adjusting for these one-time items? Thanks. The April pacings, I believe are in the 3.5% range with KAU TV. That's what we have as far as the pacings as they exist right now. The second quarter is flat with KAU TV and your second question was ABC-related I believe, Craig? In regard to the Globe, the Globe will be down both Daily and Sunday. We are fine tuning those numbers due to the credit card situation, so I don't have those numbers available to your right now, but we will definitely be down both Daily and Sunday. Yes, we adjusted for About.com, depreciation and amortization we were up 2.4%. If you took KAU out we would be up 2.2%. Craig, I just want to remind you that until we've filed with the Audit Bureau of Circulation we're not permitted to give out numbers. We can give you directional guidance but that's the extent of it. Thank you. If you can give us some more color on your comments on the cost for the back half of the year. Could you give us a sense of how much lower you expect costs to trend for the back half of the year? Are these largely coming from incremental benefits from the staff reductions? Do you think we can actually see a margin expansion in the back half of the year? I'll take the last question first. The answer is yes. We expect margin expansion. The cost savings that we're seeing are coming from a variety of sources, clearly we're beginning to see the staffing kick in. All of the process mapping initiatives that we are undertaking are beginning to have an effect. The first quarter had some cost increases that were discretionary that will not be there at the balance of the year. So we're very optimistic that even with modest revenue growth, you will see cost expansion over the balance of the year that will be less than revenue growth. As we may have said on another call, we have actually committed the Company to that as a goal, and it's a commitment that we're going to meet. All our color capacity is in place as of fourth quarter last year. As a percentage of our total revenue base for the first quarter, we were about 27%. Our color premium growth year-over-year was in the high single digits. The first quarter traditionally tends to be a slower start to the rest of the year, but close to 10% growth year-over-year. Yes, can you just quantify what the percent change was in movie studio advertising in 1Q? And what that category represents as a percentage of total for The Times right now? How do you expect that category to fare in 2Q? Thanks. The entertainment category declined significantly for us in the first quarter, in large part due to the Oscar season this year, the uneven release schedule, the small distribution platforms, and the generally soft race among the contenders. We've continued to see weak holdover in the releases in the first quarter. All of that added up to a quarter that was significantly down for us in double digits. But for that decline, we would have realized close to mid-single digit growth overall for the business. Yes, thank you. Len, given your comments about your share price and your thoughts about the valuation, your share repurchase has been notably light, and I wondered -- I know this is not the easiest time for you to do that, but what your thoughts are going forward on share repurchase? Whether you are willing to leverage up the balance sheet a little bit to do that? Secondly, on help wanted it looks like online you haven't raised prices in quite a while. What is the pricing outlook on your online classified and what are your thoughts there? Thank you. Fred, to be as straight-forward as possible we have clearly always said that share repurchase is done for two reasons. One it is to offset dilution from the issuance of options and exercise of options; and two, when we see it as a high return, alternative investment. We frankly see high alternative uses of our cash. If we're going to leverage our balance sheet, we would prefer to see another About.com. Our goal is to look for those kind of digital investments in our businesses, and I wouldn't rule out increasing share repurchases. Obviously at a certain price it becomes very attractive and a high return, but we think the share price will take care of itself as we drive our business going forward. With regard to the online postings, job postings, Fred, we have not raised the prices on job markets since January of '05, but that's a relatively small percentage of the total. We had given increases in July of '05 and in January of 2006 on other products on the job market site. So those other products are packaged with our print product. Thank you. Another question on cost for you. I was wondering if you would give us a better sense on how costs in Boston specifically are trending? That entire balancing cost cuts with spending on the new product initiatives, that you mentioned earlier? I'll do a brief one and Janet can jump in. Basically costs in Boston are flat to down, and we don't give that kind of information out specifically. But they are doing Yeoman work on managing what is a very difficult environment and we expect those trends to continue in Boston. We are specifically -- and we have said this often -- about 18 months ago this Company took a very strong commitment to looking at productivity and efficiency in a very, very disciplined and rigorous way. Boston has been one of the poster children within our organization in doing so, they have done outstanding work. They have utilized not only a look at process mapping and efficiency, they have also looked at better use of technology, they have looked at staff reductions, they have exercised outsourcing options when appropriate. They have used every tool to their advantage, and they are continuing to do so. As I said earlier, they are sizing the cost structure of their business, but they are doing so with the core value in mind in regard to great journalism and how, indeed, they can create a richer experience for the reader. They are doing that, as I noted, by adding new products, but they are very careful in regard to how they are adding product and what costs of those products are being analyzed. Two financial questions. First, the About margins at 40%, very impressive this quarter. Is that the target level? Is that the sustainable level of margins for About? And then on Discovery Times, was that a profitable enterprise? Did it contribute anything to the equity earnings line? Peter, you didn't quite come through on the first question with regard to About. I thought I heard you say something with regard to margins but I wasn't clear. Could you repeat that? This, as you know, is a business that drops a lot of revenue to the bottom line, and we would expect those trends to continue, we would expect the revenue growth to continue. I would only wish it would grow as rapidly over the next couple of years as it's growing this year, but I just want to remind you that when we did the deal, the projections we used were very modest, essentially about what industry projections were. We said at the time that if we can achieve those that this would have a very high return. Well, clearly the numbers have been much, much greater than that, so while we don't think 70% to 90% is sustainable year in, year out, we are quite optimistic about the growth over the next couple of years and we think that as we look back five years from now, this will turn out to be an extremely inexpensive acquisition. There is a very disciplined road map in place, Peter, in regard to the growth of About that I think supports what Len said in regard to not only sustaining these margins, but growing them. We are adding 100 guides this year and will continue to do so for many years to come. There is wonderful rate flexibility as well as our traffic increases, as I noted earlier, just within the last year the traffic has increased 40%. We are building out strong verticals in About, health being one where there is very strong traffic coming now, but there is real opportunity for that specific vertical and others to grow quite dramatically in the days to come. We also have international aspirations for About and very strong opportunities in regard to video and mobile with About as well. So there is a very robust game plan in place for what we can do with About, not only today but certainly for tomorrow. Peter, I think you asked the question about Discovery and if it was profitable. It did turn modestly profitable this year, but as we looked in totality at our investments and uses of cash and took a very disciplined approach to it, the better move for us, the smarter move for us was to exercise our put. Had that contractual ability not existed we were quite pleased with Discovery, but it was a slow growth and we're looking at alternatives in the web that make the investment in the web more attractive today. Peter Appert - Goldman Sachs Right. Got it. Len, a follow-up to an earlier comment you made. You guys have obviously done exceptionally aggressive work on the cost side, what do you think is a reasonable expectation over the next several years in terms of what the baked-in level of cost growth is we should assume? I'm thinking about '07, '08 timeframe. Well, you're thinking way ahead of what we're thinking publicly. I think what you can assume is that the modest levels of expense growth that you have seen will continue going forward. We're committed to that. We don't believe that our process improvement work has run its course. We think there is still an opportunity to continue to leverage our shared service center, and we're looking at ways to involve the data centers and IT operations. So these are, we think, incremental gains on the expense side that will be with us for some time. We continually look to see those kind of improvements. The discipline and the commitment, Peter, to this side of our business and consequently margin improvement is extremely robust within our Company. I think what I said earlier about The Globe holds true of the entire Company. We are utilizing every tool possible to make sure we are looking at cost reduction in a smart way for the Company. I'd also just add to Len's comment in regard to Discovery Times, we were very pleased with this relationship, they are great partners and we look forward to working with them on future opportunities going forward. But it's very important for us to constantly look at what we own within our portfolio and one of the things that we did was to look at this in regard to how that would fit with our future needs and what indeed we were focusing on in regard to the web and that short-form video that is becoming so lucrative for us, not only at NYTimes.com, but About. Thanks, Jan, recognizing what you said about Boston and broadband and the upgrade to The New York Times website. Just wondering what you thought of Jack Schaeffer's comments from Slate, he said the website was so good he was going to drop his print subscription⦠And sort of continue to think of how you monetize, get more revenue out of the website? I may buy Mr. Schafer a subscription just as a gift so he can have the pleasure of reading it in a tactile fashion. From a perspective of him really praising our redesign at NYTimes.com, we're thrilled. It's very important, I think, for everyone to realize that we are very pleased with what we have done with this redesign. It is an extremely robust user experience. As I noted earlier with My Times being a real differentiating feature of the redesign, we really think that it will increase traffic quite dramatically. One of the things that I noted that you may not have heard, but I want to make sure that I reiterate it, is that advertiser opportunities with the redesign are much more robust than they were before. Not only in regard to the home page in regard to the size of the units, but also in regard to how much more inventory we think we will get by this redesign. The early responses not only in the press but even in regard to traffic analysis really bodes well in regard to what this redesign will mean for traffic consequently monetizing what the website can really mean for us. Just sort of thinking back to your comments about Boston, what are the other opportunities for monetizing subscription revenue online? Thanks. We are looking at Boston.com very closely, particularly to search. We have a huge search project in play right now that Michael Zembalist in fact is working very closely on with his colleagues in Boston to really accelerate our ownership of that market. We intend on being all things Boston, whether it be in print or whether it be online and we are investigating ways in which we can monetize Boston.com even more than we have right now. There are many learnings that we know we will get from the redesign of NYTimes.com that will migrate to what we see at Boston.com. We also see, because of search engine optimization and what About has brought to us in that area strong increase in traffic in Boston.com that's increasing inventory and consequently increasing their percentage of growth. I was wondering if you could talk a little bit of what is driving the improvement in pricing power at About? Thanks. We have a five-point strategy and I think each of the five parts contribute to that rate growth. Content quality as Janet mentioned, we have added a number of new guides. We continue to make improvements in the site's design. We're investing in marketing the site both to the trade and to consumers. I think particularly there by explaining more clearly what About represents and the value we deliver to advertisers, it's giving us more flexibility in rates, and being a part of The Times Company definitely helps. It gives us more presence with the advertising trade and it's also enabled us to recruit better guides. Hi, this is Chris Ferris calling in for Mike Kupinski. Two questions on advertising if you will. You guys had some significant price increases at the beginning of the year, and I was wondering if any of the weakness that you are seeing in terms of New England or New York, could that be any push back from advertisers, or do you really see it as sort of a still more of a challenge to advertising environment? What do you think is the issue there? Secondly on help wanted, you were down 1.8% in the quarter, I believe. I think that's the weakest number you have had in quite sometime. I was wondering what do you think is going on with help wanted? Is it any particular market and do you see it improving? Was January and February just an aberration? Thank you. Let me just comment on the rate increases. The rate increases at the beginning of the year were not peppy. At the regionals it was only 3%. At New England it was only 2%. At The Times it was only 5% which is in fact a little bit lower than in 2005 and certainly lower than 2004. So these are not robust rate increases and the softness in the advertising market is more a function of consolidation in key categories as opposed to rate structure. We are continuing, certainly to work with our advertisers, many of whom are on contract, but these rate increasing really aren't out of the ordinary in any way, shape, or form. If you look at The Times ad performance against the backdrop of the industry, we're certainly in the median with where we're advertising growth has been. On the help wanted question, it's clearly related to markets. Our regional group is doing quite nicely on help wanted. Boston, as Janet noted, is a very, very tough economic environment and they are struggling with recruitment advertising at the moment, and New York is having a bit of a soft spot as well. So I think this is driven by economic conditions locally. It's not a reflection of changing shift from print to digital. This is Scott Heekin-Canedy I'll just add a little bit to what Janet said. The rate increases we put in place for '06 are in a modest range, I would suggest, and in the first quarter we're realizing those rate increases. As I said in one of the earlier questions, but for the performance of the entertainment category our overall performance would be solidly in the mid-single digit range. We're seeing volume declines attached to a couple of categories that have their own industry specific challenges. That's best exemplified by entertainment and then recruitment, just adding to what Len said the New York marketplace is a challenged marketplace. There is no dominant market leader. It's a very competitive marketplace among the recruitment services offered. This has been a challenging category, I believe, for everybody in the market. It just seemed to turn pretty quickly on you in January and February, but then it rebounded a little bit in March. Do you think January and February was an aberration? Should we look for better growth going forward? Or do you think it's a challenge going forward? Our overall business in this category in particular has been extremely volatile with limited visibility for a couple of years now, and I wouldn't dare give you a direction with regard to that answer. Two quick questions. Can you quantify the first quarter benefit that you received presumably on the TV side for the Winter Olympics? Looking ahead to the fourth quarter, can you give us your anticipation of the revenue benefit from the extra week? And I have a quick follow-up. The extra week in the fourth quarter, that's just essentially 1/52 of the year or is that a particularly strong extra week you are getting, because it's the holiday season? No it tends to be less. Obviously it's at the end of the year. It's at a time when I would not expect it to be quite as robust. My follow-up is the stock over the last two years has gone straight down over 50% and yet total executive compensation has risen every year. This year I noticed in your prospectus that you doubled and in some cases tripled stock option grants to senior executives. Can you explain that philosophy? I think from a standpoint of executive compensation, we look to be competitive in the marketplace, and it's extremely important for us to evaluate those compensations in regard to what is being paid in the marketplace within our industry. We are very, very focused not only in regard to looking at -- and it's important to note actual pay and target pay. Because when indeed you are analyzing executive compensation, many people make the mistake of not looking at what the actual pay really is as opposed to target. So I think that's a very important point to remember in regard to this. Well, I notice that you haircut the bonuses because of the failure to reach certain targets and I guess that's commendable, but it looks like you made up for that by tripling the stock option grants. Would that be fair to say? Our long-term compensation is very specifically tied to goals, and as I indicated earlier, we set for ourselves one of those financial goals of revenue growth over expense growth. So that when you look at actual compensation at the end of the year, as opposed to targeted compensation to Janet's point, the numbers will be reflective of whether or not we deliver on the financial goals. The only other comment I would make is that when it comes to executive pay, the Compensation Committee of the Board takes on that responsibility. They have a very rigorous methodology they follow, looking at where we fit or fall against a whole slew of companies, not all of which are media companies. They target the 60th percentile, and many of those increases that you saw were related to the targeting of the 60th percentile. We have no further questions at this time and I would like to turn the conference back over to our host for any additional and or concluding comments. Ladies and gentlemen, this does conclude today's conference call we thank you for your participation. At this time you may disconnect and have a great day. |
EarningCall_234089 | Hereâs the entire text of the Q&A from Corningâs (ticker: GLW) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Thank you very much. I have two questions. One on television and the other on margin. In terms of the historical data on television volumes across recessions, was that consistent strength was that accurate from a high end as well as low-end television sets? And then I have a follow-up. So actually, haven't looked at the television sales during those these period of time by sales of television and that is relatively true that it was evenly placed. Not perfectly across the different sizes. And we don't have price data back to the '70's but we looked at the various sizes of televisions. Back then a 27 was a big one. It was relatively evenly spread versus small ones. That is helpful. And then in terms of margin, the way I look as it that there are three drivers of margin expansion. One, LCD becoming a larger part of the overall corporate mix. And then second of all the up tick increased sales of Gen6 and Gen7 your the overall LCD volumes. And then third the improvement in the individual generations, let's say for instance Gen6 due to the improvements of yields net of pricing competition. As you think about your business over the course of the next few quarters, how do you rank order the importance of each of those three factors in terms of driving up margins? Well, I think that the most important thing for us would be the additional volume of Gen6 and ultimately Gen7, which shows up in our base business. Right now our base business is really only Gen6. Our Gen7 is at S&P. We expect to have Gen7 on '5 and Gen8 in next year for our business. I think that the things you're missing in the margin would be the impact of price as a negative. And then the other impact will be our own ability to continue to improve our cost structure. And as you know, most of our additional capacity we are ramping in Taiwan where our cost structure is very, very low. So, I think those things are the other things you ought to be putting in your model. Thank you, I had a couple of questions. First of all, you gave us a sense that the LCD gross margin was up sequentially. Can you just give some color on the other businesses, whether the gross margin trend up or down and what was the gross margin in SCP in the quarter? And the second question I have is, you mentioned royalty income. Can you elaborate on what business that was reported in and what was the amount? Thank you? The royalty income is all within one business. It is basically a royalty that comes out of our overseas operations in display paid to the U.S. where we developed the technology. But because of our tax treatment in the United States it absolutely helps our overall tax rate. In terms of the gross margins and the other businesses, environmental was basically flat. Life sciences was down a little and the other materials were down a little bit, too. But nothing material there. Right. I'm trying to get a sense of the profitability the core profitability of the LCD business. As you look at it second quarter versus third quarter it seemed to have improve dramatically. And I'm trying to get a sense was that mostly the gross margin improvement or was it kind of split evenly? Did the royalty income change dramatically sequentially? The royalty income wouldn't affect the display as you've seen it in the segments you see it. Because it is both an expense over in Taiwan and then an income in the United States and then consolidated, so you don't see it. What's driving the margin improvement in the display business is our gross margin percent increasing, the overall growth of the business, leveraging our SG&A and R&D. And then lastly as I indicated that the way we allocate taxes, sequentially compared to quarter two, the tax benefit was great because we had this overall lower tax rate. Good morning. A couple of questions here. Yes first I guess first off, for your gross margin for your core display business you alluded to it getting closer to SCP. Can you give us I guess a tighter range in terms of what that number was like? Okay. I guess looking forward to Q4, you gave up guidance for glass volumes. Yet your gross margin guidance is considerably low are than what you achieved in the third quarter. Can you comment on why that is? So, overall for the Company, what you are going to see is the telecom business going down. And remember we have basically when you we lose the telecom revenues they fall at a very high incremental rate. And that is providing most of the down, if you will. If you all the way to the 43% versus the 46%, the telecom drop off is about 2/3 of that. The other potential pressure we see will be the question of what is the ultimate pace of price declines in the LCD business? As we indicated, we expect them to be only slightly down. Slightly is what we would think about similar to what we had in quarter one. So, that will be the potential, and I stress potential, downers within it. The up will be depends on how well we do in manufacturing in Taiwan where we are bringing on a number of new tanks. Okay. And final question from me. I know glass and panel shipments don't necessarily correlate one to one but you're flat to up 5% guide for SCP seems rather conservative relative to Samsung's guide of up 8% and LPL's guide of mid teens growth in the fourth quarter. Can you help me understand the disconnect there? Well, really remember what we've shipped to them in quarter three is showing up in their outlook in quarter four. And I think they indicated that their actual that their ramps were done. So, they are not adding manufacturing capacity really in this quarter. What you are seeing in their sales going out is what's coming out of what they've already manufactured and the inventory they have. But I think both of them indicated that they had achieved their ramped capacity on those two fabs. Got you. So, your guide of flat to up 5% would suggest panel shipments out of Korea will be up sequentially in the first quarter? Hi, good morning. Jim, first of all going back to some of the comments you made about the excess inventory potentials. Is there any chance the panel makers would try to hold price and slow production as opposed to first trying to drop price and net pricing on say panels may not be a good leading indicator for monitors? This is Wendell. So, yes, there is always that chance but past behavior has not, if past behavior is any predictor of the future then they wouldn't do that. And if there was to be some kind of inventory correction that had to go on what do you think the lead time would look like in terms of them slowing production? It depends on the segment. As Jim pointed out, the pipeline tends to be shorter and under tighter control in monitors. Right? As opposed to LCD TV. Right now we don't see much concern in LCD TV, as Jim has said. But we do have to take a close look at what happens what our customers believe will happen in quarter one for monitors. Because we are counting on increased penetration in that. And it is once again, as Jim just said, we will sell glass in in quarter four for what ultimately our customers sell out in quarter one. And then just a quick question rate Jim. Is 25% a good number 20% to 25% a good number to flow through into an '06 model at this point? Yes, I think that is a reasonable estimate right now. We will try to give you a lot more help on that. Obviously, we are having a little trouble doing the forecasting tax rates. But I would say for right now that is a good rate to use. I guess two quick questions. One, I noticed a change in the language in your press release. I'm talking about that LCD television penetration could be between 20% and 25% in '07 versus I think 21% is your latest forecast. Has the market researchers, have they changed their view or are you more optimistic about LCD TV? I won't speak for all the market researchers but we clearly have moved up our own expectations of what we think LCD television penetration is going to be next year. Thank you. And secondly given that fiber volume turned out much better than expected in Q3, could that accelerate the reopening of Concord or does that increase the probability of it opening next year? No, I would say that we unless there was a more significant rebound in China it is not likely to be in '06. Hi, you gave us a lot of information about how consumers might behave relative to the TV market. And obviously we've talked about how that market can quickly result in corrections. But can give us your view on the monitor and notebook side, how higher energy prices and these types of things may impact that? And you had mentioned that you can see quicker corrections in inventory in the monitor market. But just kind of talk about how guard at the panel makers may impact you on the monitor side since that's really the bulk of the volume still. We don't have the same kind of history on the, IT usage of this during a long number of recessions in particular. Remember about the IT market, it is driven not only by the consumer behavior but also by the corporate IT budgets. So, we don't have the same ability to say what's happened. What we have focused a little bit on, is done informal surveys of other CFO's about what their IT budgets are for the upcoming year on the corporate side and basically we're not I'm not sensing declines. If anything, in fact, they're up. But it is hard to judge and it is very possible that a consumer who might have been thinking about a flat panel display might put off that purchase but we just don't have enough history about it. As you've indicated the bad news about the monitor market is it is probably flows quicker to us than the television does. But we just don't have any kind of history to judge that. I would say if the thing that we focus most on right now, is what is happening in the monitor market rather than the television market in terms of potential impact on us from December and January. And then if I could have a quick follow-up on the pricing changes in the pricing environment. Over the last couple of quarters we saw some pricing I guess down in the first quarter, flat in the second and third quarter and then you are expecting to be down a little bit into this next quarter. As we look out into 2006, given that you are seeing pricing competition really for the first time in Gen6 now, should we expect the price declines to be steady sequentially throughout the year or would it follow a similar trend? Well, what we have said consistently what we anticipate is price declines on an annual basis in the high single digit range. And we've provided information in the past that shows that though you can have given years where it is a little more shallow or a little more steeper; that the important point is when we show how we have done on cost that we have been able to over that period of time decrease our costs by at least the rate of price decline. Yes. Investors probably appropriately focus on the size mix of LCD glass substrate. Can you comment on the non-size parameters like surface properties, expansion coefficients and perhaps in the future poly silicon and its impact on purchase decisions? On TV. So I think that the three main areas to focus on from the technical standpoint is; that as you go bigger the challenge gets harder. From both the stress standpoint and on overall glass requirements. And that tends to play to our strength. So, we continue to have product entries that will I think match up nicely with those tightening specifications. To Poly Side we don't think that is going to be a force in TV. However, that we will see it in smaller displays. And once again, the technical challenges of the glass increase in Poly Side especially around processing temperature. And, once again, we have got some new technology that we feel really good about that will position us very nicely in that market. Good morning, gentlemen. Two questions, if I may. Firstly, on the ASP's I think in the past you've said that historically you have commanded a double digit premium in terms of your glass ASP's relative to the competition. I'm wondering if that is still the case? And whether or not you are seeing any pressure to bring down that premium as the as Asahi and so on get better at supplying Gen6 glass? And then secondly on the diesel business, if we can switch gears a bit. Can you give us an update on where you are with your letters of intent with North American and European customers? And when might we see some of those LOI's converted to formal deals? Thanks a lot. First a general comment on the competition and your particular focus on Gen6. I think it is important to remember that we started commercial production in Gen6 sort of mid 2003. And really the first competition showed up selling in Korea to a customer who isn't that close to Samsung Corning precision and therefore, had a lot of motivation to buy it from someone else in the fall of 2004. And we are still the majority supplier there. Now, 2.5 years later we have another competitor finally showing up with commercial quantities in Taiwan and Japan. We anticipated competitive entry long before this and are more than ready for that. Remember, we only had about a one-year lead in Gen5 and we have continued to expand our profitability in that product line. A part of that relates to the premium that you spoke to but more importantly is continued improvements in productivity. We would expect to continue to have some degree of premium. Mainly because of the better glass quality and our strong reputation for being able to reliably produce it. Remember, we've already turned in a commercial producing Gen7 and have already begun sampling larger sizes and are in the midst of building our Gen8 plant. Diesel, you asked about where we are on the supply agreements. We are continuing to negotiate. These are difficult contracts. Not so much for price but more to make sure we understand the warranty and performance requirements in the contract. But we continue to make very good progress on that with our customers and are hopeful of reaching conclusion in the fourth quarter. I'm not sure any one said nice quarter yet, guys but maybe that is becoming a little bit routine to you. The questions first on Dow Corning, which is also non-petroleum based but they sell into markets with a lot of petroleum based alternatives. So, in a high-energy environment, should we be expecting their earnings to accelerate here? I would not be expecting acceleration right now. They're they have some energy components sales. Although, obviously much more smaller than most of the commodity players. But they are also running very close to near capacity at there basic plants. So, I don't see a lot of room for big acceleration. But we do have a seasonality method. As you know, the first half for Dow Corning is usually much stronger than the second half. And then when we talk about the LCD share of the TV market, it is sort of with the assumption that the total TV market is not growing. But as we get a ramp in digital broadcasting over the next couple of years, the installed base of TV's still have very little digital penetration, I think. So, should we be thinking about the total TV market maybe accelerating a little bit and then LCD picking up a good part of that incremental growth? I think that is a good point. The overall category growth that we would say for TV have increased in the low single digits. And that with the advent of a strong digital broadcasting and the move towards digital, it could have a prompting to give people a reason to have to buy a TV. Especially, if the digital broadcasting bill that is work its way through Congress right now goes through. Because people's analog sets will be obviously challenged. Remember, that digital goes very well with LCD TV since it is naturally digital. So, perhaps there's is a an opportunity here with digital signaling becoming predominant providing some upside to overall category growth. Remember, the key thing we want is people to have a good reason to buy TV's. Once they have that we feel really good about the competitive nature of the LCD TV technology. A couple of quick questions about that. Now, that you are in sort of a net cash situation I think for the first time in almost 20 years; what do you intend to do with that cash in 2006 and beyond? Do you want to continue to have leverage on the balance sheet or what will you use that for? So actually, we were kind of researching to figure out the last time we had the situation. I appreciate you pointing that out to us. We are going to keep a large amount of cash going forward simply as part of our stability metric. Because we know we are in tech businesses, we will have some debt. We don't expect it to get greatly above the amount of debt we have. What we're really going to do with that cash is reinvest it in the business and there is two places. One is obviously our capital expending for near term business, such as either display or diesel. More importantly, I think for investors, is that reinvesting in our research and development for hopefully businesses that will be appearing at the end of this decade. So, that is why we are maintaining the cash for both stability purposes and the ability to reinvest in R&D. And when you look at your planned extension of Gen8 capacity that's being over there, Gen8 and higher, when do you expect that to come online? I think you mentioned 2006 but you didn't indicate whether it is the middle of the year or end of the year. In the first part. So, is it safe to assume that the second quarter would be seeing a ramp over there? We clearly expect it to start in the second quarter. But ramps of new big fabs don't happen really fast. So but we clearly intend to be prepared to ship Gen8 glass in the second. Okay. Just moving on to the operating margins in the environmental business. Those margins have been hovering in the close to zero for awhile now. I think largely driven by your sort of large investments in the diesel opportunity. Are you seeing any deteriorating trends right now in the regular auto business? And then in the diesel opportunity, when do you expect like the sort of margins over there to move up into double digits? How many quarters or years would it take? So, we are not seeing a deterioration in auto. We would like to see a little by the more improvement in auto but we are not seeing a deterioration. Diesel, I don't think you should look for much improvement before the beginning of '07, when we begin shipping quite a bit of volume. I do. Just a few closing comments. Clearly we are very pleased with our outstanding performance in the third quarter and are excited about our prospects for the fourth quarter. We've got excellent momentum as we start the fourth quarter especially in LCD glass. And with regards to display, we are looking forward to seeing how successful LCD television continues to be in this very important holiday season. Our belief is retail prices will generate substantial sell through and that '06 will turn out to be the inflection point in LCD television. One late breaking piece of new. I'm aware that Verizon announced this morning their 2006 plans for homes past. And they announced the 3 million homes and also the details on their connect rate where they have been marketing the service and that looks favorable to us. So, we are pleased by that news now also. Two final notes. On investor relations announcements; on November 2, I will be presenting at the Morgan Stanley conference in Phoenix. And then November 15, Pete Volanakis, our Chief Operating Officer, will be presenting at the UBS Global Communications Conference in New York City. Ken? Thank you Jim. Thanks Wendell. Thank you all for joining us this morning. A playback of the call will be available beginning at 10:30 Eastern Time today. Will run to 5:00 pm Eastern Time on November 10. To listen dial 402-220-9717. No password is required. The audio cast is also available on our website during that time and that concludes our call. Please disconnect all lines. 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EarningCall_234090 | Hereâs the entire text of the Q&A from Sohuâs (ticker: SOHU) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Good quarter. I have two questions. The first is on Olympics. I try to understand it better; is there any direct revenue opportunity coming out from the Olympic sponsorship, meaning that would you be able to put on advertisements on the Olympics Web site or will you be able to have links from the Olympic's Web site to several sites where you can commercialize on it? And the second question is also on the Olympics. How much did you pay for the sponsorship given that it is a very sought after opportunity and how would you account for that and how would it impact the I guess marketing expense for your Company going forward. Let me answer the first question. The Olympic Web site, which is at Beijing 2008.com is an Internet platform for if there is any partnering opportunity will be foe all the partners including companies like Adidas, China Mobile and Coca Cola and right now there is not clear opportunity for SOHU to advertise on that site so we'll build that site but SOHU has the responsibility to market that site so SOHU.com had the responsibility to use it as a content distribution channel to promote that site so you'll see links on the SOHU side to that site. And also if you look at a SOHU web site today, it's already with a SOHU logo and a combined logo of the Olympics, regional Olympics and that brings trust and basically endorsement from the BOCOG. That will give our current advertisers and those Olympic sponsors and partners confidence in SOHU platform and believer that this SOHU.com and its affiliated work site are trusted platforms so this will not immediate, but on long term for the few years will have impact on our advertising clients. And also not only for overall advertising clients but also for this specifically for these Olympic partners for their investment in sponsoring Olympics they normally spend multiples amount of dollar amounts to promote this sponsorship or partner ship, like Lenovo, like Adidas and Coca Cola. They spend much more money than the sponsoring amount itself to promote off line and on-line and through traditional media so naturally this will be a club of-- exclusive club of Olympic sponsorships and partners and who-- and supposed to help each other. That's actually in the spirit of the Olympic Committee to make sure that partners are successful. So these will have a more direct impact on the advertising of SOHU revenue. Dick, to elaborate on Charles response, the Olympics site, the Bokoff site, site belongs to Bokoff. We helped him and we'll provide exclusive service to help them construct and maintain and host that site. The site belongs to Bokoff so is the advertising space on that site so SOHU does not host the advertising space on that site but as Charles has mentioned, we provide links to that site. You can actually see it on our front page. Answering your second question regarding how much we paid for this, it is confidential. We do not disclose the amount but I can tell you that the consideration that we have to give in return for getting this honor is a cash portion plus a services portion, the services being as I have explained is to construct and maintain and host the site for Bokoff. The cash portion is advertised over the life of the contract, which is roughly about 38 months, and the cost for services is recorded on an as incurred basis and I have explained in my script that these two elements has been taken into consideration in the Q4 EPS guidance that we gave out. Thanks. Thank you, two questions also, one on advertising and one on search. The advertising business was stronger than expected in the quarter. You indicated that 17173 probably did better but I'm curious if some of the verticals where you had trouble with at the end of Q2 in the southern part of china, did they come in stronger than expected? Could you also comment on your efforts that you initiated last quarter to diversify your revenues in the quarter? My question on search, could you maybe address two things? First of all, a little more color on your sales efforts in search? I know you did some reorganization of your distributors. Could you maybe give us an update on how many distributors you have and how this compares to your competitor and then secondly, could you give us a little color on your sales message in search? What is the message that SOHU takes out why people should advertise a search on SOHU relative to some of your competitors? Thanks. I'll take the question on the advertising side. South china we reported in the last conference calls the two trouble areas for us is our on-line games and some of our southern china clientele. We do not see much improvement from the southern china clients that we are seeing but we do not see further deterioration as well because as in last quarter we were concerned whether there would be further deterioration. In terms of diversification, we continue to do more in, as Charles has explained in his call, real estate, automobiles and IT and these still come in at very strong factors. IT.coms and on-line games are showing very good growth as well so this is on the advertising side. Regarding the number of distributors we have about 200 of them and maybe I'll turn the question, turn the floor over to Charles to talk about the search strategy. For the search, as I described in a previous talk is a transition where we change the distributors structure from a sole distributor to a multiple distributor and also increase for competition so these two reasons contributes the lackluster growth. Normally search business would grow much faster but this quarter it's only 3% growth but we believe that we are looking at the long term. The long-terms success of search business is really depend on traffic. If you have a lot of traffic then you're guaranteed the search results. We have a pretty good network software. Networks of agents to sell our products. These networks are focused on selling the sogou search but we are transitioning to sogou search and that also the network is quite expensive and is focusing on selling sogou search and also SOHU's affiliated home Web sites. But now the efforts are shifting toward selling sogou search so the revenue and the side is less important compared to the traffic gross which the long term is guarantee offer discussed. That's how we've been focusing on, increasing traffic and traffic has grown 50% Q3 over Q2 internal data because Alexa is a-- people all look at Alexa and sometimes it's not an absolute standard. Charles, I guess could you maybe comment on what your sales message is? If you're out competing for let's say a business and Baidu or Google guys are in there and they're trying to decide whether they should do search with you relative to one of your competitors, what's the message? Why would someone choose to advertise on SOHU rather than one of your competitors? First of all SOHU is just a much more dominant brand name and over the years we've been developing these networks. We have very trusted networks and with the end clients and SOHU has been around for eight years and the distributors or end clients in the local towns and throughout china they know SOHU. The brand names of SOHU are much bigger than the other competitors and also the sogou is perceived as the newcomer with just a new generation of technology and with and also not only the page search but also a featured search better user experience like on news search or music search and also this-- we're in the process of upgrading our local map search because after that position go to map combined with the sogou technology so all these, first it's the SOHU brand name and also the sogou perceived as the new comer, the new kid on search and the traffic is really growing and also for users. These reasons combined will be perception to the end users. This is Paul Beaver for Safa Rashtchy. Congratulations on a good quarter. I was hoping that you could provide us with more color on the wireless recovery. Are there any particular services or new products that are doing particularly well? And also, just a quick clarification, was the decrease in gross margins of the non-advertising business related to the Unicom charge? Well, I mean for the wireless part is business as usual. We don't have any major new launch of products. This is a cautious recovery. The biggest growth coming in for Ethernet business, which is 23%. And to your second question, yes, the decrease in the margin mainly comes from the charge by Unicom. I have two questions. The first question I just noticed that some of your competitors have different leading and advertising categories. Yours, obviously, or your cost are in financial and the FMCG some of your closest competitors keep saying auto, property in IT sectors and I'm just wondering what costs is averaging and is this one--? Richard, let us clarify. Our biggest category is real estate, IT and auto and the categories that you mentioned is our fastest growing category, so one are the biggest and one are the fastest. Okay, yes. Thanks for the clarification and what is your pricing trend and also advertising client base goals in the previous quarter? Pricing remains like what we have said all the time is hand-in-hand with our other competitors we increase prices every 6 months. We are looking at another one for 2006 right now and as we have explained many time on the call, we do not expect our revenue growth coming in through price increases because our revenue growth really comes from the spending budget coming from