Nick Perry (Schaeffer's Investment Research) submits: Last week we saw a bounce backled by the SPDR Homebuilders (XHB). This week we find that bounce was short lived (click to enlarge):Complete Story »
U-Store-It Trust (YSI)Q3 2007 Earnings CallNovember 2, 2007 11:00 am ETExecutivesDean Jernigan - President and Chief Executive OfficerChris Marr - Chief Financial OfficerAnalystsChristine McElroy - Banc of AmericaSadler Jordan - CitigroupKristine Kim - Deutsche BankPaul Adornato - BMO Capital MarketsMichael Knott - Green Street AdvisorsDavid Toti - Lehman BrotherChris Pike - Merrill LynchJeff Donnelly - Wachovia SecuritiesBuck Horne - Raymond JamesPresentationOperatorGreetings, ladies and gentlemen, and welcome to theU-Store-It Trust third quarter 2007 earnings release conference call. At thistime, all participants are in a listen-only mode. A brief question-and-answersession will follow the formal presentation. (Operator Instructions) As areminder, this conference is being recorded.It is now my pleasure to introduce your host, Mr. DeanJernigan, President and CEO for U-Store-It Trust. Thank you, Mr. Jernigan. Youmay begin.Dean JerniganGood morning to all of you. I'll start with the cautionarystatement.The Company's remarks will include certain forward-lookingstatements regarding earnings and strategies that involve risks, uncertaintiesand other factors that may cause the actual results to differ materially fromthose forward-looking statements. These risk factors that could cause ouractual results to differ materially from forward-looking statements areprovided in documents that the Company files with the SEC, specifically Form8-K filed this morning, together with our earnings release with Form 8-K in the"Business Risk Factors" section of the Company's Annual Report onForm 10-K. Additionally, the Company's remarks will include reference tonon-GAAP measures. A reconciliation between GAAP and non-GAAP measures can befound on the Company's website, at "u-store-it.com."This morning, I'll let Chris Marr, our CFO, start and talkabout the quarter. And then after Chris, I will come back and make somecomments. And then we'll go to Q&A. Chris?Chris MarrThanks, Dean. And as Dean mentioned, he'll proving anoverview of the operational achievements for the quarter. I'll touch briefly onthat and then focus on the balance sheet and P&L points of focus for thethird quarter of 2007. We are pleased with the occupancy gains that we were able tomake during the quarter, a sequential gain of 220 basis points over -- on ouraverage occupancy, over what we were able to achieve in the second quarter of2007 and as compared to the third quarter of last year a 130-basis-pointimprovement.We've addressed and resolved our issues that we had withaccounts receivable, which when you think about the fact that moving most ofthose tenants out and auctioning of the units actually creates, obviously, avacancy. The occupancy achievements that we were able to realize during thequarter are even that much more satisfying to us.From a balance sheet point of view, we did close inmid-September on the 14-property acquisition for a $121 million. To financethat acquisition, we entered into a $50 million financing, which we were ableto do with spreads equal to our existing credit facility, which when you thinkback to the market turmoil in mid-September was execution that we are pleasedwith.We drew down actually on that facility $47.4 million andwhen we used our revolver to fund the remaining capital needed for thatacquisition. We also paired back our floating rate exposure late in the thirdquarter by entering into $75 million of swaps and $40 million of caps, andthose are outlined in our supplemental material, which is available on ourwebsite. We currently have approximately $58.5 million of capacity under theexisting credit facility.We were impacted by the sharp rise in LIBOR during the quarter.And then on the acquisition that I just spoke about, we actually lapped into30-day LIBOR on the day it spiked up to 5.8%.So the combination of the higher 30-day LIBOR on the varioustranches in our revolver and term loan and the impact of the time period inwhich we owned those 14 assets and the related borrowing impacted our quarterlyexpectations to the negative by about $0.01.Looking at the P&L. rental revenues came in line withour expectations. As we noted in the release, we moved even more aggressivelyduring the quarter on our discounting program and waived the admin fee on ourlower occupied unit types. This impacted our sequential FFO growth by about$0.01, and our same-store total revenue growth would have been about 3.2%before the impact of the lower fee income.G&A at $5.2 million came in line with our expectations.We had previously provided an estimate of the charge to move out of the officespace in suburban Cleveland and the impact of our subleasing that space toanother tenant, and that charge came in line with our guidance. We had notprovided an estimate of the write-off of the undepreciated TI, etcetera, andthat charge in the quarter was approximately $500,000. The rise in our operating expenses correlated with thecontinued strategy of investing to gain physical occupancy. Repair andmaintenance, promotional material, and personnel costs were up bothsequentially and year-over-year. These costs reflect repairing and placing inservice-damaged units sprucing up the assets and taking advantage of the warmerweather to accelerate our capital improvements into the quarter.We look at the gains and physical occupancy as a measure ofthe near-term success from these investments. Our fourth quarter expectationsassume continued investment in the assets through discounting and making asmany improvements as weather will permit with the objective of limiting theseasonal decline in physical occupancy asmuch as possible in order to make2008 a more profitable year.With that, I'll turn it back over to Dean.Dean JerniganOkay. Thanks, Chris. The quarter is a good example of whatI've thought for many years is a difficult environment for a real estatecompany who owns and manages and operates long-lived assets to be measured on aquarter-by-quarter basis.We played a very good gain during the third quarter.However, the final score did not result. The final score did not represent, Ithink, the gains that we achieved during the quarter. And I want to talk aboutsome of those.When we started the heavy discounting in June 15, we talkedabout their last quarter's call. We obviously enter into a rebuilding year, asfar as I'm concerned for '07. We knew '07 was going to be a rebuilding year tobegin with. Going into the year that became an even more important rebuildingyear, as we met the market with discounts and started to add occupancy, whichChris spoke about and it's, of course, in our new release during the thirdquarter.We also, as Chris mentioned, invested in our assets duringthe third quarter. We have added, at each division -- four divisions across thecountry. Some very important people to us are called facility service managers.And these are construction guys who are responsible forbringing our product up to a certain level of acceptance as far as we areconcerned from a management standpoint and as far as we are concerned from amanagement standpoint and as far as our customers are concerned.For example, so far this year, we've repainted 100properties. We have about another 60 to go. So during the quarter, as you wouldthink, considering the climate across 26 states in which we operate, we got alot of work done in the third quarter -- in the second quarter. So we weren'ttoo concerned about going through budgets, because we're managing these assetsfor the long-term.We knew we were doing a lot of discounting. But we wanted toconcern about the short-term effect of that because, again, we are managingthese assets for the long-term. We have, in fact, provided discounts of over $13 million onall stores, so far this year. And we think, in the third quarter, we're $5.383million in discounts. As Chris mentioned, we also waived about $500,000 in anadmin fees for Q3. We're very pleased with the results, as you have seen inindustry reports and other -- our two other friends who have reported -- publiccompanies who have reported to this point that as it is typical in the thirdquarter, occupancy does drop off from a seasonality standpoint.And we are able to buck the trend, if you will, and gainsubstantial occupancy points in the third quarter. So that is good from anoccupancy number standpoint. But what does that do for us on the bottomline oron the top revenue line, if you will?We have a unit of measure we call projected rent, which isbasically just adding up all the leases. It does not take in consideration thediscount on the front-end nor any dollars you may write-off in bad debt. Q1 toQ2 to Q3, we've run that projected rent just over 8%. And the drop-through isabout 50%. It was 61% Q2 over Q1 and 51% Q3 over Q2. So what is that? And a question that I'm sure many of youmight have and I'll answer on the front-end is so you give away a month's freerent; did that customer just stay for a month and leave? What -- how does theturnover differ from a customer who pays full rate day one? And we have done this study, and we had concluded that thereis no material difference between a customer who pays full rent day one versusthe customer who gets a month free. And intuitively, that should make somesense because if you put yourself in the shoes of a potential customer, whowants to go out on a Saturday morning and rent a storage unit just because itmight be free for 30 days, you cannot really have a need for it.So our customers are staying on an average, as of yesterdayafternoon, 349 days. Almost 12 months now our customers are staying with us onaverage. To move out 0 to 30, whether it's with the month free or whetherpaying full rate, is about 18% in the first month. It drops to about 14.5%, 31to 60, and down to 10.5%, 60 to 90. That's just normal turnover. That's justnormal churn, normal vacates.And so it's kind of like having the paper cup with a wholein the bottom of it. As long as you put more water in at the top and it'sleaking at the bottom, eventually, that cup is going to fill up. And that'sexactly where we are with our U-Store portfolio. We're putting in far morewater at the top than we had leakage at the bottom.So I'm very pleased with the leasing results. The turnoverand the vacates are normal. So we accomplished a lot in Q3, as it relates tofilling up the cup. And we know from our good CenterShift (ph) data exactly whowas staying and who was departing and how long they're staying.The maintenance CapEx in the R&M Chris spoke about, weare investing heavily in our properties to bring them to what I'll considermarket standards. At this point in time, I've seen the vast majority of ourproperties. And I can tell you that they are competitive properties. Some arenot the prettiest, some are not the best located, but generally, by and large,we have competitive properties. They have not been maintained as well as weplanned to maintain them on a go forward basis.Prior to me joining this company and as you would expectwhat a new public company with a new management team who had no previous publiccompany experience, they were very much driven by expectations in the market.And somewhere along the line, it was determined that $0.20 per square foot formaintenance CapEx was the absolute maximum this company could afford to spend.And of course, we developed some NOLs and (inaudible)measures out of that. I can't tell you how many times I have pulled up to aproperty. It looks good as I pull it into the parking lot. But then as I go inand meet the manager and start walking the property, I'd notice that only thefront part of the property has been repainted. Something ran out of maintenanceCapEx dollars and they bumped up against the $0.20 a square foot. Let me tell you we had no limit -- no arbitrary limit onmaintaining our assets by $0.20 a square foot. In fact, we've spent $7.344million, so far this year, in maintenance CapEx, which is about $0.29 a squarefoot. And we'll spend more in the fourth quarter. We're investing in these properties for the future, not fora year top, not for year 2007.Our maintenance CapEx -- correction -- our repairs andmaintenance, we spent $2.640 million year-to-date, about $0.11 a square foot,and we'll spend more in the fourth quarter. I would tell you by the end of thefourth quarter, it will not all be complete.We will still have some work to do on the maintenance CapExstandpoint for year 2008. As I mentioned, we still have 60 properties to paint.We have invested heavily in landscaping this summer to bring up our curveappeal.And I can tell you without hesitation that no potentialcustomer drives up to one of our property now and fails to get out the carbecause of the appearance of the property. So we've cleared that hurdle. Andobviously, with the rental achievements we've had in the third quarter, it'svery clear to me that our customer has accepted our product. So those of you who have asked me the question over the last12 months, is there a structural vacancy in the U-Store portfolio that needs tobe addressed, needs to be talked about, and I can tell there is no structuralvacancy. These properties are acceptable to the consumer. And I think ourrental reserves indicate that. We just completed our October survey. This is a survey thatI've been doing, I think, since 1995 that I've been in the business. And itreally amazes me, because this result is very similar each year and the onethat just is striking is that 47.3% of our customers are still first-timeusers. To me, it speaks to the vast pool of potential users we still have outthere as a sector.I'm going to talk some more about this sector, and I'll giveyou some results -- a little bit more about the results of the survey. 55% ofthe people renting from us in the month of October -- this is a short surveyconducted all the way across the United States. The sampling is large. It is very, very close to being veryaccurate. Plus or minus 2%, I think, is probably the factor. 55% of ourcustomers living in with this in October were people moving. So then you'll askthe question, "Well, what is the subprime bull-up doing to us?" Andit appears to be doing nothing to us.I think it's neutral. There has been quite a bit said aboutit recently, with other players in the sector and with what's written, and noone can fine a correlation to subprimeness to any type of downturn in demandfor our product. As far as how people are finding us, this has changed overthe year, changed dramatically, and this impacts how we plan to invest ourmarketing dollars, going forward. 48% of our customers found us by drive-by.In other words, we live and we have our facility very closeto where they live or between where they live and where they work, well locatedproperties -- very important, location, location, location. Only 17% of ourcustomers are now finding us through the Yellow Pages.And this, of course, is the death nail of the Yellow Pagebook, I think, within next few years, as we know it today. We will be spendingfewer dollars, going forward, on Yellow Pages and more dollars on Internetadvertising. We still yet are at a lowly (ph) low number, with 5% of ourcustomers coming through the Internet. We are renting 7.1 units per day through our website, about1,289 visitors per day. That 7.1 rentals per day should build next year or atleast over the next 18 months, two rental seasons, to about a 125 rentals perday coming through our website on our existing portfolio.So we're doing well in referrals. We've got 12% of ourcustomers coming from referrals, 16% repeat customers, which also speaks to thequality of our asset, and 2% other. So the reasons -- and this one is also always striking tome, and I think it speaks to my frustration with having to give away so muchfree rent -- the top three reasons for people selecting U-Store, first one islocation. 45% of our customers tell us that that is the main reason they selectour property.The second group, 23%, is our good managers out there. Theyfind our managers to be very helpful. That's the second most compelling reasonwhy they rent from U-Store. The thirdis always price. Only 10% of our customers enrolling in our survey tell us thatthe compelling reason to rent from us is price.So as I get on my shelve box and continued to preach, whyare we giving away so much free rent? Why do this company have to have $13million of discounts over the first three quarters this year? It's beyond me,except for the fact, this company is the only meeting the market. Only meetingwhat the market demands, because we have other folks out there giving away freerent when there is not necessary in my opinion.So 10% of our customers coming to us on price obviously, thefree rent. As far as our managers built enthusiasm with their telephone calls,waiving the discount or waiving the admin fee gives even more. Down to thestep, if you will in the presentation look you can move in here for free.There's still only 10% of our customers who are telling us that is a compellingreason.I'll speak to markets just for a minute. And then turn itover for questions. But, listening to the two conference call and readingsreports, I think we are all right on the same pages. It appears to us as ifFlorida has stabilized.I don't see any significant vacate movement in Florida, as aresult of the hurricanes two years ago. So, I think we are at normal levels inFlorida, although our level is not acceptable as far as being normal. We are at83.5% at the end of the quarter, and I would expect that to be about 5percentage points higher.That of course, is our whole portfolio. I expect to be about5 percentage points higher as we have this call hopefully come down toward theend of winter season next year. But the all other markets across the countryare stable, are growing many of which are growing, especially Colorado,Illinois, Ohio, New York, Indiana, Atlanta is doing well. Salt Lake City isbest ever seeing it, Denver is the best I have seen it, doing exceptionally 12properties there.So, we have no headwinds that we're really facing exceptthose that we are creating ourselves. As far as I'm concerned about all is todiscounting. We have, just to finish up on the markets, Hartford Connecticut isthe only market that I have right now on the watch list as there is somesoftness in that market, but we don't have that much invested around Hartford,but as far as all the market plots in country varies in spite do in fact have atailwind.As we move forward, I mentioned earlier I think at that wethere we started in November collecting admin fee again and we do except on thego forward basis to be trimming our discounts.We will just by nature having few loans over Q4 and Q1 at adiscount number will be down in whole dollars. But as we continue to fill upour properties, because we do offer a discounts to people on a unit-by-unitbasis, in other words if we have certain units tight that's below the certainlevel that we are not satisfied what we will give a discounts. As thoseproperties fill up the discounts will start to burn off and we'll start toenjoy much more rough through to the bottom line There was a difficult quarter and that we changed our recentstrategy mid-year to mid-market demands. 2007 has been definitely a rebuildingand we are without question, as you can see in our numbers, investing in ourproperty, investing in our people to build this company into a very successfuloperator self-storage facilities in 2008.With that, I will stop and we'll then go to questions.Operator?Question-and-Answer SessionOperatorThank you. We'll now be conducting question-and-answersession (Operator Instruction). Our first question comes from Christine Mcelroywith Banc of America.Christine McElroy - Banc of AmericaHi, good morning. In the past you guys have talked about theportfolio is being in different buckets, some of which are good assets, some ofwhich either need to be proven or need work. Can you give us a sense, as youlook at portfolio today? What's your strategy for non-core assets sales?Chris MarrHi. Christy, it's Chris. As we come to the close here inthis year we are also bringing to a close a process that we've been workingthrough for the last several months and looking at all of the assets in theportfolio and developing a ranking with your best asset all the way down to theassets that falls through to the bottom of the list.It's a process that we did at storage USA and it wasrepeated. Thereafter, the company was sold and we basically replicated thatprocess here. And it gives us a fabulous amount of data on each asset andallows us to eventually look at things from really a hold IRR type approach tosay, if an asset may in fact to be well occupied, but is in a lower rent partof the country, and the upside to that asset is fairly muted to perform ananalysis to say we better off on all things relative, taking in to account caprates in those markets etcetera.Looking to exit that asset and redeployed that capital in tomarkets that have higher growth potential, even if in the near term, it's at alower cap rate. That process is drawn to close, out of that will come adisposition effort, which will begin later this year, or at the beginning ofnext year.And we do anticipate having as a source of capital in 2008,proceeds from the sales of those assets that don't fit long-term into thegrowth strategy of the portfolio.Christine McElroy - Banc of AmericaAnd then, what about assets that are in a non-great shape,but on really good real estate, is there any redevelopment in our expansionpotential within your portfolio? And you -- would you ever consider bringing --potentially bringing in a partner to help provide investment capital?Chris MarrWell, Christy, I'll let Chris to speak to the capital partout. As far as the assay is concerned, I mean we certainly have ongoingprograms as it relates to income producing capital expenditure programs, wherewe are converting some stage decline withdrawal. We've had an addition goingand we will have some, I'd recall, an early model product, maybe one that'sbuild in the 80s who have a situation where we will redo the office completely.Maybe chop-up the officer and build a new storey building. So, those are goingto speak the capital and I'll be surprise when you look partner for that.Dean JerniganA partner for that given the dollar volume is probably, notnecessary nor the right answer. In general, we've spoken before, we have hadgreat experiences with the joint venture concept in the past. We had several inplaces at storage USA. And so, again as we work through the assets and ourability to move forward growing the NOI.The idea of potentially bringing in a partner given wherethe equity capital markets are today to help provide some growth capital issomething that we will continue to look at.Christine McElroy - Banc of AmericaOkay. And then just lastly in terms of the incrementalrepair and maintenance and housekeeping cost, I just want to make sure Iunderstand your comments earlier. How much of that increase will be recurringgoing forward? And how much was one time in nature? Is this basically the newrun rate for operating expenses?Dean JerniganI think our R&M will settle down for next year. And inother words, we're getting everything fixed this year that would be expenses inR&M item. As far as the maintenance CapEx item is concerned, we still dohave some paining. And I'll Chris speak to that, but we do still have some workto do next year.Chris MarrAnd right now as we are looking at the capital per squarefoot for next year that number is coming in on the entire portfolio around$0.30 a foot.Christine McElroy - Banc of AmericaOkay. So, the expense part of that should settle down, butthe capitalize cost should stay?Dean JerniganThey are consistent right. And I think just given all thework that was able to get done in the warm October, the way we've reflected theguidance, we've assumed the continuation into the fourth quarter of heavierR&M and then that will stabilize in '08.Christine McElroy - Banc of AmericaOkay. Thanks guys.OperatorThank you. Our next question comes from Jonathan Litt withCitigroup.Sadler Jordan - CitigroupHi, this is Sadler Jordan with Jonathan Litt. Given thatcash flow excluding one timers was around $0.20 and the dividend is $0.29 whatwould be a recognition of the quarter?Dean JerniganYeah, good question. We've been very consistent in ourresponse to that question. In mid December, we have an annual board planningsession, at which point we will have the 2008 budget process completed.We will have our capital expenditure budget another $0.30number as I spoke as if today finalized and we will go through a process rootedin data in facts to identify our '08 expectations. And then the ultimatedecision on the dividend will come out of that process.It is Board decision as to what the dividend policy is fornext year, and we've said all long we'll have all the facts that you wouldexpect we would have and would need to make a decision on that. It will be madein December. And we will provide both the dividend as well as the FFO guidanceat that time.Sadler Jordan - CitigroupOkay. And on asset sales of I guess non-core asset sales, doyou have any idea of the expected range of proceeds in 2008?Dean JerniganNow at this point in time as I said, we are coming to theend of the process and we'll have more information for you and an ability toquick dollars around that in an accurate way as we talk after the fourthquarter.Sadler Jordan - CitigroupAnd my final question is, when did, I guess which was thedecision to spend the money to or spend the money now to improve if we look atthe assets, as suppose to I guess starting on this earlier or later?Chris MarrAs far as early is concerned, as far as earliest we could doit. As I said there are facility service managers in place in the secondquarter and I mean its not like that we wont investing in the obvious step, butbeing in 26 states and many on Northern state's is very difficult to get thingsdone in the first quarter and even into most of the summer second quarter.So that lot of work just does fall in the summer time, butwe are investing when and where appropriate adequate numbers of dollars to makethis portfolio competitive and or getting there.Sadler Jordan - CitigroupOkay. Thank you.OperatorThank you. Our next question comes from Kristine Kim (ph)with Deutsche Bank.Kristine Kim - Deutsche BankHi, good morning. Just in terms of the expense this quarterand it looks like drivers, there was a primary driver for the reduction inguidance, I mean when do we changed from last quarter that you didn't know thenin terms of how much you are going to spend on this properties?Chris MarrWell it's not the fact to being out there, but it'sbasically everything that we've talked about. We have brought the people onboard to go out and make sure that the asset is as presentable as it needs tobe. There are things that can get done that we were able to get done during thequarter that came at a cost.The continuation of having Sunday hours, the adding ofpersonnel at the sites to make sure that we always had our Manager, President,that we were stepped up to meet customer demand. All things driven towardsmaking sure that we're able to capture more than our share of the customers,who drove by or picked up the phone and calledSo it became just a continued investment in both people andassets to gain the physical occupancy and that ended up paying-off, we think interms of the gains we're able to make versus what the industry, national datashows and what we've seen reported from the other public companies.Kristine Kim - Deutsche BankDoes that all make sense, but and it was skill for theprogram just not as big when you gave your guidance last quarter?Chris MarrI think it's the skill for the program, its the pace thatwhich things were able to be accomplished, it was the collaboration of thewhether which allowed for a lot of the patching and painting and things likethat to get done. It was culturally a push to say, we want to be in a positionon January 1 that we've got this work complete.We've got the people in place to rent the units. We've gotthe facilities looking as good as they can. And less gain as much occupancy aswe can between now and then. So that we hit 1-1 on a much higher basis thanwhere we started 1/1/07 and then built for mat occupancy objectives as we gotto July 31 of next year.Kristine Kim - Deutsche BankAnd could you just touch upon how the occupancy is beentrending following the end of the quarter and what sort of occupancy pick upyou have in your new guidance assumptions?Chris MarrWe're now moving into a seasonal mode where you would expectto see net vacates as we remove through toward the end of the year, so our samestore occupancy assumption for Q4 is an average occupancy of 82% and thatcompares to the average occupancy during the quarter of 83.6.So you can see the seasonal trends, as things slowdown inSeptember, you have less move-inn and October, November, December. The flip sideof that is, you also have less move-outs. But generally speaking we wouldexpect net vacates during the final three months of the year.Kristine Kim - Deutsche BankGreat. Thank you.OperatorThank you. Our next question comes from Paul Adornato withBMO Capital Markets.Paul Adornato - BMO Capital MarketsThanks. I was wondering, if you could just give us anexample of some capitalized items that you spent on during the quarter.Chris MarrItems that get ended up being hunk up on the balance sheetor items that ended up getting expensed?Paul Adornato - BMO Capital MarketsOn, the balance sheet.Chris