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BUSINESS OVERVIEW

We are a diversified manufacturer of highly engineered industrial products. Comprised of five segments – Aerospace & Electronics, Engineered Materials, Merchandising Systems, Fluid Handling and Controls – our businesses give us a substantial presence in focused niche markets, producing sustainable returns and excess cash flow. Our products have primary application in the aerospace, defense electronics, recreational vehicle, transportation, automated merchandising, petrochemical, chemical and power generation industries.

Since our founding in 1855, when R.T. Crane resolved “to conduct my business in the strictest honesty and fairness; to avoid all deception and trickery; to deal fairly with both customers and competitors; to be liberal and just toward employees, and to put my whole mind upon the business,” we have been committed to the highest standards of business conduct.

Our strategy is to grow the earnings of niche businesses with leading market shares, acquire businesses that offer strategic fits with existing businesses, aggressively pursue operational and strategic linkages among our businesses, build a performance culture that stresses continuous improvement, continue to attract and retain a committed management team whose interests are directly aligned with those of our shareholders and maintain a focused, efficient corporate structure.

We use a comprehensive set of business processes and operational excellence tools that we call the Crane Business System to drive continuous improvement throughout our businesses. Beginning with a core value of integrity, the Crane Business System incorporates “Voice of the Customer” teachings (specific processes designed to capture our customers’ requirements), value stream analysis linking customers and suppliers with our production cells, prescriptive and uniform visual management techniques and a broad range of operational excellence tools into a disciplined strategy deployment process that drives strong financial results by focusing on continuously improving safety, quality, delivery and cost.

We employ approximately 12,000 people in North and South America, Europe, the Middle East, Asia and Australia. Revenues from outside the United States were 39.8% and 37.8% in 2008 and 2007, respectively.

Business Segments

For additional information on recent business developments and other information about us and our business, you should refer to the information set forth under the captions, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II, Item 7 of this report, as well as in Part II, Item 8 under Note 13, “Segment Information,” to the Consolidated Financial Statements for sales, operating profit and assets employed by each segment.

Aerospace & Electronics

The Aerospace & Electronics segment has two groups, the Aerospace Group and the Electronics Group. In 2008, Aircraft Electrical Power (a portion of the Eldec business) was reclassified from the Aerospace Group to the Electronics Group as part of Power Solutions. The Aerospace Group’s products are organized into the following solution sets which are designed, manufactured and sold under their respective brand names: Landing Systems (Hydro-Aire), Sensing and Utility Systems (Eldec), Fluid Management (Lear Romec) and Cabin Systems (P.L. Porter). The Electronics Group products are organized into the following solution sets: Power Solutions (Eldec, Keltec, Interpoint), Microwave Systems (Signal Technology), Electronic Manufacturing Services (General Technology) and Microelectronics (Interpoint).

The Landing Systems solution set includes aircraft brake control and anti-skid systems, including electro-hydraulic servo valves and manifolds, embedded software and rugged electronic controls, hydraulic control valves, landing gear sensors and fuel pumps as original equipment to the commercial transport, business, regional, general aviation, military and government aerospace, repair and overhaul markets. This solution set also includes similar systems for the retrofit of aircraft with improved systems as well as replacement parts for systems installed as original equipment by aircraft manufacturers. All of these solution sets are proprietary to us and are custom designed to the requirements and specifications of the aircraft manufacturer or program contractor. These systems and replacement parts are sold directly to aircraft manufacturers, Tier 1 integrators (a company who makes products specifically for one of the aircraft manufacturers), airlines, governments and aircraft maintenance and overhaul companies. Manufacturing for Hydro-Aire is located in Burbank, California.

The Sensing and Utility Systems solution set includes custom position indication and control systems, proximity sensors, pressure sensors and true mass fuel flow meters for the commercial business, regional and general aviation, military, repair and overhaul and electronics markets. These products are custom designed for specific aircraft to meet technically demanding requirements of the aerospace industry. Our Sensing and Utility Systems products are manufactured at facilities in Lynnwood, Washington; Daventry and Northants, England and Bron, France.

Our Fluid Management solution set includes lubrication and fuel pumps for aircraft and radar cooling systems for the commercial and military aerospace industries. It also includes fuel boost and transfer pumps for commuter and business aircraft. Our Fluid Management solutions are manufactured at a facility located in Elyria, Ohio.

Our Cabin Systems solution set includes motion control products for airline seating. We hold leading positions in both electromechanical actuation and hydraulic/mechanical actuation for aircraft seating, selling directly to seat manufacturers and to the airlines. Our Cabin Systems solutions are primarily manufactured in Burbank, California.

Our Power Solutions solution set includes standard and custom power converters and custom miniature (hybrid) electronic circuits for applications across various markets including commercial, space and military aerospace and fiber optics. Facilities are located in Redmond and Lynnwood, Washington; Ft. Walton Beach, Florida; Daventry, England and Kaohsiung, Taiwan.

Our Microwave Systems solution set includes sophisticated electronic radio frequency components and subsystems. These products are used in defense electronics applications that include radar, electronic warfare suites, communications systems and data links. We supply many U.S. Department of Defense prime contractors and foreign allied defense organizations with products that enable missile seekers and guidance systems, aircraft sensors for tactical and intelligence applications, surveillance and reconnaissance missions, communications and self-protect capabilities for naval vessels, sensors and communications capability on unmanned aerial systems and applications for mounted and dismounted land combat troops. Facilities are located in Beverly, Massachusetts and Chandler, Arizona.

Our Electronic Manufacturing Services solution set includes customized-contract manufacturing services and products focused on military and defense applications. Services include the assembly and testing of printed circuit boards, electromechanical devices, customized integrated systems, cables and wire harnesses. Our Electronic Manufacturing solutions are manufactured in Albuquerque, New Mexico.

Our Microelectronics solution set, headquartered in Redmond, Washington, designs, manufactures and sells custom miniature (hybrid) electronic circuits for applications in commercial, space and military aerospace, fiber optics and medical industries.

The Aerospace & Electronics segment employed approximately 3,100 people and had assets of $472 million at December 31, 2008. The order backlog totaled $418.4 million and $392.8 million at December 31, 2008 and 2007, respectively.

Engineered Materials

The Engineered Materials segment is largely comprised of the Crane Composites fiberglass-reinforced plastic panel business. The segment also includes the Polyflon business.

Crane Composites manufactures fiberglass-reinforced plastic panels for the transportation industry, in refrigerated and dry-van trailers and truck bodies, recreational vehicles (“RVs”), industrial building applications and the commercial construction industry for food processing, restaurants and supermarket applications. Crane Composites sells the majority of its products directly to trailer and recreational vehicle manufacturers and uses distributors and retailers to serve the commercial construction market. Crane Composites’ manufacturing facilities are located in Channahon and Joliet, Illinois; Jonesboro, Arkansas; Grand Junction, Tennessee; Florence and Henderson, Kentucky; Goshen, Indiana; and Alton, Hampshire, United Kingdom.

Noble Composites, Inc. (“Noble”) was acquired in September 2006 and during 2007, was integrated into Crane Composites. Noble specializes in the manufacture and sale of premium, high-gloss finished composite panels used by recreational vehicle manufacturers. Noble’s manufacturing facility is located in Goshen, Indiana. In September 2007, we acquired the composite panel business of Owens Corning, which produces high gloss fiberglass-reinforced plastic panels used by manufacturers of recreational vehicles. The acquired business was integrated into the Noble business during 2008.

Polyflon is a manufacturer of specialty components and materials, primarily microwave substrates utilized in antenna applications. Polyflon is located in Norwalk, Connecticut.

The Engineered Materials segment employed approximately 700 people and had assets of $271 million at December 31, 2008. The order backlog totaled $6.9 million and $14.8 million at December 31, 2008 and 2007, respectively.

Merchandising Systems

The Merchandising Systems segment is divided into two groups, Vending Solutions and Payment Solutions, both of which were significantly expanded in 2006 with our investment of over $200 million for the acquisitions of four complementary businesses.

Vending Solutions includes Dixie-Narco Inc. (“Dixie-Narco”) and Automatic Products International (“AP”) (two businesses we acquired in 2006), National Vendors, GPL, Stentorfield and Streamware. These businesses, which are primarily engaged in the design and manufacture of vending equipment and related solutions, create customer value through innovation, reliability, durability and reduced cost of ownership. Our products are sold to vending operators and food and beverage companies throughout the world. Vending Solutions has leading positions in both the direct and indirect distribution channels. Streamware provides vending management software to help customers operate their businesses more profitably, become more competitive and free cash for continued business investment. Major production facilities for Vending Solutions are located in St. Louis, Missouri; Williston, South Carolina and Chippenham, England.

Payment Solutions includes National Rejectors (“NRI”), which makes coin changers and validators, and two businesses acquired in 2006, Telequip Corporation (“Telequip”) and CashCode Co. Inc. (“CashCode”). With the acquisition of these two businesses, Crane is a full-line supplier of high technology payment systems products. NRI is headquartered in Buxtehude, Germany; CashCode is in Concord, Ontario, Canada and Kiev, Ukraine and Telequip is located in Salem, New Hampshire.

The Merchandising Systems segment employed approximately 1,800 people and had assets of $302 million at December 31, 2008. Order backlog totaled $23.4 million and $34.1 million at December 31, 2008 and 2007, respectively.

Fluid Handling

The Fluid Handling segment consists of the Crane Valve Group (“Valve Group”), Crane Pumps & Systems and Crane Supply. In 2007, the Valve Group aligned its business units as follows: Crane ChemPharma Flow Solutions, Crane Energy Flow Solutions, Building Services & Utilities (formerly, “Crane Group UK”) and Crane Valve Services. This alignment provides greater focus on the chemical, pharmaceutical, oil, gas, power, building services and utilities and nuclear power end markets.

The Valve Group, with manufacturing facilities in the United States as well as operations in Australia, Belgium, Canada, China, England, Finland, France, Germany, Hungary, India, Indonesia, Italy, Japan, Korea, Mexico, the Netherlands, Northern Ireland, Singapore, Slovenia, Spain, Sweden, Taiwan, United Arab Emirates and Wales, sells a wide variety of industrial and commercial valves, corrosion-resistant plastic-lined pipe, pipe fittings, couplings, connectors and actuators and provides valve testing, parts and services for the chemical processing, pharmaceutical, oil and gas, power, nuclear, mining, waste management, general industrial and commercial construction industries. Products are sold under the trade names Crane, Saunders, Jenkins, Pacific, Xomox, Krombach, DEPA, ELRO, REVO, Flowseal, Centerline, Stockham, Wask, Viking Johnson, Hattersley, Nabic, Sperryn, Wade, Rhodes, Brownall, Resistoflex and Duochek.

Friedrich Krombach GmbH & Company KG Armaturenwerke and Krombach International GmbH, (“Krombach”) were acquired in December 2008 and will be integrated into our Crane Energy Flow Solutions business unit. Krombach manufactures specialty valve flow solutions for the power, oil and gas, and chemical markets which complement our product offering in our global power and energy infrastructure business, particularly for larger diameter, highly-engineered valves. In addition to Krombach’s manufacturing and headquarters location in Germany, Krombach currently has foundry, machining and assembly facilities in Slovenia and China.

Delta Fluid Products Limited (“Delta”) was acquired in September 2008 and is being integrated into our Building Services & Utilities business unit. Delta designs and manufactures products for the natural gas and building services markets which are complementary to Crane’s Building Services & Utilities product lines. This acquisition will broaden our product offering and will strengthen our existing business. Delta’s office and manufacturing operation is located in St. Helens, England.

Crane Pumps & Systems manufactures pumps under the trade names Deming, Weinman, Burks, and Barnes. Pumps are sold to a broad customer base that includes industrial, municipal, and commercial water and wastewater, commercial heating, ventilation and air-conditioning industries and original equipment manufacturers and military applications. Crane Pumps & Systems has facilities in Piqua, Ohio; Bramalea Ontario, Canada and Zhejiang, China.

Crane Supply, a distributor of valves, fittings, piping and plumbing supplies maintains 32 distribution facilities throughout Canada.

The Fluid Handling segment employed approximately 5,700 people and had assets of $889 million at December 31, 2008. Order backlog totaled $302.7 million and $242.6 million at December 31, 2008 and 2007, respectively.

Controls

The Controls segment provides customer solutions for sensing and control applications and has special expertise in control solutions for difficult and hazardous environments. It includes five businesses: Barksdale (ride-leveling, air-suspension control valves; pressure, temperature and level sensors), Dynalco (safe instruments and controls for industrial engine monitoring and protection), Azonix (ultra-rugged computers, mobile rugged displays, measurement and control systems and intelligent data acquisition products), Crane Environmental (specialized water purification solutions), and Crane Wireless Monitoring Solutions (wireless sensor networks and covert radio products ).

The Controls segment employed approximately 500 people and had assets of $83 million at December 31, 2008. Order backlog totaled $30.5 million and $35.3 million at December 31, 2008 and 2007, respectively.

Acquisitions

We have completed 13 acquisitions since the beginning of 2004.

During 2008, we completed two acquisitions at a total cost of $79 million in cash and the assumption of $17 million of net debt. Preliminary allocation of these purchase prices resulted in goodwill for the 2008 acquisitions of $48 million.

In December 2008, we acquired all of the capital stock of Friedrich Krombach GmbH & Company KG Armaturenwerke and Krombach International GmbH, both of Kreuztal, Germany. Krombach is a leading manufacturer of specialty valve flow solutions for the power, oil and gas, and chemical markets. Krombach’s 2008 full year sales were approximately $100 million, and the purchase price was $51 million in cash and the assumption of $17 million of net debt. Krombach is being integrated into our Fluid Handling segment.

In September 2008, we acquired all of the capital stock of Delta Fluid Products Limited, a leading designer and manufacturer of regulators and fire safe valves for the gas industry, and safety valves and air vent valves for the building services market, for $28 million in cash. Delta had full year sales of $39 million in 2008 and is being integrated into our Fluid Handling segment.

During 2007, we completed two acquisitions at total cost of $65 million. Goodwill for the 2007 acquisitions amounted to $29 million.

In September 2007, we acquired the composite panel business of Owens Corning, which produces, among other products, high gloss fiberglass reinforced plastic panels used in the manufacture of recreational vehicles. The purchase price was $38 million in cash. The acquired business had $40 million of sales in 2006 and was integrated into the Noble Composites business within our Engineered Materials segment.

In August 2007, we acquired the Mobile Rugged Business of Kontron America, Inc. (“MRB”), which produces computers, electronics and flat panel displays for harsh environment applications. The purchase price was $26.6 million. The acquired business had sales of $25 million in 2006 and was integrated into the Azonix business within our Controls segment.

During 2006, we completed five acquisitions at a total cost of $283 million. Goodwill for the 2006 acquisitions amounted to $148 million.

In January 2006, we acquired substantially all of the assets of CashCode, a manufacturer of bill validators, storage and recycling devices for use in a variety of niche applications in vending, gaming, retail and transportation industries, for $86 million in cash. CashCode had sales of $48 million in 2005. CashCode is located in Concord, Ontario, Canada and Kiev, Ukraine, serving a global marketplace with 75% of its sales outside the United States, of which the majority are in Europe and Russia. CashCode was integrated into our Merchandising Systems segment.

In June 2006, we acquired all of the outstanding capital stock of Telequip for a cash purchase price of $45 million. Telequip, with headquarters in Salem, New Hampshire, was manufacturing coin dispensing solutions since 1974. Telequip provides embedded and free-standing coin dispensing solutions principally focused on applications in supermarkets, convenience stores, quick-service restaurants and self-checkout and kiosk equipment markets. Tele- quip’s coin dispensers have a particularly strong position in automated self-checkout markets. Telequip had total annual sales of $20 million in 2006. Telequip was integrated into our Merchandising Systems segment.

In June 2006, we acquired certain assets of AP, a privately held manufacturer of vending equipment. In September 2006, additional assets of AP were acquired and a second payment made for a total purchase price of $30 million. The acquisition included AP’s extensive distribution network, product line designs and trade names, manufacturing equipment, aftermarket parts business, inventory and other related assets. The purchase did not include AP’s manufacturing facility located in St. Paul, Minnesota. AP equipment production was consolidated into our Merchandising Systems facility in St. Louis, Missouri. AP had total annual sales of $40 million in 2006.

In September 2006, we acquired all the outstanding capital stock of Noble for a cash purchase price of $72 million. Noble, located in Goshen, Indiana, specializes in the manufacture and sale of premium, high-gloss finished composite panels for use by recreational vehicle manufacturers. Noble had annual sales of $37 million in 2005. Noble was integrated into our Engineered Materials segment.

In October 2006, we acquired all of the outstanding capital stock of Dixie-Narco for a purchase price of $46 million in cash. Dixie-Narco is the largest can/bottle merchandising equipment manufacturer in the world. Dixie-Narco’s customers are the major soft drink companies; in addition, equipment is marketed to global vending operators. Dixie-Narco had total annual sales of $155 million in 2006. Dixie-Narco was integrated into our Merchandising Systems segment.

During 2005, we completed two acquisitions at a total cost of $9 million. Goodwill for the 2005 acquisitions amounted to $5 million.

During 2004, we completed two acquisitions at a total cost of $50 million. Goodwill for the 2004 acquisitions amounted to $37 million. In January 2004, we acquired P.L. Porter (“Porter”) for a purchase price of $44 million. Porter is a leading manufacturer of motion control products for airline seating and was integrated into the Burbank, California Aerospace facility. Porter holds leading positions in both electromechanical actuation and hydraulic/mechanical actuation for aircraft seating, selling directly to seat manufacturers and to the airlines. Electrically powered seat actuation systems provide motive power and control features required by premium class passengers on competitive international routes. Porter products not only provide passenger comfort with seat back and foot rest adjustment, but also control advanced features such as lumbar support and in-seat massage. In addition to seats installed in new aircraft, airlines refurbish and replace seating several times during an aircraft’s life along with maintenance and repair requirements. Porter’s 2003 annual sales were $32 million. The operations were integrated into our Aerospace & Electronics segment.

Also in January 2004, we acquired the Hattersley valve brand and business together with certain related intellectual property and assets from Hattersley Newman Hender, Ltd., a subsidiary of Tomkins plc, for a purchase price of $6 million. Hattersley branded products include an array of valves for commercial, industrial and institutional construction projects. This business has been integrated into Crane Ltd., which is part of our Fluid Handling segment.

Divestitures

In December 2007, together with our partner, Emerson Electric Co., we sold the Industrial Motion Control, LLC (“IMC”) joint venture, generating proceeds to us of $33 million. Our investment in IMC was $29 million, and we recorded income in 2007 and 2006 of $5.3 million and $5.6 million, respectively.

In April 2006, we completed the sale of the outstanding capital stock of Westad Industri A/S, a small specialty valve business located in Norway. This business had $25 million in sales in 2005. Westad was included in our Fluid Handling segment. In May 2006, we completed the sale of substantially all of the assets of Resistoflex-Aerospace, a manufacturer of high-performance hose and high-pressure fittings located in Jacksonville, FL. This business had sales of $16 million in 2005. Resistoflex-Aerospace was included in our Aerospace & Electronics segment. In December 2004, we sold the Victaulic trademark and UK-based business assets for $15 million in an all cash transaction.

Restructuring Activities

Recent disruptions in the credit markets and concerns about global economic growth for industrial businesses have had a significant adverse impact on financial markets and, to an extent, our operating results in 2008. For example, our Engineered Materials business segment experienced significant declines in operating profit when compared to 2007. This decline reflected substantially lower sales to our traditional recreational vehicle customers, driven largely by the inability of consumers to obtain financing for RV purchases. Similarly, declining vending machine demand resulting from depressed conditions in the North American vending market has put pressure on our operating margins within our Merchandising Systems segment. In our Fluid Handling segment, sales were adversely impacted during the second half of 2008 by slowing orders from short-cycle North American businesses (where we generally deliver product within 90 days after order receipt) and delays of several large valve projects into 2009. In order to align our cost base to current market conditions, during the fourth quarter of 2008, we initiated a broad-based restructuring program that included facility consolidations, severance and other related costs (the “Restructuring Program”), resulting in a pre-tax charge of $40.7 million. We expect to incur additional restructuring charges of approximately $10.7 million during 2009 in connection with this program (total pre-tax charges, upon program completion, of approximately $51.4 million).

During the fourth quarter of 2007, we commenced implementation of a restructuring program designed to further enhance operating margins in the Fluid Handling segment. The planned actions included ceasing the manufacture of malleable iron and bronze fittings at our foundry operating facilities in the UK and Canada, respectively, and exiting both facilities and transferring production to China (the “Foundry Restructuring”). In December 2007, pursuant to this program, we sold our foundry facility in the UK, generating a pre-tax gain of $28 million. As of December 31, 2008, we have recognized $11 million in pre-tax charges in connection with this program and we expect to incur total pre-tax charges, upon program completion, of approximately $14 million.

