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Creative Technology (OTCPK:CREAF)

Q2 2006 Earnings Conference Call

January 25th 2006, 7:00 PM.

Executives:

Phil O’Shaughnessy, Senior Director of Corporate Communication

Craig McHugh, President of Creative Labs

Sim Wong Hoo, Creative’s Chairman and Chief Executive Officer

Ng Keh Long, Chief Financial Officer

Analysts:

Richard Todaro, Kennedy Capital

Jamie Doyle, Halfway Capital (ph)

Jim Red, Red Capital Management

John Chi (ph), UBS

(Indiscernible), Citigroup

Operator

At this time, I would like to welcome everyone to the Creative Technology Q2 Fiscal Year 2006 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. If you would like to ask a question during this time, you may press “*” then the number “1” on your telephone keypad, to withdraw your question press “*” then the number “2” on your telephone keypad. I would now like to turn the conference over to The Director of Corporate Communications, Mr. Phil O’Shaughnessy.

Phil O’Shaughnessy, Senior Director of Corporate Communication

Thank you. Good morning to those of you joining us in Singapore and good afternoon and evening to everyone in the US. Thank you for joining us today. I am Phil O’Shaughnessy, Creative’s Senior Director of Corporate Communications and I would like to welcome you to Creative Technology second quarter of fiscal year 2006 earnings release conference call. The press release can be downloaded from our website which is www.creative.com. We’re also offering a webcast of today’s call, which you can access through the Investor Relations page on creative.com. Today’s call will be hosted by Craig McHugh, President of Creative Labs. Craig will be joined on the call by Sim Wong Hoo, Creative’s Chairman and Chief Executive Officer, and Ng Keh Long, our Chief Financial Officer.

During our call today, Craig and the other participants, who may be speaking on todays call will, with the exception of historical information, will be making forward-looking statements, including statements relating to inventory, operating expenses and gross margin. These forward-looking statements are based on the information that is available to us as of today and reflect management’s current analysis, belief, or expectations. Actual results could materially differ for a number of reasons including those detailed in today’s press release and in our filings with the Securities and Exchange Commission over the last 12 months. We are urged to review the risk factors set forth in our press release and in our SEC filings including our annual report on Form 20-F. Also please note that Creative undertakes no obligation to update any forward-looking statement made in today’s conference call or in our press release to reflect events or circumstances that occur after today.

For today’s call, all results are stated in US dollars. We will begin today with Craig McHugh providing a review of the results of the second quarter of our 2006 fiscal year. We will then open up the call for questions and answers. At this time, I would like to turn the call over to Craig McHugh, President of Creative Labs. Craig?

Craig McHugh, President of Creative Labs

Thank you, Phil. Sales for the second quarter were $390.8 million up from $375.1 million for the same period last year. This represents our highest revenue for any quarter in the last 5 years. We increased year-over-year sales in our key product lines, MP3 players, audio, webcams, and PC and MP3 speakers. Sales for the first 6 months of our fiscal 2006 were $671 million up 15% from $585.2 million for the first 6 months last year. In the second quarter, with our revenues of $390.8 million, we achieved our growth of returning the profitability by the end of the calendar year. Our Q2 net income was $8.2 million with EPS of $0.10 including an investment gain of $6.9 million. Excluding the investment gain, net income for the second quarter was $1.3 million with EPS of $0.02. This compares to net income of $11.8 million with EPS of $0.14 for the same quarter last year including an investment gain of $51.5 million and a non-cash impairment charge of $65.2 million. Excluding the investment gain and non-cash impairment charge, our net income for the same period last year was $25.5 million with EPS of $0.13.

Now I would like to turn to review of our product categories and regional business performance. Sales for our Personal Digital Entertainment or PDE category which includes the MP3 players and web cameras was up 9% year-over-year and contributed 67% of total sales in the period. This compares to 66% of revenues last quarter and 64% of revenues from PDE in the same quarter of last year. During the quarter, we launched our Zen Vision:M, 30 gigabyte MP3 photo and video player that can carry up to 15,000 songs, tens of thousands of photos and 120 hours of video. We held press launch events in Asia and in Europe in December and launched in US with the consumer electronics show know as CES this month in Las Vegas, where this Zen Vision:M won the best of CES award for the MP3 and portable video category. The Zen Vision:M also won the overall best show award, leading out every product at the entire show.