MarrThat would be painting an entire facility, re-roofing,replacing all of the light fixtures those type of cost.Paul Adornato - BMO Capital MarketsOkay. How much do you expect to spend on those items goingforward.Chris MarrThat would be the $0.30 per foot that we talked about in2008.Paul Adornato - BMO Capital MarketsOkay. And finally on the rising type portfolio, whateconomics did you achieve on bringing those in-house.Chris MarrYeah. The integration now, obviously was very easy as wewere managing those asset, those facilities, it's a great question, and let memake one point. Our total portfolio occupancy, as we have laid out in theearnings release at 81.5% at September 30. That does include the rising tightassets in that figure. So those asset at the end of September were 70.6%physically occupied.So absent those, the entire portfolio was 82% physicallyoccupied, I thinkthat's a point that I'm glad you brought about, it'simportant for folks to look at.The cap rate, that we're looking at as we look at Q4guidance for those asset is they'll yield about 5% in the fourth quarter, andas we said on the last earning call our expectation for all of 2008 is thosemove up closer to 6% as we lease them up, but clearly there will be dilutionnot only in Q4, but in the first two quarters of next year until we really getin to court of rental season.Paul Adornato - BMO Capital MarketsOkay. And looking at bad debt, is that 2.4%, does that haveany kind of hang over clean up from earlier in the year.Chris MarrYeah, I would say the third quarter as we expected, we stillhad some clean up in the early parts of the quarter, but as we have said theproblem has been fixed, it's not something that we would find it necessary todwell on going forward, and again I think as we move in the 2008 the year-over-yearcompression will be much to are benefit.Paul Adornato - BMO Capital MarketsOkay. And so what should we assume as a percentage of baddebt going forward?Chris MarrThe 2.4 -- just also make sure, we are all here on the samepage. That's the AOR, that's actually greater than 30 days old as a percentageof our projected rent. Bad debt as a percentage of revenues have been runningright around 3%, coming down from as much as 5% in the fourth quarter of '06.And you would think both revenue growth and that number comes down in Q4 goingforward that 3% will just trend down.Paul Adornato - BMO Capital MarketsOkay, thank you.OperatorThank you. Our next question comes from Michael Knott withGreen Street Advisors.Michael Knott - Green Street AdvisorsHi, guys. Can you talk for a minute about the performance ofthe non-same store pool? I think it's about fixed in 6 million square feet orso. It looks like the NOI actually came down a lot compared to second quartereven though you added the Rising Tide at some point during the quarter. Can youjust talk about the performance of that pool?Chris MarrSure. That would be mostly the assets that were purchased in2006. From a yield perspective, while the net operating income across the boardwould have been negative, those assets -- it's a tough comp, because you'regoing to have them coming in obviously on a staggered basis during the firstfew quarters of 2006, and then we've got them for the whole period.The other thing that tends to impact those assetsnegatively, when we talk about the prior question on bad debts, now those aresome assets where we would have had slightly heavier write-offs, as we broughtin receivables and then had to go through the integration of making sure themanagers that are there either stay and if they don't stay bringing inreplacement managers etcetera.So those are an area. We are on the integration of thoseproperties into the portfolio. There is usually some slippage there. And weended up paying for that a little bit more heavily in that pool as we cleanthat up.Michael Knott - Green Street AdvisorsIf I look at the 2Q supplemental and compare it to the 3Qsupplemental, it look like the NOI from that pool fell by 40% or so, is thatbigger variance explained by all those sectors?Chris MarrNo, I also think that you have got that as kind of a bit ofa bucket that's the catchall for operating expenses that don't really hit, thatare not property specific to some extent. So there is clearly some -- bylooking at the way you're looking at it, you are taking a lump of non-directproperty operating expenses that in the data that you have right now is hittingthose and you're going to look at it that way. So it would be, I think as weget the filing the Q, I think the tables in there will be a little bit moreself-explanatory to break those out without those costs.Michael Knott - Green Street AdvisorsAnd what's the aggregate cost of this non-same store pool?Chris MarrThe actual investments are in those assets?Michael Knott - Green Street AdvisorsYes.Chris MarrWell, I don't have that number of top of my head.Michael Knott - Green Street AdvisorsOkay.Dean JerniganHi Mike, it's Dean. When I am out there looking atproperties, when I am out there talking to managers and our DMs and whatnot, Ireally don't see a lot of difference between the non-same store and the samestore. I mean, we're just liking to see numbers pretty close, we're operatingthem saying.So I am not sure what the accounting perspective is on thisand what you're -- the answer, that Chris has gave you, but I mean, I think itspretty safe to say debt arising type coming in at 70% as I see, during quarterthat our non-same store properties tend to look like our same store propertiesof this point in time.Michael Knott - Green Street AdvisorsThanks.OperatorThank you. Our next question comes from David Toti with LehmanBrothers.David Toti - Lehman BrotherGood morning guys.Chris MarrGood morning.Dean JerniganGood morning David.David Toti - Lehman BrotherCouple of question maybe I missed this. Could you talk aboutyour, if there is any strategy around 2009 debt explorations?Chris MarrThe majority, we did not. Good question. The majority of thedebt that comes due in 2009 is the term loan and the credit facility both ofwhich have one-year extension options that can be pushed back into 2010.So that is all our floating rate debt. And at this stagewe're still looking at, what the various strategies are to, either term thatout or pay that down as we go forward whether that proceeds from dispositions,whether that's proceeds from a joint venture as we talked about earlier whetherthat's simply terming that debt out or re hoping on the revolver.David Toti - Lehman BrotherOkay. Second question will be different, are you seeing anychange in the dynamics between the mix of residential, private customers andbusiness customers? And with regard to the business customers is there anychange in the length of stay for those customers on average?Dean JerniganWe're not seeing change David and that really surprises mebecause the numbers that I am looking at know and in the October surveys,basically the same as we saw on the September surveys that we did back in 1995and 1996, about 40% of your first time, -- I mean the customers walking upduring the months of October, 20% said that were restoring for commercialreasons.And what happens as your, 10 years ago 12 years ago, ouraverage length of stay or our length of stay was about 11 months and you heardme say that we're now up to almost 12 months, which would state to thecommercial customer staying a little bit longer.It has been 26 months average length of stay for thecommercial customer and about and about 6 months, 6.5 months for theresidential customer. We're refining those number right now obviously ourSeptember our October surveys we just over with couple of days ago. But itdoesn't appear at first glance that it's changing much.When you say 20% in your customers are commercial customersthen if you do the math and you say the other 80% change turned on a 6 to 6.5months basis and the 20% you keep to adding and they stay 26 months.If you take snapshot of your facility, each facility shouldlook, like it has about 30%, I mean, one point of time -- between 30 to 35%commercial customer usage, but those are kind of the numbers away they are nowand as we refine our survey results we'll write off some more bad debts as wego forward.David Toti - Lehman BrotherOkay. Thanks just and then just one last question. Can yougive us a quick update as to the state of your internal systems in terms of theintegration with the facilities, if there is any dynamic pricing capacity thatyou integrated from these systems recently, I am just wondering what theprogress is there?Chris MarrYes, we integrated this CenterShift system. All theproperties were up on that in October of last year. So we are quite happyhaving October of this year come upon us because we now have the ability toanalyze information on a year-over-year basis coming out of the same system andpresented in the same fashion, so that will make our lives much more productivehere going forward.Within the capabilities of that system, there are revenuemanagement components to it that impact pricing. We do have two-person revenuemanagement department, which analyzes all of the data available to us on adaily basis and helps make decisions on increasing rents to existing customers,changing street lamps etcetera.So we are about 12 months under our belt now with thatsystem. We now have a full 12 months worth of historical data, which is veryimportant to be able to build off of going forward. And so I think our revenuemanagement capabilities are going to be sequentially improving as we moveforward now that we have good historical data.David Toti - Lehman BrotherGreat. Thank you, guys.Operator: Thank you. Our next question comes from Chris Pikewith Merrill Lynch.Chris Pike - Merrill LynchHi. Good morning, everybody.Dean JerniganHi. Chris.Chris Pike - Merrill LynchReal quick, just to follow-up back upon that, who is doingyour revenue management?Chris MarrWithin the company?Chris Pike - Merrill LynchYeah. Are there any new hires either regionally, back at homeoffice specifically for this job, I mean who is doing that?Dean JerniganWell, what's the -- as far as the particular people areconcerned, one is the former Storage USA employed and the other one was aU-Store-It regional manager when we got here, You know it was that MBA-typethat is very keen on this particular job, and he was a natural fit for us. Andthey have been at the job now for about a year, but the fact is that we have --the data that they had worked with is been -- we have been refining that datafor the past year.And as Chris said, now that we have year-over-year numbers,we expect to have even better forecasting models and the opportunity for thesefolks to do their job in a little bit better fashion.Chris Pike - Merrill LynchSo Dean, I guess, is the staffing both at the regional andtheir new headquarters, is everything complete? Should we expect any new hiresin the next three, six, nine months? Are you lacking in any capacity in anyformat?Dean JerniganYes. I will tell you as we go forward, there is a key hirethat I have online was for 2008. And that is someone who has real estatedevelopment experience in self-storage as we moved into a development stage in2008. Right now, I'm the developer in the company and I'd be looking for somesupport. So, there would be -- that's my only key hire. Everything else isdone, in place, but I am looking to add one person in 2008.Chris Pike - Merrill LynchOkay. And I guess back to your comments regarding the dispositionstrategy. Are there any assets out in the marketplace right now or is thatgoing to happen later on in '07, early '08?Chris MarrYou would expect to see things come out in later in thisyear, in the early next year.Chris Pike - Merrill LynchThat means announced sales or you guys are putting assetsout in the market?Chris MarrPutting assets out in the market.Chris Pike - Merrill LynchOkay. And the proceeds of those assets -- I am sorry -- Igot on a little late -- what would be the ultimate proceeds of those assets?Chris MarrYes. We have not put a dollar parameter around that yet.We're getting close to finalizing that whole program and so we would have moreinformation on that as we release the report?Chris Pike - Merrill LynchNo, no. Where would they be if recycle bin too--?Chris MarrI am sorry, Chris. I didn't understand the question.Chris Pike - Merrill LynchI'm sorry about that.Chris MarrWe would look at a combination of bringing down the leveragethat was put on to acquire the 14 assets we closed on in September. And than aswe always have, take a look at where the shares are trading and the relativeaccretion, both FFO and NAV from a buyback and always look at -- have theacquisition markets here move in 2008 and see if there is any compellingopportunity there on top of what we could get by, by buying back our shares.Chris Pike - Merrill LynchGood. That was my next question, Chris. I guess the Form-IVshowed some relatively modest and sober buying display to where the shares weretrading this quarter and can you just remind me if your current authorizationand I guess, Dean, can you talk about how you feel about buying back stock, withthe ten handle on it right now?Chris MarrThe current authorization is $3 million. Given the capitalconstraints following our closing of our acquisition, we have not yet utilizedthat capacity. And again, as you would expect, we look at it by saying what'sthe relative NAV accretion, how does it impact FFO? And consistent with what wesaid last quarter, to the extent we have proceeds that would allow us to buyback stock without continuing to increase our leverage, that is certainlysomething we find attractive.Chris Pike - Merrill LynchWhat kind of NAV accretion do you guys think you have betterin that proposition?Chris MarrI mean that kind of comes back to where do we think our owninternal NAV is and that's something that we've never been comfortable puttingout there.Chris Pike - Merrill LynchOkay. I guess you're pretty pragmatic on your forecasting,Chris. I guess as we stand today here and when we look at over '08, '09, whendo you think the dividend will be covered by AFFO given your upsize CapExassumptions?Dean JerniganYeah. I mean, that comes to the question that was askedearlier on how do we look at dividend and the answer was we have a Broadstrategic planning meeting in mid December when will have the 2008.internalbudgets and be able to look at our AFFO.We've talked a lot about what are CapEx requirements are andthe mode at that pointarmed with the facts will make a dividend policydecisions for 2008. And I think the outcome of that will make answering yourquestion a lot you hear in the next call.Chris Pike - Merrill LynchWell, I guess I didn't ask, what the board, what you'rerecommendation for the board will be, with their ultimate decision would be Iguess, the question was, where we stand right now, when is the dividendcovered?Dean JerniganFrom an AFFO prospective.Chris Pike - Merrill LynchYes.Dean JerniganIt's hard for me that answer because again will be jumpingthe gun on what our outlook is for 2008 even on a run rate basis so I prefer tomaybe able to answer that afterwards.Chris Pike - Merrill LynchI guess for Dean, I guess you indicated that your assets arecompetitive and everything is market based in terms of where the demand is. ButI guess, if you were to put your assets into let say three buckets, where youwould consider one bucket being B plus, A minus assets or A assets, anotherbucket being institutional quality, but let say little order, a little moretired with C plus B minus assets.And then if there are any outliers, which, could be some ofthese, disposition candidates. What percentages of your total portfolio wouldfall to each of those three buckets?Dean JerniganBrian (ph) I think there's even a little bit more then toit. So I think, as I've said before ideally you locked on this many propertiesas you can in the best markets in the United States. And I have a goal of maybehaving more then 50% of our AFFO coming out of, half of those markets, five orsix markets.So, not only are you, it also gets back to markets and submarkets forgiving about the quality of the assets. And right now we are in 26states and we're spread across in a lot of states with not much representationsin those states and even though the quality is good, the location might havebeen good from a growth potential stand point you'd be better off moving thosedollars out of Mississippi to California, Florida for a example.And so, we are as Chris said, we have over the last, probablyfour months now, would help us on outside consultants survey, all 400 plusassets and we put them into Court House. And so, that is almost finished and wehave not grown the line there what you are asking about, where is the line,where is the bottom whatever you're ready to just spin out.And I don't think it will be aclear distinct line because I think it will be really as I said some drivenmore market driven than property, quality or location driven. But in a roundabout way I'm trying to answer your question without giving you a number, but Itell you that we do expect to re position this portfolio on a substantial basisas we go forward, moving assets, moving investment dollars out of lower qualityassets, out of lower growth potential markets into higher quality assets andhigher growth markets.Chris Pike - Merrill LynchOkay. Thanks a lot guys.OperatorThank you. Next is a follow upquestion from Michael Knott with Green Street Advisors.Michael Knott - GreenStreet AdvisorsHey, guys. I know the formermanagement team, some of the family members have been on public record beforesaying they were supporting the board to consider strategic alternative thatare sale. What do you think the boards outlook will be with respect to theoperating turnaround going with an outlook have gone into '08?Dean JerniganWell, we have a very importantmeeting coming out in Czech (ph) December where we will lay out the operatingplan for 2008 and beyond for that matter. And that is appropriate time, that isa strategic plan and meeting. That is appropriate time to look at allalternatives not only internal but external alternatives.And so it would be quite a guess onmy part to venture out to answer you question right now Michael. But weclearly, had that on the docket for December and as we get by that meeting. I'msure you'll here more and more as to, how this company will be positioningitself on a go forward basis.Michael Knott - GreenStreet AdvisorsOkay. And then as to your lastcomment about repositioning the company should we take that to mean as you sortof higher cap rate markets and maybe eventually reallocate capital to lower caprate markets. But that could have a negative impact on the earnings profile butit should be at least neutral from a shareholder value perspective if notpositive?Dean JerniganYeah. That's where I cannot, Chrisdo it sometimes because I'm looking five years out as far as the growthpotential for a market is concerned. For example, to plan we got a lots ofexamples. But I'll be looking and it could be you might so at a higher cap rateon a short-term basis and move in something on a lower cap rate where you'vegot a negative arbitrage if you will.On cap rates and it could hurtlittle bit short-term but long-term it's the right decision. And then it justcomes back to kind of what I was talking about earlier. As far as maintainingthese assets for the long-term that's short term.And same thing there, you want to-- you want to be in the markets in the sub markets where you has a greatestopportunity for growth going forward on a long-term basis. We're not going tomanage this company for short-term for the third quarter results.Michael Knott - GreenStreet AdvisorsOkay.OperatorThank you. Our next question comesfrom Jeff Donnelly with Wachovia Securities.Jeff Donnelly - WachoviaSecuritiesHey guys, I guess my firstquestion, have to with. How do we keep the management and the employees andmotivate it. You know since, you guys have joined another people who have hiredthere and I believe most of the subject either stock or option grants. You knowthe price is down about 50% and I guess I'm wondering how do we keep that teamfocused to execute upon this turnaround. Should we be expecting sort of a newcomplaint in '08 to address that?Dean JerniganWell, I think that's my job. And I don't consider that to besuch a huge job right now, we've got to motivated to the people who understandthe long-term prospects of this company and we put a complaint in place, thispast February. That is working, and I think on a go-forward basis, we willcontinue to look at our folks and how motivated they are. But, they are notshort-term motivated, they are long-term motivated and we have a comp plan inplace, which I think works. And I don't think that will be such a big issue ona go-forward basis.Jeff Donnelly- Wachovia SecuritiesThat's helpful. And considering the (Inaudible), I believethey are no longer insiders. Does that make them, I guess, subject to maybeownership waivers that you might see for so called, traditional institutionalinvestors, when they own reeds. And that's what they have to make theirintentions known to you until they themselves buy or sell shares.Chris MarrYeah. I'm not a lawyer, but I do believe they have filingrequirements to the extent they buy or sell shares given the percentage of thestock that they own. And I also believe that the IPO, there were provisions putin place to address the five and fewer rule that I believe, allow them to ownup to the high 20% range. I know I can't quite tell you facts whether it's 28or 29, but they do have that ability.Dean JerniganYeah, I think it's just over 29. It's in the chart.Jeff Donnelly- Wachovia SecuritiesWas it conceived when you guys were working on the risingtide, I guess purchase from them that they would use their proceeds to reinvestit back into the stock. Was that, I guess, part of the negotiation or was thatsomething that they did after the??Dean JerniganThey did not ask us how we thought they should use theirproceeds. You wanted to ask them whether that was not part of the negotiations,as to what they were going to do with the proceeds.Jeff Donnelly- Wachovia SecuritiesOkay. Thanks, guys.OperatorThank you. Our next question comes from Buck Horne withRaymond James.Buck Horne - Raymond JamesGood morning, guys. Just wanted to get a little bit morespecific on some markets here, and particularly California. And just -- maybeyou can talk about what the market is like out there, why the occupancy doesn'tseem to be moving dramatically or what is it going to take to move the needle inCalifornia and any other additional color you can give me on the competitiveenvironment out there?Dean JerniganI mean California, it's a big state, and so let's break itout. You can't even break it into three components. You really need to break itinto multiple components. Right now, I guess, the Sacramento, that valley areaup there is a little bit weak. The Bay Area is strong. Orange County is alwaysstrong. San Bernardino is weak, and I'll come back to that one. San DiegoCounty always manages to do well.And so our concern right now is San Bernardino, where wehave I think 16, 17 properties, and one market. We own the market to an extentand we have a good upside opportunity, and you heard me speaking in the pastabout the fact that on my trip out there, on two different occasions, Idiscovered that we had no Spanish-speaking managers, and about 75% of themarket is Hispanic.And so, we are almost ready, in fact, I am suppose to see itthis week, today, I guess, the results of the marketing program that we havehired to specifically market to the Hispanic folks, not only in San Bernardino,but also Southern California, Southern Texas and Southern -- South Florida. SoI think the 76% occupancy you see right now has tied to California, mainly isbrought down by San Bernardino and we have marketing getting ready to in placethat we will hopefully be able to address that in a positive way for 2008.Buck Horne - Raymond JamesThanks, guys.OperatorThank you. Our next question comes from Chris Pike, withMerrill Lynch.Chris Pike - Merrill LynchHey, guys I just had a follow up, to the Green Streetquestion regarding the MSTEL (ph). I guess part of the settlement was that,they have to see some to assist. Is there a time limit on that or is itpossible that in 6, 9, 12 months we start getting rumbling from these guysagain?Dean JerniganOn Atlantic the set of filings that we do have standstillwith them through XGN (ph).Chris Pike - Merrill LynchOkay. Thank you.Dean JerniganOkay.Operator(Operator Instructions) There are no further questions. I'dlike to now turn the floor back over to management for closing comments.Dean JerniganOkay. Thanks. Again top result for the quarter, made a lotof gains during the quarter. The company is poised to do much, much better ongo-forward basis. As it relates to our systems in place and people in place weappreciate those of you who continue to supporters of the company as we continueto manage this company for long-term growth and success.Thanks. We'll be looking forward to, speaking to you againnext quarter.OperatorLadies and gentlemen, this concludes today's teleconference.You may disconnect your lines at this time. Thank you for your participationCopyright policy:All transcripts on thissite are the copyright of Seeking Alpha. However, we view them as an importantresource for bloggers and journalists, and are excited to contribute to thedemocratization of financial information on the Internet. (Until now investorshave had to pay thousands of dollars in subscription fees for transcripts.) Soour reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition thatyou attribute the transcript to Seeking Alpha and either link to the originaltranscript or to www.SeekingAlpha.com.All otheruse is prohibited.THE INFORMATION CONTAINED HERE IS ATEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCEPRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDEAN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, ORINACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. INNO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHERDECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANYTRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIOPRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANYINVESTMENT OR OTHER DECISIONS.If you have any additional questionsabout our online transcripts, please contact us at: transcripts@seekingalpha.com.Thank you!Complete Story »