For additional segment level information related to restructuring activities, you should refer to the information set forth under the caption, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this report, as well as in Part II, Item 8 under Note 15, “Restructuring” to the Consolidated Financial Statements.

Competitive Conditions

Our lines of business are conducted under highly competitive conditions in each of the geographic and product areas they serve. Because of the diversity of the classes of products manufactured and sold, they do not compete with the same companies in all geographic or product areas. Accordingly, it is not possible to estimate the precise number of competitors or to identify our competitive position, although we believe that we are a principal competitor in most of our markets. Our principal method of competition is production of quality products at competitive prices in a timely and efficient manner.

Our products have primary application in the aerospace, defense electronics, recreational vehicle, transportation, automated merchandising, petrochemical, chemical and power generation industries. As such, our revenues are dependent upon numerous unpredictable factors, including changes in market demand, general economic conditions and capital spending. Because these products are also sold in a wide variety of markets and applications, we do not believe we can reliably quantify or predict the possible effects upon our business resulting from such changes.

Our engineering and product development activities are directed primarily toward improvement of existing products and adaptation of existing products to particular customer requirements as well as the development of new products. While we own numerous patents, trademarks, copyrights, trade secrets and licenses to intellectual property, none are of such importance that termination would materially affect our business. From time to time, however, we do engage in litigation to protect our intellectual property.

Research and Development

Research and development costs are expensed when incurred. These costs were $153.4 million, $106.8 million and $69.7 million in 2008, 2007 and 2006, respectively, and were incurred primarily by the Aerospace & Electronics segment. Funds received from customer-sponsored research and development projects were $15.5 million, $8.4 million and $8.8 million in 2008, 2007 and 2006 respectively, and were recorded in net sales.

Our Customers

No customer accounted for more than 10% of our consolidated revenues in 2008, 2007 or 2006.

Raw Materials

Our manufacturing operations employ a wide variety of raw materials, including steel, copper, cast iron, electronic components, aluminum, plastics and various petroleum-based products. We purchase raw materials from a large number of independent sources around the world. Although market forces have generally caused increases in the costs of steel and petroleum-based products, there have been no raw materials shortages that have had a material adverse impact on our business, and we believe that we will generally be able to obtain adequate supplies of major raw material requirements or reasonable substitutes at reasonable costs.


CEO BACKGROUND

DONALD G. COOK 10,042
Age 62; Director since August 2005. General, United States Air Force (Retired). Commander, Air Education and Training Command, Randolph Air Force Base, San Antonio, TX from December 2001 to August 2005. Vice Commander, Air Combat Command, Langley Air Force Base, Hampton, VA from June 2000 to December 2001. Vice Commander, Air Force Space Command, Peterson Air Force Base, Colorado Springs, CO from July 1999 to June 2000. Other directorships: Burlington Northern Santa Fe Corporation; Hawker Beechcraft Inc.; USAA Federal Savings Bank.


R. S. EVANS 512,419
Age 64; Director since 1979. Chairman of the Board of Crane Co. since April 2001. Chairman and Chief Executive Officer of Crane Co. from 1984 to 2001. Other directorships: HBD Industries, Inc; Huttig Building Products, Inc.


ERIC C. FAST 1,613,608
Age 59; Director since 1999. President and Chief Executive Officer of Crane Co. since April 2001. President and Chief Operating Officer of Crane Co. from September 1999 to April 2001. Other directorships: Automatic Data Processing Inc.; National Integrity Life Insurance.


DORSEY R. GARDNER 51,868
Age 66; Director from 1982 to 1986 and since 1989. President, Kelso Management Company, Inc., Boston, MA (investment management) since 1980. Other directorships: Huttig Building Products, Inc.; Kelso Management Company, Inc; Otologics, LLC; The Thomas Group, Inc.


MANAGEMENT DISCUSSION FROM LATEST 10K

We are a diversified manufacturer of highly engineered industrial products. Our business consists of five segments: Aerospace & Electronics, Engineered Materials, Merchandising Systems, Fluid Handling and Controls. Our primary markets are aerospace, defense electronics, recreational vehicle, transportation, automated merchandising, chemical, pharmaceutical, oil gas, power, nuclear, building services and utilities.

During 2008, we completed two acquisitions at a total cost of $79 million in cash and the assumption of $17 million in debt. Specifically, in December 2008, we acquired Friedrich Krombach GmbH & Company KG Armaturenwerke and Krombach International GmbH, (“Krombach”), a leading manufacturer of specialty valve flow solutions for the power, oil and gas, and chemical markets for $51 million in cash and the assumption of $17 million of net debt, and in September 2008, we acquired Delta Fluid Products Limited (“Delta”), a leading designer and manufacturer of regulators and fire safe valves for the gas industry, and safety valves and air vent valves for the building services market, for $28 million in cash.

Items Affecting Comparability of Reported Results

The comparability of our operating results for the years ended December 31, 2008, 2007 and 2006 is affected by the following significant items:

Restructuring and Related Costs

2008 Actions . During the fourth quarter of 2008, we initiated broad-based restructuring actions to align our cost base to current market conditions which include facility consolidations, headcount reductions and other related costs, (the “Restructuring Program”). At December 31, 2008, we recorded pre-tax restructuring and related charges in the business segments totaling $40.7 million as follows: Aerospace & Electronics $2.0 million, Engineered Materials $19.1 million, Merchandising Systems $13.1 million, Fluid Handling $5.7 million and Controls $0.8 million. The charges include workforce reduction expenses and facility exit costs of $25.0 million and $15.7 million related to asset write-downs.

We expect the 2008 actions to result in net workforce reductions of approximately 700 employees, the exiting of five facilities and the disposal of assets associated with the exited facilities. We are targeting the majority of all workforce and all facility related cost reduction actions for completion during 2009. Approximately 68% of the total pre-tax charge will require cash payments, which we will fund with cash generated from operations. We expect to incur additional restructuring and related charges of $10.6 million during 2009 to complete these actions as follows: Aerospace & Electronics $1.3 million, Engineered Materials $2.0 million and Merchandising Systems $7.3 million We expect recurring pre-tax savings subsequent to completing all actions to approximate $51 million annually.

2007 Actions. During the fourth quarter of 2007, our Fluid Handling segment commenced implementation of a restructuring program designed to further enhance operating margins through ceasing the manufacture of malleable iron and bronze fittings at foundry operating facilities in the UK and Canada, respectively, and exiting both facilities and transferring production to China (the “Foundry Restructuring”). The program primarily includes work- force reduction expenses and facility exit costs, all of which are expected to be cash costs. In December 2007, we recognized workforce reduction charges of $9 million and, also in December 2007, pursuant to this program, we sold our foundry facility in the UK, generating a pre-tax gain of $28 million. We expect to incur total pre-tax charges, upon program completion, of approximately $14 million. The Foundry Restructuring is expected to be substantially completed by the middle of 2009. We expect pre-tax savings to approximate $7 million annually.

Environmental Charge

For environmental matters, we record a liability for estimated remediation costs when it is probable that we will be responsible for such costs and they can be reasonably estimated. Generally, third party specialists assist in the estimation of remediation costs. The environmental remediation liability at December 31, 2008 and 2007 is substantially all for the former manufacturing site in Goodyear, Arizona (the “Site”) discussed below.

The Site was operated by UniDynamics/Phoenix, Inc. (“UPI”), which became an indirect subsidiary of ours in 1985 when we acquired UPI’s parent company, UniDynamics Corporation. UPI manufactured explosive and pyrotechnic compounds, including components for critical military programs, for the U.S. government at the Site from 1962 to 1993, under contracts with the Department of Defense and other government agencies and certain of their prime contractors. No manufacturing operations have been conducted at the Site since 1994. The Site was placed on the National Priorities List in 1983, and is now part of the Phoenix-Goodyear Airport North Superfund site. In 1990, the U.S. Environmental Protection Agency (“EPA”) issued administrative orders requiring UPI to design and carry out certain remedial actions, which UPI has done. Groundwater extraction and treatment systems have been in operation at the Site since 1994. A soil vapor extraction system was in operation from 1994 to 1998, was restarted in 2004, and is currently in operation. On July 26, 2006, we entered into a consent decree with the EPA with respect to the Site providing for, among other things, a work plan for further investigation and remediation activities at the Site. We recorded a liability in 2004 for estimated costs through 2014 after reaching substantial agreement on the scope of work with the EPA. At the end of September 2007, the liability totaled $15.4 million. During the fourth quarter of 2007, we and our technical advisors determined that changing groundwater flow rates and contaminant plume direction at the Site required additional extraction systems as well as modifications and upgrades of the existing systems. In consultation with our technical advisors, we prepared a forecast of the expenditures required for these new and upgraded systems as well as the costs of operation over the forecast period through 2014. Taking these additional costs into consideration, we estimated our liability for the costs of such activities through 2014 to be $41.5 million as of December 31, 2007. During the fourth quarter of 2008, based on further consultation with our advisors and the EPA and in response to groundwater monitoring results that reflected a continuing migration in contaminant plume direction during the year, we revised our forecast of remedial activities to reflect an increase in the number of extraction systems and monitoring wells in and around the Site, among other things. Our revised liability estimate of $65 million, which is included in accrued liabilities and other liabilities in our consolidated balance sheet, resulted in an additional charge of $24 million in December 2008.

M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS .



On July 31, 2006, we entered into a consent decree with the U.S. Department of Justice (“DOJ”) on behalf of the Department of Defense and the Department of Energy pursuant to which, among other things, the U.S. Government reimburses us for 21 percent of qualifying costs of investigation and remediation activities at the Site. As of December 31, 2008, we have recorded a receivable of $14 million for the expected reimbursements from the U.S. Government in respect of the aggregate liability as at that date.

Asbestos Charge

With the assistance of outside experts, during the third quarter of 2007, we updated and extended our estimate of our asbestos liability, including the costs of settlement or indemnity payments and defense costs relating to currently pending claims and future claims projected to be filed against us through 2017. Our previous estimate was for asbestos claims filed through 2011. As a result of this updated estimate, we recorded an additional pre-tax provision of $390.2 million during the third quarter of 2007 (this amount includes a corresponding insurance receivable).

Civil False Claims Settlement

During the third quarter of 2007, we recorded a $7.6 million charge related to a civil false claims proceeding by the U.S. Government, arising out of allegations that certain valves sold by our Crane Valves North America unit (“CVNA”) to private customers that ultimately were delivered to U.S. military agencies did not conform to contractual specifications relating to the place of manufacture and the origin of component parts. The allegations originated with a qui tam complaint filed under seal by a former CVNA employee. The Civil Division of the Department of Justice (“DOJ”) ultimately intervened in that case, and on March 31, 2007, filed a complaint against us in the United States District Court for the Southern District of Texas seeking unspecified damages for violations of the False Claims Act, and other common law claims. The complaint alleged that CVNA failed to notify the correct U.S. military agency when our manufacturing location for Mil-Spec valves listed on the Qualified Products List was moved from Long Beach, California to Conroe, Texas in 2003. As a result, the complaint alleged that the valves manufactured in Texas were not properly listed on the Qualified Product List as required by the contract specifications.

We received a letter from the Department of the Navy on February 14, 2007, conveying the Navy’s concerns about the Qualified Products List allegations raised by the DOJ. The Department of the Navy advised us that, if true, these allegations could potentially result in us and our subsidiaries and affiliates being suspended and/or debarred from doing business with the U.S. Government.

We cooperated with the Government’s investigation of these matters and executed a settlement agreement with the DOJ providing for, among other things, the payment of $7.5 million to the United States and $125,000 to pay the legal fees of the former employee who filed the qui tam complaint. In addition, we negotiated an administrative agreement with the Department of the Navy for a term of three years pursuant to which we have implemented certain changes to our compliance programs and report to the Navy on a quarterly basis. These agreements were executed and became effective on July 27, 2007. We acknowledged the failure to notify the Navy and update the Qualified Products List but we denied that this omission violated the False Claims Act. The failure to notify the Navy was unintentional and there was no misconduct by our personnel. We decided to settle this matter to avoid the risks of costly and protracted legal proceedings.

Divestiture

In December 2007, together with our partner, Emerson Electric Co., we sold the Industrial Motion Control, LLC (“IMC”) joint venture, generating proceeds to us of $33 million and an after-tax gain of $5.8 million. Our investment in IMC was $29 million and we recorded income in 2007 and 2006 of $5.3 million and $5.6 million respectively.

Repatriation of Foreign Earnings

During the fourth quarter of 2007, we concluded that our cash balances overseas were in excess of our projected future needs outside the U.S. As a result, we established a $10.4 million deferred tax liability related to the estimated additional U.S. federal and state income taxes due upon the ultimate repatriation of $194 million of such cash balances.

2007 Compared with 2006

Sales in 2007 increased $362 million, or 16%, to $2.619 billion compared with $2.257 billion in 2006. The sales increase was primarily due to core business growth of $163 million (7%) and revenue from net acquisitions and dispositions of $134 million (6%). Sales growth also included $65 million (3%) from favorable foreign exchange. The Aerospace & Electronics segment reported a sales increase of $63 million, or 11%. Excluding Resistoflex-Aerospace which was divested in May 2006, segment sales were up 12%. The Aerospace Group had strong commercial OEM (Original Equipment Manufacturer) sales and aftermarket revenue. The Electronics Group experienced a 5% sales increase year over year. In the Engineered Materials segment, demand for fiberglass-reinforced panels from the recreational vehicle and transportation trailer markets declined 9% due to lower industry demand. The Merchandising Systems segment showed a $130 million revenue increase in 2007 mainly from the four acquisitions made in 2006. The Fluid Handling segment’s sales increased $136 million, or 14%, including a net decline of $10 million related to disposed businesses. Excluding dispositions, this segment’s sales increased $147 million, or 15%, $97 million (10%) from core growth, reflecting the strong conditions in general industrial markets and $50 million (5%) from favorable foreign exchange.

Total segment operating profit was $69 million, or 24% higher, in 2007 when compared to 2006. Total Fluid Handling segment operating profit was $52 million higher, or 49%, in 2007 compared to the prior year. As a percent of sales, total segment operating margins increased to 13.5% in 2007, compared to 12.6% in 2006. The increase over the prior year was driven primarily by improvement in the Fluid Handling and Merchandising Systems segments.


MANAGEMENT DISCUSSION FOR LATEST QUARTER

This Quarterly Report on Form 10-Q contains information about us, some of which includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements other than historical information or statements about our current condition. You can identify forward-looking statements by the use of terms such as “believes,” “contemplates,” “expects,” “may,” “could,” “should,” “would,” or “anticipates,” other similar phrases, or the negatives of these terms.

We have based the forward-looking statements relating to our operations on our current expectations, estimates and projections about us and the markets we serve. We caution you that these statements are not guarantees of future performance and involve risks and uncertainties. In addition, we have based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. For example, in response to a weakening global economy, we are critically reviewing our cost structure in an effort to better position our operations to accommodate a potential decline in demand for our products and services. Considering the current uncertainty in estimating both the potential costs related to such efforts as well as projected levels of efficiencies that we expect to achieve, our actual outcomes and results may differ materially from what we have expressed or forecast in the forward-looking statements. There are a number of other factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking statements. The factors that we currently believe to be material are detailed in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 filed with the Securities and Exchange Commission and are incorporated by reference herein. Additional risks and uncertainties not currently known to us or that we currently do not deem to be material also may materially adversely affect our business, financial condition and operating results.

Reference herein to “Crane”, “we”, “us”, and, “our” refer to Crane Co. and its subsidiaries unless the context specifically states or implies otherwise. References to “core business” or “core sales” in this report include sales from acquired businesses starting from and after the first anniversary of the acquisition, but exclude currency effects. Amounts in the following discussion are presented in millions, except employee, share and per share data, or unless otherwise stated.

Overview

We are a diversified manufacturer of highly engineered industrial products. Our business consists of five segments: Aerospace & Electronics, Engineered Materials, Merchandising Systems, Fluid Handling and Controls. Our primary markets are aerospace, defense electronics, recreational vehicle, transportation, automated merchandising, chemical, pharmaceutical, oil, gas and power, nuclear, building services and utilities.

Our strategy is to grow the earnings of niche businesses with leading market shares, acquire companies that fit strategically with existing businesses, aggressively pursue operational and strategic linkages among our businesses, build a performance culture that stresses continuous improvement and a committed management team whose interests are directly aligned with those of the shareholders and maintain a focused, efficient corporate structure.

Outlook

Recent disruptions in the credit markets and concerns about global economic growth for industrial businesses have had a significant adverse impact on financial markets and, to an extent, our operating results through the first nine months of 2008. For example, during the three and nine-month periods ending September 30, 2008, our Engineered Materials business segment has experienced significant declines in operating profit when compared to the same periods last year. This decline reflects substantially lower volumes to our traditional recreational vehicle customers, driven largely by the inability of consumers to obtain financing for RV purchases. Similarly, declining vending machine demand resulting from depressed conditions in the North American vending market has put pressure on our operating margins within our Merchandising segment. In response to these unfavorable market conditions, during the past six months, we have taken significant steps to reduce costs in both our Engineered Materials and Vending Solutions businesses, including reducing headcount by 32% and 16%, respectively. In our Fluid Handling segment, while demand from the global chemical, pharmaceutical and energy industries remained firm, sales were adversely impacted during the third quarter by slowing orders from short-cycle North American businesses and delays of several large valve projects into the fourth quarter. Continued weakness in short-cycle North American businesses and/or further delays in large valve projects may put further pressure on operating margins in the Fluid Handling segment.

Our Aerospace & Electronics segment has also experienced a significant decline in operating profit during the three and nine month periods ending September 30, 2008 when compared to the same periods last year. These declines were driven by substantially higher engineering expense in the Aerospace Group related to the development of new products for the Boeing 787 and Airbus A400M programs. Reflecting changes in certain requirements requested by our customers, there exist potential engineering cost recoveries to partially offset the unfavorable impact of continued development expenses (the timing and amounts of which are uncertain). Spending will likely remain at high levels until key test flights are completed in 2009. In addition, while the decline in operating profit for this segment is almost entirely due to the increase in engineering expenses, further deterioration in airline industry market conditions could have an unfavorable impact by, for example, reducing higher margin aftermarket product sales.

Reflecting on our operating results for the third quarter 2008 and our expectation of a potentially more difficult operating environment, we are taking further steps to reduce our cost structure across all business segments. These initiatives could result in a fourth quarter pretax charge of up to $25 million (primarily non-cash) related to reductions in headcount and consolidation of several plants. Although we currently expect the savings from these initiatives to exceed the amount of the potential charge, we will continue to review our estimates as we evaluate our cost structure and finalize our plans during the fourth quarter.

Results from Operations

Third quarter of 2008 compared with third quarter of 2007

Third quarter 2008 sales decreased $21.4 million, or 3.2%, over the third quarter of 2007. Core business sales for the third quarter declined approximately 4.2%, or $27.9 million. Acquired businesses (the Composite Panel business of Owens Corning and Mobile Rugged business of Kontron America, Inc.), net of $3.5 million of lost sales resulting from divestitures, contributed 0.6% growth, or $3.8 million. The impact of currency translation on sales increased reported sales by approximately 0.4%, or $2.7 million, as the U.S. dollar was weaker against other major currencies in the third quarter of 2008 compared to the third quarter of 2007. Net sales related to operations outside the United States were 41.9% and 39.0% of total net sales for the three-month periods ended September 30, 2008 and 2007, respectively.

Operating profit was $54.6 million in the third quarter 2008 compared to an operating loss of $312.6 million in the comparable period of 2007. The operating loss in the third quarter 2007 included a $390.2 million provision to update and extend the time horizon of our estimate of asbestos liability from 2011 to 2017 (see Note 9 in the financial statements under Item 1 included in this Report). In addition, the third quarter of 2008 reflected substantially weaker performance in our Engineered Materials and Aerospace & Electronics segments when compared to the same period in 2007.

The third quarter 2008 sales increase of $0.7 million reflected a sales increase of $3.8 million in the Aerospace Group and a decrease of $3.1 million in the Electronics Group. The segment’s operating profit decreased $12.2 million, or 52.8%, in the third quarter of 2008 when compared to the same period in the prior year. The decline in operating profit was driven by substantially higher engineering expense in the Aerospace Group, which was $32.5 million in the third quarter of 2008 compared to $17.8 million in the third quarter of 2007. The increase in engineering expense is related to our investments in the Boeing 787 and Airbus A400M programs. Aerospace Group sales of $100.9 million increased $3.8 million, or 4.0%, from $97.1 million in the prior year period. This increase is attributable to continued strong demand in the aerospace industry, and is related to original equipment manufacturer (“OEM”) products. Operating profit declined by $12.9 million in the third quarter of 2008, compared to the third quarter of 2007 which was due to the aforementioned $14.7 million increase in engineering expenses and higher OEM sales mix.

