Canon Inc (CAJ) 2002 Q3 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Imagistics International third quarter 2002 earnings release conference. Hosted by Marc Breslawsky, Chairman and Chief Executive Officer. Today's meeting will be tape recorded. Taping and rebroadcasting of this call are prohibited without expressed permission of Imagistics. After the initial remarks there will be a question and answer session.

During this meeting, Imagistics management will make comments that constitutes forward-looking statements within the meaning of the Private Securities Litagation Reform Act of 1995. Forward-looking are statements based on assumptions and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause actual results to differ materially is included in the company's 2001 form 10-k and other filings. The company does not intend to update any forward-looking statements made during this meeting. At this time I'd like to turn the meeting over to Mr. Marc Breslawsky, Chairman and Chief Executive Officer. Mr. Breslawsky, you may begin.

Good morning, ladies and gentlemen. And thank you for joining us for our third quarter earnings conference call. I have with me this morning Joseph Skrzypczak, our Chief Financial Officer, Matt Gifford, our Vice President of Product Development and Marketing, and Chuck Wessendorf, our Vice President of Corporate Communications and Investor Relations. First, I'd like to speak briefly about our third quarter results as well as the progress that we've made in executing our strategic business model. Then I'd like to have Joe cover some of the details of our results and our outlook. We'll then devote the rest of the time to addressing your questions.

I'm going to start by assuming that you've all had the opportunity to read our earnings announcements along with the financial schedule that we have released early this morning. This is our third consecutive quarter as a newly public company with our operating and financial results clearly on track. I believe our results are a strong indication of our ability to execute against our strategic business plan and achieve strong earnings growth despite a slow economy. This was another excellent quarter for Imagistics. Earnings as you've seen, were 22 cents per share compared with one cent per share for the same period last year. In the third quarter we generated $22 million of free cash flow. And as a result, we were able to reduce our debt and also buy back our stock while maintaining a strong cash position. I'm particularly pleased with the improving quarterly trends this year in copier sales and copier rental revenue.

Although our third quarter revenue declined 1%, they are in line and consistent with our previous projections. Again, our focus for this year and next year is on improving the profitability of our revenue generation. Despite a weaker economy and declining revenues from our facsimile product line, we have still been able to maintain our total revenues at a level that is just slightly lower than last year. Revenues in the short-term have been and will continue to be impacted by our disciplined focus on improving profit margins. Clearly again this quarter there was business that we just didn't take because it didn't meet our profitability criteria.

Our focus is to profitably build our copier rental business while we allow Imagistics to sustain a higher level of recurring revenue.

Revenues have also been impacted by some diversion from sales to rentals. Reflecting our strategic emphasis on renting rather than selling our copiers and multifunctional products with service contracts. As a result of these actions, we are seeing stronger sales margins exclusive of the impact from sales to Pitney Bowes Canada.

In addition, our rental margins are improving as well. Improvements in our rental gross margins, highest service contract revenues, and lower selling service and administrative expenses enabled us to report earnings of 22 cents per share compared with earnings of 1 cent per share last year. During the quarter we continued to generate strong cash flows.

In the quarter, we produced $22 million of free cash flow, allowing us to reduce our debt by an additional $8 million, down to $74 million. And also to buy back $17.5 million of our stock. We completed the initial $30 million stock buyback program authorized last March. And our board recently increased the total buyback authorization to $58 million. We have a consistent, established customer base with a strong, dependable recurring revenue stream. We continue to make substantial investment in rental assets to sustain our higher levels of recurring revenue.

In the third quarter this recurring revenue stream consisting of rentals, supply sales, and service rentals was 75% of our total revenues. Our operational and financial results so far this year represent significant progress to our goal of becoming a leading independent provider of enterprise office imaging and document solutions. We believe the market opportunities for Imagistics products and solutions both in the United States and elsewhere continue to be significant.

Our office document imaging market in the United States alone is expected to grow to $34 billion by 2006. That's the marketplace that we're in today. I continue to believe that the combination of our best of breed product sourcing strategy, our highly respected direct sales force, which, by the way, was recently named the 10th best sales force in the United States by "Selling Power" magazine and also our national service network provides an unparallelled opportunity for to us satisfy our customer's documenting and imaging requirements.

To capitalize on that opportunity our major brand awareness campaign, which is currently running using television, radio, and print ads in major financial publications and trade magazines, highlighting the dependability of our products, reinforcing our commitment to customer service and support. And this also brings a major focus to our national sales and marketing efforts.

I hope you've been seeing our ads on television, listening to them on the radio, and observing them in "The Wall Street Journal", "Business Week", and "Forbes" magazine along with many other magazines. We'll spend close to $10 million this year on our advertising campaign. We believe we have a unique strategic business model. And we are absolutely focused on executing on that model. We'll continue our focus on improving the profitability of our revenue generation and have implemented many actions to improve the profitability of our revenue generation. Amongst these actions have been changes in our sales force compensation, pricing structures, and terms and conditions of customer contracts. All resulting in higher growth margins.