NxStage Medical, Inc. (NXTM)Q3 2007 Earnings CallNovember 2, 2007, 10:00 am ETExecutivesRobert Brown - Chief Financial OfficerJeff Burbank - President and Chief Executive OfficerAnalystsBen Andrew - William BlairRobert Faulkner - Thomas Weisel PartnersTaylor Harris - JPMorganSuraj Kalia - Piper JaffrayAnthony Ostrea - JPM SecuritiesBill Plovanic - Canaccord AdamsVivian Wohl - Federated Kaufman FundsAndrew Morey - Tartan PartnersPresentationOperatorGood day and welcome to the third quarter 2007 NxStageMedical Incorporated Earnings Conference Call. My name is Candice and I'll beyour coordinator for today (Operator Instructions).I would now like to turn the presentation over to your hostfor today's conference, Mr. Robert Brown, Chief Financial Officer. Pleaseproceed sir.Robert BrownThank you, Operator. Good morning, everyone, and welcome.Before I turn the call over to Jeff Burbank, I would like to review ourforward-looking statement with you. Hopefully by now, you have seen our thirdquarter press release.For your convenience, a replay of this call will beavailable beginning tomorrow for one week by dialing 1-888-286-8010 withpasscode 30934295. In addition, the press release for the third quarter resultsand a recording of this call will be archived on our website under the InvestorRelations section.I would like to remind you that statements we may make onthis call, which are not purely historical, regarding the company's or ourintentions, beliefs, expectations and strategies for the future areforward-looking statements for purposes of the Safe Harbor provisions under thePrivate Securities Litigation Reform Act of 1995.These forward-looking statements may include topics such asresults of our operations, growth of the home and more frequent hemodialysismarket in general, market adoption and demand for the System One, the roll outof the PureFlow SL, anticipated benefits of the Medisystems acquisition,anticipated improvement in product quality and financial guidance for thefuture.Because such statements deal with future events, they aresubject to various risks and uncertainties and actual results may differmaterially from these forward-looking statements. Important factors that couldcause actual results to differ materially from those in the forward-lookingstatements are discussed in our SEC filings, including our quarterly report onForm 10-Q for the period ended June 30, 2007. In addition, any forward-lookingstatements made on this call represent the company's views only as of today andshould not be relied upon as representing our views as of subsequent dates.Future events and developments may cause these expectationsto change and, while we may elect to update forward-looking statements at somepoint in the future, the company disclaims any obligation to do so. Andtherefore, you should not rely on these forward-looking statements asrepresenting our views on any date subsequent to today.Now, I would like to turn the call over to Jeff Burbank, ourCEO.Jeff BurbankThanks, Robert. Welcome everyone and thank you for joiningus. We're here to discuss the third quarter financial results, but I alsowanted to spend some time-sharing my thoughts on the transformation occurringat NxStage.Since our inception, we've been a company seeking tovalidate our innovative technology and prove that it could meet the demand formore frequent home hemodialysis. We've been striving to put all the piecestogether to prove that the opportunity is as great as we've always thought,create high-quality innovative products and build a future for NxStage as aprofitable competitive company that makes a real difference in renal care.Today, we're at the beginning of a new era at NxStage. Withthe acquisition of Medisystems complete, we've become a much larger company anda leading player in the dialysis industry. We now have five manufacturinglocations in four countries. We have over 1,200 employees and an annual revenuerun rate of over $100 million.Our products are used in the delivery of therapy to over120,000 patients. Home patients on the NxStage System One are doing about50,000 treatments a month now. With our strong Medisystems brands for theclinic space product, our customers are using millions of our tubing sets andfistula needles each month.This effect is based on proving quality products that arevaluable to our customers and their patients. In addition to our System Onebeing used in the critical care and home setting, we can now bring valuablesolutions to our partners' challenges with in-center dialysis.We now think of our business in terms of three markets, thehome market, the critical care market and the clinic market, which is where weuse the Medisystems brand. So, let me update you on these three businesses.First, the home hemodialysis market, the third quarter wasanother record-breaking one for patient additions with 342 new patientsreceiving home hemodialysis on the NxStage System One. That's a 21% increase inchronic patients since the end of Q2 of '07. You may have seen our pressrelease earlier this week announcing that in early October, we exceeded 2,000patients in 2007.This is a milestone that we're celebrating here at theAmerican Society of Nephrology Meetings that started yesterday right here inSan Francisco. With this level of adoption I'm confident that home hemodialysisis a therapy that is here to stay and going to continue to grow.In short, this is a market that has now been validated. It isa lasting opportunity, which is just starting to draw attention and we're theclear leader. As an organization, we now have what we need to turn from ourfocus on defining the opportunity to the business of educating on its benefitsand leading its evolution in maturation.I believe we're positioned well for these tasks. Last month,the Journal of American Medical Association published a clinical studyconducted out of the University of Calgary. This demonstrated the clinicalbenefits of more frequent nocturnal hemodialysis.This week, at the American Society of Nephrology Meetings,numerous presentations are being given on the benefits of home, more frequenttherapy and specifically, the NxStage System One. The evidence continues tobuild nicely. Consistently, each study concludes the vast majority of patientsprefer the overall well being of more frequent therapy.Within our patients, 15% treat themselves five times perweek, 83% treat themselves six times a week, so that's over 98% of our patientsthat are treating five or more times a week.PureFlow SL adoption continues to be strong with 65% of ourhome patients using PureFlow SL at the end of the third quarter. We're pleasedwith this continued uptick as PureFlow is an important element of our effortsto expand the NxStage System One's capability, improve its ease of use andimprove the company's gross margins.As we've discussed in the past, PureFlow SL's launch has hadchallenges. I'm pleased to say that there are no new issues, only good progress.Reliability continues to grow steadily. With these improvements in the systemand water purification pack quality, we had a 25% gain in purification packlife from Q2 to Q3.We've now completed the transition of bulk PureFlow SLdisposables into our manufacturing facility in Mexico. Not only has our costimproved, but our quality is improved with this transition as well. We expectto see the benefits of these improvements in reduced premix fluid usage andlower costs to continue.We now estimate that we've done over a quarter millionPureFlow SL treatments in the relatively brief time since it's been on themarket. Our user surveys continue to indicate that the vast majority of ourpatients prefer PureFlow SL to the alternative. So, we're confident we're onthe right track with this product. In general, I feel really good about theprogress we're making in the home market.Now turning to the critical care business, this is where ourpartners use the NxStage System One primarily to treat ICU CPU patients. Thisis a business that continues to perform extremely well for us. A demonstrationof our success is that seven of the top ten renal hospitals in the country, asreported by U.S. News and World Report, are using NxStage System One as theirtherapy system.We not only want to have the easiest system, but we want tobe the easiest company to work with. We continue to expand our training andsupport services to ensure that all of our partners are getting the supportthey expect from a leader in this business. Although Gambro announced they wereoff of the FDA import hold for their machine, they're still waiting for an FDAclearance before they reenter the critical care market.We expect to see them in the market before the end of theyear. This will increase competition in the business. However, we continue toadd large institutions of customers, winning with our product features andsimplicity, ease of training and ease of use. The advantages of our design,which eliminates scales and all of their limitations, is really gainingtraction in this market.We expect that customers will continue to appreciate ouradvantages. Let's move to a discussion about the clinic business, our newestmarket as a result of the Medisystems acquisition. We closed the transaction onOctober 1, so the entire fourth quarter will include this business.The integration is progressing on track. We'll be workingover the next few quarters to integrate all the systems and people. We'repacing ourselves to ensure that we remain focused on our rapid growth with theSystem One. From the announcement of Medisystems acquisitions, it was easy forinvestors to understand the strategic and operational advantages of thistransaction for NxStage.What was not as apparent was our belief that productopportunities exist that could improve growth in the Medisystems product line.We have just unveiled the first of these, the Streamline Airless Blood TubingSystem. I'm excited about what this does for our customers. Streamline usesinnovative tubing set technology that can play a significant role helping toachieve clinical targets while reducing waste and resources.In a recent clinical study, Streamline was demonstrated toincrease the delivered hemodialysis dose at lower cost while being simpler forusers. Streamline is also more environmentally friendly than conventionaltubing sets with 40% less plastic and using significantly less dialyses eachtreatment. We really look forward to helping our partners benefit from thisinnovative product.You'll hear more from me over the next few quarters as wemake progress towards introductions of additional offerings that take advantageof the combination of NxStage and Medisystems businesses. I believe the mostimportant driver of our business in all products is quality.Quality is a critical aspect of our growing business,whether this is the quality of our products, the quality of our therapy or thequality of life for our patients. This is our number one obligation and ourdecisions have been and will continue to be guided by quality as our firstpriority.As we discussed on our last call, we announced the voluntaryrecall of certain System One cartridges that had higher than average leakrates. We take customer satisfaction very seriously and initiated thisvoluntary recall to maintain that commitment. Although it means a short-termhit of gross margins, we're confident that our customer relationships are worthit.We're back on-track and believe we've dealt with this issueeffectively. In another demonstration of our commitment to quality, in thethird quarter, we elevated the lead quality assurance position at NxStage andpromoted Mike Webb to the newly created role of Senior Vice President ofQuality, Regulatory and Clinical Affairs. I've worked with Mike for a number ofyears and I'm pleased for him to be playing this really important role.With regard to the quality of our therapy, we continue tosee encouraging data, much of which is being presented right now at theAmerican Society of Nephrology Meetings, which we're obviously attending. Inaddition, we continue to enroll patients in our Freedom trial and now enrolled145 patients at 26 sites.I have more confidence than ever that NxStage has all thecomponents we need to reach our potential as a leading player in the dialysismarket. Our acquisition of Medisystems positions us to lead and grow thesignificant home hemodialysis opportunity as well as bring more value to ourcustomers.We're transitioning from a start-up company built on hope toan industry leader focused on execution. The execution won't be easy, but wenow have the pieces to build an innovative profitable company that istransforming renal care.Now, I'll turn the call over to Robert to review ourfinancial results.Robert BrownThank you, Jeff. Revenues for the third quarter of 2007totaled $11.6 million compared to $5.5 million in the third quarter of 2006.This represents a 111% year-over-year increase and a 16% sequential increasecompared to the second quarter of 2007. In the chronic market, revenues were$8.3 million in the third quarter of 2007 compared with $3.6 million in thethird quarter of 2006, representing a 128% year-over-year increase and a 23%increase compared to second quarter of 2007.In the critical care market, revenues were $3.3 million inthe third quarter of 2007 compared to $1.9 million in the third quarter of2006, representing an increase of 77% year over year. We added 342 patientsduring the third quarter and at the end of September, the number of patients onthe System One in the chronic care market totaled 1,957, an increase of 21%compared to the end of Q2. We added 41 centers in the third quarter, reaching atotal of 306 at the end of the third quarter.The gross margin deficit in the third quarter of 2007 was30% compared to a 15% deficit in the second quarter of 2006. The increaseddeficit in gross margin was due to $2.3 million in charges related to theCompany's voluntary recall of certain System One cartridges that Jeffreferenced earlier.Excluding the impact of the recall, gross margin deficit inthe third quarter was 10%, an improvement of five points over the secondquarter of 2007. This improvement was due to product cost reductions as aresult of contractual price commitments and the move of PureFlow disposables toMexico, along with an improvement in PureFlow reliability. We expect to reachgross margin break even during the fourth quarter of this year before theimpact of the Medisystems acquisition.Operating expenses for the third quarter were $13 millioncompared with $9.4 million in the third quarter of 2006. The increase inoperating expenses reflects increased sales and marketing expenses as we expandour sales force and increase our marketing activities and distribution expensesfor a growing number of patients.Non-cash stock-based compensation totaled $800,000 in thequarter. We reported a net loss of $16.1 million for the third quarter of 2007,including the $2.3 million impact of the voluntary inventory recall, or a lossof $0.54 per share compared to a loss of $9.6 million in the third quarter of2006 or a loss of $0.34 per share. We ended the quarter with $33 million incash, cash equivalents and short-term investments.Turning to guidance, we expect revenue to be in the range of$27 million to $29 million for the fourth quarter or $57 million to $59 millionfor the full year 2007, including the consolidation of Medisystems for theentire fourth quarter.The company expects a net loss, including Medisystems, in therange of $12 million to $13 million or $0.33 to $0.36 per share for the fourthquarter, including estimated non-cash stock-based stock compensation charges of$850,000 and amortization of acquisition intangibles of $750,000.For the full year 2007, the company expects a net loss,including Medisystems, in the fourth quarter to be in the range of $53 millionto $54 million or $1.69 to $1.72 per share. This includes estimated non-cashstock-based stock compensation charges of $3.2 million and amortization ofacquisition intangibles of $750,000. The Company expects to end the year with2,200 to 2,300 patients at approximately 320 to 340 centers offering therapywith the NxStage System One.Operator, that concludes our prepared remarks. Please openup the line for questions.Question-and-Answer SessionOperator(Operator Instructions) Our first question will come fromthe line of Ben Andrew of William Blair. Please proceed.Ben Andrew - William BlairHi. Good morning, gentlemen.Jeff BurbankGood morning, Ben.Ben Andrew - William BlairI just wanted to catch up on a couple of things. The clinicadds have been really good the last couple of quarters, I think by my countyou've added 60 some clinics here pretty quickly, I'm sorry more than thatactually. Jeff, maybe talk about the dynamic of patient adds in those centersas distinct from maybe some of the early adopters.Does it take a month or two or three to get one or twopatients, or longer? And then, when do you get those newer centers up to fiveor maybe ten patients each?Jeff BurbankAs you can imagine, there is variability. On average, acenter will start a few patients, they tend to want to see how they do andthen, they tend to put additional patients on. And a typical patient will getto somewhere between seven and nine patients over the first 12 months.Ben Andrew - William BlairOkay. And this group, and it's actually 106 clinics the lasttwo quarters, are these clinics kind of similar in that dynamic so far?Jeff BurbankOur averages haven't changed.Ben Andrew - William BlairOkay. And as you think about the impact of nocturnal, haveyou seen any greater push by clinics themselves? Or where are you all on theclinical side to push that towards a regulatory approval?Jeff BurbankYes, Its an area we're interested in, we're working with theFDA to understand what the requirements for that will be. And as soon as wehave clarity on that, well, we'll come back to you and share that. But it's anarea that NxStage is interested in. And we think it's important to have a rangeof therapies, you've seen us systematically grow our capabilities over the lastyear or two.We are now with the PureFlow SL much better prepared to givehigher dose and longer therapies, including also less frequent therapies,which, as I mentioned, very few do because they tend to prefer the well beingof the more frequent therapies. But, we want to be a system that allows aclinician to do any of the types of prescriptions he's interested in doing. So,we see nocturnal as being one of those pieces.Ben Andrew - William BlairOkay. And the Freedom trial continues to plug along, it'smaybe a little bit slower on the enrollment side than we expected, maybe talkabout the dynamic there and when we should be looking for a first traunch ofdata.Jeff BurbankYes, I'd agree with you on the a little bit slower than weall hoped for. I think the events of the third quarter didn't help us there.When you're dealing with some of the issues that we dealt with, customers tendto hunker down a little bit versus doing some of those things.So, I think we saw some of those affects in those numbers.We'll watch. Fourth quarter is never an exciting new enrollment, whether it'sfor patients or patients in Freedom trials, so it's going to be a hard quarterto judge against, but we should see some progress there over the next twoquarters.What was the second part of the question? Sorry, Ben.Ben Andrew - William BlairNo, it's all right. The other piece I was going to ask aboutwas actually for Robert on the cash side. With $33 million, I know you'vetalked about putting in place some debt, where are you in that process? Andwhen might we hear something on that?Robert BrownYes, we're in final discussions with a number of financialinstitutions at this point, and I think we're still on our time line to getsomething done this year.Ben Andrew - William BlairOkay. And you still think you can fund through cash flowpositive with that debt?Robert BrownYes. That's what our model shows us right now.Ben Andrew - William BlairOkay, thank you.OperatorOur next question will come from the line of Robert Faulknerof Thomas Weisel. Please proceed.Robert Faulkner - Thomas Weisel PartnersSorry, good morning.Jeff BurbankGood morning.Robert Faulkner - Thomas Weisel PartnersA few things, I wondered if you could just comment on whatyou think the impact of your constraints on the cycler, because some of thewarranty issues associated that came as a result of the leaks in thecartridges, so what was the impact of that on patient enrollment? What do youthink it might have been?Jeff BurbankThat's speculation, there was an impact I can assure youthat it's probably somewhere between zero and 100, but probably towards themiddle of that. We have really no precise way of knowing, but that's a gut feelI think from the NxStage team, we feel it's about that.Robert Faulkner - Thomas Weisel PartnersOkay. And what was the dynamic that would have determinedwhether someone was or wasn't added because of a constraint? Did you just nothave cyclers for a while to send out?Jeff BurbankYes, when we did our 8-K on the leaks and the consequence ofthose, some of the leaks caused service events for the machines, so there was ahigher demand on machines than we anticipated. So we had to manage demand ofthat, we just couldn't meet all those needs given the growth rate combined withsome cyclers requiring a higher rate of service.Robert Faulkner - Thomas Weisel PartnersOkay. And that was handled at the sales person level or indiscussion with people at the clinic saying, hold off on this?Jeff BurbankIt was a management of timing of put ons, yes.Robert Faulkner - Thomas Weisel PartnersOkay. And you gave us a margin update, I wonder if you couldtalk, Robert, about the distribution line next quarter and going forward?Robert BrownYes, the distribution line is a little higher than weactually want at this point, but we're actually putting some processes in placeto drive that back down and kind of manage that. I think we still feel verycomfortable with our long-term distribution goal of getting it down to 10%, andwe're now taking a look at it and putting some resources in place to manage itdown to that level over a period of three to four years.It will start to trend down a couple of points per quarteras we go forward, that's what we're looking at.Robert Faulkner - Thomas Weisel PartnersOkay. And for either of you, can you talk about the natureof Medisystems sales with respect to volatility? Are they volatile quarter toquarter or are they very consistent? How should we think about that?Jeff BurbankYes, I think that's probably a good point. There is somechunkiness and there is some potential for rationalization as we get our handsaround the business. We're going to be focused on selling the right value,creating nietotic (ph) lines over time. So, there is a potential for that. Andas you all know from our relationships and our contracts, there are somesignificant customers there.I think we have really solid product offerings that will dovery well in the market, but there is a potential for a little of that movingforward so, we've got to walk our way through that. But the products arestrong, we're launching an additional product, which I think strengthens ourposition there and we're learning as we go a little bit, but have the solidMedisystems team that came over with us.So, I think we've got to get our hands around that a littlebit, but it feels good from where we're are.Robert Faulkner - Thomas Weisel PartnersCan you give us an example or quantification of thehistorical quarter-to-quarter volatility?Jeff BurbankMost of the volatility in that product has been due toconsolidation in the industry, if I look back and look for some generic bucketsfor you guys. For instance, when somebody like an RCG gets purchased byFresenius, they tend to get converted from whatever they were using toFresenius products. So, a lot of the chunkiness historically has been due tothose strategic moves.There is a potential for those going forward, I don't thinkthey're quite as large as what they were in the past because we now haveconsolidation to two significant vendors, DaVita and Drasinia (ph). But that'sreally been the only case of Medisystems losing business in the market, it'sbeen they lost a customer due to acquisition. Robert Faulkner - Thomas Weisel PartnersAnd just in terms of at the micro level quarter to quarter,should we think of this as being very even quarter to quarter, Robert? Or isthere a seasonality to it?Robert BrownIt is fairly even. I will make one comment about that isthat the products do go through distributors. So, depending how the supplychain, you may actually have something go between quarters because somethinggot dropped on the first day of the month versus the last day of the month.That's really the only choppiness we see from a financial impact.Jeff BurbankAnd Rob, I want to be clear because the information is outthere. We have a needle contract with DaVita that comes up in December forrenewal, that's an important piece of business for us. And we have a tubing setcontract coming up with DaVita for renewal towards the end of third quarter,beginning of fourth quarter next year.So, those are important dates for us. DaVita and even itsprecursor has used Medisystems products for over 20 years now, so it's been aconsistent high-value relationship on both sides, we've been good partners onboth sides. And we're going into that with more value than I think we've evergone into it, but nothing's for sure in this business. Robert Faulkner - Thomas Weisel PartnersOkay, great. And finally, if I may, any other Renal Weekhighlights, anything you think is going to be a core message of Renal Week withrespect to NxStage Home?Jeff BurbankA lot of good, solid progress. Today is my big day for that,I was mostly preparing for this call, so I haven't had a chance to poke intothat. But, I've reviewed the abstracts. A lot of good work that I think willcontinue to move the ball forward, much more experience and data with theNxStage system.Historically, it's been more with other systems, so I'm veryencouraged by that and even more encouraged that the data looks as good orbetter, that kind of thing. So, it looks pretty solid, but a little too earlyfor me to call because I've got to get out of this conference room and go talkto customers. Robert Faulkner - Thomas WeiselPartners37 Right. Okay, thanks, I'll hop back in the queue.OperatorOur next question will come from the line of Taylor Harrisof JPMorgan. Please proceed. Taylor Harris - JPMorganThanks. Jeff, I'll try to be brief so you can get on to thecustomers there. So, going into the fourth quarter last year, we ended upseeing more seasonality than we thought and I'd just love for you to comment onwhat the gives and takes are this year, what you think may be different thisyear.Jeff BurbankYes, I think our planning assumptions are it's going to beabout like last year in terms of what the individual centers are doing. There'sa few more centers out there, so we have the benefit of that. And you can seeby the numbers, we expect to add more in this fourth quarter than last fourthquarter just because of the growth of our base.But, we're predicting similar behavior, having no knowledgeof anything significantly different, so that's our planning assumption at thispoint, Taylor.Taylor Harris - JPMorganOkay. But at the top end of the range, you would have to addthe same number of patients in the fourth quarter that you did in the thirdquarter, which didn't seem to be the pattern last year. But, it also seemed tome that you were capacity constrained this third quarter and you've opened up aton of new centers, so I thought that might change the dynamic this year.Jeff BurbankThere is a little bit of that dynamic in there, yes.Taylor Harris - JPMorganOkay. And then, Robert, on the fourth quarter gross margincomment that you made, I just want to clarify. Do you think you will be breakeven for the full fourth quarter without the Medisystems business? Or do youreach that by the end of the fourth quarter?Robert BrownYes, right now, we feel very comfortable that we'll reach itwithin the quarter and I think we'll be somewhere between breakeven and minus2% or minus 3%.It's a little tough to call right now depending on wheresome of the projects are coming in, in the quarter, but we've got six or sevenpoints that we feel very good about and there's about two or three points thatreally depend on when they actually hit in the quarter.If they hit it more towards the beginning of the quarter,we'll tend to break even, if they hit towards the end of the quarter, thenwe'll probably be a negative 2% or 3%.Taylor Harris - JPMorganOkay and then just a few questions on Medisystems to help uswith our model there. The Medisystems business looks like gross margin of 23%,24%, that includes the revenue to you guys. Once we strip that out, are youstill at about the same gross margin level on the residual sales?Robert BrownRight, we're about 22%, 23%.Taylor Harris - JPMorganOkay, 22%, 23%. And then, the Medisystems businesshistorically had been pretty close to break even on an operating basis. For'08, should we make the same assumption? Or can it be more profitable combinedwith you?Robert BrownYes, it was actually break even, but in there was a $5.8 millionroyalty paid to another David Utterberg entity. That royalty actually goes awayand they historically, once you take that royalty out, they've been about 9% or10% on the bottom line.Taylor Harris - JPMorganOkay, great. So, that whole royalty expense line goes away.Robert BrownRight.Taylor Harris - JPMorganOkay, very good. And then growth in the Medisystemsbusiness, it seems like most of it has been generated by sales to NxStage, isthat fair? And should we assume flat sales in Medisystems next year or could itbe better than that?Robert BrownI think in this call, what we?ve say is that growth rate isabout market growth rate for those products, which is somewhere between 4% and6%, right in that range.We'd like to come back to you and say how we're going toimprove that, we think there is opportunity, but we'll get more specific, Ithink, as the next two quarters come and we get some experience under our belt.But we didn't buy it for 5% growth rate. We bought it,because we thought the synergy could enhance that.Taylor Harris - JPMorganGreat. And then last question, Jeff, strategically, you'vehad a lot of activity this year between the contract with DaVita, Medisystems,anything that you're thinking about considering as we go into '08? Or do youfeel like you're moving more towards a phase of all right, we have thefootprint that we want, let's go out and execute?Jeff BurbankIt's a fair question. I couldn't tell you, if we were workingon something really big and strategic, but the reality is that's what themessage I was trying to convey in our talk track was that we really feel likewe've got what we need, we've got the platform or the foundation to now goexecute.I'm really excited that we got all that we got done thisyear, so we can focus on execution fourth quarter and beyond.Taylor Harris - JPMorganGreat. Enjoy San Francisco.Jeff BurbankThank you.Robert BrownThank you.OperatorOur next question will come from the line of Suraj Kalia ofPiper Jaffray. Please proceed.Suraj Kalia - Piper JaffrayGood morning, gentlemen, congratulations.Jeff BurbankGood morning, thank you.Suraj Kalia - Piper JaffrayJeff, in terms of synergies from integration, I think so wehave the Medisystems P&L and if we back everything out, can you shed somecolor on what are the key components you'll expect to derive synergies from inFY '08?Jeff BurbankYes, it's not the synergies you get in traditional forms ofacquisitions, where you see overhead synergies.We don't see synergies in headcount and overhead, where wesee it is some of the products and capabilities we have, and some of those aretechnologies and some of those are pure marketing capabilities and sales andmarketing and customer relationships and those kinds of things. And then, wedid not take advantage of Medisystem?s full complement of technology in theNxStage products.So, for instance, we didn't use all their components in oursystems. You know, we were in a negotiation, so I wanted to retain some of thatvalue for us. So, it's more in new products, ability to grow products in themarketplace and integration of similar components and technologies.Suraj Kalia - Piper JaffraySo, if I heard you correctly, Jeff, that the 700 or soemployees of Medisystems, that is not going to be a core focus. Can you shedsome color on in terms of R&D, SG&A? Will everything pretty much remainintact? How should we break out those line items for the combined business?Jeff BurbankYes, you can't see our heads shaking, but Robert and I tellyou know, it tracks straight across, we don't expect any significant changes inthose investment rates.Suraj Kalia - Piper JaffrayOkay. Any color from your competitive intelligence onBaxter's efforts in home hemo?Jeff