Electronics Group sales of $58.8 million decreased $3.1 million, or 5.1%, due primarily to lower sales in the group’s Custom Power business. Operating profit increased by $0.7 million in the third quarter of 2008 when compared to the third quarter of 2007 which was driven by favorable sales mix in the Standard Power business, offset by deleverage associated with the aforementioned volume decline in the Custom Power business.

CONF CALL

Richard Koch

Thank you operator. Good morning, everyone. Welcome to Crane's fourth quarter 2008 earnings release conference call. I'm Dick Koch, Director of Investor Relations. On our call this morning we have Eric Fast, our President and CEO, and Tim MacCarrick, our Vice President and CFO.

We will start off our call with a few prepared remarks after which we will respond to questions. Just as a reminder, the comments we make on this call may include some forward-looking statements. We would refer you to the cautionary language at the bottom of our earnings release and also in our annual report, 10-K, and subsequent filings pertaining to forward-looking statements.

Also during the call, we will be using some non-GAAP numbers which are reconciled to the comparable GAAP numbers in the table at the end our press release which is available on our website at www.craneco.com in the Investor Relations section.

As another reminder, we will hold our annual investor conference on February 19 in New York City from 8:30 until noon. Eric, Tim, and the Group Presidents will be sharing their outlook and strategies for 2009. Please contact me if you would like to attend.

Now, let me turn the call over to Eric.

Eric Fast

Thank, Dick. Last night we reported a fourth quarter 2008 net loss of $8.3 million or $0.14 per share, compared with fourth quarter 2007 net income of $45.2 million or $0.74 per share. Fourth quarter 2008 results were adversely impacted by an after-tax restructuring charge of $25.7 million, $0.44 per share, and an after-tax environmental provision of $15.8 million, $0.27 per share.

Excluding special items in both years, fourth quarter net income was $33.2 million or $0.56 per diluted share, compared to $47.3 million or $0.77 per diluted share in the fourth quarter of 2007. Full year earnings per share, excluding special items in both years were $2.93 in 2008, as compared to $3.19 in 2007.

I believe the company is well positioned given the current credit crisis and sharp downturn in economic activity. Over the past several years, we have been very disciplined in our acquisitions and allocation of capital which has resulted in a continuing strong balance sheet with excellent liquidity.

As you saw in our press release, we ended the year with $232 million in cash; a $300 million committed revolving facility, and debt maturities that are far out in the future.

While the economic decline clearly accelerated in the fourth quarter, several of our short-cycle businesses, particularly Engineered Materials and Vending began to feel the slowdown earlier in the year, and we have taken significant steps to reduce costs in those businesses.

Overall, employment levels were reduced 34% in Engineered Materials and 16% in North American Vending and general expense reduction programs were implemented.

With the accelerated decline in economic activity in the fourth quarter reflected in our core sales decline of 7%, we increased the size of our Restructuring Program and initiated general spending reductions across the company. With the $37 million in savings from the Restructuring Program, expected reductions in Aerospace Engineering from the completion of key milestones on several large development programs and our overall cost containment efforts, savings in 2009 will approach $75 million.

Our earnings per shares guidance of $2.10 to $2.40 per share reflects the considerable uncertainty in the economy and the end markets we serve. However, with strong discipline in our working capital management, we expect free cash flow to exceed the $146 million achieved in 2008.

While executing on the Restructuring Program, our focus in 2009 will be winning in the marketplace. Our plans are to maintain our customer-facing activities, continue to drive our operational excellence programs, accelerate the introduction of new products to win market share, and selectively and carefully make acquisitions.

We have continued to invest in our sales and manufacturing capabilities in Fluid Handling with our new regional sales office in Dubai, we have increased our customer focus in the Middle East, and deployed additional sales personnel in Asia and CIS as well.

Our presence in Eastern Europe was enhanced by the December '08 acquisition of the Krombach group, a leading manufacturer of leading manufacturer of specialty valve flow solutions for the power, oil and gas, and chemical markets, and provides our expanded global sales force with additional products. Krombach greatly expands our capability to make large valves, and we now have production capability for valves up to 11 feet in diameter.

In Merchandising Systems, we are looking to take market share with our successful glass front machines at the major bottlers and the new merchant snack machine with full line operators. The new Currenza c2 is being introduced this spring, and will be our new global coil validation offering.

Within our Aerospace business during the fourth quarter we've reached key milestones for the 787 program, including delivery of initial hardware and software for first flight, and expect to complete a version for commercial application during the second quarter.

We do expect that there will be modifications to the products we have delivered as information from the test flight and other analysis is completed. However, absent new major change requests, development spending will be reduced substantially in 2009.

No doubt, 2009 will be an extremely challenging year with considerable uncertainties. However, I am confident in our ability to execute our plans successfully. Now, let me turn the call over to Tim MacCarrick, who will provide additional details on our fourth quarter results, strong liquidity position and cost focus in 2009.

Tim MacCarrick

Thank you, Eric. Turning now to specific segment comments, including operating profit results before restructuring charges which compare the fourth quarter of 2008 with 2007. Aerospace Group sales of $93.6 million decreased $1.7 million or 2% from $95.3 million in the prior-year period.

OEM sales declined 4% compared to the fourth quarter 2007, and after-market sales were flat on a comparable basis. The OEM after-market mix was 59% to 41%, compared to last year's fourth quarter of 60% to 40%.

Operating profit in Aerospace declined $3.8 million, primarily reflecting the $6.8 million increase in engineering expense due to the heavy investments in the 787, and the A400M and lower OEM sales from the Boeing strike, partially offset by cost reductions.

In the fourth quarter of 2008, our Aerospace engineering spending was $28 million, compared to third quarter 2008 spending of $33 million and $21 million in the fourth quarter of 2007.

This engineering spend, all of which is expensed, is due to the heavy investment in 787 and A400M programs. The decline in engineering spending from the third to the fourth quarter reflects the delivery of key parts of the 787 and A400M programs, and the scaling back of the number of contract engineers, overtime, expediting in other costs.

Our Aerospace engineering spending was about 27% of sales in 2008, and we anticipate, this should begin to decline in the second half of 2009, during a transition year in which we expect the 787 to commence test flights. This would provide us with about a $50 million pretax tailwind to our operating profit from 2008 to 2010, based on 2008 sales levels. We expect that we will realize about half that benefit in 2009, which will help mitigate the effects of expected lower aftermarket sales.

Our engineering spending on the Boeing 787 and the A400M accounted for about 65% of our engineering expense of $111 million this year. As we mentioned on previous calls, we are in dialogue with certain customers concerning cost recoveries for engineering work, and those discussions are continuing.

Electronics Group sales of $61 mill]]>Fri, 13 Mar 2009 11:30:35 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1998/http://www.dailystocks.com/forum/showtopic.php?tid/1998/
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BUSINESS OVERVIEW

General

We commenced operations in 1886 and were incorporated in the State of New York on January 27, 1916. We are a global manufacturer and marketer of beauty and related products. We conduct our business in the highly competitive beauty industry and compete against other consumer packaged goods (“CPG”) and direct-selling companies to create, manufacture and market beauty and beauty-related products. Beginning in the fourth quarter of 2008, we changed our product categories from Beauty, Beauty Plus and Beyond Beauty to Beauty, Fashion and Home. Beauty consists of cosmetics, fragrances, skin care and toiletries (“CFT”). Fashion consists of fashion jewelry, watches, apparel, footwear and accessories. Home consists of gift and decorative products, housewares, entertainment and leisure, children’s and nutritional products. Sales from Health and Wellness products and mark. , a global cosmetics brand that focuses on the market for young women, are included among these three categories based on product type.

Unlike most of our CPG competitors, which sell their products through third-party retail establishments (e.g., drug stores, department stores), our business is conducted worldwide primarily in one channel, direct selling. Our reportable segments are based on geographic operations in six regions: Latin America; North America; Central & Eastern Europe; Western Europe, Middle East & Africa; Asia Pacific; and China. We also centrally manage Brand Marketing, Supply Chain and Sales organizations. Financial information relating to our reportable segments is included in the “Segment Review” section within Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) on pages 20 through 39 of this 2008 Annual Report on Form 10-K, and in Note 12, Segment Information, on pages F-30 through F-33 of this 2008 Annual Report on Form 10-K. Information about geographic areas is included in Note 12, Segment Information, on pages F-30 through F-33 of this 2008 Annual Report on Form 10-K.

Distribution

We presently have sales operations in 66 countries and territories, including the U.S., and distribute our products in 44 more. Unlike most of our competitors, which sell their products through third party retail establishments (i.e. drug stores, department stores), Avon primarily sells its products to the ultimate consumer through the direct-selling channel. In Avon’s case, sales of our products are made to the ultimate consumer principally through the direct selling by 5.8 million active independent Avon Representatives, approximately 457,000 of whom are in the U.S. Representatives are independent contractors, not employees of Avon. Representatives earn a profit by purchasing products directly from us at a discount from a published brochure price and selling them to their customers, the ultimate consumer of Avon’s products. We generally have no arrangements with end users of our products beyond the Representative, except as described below. No single Representative accounts for more than 10% of our net sales.

A Representative contacts customers directly, selling primarily through the Avon brochure, which highlights new products and special promotions for each sales campaign. In this sense, the Representative, together with the brochure, are the “store” through which Avon products are sold. A brochure introducing a new sales campaign is usually generated every two weeks in the U.S. and every two to four weeks for most markets outside the U.S. Generally, the Representative forwards an order for a campaign to us using the mail, the Internet, telephone, or fax. This order is processed and the products are assembled at a distribution center and delivered to the Representative usually through a combination of local and national delivery companies. Generally, the Representative then delivers the merchandise and collects payment from the customer for his or her own account. A Representative generally receives a refund of the full price the Representative paid for a product if the Representative chooses to return it.

We employ certain electronic order systems to increase Representative support, which allow a Representative to run her or his business more efficiently, and also allow us to improve our order-processing accuracy. For example, in many countries, Representatives can utilize the Internet to manage their business electronically, including order submission, order tracking, payment and two-way communications with Avon. In addition, in the U.S., Representatives can further build their own Avon business through personalized web pages provided by us, enabling them to sell a complete line of our products online. Self-paced online training also is available in certain markets, as well as up-to-the-minute news about Avon.

In the U.S. and selected other markets, we also market our products through consumer websites ( www.avon.com in the U.S.) . These sites provide a purchasing opportunity to consumers who choose not to purchase through a Representative.

In some markets, we use decentralized branches, satellite stores and independent retail operations to serve Representatives and other customers. Representatives come to a branch to place and pick up product orders for their customers. The branches also create visibility for Avon with consumers and help reinforce our beauty image. In certain markets, we provide opportunities to license Avon beauty centers and other retail-oriented opportunities to reach new customers in complementary ways to direct selling.


The recruiting or appointing and training of Representatives are the primary responsibilities of District Sales or Zone Managers and Sales Leadership Representatives. In most markets, District Sales or Zone Managers are employees of Avon and are paid a salary and an incentive based primarily on the achievement of a sales objective by Representatives in their district, while in other markets, those responsibilities are handled by independent contractors. Personal contacts, including recommendations from current Representatives (including the Sales Leadership program), and local market advertising constitute the primary means of obtaining new Representatives. The Sales Leadership program is a multi-level compensation program which gives Representatives, known as Sales Leadership Representatives, the opportunity to earn bonuses based on the net sales made by Representatives they have recruited and trained in addition to discounts earned on their own sales of Avon products. This program limits the number of levels on which commissions can be earned to three and continues to focus on individual product sales by Sales Leadership Representatives. The primary responsibilities of Sales Leadership Representatives are the prospecting, appointing, training and development of their down-line Representatives while maintaining a certain level of their own sales. Development of the Sales Leadership program throughout the world is one part of our long-term growth strategy. As described above, the Representative is the “store” through which we primarily sell our products and given the high rate of turnover among Representatives (a common characteristic of direct selling), it is critical that we recruit, retain and service Representatives on a continuing basis in order to maintain and grow our business. As part of our multi-year turnaround plan, we have initiatives underway to standardize global processes for prospecting, appointing, training and developing Representatives, as well as training and developing our direct-selling executives.

One of our key strategies to recruit and retain Representatives is to invest in the direct-selling channel to improve the reward and effort equation for our Representatives (Representative Value Proposition or “RVP”). We have allocated significant incremental investment to grow our Representative base, to increase the frequency with which the Representatives order and the size of the order and have undertaken extensive research to determine the pay back on specific advertising and field tools and actions and the optimal balance of these tools and actions in key markets. In addition to a research and marketing intelligence staff, we have employed both internal and external statisticians to develop proprietary fact-based regression analyses using Avon’s vast product and sales history.

From time to time, local governments and others question the legal status of Representatives or impose burdens inconsistent with their status as independent contractors, often in regard to possible coverage under social benefit laws that would require us (and in most instances, the Representatives) to make regular contributions to government social benefit funds. Although we have generally been able to address these questions in a satisfactory manner, these questions can be raised again following regulatory changes in a jurisdiction or can be raised in additional jurisdictions. If there should be a final determination adverse to us in a country, the cost for future, and possibly past, contributions could be so substantial in the context of the volume and profitability of our business in that country that we would consider discontinuing operations in that country.

Promotion and Marketing

Sales promotion and sales development activities are directed at assisting Representatives, through sales aids such as brochures, product samples and demonstration products. In order to support the efforts of Representatives to reach new customers, specially designed sales aids, promotional pieces, customer flyers, television and print advertising are used. In addition, we seek to motivate our Representatives through the use of special incentive programs that reward superior sales performance. Avon has made significant investments to understand the financial return of such field incentives. Periodic sales meetings with Representatives are conducted by the District Sales Managers or Zone Managers. The meetings are designed to keep Representatives abreast of product line changes, explain sales techniques and provide recognition for sales performance.

A number of merchandising techniques are used, including the introduction of new products, the use of combination offers, the use of trial sizes and samples, and the promotion of products packaged as gift items. In general, for each sales campaign, a distinctive brochure is published, in which new products are introduced and selected items are offered as special promotions or are given particular prominence in the brochure. A key current priority for our merchandising is to expand the use of pricing and promotional models to enable a deeper, fact-based understanding of the role and impact of pricing within our product portfolio.

Investment in advertising is another key strategy. We significantly increased spending on advertising over the past three years, including advertising to recruit Representatives. We expect this to be an ongoing investment to strengthen our beauty image worldwide and drive sales positively.

From time to time, various regulations or laws have been proposed or adopted that would, in general, restrict the frequency, duration or volume of sales resulting from new product introductions, special promotions or other special price offers. We expect our pricing flexibility and broad product lines to mitigate the effect of these regulations.

Competitive Conditions

We face competition from various products and product lines both domestically and internationally. The beauty and beauty-related products industry is highly competitive and the number of competitors and degree of competition that we face in this industry varies widely from country to country. Worldwide, we compete against products sold to consumers by other direct-selling and direct-sales companies and through the Internet, and against products sold through the mass market and prestige retail channels.

Specifically, due to the nature of the direct-selling channel, Avon competes on a regional, often country-by-country basis, with its direct-selling competitors. Unlike most other beauty companies, we compete within a distinct business model where providing a compelling earnings opportunity for our Representatives is as critical as developing and marketing new and innovative products. As a result, in contrast to a typical CPG company which operates within a broad-based consumer pool, we must first compete for a limited pool of Representatives before we reach the ultimate consumer.

Within the broader CPG industry, we principally compete against large and well-known cosmetics and fragrances companies that manufacture and sell broad product lines through various types of retail establishments. In addition, we compete against many other companies that manufacture and sell more narrow CFT product lines sold through retail establishments and other channels.

We also have many competitors in the gift and decorative products and apparel industries globally, including retail establishments, principally department stores, gift shops and specialty retailers, and direct-mail companies specializing in these products.

Our principal competition in the fashion jewelry industry consists of a few large companies and many small companies that sell fashion jewelry through retail establishments.

We believe that the personalized customer service offered by our Representatives; the amount and type of field incentives we offer our Representatives on a market-by-market basis; the high quality, attractive designs and prices of our products; the high level of new and innovative products; our easily recognized brand name and our guarantee of product satisfaction are significant factors in establishing and maintaining our competitive position.

International Operations

Our international operations are conducted primarily through subsidiaries in 65 countries and territories outside of the U.S. In addition to these countries and territories, our products are distributed in 44 other countries and territories through distributorships.

Our international operations are subject to risks inherent in conducting business abroad, including, but not limited to, the risk of adverse currency fluctuations, currency remittance restrictions and unfavorable social, economic and political conditions.


See the sections “Risk Factors - Our ability to conduct business, particularly in international markets, may be affected by political, legal and regulatory risks” and “Risk Factors - We are subject to other risks related to our international operations, including exposure to foreign currency fluctuations” in Item 1A on pages 11 and 13 of this 2008 Annual Report on Form 10-K.

Manufacturing

We manufacture and package almost all of our CFT products. Raw materials, consisting chiefly of essential oils, chemicals, containers and packaging components, are purchased for our CFT products from various suppliers. Almost all of our non-CFT products are purchased from various suppliers. Additionally, we design the brochures that are used by the Representatives to sell our products. The loss of any one supplier would not have a material impact on our ability to source raw materials for our CFT products or paper for the brochures or our non-CFT products. Packages, consisting of containers and packaging components, are designed by our staff of artists and designers.

The design and development of new CFT products are affected by the cost and availability of materials such as glass, plastics and chemicals. We believe that we can continue to obtain sufficient raw materials and supplies to manufacture and produce our CFT products.

As further described in the “Overview” and “Strategic Initiatives” sections within MD&A on pages 20 through 23, we have begun implementing SSI to reduce direct and indirect costs of materials, goods and services. Under this initiative, we are shifting our purchasing strategy from a local, commodity-oriented approach towards a globally-coordinated effort.

We are also implementing an enterprise resource planning (“ERP”) system on a worldwide basis, which is expected to improve the efficiency of our supply chain and financial transaction processes. The implementation is expected to occur in phases over the next several years. We completed implementation in certain significant markets, and will continue to roll-out the ERP system over the next several years.

Trademarks and Patents

Our business is not materially dependent on the existence of third-party patent, trademark or other third-party intellectual property rights, and we are not a party to any ongoing material licenses, franchises or concessions. We do seek to protect our key proprietary technologies by aggressively pursuing comprehensive patent coverage in major markets. We protect our Avon name and other major proprietary trademarks through registration of these trademarks in the markets where we sell our products, monitoring the markets for infringement of such trademarks by others, and by taking appropriate steps to stop any infringing activities.

Seasonal Nature of Business

Our sales and earnings have a marked seasonal pattern characteristic of many companies selling CFT, gift and decorative products, apparel, and fashion jewelry. Holiday sales cause a sales peak in the fourth quarter of the year; however, the sales volume of holiday gift items is, by its nature, difficult to forecast. Fourth quarter revenue was approximately 26% and 31% of total revenue in 2008 and 2007, respectively, and fourth quarter operating profit was approximately 28% and 26% of total operating profit in 2008 and 2007, respectively. The fourth quarter operating profit comparison between 2008 and 2007 was impacted by costs to implement our restructuring initiatives and costs related to our PLS program. The fourth quarter of 2008 includes cost to implement our restructuring initiatives of $7.4, whereas the fourth quarter of 2007 includes $100.9 of costs to implement our restructuring initiatives and $103.7 of costs related to our PLS program.

Research and Product Development Activities

New products are essential to growth in the highly competitive cosmetics industry. Our research and development department’s efforts are significant to developing new products, including formulating effective beauty treatments relevant to women’s needs, and redesigning or reformulating existing products. To increase our brand competitiveness, we have increased our focus on new technology and product innovation to deliver first-to-market products that deliver visible consumer benefits.

Our global research and development facility is located in Suffern, NY. A team of researchers and technicians apply the disciplines of science to the practical aspects of bringing products to market around the world. Relationships with dermatologists and other specialists enhance our ability to deliver new formulas and ingredients to market. Additionally, we have satellite research facilities located in Brazil, China, Japan, Mexico and Poland.

In 2008, our most significant product launches included Anew Ultimate Contouring Eye System, Bond Girl fragrance , Pro-to-Go Lipstick , Anew Ultimate Age Repair Elixir, Supershock Mascara, Ultra Color Rich Plumping Lipstick, U by Ungaro fragrances and Anew Rejuvenate Eye.

The amounts incurred on research activities relating to the development of new products and the improvement of existing products were $70.0 in 2008, $71.8 in 2007, and $65.8 in 2006. This research included the activities of product research and development and package design and development. Most of these activities were related to the development of CFT products.

Environmental Matters

In general, compliance with environmental regulations impacting our global operations has not had, and is not anticipated to have, any material adverse effect upon the capital expenditures, financial position or competitive position of Avon.