CES is the world’s largest consumer electronics trade show and the largest annual trade show in the United States. Thousands of company’s go each year including the giants in Consumer Electronic in personal computing. The majority of our major retail partners in the US and many of our key retailers in Europe, were at CES as well as each of our strategic partners. They were highly impressed by Creative’s strong presence at the show and our best in show award. iPod was one of the judges for the Best of CES awards well about the Zen Vision:M. And I quote with the brighter screen, better barrier life and more features, the Creative Zen Vision:M certainly has the goods to give you iPod a run for its money. In addition to a voice recorder and an FM tuner, the $330, 30 gigabyte Zen Vision:M supports a wide range of video formats, worth for the growing number of online stores and is compatible with subscription services. So many has the best in show pick is the winning design and quote.

The Australian website maximum power computing just wrote about the Zen Vision:M and I quote within just a minute of planning with the new Zen Vision:M, this is the player to on all players. It’s definitely, and any drop that gorgeous. This is the sort of gadget, you just have to have the moment you see it. Much like PSP was but even their Creative features, Sony some crunching lessons in style and user friendliness and quote.

Now shipping in 5 dazzling high last colors this Zen Vision:M features the stunning 262,144 color screen and 4 hours of battery life for video, that’s 4 times a color and twice the battery life for the iPod video. And it fully supports to major subscription services not available for the iPod. Including Yahoo Music unlimited, Napster to Go, Rhapsody to go service. At CES, we also introduced that new ZenCast application that provides easy access for thousands of Free Audio and Video Blogs that you can enjoy on your new Zen Vision:M or your Zen Vision Player. You can experience the public beta version of ZenCast today by going to zencast.com and downloading the free content you’re interested in from major broadcasters such as CBS and ESPN as well as individual bloggers. The ZenCast homepage offers different channel, the subject ranging from breaking news to world affairs, the tech gadgets and entertainment. The free ZenCast organizer can be set to subscribe your favorite ZenCast programs and to download them directly to the Zen Vision:M and the Zen Vision.

Also in the PDE category, we just introduced our latest webcam, the Live! Wireless, which enables anyone within Internet connection in a wireless network, to remotely watch what’s happening at your home or office. Just place the camera anywhere you would like and setup your free secure web address, so wherever you are you could use the Internet, so you could remotely see live video from your Live! Wireless webcam. The live webcam, the live, the webcam live also have the motion detection feature, so that when you are away it could be set to capture picture and it senses motion and send them to your email address.

And looking at our audio category, we are really pleased with the sale results for audio sound blaster X-Fi family of soundcards, which for the first time when the channel for the fourth quarter, the success of the sound blaster X-Fi help us to grow audio revenues 7% year-over-year, contributing 13% of overall revenues consisting with 13% revenues last quarter and 13% of revenues for the same quarter last year. We continue to achieve tremendous clerical acquiring for sound blaster X-Fi cards and X-Fi extreme fidelity audio standard. Including the best of what’s year over from Popular Science Magazine in the December issue. Popular Science has recognized the best from categories that include space, aviation, home entertainment, computing and healthcare. The X-Fi extreme fidelity audio processor was selected as the best of what’s new in home entertainment. In the home entertainment category, so bring outstanding audio quality to MP3 music. And reviewing the sound blaster X-Fi processor, Popular Science Growth and I quote, Creative’s X-Fi is an audio processing chip that identifies the specific sound patterns, that are typically damaged in music final conversion, then it enhances them, restoring audio file quality to the digital file and quote. This is a significant achievement for us to have sound blaster X-Fi processor selected in a home entertainment category it recognizes our X-Fi audio technology can move into any room in the home.

Our speaker business contributed 13% of revenues in the second quarter consistent with 13% of revenues last quarter and compare to 15% of revenue for the same period last year. We are also bringing exiting new innovations to our speaker category. We just announced our GigaWorks ProGamer G550W, a 5.1 speaker system which wireless, which wirelessly transmits music, movie and game audio to its 2 rear speakers up to 30 feet away. The G550W enables you to experience powerful multi-channel audio without having to cut all, the new wall or ceiling to run wires just to get sounds to your rear speakers. This THX certified system eliminates clutter and hassle without compromising power or performance.

Revenues from all other products accounted for 7% of sales for the period. Looking at the breakdown at revenue by specific geographic regions, the America has represented 37% of sales compared to 41% for last quarter and 42% for the same period last year. Europe contributed 48% of total sales compared to 39% last quarter and 39% for the same period last year. Asia contributed 15% of revenues 20% at last quarter and 19% for the same period last year. Operating expenses for the second quarter was $78 million coming in at 20% of sales this compares to $80 million or 21% of sales for the same quarter of last and $65 million of operating expenses or 23% of sales last quarter.