our customers, so that's answered the first part of your question and the second part is what? Sorry, I just missed that. I guess you sort of addressed that. If you don't raise price clearly all of your advertising growth is more or less driven by client base expansion. Yes, indeed and as to my last question, is regarding research and how would you structure a split between pay for performance and the fixed listing? What would be the breakout the potential--? This is rather a technical question, but if I look at your revenue from non-advertising, non-wireless, non-ecommerce, others than I think it improved from 1.7 million in the second quarter to 1.8 million in the third quarter. I understood that you started consolidating Go2map in June, so I was surprised that there wasn't a bigger revenue increase. Can you talk a little bit about how much Go2map contributed to the other non-advertising revenue? Go2map has a very small operation and as we have explained when we did the acquisition that we did buy it because for revenue purposes, so the revenue that comes in is very small. The bulk of that non-advertising revenue comes from our on-line games business. Go2map, we bought the Go2map for its technology, for its geo system. The geo information system and once we bought it; it was still under, with the sogou technology development we are going to launch. Now, we, actually next week we are going to launch a sogou version 2.5 and after this sogou version 2.5 we will upgrade early 2006 our local search based on sogou technology and the Go2map's information system, so it will be we expect this new map search and local search to bring-- to continue to accelerate the traffic growth of sogou and when the traffic grow to the map search become a good percentage of our overall traffic, we believe we will be able to monetize through spot search and advertising. My second question is a more general one. I think you're guiding for mid-twenty percents year-on-year revenue, advertising revenue growth for '05. And that's with the difficult Olympics comp in '04 and with some weakness in the first half of the year from property and from Southern China I think you said. For 2006 do you think that you can accelerate that year-on-year advertising growth rate up to around 30% or do you think it will be similar? For the first nine months we-- the year-on-year growth for advertising sales is 27%, as Charles has explained in this call. With the Olympics and everything we would like to assess the 2006 growth on the next call because we just signed an Olympics deal and we are in the process of signing up three more contracts for next year and, James, to answer your earlier question Go2map accounted for less than, or around $400,000 of revenue for Q3. Okay and then sorry, just to follow up on my first question. So Go2map was 400, so other was 1.4. Other includes on-line games? Okay. It just looks awfully clear, as if something was slightly weaker quarter-on-quarter in that mix because I think Go2map went from 100 and something in the second quarter to, or 200 odd in the second quarter to 400 in the third quarter? First question, could you just give us an update on your game strategy, your internal development team, where they're at, how big they are and any update on strategy there? We have an in internal development team about 60 people working full time on our next new game. We continue to see game strategy as part of our community strategy. As Charles has explained, we now have the biggest community in the Internet space, China Rand and the PBS and Blog and so on, so we will continue to use our game products to increase the cohesiveness and stickiness of our community and we expect to launch this new game, which is developed in-house sometime next year. No. It will be another Animal preachy game, but it would be a centerpiece of our community strategy instead of just growing the games itself. The new game is a stand alone RPG game that you will be using a traditional collection payment structure to monetize, but we also have many other kinds of games and also the-- we laid the line-on-line free and also we've-- so these kind of games and the free on-line, the previous games will contribute to the overall-- it will be built based on the large communities that we are developing and it will increase the overall Web site cohesiveness, stickiness. Okay, great and could you just give us a sense of how you're thinking about marketing spend for wireless value added services going forward fourth quarter and maybe beyond, if you could comment on that? Thanks. Two questions-- one, on the search engine sites could you explain why the search engine-- the search revenue margin was down for the quarter? Also, could you give us more color on the sogou 2.5 version, what kind of new features we will look at for this new version? And if you could then the number of clients for the search business that you can update us with? Also, the other is on the gaming side. For the Late On-line it went free in October, do you guys-- On the search engine the margin decreased primarily because of certain map data collection costs as we put it through as cost of revenue because map becomes our content and the maintenance cost of that would be going into the cost of revenue and also the additional servers and bandwidth that we need to put in due to increased traffic are for the number of clients we have close to 40,000 clients up to now and I will leave the 2.5 question on sogou to Charles and then I will answer your Night On-line question first. User number goes up. It's 3,000 before it goes free and is right now over 10,000. We are seeing picking up of these selling of virtual good products from this free game now, so Charles? Similar to the upgrades in February 2005 from version 1.0 to version 2.0 this version 2.5 first of all will be a good increase of the number of Web pages indexed. It was upgraded to 1 billion pages, but now it will be upgraded to even more pages, but with more quality pages and also, the search algorithms and the data IOE input/output reading and the typology of the server frame will be resulted in a fast response of the search. A more accurate guess at the searchers intention to search, not only for the Web site navigation, but also for information navigation, so there's few parameters that search business-- this search engines are measured are upgraded, so-- and there will be-- we believe that will be strongly-- it will felt by users and will be a result in the Web page search traffic. While developing this page search quality, response time, accuracy and we also we have achieved success in specialized research, which are a lesser challenge, but based on the overall search technology for specializing the search like our music search and like a news search and so it's I think this version 2.5 is a-- I would say on the same level of upgrade as we did in the February and as you remember in February once we upgraded as version 1.0 to 2.0 the traffic has grown much faster. The correlation of traffic and the quality of the search are quite related, quite direct. Two quick questions. Regarding the Olympic games, the exclusive content deal, does it include the wireless value added service portion or is that just on the Web site? We are under the contract with phone call we are required to construct a Web version of the site as well. Okay, so would you be able to get the exclusive content deals afterward for the wireless value added content offerings or is that still in discussion? The other income it turned positive this quarter versus negative during the past few quarters. Can you tell me what's in there, please? We have a tax exemption granted by the government and we reverse it in accruals that we made in previous quarter, so that number turns positive. One way or the other. From time to time we will have some one-time charges or one time quote "gain" that we'll put into that item, but it will not be anything material. I think two questions. First one, regarding the impact of Olympic deals, should we expect, in terms of margin, should we expect the Company have to spend a little more on service and bandwidth in, say, in the first two quarters of '06 and then revenue will come in the later half of 2006? And second question is regarding the strategies on the music search. You know, recently there's a lot of discussion regarding the lawsuit on some of your competitors. Because of that would you change your strategies on music search? I'll take your first question on the Olympic cost and revenue part. No, we do not expect the revenue, the major costs to come in for the first two quarters of 2006. The reason for that is because we expect the bulk of the traffic to come in really at the '08 when the games are there, so right now the traffic on that Web site is very affordable as far as our existing infrastructure is concerned, so it would not have a major impact on the cost structure for the bandwidth and server, or depreciation on service and on the music search I'll turn it over to Charles. The music search in China is a unique phenomenon because the traditional record music industry was not making much money because of the piracy, so that kind of-- that's why on-line music also reflects that traditional musical industries situation. The-- right now there's the lawsuits with our competitors and it's a collective group thinking in terms of label companies and search engines and also the Web sites that providing MP3 music. I think it will take some time for this group discussion to continue and eventually there will be a new value chain might be able to be established on the on-line music distribution, which is either direction for the future of musical distribution. Unlike in the U.S. where the musical industry already makes huge amounts of money and in China it's actually is really exploratory for us where multiple parties are searching for the right business model, so we believe that this on-line distribution for the free music will continue for a while and then eventually there will be some paid music business model emerge, so sogou music search will continue and not only on searching, but especially by providing the best listening software to enable, enhance user experience and then for users to manage their music, so when music, paid music and copyrighted music, everything becomes mainstream our technology and software continue. And also, these music searches are also bringing traffic that will stay and for the users to search our Web pages and news and other searches, so it is a long-term strategy. Okay, I just have one simple follow-up, so regarding the top-line impact from the Olympics, should we expect that it would come actually in 2006 starting from which quarter? We just got it literally a couple of days ago, so we will give out the specific guidance on the outlook of our advertising revenue on our next call. Thank you. Ladies and gentlemen, due to time restraints we are unable to take any further questions at this time. I'd like to turn the call back over to Mrs. Shea. Please go ahead, ma'am. Thank you. We would like to thank everyone for participating in today's call. The management team will be on the road in the U.S. to meet with investors in early December. Please contact us with any additional questions that you may have. Thank you, very much. 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EarningCall_234091 | Thanks for holding everyone and welcome to the Novellus Systems 2005 Third Quarter Earnings Release Conference Call. During the presentation all participants will be in a listen-only mode but afterwards you will be invited to participate in the question and answer session. Also, I would like to remind you that this conference is being recorded. Your speakers for today are Richard Hill, Chairman and Chief Executive Officer, William Kurtz, Chief Financial Officer and Robin Young, Vice President, Treasurer in Investor Relations. I would now like to the turn over to Ms. Robin Young. Thank you operator. Good afternoon everyone and thank you for joining the Novellus Systems Third Quarter 2005 Earnings Conference Call. With me today are Richard Hill, Chairman and CEO, William Curtis, Executive Vice President and CFO. Financial results for our third quarter were released on PR Newswire shortly after 1:00 pm Pacific Time. You can obtain a copy of the news release in the investor section of our website at www.novellus.com. Todayâs earnings call contains forward-looking statements about Novellusâ Business outlook. These forward-looking statements and all other statements made on this call that do not concern historical facts are subject to risks and uncertainties that may materially affect actually results. Specific forward-looking statements include but are not limited to our expectations regarding semiconductor industry growth in capital equipment spending. Our progress in securities bookings with leading semiconductor manufacturers, the demand for and competitiveness of the companyâs products, managementâs projected bookings shipments, revenues, growth margins and earnings per share target for the fourth quarter of 2005, our 2005 financial models, our anticipated tax rate for the fourth quarter of 2005 and other anticipated future events. Information concerning these risk factors is contained in todayâs press release and in the companyâs filings with the Securities and Exchange Commission including itâs Form 10-K for fiscal 2004 and itâs most recent Form 10-Q and Form 8-K. Forward-looking statements are based on the information as of October 17, 2005 and the company assumes no obligation to update any such statements. William Kurtz will begin todayâs call with a review of the financial results for the third quarter followed by guidance for the fourth quarter of 2005. Richard Hill will then discuss the state of the business and then we will open the conference call for questions. I will now turn the call over to William. Thank you Robin and good afternoon everyone. As you know this is my first earnings call with Novellus. As Robin has indicated I will review the third quarter financial results and provide a financial outlook of our key metrics for the fourth quarter. The focus of my comments will be to provide you with insight and transparency where possible to better understand our financial results and outlook. The key metrics for the third quarter which include bookings shipments, revenue and earnings per share, were all either inline or exceeded the guidance provided on our mid quarter update call on August 30. First I will provide you with a summary of those key metrics for the quarter and then provide additional analysis. Net bookings of $287 million were at the midpoint of our guidance and were 7% in the second quarter. By way per size bookings were 77%, 300 mm and 23%, 200mm. Shipments of $316 million was slightly above guidance and were down 9% from the previous quarter. Revenues of $339 million exceeded our guidance and were up 3% in the June quarter. Net income was $23 million or $0.17 per share on a GAAP basis. Net income on a proforma basis was $29 million or $0.21 per share, which was at the high end of our guidance range. I will provide some additional analysis to help you better understand our third quarter results. Third quarter revenues by geographic region were as follows. United States 25%, Korea 17%, Japan 16%, Taiwan 15%, Europe 13%, Southeast Asia 10% and China was 4%. Gross margins were 43.4% in the third quarter down from 47.8% in the previous quarter. Excluding restructuring charges, which were included in cost of goods sold, gross margin on a proforma basis was 35.0 for the third quarter, which was down 2.8 points from the second quarter. The decrease in gross margin on the proforma basis is primarily a result of higher warranty cost, low absorption of manufacturing overheads and other timing related effects. Higher warranty costs are a result of an increased proportion of new 300mm tools that were installed over the past several quarters, which are experiencing higher warranty costs in the earlier period of installation. We expect this higher level of warranty cost to continue for another quarter and then improve thereafter to ultimately return to historical levels. On prior earnings calls we have disclosed the effect on gross margin related to the sales of previously reserved inventory. During the third quarter the sale of previously reserved inventory was not materialized. Total operating expenses for the third quarter were approximately a $150 million, which was essentially flat with the prior quarter. Now we have initiated a comprehensive strategic planning process in September and as part of process we are reviewing our entire product portfolio over the balance of this year to assess the results achieved to date of our R&D spending programs and determine the companyâs strategy and business plan for 2006 and beyond. Included in our results for the third quarter is a $9 million pretax charge primarily related to the write down of inventory and safety factors resulting from our decision to relocate our Arizona operations to California and Oregon. The details of this restructuring are contained in todayâs earnings release and our memo to our Form 8-K filed earlier today. These charges reflect the consolidation of facility and operations, which will reduce future operating costs and improve our ability to more tightly integrate the CMP business with the rest of Novellus. We expect record addition charges of approximately $6 million in the fourth quarter of â05 and $13 million in the first quarter of 2006 in connection with this restructuring. When the announced restructuring is fully implemented by Q2 â06, the total savings are estimated at $1.2 million per quarter. Our tax rates was approximately 25.9% for the third quarter, on a proforma basis our effective tax rates were 28.7% which is about 1% lower than the prior quarter due to a recession in our fiscal â05 net operating profit forecast. We anticipate an approximate effective tax rates just below 30% for the fourth quarter of â05. our third quarter net income was $23 million or $0.17 per share compared a second quarter income of $33 million of $0.24 per share. And on a proforma basis net income was $29 million or $0.21 per share. Now turning the balance sheet, we ended the quarter with $889 of cash, short term investments and restricted cash which was an increase of $35 million over the prior quarter. The increase is primarily due to positive cash flow from operations of $52 million along with proceeds from employee option exercises and stock purchase plans of $10 million offset by a repurchase of common stock of $30 million and debt repayments of $12 million. Net accounts receivables of $344 million grew by $23 million in the quarter. This increase is due to mainly to the timing of shipments in the September quarter and a slight increase in payment terms which resulted in our DSO growing from 87 days to 96 days at the end of the September quarter. Inventories came in at $206 million at the end of the quarter, which is a decrease of $30 million from the June quarter. Now $5 million of this decrease was the result of the right down of inventories associated with the CMP restructuring. The remaining 25 (0905) came from operational reductions, which was the result of the main inventory model that is being led and implemented by our operations team. Capital expenditures were $9 million and depreciation and amortization totaled $20 million for the September quarter. Now with that let me turn to our outlook for the fourth quarter. For the fourth quarter we expect bookings to be flat, to up 10% compared to the third quarter, shipments are forecasted to be in the range of down 5% to 10% and revenue is also forecasted in the range of down 5% to 10%. Based on that earnings per share excluding any additional restructuring of special charges are expected to be $0.15 to $0.17. With that I would now turn it over to Richard Hill who will comment on our customer and business environment and then open it for Q&A. Richard⦠Thanks William. Good afternoon ladies and gentlemen. I appreciate you joining in the call the overall business is flattish to slightly up. Our bookings in this quarter, if we had $34 million of debookings, so if one look at gross bookings of 320 million it look like a fairly strong third quarter, but ended down unfortunately due to the debookings. However the new bookings front does look relatively positive, and as build just reported. We are looking at flat up again for the fourth quarter. It continues to be a difficult pricing environment particularly in some of our newer product, where we are trying to penetrate the markets specifically PVD and CMP in other areas where our products have substantial market share the pricing ability is somewhat easier. The technical demand on all our products continuous to grow, as we make the transition from 130 to 90 and 90 to 65 nanometer technologies. On a regional basis the US was strong this quarter Japan is jump a little bit and Asia remaining fairly steady during the third quarter. The capacity drivers today are clear flash memory particularly NAND continuous to be a strong driver, and we expect that to be true going forward. Graphics gain more is demand is very, very high, and so we see some demand within the foundries are causing capacity to be added. And of course there has been a steady PC demand well not as robust historically as it has been, it is still relatively strong and therefore unit volumes continued to grow despite ASP erosion, those with cash are continuing to vast. Overall for our product standpoint I think we are very, very well position in PV, CVD, HDP Electrofil and tungsten, stripped has begin to win substantial markets share with in Asia, which I think both well for the future. In the area PVD, we continued to show good technical performance, but as a same time seen to not be able to convert that technical performance to repeat orders, and shipments however we are anticipating that to occur moment early CMP as I told you is a 2006 story, and we still believe that to be the case. Service and spare parts continues to be strong, and a good business opportunity itâs also a leading indicator of capacity utilization, as we see these numbers grow we see likelihood of capacity expansion in the industries. And the macro economic front, we continued to remain conscious, because a lot of the demand thatâs currently in the market place is driven by consumer product rather than an industrial products, and as subject to macro economic environmental around us. On an operational know we have challenges in gross margin as build reported, but we are dressing those challenges continuing to drive down in material cost and increasing our overall operating efficiency. Our return on R&D is subject to our ability to continued to grow market share, and some of the newer product segments and from our asset management needs to come under control in other areas as you can see by the inventory numbers weâve made substantial progress there. And we are continued to do so, DSO is slip back a little bit, but more due to a timely issue, then a lack of focus and I think you will see that corrected in the fourth quarter, but we still have a large he number of the evaluation systems, that are currently out in the market place, which drives up our other assets, which certainly can use some improvement. So with that flavor I will open it up to any Q&Aâs you might have. |
EarningCall_234092 | Hereâs the entire text of the Q&A from Amgenâs (ticker: AMGN) Q3 2005 conference call. The prepared remarks are in a separate article. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. [Q]: Thank you. My question is on the security business. You had a strong rebound this quarter. I also note that overall, Europe was very strong this quarter for the company. Can you elaborate where you saw the strength and security by region? Thank you. [A]: Hi, Nikos. The security business and the strength was actually pretty balanced across the theaters, across geographies, across customer types. We continue to see success of the security products in the service provider customer base. We continue to see growth and acceptance in both the number and type of enterprise or private network customers. I wouldn't say because we didn't really see this attachment. I do not know if you were meaning to ask these two questions linked to one another, but the growth of the security business was not a disproportionate contributor to the strength in Europe. We have several large relationships or large account relationships in Europe, probably with the service providers, but also with a number of key enterprise customers as well and we've been focused there also, but I wouldn't attach the strength in Europe to the growth and security. The security business delivered pretty balanced results across the company and across the theaters and markets. [Q]: Great. Thanks. I was wondering if you could give us a little more of an update on what is going on with the distribution channel. You'd set out a goal at a conference back last year to bring your distribution channel up by almost double what it was at the time. I believe you were around 500 and we were talking about bringing it up into the 1200 vicinity in terms of ad bar distribution. Can you give us an update on where you are on that? Where that change in structure is going and how the integration of the new acquisitions fit into that structure. [A]: I sure can. And there is actually a goal to bring the number of partners up and down. Let me explain what I mean. In terms of the elite partners or those or select partners, labels we give them, but essentially the top tier partner who's are deeply skilled and trained on the products and have demo and support and service and sophisticated capabilities to offer to their customers, our goal is to actually not necessarily drive that number up, but down so that it is truly a valued status. And those partners will take a significant percentage of the business and will be rewarded for the value that they can add a to the network. Now, the balance of the partner base is one, which we are intending and have seen growth and increase in. Some of it is flipping from one status to another, but growing the partner base in absolute numbers is a good measure of the brand strength of the company because partners may not be as deeply invested, can still be drawn into our partner fold because of the demand generated at the end user customer, who says to, perhaps a trusted partner that isn't in our fold, âI've heard about Juniper and the magic quadrant or I have seen from someone I met or someone I know in the industry, they have had success with Juniper and I want to bring that product into the company.â And you want to see that demand creation. And one of the ways to measure it is whether the absolute number of partners goes up. But those partners may be doing that purely on a response demand basis. And That's different than a partner commit on a pro active basis to build and grow the presence of Juniper in the market. So two different kinds of partners. We have deliberately driven the number of our top tier partners down to those who are really able to commit, and they see a larger reward for demand generation and we have seen the total number of partners go up in response to the brand and the marketing and the company itself. [A]: There are a couple thousand partners in total. But of those a number, it is actually saying in America's update yesterday, where the number is in the low hundred's, and worldwide it is only going to be a few hundred of the really top tier partner that we're in search of in certain markets. But it will be, and it is in the thousands worldwide for total partners. I should also make sure I include here these are in our terminology, these are distinct from our Global Partners. Those being Siemens, Erickson, Lucent and NEC, who, as we mentioned with Siemens the strength in that business continued support and strength from Lucent, obviously with BT-21C and other project had been involved with, Erickson as well the strong contributor, any season important relationship. Those are in a different category of co-partner, but that, if that helps that's a little more color on numbers. [Q]: Thank you. Could you just go over the break of infrastructure from security from service revenue? And why the service revenue was up so strongly it is? Is there a seasonality for renews on contracts? [A]: It was up about 15% from last quarter, Gina. And some of that, by the way, some of that strength is a function of focusing on the broad portfolio and attach rates that we get of service contracts and a real deliberate move to drive service into the business and into the customer relationship more aggressively. It is not really seasonal or attached to any outside phenomenon. That's much more internally generated as we look to push the value of service and support for the customers into the product sales and into the partner relationships. [Q]: I wanted to drill down a little bit on the trends and in terms of the triple play you talked about. I guess what I'm trying to really understand is should we think about your sales into these applications as a leading indicator, coincident indicator or lagging indicator? And obviously we're relatively early, but what I'm getting at is trying to get a sense of lumpiness you anticipate in terms of the carriers building out capacity that they will fill up and we can expect slow downs at some point, or do you see it as a steady trend related to triple play again? Thank you. [A]: That's a good question, Simon. I think, I would say the answer is changing, or at least our view of this. This is can be a bit of a generalization I guess out of necessity, but I guess we had one of the greatest leading indicators in history through 2001 and 2002 when this whole infrastructure billed out and moved to next generation got way ahead of itself. And been a lot of the roads were built before any of the traffic was ready to travel across it. And then the slow down sort of stopped all of that. Well the traffic generated, although traffic continued throughout, of course, but this not at the same rate that the infrastructures got built out. And so the question, which I guess is most interesting, looking forward to your point, is it now coincident? I don't know the answer to that. I would certainly say that there are a lot of things going on, that give us enthusiasm just looking at the numbers. Just it is 308, I just looked for example through some of the numbers today. There are 384 million unique global visitors to Google as of midyear. There is 180 million global broadband subscribers in 2004 there's was 1.1 trillion SMS messages and there is 79 million pay pal accounts, it will be 600 million cell phones this year sold with cameras and browsers on them. Thatâs the sales expected this year alone. Along with lots of other numbers like that, so I think we're in a position where the variability between infrastructure and service billed out as much less. We're not going to get way ahead and nobody is going to get way behind because there is still an awful lot of demand being generated for the services. The drivers in this triple play trend are really competitive in nature amongst the providers. The cable is pressured by satellite and wire line is pressured by cable, wireless pressures everybody in one dimension or another. It is amazing the rate at which iPod sales are taking place and all the things, you know, surrounding it. I think what we're seeing is kind of the second wave here which is we've reconciled the discrepancies between leading and lagging deployment of infrastructure largely. And what we will see, whether still has the opportunity to demonstrate some lumpiness to it for sure, is that we will see much less variance between service acceptance and infrastructure build out. I hope that helps to answer your question. [Q]: I think I will drill down just a little, are you very dependent on acceptance of video as an element to fill up the networks? Or did that not have to happen? [A]: Well, I sure hope everyone out there gets excite about HDTV. Just, if you are asking me from a bandwidth point of view, let me put in a small commercial for that. But other than that, I think these are all trends that are pretty aggressively underway, whether it is in the form of fiber optic build outs or the growth in Voice over IP, putting coincident pressure from another perspective on this market. And we are seeing the IPTV and otherwise just video over the new infrastructures happening in all 3 major theaters. It is obviously the topic of the day here in the U.S., but it is significant in Europe and it has been big in Asia. That's not only video, but again HD video, and, you're right. Those are dramatic differences in the amount of bandwidth consumption. So the more of that that happens and the faster it happens and the more of it is HD, the better it will be, but I think there is an awful lot of momentum behind it worldwide. So we feel reasonably well diversified here. [Q]: Thank you, I have first just clarification, we need the option expense for the quarter just for our own model, also if you can clarify the 17%, you have sequential growth. Is this, can you compare it apples to apples ? You said the service layer technology, the security grew 8% and I'm trying to see how much of the other part of the 17% is growth because of full consolidation of businesses this quarter and how much of it is really organic growth quarter-over-quarter. And in this context if you can also give the J-series update . What happened this quart ?. [A]: Well on your first question, we don't have the stock option expense element for this call. We will have that in the queue, as a note to the queue, but we don't have it prepared for this call. And as you know, we are now reporting that as part of our GAAP at the moment. With regard to the clarification of that 17%, we did point out that the security portfolio portion of it grew 8% and we also indicated that the new acquisitions represented about 2% although increase quarter-to-quarter and so you can compute some are different numbers in there, but we don't want to go into the exact quarter-to- quarter changes for some of these companies that you are running during the second quarter. You know, we reported on what they were in during the third quarter, when we had the results ourselves. [A]: Yes on both the J series and the product categories in general, j series was up actually it was the strongest percentage growth in the quarter, but again of a small base it is still in the 2-3 million-dollar range. But in each of these product there's there is a couple of points to make. One is, as we run these businesses integrated with Juniper, relative to stand alone status, we disassembled the service revenue and that becomes part of our aggregate service reporting and is a single unified service business. So we're going to, so those all run distinct from product. And then there are significant efforts underway in the form of integration of some of those products. So part of this also is to focus on and report on the way in which we are running the business going forward. [Q]: As kind of the network architecture is changing and the IPTV front, some people are going to go through ABRaz router may be the E320 others may go direct Ethernet. How does your opinion change or not change on your need to have a Ethernet switches part of your portfolio now both enterprise and carrier? [A]: More there is a couple questions in that and let me departs it into two. The notion of the network architecture and the, then upon E320 and fasters some that may not followed the architecture was quite as closely in all of this, there are clearly a couple schools who thought about how video over IP or IPTV in particular will be deployed. One model is to push the intelligence out there, literally thousands or millions of end points. And the other model is to do it in more centralized fashion. We don't believe here that intelligence deployed to hundreds of thousands or millions are eventually millions of endpoints is a scalable way to grow these networks. And so one of the reasons for the E320 and for the focus on having concentrated points of intelligence within the network is that it is, that actually only way any network but we know of in histories ever scaled, which is that you (indiscernible) 49:28 assemble control points in the network that used to be called. And now it is all part of the infrastructure for IP. That is exactly targeted the E320 has been built for. One of the reasons why its gone so quickly from shipments from announcement and market availability to shipments to revenue as Bob mentioned in the same quarter. And then to the second half of the question around Ethernet and aggregation, Ethernet is clearly important in all of this, which is an interface type. And That's kind of different than the question of whether you have a switch architecture is needed and what's required there. We clearly believe Ethernet as an interface in strategic and if nothing else, just because it is simple. And it is cheap. And so there is a lot of the Current business that we recognize and product that we ship. If you look inside the port revenues, a pretty significant percentage of those port shipments are actually Ethernet ports within the routed infrastructure. And this architectural reasons people are doing that because they need the intelligence of routing, but they need it presented through the simplest and lowest cost port you can give them, and that's why those ports are a reasonable composition in our product mix. So we think we are at a pretty good spot here in terms of being able to deliver value, which is what the Routers do and then the security that goes with that and so being able to deliver it through low cost and interface types which is what the Ethernet ports do. [Q]: Hi, thanks, guys. I'm wondering you can give us an update on the WAN optimization products you acquired a quarter ago? Last quarter you indicated that you think this is a billion dollar market opportunity. I'm wondering if you can give us an idea of what you think that market might be today and maybe in 2006 as well as your position there? [A]: Scott, this is actually one of the very exciting products that we see in terms of growth. I was just meeting with our teams on an update of the quarter and the business, and in these new, actually I'll give you this number because it is a collective of not only when Optimization, but the application front end technologies as well, but what we call our application acceleration or application assurance. Am I just looking at some data for the website and what our qualified leads generate from the website is. And the number of qualified leads that are coming through our website for these application Technologies both WAN optimization and FE is about three times their contribution of revenue compared to other products on the same website. In other words, there is a significantly disproportionate interest in people coming to Juniper, in many cases unsolicited and when we think qualified lead, it is more than just out looking around the side. It is somebody that wants to be contacted by us because they have a need and That's our definition of a qualified inquiry. The WAN optimization in particular, is pretty straightforward because you can install it in a couple of hours. You can see in many cases twice the benefit relative on the same line and running at the same speed, twice the benefit and twice the throughput in terms of user experience. So we have programs let say, may be 2 X 4 program, .you put it in 2 hours you get twice the benefit. If you don't buy it, we will give steak dinner for two. And we are not selling a lot of steaks. So this is a very good area for us, and the whole market for making these applications run better across these networks and really stepping up to help CIOâs with strategic issues in the application area is something that we're seeing a lot of benefit from. [Q] Great, Scott. Do you have an idea what your market share in both the application side and the WAN Optimization side might be? [A] I don't know, I donât have market share numbers on this. Some of the categories still, what products billion and not into the categories is, things are still under some debate. But one of the things we do see in both these categories is that we're operating in this magic quadrant of Gratners where it is the place of having both the vision and the ability to execute and what have you so, you know, there are numbers talked around about the market it being a billion dollars and I think thatâ certainly something we will see, but I think at the moment some of the categorization is little difficult. The main goal that we have for the moment is just to make sure that our share of mind and our participation and our ability to deploy these products into a growing customer base is something that meets the internal targets. And that found that to be more valuable in the early stages of a market than external measurements until it gets established, and this is clearly still a lot of new frontier that's we would pretty excited about. [Q]: Hi, Scott. I was wondering if you guys could give us an outlook with regards to your enterprise business, you talked about it being a third of revenues now. Where do you see that growing to as part of your mix overall? And how do you think about making incremental investments in a higher touch sales force? How important is that to the success of this business? And might we see a continued expansion of that over the next several quarters? Thanks. [A]: Brant, happy to take both those. It is kind of interesting, isn't for a company that is, co-trying to get into the enterprise business to actually be running a three quarter or a billion dollar business in that market is not bad. So, when we look at how we grow that or what we do with it, what we're trying to do here is really kind of two fold. One is on the competitive front, I guess, when we look at our positioning. I think there is three categories in which you can compete. You can either bring the best, the most or the cheapest answer. And our focus is on bringing the best answer. And in order for that to be successful, it has to be pointed at a real strategic need that a customer has, because if they don't care that much or if it is not strategic they will take it from the convenient supplier who has the most or from the cheapest supplier who gives them a deal and, so for us, that does translate into higher touch. But it is higher touch in two forms of the one is demand generation for our partners. and doing that with our major account, territory account managers who's are very active in the market place around the world with dedicated assignments either on a specific set of major accounts or on a territory basis. And then the other is to really equip and support and incent, the key strategic partner relationships that we have around the world where they have already built trusted partner relationships with their customers and we are enabling them to bring value to those relationships through what we can support then with in terms of the best technologies. So, it is a little bit of both demand generation with a lot of direct touch on the targeted major accounts and in the accounts in the major geographies we want to be personally and sometimes deeply involved with and including myself. We made a point over the last year actually of spending a lot of time on this. But a lot of it also is using these strategic partners and making sure that they have the kind of support that they need for the relationships they already have, so it is two fold. And our outlook as a result of all this is a key part of the momentum that we see in the business and the growth that drove us to raise guidance. [Q]: My Question is on the op ex increases, not for just this quarter, but if you look at over the last four or five quarters you added a head count of almost about thousand people couple hundred coming from acquisitions, could you talk about, How much of that is gone towards traditional routing and security businesses versus some of your new initiatives in the enterprise area and when you expect some sort of a revenue ramp from those investments over kind of what period? Thanks. [A] Okay, I'll answer that question first and then Scott will talk about it as well. The way we report the numbers is in specifically by standing by those two groups. But I can say that will we spent significantly in the both IPG and SPG, R&D areas. We have been introducing a number of new products in both of those areas are quite a lot of R&D spending growth, and then we've built out our direct touch sales model and regional by sales organizations as well so. Most of the spending came in increases in head count in the research development area as we mentioned we have an increased focus on internal development there and then we've continued to increase sales head count on both the regional basis and more people in existing countries to improve our high touch models. So these are the two areas for the spending and then I mean Scott will elaborate more on that tomorrow too. [A]: Yeah Subu that really covers most of it, itâs Bob mentioned, I mean, as a percentage and I guess within the operating model it is really not changed a great deal. In R&D was up a 10th of percent this quarter sales and marketing up by half a percent, but operating expenses up .6 times of percent but in total if you see from those gross margin the operating income were within the model and expect it will stay within the model. The opportunities we have are tempting, some frankly. Because there is a lot of potential, so I guess it whatâs you call a target rich environment for development. Because there is both momentum on the stand alone products and some of those in particular that have come to Juniper as a result of recent acquisitions, but also there is a lot of Opportunity for integration. And we are doing some of all of that. We are doing it in India and China, Israel and Canada and, you know, around the world here. So there's clearly an opportunity to do that. On the sales side of things, as we look at Eastern Europe, I was in Moscow a couple weeks ago, as we look at the Middle east itself and as we look at countries in Asia, there are a lot of opportunities for us to expand our footprint along with then having the product portfolio or the capabilities to take advantage of that expansion. But overall, and I guess the main thing which keeps us from some of these temptations, is that we're going to be prudent in managing the business relative to the operating model that we have as a company and that we have had for some time. And you see that in the results this quarter and over the last several and you'll see that going forward. [Q]: Hi, thank you very much. My question is that, first of all Bob, I want to make sure that I understand when you said the acquisitions corresponded to 2% of the growth, when I calculate there is that the acquisitions went to about $9 million this quarter up from approximately $3 million this last quarter, the j-series and then backs about $3 or $4 million up from $2 million in securities but $95 million up from $88 million last quarter. Am I in the ballpark of the right things in terms of how I am interpreting the 2% number? [A]: Well, I said Approximately 2%. So I don't want to be more precise on that, but the, our move have been very pleased FE acceptance of the New acquisition Products by the sales force. I think they are getting off to a great start. Scott just mentioned how we are getting a lot of leads associated with those products. So we're very pleased with the way the new acquired products are going to be taking off from the company. [Q]: Okay. So if it $9 million is in the ballpark there, is that, you expect that to grow, the acquisition part of your business now you got a full quarter in there, those three businesses, do you expect that to grow faster going forward than the other parts of your business, or just , they must grow in line with the J series and net screen and your routing business? [A]: Actually, through the perspective on this, likely helpful in terms of though then I eluded in this in the script, but I'll just expand for a moment on our strategy. The primary goal and it actually goes back to a question that Brant had asked earlier about the higher touch model and the need to build these strategic relationships with partners and customers. We have a primary goal and we motivate in commission in our sales organization and our channel organization in support of our partners, which is to establish the presence and the strategic value of the Juniper brand in the eyes of our customers. And that translates into going into targeted opportunities where we think there is long-term potential for a trusted partner relationship to be built with a customer. And so their compensation and their measurement is tied to success in building that relation ship and in some cases that I mean that they will prefer WAN optimization and in some cases it will be access routers or fire walls or IDP or we have the benefits of having the portfolio is that, we can bring them best in class answers in a lot of different areas. But we don't compensate them on the basis of saying build this major account relationship by selling three fire walls, two IDPâs, WAN optimization and four Routers. So as a result, their goal, its like a use an analogy, their goal is to score points and win the game. It isn't to make sure that every single player on the team Scores in every quarter. And as a result they are not really trying to Throw a pass to every single player on the team. We are just trying to extend our current 13-game winning streak here to 14 and 15 and beyond. And so while we obviously want balance performance of the products over time, we clearly need all these products to contribute in an on going and a predictable way when we look at the performance year-over-year. The strategic objective is on a given quarter or a given snap shot or an instance in time is to build that trusted relationship and we assume the product balance will come over time. So certainly you will see probably higher growth on a percentage basis for some of the smaller absolute dollar product categories but I just want to take the chance to elaborate on the way that work, managing the sales force as we build the brand presence that we have in the market. [Q]: Yes, Congrats on the good quarter. Just revisiting the security piece just to be clear, that is all organic when you say that grew 8% sequentially, is that correct? [Q]: And were there any specific product that's did particularly well, and how is the linearity for the quarter in security? [A]: I can take a piece of that, Eric. It was pretty balanced, actually the firewall products and our deep inspection securities is certainly a factor in this. We have a product called the ISG, which is integrated product for intrusion detection and prevention, which is certainly a driver. The 5 VT products which is a product that integrates wireless access points for Wi-fi with security capabilities is a great product. In fact, That's one of those product that's is often selling through the website. In fact, we've given a few of those away to show people how they work and they have come back and bought more. There has been a pretty good distribution of those products and of their contributions and of course with the development investments we expect to see more examples and a broader range and more integration as we go forward, and then again as Bob mentioned, thatâs all at this stage that's all growth in the last quarter is organic through either existing products or the result of Development efforts undertaken in the company itself. [A]: I'm sorry, I forgot the second half of that. It's never as good as you would like it to see. You would like for it to be done on the first day. It is more back end loaded than ideal, although it is getting better. And it is something we are very focused on managing and trying to drive as a behavior in the market place and so I expect to see continued improvement on that. [Q]: Scott, I wonder if you could give any insight you might have with respect to competing for edge routing business with respect to IPTV applications, in the sense that we have seen the majority of those awards thus far go to a single vendor who's acting as both the integrator and the product supplier. And I'm just wondering, do you have a specific strategy for competing in that type of environment? [A]: Certainly our objective here is to play in as many areas with the network as possible. We currently enjoy more than 25% share of the multi service edge market and the IPTV application is one example of the Multi service edge and we have seen a lot of opportunity in the market place to begin to differentiate ourselves competitively by being focus on delivering capabilities and performance and intelligence in architectures to scale. So it is something that we can, that we think we can leverage going forward in the IPTV and video over IP are clear opportunities. And then one of the most powerful attributes in this, which IPTV is one example, although there are others is really to wrap all of this up in security because in affect, infrastructure without securities has no value, I mean there is actually no such thing. And secure infrastructure is not a two-part concept. It is one comprehensive solution proposition that is needed. So I think one of the things we are seeing that is helping us with our momentum and one of the reason that's we've been able to raise the guidance yet again this time this quarter is because we're seeing an ability for the solution and for the security elements as an integral part of that to be increasingly strategic and people need to see those combinations and need to see those solutions in order to have confidence to go forward, and so it's a trend that we are quite into the yard stick about and that has made a pretty significant contribution to our presence at the table and in all of the opportunities and really all of the applications worldwide. |