Employees

At December 31, 2008, we employed approximately 42,000 employees. Of these, approximately 6,100 were employed in the U.S. and 35,900 in other countries.


CEO BACKGROUND

W. DON CORNWELL Director since 2002 Age: 60 Mr. Cornwell is Chairman and Chief Executive Officer of Granite Broadcasting Corporation, a group broadcasting company that owns and operates television stations across the U.S., which he founded in 1988. On December 11, 2006, Granite Broadcasting Corporation filed for voluntary reorganization under Chapter 11 of the U.S. Bankruptcy Code and emerged from its restructuring on June 4, 2007. Previously, Mr. Cornwell was Chief Operating Officer for the Corporate Finance Department at Goldman, Sachs & Co. from 1980 to 1988 and Vice President of the Investment Banking Division of Goldman, Sachs from 1976 to 1980. He is a director of Pfizer, Inc. He is also a director of the Wallace Foundation and is a trustee of Big Brothers Big Sisters of New York.

EDWARD T. FOGARTY Director since 1995 Age: 71 Mr. Fogarty was the Chairman, President and Chief Executive Officer of Tambrands, Inc., a major global consumer products company, from September 1996 to July 1997. Prior to assuming that position, Mr. Fogarty was President and Chief Executive Officer of Tambrands from May 1994 to September 1996. Previously, he was President-USA/Canada/Puer to Rico for the Colgate–Palmolive Company from 1989 to 1994. From 1983 to 1989, he was President, Worldwide Consumer Products, at Corning Inc.

FRED HASSAN Director since 1999 Age: 62 Mr. Hassan is the Chairman and Chief Executive Officer of Schering-Plough Corporation, a research-based global pharmaceutical company. Prior to assuming this position in April 2003, Mr. Hassan had been Chairman and Chief Executive Officer of Pharmacia Corporation since February 2001. Prior to that time, he served as President and Chief Executive Officer of Pharmacia after its creation in March 2000 from the merger of Pharmacia & Upjohn, Inc. with Monsanto Company. Before that he served as President and CEO of Pharmacia & Upjohn since May 1997. Mr. Hassan previously held senior positions with Wyeth, including that of Executive Vice President and Board member. Mr. Hassan is a director of Schering-Plough Corporation.

ANDREA JUNG Director since 1998 Age: 49 Ms. Jung was elected Chairman of the Board of Directors and Chief Executive Officer of the Company effective September 2001, having previously served as Chief Executive Officer since November 1999. Ms. Jung has been a member of the Board of Directors since January 1998 and was President from January 1998 to January 2001 and Chief Operating Officer from July 1998 to November 1999. She was elected an Executive Vice President of the Company in March 1997 concurrently continuing as President, Global Marketing, a position she held from July 1996 to the end of 1997. Ms. Jung joined the Company in January 1994 as President, Product Marketing for Avon U.S. Previously, she was Executive Vice President for Neiman Marcus and a Senior Vice President for I. Magnin. Ms. Jung is a director of Apple Inc. and the General Electric Company. She is a member of the N.Y. Presbyterian Hospital Board of Trustees, a member and former Chairman of the Board of Directors of the Personal Care Products Council (formerly the Cosmetic, Toiletry and Fragrance Association) and a director of Catalyst.



MARIA ELENA LAGOMASINO Director since 2000 Age: 59 Ms. Lagomasino is the Chief Executive Officer of GenSpring Family Offices, an affiliate of Sun Trust Banks Inc. Prior to assuming this position in November 2005, Ms. Lagomasino was Chairman and Chief Executive Officer of JP Morgan Private Bank, a division of JP Morgan Chase & Co. from September 2001 to March 2005. Prior to assuming this position, Ms. Lagomasino was Managing Director at The Chase Manhattan Bank in charge of its Global Private Banking Group. Ms. Lagomasino had been with Chase Manhattan since 1983 in various positions in private banking. Prior to 1983 she was a Vice President at Citibank. She served on the Board of the Coca-Cola Company and as Trustee of the Synergos Institute. Currently, she is a Trustee of the National Geographic Society and is a Board member of Lincoln Center Theater.


ANN S. MOORE Director since 1993 Age: 57 Mrs. Moore is Chairman and Chief Executive Officer of Time Inc. Prior to assuming this position in July 2002, Mrs. Moore was Executive Vice President of Time Inc. since September 2001, where she had executive responsibilities for a portfolio of magazines including Time, The Parenting Group, People, InStyle, Teen People, People en Español and Real Simple. Mrs. Moore joined Time Inc. in 1978 in Corporate Finance. Since then, she has held consumer marketing positions at Sports Illustrated, Fortune, Money and Discover, moving to general management of Sports Illustrated in 1983 and to publisher of People in 1991. She is also a director of the Wallace Foundation.

PAUL S. PRESSLER Director since 2005 Age: 51 Mr. Pressler was President and Chief Executive Officer of Gap, Inc. from September 2002 to January 2007. He also served on Gap, Inc.’s Board of Directors from October 2002 until January 2007. Prior to joining Gap, Inc., Mr. Pressler spent fifteen years with The Walt Disney Company where he was Chairman of the company’s Global Theme Park and Resorts Division. Mr. Pressler previously served as President of Disneyland, President of The Disney Stores and Senior Vice President of Consumer Products. Prior to Disney, he was Vice President of Marketing and Design for Kenner-Parker Toys. Mr. Pressler is a director of Overture Acquisition Corp. He serves on the Board of Big Brothers Big Sisters of America.


GARY M. RODKIN Director Nominee Age: 55 Mr. Rodkin is the Chief Executive Officer of ConAgra Foods, Inc. Prior to assuming this position in October 2005, he was Chairman and Chief Executive Officer of PepsiCo Beverages and Foods North America (consumer products and manufacturing) from 2002 to 2005. Mr. Rodkin also served as President and Chief Executive Officer of Pepsi-Cola North America from 1999 to 2002, and President of Tropicana from 1995 to 1998. He held various management positions at General Mills from 1979 to 1995, including President of Yoplait Yogurt. He serves on the Boards of the Grocery Manufacturers of America and Boys Town.


PAULA STERN, PhD. Director since 1997 Age: 63 The Honorable Paula Stern is Chairwoman of The Stern Group, Inc., an international advisory firm in areas of business and government strategy established in 1988. She was Commissioner of the U.S. International Trade Commission from 1978 to 1987 and Chairwoman from 1984 to 1986. Dr. Stern is a director of Hasbro, Inc. She is Vice-Chair of the Atlantic Council of the United States and serves on the Board of Trustees of the Committee for Economic Development and on the Advisory Council of Columbia University School of Social Work. She is also a member of Council on Foreign Relations, Inter-American Dialogue, Bretton Woods Committee, and the High Level Advisory Group for the Global Subsidies Initiative of the International Institute for Sustainable Development.

LAWRENCE A. WEINBACH Director since 1999 Age: 68 Mr. Weinbach is a partner in Yankee Hill Capital Management LLC, a private equity firm. On January 31, 2006, he retired as Chairman of the Board of Unisys Corporation, a worldwide information services and technology company. Mr. Weinbach joined Unisys in September 1997 as Chairman, President and Chief Executive Officer. In January 2004, his title changed to Chairman and Chief Executive Officer and he held the position of Chairman from January 2005 until his retirement. He previously was Managing Partner–Chief Executive of Andersen Worldwide, a global professional services organization from 1989 to 1997 and had held various senior executive positions with Andersen for a number of years prior thereto. Mr. Weinbach is a director of Discover Financial Services, Quadra Realty Trust, Inc. and UBS, AG.

MANAGEMENT DISCUSSION FROM LATEST 10K

OVERVIEW

We are a global manufacturer and marketer of beauty and related products. Our business is conducted worldwide, primarily in the direct selling channel. We presently have sales operations in 66 countries and territories, including the United States, and distribute products in 44 more. Our reportable segments are based on geographic operations in six regions: Latin America; North America; Central & Eastern Europe; Western Europe, Middle East & Africa; Asia Pacific; and China. We centrally manage global Brand Marketing, Supply Chain and Sales organizations. Beginning in the fourth quarter of 2008, we changed our product categories from Beauty, Beauty Plus and Beyond Beauty to Beauty, Fashion and Home. Beauty consists of cosmetics, fragrances, skin care and toiletries (“CFT”). Fashion consists of fashion jewelry, watches, apparel, footwear and accessories. Home consists of gift and decorative products, housewares, entertainment and leisure, children’s and nutritional products. Sales from Health and Wellness products and mark. , a global cosmetics brand that focuses on the market for young women, are included among these three categories based on product type. Sales are made to the ultimate consumer principally through the direct selling by 5.8 million active independent Representatives, who are independent contractors and not employees of Avon. The success of our business is highly dependent on recruiting, retaining and servicing our Representatives.

We view the geographic diversity of our businesses as a strategic advantage in part because it allows us to participate in higher growth Beauty markets internationally. In developed markets, such as the United States, we seek to achieve growth in line with that of the overall beauty market, while in developing and emerging markets we seek to achieve higher growth targets. During 2008, approximately 80% of our consolidated revenue was derived from operations outside the U.S. When we first penetrate a market, we typically experience high growth rates and, as we reach scale in these markets, growth rates generally decline.

At the end of 2005, we launched a comprehensive, multi-year turnaround plan to restore sustainable growth. In January 2008, we announced the final initiatives of our restructuring program that was launched in 2005 under our turnaround plan. In 2007, we completed the analysis of our optimal product portfolio and made decisions on exit strategies for non-optimal products under our Product Line Simplification program (“PLS”). In 2007, we also launched our Strategic Sourcing Initiative (“SSI”). We expect our restructuring initiatives to deliver annualized savings of approximately $430 once all initiatives are fully implemented by 2011-2012. We also expect to achieve annualized benefits in excess of $200 and $250 from PLS and SSI, respectively, in 2010. As discussed further below, in February 2009 we announced a new restructuring program under our multi-year turnaround plan.

During 2008, revenue increased 8%, and Active Representatives increased 7% (with increases in all segments), fueled by investments in advertising and the Representative Value Proposition (“RVP”). Sales from each of our product categories increased, with products in the Beauty category increasing 10%. During 2008, revenue grew in all segments except North America, which was adversely affected by the slowing macro-economic environment, deteriorating consumer confidence and higher year-over-year fuel prices. We benefited from strength in developing and emerging markets around the globe that more than offset the unfavorable impact of economic softness in North America. See the “Segment Review” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information related to changes in revenue by segment.

During the fourth quarter of 2008, revenue declined as compared to 2007, due to the significant negative impact of foreign exchange and the depressed economy. We expect the global economic pressures and negative impact of foreign currency will continue or could worsen in the foreseeable future and 2009 will be a challenging year. Given the current macro-economic environment, we expect that revenue growth in 2009 will be somewhat lower than our long-term revenue growth, which is expected to average mid-single digits, excluding the impact of foreign exchange. We also expect that operating margin in 2009 will continue to be pressured by the unfavorable impacts of foreign exchange. Operating margin will also be negatively impacted by additional restructuring charges during 2009. We believe benefits from our SSI program, focusing on manufacturing productivity, changing sourcing of raw materials and finished goods to use exchange rates to our advantage, and some softening in commodity costs will help to partially offset the negative impact of foreign exchange. We will continue to look for ways to transform our cost structure and intend to reduce non-strategic spending during 2009. We will also continue our strategies of investing in advertising and our Representatives.

We believe that our strong operating cash flow and global cash balances of over $1 billion, coupled with the continuing execution of our turnaround strategies and the competitive advantages of our direct selling business model, will allow us to look beyond our anticipated challenges in 2009 and continue our focus on long-term sustainable, profitable growth.

STRATEGIC INITIATIVES

Advertising and Representative Value Proposition (“RVP”)

Investing in advertising is a key strategy. We significantly increased spending on advertising over the past three years. During 2008, we increased our investment in advertising by $22.1 or 6%. Approximately 70% of the incremental spending was spent in Russia, China and the United Kingdom. The incremental spending on advertising was at a rate somewhat less than revenue growth. The advertising investments supported new product launches, such as , Anew Ultimate Contouring Eye System, Bond Girl fragrance , Pro-to-Go Lipstick , Anew Ultimate Age Repair Elixir, Supershock Mascara, Avon Solutions Hydra-Radiance, U by Ungaro fragrance s and Anew Rejuvenate Eye. Advertising investments also included advertising to recruit Representatives. We have also continued to forge alliances with celebrities, including alliances with Patrick Dempsey and Ferragamo Parfums S.P.A. for the “U by Ungaro” line of fragrances.

We continued to invest in our direct-selling channel to improve the reward and effort equation for our Representatives. We have committed significant investments for extensive research to determine the payback on advertising and field tools and actions, and the optimal balance of these tools and actions in our markets. We have allocated these significant investments in proprietary direct selling analytics to better understand the drivers of value for our Representatives. We measure our investment in RVP as the incremental cost to provide these value-enhancing initiatives. During 2008, we invested approximately $83 incrementally in our Representatives through RVP by continued implementation of our Sales Leadership program, enhanced incentives, increased sales campaign frequency, improved commissions and new e-business tools.

Product Line Simplification

During 2006, we began to analyze our product line, under our PLS program, to develop a smaller range of better performing, more profitable products. The overall goal of PLS is to identify an improved product assortment to drive higher sales of more profitable products. During 2007, we completed the analysis of our product portfolio, concluded on the appropriate product assortment going forward and made decisions regarding the ultimate disposition of products that will no longer be part of our improved product assortment (such as selling at a discount, donation, or destruction). During 2007 and 2006, we recorded PLS charges of $187.8 and $81.4, respectively, primarily incremental inventory obsolescence expense of $167.3 and $72.6, respectively. We recorded final PLS charges in the fourth quarter of 2007. During the first half of 2008, we began to implement PLS in the U.K and early results appear favorable; however, the transition is a long process and will continue into 2009. In the second half of 2008, we began implementing PLS in all other markets, with full implementation expected by the end of 2009.

We expect that sales and marketing benefits will account for approximately 85% of our projected benefits. Improving our product assortment will allow us to increase exposure and improve presentation of the remaining products within our brochure, which is expected to yield more pleasurable consumer shopping experiences, easier Representative selling experiences, and greater sales per brochure page. A second source of benefits from PLS results from “transferable demand.” Transferable demand refers to the concept that when products with redundant characteristics are removed from our product assortment, some demand from the eliminated products will transfer to the remaining products that offer similar or comparable product characteristics. As part of PLS, when we identify products that have sufficient overlap of characteristics, we will eliminate the products with the lowest profitability and we expect the products that we retain will generate more profit. A third source of benefits from PLS is less price discounting. As we implement operating procedures under PLS, we anticipate introducing fewer new products and lengthening the lifecycle of products in our offering, which we expect will lead to less aggressive price discounting over a product’s life cycle.

In addition to the benefits above, we also expect supply chain benefits to account for approximately 15% of our projected benefits. We expect improvements to cost of sales once PLS is fully implemented, primarily from a reduction in inventory obsolescence expense as a result of better managed inventory levels, lower variable spending on warehousing, more efficient manufacturing utilization and lower purchasing costs. We also expect operating expenses to benefit from a reduction in distribution costs and benefits to inventory productivity.

We estimate that we realized total benefits of approximately $40 during 2008 and we expect to realize benefits of approximately $120 in 2009 and in excess of $200 in 2010.

Strategic Sourcing Initiative

We launched SSI in 2007. This initiative is expected to reduce direct and indirect costs of materials, goods and services. Under this initiative, we are shifting our purchasing strategy from a local, commodity-oriented approach towards a globally-coordinated effort which leverages our volumes, allows our suppliers to benefit from economies of scale, utilizes sourcing best practices and processes, and better matches our suppliers’ capabilities with our needs. Beyond lower costs, our goals from SSI include improving asset management, service for Representatives and vendor relationships. During 2008, we realized benefits of approximately $114 from SSI. In addition, we were able to offset commodity cost increases of approximately $21 for full-year 2008 due to SSI actions already in place. We expect to realize annualized benefits from this initiative in excess of $250 by the end of 2009, with a full year of benefit in 2010. As a result, we expect to realize benefits of approximately $200 in 2009 and benefits in excess of $250 in 2010.

We continue to implement a Sales and Operations Planning process that is intended to better align demand plans with our supply capabilities and provide us with earlier visibility to any potential supply issues.

Enterprise Resource Planning System

We are in the midst of a multi-year global roll-out of an enterprise resource planning (“ERP”) system, which is expected to improve the efficiency of our supply chain and financial transaction processes. We began our global roll-out in Europe in 2005 and have since implemented ERP in our European manufacturing facilities, our larger European direct selling operations and in the U.S. As part of this continuing global roll-out, we expect to implement ERP in several countries over the next several years leveraging the knowledge gained from our previous implementations.

During 2008, we worked to improve the effectiveness of ERP in the U.S. and began to implement in the other markets within North America, as well as in certain smaller European direct selling operations. During 2008, we also began the multi-year implementation process in Latin America in one market. In Latin America, we plan to implement modules of ERP in a gradual manner across key markets over the next several years.

Zero-Overhead-Growth

We have institutionalized a zero-overhead-growth philosophy that aims to offset inflation through productivity improvements. These improvements in productivity will come primarily from SSI and our restructuring initiatives. We have defined overhead as fixed expenses such as costs associated with our sales and marketing infrastructure, and management and administrative activities. Overhead excludes variable expenses within selling, general and administrative expenses, such as shipping and handling costs and bonuses to our employees in the sales organization, and also excludes consumer and strategic investments that are included in selling, general and administrative expenses, such as advertising, RVP, research and development and brochure costs.

Restructuring Programs

2005 Program

We launched our original restructuring program under our multi-year turnaround plan in late 2005 (the “2005 Program”). In January 2008, we announced the final initiatives that are part of the 2005 Program. We expect to record total restructuring charges and other costs to implement restructuring initiatives under this program of approximately $530 before taxes. We have recorded $504.2 through December 31, 2008, ($60.6 in 2008, $158.3 in 2007, $228.8 in 2006 and $56.5 in 2005) for actions associated with our restructuring initiatives under the 2005 Program, primarily for employee-related costs, including severance, pension and other termination benefits, and professional service fees related to these initiatives. We expect to record a majority of the remaining costs by the end of 2009.

2009 Restructuring Program

In February 2009, we announced a new restructuring program under our multi-year turnaround plan (the “2009 Program”). The restructuring initiatives under the 2009 Program are expected to focus on restructuring our global supply chain operations, realigning certain local business support functions to a more regional basis to drive increased efficiencies, and streamlining transaction-related services, including selective outsourcing. We expect to incur restructuring charges and other costs to implement these initiatives in the range of $300 to $400 before taxes over the next several years. We are targeting annualized savings under the 2009 Program of approximately $200 upon full implementation by 2012-2013.

CRITICAL ACCOUNTING ESTIMATES

We believe the accounting policies described below represent our critical accounting policies due to the estimation processes involved in each. See Note 1, Description of the Business and Summary of Significant Accounting Policies, for a detailed discussion of the application of these and other accounting policies.

Restructuring Reserves

We record severance-related expenses once they are both probable and estimable in accordance with the provisions of FAS No. 112, Employer’s Accounting for Post-Employment Benefits for severance provided under an ongoing benefit arrangement. One-time, involuntary benefit arrangements and disposal costs, primarily contract termination costs, are accounted for under the provisions of FAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities . One-time, voluntary benefit arrangements are accounted for under the provisions of FAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits . We evaluate impairment issues under the provisions of FAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets . We estimate the expense for these initiatives, when approved by the appropriate corporate authority, by accumulating detailed estimates of costs for such plans. These expenses include the estimated costs of employee severance and related benefits, impairment of property, plant and equipment, contract termination payments for leases, and any other qualifying exit costs. These estimated costs are grouped by specific projects within the overall plan and are then monitored on a quarterly basis by finance personnel. Such costs represent management’s best estimate, but require assumptions about the programs that may change over time, including attrition rates. Estimates are evaluated periodically to determine if an adjustment is required.

Allowances for Doubtful Accounts Receivable

Representatives contact their customers, selling primarily through the use of brochures for each sales campaign. Sales campaigns are generally for a two-week duration in the U.S. and a two- to four-week duration outside the U.S. The Representative purchases products directly from Avon and may or may not sell them to an end user. In general, the Representative, an independent contractor, remits a payment to Avon each sales campaign, which relates to the prior campaign cycle. The Representative is generally precluded from submitting an order for the current sales campaign until the accounts receivable balance for the prior campaign is paid; however, there are circumstances where the Representative fails to make the required payment. We record an estimate of an allowance for doubtful accounts on receivable balances based on an analysis of historical data and current circumstances. Over the past three years, annual bad debt expense has been in the range of $145 to $195, or approximately 1.7% of total revenue. We generally have no detailed information concerning, or any communication with, any end user of our products beyond the Representative. We have no legal recourse against the end user for the collectability of any accounts receivable balances due from the Representative to us. If the financial condition of our Representatives were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Allowances for Sales Returns

We record a provision for estimated sales returns based on historical experience with product returns. Over the past three years, sales returns have been in the range of $295 to $370, or approximately 3.4% of total revenue. If the historical data we use to calculate these estimates does not approximate future returns, due to changes in marketing or promotional strategies, or for other reasons, additional allowances may be required.