At this time we are fine-tuning our outlook for the full year 2002. Diluted earnings per share we are projecting to be 86 cents per share, which is above our previous guidance that we had given you all of 81 to 85 cents per share. For 2003, we are establishing an additional outlook of $1 to $1.05 per share. We also expect significant growth in earnings per share in 2004 and beyond. We believe we are very well positioned for the future. We're confident in our products and solutions, our people, and also our ability to generate significant shareholder value. Now what I'd like to do is turn this over to Joe Skrzypczak for further comments on our financial results and outlook. Joe?

Thank you, Marc. Good morning, ladies and gentlemen. I would like to provide some further comment on our third quarter results. Our reported revenue for the third quarter declined 1% compared with the prior year. But on the compareable basis, excluding sales of equipment and supplies to Pitney Bowes Canada, our revenues declined 4% in the quarter.

As mentioned before, as part of our spinnoff from Pitney Bowes we entered into a reseller agreement with Pitney Bowes Canada, under which Pitney Bowes Canada sources copier and facsimile products from Imagistics. Accordingly, under our reseller agreement with Pitney Bowes Canada revenues are recorded as external sales this year rather than intercompany transfers.

Total copier sales and copier rental revenues continued their improving quarterly trends this year and for our core business excluding sales to Pitney Bowes Canada who order from us to fulfill their sales of our products our total third quarter revenues represented the highest quarterly revenue this year. Sales revenue, excluding sales to Pitney Bowes Canada, declined 9% versus last year. Copier sales continued their gradually improving trend quarter by quarter this year but declined 8% compared with last year. Fax sales were down 12% reflecting declines in equipment and supply sales. The sales declines are largely the result of our strategic focus on renting rather than selling copiers and multifunctional products to large national accounts. Clearly, a rental brings in significantly less revenue in the current period than a sale contract.

As Marc mentioned, our revenue results are also a function of our disciplined focus on improving profit margins which means that currently on a go-forward basis we're not going to take business that doesn't meet our profitability criteria. Total rental revenue declined 1% from last year. Consistent with our strategy, copier rental revenue increased 13% as our newer, higher end digital products continue to do well in the marketplace. Fax rental revenues declined 9%, reflecting, as expected, lower pricing and a slightly lower rental population.

Our third quarter support service revenues from service contracts increased 6% from last year year which was primarily the result of higher contract pricing, associated with changing product mix. Our third quarter sales growth margin, excluding the sales to Pitney Bowes Canada, improved 1.8 percentage points from the third quarter last year and was primarily attributable to the emphasis on improving margins, lower product costs, and lower provisions for obsolete inventory. These favorable items were partially offset by an increase in the mix of our copier and multifunctional product sales which have a lower gross margin than facsimile sales.

We are also continuing to make good progress on our objective on improving our rental gross margin despite an increase in the mix of copier rentals which have a lower gross margin than fax rentals. Our rental gross margin of 63.9% improved 4.1 percentage points compared with last year. The improvement was primarily attributable to profitibility emphasis on rental contracts and lower product costs. This was partially offset by the impact of the changing mix towards lower margin copier rentals rather than fax rentals. Our selling service and administrative expenses declined $4 million or 5% in the quarter and represented 50.4% of revenues compared to 52.2% last year.

The year-over-year improvement is primarily driven by lower bad debt write-offs, the impact of lower employee levels, and the absence of severance charges incurred last year. These improvements were partially offset by advertising expenses associated with our major brand awareness campaign and our investment in our ERP program.

As Marc mentioned, we expect to spend close to $10 million on our advertising campaign this year and our total stand alone expenses this year will be about $26 million compared with $13 million for the 2001 full year. Our third quarter investment in the Enterprise Resourse Plan System, or ERP, was approximately $7 million, which $3 million was expensed and $4 million was capitalized. The ERP project is now in full swing. We have completed phase one and have started phase two. The project was intiated in the latter part of last year, and is designed to improve our long-term operational efficiency and provide higher levels of customer service and support. Our ERP investment represents an investment of over $50 million.

While we continue to make investments in our rental assets---our rental asset base to sustain a high level of recurring revenue, invest in our ERP project, invest in our brand awareness campaign as well as incur additional costs to establish us as a separate legal entity, we continue to generate strong free cash flow. Free cash flow total $22 million in the third quarter and $79 million for the first nine months of this year. During the third quarter we reduced our debt by an additional $8 million to $74 million. As Marc mentioned in September, we also completed the initial $30 million stock buyback program authorized in March and our board increased the total authorization to $58 million.