EarningCall_234093 | Good morning ladies and gentlemen, my name is Melissa and I will be your conference facilitator today. At this time I would like to welcome everyone to the China BAK Battery Inc. first quarter financials and corporate update conference call. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks there will be a question and answer period. If you would like to ask a question during this time please press star then the number one on your telephone keypad. If you would like to withdraw your question press the pound key. Thank you. It is now my pleasure to turn the floor over to your host Matt Hayden from Hayden Communication. Sir, you may begin your conference. Thank you Melissa and thank you to everyone whoâs joining us on the call today. As we recently passed the one year anniversary of China BAK Battery becoming a publicly traded company we wanted to take this opportunity to provide shareholders and investors with a summary of the first quarter and fiscal 2005 year-end results as well as an update regarding the Companyâs progress and growth strategy for this year. 2005 witnessed several material events as the Company significantly grew its business, raised capital to expand its manufacturing capacity and grew its customer base while controlling manufacturing costs, improving yields and began the tradition to a broader product portfolio, all which positively impacted margins. Our call today with be hosted by Mr. Jim Groh, the Companyâs U.S. based Executive, who will provide a business overview, summary of last yearâs accomplishments, a perspective of the market opportunity as well as a discussion of the growth initiatives for 2006. In addition Michael Drennan, the Companyâs Financial Advisor, will discuss the Companyâs first quarter and fiscal 2005 results, while Dr. Henry Mao, the Companyâs Chief Operating and Chief Technical Officer, will be available to answer technical questions during the Q&A session. Before we get started Iâm going to review the Safe Harbor statement. Statements in this conference call that are not descriptions of historical facts are forward-looking statements related to the future events and as such all future forward-looking statements are made pursuant to the Securities and Litigation Reform Act of 1995. All forward-looking statements related to the business of China BAK Battery and its subsidiary companies which can be defined by the use of forward-looking terminology such as believes, expects or similar expressions, involve known and unknown risks and uncertainties. China BAK Battery is under no obligation and expressly disclaims any such obligation to update or alter its forward-looking statements whether as a result of new information, future events or otherwise. The company is subject to the consideration and risks of operating in the PRC. These include risks associated with the political and economic (inaudible), foreign currency exchange and the legal system in the PRC. With that out of the way, I will now turn the call over to Jim Groh. Jim congratulations on a solid year and a great start to 2006. The floor is yours. Thank you Matt and thank â good morning and thank you to everybody joining us. We welcome those of you who are new and learning about BAK and we also welcome our old friends whoâve been involved with us from the beginning here. Fiscal 2005 indeed was a successful year for our company as we topped $100 million in revenues for the first time, expanded our margins, and we completed two financings which raised approximately $60 million. This capital set the stage for continued growth by enabling us to expand our production capacity while leveraging a larger base of working capital. We utilized this capital infusion to expand our manufacturing capacities which came online and has enabled us to operate at a production rate of 22 million cells per month when we exited the first quarter in December, up from 15 million cells per month previously. Itâs important to note that since this increased capacity just recently came online and provides incremental growth capability during quarters two to four of this fiscal year, we also announced yesterday new manufacturing agreements with original equipment manufacturers including Lenovo and A123 Systems. These announcements represent significant growth opportunities and are key to our future strategies. Iâm going to expand on this later. We also installed the capability and began producing lithium polymer batteries, which address a large number of growing applications for various electronic devices. As we brought new production online we began to build inventory in anticipation of new business both being won and pursued which positions us well for fiscal 2006 and beyond. Since this is our first conference call and since we have many people joining us who are new to the BAK story, Iâm going to start by providing an overview of the Company, discussing our core market verticals and our growth opportunities. Iâll also spend some time discussing our operational initiatives and how the business is involving to plan. After Mike Drennan discusses the first quarter and fiscal 2005 financial results, Iâll then discuss the Companyâs macro drivers and our 2006 goals and objectives and open the floor for questions. Shenzhen BAK Battery Company Limited was founded on August 3, 2001 and has grown in that short time to become one of the largest manufacturers of replacement lithium-ion or LI-ION battery cells in the world. On January 20, 2005 China BAK Battery Inc. completed a reverse merger and began to trade publicly in the U.S. with a formal name change happening in February. We currently maintain a 1.9 million square foot manufacturing facility located on a 90 acre manufacturing campus in Shenzhen, China. We employ approximately 8,250 people. For those of you who are new to our industry Lithium-ion is the de facto standard for rechargeable battery technology used in portable applications. If youâve got a cell phone itâs a 99.9% chance that that cell phone utilizes Lithium-ion technology. Lithium-ion technology offers significantly higher power in a given footprint, are light-weight and the batteries have much longer cycle life and have no memory effect. Our technology has essentially replaced NiCad and nickel-metal hydride technology in portable applications. When established, the Companyâs first major business segment was the production of cell phone battery cells which were sold to replacement battery manufacturers. These are third party manufacturers who sell under their own brand name or sell to major retailers under a private label. This is a very good business, especially in China where it is estimated that there are more than 380 mobile phone handsets in use today. To put this into perspective, this amounts to more handsets than there are people in the United States and this number is expected to substantially grow in the next several years. Also an interesting and unique characteristic of the market is that used cell phones in China are not disposed of like they are in the U.S. Instead they are sold and resold to an existing distribution network as even the poorest segments of society have need for a cell phone. This has resulted in a geometric increase in the installed base of handsets which continually need batteries and where our replacement batteries â battery cells are sold. Our potential market is the total installed base of handsets. Currently we estimate that BAK has achieved a market share in this segment in excess of 60%. This business provides a solid base and platform from which we will expand. On September 16th we raised $43 million with the proceeds being utilized to build-out increased manufacturing capacity of our existing products, automate certain manufacturing processes to increase both through-put and yields and to fund expansion of our production capabilities to include new products, specifically laptop computer batteries and lithium polymer battery cells. We have also established production on a new high power lithium battery cell for a new customer named A123 Systems. With A123 we jointly developed a new 36 volt battery to drive a new line of cordless power tools produced and marketed by Dewalt. We made good progress in expanding our capacity and product expansion plans during the past year, positioning us well for 2006. In our mobile phone sales we have increased our capacity from 15 million pieces per month last August to its current level of 22 million pieces per month. This capacity expansion came online near the end of the first fiscal quarter, which was the quarter ending in December, and emanates from increased manufacturing lines, increased staffing and additional automation that has improved through-put on all of our lines. Simultaneous with this, we have been able to reduce material cost in approved yields all of which has positively impacted our margins. In terms of new products we are right on track. We invested a portion of the proceeds from the September capital raise in a high volume production line for lithium polymer batteries. Lithium polymer batteries utilize Lithium-ion energy technology in customizable small formats. They are used to power Bluetooth headsets, mp3 players and ultra light-weight cell phones. We have begun a ramp up of lithium polymer products and have seen capacity grow to one million pieces per month. Further product growth is being pursued in the form of laptop computer sales. All production equipment for this product line has been ordered and the production line is currently under construction. We estimate that our facilities will be ready for production early in the second calendar quarter. Lastly in terms of new customers and new products, we recently announced an exciting partnership with a company named A123 Systems and a manufacturing agreement with Lenovo, a company which is becoming a dominant player in cell phone production. A123 Systems is an emerging supplier of specialty high-powered batteries which utilize a new nano lithium phosphate technology based on patented nano technology developed at the Massachusetts Institute of Technology or MIT. A123 is the exclusive licensor of this technology and we began collaborations with them in early 2005 to design, develop and establish a commercially producible product in a high volume production line exclusively for the manufacturing of the A123 batteries. According to our partner A123, its new high powered battery products will be used in a variety of product applications including power tools, medical devices and hybrid electric vehicles. These products meet the most stringent tier-one OEM quality requirements. This is a cutting edge breakthrough technology and we are delighted to be part of this project which we anticipate will carry more favorable margins than our core business. The first commercial application for these high powered batteries are for power tools. Dewalt, a division of Black and Decker, recently hosted a coming out party in the form of a large press event in Orlando, Florida where the companyâs power tool division president and other key members of the management team unveiled the new 36 volt family of products with the tag line The Power of Corded Without the Cord. Bruce Brooks, President of Dewalt Construction, commented that this was one of the most exciting product launches in a number of years. Currently the company Dewalt produces over 30 cordless products and has sold an estimated 50 million 18 volt rechargeable batteries to power their tools. Dewalt embarked on a multi-year project to identify a rechargeable battery technology that could meet the power demands where cordless power tools would replace corded power tools. This search ended when they met 123 who had developed the technology to create some of the most powerful, durable and light-weight batteries available today. Earlier this year Dewalt launched seven new products featuring this 36 volt battery: the drill, a full-size circular saw, reciprocating saw, SDS rotary hammer, impact wrench and jig saw. These new â the batteries employed in these power tools offer two to three times the run time of 18 volt batteries, significantly higher power while offering users 2,000 charges and all of the same weight of traditional batteries. As A123âs manufacturing partner we are the fourth â we are at the forefront of technology and we are excited about the future. According to A123 its new high-powered battery products will be used in a variety of other product applications including medical devices and hybrid electric vehicles. We had previously disclosed the companyâs plan to expand into the OEM channel of distribution. We made significant progress here also. In the fourth quarter over 20% of our business came from the OEM channel and in the first fiscal quarter OEMs represented 26% of our sales. We have also recently announced a strategic partnership agreement with Lenovo. You probably know Lenovo from their purchase of the IBM PC business. What you might not be aware of is that their executives recently announced plans to make cell phones the second product pillar of the company and their goal is to become the largest manufacturer in China. This progress is already well underway as they sell a unique perfume emitting cell phone that women in China simply canât resist. We believe that this partnership with Lenovo represents a significant growth opportunity for our company. We have been producing Lithium-ion cells for Lenovo since August of last year and our new strategic cooperation agreement will allow both companies to jointly contribute and share resources to further product development efforts. This will expand our current relationship and facilitate the development of new battery solutions for Lenovo. And for anyone whoâs interested in looking at the announcement, Iâll refer them to the online Shanghai Business Daily dated November 22, 2005. We are also continuing through qualification and negotiation with other leading cell phone OEMs. We have a lot of horses in the race here and our intent is to grow OEM sales significantly during 2006 and beyond. Besides growth in the cell phone business we believe that our success in forging a relationship with A123 and our ability to successfully introduce a lithium polymer battery line to the OEM channel are testaments of our teamâs ability to execute to a plan. Now letâs touch briefly on operations. We have a multi-facetted strategy to manage and optimize our product costs. First of all we addressed the reduction of every element of product cost on a cost sheet. We are relentless in our pursuit of material cost reductions through strategic sourcing initiatives and use of our purchasing power to gain the lowest material cost. We use the availability of low cost labor to minimize both direct labor and SG&A expenses. We have low construction cost and weâve executed several successful initiatives to improve product yields in manufacturing. For those of you with an appreciation of manufacturing operations, please note that we accomplished these yield increases while increasing our manufacturing capacities by over 40%. Another key facet of our cost strategy is to employ world class automation where it optimizes cost or increases value in terms of through-put, yield improvement, waste reduction or product safety. Execution of these strategies is evident in the gross margin improvements weâve been able to accomplish. Our growth is further absorbing fixed manufacturing costs while a favorable product mix is just starting to have itâs impact. These factors combined have enabled BAK to become a low cost manufacturer and to effectively compete for new business while growing revenues with current customers. Lastly Iâd just like to briefly comment on the technical side of our business. Those of you who know us understand that our strategy is multi-faceted. Itâs based on technical excellence but in a low cost manufacturing environment. The architect of our technical strategy is Dr. Henry Mao, our COO and CTO, who is on the call with me today. He is currently in Korea where he is already working to sell out the laptop computer capacity which will be coming online in April of this year. Henry is known worldwide as an expert in Lithium-ion technology. He has constructed a technical capability that we believe is second to none. We have a new advanced Lithium-ion research lab on our manufacturing campus where we invested millions of dollars for specialty equipment and instrumentation. We have staffed the department with engineers from Japan, China and Canada. We believe we have crafted a unique ability to take laboratory developments and transfer them in partnership with a third party to a commercially viable product which is then produced in one of the lowest cost facilities in the world. We think that the advantage of our approach is that it gives us great leverage and partnering with best-in-class researchers and avoids the situation where we spend lots of money and research on a product thatâs never produced. The A12 relationship â the A123 relationship reflects the successful execution of this strategy. Before I get into a discussion of the industry and the macro trends which drive our results, let me turn the call over to Mike Drennan, the Companyâs Financial Advisor, for a discussion of our financial results. Michael. Thanks Jim. Good morning everyone. Rather than taking this time to simply read the numbers that are already in the December 10-QSB and the September 10-KSB filings, since those are already available to you on the SEC website, I thought that I would spend this time to put them in perspective and to try to give you some additional insight into them. As I review the Companyâs results all of the numbers will be in U.S. dollars which is the Companyâs reporting currency. Also please remember that our year-end is September 30th so that the fiscal 2005 year ended September 30, 2005 and the first quarter of fiscal 2006 ended on December 31, 2005. Iâll start by focusing on the Companyâs most recent financial results for the first quarter ended in December and then finish by touching on fiscal 2005. Revenues for the first quarter were $26.1 million almost $1 million or 4% more than a year ago primarily due to higher volumes. The number of units sold during the quarter increased by 11% in total with most of this increase in aluminum K cells. The overall weighted average unit selling price was 7% lower than last year with decreases in all product lines other than aluminum K cells. The big story for the quarter was the improvement in gross margins increasing from 17.4% of revenues last year to 27.1% this year. This 10 point improvement in margins is broken down as follows. Six points came from lower raw material prices through increased volume pricing and 4 points were contributed by improved labor efficiencies with yield improvements offsetting all other cost increases. Operating expenses were up about $1 million from last year from 8.1% of revenues last year to 11.8% of revenues this year. One of the biggest contributors to this increase were the public Company expenses since this year the Company had to deal with the SB2, 10-KSB, other regulatory filings, an audit, investor relations and you know the rest of the drill. But last year they didnât have to deal with any of that as a private company in the first fiscal quarter. The Company also invested significantly more in research and development and selling efforts this year in anticipation of the increased manufacturing capacity that came online. Finally the Company incurred additional bad debt expense in order to increase its receivable reserves and Iâll talk to that a little bit more later. The end result of all this is that operating income increased by over $1.6 million or 70% from the first quarter of last year. Finance costs were about the same as last year but the Company did benefit from their improved cash position by investing some of their unrestricted cash to earn over $300,000 of additional income this quarter. Income taxes were only 3.3% of pretax income, significantly lower than the preferential 15% tax rate that the company enjoys by locating its facilities in the Shenzhen Special Enterprise Zone due to the recent significant plant and equipment investments it has made. As a result, net income for the quarter increased almost $2 million or 110% on a 4% sales increase from 7.2% of sales last year to 14.5% of sales this year. Earnings per share only increased from $0.06 per share last year to $0.08 per share this year since the number of shares increased by 18 million due to the two equity offerings during fiscal 2005. Turning to the balance sheet, the big story here from a year ago is the improvement in liquidity. Working capital improved from a deficit of $28 million last year to a surplus of $18 million this year primarily due to the $56 million of net proceeds from the two equity offerings in fiscal 2005. Total cash of $36 million at December 31, 2005 included restricted cash of $25 million that served as security for the Companyâs $73 million of short-term loans and notes payable. Accounts and notes receivable increased another $23 million from $27 million or 99 days of sales a year ago to $50 million or 175 days of sales this year. Let me provide some detail there. Notes receivable at December 31, 2005 were $9.4 million and were essentially comprised of December sales to three high volume customers with good payment histories. All these notes are due by June 30, 2006 and $1.4 million of them had been discounted as of the end of December. Gross accounts receivable were $42.5 million at December 31, 2005 but the reserve of $1.8 million or 3.5% of total receivables for a net balance of $40.7 million. There were 13 customers with individual balances of $1 million or more comprising about 70% of the total aging. 63% of the total aging is due within 90 days with another 25% due within the next 90 days. The accounts receivable reserve fully covers all receivables older than 270 days, 100%. Now the company has a dedicated credit department that closely monitors each customerâs purchases and payments as well as their financial condition so that they can intervene if they spot any problems. While the company is concerned with the growing levels of these receivables, they also recognize the need to work with their key customers as they look to grow their revenues to fill their new production capacity. Inventories also increased by $18 million from a year ago with turns dropping from 4.3 last year to 2.1 as of this quarter. Now the company purposely built inventory this year in anticipation of the sales ramp that has already started in the second quarter of fiscal 2006 as well as to provide adequate finished goods to cover the plantâs shutdown for the Chinese New Year celebration. The company expects to work its two-month supply of finished goods at December 31, 2005 down to one and a half months at current sales levels by the end of the second fiscal quarter with further improvements as sales continue to ramp up in the future. The company was also able to benefit with a six point improvement in gross margins due to this increased level of purchasing during the quarter. Property plant and equipment increased by $43 million from a year ago with sales per dollar invested dropping from $4.10 a year ago to a $1.70 this quarter. The Company expects this measurement to recover in the future as they fill the available production capacity. Short-term loans and notes payables increased by $20 million from a year ago but the increase in equity more than offset this as the debt-to-equity ratio dropped from 2.5 a year ago to eight tenths currently. Despite the $91 million increase in total assets from a year ago, the Companyâs increase in earnings more than compensated, raising the return on assets from 6.6% a year ago to 7.8% this year. With respect to fiscal 2005, the Company enjoyed another consecutive record year for both revenues and profitability. Net income grew $5.6 million or 83% on revenue growth of $38.2 million or 60% from the prior year. As a percentage of revenues, net income increased from 10.6% in fiscal 2004 to 12.1% in fiscal 2005 with all the improvements coming once again from gross margins which increased 350 basis points. Weighted average unit selling prices increased 2% from fiscal 2004 to fiscal 2005 while manufacturing costs decreased 1.5%, with steel sales contributing the major of the increase. Thanks Mike. Okay Iâd like to turn our view from internal to external and talk a little about some of the macro trends in our business. The market for Lithium-ion batteries is estimated to be in excess of $2.5 billion and I want to explain that as at our cell prices and weâre certainly up-channel. We believe this business will grow in excess of 20% on a worldwide basis and at even a greater rate in China. Beyond cell phones there are a variety of other applications including laptops, power tools, hybrid electric vehicles, mp3 players and other consumer electronics. Some of these applications like power tools and ATVs have required further development of the core technology in order to make lithium energy technology suitable for particular applications. As evidenced by our announcement with A123 this development is not only underway but at BAK itâs been put into production. These new technological achievements create a plethora of new opportunities for us to manufacture an ever increasing line of battery cells for power hungry portable applications. As most of you know, the Chinese market for cell phones is tremendous. The handset user base was approximately 380 million as of the end of October, ranking number one in the world according to the Ministry of Information Industry. Chinaâs stated goal is to add another 250 million users, significantly more than exists in all of the U.S., in China over the next five years. If this happens, China alone with account for 25% of the global mobile phone market. We like folks to understand that we sell consumable products. While Lithium-ion technology produces consumables which last far longer than competing technologies it is consumable nonetheless. Accordingly a portion of our ongoing revenue is recurring due to a razor blade business model. As the installed base of devices continues to develop, our potential market opportunity expands geometrically. We will benefit from the sale of cells for the original handsets to the OEM and re-sell battery cells for those devices again and again in the replacement market. The appeal of a consumable business is the nature of its growth, the stability it imparts and the fact that you see major changes coming long in advance. So as you can see the market is substantial and our opportunity to grow our market share is significant as we continue to be a low cost supplier of high quality Lithium-ion and lithium polymer battery cells. New portable products are transitioning from older technology to Lithium-ion and the trend towards mobile entertainment and communication products is driving additional growth. New cell phones require significantly more power to accommodate new features like digital cameras, mp3 players, GPS locating technology and other technologies. Coupled with the sheer growth in consumers in places like China we feel we are very well positioned to grow both our market share and grow with the overall markets we participate in. Let me spend just a moment talking about 2006 initiatives. The first is the continued pursuit of expanding our OEM relationships particularly with cell phone manufacturers including names like Lenovo I discussed earlier. This initiative extends to other applications as well including small consumer electronics and laptops. Speaking of laptops, this is our second main growth initiative. It is a product initiative and we believe it offers a significant opportunity to the company. Lastly we see a significant scale-up in the volumes of high powered lithium phosphate battery cells accruing from our relationship with A123 Systems. Mr. Lee our CEO and Mr. Han our CFO and the members of the Senior Management Team believe this year will be another solid year characterized by rapid growth. While we decline to give specific sales targets or sales volumes by product line, Mr. Lee and Mr. Han do have a view towards their expectations in terms of net income and expect to report a minimum increase in net income of 100% for fiscal 2006 over fiscal 2005. This would be in the $24 million range. Depending on the scale-up of certain customer programs, the Company may achieve or even exceed the $27 million make good number that has been disclosed on our SEC filings. We will get a better feel for this in the next quarter as we see how our initiatives and more importantly our customer scale-up develop. It has been a very productive first year for BAK as a public company and we hope that our shareholders are pleased with our progress, financial performance and growth prospects. Iâd like to thank all of you for being on the call today. Just in terms of housekeeping, I would like to confirm with everyone that the Company will be speaking, specifically Dr. Henry Mao and myself, at the Roth Capital conference on February 21st and we may have an opportunity to see some of you folks out there. So we welcome those of you new to BAK and we thank you for your interest in our company. And very importantly, weâd like to thank those early investors who not only provided the company with financial support but with advice and counsel that has been so critical to the development of our company. At this time I would like to remind everyone if you would like to ask a question press star then the number one on your telephone keypad. Weâll pause for just a moment to compile the Q&A roster. A couple of questions here, just a number of shares outstanding. Weighted average share was around 50 million for the quarter, whatâs it going to be for the year once we include all the deals that have been done? Well the actual shares outstanding right now are 48,878,000 so that base will stay that way through the entire year. The share equivalents are going to change as the stock price changes throughout the year, I think around 300 thousand shares in the quarter, so total number of options outstanding are 2 million. So the most that it will be at it will be 2 million shares due to the options so some place in that range you know in the $50 million range is where it should stay for the balance of the year. Okay so all in at 50 million and at 24 million guidance in here. In other words weâre talking somewhere are $0.50 a share. Okay. Secondly, the major increase here in production, going from 15 million units to 22 million units, help us understand that a bit. If you already have 60% of the domestic market youâre increasing your production capability there 47% I donât think youâre going to 90% of the market. What â how long does it take to â in other words whatâs the rationale for that kind of major increase in cell production per month and secondly when will that not only be capacity but actually production? Okay Wilson I was going to repeat the question back to you to make sure I got it. This is Jim Groh and Iâll field the question. Your question is that weâve increased our capacity from 15 million to 22 but with 60 â your question is with 60% share why would we increase the capacity that much? Okay let me address that first. The 60% share number is in a very specific segment. That is sales to replace â the third party replacement battery manufacturers. These â you know itâs not the replacement battery market, itâs replacement battery third party manufacturers. If you go into a Radio Shack or a Circuit City you may â youâll see batteries up there; they donât say Nokia or Motorola they may send Radio Shack brand. Thereâs a 60% chance that that is our product. So that specific product that specific segment. We donât have 60% of the overall cell phone battery business, weâve got significant opportunity to grow share there as we have been especially in replacement share that has historically been held by Japanese and Korean manufacturers because we offer equivalent or better quality at much lower cost. Yeah the second question is when do you think â I mean weâre talking about 22 million pieces per month in capacity, when will that capacity be utilized. In other words when will you ramp that production? Thatâs already â we are producing at a rate of 22 million cells per month (inaudible) not only was the capacity brought on but you know I think you and I have had this discussion before with Paul you know you look at our theoretical capacity all in seven days a week or whatever is about 25 million cells per month but of course nobody ever achieves 100%. Weâre running right now at 22 million, thatâs about maxed out of practical capacity and weâre producing at that rate. Could you talk a little bit about the registration of the two issue pipes that are out there, where you stand on that and I know predictions arenât very good in this arena working with the SEC but help us with that a little bit. Yeah Wilson thatâs basically what Iâve been working on for the last month. All of the filings that the SEC has given us comments on have already been resubmitted to the SEC, thatâs both the SB2 filings for the two offerings that you mentioned. Because of comments that came out of there we restated the â basically all the financial statements between an 8-K that was filed on April 7th, the March 10-Q or June 10-Q all of that is back into the SEC right now. And as of last night we had not received any comments. Theyâve acknowledged receipt of it and said they were looking at it but we hadnât received any comments back from them with respect to it. So weâve got our fingers crossed right now that theyâve got everything they need at this point and hopefully theyâll be able to get us effective very soon. Okay. Just to make sure we understand the company here, basically all the revenues generated so far have been in the cell phone battery market. Is that correct? Good, and how about the high powered relationship here with Dewalt. Can you talk about what the volume might be there or what weâre looking at the order rate or whatever? Again especially the sensitivity of the confidentiality with A123. They have been very kind to allow us to talk about the nature of the relationship but we canât specifically release any sales numbers weâve made to them. I will say that we started shipping products in volume right at the end of the calendar year and that is ramping up now. You know the product wasnât announced to the trade by Dewalt until I think it was January 16th so itâs pretty new stuff. And thatâs â weâve been held back because until it really got out in the market nobody wanted us to talk about it. You know I donât know. I tell you what thereâs two places I could send everybody for information. If youâd like to read about A123 there was a Wall Street Journal article on page B1 which ran November 2, 2005 so if youâre a Wall Street Journal online subscriber you can go pull that article. The other thing is go to the Black and Decker website and the Dewalt section. Theyâve got videos on these new products and kind of their promotion plan. I think youâll learn about it there. I donât know if theyâve filled the channel yet weâre more interested in filling the channel with Dewalt. Pretty good, just a couple of follow-up questions. I donât see depreciation or amortization broken out on this one. Do you have that number? Hold on just a second. Itâs â the Q is actually on the SECâs website I saw it there this morning (inaudible) Iâll give you the number. I just want to let you know that itâs available. In the quarter it was $1.2 million. And I take it does that explain some of the G&A expense that appears to go up year-over-year or Iâm sorry quarterly? That explains some of it but itâs â you know most of that is up in cost of goods sold. But most â the big increase was the public company expenses. What would be your estimate of total OpEx excluding cost of goods sold? I mean would it be in this kind of low 3 range? Yeah would this be â would this last quarter be representative of what itâs going to be as a public company? Well itâs probably as high as itâs going to be. I would expect it would go down from here. Letâs see you talking about just G&A? Itâs about 5.6% of revenue. Itâs going to trend down from there because a lot of those costs fixed and as they build capacity and increase the revenue itâs going to drop from there. Okay. And you mentioned in the press release you know business impacted by seasonality. Can you maybe expand on that a little bit as far as Chinese New Year would be in this current quarter, correct, and not in the December quarter, right? What we meant by that was we were referring to the increase in inventory that we had increased the inventory because of the Chinese New Year in anticipation of it. But in terms of sales the big story going forward is going to be increasing capacity and phone (inaudible) capacity which really doesnât relate to seasonality. Absolutely. That was part of it. The other part of it is the, you know, the company is increasing the revenue going forward, itâs already started, and they built inventory in anticipation of doing that. Thatâs â basically itâs three customers. Theyâre large customers; theyâve got good credit histories. Although those sales were made in December all of the notes receivable are due by the end of June so it was a way of working with the customers and at the same time securing the receivable balance a little bit better so that they could actually discount those notes. Theyâve discounted some of them, about $1.4 million. Okay. Is this going to be an ongoing arrangement where you would expect to see that line continue or is this a one-off situation? Just a quick question on the capacity increase from 15 to 22 million units per month. This refers to the cell phone only and is that true? Thereâs no capacity for laptops and power tool it has some in there but again Iâve got to steer clear of giving specific power tool numbers if you donât mind. But needless to say that the building has space for quite a bit of additional capacity once the laptop and power tool were to ramp? Yeah it does. I was just in the facility a couple of weeks ago and we did a tour and you can see thereâs a lot of production coming out in the power tool area and thereâs a lot of new stuff going in the backend of the building, but yes weâve got plenty of space to expand. To optimize facility cost, we sometimes build out facilities that remain empty for several months and have no equipment in them. But the way construction works in China, crews actually move there and once you kind of get them there itâs lower cost to put up the facility if youâre expecting to be able to fill it later than to do it in smaller pieces. So weâve got plenty of room to expand. Yes I had looked at the registration for insider trading and noticed that in January of this year thereâs almost three quarters of a million shares that are up for sale. I was wondering in view of everything being positive here why thatâs â you know, why that is? That youâre referring to and those as you know are notices of intent to sell. Doesnât mean necessarily that the companies are â the investors are necessarily going to sell the shares but they wanted to have the flexibility to do that and thatâs as far as I know is why they filed the Form 144s. Yeah these are some of the very early original investors in the initial capital raises who bought in at I think the official cap raise was done somewhere in the $2 dollar. Some of these funds only get to recognize profits after theyâve transacted. So at the current share price theyâve had a pretty good run and I can only guess that some folks are feeling they want to take the profits off the table on behalf of their â you know the people have money in their funds. Thank you. Once again I would like to remind everyone if you would like to ask a question please press star then one on your telephone keypad. Good morning gentlemen this is Beau Johnson. Iâd like to ask you about your previously announced intention to achieve certification from Motorola and how that particular relationship has developed? You know itâs progressing; itâs not progressing as fast as we would have liked. We are still in the process of being qualified by Motorola. There have been evaluations and visits where we are improving certain of our capabilities of that certain of the tier-one OEMs want us to have. You know weâve expanded our OEM, letâs say our OEM work beyond just Motorola to as you saw Lenovo and we have others we have not yet disclosed that are tier-ones. And Iâd say our approach now though is to pursue the sale of our capacity with tier-one OEMs as fast and as furiously as we can so I think weâre kind of thinking weâre not Motorola dependent to succeed in the OEM business, it could come from any number of tier-one OEMs. But specific to your question, we donât have an announcement as of yet. We are proceeding and we do expect to be shipping mobile phone cells to OEMs in significant quantity later this year. Thank you. One other question, can you share with us your strategy as far as the eventual listing of this on a major exchange? You know all energies are going through â getting through the registration statement and anything we might have done in that might have caused us to re-file it. We will pick up all those issues as soon as we get you know the initial fundraising shares registered. But clearly the company has a plan to migrate to a different exchange from the OTCBB once we get the stuff behind it. We have identified independent directors; weâve taken some of the steps to put in the required corporate governance. When we get through the registration weâre ready to make some steps and make an announcement. Thank you gentlemen, as an early investor in this thing weâre very, very proud to have you in our portfolio thank you. There appear to be no further questions. I would like to turn the floor back over to Mr. Groh for any closing remarks. Iâll just reiterate the thanks from all of the management team for the support we got. As I said not just financial but as a newly traded public company in the last year weâve received invaluable wisdom and counsel from a lot of you. We thank you, we appreciate it, we hope youâre pleased with us, and we look forward to speaking to you in the future. Thank you. |