Provisions for Inventory Obsolescence

We record an allowance for estimated obsolescence equal to the difference between the cost of inventory and the estimated market value. In determining the allowance for estimated obsolescence, we classify inventory into various categories based upon its stage in the product life cycle, future marketing sales plans and the disposition process. We assign a degree of obsolescence risk to products based on this classification to determine the level of obsolescence provision. If actual sales are less favorable than those projected by management, additional inventory allowances may need to be recorded for such additional obsolescence. Annual obsolescence expense was $80.8, $280.6 and $179.7 for the years ended December 31, 2008, 2007 and 2006, respectively. 2007 and 2006 included incremental inventory obsolescence charges of $167.3 and $72.6, respectively, related to our PLS program and 2006 also includes $20.5 related to our decision to discontinue the sale of heavily discounted excess products. Obsolescence expense for 2008 benefited by approximately $13 from changes in estimates to our disposition plan under our PLS program.

Pension, Postretirement and Postemployment Benefit Expense

We maintain defined benefit pension plans, which cover substantially all employees in the U.S. and in certain international locations. Additionally, we have unfunded supplemental pension benefit plans for certain current and retired executives (see Note 11, Employee Benefit Plans).

For 2008, the weighted average assumed rate of return on all pension plan assets, including the U.S. and non-U.S. plans was 7.66%. In determining the long-term rates of return, we consider the nature of the plans’ investments, an expectation for the plans’ investment strategies, historical rates of return and current economic forecasts. We evaluate the expected long-term rate of return annually and adjust as necessary.

The majority of our pension plan assets relate to the U.S. pension plan. The assumed rate of return for 2008 for the U.S. plan was 8%, which was based on an asset allocation of approximately 35% in corporate and government bonds and mortgage-backed securities (which are expected to earn approximately 4% to 6% in the long term) and 65% in equity securities (which are expected to earn approximately 8% to 10% in the long term). Historical rates of return on the assets of the U.S. plan for the most recent 10-year and 20-year periods were 2.0% and 7.6%, respectively. In the U.S. plan, our asset allocation policy has favored U.S. equity securities, which have lost .7% and returned 8.4%, respectively, over the 10-year and 20-year periods. The plan assets in the U.S. lost 26.2% and returned 9.3% in 2008 and 2007, respectively.

The discount rate used for determining future pension obligations for each individual plan is based on a review of long-term bonds that receive a high-quality rating from a recognized rating agency. The discount rates for our more significant plans, including our U.S. plan, were based on the internal rates of return for a portfolio of high quality bonds with maturities that are consistent with the projected future benefit payment obligations of each plan. The weighted-average discount rate for U.S. and non-U.S. plans determined on this basis was 6.11% at December 31, 2008, and 5.88% at December 31, 2007.

Our funding requirements may be impacted by regulations or interpretations thereof. Our calculations of pension, postretirement and postemployment costs are dependent upon the use of assumptions, including discount rates, expected return on plan assets, interest cost, health care cost trend rates, benefits earned, mortality rates, the number of associate retirements, the number of associates electing to take lump-sum payments and other factors. Actual results that differ from assumptions are accumulated and amortized to expense over future periods and, therefore, generally affect recognized expense in future periods. At December 31, 2008, we had pretax actuarial losses and prior service credits totaling $538.4 and $260.6 for the U.S. and non-U.S. plans, respectively, that have not yet been charged to expense. These actuarial losses have been charged to accumulated other comprehensive loss within shareholders’ equity. While we believe that the assumptions used are reasonable, differences in actual experience or changes in assumptions may materially affect our pension, postretirement and postemployment obligations and future expense. During 2008, the plan assets experienced significant losses, which were mostly due to unfavorable returns on equity securities. These unfavorable returns will increase pension cost in future periods. For 2009, our assumption for the expected rate of return on assets is 8.0% and 7.2% for our U.S. and non-U.S. plans, respectively. Our assumptions are reviewed and determined on an annual basis.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

OVERVIEW

We are a global manufacturer and marketer of beauty and related products. Our business is conducted worldwide, primarily in the direct selling channel. We presently have sales operations in approximately 66 countries and territories, including the United States, and distribute products in approximately 48 more. Our reportable segments are based on geographic operations in six regions: Latin America; North America; Central & Eastern Europe; Western Europe, Middle East & Africa; Asia Pacific; and China. We centrally manage global Brand Marketing and Supply Chain organizations. Product categories include: Beauty, which consists of cosmetics, fragrances, skin care and toiletries; Beauty Plus, which consists of fashion jewelry, watches, apparel and accessories; and Beyond Beauty, which consists of home products and gift and decorative products. Sales from Health and Wellness products and mark., a global cosmetics brand that focuses on the market for young women, are included among these categories based on product type. Sales are made to the ultimate consumer principally through over 5.5 million independent Representatives, who are independent contractors and not employees of Avon. The success of our business is highly dependent on recruiting, motivating and retaining Representatives.

We view the geographic diversity of our businesses as a strategic advantage. In developed markets, such as the United States, we seek to achieve growth in line with that of the overall beauty market, while in developing and emerging markets we seek to achieve higher growth targets. During 2007, approximately 80% of our consolidated revenue was derived from operations outside the U.S. When we first penetrate a market, we experience high growth rates and, as we reach scale in these markets, growth rates decline.

At the end of 2005, we launched a comprehensive, multi-year turnaround plan to restore sustainable growth. In January 2008, we announced the final initiatives of the restructuring program under our turnaround plan. In 2007, we completed the analysis of our optimal product portfolio and made decisions on exit strategies for non-optimal products under our Product Line Simplification program (“PLS”). In 2007, we also launched our Strategic Sourcing Initiative (“SSI”). We expect our restructuring initiatives to deliver annualized savings of approximately $430 once all initiatives are fully implemented by 2011-2012. We also expect to achieve annualized benefits in excess of $200 each from PLS and SSI, which would bring total annualized savings and benefits from all three programs to over $830 when fully implemented. After more than two years of implementing our turnaround plan, we believe we have repositioned Avon for long-term sustainable, profitable growth.

During the first nine months of 2008, revenue grew in all segments except North America, which was adversely affected by the slowing macroeconomic environment, higher year-over-year fuel prices, deteriorating consumer confidence and service-related problems experienced during the first half of 2008. We continued to benefit from strength in developing and emerging markets around the globe that more than offset the unfavorable impact of economic softness in North America. See the “Segment Review” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information related to changes in revenue by segment.

During the first nine months of 2008, revenue increased 15%, and Active Representatives increased 9% (with increases in all segments), fueled by investments in advertising and the Representative Value Proposition (“RVP”). Sales from each of our product categories increased, with products in the Beauty category increasing 17%.

OUTLOOK

Our strategy is to invest in both our brand and direct-selling channel to drive sustainable, profitable growth. As a result, we continue to expect revenue growth over the long term to average mid-single digits, excluding the impact of foreign exchange.

As of the date of this filing, we have not experienced a measureable impact from the current economic and financial crisis on our business outside of North America. While we consider the consequences of possible deterioration in these economies and remain watchful of our business trends in these markets, we expect 2008 fourth quarter local-currency revenue growth rates in these markets similar to those of the third quarter of 2008. The negative consumer environment in North America continues to weigh on our performance in that region, and we expect the trend to further deteriorate in the fourth quarter of 2008. Additionally, recent significant movements in foreign-exchange rates, if maintained at current levels, will negatively impact our fourth-quarter and full-year 2008 growth rates and operating margins. As a result, we now expect a 2008 full-year operating margin in the range of 13%, compared with our previous expectation of an operating margin approaching 2005’s level of approximately 14%. We are providing no operating margin guidance beyond 2008.

We believe that our strong operating cash flow, combined with global cash balances approaching $1 billion and our investment-grade credit rating (Standard & Poor’s rating of single A and Moody’s rating of A2), should more than enable us to meet our financial needs.

STRATEGIC INITIATIVES

Product Line Simplification

During 2006, we began to analyze our product line, under our PLS program, to develop a smaller range of better performing, more profitable products. The overall goal of PLS is to identify an improved product assortment to drive higher sales of more profitable products. During 2007, we completed the analysis of our product portfolio, concluded on the appropriate product assortment going forward and made decisions regarding the ultimate disposition of products that will no longer be part of our improved product assortment (such as selling at a discount, donation, or destruction). During the first quarter of 2008, we began to implement PLS in the U.K. In the third quarter of 2008, we began implementing PLS in several other large markets.

We expect that sales and marketing benefits will account for approximately 85% of our projected benefits. Improving our product assortment will allow us to increase exposure and improve presentation of the remaining products within our brochure, which is expected to yield more pleasurable consumer shopping experiences, easier Representative selling experiences, and greater sales per brochure page. A second source of benefits from PLS results from “transferable demand.” Transferable demand refers to the concept that when products with redundant characteristics are removed from our product assortment, some demand from the eliminated products will transfer to the remaining products that offer similar or comparable product characteristics. As part of PLS, when we identify products that have sufficient overlap of characteristics, we will eliminate the products with the lowest profitability and we expect the products that we retain will generate more profit. A third source of benefits from PLS is less price discounting. As we implement operating procedures under PLS, we anticipate introducing fewer new products and lengthening the lifecycle of products in our offering, which we expect will lead to less aggressive price discounting over a product’s life cycle.

In addition to the benefits above, we also expect supply chain benefits to account for approximately 15% of our projected benefits. We expect improvements to cost of sales once PLS is fully implemented, primarily from a reduction in inventory obsolescence expense as a result of better managed inventory levels, lower variable spending on warehousing, more efficient manufacturing utilization and lower purchasing costs. We also expect operating expenses to benefit from a reduction in distribution costs and benefits to inventory productivity.

Strategic Sourcing Initiative

We launched SSI in 2007. This initiative is expected to reduce direct and indirect costs of materials, goods and services. Under this initiative, we are shifting our purchasing strategy from a local, commodity-oriented approach towards a globally-coordinated effort which leverages our volumes, allows our suppliers to benefit from economies of scale, utilizes sourcing best practices and processes, and better matches our suppliers’ capabilities with our needs. Beyond lower costs, our goals from SSI include improving asset management, service for Representatives and vendor relationships. During 2007, we completed an analysis, based on 2006 data, which identified approximately $4,000 of spending to be targeted for cost reductions. Additionally, during 2007, we implemented the first of three waves of this initiative, which has addressed approximately 38% of the identified spending and is expected to generate approximately 50% of the expected benefits. During the fourth quarter of 2007, we launched the second wave of this initiative, which is expected to address 45% of the identified spending and generate approximately 30% of the expected benefits. We are currently in the process of implementing the second wave of this initiative.

Restructuring Initiatives

We launched our multi-year restructuring program in late 2005. In January 2008, we announced the final initiatives that are part of this program. We expect to record total restructuring charges and other costs to implement our restructuring initiatives of approximately $530 before taxes, of which we have recorded $496.8 through September 30, 2008 ($53.2 in 2008, $158.3 in 2007, $228.8 in 2006, and $56.5 in 2005). We expect to record a majority of the remaining costs by the end of 2009.

Enterprise Resource Planning System

We are in the midst of a multi-year global roll-out of an enterprise resource planning (“ERP”) system, which is expected to improve the efficiency of our supply chain and financial transaction processes. We began our global roll-out in Europe in 2005 and have since implemented ERP in our European manufacturing facilities, our larger European direct selling operations and in the U.S. As part of this continuing global roll-out, we expect to implement ERP in several countries over the next several years leveraging]]>Thu, 12 Mar 2009 11:44:12 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1981/http://www.dailystocks.com/forum/showtopic.php?tid/1981/
Target (TGT)
Investor William Ackman said he will ask Target's board to consider certain candidates as directors. Ackman said his representatives have met and may meet again with management to discuss ways to enhance shareholder value. Ackman may also contact other shareholders to discuss those issues. Ackman's Pershing Square Capital Management holds 58.39 million shares (7.8%).

BUSINESS OVERVIEW

Target Corporation (the Corporation or Target) was incorporated in Minnesota in 1902. We operate large-format general merchandise and food discount stores in the United States, which include Target and SuperTarget stores. We offer both everyday essentials and fashionable, differentiated merchandise at exceptional prices. Our ability to deliver a shopping experience that is preferred by our guests is supported by our strong supply chain and technology infrastructure, a devotion to innovation that is ingrained in our organization and culture, and our disciplined approach to managing our current business and investing in future growth. We operate as a single business segment.

Our credit card operations represent an integral component of our core retail business. Through our branded proprietary credit card and debit card products (REDcards), we strengthen the bond with our guests, drive incremental sales and contribute meaningfully to earnings. We also operate a fully integrated online business, Target.com. Although Target.com is small relative to our overall size, its sales are growing at a much more rapid pace than our in-store sales, and it provides important benefits to our stores and credit card operations.

We are committed to consistently delighting our guests, providing a workplace that is preferred by our team members and investing in the communities where we do business to improve the quality of life. We believe that this unwavering focus, combined with disciplined execution of the fundamentals of our strategy, will enable us to continue generating profitable market share growth and delivering superior shareholder value for many years to come.

Financial Highlights

Our fiscal year ends on the Saturday nearest January 31. Unless otherwise stated, references to years in this report relate to fiscal years, rather than to calendar years. Fiscal year 2007 (2007) ended February 2, 2008 and consisted of 52 weeks. Fiscal year 2006 (2006) ended February 3, 2007 and consisted of 53 weeks. Fiscal year 2005 (2005) ended January 28, 2006 and consisted of 52 weeks.

For information on key financial highlights, see the items referenced in Item 6, Selected Financial Data, and Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K.

Seasonality

Due to the seasonal nature of our business, a substantially larger share of total annual revenues and earnings occur in the fourth quarter because it includes the peak sales period from Thanksgiving to the end of December.

Merchandise

We operate Target general merchandise stores with a wide assortment of general merchandise and a limited assortment of food items, as well as SuperTarget stores with a full line of food and general merchandise items. Target.com offers a wide assortment of general merchandise including many items found in our stores and a complementary assortment, such as extended sizes and colors, sold only online. A significant portion of our sales is from national brand merchandise. In addition, we sell merchandise under private-label brands including, but not limited to, Archer Farms®, Boots & Barkley®, Choxie®, Circo®, Durabuilt™, Embark®, Gilligan & O'Malley®, Home and Bullseye Design, Kaori™, Market Pantry®, Merona®, Playwonder®, ProSpirit®, Trutech® and Xhilaration®. We also sell merchandise through unique programs such as ClearRx SM , Global Bazaar and GO International®. In addition, we also sell merchandise under licensed brands including, but not limited to, C9 by Champion, Converse, Chefmate, Cherokee, Eddie Bauer, Fieldcrest, Genuine Kids by Osh Kosh, Isaac Mizrahi for Target, Kitchen Essentials by Calphalon, Liz Lange for Target, Michael Graves Design, Mossimo, Nick & Nora, Perfect Pieces by Victoria Hagan, Sean Conway, Simply Shabby Chic, Smith & Hawken, Sonia Kashuk, Thomas O'Brien, Waverly and Woolrich. We also generate revenue from in-store amenities such as Food Avenue®, Target Clinic SM , Target Pharmacy SM , and Target Photo SM , and from leased or licensed departments such as Optical, Pizza Hut, Portrait Studio and Starbucks.

Distribution

The vast majority of our merchandise is distributed through a network of 32 distribution centers. General merchandise is shipped to and from our distribution centers by common carriers. Certain food items are distributed by third parties. Merchandise sold through Target.com is distributed through our own distribution network, through third parties, or shipped directly from vendors.

Employees

At February 2, 2008, we employed approximately 366,000 full-time, part-time and seasonal employees, referred to as "team members." During our peak sales period from Thanksgiving to the end of December, our employment levels peaked at approximately 396,000 team members. We consider our team member relations to be good. We offer a broad range of company-paid benefits to our team members, including a pension plan, 401(k) plan, medical and dental plans, a retiree medical plan, short-term and long-term disability insurance, paid vacation, tuition reimbursement, various team member assistance programs, life insurance and merchandise discounts. Eligibility for, and the level of, these benefits varies depending on team members' full-time or part-time status and/or length of service.

Working Capital

Because of the seasonal nature of our business, our working capital needs are greater in the months leading up to our peak sales period from Thanksgiving to the end of December. The increase in working capital during this time is typically financed with cash flow from operations and short-term borrowings. Additional details are provided in the Liquidity and Capital Resources section in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

Competition

Our business is conducted under highly competitive conditions. Our stores compete with national and local department, specialty, off-price, discount, supermarket and drug store chains, independent retail stores and Internet businesses that sell similar lines of merchandise. We also compete with other companies for new store sites.

We believe the principal methods of competing in this industry include brand recognition, customer service, store location, differentiated offerings, value, quality, fashion, price, advertising, depth of selection and credit availability.

Intellectual Property

Our brand image is a critical element of our business strategy. Our principal trademarks, including Target, SuperTarget and our "Bullseye Design," have been registered with the U.S. Patent and Trademark Office.

Geographic Information

Substantially all of our revenues are generated in, and long-lived assets are located in, the United States.

Available Information

Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge at www.Target.com (click on "Investors" and "SEC Filings") as soon as reasonably practicable after we file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Our Corporate Governance Guidelines, Business Conduct Guide, Corporate Responsibility Report and the position descriptions for our Board of Directors and Board committees are also available free of charge in print upon request or at www.Target.com (click on "Investors" and "Corporate Governance").

CEO BACKGROUND

Director
Roxanne S. Austin
Class II
Term expires in 2008


Principal Occupation and Other Information
Age
46


Director
Since 2002



Roxanne S. Austin served as Executive Vice President of Hughes Electronics Corp., a provider of digital television entertainment and technology services, and as President and Chief Operating Officer of its subsidiary, DIRECTV, Inc., until December 2003 when Hughes was acquired. She joined Hughes in 1993 and held various positions in finance. In July 1997, she was named Chief Financial Officer of Hughes. In May 2001, she was elected Executive Vice President of Hughes and in June 2001, she was named President and Chief Operating Officer of DIRECTV. She is a director of Abbott Laboratories and Teledyne Technologies.


MANAGEMENT DISCUSSION FROM LATEST 10K

Executive Summary

Fiscal 2007, a 52 week period, was a year of slower sales and earnings growth for Target than in our recent past. Net earnings increased 2.2 percent to $2,849 million, and on this same basis, diluted earnings per share rose 3.9 percent to $3.33. Sales increased 6.2 percent, including comparable-store sales (as defined below) growth of 3.0 percent. The shorter fiscal year in 2007 adversely impacted sales growth by 1.9 percentage points but had no impact on comparable-store sales growth. The combination of retail and credit card operations produced earnings before interest expense and income taxes of $5,272 million, an increase of 4.0 percent from 2006.

Net cash provided by operating activities was $4,125 million for 2007. During 2007 we repurchased 46.2 million shares of our common stock for a total investment of $2,642 million. Additionally, we paid dividends of $442 million and invested $331 million in call options on our own common stock. We also opened 118 new stores in 2007, or 103 stores net of 14 relocations and one closing.

Management's Discussion and Analysis is based on our Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Analysis of Results of Operations


Total revenues for the three and nine months ended November 1, 2008 were $15,114 million and $45,388 million, respectively, compared with $14,835 million and $43,496 million, respectively, for the same periods last year, an increase of 1.9 percent and 4.4 percent, respectively.



Net earnings for the three and nine months ended November 1, 2008 were $369 million, or $0.49 per share, and $1,605 million and $2.06 per share, respectively, compared with $483 million, or $0.56 per share, and $1,821 million and $2.11 per share, respectively, for the same periods last year. All earnings per share figures refer to diluted earnings per share.



As described in Notes 1 and 12, we changed our reportable business segments in the first quarter of 2008. Additionally, as described in Note 3, we changed our cost classification policy with respect to certain supply chain costs.

EBITDA is earnings before interest expense, income taxes, depreciation and amortization.

EBIT is earnings before interest expense and income taxes.

(a) New account and loyalty rewards redeemed by our guests reduce reported sales. Our Retail Segment charges the cost of these discounts to our Credit Card Segment, and the reimbursements of $24 million and $75 million for the three and nine months ended November 1, 2008, respectively, and $24 million and $73 million for the three and nine months ended November 3, 2007, respectively, are recorded as a reduction to SG&A expenses within the Retail Segment .