During the third quarter we bought back 917,000 shares for a total value of $17.5 million. Our share repurchases since the stock program began in March have totalled 1.6 million shares for a total value of $30 million. We have fine tuned a 2002 full-year estimate to approximately 86 cents per share. As you are aware, the last guidance we gave projected full-year 2002 EPS to be between 81 and 85 cents. Our initial outlook for 2003 is for earnings to be approximately $1 to $1.05 per share.

Our financial model assumptions for next year include flat revenues, a modest increase in gross margins, and a slight increase in SS and A expense as a percent of revenue, mostly driven by additional ERP implementation costs and training. Despite the weaker economy, we are confident that we will continue to deliver good earnings growth and increase shareholder value. Now I'd like to turn it back to Marc.

Thank you very much, Joe. Now what I'd like to do is take your questions. I understand we've had a little feedback on the line it sounds like it's gone right now. But why don't we open the floor up for questions.

Thank you. We will now begin the question and answer session. If you have a question, you will need to push the one on your touchtone phone. You will hear an acknowledgement that you've been placed in queue. If your question has been answered and you wish to be removed from the queue, please press the pound sign if you're using a speaker phone, pick up the hand set before pressing the numbers. Once again if there are any questions, press the one on your touchtone phone. One moment. Our first question today from Brett Faracall(ph) from Performance Capital. Please go ahead.

Is $10 million in advertising spending a normal number per year or just introducing the brand?

I don't believe there's a normal number to have we're trying to determine what we'll spend next year on advertising. But companies spend from zero to probably $25 million in our industry on advertising. It's very dependent upon the economy and upon if you have a new product introduction. So I can't give you a normal number.

Ok. And just touching on 04 as the ERP plan and some other double spending runs off. How much--can you give any color on what you would expect to pick up in '04?

Well, this is Joseph Skrzypczak. We spent or expensed in the first quarter about $3 million. I'm sorry. In the first and second quarter. And approximately $3 million -- I'm sorry. $2 million in the first quarter, $2 million in the second quarter, and about $3 million in the third quarter. We expect that to continue on throughout all of next year and probably go into the beginning of 2004 also.

Okay, thank you.

Our next question from Herb Hart with [INAUDIBLE]. Please go ahead.

Good morning.

Good morning.

You had mentioned late last year as you were training salesmen, ones who had been only selling faxes and going over to copiers and vice versa, that this was a project that would take a while. Can you give us a sense of how the efficiency in that cross training has gone?

Yes. The efficiency has improved quite a bit. People are trained consistently. We have training actually in their offices once a week. So they become better and better with copiers. Their comfort level is much greater. They have closed some big accounts. The commercial organization, which deals with mid-sized businesses, their productivity is improving also. This is moving in the right direction.

The people who'd been selling fax for a long, long time, as I had previously mentioned, were certainly the best in the industry. There were no finer people in the industry. When we added another new major product line to them, obviously they had the customer contacts but didn't have the copier experience. They've been getting that experience. I've seen them in action personally. And they've -- they're just getting better and better at it. I would still say in the copier area I wouldn't consider them to be yet "A" players, in fax they are definitely "A" players, in copiers they've made good progress from where they've been. I believe they will be "A" players in the future. And I believe they're moving in that direction.

But I am very satisfied overall with the progress they've been making. What has really gotten me excited -- you know how we -- I guess we always believe people who work for us could do a better job. I think everybody does that. And everybody is more and more demanding. But it seemed great when in fact, this organization was rated as one of the top 10 in the United States. That gave me a lot of confidence about the organization's ability to be stretched further and further.

The other question I had was you made no comment about England. And I know there were some longer term plans about establishing a broader base there and on to the continent. Can you give us some sort an update on that?

Our UK operation has shown good profit growth versus last year. Last year actually we had a lost -- a loss. But we're see going profit growth. We are on track to launch copiers in the first quarter of next year in our UK operation. We have already told the sales force about it, training is going on now. And product ordering is taking place also. So we should be recording revenues for copiers in the UK starting in the first quarter.

Thank you.

You're welcome.

Our next question from Lloyd [Zytman](ph) from Bernstein Investment Research. Please go ahead.

Good morning, folks. Marc, just let me say, I enjoyed that article on you in the Wall Street --

Thank you. Thank you very much.

You're welcome. A couple of things here. First of all, on the rental side. It looks like we have this essentially imbalance between the fax side and copier side which we've been seeing for a while now. Is it essentially just the fact that faxes are down, installations are down, pricing is down, copier is growing? Could you talk about copier pricing? And also, is there any impact from the fact that interest rates on year to year bases are a good bit lower than they were?

I'll let Joe talk about the interest rate. On the rental area, fax simply, as you've said, it's accurate. Volumes on fax simply are going down in usage. A big part of our revenue, supply revenue, that is going down. Customers are using machines less. They have fewer machines. And there is some pricing pressures in the area. And we had said from launch this is exactly what we've anticipated. And we've been seeing that. We have not been losing -- we have not been losing market share. Have not been losing to anybody else.