EarningCall_234094 | A - Richard Hill: Well, certainly as I mentioned flash is the key area for demand going forward. And I think that will continue, and again the gain more is also which is a foundry driven business. So itâs largely an Asia centric growth from when I am going forward. Q: Okay and then I can just ask the quick second one for William. Did each of the issues though that you said the cost the lower gross margin have a similar impact or I just want them such as higher warranty cost have the greater impact in the quarter. Thank you. A â William Kurtz: Sure hi Steve the warranty was the largest impact followed by the smaller impact due to the lower absorption, and then finally the timing impact, you know was about the same the same as the absorption impact, so by far the warranty impact have these impacts on of course. Q: Hi quick question on the installation on warranty cost. Can you comment on which product line that is and if the trend, if the transition period for this product is over in 2005, because the customer will have already signed off or you changed the product. Can you just comment on going forward which expect and a lot of changes, thanks a lot. A â William Kurtz: This is William its more its not one particular product line as it is more the deployment of the new tools in the 300 millimeter cost, it had this trend for us I look back on the historical has been seeing before, when the tools are deployed. And so we see that the early part of the implementation occurs, which we projected we continue for another quarter and then start to improve after that. Q: So if this and is truth both I guess your higher volume higher market share products like the PVD, CVD and HTP as well as for the PVD plus a product. Q: Hi just seen guys, two quick questions if I can just housekeeping to make sure to understood this. William Kurtz quick question you mentioned restructuring could I get this right the sequentially its 9 followed by 6 million followed by 13 million for a total of 28 and estimated saving of 1.2 million a quarter, is that am I correct. A â William Kurtz: Thatâs correct and the 1.2 million is after the complete restructuring is completed by the second quarter. Q: Okay and on the guidance front you said $0.16 to $0.17 before restructuring but I am assuming it does already include the 6 million just nothing on top of that. Always excluding, its just an underlying basis then excludes the 6 million. A - William Kurtz: It would include whatever benefits expected in the fourth quarter although I would say its pretty small. Q: Good afternoon and this is Amanda Henry in for Covello. I have a few quick questions. Can you help me better understand what you mean by timing affects when you referring to one of the issues due to impacted gross margin. I understand it was one of the smaller impacts for I just want to get some better sense in what you are referring to, I am not sure if it is SAB101 related. A - Richard Hill: No, you hit it right on the notes it is the SAB101 and it is the bifurcation affect that will vary from quarter-to-quarter depending on the timing associated with that and so I captured that affect under timing Q: Okay thanks and then I know you are not giving exclusive gross margin guidance today but I am wondering if you can help us understand we are magnitude what we should be thinking about for gross margins in Q4? A - Richard Hill: We are not providing specific guidance on gross margin for Q4. We do expect that the trend that weâve seen in Q3 will continue into Q4. A - Richard Hill: The additional warranty expenses will continue, as far as the business itself the ASPâs are holding fine. And so when you say under pressure I wouldnât want you to interpret you know anything other than the fact that the incremental warranty expenses are the point its impacting gross margin at this time. Q: Yeah, just one quick question I guess, given the SAB101 you get a little longer lookout in your gross margins based on your deferred revenue. Could you talk a little bit about like your shipment based gross margins currently and where thatâs running and what might actually suggest your gross margin might be a quarter or two from here. Q: Can you color in anyway a little bit, we need a lot of help on this, this is probably _____ this quarter. A - Richard Hill: I think the standpoint of the gross margin at this juncture you should assume that flat with occasional variability due to warranty expenses we cannot get it under control in short order. Certainly there is the major focus on gross margin right now and a major factor in our gross margin erosion has been installation and warranty expense which we are hoping we can get under control in one quarter, in which case we are continuing to drive for the model which is 52 % to 54 % gross margin. Q: Hey. Richard what do you mean by installation and warranty expense when it pertains to new tools here. Are these tools just not coming up or is it too much of a give away here up front in terms of trying to get these seated. What is going on here? A - Richard Hill: Well I think that one of the things that you are seeing in the market place today is as technological demands continue to accelerate, the ability to be able to meet the customers demands dynamically and the ability to be able to maintain price for the long term has over the past 6 to 9 months, I think cost us to be a little less disciplined that we should be relative to no charge items on purchase orders and shipments and so I think that is something that we are getting under control at this point in time and hopefully that will have a positive effect long term. A - Richard Hill: This is just not the way to say that however certainly we are taking a hard look at what we have been doing and making sure that our value is received for the goods that are delivered. Q: Richard, when you say you are reviewing all your R&D going forward to the side of the â06 plan, does that mean you might be looking at making some hard decisions of cutting some lines and we are wondering also if you could update us on what the CMP is costing you these days? A - Richard Hill: Well we donât divulge any single line, however clearly this time of year is when we always review our strategic plan and as part of the strategic planning process, we look at our priority and given the revenue growth that we have had we clearly have to have a priority to list relative to R&D program. We canât fund all of our customers R&D desires. Now does that mean that there are wholesale product lines that are up for chopping off? At this time I would have to tell you absolutely not. I think the credit for us to be successful. But do we have program that we are funding that infact have well I would classify less than high probabilities of success? The answer to that is yes. And we will have to make hard calls on those programs in order to bring our R&D inline with I think what the industry can support at this juncture. Q: Hi Richard, I actually had two things. Number one, cancellations were particularly high this quarter and if I look in my model this is even more cancellations than post 2000, so I am wondering why they were so high, number one and then I have a follow up, thanks. A - Richard Hill: Yeah. First of all I have no idea why they were so high this particular quarter, but I think it is driven largely by the fact that there are some customers who are all customers at this juncture that are driving their businesses based on cash flow and when they havenât seen the cash flow materialized in order to avoid cancellation chargers, they are canceling things prior to having to be able to take 100% of those products into their factory and therefore jeopardize their cash flow. And I think thatâs a major area. So companies with less cash flow wore the character of the companies that made the cancellation. Q: Yeah I guess this is a somewhat odd because other equivalent companies donât have cancellation that big but I guess, the second question was, is your guidance part of 10% on orders, is that often the gross bookings numbers or of the net bookings number? A - Richard Hill: Those are for the net, we always quote net, we didnât try quote gross bookings. I just gave you the number of what cancellations were net-to-net. Q: Thank you good afternoon. Back to the warranty issues, you spoke I think about warranty costs continuing and then kind a coming down after that, how long will it take it back to normalized levels and when do you think we can start converting some of these evaluation systems? A - Richard Hill: I think some of the evaluation systems will convert within the fourth quarter and then there is a series of schedules going out through the first half of next year that will convert and of course there are incremental evaluation systems that will go in. But definitely at a rate slower than whatâs going out. Relative to warranty costs, I think over the last month weâve spent a long time taking a look at whatâs been committed and what we need to do in order to fill the customer requirements and we are a long way into that thatâs why we said it would take through this quarter to get a handle on it. And I believe that beginning in the first quarter and the second quarter weâll start to get back to levels that were more normal. The $5 million incremental expense was higher than we had anticipated. Q: Okay one follow up Richard, can you give us an idea of how the numbers just your quantity of evaluation systems has changed over the course of the year. Is that up by a factor of two by 50%? Q: The number of the evaluation units you had out there, how is that changed over the course of â05 is it up by a factor of two? Q: Hi good afternoon I wanted to touch base on the bookings again. You made comments that the environment is flat up slightly and may be including this cancellations, but if we kind of look at the business excluding those cancellations it sounds like youâre bookings would still be down. So what am I missing there from that perspective on why you guys are _____? A - Richard Hill: Well thatâs why I have a hard time quoting gross bookings versus net booking all of the time and I always go net to net, okay? And so the reality is what we are putting on our books relative to the backlog is a function of the 289 number that we shipped it would go from 309 to 320 on a gross bookings basis from Q2 to Q3. If you just looked at the number on a gross basis we donât do that, so we are basically saying that we have gone down from Q2 to Q3. And weâll go back up again in Q4 by what we said. You know itâs a math problem. A - Richard Hill: They were very concentrated and as I articulated before it seems to be centered around companies with somewhat limited cash flow and its designed basically to I think take care of potential cancellation charges. Q: Thanks very much good afternoon, I have got two issues I would like that ask you about. The first one is in terms to the companyâs strategic direction, itâs a follow up on Bredâs question. The fact that you are willing to evaluate or reevaluate some of the R&D programs. Is this a precursor to reevaluating the whole multiple product line strategy or the conglomerate strategy that the company is on? Thatâs the first question then I have got a follow up. A â Richard Hill: Well first of all I wouldnât say that we are on a conglomerate strategy, clearly having multiple product lines addressing the semi-conductor industry is definitely not I think a conglomeration. Now if you are commenting regarding Peter Walters piece of the business which is directed and again in an industrial segment of polishing and folds on our core expertise and knowledge deposition and removal of material. I think they are very strategist and there is a lot of leverage that can be had even though we managed those two businesses separately. I think what I articulated earlier to Bredâs question was the fact that I think what weâve done is gone out and chased a lot of business with ideas thinking that we can do everything that the customer request us to do and still be able to run a profitable business. And I think we are clearly re assessing that strategy and going back to a more focused prioritization and picking the areas to where we want to focus. I think that part of what is happened within our R&D is each individual business unit in attempting to go after every small piece of business in their particular segment, hasnât been as disciplined in picking R&D projects and engineering projects and it has cost our R&D numbers to balloon somewhat. And as a result we see that there is opportunity there to improve dramatically. And we will do it in a very organized process where we ask ourselves where is the industry going and what are the key engineering programs that are likely to be successful and then focus in those particular areas. I think we have been using lately a more shotgun approach, when the customer has an idea, we become the implementation tool for that idea and I donât think we are of the size like an employ that strategy. And so I think thatâs the fundamental change Jay. Q: So that is within a product line reducing the number of flavors or variations as it was suppose to potentially cutting out of product line. Q: Okay then the second issue that I had is that you had two announcements recently on management changes, one who was making Chi-Foo Chen the CPO, and the other one was making Susan Chen the CPO of Asia, correct me if I am wrong but wasnât she the person that was doing PE CVD presentation at Semicon West? A â Richard Hill: Well she was in PE, CVD for a very, very short time. And one of the elements when you put a lot of products out into the CO is when you are integrating him within a facility there is a lot of high technology interaction that needs to go on and since we have made tremendous inroads within Asia, we have not really taken our technical expertise up to the level it needs to be within the local geography. So weâve made a calculated move of taking one of our brightest people to put into Asia to help us to develop our technical expertise there. Now why are we doing that? Well we are doing that because we waste R&D dollars when our R&D engineers are out doing work within the field that we have field process engineers and field service engineers that we need to bring up to a level to be able to handle on a routine basis. And so this is the first ways of really trying to get our technical expertise closer to the customer and thereby been able to have the business units focused more on closing the problems on products back within the factory without all of them being in the field. And that is the reason we made that move. A â Richard Hill: _____ drives the business unit has he has done since the day that he has gotten here. And he continues to do that with no change. Q: Yeah I have quick question. When you look at the cancellations in the quarter can you help me understand the timeframe that you might see those rebooked? And was this mainly PVD or was it spread across PVD and CVD and I am just wondering if you can tell me if it was concentrated what type of device type logic memory or foundry? Thanks. Q: No when you look at the cancellations in the quarter Rick, I am kind of curious you should say that this was done for a company to not have to pay a penalty charge and I am wondering at what point do you expect these bookings to be rebooked and then help me understand with this PVD, CVD or both and then DRAM company, logic company or foundry company? Thank you. A â Richard Hill: Yeah I think there was a substantial amount of the D-bookings, which evolved around some 8-inch business. That will be replaced by 300 millimeter. A â Richard Hill: Yes, I would anticipate that it will probably not happen until after the first of the year. A â Richard Hill: I donât have that breakup and I would not disclose it if I did. So thanks for trying though John. A â Richard Hill: I really donât want to go that deep. I just keep narrowing the playing field and I wouldnât be fair to them either. Q: Maybe one last question, could you help me a little about the pricing environment in PVD and whatâs your outlook as you move to the fourth quarter and first quarter of next year on pricing? A â Richard Hill: Well I think that from a standpoint of PVD it is quite clear our competition would like us not to be able to continue to succeed in eroding market share so, I have to tell you this as intense as I have seen within this industry. Q: Thanks. Rick any thoughts on how the quarter beyond December would shape up and some of your peers are talking about growth continuing beyond the December quarter and it doesnât seem like a one-quarter bounce, as you bounce along the bottom and can you share your thoughts on that? Thanks. A â Richard Hill: Yeah Suresh, I think its the overall industry itself is being driven on some good fundamentals from a standpoint of cash flow from our customers, which I think is a good sign that the levels we are at are going to continue to sustain themselves. Now to the extent our customers suddenly gain tremendous profitability through hot new products or something that they want to expand capacity to sell then I think you will see an up ticking growth. Otherwise I anticipate the business staying within this band of growth from the 0% to 10% range in declines in the 0% to 10% range indefinitely at this juncture. Again caution that the real changes of the macro economic because its consumer driven more so that industrial driven. Q: If I can take on a follow up. Is there a fundamental change in the CMP environment that the consolidation makes sense now that it did not when you acquired Speed Sam? Q: When you bought speed Spped Sam you probably had thought through some kind of a consolidation, why does it make sense now, when it did not two years back? A â Richard Hill: Well I think as I have articulated before relative to the purchase of Speed Sam I-Tech, it was both an offensive and a defensive strategy. I think if you go back into the 90s there were competing products in every single area. And gradually through the 90s a lot of those companies failed. And other people got out of the business for example LAM getting out of CMP. LAM was providing an effective competition, although they werenât winning any business against a major CMP manufacturer and as a consequence it didnât allow them to deploy, excessive gross margins against other core products. Well as LAM made the decision to pull out of CMP there became no viable competition for one player, now thatâs a very dangerous situation in our business, because given the history of their anti-competitive practices of bundling, there is the possibility of them, basically taking profits and putting them against our strong product lines. So the industry is changed enough today where the critical element is that there is competition at every level. And either we have to provide it ourselves or that there have to viable competitors in the market place. And I think our customers are beginning to wake up to that factor, and as a result I think itâs an opportunity to grow in these businesses where there has been a single dominant market share player. And I think that, thatâs the rational and that rational still holds true. Q: Yes. The question is getting back to the warranty and other installation costs issues. Is it a fundamental change in company philosophy that might have been in place with the managements that have left the company? Q: Well relative to the method of getting equipment into customers, some large competitors use a fairly large balance sheet and an ability to put a lot of tools at the customer at lower or minimal cost to sort of gain a share. Is this change in philosophy to perhaps not take that sort of direction in trying to place equipment with customers? A â Richard Hill: Well I think we will always be placing equipment with customers but I think clearly use that to be able to do it in a way where you are likely to succeed and the reward for the investment is contemplated, calculated and then executed upon. I donât think you can do this business any other way. Now if you are asking can a company the size of Novellus do the exact same thing as a competitor who is four or five times as large, the answer is clearly they cannot. We have to be more selective, I think we have to be quicker in what we do, weâve got to be more astute where we want to focus and I think to a certain extent, we lost that. I think it was one of the assets we had as a company and I think itâs one we still have, we just have to have the discipline and place to do it. And I think we are putting that discipline in or back in. Q: Yeah. Richard, on the macro environment, last week was the conference call from your occasional marketing partner and thatâs LAM Research. They seem to have a more positive spin on the overall order outlook, could it simply be that they are picking up market share in certain markets, or you are more conservative? A â Richard Hill: Well, I think that they are clearly winning market share, itâs going down to a two player market, an edge between LAM and TEL so that we see is a very, very positive sign for us as there is just one more area where more money has to funneled by our large competitor and they have done a great job. You canât take anything away from what theyâve been able to accomplish. So they forecasted what they forecasted and we see what we see. Part of it is the difference in approach to the market, we are in an area where weâve added so much productivity into the market as we grow markets we shrink markets. And from a standpoint of what they were before, but thatâs a path weâve chosen to take. The S market hasnât found itself conducive to that strategic attack but the deposition market clearly has been and I think you will find the same is true with the CMP market. But thatâs just a different strategy and the important thing is to try to get a return and we need to drive our returns up from where they are. Although there is a whole bunch of people in a lot of industries even in this one that would die for our returns, but of course we are not satisfied with them either. Q: Hi Richard, I know you have a gross margin target of 52% but maybe give us some road post like, say $320 million revenue level where once you have fixed these issued, some 320 - 350 how the gross margins would look? And then I have one more. A â Richard Hill: Okay. First of all at the 320 I would have expected them to look a lot better and at 338 I would even expect them to look substantially better than a 320, however, given some of the things that we have done in order to position ourselves going forward as we have already articulated, weâve sold somethingâs at levels we would not have ordinarily have sold them at. So from that standpoint, we were disappointed given the amount of revenue that was generated, what the gross margins were. On the other hand however, once we get these shipments out, and we secure a new bookings and billings it is our anticipation that coupled with reduced cost, that we are continuing to drive within the company weâll see an acceleration in the improvement of gross margins, but again weâve got to prove that, we canât just talk about that. Q: On the CMP side, how do you incrementally feel that, do you see any light out of the tunnel, I mean what do you think needs to happen, you showed up last year around summer time frame, a lot of significant improvement and what not, but it has not really played out on a market place, could you give us what went wrong and where are the next set of improvements that are going to come which will make the in roads in the CMP. A â Richard Hill: I think there is a light at the end of the tunnel and that light at the end of tunnel is our customers have to continue to be competitive. The reality is if you look at the industry, five years ago you would have one deposition tool, you have a PVD, you would have three PVD tools followed by one Electrofill tool followed by four CMP tools. Today you have one PVD tool followed by one Electrofill tool followed by three CMP tools. Now that three CMP tools has gotten there just because Novellus is a player in the market or it would still be at four CMP tools for every one Electrofill tool sold. I think we can take to one PVD tool to one Electrofill tool to one CMP tool, which is a tremendous productivity enhancement to the industry. At the same token given our low levels of revenue itâs a 100% growth opportunity for us. And so I think thatâs the dynamics that will make us successful in the market, the continued ability to be able to lower our customers costs and also be able to do it from a standpoint of our technical performance basis. Now one of the things that has slowed the process in doing this is the fact that there are limited number of customers who have positive cash flow and the investment capability to continue to evaluate new equipment and some people due to their level of investment and what they are trying to do are out of the game now, for equipment evaluation so the process is a little slower and they are doing it based on cash flow but the trend is undeniably such that we have got to lower our customers costs and thatâs where we are focused. And we think thatâs where we will be successful doing with CMP and we are still committed to it and believe that it will happen. Okay. Q: Hi Richard quick question for you, you talked a little bit about the cancellations and saying that there were cash flow issue there. Are you hinting at all the present risk out there with your DSOs right now? Q: Okay and then, you have seen a couple of partings this year of two key executives this year with the most recent being Tom Dennis who was heading your sales organization I have two questions surrounding this, one is do you expect any more departures from your executive staff over the next six months? And two, what changes can we expect in leadership in your sales organization over that same time frame? A â Richard Hill: Well I think first of all from the standpoint our leadership in the sales organization you can expect that to be filled in by the first of November. From the standpoint of further departures if we donât get results there have to be departures. Because whatever we talked about the business the most important thing is to getting a return and getting the company back on the trend of the profitability levels we have historically experienced and nothing will keep us from that path. Now are there any planned to purchase that I know of that you would like to me to announce? Absolutely not. Q: Yes thank you good afternoon question for Richard. Could you provide some color on a level of bookings in Q3 that Peter Walters contributed and what you expect in Q4? Thank you. A â Richard Hill: You wanted some color on the level of booking in Q3 and what was the little nuance there? Q: Yeah the level of bookings in Q3 that Peter Walters contributed and what you might expect or what you are expecting in Q4 from Peter Walters. A â Richard Hill: Yeah we donât disclose on an individual basis the bookings but Peter Walters at this juncture is not the major factor at all if any factor in the growth of the bookings going forward. Q: Yeah just one housekeeping, did you actually mention what the warranty reserve dollar was this quarter and can you give us a base number from last quarter and then just Richard from a summery perspective what do you think wafer fab equipment spending will end up doing in 2005 and do you think youâve picked up, or maintained or lost market share? A â Bill: This is Bill, let me address the question on warranty. We are not providing the total reserves on warranty but we are giving you insight into the variation in gross margin that we experienced in the past quarter as a result of an increase in the warranty expenses that we are reflected. So, hopefully we have given you enough insight to understand that. A - Bill: As for as the queue we donât specifically disclose the level of warranty but we would comment in MD&A about the impact of warranty as we normally would be required to do so. Q: Yeah I guess first of all from your perspective where do you think wafer fab equipment goes in total in 2005? Up, down, flat, whatever number you want to throw out at us and in regards to the spaces that you service. Do you think you maintained, gained, or lost share? A - Bill: I donât have the numbers handy but Iâll have them with us at the next meeting and including the quarterly update try to answer that for you. Q: Yes, Richard you talked about what you are going to do improve the gross margins going forward, and you talked a little bit about the need to take a harder look at R&D but if you look at expenses they are about flat in the quarter whatâs your outlook for that? Do you think you can hold expenses roughly flattish in this environment? Q: Okay so and if we look at it. Where is the biggest opportunity you talked about the R&D but can SG&A come down as well? What are your thoughts on that? A â Richard Hill: Well I think in order for SG&A there to come down we have got to fix some of the areas relative to training of people in the field to make them more efficient which then allows our factory to be more efficient and so there is a series of things that will happen and that will take us a little while to accomplish. Q: Okay. And then finally you talked about guidance bookings to be flat-to-up but shipments and revenues guidanceâs is down. How long would it take given SAB101 timing for the bookings to translate into better shipments and revenues - from what you can see right now? A â Bill: First of all the bookings as you know right, turn into shipments and then shipments turn into accepted revenue. A â Bill: It is about on average a two-quarter process. There are timing differences that are depended on the way the acceptance is are either zero or 100 or they are bifurcated so there is variation when the mix changes, but as a general rule of thumb, there is about a two-quarter process. I also wanted to make a comment on our point about our operating model and our financial model. Because I think itâs important for all of you to understand what we are communicating here. As weâve look at the companyâs financial performance and compare it to current performance to our desired target model there are two areas that jump off the page. One is gross margin we have talked quite a bit about that. We know what we need to do to improve that and second is R&D productivity, and that is the other reason we mentioned our strategic plan process. We are also looking at everything else on the income statement as well as the balance sheet to improve but those are the two that have the clearest indications to us that we want to see improvement as we move our business forward. Q: Hi. Actually I just had a follow up for Bill and a follow up for Richard. Firstly Bill, you come to Nevada obviously you have a lot of financial experience. Can you just share with us what are the variables that you would be looking to determine what is the right amount of cash for this business to hold and when would you expect to start recommending to the board that the company pay a dividend? A - Bill: Yes. Tim thanks for that question. Variables to look out obviously include the cycles of the business to understand what your working capitals would need in a down cycle so that you can weather the storm. As well as the investments that you need to grow the business. So I donât come here today with a formula that I can provide to you for recommendation. Our goal though is to make sure that our cash is being used where it can be to grow shareholder value. Q: Okay thanks may be a followup then for Richard just on the PVD side. Can you just share with us, maybe a little bit more in terms of how you have been marketing the PVD product. Broadly has it been a similar price tool with more free putt and therefore a lower cost wafer then your competitors, or are you really pitching it more as a differentiated technical performance? If you have got some data or something to illustrate that will be very helpful. A â Richard Hill: Well I think what you can see is that the eNova has been built and has demonstrated the ability to extend PVD technology down to 45 nanometers. If you go back to when the system was implemented everybody was telling how ALD was going to be in at 90 nanometers and then 65 and then 45 and now itsâ down to 32 nanometers. So, I think it has been a compelling story that the hollow cathodes magnetrons has demonstrated the ability to be able to utilize the technology that the main developer of what I would call sort of older generation PVD had themselves seen a limit at 90 nanometers. Now the advent of ACM has forced them to go into massive redesign and to their credit they have done an extremely good job in copying elements of the eNova in order to extend their technology and they have used their power of position to the best of their ability to maintain that position. But clearly it has been an enabling technology. Most of the game chips that are being produced today are being produced on the eNova system from a copper PVD standpoint and as a result it was an enabling technology because this is a state of the art technology driving the industry today. And so clearly, it has been a technologically driven business with productivity. Even today our competition canât meet our productivity and when you look at the elements of simplicity and design, the design is much simpler and therefore we believe our ultimate reliability produceability, utilization and uptime will be substantially better than our competition. But I think itâs a combination of this business and the inhibitor has been more function of the industry in the number of people to invest rather than the technology or the capabilities of the product. Okay? Q: I have a question on the accounting for the evaluation systems. Is it true that when you send out an Eval you keep it in inventory before it is accepted because, inventory is coming down pretty significantly yet there are a lot of evaluation systems in the field that are resulting in installation and warranty expenses being, so much higher, so I am wondering how those two jive? A âBill: The accounting for Eval systems is that they are placed into service, they are put in dollar assets and then depreciated. Q: May be just, there has been so much focus on the expense, just give a little more color on just the areas where you are seeing this up a little bit trend across the board and a little bit more color on memory not just NAND related which we know is strong but what your thoughts on DRAM over the next several quarters, and what are your thoughts on foundry sounds like foundry has picked up a little bit, is that broad based or is it one or two specific customers? Thanks. A â Richard Hill: Thanks Michael. I think first of all as I mentioned before NAND/growth is one of our largest drivers going forward. And itâs not only NAND for a single application but itâs what we have talked about before. Itâs the multitude of the application thatâs allowing it to be much more stable predictable growth and so I think thatâs a good thing. Relative to DRAM part of the expansion of capacity for NAND flash has been the fundability of DRAM capacity in the NAND flash and as a consequence there has been a increase profitability in the DRAM and given their still expansion in Bit growth, we have seen some continued investment in DRAM and we will continue to see that going forward. So I think that holds well for the NAND DRAM market. In the foundry areas I think that business is being driven by supply chains to in particular to the gain mores business. And I think this Christmas time and the success of those programs will be a major factor in the continued expansion of foundry capacity. But make no mistake the concept of the foundry is only going to continue to grow as the expense to transition to new technology increases. So I see that the future for the foundry continues to be extremely good and for the guys who are capable of staying on the technology curve, they will have the greatest opportunity going forward and I think there are three or four players who will fill this void and then there will be people trying to be foundries beyond that. Q: So is the improvement in your outlook for orders any help from a foundry perspective just one customer or more. A â Bill: I think itâs from multiple customers, it comes in certainly the foundries are a factor, NAND flash is a factor, but so is the Microprocessor market place and continued growth there. Q: Yeah. Hi Richards, a quick question, we have pointed numbers recently and itâs seems to us like your overall market share, is a little better with the memory customers in this with Logic would you agree with that? A â Richard Hill: Well certainly, our market share is extremely well in the memory arena. I think whether or not itâs better than it is within the foundry, I think it depends upon the product and it depends upon the ordering cycle. But today we are pretty balanced across Logic and memory and certainly you only need to look at Electrofill, which dominates the market and certainly the foundries are bringing on only copper capacity going forward. So there tends to be a bias for us there. And certainly where our PVD product is having the most success again itâs in the foundry environment and so that again is a bias for our success. So itâs hard to just say, I am not sure to be accurate to say we are preponderance in memory although we are strong there. A â Richard Hill: Well thank you very much for joining us, we look forward to talking to you at our mid-quarter update. And we look forward to continued growth in the semiconductor industry and continued improvement in our operations. Thanks very much. |
EarningCall_234095 | Good afternoon and welcome to Freescale Semiconductorâs 2005 Fourth Quarter and Yearend Results Conference Call. All participants will be able to listen-only until the question and answer session of todayâs call. At that time, to ask a question, press â*â â1â and record your name when prompted. As a request of Freescale Semiconductor, this conference is being recorded. Should you have any objections, you may disconnect. I will now turn the conference to Mr. Mitch Haws, Vice President Investor Relations. Sir you may begin. Thank you, Sam (ph). Thank you and welcome to our fourth quarter and yearend 2005 conference call. With me today are Michel Mayer, our CEO and Alan Campbell, our Chief Financial Officer. Earnings release and financial statements weâre discussing today are available at the Investor Relations section on our website at freescale.com. The call is being webcast live at our site as well. Today we will make certain forward-looking statements. These statements are based on our current expectations and assumptions and we cannot assure you that these expectations will be correct due to the inherent risks and uncertainties for actual results could differ materially. Please review our documents on file with the SEC for detailed discussion contained the factors that could cause our results differ from the statements we make today. This presentation is being made on January 19, 2006. It includes some sensitive information as the company undertakes no obligation to correct or update any information presented on the call. Now during the, todayâs call we may also reference some non-GAAP financial measures that we believe provide useful information about our performance, you may find on our website that were correct reconciliations. Also as noted in that release, we did make some amount of reclassifications to certain expense items, the details are attached with press release and also on our website and Iâm happy after the call to answer any questions about the reclassifications. With that, Iâll turn the call over to Michel. Thank you, Mitch. Good afternoon welcome to our fourth quarter earnings call. Joining me as always is Alan Campbell, our CFO. Today, weâre going to talk about our continued solid progress at bench with respect to our finance performance and spend some time on dynamics of our markets and portfolios as we head into 2006. So, a few of the highlights of our results weâve made purely significant progress toward our target model in both gross margin and operating margin and weâve made that well ahead of our brand. In the Fourth quarter of last year, we did reach our gross margin model of 45% and our operating margins were 30.7%. Our net earnings for the year grew 352 million to 563 and our EPS at $1.33 is more than double, the prior year. We increased cash and investment balance by a further 650 million in the year, ending the year $3 billion. This level of performance is clearly attribute to the team and their ability to execute better however, I recognize, we recognize that we still have a long way to go to reach our full potential as a company and we are not satisfied with those results. As mentioned, our gross margins are effectively at the level of the target model that we established at the time of the IPO. This was reached ahead of our plans and I hope it demonstrates our commitments to execution, I think we have established so far a good track record over the past year, with all execution and steady progress towards the model. We, consistent with the fact that we are not content about level of margin, weâve deployed much more aggressive goals internally and we are in the process of deploying more aggressive goals internally as we start this year. And we have already mobilized the team to execute these more aggressive plans. Given our current portfolio, we believe at this point that the business can support additional margin expansion or at least 200 or 300 basis points in the next 18 months. Obviously, with a lot of the benefits of the increased utilization and depreciation leverage behind us, the base of incremental improvement will be somewhat more challenging going forward. And, in order to drive further improvements in operating performance, we have recently added 2 executives to compliment out manufacturing team. Chris Chi, formerly President for UMC in Europe, joined as Vice President of external manufacturing and Gulzar Mohd Ali, formerly with Intel, joins as Vice President of final manufacturing overseeing assembly and test operations. Chris has started and operated both 200-mm and 300-mm fabs, and he was President of UMCi Limited and Gulzar has have numerous important positions at Intel during her career. So we think theyâre going to help us. We might, as we make progress going forward, update our model further but at this point, we believe, pickup and used to be very importance to articulate our plans that we know we can meet. We spent much of 2005 driving gross margin improvement. At the same time, we were also examining our portfolio and our re-trading between revenue growth and margin expansion. I will have to remind you that we made decisions during the year that weâll research in revenue decline in certain areas. In the long run, I believe the portfolio is getting much stronger from a margin perspective. We divested our long core clock business in the third quarter of â05. That was a 25 million annual business in our networking segment. We also decided to exit lower margin analog business in printers and focus all resources of higher growth better margin business. Apple which represents around 3% of Freescale revenue, weâve transitioned away this year. In fact, that transition has already started. Q4 2005 revenue for Apple was significantly lower than Q3. Now we expect the transition, we continue during the first quarter with little on the revenue starting in second quarter. When taken together, this represents $200 million to $250 million of lost revenue which as you know will impact, our overall work pace for 2006 and partially offset the progress that we are making with our growth initiatives. With that being said, I am becoming more confident in our ability to go to top line in the back half of 2006 and into 2007. And this is based on the base and quality of design wins across the portfolio. Looking at opportunity across the segment, the competitiveness of our power management and our RX solutions, including RX EDGE is a significant growth driver. We are well-positioned to gain share of Motorola and in the merchant market with these products which will benefit us both later this year and into next year. Stay tuned fro some news at 3G GSM. In addition, we expect 3G to ramp strongly in volume at some point during 2006; we continue to make progress with Tier 1 handset manufacturer has been using our technology. Our comprehensive matured chipset is significant competitive at that base price. A good indication of the collection in wireless is a credit to Q1 which looks to be much more favorable than the typically historical to the 92 that we have experience in the past. Looking beyond handsets, our wireless business have a very exciting showing CES earlier month in Vegas, our multimedia applications processor and power management chip are powering the new Toshiba gigabeat S Series Video players, we are in fact gaining good caption with our i.MX applications processors. They are being designed into more and more high performance mobile entertainment devices and smart phones. This is another new growth area for us that is starting to yield reserves. Techno, one of Chinaâs leading consumer electronics manufacturers has introduced two portable media players, both powered i.MX. Axia and Timfo (ph) unveiled their first smart mode models utilizing i.MX and Royal takes advantage of their high-end graphics ability of i.MX for the portable AmeriGo GPS Navigator and some major GPS brands that we canât mention here also using our technology. Within our emerging wireless portfolio Freescaleâs use of UBs will power wideband silicon software is being integrated into consumer products from Belkin and Gefen. This must release first use of UB-enabled consumer products for the US market, is for their talent educated to be on the market in the first half this year within a few months. Let me now turn to Transportation and Standard Products. We saw double digit growth in both our 16 and 32-bit microcontroller portfolios for the year. We have been focused, as I said repeatedly on growing the consumer portion of this business especially in analog and are very encouraged as well by the double-digit growth price achieved during 2005. And we are expecting the trend; we are expecting that trend to continue in 2006. As you know, we are the #1 supplier in automotive and expect to continue to hold that position in 2006. The worldwide automotive market was healthy in â05 driven by demand in China and North America. Itâs interesting to know that the demand in China was served by minimum car companies including the Big Three. However the worldwide automotive for production continues to shift to Asian manufacturers, Japanese, Korean due to market share loss of the Big Three in North America. We continue to make further as winning business in the Asian markets, who are Tier 1 customers, while of course continuing to be committed to our North American customers. We also got used to expand our portfolio with the introduction of our intelligence distributed console devices that combine our smart mode power management, with 8-bit flash microcontrollers and local interconnect networking. These dramatic reviews, is component count on wiring, in wending machines, poise of sales terminal and variety of power assisted automotive applications. You will see more and more SoC and military function applications coming out of Freescale as we increasingly leverage the incredible breadth and size of our portfolio to come together with integrated solutions. Demand in automotive and consumer is strengthening and we are at a point where we are chasing supplies. We expect the TSPG business to grow in the first quarter but the extent of that growth will depend on how much valuables we shift. In networking, based on our checks and demand we expect to see a recovery in our infrastructure business. However, we expect that goals to be more evenly distributed throughout the year, then in the prior, in the prior 2 years â04 and â05. As I said earlier, we expect the Apple transition to continue into first quarter, given the growth that we are seeing in other markets, we believe the new business can largely offset the loss of the Apple business, as it occurs. We remain fully committed to the PowerPC architecture and during the past year those process have gained the increased popularity in the home-networking, consumer electronics markets, wining designs in applications such as voice-enabled VPN routers, residential gateways, home media serves, IPTV set top boxes and network storage, of course IBM is a 100% market share in gaming, also a lot of progress in printing and imaging and wireless in Transceiver base station and wireless LAN access points. You will hear more from us and partners on topic initiatives. In the fourth quarter, I will make our corporation announce the store center network hard drive, a fast complete solution for storing, enhancing, experiencing ensuring all kinds of digital components on a home or small business network, based on PowerQUICC II processor. This processor provides more than enough power to support sending files directly to PCs and network attached entertainment devices. I want to highlight the fact that the pace of design wins in networking has been a especially encouraging in the enterprise base, in 2005. With major enterprise networking companies and we expect these wins to contribute to other new significance towards the end of 2006 as well. To sum things up, we deliver them all gross margin commitment ahead of plan, we expect continued progress on margin in 2006, where we deliver our Q2 to 300 points basis points of improvement over the next 18 months. We are beginning to see the early benefits of our focus on accelerating growth. We expect to close the GAAP versus industry sale growth rate starting in 2007. Given the anticipated of the rational improvements, we expect to achieve the high-end of the range of analyst estimates for EPS in 2006, which is at 30% to 35% growth rate from $1.33, before taking option expensing into account. Thank you for your attention and having said that, I would like to turn the call over to our Chief financial officer Mr. Campbell. Well thank you Michel. As our results show, we have made solid progress in 2005 driving financial improvement. As a team, we are pleased with the progress as Michel officially if heâs relating, heâs at a still leads for continuous improvement. Michel also noted we have some small line item changes at a minor impact on our operating expenses and margins in each of our segments. There was however low impact to net income or EPS, and we will be happy to answer question on any of those issues after todayâs call. Let me now turn to the business. Our fourth quarter revenues were 1.48 billion; this represents a 4% increase from the same period last year, and a slight sequential increase. Autos for the fourth quarter were 1.5 billion representing a 1.01 book-to-bill, for the year, our sales ending at $5.84 billion. As Michel mentioned, also our continued focus on elements of gross margin resulted in the rush reaching our target model this quarter. Margins for the quarter were 45%, including some reclassification of 960 basis points from last year and also up 210 basis points from last quarter. We continued to realize benefits from operating efficiencies, continued across cost controls and factory utilizations. And