BurbankNot really anything more than you all know. They announced adevelopment deal with DEKA and Dean Kamen?s team. We take them seriously, wethink it's great for the industry, it's been a validation on the segment or thebusiness and we won't stand still, we're going to lead the market.Suraj Kalia - Piper JaffrayOne final question and I'll hop back in the queue, Jeff, andit might be a little convoluted question, but do you guys have any insight orcan you share your intelligence on the percent of patients on PD that are beingconverted to home hemo?Jeff BurbankYeah, that's a number that is kind of tough to get at becauseof the way it happens. Typically, when PD patients fail with therapy, theytypically don't plan the failure, meaning they don't predict that they're goingto be needing to come off of PD in two or three months, therefore they'retraining on home hemo.They typically fail PD, end up in a center and then get putin the queue to learn how to do home hemodialysis and go back. And part of thatis they tend to be missing their clinical targets towards the end of PD, sothey're not as well as, you'd like them to be. So, there's that stabilization.So, when we look at our survey numbers of patients that gofrom PD to NxStage, it's very, very low. However, when we've had just kind ofconversations of how many of our patients have been on PD, it's a pretty significantnumber.I'd like to try to get that data, we haven't made thateffort, but it's kind of our general belief that the majority of our patientshave been on PD at one time or another.Suraj Kalia - Piper JaffrayOkay. So and if I were to make a broad brush, Jeff, if Iwere to draw a pie chart and say these are the absolute new patients that arecoming on to home hemo or these are converts from, let's say, a Fresenius, andthey're coming over to NxStage's System One and maybe a third category of PD,which obviously like I heard you is unknown.How would the pie chart look like? I mean, is there a bigskew towards one element?Jeff BurbankIt would be 80% or 90% converted.Suraj Kalia - Piper JaffrayConverted. Okay, gentlemen, nice quarter, thanks.OperatorOur next question will come from the line of Anthony Ostreaof JPM Securities. Please proceed.Anthony Ostrea - JPM SecuritiesHey Jeff, Robert, how are you?Jeff BurbankGood.Robert BrownGood.Anthony Ostrea - JPM SecuritiesFew questions, I actually wanted to get a better handle onyour costs. First, would it be possible for you to strip out just theMedisystems contribution in Q4 to operating income?Robert BrownContribution to operating income, if you look at it as we goforward, we're looking at being right around break-even on the gross margin,spending up on our side won't be up significantly.So, our operating loss will be generally what our SG&Aspending is for the quarter, so it was $13 million in Q3 it'll be maybeslightly higher than that in Q4 and then, the rest will be related toMedisystems and there is also $750,000 in there related to the amortization ofthe acquisition intangibles.Anthony Ostrea - JPM SecuritiesOkay. So, $13 million being flat quarter on quarter so therest of it is really differences with Medisystems? Robert BrownRight. And intangibles from the acquisition.Anthony Ostrea - JPM SecuritiesOkay. And are you still essentially doubling up on the bagson certain PureFlow patients? Or has that stopped?Robert BrownIt's come down slightly. I think in the past we've said thatright now, PureFlow is costing us about 4 to 5 points of gross margin aroundthe reliability. I would say I'd put it around 3% to 4% right now. I think,we've picked up a point, point and a half in the Q3 time frame.Anthony Ostrea - JPM SecuritiesBut for your guidance though for Q4 assumes stillsome levelof??Robert BrownYes, we've got modeled in about 4 points.Anthony Ostrea - JPM SecuritiesOkay. And then in your press release, I think, you hadmentioned something about increasing sales, marketing and distribution expensesin Q3. Jeff, maybe can you just talk about what the make up was of those costs,whether it was one-time, were there people? I'm just trying to understand thatmake up.Jeff BurbankYes, that was actually our year-over-year growth rate inthere and it really comes down to your core sales and marketing. So, it'sputting more reps on the street and doing more marketing activities in general.Anthony Ostrea - JPM SecuritiesDid you add new reps between Q2 and Q3?Jeff BurbankYes, we did, we added approximately 4 reps in the chronicmarket.Anthony Ostrea - JPM SecuritiesFour reps. And then, the last question from me, Robert, Ithink you had mentioned earlier on an earlier question on your distributionexpenses, you had mentioned that you are working on certain activities to bringthat number down. Two questions there, one, I think you said was it 2 pointsper year? And second question -- Robert BrownNo, I would look at it 1 or 2 points per quarter goingforward. We've actually in the last 90 to 120 days, we've really brought insome new individuals into that organization, their feet are on the ground now,they're actually starting to get some traction there. So, I'm expecting to get1 or 2 points per quarter as we move forward.Anthony Ostrea - JPM SecuritiesAnd what kind of activities are these, essentially, to bringthat down? Are you maybe you can?Robert BrownWell, I mean they're taking it all the way down to lookingat our shipping lanes. So, taking a look at long haul shipping versus the lastmile. When you ship the last mile is pretty expensive, so you don't want tobasically have small loads going across the country from the distributioncenter. So, they're trying to balance that out of how do you take a semi loadto a certain point and then basically break it down there to actually deliverit to the home.So, they're looking at the shipping lanes all the way fromdistribution center all the way to the end customer and then looking at thedifferent providers of freight that we use and looking at our contracts aroundthat and then also looking at our patient density. So, I mean they're basicallydoing a diagnostic on the whole infrastructure around that.Anthony Ostrea - JPM SecuritiesGreat. Thanks. I'll hop back into queue.Robert BrownOkay.OperatorOur next question will come from the line of Bill Plovanicof Canaccord Adams. Please proceed.Bill Plovanic - Canaccord AdamsCanaccord Adams, but that's close enough, good morning.Jeff BurbankGood morning, Bill.Bill Plovanic - Canaccord AdamsI just actually have one housekeeping question. Did you giveus the number of hospitals that you added in the quarter?Jeff BurbankFor clinical care?Bill Plovanic - Canaccord AdamsYes.Jeff BurbankNo, we didn't. But thanks for caring.Bill Plovanic - Canaccord AdamsJust trying to get my model up to date, that's actually allI have, thanks.Jeff BurbankAll right.OperatorOur next question will come from the line of Vivian Wohl ofFederated Kaufman Funds. Please proceed.Vivian Wohl - Federated Kaufman FundsGood morning, guys.Robert BrownGood morning.Jeff BurbankGood morning.Vivian Wohl - Federated Kaufman FundsDid you give us the number of patients or percent ofpatients that are on PureFlow now? And can you update us if the reliability isat the point where you really are starting all the patients out on PureFlow atthis point?Jeff BurbankYes, the first part of the question, it's 65% at the end ofthe third quarter, so we continue to make progress there. The vast majority ofnew patients are going on to PureFlow. There are certain local issues to dowith local surveyors that we are working through. It hasn't been a significantimpact but, as with everything, nothing's universal, there are alwaysexceptions.Vivian Wohl - Federated Kaufman FundsAnd is that because of regulatory issues at the State levelor because of different water issues around the country?Jeff BurbankIt's only the States' interpretations of the regulatoryissues.Vivian Wohl - Federated Kaufman FundsOkay. And given that it is at 65% then at the end of thequarter, I mean, I appreciate all the efforts on the distribution line, butmaybe you can help us understand what the distribution costs would have beenlike in the quarter if you didn't have the recall issues?Robert BrownWell, the distribution line in the quarter, actually we tookout the impact of the recall, or at least the direct impact of it. There weresome indirect impacts where, because we ran into a low point on the cyclers, wewere actually doing quite a bit of expediting on the cyclers to get patients upand running. So, there was a fairly what I'd say, to get the impact from that,that we're working out of right now. So, I don't have that number right infront of me how much that was.Jeff BurbankWe probably would have added it to the write off if it waseasily quantifiable and that was the challenge we had. We know it's in there,but it's very hard to come to a specific number. So, we know there was anaffect, but tough to quantify.Vivian Wohl - Federated Kaufman FundsWell, I guess I'm just trying to understand why thedistribution costs then haven't come down more as a percent, given that we'reat 65% conversion. Emancipation, we're looking for emancipation now. Is theresome other assumption in there that changed?Robert BrownNo, because I think we're seeing on the individual shipmentsof a PureFlow patient versus a bag patient, we're seeing those costs comingwhere we want them to come to. But, I think the fact is that, when you get to apoint where you're low on cyclers, you end up starting to move cyclers around alittle bit where you don't really want to.And you're also expediting some cyclers and there is cost inthere. It's related to the recalls, but it wasn't directly related to therecall. And so, as we work out of that, we'll get improvement there.Vivian Wohl - Federated Kaufman FundsSo, do you have enough cyclers at this point on November 2that this quarter we don't need to be expediting as much?Robert BrownYes, we do.Vivian Wohl - Federated Kaufman FundsOkay. And then, if I can just ask a different question onreimbursement, what are you hearing from the grass roots about the policiesmaybe being put into place, or contracts with private payers in with Medicareas far as how many times a week they're paying? Is there any standard evolvingin?Jeff BurbankWe continue to hear encouraging things about our customers'ability to receive additional payments. I haven't heard standards, we've alwaysheard in the 4 to 4.5 range is where it tends to settle out and we haven't hadany real new input on that. We may learn some things, while we're talking tocustomers here at ASN, but nothing significantly different than what we'vealways heard.There are a lot of on the horizon with bundling in a coupleyears and whether and when and those types of things, but not any big changeson the way and the frequency of reimbursement for our customers.Vivian Wohl - Federated Kaufman FundsOkay, great. Thanks very much, Jeff and Robert.Operator(Operator Instructions) Our next question will come from theline of Andrew Morey of Tartan Partners. Please proceed.Andrew Morey - Tartan PartnersYes, I guess, can you hear me?Jeff BurbankYes.Robert BrownYes.Andrew Morey - Tartan PartnersOh, thanks. One, just review on Medisystems quickly, remindme again, what was the price you paid as a multiple of sales, sorry, for thereview?Robert BrownAs a multiple of sales, it was about 1.2.Andrew Morey - Tartan Partners1.2 times, great. And just going over to the balance sheetfor a sec, I think this earlier first quarter of '07 showed a little bump inreceivables. It was my impression that was due to some of the seasonality lastfourth quarter, so when someone was asking about seasonality this fourthquarter, do you think that's possible as well that maybe some of the sales comea little bit later and maybe the cash flow, there is a little bit of a stretchin the receivables?Jeff BurbankIn Medisystems or in NxStage?Andrew Morey - Tartan PartnersI guess overall from the seasonality.Jeff BurbankEver so slightly.Andrew Morey - Tartan PartnersRight.Jeff BurbankEverybody is trying to make the balance sheet look good atyear-end, so you may see a little bit late payment there, but ever so slightly.Andrew Morey - Tartan PartnersOkay, great, great, thank you. And last question, is thereanything you think you can do in any of the changes to help with the capitalintensity of the business? Just the field equipment, just how that rises inrelation to your growing sales, obviously the patient growth is terrific, butI'm just curious if there's anything you can do there just with respect to thatfield equipment line?Jeff BurbankWell, I'll take part of it and Robert can add in. I mean,the two great things on that, the first one is our relationship and structureof that with DaVita, whereby DaVita and some of the other large providers arebuying versus renting. The second is that we believe debt facility can get putin place that would help us with that as well, so Robert's been working on thatand we have multiple interested parties. So, we think both of those things willhelp us nicely.Robert BrownAnd third point is that, we've moved a portion of our cyclerproduction down to Mexico. Getting lower cost cyclers out of Mexico willdefinitely help there and we've seen over the last year and a half, two years,the cost of the cycler come down on a steady state. So, it's coming in nicelywhere we think it should really come into long term.Andrew Morey - Tartan PartnersAnd I missed the front part of the call, so perhaps youalready answered this, did you quantify, whether it?s centers or new patients,any impact from DaVita in the quarter?Jeff BurbankDon't know exactly the question.Andrew Morey - Tartan PartnersWell, just from your relationship, you kind of formalizedearlier in the year just any additional color on how much DaVita kind ofcontributed to the number of new centers added, and the number of net newpatients?Jeff BurbankYes, they continue to be a good partner to work with, theycontinue to grow how we expect them to grow. So, they're providing the centergrowth and the patient growth that we had hoped for.Andrew MoreyOkay. Thanks.Jeff BurbankYou're welcome.OperatorLadies and gentlemen, this concludes the question-and-answerportion of today's conference. I will turn the call back to management for anyclosing remarks.Jeff BurbankWell, thanks everyone for joining us today. If you'll beattending the ASN meeting, we'll invite you to visit our booth, otherwise welook forward to updating you on NxStage's progress in our next call. Have agreat weekend, bye-bye.OperatorThank you for your participation, you may now disconnect.Have a great day.Copyright policy:All transcripts on thissite are the copyright of Seeking Alpha. However, we view them as an importantresource for bloggers and journalists, and are excited to contribute to thedemocratization of financial information on the Internet. (Until now investorshave had to pay thousands of dollars in subscription fees for transcripts.) Soour reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition thatyou attribute the transcript to Seeking Alpha and either link to the originaltranscript or to www.SeekingAlpha.com.All otheruse is prohibited.THE INFORMATION CONTAINED HERE IS ATEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCEPRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDEAN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, ORINACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. INNO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHERDECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANYTRANSCRIPT. USERS ARE ADVISED TO REVIEWTHE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'SSEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.If you have any additional questionsabout our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!Complete Story »
Alliant Energy Corp. (LNT)Q3 2007 Earnings CallNovember 2, 2007 2:00 pm ETExecutivesBecky Johnson - Manager of Investor RelationsBill Harvey - Chairman, President and Chief ExecutiveOfficerEliot Protsch - Chief Financial OfficerAnalystsSteven Rountos - Talon CapitalSteve Fleishman - Catapult PartnersPresentationOperatorPlease standby, we?re about to begin. Thank you for holding,ladies and gentlemen, and welcome to Alliant Energy's Third Quarter 2007Earnings Conference Call. At this time, all lines are in a listen-only mode.I would now like to turn the call over to your host, BeckyJohnson, Manager of Investor Relations at Alliant Energy.Becky JohnsonGood afternoon. I would like to thank all of you on the calland on the webcast for joining us today. We appreciate your participation. Withme here today are Bill Harvey, Chairman, President and Chief Executive Officer,and Eliot Protsch, our Chief Financial Officer, as well as othermembers of thesenior management team.Following prepared remarks by Bill and Eliot, we will havetime to take questions from the investment community. We issued a news releasethis morning announcing Alliant Energy's third quarter 2007 earnings. Therelease is available on the investors page of our website atwww.alliantenergy.com.Before we begin, I need to remind you that the remarks wemake on this call and our answers to your questions include forward-lookingstatements. These forward-looking statements are subject to risks that couldcause actual results to be materially different.Those risks include among others matters discussed inAlliant Energy's press release issued this morning and in our filings with theSecurities and Exchange Commission. We disclaim any obligation to update theforward-looking statements.At this point, I would like to turn the call over to Bill.Bill HarveyThank you, Becky. Good afternoon and thanks for yourcontinued interest in our company. My comments this afternoon are primarilyfocused on updating you on our progress with our generation buildout and otherstrategic initiatives.Later in the call, I will turn it over to Eliot to provide aregulatory update and a more detailed discussion of our quarterly earnings andfinancial guidance.Due to the seasonal nature of our business, the thirdquarter is historically a big contributor to the annual earnings of our utilitybusiness. This year was no exception. Our third quarter results from continuingoperations were $1.05, compared to $0.75 for the third quarter of 2006.Later in the call, Eliot will discuss some of thequarter-over-quarter variance drivers. Suffice it to say, however, we arepleased with the solid financial performance produced this quarter. Moreimportantly, as a result of this strong third quarter results, we have narrowedour consolidated earnings guidance for 2007 to what had previously been the tophalf of our range.As for our utility operations, two of our coal plants wererecently named 2007 best performers by the electric utility cost group. TheEdgewater generating station in Sheboygan, Wisconsin, received the award in thelarge plant category; those stations greater than 250 megawatts and the Lansinggenerating station in Iowa received the award in the small plant category.We are pleased by this recognition of our commitment tooperational excellence and reliability. Moving on to our generation buildout.Last week in Wisconsin we celebrated the official groundbreaking of the CedarRidge wind farm, Alliant Energy's first of many planned rate-based wind farms.We began construction of turbine access roads, foundationsand the substation. This infrastructure work is ongoing and will be completedby year-end. Turbine deliveries are scheduled for the second quarter of nextyear, with turbine erection occurring in the summer of 2008.This 68-megawatt wind farm is expected to be operational bythe end of 2008, at an estimated cost of approximately $165 million.In addition to Cedar Ridge, WP&L continues to evaluatesites for an additional 200 megawatts of owned wind generation. Our focus hasbeen on sites in our southern Minnesota service territory, where the windregimes are superior to those found in Wisconsin.We are in the final stages of preparing thee certificate ofpublic convenience and necessity application, requesting regulatory approvalfor this project. Similar to Cedar Ridge, we plan to use traditional ratemaking procedures for the recovery of and return on this incremental 200megawatts of wind generation.Pending regulatory approval and the availability ofturbines, we currently project 100 megawatts of this capacity to be online in2009 and the balance in 2010, both for a total cost of approximately $360million to $440 million. Checking in on baseload generation, we continue tomake progress in Wisconsin on the development of a 300-megawatt coal plantlocated at WP&L's existing Nelson Dewey site in Cassville, Wisconsin.The proposed unit will utilize circulating fluidized bedtechnology and is being designed to burn biomass. We intend to rely onrenewable resource fields for 10% of the BTU input for the facility.Last February, WP&L filed a request with the PublicService Commission of Wisconsin for the approval to build Nelson Dewey 3 and alsofor fixed financial parameters and ratemaking principles for the recovery ofthis investment under the auspices of Wisconsin Act 7.We are moving through the regulatory process and anticipateapproval of the certificate of public convenience and necessity in the secondhalf of 2008. Our current expectations of the timeline for securing thenecessary permits and procuring hardware allows for an in-service date of 2013.We are in the final stages of negotiating the EPC contractfor the Nelson Dewey expansion, and expect an agreement to be executed in thenear future. In addition, our major equipment specifications are nearingcompletion, and we have issued an RFP for the boiler.As a part of our application process, we updated theestimated cost of this facility to a range of $850 million to $950 million,excluding AFUDC if applicable. This increase is reflective of changes in scope,since our original application, primarily increased biomass capability andreduced wetlands impacts.In April, WP&L filed an application with the PublicService Commission of Wisconsin to purchase the Neenah generating facility, anexisting 300-megawatt simple cycle gas-fired facility, located in Neenah,Wisconsin. This purchase by WP&L is intended to replace the output currentlyavailable under our purchase power agreement with Calpine's RockGen facility.Pending regulatory approvals, the purchase is expected to occur in 2009.Let me now discuss the status of our IP&L generationprojects. IP&L is making progress on the development of a baseload coalfacility at our existing Sutherland generating station site in Marshalltown,Iowa. We plan to utilize supercritical pulverized coal technology for the newunit. The boiler will be designed to burn biomass, such as switch grass, cornstover and wood chips. And similar to Nelson Dewey, the plant is being designedto burn renewable resource fuels for up to 10% of the BTU input for thefacility.Provisions are also being made to allow for cogeneration atthe plant. In July, we filed our siting application with the Iowa UtilitiesBoard, seeking approval to create Sutherland Unit 4. The facility will produce649 megawatts and IP&L plans to utilize up to 350 megawatts of the plant'soutput. IP&L anticipates the IUB decision on this application in the secondhalf of 2008.In the first quarter of 2008, we plan to file for advancedrate making principles under House File 577, similar to the process we used forour Emery plant. We have begun the equipment procurement process for theSutherland expansion by issuing RFPs for the boiler, turbine, and air qualitycontrol systems. Pending regulatory approvals, we currently expect thisfacility to begin commercial operation in 2013. We estimate that our 350megawatts share will cost between $840 million and $910 million excludingAFUDC.Earlier this year, Corn Belt Power Cooperative and CentralIowa Power Cooperative signed letters of intent to be joint partners in thisfacility. We are putting the finishing touches on the joint operating agreementamong us, which we expect to execute later this month. In addition, IP&Lcontinues to negotiate with other potential partners in the plan.Concerning our wind generation in Iowa, in September wefiled our application with the Iowa Utilities Board for determination ofratemaking principles for up to 200 megawatts of wind generation.As part of the filing, IP&L requested a 12.3% return onthe equity component of the investment. We have entered into negotiations withthe developer for the purchase of a 200 megawatts site in northern Iowa andexpect to execute an agreement for the purchase later this month.We anticipate the IUB's decision by the end of 2008. Pendingregulatory approval and the ability of turbines, we expect the 200-megawattwind farm to be completed in the 2009?OperatorPlease stay online. We are experiencing a short interruptionin our program. We will return in just one moment.Bill HarveyHello everyone. This is Bill Harvey. Wisconsin is still hereand so is Alliant Energy. We did have a breakdown in telecommunications. Butlet me back up in my prepared remarks just a little and begin with a discussionof an update on proposed sale of our IP&L transmission assets to IPCHoldings.We continue to move forward through the various regulatoryprocesses. In September the Iowa Utilities Board formally allowed the sale tomove forward, which was a major milestone in the process.Recently, the Office of Consumer Advocate has soughtjudicial review of the IUB's decision. We do not expect the judicial review tobe successful or delay the anticipated closing of transaction. But, as youwould expect, we cannot provide any assurances that the judicial review will beresolved in a timely or satisfactory manner.In addition to Iowa we have received approval from theMissouri Commission. We have also made applications jointly with IPC inMinnesota, Illinois, and at the FERC. We expect to receive the Minnesotaadministrative law judge's recommendation this month. The FERC does not have adefined period of time within which to act, however, we are also expectingtheir decision this month.In addition, both IP&L and IPC have made theirHart-Scott-Rodino filings. The FTC acted on behalf of both organizations, andthe investigation was completed in May. The sale of IP&L's transmissionassets is expected to be positive for our customers and our shareowners.Assuming all regulatory approvals are received on a timely basis, we expect tocomplete this transaction by year-end.In closing, I will summarize the key takeaways from thequarter. First, strong sales and improved electric margins drove better thanexpected third quarter results. Second, we are narrowing our earnings guidanceand have increased the midpoint of our consolidated guidance by $0.05. Third,we successfully completed our $400 million share repurchase program.Fourth, substantial progress has been made on theconstruction of the Cedar Ridge wind farm in Wisconsin, which is slated tobegin commercial operation next year. And finally, the regulatory proceedingsrequired to build our coal and wind facilities and to sell our IP&Ltransmission assets are progressing. We appreciate your continued support forour company and now I would like to turn the call over to Eliot.Eliot ProtschThanks, Bill and thanks to all of you for joining us today.My primary focus will be to provide additional analysis on the quarter as wellas update you on our rate cases and discuss our revised financial guidance. Myremarks pertain exclusively to results from continuing operations.First, as noted in our press release, we have postedsupplemental slides on our website to assist you in your earnings analysis. Youmay want to have these slides available for reference during my remarks. As wewalk from third quarter 2006 to 2007. There are three items that negativelyimpacted third quarter of 2006 earnings, which improved this year.First, $0.07 related to net impacts of weather and weatherhedging, second, $0.07 related to WP&L fuel recovery-related items. Andfinally, Q3 2006 earnings included a $0.05 loss for our New Zealand operations,which have since been sold.Positive EPS drivers for 2007 are as follows: the accretiveimpact of the share buyback was $0.05 per our utility in Q3 2007. In addition,third quarter earnings reflect improved electric margins and a forset benefitfrom the settlement of a federal income tax audit for the period 1999 to 2001.Drilling further into third quarter 2007 utility results compared to 2006. Iwould like to highlight the following.Primarily as a result of increased retail electric salesvolumes, electric margins were approximately $0.07 higher than last year. Wecontinue to experience increased customer usage in general, as well as positiveeffects from the growth in the agricultural processing industry in our serviceterritory.The net impacts of weather and weather hedges were slightlypositive this year as our summer weather hedge functioned as intended. We alsohad a slight pickup from a warmer than normal September which is outside thesummer hedging period. Incentive compensation related expenses were $0.05higher than the same period last year.However, focusing on the right column on the post slide,please note that on a year-to-date basis, incentive compensation expenses areflat. The variance this quarter is related to the timing of the accruals andimproved annual earnings projections. WP&L's fuel recovery was neutral inQ3 '07.WP&L reached a settlement agreement in August to refundany over collection of retail fuel-related costs for the period of June throughDecember 2007. Therefore, we would expect that the fourth quarter will beearnings neutral as well.Now, I will update you on our various rate matters. Withregard to Wisconsin retail rates in June, the Public