The copier market, our rental revenue being up 13% in copiers. I believe we're growing much faster than the rest of the market is. When you look at other public companies reporting, copier revenue, I don't think you're seeing growth in copier revenue as we are seeing. We're up 13%. There hasn't been a major amount of pressure on pricing at all here. So I wouldn't say it's held back our pricing.

Again what I believe happened in the copier industry is many of the companies over the past three or four years hurt themselves badly by cutting pricing on copiers fairly significantly. And I think you're seeing less and less of that generally in the industry. It's not that there isn't pressure on copier pricing. There always is it's not that we don't lose business on pricing because we do in many, many occasions. But I would say today people become more demanding. We charge for what we do. We do an excellent job at providing the best of breed copiers. We do an excellent job at providing service and connecting the products to our customers' network. And our expectations when we negotiate a contract is you know, the customers we're looking for are those that want the products and services and are willing to pay for those.

And Lloyd, as far as interest is concerned, the recent changes in interest is really -- have not really had an impact on Imagistics. As you know when we spun off our credit facility required Imagistics to take interest protection out on 50% of its term loans. We've done a very good job in reducing our debt levels. And we're almost down to that level. So really the change in our interest expense has really been a function of just lowering our debt levels.

What about in terms of rental pricing? And the reduction in rates?

The rental pricing we've seen hold pretty consistent. Throughout the year. We haven't seen major changes in rental pricing.

Ok. And ---could you---let's see, just a couple more things. Could you talk about supplies? And consumeables overall? How have those revenues held up? Could you give us some guidance on that?

One of the things that we're seeing, Lloyd is from our facsimile basis, lower supply revenue. What is happening there is that our base---even though our base is slipping a little bit as far as people pulling the fax units out from our rental base, what we're finding is that people are using the fax machines less and less in the avent of email and other printers. So our supplies revenues have been effected by that and that's actually hurting our total sales line.

But that was something again that's been in it our business plan.

Right, and what about supplies, sales overall? Are they up year to year for the three and nine months? Could you give us some numbers possibly on that?

Total supply sales for the quarter were basically flat.

Ok. And let's see. Could you run through the '03 expectations again? I have essentially flat overall revenues, cost of rentals coming down, and SS and A going up as a percentage of revenues?

Slightly. Our projections are more or less that we'll have significant improvement on the profitability of our revenue generation. Although there'll be a change. We feel [fax simply] will continue to slide. We do expect growth in copier with the net flat revenue projection. Overall we believe margins will improve as we again focus on getting stronger margins, improving our profitability, enforcing a stronger discipline towards our sales approach, as well as lowering our overal product costs.

Okay, and in terms of SS and A, that will be up a little bit, as you mentioned, because of ERP? And is there anything else essentially then? Have you gotten well below hanging [INAUDIBLE] on the SG and A side?

Well, right now actually there's a change that's happening within our SG and A as we continue to look for operational efficiencies and lower our overall costs. We are making investments in certain areas such as brand awareness and ERP.

The core areas we continue to make improvements in. That never stops. But the areas, you know, putting more efforts into ERP in 2003 increases our costs. The training, heavier training of people in 2003, increases our costs also. So we would expect that probably to be the key area where costs would go up in 2003. Again, but knowing that and knowing the advertising of getting an idea on the advertising that we would spend, we still feel very comfortable that the improvement in productivity and in margin would allow us to deliver this estimated earnings per share that we have talked about.

Okay, thanks very much.

Our next question is from Chuck Witmer(ph) with Eagle Capital. Pleas go ahead.

This is Meryl Nice quarter.

Thank you, Meryl.

Thank you. And just -- I don't know. Did you give the dollar amount spent in the quarter on advertising?

We haven't broken out by quarter. What we're saying is for the full year we'll hit approximately $10 million.

And is it--I actually noticed quite a few advertisements. Would this be certainly a quarter of that?

It was the third quarter was definitely the highest quarter of the year for advertising.

Ok. And then on the ERP spending. You said that you expensed $3 million. How much hit the cap spending line?

$4 million. Total cash outlay was $7 million for the quarter.

Okay.

$4 million was capitalized. $3 was expensed.

Okay.

We're really governed by the accounting rules as to what needs to be capitalized and what needs to be expensed.

Okay, and then last quart he, that $7 million was $5 million.

Yes, that's right.

Ok. And just--once you're through the whole ERP, which I think you said the cost of it is about $50 million, will that generate sort of a return on the money you've put into it? Or is that something that just needed to be done to get that whole part of the business up to snuff?

It had to be done for a number of reasons. Number one, we were on and still are on Pitney Bowes's computer systems.

Um-hum.