Moving on to the balance sheet, we ended the quarter with $200.4 million in cash compared to $171.8 million last quarter and $246.3 million for the same quarter last year. During the quarter, we reduced net inventory by 18% to $301 million compared to $366 million at the end of last quarter. Day sale outstanding at the end of the second quarter were 47 days down from 54 days last quarter and consistent with 48 days for the same period last year. The value of our investment portfolio as of December 31 was $98.3 million. Of this total, approximately $86.4 million is in listed investments including $40.2 million of unrealized gains. During the second quarter, we did not purchase any shares from our share buyback program.

Looking at our business moving forward, I will highlight some of our key areas and strategic focus. #1, when it build on the successful launch of this Zen Vision:M and maintain the momentum we have established in our MP3 category while we focus on profitability in the category, two, further reductions of our net inventory levels, three, producing our overall level of operating expenses over the next few quarters, four, increasing our focus on a higher margin product categories, this particular emphasis on our audio business and expanding the market of our extreme fidelity of audio standard outside the PC.

At this time, I would like to open up the call to question and answers. Operator, if you can help us with the Q&A please.

Questions-and-Answer Session

Operator

At this time, if you would like to ask a question, please press “*” then the “1” on your telephone keypad. We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Richard Todaro of Kennedy Capital.

Q - Richard Todaro

Hi guys. Can you guys talk about how the new products are selling and maybe like retailers how they receiving it, it seems like you guys do really well at the shows, but then the sales and the when you get into the battle with Apple, you don’t seem to do as well. So how do you think your consumer and retailers are receiving the product?

A - Craig McHugh

If you look at, as we shared just few minutes ago our revenues for the quarter with the highest we’ve had in 5 years. Our sales were up in each of our key GAAP categories, our MP3 sales were up, our audio sales were up, our MP3 and PC speakers were up and our web cameras were up across the board. I think it reflects the excitement of the product line and how well we are positioned? As you may have noted, from my presentation that we had a seller quarter, a year Europe represented a very high percentage of overall sales and it did particularly well in retail. And if you can talk to any major retailers in the US if you look at our partners with MP3 with BestBuy, Circuit City and Wal-Mart, Fry’s Electronics, Staples, I think they will tell you they had just super holiday sell-through with our products. Anyhow with the effort by the major European retailers, dealers like Dixons, FINAC, Media Market in Germany, we had exceptionally strong sell-through, in the period. I think that’s why contributed to the revenues being up in each of the categories. And I think if you look at the significant of CES there was a steady of 1000 of companies Sony was there Samsung, LG all of those Japanese companies Panasonic Toshiba and the excitement not just in our group, but I think sign we generated with the consumers will be reflected in our business going forward. And being selective by the product decision, talk about an exciting product this was across all categories. The feedback we are getting from the Zen Vision:M is truly outstanding. I register couple of the quotes regarding from our Sound blaster X-Fi, and X-Fi have been in the channel for of course. We are excited about what we are doing in retail. Our retail channel positions in Europe and US are very good right now. I think represent a very strong holiday sell-through. So, the question which you mentioned Apple they had a large number of player sold, but we see that our MP3 and webcam represented a 68% of our total revenues, I think it reflects a very strong holiday season for Creative as well. If you go back to our previous quarter, we said we are going to focus on profitability in that category we are going to focus on our margins in the category, and I think we have been able to achieve those strong sell-through, very good market share, improving our overall market position and perception and at the same time we aim to deliver highest revenues in five years.

Q - Richard Todaro

Okay, can you talk about the inventory position and $300 million going into the next quarter and I assume you guys had built inventory last year, anticipating demand that you guys had on prices and what you are going to do going forward on the inventories, so that you are going to focus on it, can you talk about how you are doing it?

A - Craig McHugh

In the past quarter, we dropped inventories approximately 80% over the sequential quarter. We have several new products that we are just getting into the channels they mentioned this Zen Vision:M. We had some other products as well and we are also just getting really going with our Sound blaster stream fidelity, the X-Fi family soundcards, so we expect on the sound cards. So we did buildup inventory not just for the holiday for our new product launches. And last year, we overhang from mid-year when we had too much inventory; we are quite open about that. If you look at the past 2 quarters, we reduced our inventories substantially. And our plan is to continue to focus and bring the levels down further. I don’t want to go into the specifics of what our, where our target levels would be so I can share specific financial information. We feel that we can reduce them further. And we intend to do so. Our inventories today, we look at the make up of our inventories, they reflect the overall percentages of revenue. Our PDE inventories about over 60% of the total. So we’re very integral quite please with the mix of our overall inventories, about 47% is in finished goods, about 3% in the balance of that inventory is in components. So I think we are, I think we are positioned well to be able to reduce inventories further in the next couple of quarters.