net income was $192 million or 15% of sales. This performance compares favorably to the same period year, and the sub quarter level 164 million. Let me now discuss some of the operating expenses which were 465 million again under the re-class method. The bulk of the line item re-classes was to reflect in cents of course to the appropriate line items and the income statement. Most of this represented a change from SG&A to R&D and Cost of Goods Sold. For SG&A was off on a sequential and year-on-year basis, driven by a higher level of spend on granting and an increase on incentives paid prior to our operating performance. But R&D was lower sequentially due to a higher rate of grant to typically occur in the fourth quarter. Our net interest income in the fourth quarter was $9 million compared to $5 million experienced a year ago and $1 million income this quarter. Again, this was driven by higher returns on our cash balance. Our operating margin for the fourth quarter was 15.7%, the highest level since 1995. Depreciation and amortization represented 10.7% of sales compared to 15.4 a year ago and 11.4 last quarter. Our EPS was $0.45 per share, EPS a year ago was 1 penny or $0.18 excluding restructuring and separation cost. In the fourth quarter, we began to execute on the share repurchase program and bought back 4 million shares for $103 million. The exhibited, muted the impact of option dilution, and the fully diluted shares trend is 429 million. Our effective tax rate for the full year was 18%, with a cash tax rate of approximately half of that. Now I will summarize some of the performance within this segment, I intent to report the segments including the reclassifications. As discussed, the impact is minor and the summary of the changes has included in the earnings release. The transportation segment in terms of product segment reported fourth quarter revenues of 649 million. This of course is 672 million before re-class, which is up 5% sequentially. Compared to the same period last year, we had a growth rate of 5%, as Michel said; it was driven by growth in Asia and Japan. But a particular strength across 16 and 32-bit microcontrollers as well as our strength is product. Our operating margin in the fourth quarter was 18%, excluding the impact of Delphi operating margins were 17%, this compares favorably to the 8.7 reported the same time last year, and 11.8% in the last quarter. Once again, key drivers of improvement of factory utilization and operation efficiencies. On a year-on-year basis, operating margins were 14.1% again comparing favorably to last year of 10.5%. Our networking and computing system revenues was 358 million representing a 6% decrease sequentially. This was driven by softness in the infrastructure spending, but was costly outset sequential data performance in the enterprise market. On the full year basis our revenues declined 2%. Our operating margin again was very strong. Fourth quarter was 21.6% compared to 10.9% last year and 19% in the last quarter. For the full year the operating margins were 19.9% up from the 2004 level of 18.7%. The last business segment of wireless revenues, in the fourth quarter were 476 million or 453 million up prior to re-class, which is up 5%, continuing the change we saw in Q3. We continue to see strong units in 3Cs off by, offset by typical price of these 3Cs. Fourth quarter margins were 8%, again this compares to 7.5% a year ago and 7.7% last quarter. For the year operating margins were 4.4% compared to our loss of 5.7% last year. That concludes the discussion on the segment. Now we are going to take a quick look at the balance sheet. Cash for short term investments in marketable securities, at the end of the fourth quarter was $3 billion, which gives us another of 143 million from the end of last quarter. Our domain results include 103 million for the repurchase of stock. Our capital expenditures were 147 million in the quarter or 491 million for the year representing 8.4% of sale. We continue to be very focused and make good progress on improving working capital. Our previous eatables and favor base in the quarter were 52 days and 62 days respectively. And this compares to 55 and 47 days in the sub-quarter. Inventories increased slightly by $10 million following a $105 million reduction since the beginning of 2005. Inventory days were 71 compared to the 69 days in the last quarter. Distribution inventories were down slightly and weeks of sales drop to below 10 weeks. This level has remained consistent for the past 8 quarters. Now looking ahead into the first quarter of 2006, we expect revenues to be in the range of $1.435 billion to $1.535 billion. We expect gross margins to increase slightly from the operational level of 14 in the fourth quarter. Expiring the impact of Delphi and expiring the impact of stock option expense. During the first quarter of 2006 we will begin the expense, expensing stock options in accordance with FAS 123, to expect expense associating with this to be approximately $0.04 per share in the first quarter. This will impact the line items by approximately 4 million in gross margin and remainder spread evenly across R&D and SG&A. That concludes the remark today and I will happy to turn it over to the operator and open it for questions. Thank you. We will now begin the question and answer session. If you would like to ask a question please press â*â â1â and record your first and last name. To withdraw your question you may press â*â â2â. Once again if you would like to ask a question please press â*â â1â and record your first and last name. One moment for our first question. Iâd like to focus my question on gross margins. First part, when you talk about gross margin being up slightly from the operational level as in â05 and as in operating expenses. Is that 45.4 or 45 could you speak clear about that point please. Yes, Tom let me try and state that one. The operational, the gross margins on the, the historical method that you are; that you are used to, it was 45.4, a significant achievement by the whole team. With some of the re-class that was reduced to 45. If you then exclude Delphi or the reverse that we took is approximately half a point. So, what we are saying is from the 44.5 we expect some operational improvement. But, Iâd like to just join in here, itâs an improvement no matter which one, what we are guiding is an improvement, if you had kept the old reporting to us. You would see sequential improvement from the 45.4 level neither than 5 minus reductions; if youâre taking the new re-class, youâre going to see closing come back so. You know that one, it doesnât matter which one you, you choose. Youâre going to see incremental improvement, do I make sense? Okay well, going forward ask us, because we are starting Q1 â06 we do reclassify. We, our gross margin went down to 45% in Q1 from 45.4. So we are going forward studying Q1 â06, itâs going to be 0.4%, we know where we were during 2005. Okay, and then your comment about the goal of increasing the margin target for the range by 2 to 300 basis points over the next 18 months. Youâre referring to gross margins I assume, is that correct? Yeah, I think what we see Tom is that when you look out our performance over the last 18 months, that was steady as she goes and I would suggest that, it certainly going to get tougher as we go forward, as utilization rates and depreciation is not, are not going to be as significant or portion of the improvement. Although there has been significant efforts put in place on mobilizing the internal things to really focus on continued improvement while we, we will be formulating more detailed plans in communicating, but thatâs steady as she goes. Thank you. Michel your implied EPS guidance for the year, is somewhere between 122,123 and 129 and 180, recognizing that youâre talking the higher gross margin. Can you just try to give us a sense of how much of, the incremental EPS coming from revenue growth versus margin growth? Well as, as you know in, I mean, the net of our view of â06 at this point, I mean we, we, of course, we donât, Glen, much share whatâs going to happen in the overall economy in the second half of the year and I am sure that we, what we have the net of our view for â06 is that we expect to roughly go within this free end and then loose that $200 million to $250 million that I talked about. And therefore as a result of that, goal, well the half of the rate of the industry, thatâs the model that, lot of you guys have out there on that and of course, we hope to beat it, but at this moment so, were itâs a, itâs a reasonable, itâs the reasonable model. So, so when you look at where we are and we with some gross margin improvement into 2006, we are at this point, reasonable with the high end of the, of the earnings and in part of this is coming from, it can be pricing, we are releasing at $0.45 a quarter, right? So you do the math and, and you look at that. So we expect some pressure on the ASP that it will be about, so thatâs why we are saying. So, so, what I am trying to say is that if, if gross margin in a sense that we have achieved our model earlier and therefore as we enter the year, weâve had a higher level than it was for we previously modeled that gives us comfort that we can deliver the high end of the range. Campbell youâve, when you are talking about raising your gross margin guidance, youâve said, that you wouldnât do it unless you failed, pretty much 100% helpful that you could deliver that in, in someday reasonable timeframe. See, I am really assume if thatâs sure about the guidance that youâve given us and also you can give us examples of, what we contribute to that hopefully? Okay Glen, first of all from a Scotsman nothing is 100%. So, letâs be very clear there. But we do believe that it is important to execute and did what we said we were going to do and, I think we do have some history there. Most of the, the enhancement in margin opportunity will come from the operational efficiency state of decreasing which is, as weâve said before it includes a number of different things improving yields, looking at the portfolio of RF ICs continued supply chain focus. And there will be a small amount associated with depreciation towards the second half of next year; this depreciation will continue to fall off. Let me evaluate to follow Glenn, because, I think I trying to assume your question. Our, the bulk of our focus in the first 18 months on gross margin improvement came from foreign bank from silicon wafers. And we are getting closer, we still have a little bit of improvement I mean, weâve made a lot of progress, we can still, we are not benchmark yet on that yield, well we are becoming much better, but we still know that we have some improvement on yield and we can see that and as you know, that the material cycles with the fab and takes time. So that, those type of things you can pretty much predict whatâs coming in front of you with a bit more confidence. But a lot of the improvements need to be done in GSM, and test backend, and we, as well as total yield at the guide level. We know that we have progress to make, which is good news, because weâve identified those. So, thatâs another area where you are going to see and thatâs why I was highlighting the horse power that we are adding to the, to the manufacturing team here, to help get us to the next level, but weâve benchmarked, weâve done a lot of work with consultants and started the distinct cycle approached, weâve used for a quantum size, we are in the process of applying, so further applications and also to supply chain level, we know we have some improvements. So, one of those depreciations of course as well, we have felt that depreciation coming in second half of â06. I think and⦠I want to drill down on the wireless business; weâve been fearing for sometime that, now you might be able to show some, some activity outside of your, your major customer on. Can you give me some additional color there in terms of potential timing, or at least what you hope so. I know you canât bring out your customers, but at least give me some senses to what we might look for. Thank you. Well, we should, we knew that we are going to start shipping some significant things in the first half of â06, let me say first half of â06, to be a little bit competitive here. I donât want to preview when you will get the visibility, Joe has got some of it, youâll get visibility for announcements, some of which will probably get the visibility for Tier 1 website, when people choose not to announce with that and thatâs particularly to for components, like, if we were to doing significant RX EDGE, which is an area where we think we are strong. I am not sure I mean, some of it will be announced some of it will not. But I think, by the time we reach 3G GSM in a few weeks, they will start to be some visibility of our progress. Then in â06, we will, youâll see more of the base band. The base band side, the platform side, itâs the thing thatâs the longest pole right in the current, thatâs the one that takes the longest time to off the vision engagement from when to bring you, or ready to shift. So that, you are going to see an end and there is also going to be some evidence as we go in the year that our wireless revenue is willing to go. Okay, great. I am sorry, I got, I thought I had, I thought it out in your last comments so, I guess but, when I heard you talk about shipping some 3G revenue outside of your major customer, I guess the implication there when I were asking you about is the digital base scan business there. Are you saying you are going to ship digital base band in the first half or something else? No in the first half we are going to ship all the thing, I again, I enjoy, I am trying to QC, I really donât want to, I want to continue to be on the conservative side because we have phones that are getting ready here, but this is an industry where as you know very well that until people stop shipping their phones and some of those handset manufacturers, make those achievements, pretty late in their design cycle. Well, I repeat what Iâve been saying last quarter; we have 100s of engineers engaged with this Tier 1 handset manufacturer. We are making good progress, but then every time closer to the shipment base, I expect in the first half to have final decisions of shipments, I donât confirm when those shipments happen from customers. But we are getting closer. Thatâs fine I am not trying to humiliate down to too much detail. And my other question is simply looking at the gross margin, if I look at the extents to which, you have dropped, unprofitable businesses and your refocusing, the revenue that you have, I get to your guidance really almost just organically without assuming anything else. Is that basically whatâs going on here, and youâve liked yourself more room or am I wrong and is this, does this target must be given also encompass the operational improvements that you talked about? I think Joe, is the combination, you got, we executing a part of just Joe Iâm sorry, weâre executing a path in 2005 to look at portfolio. And we will continue to aggressively ensure that we do have the portfolio and that portfolio makes money. Weâve talked about penetrating and pushing more of distribution, discount of our new products, or trade view margins. But at the same time, there is not enough one, one leg itâs still, I think itâs very important to focus on the resonance supply chain on the yield, and it will be all of us again that would contribute improvement. We clearly, I mean, believe some at the amount of, I donât want if it comes out of given, but so many amount of digital room for pension in our guidance, but as we said we, I really believed it is extremely important and than when we do usual guidance, we made it no, couldnât quote, no matter what happens in the industry conditions. If we could Alan, did you offer any guidance from the tax rate for the first quarter and the full year for â06? Yeah, I think Doug, it, I think it fair to, for modeling purpose, is to continue at 8% tax, as we enter for 2006. Always those are going to be a function of profitability between the domestic and international. But for modeling I think itâs safe to say that 8% is reasonable at this point. And then Michel would it be possible for you to give us some idea of sort of the wireless growth that you are expecting in the area, I know you donât want to disclose customers, but maybe if you would give us some idea of growth that you might expect to see from the wireless segment that might help us understand this is what magnitude success you are planning on? Yeah, well you know seats we expect, rules that, I mean, it really should accelerate in the second half of â06. So, we havenât been guiding followed by segments. We expect to obey share clearly, we unless it has become thinking so why you want to stop guiding on router, then I donât think I didnât. So, I am going to say, weâre fit to go year-over-year, we, I need to add a little bit more visibility on the two things like the success of my customers with the model that we introduce, because, this is not existing business, that I have a good handle on, and so I donât want to be speculating on those type of, and thatâs part of question, because I have a good seem for the most all recognitions obviously, and I have the historical data that allows me to judge, I am entering into periphery area I do not have a country, so its going to go grow, but itâs a little bit too early to stay back by how much. Okay. If I could, two just, two more questions on sort of house keeping, percentage of sales that weâre going through distribution and then the percentage of wafer supply that was from external sources? Yeah distribution revenues as a percent of the total deal were relatively flat from last quarter and itâs fair 15% range and the outsourcing that we did also I think was relatively flat, is 17% was the volume of silicon that we outsource. Thanks, and I got those, congratulations. Just a question on the operating margin in the Transportation Good showed a nice pop, even if you scrub it down as the Delphi, what sort of incremental improvements could we see going forward from that level? And if I recall correctly, a year above what your target operating margin was in that group. And should we be thinking about a new benchmark? Thanks Ross first of all, it was just an outstanding performance within the program and at least our Transportation that have grip, literally that had on all selling those in this quarter within the grip, for you know we were fortunate with the utilization of our five seats we had some Delphi dealings and there was a lot well operational efficiencies with, as well as the portfolio. So, thatâs hit on all cylinders. We, when are we going to get guidance obviously but we are re-looking at raising the bar across all three segments, and I think youâll hear more to come in that one. So of late, a light it deflect or let go at this point on Germanâs specific on opportunities, they did exceed expectations even after adjusting for Delphi. So, full credits on our full team. And then a couple of more house keeping related ones, on the orders, you gave the total orders, I believe in prior quarters, youâve given them by segment, can we get that again in this quarter please? Yeah, I think the order rate for our Transportation, it was just over 1, I think it was at 1.03 our networking was stronger of 1.06 and our wireless was just a low 1.97. Okay then the final question somewhere to the prior 1, on the utilization side I think what was your internal fab utilization in the quarter please? Again, thatâs 3, I donât think about disclosing specific utilization but, utilization nor said continued to improve for almost first quarter raise into the fourth quarter. If I recall right that would put you somewhere in the very high 80s or low 90s. Is there a level at which you really have to start investing more capital or it is growth pickup, any sort incremental capacity need that you, that may arise over the course of the year? Yeah I think first of all, that is the level of revenue, while looking at the whole capital expenditure is, this week we spend, as we said 8.4% of sales and 2005 and up our model has said that weâre late to the accumulates of the 10%. So we are looking at the whole the capacity situation, and we will be looking to make things sure, as much as we can, thatâs we are selling in towards capacity bottle makes are becoming half. I am just, good afternoon guys, I am here to get one follow up on the last point. And if you could just talk about 2006, what your guidance for capital spending will be? Well again we donât give guidance specifically Randy for CapEx, but we can tell you that weâll continue to be flexible through the market, and we are going to open it with in the cumulative 10% percent levels. So if we continue to see the solid performance that weâve seen in 2005, and going into â06. We will, we could spend slightly even more than the 10%. But we are keeping to the model of that cumulative 10% model. Okay, in the middle looking at your networking business, it looks like the enterprise side performed a little bit better than the carrier side. Could you talk about what you are seeing with trends, I think you, how it differs from big design wins coming, maybe just talk about the products and the opportunity you have on the enterprise side of networking. Iâll leave that to Alan so, for this the networking; but by the way I, networking result, I am sure you guys have picked up at my comments about how offer revenue was eventually lower in Q4 then it was in Q3. And the Delphi wasnât conceding it again and so thatâs something also you have to do such earnings to judge the health of the networking business. What we, what have happened in 2005, I understand what your question is, recently significant over us in designing profit share into wireless and switches, with using enterprise networking company. And so thatâs whatâs behind my comments, as those product are but in starting in the end of the 3 kind of 7 and we expect a significant improvement. Do you also hold until we expect what I was trying to communicate, what we, if we look at our pipeline to design wins, we know we are positioned to stop gaining shares, at least you can see the relieve on near the end of, in the second half of season then going forward. Short-term, we are seeing some, we are seeing some strengthening, but I mean not gaining to be, the overall market, I mean there is nothing to be worried about us. Okay fair enough, and then just lastly on the R&D expense I think youâve heard about the credits that went down sequentially. And when we look at the first quarter should we use third quarter run rates of what to move ahead from and maybe talk again about SG&A kind of what your expectations are over next couple of quarters for growth in SG&A. A - Michel Mayer Yeah, well we to suggest them on the, its somewhat confuses, some of the reclassifications and to simplify is probably easier to keep it relatively flat from the fourth quarter levels. So keep operating expense and total reasonably flat. Hi actually itâs Jim Covello. But, first of all, congratulations on the continued great execution. Secondly, your big wireless customer tonight on their conference call were suggesting that they were short of some components not so I can, but I guess some other custom mechanical component. And that prevented them from shipping a little bit more and they may could have been in the fourth quarter. Do you have any thoughts on how that might have impacted you business in Q4 and how it might impact your business in Q1? Well I donât, Jim, good evening before but, as you, as you know we, we shared the word a little bit from guiding on more on our customers in general and somewhat all are in particular with that being said we, we probably could have shift I think we you are right, if only could we have shipped a little bit more, silicon to them so, so I think we could, on the revenue we, we do not, we do not expect Q1, I mean Q1 I think they might, because of all that and anyway we entirely say, yes, it could have, let me be, it could have shipped more including Q4 and Q1 we are guiding quarter-to-quarter. Fair enough, I think I, think I understand that. Next question said on the margin improvement and particularly relative to the utilization, how important is continued very high utilization levels to this continued margin improvement, in other words is there any slack in, in the margin improvement goals though that if you were to see any down picking utilization that you could still see the improvement in margin over the next, 6 or 9 or 18 months. Utilization rate first of all I would suggest that there wonât be as much leverage of the continued improvement as the result of utilization of our factories. Obviously the market conditions fluctuate well more and one of the things that we pride our self and this is the kind of the flex, the flexibility that we have between the different relationships and partnerships internal to external, but we didnât anticipate the major fluctuations and margins as a result of utilization mix been done. One of the thing that may have the apparent from the, from an external view is that weâve spend a lot of time in mid, since mid 2004, really improving our supply chain end-to-end and part of it was sourcing capability driver-sourcing and really making the flex model work and so part of the high utilization granted is the result of a market condition, but frankly more and more of it is the result of the, a better supply chain which allows us to, to flex in and out better and therefore if you want to maintain high organization going forward against the, remember we, we do use 17% of the external foundry and, and I think 50% of external assembly and test, so I think we are more sophisticated in our, in our model now of course. We, we wonât read about any, complete collapse of the industry and you might, we all understand that right. Thanks and this is Sami Feroz (ph) for Chris Danely. Question on what would be in the scenario typical Q1 seasonality given, the reclassification that have been going on and, and you know some of the end-markets now, changing it all in terms of outlook? Yeah, it seem outlooks, I would suggest first of the reclassifications one impact anything on seasonality from our, our revenue standpoint we historically see seasonality in the first quarter being down slightly from now in the fourth quarter. When those seeing that typical seasonality at this point, but we are seeing a little bit change across the businesses, for it anticipate typical seasonality as we enter into the first quarter. And then a follow up on Disty selling was to sell through, could you comment on what were the rates in the fourth quarter and any of your expectations for the first quarter and then I have one follow up please? For, Disty that as weâve said before that we, we recognized revenue in our sale-on basis, we show very good controls on mechanisms in place to monitor, what the re-sales are as well as the inventories and as we are speculated on the call, the inventories are actually continuing to decline so we feel very comfortable in terms of guiding for Disty going follow up, so Iâm not sure I want to do that risk point. But, from a control mechanism we do that sale-on basis. Great and then one final question is on pricing trends. Could you comment on what do you see as the general pricing pressures in some of the end-markets? Yeah the, the pricing trends are always going to be theyâre a function of markets as well as volumes. As weâve said before on our three business segments are, our wireless business is more exposed to much heavier pricing than the role of two businesses, again we have, as weâve seen in our wireless business seeing significant unit growth and that has been offset by, maybe typical but very aggressive pricing. You donât see the same in our transportation but the all businesses are on the pricing pressure, the key issue is to, as you go on last, introduce the new products with additional volumes and try optimize on those basis. I think Ambrish hi, I think we said that the depreciation in the quarter was 10.8% and we have given guidance to get to 10%. You should see some improvement in depreciation primarily focus in the second half of the year to the churn of half a point. Okay thanks. A couple of questions for you Michel, if, if you look at the comments, I think you have made on the, accelerating growth in the back half of the year, which segments or step segments do you expect to drive that and then on the wireless front, I guess you have addressed some of it. If you look at the largest customer unit growth, they are 3% to 40% year-over-year and when you look at your growth essentially flat, how much of that, is a typical pricing and it sounds like itâs a little bit more than typical. Do you expect that to abate or do you only hope for that abating is getting customers outside if youâre going to out customers?. Thanks. Yes the two questions, so, so the 34% from that role out is according is this to revenue or unit, I think its unit right? Okay thatâs unit. So our unit growth in wireless, I mean I donât think weâve disclosed it we can disclose it, is what I thought of fair, itâs that 20, I think the wireless is roughly 25%. So, half is you want, half of the role of, of and Iâm sorry, you want to pretty assume. So did, did some of net value is that, with what has been growing in the low end, a little bit faster in particular, when this source operator side and, that using OEMs which Iâll let make setting using off sheet, so you cannot make a one for one comparative between not all unit shipments and off shipments. So, but you are right. Although we have increased, around 30% of something in term of volume year-over-year, our revenue is seen of various improvements and you can derive from that, a reduction that we have, we have delivered. Part of it, is because we, we have to become more competitive. I think, year-over-year from our falling position and so you could say that this professional demand of our, with production improvement in that segment has been stuck in terms of if the reduction and the second thing is that there, there has been normal I mean there has been higher pressures in â05 on chipsets, ASPs compared to phones because of the slow rank of 3G and so, so what you seen, youâve seen a, a longer cycle if you want that 2G phones and 2.5G phones with the normal curve of reduction and not at this point yet, we, -- if you want from the next generation, thatâs really because typical some decreases generation where you look 1, 1.5 to 2 to 2.5, the page which you want for replacement of, of the quick and quick, all that technology by the newer was a little bit faster and therefore was the pricing in industry is then along those lines with 2.5G chipset continuing to go down aggressively. So, you have all of those things. Now going forward I think I know weâll fight very competitively, we expect 3G to finally faster on that, in 2006 and so I do not expect that same aggressive trend to continue into â06. Okay, thanks Michel, I appreciate the calendar and the other question was on the growth in the second half of the year, which segment you expect to drive that. but the one that weâve been highlighting since into 2 quarters which is consumer in planning and in analog business and consumer electronics power management, i.MX and so the whole consumer electronics initiative, our RX business in wireless we expect to be kept and networking enterprise business. Quickly, you, and in your press release you referenced manufacturing ownership realignment and cost allocations and product allocations between the segments, that seems to have you uncovered them, some very healthy increases in profitability of TSPG, given this sort of refocus on who owns, what in terms of manufacturing and where products belong and how cost are allocated. Do you have any thoughts as to, where TSPG is sits in the longer term structure of the organization it seems as though you crystallized the profitability there, are there opportunities perhaps to consider, consider strategic alternatives for that unit. First, Tim thanks for your question. First of all let me tell you just, that more collateral into, what happened and whatâs been happening. The historical method was that the business segments actually owned the factories over the landlord of those factories many under utilization of cost where it picked up. As the factories have got fuller and there is so much more shading taking place, is more appropriate to know that the each of the segment fees is an average unit cost and weâve a volume there are not pay for. The impact of that in the reclassification actually was I think relatively remainder that was a, just about 1% point and the, and networking and transportation are with 0.6, 0.7 with in our wireless business. As we go forth again as we said earlier we will be looking at the, the goals for each of the segments, obviously as Michel said we both are going to still more satisfy we continue to raise the bar and I think where we would asked to just hold often, we owners giving some additional color on some of those models when going forward. Thatâs your, your strategic I got the question, I mean we, weâve said very clearly from the beginning that business that do not perform to a satisfaction might be looked back, but I mean at this point we are still very committed to that business we like it itâs a, we were getting significant growth in 15 and 32 bit, the consumer electronic part of the business is, is improving very nicely internal outstation in particular. As we are able to, in position resources which weâre serving low margin printer and automotive analog opportunity then weâve able to reposition them to attract growth opportunity and then thatâs a little bit and then its going to be interviewing in the case, some of the quick and quick confirmation that you see of the STG model but that were more to come as we, as we⦠One follow up, given, given that in your access cash position you see opportunities either to, of the mark capital structure further buyback more stock, it seems as through youâre operating with the nice war chest, what are, what are you looking you looking at and how did you look at enhanced value for shareholders. Yeah at this point, we got inspiring with our current model, we do communicate east and when appropriate that, at this point to the question I am really focusing the company on necessity and weâre on, we are focused on that. Yeah thanks, first of all congratulations on the execution your stock has done very well from the IPO and you have beaten your guidance almost every quarter, and yes congratulations for the whole team. Yes, yes you have. Yes, few questions here you have #1 is that on the margin side, I know that here quite a lot of time has been spent in trying to explain that, I mean you are at a $5 billion semiconductor company with 87% of the manufacturing internally. What I am trying to figure out is that when would your sales, AKA your capacity utilization going up and down would start increasing the margin more than what it has been. In other words can you give us an idea that out of the 200 to 300 improvement in the margin, weâre talking about the next 2 years time or so, how much of that is depending on your internal manufacturing efficiency and the mix and how much of that is going to be depending on the market condition? Now let me try to take that one that, let me thanks that we, weâve tried to put focus improvement with that depending solely on market conditions on revenues. So one of our challenges is as we drill that in a non-improving is to come out with the details that will, get our improvement with over revenue growth. Most of the, the numbers that Michel talked about in terms on health improvement will come as a result of our internal factories; although but we are going to very focused on supply chains. We said supply chain was a big element yield which is our internal factories in the big element. But we are not going to be as, weâve not done in the past being specific and breaking down the operational efficiencies by, by the subcategories. In other wards it is 200 to 300 basis point improvement or would not be too much dependent on the market condition. The market can not so much, the market conditions are obviously going to help and give us tail enders weâve said before but again our management philosophy in the show and I as, we want to continue to improve what we can control and know what the market controls. Just if I may, just a follow up question, on the wireless book-to-bill you give a book-to-bill of 0.97, is that different and is that because of the seasonality of the wireless market or its something else going on out there. Well I donât think I would worry too much of both, I mean if you think about the third quarter our book-to-bill was reporting the third quarter was 1.3. So, I wouldnât, first the fact the, book-to-bill about wireless uniquely by far the least reliable of our, of our three units for very that it very dependent come one last customer order and, and those tend to fluctuate. So I would, I would not focus too much on that, on that number. Okay thank you lets go to the next question. Operator? Okay great. So that gives you an opportunity to close the call. Thank you and have a good evening thank you very much. Bye, bye. |
EarningCall_234096 | Good morning, ladies and gentlemen. My name is Brianna and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Cablevision fourth quarter earnings conference call. (Operator instructions) It is my pleasure to turn the floor over to your host, Bret Richter, Senior Vice President Financial Strategy and Development. Sir, you may began your conference. Thank you, Brianna. Good morning and welcome to Cablevision Systems Corporation's fourth quarter and full year 2005 earnings conference call. Joining us this morning are members of the Cablevision executive team, including: Jim Dolan, our President and CEO; Hank Ratner, our Vice Chairman; Tom Rutledge, our Chief Operating Officer; Mike Huseby, Chief Financial Officer; Josh Sapan, President and CEO of Rainbow Media; John Bickham, President of Cable and Communications; and Wilt Hildenbrand, EVP Engineering and Technology. Following the discussion of the Company's fourth quarter and full year 2005 results, we will open the call for questions. If you do not have a copy of today's earnings release, you may obtain one from our website at Cablevision.com. This call can also be accessed via our website. Please take note of the following: this discussion of Cablevision's results and any discussion of the Company's 2006 outlook may contain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that any such forward-looking statements are not guarantees of future performance or results, and involve risks and uncertainties that could cause actual results to differ. Please refer to the Company's filings with the Securities and Exchange Commission for a discussion of risks and uncertainties. The Company disclaims any obligation to update the forward-looking statements that may be discussed during this call. Let me point out that on page 7 of today's earnings release, we provide consolidated operations data and a reconciliation of adjusted operating cash flow (AOCF) to operating income. I would now like to introduce Jim Dolan, President and CEO of Cablevision. Good morning. I am pleased to share with you today our results for the fourth quarter and full year 2005. 2005 was a strong year for Cablevision. Our cable operations continued to lead the industry in numerous operating metrics. We delivered our seventh consecutive quarter of basic subscriber growth, achieved record RGU growth with over 1.3 million new additions, and more than doubled our Optimum Voice customers to over 730,000. Our ability to continue increasing the market penetration of all our services provides further evidence of the strength of our telecommunications services, competitive position and the outstanding execution by our team. For the full year 2005, Cablevision exceeded $5 billion in revenue for the first time in our history. Consolidated revenue for the full year grew 9% to $5.2 billion and 2005 AOCF increased over 13% to $1.6 billion. For the fourth quarter, consolidated revenue grew more than 12% to just under $1.5 billion and AOCF increased 49% to $480 million. The AOCF growth rate for the quarter was impacted by the impairment charges noted earlier. Excluding those charges, the 2005 fourth quarter AOCF would have increased 21% as compared to 2004. As we begin 2006, we are pleased with the performance of Cablevision's core business, our competitive position and our prospects for continued growth. Before we move on to telecommunications, let me touch briefly on a recent announcement. On January 31st, the Company disclosed in an 8-K that the board of directors is expected to begin reconsideration of a possible special dividend at its regularly scheduled meeting in March. The filing also stated that there could be no assurance that the board will decide to move forward with the special dividend, or as to the size or timing of any dividend. Please note that we will have no further comment related to this matter at this time. Now I would like to turn the call over to Tom Rutledge, who will discuss the results of our telecommunications segment. Thank you, Jim and good morning. Our core cable television business continued to produce excellent results for the fourth quarter and full year 2005. During the fourth quarter, we added more than 360,000 revenue generating units (RGU) and for the full year, we added over 1.3 million RGUs. Our continued RGU growth, and the resulting growth in average revenue per subscriber, contributed to cable television revenue growth of approximately 16% and AOCF growth approaching 17% for the quarter. Our average revenue per subscriber (RPS) reached a milestone of over $100 for the first time. Fourth quarter RPS was $100.46, an increase of $3.77 versus the third quarter and an increase of $12.13, or 14%, as compared to the prior year period. This was our 11th consecutive quarter of year-over-year, double-digit percentage RPS growth. The $3.77 quarterly increase was primarily driven by RGU growth, as our Triple Play strategy continued to produce solid results. As of December 31, 2005 nearly 256,000 customers had taken our Triple Play offer. We continue to see positive effects of both our Double and Triple Play offers in our sales results and improving customer churn. Cable television capital spending totaled $190 million for the fourth quarter. Consumer premises equipment accounted for the majority of the capital expenditures, followed by scalable infrastructure and support capital. This continued investment in infrastructure is to improve our product and strengthen our competitive position. The increase in scalable infrastructure expenditures for the quarter was primarily due to the increase in speed of our high speed data service to 15 MB and the rollout of our 30 MB Optimum Boost service. Now let me touch briefly on the results and accomplishments of each of our services. The fourth quarter is our seventh consecutive quarter of basic subscriber gain, as we added nearly 18,000 basic video subscribers. For the full year 2005, we gained nearly 64,000 basic video subscribers representing a growth rate of 2.2%. Our digital video service, IO, added just over 119,000 customers for the quarter. These net adds increased our digital penetration rate by 3.5 points sequentially, resulting in an industry-leading 65% penetration of digital video subscribers. Digital adds continued to grow notably as we surpassed 2 million digital video customers at the end January. Our high definition video subscribers continued to grow as well. At the end of the fourth quarter, we had more than 325,000 high-definition customers, up 26% from September and 136% from Q4 in 2004. We currently offer 18 high definition services, the highest in the cable industry, at no additional cost to our digital cable customers. Optimum Online, our high speed data service, recorded a net gain of nearly 94,000 customers in the quarter. The penetration of homes passed at the end of December was 38% and now more than half our video customers are also OOL high speed access customers. Despite the noise in the marketplace about new competitive offerings and discounted DSL offerings, our high speed data momentum continues to be strong as we grew 7.4 points of penetration in Q4 2004 and 2 points of penetration from Q3 2005. We believe that we can continue to drive penetration rates and roll out product enhancements such as Optimum Online Boost, which was launched in Q4 2005. We have already rolled out Optimum Online Boost on Long Island and more recently in Connecticut and we are on track with our plans for full deployment across our entire service area by the middle of this year. Our Optimum Voice service continued its strong performance, passing the 730,000 customer mark in the fourth quarter with net additions of 130,000. More than 40% of our Optimum Online high speed data customers now take Optimum Voice as well. Lastly, we are pleased that Optimum Online and Optimum Voice were named the nation's top high speed Internet and VoIP services in PC Magazine's reader satisfaction survey. This was the second year in a row that Optimum Online received this distinction. It was the first year PC Magazine had conducted this survey of VoIP providers. In addition to continuing to focus on the growth and quality of our consumer services in 2006, we have also begun to focus resources upon expanding our data and voice services to small and medium-size business customers in our footprint. Optimum Lightpath continues to market to larger businesses with a focus on offering Ethernet data services. Optimum Lightpath's target market is medium to large-size business customers who seek increased bandwidth capabilities and reliability at lower cost. Optimum Lightpath recorded $51 million of revenue for the quarter, up 15% from the prior year period. AOCF grew 16% to $17 million. These increases are primarily due to growth in Ethernet data revenue, as well as growth in traditional data services. The growth in AOCF reflects both the growth in revenue and impact of certain settlement agreements in the quarter. We recently experienced a number of key business customer acquisitions and expect these efforts to become easier to repeat. We also expect Optimum Lightpath to become an increasingly important part of our telecommunications segment as we continue to drive customer and product penetration. Thank you, Tom. For the fourth quarter, revenue at our national programming networks -- AMC, ISC, and WE, Women's Entertainment -- increased 4% to $143 million and AOCF for the quarter was $66 million, up 20% as compared to the prior year. The results reflect a 19% increase in quarterly advertising revenue, offset in part by lower affiliate revenue. The increased advertising revenue is a result of higher overall prime time CPMs and increased direct response advertising at AMC and WE, Women's Entertainment. For the full year 2005, AMC, IFC and WE revenue increased 7% to $557 million and AOCF for the three networks rose 6% to $248 million. For the full year 2005, there was advertising revenue growth of approximately 22%, a 6% increase in AMC's prime time rating to 1.9 and increases in viewing subscribers of 3% for AMC, IFC and WE combined. Looking ahead to 2006, we are projecting revenue and AOCF percentage growth rates at AMC, IFC, WE in the high single-digit range. The primary drivers are expected to be strong continued growth in ad revenue, resulting from our increased investment in original productions and a continued focus on improving ratings. Turning to Rainbow's other programming businesses, which primarily include our Fox Sports Network, Regional Sports Networks, Fuse, our music-based service, News 12, IFC Entertainment and VOOM HD Networks, and our VOD services, Mag Rack and Sportskool. For those other programming businesses as compared to the prior year, fourth quarter net revenues declined 19% to $75 million and the AOCF deficit declined from $93 million to $23 million. The decline in the fourth quarter revenue resulted primarily from lower affiliate revenue at Fox Sports Network Chicago, relating to the loss of certain professional sports content and from certain payments not being received in accordance with an existing affiliation agreement. Revenue was also affected by the closure of two metro channels. These declines were partially offset by increased revenues at Fuse from growth in viewing subscribers and advertising revenue and increased revenues at IFC Films and IFC Productions. For the year 2005, revenue declined 31% to $297 million and the AOCF deficit improved by 35% to $90 million in Rainbow's other programming businesses. The decline in revenue relates primarily to lower affiliate revenue at Fox Sports Network Chicago and the closure of two metro channels. The improved AOCF deficit, both for the quarter and for the year, was primarily due to the impact of impairment charges offset by the decline in revenue at Fox Sports Network Chicago. During 2005, Rainbow's other programming businesses made some significant strides. Advertising revenue at Fuse increased 41%, combined Mag Rack