So we don't want to stay on them. They don't want to us stay on them, okay. We have to be off of their systems and on to our own in the second place that the system that we were on of Pitney Bowes was much more focused on their customer base as it should be. Than our customer base. So our customers have unique requirements for the way they'd like to be billed. Mostly around the service costs, supply costs, operational costs per copy of a product. We needed to, you know, ERP starts out as a fairly standard system and then needs to be customized. For all of the copier components of the business, that needed to be customized. That's what we've been doing. So you know, the costs, as we've said, will be in excess of $50 million. And the difficulty with us coming up with hard numbers there is the customization, the customization cost there always seems to be moving as the requirements. That's why we say it will be in excess of $50 million. And there will probably be some overhang even into 2004. We believe we'll get benefits in 2004, but there will be some overhang onto 2004 also. We have not given what an ROI would be on that--on that investment. I think that would be difficult for us to do that at this time. But knowing it's actually a requirement of the company that we literally had to get something and we did want to fully integrated system. Itself was the driving factor here. Another driving factor, again is reducing overall G and A, SG and A costs.

Right, I know that's a huge focus of yours. That's why I was wondering if there is some sort of return. But, I understand you don't have one yet.

There will be a return. I'm not sure we're prepared to say what it is with any degree of accuracy today.

Meryl, there's another point also to be made as we get off Pitney Bowes's systems, we will not be required to pay for them. Today we are incurring the costs of implementing a new system while at the same time paying Pitney Bowes to stay on their Legacy systems.

And is that public what that amount is? Does anyone have a rough number?

We haven't disclosed the exact number. But it's in excess of $5 million.

Ok. Thank you very much.

I have a couple questions, if I could. What's your capital expenditures plan for this year and for next year total? Has that come down at all? And also, the actual shares outstanding. And then the final question, I got put off the call for one second. But if you continue to expect the sales force to continue to improve the gross margins?

Let me talk to the gross margins. I'll turn the Cap Ex question over to Joe. We anticipate gross margins will still improve. We've made a pretty dramatic improvement this year. We would expect through our disciplined approach that margins would continue to improve. Margins are two-sided anyway. The sales organization is one portion of it. The mix of products is another portion. Which I guess I still feel put under sales organizations, not necessarily the prices you get. But the third portion is our ability to continue to negotiate prices with the many suppliers that we have on the products. There's always a focus on that also. We continue to do business with more and more companies. We continue to be more and more attractive to all manufacturers. And I think anyone that you talk to would tell you from a manufacturing point of view that we have a strong focus on margins.

As far as the capital expenditures are concerned, Chuck, basically we spent about $17.6 million in the second quarter. And that went up to about $21.2 million in the third quarter. Mostly driven by an increased capitalization of ERP, or additional ERP spend. What we continue to spend in fixed assets is our investment in rental revenue which allows to us have a recurring revenue stream as high as 75%. In the second quarter we spent about $14 million in the investment and rentals. And in third quarter, it was exactly around the same, about $14 million also.

What do you expect for the fourth quarter and then for next year in the total Cap Ex?

We haven't given any projections for next year in Cap Ex. But I would think in the fourth quarter you will see similar types of expenditures.

Okay, and then what is your--

As far as number of shares outstanding, we started off at 19.5 million when we [spun]. And we bought back 1.6 million so far.

Okay, thank you. And congratulation on a good quarter.

Thank you very much.

Our next question comes from Stanley Bogan(ph) with Bernstein Investment Research. Please go ahead.

Hi, Marc.

Hi, Stanley.

Chuck, I've never met you. But how do you do? Question has to do with rental revenues. I notice that your depreciation amortization for the nine months was $60 million, I mean, thats five times your net income. And that your expenditures for fixed assets were less, $53 million, which was quite unusual for a company that's aggressive in growing. My question, what's your depreciation policy on your rentals? And residual values over how many years?

Okay, Stanley, basically, it's pretty straight forward. Facsimile products are deappreciated on a straight line basis over five years. We book no residuals at all. As far as copiers are concerned, we deappreciatite them over three years and again with no residuals booked associated with those.

Could you tell me why your depreciation amortization was $60 million or $3 a share?

It's really accumulation of our overall business over the last five years basically. All of the products that we have launched out there and what the depreciation is scheduled out. And those are the depreciation numbers.

Of course, in the relation to the amount of rental revenue, the number is a fairly low number. As we put new rental assets on the market, what we continue to do is buy them at much lower costs than the original assets that we bought. So we get a positive cash impact.

Now why is that?

Just a---we've been able to negotiate better and better prices with the manufacturer. They believe we are becoming a stronger and stronger factor in this marketplace. We're able to negotiate better---we're able to negotiate better prices with them. So what goes on the balance sheet as rental assets is a lot less than what used to go on the balance sheet as rental assets in the past. And again the depreciation policy with a three-year and five-year depreciation policy. They come off fairly quickly and we leave, as Joe said no residual value at all on the efforts.

Do they have any value?