Sales



Sales include merchandise sales, net of expected returns, from our stores and our online business, as well as gift card breakage. Total sales for the Retail Segment for the quarter were $14,588 million, compared with $14,342 million for the same period a year ago, an increase of 1.7% percent. For the nine month period ending November 1, 2008, total sales for the Retail Segment were $43,861 million, compared with $42,132 million for the same period a year ago, an increase of 4.1 percent. Total sales growth in the Retail Segment was positively impacted by our new stores, somewhat offset by a decline in comparable-store sales.



Comparable-store sales is a measure that indicates the performance of our existing stores by measuring the growth in sales for such stores for a period over the comparable, prior-year period of equivalent length. The method of calculating comparable store sales varies across the retail industry. As a result, our calculation of comparable store sales is not necessarily comparable to similarly titled measures reported by other companies.



Comparable-store sales are sales from our online business and sales from general merchandise and SuperTarget stores open longer than one year, including:

• sales from stores that have been remodeled or expanded while remaining open

• sales from stores that have been relocated to new buildings of the same format within the same trade area, in which the new store opens at about the same time as the old store closes

Comparable-store sales do not include:

•sales from general merchandise stores that have been converted, or relocated within the same trade area, to a SuperTarget store format

• sales from stores that were intentionally closed to be remodeled, expanded or reconstructed

In fiscal 2008, the decline in comparable store sales was driven by a decline in the number of transactions, partially offset by an increase in average transaction amount, which reflects the effect of a decrease in number of units per transaction partially offset by higher dollars per unit within the transactions.



Transaction-level metrics are influenced by a broad array of macroeconomic, competitive and consumer behavioral factors, and comparable-store sales rates are impacted by transfer of sales to new stores.



Gross Margin Rate



Gross margin rate represents gross margin (sales less cost of sales) as a percentage of sales. See Note 3 for a description of expenses included in cost of sales. In the third quarter of 2008, our gross margin rate was 30.6 percent compared with 30.0 percent in the same period last year, driven by increases in gross margin rates within categories that benefitted the rate (approximately 1.0 percent), partially offset by the mix impact of faster sales growth in lower margin rate categories (approximately 0.4 percent). Rate improvement within categories during the quarter was driven partly by an array of inventory control initiatives that minimized markdowns and by a favorable supply chain expense rate (0.2 percent), about half of which was driven by improved workers compensation expenses. For the nine months ended November 1, 2008, our gross margin rate was 30.8 percent, unchanged from the same period last year. While our year-to-date gross margin rate was flat, we experienced increases in gross margin rates within categories that benefitted the rate (approximately 0.6 percent) that were entirely offset by the mix impact of faster sales growth in lower margin rate categories (approximately 0.6 percent). The same factors that drove changes in our quarterly gross margin rate affected our year-to-date gross margin rate, except that the changes in sales mix on the gross margin rate fully offset the factors driving rate improvements within merchandise categories.



Selling, General and Administrative Expense Rate



Our selling, general and administrative (SG&A) expense rate represents SG&A expenses as a percentage of sales. See Note 3 for a description of expenses included in SG&A expense. SG&A expenses exclude depreciation and amortization. In the third quarter of 2008 and 2007, our SG&A expense rate was 22.1 percent. For the nine months ended November 1, 2008, our SG&A rate was 21.3 percent compared with 21.5 percent in the same period last year. We were able to achieve these essentially flat expense rates due to continued productivity gains in our stores and disciplined control of expenses across the company.

Depreciation and Amortization Expense Rate

Our depreciation and amortization expense rate represents depreciation and amortization expense as a percentage of sales. In the third quarter of 2008, our depreciation and amortization expense rate was 3.2 percent compared with 3.0 percent for the same period last year. For the nine months ended November 1, 2008, our depreciation and amortization expense rate was 3.1 percent compared with 2.9 percent for the same period last year. The rate unfavorability resulted from sales growing at a slower pace than capital expenditures.

Credit Card Segment

We offer credit to qualified guests through our REDcard products, the Target Visa and the Target Card. Our credit card program strategically supports our core retail operations and remains an important contributor to our overall profitability. Our credit card revenues are comprised of finance charges, late fees and other revenues. The substantial majority of credit card receivables earn finance charge revenues at rates tied to the Prime Rate. In addition, we receive fees from merchants who accept the Target Visa credit card.

(a) New account and loyalty rewards redeemed by our guests reduce reported sales. Our Retail Segment charges the cost of these discounts to our Credit Card Segment, and the reimbursements of $24 million and $75 million for the three and nine months ended November 1, 2008, respectively, and $24 million and $73 million for the three and nine months ended November 3, 2007, respectively, are recorded as an increase to Operations and Marketing expenses within the Credit Card Segment.

(b) Amounts represent the portion of average credit card receivables funded by Target. These amounts exclude $5,473 million and $4,176 million for the three and nine months ended November 1, 2008, respectively, and $2,845 million and $2,296 million for the three and nine months ended November 3, 2007, respectively, of receivables funded by nonrecourse debt collateralized by credit card receivables.

(c) ROIC is return on invested capital, and this rate equals our segment profitability divided by average receivables funded by Target, expressed as an annualized rate.

(a) Balance-weighted one-month LIBOR

(b) As a percentage of average receivables

(c) Spread to LIBOR is a metric used to analyze the performance of our total credit card portfolio because the vast majority of our portfolio earns finance charge revenue at rates tied to the Prime Rate, and the interest rate on all nonrecourse debt securitized by credit card receivables is tied to LIBOR.

(a) Balance-weighted one-month LIBOR

(b) As a percentage of average receivables

(c) Spread to LIBOR is a metric used to analyze the performance of our total credit card portfolio because the vast majority of our portfolio earns finance charge revenue at rates tied to the Prime Rate, and the interest rate on all nonrecourse debt securitized by credit card receivables is tied to LIBOR.

We measure the performance of our overall credit card receivables portfolio by calculating the dollar spread to LIBOR at the portfolio level. Our primary measure of profitability in our Credit Card Segment is the EBIT generated by our total credit card receivables portfolio less the interest expense on nonrecourse debt collateralized by credit card receivables. We analyze this measure of profit in light of the amount of capital Target has invested in our credit card receivables. At the portfolio level, the decline in dollar spread to LIBOR is almost entirely due to increased bad debt expense, resulting from higher current period write-offs and additions to the reserve for anticipated future write-offs of current receivables. In addition, our Credit Card Segment profitability was also affected by finance charge yield pressure from the impact of reductions in the prime rate and higher interest expense resulting from increased third-party funding of our receivables in 2008, as compared with 2007.

Average receivables in the third quarter increased 19.4 percent to approximately $8,745 million from approximately $7,324 million at the end of the 2007 third quarter. Average receivables in the nine months ended November 1, 2008 increased 24.0 percent to approximately $8,568 million from approximately $6,908 million in the nine months ended November 3, 2007.

In part, the growth in receivables is the annualized impact from last year’s product change from proprietary Target Cards to Target Visa cards for a group of higher credit-quality Target Card Guests. A product change to a Target Visa card generally results in a higher receivables balance because it can be used for purchases outside of Target stores and has a higher credit limit. Accounts converted from a Target Card to a Target Visa accounted for approximately 15 percentage points of the growth in average receivables. The remainder of the growth was primarily due to lower payment rates on accounts, offset by lower charge activity across all segments of the portfolio.

As a result of domestic economic conditions and the related impact on the performance of the overall portfolio, including increased bad debt expense and growth of past due receivable amounts from prior period levels, we have adjusted our risk management controls on portfolio underwriting, including decreasing the number of new accounts that are opened, decreasing the average credit lines associated with the accounts, and engaging in proactive collection activities.

Other Performance Factors

Net interest expense was $234 million and $652 million, for the three and nine month periods ended November 1, 2008, respectively, a $58 million and $185 million increase from the three and nine months ended November 3, 2007, reflecting significantly higher debt balances supporting capital investment, share repurchase and the receivables portfolio, partially offset by lower average debt portfolio interest rates.

Our effective tax rate for the third quarter of 2008 was 41.7 percent compared with 38.1 percent for the third quarter of 2007. The increase in the effective rate between benchmark periods primarily resulted from negative capital market returns on company owned life insurance investments. We use these investments to economically hedge market risk in our deferred compensation plans. Returns on company owned life insurance investments are not taxable. In the third quarter of 2008, we incurred losses related to capital market returns from company owned life insurance investments as compared to gains from these investments in the third quarter of 2007. The losses in the third quarter of 2008 resulted in a lower amount of non-taxable income than in the third quarter of 2007. This resulted in a higher effective tax rate for the third quarter of 2008 as compared to the third quarter of 2007. Future periods’ tax rates will be directly affected by capital market returns in those periods. The year-to-date effective tax rate slightly decreased to 38.1 percent in 2008 from 38.5 percent in 2007.

Accumulated other comprehensive income/(loss) may be adversely impacted at the end of our fiscal year as a result of the non-cash remeasurement of the plan assets and benefit obligations required under SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).” The impact is dependent on the fair value determination of plan assets and benefit obligations at the measurement date.

Analysis of Financial Condition


Liquidity and Capital Resources


Our financial condition remains strong. In assessing our financial condition, we consider factors such as cash flows provided by operations, capital expenditures and debt service obligations. We continue to fund our growth

through a combination of internally-generated funds and debt financing, including notes payable under our commercial paper program. We funded our 2008 peak sales season working capital needs through our commercial paper program, consistent with prior years and without any funding disruptions. Notes payable under our commercial paper program totaled $1,382 million and $578 million at November 1, 2008 and November 3, 2007, respectively.


Gross credit card receivables at quarter end were $8,764 million compared with $7,652 million at the end of the third quarter 2007, an increase of 14.5 percent. Inventory at quarter end was $9,050 million compared with $8,746 million at the end of third quarter 2007, an increase of 3.5 percent, reflecting the natural increase required to support additional square footage and sales growth.


Capital expenditures for the nine months ended November 1, 2008 were $2,827 million, compared with $3,418 million for the same period a year ago. This decrease was driven by lower capital expenditures for new stores, remodels and technology-related assets. In light of the current operating environment, we have fewer opportunities to productively invest capital and have reduced our forecasted capital expenditures for 2009 to levels below prior periods.


During the quarter ended November 1, 2008, we repurchased 2.5 million shares of our common stock. The cash investment of $140 million ($54.93 per share) related to these shares was a prior period outlay. Since the inception of our current share repurchase program, which began in the fourth quarter of 2007, we have repurchased 93.3 million shares of our common stock, for a total cash investment of $4,826 million ($51.70 per share). Refer to Note 10 for additional information.


In light of our current business outlook, in November 2008 we announced a temporary suspension of open-market share repurchase program.


As described in Note 6, we sold a 47 percent undivided interest in our credit card receivables for approximately $3.6 billion during the second quarter of 2008.

Outlook for Fiscal Year 2008


The increasing financial challenges and economic uncertainty facing U.S. households as well as increased competitive pressure are expected to continue to negatively influence our performance for the remainder of the 2008 fiscal year.

In our Retail Segment, our sales performance in the fourth quarter is expected to be adversely impacted by the current economic environment and a compressed holiday season due to fewer days between Thanksgiving and Christmas. Despite conservative inventory management and tight expense control, this weak sales outlook is expected to pressure fourth quarter gross margin and expense rates and result in a moderate decline in fourth quarter operating margin rate from 2007. It is our expectation that comparable-store sales in the fourth quarter will be lower than the third quarter, and the range of possible outcomes is broad.


In our Credit Card Segment, we expect to end the year with receivables up to 10 percent higher than 2007, reflecting typical seasonal growth and the annualization of last year’s product change. We expect our fourth quarter annualized net write-off rate to be in the range of 10 to 11 percent, resulting in a full-year net write-off rate slightly above 9 percent. As the full benefit of terms changes are realized in the fourth quarter, our key overall measure of portfolio performance, spread to LIBOR, and our key measure at the segment level, pre-tax ROIC, are anticipated to be around or slightly above our third quarter levels.


We expect that there will continue to be variability between our individual quarterly and full-year effective tax rates as tax uncertainties arise and are resolved. For the full year 2008, we expect an effective tax rate in the range of 38.0 to 38.5 percent.


Forward-Looking Statements

This report contains forward-looking statements, which are based on our current assumptions and expectations. These statements are typically accompanied by the words “expect,” “may,” “could,” “believe,” “would,” “might,” “anticipates,” or words of similar import. The forward-looking statements in this report include: the anticipated impact of new accounting pronouncements; the adequacy of our reserves in light of the expected outcome of litigation and tax uncertainties; the impact to accumulated other comprehensive income / (loss) for the remeasurement of plan assets and benefit obligations; the amortization of hedged debt valuation adjustments; for our Retail Segment, our outlook for sales, operating margin rate, comparable-store sales, gross margin rate, and depreciation expense; for our Credit Card Segment, our outlook for year-end receivable balances, net write-off rates, dollar spread to LIBOR, and pretax segment ROIC; and our expectations with respect to our full-year effective tax rates.

All such forward-looking statements are intended to enjoy the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Although we believe there is a reasonable basis for the forward-looking statements, our actual results could be materially different. The most important factors which could cause our actual results to differ from our forward-looking statements are set forth on our description of risk factors on Exhibit (99)A to this Form 10-Q, which should be read in conjunction with the forward-looking statements in this report. Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement.

CONF CALL

Gregg W. Steinhafel

Good morning and welcome to our 2008 fourth quarter and year-end earnings conference call. This morning I will briefly review our performance and discuss the actions we are taking to improve sales, capture market share and increase profitability in this challenging economic environment. Then Doug Scovanner, Executive Vice President and Chief Financial Officer will discuss our financial results and outlook for 2009. Next, Kathy Tesija, Executive Vice President Merchandising will describe initiatives we are pursuing in support of both the Expect More and Pay Less side of our strategy. And finally we will open the phone lines for a question-and-answer session.

As the economy contracted at its fastest pace in decades during the final months of 2008, Target experienced challenges in both our retail and credit card segments that resulted in a decline in our fourth quarter financial performance. In our retail segment our results were characterized by a fundamental change in consumer spending patterns that negatively impacted both our traffic and sales, particularly in higher margin discretionary categories like seasonal, apparel and home; an elevated level of markdowns resulting from weaker than expected sales and intense promotional activity across the retail industry; and exceptional expense control, particularly in our store hourly payroll.

By carefully managing our inventory levels and taking appropriate pricing action to remain competitive, we continued to capture market share during the holiday period and we were able to exit the year in a very clean inventory position.

In our credit card segment our performance, like that of other credit card issuers, was adversely affected by the deteriorating risk environment. As a result, we incurred higher than expected bad debt expense as we wrote off accounts and added significantly to our reserve in anticipation of additional write-offs of receivables in 2009.

While we cannot control the broader economic conditions that have affected our recent performance, we can remain firmly focused on managing our business to deliver strong performance in the near term while staying true to our strategy in the long term. We seek to make Target the preferred shopping destination for all our guests by delivering outstanding value, continuous innovation, and an exceptional guest experience by consistently fulfilling our Expect More, Pay Less brand promise.

As a result, we are taking thoughtful yet aggressive actions, balancing offense and defense to insure that we remain relevant to our guests; drive sales; and improve profitability; and sustain our competitive advantage.

These actions include an enhanced focus on frequency driving strategies which are centered on food, pharmacy and commodities; a consolidation of our own brand portfolio to make a more powerful statement about these exclusive, high quality, affordable assortments; greater emphasis on communicating our value message including both the exceptional prices and the outstanding quality throughout our assortments; and an intense devotion to operational discipline, including an enterprise wide commitment to expense control and careful inventory management, particularly in the seasonal and high risk categories.

We will continue to pursue thoughtful ways to increase efficiency and productivity throughout the organization, but we are firm in our commitment not to take actions that will damage our brand in pursuit of a short run decrease in expense.

To mitigate risk and improve our financial performance on the credit side of our business, we have taken action on several fronts. We are firmly focused on driving revenue to offset higher costs in the current environment, and we are refining all aspects of our risk management strategies to address an environment in which consumers are more likely to encounter financial stress.

Our relationship with J.P. Morgan-Chase continues to be beneficial, with both companies working to define our products and services in a way that exceeds cardholders’ expectations but also preserves profitability. We believe this partnership will strengthen throughout 2009, resulting in improved profit in our credit card operations.

During 2008, Target opened 114 total new stores or 91 stores net of relocations and rebuilds. In support of this store growth, we created over 16,000 new jobs across our organization with the majority in our stores and distribution centers.

As we continue to focus on efficient capital deployment and maintaining strong liquidity, we have reduced our store opening plans in 2009. Our three store opening cycles in 2009 envision the addition of approximately 75 total stores or about 60 net new locations with 27 stores in our upcoming March cycle, including our first two stores in Hawaii. On average each of these new stores is expected to create well over 150 new jobs in the communities where they open.

We continue to invest in technology to maintain our competitive advantage including the development of new pharmacy, finance and compliance systems in support of our growing scope and scale.

In addition, reflecting our growing commitment to food, we are making significant investments in support of our perishable food distribution capabilities. We also continue to invest in our food offerings in recognition of its importance in driving greater frequency, increasing guest loyalty and making Target a preferred shopping destination. In recent years we have expanded our selection and assortment to provide improved convenience and outstanding value, and in 2009 we plan to further enhance our assortment of dry, dairy and frozen and add perishable items in new and remodeled general merchandise stores.

As we work to address the challenges currently facing our business, we remain firmly committed to the values and strategies that have driven our success for nearly 50 years. We are passionately committed to providing a workplace that is preferred by our team members. We recognize that the strength of our brand and our strategy over time lies in the talent and dedication of our team.

We are also keenly focused on remaining relevant to our guests by anticipating their needs and wants. In a macroeconomic environment that is characterized by a more frugal consumer mindset, we believe Target is well positioned to capture profitable market share growth. While we expect continued volatility in the coming year, we are more determined than ever to strike the right balance of Expect More, Pay Less for our guests.

We continue to give 5% of our income to support and enrich the communities we serve. And we are proud of our long history of strong corporate governance and remain disciplined stewards of this corporation’s assets, diligently focused on generating superior shareholder value over time.

Now, Doug will describe our fourth quarter and 2008 results and share more detail on our 2009 outlook, including our capital investment plans.

Douglas A. Scovanner

Thanks Gregg. As a reminder, we are joined on this conference call by investors and others who are listening to our comments today live via webcast. Following our prepared remarks, we’ll conduct a Q&A session and John Hulbert and I will be available throughout the remainder of the day to answer any follow-up questions you may have. Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings.

This morning I’ll first focus my comments on the fourth quarter and full year 2008 results in our retail and credit card segments. Then I’ll discuss some current trends and themes surrounding our generation of cash flow and how we intend to apply it in 2009. And in conclusion I’ll provide some clarity on our outlook into 2009 and beyond.

Let’s begin with a view of our retail segment performance. On the sales line we recorded just under $63 billion this year, in total up 2.3% from 2007, although on a same store basis we were down 2.9%. As you know our fourth quarter sales performance was much weaker than our full year performance despite an easier base of prior year sales comparisons. Specifically, our fourth quarter total and same store sales metrics were three to four percentage points weaker than our full year performance as the effect of sharp macroeconomic deterioration played through our sales equation, especially on our more discretionary apparel, home and seasonal categories.

We successfully promoted our way to an ending point of very clean inventories, but at the short term cost of some additional gross margin rate pressure. Ultimately, we delivered about $5.9 billion of EBITDA and $4.1 billion of EBIT in our retail segment for the year. These figures were of course below our beginning year expectations, driven in part by sharply lower sales especially across many of our more discretionary categories.

Importantly though our EBIT benefited from a very thoughtful and comprehensive effort on expense control. In fact, our expenses in the fourth quarter were actually below last year’s levels in dollars, all the more remarkable in light of our operating 91 additional stores this year and the costs we recently disclosed related to team member reductions. Expense control continues to be a key strength of ours in this harsh environment.

In our credit card segment we experienced sharp increases during the fourth quarter on a wide variety of leading indicators of future risk. While our write-offs in dollars were in line with our expectations, these risks compelled us to add meaningfully to our reserves for future credit losses on existing receivables. In the quarter we accomplished this by expensing $245 million more than we wrote off. We ended the year with a reserve just over $1 billion representing 11.1% of year-end gross receivables. This reserve was $440 million more than our reserve just 12 months ago. Notably the magnitude of our accrual for future write-offs created an operating loss for the fourth quarter, an outcome experienced by nearly all large U.S. owners of similar card portfolios.

For the year, our overall portfolio delivered profits representing a 1.4 percentage point positive spread to one month libor. And that’s after expensing 14.4% of average receivables for currents and projected write-offs on our existing receivable. One way to think about this 14.4% expense figure is that it is equal to the sum of the 9.3% of average receivables written off during the year and the 5.1% of average receivables we added to our reserve by accruing expense this year for expected trouble to follow.