Q - Richard Todaro

Can you talk about from an investor’s standpoint, two things? One, you have Apple with all time highs here, I think from the US investor standpoint, are you out doing a road-show, are you meeting with investors, going to conferences, recruiting analysts, what are you doing to get the Creative story out in the US?

A - Craig McHugh

We are focused very heavily on our results right now. I think the beginning in the August timeframe we share that, we’re going to return the profitability by the end of the year. We wanted to reduce our inventories, and we wanted to release a new family of products to holiday series, a holiday period and we delivered on each of those. And our focus is been on delivering those results being able to improve our profitability, improve our margins, and be able to I think, nearly raise the perception accretive in the Zen brand and launched the sound blaster stream fidelity, we’ve been very busy doing that. Our focus, going forward is the 5, the 4, 5 key strategic items I shared with you today and this call is really just a real open forum so our investors and the analysts can understand both our products, our positioning and the strength in these categories. So right now, that’s our key focus.

Q - Richard Todaro

Right. The last question is why would the company given, the surplus cash position they have, why wouldn’t they be buying back a significant amount of stock here. Though it seem like you buyback $100 million worth of stock or something, given the valuation, given the excess cash.

A - Craig McHugh

For that perhaps, I would ask Keh Long to answer that but I would first share that last quarter we did announced our quarterly earnings call that we purchased approximately 1 million shares accretive stock in the period, we did not buy any in the current period. Long would like to add to that?

A - Ng Keh Long

We, in deciding on cash price, share buyback we have to lead, we consider cash requirement, working capital requirements at the future capital expenditure requirements that we need in the future quarters.

Q - Richard Todaro

Okay, that’s all the questions I have.

A - Craig McHugh

Thank you very much. I appreciate it.

Operator

Your next question comes from the line of Jamie Doyle, Halfway Capital (ph).

Q - Jamie Doyle

Hi its, Jamie Doyle, just a question about the progress in profitability at the PDE segment, the Q2 shape up better than expected and how about in the second half?

A - Craig McHugh

Hi Jimmy, thank you, the very openly I think we did our expectations, for the PDE section as far as pricing. There wasn’t significant volatility in pricing or prior to operating is very strong. We aggressively price going into the period, in the previous 2 quarters I think we shared that aggressive pricing by our competitors, cause us to make some unplanned price moves to respond. So we positioned ourselves well in the quarter with PDE representing a 68% of sales in the period and our margin still rising, we accumulated 20% gross margins in the period. I think that reflects that as we position our prices appropriately, we’ve been able to drive down our cost, because of our very strong volumes. So we are actually very, very pleased with that. We didn’t have to make any unplanned moves; I think we’ve been able to anticipate the aggressiveness of our competitor better than we’ve had in the past.

Q - Jamie Doyle

For the second half?

A - Craig McHugh

Going forward the flash market continuous to be a difficult one there was vigorous simplified by a shortage of availability in the last 4 months of the calendar year. There seems to be more availability at least in the short term of flash, which has some volatility on flash pricing. But its not overly available right now, there is no blooded all flash in the market which does tend to call us a greatest volatility. So we don’t just foresee significant price wins at least for the foreseeable future. The 6 months vendor is very difficult, I think as you know our business that would be a, kind of a long range look at pricing right now. So, we continue try and track down our inventory level, so we can be more nimble. Our inventory levels in the channel are, had at a very low level right now, which allows us to be very flexible and be able to be very quick and nimble on pricing. So, I think we are well positioned for the first half, but I can’t really comment on, the long range of the pricing that we’ll go.

Q - Jamie Doyle

Okay thank you.

A - Craig McHugh

Thank you Jamie.

Operator

Your next question comes from the line of Jim Red of Red Capital Management.

Q - Jim Red

Gentlemen good evening, in your last conference call, you’ve said you were targeting 2 million MP3 shipments in the December quarter, my first question is could you do that number or what actually was the number of unit shipments in the quarter?

A - Craig McHugh

Hi Jim this is Craig.

Q - Jim Red

Hi Craig.

A - Craig McHugh

We far exceeded the 2 million units that we were targeting for the period.

Q - Jim Red

Okay, and your part of number of that, was it 4 million?

A - Craig McHugh

It was over 2.6 million.

Q - Jim Red

And can you tell me what the average selling price with MP3 category was on the quarter?

A - Craig McHugh

No. For competitive reasons, we don’t break that out in the PDE category we have our web camera family as well as our MP3 players.

Q - Jim Red

Okay well and your closest competitor Apple, I believe their average selling price was from 189 to 207 in the quarter and they had a good portion on the quarter with the video iPod in there. But answer this, you’re introducing the Zen Vision, I don’t think you’re having any shipments in the US during the fourth quarter, you might all decide starting shipment in December, the average selling prices are higher, what’s the incremental cost comparing to video to an MP3 players, is it $10 to $15 per unit am in the ball park?