and Sportskool subscribers increased over 300% to $17.1 million and IFC Films Trans America, a co-release with the Weinstein Company, has garnered Felicity Huffman a Golden Globe Award and an Academy Award nomination for Best Actress. I'd now like to turn it back over to Jim Dolan, who will discuss the results for Madison Square Garden. Thank you, Josh. I'd like to start by congratulating the nine Rangers players who represented five different countries in this year's Olympics. They represented our organization extremely well and we are looking forward to their return to the Garden for the remainder of the exciting season for the Rangers' franchise. I would particularly like to congratulate Henrik Lundqvist on being the goalie for the Sweden team and winning the gold. Just to touch upon some highlights for 2005, MSG Networks entered into multi-year carriage agreements with key affiliates. Hockey returned to the Garden in the fourth quarter with the end of the lockout, and more than 6 million people attended more than 1,300 events at the Garden and Radio City. Turning now to MSG's operating results. Fourth quarter revenue totaled $338 million, up 13% from the prior year period. AOCF for the quarter was $86 million, an increase of 56% from 2004. The increases were primarily due to the return of hockey for the 2005/2006 season, lower net charges for team personnel transactions and lower baseball rights payments expense. The AOCF increase was partially offset by an NBA luxury tax provision for the 2005/2006 season. For the full year 2005, MSG recorded revenue of $804 million, up 3% and AOCF of $120 million, down 29%. MSG's full year comparison includes the impact of $106 million of receipts and credits related to the Mets transaction and an NBA expansion payment in 2004. Excluding these items, 2005 revenue would have increased 5% and AOCF would have increased 89%. The increase in revenue is primarily due to higher MSG network affiliate revenue, offset by the impact of the NHL lockout. The increase in AOCF is primarily due to the increase in revenue, cost savings and cost savings from the lockout and net team personnel transactions. I would now like to turn the call over to Mike Huseby, who will briefly cover the Company's overall financial results. Thank you, Jim. Before we discuss the Company's overall financial position, I would like to take a moment to mention that on Friday we entered into new, secured credit facilities that total $2.4 billion at CSC Holdings, which replaced our existing bank facility that was scheduled to mature in June of this year. The new credit facilities provide us with approximately $1 billion of undrawn capacity for general corporate purposes. The terms of the new credit facilities also allow the Company to access up to $3.1 billion of additional funds from an uncommitted incremental secured credit facility. Now I would like to turn to our financial performance for 2005. The operating performance that Jim, Tom and Josh just summarized translated into the strong AOCF growth that they noted, and the generation of approximately $157 million of free cash flow in 2005. Going forward, the level of consolidated free cash flow will continue to depend on a number of variables, in addition to our operating performance, including: Turning to leverage and liquidity. At December 31st, the Company's consolidated leverage ratio, net of cash on hand and collateralized indebtedness, was 4.9X. The CSD Holdings restricted group leverage ratio is at 4X. Currently, Rainbow National Services has no borrowings under its $350 million revolving credit facility, and the ratio under its bond leverage test as of December 31 was 4.8X. The Company's consolidated cash position as of year end 2005 was approximately $397 million, which was primarily at Madison Square Garden and Rainbow National Services. Finally, in November, we closed on the sale of the Rainbow One Satellite to Echo Star. The $200 million of cash proceeds from that sale was used to fund certain Rainbow DBS-related shutdown costs, restricted group bank debt and for other general corporate purposes. Operator, we would now like to open the call for questions. Hi, good afternoon. Two quick questions. On the basic sub growth guidance that you guys gave for '06, I was wondering if you could elaborate on what you think the category growth is for Pay TV adoption within your footprint? In other words, are you assuming that you can steal some subs from satellite over the next year? Or, do you think the category growth is in the 2% to 2.5% range? Second, I was just wondering if you could give us any updated thoughts on the potential relocation of the Garden? Thanks so much. With regard to the category growth question on basic subscribers, if you look at the guidance by two big satellite companies, it looks like on a national basis that is around 2%. So the implication --whether that's true in New York or not, I don't know exactly -- but that is what their national number is, and you can see our guidance is slightly higher than that. On the Garden, we continue to work and move forward on our renovation plans while we explore all possible alternatives, one of which people have read about is the Farley post office building. At this point in time, we are still exploring all alternatives and again, moving forward with our renovation plan. Thank you. A couple things. I know you're not giving specific guidance on each RGU for '06, but should we assume, at least directionally, that the mix is pretty similar in '06 relative to '05? The second question, I was wondering if you could talk generally about the profitability of VoIP, namely how close you are to -- I think you gave out a 40% to 45% margin target in the past, at some point. I was just wondering, how close are you to that goal? That was our forecast for the business. We have not changed that forecast and we don't give guidance on that particular item, margin on the voice business. But you can see that our overall margins are the same or slightly improved over last year and that we've added a lot of voice customers. Our average margin is very close to 40% across our whole product range. With regard to the RGU growth, the mixture I think will, as we increase our digital penetration, skew a little away from that in terms of total RGUs. That is the digital portion of it. We have not broken that out. Thank you. I have a couple of questions also. First on the national networks. Could you comment, Jim, on how strategic these are to you? Do you need to keep them or would you consider selling? Finally, could you just review with us your DVR strategy, whether you plan on keeping the programming in your surplus head end? Could you talk about the copyright issues? Or, would you reconsider the strategy in light of DBS becoming much more aggressive in terms of DVR giveaways, pushing DVRs? Okay, I think I will give the last one to Tom. The first one was on how important the networks are to our overall strategy. Was that the first one? We think that those businesses are important. We think it's important for us to be in the programming business as well as the distribution business. We continue to explore new ways of doing that and we have had a lot of success with networks like IFC, WE and AMC. We have no plans at this time to change that mix, but I would never rule anything out. With regard to the Voom HD loss - we didn't break that out. With regard to DVRs, Jessica, we are marketing DVRs. We don't break out our results with DVRs, the guidance or reported numbers that we have. We are selling them and marketing them across our footprint. We also are on the verge of beginning our network DVR experiment. We have combined all the elements that we think we need to do a successful experiment to privatize a network-based DVR service and we will be starting that shortly. With regard to the copyright issues, we think the copyright network DVR is the same as for a physical DVR in a house, where the customer uses the material for their personal use. Yes, good morning. Tom, a couple of questions. First, can you update us on what you're seeing with respect to FiOS in the markets where they have rolled out, America and elsewhere. Secondly, as I understand it, you're now treating small/medium business inside of the Cablevision business rather than in Lightpath. With the results that you're seeing not broken out separately in Lightpath, can you just tell us what kind of success you're seeing in small/medium business? How big a business could eventually that get for you inside of the telecom unit? With regard to FiOS, the percentage of our service area that is covered by FiOS activity is about 15% of our passed. The penetration after a year that they have been able to achieve has been about 2% of the homes passed in our service area. The vast majority of that 2% has not come at our expense. It did not come from our customers. It looked like they were conversion from DSL and/or satellite. There are three small franchises granted, less than 10,000 passing and no discernible activity that we have been able to measure yet., although they have not been in business long. There are three franchises pending in New Jersey and no other active pending franchises anywhere. Nationwide, they have 3 million passing, it looks like around 3,000 customers. With regard to the small business opportunities. In our service area, in total there is about $5.2 billion of commercial revenue. Currently, almost all of which has gone to incumbent ILEC. Of that, $3.2 billion is small business and $2 billion is large business. Lightpath is going after the $2 billion segment and the cable company is going after the $3.2 billion small business segment. We have launched a multi-line product to small business. We are ramping that business up. We have had no numbers that we are reported yet, so they are inside of our numbers. I would describe it in the ramp-up phase, but there is a huge opportunity for us. We can serve that business with our existing plant. We can cut the prices dramatically. We can achieve significant market share, like we have in the residential. Thanks, good morning. Just a few quick questions. Given your comments, Tom, on FiOS and the fact that you're really not seeing them around your market; and, given the fact that your guidance for '06 is quite strong and more of the same versus '05 in terms of sub growth, RGUs and cash flow; are you assuming in '06 that you're really not going to see an impact from FiOS? Or, do you think it is really more of an issue for the future versus anything near term? Secondly, if you look at the basic sub footprint, can you give us a percentage of the basic subs that are now on the Triple Play offering? Lastly, before you had given us an ARPU number for the bundle. Obviously the offer -- I think is around $90 -- but you've talked about $110 ARPU. Are you seeing the same kind of uplift or any sort of change to that? Thanks. With regard to our guidance, we have considered satellite and FiOS, the competitive situation. and given our guidance with that in mind. What they will do beyond the guidance period, I don't know. It is really a function of whether they can continue building without getting subscribers and whether they can take away our customer base. One of the things that we're finding is that we have a reduced churn environment as a result of having Triple Play products. In the areas where FiOS' plant has been constructed, we actually have much higher penetration. Over half of our pass areas where there is a FiOS plant have high speed data from us, for instance. Not half our customers, half our pass. So we have very high penetrations in those areas and higher Triple Play product penetration. It is a situation where they are building a "me too" product at great expense. There is really no reason to leave when you have the value proposition that we provide. I forget the rest of your question. Well as you know, the ARPU went over $100. The rate that Triple Play customers are coming on continues to be over $115 on average. They step up to $140 after a year, on average. After 19 months, the average Triple Play customer has a 14.3% more likelihood of remaining a customer than a non-Triple Play customer historically does. All 730,000 reported Optimum Voice customers -- almost all of them -- are Triple Play but actually on the offer, I believe there are about 250,000 Triple Play customers. Thank you very much. Good morning. On the national mix, it seems like your guidance implies some kind of continued spending on programming costs, particularly given the easy comparisons in 2005. I was expecting some stronger numbers there. Could you comment on the trends in the scatter or cable scatter market and what you expect to see in terms of affiliate fees that is implied in that guidance? Separately -- Jim, maybe for you on the wireless strategy -- do you worry that it's taking a little bit longer than necessary to articulate what your wireless strategy is? Particularly given the experience that you had in the digital launch, in which you came off slower than your peers but ramped up pretty quickly. I was looking for some comments on how you anticipate your wireless strategy to evolve. I know you have talked about WiFi hot spots in the past, but just some more color on that would be helpful. Thank you. The cable scatter market is in accord with our expectations. We have increased, and continue to increase, our spending on programming -- we think reasonably -- year-over-year and have, as we mentioned, increased both AMC and WE's prime time ratings, which is what turns into ad revenue. So what does that mean for affiliate fees outlook for 2006? Do you expect that to decline or to increase commensurate with the mid single-digit or high single-digit outlook? The rate of our ad revenue growth has been double digits and high double digits year-over-year. We have seen, and expect to see, affiliate rate increases in the roughly low to mid single digits. There has been some moderation on the wholesale rate side of our business. Tom RutledgeSure. This is Tom Rutledge on the wireless strategy. We have a variety of strategies that we are contemplating. We have the ability to opt into a Sprint deal, which other cable operators have entered. We have not yet done that. We are selling wireless hot spot subscription services to the third parties. We are experimenting with various WiFi mesh networks and have deployed some of those in parts of our service area on an experimental basis. We are considering various opportunities that that may present us to build a fourth leg of our product mix. You gave 2006 CapEx guidance, spending down from 2005. I wonder if you could talk or give a little bit more detail on, for example, might the CPE spending be up in '06? What new boxes or features you may be rolling out in '06? Is the CSR support level? Is that where you want it to be? Lastly on CapEx, isn't there some plant on the Island that although may be above 550, may have been there for a while and may be due for an upgrade? So that was: CPE spending, new digital box features, CSR where you want it, and is there a plant that may be due for an upgrade? Thanks. I will start with the last question. No, there is no plant upgrade required or contemplated. We have completely rebuilt our plant and created very small node sizes with the opportunity, actually, to go smaller if we want to with a drop-in upgrade. We don't think we will need that in the near term or mid term, if ever. We have an experiment going on right now in Patterson, New Jersey. It's a switch video, which allows us to capture a lot of bandwidth and use the VOD spectrum essentially to have an infinite amount of channel capacity. So I think the one thing we can say with great assurance is we will not need to do another upgrade of the physical plant. With regard to boxes, we are continuing to buy Scientific Lab boxes and the mix in those, we have not changed any models we are buying. Although as I said, we are marketing DVRs. So the mix of DVRs to other boxes may change. Also, the high definition box mix continues to be much greater. I think more high definition sets were sold last year than standard definition sets. So you have that as well, although it is not a different product line for us, just a mix change. With regard to customer service representatives, we continue to scale customer service personnel. We are hiring lots of people as our subscriber growth increases. I don't think the ratio of employee to subscribers, including the RGU effect and the growth effect, is going to move negatively. In fact, I think it's more likely to move in a positive direction. As we do more and more Triple Play connects, the total amount of connects per dollar of revenue actually goes down even more. Hi, thanks. A question for you, Josh. Can you talk a little bit about the VOOM HD channels? In particular, how many subs do you currently have? Who is carrying them besides Echo Star? In particular, is Cablevision carrying them? What is the net cash requirement? What do they generate in terms of losses in '05 and what do you expect them to do in '06? When do you expect to be breakeven? Thanks. Echo Star is our charter affiliate and partner, as we have previously disclosed, in our VOOM HD offering. In early February, just about a month ago, they began to aggressively roll out and sell their new MPEG for HD offering, of which VOOM is a component. So we are less than 30 days into that experience. That is pretty much the summary of our experience with Echo Star. It is really occurring right now in its early stages. We are having discussions with other distributors across the country about their interest in carrying VOOM and we will pursue them through the year. We did not detail the individual VOOM expenses. We have disclosed information earlier on our relationship with Echo Star, and there is information included in that. Hi, a couple of questions. One, could you just talk about churn on the voice product? Last year, you said it was too early to give any sense of that but now that we're several quarters into this, where do we stand now with voice churn? Mike, you mentioned the fact that the board is still ongoing in terms of its review of a special dividend. Could you just maybe comment -- or maybe this is a question for Jim -- why not look at a tender offer in terms of a share buyback or just an ongoing, larger share buyback program versus simply a dividend? What is the reason behind the focus on a special dividend? Thanks. Richard, to your question on churn, we don't report churn for voice. I will say this -- the churn trend line for voice is very similar to our experience with high speed data. Our ability to forecast our voice churn is very good because we use our experience with high speed data and the results of that experience as a basis for making our churn forecast. While I can't tell you what our number is, it's favorable and moving in the right direction. Richard, this is Jim. I said before we are not going to comment on it. The board is considering the dividend but there is no guarantee that it will move forward with that or that it won't go in any other direction. So as I said before, we are really not discussing it at this time. And then if I could just follow up, could you just follow up on Kathy's question of why Cablevision is not yet carrying the VOOM HD networks? Well we are in the process of bandwidth reclamation and we have a variety of bandwidth initiatives going on that, at the moment, make it not easy for us to carry 15 more additional channels of HD, but later this year, we will have that capability. When we do, we will evaluate them in that light. We want to thank you all for joining us this morning. A replay of this conference call will be available on Cablevision's website and on streetevents.com through March 6. |
EarningCall_234097 | Hereâs the entire text of the Q&A from AutoZoneâs (ticker: AZO) fiscal Q1 2006 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and weâll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha. Bill, can you comment just a little bit more, I don't know, Brian if you can go one more step into the SG&A a little bit, and just give us a little more feel as to how much of that spending of 40, $45 million, X the charges, how much continues, how much, what can you, just go one step further on that, please? Well, John, as we've mentioned on the call, some of it was directly related to resetting our stores. That portion will not continue. It will continue in the second quarter, as we finish that initiative. But the rest of it will continue. And some of it is specifically related to these initiatives that we talked about, and then some of it is the growth in new stores as we highlighted on occupancy expenses. But we are very, very excited about resetting the stores. We've reset 2250 stores in the quarter, and when you walk into those stores, they all look and feel exactly the same. And it is much easier for our AutoZoners to know where our products are, and it is much easier for our customers to know where our products are. I am very excited about what that is going to mean to our future. And once again, I know you don't want to give the amount, but is that the magnitude or a small amount of that increase? Bill, just a follow-up on the resets. Can you give us a little more color in terms of, were these in car store resets how disruptive, if it was at all, were the resets, what was your strategy, in terms of picking the first 2250 stores? Was it geographically based? The oldest stores? Can you give us any color there? Okay. Terrific. Let me address why we did it. Over the last several years, many of our stores had become, they put different planograms in different places. We had an initiative to go and merchandise the stores in the stores so some of the store managers put things in different places and we also had hundreds if not thousands of different prototypes. We made the decision that we wanted our stores to look and feel exactly the same. So our store operations team took the initiative on themselves to go out and reset them all. They were not geographically determined. They were determined by each individual district manager. So the majority, a district manager has done 60 or 70% of their stores. What they do is they reset the entire sales force. All of the gondolas to make sure the right merchandise is in the right place on the gondolas. So when you walk into a wide prototype store, all the merchandise is in the same place in all the wide prototype stores. When you walk into a narrow prototype store, all of the merchandise is in the same place in those prototype stores. Was it disruptive? Yes, it was a little bit disruptive, Bill, but I don't want to overstate that. Our team really did a remarkable job of resetting them. They did a lot of it at night. And they did a lot of it in off-hours with specific crews that were dedicated to completing that project. My second question is starting in the fourth quarter you started increasing staffing levels, you increased the hours. Where do we stand at that? Are you now comfortable with the staffing levels in the store or the hours raised at all the stores you wanted to be increased? And then other than the system's upgrade in the back half of fiscal '06, are there any other incremental expenses we should come to expect? Are we comfortable with where our staffing levels are? Today we're comfortable with them but this is retail and every day we're trying different things we try higher levels of service, or of labor, we try lower levels of labor to make sure that we have always got it right. We have launched all of the initiatives as of the end of the quarter that we intended to launch. They were staggered somewhat throughout the quarter but at the end of the quarter they have all been launched. My final question is Bill, you have been at the helm now for a little over two quarters I believe, how are things going relative to your initial expectations, relative to your plans? Are they going better, the same, or slightly worse than were you planning? I didn't have a lot of time to create that plan. I wasn't planning to be in this role on March the 12th, and on March the 13th, I was, so it wasn't really something I sat down and reflected on a tremendous amount. I will tell you I am very proud of what we're doing. I'm very proud of our AutoZoners. We have a wonderful management team from our executive committee and our CEO team all the way down into our stores. I am very excited by what I hear from our store operators, from being in our stores, they're excited about what they're doing, they understand what our strategy is, they embrace our strategy, and they're out executing our plan. I would like to ask you just a couple of questions. First of all, following up on the labor question, if you forget for a moment about the resets and the costs and hours associated with that and also about the extra store operating hours and just sort of think on a comp basis, can you say whether your payroll hours on the store are up versus the prior year? We haven't given specific guidance on specific payroll hours, Matt, and I don't really want to get into that because we constantly managed our payroll based upon the trends that we're seeing in the business each and every week, so I don't want to get into a routine of communicating whether payroll was up or down and we kind of had a history of not doing that. I can tell you that I am very comfortable with the payroll that we are spending in our stores today. I think it is the right amount. But let me ask you another sort of related question then. If you look at the increase in SG&A dollars, did some of that reflect increases in say fuel costs and energy costs and related nonlabor items that seem to be rising from the entire marketplace? Unquestionably. It wasn't the broader part of it, but there are clearly some inflationary pressures from energy costs and the like. Got you. Okay. Just a couple of others. On the buyback front, obviously you're buying back stock commensurate with your targeted levels of debt coverage. Based on your plan, is it your expectation that you will be able to buy back stock over the course of this year? Without a doubt. What we said is we have two governors on our stock repurchase program, one governor is 2.1 times EBITDAR and the other governor is, as long as it is accretive to earnings. It is clearly very accretive to earnings at these levels. But as you've seen, over time, and this quarter was not inconsistent with what you saw last quarter, the first and second quarters are our seasonably low cash flow quarters. The third and the fourth quarter are where we generate a tremendous amount of cash. We are absolutely committed to our share repurchase program. And it has provided a lot of value over a long period of time. We have initiated a search. I think we put it in a press release about six or seven weeks ago. I'm pleased with the progress that we're making on the search but don't have an announcement that is imminent at this point in time. I also want to say, I am very proud of our finance team that we have in place here. We have a great group of finance leaders and they are doing a fantastic job. And so I'm not in any rush, I certainly want to hurry up and get it done, but I'm also very comfortable with the team that we have in place, and really want to thank them for stepping up, and leading the finance organization over these last couple of months. The first question is, on proprietary brands, can you give us an update on what percentage that is of the mix, and where you think that can go? Yes, Matt. We have said over time that our proprietary brands represent over 50% of our sales. And that really hasn't changed that significantly. It has grown a little bit in recent months. I think there is this misperception out there that we have evolved into this private label house, we call it our brands where we were all using national brands before, and that's simply not the case. What we've done over the last 18 months or so is we have migrated a bunch of brands that didn't, that were so small, they didn't have any meaning in our stores so nobody knew they existed but they were proprietary brands at that point in time and we have taken those brands and rolled them into Duralast and Duralast Gold brands so many categories before, we had Deutsche oil and air filters, well, those are gone now, we had Ultra Spark, spark plug wires, those are now Duralast spark plug wires, we had Albany brake pads which are now Duralast brake pads so it is pulling all of those, in some respects, meaningless brands into one powerful brand that we can communicate the qualities of those brands to our customers so they have great meaning with them. And then just to follow up on the new product that you've introduced, in your stores, how big is the, are the catalog sales for you right now? Is that, I know you've introduced a performance catalog. lower log, I think you have a salvage catalog, how big of a piece is that? We haven't specifically disclosed that but I can tell you I am very excited with what we've done, we call it "project got it" and we're continuing to find more ways that we can say yes to our customers. First of all, it gives us that sale at that point in time when the customer is in our stores but it also, our main objective is to make sure that we're the only store our customer shops. And if we ever say no to them, then they're going to have to go fill their needs somewhere else. So "project to it" is about making sure we say yes and we deepen the relationship that we have with those customers. Our ticket continues to grow. Our traffic was down slightly. But we're pleased with the trends that we're seeing in our traffic as well. Thanks. A couple of questions on the commercial business. The number of stores was unchanged from the end of Q4. Do you expect to add programs in fiscal '06? And then also in commercial, you mentioned some tests. What types of things are you trying in the commercial business? Our commercial store count didn't change during the quarter. We continue to look for different ways to make sure that we have the right programs in the right places. We think we do right now. But we also don't want to open a bunch of commercial programs going into the winter selling season. It is our least profitable selling season, especially on the commercial side of the business, so we don't look to ramp up commercial stores as we go into the winter. We will be continuing with our assessment of which stores need to be on the commercial program as we go into the spring, and we will continue to open new programs during the, as far as the specific test, I'm not going to get into too many specifics, it is too early to tell, but our team went back and said okay, what are all the different things that we need to do to improve this business. And we're trying those in a couple of different markets, and we will see how they do. I'm very excited from what we've learned to date and look forward to taking the learnings and rolling them into our commercial program across the country. Great. And one other question, on the loyalty program, planning for that, for six more months, are you making any changes for the program from the first version? I think the only thing that changed was the picture that was on the loyalty card so that it looks a little bit different. It was launched on December the 1st. It is in stores now, if you want to go see it. But it is the same program. Five punches, five purchases of $20 or more equates to a $20 gift certificate. We've been very pleased with the performance of the loyalty card so far. It is giving people a reason to come back into our stores more frequently. And at this point in time, when we're proud of what we're doing in our stores, we want them to keep coming back and getting new experiences. Hi, thanks. I have two questions. One was just to make sure I got the numbers right on the resets. It was 2200 stores that you did during the quarter? And were all the stores done, were there any that were done late last year or were they pretty much all in the first quarter? Okay. Toward the back part, great. Is the working capital and the payables ratio, if you just look at the free cash flow in the quarter, and I guess what resulted in lower share buyback, a lot of it was that being up also versus a year ago. Could you just describe why the payables drip down a little bit versus inventory? Sure. Again, our goal by the end of the year is obviously to continue to improve on the payables ratio, and we expect to be driving towards that. In the quarter, it was just seasonality, Greg. There wasn't anything special. It was based on the mix of goods that were sold. And the process. And we were close to the number of last year, but again, we look to show improvement. So it was nothing more than seasonality with accounts payable to inventory. We have our goal of reaching 100% accounts payable to inventory, and that is, we have every option and initiative to go forward to get that number. I think that it is still early in the process, while we've reached out,and started to do due diligence on the initiative, it has had some early impacts but it is very early, still. We expect that initiative to just gain traction as the year goes on. How much of the purchases that you have come from overseas? You said it is pretty negligible right now and how much do you expect that to go to? Well, first of all, we haven't disclosed exactly what the percentage of purchases that come from overseas are today, but understand, as far as us direct importing, virtually that number is zero. Now, we have started some over the last couple of quarters but it is very insignificant at this point in time. Now, that being said, we have many people that are buying things, are buying products overseas, and selling them to us, so we have gained some portion of the benefit over time by encouraging our vendors to move their manufacturing facilities over there or finding importers who can do that for us. But what we're doing now is looking at certain opportunities where we can directly import it, and cut out the middle person. And I mean any idea in terms of with the year-over-year improvement in gross margin, how much of that came from, would you say the bulk of the improvement came from these initiatives of you trying to push your vendors overseas and move more towards overseas? No, I wouldn't, Jerry, it would still be premature. That is an initiative that is just beginning at this point. No, it is just the standard process of us working with our vendor community, and sales mix, to grow our margins. Okay. Did I hear right, Brian, did you mention that rent charges were up 49 basis points, added 49 basis points to your SG&A on a year-over-year basis? Did you guys increase your percent of lease versus owned? Over the last year and a half or so the rent-to-own mix has changed. A lot of that has driven by where the new store openings have been. In the northeast and on the West Coast where it has more of a challenge for us to find purchased property, we have been leasing and what we have said was a combination of rent and depreciation expense was up 49 basis points, a combination of the two of those. And last question. Bill, you kind of talked about your customer research in the commercial end of the market being more towards those customers saying the biggest thing that they care about is reliability. Have you done any research toward the actual end customer who shops those repair shops and what they're looking for, because it just seems to me like there is that, that they're missing out on the opportunity of realizing how much lower cost they could get if they were buying from AutoZone? I think that is a great point. No, we haven't done specific research of our end consumer, of the ultimate end consumer from the shops. We have spent a lot of time working with our partners, our customer partners, on how we can help them improve their business. And clearly, one of the things that we continue to reinforce with them is using us will, one, give you high quality products, great service, but also lower economics,, or improved economics, that's one of the things that we talk about a lot of times when people talk about our brands versus the national brands. I'm a big believer in over the long term economics win, and when we can provide our products at the same or better values for lower costs, over the long term economics are going to win. Yes, hi, it's actually Brad Thomas for Alan. Most of my questions have been answered but just wanted to follow up quickly on some of the sales. You had talked about the commodity prices being up low single digits. I was wondering if you had had any benefit from inflation in your comps? Not materially. It was, while there are certain corrections on certain lines to the overall mix it was not a material impact. Okay. Then I know you all continue to talk about having a correlation in your business with gasoline prices. Would it be fair to believe then that your business accelerated towards the end of the quarter? We have not provided guidance on run rates throughout the quarters. What we have said is that gas prices, we continue to see correlation but we're just continuing, we more firmly believe that as long as we execute on the initiatives that we have in place, working with our customers, we can provide a solid opportunity for growth in the future. But we have not given the guidance on performance throughout the quarter. Yes, Brad, we have a practice of not discussing individual regional differences, but what I can tell you is we've been pleased with the improvements we've seen across the country. Hi, good morning. Most of my questions have been answered as well but just two. First, is can you touch a little more on your strategy regarding your, keeping within that adjusted debt to EBITDAR, because this one had came at 2.0 times and it looks like you paid down some debt and the follow-up is what your, what your strategy is in the event of a rise in interest rates? Okay. A couple of different questions there. First, it did come out at 2.0, Cid, but I think it is 2.047, and these two quarters are our seasonably lowest quarters for cash flow. So we want to make sure that we stick within our guide of 2.1 times EBITDAR. So it is very close. It wasn't anything specific other than making sure that we were in good shape as we go into the second quarter. Second question regarding interest rate fluctuations, if you look at our debt, about 85% of our debt is fixed today. So certainly, over the medium term we're hedged well against any rises in interest rates. Okay. And then my actual second question is, if you can touch a little more on your advertising strategy, as it relates to Duralast, and any color in terms of the cost and what we can expect going forward? Well, we rolled out a new Duralast battery commercial during the latter part of the summer. And early into this quarter. And it is a fantastic commercial. We have been very pleased with the results of that commercial. And I think it is airing in a market near you today. So we're continuing to find different ways to build the Duralast brand. It is a great brand. They are great products. And they're very well received by our customers. So we're going to continue to exploit that brand by telling the consumer how powerful it is. Not materially different. Just in different places. What we want to do is make sure that we, it is not about how much we spend, but how effective we spend it. And we're doing some different things to make sure that we hit our customers in different ways. And I mean the whole Kenny Wallace number 22 Busch car is a different way to go hit our customers, and clearly, I went to a couple of races this year, clearly, that is very focused on our core customer. And it is hitting them in a different way than we have ever hit them before. Focusing on Duralast, that is another new way to hit them rather than the same messages. So I'm very excited. I'm very pleased with what our marketing department has done from those various marketing initiatives to the loyalty card program. My only question here is on the Z-Net system upgrade. I was wondering if you could provide some additional details how that differs from the previous parts lookup system you had in your stores? Well, our parts lookup system that we have in our stores today is a green screen. I will tell you, it is a very powerful tool. It has more information, more robust information behind it than any other tool that I've seen in the marketplace. It is a very intuitive and very easy for someone to learn but it is based on green screen technology. Our new Z-Net tool is going to be based on the latest and greatest technologies, XML, GUI interface, those kinds of things and what those advances in technology do is allow us to provide even stronger information for our customers and our AutoZoners. We can provide graphics, we can provide diagrams, we can deploy more specific repair information and it will allow us to use ALLDATA in our stores as well. So we're very excited about it. It is going to be, it is going to beta test this quarter and then be rolled out sometime later in the second half of the year. An indication reviewing last year is your best guidepost for this year's option exposure. So if, in our footnotes we pro forma from the previous year's 10-Qs what our expense exposure would be and we encourage you to look at those numbers. Okay, that's fine. Also, can you guys help me understand a little bit better the difference between the remodels that you've previously referenced and the resets and are the resets in addition to the remodels, is the remodel program still going on or this is instead of? Just help me understand what is incremental and what is kind of just a continuation of? There are actually two completely different programs, Scott. A remodel is we will go in and change the tile in the store and we will change the layout of the store and we will change out parts counters and make them into parts pods, those kinds of things so it is a fairly extensive remodel of the whole store. I almost said reset. But the resets are taking the planograms that are in the stores and putting them in the same exact place in every individual AutoZone store that is set on that prototype. So it is like setting our wiper blades on the insides of the gondola in every store that is set to a wide prototype. It is about setting the tools on a high gondola in every store that is second high gondola in every store, and what has happened, especially when we went back and made our gondolas higher, in some cases, we had categories that were designed to be on a low gondola but they're actually set on a high gondolas, so the AutoZoners had to spread the merchandise out. So it was not a very compelling presentation to the customer. With this initiative, all of those issues are done. Thank you, Scott. Okay. Before we conclude the call, I would like to take a moment to reiterate that we know we have an incredible business built on a strong foundation of disciplined processes, focused on delivering great customer service. As we continue to focus on the basics, we are confident that we will continue to be incredibly successful while continuing to optimize long-term shareholder value. I want to thank each of you for participating in today's call. And look forward to talking to you soon. Wish you all very happy holidays. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANYâS CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANYâS CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANYâS SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