Yeah. They do have a value. I think we're conservative in our policy. So what we do at the end of the periods, typically is we have programs selling used equipment. So at the end of three years if we sold the fax machine, it would have zero costs so it would be 100% margin if it were used or it might have a slight cost or if we sold a copier after the fax machine would be after five years that it has no costs. Copier after three years that it has no costs in copier, what we will typically do quite often is refurbish the machine so the cost associated with the machine would be a refurbishing cost. The margin, nevertheless, would be typically very good on used equipment. In total, the margins on used equipment are stronger than they would be on new equipment.

And in our sales comp plans, they've been geared towards emphasizing renewals also. It's very beneficial. We get a higher yield on that initial cash outlay for that rental asset. If we can establish a renewal for an extra 12 months or so.

So if a customer does renew, we do not recapitalize the equipment again. But we basically the end of the three years, in a copier, if they renew it for another year or two years, we then have zero depreciation associated with that copier.

Can I assume you have reduced costs if it's used equipment? Reduced selling price or rental price?

Yeah, absolutely, absolutely. If we sell rental equipment, it's a reduced -- it's a reduced price. Also, the service cost on that product would be slightly higher than it would be on a new piece of equipment.

Okay, thank you.

The overall economics on used equipment is very good for us.

You seem to have a building margin developing here.

Well, one of the strategies is to improve the margin. We have to price the products competitively. So the way we manage that asset base is very, very critical to our overall success in this business.

Thank you very much.

You're welcome.

Our next question comes from Brian Alexander with Raymond James. Please go ahead.

Thanks, just a couple of questions. One in your guidance for flat revenues next year. Would you care to give us a sense for how you're thinking about copier versus fax? And then also your comment earlier on the shift, the paradigm shift, if you will from sales to rentals. Is that something you would say is company specific or industry wide? Is it applicable to both copiers and fax? And what are the key drivers of that shift?

It's company specific, okay. In fact, we've always done that. We've grown the business and now are the leader in the marketplace through a very, very strong and solid rental base combined with very high customer satisfaction. In the copier marketplace, it's a shift. We've given much more focus to the rental business, and that's why the rental business this quarter again was up 13%. It has been very strong and growing all year. So this is something -- we believe we provide the customer with greater value by renting.

The costs on the rental, you know, they pay a combination cost to customer which includes service and supply and the rental--and the rental of the asset. It's something that we believe we sell very effectively to large corporations. Some large corporations will only rent so those focusing on the large corporations, that would be specific, say, to major accounts. But not to all companies. All companies don't do that. We probably as a company have the greatest mix of rental to sale on the marketplace. The economics on rental on the long-term basis are very good.

On the short-term basis, if we took all of our rentals and converted them to sale, we would have much more revenue on a short-term basis and much more profitability on a short-term basis. But again, our focus here is, as we said, to build a long-term recurring revenue stream. When you're going to a poor economy, if you have recurring revenue, it doesn't make your recession resistent. Recession-proof. But it certainly allows you to hold up better in a weaker economy. It's probably a more conservative approach that we take to the marketplace.

And then guidance for next year? Any comments on what your expectation are?

Expectations are facts we'll continue to decline in rental revenue. Copier rental revenue will increase. But, we haven't got to the point where we are specific with each component of revenue. We let all you figure that out.

Thank you.

Our next question comes from John Freedland(ph) from Porter Feldman. Please go ahead.

Hi, I have a couple of questions. First, could you talk about the average length of rental for a fax, and for a copier machine? Secondly, I was hoping you could comment on the balance sheet in particular working capital. How--to what extent you're done squeezing out working capital or to what extent there's more room. And finally, with regard to this SS and A, could you just go over how we ought to think about this as we look back to 1998 and 1999? Clearly it was in the mid to high 30s as a percentage of sales. And is that something we ought to be thinking is obtainable a few years out as this ERP process concludes?

There's a lot of parts to the question. I'll answer some, let Joe answers others. Okay. On the rental lives of the contracts, there's two things. There's the original contract, and then there's how long the equipment stays out. Ok? Those are two different things. So you can sign typical contracts, typically run three years. Ok? Typical length of time that equipment will stay out, in fax, it's been about five years. It's been I think slightly over five years, the average fax machine will stay out on rental. The average copier is I think about 40-42 months. I believe it's somewhere -- did copy contracts for a three-year period. But again, they do -- a number of them get extended also. So there's depreciation. We haven't gotten caught having to write off, you know, assets because of depreciation life is too long on them, okay. I think again in general, in copier industry, companies typically write copiers off over three to four, perhaps five years in the upper segments I think that's what most of our competitors would do.

In fact, there's probably no general. Because we by far dominate the rental market in fact. I'm not sure if anybody has any significant rental business. In fact -- in facsimile other than us. So I'm not sure there's any industry practice there. We've been depreciating fax over a five-year period for as long as I can remember. We did it at Pitney Bowes also.