Service Commission agreedwith our request to reopen WP&L's retail rate case. In September, the PSCstaff issued its briefing memorandum, which was supportive of a $26 millionelectric rate increase in addition to our request for AFUDC clarification.At its open meeting last week, the Commission directed staffto draft an order, which we expect to be approved sometime in the fourthquarter proposing new rates effective January 1st, 2008. We pursued thisre-opener because both the Public Service Commission of Wisconsin and WP&Lhave a desire to evolve to a biannual rate case cycle. WP&L currently plansto file its next base rate case in early 2008, with a 2009-2010 forecasted testyear.As for WP&L's wholesale business which representsapproximately 15 to 20% of WP&L's electric revenues, formula rates becameeffective June 1st, subject to refund and continue to make progress in ourdiscussions with customers with respect to settlement of this case.We look forward to having formula rates become an ongoingcomponent of our wholesale business as we embark upon our generation build-outprogram. I would also like to provide an update on WP&L's gasperformance-based rates or what we refer to as PBR.In our last base rate case order, the Public ServiceCommission of Wisconsin changed the sharing mechanism for PBR to 65% customersand 35% shareholders. In addition, the commission directed staff to work withthe company on exploring various alternatives to the design of the program.In October, the commission issued an oral decision on thefuture of WP&L's PBR mechanism. In its oral decision, the commission gaveWP&L the option to accept a new PBR sharing formula, or to implement atraditional pass through approach. Unfortunately in our judgment, the newmechanism did not include an appropriate risk return tradeoff for customers andshareholders.For thatreason, we have selected the traditional passthrough approach. In each of the last two years, the previous PBR formula hasresulted in savings of approximately $13 million for our customers, and an EPScontribution of approximately $0.06 to $0.07 for shareholders.We currently fully expect the full year EPS contribution forPBR to be $0.02 in 2007. We may choose to revisit PBR alternatives as a part offuture base rate case applications. Now to summarize our capital plans.Our projected capital expenditures for 2008 remain unchangedat $580 million. Future capital expenditures beyond our maintenance capitalneeds are, of course, a function of the timing of the capital spending for ourvarious infrastructure projects, and the availability of wind turbines.In addition to new generation, we plan to make significantcapital investments in environmental compliance over the next decade. Thisincludes the installation of emissions controls, utilizing both pre and postcombustion technologies, while using the allowance market as a balancingmechanism.Our 10-Q disclosure includes our current estimated ranges ofcapital spending to achieve compliance. In addition, for those of you who areinterested in more detail on our environmental strategy, emissions profile andcompliance plans, we recently published our annual environmental report, whichis available on our website.Of special note, with respect to NOx reductions, we havealready achieved strong results due to the installation of combustion controltechnology at several WP&L and IP&L units.In October, WP&L filed a certificate of authority withthe Public Service Commission, seeking approval for the gas portion of theadvanced metering infrastructure project in Wisconsin. The electric portion ofthe AMI project does not require a similar type of regulatory approval process.WP&L plans to install both gas and electric meters.We estimate the total expenditures on AMI in Wisconsin to beapproximately $95 million. We also plan to install AMI in our IP&L serviceterritory. The estimated cost for full deployment at IP&L is $105 million.Deployment at both WP&L and IP&L will be phased in through 2011.The timing and the amount of this investment is conditionalupon appropriate regulatory treatment in the various jurisdictions. Before Ileave CapEx, I would like to briefly comment on the slide posted on the websitedetailing our generation plan.This table, which is also included in our 10-Q, now includesthe amount of capitalized cost incurred to date for the major generationprojects listed. This totals $63 million as of September 30th, 2007. We expectthese expenditures to grow over time and thought it would be useful forinvestors to know what has been expended to date, and what amounts may bereflected in rates and thus in our earnings.Now, an update on our various financing activities. InAugust, WP&L completed a $300 million long-term debt issue. The proceedswere used to reduce short-term debt balances to re-capitalize WP&L inconcert with the rate order received earlier this year and to fund capitalexpenditures.Looking ahead to the remainder of this year, as in pastyears, we have now hedged our heating system season margins and as previouslymentioned. We expect to be neutral on WP&L fuel recovery. Thus, when wecombine our fourth quarter outlook with our strong year-to-date performance, weare narrowing our earnings guidance range to $2.52 to $2.62 per share.Finally, with respect to 2007, we are reaffirming our 2007cash flow guidance of $525 million to $575 million. 2008 earnings and cash flowguidance as well as 2008 through 2010 capital expenditure guidance will beissued in mid-December after our budget is approved by our Board of Directors.In closing, we look forward to the opportunity to meet withmany of you at next week's EEI conference. And at this time, I would like toturn the call back over to Katie to guide us through the question-and-answersession.Question-and-Answer SessionOperatorThank you, Mr. Protsch (Operator Instructions). We'll gofirst to Steven Rountos with Talon Capital.Steven Rountos - Talon CapitalGood afternoon, everyone.Eliot ProtschHi, Steven.Bill HarveySteven. Steven Rountos - Talon CapitalI was wondering if you comment on the OCA's request forjudicial review. What is the timing of that? And what are the next steps forthat?Bill HarveyWell, the process is a relatively traditional judicialreview process. The timing of its review is something that's controlled by thereviewing court, not by some other mechanism. I think the important thing towatch for is whether or not there is any quick action by the court.And, secondly, whether or not there's any action by thecourt relating to any possible request for a stay of the sale. There has beenno such request today and we think the probability of any such request beingsuccessful, if it were made, is very low.Steven Rountos - Talon CapitalOkay. And then on Nelson Dewey, I think that you hadmentioned that the CapEx has increased because of the need to be able to firebiomass in it as well. Can you give us an idea on what the increase is and howit plays out over the '08 to 2010 timeframe?Bill HarveyI think in my prepared remarks, I indicated what the totalcapital cost increase was for our share of the facility, but you can think ofit as approximately a $50 million increase in costs. Some of that relates tosite reconfiguration relating to wetlands on the site.Some of it relates to reconfiguration associated with theability to logistically handle the biofuels that will be burned at the plant.And some of it relates to alloy changes in the boiler that will accommodate thecombustion of higher levels of biofuel and what we had originally anticipated.Eliot ProtschSteven, with regard to year-by-year estimates when we fileour 2008 guidance, we will give you our best estimate at that point in time interms of year-by-year expenditures for that plant.Steven Rountos - Talon CapitalOkay. Thank you very much.Operator(Operator Instructions) We will go next to Steve Fleishmanwith Catapult Partners.Steve Fleishman - Catapult PartnersYes, hello.Bill HarveyHi, Steve.Steve Fleishman - Catapult PartnersCould you on the non-regulated businesses in the quarter,could you -- outside of the absence of the New Zealand loss last year, whatwere the drivers at the non-reg generation and the, transport RMT WindConnect?Bill HarveyWell, the drivers were really twofold. Number one,substantial increase in the earnings associated with the WindConnect businessand the second is the increase in earnings in the non-regulated generationbusiness due to the retirement of debt associated with that business andconsequentially less interest carrying costs.Steve Fleishman - Catapult PartnersOkay. Are these things that could be ongoing to the pointwhere these businesses maybe start going at a higher run rate than before or isthis kind of some just strong performance in the quarter, do you think?Bill HarveyWell, the wind connect businesses has been strong. It'sdifficult to predict whether or not that will sustain over the long term. Thenon-regulated generation business, obviously, that debt is gone.Steve Fleishman - Catapult PartnersOkay.Bill HarveySo its performance ought to be enhanced over time, butimportantly, the transportation business is benefiting substantially from thetremendous expansion in the ethanol marketplace in Iowa. So, we hope thatbusiness will perform more strongly over time as well. What we expect in thatarea will obviously be reflected in the guidance that we issue in December ofthis year. But I think that's a fair qualitative summary.Steve Fleishman - Catapult PartnersOkay. And then one last question, what is your currentexpectation for use of proceeds from the transmission sale?Bill HarveyRight now, our expectation is that we will probably redeploythat to our utility business; reduce a little bit of debt at IP&L.Steve Fleishman - Catapult PartnersOkay.Bill HarveyEverybody is still there?Steve Fleishman - Catapult PartnersOh, sorry. So you said redeploy the utilities?Bill HarveyDividend it up to the parent for redeployment both inreducing debt at IP&L and redeploying the capital program of the utilityand otherwise investing it in short-term interest bearing obligations.Steve Fleishman - Catapult PartnersOkay. Thank you.OperatorThank you. Ms. Johnson, there are no further questions atthis time.Becky JohnsonWith no more questions, this concludes our call. Thanks foryour continued support of Alliant Energy and feel free to contact me with anyof your follow-up items. A replay of this call will be available throughNovember 9th, 2007 at 888-203-1112 for U.S. and Canada, or 719-457-0820 forinternational callers should reference conference ID 4510812.In addition, an archive of the call and the script of ourprepared remarks will be available on the Investors section of the company'swebsite later this afternoon. Thank you.OperatorWe thank you for today's participation. That does concludetoday's conference call.Copyright policy:All transcripts on thissite are the copyright of Seeking Alpha. However, we view them as an importantresource for bloggers and journalists, and are excited to contribute to thedemocratization of financial information on the Internet. (Until now investorshave had to pay thousands of dollars in subscription fees for transcripts.) Soour reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition thatyou attribute the transcript to Seeking Alpha and either link to the originaltranscript or to www.SeekingAlpha.com.All otheruse is prohibited.THE INFORMATION CONTAINED HERE IS ATEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCEPRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDEAN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, ORINACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. INNO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHERDECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANYTRANSCRIPT. USERS ARE ADVISED TO REVIEWTHE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'SSEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.If you have any additional questionsabout our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!Complete Story »
Emergent Biosolutions, Inc. (EBS)Q3 2007 Earnings CallNovember 2, 2007 9:00 am ETExecutivesRobert Burrows - Vice President of Investor RelationsFuad El-Hibri - Chairman and Chief Executive OfficerDon Elsey - Chief Financial OfficerAnalystsGene Mack - HSBC SecuritiesRichard Smith - JPMorganEric Schmidt - CowenGene Mack - HSBC SecuritiesDaniel Mallin - WBB SecuritiesPresentationOperatorGood day, ladies and gentlemen, and welcome to the ThirdQuarter Emergent BioSolutions Earnings Conference Call. My name is Lacey, andI'll be your operator for today's call. At this time, all participants are in alisten-only mode. We will conduct a question and answer session towards the endof this conference (Operator Instructions). As a reminder, this conference isbeing recorded for replay purposes.I would now like to turn the presentation over to our host,Mr. Robert Burrows, Vice President of Investor Relations. Please proceed.Robert BurrowsThank you. Good morning, ladies and gentlemen, and thank youfor joining us today as we discuss Emergent BioSolutions financial results forthe third quarter of 2007. As is customary, our call today is open to allparticipants.In addition, the call is being electronically recorded andis copyrighted by Emergent BioSolutions. My name is Bob Burrows and I am VicePresident for Investor Relations for the company. Joining me this morning willbe Fuad El-Hibri, our Chairman and Chief Executive Officer, and Don Elsey, ourChief Financial Officer.Additional other members of senior management will bepresent on the call for purposes of Q&A. The agenda for today's call isstraightforward. Following my brief introduction, Fuad will briefly discussthird quarter results as well as third quarter accomplishments, progress ontyphoid and an update on DoD.Don will then review our financials for the third quarterand the first nine months of 2007 and will also discuss the upward revision toour 2007 revenue guidance. We then will move to the customary Q&A session.Please note that any statements about the company's prospects or futureexpectations are forward-looking statements.As you know, forward-looking statements involve substantialrisks and uncertainties, and actual results may differ materially fromexpectations. Please refer to the press release issued earlier today and,importantly, to our filings with the SEC for more information on the risks anduncertainties that could cause actual results to differ.Also, Emergent BioSolutions assumes no obligation to updatethe information in today's press release or as presented on this call except asmay be required by applicable laws and regulations. Today's press release maybe found on our website at www.emergentbiosolutions.com, either the home pageor under investors/press releases.And with that briefintroduction, I would now like to turnthe call over to Fuad El-Hibri, our Chairman and CEO. Fuad?Fuad El-HibriThank you, Bob. Good morning, everyone. Thank you forjoining us today on our quarterly conference call.This morning, we announced financial results for the thirdquarter and first nine months of 2007. In summary, for the third quarter, wereported total revenues of $43.6 million and net income of $2.8 million, or $0.10per share. At September 30th, we have cash and cash equivalents of $24.3million and $42 million of accounts receivable.During the quarter, we announced the signing of a multi-yearcontract with HHS valued at up to $448 million. Under this contract, HHS hasagreed to purchase 18.75 million doses for a firm fixed-price of $400 million.We would receive an additional $34 million upon obtaining regulatory approvalfor four-year dating. I will go into more detail on this contract in a moment.We are also cultivating additional markets for BioThrax,most notably foreign governments. We continue to establish relationships withforeign governments, and recently, we successfully completed the meaningfulsale of BioThrax to an allied foreign government.We are pursuing regulatory approval in a number of foreignjurisdictions and have had numerous discussions with representatives of alliedforeign governments interested in purchasing BioThrax.We aim at further expanding our international marketopportunities and remain encouraged by our recent sales and the current levelof interest from several governments around the world.Given the positive developments to date, including theexpanding demand for BioThrax, we are pleased to announce an increase in ourrevenue projections for the year to now reflect an anticipated year-over-yeargrowth of 16% to 18%.We also continue to anticipate positive net earnings for theyear. With that introduction, I will now take you through a more detaileddiscussion of our accomplishments for the third quarter, notably the HHScontract and the NIAID/BARDA funding for our anthrax immunoglobulin candidate,a review of more recent news regarding progress within our commercialportfolio, specifically our oral typhoid vaccine candidate, and an update onthe current status of our negotiations with DoD.In reviewing our accomplishments for the most recentquarter, there are a number of milestones that I would like to highlight.First, the HHS contract. As we previously announced on September 26th, wesigned the largest contract in the history of our company, a multi-yearcontract with HHS valued at up to $448 million.Components of this multiyear contract include $400 millionfirm fixed-price for delivery of 18.75 million doses of BioThrax for inclusionin the Strategic National Stockpile, $34 million for receipt of regulatoryapproval of four-year dating for BioThrax payable through a combination of alump sum payment reflecting a price per dose increase for certain dosesdelivered prior to approval and an increase in the per dose price to be paidper doses delivered following approval.Up to $11.5 million in milestone payments in connection withadvancing our post-exposure indication program for BioThrax, and $2.2 millionfor logistics and other related support services.The contract runs through September 2010. It is important tonote that the 18.75 million doses reflect the maximum number of doses indicatedin the original RFP issued by HHS on May 3rd.At the time we announced the contract, we anticipateddelivering at least 6 million doses of BioThrax into the Strategic NationalStockpile by year-end. We continue to be on track to meet that goal.During the third quarter, we completed the first delivery ofdoses, which generated revenues of $41.8 million. Importantly, these doses weresold to HHS at a discounted price due to the slightly reduced remaining shelflife for these specific doses.This discount only applies to the first 5.5 million doses ofthe 6 million doses to be sold and delivered to HHS this year. This discountwill not apply to any other doses to be sold and delivered to HHS under thecontract in the following years.This contract provides visibility to our future revenuesthat will support the development of our product pipeline and growth strategy.I would now like to talk about our anthrax immunoglobulin candidate, which weexpect will be our next revenue source, driven by what we anticipate will bethe government's continued demand for doses of an anthrax therapeutic and theirpreference to have multiple suppliers.In September, the National Institute of Allergy andInfectious Diseases, National Institutes of Health and the Biomedical AdvanceResearch and Development Authority agreed to provide us with up to $4.5 millionin development funding to support non-clinical and clinical studies of ouranthrax IG product. We're developing our AIG product candidate as anintravenous therapeutic for treatment of patients who present with symptoms ofanthrax disease following exposure to anthrax.Earlier this year, AIG received fast-track designation fromFDA. With this recent funding, in combination with previous development fundingof $3.9 million from NIAID in 2006, we are encouraged by the government'scontinued funding commitment to our anthrax IG product.We are honored to continue our longstanding relationshipwith the U.S. government and appreciate the dedication and professionalism ofthe senior leadership within HHS and BARDA in taking these important stepstowards enhancing our domestic biodefense infrastructure.Let me now take a moment to update you on recentdevelopments within our advanced pipeline, specifically our lead candidate, ouroral typhoid vaccine. As you know, our typhoid product candidate is part of ouradvanced stage pipeline, which also includes our hepatitis B therapeuticvaccine candidate and our Group B strep vaccine candidate.On October 10th, we announced the completion of a Phase IIclinical study of our oral typhoid vaccine candidate. The Phase II studydemonstrated that our single-dose drinkable typhoid vaccine candidate achievedthe study endpoints for safety and immunogenicity.In this clinical study, we recruited children between 5 and14 years of age. A total of 101 children received a vaccine candidate and 50children received placebo. This clinical study, which was conducted in Vietnam,is the first study of this product candidate in a pediatric population in aregion in which typhoid is endemic.The trial was performed in collaboration with OxfordUniversity and the Hospital for Tropical Diseases in Vietnam. Clinical studywas financially supported by the Wellcome Trust, which also provided supportfor the Phase I study of our candidate.The data from this Phase I, excuse me, Phase II clinicalstudy, which is still being analyzed, supports the following key findings.Vaccine was immunogenic and met the predefined criteria of an overall immuneresponse rate of greater than 50% with 95% confidence. Vaccine inducedsignificantly higher antibody concentrations, indicative of systemic responsesin children in the vaccine group compared to the placebo control group.Vaccine was well tolerated with no serious adverse events ordeaths reported and no subject withdrew due to adverse events. And overall,there were no statistical differences in the incidence of adverse eventsbetween the vaccinated and placebo-treated groups.This data is encouraging and indicates promise for whatwould be the first single-dose strength of typhoid vaccines. Typhoid is endemicin many developing countries, putting countless international travelers andfamilies who visit these nations at risk. This infectious disease claimsapproximately 200,000 lives each year worldwide.We are encouraged by the continued development success ofour typhoid vaccine candidate and look forward in the coming months toproviding additional detail on the Phase II data, as well as visibilityregarding our next steps with this promising product candidate.Now, an update on DoD. At a quick review on May 7th of thisyear, DoD issued a request for proposal for BioThrax. We submitted our responseto DoD in July. We have been in discussions regarding the supply of BioThrax toDoD and have been reassured that DoD's operational requirements remain and thatDoD has continued commitments to procure BioThrax for its active immunizationprogram.However, we anticipate that the procurement process willtake longer than previously expected. The reason for this is the recent GAOreport and Presidential Directive, which outlines the U.S. government'sobjective to enhance coordination and cooperation among federal agencies withrespect to countermeasures, procurement and stockpile management.As I stated earlier, we believe DoD's operational requirementsremain and that DoD has the continued commitment to procure BioThrax for itsactive immunization program. While we are confident that this procurement willbe completed, the timeline has now been pushed out into the next year by therecent reports that I have just mentioned.In conclusion, as I began my comments, we are a profitablebiopharmaceutical company with growing revenues. We are focused on expandingthe market for our products as well as developing and commercializing newproducts that address multiple growing market opportunities worldwide.That concludes my prepared comments. I will now have mycolleague, Don Elsey, Emergent's Chief Financial Officer, take us through ourfinancial results for the third quarter of 2007 and our revised financialguidance for the year. Don?Don ElseyThank you, Fuad. Good morning, everyone. As Fuad mentioned,we released our third quarter 2007 financial results this morning prior to theopening this month. We will be filing with the SEC our quarterly report on form10-Q later today.The press release is available on our website today and theForm 10-Q will also be available on file on our website and on the SEC'swebsite. We are very pleased with our results for the third quarter of 2007 andfor the first nine months.These results reflect our ability to deliver product to bothDoD and HHS and to fund our continued product development programs. During thethird quarter of 2007 and through the first nine months of the year, thefinancial results we have achieved are aligned with our internal expectations.With this background, I will begin the discussion of ourfinancial results. In terms of format, for each financial element discussed, Iwill first address the third quarter period followed by the nine-month period.And we'll start with a discussion of product revenues.Product sale revenues increased by $900,000 to $41.8 millionfor the third quarter of 2007, up from $40.9 million for the third quarter of2006. This increase in product sales revenues was primarily due to a 43%increase in the number of doses of BioThrax delivered, offset by a 29% decreasein the average sales price per dose attributable to the discounted price thatFuad indicated earlier.This discounted price provided to HHS was due to theslightly reduced remaining shelf life for those specific doses delivered. Thisdiscount will apply to a portion of the doses remaining to be sold anddelivered to HHS during 2007. Again, as Fuad mentioned, we do not expect thisdiscount to apply to any other doses to be sold and delivered to HHS under thecontract.Product sales revenues for the third quarter of 2007consisted of BioThrax sales to HHS of $41.8 million, as compared to productsale revenues for the third quarter of 2006, which consisted of BioThrax salesto HHS of $17.5 million and to the DoD of $23.4 million. For the first ninemonths of 2007, product sales revenues increased by $28.5 million to $89.8million for the first nine months of 2006.This increase in product sales revenues was primarily due toa 76% increase in the number of doses of BioThrax delivered, partially offsetby a 17% decrease in the average sales price per dose attributable to the samefactors that applied to the three-month product sales figures.Product sales revenues for the first nine months of 2007consisted of BioThrax sales to HHS of $63.5 million and sales to the DoD of$26.2 million. Product sales revenues for the first nine months of 2006consisted of BioThrax sales to HHS of $35.4 million and sales to the DoD of$25.3 million and aggregate international and other sales of $630,000.Moving on to contracts and grant revenues. Contracts andgrant revenues increased by $600,000 to $1.9 million for the third quarter of2007, up from $1.3 million for the third quarter of 2006.Contracts and grant revenues for the third quarter of 2007consisted of recognition of $500,000 related to the amortized upfront paymentreceived in 2006 and development service revenue from the Sanofi Pasteurcollaboration, grant revenue from NIH of $900,000 and grant revenue from theWellcome Trust of $400,000.Contracts and grant revenues for the third quarter of 2006consisted of the amortized upfront payment received in 2006 and developmentservice revenue from the Sanofi Pasteur collaboration. For the first ninemonths of 2007, contracts and grant revenues decreased by $1.1 million to $3.5million from $4.6 million for the first nine months of 2006.Contracts and grant revenues for the first nine months of2007 consisted of $2.2 million for recognition of the upfront payment receivedin 2006 and development service revenue from the Sanofi Pasteur collaboration,grant revenue from NIH of $900,000 and grant revenue from the Wellcome Trust of$400,000.Contracts and grant revenues for the first nine months of2006 consisted of $3.2 million from the recognition of the upfront payment anddevelopment service revenues from the Sanofi Pasteur collaboration and $1.5million in grant revenue from the Wellcome Trust.We'll move on to the cost of product sales and grossmargins. Cost of product sales increased by $4.1 million to $11.4 million forthe third quarter of 2007 from $7.3 million for the third quarter of 2006. Forthe first nine months of 2007, cost of product sales increased by $11.2 millionto $22.8 million, up from $11.6 million for the first nine months of 2006.The increase for both the third quarter and the nine-monthperiod of 2007 was primarily attributable to the increase in the number ofBioThrax doses delivered, coupled with increased costs associated with ourannual production shutdown, the related impact on production yield and thewrite-off of waste during the period.In addition to the normal variation in cost of production,the discounted price, which again was a discount that was a part of thenegotiated contract and applies only to those doses sold in the third quarteras well as a portion of the remaining doses to be sold to HHS by year-end.So the discounted price for product delivered in thirdquarter negatively impacted the gross margin for the third quarter. This impactwill carry into the fourth quarter, but not beyond that.Looking at research and development expense, as we discussedin second quarter, we began an increase in the level of investment in R&Dback in third quarter of 2006. The R&D