A - Craig McHugh

Jim you need to look at the several factors. There is cost requirement, there is the video codec that you choose , it depends on the stream and the streams can vary substantially in price and the size of the stream so its on different players, today we talked about the Zen Vision:M has ultra high quality, 262,044k color screen. So its very high resolutions, it’s a beautiful screen, its really gives a stunning video. Creative’s Zen MicroPhoto we use an OLED screen that supports photo but not video and our Zen Vision has a very large screen, the Zen Vision is really designed for, really having enjoyable movie video experience watching TV shows, that’s a very, very high-end screen, that’s a very costly screen, so there’s 3 different types of levels, so they, the $10 to $15 arrangement should does it really take into account that wide variance and screen cost.

Q - Jim Red

Okay. Do you want to throw a number on how much this screen would add?

A - Craig McHugh

I think we want to go into specifics, are you sure its difference in retail pricing, the Zen Vision:M retail price 330, and our suggested retail price in US for this end-vision is 399. But has $70 difference in retail price that now reflects the, the largest screen and the higher cost.

Q - Jim Red

Okay, then we come to this question, following up on that. Do you think the incremental gross margin is higher on the video mp3 players and on sustained rates?

A - Craig McHugh

Do you look it…

Q - Jim Red

I think it is but, you guys have the numbers.

A - Craig McHugh

Thank you Jim, the in regard pricing and each of our products we continue to be aggressively priced and our hard drive players at least in the current market you provide opportunities for higher margins.

Q - Jim Red

Okay. Let’s see if you have any forecast for average selling prices over the course of the year, there was some out there on your competitor which were quite a bit higher than what they actually attained in the December quarter but do you think its on the label or forecasting any kind of thing have been declined in the ASP this year?

A - Craig McHugh

Well, our overall ASPs, a…

Q - Jim Red

On the mp3…

A - Craig McHugh

Yeah, we’re, I think you can price from our presentation today is Jim’s quote in the press release, this Zen Vision:M is truly in our standing product. The feedback we’ve gotten from the retailers, from the reviewers and the consumers who are fortunate enough to get the initial shipments, they absolutely love it. $303 is substantial higher price than Zen MicroPhoto and our Zen Micro, so we have the opportunity to shift to a higher selling price for our product line overall.

Q - Jim Red

Okay. All right, good. Now just turning to operating expenses for a minute, we are thinking them as the percentage of overall revenue; of course you have that nice 39% surging sequential revenue. I think it actually rose over an absolute terms from, I think it was 65 million to about 78 million in the quarter, what are you actually doing about the absolute level of operating expenses, not just the percentage of revenue but the absolute level, to share over $300 million rate operating expenses, I’m not just saying it was quite high, I’m wondering if you can take 50 million or 90 million out of your operating expenses and really tried.

A - Craig McHugh

No I think, the numbers you were quoting Jim were sequential quarter-over-quarter.

Q - Jim Red

Right.

A - Craig McHugh

And we have a very large Christmas quarter, the highest revenue in 5 years; I think it’s more appropriate to do your operating expense analysis on a year-over-year basis. If you compare our previous fiscal year our operating expenses came in a just approximately 80 million versus the 78 million, so we were down on just about $2 million, $2, $2 million reduced year-over-year. At the same time, revenues were up about 15 about $30 million year-over-year.

Q - Jim Red

10 million or 15 million?

A - Craig McHugh

15 million and its 20% that would account for 3 million, so I think if you did a year-over-year comparison our $2 were down about $5 million and if you were to take constant spending. We shared today that one of our strategic ways of focus is reducing our overall expense in the next few quarters. And I’d say over the next few quarters because we are very excited about our product offerings. Now even today we said that we have just launched major new products in each of our category, and each of our key categories is up revenue year-over-year for the holiday quarter. So, I think it not be prudent for us to cut expenses and kill some of the momentum and some of the opportunities that we have. We organ with the every, that area of our business, we will look at what we can do to improve productivity and which area we can reduce expenses. I would say is product S2 stay where its strategy of gradually reducing expenses over the next few quarters. I think that the same time we have wonderful opportunities right now. The areas and categories we’re in, I think are doing extremely well in the market, where the areas of greatest excitement and a few changes of the Consumer Electronic Show, but the areas we were focused on is the hottest in years NetShow, video entertainment, MP3, portable video, video versus messaging, we just announced new products that’s supports stripe, so I think we’ve made investments in R&D and all the right areas and at the same time that we don’t want to forego momentum by pulling back too far. So I wanted to share with you that we are going to gradually pull down our expense over next few quarters and we’re going to bounce that late and maybe surely don’t miss some of the key opportunities going forward. I know, I’m sure of the absolute dollar what we are targeting, but I think as you’ve seen Creative in the past or we’re able to manage expenses very well to our target and I think if you look at us by the end of the calendar year, you’ll see fairly substantial reduction in year-over-year operating expenses Jim.