Looking beyond the results of our two segments, we’ve been very deliberate in the management and application of our cash resources in the current environment. We continue to evaluate and underwrite proposed new store projects one at a time, and over the past several months we have committed to only a small handful of new stores entering our new store pipeline.

Lead times in this arena are such that our March and July opening cycles in 2009 will look similar to historic patterns of growth, but we will begin to taper off sharply in the fall of 2009 and well into 2010. While there isn’t a lot of visibility into 2010 at the moment, a rough range of total new store possibilities would be framed by, say, five stores on the low end and perhaps 30 on the top end.

In total, our base capital investment plan for 2009 envisions investing just over $2 billion. Alternatively, we might invest as much as say $2.5 billion if we were to see clear and measurable signs of improvement in the economy that led us to return to meaningful numbers of new stores in 2010 and beyond.

This leads directly to another of our great strengths in the current environment. The combined impacts of this forecast of capital investment and the curtailment of open market share repurchase means that we are likely to enjoy one of our strongest years ever in generation of free cash flow in 2009. Specifically I expect Target to again generate more than $4 billion in cash from operations in 2009, which would provide ample cash from internal sources to fund our projected capital investments, and pay dividends on our common stock, and fund our $1.3 billion of debt maturing and have cash remaining, all without the need to access the term debt capital markets this year.

To be clear, we continue to have that access and might even use it to provide additional liquidity insurance or to engage in opportunistic refunding of some of our debt before it is due, but it is not a necessary element of our plan in the near future.

Now we’ll turn to a similarly specific performance outlook for our two segments. In our retail segment we continue to enjoy positive same store sales and continue to gain market share across most non-discretionary categories in our store.

In contrast, while we’re also gaining a meaningful amount of market share in our more discretionary categories, our sales performance in these higher margin areas continues to be much, much softer. Overall this is a recipe in the front half of 2009 for a continuation of mid single digit decline in same store sales. This sales and mix expectation will very likely lead to a generation of EBITDA and EBIT in our retail segment below last year’s profits for at least the next six months, even in light of continued very strong expense performance.

In our credit card segment we’re actually seeing some encouraging early stage measures of risk, although it’s clearly premature to plant a flag and declare victory. Our write-offs are likely to stabilize in the range of $300 million in each of the next two quarters, levels we anticipated in establishing the year-end reserve I discussed a few minutes ago. We do not currently anticipate the need to add any meaningful reserves in the foreseeable future, especially in light of the high likelihood of modest decreases in our gross receivables. Overall this means that we’re highly likely to return to moderate rates of profitability in this segment in the next two quarters but not likely as strong as the profits we generated in the first two quarters of 2008.

Net net, this is a recipe for EPS in the next two quarters well below last year’s levels in line with our recent experience. How soon we return to quarterly growth will be determined entirely by the question of when and to what degree we turn the corner in sales and to a lesser extent when and to what extent we begin to enjoy clear and measurable benefits of our risk management efforts in the credit card segment.

Ultimately we’re positioned not just to survive but to prosper in some very clear ways. Compared to our position exactly five years ago, we have 457 or 37% more stores and 159 million or 17% fewer shares outstanding. In short, ownership of a single share of our stock at that time was associated with about $45 of retail sales in our just ended 2003 fiscal year. And our share price was in the range of $40 per share. Today a share represents a form of ownership associated with about $84 in 2008 fiscal year retail sales and yet today we trade in only the high-$20s.

Combined with our expense discipline and unwavering commitment to the brand dynamics that continue to resonate with our guests, these dynamics provide the platform at some point for a sharp increase in measured financial results per share and create the clear potential for even sharper increase in the market’s assessment of the value of a share of TGT. Until then, we will continue to thoughtfully navigate through these troubled waters.

Now Kathy will share some of the key merchandise initiatives we are pursuing in the new fiscal year. Kathy.

Kathryn A. Tesija

Thanks Doug. As Gregg mentioned the current economic conditions have created a fundamental shift in shopping behavior as consumers seek ways to stretch their dollars and pull back on their purchases of discretionary items. In this environment, Target is keenly focused on delivering a merchandise assortment and experience that meets our guests evolving expectations for price, quality, newness and convenience without compromising core elements of our brand.

We believe Target’s record of innovation and our balanced Expect More, Pay Less strategy uniquely positions us to continue to capture meaningful market share growth in this climate. To remain relevant to our guests and achieve our financial goals, we are focused our attention on initiatives that increase shopping frequency and help guests better understand the exceptional value and quality of every Target shopping trip.

For example, in our new and remodeled stores we are allocating more shelf space to non-discretionary categories such as food; household; personal and baby; and healthcare and beauty products. And we’re leveraging our marketing vehicles to drive awareness of this merchandise. In our weekly circular we’re devoting more space to frequency driving categories and using themes to drive trips and basket size. And we’re leveraging receipt marketing and vendor funded program.

But we know in today’s economy that guests won’t come to us for their everyday necessities if those necessities aren’t priced right. Our competitive shop process which has been a consistent element of our strategy for well over a decade insures that we are priced within one to two percentage points of Wal-Mart on like or identical items within local markets.

However, guest perceptions do not reflect this reality. As a result, we are intently focused on improving perception so guests understand that not only are we the right destination for all their needs, but we can meet those needs without compromising quality or the guest experience at prices that meet the competition.

To boldly and accurately convey our value message we have redesigned our circular to reduce the number of sub-featured items, allowing us to enlarge photos of featured items and present bold, straightforward value headlines. These changes allow us to make a stronger impact with key items and prices. And we’ve increased single price point end caps so that they now represent approximately three-quarters of end caps in our stores. We’re merchandising great value much more aggressively with fewer, bigger items and new signings that present the much stronger value statement.

We’re also expanding our own brand presence because we know these brands, with their lower prices and national brand quality, deliver exceptional value to our guests. They also provide a great opportunity to strengthen guest loyalty, generate incremental trips, and increase sales and profitability.

This spring we’ll re-launch two of our own brands to more clearly communicate their value to our guests. We’ve consolidated more than eight owned brands across multiple divisions to create a stronger presence for Circo, our exclusive brand for kids across all merchandise categories. This consolidation allows us to tell our guests a more complete brand story as they shop throughout the store.

In Target Home we’ve taken a similar approach by consolidating multiple sub-brands into a single brand with quality enhancements and redesigned packaging that better calls out product features and benefits. We are editing the assortment and reducing SKU count to allow for cleaner presentation and to more clearly communicate the strength of this brand to our guests.

And in grocery, Archer Farms, our premium brand and Market Pantry, our value brand, continue to grow reaching a penetration of 20% at year-end 2008, a significant new milestone. We believe that our commitment to developing and marketing these brands will lead to their continued growth in 2009.

And though we are focused on better communicating the Pay Less side of our brand promise, we are as committed as ever to the Expect More side of that equation. We continue to deliver the newness, differentiated content, and exceptional value that we believe are key to driving growth at Target.

Now more than ever we are giving our guests compelling reasons to shop our stores. We will showcase nine designer partnerships in the first half of 2009 compared to eight in the first half of last year and have seen fabulous results from our first designer of the year, Orla Kiely. The Irish born designers’ exclusive home décor collection for Target features practical yet fanciful designs that are full of color, pattern and texture, making the assortment both timeless and uplifting.

Next, we’re really excited to kick off our first design collaboration with fashion icon, Alexander McQueen and his edgy McQ for Target collection, which launched with pop-up store during Fashion Week in New York.

We continue to partner with up-and-coming designers as well and will highlight two new eco-friendly lines during Earth Week in April. Loomstate, a line for men and women by returning designer Rogan Gregory and partner [Scott McKinley Hahn] and [Neo], an outdoor living collection. Also in April our limited time only program will feature Felix Rey in handbags and Miss Trish of Capri in shoes.

And the bold and colorful prints of [Tracy Feis] will launch our next Go International line setting in May. Feis has been on the fashion scene more than 25 years and has developed a brand that is known for its elegance and barefoot luxury that looks as good on the beach as the red carpet. Feis designs are now sold in four independently owned stores on the East and West Coasts and a select few high end specialty boutiques across the country.

We are confident that the actions we are taking to drive frequency, strengthen price perception and reinforce our reputation for high quality, well designed content are the right actions to address current business challenges and position Target for long term growth.

Now Gregg will provide some final comments. Gregg.

Gregg W. Steinhafel

Target is intently focused on driving profitable sales and honing our position as a one stop destination for all of our guests’ wants and needs. While we are experiencing challenges not seen before in our business, we believe we are in a unique position to capitalize on the opportunities and leverage our iconic brand, singular vision and talented team to transform Target in ways that will resonate with our guests well into the future.

We are as committed as we have ever been to sustain our competitive advantage and create substantial shareholder value. That concludes our prepared remarks. Now Doug, Kathy and I will be happy to respond to your questions.
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BUSINESS OVERVIEW

Overview

World Fuel Services Corporation (the “Company”) was incorporated in Florida in July 1984 and along with its consolidated subsidiaries is referred to collectively in this Annual Report on Form 10-K (“Form 10-K”) as “World Fuel,” “we,” “our” and “us.” We commenced business as a recycler and reseller of used oil and provider of aviation services. We have since ceased the activities of a recycler and reseller of used oil. In 1986, we diversified our operations by entering the aviation fuel business. In 1995, we entered the marine fuel and related services business by acquiring the Trans-Tec group of companies. In 2003, we entered the land fuel and related services business.

We are engaged in the marketing and sale of marine, aviation and land fuel products and related services on a worldwide basis. We compete by providing our customers value-added benefits, including single-supplier convenience, competitive pricing, the availability of trade credit, price risk management, logistical support, fuel quality control and fuel procurement outsourcing. We have three reportable operating business segments: marine, aviation and land. In our marine segment, we offer fuel and related services to a broad base of maritime customers, including international container and tanker fleets, commercial cruise lines and time-charter operators, as well as to the United States and foreign governments. In our aviation segment, we offer fuel and related services to major commercial airlines, second- and third-tier airlines, cargo carriers, regional and low-cost carriers, corporate fleets, fractional operators, private aircraft, military fleets and to the United States and foreign governments, as well as a private label charge card used to purchase aviation fuel and related services by customers in the general aviation industry. In our land segment, we offer fuel and related services to petroleum distributors operating in the land transportation market, retail petroleum operators and other end users. In June 2008, we acquired certain assets of Texor Petroleum Company, Inc., including the assets comprising its wholesale motor fuel distribution business and the Texor Petroleum trade name (collectively, the “Texor business”). The Texor business is primarily an independent distributor of branded and unbranded gasoline and diesel fuel to retail petroleum operators and industrial, commercial and government customers and operates a small number of retail gasoline stations.

We have offices located in the United States, the United Kingdom, Denmark, Norway, the Netherlands, Germany, Greece, Turkey, the United Arab Emirates, Russia, Taiwan, South Korea, Singapore, Japan, Hong Kong, Costa Rica, Brazil, Chile, Argentina, Mexico, Colombia, Canada and South Africa. See “Item 2—Properties” for a list of principal offices by business segment and “Exhibit 21.1—Subsidiaries of the Registrant” included in this Form 10-K for a list of our subsidiaries.

Financial information with respect to our business segments and the geographic areas of our business is provided in Note 12 to the accompanying consolidated financial statements included in this Form 10-K.

Our principal executive offices are located at 9800 Northwest 41st Street, Suite 400, Miami, Florida 33178 and our telephone number at this address is (305) 428-8000. Our internet address is www.wfscorp.com and the investor relations section of our website is located at http://ir.wfscorp.com . We make available free of charge, on or through the investor relations section of our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) with the Securities and Exchange Commission (“SEC”) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Also posted on our website are our Code of Corporate Conduct and Ethics, Board of Directors’ committee charters, and Corporate Governance Principles. If we make any substantive amendments to our Code of Corporate Conduct and Ethics (the “Code”) or grant any waiver, including any implicit waiver, from a provision of the Code to our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”) or Corporate Controller, we will disclose the date and nature of such amendment or waiver on our internet website or in a Current Report on Form 8-K. Our internet website and information contained on our internet website are not part of this Form 10-K and are not incorporated by reference in this Form 10-K.

Marine Segment

We market fuel and related services to a broad base of customers, including international container and tanker fleets, commercial cruise lines and time-charter operators, as well as to the United States and foreign governments. We provide marine fuel and related services throughout most of the world under the following trade names: World Fuel, Trans-Tec, Bunkerfuels, Oil Shipping, Marine Energy, Norse Bunker, Casa Petro and Tramp Oil.

Through our extensive network of offices, we provide our customers global market intelligence and rapid access to quality and competitively priced marine fuel, 24 hours a day, every day of the year. Our marine fuel related services include management services for the procurement of fuel, cost control through the use of price hedging instruments, quality control and claims management. Our customers require cost effective and professional fuel services, since the cost of fuel is a major component of a vessel’s operating overhead.

As ship owners, time charter operators and suppliers continue to outsource their marine fuel purchasing and/or marketing needs, our value-added services have become an integral part of the oil and transportation industries’ push to shed non-core functions and reduce costs. Suppliers use our global sales, marketing and financial infrastructure to sell a spot or ratable volume of product to a diverse, international purchasing community. End customers use our real-time analysis of the availability, quality, and price of marine fuels in ports worldwide to maximize their competitive position.

In our marine segment, we primarily act as a reseller. When acting as a reseller, we contemporaneously purchase fuel from a supplier, mark it up, and resell the fuel to a customer, normally taking delivery for purchased fuel at the same place and time as we make delivery for fuel sold. We extend unsecured credit to most of our customers. We also act as a broker. When acting as a broker, we negotiate the transaction by arranging the fuel purchase contract between the supplier and the end user, and expedite the arrangements for the delivery of fuel. When acting as a broker, we are paid a commission by the supplier.

We purchase our marine fuel from suppliers worldwide. We enter into derivative contracts in order to mitigate the risk of market price fluctuations, and to offer our customers fuel pricing alternatives to meet their needs. Our cost of fuel is generally tied to spot pricing, market-based formulas or is government controlled. We are usually extended unsecured trade credit from our suppliers for our fuel purchases. However, certain suppliers require us to provide a letter of credit. We may prepay our fuel purchases to take advantage of financial discounts or when limited by the amount of credit extended to us by suppliers, or as required to transact business in certain countries.

Because we typically arrange to have fuel delivered by our suppliers directly to our customers, inventory is maintained only for competitive reasons at three locations and is hedged in an effort to protect us against price risk. We have arrangements with our suppliers and other third parties for the storage and delivery of fuel.

We utilize subcontractors to provide various services to customers, including fueling of vessels in port and at sea, and transportation of fuel and fuel products.

During each of the years presented in the accompanying consolidated statements of income, none of our marine customers accounted for more than 10% of total consolidated revenue.

Aviation Segment

We market fuel and related services to major commercial airlines, second- and third-tier airlines, cargo carriers, regional and low-cost carriers, corporate fleets, fractional operators, private aircraft, military fleets and to the United States and foreign governments. Our aviation-related services include fuel management, price risk management, arranging ground handling and arranging and providing international trip planning, including flight plans, weather reports and overflight permits. We also offer a private label charge card to customers in the general aviation industry. We have developed an extensive network that enables us to provide aviation fuel and related services throughout most of the world under the following trade names: World Fuel, PetroServicios de Mexico, Tramp Oil, PetroServicios de Costa Rica, Baseops, Airdata and AVCARD.

In general, the aviation industry is capital intensive and highly leveraged. Recognizing the financial risks of the airline industry, fuel suppliers generally refrain from extending unsecured lines of credit to airlines and avoid doing business with certain airlines directly. Consequently, most carriers are required to post a cash collateralized letter of credit or prepay for fuel purchases. This negatively impacts the airlines’ working capital. We recognize that the extension of credit is a risk, but believe it is also a significant area of opportunity. Accordingly, we extend unsecured credit to most of our customers.

We purchase our aviation fuel from suppliers worldwide. Our cost of fuel is generally tied to market-based formulas or is government controlled. We are usually extended unsecured trade credit from our suppliers for our fuel purchases. However, certain suppliers require us to provide a letter of credit. We may prepay our fuel purchases to take advantage of financial discounts or when limited by the amount of credit extended to us by suppliers, or as required to transact business in certain countries. We also enter into derivative contracts in order to mitigate the risk of market price fluctuations and to offer our customers fuel pricing alternatives to meet their needs.

Fuel is typically delivered into our customers’ aircraft or designated storage directly from our suppliers or from our fuel inventory. Inventory is held at multiple locations for competitive reasons. Inventory is purchased at airport locations or shipped via pipelines. Inventory in pipelines is hedged in an effort to protect us against price risk. We have arrangements with our suppliers and other third parties for the storage and delivery of fuel. We engage in spot sales and contract sales. Spot sales are sales that do not involve continuing contractual obligations by our customers to purchase fuel from us, whereas contract sales are made pursuant to fuel purchase contracts with our customers who commit to purchasing specified volume of fuel from us over the contract term.

We utilize subcontractors to provide various services to customers, including into-plane fueling at airports and transportation and storage of fuel and fuel products.

During each of the years presented in the accompanying consolidated statements of income, none of our aviation customers accounted for more than 10% of total consolidated revenue.

Land Segment

We market fuel and related services to petroleum distributors operating in the land transportation market; and through our acquisition of the Texor business in June 2008, we also offer branded and unbranded gasoline and diesel fuel to retail petroleum operators and industrial, commercial and government customers and operate a small number of retail gasoline stations. Our land-related services include management services for the procurement of fuel and price risk management. We provide land fuel and related services throughout most of the United States as well as parts of Brazil and the United Kingdom under the following trade names: World Fuel, Tobras and Texor.

In our land segment, we principally act as a reseller. When acting as a reseller, we contemporaneously purchase fuel from a supplier, mark it up and resell it to our customers through spot sales and contract sales. We purchase our land fuel from suppliers throughout the United States as well as parts of Brazil and the United Kingdom. Our suppliers typically extend us unsecured trade credit for our fuel purchases. Our cost of fuel is generally tied to market-based formulas. We extend unsecured credit to most of our customers and offer them fuel-pricing alternatives through our price risk management services.

Fuel is delivered to our customers directly at designated tanker truck loading terminals commonly referred to as “racks” or directly to customer locations through third party carriers. These racks are owned and operated by our suppliers or third-party consortiums. We engage in spot sales and contract sales. Spot sales are sales that do not involve continuing contractual obligations by our customers to purchase fuel from us. Contract sales are made pursuant to fuel purchase contracts with our customers who commit to purchasing specified volume of fuel from us over the contract term. We also enter into derivative contracts to offer our customers fuel pricing alternatives to meet their needs.

During each of the years presented in the accompanying consolidated statements of income, none of our land customers accounted for more than 10% of total consolidated revenue.

Competitors

Our competitors within the highly fragmented world-wide downstream markets of marine, aviation and land fuel are numerous, ranging from large multinational corporations, principally major oil producers, which have significantly greater capital resources, to relatively small and specialized firms. We compete with the major oil producers that market fuel directly to the large commercial airlines, shipping companies and petroleum distributors operating in the land transportation market as well as fuel resellers. We believe that our extensive market knowledge, world-wide presence, extension of credit and use of derivatives to provide fuel pricing alternatives give us the ability to compete in the marketplace.

Employees

As of February 20, 2009, we employed 1,164 people worldwide.

Regulation

Our current and past activities are subject to substantial regulation by federal, state and local government agencies, inside and outside the United States, which enforce laws and regulations governing the transportation, sale, storage and disposal of fuel and the collection, transportation, processing, storage, use and disposal of hazardous substances and wastes, including waste oil and petroleum products. For example, U.S. federal and state environmental laws applicable to us include statutes that: (i) allocate the cost of remedying contamination among specifically identified parties, and prevent future contamination; (ii) impose national ambient standards and, in some cases, emission standards, for air pollutants that present a risk to public health or welfare; (iii) govern the management, treatment, storage and disposal of hazardous wastes; and (iv) regulate the discharge of pollutants into waterways. International treaties also prohibit the discharge of petroleum products at sea. The penalties for violations of environmental laws include injunctive relief, recovery of damages for injury to air, water or property, and fines for non-compliance. See “Item 1A—Risk Factors,” and “Item 3 – Legal Proceedings.”

Forward-Looking Statements

Certain statements made in this report and the information incorporated by reference in it, or made by us in other reports, filings with the SEC, press releases, teleconferences, industry conferences or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,” “could,” “would,” “will,” “will be,” “will continue,” “will likely result,” “plan,” or words or phrases of similar meaning.

Forward-looking statements are estimates and projections reflecting our best judgment and involve risks, uncertainties or other factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by the forward-looking statements. These statements are based on our management’s expectations, beliefs and assumptions concerning future events affecting us, which in turn are based on currently available information.

