5000 CTP Devices and What to Do With Printcafe?: Summary of Creo's Q2 2003 Earnings Call By Gail Kailing May 12, 2003 - Creo Inc. (NASDAQ:CREO, TSX:CRE) reported Second Quarter Fiscal 2003 financial results, in US dollars, for the quarter ended March 31st, 2003. For the second quarter 2003, Creo's revenue was $141.5 million, up 9% from $130.1 million in same period last year, and down from $142.8 million in the previous quarter. Gross margins increased to 45% this quarter and net operating expenses were $62.4 million. The company recorded a loss of $1.2 million or $0.02 per share this quarter compared to a loss of $17.1 million or $0.35 per share last year and net income of $1.5 million or $0.03 per diluted share in the previous quarter. Cash and cash equivalents were $62.3 million at the end of the quarter. For the six-month period ended March 31, 2003, Creo's revenue was $284.2 million, up 5% from $269.6 million the same period last year. Earnings were $0.3 million or $0.01 per diluted share for the six-month period compared to a loss of $22.1 million or $0.45 per share for the prior year. Topics include: * Market Summary * Financial Summary and Guidance * Outlook * Q & A Market Summary "We will do what is necessary to make the business successful," said Mr. Amos Michelson, CEO, of Creo. While he stated that he was not pleased with the quarter's financial results, they performed as expected. The US economy has impacted results and though it appears the market is optimistic, there is no increased activity as yet. During the quarter, Creo shipped its 5000th CTP system and now has in place more than one-third of all CTP devices installed. For the first time the EMEA (Europe, Middle East, Africa) segment has surpassed the Americas in revenues. The 8-page and large format markets are doing well in Europe. The Asia-Pacific market is good. Japan has new strength. Creo management is watching the SARS impact and has implemented some internal controls, but overall there has been only a small effect on business. As far as the attempt to acquire Printcafe: Creo did feel at the time that there was opportunity in the acquisition. However at the current bid price, the economic opportunity is no longer there. Creo will continue to pursue its plans to interface with multiple print management systems. Financial Summary Mr. Mark Dance, CFO/COO, provided the financial summary and guidance for next quarter. Revenues were up 9% in the quarter over last year. While product revenues declined, service revenues increased 7.1%. Gross margins were 45% up from 42% from the same quarter last year. Revenue from the Americas was $55 million, topped by $56 million (up 13%) in EMEA. Asia Pacific revenues of $16.3 million were up 25% over the same period last year. While the OEM segment showed improvements in Xerox revenue, the total of $14.1 million was down 13% from last quarter and down 18% from the previous year. Increased expenses resulted from (1) restoration of salaries to market rates, (2) currency exchange effects of $5 million, (3) restructuring costs of $2.1 million resulting from consolidating operations in the Americas and moving facilities to Vancouver BC, and (4) other increased costs. Day Sales Outstanding (DSO) improved from 83 days to 77 days and actual inventories are stable. Any apparent increase in inventory is due to changing exchange rates. Printcafe effects Creo recorded a non-cash loss of $2.3 million due to increased ownership in Printcafe (NASDAQ: PCAF). If Creo does tender its Printcafe shares it would benefit from an influx in cash. Tendering its shares would also accelerate any debt owed by Printcafe. Guidance The outlook for the remainder of 2003 is positive. The company has experienced a downturn in orders in the Americas and has felt some small impact due to SARS. Creo is projecting third quarter revenues of $135-140 million, significantly above last year. The last quarter should return to levels similar to the first two quarters of the year. Creo will continue to manage prudently and reduce expenses to keep the run rate to $60 million or less per quarter. GAAP earnings are projected to fall between -2 and 3 cents per share. Outlook There remains concern about the world economy. No sign of a turn around in the US is balanced by the company's advantages in Europe - a strong support network and popular products. The proofing products provide a differentiator for the CTP devices. More than 600 have been installed, generating ongoing revenue from proofing consumables. Creo can now offer both DuPont and Fuji consumable bundles. The introduction of the Varis product is progressing and will have some small impact in the last quarter. The roll out will ramp up over the next couple of quarters. The Varis product is based on new technology that will form the basis for the development of new