Q - Jim Red

Alright, a year off from now how, how should we measure success, or how would you measure success to your company. You are trying on the equity now.

A - Craig McHugh

I think its, maybe as Sim will view it, I think it was appropriate, if our Chairman adds how we would measure our success…

Q - Jim Red

That’s fine I would love to hear from Sim.

A - Wong Hoo Sim

Hi Jim, great day.

Q - Jim Red

Yes sir.

A - Wong Hoo Sim

Hi, I think the, we have a lot of opportunities here at now, if you look at the MP3 category although we’re be the number one, we received a number two, our, our, our product is the best over there in term of features, quality, everything and right now we even won the consumers, gorgeousness and house keepings, so there is a huge opportunity here and we are hoping to get the market known about us, we did not thank as mush as what I will suppose to spend because of the whole market change on last year. We have to start focusing, in the past of our focusing on the March quarter market we shall undergo for second mentioned brand where we can go give the lowest cost to our product which is lower margin and in some way high risk, because of the volatility of the flash memory prices. So right now by focusing on the high end product if you look at the pricing of our Zen Vision:M we are able to price higher $330 versus the iPod at $300. We are helping to sub to, to risk on marketing position which I think right now is the, our strategy very well going forward and going forward, we had X-Fi on our account loss there, which is very well received we will put X-Fi into our portable players to high end which we can command higher margin. So all this requires investment in R&D this be a high margin either higher margin business that we are talking about. So what we wanted to do is to focus our energy all the way we focus into this kind of high margin business. And in that capability and I think we do have a lot of opportunities right now, there will be new exciting MP3 players that were planning for to come out in the, this calendar year, which will be even more exciting and that of the X-Fi and the other speakers and webcams all this represents a lot of opportunities, so these are areas that we are going to focus on. Now, we will be deemphasizing some of the business substances that you were in, in a process represents higher resale, higher cost and look at how to move from them and how to reallocate discount resources or cut the expenses there. So, this is what we measure and so a year from now I think the, the success of our product and returning to good profitability that what we have in the past would be our goal and that’s something that I’ve mentioned earlier.

Q - Jim Red

And I guess more specific for, are you planning on getting out some of the unprofitable businesses?

A - Wong Hoo Sim

I think, we will, we certainly have to deemphasize the focus and then kind of measure each business capability and before we have meet that, but at present the, it was unprofitably something that we’re going to be now carrying.

Q - Jim Red

I was actually hoping that perhaps you had to return on equity goal, I locate your numbers and I think a lot better and was looking at your next generation. And, if I go through, it doesn’t require a heck of a lot to get at 15% to 20% average return on equity. It’s 90 million to 120 million is from, calculating my numbers Wong, and you said that 300 million in operating expenses and I’m not talking about having R&D preside. I am just wondering if you make any kind of step forward that you can cut, at least million under those operating expenses absolute level. So what kind combination of operating expense reductions and, and shift to higher prices and higher incremental gross margins, could end up with the 15% to 20% recurrent in my view, but I’d like to hear that from the company and actually have a long-term goal?

A - Craig McHugh

And Jim, you want to break out specifics and the financial specialty over there, each days just mentioned early in our strategic goals looks some profitability which is expenses over the next few quarters and increasing emphasis in our higher margin products. I don’t want to take the specific goal.

Q - Jim Red

Okay. All right, thanks gentlemen.

A - Craig McHugh

Thank you.

Operator

Your next question comes from the line of John Chi (ph), UBS.

Q - John Chi

Hi good morning gentleman, I like to ask a question on your X-Fi settlements, I heard Sim mentioned about, having on that X-Fi is MP3 player or could you; you have experienced positive state or period of launch?

A - Wong Hoo Sim

We are planning to have some X-Fi, X-Fi MP3 players especially to high end on one high buyer on this year just got another year.

Q - John Chi

What’s so specifically wish to end of each quarter of this brand area?

A - Wong Hoo Sim

They won’t be, I can’t be specific.

Q - John Chi

Okay, okay, we understand the, all right. Are there any quarter book, how about the X-Fi in term of technology licensing and similar to other product categories is, towards of a managed digit of licenses.