So it goes back years and years and years. Years ago, copiers, they depreciated five years also. But that didn't seem to make a lot of sense. And even in Pitney Bowes, we changed that policy. Probably over 10 -- about 10 years ago is my guess, to 2 or 3 LI's. So we've been consistent on the life. We're doing the same life now we've done at Pitney Bowes. We've also been consistent in having no residual value on the equipment. So a lot of people also can say, you know, I would -- you know, it's ok to do it over three years, but obviously -- five years. But obviously the equipment is worth something.

And have those periods of time been pretty stable that the equipment stays with the customer?

Yeah we haven't -- we have not seen a lot of changes within that area. We haven't seen that at all. And it could be that customer or it could be marketing it to a different customer. It's not always the same customer. That we would market it to.

Ok.

As far as your question about the balance sheet, we have made very good improvements in working capital as you've seen in our cash flow statements. Our day sales outstanding has declined from year end by 57 days to approximately 52 days at the end of the third quarter. Our inventory turns are around two turns at the end of last year and at the end of September. Obviously we believe as a distribution company those inventory turns. There's room for improvement. And we are focused in on that objective.

Ok. The third question was -- I'm forgetting now.

Your final question was on the levels of SS and A, can we get back to the levels of four or five years ago. Some of the things we didn't have in those. Remember, we're an independent company today. A lot of those levels, the things, the investor relations types of things, having our own collections people, the advertising, things like that. The legal department. They were never -- they were not part of our business then.

So we believe they can be a lot better than they are today. They can be a lot better than they are today. So our typical long-term guidance is continued improvement in this area. But I think it would be probably unrealistic to say they get back to the exact same levels of that point in time.

Our additional stand alone costs have increased by $26 million per full-year basis. That's exclusive of advertising. And again, as Marc alluded to that includes things like a tax department and setting up all the financial reporting that is required by the SEC, that sort of thing so those costs will stay, obviously.

But in the areas of improved productivity, we would expect to continue. We'd expect to get more productivity out of service people. Higher productivity out of our sales organization as they become better. And better trained. After ERP is in place, lowering of the administrative activity. We have a huge number of administrative people which probably will go up as we implement ERP, but then in the long-term basis we would expect that to drop. So there's offsets, but it would be very difficult for us to project an exact number going out. We know there's a lot of room from where we are now.

Thanks so much, guys.

You're welcome.

Our next question from Matt Tupowitz(ph) from Quaker Capital management. Please go ahead.

Sure, I have a few questions. Maybe I'll just give you a couple at a time. On the earnings projection laid out for '03, what's the share count assumed in that number and what tax rate?

We're assuming a flat tax rate at this point. We have not actually given any kind of guidance as to how many shares we'll have outstanding at that time. A lot of it is dependent upon really our share price, too. That will impact the dilution calculation. But we have not given guidance on that.

Ok. So, I guess it's fair to assume then that number doesn't assume you buy any further shares for now? You're not really saying?

I don't think we're giving that detail at this point in time.

Ok.

This is our first shot at guidance for 2003.

I only asked because obviously you had to make some assumptions to get there. But anyway did the company buy any further shares during Q4 as part of the further authorization?

We have not purchased any shares as of yet.

Ok. I believe you broke out the Cap Ex numbers that are attributable to your rental assets at being roughly $14 in Q2 and Q3.

That's right.

What's the depreciation amortization tied to rental assets? Do you have that?

The actual expense?

Right.

Well, most of the depreciation amortization that you see on our cash flow statement is really associated with depreciation. That would be over 90% of it.

Okay, would you say not depreciation then, of which assets? Are we talking the rental assets or--?

Yes. All rental assets.

Okay, so you're saying, roughly 90% of that number is --

It would be over 90%. Because we really don't have a lot of other assets.

Ok. And could you talk to the significant improvement in your receivable allowance. Year to date. And I wondered what the number was as of September 30.

Let me just get the number. We continuely take a look at our receivables and the allowance for [INAUDIBLE] accounts. And what we do is we actually follow a formula looking at our aging, as well as selected accounts that we feel might devalue let's say the overall value of the receivable itself. As far as the actual allowance at the end of the quarter, we are showing an allowance of about $7.1 million. At the end of September 30, 2002. Versus an allowance at the end of last year of about $6.2 million.

Do you think you're doing a better job as an independent company and assessing risk or just--?

I think -- we basically have established what we believe is a very good standard criteria to evaluate the risks associated with our portfolio. I would say we're slightly conservative.

Well good, on your rental, do you have any sense of what your overall market share is in the rental copier?

It's pretty small. Our market share is pretty small in copier. We have a huge opportunity. It's probably -- our market share in the copier market is about 3%. So there's a lot of opportunity up for growth in that business. That's why we believe this is the driving factor. Also, the marketing copier is about nine times greater than the total market is in fax, in fax we dominate the market. But it's nine times greater in copier, so that's the opportunity to take that sales organization and move them aggressively into the copier business. Should, we believe, pay some very handsome returns for us.

I believe I'm right on this. The copiers that you rent, they're rented with your name on them.