investment for the third quarter of2007 is actually less than the third quarter of 2006 and the increase inspending for the first nine months of 2007 is a reflection of that increasedlevel of investment overall in R&D as we continue to advance our productsin their pipeline.When comparing third quarter of 2007 to third quarter 2006,research and development expenses decreased by $700,000 to $12.8 million from$13.5 million in 2006. For the first nine moths of 2007, research anddevelopment expenses increased by $12.5 million to $41.7 million, up from $29.2million for the first nine months of 2006.In evaluating the R&D spending for both the thirdquarter and the first nine months of 2007, the primary driver was the effort toadvance all of our product candidates as we completed various studies and begansubsequent studies and trials.As we begin to enter later stage trials for our variouscandidates, we may need to again increase R&D spending. Consistent with ourstrategy, we would manage these costs through non-dilutive partnerships withindustry, government and non-government entities.Moving on to SG&A expense, as we have highlighted inprior quarters, our investment in G&A began to ramp up also in Q3 2006 inpreparation for our IPO. Recently, the rate of increase in G&A spending hasbegun to slow as we have established the infrastructure to manage our Company.For the third quarter of 2007, selling, general andadministrative expenses increased by $3.8 million to $15 million, up from $11.2million for the third quarter of 2006.The increase in G&A spending was primarily attributableto an increase in general and administrative expenses for the addition ofpersonnel related to our transition to being a publicly traded company andincreased legal and other professional services for our headquartersorganization.For the first nine months of 2007, selling, general andadministrative expenses increased by $8.5 million to $38.9 million, up from$30.4 million for the first nine months of 2006. The increase in spending forthe nine-month period was driven by the same factors as for the third quarter.Turning to net income, net loss, we reported net income of$2.8 million for the third quarter 2007, or $0.10 per share, as compared to netincome of $4.4 million, or $0.19 per share, in the third quarter of 2006. Thedecrease in net income was driven primarily by a $3.1 million increase inoperating expenses.For the nine months of 2007, we reported a net loss of $4.8million, or $0.17 per share, as compared to a net loss of $3.3 million, or$0.15 per share, for the first nine months of 2006. The increase in net losswas driven by an increase in revenues of $27 million, which was offset by anincrease in cost of goods sold and operating expenses.Looking at the balance sheet, as Fuad mentioned, cash andcash equivalents at September 30th was $24.3 million, with an additional $42million in accounts receivable generated by our product sales at the end ofSeptember to HHS under the new contract.During the nine months, the net decrease in cash and cashequivalents of $52 million resulted primarily from operating expenses,including research and development, capital expenditures, the payment of 2006income taxes and the repayment of an existing revolving line of credit.This was offset by collection of accounts receivable relatedprimarily to amounts due from HHS and the DoD that were billed in December of2006 and received in January 2007.Additionally, in the third quarter we received approximately$15 million in net proceeds related to an increased loan agreement with HSBCthat was completed at the end of the second quarter.Moving on to our guidance for 2007, as Fuad indicated in hisremarks, we are increasing our financial guidance for 2007 revenue.Specifically, we anticipate growth in total revenues of 16% to 18% basedprincipally on delivering doses according to the schedule in the HHS contract.With respect to net income, we continue to expect to achievepositive net earnings for 2007. This as well is predicated on deliveriesaccording to schedule as well as continued management of operating expenses.Please note that any statements about the company'sprospects or future expectations are forward-looking statements. As Bob statedearlier, forward-looking statements involve substantial risks anduncertainties, and actual results may differ materially from expectations.Please refer to our press release on our financial resultsissued earlier today and to our filings with the SEC for more information onthe risks and uncertainties that could cause actual results to differ.That concludes my prepared comments, and I will now turn thecall back to the operator so we can begin the question-and-answer portion ofthe call. Operator, please proceed.Question-and-Answer SessionOperator(Operator Instructions) And our first question comes fromthe line of Gene Mack with HSBC Securities. Please proceed.Gene Mack - HSBC SecuritiesThanks. Fuad, I wonder if you could just give a little moredetail on. I mean I guess if I do the back calculation, I think I come up withabout -- again took consideration of discount something like 2.5 million dosesdelivered.Can you just give us an idea of how many doses weredelivered to HHS, how many you'll deliver by year-end and what's left ininventory right now?Fuad El-HibriWell, the delivery schedule is one thing that we do notdisclose. All I can say is that we are on track with delivering, I would say, atleast 6 million doses by year-end.Gene Mack - HSBC SecuritiesOkay. And can you just comment on how much is in inventoryright now? Fuad El-HibriThat's also something that I'm sorry I can't comment on.Gene Mack - HSBC SecuritiesOkay. Can you give us a little bit more detail on what theoperational requirement is for DoD on sort of an annual basis or what ballparknumber of doses that might amount to?Fuad El-HibriAgain, when you look at the historic requirements over thelast few years, you'll see that it has been somewhere between 1.5 million to 2million doses a year.As recent as some discussions we had very recently, DoDconfirmed that that requirement stands. So I can say with some confidence that1.5 million to 2 million doses is not an unreasonable expectation going forwardannually.Gene Mack - HSBC SecuritiesIs it safe to say that the mandatory injections haven'tnecessarily raised that requirement just yet?Fuad El-HibriWell, there are lot of moving pieces. One is the nature ofthe immunization program, whether it is mandatory or voluntary. Then also inwhat arenas are we actively engaged. And then also the rotation strategy ofmilitary personnel in and out of these theaters.So, there's really a lot of variables that affect the exactrequirement. But if you look back and from what we've heard looking forward, Ibelieve that 1.5 million to 2 million is a very reasonable range. Gene Mack - HSBC SecuritiesOkay. I've got more questions, but I'll jump back in thequeue.Fuad El-HibriThank you, Gene.OperatorOur next question comes from the line of Richard Smith withJPMorgan. Please proceed. Richard Smith - JPMorganYes, good morning, everyone. Just a quick question on AIG.Could you just give us a sense, and apologies if you mentioned this in yourcomments, with respect to timing of a potential contract from HHS? I think yousaid previously in 2009. Is this something that could happen in 2008, and whatneeds to be done to get it?Fuad El-HibriThat's a very good question because with the introduction ofBARDA, which helps the developers through the advanced development stage ofproduct development, actually could mean that for the next year or two years wecontinue working on funding with BARDA.The procurement would, could come really at any time, but Iwould estimate that with the introduction of BARDA that that typically happenswhen you're reasonably close to having a licensable product.And as we said earlier, we expect that our product will belicensable by '09 and certainly in '08, an event I would not exclude fromhappening. So it's really something that could happen anytime late '08, early'09.Richard Smith - JPMorganSo I mean if we look at what Cangene has with respect todata when they got their contract, what did they have in hand when theyreceived it from the HHS?Fuad El-HibriWell, we can't really comment other than that we believe itwas relatively early stage. And I think the government had, since the BARDAintroduction and since some lessons that HHS has learned, I think now they waitfor product to become more mature before they actually issue a procurementcontract.Because as we stated earlier that under a procurementcontract, at least prior to the BARDA authority, there typically weren't anyadvance payments made. And the developer had to basically develop at risk untilsuch time as they could deliver licensable product into the Strategic NationalStockpile.So I think that the paradigm has somewhat changed to whereBARDA now enters into a development contract with developers, and once aproduct is developed to a point where it's late stage, I think then thatproduct becomes interesting for a procurement by HHS.Richard Smith - JPMorganOkay. Thank you very much.OperatorOur next question comes from the line of Eric Schmidt withCowen. Please proceed.Eric Schmidt - CowenHi, good morning. Fuad, what drives your confidence that theDoD is still interested in completing a procurement contract and that this GAOreport won't lead to maybe better cooperation and a shifting of BioThrax fromone agency to the other?Fuad El-HibriThanks, Eric. I do agree that it may shift the procurementof additional doses from DoD to HHS and that's exactly, I believe, as Iunderstand it, the GAO report suggests and the Presidential Directive suggests.But that doesn't really speak to the requirements of DoD. Idon't think that the GAO nor the Presidential Directive address at all therequirements. I think the requirements remain, and it's a question of whetherit is going to be in a separate contract with us and DoD or that it may beprocured through HHS.So we do expect once the workings between the two governmentagencies have been sorted out, that it will result in either an increase in HHSprocurement from us or a direct contract between DoD and us.Eric Schmidt - CowenThe total number of doses between the two agencies you expectto decline modestly versus your previous expectation three months ago?Fuad El-HibriNo. I would still believe that the total requirements forDoD remain and that there's a good possibility that HHS will make thecommensurate adjustment to the contract.Eric Schmidt - CowenI guess, I'm a little bit confused. Maybe we need to stepback a bit. But I had read that the GAO contract is suggesting that there'ssome wastage and that if the two agencies were in better communication, productfrom HHS that was going to go back could be shipped to DoD with a commensuratedecrease in the overall requirements for the government. Is that incorrect?Fuad El-HibriIt's a good question. It would require a lot of logisticalcoordination to manage effectively doses that are getting close to expiring. Sothat's, again, I can't sit here other than to tell you that the DoD requirementstands and that I believe that the HHS contract would be adjusted accordingly.Eric Schmidt - CowenOkay.Fuad El-HibriAnd how logistically maybe this gives an opportunity for HHSto maintain more dated product in the stockpile.Eric Schmidt - CowenOkay. And is the DoD, RFP still out there?Fuad El-HibriIt's still out there, yes. It wasn't formally withdrawn. SoI think that the GAO report and the Presidential Directive I think may havealso taken DoD a bit by surprise.So they're still evaluating the consequences, and theyconfirm to us that the requirement stands. How they're going to procure isgoing to be discussed with HHS.Eric Schmidt - CowenOkay. And last question on this issue, do you have anyvisibility into where the DoD's inventory is in order that they have, ineffect, seemed to continue to satisfy this requirement?Fuad El-HibriWell, we neither have a visibility into it nor do would webe able to disclose it. So I can't help you with that.Eric Schmidt - CowenOkay. And then a question for Don on the SG&A run rate.Is the $15 million in Q2 an estimate to base off going forward, or were theresome sort of one-time legal costs and others that bumped that up sort ofartificially?Don ElseyI'm assuming you meant to say Q3?Eric Schmidt - CowenYes. Sorry.Don ElseyOkay. There was some additional activity in Q3 that takes itsomewhat higher than our run rate. But if you take a look over the past coupleof quarters and average those out, I think you'll see pretty much a run ratethat you can develop from there.Eric Schmidt - CowenOkay. And last question on AIG, have you started humantrials yet?Fuad El-HibriNo, we haven't. We're preparing for it.Eric Schmidt - CowenWill that be a Q4 event or an early '08 event?Fuad El-HibriWhat we can say right now is that it's going to be an '08event.Eric Schmidt - CowenOkay. Thank you.Operator(Operator Instructions) Our next question is a follow-upfrom the line of Gene Mack with HSBC Securities. Please proceed.Gene Mack - HSBC SecuritiesThanks for taking a follow-up. Wondering if you could just,Fuad, I apologize if you mentioned this already but could you just give us alittle more detail on the typhoid vaccine and timelines there in terms ofmoving forward?Fuad El-HibriYes, what I mentioned earlier is that we are stillfinalizing the review of the data. We've given some preliminary data to youalready. We expect that to be completed by the end of this year.And then in terms of milestones going forward, we anticipatea study in the U.S. that would where we would use the scaled-up material. Sowe've completed our process development and process scale-up.We would use the scaled-up material in a small study here inthe U.S. in '08. And we would also expect to commence a small study leading upto a Phase III study in India in children two to five. So those are the twoevents, the two commencements of trials that we expect in '08.Gene Mack - HSBC SecuritiesOkay. And that could be anytime in 2008?Fuad El-HibriSorry?Gene Mack - HSBC SecuritiesAnd that could be anytime during 2008?Fuad El-HibriYes. And then in 2009, we expect to commence thefull-fledged Phase III study.Gene Mack - HSBC SecuritiesOkay. And question on R&D, Don, and I apologize if youwent through this as well. It looks like the trend continued to go down overthe last three quarters. Just wondering where that ends up maybe for this yearand what you're thinking in terms of next year as far as directionally where itgoes? Thanks.Don ElseyWell, we're not in a position to provide guidance at thispoint in 2008. I will tell you that as you step back to third quarter of 2006,as I referenced, we basically took a step up in the investment level inR&D.And then as you go quarter-by-quarter, as various trialscomplete or commence, and as you probably know, we subcontract out a fairamount of development activity, you're going to have contracts that come tofruition and contracts that are completed, and you're going to see somevariation in the run rate.But that the investment levels that you've seen over thepast couple of quarters again, if you take a look at those, you're going to geta fairly good run rate from the steady state perspective that you could use.As I mentioned in my comments and as Fuad just indicated, aswe approach 2009 and beyond and we get into some of the Phase III trials, youcould expect reasonably that the investment in R&D will increase again, andwe'll mange that internally and hopefully with partners of a non-dilutivenature.Gene Mack - HSBC SecuritiesOkay. And just one final question. You mentioned that therewas a meaningful sale to another government agency, another foreign government,allied government. And I'm just wondering; if you care to maybe give a littlemore detail on who that is?Was it somebody that you've dealt with in the past as far asordering, or is this a new customer?Fuad El-HibriWhat I can disclose is that it was approximately $2 million.What I can't disclose by agreement with that government is I can't tell youwhich government, and I can't tell you how many doses. But I can tell you itwas $2 million, and it was in line with our standard international sales prices.Gene Mack - HSBC SecuritiesWas it somebody you've dealt with in the past or ??Fuad El-HibriI'm sorry, I can't answer that.Gene Mack - HSBC SecuritiesOkay, thanks.Fuad El-HibriThank you.OperatorOur next question comes from the line of Daniel Mallin withWBB Securities. Please proceed.Daniel Mallin - WBB SecuritiesHi, guys. Thanks, and congratulations on the quarter. Quickquestion. Was wondering if you can give us an update on the shelf lifeextension program with the FDA? Specifically, what would you expect withrespect to timing?And if you could state if you know whether or not thisextension, once it were to go into effect, would it apply to only futureshipments or would it also to apply to shipments that have already been madeand out in the field?And I'm wondering, if you can give us a little bit of color,I guess the discount that you received on or that was applied to doses thatwere previously shipped with slightly shorter shelf life, I think, you alsohave an increase in the price that's tied to the shelf life extension. If youcan just give a little bit more color on that, I'd appreciate it.Fuad El-HibriYes, absolutely. First of all, we do have till September2010 to get four-year dating approved by FDA. Second, we retroactively, so tospeak, would get a price bump of those doses that we've already delivered, andwe'll get a higher price for those doses to be delivered.Now, the first 5.5 million doses, however, won't beadjusted. So that was because we were building up inventory and because thenegotiations with the government took a little longer than expected, and thosedoses in inventory had a slightly shorter shelf life.So we made a concession and sold those to the government ata reduced price, which won't be recouped. But beyond the 5.5 million doses, theremaining doses, if we get four-year dating approved by FDA, then whether it'sprospectively or retroactively, we would get the higher price.Now, and I'm trying to remember every element of yourquestion. And as to how soon we might get an approval, I can only tell you thatwe are working it very carefully and diligently. The timeline is pretty much inFDA's hands.And we are collaborating, cooperating, and we hope thatwe'll be able to complete that within that timeframe.Daniel Mallin - WBB SecuritiesSo the timeframe is by 2010?Fuad El-HibriYes.Daniel Mallin - WBB SecuritiesSo it's reasonable to think that this is not going to happenanytime within the next year or year and a half? Fuad El-HibriNo. I'm sorry; I didn't mean to communicate that. I'm justsaying we have until that time, until 2010 to do it. We expect it significantlyearlier than that. Daniel Mallin - WBB SecuritiesOkay. And I think I heard you say that the approval could beeither for all future doses or could also apply to doses previously shipped?Fuad El-HibriNo, the approval applies only to future doses. But thepayment also calls back to previous shipments.Daniel Mallin - WBB SecuritiesOkay, that's all I was interested. Thank you very much.Fuad El-HibriThank you.OperatorAt this time there are no questions in queue. I would nowlike to turn the call back over to Robert Burrows for closing remarks.Robert BurrowsThank you. Ladies and gentlemen, that concludes today'scall. We certainly appreciate your collective participation. Please note thattoday's call has been recorded and a replay will be available beginning latertoday through November 16th.Alternatively, there's available a webcast of today's call,an archived version of which will be available later today, accessible throughthe Company's website, again at www.emergentbiosolutions.com and clicking onthe investors tab.Thank you again, and we look forward to speaking to you allin the future. Thank you.OperatorThank you for your participation in today's conference. Thisconcludes your presentation. You may now disconnect. Good day.Copyright policy:All transcripts on thissite are the copyright of Seeking Alpha. However, we view them as an importantresource for bloggers and journalists, and are excited to contribute to thedemocratization of financial information on the Internet. (Until now investorshave had to pay thousands of dollars in subscription fees for transcripts.) Soour reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition thatyou attribute the transcript to Seeking Alpha and either link to the originaltranscript or to www.SeekingAlpha.com.All otheruse is prohibited.THE INFORMATION CONTAINED HERE IS ATEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCEPRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDEAN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, ORINACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. INNO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHERDECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANYTRANSCRIPT. USERS ARE ADVISED TO REVIEWTHE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'SSEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.If you have any additional questionsabout our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!Complete Story »
CenterPoint Energy, Inc. (CNP)Q3 2007 Earnings CallNovember 02, 2007 11:30 am ETExecutivesMarianne Paulsen - Director of Investor RelationsDavid McClanahan - President and Chief Executive OfficerGary Whitlock - Executive Vice President and Chief FinancialOfficerAnalystsDaniele Seitz - Dahlman RoseLasan Johong - RBC Capital MarketsCarl Kirst - Credit SuisseDebra Bromberg - Jefferies &CompanyCharlie Spencer - Morgan StanleyFaisel Khan - CitigroupPatrick Forkin - Tejas SecuritiesSteve Gambuzza - Longbow CapitalDavid Grumhaus - Copia CapitalJosh Silverstein - Highbridge Capital ManagementCharlie Spencer - Morgan StanleyPresentationOperatorGood morning and welcome to CenterPoint Energy's ThirdQuarter 2007 Earnings Conference Call with senior management. During thecompany's prepared remarks, all participants will be in a listen-only mode.There will be a question-and-answer session after Management's remarks(Operator Instructions).I'll now turn the call over to Marianne Paulsen, Director ofInvestor Relations. Miss Paulsen?Marianne PaulsenThank you very much Luan. Good morning everyone. This isMarianne Paulsen, Director of Investor Relations for CenterPoint Energy. Iwould like to welcome you to our third quarter 2007 earnings conference call.Thank you for joining us today.David McClanahan, President and CEO, and Gary Whitlock,Executive Vice President and Chief Financial Officer, will discuss our thirdquarter 2007 results and we'll also provide highlights on other key activities.In addition to Mr. McClanahan and Mr. Whitlock, we have other members ofmanagement with us who may assist in answering questions following preparedremarks.Our earnings press release and Form 10-Q filed earlier todayare posted on our website, which is www.centerpointenergy.com under theinvestor's section. I would like to remind you that any projections orforward-looking statements made during this call are subject to the cautionarystatements on forward-looking information in the company's filings with theSEC.Before Mr. McClanahan begins, I would like to mention that areplay of this call will be available until 6:00 p.m. central time throughFriday, November 9th, 2007. To access the replay, please call 1800-642-1687 or706-645-9291 and enter the conference ID number 19320755. You can also listento an online replay of the call through the website that I just mentioned. Wewill archive the call on CenterPoint Energy's website for at least one year.And with that I will now turn the call over to DavidMcClanahan.David McClanahanThank you, Marianne. Good morning, ladies and gentlemen.Thank you for joining us today and thank you for your interest in CenterPointEnergy. This morning we reported our third quarter earnings. We had a goodquarter.Our performance is consistent with our expectations for thisyear and I'm pleased with our overall results. Net income was $91 million forthe third quarter of 2007 or $0.27 per diluted share. This compares to net incomeof $83 million or $0.26 per diluted share for the same period last year.Operating income was $287 million for the third quarter of2007 compared to $284 million for the same quarter of 2006. The increase inoperating income for the quarter was driven by strong performances in ourinterstate pipeline and field services businesses and continued improvement inour natural gas distribution utility, partially offset by the effect of ourelectric rate settlement that was implemented in October of last year.Houston Electric reported operating income of $166 millionfor the third quarter of 2007, compared to $187 million last year. Excludingincome from the CTC of $11 million this year and $14 million last year, ourcore regulated electric utility earned $155 million, compared to $173 millionfor the same period of 2006.While Houston Electric continues to enjoy the benefits ofstrong customer growth in our service territory, adding more than 47,000customers since last September, the rate settlement implemented last Octoberreduced this quarter's operating income by $25 million.Considering the impact of the rate settlement, HoustonElectric's financial results were as expected and it continued its solidoperational performance. Our Natural Gas Distribution segment reported anoperating loss of $8 million for the quarter compared to a loss of $11 millionfor the same period last year.We continue to experience positive results from ourproductivity improvement efforts and from strong customer growth, adding nearly48,000 customers since September of last year. However, this is a seasonalbusiness and the third quarter is typically the weakest of the year.I'm pleased that we were able to settle the Arkansas ratecase. We worked diligently with the commission staff to find common ground, andthus avoided extended litigation. The final order issued by the commissionapproved a base rate increase of $20 million, which went into affect yesterday.In addition, the commission approved a decoupling mechanismthat will help stabilize revenues and earnings and will be consistent with theArkansas commission's initiative, as well as our desire to promote energyefficiency.Overall, I am very pleased with the progress we continue tomake in pursuing rate strategies and operational efficiencies in order toimprove the financial performance of our Gas LDC businesses. Our competitiveNatural Gas Sales and Services segment reported operating income of $4 millioncompared to $11 million for the third quarter of 2006.The decline is primarily related to a reduction inlocational and seasonal natural gas price differentials, which in turn reducesthe opportunity to create value from optimizing our pipeline and storageassets.In addition, we recorded a $2 million gain frommarked-to-market accounting for derivatives used to lock in margins, comparedto $21 million marked-to-market gain last year. We also recorded a $5 millionwrite-down of natural gas inventory to lower of cost or market in the thirdquarter of this year, compared to $26 million inventory write-down last year.Year-to-date, we have recorded operating income of $56million compared to $44 million last year. Some of the income recorded in theearly part of 2007 related to transactions that originated in the more volatilemarkets in the aftermath of hurricanes Katrina and Rita. Market conditionsduring most of 2007 have been less volatile and more like historical norms.As a result, we have not had as many opportunities for assetoptimization this year. Nevertheless, our base commercial and industrial salesbusiness continues to do well and we remain well positioned to take advantageof future market opportunities, should they arise. Our Interstate Pipelinessegment recorded strong results this quarter, reporting $70 million ofoperating income, compared to $48 million in 2006.The main contributor to this increase was the completion ofthe first two phases of our new 172-mile pipeline between Carthage, Texas andour Perryville hub in northeast Louisiana. Phase I with almost 1 billion cubicfeet per day of capacity went into service on May 1st. Phase II, which addedabout 250 million cubic feet per day went into service on August 1st.Ultimately, we plan to expand this project to a total of 1.5billion cubic feet per day by adding additional compression and increasingoperating pressure. All approvals have been received and we expect the thirdphase to be in service in the first quarter of 2008.A second major project, the Southeast Supply Header, orSESH, a joint venture with Spectra, continues to make progress. A solid groupof shippers has subscribed to approximately 95% of the 1 Bcf per day capacity.We received FERC authorization to build the new pipeline in September andconstruction is underway. We anticipate that it will be in service in themiddle of next year.Earlier this year, we executed contracts with SouthwesternElectric Power, a subsidiary of AEP, to construct pipeline and compressionfacilities to serve a new power plant with up to 480 megawatts of capacity. Ourfacilities will be built in two phases. The first phase was quite into servicea few months ago and the second phase is expected to be in service in thesecond quarter of 2009 following FERC approval.Our Field Services segment also reported solid results withoperating income of $26 million compared to $21 million in 2006. The corebusiness continues to benefit from strong drilling activity in the midcontinentarea and higher demand for ancillary services.This year we expect to invest over $100 million in newfacilities. Natural gas development near our existing assets remains veryactive and additional facilities will be needed to get natural gas reserves tomarket. We are very active in pursuing these projects.Overall, we are pleased with the continued growthopportunities and the financial results of this segment and we expect tocontinue to grow this business. Now let me provide you an update on some otherimportant initiatives.Houston Electric continues to actively pursue advancedmetering, using broadband over power line technology and multifunctional smartmeters and ultimately the implementation of an intelligent distribution grid.As part of our assessment of the advanced metering system,we have installed approximately 10,000 smart meters to evaluate any issuesrelating to system-wide implementation. Results so far have been encouragingand we continue to take a very disciplined approach to ensure the technologycan be scaled up efficiently to serve our entire system.An advanced metering rule pertaining to technicalrequirements for installing these type of systems and a valuation model for anadvanced metering surcharge have been approved by the Texas Public UtilityCommission.We expect to file a deployment plan and a request forsurcharge before the end of this year. This plan would entail the rollout ofadvanced meters over a five-year period at a cost of approximately $150 millionper year. Any decision to move forward with this plan will depend on theresults of the limited deployment program and an appropriate PUC order.I know that you are interested in the status of our true-upappeal. Unfortunately, there is nothing new to report. As you recall, we'veappealed decisions by the Texas PUC that, in the aggregate, total $1.3 billion.Interveners have also appealed various aspects of the PUC's final order. Ourtrue-up appeal remains at the Third Court of Appeals, where oral arguments wereheld in January.There's no statutory time frame under which the court has torender a decision on the appeal, but a decision could come at any time. Ofcourse, regardless of the outcome, we expect parties to appeal the decision tothe Texas Supreme Court.In closing, I would like to remind you of the $0.17 pershare quarterly dividend declared by our Board of Directors on October 25th.And we believe our dividend actions continue to demonstrate a strong commitmentto our shareholders and the confidence the Board of Directors has in ourability to deliver sustainable earnings and cash flow. Now I'll turn the callover to Gary.Gary WhitlockThank you, David, and good morning to everyone. I would liketo discuss a few items with you this morning. Over the last several months, wehave taken a number of steps to continue to strengthen our liquidity.As I mentioned during our last call, in June we amended ourthree bank credit facilities, which now total $2.45 billion and extended theirmaturities to 2012. Over the last four years, we have steadily andsignificantly strengthened our liquidity and enhanced our financial flexibilitythrough the improvement in size, price, and tenor of our working capitalfacilities.Last week we closed on the sale of $500 million of CERCnotes split between two series, $250 million of 10-year notes bearing a couponof 6.125% and $250 million of 30-year notes having a coupon of 6.625%.Proceedsfrom these notes will be used to retire $300 million of CERC debt that matureson February 1, 2008, and to pay down short-term debt at CERC.Even though the $300 million of CERC debt is not due tomature for about three months, we wanted to lock in the rate at today'srelatively attractive rates, particularly given the volatility in the debtcapital markets that we have seen this year.We believe this step to be consistent with our conservativefinancial policy. We are also working to securitize the balance of our true-upcosts that we are currently recovering through a competition transition chargeor CTC. As we have previously discussed, last spring the Texas legislatureamended the law relating to securitization. The change permits us to securitizethe balance of our CTC.In September the PUC issued a financing order, authorizingus to issue approximately $500 million of additional transition bonds. We hopeto be able to complete that process before the end of the year. In addition, ifwe are successful in our true-up appeals, we plan to request a financing orderto securitize any amount, which ultimately results from these appeals. Thisleads to my next topic.Among the issues raised in our true-up appeal is the PUC'sreduction of stranded cost recovery by approximately $146 million for thepresent value of certain deferred tax benefits associated with our formerelectric generation asset.We believe that the PUC based this reduction in large parton proposed normalization regulations issued by the Internal Revenue Service inMarch of 2003, which were withdrawn after the PUC issued its true-up order.In August of this year, we received a private letter rulingin which the IRS concluded that such reductions would cause normalizationviolations. We do not believe the PUC intended that its action in the true-upproceedings should have the consequence of depriving us or our customers of thedeferred tax benefits. In September, the PUC requested the court to remand thenormalization issue in light of the position taken by the IRS in the PLR.We cannot predict whether the court will remand the issue tothe PUC or the ultimate outcome of this matter, but we hope that in light ofthe private letter ruling, all parties will see the benefit of permitting us torecover the disallowed amount plus interest.Let me also discuss ourfinancial strategy as we continue tofocus on improving and growing the profitability of our businesses. Weincreased our dividends in each of the past two years while funding asignificant number of excellent growth opportunities, as well as our ongoingcapital requirements.We accomplished this largely through internally generatedcash flow and true-up proceeds with a minimal increase in debt. Future growthopportunities will be funded through internally generated cash flow anyadditional true-up proceeds and the optimum mix of debt and equity.We remain committed to taking steps necessary to maintainand enhance the credit metrics and credit ratings of both the parent companyand our utility subsidiaries.Finally, I would like to discuss our earnings guidance. Thismorning in our earnings release, we announced that we expect our 2007 earningsto be at the high end of our previously provided guidance range of $1.02 to$1.12 per diluted share.In making our earnings estimate for the year, we haveassumed normal weather for the balance of the year and we have made certaineconomic and operational assumptions, including the timing and outcome ofvarious regulatory and legal proceedings.Now let me thank you for your interest in the Company andI'll turn the call back to Marianne.Marianne PaulsenThank you very much, Gary. With that we'd now like to takeyour questions. And in the interest of time, I would ask you to please limityourselves to one question and a follow-up. So, LuAnn, would you please givethe instructions on how to ask a question?Question-and-Answer SessionOperator(Operator Instructions) Your first question comes fromDaniele Seitz with Dahlman Rose.Daniele Seitz - Dahlman RoseHi. I just was wondering the advance metering, have you hasalready been in principal allowed by the commission and when do you anticipatethis to go into place?David McClanahanDaniele, we'll be filing, like I said, our plan in December.They have 150 days to make a decision, so we would anticipate a decision byApril or May of next year. And assuming that we get an appropriate order out ofthe commission that gives us some assurances we're going to get full recoveryof our investment here, because it's a large investment, we'd start deployingmeters in the second half of next year and really get in probably the realswing of things in early 2009.Daniele Seitz - Dahlman RoseAnd will you ask for some sort of rider or is it going to bethe kind of thing that you will have to file for on a regular basis?David McClanahanNo. The PUC has provided a special tariff. It's an advancedmetering tariff, which we would start immediately employing. The way we havebeen and expect to propose it is that we would apply this tariff to allcustomers from the get-go, so we would have some pre-funding, so to speak, aswe went through this, but we don't have to go in and ask for a rate case,change our rates, this will be a separate tariff that is a rider onto ourexisting tariff.Daniele Seitz - Dahlman RoseGreat. Thank you.OperatorYour next question comes from Lasan Johong with RBC CapitalMarkets.Lasan Johong - RBC Capital MarketsGood morning. Nice quarter. I wanted to ask you kind of moreof a strategic question, pulling back from some of the micro details. Longerterm, say five years out, how do you project earnings growth rate to look likefor CenterPoint?David McClanahanWell, Lasan, I guess it depends on a number of things, butcertainly every aspect of our business we intend to grow. We've had somewonderful opportunities in our pipeline business, in our field servicesbusinesses and, to be very frank, we're in a very good spot right now.Strategically, the areas in the United States where there'slots of drilling, it's right in our footprint. That gas has to be gathered,some of it has to be processed and certainly it's ultimately going to have toget to market.So, I think it creates a lot of opportunities there.Clearly, storage and other opportunities of that sort are clearly on our mindas well. So we expect our pipeline and field services business to continue togrow.Now, our regulated utility business, as you know, basicallygrows as fast as our service territory and our investments to serve these newcustomers, but we serve very nice, fast-growing areas of the country,Minneapolis, Houston, and we've had a growth rate of better than 2% there forthe last ten years.So we don't expect any slowdown. There'll be dips along theway. The softness that other areas of the country are seeing in housing, we seea little of that in Houston, not a lot, to be very honest. So we expect thosepieces of our business will grow slower, but we still believe there's going tobe nice, rate-based growth, which is going to provide for growth in earningsthere as well.Lasan Johong - RBC Capital MarketsThat's great. One quick follow-up question, to Daniele'squestion, any chance that you guys might do a metering question in Minnegasco?David McClanahanThis is an electric initiative, so the gas side, though,will be implemented in Houston, because it will piggyback on the electric meterand really we already have automated metering deployed in Minnegasco to behonest. We have Hertz on every meter and so we don't send out meter readers aswe do here in Houston.So, but if Xcel or others in Minneapolis and Minnesota woulddeploy something like this, we would look to see if there would be a better wayto read the gas meters. But we've already done a lot of that in Minnesota, Iguess what I'm saying.Lasan Johong - RBC Capital MarketsThank you.OperatorYour next question comes from Carl Kirst with Credit Suisse.Carl Kirst - Credit SuisseGood morning, everybody.David McClanahanGood morning.Carl Kirst - Credit SuisseNice quarter as well. Could you refresh us on where we are,just looking at the legacy true-up costs, the stranded costs? If we take the1.3 and the $146 million that's included in that, what are those numbersinclusive of interest expense right now?David McClanahanI can tell you what the $146 million, which is thenormalization issue that Gary spoke of is probably with interest $250 milliontoday. Maybe a little bit more than that. I honestly haven't run the numbers onthe $1.3 billion. Obviously, it's going to be a number a lot bigger than that.Have we run any numbers on the 650 that, let us, thedistrict court overturned the commission on two issues that amounted to about$650 million and I think with interest today, that would be on the order of --it's north of $1 billion.Gary WhitlockNorth of $1 billion.David McClanahanYeah.Carl Kirst - Credit SuisseNorth of $1 billion from the lower court's decision?David McClanahanCorrect.Carl Kirst - Credit SuisseOkay. That's very helpful. And then just one other questionon the securitization, hopefully that come by year-end. Has it been sort offormally declared what use of proceeds will be for that?David McClanahanWell, we have to, under the law, we have to either pay downdebt or pay down equity and what we'd expect to do would be to dividend thatmoney out of Houston Electric to the parent company.Carl Kirst - Credit SuisseRight. But from there?David McClanahanWe have lots of -- Gary, you might want to speak to, thisbut we have lots of growth projects on the table and they'd go towards thesegrowth projects.Gary WhitlockCarl, the way you look at it, if you look at our debt thisyear, we started the year with about 6.75 of corporate debt. It's about 7.4now. In other words, $657 million up. This would effectively go to pay downdebt.The ultimate use, the course as David described, has been tofund our capital projects. So, it effectively will pay down the debt andcontinue to fund the capital projects.Carl Kirst - Credit SuisseGreat. Thanks, guys.OperatorYour next question comes from Debra Bromberg with Jefferiesand Company.Debra Bromberg - Jefferies &CompanyHi. Good morning.David McClanahanGood morning.Debra Bromberg - Jefferies &CompanyWhat was the amount of the settlement of the state taxissues at Pipelines? And also, could you provide a little more color aroundresidential electric sales in the quarter?David McClanahanThe settlement was $4 million around the taxes, Debra.Weather was basically normal for the quarter. We had a real mild July andAugust and we caught up in September. We continue to see a little bit ofweakness in usage. We don't really know if our models can't determine how muchis weather and how much is usage, but we're watching that pretty closely.Electric rates have continued to stay pretty high in Texasand we think there's probably some conservation impact there. It's not a hugeamount. And certainly the growth that we're seeing more than outstrips anyweather usage decline, but I think it's worth watching to make sure it's not abig pattern here.Debra Bromberg - Jefferies &CompanyThank you.OperatorYour next question comes from Charlie Spencer with MorganStanley.Charlie Spencer - Morgan StanleyGood quarter, guys. In Texas, the Houston zone is becomingone of the more congested areas and I was wondering if that's going to upfurther transmission CapEx opportunities for you, potentially going up(inaudible) connecting towards the north?David McClanahanIt is. North into Houston is congested and I think ERCOT islooking at some new transmission that would need to be built in order toalleviate that congestion. And yeah, I think it would open up someopportunities for Houston Electric to build it. It would be in part of the areathat we typically build transmission.So, we work with ERCOT very closely on that and we put, I'dexpect we're going to put some dollars in our future capital budgets to reflectsome of that in the next three to four years, if not sooner.Charlie Spencer - Morgan StanleyDo you have any idea just the general dollar amount?Obviously, it's early days at this point, but just any sort of general range asto how much money that might take to help alleviate some of that congestion.David McClanahanWell, last year, we had $400 million worth of transmissionin our five-year capital budget, and that was without any of these largecongestions being resolved. I would imagine it's going to be north of 4,probably north of $500 million. We haven't got all those numbers, but they'reincreasing just because of this congestion issue you noted.Charlie Spencer - Morgan StanleyThank you.OperatorYour next question comes from Faisel Khan with Citigroup.Faisel Khan - CitigroupGood afternoon.David McClanahanGood afternoon.Faisel Khan - CitigroupWith the recent sale of TXU to private holders, there's apossibility that a piece of their delivery business could come up for sale. Howstrategic are those assets? Would they make sense to operate those assetstogether with yours or how much you guys thinking about something like apotential opportunity like that?David McClanahanWell, Faisel, I think we've said in the past, we'reinterested in T&D businesses, we like the business, we would like to ownmore of the business. We clearly believe there would be a fair amount ofsynergies between our business and a business like Encore.So, and if in fact that business goes on the market, we'dabsolutely take a look at it. But we do think there would be a lot of synergiesin operating them together. There's no question about it in our mind. Wehaven't done any detailed work on that, but just general business knowledge, webelieve it would be pretty strong.Faisel Khan - CitigroupOkay. And on the appeals case, is there any precedence for acase taking this long to be decided? Have cases in the past taken this long tobe decided?David McClanahanLet me ask Scott Rozzell to address that.Faisel Khan - CitigroupThank you.Scott RozzellFaisel, yes, it's not uncommon for appeals to last thislong. In fact, we have another appeal before that same court that's actuallybeen pending for an additional two months longer than this. And there are othercases on the docket that are longer.I would say, as we've said before, that a good benchmark forevery level of the appellate process is about a year from filing todisposition. And this one is getting closer to two years now. So I think thisis a much longer time than is normal, but it's certainly not longer than wehave seen in the past for complicated matters.Faisel Khan - CitigroupOkay, great. Thanks for the time.OperatorYour next question comes from Patrick Forkin with TejasSecurities.Patrick Forkin - Tejas SecuritiesGood morning. Just wanted to clarify, the total investmentopportunity for the smart metering project is $750 million over five years?David McClanahanThat would be $750 is probably a little over five years. Itwould be five or a little over five years. And that's just the advancedmetering on the electric side. We do have some additional dollars that we'dspend for the intelligent grid.Those aren't going to be spent nearly as quick, but there'sprobably another $150 million or so that over a seven, ten-year period thatwould be spent there. But metering is about $750 over a little over five yearsbased on the plan we're going to propose.Now the PUC is going to weigh in on this too, I'm sure, butI think they're going to like our plan, because I think we've got a good, solidplan. And I expect we're going to be the first one in the state to file it.Patrick Forkin - Tejas SecuritiesOkay. And then assuming you do make that filing in December,does that indicate that you're happy with the technology that you've tested in,and subject to approval from your commission, that you're going to moveforward?David McClanahanYeah. We've been testing lots of pieces of this. The Itronmeter, the OpenWay meter. We've been testing our BPL technology and we've alsobeen testing a lot of prototype models where you have to gather all themetering data and give reps access to it.All along the way, we've been very pleased with how thistechnology has come together. We haven't identified any deal breakers,obviously. They've been making improvements as we went along, but at this pointin time, we're pretty pleased with what we've seen so far. We think we've gone-- we're pretty much to the end of that pilot phase.Patrick Forkin - Tejas SecuritiesOkay, very good. Thank you.OperatorYour next question comes from Steve Gambuzza with LongbowCapital.Steve Gambuzza - Longbow CapitalGood afternoon.David McClanahanHello.Steve Gambuzza - Longbow CapitalHi. I'm sorry if you covered this already, but is there anyexpected timing on the appellate court decision?David McClanahanYou know, there's really not. Scott Rozzell, our GeneralCounsel addressed this. We really expected it to have happened by now, but itcan be anytime. But we just haven't heard anything yet.Steve Gambuzza - Longbow CapitalOkay. So really there's no kind of when you look at thecalendar of the court, are there any particular windows where you would expectthere not to be a decision? So for example, if you were not to get a decisionby December 15th, would that automatically push it through to past the NewYear, or any color on that in terms of the court calendar?Scott RozzellWell, there's nothing this is Scott Rozzell, there isnothing really that would indicate that the court doesn't issue decisions atany particular point in time. I think just as a matter of human experience, weknow that things slow down during the holidays, but that's about as much as Icould offer on that. I think this is, as David mentioned, a decision that couldcome at any time.Steve Gambuzza, Longbow CapitalSo the process has completely run its course and the nextstep is the court will issue its decision, which it could happen tomorrow or itcould happen three months from now?Scott RozzellThat's right. There's no statutory deadline that the courthas to abide by and they will issue this decision when they've completed theirdeliberations and the process of drafting and having that opinion reviewed.Steve Gambuzza - Longbow CapitalOkay. And then finally, the 750 over five years for the AMI,that's just for the meters and then $150 million for additional smartgridtechnology over a longer period; is that correct?David McClanahanYeah. The 750 obviously is much more than meters. There'slots of BPL technology. There's lots of computer programs and architecture thatgoes along with that. But that is the 750 is the way we've couched this wholeadvanced metering project, just a lot of components of it.The additional amount is unrelated to the metering. It'sjust how you manage the grid, putting sensors on the grid, being able tooperate the grid digitally, monitoring performance of the grid and that wouldroll out over a fairly lengthy time. But at this stage, we're thinking $150million or so is an appropriate number to be thinking about.Steve Gambuzza - Longbow CapitalGreat. Thank you very much.OperatorYour next question comes from David Grumhaus with CopiaCapital.David Grumhaus - Copia CapitalGood morning, guys.David McClanahanGood morning.David Grumhaus - Copia CapitalTwo quick questions for you. One, on the court case, thenormalization with the Texas attorney general coming back to the court, is thatslowing the process at all, or does that not have any affect on the renderingof the decision?Scott RozzellI don't think that that will this is Scott Rozzell again. Idon't believe that that will have an impact on the pace of the overall appeal.What the attorney general did was to ask the court to remand the normalizationissue back to the commission in light of this private letter ruling that we'vereceived.And the commission could choose to do that remand as a partof its I'm sorry, the court could choose to do that remand as a part of itsdecision on the overall appeal, or it could choose to sever that issue andremand it earlier. But either way, I don't think it slows down the resolutionof the remaining issues.David Grumhaus - Copia CapitalOkay, that's helpful. Then field services, another solidquarter, are you still seeing good growth opportunities there is? I know youlike your positioning -- is your view you can continue just to keep growing thatbusiness at the rate for '08 you've been able to do so in the last couple ofyears?David McClanahanWe continue to see a tremendous amount of activity. We'llconnect 400 wells again this year. We have each of the last four years,including this one. That's from an historical level of 220 a year, soactivity's way up, but we're seeing a lot of activity around the shale playswhich are right near.Where we have facilities and some other new developmentareas. So we really think that we're in the right spot when it comes to fieldservices and there's going to be lots of opportunities. We clearly have tocapture them and we so it's up to us to get out there and do that, but we'vegot a lot in front of us that we can work with.David Grumhaus - Copia CapitalOkay that's helpful. Look forward to seeing you at the EI.Take care.David McClanahanGreat.OperatorYour next question comes from Carl Kirst with Credit Suisse.Carl Kirst - Credit SuisseSorry, guys. Just two quick follow-ups. The first is aactually, want to clarify the smart meter spend one more time. The $750 was alittle bit higher than we were expecting. Is that just electric or does thatinclude the $100 million of gas?David McClanahanNo, that's just electric.Carl Kirst - Credit SuisseSo, I don't know if you can say before you actually file,but have you decided against, then, spending on the gas or is that going to beaddressed as a separate issue?David McClanahanNo. We wouldn't file that in the electric case, but to bevery honest, we jointly read meters in Houston now, gas and electric, and so wewould expect that it's just a follow-on on this technology and I think anywherefrom $80 million to $90 million, $100 million over a five or six-year period onthe gas side is what we'd see there. But we would expect to deploy that at thesame time.Carl Kirst - Credit SuisseOkay.David McClanahanBut it wouldn't about be part of this of the proceeding atthe commission.Carl Kirst - Credit SuisseVery helpful. And then just lastly on the gas side,Minnesota, as far as the potential for rate relief next year, has there beenany update in thinking or magnitude?David McClanahanNo, not at this stage. They passed a law last earlier thisyear, I guess, that what I wanted to do some piloting on decoupling. Certainly,we're interested in decoupling, especially in Minnesota and we're trying todecide now exactly how to manage that and what that means to us.And whether it means we have to go in for a rate case to doit or we can do it some other way. But we're not ready to announce anything,because it's still under consideration. Carl Kirst - Credit SuisseFair enough. Thanks, guys.OperatorYour next question comes from Daniele Seitz with DahlmanRose. Daniele Seitz - Dahlman RoseJust I was wondering if there were any other projects alongthe pipeline area aside from the next one that you have been talking about fora while?David McClanahanWe continue to look at a number of projects there, Daniele,but we have nothing to announce. There's clearly a lot of gas in the shalereserves and in the mid-continent area that are going to have to get to market.And our assessment is you're going to need some morepipelines to do it, but we haven't got anything to announce there.Daniele Seitz - Dahlman RoseOkay, great. And as far as the rate-making regardingtransmission, is it are there incentive returns, etcetera and riders forspecific projects, or is it just going into a base like any other incrementalcapital expansion?David McClanahanWell, in Texas, we have something called TCOST, transmissioncost of service where you can get an update to your tariff for transmissionwithout going in for a full rate case and then you reconcile it when you do goin for a rate case.And we can go in 2008 as part of our overall ratesettlement. We agreed to not go in and ask for an increase in our transmissionrates before then, but we might very well, we've spent a fair amount of moneyand I think we're looking at whether or not we need to go in toward the end ofnext year for a TCOST revision.Daniele Seitz - Dahlman RoseOkay. Thank you.OperatorYour next question comes from Josh Silverstein withHighbridge.Josh Silverstein - Highbridge CapitalManagementHey, guys. Just had a similar question to Daniele. Was justwondering given the increase in cost for services, steel, transmission lines,given that you guys are operating under a rate freeze right now, would thatkind of pressure earnings growth there until you come out of the rate freeze,or can you actually go in or are there savings that you guys are finding on theOEM side right now?David McClanahanWe can't go in and file until '010. So we are under afreeze. We do have a very attractive service territory that continues to growat a very nice clip and clearly the growth there can offset expense increases.Just like any other company, we continue to see some laborincreases, where we have a lot of and the biggest part of our cost is labor,other than capital. But we constantly are looking for ways to be moreefficient.We know we're in a rate freeze. We know we have to be moreefficient, and we have folks looking at that every day. And if you look at ourtrack record over the last three, four years, I think we've been verysuccessful in being able to hold down cost and find efficiencies and wecontinue to look for those.Josh Silverstein - Highbridge CapitalManagementGot it. Great. Thanks.OperatorYour next question comes from Lasan Johong with RBC CapitalMarkets.Lasan Johong - RBC Capital MarketsYeah, David, I just wanted to ask you quickly aboutpreparations or how preparations are going for the transition towards nodalmarket within maybe about a year and change?David McClanahanI'm not sure I'm the best one to answer this. It is movingforward. It's a very expensive proposition. ERCOT is dealing with it,obviously, as well as the PUC, but they're still moving forward with a 2009expected implementation, but there's lots of work to be done between now andthen. But it's still moving forward, Lasan.Lasan Johong - RBC Capital MarketsHow much do you think it's going to end up costing you andwill you get rate recovery or rate relief from it, for it?David McClanahanI think ERCOT is going to spend something like $250 plusmillion and really they'll recover that through an increased fee they chargeand it really won't be us. We don't have a lot of costs that will be and thatwill incur as a result of this, but certainly the market and ERCOT are havingto redevelop their systems and we may have some minor cost increases just tointerface with them.But this isn't really a ticket for us, it's for others thatare dealing with that.Lasan Johong - RBC Capital MarketsPerfect, thank you.Operator(Operator Instructions) Your next question comes from CharlieSpencer with Morgan Stanley.Charlie Spencer - Morgan StanleyHi. Just one follow-up on someone else's earlier question.In terms of potential other P&D opportunities, in terms of investingoutside of your territory, would you be interested in like minority stakes?I understand the synergies on buying entire businesses, butfrom a minority stake, is that something that interests you or is that I mean?David McClanahanI think, Charlie, it really depends on where we think theinvestment would take us. If we think it positions us for a bigger stake andmaybe a stake to own the whole thing, we might very well be interested.If it's simply a minority stake that you never could get thekind of efficiencies and synergies if you own the whole thing, than we probablywouldn't be as interested in that.Charlie Spencer - Morgan StanleyThank you.OperatorThere are no further questions at this time.Marianne PaulsenOkay. Great. Thank you very much, everybody, for participatingin our call. We appreciate your interest and support as always. Thank you andhave a great afternoon.OperatorThis concludes CenterPoint Energy's third quarter 2007earnings conference call. Thank you for your participation.Copyright policy:All transcripts on thissite are the copyright of Seeking Alpha. However, we view them as an importantresource for bloggers and journalists, and are excited to contribute to thedemocratization of financial information on the Internet. (Until now investorshave had to pay thousands of dollars in subscription fees for transcripts.) Soour reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition thatyou attribute the transcript to Seeking Alpha and either link to the originaltranscript or to www.SeekingAlpha.com.All otheruse is prohibited.THE INFORMATION CONTAINED HERE IS ATEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCEPRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDEAN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, ORINACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. INNO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHERDECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANYTRANSCRIPT. USERS ARE ADVISED TO REVIEWTHE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'SSEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.If you have any additional questionsabout our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!Complete Story »