A - Wong Hoo Sim

we are presently looking at, for the policy right now, is of course getting the X-Fi soundcard into a huge effect which is what I presume the, that is a low hanging for we guess go off the market that we are very familiar with, its streaming momentum which is good. Then after that we are looking at X-Fi into headphones and speakers, that is the next step which will be out also this calendar year and then we’ll look at the MP3 players, today our view is with that on the, all the MP3 players, especially in the Zen Vision the quality is outstanding. And you should be expected to X-Fi in these high-end players, at this calendar year. Then in terms of our technology licensing, there’s something longer because we have to do more work, we have to more put in more investment because we have separate team of people doing these kind of wireless technology licensing plus the development and house keeping so, its still a whole new market that we are not familiar with, its something that we will be looking at in the future, but we will be looking at booking X-Fi in the motherboard and so there are a quite number of interest out there that we are expecting right now.

Q - John Chi

Okay all right when you talk about DTS at low hanging fruit right now, we do have attended PC shipments, are they achieved growing, getting deemphasized from desktop to notebook so, how do you plan to compete effectively in that area?

A - Wong Hoo Sim

Well we can actually target also high end notebooks and we put X-Fi chippings in notebook, that is what we he current chip can do and the current box just what we can have; we don’t have PCI topped on the notebooks so that we come to adding cut. But going forward, the future express box will become prevalent, somewhere in next year, early next year, I would say. Then depending on the list of your operating system shipping, we will be having PC Express Solution so the PC Express Solution you can actually have an external X-Fi box to attached on to PC Express box, just plug in on the side. So that will be potential market I would adjust a noble market and I think the trend will be going that way. Well, across the more direct solution will be to target the motherboards and then push through motherboards.

Q - John Chi

Right. So you tell that as the, there’s something project continuing prospect to one of its shipping, its somewhat the motherboard need to have accretive pushing the company to offer some, to incorporate some of these solutions, am I right to further?

A - Wong Hoo Sim

Well talking to them and our interest is high out there, but to put into motherboard this time, is a long process.

Q - John Chi

Long process, so you taken that probably one of the labels which is a year?

A - Wong Hoo Sim

It can be anywhere, it can be across.

Q - John Chi

Right, okay. All right, with respect to inventories split rate 47% in finished goods was I point out, so I get exact, how much of the as the in new products?

A - Craig McHugh

Yeah, hi is Craig. Yeah, I want to make sure as though probably the finished goods is 50% and components is 47%.

Q - John Chi

All right, okay.

A - Craig McHugh

And the makeup of the inventory is very similar to our sales assured due to APD revenues were 68% that represents a fairly good step to what our inventories are. It freeze with the balance of our inventories because significant portion is in finished goods, either in transit to our regional centers our air regional centers so that’s very good and our components very pleased with our machine components, that’s I’d say it reflects the newer products.

Q - John Chi

Most of it in the newer products, right?

A - Craig McHugh

Right.

Q - John Chi

Okay and my final question is on the geographical focus realized that the Europeans have gone up quite substantially show respect intention us if you move away from America to focus on Europe and the effects of, in terms of case are you guys look at the European market?

A - Craig McHugh

We are not shifting away from the US, our US business and US partners are exceptionally strong right now, but in he holiday period, we felt in several countries Europe our flash is number one and our hard drive player has a much larger market share against our largest competitor than we do in US, so in particular our emphasis on our MP3 was in Europe in the holiday, I think it was the right call because we built our market share as many of the countries throughout Europe, with our major launch of the Zen Vision:M, we did launch in December in Europe in December in Asia and we held off till January in US, so we could build up the quantities that we need to fill the US market. So I think you’re going to see very strong emphasis on the US this year but we expect continued growth in Europe. In Europe, we have very strong sales and marketing organization, we have 12 local offices, in our local offices we actually do the sales, PR public relations in marketing locally in country. So, we have very strong localization services for products localized in 17 different languages and we support in 15 different languages in our support center in Ireland. So based on Europe, we still have end support substantial growth as well as new product category. So to say that we had a high level of success in Europe, but please don’t read into that that there’s any de-emphasis in that stage level.

Q - John Chi

Okay, thank you just one last question, does the amount of cash, you’ve said in fourth quarter of the financial year, how I read you guys being that you are going to remain profitable?

A - Craig McHugh

As we shared about 3 quarters ago, we are no longer breaking out specific financial guidance, we shared, so we’re not going to breakout what our profit goals right now, but so vital to say we’re heavily focused on profitability with higher margin as well as reducing our cost to assist in the our push to profitability. Sim, do you want to add anything to that?

A - Wong Hoo Sim

No.

A - Craig McHugh

Okay, thank you.

Q - John Chi

All right thank you.

Operator

Your next question comes from the line of (indiscernible) Citigroup.