products. Trapping and color management introduced for the Prinergy systems will ultimately reduce the cost of goods sold and make the systems more competitive. In a changing competitive landscape, Creo is looking to establish Stacatto as a world standard. Stacatto is taking off and print customers are resetting their expectations for print quality. Being able to offer photo quality for commercial print is becoming a competitive differentiator for print service providers. In a market that has traditionally emphasized speed over quality; the newspaper market is now accepting Stacatto. The newspaper team closed a ten-device/five-site deal to produce auto trade publications using Stacatto. The Networked Graphic Production (NGP) initiative to unite all functions digitally is getting positive reactions from customers. NGP is the next logical step from CTP. It is not a product or set of products but a framework on which printers can build their future plans. The NGP partnership program will promote PDF/JDF standards. KBA has now joined the program, and Creo will partner with workflow systems vendors in Europe and Asia. "Creo is not waiting for economic recovery - but helping its customers to be successful now," stated Mr. Michelson. Q&A Summary 1. An increase in R&D costs came from returning salaries to market levels. Half the R&D staff is Canadian and half is Israel-based. 2. Creo believes that the potential European and North American markets are about the same size. While there is no real growth in Creo's market share in the Americas, the company is seeing increased market share in Europe. 3. Sales into the packaging segment were disappointing last quarter - weaker than hoped. No real improvement is foreseen. Creo's newspaper/packaging segment revenue is around 20% of the total. 4. The impact of the changing Canadian dollar against the US is approximately $100,000 to the bottom line for every 1-cent change in the exchange rate. 5. While Agfa is doing well in the 4-up market, Creo is focusing on the high end: 8-page and newspaper. Creo doesn't have consumables to offer the 4-up market so must focus on the high end where the contribution is from the equipment. Creo is continuing to focus on a consumables strategy to bundle consumables and machines. Pricing is improving, however the company expects to be able to compete most effectively in the 4-up market with consumables sometime in the first half of 2004. 6. When offering bundled consumables, there is a floor price given by the vendor. Creo must sell above the vendor's floor and will pull out of a deal if a competitor drops its prices below Creo's costs. The company is looking to get a floor price similar to Agfa's to be competitive. Creo is competing with equipment/consumables bundles, not equipment to equipment. There are low cost plate manufacturers coming to market with low cost thermal plates with superior performance and that will help Creo. 7. Stacatto is a key differentiator and is showing success especially in Japan and Europe. Creo is winning more sales because of Stacatto, but the slow down in the US economy has slowed down the investment in equipment. 8. Sales to smaller printers (less than $5 million) are about 30% of sales. 9. Leasing is stable - around 30% in North America and 10% in Europe. 10. Creo is willing to walk away from unprofitable deals. The company is willing to discount equipment when it can make up the difference with consumables. 11. While Creo continues to take steps to reduce costs, if revenue is at or below $140 million per quarter, the company will need to cut costs further. The company is balancing between long-term growth and short-term profit. Rather than make severe cuts now, Creo is working to bring up the revenue instead. 12. In Europe, Italy and the UK are doing well, France less so, and Germany has had the worst performance. 13. The NGP initiative provides value to printers in a number of areas. For example, increasing machine utilization from 50% to 75% because of reduced make-ready time. The industry is not growing from sales of presses to increase capacity, there are other ways be more efficient. By improving efficiency with software, a printer can improve production without having to buy a $3 million press. 14. On a global basis, the 8-up market is the most lucrative. Creo has 45-50% of the market share in North America and 25-35% in Europe. There was some decline in the 4-up market in North America last year; in Europe Creo market share is stable in the mid-teens. 15. Creo has in place strategic initiatives with Printcafe that will continue. Creo intends to connect to all Printcafe workflow systems. To connect with other vendors, the company will prioritize the opportunities because it can't be done all at once. Creo has also published a JDF interface to allow other companies to connect with Creo products.