That's correct. Every product whether it's copier or fax or anything else that we sell, it's an Imagistics product. We don't manufacturer anything ourselves. We and these products, sometimes we make modifications to them, customize them, put our operating systems in. Sometimes we enhance the insides of the products, the guts to make them more reliable. Everything we sell is sold under Imagistics. So if the customers order machines say at two of different levels of speed or something and they would come from two different manufacturers, they would see Imagistics name. They would not see the manufacturers' names. In addition to that, we are relabeling the products that all say Pitney Bowes on them. When we go out and do a service call, we would then put an Imagistics label on at least the more current products we put the label on. The digital, all the digital copiers and the fax machines. So effectively the customers-- most customers know we're not manufacturers. Ok?

Ok. And the last question here. Within the a--you may have addressed this. Within your view of essentially flattish revenue for '03, any comment in terms of what your expectations are for sales revenues, rental revenues, and support service revenues?

We don't break that down. Again, we have the negative component, which is the fax side of it. The positive component in the forecast which is the copier side. We also continue to have contracts that we are servicing equipment today and selling equipment today that we still make no money on. So you'd still see the disappearance of those types of contracts also. We believe on a long-term basis we are in the a flat revenue company. We believe in a long-term basis that our revenue should grow at about 8% per year. But we know, again. We've said it. We established this last year. When we did the spinnoff, we said the focus is much more this year and next year on the quality of the revenue and not the quantity of the revenue.

Ok. And it is your expectation that you should've purged the low margin business by the end of next year or is that--?

We think by the end of next year most of that business -- probably not all of it but most of it would have gone away.

Okay, thank you.

Thank you.

Our next question from Daniel Barack(ph) from MLT. Please go ahead.

Yeah, on your press release that [INAUDIBLE] expects significant growth in earnings per share of 2004 and beyond is I guess a little bit ambiguous. What--what--I understand if you can or won't give us specifics EPS goal for 2004, but could you just perhaps give a range of what you--given-- using 2003 as a base year of $1.05, what would, say, be your three-year percentage growth kind of goal, target.

We've said in the past we expect the EPS, earnings per share to grow in excess of 20% per year.

Including the three years out beginning in 2003?

Yes.

Ok.

Once again if there are any further questions that the time, please press the one on your touchtone phone. I have a followup question with Lloyd Zytman(ph) from Bernstein Investment Research. Please go ahead.

Okay, hello again. Just a couple of things. The used equipment that you regain and refurbish and sell, is that all done in-house or do you use any third parties to sell this equipment?

We do that all in-house. We don't outsource. We've checked on outsourcing a few times. But at this point we can do it more effectively in-house.

And have you seen any noticeable changes in the market for used equipment? Is the marketplace more receptive or less receptive?

I haven't noticed any significant changes at all. I think it becomes more our focus on that. How much of our efforts we want to focus on used versus new. Things typically tie to two things. One is customers' needs. The other is sales force compensation. So you know, there's markets for both the sales people typically will look for, you know, what they get paid the best on. So we try to balance them. We don't want to sell all used equipment. We don't want to sell all new equipment. We'd like a mix.

Ok. And the support revenues. You mentioned in the release that pricing was up due to the mix, and I would imagine that's the result of copiers needing more support than faxes. Is that the sole reason for the improved pricing?

It's not the sole reason, no. It's one of the reasons but not the sole reason. Just a--again, if you think back to some of the conversations that we had when we launched the business, we just weren't monitoring very well, you know, a year ago, or nine months ago, the prices we were charging customers. We had the wrong incentives in place in our sales organization. And they would--they would go with minimum prices to customers on service. So now we've spent time focusing their attention on the cost of quality service. And we think we've also---so we've gotten benefits from our own sales organization understanding the value and that we're going to provide quality service to our customers, we have to be paid for it. So that becomes part of it also. We also compensate now sales people on the total of sales and the service combined where as before we would have compensated them on only the sales component and not the service component.

I think it's important also to note, Lloyd, as we are moving more and more up the ladder in higher segment machines, obviously those higher segment machines have higher prices for service. And that also will impact or has impact the our third quarter results.

Okay, great. Thanks very much.

Thank you, Lloyd. Are there any further questions before we close the conference?

No, sir, not at this time.

Ok. What I would like to do is reiterate with you the fact that our group is absolutely focused on the execution of the unique strateg--business model that I have previously talked about we're there. We haven't had to make any changes. Since we've started the business, I think we've anticipated the market properly, the ups and the downs on the marketplace. And I continue to feel we can take advantage of that opportunity. I hope I can meet with more of you personally as we go into the future. Both Joe and I and Chuck do a lot of investor visits to try to answer any questions that people have. We are very supportive of our shareholders and we believe both of our shareholders and us are in the same boat, committed to improved shareholder value. So thank you all for joining this very long call. And we'll speak to you all soon. Thank you.

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