Q

Hi there good morning everyone. But I just have a few questions here, the first one I want to ask is, in view of your aggressive product launches for the rest of this calendar year, I want to know how realistic do you think it is that you can, you are able to cut your OpEx and yet quote your revenue, because I understand they have to accretive someway, so if you can provide some guidance on this, on this you should help that will be very much useful?

A - Craig McHugh

Lu (ph) this is Craig, just as Sim mentioned, we are going to carefully look at all of our operations, all of our product areas, and all of our product categories and we’re going to focus very heavily on growing our higher products, we’re going to focus very heavily in continued use of an MP3 where I think there’s tremendous growth opportunities and we’re introducing, I think some of the most exciting products in our history but not as many products in our history. For example, our Zen Vision:M was our key launch in the period before that was the Zen MicroPhoto so you may have seen as many products but I think you’re going to see a selection of greater products more exciting products that we’ve done in the past and by reducing the shared number of products that, it goes a long rate helping us in product development cost, product launch cost, introduction cost and as Sim mentioned we’re going to very carefully look at all of our businesses and hold all of our managers and directors and kind of vote for delivering profitable businesses, improving the level of the productivity, Lu (ph) you didn’t mentioned, I believe there is excellent opportunities for increased productivity in our manufacturing facilities and our product launch processes to be able to reduce cost of shares, reduced cost for our products and also reduce some of our operating expenses, suddenly you’ll see an overall increase in our product development as far as exciting new products still we reduced a number of products, it really home in on just, just really terrific products and I am really excited to see the market reaction is sabotaged that we know is going to come out this year. And I wish you had a chance to be at CES and keep talking about it because of the reception for our product line is truly phenomenal, even this new products in the webcam space and that’s the type of generation you wanted to talk about that also highlights, part of our marching efforts is to focus very heavily on PR, getting the awards from Popular Science which is highly reputable as it was very well recognized, getting the best of CES award and actually just go to the internet and look at the number of new stories that are on the sound blaster X-Fi, the number of new stories about the Zen Vision:M, its truly outstanding.

A similar thing, we’ve really submitted our position in the marketplace as a very strong industry leader, number 2 in the MP3 space behind Apple, so I think that positioning helps us to be able to improve our marketing and market awareness without substantially raising and increasing our amounts, as Sim mentioned we didn’t spend the amount of operating spends and advertising last year as originally planned, but we still generate a lot of excitement for our products. So Nick (ph) as it look going forward, we kind of believe our managers to deliver profitable businesses, the movement away from our lowest margin or for any other unprofitable businesses or turning them around, hopefully turning them around in the profitable business in the short-term, things are going to help our operations. So I think we do feel that we can gradually reduce expenses and that’s why you didn’t hear comment like we’re going to take an apt study of operating expenses or we’re going to do anything rapidly, because we do to invest in our business opportunities, we wanted to be able to bring these products to market and improve our market position, so we reduce the expenses where we can, we’re going to focus on the higher margins and improved productivity, so I think those combined can allow us to improve our overall operating results that have been made just wholesale and cuts…

Q

Okay. Would it be fair for me to assume that the fastest and easiest way for you to cut down your April OpEx is also more?

A - Craig McHugh

Yeah, of course its…

Q

We feel that you’re outsourcing more of your predominantly operations, as one of the another alternative to use your OpEx?

A - Wong Hoo Sim

I will solve it, definitely one thing that we can see but there is double digit thought. You can outsource and you can cut the manufacturing cost but actually will be paying higher cost than with your margin will reduce. So, we have to actually have lay that difference between these two, but we are certainly exploring these opportunity now.

Q

Okay and just one last question, I’m going quickly in your, P&L statement you had one line under audit of which you have reported a loss $5 million, can you give some color with regards to this?

A - Ng Keh Long

The bulk of basis side, a change difference as….

Q

Okay. All right, thanks very much.

A - Craig McHugh

Thank you.

Operator

Again, if you would like to ask a question, please press “*” “1” on your telephone keypad. Mr. O’Shaughnessy, we have no questions at this time.

Phil O’Shaughnessy, Senior Director of Corporate Communication

Okay, on behalf of Creative and all folks in Asia and US thank you very much for joining us this evening and this morning and Happy New Year to everyone. Thank you.

Sim Wong Hoo, Creative’s Chairman and Chief Executive Officer

Thank you and Happy New Year.

Operator

This concludes today’s Creative Technology Q2 fiscal year 2006 earnings conference call. You may now disconnect.

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Source: Creative Technology F2Q06 (Qtr Ending Dec 31, 2005) Earnings Conference Call Transcript (CREAF)

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