EarningCall_234098 | Good evening ladies and gentlemen, I am Pratiba the moderator for this conference. Welcome to the Satyam conference call. Operator instructions. I would now like to hand over to the Satyam management. Thank you and over to Satyam. Thank you Pratiba. Good morning and good evening to you all and thank you for joining us to discuss our fourth quarter and full year results. Joining me on this call are Raju and Ram from Satyam and Venkatesh from Nipuna. Before we start the discussion I would like to draw your attention to the fact that during this call we will make certain forward-looking statements regarding our future growth prospects, such statements may involve a number of risks and uncertainties associated with our business. Please refer to our various periodic filings with SEC for a description of such risks. The company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the company. I now handover the session to Raju. Thank you, Srinivas. Hello everyone and thank you for joining us on the call today. It is with a great sense of pride and joy that I report Satyamâs entry into the billion dollar club. Achieving this significant landmark has been made possible by the support received from our customers and investors and the commitment of our associates. I would like to place on record my heart felt gratitude to all stake holders who made this possible. I am pleased to report that our performance exceeded the guidance in Q4. Volume growth at 0.8% was a key driver in this quarter. For fiscal 2006 we achieved revenues of INR 4793 crores, and an EPS of INR 30.05, an annual growth rate of 36.1% and 36.2% respectively. This growth is one of the highest in the industry for this fiscal and was achieved against an initial forecast of 26-28% revenue and 20-22% EPS growth. Fiscal 2006 witnessed the gross addition of 120 customers including 12 global and US Fortune 500 corporations providing a strong platform for future growth. Nipuna, our BPO subsidiary, reported revenues of USD $20 million for the fiscal against a target of USD $18 million. Achievement of cash breakeven by Nipuna in Q4 as per expectations is encouraging and points towards enhanced profitability in financial year 2007. We continue to see increased traction in the BPO space and expect the company to achieve a revenue of USD $36 million in the financial year 2707 representing an annual growth of 80%. In Q4 Satyam made its presence felt in the large-deals category by securing long-term contracts from leading global auto majors. Our integrated solutions offering coupled with global program management capability would make us a strong contender in garnering a higher share of such deals going forward. The strong demand in the market coupled with the increasing complexity of business solutions has also brought, in its way, higher demand for associates with the right kind of talent and competence. Apart from attractive remuneration in general, we are also introducing restrictive stock unit selectively to enhance our position as an employer of choice. We believe that these steps would bear fruit in the long run, though they tend to be margin dilutive in the short term. We believe that the demand environment will continue to remain buoyant in fiscal 2007 due to increased IT spend by organizations as well as greater acceptance of the global delivery model. To address the availability opportunities we are strengthening our business solutions capability by hiring best-in-class associates from across the world and are making a focused attempt to enhance our competence in new service areas that would be drivers of growth going forward. Inorganic growth as a means to accelerate our competency continues to be a key objective of our long-term growth plan. Against this backdrop we look forward to a revenue growth of 25.2-27.3%, and an EPS growth of 18-20% as per consolidated Indian GAAP financials while the corresponding revenue and earnings per ADS figure under U.S. GAAP would be 24-26% and 20-22% respectively. I am pleased to report that Ram Mynampati our President, Commercial and Healthcare Businesses, is being inducted into the board as a full time director subject to shareholder approval. The board has proposed a bonus issue of 1:1 and also recommended a final dividend of 250%. The total dividend for the fiscal 2006 stands at 350% including the interim dividend. I now request Srinivas to discuss the financial highlights for Q4 and as well the financial year 2006. Thank you, Raju. Our detailed financials have been posted on the web and I assume that most of you would have got an opportunity to go through the same. However, I will now share some highlights. Fiscal 2006 has been a year of milestone at Satyam. As Raju mentioned earlier the company crossed an important milestone of a billion dollars of revenue. Net associate addition was 7,347, the highest in our history. Margins for the parent company showed an improvement over FY05, arresting five years of continuous decline. On the inorganic front, Satyam acquired CitiSoft based in the U.K., and Knowledge Dynamics based in Singapore. Nipuna, our BPO subsidiary, reported cash breakeven in Q4 for FY06. The year also saw Satyam unlocking the value of its investment in Sify when the entire holding was divested for a consideration of USD $63 million. Now, coming to Q4, revenue under consolidated Indian GAAP grew 3.8% and EPS grew 5.1% QoverQ. The parent company saw a 6.8% growth in volumes while billing rates increased marginally compared with the previous quarter. Margins registered an improvement despite a 2.2% rupee appreciation because of a 100 basis point shift in business to offshore and other operational efficiency initiatives taken by the company. Net manpower addition for the parent company was 3,079 including 2,442 freshers(?). We expect the gross manpower addition for FY07 to be between 10,000-12,000. Capex for Q4 was USD $13 million. Total cash outflow on capex for the entire year was USD $53 million. We estimate that capex for FY07 would be around USD $75 million. As Raju mentioned, the company is proposing to introduce a restrictive stock unit scheme selectively with effect from October 2006. The total charge for the units expected to be granted during the current financial year, that is FY07, is estimated to be around 150 crores over the period of the listing and the charge for the current year is estimated to be around 40 crores. Increments for the year have been finalized at 6% for onsite associates and around 18% for offshore associates, which is higher than last year. To align our compensation cycle to performance management cycle the increment cycle has been changed to July to June period and increments will be effective from July 1st 2006. After factoring in increments and the RFCO charge, we expect consolidated margins for FY07 to be around 100 basis points lower compared to FY06. Our guidance is based on an exchange rate of INR 44.80 to USD $1.00. Coming to U.S. GAAP for FY06, revenue under U.S. GAAP was USD $1.1 billion, a year-on-year growth of 38%. Basic earnings per ADS for the year was USD $1.3, a growth of 37%. It is heartening to note that during FY06 the cost of revenues declined by 100 basis points over FY05 on the back of various operational efficiency initiatives taken by the company. However, in view of increased investments from marketing, the EBIT margins was marginally down by 44 basis points, this is in line with our guidance. Thank you, and now we throw open the session to Q&A. Thank you very much sir. At this moment I would like to hand over the floor to April to conduct the Q&A session for participants at the international center. This will be followed by a Q&A session for India. Thank you and over to April. Great guys, wanted to ask you a question about the guidance for the next year. It looks like the June quarter guidance implies a lower growth rate than what you have achieved over the last 12 quarters, and I wanted to see if you could tell us some of the dynamics that are making you (inaudible)? And then also what makes you confident of acceleration in the latter part of the year, which is also implied by your full year FY07 guidance? Yeah Rod, good morning, this is Ram Mynampati here. You know when we look at the yearly guidance for the revenue, we have given a guidance for the year of about 25-27%, if you look at the Q1 guidance, you know, our guidance is as a result of number of parameters that we have considered in coming up with a realistic assessment of our guidance. But various other things that have gone into computing the annual guidance include the ramp up plans, so we have for the contracts that we already have on hands, the opportunities that we see in the existing customer base and the new opportunities that we are pursuing and the cycle times involved thereof. Overall we believe that we are operating in an environment that is fairly robust, a fairly buoyant market place, and we are fairly positive about the growth potential that exists in the market. But taking all the factors into consideration to make sure that we share with the investors the realistic assessment of where our business is positioned today, we have come up with a 4% guidance in Q1, but overall the sentiment that we share regarding the market is very positive. OK. Could there be something happening with the ramp up on large contracts that will cause June sequential growth to be lower than that of the rest of the year? And I guess, you know, more specifically, if there is any color commentary you can provide on what you are assuming in sense of large contract wins in the contribution of these large deals in your FY07 financials? This is Raju here, the larger contracts that are ramping up may be one of factors, but not the only factor, and generally speaking we have been in negotiations in number of instances with regard to large deals, and the environment for establishing relationships on a larger scale today is fairly positive. In that sense which we expect to be one of the significant operator to be participating in larger deals. Just to add to what Raju said, Rod, the contributions from large deals also have been factored into the overall guidance, both for Q1 as well as for the fiscal. Well, each deal is different in terms of what the customer is looking for from us, in some cases customer is looking for us to take accountability and ownership for services to be delivered, in some cases, you know, it is the incremental business that we need to put in, it is multi-year, multi-engagement type of opportunities, so there is no one uniform color that we can associate with these deals that we are pursuing. They tend to be different in expectations, ramp up, and the type of competencies and the strategies that we need to adopt. In that sense the margins tend to be different for each type of deal, there is nothing uniform that we can say based on our experience that would suggest that they are going to be either margin accretive or margin dilutive at this poin. Our endeavor continues to be to pursue opportunities that are broadly in line with our overall business management strategy, and that is what we are focused on delivering. OK, anyway one final small point on the GE relationship. GE revenue has declines in the quarter, what do you expect from GE in your FY07 outlook? Thanks. You know as most of the investors know, GE has been the largest customer for Satyam, it continues to be the large customer, while we have refrained from making specific comments on any one customer given that GE has been the largest customer, we would like to reiterate the importance and the criticality of GE to Satyam and we will continue to strengthen the relationship with GE and look at the opportunities that are broadly in line with our overall business management philosophy. Hi, gentlemen, my first question here is around margins. Could you give us a little color on the wage inflation and its impact in the June quarter, and just maybe a little more color on where you see margins headed in 2007. I know that you have already given guidance on that? Yes. This is Srinivas here. As I was mentioning in my initial speech, we are looking at a decline of around 100 basis points, it is on a year-on-year basis. The primary reason for this is of course the increments and the RFCO charge. We have decided to, as Raju was mentioning, we have decided to introduce the restrictive stock unit scheme, because of that we have to take around 40 crores, which is roughly around USD $7.5-8 million for this year. After factoring in that the total year-on-year decline is roughly 100 basis points. Since it is a non-cash charge, for a while, if we remove that impact, then the decline will be on a year-on-year basis around 40 basis points. So, even though we are giving increments which account for roughly 4% of our revenues, we are I think doing a lot of margin management by bringing in various productivity improvement, cost optimization measures during the year and then trying to reduce the impact to the minimum possible, so that is the situation. And as far as those margin levers are concerned, where do you see maybe the onsite offshore revenue mix moving in 2007 or utilization and pricing? We are not basically talking about all those metrics. One thing I can talk about is the pricing, we have not factored in any improvement in the pricing, we have taken a flattish kind of a scenario when it comes to both offshore and onsite pricing. Number two, on the exchange rate, we have taken INR 44.80 to one dollar, so there is another assumption. So, otherwise, the other parameters like offshore onsite mix, yes while our endeavor is to increase the offshore component to the extent possible, for example, in Q4 we have seen 100 basis points improvement and that is one of the primary drivers for the margin improvement in Q4. That continues to be our endeavor, and also there are various other things like better fixed bid project management and, for example, reducing the cost of delivery by increasing the intake of entry level training program, that is gamut of things we are aiming. Tsum and substance and the quintessence of all these measures is what we are guiding at the margin level of what we are saying less than 100 basis points decline. Just one last questions, from a human resources perspective, do you plan on, maybe you could just give us a little color on what your current recruitment split is, campus versus laterals, and if you could give us maybe some color on where you see the attrition, I know it went up percentage point this quarter, anything that you guys are doing on the human resources front going into 2007? On the resources front we are definitely at this point in time putting plans to recruit 10,000-12,000 people, and out of this the majority will be entry-level trainee programs, that is our plan at this point in time. Of courses, with maybe, based on what business demands, otherwise that is the plan, to recruit around 10,000-12,000 gross. Good morning guys. Can you talk a little bit, Srinivas, about your expectations on a couple of different fronts, I guess I'm wondering as you go through FY07 what your expectations are for utilization levels and for pricing in particular? I think I already mentioned about pricing that our expectation at least in the model while it is our endeavor to increase the pricing to the extent possible, but at least for the model perspective we have not factored in any increases. We have taken a flattish kind of scenario. On the utilization, I mean, as you know we have, we are investing (inaudible) when it comes to loading factor utilization, so that continues to be one of the focus areas going forward as well, but maybe quarter on quarter the loading factor maybe a little, coming down little bit. For example last quarter we added 3,000 entry level trainee programmers. So that may to some extent depress our loading factor maybe in Q1, but that is one of the focus areas and it is our endeavor to ensure that the loading factors are at a very high level. OK, and then just to be clear, the guidance that you are giving on the margin side, it sounds like there is a new element which is a restrictive stock unit chargeable at about $8 million. In addition to that there is also stock option compensation, stock option compensation is roughly $14 million, is that correct for FY07? OK, the two elements, both of those are factored into this G&A(?) number, so what is the percentage of revenue from sales and marketing or the SG&A line as we look at that for FY07? Julio, while I will not be able to give any specific number there, but again our philosophy as we keep telling you really remains the same, that we want to invest in selling and branding and we want to keep a tight control on the G&A which is another overhead. So that philosophy continues into the future as well. OK. And on the turnover side, other than the current things that you have to do with the new wage increases and the RSU program, what other things are you guys doing to stem some of the increases in the turnover on the employee side? This is Raju here. One of the biggest initiatives for us is to provide significant increases in the base case as such. We believe that added to that the restrictive stock units should significantly help. Apart from that we are taking a number of initiatives so that we can significantly bring down the attrition levels and that, we believe, is something that we are doing to invest into the future. We have also taken a number of measures to substantially enhance the leadership and provide a much better environment of course. Hi. Actually most of my questions have already been answered, I just want a clarification on the assumption in the guidance on the subsidiary performance. To me, that seems like one of the biggest levers for holding the margins, could you just elaborate on what you assume for Nipuna and the rest please? I will not be able to⦠basically, as a policy we are giving guidance only at a consolidated level, but I can just share with you color. Yes, I mean, that is one of the important levers and we are expecting all our subsidiaries to perform better in the coming year. Whatever upside that may accrue to us we have already factored into our guidance. And just one more thing on the tax, could you just tell us what tax rate should we model in for the coming year? Hi, this is (Druve Maniktalas?) for Ed Caso. Most of my questions have been answered, but I was curious as to, can you throw some color on the signing of the new customers? It seems like it has been running a little bit lower than what we have seen in the previous quarters? This is Ram Mynampati here. While we have been averaging roughly about 20-30 customers per quarter, there will always be some variations related to the number of customers that we have been able to completely complete the process of signing master services agreement with. I am not too sure whether there is anything abnormal in terms of the number of 22 versus 28 or 34, and we are very positive about the market and our ability to pursue the opportunities in the market. You know, 22 new customers being added in a quarter itself is a substantial number, and today we have roughly about 475 or so anchor customers that we are fortunate enough to partner with. So I am not sure whether there is anything abnormal or anything to read into that number. Good evening. Have you changed the timing of your annual salary increment, and if so, what might be the thinking behind this? Ashish, yes, that is what I was saying. We have changed it to 1st July. Now July to June will be the increment year going forward because we thought that by changing the compensation cycle to this will basically give us lot of comfort at the operational level. Because April to May at that point in time as you know we are all engrossed in working about the next year budgets and guidance and so many things, so for our HR folks to work on increments from 1st April it is not really working out and most of the time they are missing on their SLAs. So to that extent what we thought is if we make it effective from 1st July then it will give them sufficient time to plan the appraisal process and complete everything, get it ready, and then the letters can go on 1st of July to the associates. OK. And just moving onto attrition, it seems that that has picked up as well, is there any significant fallout on attrition from what one has read recently about misrepresentation of credentials by certain employees? This is not a Satyam specific issue, it is an industry issue. Generally speaking the demand for the skill sets in India has been very high and therefore there has been an associated higher level of attrition. We believe that there is an opportunity for us to significantly reduce the attrition levels in the company, and one of the significant steps that we have now taken is to enhance the remuneration packages so that we become very, very competitive and lay the foundations for building a very strong work force for the future. OK. And then just talking broadly about margins, all of your immediate competitors have guided explicitly or otherwise towards stable operating profitability in FY2007. Based on the ability to invoke multiple profitability levers that you spoke about, at what point in time can Satyam expect to be in such a position as well? Well, the 100 basis point decline is not a very significant one, and particularly given the fact that we wanted to reciprocate rather well the good services that our associates have been providing and provide a very healthy environment internally for long term growth. Given the fact that we are already going to be achieving significant enhancement in margins after having provided for almost 4% of revenues equivalent increment, it speaks for our ability to manage margins fairly well. We have done that last year. We have performed better than what we have guided for and therefore we are stepping into this year with that confidence. OK, just a clarification, excluding the non-cash items, that drag will go from 100 basis points to 40 basis points, is that right? Good evening gentlemen. A couple of questions, firstly on your guidance. Your US GAAP full year guidance is materially lower than the guidance you were giving this time last year for FY06. Yes I think almost without exception, your peers among the Indian Sis, the guidance they have been giving or at least indicating is pretty much in line with the guidance they gave this time last year. So are you seeing FY07 as being somewhat lower opportunity than FY06? In our opinion it would not be appropriate to compare the last yearâs performance on a one-on-one basis with this yearâs guided performance. Last year we were quite happy about the fact that we have delivered results both at revenue as well as EPS growth levels that are among the best in the industry. All we could state is that this yearâs guidance is based on a model that we built taking many variable things into account and what we believe to be realistic assessment, and we are doing it in an environment where essentially the market condition continue to be good. Our confidence levels are to be able to realize the market opportunities are also being as good. Just to sort of, I guess, ask the question in a different way, are you seeing any material decline in demand from any sections of your customer set or among your prospective customers? OK. And in terms of competitive landscape, are you seeing any enhanced competition which made you feel that your win rate might be less good than last year? No, in fact you would find that last quarter our performance was better than the quarter before, but for the fact that the rupee appreciated last quarter, and therefore in percentage terms the growth may have appeared to be lower, but in fact it was better both in volume terms as well as in terms of growth if we have discounted the rupee appreciation. So the point I am trying to make is that we have consistently delivered good results all through not only last four quarters but earlier also, and in that sense we remain positive and there are no concerns at this time but for the fact that when you have a customer base as large as 450 or so, there are many customers who are ramping up. There may be some who are ramping down or whatever, and we have learned over a period of time to rely to a greater degree on what the model is telling us and these are the numbers that the model has thrown out. OK. And my second question, just coming back to Nipuna BPO, you said you turned cash positive in quarter four with what looks like a fairly small lot, I think it was $600,000. You are implying in your guidance that you should turn profitable for Nipuna in FY07. Can you give any further clarification on that, and whether you expect profitability to increase in a sustained fashion or whether there maybe the occasional hiccup as you take on new contracts during the year? Hi, this is Venkatesh here. I think the last two quarters or so, the trend has been exceptionally positive based on which we have given the guidance, and the intention of this point is that we will continue to be a profitable company during the course of this year. That is the outlook we have at this point in time. At this moment, there are no further questions from participants outside of India. I would like to hand over the proceedings back to the Indian moderator. Thank you very much, April. We will now begin the Q&A interactive session for participants connected to WebEx India. Operator instructions. First in line we have Mr. Mahesh Vaze from BRIC Securities. I just wanted to understand the margin movement. See, you have talked of 100 basis decline for the year, now the Q1 we are having decline because of the celebratory expenses. As an reply to an earlier question you talked of about 400bps going because of salary hike, which will happen in Q2, so there should be some sort of sequential decline, and Q3 is when the RSU charges will come, so there could be another sequential decline. So what are the levers which will work the other way round? Am I correct in assuming that Q2 over Q1 would be a sequential decline in margins? And Q3 over Q2 again because of the RSU charges, there would be a sequential decline in margins? Mahesh, this is Srinivas here. While we will not be able to at this point in time give guidance for all the four quarters, quarter on quarter basis, I think keeping in view whatever model we have built and after considering various levers which I already articulated in this call earlier, we are very confident of achieving this 100 basis point decline, that also if you factor in, if you remove this non-cash charge of 66bps because of this 40 crores RSU hit, I think the decline is only going to be around 34 basis points, which is more or less in line with the current year. So there are various levers and I think we have already proved it last year: 300, as you know we gave increments of 300bps last year and we ended the year with just 36bps decline. So there are levers available to us. As I was mentioning, maybe just at the cost of repetition, things like, we are expecting our subsidiary performance to improve. We are basically expecting our cost of delivery to come down because of more and more entry level trainee programmers joining us and also we want to keep the SG&A under control. Apart from this, other things like better fixed bid project monitoring. So a gamut of things are there. We have factored in all that and then we are confident about the guidance we have given. Yes, we will have. Under the US GAAP the charge will be higher, I mean, if you look at last year that is FY06 US GAAP numbers, we reported a pro forma EPS, there we have taken a hit of around 23 million or so towards under FAS 123. The corresponding charge for FY07 is roughly around 14 million US dollars. The charge because of the RSU is another additional 8, so total 22. So under US GAAP the charge is going to be $22, and under Indian GAAP the charge is going to be only 8 million dollars. OK fine. And Nipuna side we saw almost 50% sequential growth this quarter, so just wanted to understand what happened, it is a very strong performance? Very specifically, as I mentioned in answer to an earlier question as well, I think quarter on quarter we are beginning to see positive movement and traction on the business front. And it is expected that that kind of momentum continues during the course of the year. Yeah. But sir a 50% kind of jump sequentially is a bit unusual, so meaning, this time around did we get some new clients going, what exactly happened this time is what I wanted to understand? This time around it is predominantly driven around a couple of deals that we have concluded on the animation front, which actually we started booking revenues for that from the last quarter of last year onwards. So the jump was predominantly on account of that. Thank you very much sir. Next question comes from the line of Mr. Amit Khurana with ILFS. Please go ahead sir. Hi, thank you very much. Srinivas, can you just throw some color, what went into finalizing an 18% offshore salary hike, was it more because we are sort of, you know, being a time lag of one quarter or is there something more to it. Also if you can throw light on as to how it works across various levels. Is it more at certain levels and is it less at certain levels? Yes, these whatever percentages we are talking of they are the company average, and depending, I mean, this definitely varies based on the level and based on the performance, and we have a performance appraisal methodology where we rate all our associates. So based on that rating the increments will be decided. So to that extent there maybe associates who maybe getting much higher than the 18%, the range could be as low as 10% to as high as 40-50%. And any particular reason it seems to be comparatively higher compared to your peer group? Is it because of the time lag or just that you are feeling the pressure of attrition more so? I think Raju answered this on an earlier question. So basically we thought that we need to reward the associates, and yeah, one of the drivers is the high attrition we have, and also factoring in the cost of attrition, we thought on balance giving higher than normal increment this year will be beneficial to the company at the end of the day. So we thought that we take this, and so to that extent we are internally thinking it is more an investment rather than an expense. OK. Sir, just one last question on the expensing that we do in year subsequent to 2007, does that amount move up any clarity that you can offer us related to that? Yeah, I mean, this year again there are differences between the GAAP. Under Indian GAAP the charge is 40 crores this year and it will go up to around 70 to 75 crores next year, and then after that it will steeply come down. So maybe 10 crores or so, and then by the fourth year it will completely go away. Thank you very much sir. Next question comes from the line of Mr. Sandeep Shah with Motilal Oswal. Mr. Shah? Are you on speaker phone sir? Please go ahead sir. If we split the sales growth for this quarter, most of the growth has been driven by the growth in the domestic business, maybe export business has just grew by 2%, what is the reason behind that? Hello? I am asking why the export growth during this quarter is just 2% when most of the growth has been driven by the domestic growth? Basically the domestic includes the offshore related business, which we do for the multinational corporations, that technically will be called as domestic but that basically we categorize as offshore revenues. OK. And sir you said that the Q1 profit growth will be lower than the sales growth on account of the celebration charges, can you just give us the quantum of that? No, no. I donât think this is because of the celebration charges. That is maybe one of the things, that is smallest of the things. I think the bigger reason for the decline is the impact of salaries for the 3,000 odd ELTPs whom we have taken on board in Q4. As they have joined throughout the quarter, throughout Q4, that salary has not been fully reflected in Q4 salaries. So most of it is getting reflected in this quarter. So, Q1 will take the full hit. So that is the primary reason for whatever dilution we are seeing at the margin front. Hi, this is Divya. What is the head count in Nipuna as of now, and what are the plans for ramp up there? We closed the year at 1,765, the head count. And, I mean, I think business is going to drive the growth in terms of head count during the course of the year. So at this point in time we would leave that open, but the number as of 31st March is 1765. Right. Some of the large contracts that you have bagged during the year, when are these scheduled to start, if you could give us some idea on that? Well, every contract is different, and so is the ramp up schedule for every contract. We certainly are hopeful that the ramp up would start in Q1 itself, but it is fairly scattered schedule, depending on the type of the customer and the type of the engagement we expect most of that would happen in the first two quarters, but it is very difficult to pinpoint any timetable of when the ramp up will happen. Hi sir. On revenue growth, I am noticing that last two quarters suddenly we had seen volume growth coming off from the previous quarters, and again next quarter you are not guiding to a strong volume growth, what is the reason behind that? Bhuvnesh, this is Ram Mynampati here. Volume growth at least from what we see is fairly robust. This quarter also, that is Q4 we have reported a fairly decent volume growth, that is, 6.8% volume growth, and in the previous quarters we may have reported 8% or 9% whatever, but mid to high single digit volume growth in a quarter is fairly respectable one, there is nothing abnormal. We are fairly confident of volume growth driving the revenue growth opportunities moving forward, nothing abnormal in our perspective. Sir, just one clarification on that, when you mean robust revenue growth for next four quarter going forward, would a 5-7% quarter on quarter volume growth classify as robust? Or do you mean much stronger growth than that? Well again, I think all we have to do is establish the frame of reference as the guidance that we have given. We said that in Q1 our guidance is 3.5-4% on top line and for the year we said the guidance is 25.2 to 27.3. We are fairly confident of delivering to those number and there are number of ways of getting to those numbers, you know, some is due to volume growth, some is due to onsite-offshore shift, bunch of things, but we are fairly confident looking at the business realities that we are dealing with, we are very confident of delivering to the guidance that we have given. Fine sir. Sir, one thing on large deals, like one of your competitor, one of your peer says that they donât want to sign large deals because they donât find that the margins there are good, and they think that the business is so strong that revenue growth would not suffer. What is our take on that, are we willing to sign a number of large deals or do we think that we can avoid them and yet maintain good growth? Well, we certainly would not like to comment on anything that competitors say. We have our hands full on managing our business. Clearly, the business is business regardless of whether it is coming in the shape of large deal or a small deal, to that end the business parameters that we use to evaluate how attractive a business is to us remain broadly the same. In some cases, it is a much a longer commitment, it is a much larger commitment in terms of dollar value of the contract. To the extent that we are confident of delivering the right margins to the investors and to the business, I donât think it really matters whether it is a large deal or a small deal, in that sense we are not averse to pursuing opportunities that are attractive to us. The fact that a large deal is termed as such is incidental in the way we look at business. Sir, when you make your three-year or five-year plan, what proportion of revenues do you think would come from large deals three years forward or five years forward, would you have⦠Can you give any idea on that? I am afraid we donât have any crystal ball to give those kind of numbers. First of all the fact that we are pursuing opportunities that are termed as large deals, you know, it has been only few quarters old phenomenon. I donât think we have enough history to project out. What we are seeing though is that large deals are a fact of life that we have to deal with. Increasingly customers are looking to challenging companies like Satyam to take more accountability more responsibility to deliver a business centric value to them, and they are willing to offer commitment of a certain size of business and commitment of a relationship of a certain duration, and in return obviously they would look for organizations that are innovative and creative to deliver the value and make money for themselves in the process. So the business mix as we see today would certainly consist of large deals. What percentage of that business mix would come from large deals today and how will that move next year is very difficult for us to predict those numbers. One last small question to Mr. Srinivas. Sir, this quarter our SG&A expense went up slightly, any particular reason behind that? No specific reason. As you can make out from the schedule, the travel cost is the primary contributor and the travel went up by roughly around 18-20 crores or so. So that is the primary reason if at all. Otherwise, there is no specific reason. Do you think that this cost will come off and SG&A will go back to slightly lower levels going forward or will it stay at the current levels? Yeah, that is one thing, while we are not going to talk about specific numbers , but our broad philosophy is to ensure that SG&A remains under control, and more importantly the G&A part while we will continue to invest in selling part. So, I mean, that is all I can say about it. Good evening. Just wanted to understand why has the receivable days increased quite a bit in this quarter, and also I want to know what is the gross addition for the full year this year for Satyam? The receivable days going up is just a, I call it as just a quarterly aberration. You may not have to read too much into it. We have made a lot of progress, earlier it used to be around 110 days or so, we brought it down and this keeps varying quarter on quarter. Other than that, there is not much really into it. And in terms of the gross addition for this year, I think it should be roughly around 12000 or something like that. So I donât readily have that data. So when you are saying that next year you are planning to hire 11000 kind of gross add, do I assume that your internal attrition rates estimate same as this year or do you think they will be different? Hi sir, just wanted to know like this 3,079 employees, which have been added, do they include the BPO staff or these are⦠And secondly, the 10,000 employees which you are planning add, 10,000 plus employees which you are planning to add in 2007⦠OK. Currently sir, this is like OK, just looking at the results it seems as if your enterprise solutions, there seems to be some implementation project which has come to an end during the quarter because that seems to like be slightly slow growing, and more importantly if I just match it along with the reduction in the onsite staff, it seems to suggest an implementation project which has come to an end, which might have resulted in some slightly slower growth this quarter. Is it something of that sort or is it something else because of which the volume growth has been slightly on the weaker side? No, I think we continue to be as strong in the enterprise business solutions as we have been. If you look at our growth rates this quarter, enterprise business solutions grew roughly at about the same rate as the rest of the organization, maybe marginally higher. It has been the trend in general enterprise business solutions is at least growing at the organization growth rate and in some cases faster. We are fairly positive about the business potential in enterprise business solutions and the growth potential thereof in other areas of business for us. There is nothing abnormal. You know, while the projects coming to closure would happen in any quarter and that is not restricted only to enterprise business solutions. I donât think there is any specific noticeable trend in enterprise business solutions that would warrant our attention. There is no single customer which by itself can explain the guidance numbers because we are currently dealing with fairly sizable amount of customers. There maybe some few which together may influence it and we cannot at this time comment on the same. But generally speaking, all these things have been factored in. Sir, the only issue over there then comes like if your project starts are on a stronger pace, or they are happening at a faster pace, then your onsite effort mix should not have come down, the fact that it has come down by close to 180 basis points in the current quarter, is it a sign of some sort of weakness in terms of new project signing up? Well, in fact our endeavor continues to be to do as much as possible from offshore as we can, you know, while there is certainly a higher contribution to revenue the more we do from onsite, our model suggests that we are better off doing as much... What happens is, in a good demand environment the project start itself will be so strong that your onsite effort mix will not be reduced even if you try to move your.., so basically it will start reducing only when your project starts are lower as compared to the business that you are shifting offshore. On the contrary, many of the customers are today looking at us to demonstrate the earlier experiences of delivering greater percentage of services from offshore sooner, and in that sense it need not mean that the project has come to closure, it might also mean that we have been able to move the project offshore earlier than otherwise would have been possible in other instances. So I am not so sure whether these are all definitely black and white, I think we just have to deal with the business and we are not seeing anything alarming in the business. We continue to remain positive about enterprise business solutions in particular, we are very upbeat about the business potential there. Sir lastly, I just wanted to know like, are there any upfront costs related to any of the large contracts which you are building in your Q1 guidance? Not really. As I was mentioning the primary reason is the salary impact on the 3,000 people whom we added in Q4. OK. Sir the only thing which basically like is worrying me is the fact that 40% of your revenue is coming from enterprise solutions and in an environment when discretionary spend is expected to go up and IT budgets are expanding, your growth rate should have been higher as compared to companies which are having 15 or 20% of their revenues coming from enterprise solutions. So basically taking those factors into account your guidance looks to be extremely conservative that was the only worrying factor. Well, in fact if you look at FY06 number our growth rate has been one of the highest in the industry, so you know that kind of reinforces the same point that you are raising, but if you look at our guidance, what we want to guide is the number that we are confident of delivering, and as we evaluate the business climate today, we are comfortable in delivering to the guidance that we have given. It does not mean that we are any less positive about the environment or any less confident about our opportunities. The guidance number that we have given is a reflection of the business how we see today. Good evening to the management team and congratulations on a great FY06. On the employee side is it possible for you to share with us what is the kind of mix you have in lets say less than 3 years experience level and more than 3 years experience level, and how you have seen that changing, what you might be targeting there? Mitali, I think we will not be able to share so many details, at least we keep mentioning that our initiative, our endeavor is to increase the proportion of entry level trainee programmers to the overall mix and thereby broaden the associate pyramid and reduce the average cost of delivery. I think under that broad initiative we keep making decisions, appropriate decisions, but then all these things as you know are primarily driven by what business demands. So it is not cast in iron, while this is our goal and this is our roadmap, but we continue to make course corrections based on what business demands. Sure. Would it be possible to at least share the historic numbers and the actual numbers, I mean, I can understand you might not want to share the target⦠OK, I can just take that later. And the second thing is on the attrition side, you know, if you could give some color in terms of how that would breakdown across whatever categories you would like to break that into? On the employee attrition, if one could get some color on how that breaks up across different categories of employees whichever way you would like to classify that? Even those Mitali, we are basically, I think as a policy we are giving at a company level. I think giving that level wise and all that, putting it in a public domain may not be appropriate for business reasons, so, I mean it is suffice to say that our attrition is at 19.17% or whatever. Is it possible to get some color on, you know, has the attrition picked up more at let say the middle manager level or is it more at the fresher level, or not the fresher level but the junior level? Yeah, I mean, I think you are going around the same thing. As I was mentioning I mean this is not in the interest of the company to giving out these numbers to the public domain. I mean there is attrition and it is at 19.17% at the company level, other than that I donât think we will be able share anymore details. OK, OK sure. And the other thing is on the attrition itself, you know, like you mentioned earlier the wage hikes, the above industry wage hikes that you have given this year, is to basically bring down the attrition levels to probably more optimum levels. So in that sense when you have given us this guidance of about less than 100 basis points margin decline over the course of FY07 have you taken the possible benefit of this wage hike and lower attrition into that? Yes Mitali, I mean, as I was mentioning earlier this is a quintessence of all these things, the sigma, the sigma of all these initiatives and the positive and negative impacts each one will have, we have considered all that and then accordingly arrived at this less than, rather around 100 basis points decline year on year. OK, and one question to Ram on the pricing environment, you know, instrumentally over the last few months how would you say that pricing is trending both from new customers as well as from some of the re-negotiations? Well, Mitali our experience is probably no different today than what has been in the last few quarters. One thing is average pricing has remained largely stable and our assumptions related to pricing remain the same. We have had instances where we were able to successfully re-negotiate existing contracts for higher prices, and we have also had instances where we have been able to renew deals at higher than average prices, but those are not so frequent, not so much in number to influence the average price to be positive substantially enough to have a material impact on average price. So today other than to say a pricing environment largely remains stable at a average price level, I donât see any difference between today and last few quarters. Right, and just one clarification on RSU impact that you mentioned Srini on the call earlier, I mean this RSU is something that could again be given out, fresh RSUs could be given out next year as well right, so the impact you gave is just for the current lot? Yes Mitali, I mean at least for the future we have not taken a decision. We thought at this point in time we will make a kind of one-off kind of a thing and then, this 150 crores which I am talking of is based on this installment which we are giving now. Hi, good evening gentlemen and congratulations on achieving 1 billion dollars in revenues. Sir I just wanted to better understand your full year FY07 guidance, if I understand it correctly, Q1 you will see an impact of the salary cost of the employees that we added in Q4 therefore there will be a de-growth in earnings, that is what we indicated too. Q2 we will see the salary hikes kicking in so therefore there will be margin pressures and perhaps potentially earnings growth being flat or marginal growth. Q3 we will again see the impact on the SG&A front once the ESOPs get charged. So are you saying that Q4 will see, Q3 and Q4 particularly we will see acceleration in earnings in a significant manner? I mean, yes, what you are saying is right, this quarter there is a decline and next quarter also there is going to be decline because of the effect of the increments, and yes, the uptick we keep seeing from Q3 and Q4 because of also the fact that some of the initiatives like cost optimization and productivity enhancement initiatives also start kicking in giving the benefit to us, and some of the ELTPs whom we are recruiting now they also will start getting billed then, so all these things are giving us the confidence that Q3 and Q4 numbers will be that much better, and thereby enabling us to deliver whatever guidance we are giving for the year. Hi, good evening gentlemen. Congratulations to the management on achieving 1 billion dollar mark. My first question is, is it possible to know the margin decline, EBITDA margin decline factored during the Q1. I mean, quarter on quarter we basically generally donât talk about it, but I mean, going by the numbers for the EPS it is obvious that there is going to be a decline there. Right. OK. One more try, I donât know, I know one participant tried it earlier, any data points on fresher or the experienced people in the history, I mean, historical fact can you share in terms of, just to understand where exactly the numbers are? Trideep, if I understood your question what you are saying is although the people whom we recruited, how many are lateral and how many are entry level? I think last year, I am afraid I donât have that information, last year we have recruited gross of roughly around 12,000, which I was mentioning earlier. But out of that how many for the year, I donât have readily, but for Q4 we disclosed that, out of the 3,079, roughly 2,442 or so are the entry level, balance are all laterals. OK. My last question is in terms of, like you know, I know GE in terms of, as a unit has been growing probably a slightly slower than that of the full company, do we expect a similar kind of outlook in FY07 as that of 2006, or do you think this could vary? This is Ram Mynampati here. While GE continues to be our largest customer, I am afraid we are not going to be in a position to give guidance at customer levels, we are going to manage the relationship like the most important relationship that we have and we will do everything that we can to grow the relationship appropriately enough in line with our overall business discipline. Other than that we would not be in a position to give any greater data point on specific customer level. And in terms of your new customers, is it possible to quantify in terms of pricing whether they are coming at higher, and if so, how much as compared to the company average, or they are coming at company average? Some customers are coming in at higher than company average. There are some customers who are obviously coming in at lower, and customers at the average level of the company. There is nothing that we can say that is going to materially impact the average pricing in foreseeable future other than to say that new customers in some instances are coming at higher than average prices. Thank you and good evening everyone. My first question was on the wages, now with these wage increases that you plan to give in fiscal 2007, where would that put Satyam vis a vis your peers in terms of salary levels? It is very, very competitive, and it will make us strong in terms of being able to attract the best talent in our opinion. Would it be fair to sort of assume that during that next round of wage increases, Satyam would probably be in line with most of its peers? No, no, we are not at this time drawing any parallel or comparing with competition, with specific peers, but generally speaking our, with these increases our salaries and sales would be very attractive in the market place, and we believe that this would help us not only retain the available talent quite well but also attract lot more talent. OK, and my final question was on these large deals such as the General Motors one where Satyam may not necessarily be the prime contractor but maybe working with other IT services companies, you know, typical in these deals how do margins compare versus the once that Satyam is directly the prime contractor? I cannot comment on any specific deal but generally speaking any deals whether as Ram was saying it is a large deal or otherwise, or in some instances where we would have partnered with other vendors, we are ensuring that the margins are not compromised, and we are generally speaking not operating in any instance where we are acting as a subcontractor, you know, we have always in the last particularly one or two years been only partnering with others, and in that sense the partnership arrangements are such that our margins would be as good as any... Just one question on the attrition part, in the last two quarters we have seen a significant jump, and I believe our response in terms of salary hikes have been to that, can you give us some sense of the profile to whom we are loosing the people both onsite and offshore, is it more to theâ¦? In the last couple of years, we had generally increased presence of large global systems integrators in India, and as compared to an environment couple of years ago where someone would have left a company like Satyam to go on overseas assignment with a competitor, today there is increased level of people leaving companies like Satyam to join other large system integrators, coming from a global background or other larger companies in India, and we are also finding that our ability to attract from such players has also gone up. Therefore, it is a two-way street, and that is one significant change that we have seen. OK, can you also comment on how the attrition has been onsite and where are weloosing our people at onsite to? Onsite attrition is generally not limited to local larger players present in let us say US or other places, it is not limited to that. It is also not specific to even larger players such as IBM or Accenture. It is much more broad based. The demand for talent from India is generally higher, and therefore in the international environment it relates to a lot more companies who are there in the IT sector. I cannot comment specifically on the recent quarter but generally speaking the attrition levels as you are aware in the industry have been higher than the last five to six quarters particularly, and even other players, where there is traditionally a lower level of attrition have been on an annualized basis greater attrition levels, and the trend is not just limited to offshore, you know, it pertains to onsite also, but it is we believe going to come under control. We have operated at significantly lower attrition levels, and we believe that that status can be attained fairly quickly. Sir, just two questions, first of all, if you could just give us a qualitative flavor of the thing that you know as we assessed the demand environment or the customer behavior this time around before giving the guidance compared to last year when we had given the guidance, you know, what have incrementally changed? See, this is something that we have talked about in this call, answered extensively. All we were stating was that we have had an excellent year, and our performance was very high last year, and at a broader level there is not a significant change in the environment, but while that in the case one has to also take into consideration the fact that quarterly variations do happen. If you compare our performance in the last four quarters, each quarter was different, and similarly when one gives a guidance one has to take into consideration what a systematic assessment is telling you, and that assessment from time to time could change but one is constrained to take back as they are available at a given time and that is what we have done, and we feel fairly comfortable about the guidance because that is the best we could have done. Last year we had given a guidance based on the certain approach that we have taken, and from time to time things may have changed, but one cannot anticipate change, you know, if change happens you adjust your specific reality to that, but at this point in time having taken things into consideration we felt quite comfortable about what we have guided for. Sure, sure understood. OK, no, I was just trying to understand just this fact that you know if around the last year we had given a 26% guidance, that finally accelerated to 36%, which means that incrementally we are in a more positive off-shoring environment, so that is, it is just from that point that I wanted to understand the guidance, but any ways. And second, two quick questions for Srinivas, sir if you could just tell us the range of utilization that we now aim to be in given that we would be going in for a higher campus hiring? Yeah, as I was mentioning earlier the expectation is that the utilization level tend to come down but if we look at utilization excluding trainees, we expect that to kind of remain fairly at a high level, anywhere between 7-8%. OK sure. And second question to you sir was that if you could tell us that recruitment costs as a percentage of sales, what was that particular number in 2006 compared to 2005, recruitment costs? Recruitment cost, I donât have that readily, most of it is included in the legal and professional charges. If you look into our schedule, that is roughly around 2-2.5% of our revenues, but then that includes recruitment charges as well as H1B visa processing charges, all those things are put in that. OK. No, I was just trying to understand that if you were to qualify reducing attrition rates because of good salary hike as you were just pointing out, and if you were to point out that in the profit and loss account as a line item, which percentage will actually have a decline moving forward as attrition rates decline, I was just trying to get to that really. Yes, thanks. I just had a very broad level question, I mean, FY06 has been a great year for Satyam, and I was just wondering if you could give us your thoughts on what is sort of one key, the most important change that the organization you feel has seen in 2006 and what would be your set of top most priority for 2007? We are looking at the current year with a lot of anticipation. We believe that the last year and last few years have given us the confidence that we can compete head on with global large systems integrators, that we can establish leadership in given areas, and that we can demonstrate our ability to manage sizable projects, and therefore the general statement that we can offer at this time is that we are stepping into this year with a very positive mindset. The mood within the company is quite buoyant, and we are preparing for good things ahead of us. Thank you very much ma'am. At this moment I would like to hand over the floor back to the Satyam management for final remarks. I would like to thank every one of you for your active participation. If you have any further questions or clarifications please do get in touch with us. You can either send an email or call our IR personnel. I would like to once again thank every one of you. Good day and good night. Ladies and gentlemen, thank you for choosing WebEx Conferencing Service. That concludes this conference call. Thank you for your participation. You may now disconnect your lines. Thank you and have a nice evening. |