Riviera Holding Corp. (RIV)Q3 2007 Earnings CallNovember 2, 2007 2:00 pm ETExecutivesBill Westerman - Chairman and Chief Executive OfficerMark Lefever - Chief Financial Officer and President ofBlack HawkBob Vannucci - Chief Operating Officer of Riviera Las VegasAnalystsJane Pereira - Lehman BrothersJoseph Starke - Merrill LynchDerrick Stevens - Desert Rock EnterprisePaul Plowski - Private InvestorLouis Sarkes - Chesapeake PartnersPresentationOperatorWelcome to the third quarter 2007 Riviera HoldingCorporation earnings conference call. Today we have Mr. Bill Westerman,Chairman and CEO, Mr. Mark Lefever, Chief Financial Officer and President ofBlack Hawk, and Mr. Bob Vannucci, Chief Operating Officer of Riviera Las Vegas.Once the Company has made its comments, we will open the call up for questions.Information that Riviera Holdings Corporation represents onthis call may contain forward-looking statements as that term is defined inSection 27A of the Securities Act of 1933, and Section 21E of the SecuritiesExchange Act of 1934.Forward-looking statements include the words may, would,could, likely, estimate, intend, plan, continue, believe, expect, projection,or anticipate, and similar words, and they include all discussions aboutRiviera's ongoing and future plans, objectives, or expectations.Forward-looking statements involve significant risks anduncertainties, including hotel and casino market conditions, financingrequirements, interest rates, proposals for the acquisition of Riviera,increases in energy costs, general economic and political conditions,expansions and modernization objectives and timetables, regulatoryrequirements, planned capital expenditures, and other risks and uncertainties detailedfrom time to time in Riviera's filings with the Securities and ExchangeCommission.Riviera's actual results may differ materially from what isexpressed or implied in the forward-looking statements. Riviera does not planto update its forward-looking statements, even though Riviera's situations orplans may change in the future, unless applicable law requires it to do so.Mr. Westerman, please go ahead, sir.Bill WestermanThank you, operator, and thank you everyone for joining ustoday. After I discuss general overall view of Riviera Holdings Corporation,Mark will review the consolidated financials, Bob will discuss the Las Vegasoperations, Mark will comment on the Black Hawk operations, and I will comeback to make some closing remarks and entertain questions.Our Company once again has generated record adjusted EBITDAof $10.3 million for the quarter ended September 30th, 2007, and a recordedadjusted EBITDA of $36.1 million for the nine-month period. Additionally, weredeemed our 11% bonds on July 9th, and now have a debt structure that consistsof a $225 million 7-year term floating rate loan, which we have swapped for afixed rate of 7.5%.Plus we have a $20 million revolver, which is currently notutilized. The new credit facility is generating approximately $7.5 million inannual interest savings, and increased cash flow compared to our previous debtfinancing. Our swap agreement that fixed the company's rate on substantiallyall of the $225 million, generated a non-cash charge for the nine months endedSeptember 30, 2007 of $6.6 million.This coupled with the $12.9 million charge to redeem thecompany's previous debt has resulted in a net loss for our company for thequarter and the nine months. Please keep in mind that our current operatingresults continue to post increases, and they are the true measure of ourcompany's operation and continued financial stability.The $25 million capital expenditure plan, which wasannounced on our last call is in process. We expect 500 refurbished rooms to bein service by January of 2008. They will have flat paneled 32 inch Philips TVs,Euro beds, and new upgraded bedding ensembles.The renovation of our Black Hawk facility to meet therequirements of the smoking ban in Colorado has begun, with a targetedcompletion date of December 20th of this year. We believe that we will have themost customer friendly environment for smokers and non-smokers in that market.Two weeks ago our General Manager in Black Hawk resigned.Since then and until we find a new General Manager, Mark Lefever in his role asPresident of Black Hawk will provide the day-to-day leadership, in addition tohis current duties. We do not anticipate any disruptions to the tremendousmomentum that we are currently enjoying in Black Hawk.Now I will turn the call over to Mark Lefever to discuss thefinancial results.Mark LefeverThank you, Bill, and thank you everyone for joining ustoday. Net loss for the three months ended September 30, 2007, was $18.3million, compared to a net loss of $432,000 in 2006. The significant increasein the net loss for the quarter was a result of the write-off of $5 million ofnon-cash charges, which included the remaining deferred financing costs anddiscounts related on the 11% bonds, plus a cash charge of $7.9 million for thepremium for the extinguishment of that debt.The company also recorded a non-cash charge for $7.5million, to reflect the change in the interest rate environment on our swapagreement on the $225 million term loan. These items were offset by increasesin adjusted EBITDA of $847 million, and a $1.5 million decrease in net interestexpense for the quarter.With the term loan, we swapped substantially all of our termloan-floating rate, for a fixed rate, and now at 7.5% fixed. The loss on theeffect of the derivative is a non-cash charge, which reflects the amount ofmoney the company would have had to pay at September 30, 2007, if the companywas to break its swap agreement at that time.The continued effects of this derivative will be recordedover the life of our term loan, depending on interest rates, and will result insignificant swings in either non-cash income, or non-cash losses for thecompany in any given quarter.For three months ended September 30, 2007, the company's netrevenue was $52.4 million, or $2 million ahead of the net revenues for thethree months ended 2006. Company-wide we had increases in casino revenues of$673,000, an $816,000 increase in room revenue in Vegas, and a $477,000increase in entertainment revenues to Las Vegas.The increase in casino revenues resulted from a $1 millionincrease in Black Hawk, offset by a $332,000 decrease in Las Vegas. Theincrease in Black Hawk is related to the continued favorable impact of ourdirect marketing programs, and the effects of the continued increases in thatmarket.The increase in room revenues was a result of the increasein the average daily rate, offset slightly by a decrease in rooms occupied, aswe continue to maximize the yield on our rates with the decrease of rooms inour competitive set.The increase in entertainment revenue in Las Vegas was aresult of the effects of the show Ice, direct from Russia, which opened inApril of this year. The company's adjusted EBITDA for the third quarter 2007was $10.3 million, compared to $9.5 million in 2006, a 9% increase andprimarily a result of the increases in revenues described above, offsetpartially by an increase in G&A costs, which reflect increases in employeebenefits, consisting mainly of health insurance and performance-based bonusaccruals.The company uses adjusted EBITDA as a measure of operatingperformance, and included in our earnings release is the reconciliation betweennet income and adjusted EBITDA. In addition to interest, taxes, depreciation,and amortization, the company eliminates other costs, such as equity-basedcompensation, the effects of our swap agreement, the loss on the retirement ofthe bonds, and merger costs.Beginning in 2007, the company has included costs related toSarbanes-Oxley compliance in adjusted EBITDA. The 2006 period has been restatedfor this presentation. The net loss for the nine months ended September 30,2007 was $12.1 million, compared to net income of $1.3 million in 2006.The significant increase in the net loss for the nine monthswas a result of the costs related to the retirement of the company's bondsdescribed earlier, and a non-cash charge of $6.6 million for the accountingeffects on the company's swap, offset partially by an increase in adjustedEBITDA of $4.2 million, and a decrease of $1.8 million in net interest expense.For the nine months ended September 30, 2000, the Company'snet revenue was $158.1 million, or $3.6 million ahead of net revenues for thenine months ended September 30, 2006. Company-wide we had increases in casinorevenues of $2.7 million, a $3.2 million increase in room revenue in Vegas.These increases were offset by decreases in entertainmentand food and beverage in Las Vegas. The decrease in entertainment in Las Vegasof $1.2 million, relates to the closing of Splash on September 30, 2006, whenwe opened Ice in April of 2007. The decrease in food and beverage revenues of$817,000, relates primarily from the decrease in banquet revenues in Las Vegas,as a result of less groups with full meal banquet events in 2007.The company's adjusted EBITDA for the nine months endedSeptember 30, 2007, was $36.1 million, compared to $31.9 million in 2006, a 13%increase. The increase was the result of the increase in net revenues of $3.6million described above, and the decrease in overall costs of $795,000, whichwere a result of decreases in casino and entertainment expenses, offset byincreases in room and G&A costs, primarily a result of the increase inpayroll and benefit expenses.As of September 30th, the company had unrestricted cash of$33 million and the entire amount of our $20 million revolving line of creditavailable. Capital expenditures for the nine months ended September 30th were$6.5 million, with $4.7 million related to Las Vegas and $1.8 millionattributed to Black Hawk.We expect CapEx for 2007 to be $12.5 million, with $9million in Vegas and $3.5 million in Black Hawk. Of which $3.5 million of thatis considered renovation capital for the company.I will now turn the call over to Bob to discuss Vegas inmore detail.Bob VannucciThank you, Mark. Our revenues in Las Vegas increased $1.1million or 1.2% for the third quarter, EBITDA line increased $419,000 or 7.3%,our EBITDA margin increased to 16.2% versus 15.5% in the same period last year.We continue to focus on our revenue centers that generate anincrease to our bottom line. A slight departmental profit of $5.7 million wasup $120,000 or 2.2%, as we continue to capitalize on the Westward Ho andFrontier list of customers, and new more efficient slot marketing programs.Cash room revenue of $12.6 million increased $926,000 or7.9% over prior year, driven by a cash ADR of $79.13 versus $74.28 in the prioryear. Our RevPAR was $74.28, up $3.76 or 5.3% over the prior year.Hotel occupancy was 93.9%, down slightly from prior years ofthe 94.9%. Convention cash room revenue of $5.4 million was equal to last year.Convention room nights represented 35.7% of total cash rooms sold and 44.3% oftotal cash room revenue.Entertainment revenues in the quarter increased $497,000, assales for the new Ice show increased. Departmental profits for entertainmentimproved by $123,000 or 17.9%.For the nine months ended September 30th, revenues were up,revenues of $116.6 million, increased $1.6 million or 1.4% compared to prioryear. EBITDA improved to $24.1 million, an increase of $1.6 million, or 7.2%.Our EBITDA margin improved 20.7% versus 19.6% in the sameperiod last year. For the nine months, slot revenues were $36.6 million, up$699,000 or 1.9%. Cash room revenue of $38.6 million, increased $2.7 million,or 7.7% over the prior year. Our cash ADR was $83.19, up $7.09 or 9.3% fromprior year.RevPAR was $78.24, up $5.10 or 7% over the same period lastyear. Hotel occupancy of 94.1% is up 0.2 of a point from prior year. Conventioncash room revenue was $17.7 million, up $366,000, an improvement of 2.1%, overthe prior year.Convention room nights for the nine months represented 36%of total cash rooms sold, and 47.3% of total cash room revenue. Entertainmentrevenues for the nine months were down $980,000. Departmental profits, however,remained flat with last year, primarily due to our revised show of agreementsand new Ice show, which opened in late April.We acquired the Frontier list of premium gaming customersand hired several marketing employees from the Frontier in late August. Andhave begun marketing to the Frontier players, as we did to the Westward Ho lastyear.Our strategy to focus on the middle market and increase ourpricing accordingly has worked well. Our performance continues to improve, inspite of the decline in walk-in business, attributable to the closures of theWestward Ho, Stardust, and Frontier.We are very excited about our room refurbishment program,which will upgrade our room product, and will likely provide an opportunity tocontinue to drive our ADR. Soon, we will see the benefit of the cross trafficcreated by all of the new development in our areas, as they open both towardsthe end of this year, next year and in 2010.Now I will turn over the call to Mark to discuss Black Hawkresults more in detail.Mark LefeverThank you, Bob. For the nine months ended September 30th,Black Hawk's net revenue was $14.4 million, an increase of $978,000 or 7%. Theincrease was primarily related to an increase in slot revenue, as a result ofour database marketing efforts, the continued increase in the Black Hawk marketand improvements we have made to our slot and video poker products.EBITDA for the third quarter was $5.4 million, an increaseof $570,000 or 12%. The increase was the result of effects of increases in netrevenues, offset slightly by an increase in casino and G&A expenses,relative to the increased volumes.The Black Hawk team continues to effectively market thisproperty to the Denver community and provide our shareholders with anexceptional return.For the quarter, the average total number of slot machinesin Black Hawk in Central City decreased 340 machines or about 3%. The combinedBlack Hawk and Central City coin in was down 1.1% for the quarter; howevergross slot revenues increased 4.3%.We define fair share, as total slot coin in, in Black Hawkdivided by the number of slot machines in that market compared to our slot coinin and the number of our slot machines. Our fair share for the quarter was132%.In addition, this property continues to generate anoutstanding return with an EBITDA margin for the quarter of 38%. For the ninemonths ended September 30th, Black Hawk's net revenue was $41.5 million, anincrease of $2 million or just over 5%. The increase was primarily related toincreases in slot revenues as a result of the factors described earlier.EBITDA for the nine months ended September 30th, 2007 was$15.1 million, an increase of $2.4 million, or 18%. The increase was the resultof the effects of the increases in net revenues and improved efficiencies inoperating expenses, primarily related to our floor now being virtually 100%(inaudible) and reduced marketing expenses relating to certain low marginrevenue streams.Year-over-year the average total number of slots for theBlack Hawk and the Central City market remain the same. Combined Black Hawk andCentral City coin in was again down for the nine months at 1.1% and therevenues had increased 4.3% for the region.Our Black Hawk property generated a fair share for the ninemonths ended September 30th of 136%, and EBITDA margin for the first ninemonths of 36.5%.As you are aware the smoking ban was amended by ColoradoLegislature and effective January 1, 2008, smoking will not be allowed in thecasinos. We have begun a renovation to comply with the smoking ban and webelieve, we have designed changes that will make the experience enjoyable aspossible for smokers and non-smokers alike.As Bill had mentioned earlier, our General Manager in BlackHawk has resigned and we wish him well in our future endeavors. I am handlingthe day-to-day operations of our property and thanks to a very dedicated BlackHawk team, the transition has been very smooth and somewhat enjoyable.I will now turn the call over to Bill for some finalcomments and questions.Bill WestermanOur team continues to focus on the daily operations at bothproperties, as shown in our record EBITDA results. With our capital expenditureplan in process, we believe these improvements will enhance our guest's overallexperience, while generating stronger long-term financial results for ourcompany.Our investment adviser, Jefferies and Company is continuingit's strategic process to maximize shareholder value. The process is ongoingand as soon as we have something to report, we will. However on advice ofcounsel, we will not take any questions with respect to the process.Operator, we will now take any other questions.Question-and-Answer SessionOperator(Operator Instructions) Your first question is coming fromJane Pereira (ph) of Lehman Brothers. Jane Pereira - Lehman BrothersGood afternoon, everyone.Bill WestermanHi, Jane.Jane Pereira - Lehman BrothersHi! I just had a couple questions. Can you be more specificwith respect to what you are doing for the smoking and what is actuallyallowed? Are you allowed to have indoor enclosures or do you have to dosomething that is actually outdoors?Bill WestermanMark just came back from there last night, so he can giveyou an update on exactly what we are doing.Mark LefeverThe Colorado Legislature, it has to be outdoors and wesubmitted our plans to the City of Black Hawk, which have been approved, andthe construction has started, but we are going to have three smoking areas thatwill be outside.One will be off the front right side of the property, andthe other two will be balconies and areas off of either side of the casinofloor that will be open. One will be to the Isle, and the other to the street.But they have to be outside.Jane Pereira - Lehman BrothersAnd then will you have heating out there for the wintertime?Mark LefeverYes, absolutely. And ice melt on the floor, and someseating, and that kind of thing.Jane Pereira - Lehman BrothersOkay. And then?Bill WestermanIt's about a $1 million project, just to accommodate this.Jane Pereira - Lehman BrothersOkay. And then my other question is, are there nativecasinos nearby? And I am wondering, if so, do they have to comply with thesmoking ordinance as well?Bill WestermanThere are no native casinos within a reasonable drivingdistance of Black Hawk, and I doubt that they would comply with anything thewhite man tells them to do.Jane Pereira - Lehman BrothersOkay. So I guess that?s good they are not nearby. The otherquestion I had is, due to the fires, the wildfires in California, have you seenany drop-off this far in leisure spend, and if you do, what other spigot wouldyou turn on that?s available to you?Mark LefeverWell we rely very little on the California for most of ourbusiness. Most of our business comes from the Midwest and market, and throughour marketing programs. We have seen very little impact on the Californiabusiness coming to us. That may not be true with other operators, but ours hasbeen minimal.Jane Pereira - Lehman BrothersOkay, that's good. And I am just wondering if you can clearup some of the data that we are looking at out of LVCVA that?s indicating thatthe convention attendance this year is flat, but the economic impact isactually up 6%. Are the conventions, you are just trading up in terms of thequality of conventions, or can you explain that anomaly?Mark LefeverI think part of it is the increase in room rateyear-over-year that conventions are paying. And I would say that the peoplecoming to the convention, the attendees are spending a little bit more in thesurrounding areas, with food and beverage, and that kind of expendituresbecause those prices have increased as well.Jane Pereira - Lehman BrothersOkay. Thank you. That?s very helpful, that is it from me.Thanks.Mark LefeverThanks.OperatorThank you. Your next question is coming from Joseph Stark ofMerrill Lynch.Joseph Starke - Merrill LynchHey, guys. How are you?Bill WestermanGreat.Joseph Starke - Merrill LynchGreat, great. How you doing, Mark? Real quick question, Iknow we are not supposed to ask about the acquisition or anything like that,but I have got a quick question regarding the adjacent property. Have you guysput any thought into considering having talks about the Conrad/Waldorfproperty, just because it seems like that Strip frontage is very valuable andmost valuable probably to the Riviera?Bob VannucciThat property recently changed hands.Joseph Starke - Merrill LynchIt did?Bob VannucciYes. A local company here purchased it, and we are unsurereally what they are planning on doing with it at this point. They have told usthey have some plans of developing a shopping center there, and perhaps a hoteldownstream.Joseph Starke - Merrill LynchOkay, thank you.OperatorThank you. Your next question is coming from Derrick Stevensof Desert Rock Enterprise.Derrick Stevens - Desert Rock EnterpriseHi, Bill, hi, Bob, hi, Mark, how you doing?Bob VannucciGreat.Derrick Stevens - Desert Rock EnterpriseSo, I wanted to ask you a question really as a follow-up towhat just came up. That property that was originally going to be the Waldorf,is it fair, or do you know if it is true that that 5.4 acre site just to thesouth of Riviera Las Vegas, that the actual selling price was $180 million, orabout $33 million an acre?Bob VannucciThat is what we have heard, that it was in the mid-30s. Andit actually turns out to be about 6.5 acres, because they acquired thePeppermill portion of it also. The same buyer also acquired about 11 acres ofland behind it, which was the shopping center, and the apartments, and the onemotel back there. So he has got about a 17 or 18-acre parcel.Derrick Stevens - Desert Rock EnterpriseAnd is the number -- there is a number somewhere in the $30to $33 million an acre area overall?Bob VannucciIt appears to be the number for the front end piece, the oldLa Concha. I?m not sure what he appeared for the other sites.Derrick Stevens - Desert Rock EnterpriseOkay. Thanks much.Operator(Operator Instructions) Your next question is coming fromPaul Pilowsky, Individual Investor.Paul Plowski - Private InvestorHi. On the 6.6 million swap charge, does that come due inany sale? Bill WestermanWell, it would come due if the buyer needed to take the debtdown. If they had to refinance, then they would have to pay that. A year fromnow, they might be able to gain a profit, as this thing swings wildly.It is hard to tell what it would be at the time of salewould close. It would all depend on the interest rate gap between treasurybills and the LIBOR rates.Paul Plowski - Private InvestorAs the interest rate LIBOR goes down, that?s a benefit, andas LIBOR goes up, the swap charge would increase?Bill WestermanActually, it?s backwards, and it?s tied, the swap was donewith Treasuries, so we?ve fixed for the seven years of the loan, we are fixedat a rate of 7.489%, I said 7.5. So no matter what happens with rates, that?swhat we will be paying, if rates LIBOR should go up and rates should go up to10% or 11%, we still pay 7.5. If Treasury bills, if LIBOR goes down, we stillpay 7.5.The swap is affected by the Treasury bill rate, as it ischanged from the time we entered into the LIBOR agreement. It?s present valued,it?s very complicated, it took me days to understand it. I think Mark, maybe ifI said anything, at the end of the day in seven years, it will be zero, nomatter what happens in the interim, assuming that there is no winding down ofthe debt.Mark LefeverSo the answer, Paul, is if there was, if the loan was, the swapwas to be broken, than whatever date that?s broken, whatever the affects of theTreasury rate and LIBOR rate on our fixed, would either be an income or anexpense to breaking the deal.Paul Plowski - Private InvestorSo the Treasury rate goes down, is that a benefit to.Mark LefeverThat hurts us.Paul Plowski - Private InvestorThat hurts you. All right.Mark LefeverOkay?Paul Plowski - Private InvestorAll right. Thank you.Mark LefeverThanks.OperatorThank you. Your next question is coming from Louis Sarkes ofChesapeake Partners.Louis Sarkes - Chesapeake PartnersHey, Bill. I know that you said that you weren't or couldn'tanswer any questions related to the specifics of the process to maximize value,but I was wondering if qualitatively you could help us out like you did lastquarter on the call, where my question is, do you feel that given the time andthe upset that we are seeing in the capital markets, obviously it?s somewhat ofa less than opportune time to be out there, but is that having a marked affecton the process?Bill WestermanI think that if the situation in the credit and the capitalmarkets is having an effect on all the merger and acquisition activitythroughout the world, and I think obviously it is having an effect on ourprocess.Louis Sarkes - Chesapeake PartnersOkay. Thank you very much.OperatorThank you. There appear to be no more questions at thistime. I will turn the floor over back to your host, Mr. Bill Westerman for anyclosing remarks.Bill WestermanWell, thank you again. We look forward to speaking with youat our next quarterly earnings call. As always, you are welcome to visit theRiviera Las Vegas or Riviera Black Hawk. Especially those of you, who may becoming out to attend G2E this month, try to stop by and we would like to showyou around the property, and show you what we are doing with our rooms, andanything else you might be interested in. Thank you all again for your interestin Riviera! OperatorThank you. This concludes the third quarter 2007 RivieraHoldings Corporation earnings conference call. You may now disconnect.Copyright policy:All transcripts on thissite are the copyright of Seeking Alpha. However, we view them as an importantresource for bloggers and journalists, and are excited to contribute to thedemocratization of financial information on the Internet. (Until now investorshave had to pay thousands of dollars in subscription fees for transcripts.) Soour reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition thatyou attribute the transcript to Seeking Alpha and either link to the originaltranscript or to www.SeekingAlpha.com.All otheruse is prohibited.THE INFORMATION CONTAINED HERE IS ATEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCEPRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDEAN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, ORINACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. INNO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITYFOR ANY INVESTMENT OR OTHERDECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANYTRANSCRIPT. USERS ARE ADVISED TO REVIEWTHE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'SSEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.If you have any additional questions aboutour online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!Complete Story »