EarningCall_234099 | Good afternoon my name is Cassidy and I will your conference facilitator. I would like to welcome everyone to Brocadeâs First Quarter Fiscal 2006 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakerâs remark there will be a question and answer period. Operator Instructions. Ms. Stacy, you may begin. Thank you. Good afternoon everyone, Iâm Shirley Stacy, Brocade Director of Investor Relations. Joining me today are Michael Klayko, Brocade CEO, Richard Deranleau, Brocade Interim CFO and Don Jaworski, Vice President of Marketing. Before we begin, let me cover some housekeeping items. Brocade issued a press release detailing our first quarter financial results today over PRNewswire and FirstCall. This press release is available on our website at www.brocade.com. This conference call is being audio webcast and will be archived on our website for approximately 12 months. A telephone replay will be available today by 6 pm Eastern Standard Time through the end of day on Thursday, February 23rd. To access the telephone replay dial 800-642-1687 or for international dialers 706-645-9291, and the passcode is 4925754. As a reminder the information in the press release discussed today will include forward-looking statements including without limitations, statements about Brocadeâs financial results, business outlook and guidance. These forward-looking statements are only prediction and involve certain risk and uncertainties such that actual results may vary significantly. These are the risks that are set forth in more detail in our Form 10-K for the fiscal year ended October 29, 2005. Forward-looking statements reflect âbelieveâ, âestimatesâ, and âpredictionsâ as of today. And Brocade especially assumes no obligation to update any such forward-looking statement. Financial information that we review on todayâs conference call is presented on a non-GAAP basis. The most directly comparable GAAP information and the reconciliation between non-GAAP and GAAP is provided in our Q1 â06 press release, which isnât furnished to the SEC on Form 8-K and in the corresponding Q1 â06 slide presentation posted on our website at www.brocade.com. In addition, presented and discussed sell-through information which provide the measure of OEM and channel partner sales to end-users. Brocade does not report revenue based upon OEM sell-through information and this measurement is not intended to be viewed as a substitute for reported GAAP revenue. Sell-through is a measure of demand but itâs not a GAAP measurement of revenue and therefore is not subject to the same level with internal controls as reported GAAP revenue. Please note that certain reclassifications have been made to prior year balances in order to confirm to the current year presentation. With that Iâll turn the call over to Mike. Thanks Shirley. Good afternoon everyone and thank you for joining us. Today Iâll briefly discuss our results for the first quarter, review our SAN connectivity performance and trends and update you on our new Tapestry and service initiatives. Following my remarks Richard will provide more detail on our Q1 financial results and outlook for Q2. Our results for the first quarter of fiscal 2006 were outstanding and exceeded our expectation in what is our seasonally strongest quarter. Q1 revenue was a record $170.1 million and increase of 17% sequentially and 5% year-over-year, and substantially better than our previous revenue guidance of $156 million to $161 million. Strong end-user demand overall to a better than expected sales generating higher non-GAAP gross margin at 60.2% and increased non-GAAP operating margin to 17.3%, which demonstrate the leverage in our business model. Q1 non-GAAP diluted EPS was $0.10 as compared to $0.07 in Q4 â05 and $0.10 in Q1 â05. This exceeds our non-GAAP EPS guidance of $0.05. Our product sell-through for the quarter was also a record at approximately a 173.6 million. Our performance this quarter is a result of many factors, both external and internal to Brocade. In addition, to benefiting from growth of the storage market we were also seeing the results from the investments we made 18 months ago develop the most robust product portfolio in the industry, which is resonating with end-users customers across all geographies and OEM partners. Let me spend a few minutes describing our performance in our SilkWorm SAN connectivity business. The quarter was led once again by a record quarter and directors. We also saw growth from our embedded and fabric switches. We continue to be the only SAN infrastructure provider with an end-to-end 4-Gig offering and the only provider of a common operating system across all our switching products. This is a combination that is very appealing to our partners and customers alike. 4-Gig products represented 72% of our Q1 product sales, up from 50% last quarter and we expect 4-Gig to approach 90% of our business in Q2. Clearly the market is moved rapidly to 4-Gig technology and our product cycle has afforded us advantages and opportunities. With 4-Gig HBAs now in the market and 4-Gig storage arrays beginning to roll out, we expect the preference for 4-Gig proven technology to continue to grow. I continue to be very pleased with our execution in the enterprise category. In Q1, directors had excellent revenue growth both sequentially and year-over-year representing a record quarter both in terms of revenue and systems shipped. In addition to having the industryâs highest performance in highest-port-count director customers and partners are responding to the strength of our road map in our ability to continually deliver high quality solutions. Our strength in directors this quarter was widespread, across partners and geographies. We now had shipped over 10,000 directors worldwide which represents a formidable install base in which they add new technologies and capabilities through Blade and software upgrades. Our record quarter was fueled by a large number of deals, many of which with the expense of our competitors. Few Q1 customer wins include Porsche, IBM Global Services, China Mobile, Telstra Reach, Shinhan Bank, Yokogawa Electric Corporation. Q1 revenue per switches declined moderately year-over-year from Q1 â05 that had good growth from the prior quarter Q4 â05 reflecting strength across our, 4-Gig ports-on-demand switches. These switches allow us to cover a wide range of very competitive price and configuration points for customers and partners with a minimum number of skews. In the embedded space we saw outstanding growth for embedded SAN switches across all top server OEMs with very strong growth sequentially and year-over-year. During the quarter, we announced a new 4-Gig switch module for IBM BladeCenter and recently participated in the launch of Blade.org along with IBM, Intel and others. Itâs form the faster collaborative innovation around new BladeCenter systems and solutions. We maintain our enthusiasm for the Blade computing market and for the role of storage network as a key enabler for new Bladed computing solutions. We currently have a total of six server OEMs for Bladed server modules and expect additional design wins in the future. Let me update you on an important aspect of our supply chain and product delivery operations. A few quarters ago, I gave a brief update on Restriction of Hazardous Substances or ROHS. That directed by the European Union that mandate the reduction of six hazardous substances for all manufacturers of electronic and electrical equipment sold in Europe. Given our strong mix of European sales, ROHS compliance is critical to enable continued supply to the European community. Today I am pleased to tell you that in January, we began shipping ROHS compliance products if you are well ahead of the mandated July 1, 2006 deadline. This is a significant accomplishment and critical requirement because any supplier that is not ROHS compliance before the deadline will face difficulties in selling our products in Europe. Weâve been very proactive on this subject and have executed well on this initiative. Iâd like to now discuss the progress weâve made with our new Tapestry product family and with our services initiatives. Tapestry WAFS is a Wide Area File Services solution for branch and remote offices. Evaluations and initial appointments are going very well. We have a number of deployments across all geographies including one of the first large competitive swap up in this new growth area. Our strong product integration with Microsoft from both the technical and field sales prospective is a key differentiator in the market and to customers. As we mentioned in last quarterâs call most customers are rolling out WAFS solutions in small early deployment phases prior to broad implementations. So while we continue to gain customer win weâre currently behind expectations on our internal WAFS plan. Our continued optimism for the growth potential, a branch office optimization stems from the clarity of a customer problem and a continued feedback weâve received from end-users. We will continue to hold our skills in understanding of the market dynamics for this opportunity. During the quarter we also announced an extension of our agreement with Nortel to develop software for Nortelâs branch office solution that provide cost effective management and protection of data in remote offices. Tapestry DMM or Data Migration Manager is our unique data migration product, that simplifies the migration of data across heterogeneous storage devices on a firm. We announced Tapestry DMM in November and already beginning to see very positive customer interest with substantial quantitative benefits in both time save and easy of use. Customers had procured the solution as a traditional product or as a data migration service from Brocade. As we have provided the flexibility to deliver it either way. This last week Tapestry DMM received the âProduct of the Year Awardâ from Storage Magazine, and Storagesearch.com for its innovation and addressing a significant customer data challenge. As we mentioned in our last quarterly call many enterprise data migrations overwhelmed their plan time and cost budgets. And we believe that its simpler, faster solution for data migration will find strong customer demand. We are actively working with the services organization of one of our major OEMs and expect to announce an agreement regarding their delivery of Tapestry DMM services soon. Tapestry ARM or Application Resource Manager is an innovative solution that allows operating systems, applications and data to be quickly assigned to servers from a storage network. Itâs much faster and much more flexible way of deploying applications on servers and is an excellent example of how shared storage network can help the server and application side of the IT organization, not just the storage professionals. Quite frankly, it simplifies the operations and reduces the complexity of data centers. With recently added several new customers to our Tapestry ARM early access program and continue to get excellent feedback regarding time saving and operational flexibility. We are integrating additional features and functionality that our early access customers are requesting and expect to have broader deployments later in the first half. Also we will be rolling our Tapestry ARM through face-to-face and online seminars throughout the U.S. in Q2. I am also excited to share the momentum and progress from our services initiatives. Fueled by increasing customer demand our worldwide services bookings grew over a 100% sequentially, and is tracking to our expectations. Professional service engagements grew rapidly with the strongest emphasis on proactive onsite engineering and data migration services utilizing our Tapestry DMM tool to enable fast deterministic migrations. I am very pleased to report the reassigned service agreements this quarter with EMC in one of our top distributors Tech Data. These are the first examples of the partner friendly services approach that we described in our earlier calls whereby our strategy is to package and deliver many of our services through our major OEM and reseller partners. We fully expect to have additional partners join our program. Services remain an important investment area for the company. The need and demand for our areas of expertise and experience are significant and are being validated by our services performance. Our early results are encouraging and we planned to continue building our team and delivery capabilities. Before handing the call over to Richard, Iâd like to give you a brief update on our progress with the SEC. During the quarter we began active settlement discussions with the staff of the SEC regarding the Companyâs restatements related to stock-option accounting. As a result of these discussions, in Q1 we booked a $5 million provision for an estimated settlement expense. This settlement amount is our best estimate after time and is subject to change as our discussions with the staff of the SEC continue. Iâll now turn the call over to Richard for a review of our Q1 financial results and then Iâll be back with some concluding remarks and Q&A. Thank you Mike. Iâll now turn to a review of our Q1 results beginning with our income statement. Q1 revenues were $170.1 million in our seasonally strongest quarter. This represents an increase of 17% sequentially from the $145.5 million in Q4 â05 and 5% year-over-year from the $161.6 million reported in Q1 â05. Q1 port growth was up 17% from Q4, bringing total cumulative port shipped to over 6.4 million. Q1 sell-through was approximately 173.6 million, an increase of 8% sequentially from sell-through of approximately 160.8 million in Q4 of â05. And then increase of 7% year-over-year from sell-through of approximately 161.9 million in Q1 â05. Non-GAAP diluted EPS was $0.10, this compares to non-GAAP diluted EPS of $0.07 in Q4 â05. And non-GAAP diluted EPS of $0.10 in Q1 â05. Reporting on a GAAP basis, Q1 â06 EPS was $0.05, this compares to breakeven GAAP EPS in Q4 â05 and GAAP EPS of $0.10 in Q1 â05. Our effective non-GAAP tax rate in Q1 was 25.3%. Non-GAAP net income for Q1 excludes charges of approximately 5.6 million in net stock-based compensation expense. 0.6 million for amortization of deferred stock compensation expense related to prior acquisitions. 4 million in cost associated with the completed internal review in ongoing SEC investigation. $5 million in reserves for the estimated settlement with the SEC, and 1.9 million associated tax effects of non-GAAP adjustments. In Q1 â06 the impact of FAS 123(R) was 5.3 million and is included in the 5.6 million in net stock-based compensation expenses just mentioned. The difference between the two is a variable charge of 0.3 million for serving stock awards. Non-GAAP gross margins for Q1 â06 was approximately â was 60.2% above our guidance of 55% to 56% in our target model of 55% to 58%, this compares to non-GAAP gross margins of 55.3% in Q4 â05 and 58.8% in Q1â05. The increase in gross margins from Q4 to Q1, primarily reflect the impact of higher overall sales volume and a more favorable product mix and pricing environment. Which reflects our leadership in 4-Gig end-to-end solutions sparing directors, switches and embedded blades. Q1 ASP declines were in the single-digit, slightly better than the prior quarter, again reflecting a more favorable pricing environment. Q1 non-GAAP operating expenses excluding the items referred to previously were 73 million. These expenses were inline with our Q1 target of 73 million to 75 million. Q1 non-GAAP operating expenses increased approximately 6 million from the Q4 â05 operating expenses of 67.1 million. Recall, Q4 operating expenses included some one time savings. Q4 non-GAAP expenses excluding one-time savings were approximately 71 million. Non-GAAP operating margin for Q1 â06 was 17.3% this compares to Q4 â05 non-GAAP operating margin of 9.2% and Q1 â05 non-GAAP operating margin of 19.1%. The improvement in non-GAAP operating margins over Q4 â05 goes to demonstrate the leverage we had in our business model. Now letâs turn to the balance sheet, cash flow from operations in Q1â 06 was a healthy 20 or 32 million, compared to 39.4 million in Q4 â05. Cash flow from operations benefited from strong profitability and lower DSOs despite a traditionally lower cash flow quarter. Our cash and investments balance at the end of Q1 â05, which includes restricted investments was 789.1 million. As a reminder the restricted short-term investments represent funds satisfy for the retirement of our outstanding 2% convertible note in August of this year. Net cash excluding the convertible debt was 510.2 million up from net cash of 485.5 million last quarter. On our Q4 â05 earnings call we indicated that the company had a 93 million stock buyback authorization, and with actively repurchase our stock. Subsequently we decided that due to the potential the late filing of our fiscal 2005 Form 10-K it would be prudent sustain from repurchasing our shares. However now that all of our filings are current we expect to be in the market. Day sales outstanding and accounts receivable was an outstanding 41 days in Q1 â06 compared with 44 days in Q4 â05. DSOs were once again below our target range of 50 to 60 days primarily due to continued improvements in shipment linearity and strong collections by the Company. Our on-hand inventory was 8.2 million in Q1 â06 compared to a 11 million in Q4 â05 inline with our range of 8 million to 10 million as projected last quarter. Capital expenditures for the fourth quarter were 8.2 million, which is consistent with our target range of 6 million to 8 million. And finally, deferred revenue increased to 51 million in Q1 â06 compared to 45.5 million in Q4 â05. The increase is primarily due to continued growth in service bookings, a portion of which is deferred and recognized over the life of the service contract. Now for our outlook, while you compare your models and estimates there are some factors to consider, Q2 is historically sequentially down from a seasonally strong Q1. The seasonal pattern corresponds to a seasonally slower growth period from most of our major OEM partners and is most pronounced in the enterprise portion of the market. Our competitive position and product momentum across our entire product family is strong and we remain confident in our ability to execute. Our end-to-end 4-Gig lead is affording us many opportunities and we expect the environment to remain competitive, particularly as our competitors begin to come to market with their 4-Gig platforms. We expect ASP declines to be in the mid single-digit. When we take a look at all of these factors, our outlook for Q2 is as follows, we expect our reported revenue in Q2 to be in a range of 157 million to 162 million which is above the current consensus FirstCall analyst estimate for Q2 of 154.5 million. We expect Q2 gross margins to be in the 56% to 57% range reflecting the impact of lower sales volumes in Q1 and then increase in switch and services in the product mix. For Q2, we expect total non-GAAP operating expenses to be in a range of 75 million to 77 million. As Mike indicated earlier, we are beginning to see the benefits of our new initiative in both Tapestry and in services. We plan to continue to increase Tapestry development investments and to build out our service team and delivery capability. We expect other income, other expense net to be approximately 4.5 million in Q2. We expect our non-GAAP effective tax rate to be in a range of 24% to 26%, we expect diluted shares outstanding to be in a range of 270 million to 274 million. Before addressing EPS guidance I would like to remind you the following with respect to FAS 123(R). In Q1 â06 we adopted FAS 123(R), which requires us to include expenses related to stock compensation based on their fair value. We are providing non-GAAP EPS estimates without option expenses for comparability purposes. We have adopted FAS 123(R) prospectively and as such we are not restating prior period financial results. We expect the impact of FAS 123(R) related to fixed stock options to be approximately 4.5 million to 5.5 million per quarter in fiscal 2006. In addition we account for certain stock awards on a variable accounting basis. The changes in stock price will impact the amount of compensation expense. We expect Q2 GAAP EPS of $0.02 to $0.03. Excluding stock compensation and other one-time item we expect Q2 â06 non-GAAP EPS of $0.05. We expect capital investments to be in the 6 to 8 million range. We expect day sales outstanding will be near the low end of the 50 to 60 day range. As I indicated earlier DSOs have been below this range two quarters in a row, we will continue to monitor DSOs and to the extent we become confident in our ability to maintain a lower level, we will revise this target. We expect the inventory levels to be in a 8 million to 10 million range now that our contract manufacture transition is complete. And we expect to remain cash flow positive and expect to generate an average range of 20 million to 30 million in operating cash flow per quarter throughout the year. Before I comment on our outlook for fiscal 2006, I want to reiterate our commitment to our long-term financial model targets, which includes a gross margin range of 55% to 58% non-GAAP operating expense range of 38% to 40% and non-GAAP operating margin range up 15% to 20%. While we do not expect to operate in our target models in fiscal 2006 we do anticipate making progress throughout fiscal 2006 and expect non-GAAP operating margins to be in a range of a 11% to 12% by the fourth quarter. For fiscal year 2006, we expect to achieve 660 million to 672 million in revenue, which is above the current consensus FirstCall analyst estimate for fiscal 2006 of 650.4 million. Our expectations for gross margins in fiscal 2006 is a range of 50% to 57%, this range is slightly higher than the previous range of 54% to 56%, which was provided on our Q4 earnings call and reflect the positive effects of more directors and software revenue in our product mix excuse me, our expectation for gross margin in fiscal 2006 is a range of 55% to 57%. With that I will now turn it back to Mike. Thanks Richard. Before we open the call for questions, I would like to recap the highlights from our Q1 results. First, weâre executing to our plan, we had an outstanding quarter and are executing very well in our core business. We are especially pleased with our results in the enterprise segment. Second we are driving for growth; our results this quarter demonstrate the leverage in our model from top-line growth. Our investments in Tapestry solutions and service offerings are showing promise, with strong differentiation and customer interest. We will continue to drive new initiatives and rapidly expand our offerings in these areas. And third, Brocade is becoming more than fiber channel switching, storage networking and SAN switches are our core business and the fundamental building blocks that we are enabling and it enables us to expand into adjacent markets. Our belief in strategy is that the benefits of shared storage have an increasingly important role in driving next generation, cost efficiencies with servers, applications and storage with them and across data centers. Brocade will continue to be a leader providing innovative offerings in the areas of switching, software, services and solutions that allow customers to extend the value from their investment in shared storage and derive even greater benefits. In closing, I would like to invite everyone to our upcoming Analyst Meeting in San Francisco on March 15. We are looking forward to sharing our plans and thoughts with you in a very interactive form. With that operator, please open the call for questions. This is Min Park on behalf of Laura just a couple of questions, last quarter you provided several target metrics and remain quite firm when question on why you shouldnât be strong in number this quarter, then you ultimately blew them off, this is more of a case if you guys being always conservative in your target or how is this visibility dimish? Well, let me take that one Mike, first of all our outlook for Q2 is up from our outlook last quarter. But Q1 was seasonally stronger than we expected, so our Q4 outlook â for Q2 is up a much higher base. You can mind that our Q2 revenue guidance of 157 to 162 million is about the same revenue guidance that we provided initially for Q1, our seasonally strongest quarter. Q1 was a very strong quarter and exceeded our expectation, however Q2 as historically been our seasonally weakest quarter, it is also a seasonally weak quarter for some of our major OEMs. Also keep in mind that as our enterprise business increases we are more affected by seasonality than we have been in the past, in addition we expect the environment to be competitive particularly as our â as other vendors come to the market with 4-Gig solution. Okay, given that you guys going to be bought a leading and, allowing indictor for the storage market, what is your performance there about the industries growth for the next quarter? I think youâve seen a lot of report chart from different vendors right now, in those â it appears to be a lot of wind in the sales right now from service providers, right, today. Okay and lastly, one last question, to what extent is the softness of some of your fabric switch is? Really a function of QLogics increased presence in the space and their partnership with Cisco? Iâm not sure, what weâve seen in the fabric switch state is that we have a very strong product line or up sequentially and when we saw this quarter, it was essentially a mix ship for us from switches to directors, its unclear as exactly what happened in the switch market until everyone reports, and weâre going to, Iâll be triangulate that, I know its great, but our switches sales are stronger, up sequentially. Weâve got a very competitive product line there and I think as we execute weâll continue to see growth there. Yeah, thanks guys, congratulation for best quarter. I guess may be just a follow-up on the prior question, and may be you could help us understand what you saw from a linearity perspective throughout the quarter, and may be walk us through, the trends following December into January, and what youâve seen thus far into the current quarter? And I got a follow-on if I can. This is Richard now, Iâll attack the linearity question, very good linearity for the quarter very balanced, this followed on from Q4 which had improved linearity, and that has continued for us through the end of the quarter. So weâre really quite pleased and we would like to continue to see that trend in linearity. And was there any â may be I miss this, was there any guidance in regards to sell-through expectations in the quarter â in the current quarter from you guys? Sell-through and sell-in, we started this a few quarters ago, but right now there is no material different. So, we just reported it as â this quarter just, there is no difference any more. And then final question, may be you could help me understand, you talked about your growing install base as a director products and talking about the ability to go back into that install base and sell essentially blades going forward, how do I think about that in terms of implications for your gross margin, can we possibly see you guys have a stronger gross margin possibly towards a 60% range looking into the next fiscal year? So, I think the â certainly the blade up is an opportunity for, but we are not sure about the lifecycle it takes to do that, and from a gross margin perspective we give them the guidance, and I think weâre comfortable with that guidance. Hi Aaron, this is Tom I think it represents an after-market install base opportunity to sell up, the more of top-line thing and the gross margin thing. And high consecutive guidance, itâs refreshing actually, so thatâs good stuff. On the Tapestry initiative especially on the server side, how do you â how do you bring some OEMs into the fold on that, right, I mean that, how do you convince them, thatâs not a conflict if you will with, their own software initiatives or that they â that you can enhance if you will what they are doing on that front? Hey Tom, this is Tom here. There is a combination of things that goes on right, one is that they continue to evaluate the technology and go through their various product groups to understand the positioning within their current stack and their offering. And I think the more time they spend with our products to understand that they are actually complementary to what they are offering and can add value. But in parallel with that, letâs take a look at the multi-protocol router, we need to go out and educate customers in the marketplace about the unique added value of these products. So itâs a process, it typically takes a couple of quarters as it do with the multi protocol router, and we go through their process were all the major OEMs right now while we educate the market. And Tom, let me add a little bit of color they also â I mean weâve been doing, we got in the space â the storage space for past 10 years now, but also when you take a look at that, weâve got probably well over 2 million servers connected more, so right in the middle of the data path a thousands of mission critical applications. So we are exposed to some very interesting challenges in and around the data center from storage-to-servers-to-application and what weâve been able to do is validate a lot of the main points from a end-users customers validation, weâve been going that back and we work with our partners and we are actually working in harmony to solve these. And so, I mean do you feel like youâre getting OEM traction in that regard or is does that being sort of a need in the market, type of opportunity, I mean in the channel, media in the particular customer side. Well, it depends on the OEM that, weâre quite comfortable that the products are applicable not only with some OEMs as well as meeting in the channel and the reseller market. So itâs a combination of both depending upon the application on the paying front the customer has, Tom do you have anything. Yeah just got statements, we have over 20 OEMs and three substitute products now and most of our OEMs are in some stage of evaluation of the top tier product line, so its fairly wide spread evaluation right now Tom. Okay, and then just with respect to the OpEx guidance, I understand that a lot of that is Tapestry related but it, it seems like you, you probably have to maybe commit some dollars to sustaining some of the core products as well. The course which that comes to mind, do you put here like, you factored in everything you need with respect to next Gen core switch opportunity beyond the 48,000 architecture? Yes, I really believe we have, I think our expense can contemplate, contemplate what we need to do in our traditional space. Hey, you clearly laid out the basis for your revenue guidance, I wanted to retouch in your comments around the potential for increased competition in 4-Gig, is that a comment on what do you expect to be a shift away from the directors seasonally and exclusively, or we expecting possibly some, some more competition or some more 4-Gig enabled directors in the market this coming quarter? Paul, this is Tom Iâll start and I think Mike has the last. I think weâre just contemplating the fact that we are the only 4-Gig and then the product line right now, the other competitors have not normally begin shipping in volume in the suite spot, and at some point in time, in the near future they will. So, I think just contemplating the rest of the guys in the game with 4-Gig eventually. Okay and then, secondly if you can maybe provide us a little bit of color around what as -- whatâs software and services was as a percentage of the mix in the current quarter, and then may be if you could provide us some context as it relates to the gross margin profile around services? Okay, Paul let me go over that, we donât breakout the software and services, Paul I think we have given a view that our new services, weâd like to see those a 5% of revenue and we think thatâs achievable goal. When you look at services in terms of our gross margin model, we would like to see that in the 35% to 45% range. Itâs a little early to tell, and you know I think thatâs the goal that we want to work on and but weâre not breaking out specific at this point. Couple of question to you if I may, in terms of the headcount, piggy back on Paulâs question here, it looks like yours is up 40, 50 people from last quarter was that predominantly in services? Yeah, so, there is, yeah I donât want to break it out too much but some color on to this we invested heavily in service headcount. Okay and then in terms of, you had mentioned the stock buyback which is kind of freeze there for a while can you give us some indication as to where the plan stand and its still 93 million or as there been any change in the size of the plan? Well, and you â probably expect our board authorizes the buybacks and they have authorized the initial buyback of 100 million and so thatâs sort of where we are. I want to â also a follow-up on one of Paulâs questions, when he was asking about the competitive position in the director space of 4-Gig, in what, how important is 4-Gig for the sale of this directors right now in a competitive environment? Is that extremely important, is that where customers are coming to or it just as other features and functions in the 4-Gig is beneficial. Well, Iâll start in it, Iâm sure we could spend a lot of time on this and may be Tom will add in. Itâs the 4-Gig in the director space by itself is incredibly important but when you combine it with a server through switching, through director, one operating system all 4-Gig and you can deploy throughout your enterprise, itâs a very, very compelling story that our customers are resonating with. So, our partners like if the customers like it and frankly a lot of the customers today are building out and expanding their SANs in their infrastructure, they are building out new data center infrastructures and what they want to do is, they want to build it up with the latest technology and 4-Gig has a, a lot of technology advantages that they are taking advantage of. Hey Mark just one more comment, 4-Gig HBAs and 4-Gig storage arrays are starting to hit the market now as well. So, you know most customers making high performance data center decisions right now just move right to the latest technology â with any other technology right, to the latest â latest cycle and hold it right now. Okay. And switching CapEx you, I donât know if you can give some more color around the SEC investigation, sounds like it maybe winding down, you sort of satisfied from reserves for that, is there some increased visibility that maybe winding down? Thanks for taking my question here, I guess trying to really determine the sustainability here of the part momentum you are seeing, first question how much of the upside in the quarter would you attribute to having kind of market advantage on the 4-Gig side. Secondly, what features or other features do you expect will differentiate your platform as you start to see other 4-Gig products in the market. And then lastly does your April guidance begin the assumption that you will see pricing trends start to deteriorate as other comparative products into the market. Brent this is Tom I will start. So, obviously when you get a product side advantage that creates some momentum and if I have to reiterate what Mike said, its one aspect of it is the 4-Gig speed, the other aspect of it is we are giving customers entry level to enterprise platforms, same operating system total seeing with interoperability which translates into greater confidence when they to go deploy and build stands out right, so its the couple of things, one of which is the speed in the cycle of the technology but another aspects is just the confidence they get from having a â an entire family thatâs totally interoperable and consistent across the operating system. So thatâs hopefully a part one. Can you remind the part two of your question? Again this differentiating kind of the platforms as you start to see the competitive 4-Gig products come to market is it just single OS cross both the fabric and the director or what are the other unique differences that you can⦠Let me just touch on a couple right, and Mike I think summed it up in his prepared remarks pretty he will. SANâs are more than the switches right now, right? Everybody is making purchase decisions on the infrastructure and on the switch and director technology but their â they got other need and they are looking in many ways to have the shared storage network to be a key corner stone that solves all need, so what are you doing with software, what are you doing with virtualization, what are you doing other services, what are you doing with data mobility and so forth. Then we have some technologies inter vision there that helps customers out as well as some service offerings that will help them kind of architect and deploy their solution more reliably as well. So its â a lot of itâs the switch, and a lot of itâs the technology but a lot of is the overall solution what they are trying to do as well. Sure fair enough. And then just lastly on the assumption built in to kind of the guidance for April, do you expect kind of pricing to give little more investment there. Sure let me take that, so as I said in my remarks the ASP this quarter was down in single-digit which is better than Q4 when it was in the mid single-digit range. And we are anticipating ASP declines in Q2 to be in the mid single-digit more to where they were historically and as thus we book that into our guidance and helps review on your gross margin. Great thank you few questions if I may. I want to get back to this 4-Gig question that a few folks have asked already, so if you can tackle us somewhat differently, obviously youâve done a great job in terms of bring the full products but if you look at the OEMs they really have not been tying 4-Gig at all the past year even with some product introductions most recently, I was wondering if you give us a sense is the more of that, some of your competitors are still stub in their toes and having some company specific distractions that actually inspired or led to your revenue momentum last couple of quarters, is that right, just start to seeing some more conservative to the outlook will be grateful. So I will make our, itâs a very stub in their toes, I think weâre just executing well, we anticipated this and we, spend a lot of energy and time in developing a complete product set not just one product or point product but a complete products set, and frankly our customers who are building out their enterprises right now and they are making investments for the future, they want to have the best technology and frankly I think we have the best technology in the marketplace. Okay, and then as far as the commentary on sell through Richard I want to get a, better understanding from you why there is no difference now between sell-in and sell-through, you folks have talked about that in the past, and I just wonder why there is no distinction now between the outlook? Okay so, the message weâre really trying to send is that we are kind of focused on end-user demand right, and so when sell-through is equal to your revenue or approximately in our case, you really not going see any real impact or an OEM inventory. So by giving you both sell-through and by giving you reported revenue we can really get a good sense of through end user demand. Okay, and then just lastly here I want to get a sense to how your increased FICON capabilities played out in the fourth quarter particularly â just from your bigger customers. Sure, this is Tom, and traditionally the fourth calendar quarter is a big quarter for FICON and we did very well in the FICON space last quarter. We have a â in the FICON segment high performance and high density port counts are very valuable along with FICON certification obviously, so we have very high performances as 4-Gig in the industries type port count is 256 and when you put that together with a FICON certification itâs a very good answer. Yes, thank you very much it looks like you had a temporary advantage in the market place having a more fully featured 4-Gig offering than your competition that led for this spike in your gross margin and good results. I am concerned that this may slip a little bit over the next three to six months and as Cisco comes out with their 9513 director with over 500 ports and thatâs versus your current offering 48K with 256 ports, might that result in some head wins for you in the next three to six months, I got few more. Itâs the question how we are doing? We are doing great. I think if you take a look at our products at right now we do have the product in the marketplace, we are competing very well. If you look at it by segment, its not just the director segment and very well in that segment, but itâs a broad -- itâs the whole broad product line that were, that the customers are looking for. And so itâs not â also again in the state, the thing is that we havenât talked about here is not only itâs the 4-Gig, thatâs the best product our front product is the best product in the market. But the other thing that weâve invested heavily in is tools and education, that let the customers get the best value for their product. So, not only do we buy those products that are, I think that are leading edge, but we also provide tools and education capabilities that they can utilize these things and get the best value out of them. So we hear back from our customers and we train more than 21000 end users last year on how to get the best value and thatâs a big differentiator right now and it is a proof point that customers have come back and said, no its not, it is, the products are great. And itâs all the other things that you do to help make me successful in my environment, that makes the difference. Second question, you just had 60% gross margin, the first time in over three years point to my model. Do you think that if things go your way, I know you are not modeling those, but if things go your way this year and itâs possible that your gross margins be around 60% or near 60% for the year? So, from a gross margin point of view, again we had higher volumes in Q1 and we had more favorable product mix. And as I indicated a couple of times we had a more benign ASP environment. We also had some one-time benefit based on our execution of our 4 our 2 to 4-Gig product line better than we anticipated. And our long-term gross margin goals remain consistent in that 55% to 58%. Okay, and then on pricing you mentioned it was favorable can you give it by segment by director and the switch level? So, again we really donât break that out and weâve given you that all the color we can do on that. All right, so on competition directors are you seeing more competition from Cisco or from McData and then on the mid Entry-Level switches are you seeing more McData or QLogic. Kaushik this is Tom, in the director state, everybody did all the deals right. So we are there, we are competing head to head and we are doing very well in competing head to head with the competition and in the switch base its hard to tell right now we donât know until everybody reports exactly what happen there itâs a little more shielded from us because we are not involved in this field directly with many of those situation so it tough to tell there. Okay, thank you everybody for joining us, appreciate your time today I wanted to just conclude with some concluding comments. We look forward to speaking with you again in some upcoming conferences we are attending the Goldman Sachs Technology Symposium on February 28. Morgan Stanley Semiconductor & Systems Conference on March 7th. And the Citigroup Small and Mid-Cap Conference on March 16th. As always our presentation and breakouts are audio webcast on our website. One final note an update version of slide set from todayâs conference call is on our website and it will be available at 3 oâclock today. It will include the slide set from our outlook for Q2 and for fiscal 2006. And with that thank you very much and have a good day. |