Examples of forward-looking statements in this report include, but are not limited to, our expectations regarding our business strategy, business prospects, operating results, working capital, liquidity, capital expenditure requirements and future acquisitions. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding demand for our products, the cost, terms and availability of fuel from suppliers, pricing levels, the timing and cost of capital expenditures, outcomes of pending litigation, competitive conditions, general economic conditions and synergies relating to acquisitions, joint ventures and alliances. These assumptions could prove inaccurate. Although we believe that the estimates and projections reflected in the forward-looking statements are reasonable, our expectations may prove to be incorrect.

CEO BACKGROUND

Grant Thornton. Subsequent to 1985, Mr. Klein practiced as Myles Klein, P.A. or Klein & Barreto, P.A. until July 2006 when he sold his accounting practice to Klein, Mendez & Rothbard, LLC. He retains a one percent interest in that firm and continues to provide services to the practice on a part-time basis.
J. THOMAS PRESBY has served as a director of World Fuel since February 2003. Mr. Presby has used his business experience and professional qualifications to forge a second career of essentially full-time board service since he retired in 2002 as a partner in Deloitte Touche Tohmatsu. At Deloitte, Mr. Presby held numerous positions in the United States and abroad, including the posts of Deputy Chairman and Chief Operating Officer. Mr. Presby now serves as a director and chairman of the audit committee of American Eagle Outfitters, Inc., Tiffany & Co., and Invesco Ltd., each a NYSE company, and First Solar, Inc. and TurboChef Technologies, Inc., both NASDAQ companies. As Mr. Presby has no significant business activities other than board service, he is available full time to fulfill his board responsibilities. Mr. Presby is a certified public accountant and a holder of the NACD Certificate of Director Education.
STEPHEN K. RODDENBERRY has served as a director of World Fuel since June 2006. Mr. Roddenberry is a shareholder in the law firm of Akerman Senterfitt where he has been employed since 1988.


MANAGEMENT DISCUSSION FROM LATEST 10K

The following discussion should be read in conjunction with “Item 6—Selected Financial Data,” and with the accompanying consolidated financial statements and related notes thereto appearing elsewhere in this Form 10-K. The following discussion may contain forward-looking statements, and our actual results may differ significantly from the results suggested by these forward-looking statements. Some factors that may cause our results to differ materially from the results and events anticipated or implied by such forward-looking statements are described in “Item 1A—Risk Factors.”

Overview

We are engaged in the marketing and sale of marine, aviation and land fuel products and related services on a worldwide basis. We compete by providing our customers value-added benefits, including single-supplier convenience, competitive pricing, the availability of trade credit, price risk management, logistical support, fuel quality control and fuel procurement outsourcing. We have three reportable operating business segments: marine, aviation and land. In our marine segment, we offer fuel and related services to a broad base of maritime customers, including international container and tanker fleets, commercial cruise lines and time-charter operators, as well as to the United States and foreign governments. In our aviation segment, we offer fuel and related services to major commercial airlines, second- and third-tier airlines, cargo carriers, regional and low cost carriers, corporate fleets, fractional operators, private aircraft, military fleets and to the United States and foreign governments, as well as a private label charge card used to purchase aviation fuel and related services to customers in the general aviation industry. In our land segment, we offer fuel and related services to petroleum distributors operating in the land transportation market and retail petroleum operators and other end users. Through our acquisition of the Texor business in June 2008, we also offer branded and unbranded gasoline and diesel fuel to retail petroleum operators and industrial, commercial and government customers and operate a small number of retail gasoline stations.

Our revenue and cost of revenue are significantly impacted by world oil prices, as evidenced in part by our revenue and cost of revenue increases year over year, while our gross profit is not necessarily impacted by the change in world oil prices. However, our gross profit can be impacted by significant movements in fuel prices during any given financial period due to our inventory average costing methodology. Changes in fuel prices can positively or negatively impact gross profit during any given financial period depending on the direction, volatility and timing of such price movements.

In our marine segment, we primarily purchase and resell fuel, and act as brokers for others. Profit from our marine segment is determined primarily by the volume and gross profit achieved on fuel resales and by the volume and commission rate of the brokering business. In our aviation and land segments, we primarily purchase and resell fuel, and we do not act as brokers. Profit from our aviation and land segments is primarily determined by the volume and the gross profit achieved on fuel resales, and in the case of the aviation segment, a percentage of processed credit card charges related to our AVCARD business. Our profitability in our segments also depends on our operating expenses, which may be significantly affected to the extent that we are required to provide for potential bad debt.

We may experience decreases in future sales volumes and margins as a result of the ongoing deterioration in the world economy, transportation industry, natural disasters and continued conflicts and instability in the Middle East, Asia and Latin America, as well as potential future terrorist activities and possible military retaliation. In addition, because fuel costs represent a significant part of our customers’ operating expenses, volatile and/or high fuel prices can adversely affect our customers’ businesses, and consequently the demand for our services and our results of operations. Our hedging activities may not be effective to mitigate volatile fuel prices and may expose us to counterparty risk. See “Item 1A—Risk Factors” of this Form 10-K.

Reportable Segments

We evaluate and manage our three reportable business segments using the performance measurement of income from operations. Corporate overhead costs are allocated to the segments based on usage, where possible, or on other factors according to the nature of the activity. Financial information with respect to our business segments is provided in Note 12 to the accompanying consolidated financial statements included in this Form 10-K.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements included elsewhere in this Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to unbilled revenue and related costs of sales, bad debt, share-based payment awards, investments, derivatives, goodwill and identifiable intangible assets, and certain accrued liabilities. We base our estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We have identified the policies below as critical to our business operations and the understanding of our results of operations. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the accompanying consolidated financial statements included in this Form 10-K.

Revenue Recognition

Revenue from the sale of fuel is recognized when the sales price is fixed or determinable, collectibility is reasonably assured and title passes to the customer, which is when the delivery of fuel is made to our customer directly from the supplier or a third-party subcontractor. Our fuel sales are generated as a fuel reseller as well as from on-hand inventory supply. When acting as a fuel reseller, we contemporaneously purchase fuel from the supplier, mark it up, and resell the fuel to the customer, generally taking delivery for purchased fuel at the same place and time as the delivery is made. We record the gross sale of the fuel as we generally take inventory risk, have latitude in establishing the sales price, have discretion in the supplier selection, maintain credit risk and are the primary obligor in the sales arrangement.

Revenue from fuel-related services is recognized when services are performed, the sales price is fixed or determinable and collectibility is reasonably assured. We record the sale of fuel-related services on a gross basis as we generally have latitude in establishing the sales price, have discretion in supplier selection, maintain credit risk and are the primary obligor in the sales arrangement.

Commission from fuel broker services is recognized when services are performed and collectibility is reasonably assured. When acting as a fuel broker, we are paid a commission by the supplier.

Revenue from charge card transactions is recognized at the time the purchase is made by the customer using the charge card. Revenue from charge card transactions is generated from processing fees.

Share-Based Payment Awards

We account for share-based payment awards on a fair value basis. Under fair value accounting, the grant-date fair value of the share-based payment award is amortized as compensation expense, on a straight-line basis, over the vesting period for both graded and cliff vesting awards. Annual compensation expense for share-based payment awards is reduced by an expected forfeiture amount on the outstanding share-based payment awards.

We use the Black-Scholes option pricing model to estimate the fair value of Option Awards. The estimation of the fair value of Option Awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates and expected dividends. The expected term of Option Awards represents the estimated period of time from grant until exercise or conversion and is based on vesting schedules and expected post-vesting, exercise and employment termination behavior. Expected volatility is based on the historical volatility of our common stock over the period that is equivalent to the award’s expected life. Any adjustment to the historical volatility as an indicator of future volatility would be based on the impact to historical volatility of significant non-recurring events that would not be expected in the future. Risk-free interest rates are based on the U.S. Treasury yield curve at the time of grant for the period that is equivalent to the award’s expected life. Dividend yields are based on the historical dividends of World Fuel over the period that is equivalent to the award’s expected life, as adjusted for stock splits.

The estimated fair value of common stock, restricted stock and restricted stock units is based on the grant-date market value of our common stock, as defined in the respective plans under which the awards were issued.

Accounts Receivable and Allowance for Bad Debt

Credit extension, monitoring and collection are performed for each of our business segments. Each segment has a credit committee. The credit committees are responsible for approving credit limits, setting and maintaining credit standards, and managing the overall quality of the credit portfolio. We perform ongoing credit evaluations of our customers and adjust credit limits based upon a customer’s payment history and creditworthiness, as determined by our review of our customer’s credit information. We extend credit on an unsecured basis to most of our customers. Accounts receivable are deemed past due based on contractual terms agreed with our customers.

We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience with our customers, current market and industry conditions affecting our customers, and any specific customer collection issues that we have identified. Historical payment trends may not be a useful indicator of current or future credit worthiness of our customers, particularly in these unprecedented difficult economic and financial markets. Accounts receivable are reduced by an allowance for estimated credit losses.

If credit losses exceed established allowances, our results of operations and financial condition may be adversely affected. For additional information on the credit risks inherent in our business, see “Item 1A—Risk Factors” of this Form 10-K.

Inventories

Inventories are valued using the average cost methodology and are stated at the lower of cost or market. Components of inventory include fuel purchase costs, the related transportation costs and storage fees.

Derivatives

We enter into derivative contracts in order to mitigate the risk of market price fluctuations in marine, aviation and land fuel, and to offer our customers fuel pricing alternatives to meet their needs. We also enter into derivatives in order to mitigate the risk of fluctuation in foreign currency exchange rates. We have applied the normal purchase and normal sales exception (“NPNS”), as provided by Statement of Financial Accounting Standard (“FAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to certain of our physical forward sales and purchase contracts. While these contracts are considered derivative instruments under FAS No. 133, they are not recorded at fair value, but on an accrual basis of accounting, which means the values related to such contracts are not recorded in our consolidated financial statements until physical settlement of the contract occurs. If it is determined that a transaction designated as NPNS no longer meets the scope exception, the fair value of the related contract is recorded as an asset or liability on the consolidated balance sheet and the difference between the fair value and the contract amount is immediately recognized through earnings.

Our derivatives that are subject to FAS No. 133 are recognized at estimated fair market value in accordance with FAS No. 157. If the derivative does not qualify as a hedge under FAS No. 133 or is not designated as a hedge, changes in the fair market value of the derivative are recognized as a component of revenue or cost of revenue (based on the underlying transaction type) in the consolidated statement of income. Derivatives which qualify for hedge accounting may be designated as either a fair value or cash flow hedge. For our fair value hedges, changes in the fair market value of the hedge instrument and the hedged item are recognized in the same line item as a component of either revenue or cost of revenue (based on the underlying transaction type) in the consolidated statement of income. For our cash flow hedges, the effective portion of the changes in the fair market value of the hedge is recognized as a component of other comprehensive income in the shareholders’ equity section of the consolidated balance sheet and subsequently reclassified into the same line item as the forecasted transaction when both are settled, while the ineffective portion of the changes in the fair market value of the hedge is recognized as a component of other non-operating expense/income in the consolidated statement of income. Cash flows for our hedging instruments used in our hedges are classified in the same category as the cash flow from the hedged items. If for any reason hedge accounting is discontinued, then any cash flows subsequent to the date of discontinuance shall be classified consistent with the nature of the instrument.

To qualify for hedge accounting, as either a fair value or cash flow hedge, the hedging relationship between the hedging instruments and hedged items must be highly effective over an extended period of time in achieving the offset of changes in fair values or cash flows attributable to the hedged risk at the inception of the hedge. We use a regression analysis based on historical spot prices in assessing the qualification for our fair value hedges. However, our measurement of hedge ineffectiveness for our fair value inventory hedges utilizes spot prices for the hedged item (inventory) and forward or future prices for the hedge instrument. Therefore, the excluded component (forward or futures prices) in assessing hedge qualification, along with ineffectiveness, is included as a component of cost of revenue in earnings. Adjustment to the carrying amounts of hedged items is discontinued in instances where the related fair value hedging instrument becomes ineffective and any previously recorded fair market value changes are not adjusted until the fuel is sold.

For additional information on derivatives, see “Item 7A—Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-K.

Goodwill and Identifiable Intangible Assets

Goodwill represents our cost in excess of the estimated fair value of net assets, including identifiable intangible assets, of acquired companies and our joint venture interest in Page Avjet Fuel Co. L.L.C., a Delaware limited liability company. Goodwill is not subject to periodic amortization; instead, it is reviewed annually at year-end (or more frequently under certain circumstances) for impairment. The initial step of the goodwill impairment test compares the estimated fair value of a reporting unit, which is the same as our reporting segments, with its carrying amount, including goodwill. The fair value of our reporting segments is estimated using discounted cash flow and market capitalization methodologies.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion should be read together with our 2007 10-K Report and the consolidated financial statements and related notes in “Item 1—Financial Statements” appearing elsewhere in this 10-Q Report. The following discussion contains forward-looking statements as described in the “Forward-Looking Statements” below. Our actual results may differ significantly from the results suggested by these forward-looking statements. Various factors that may cause our results to differ materially from the results and events anticipated or implied by such forward-looking statements are described in Part II of this 10-Q Report under “Item 1A – Risk Factors.”

Forward-Looking Statements

Certain statements made in this report and the information incorporated by reference in it, or made by us in other reports, filings with the Securities and Exchange Commission (the “SEC”), press releases, teleconferences, industry conferences or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,” “will be,” “will continue,” “will likely result,” “plan,” or words or phrases of similar meaning.

Forward-looking statements are estimates and projections reflecting our best judgment and involve risks, uncertainties or other factors which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by the forward-looking statements. These statements are based on our management’s beliefs and assumptions, which in turn are based on currently available information.

Examples of forward-looking statements in this report include, but are not limited to, our expectations regarding our business strategy, business prospects, operating results, working capital, liquidity, capital expenditure requirements and future acquisitions. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding demand for our products, the cost, terms and availability of fuel from suppliers, pricing levels, the timing and cost of capital expenditures, outcomes of pending litigation, competitive conditions, general economic conditions and synergies relating to acquisitions, joint ventures and alliances. These assumptions could prove inaccurate. Although we believe that the estimates and projections reflected in the forward-looking statements are reasonable, our expectations may prove to be incorrect.

We operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for us to predict all of those risks, nor can we assess the impact of all of those risks on our business or the extent to which any factor may cause actual results to differ materially from those contained in any forward-looking statement. We believe these forward-looking statements are reasonable. However, you should not place undue reliance on any forward-looking statements, which are based on current expectations. Further, forward-looking statements speak only as of the date they are made, and unless required by law, we expressly disclaim any obligation or undertaking to publicly update any of them in light of new information or future events.

For these statements, we claim the protection of the safe harbor for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”).

Overview

We are primarily engaged in the marketing and sale of marine, aviation and land fuel products and related services on a worldwide basis. In our marine segment, we offer fuel and related services to a broad base of maritime customers, including international container and tanker fleets and time-charter operators, as well as to the United States and foreign governments. In our aviation segment, we offer fuel and related services to major commercial airlines, second and third-tier airlines, cargo carriers, regional and low cost carriers, corporate fleets, fractional operators, private aircraft, military fleets and to the United States and foreign governments. In addition, in December 2007, through the acquisition of Kropp Holdings, Inc., which we refer to as AVCARD, the brand name under which it does business, we offer a private label charge card to customers in the general aviation industry. In our land segment, we offer fuel and related services to petroleum distributors operating in the land transportation market; and through our acquisition of certain assets of Texor Petroleum Company, Inc. (the “Texor business”) in June 2008, we also offer branded and unbranded gasoline and diesel fuel to retail petroleum operators and industrial, commercial and government customers, and operate eight retail gasoline stations. We compete by providing our customers value-added benefits including single-supplier convenience, competitive pricing, the availability of trade credit, price risk management, logistical support, fuel quality control and fuel procurement outsourcing.

Our revenue and cost of revenue are significantly impacted by world oil prices as evidenced in part by our revenue and cost of revenue increases year over year, while our gross profit is not necessarily impacted by the change in world oil prices, as our profitability is driven by gross profit per unit, which is not directly correlated to the price of fuel. However, our gross profit can be impacted by significant movements in fuel prices during any given financial period due to our inventory average costing methodology. Changes in fuel prices can positively or negatively impact gross profit during any given financial period depending on the direction, volatility and timing of such price movements.

In our marine segment, we primarily purchase and resell fuel, and act as brokers for others. Profit from our marine segment is determined primarily by the volume and gross profit achieved on fuel resales and by the volume and commission rate of brokering business. In our aviation and land segments, we primarily purchase and resell fuel, and we do not act as brokers. Profit from our aviation and land segments is primarily determined by the volume and the gross profit achieved on fuel resales, and in the case of the aviation segment, a percentage of processed credit card charges related to our AVCARD business. Our profitability in our segments also depends on our operating expenses, which may be significantly affected to the extent that we are required to provide for potential bad debt.

We may experience decreases in future sales volume and margins as a result of deterioration in the world economy, transportation industry, natural disasters and continued conflicts and instability in the Middle East, Asia and Latin America, as well as potential future terrorist activities and possible military retaliation. In addition, because fuel costs represent a significant part of our customers’ operating expenses, volatile and/or high fuel prices can adversely affect our customers’ businesses, and consequently the demand for our services and our results of operations. See Part II – Other Information under “Item 1A – Risk Factors” of this 10-Q Report.


CONF CALL

Frank Shea

Good evening everyone and welcome to the World Fuel Services fourth quarter conference call. I am Frank Shea, Executive Vice President and Chief Risk and Administrative Officer, and as is evident, I am doing the introductions on this evenings call. Today's call is also available via webcast. To access this webcast or future webcasts, please visit our website and click on the webcast icon.

With us on the call today are: Paul Stebbins, Chairman and Chief Executive Officer, Michael Kasbar, President and Chief Operating Officer, Ira Birns, Executive Vice President and Chief Financial Officer, and Paul Noble, Senior Vice President and Chief Accounting Officer. By now, you should have all received a copy of our earnings release. If not, you can access our release at our website.

Before we get started, I would like to review World Fuel's Safe Harbor statement. Some of the comments to be made on this evenings call may include forward-looking statements under the Private Securities Reform Act of 1995.

These statements involve risks and uncertainties including, but not limited to, quarterly fluctuations in results, the credit worthiness of customers and counterparties and our ability to collect accounts receivable and settle derivative contracts, fluctuations in world oil prices and foreign currency, changes in political, economic, regulatory or environmental conditions, adverse conditions in the markets or industries in which we and our customers operate, our failure to effectively hedge certain financial risks associated with the use of derivatives, non performance by counterparties or customers on derivatives contracts, the integration of acquired businesses, uninsured losses, our ability to retain and attract senior management and other key employees and other risks detailed from time to time in the company's Securities and Exchange Commission filing.

Actual results or facts could differ materially from such statements. Detailed information about these risks is contained in the company's SEC filings which are available on the website or from the SEC.

We will begin with several minutes of prepared remarks, which will then be followed by a question-and-answer period. At this time, I would like to introduce our Chairman and Chief Executive Officer, Paul Stebbins.

Paul Stebbins

Thank you, Frank. Good afternoon and thank you for joining us today. Today, we announced earnings of $29 million or $0.98 per diluted share for the fourth quarter of fiscal 2008. Our earnings for the year were $105 million, or $3.62 per diluted share, a 62% increase over fiscal 2007. In Q4, our return on working capital increased to 69%, our return on equity was 19% and our net trade cycle fell to six days.

Our operating cash inflow in the quarter was $195 million. Our cash balance at the end of the quarter was $314. Shareholders equity was $608 million and we ended the year with over $900 million in liquidity. Notwithstanding an extremely challenging operating environment, we were able to deliver record performance as a result of our continued focus on four key metrics.

Credit and counterparty risk management, liquidity, margin, and return on working capital. By any measure the company had an exceptional year. But the financial metrics don't tell the full story. As you all know, Q4 was the period of continued upheaval in the global financial market. Credit and liquidity remained tight. The global economy continued to deteriorate and the operating environment for our customers and suppliers remained challenging.

In response to these market conditions, we became more discerning in our customer base and conservative in our appetite for credit risk, and because our unique position in the market gave us a competitive advantage in procurement, we were able to maintain margins despite the drop in oil prices. The hard work we did in Q2 and Q3 to derisk our business resulted in a significant improvement in our receivables portfolio and no increase to our provision in the quarter.

Given the difficult operating environment, our global team did a very good job in Q4 of fortifying the balance sheet, strengthening liquidity and reducing our risk, while delivering great value and reliability to our customers, suppliers, and shareholders.

Our Marine segment delivered a strong finish to an exceptional year. Gross profit and operating income for the year were up 78% and 140% respectively. While freight rates deteriorated and overall trade slowed in the fourth quarter, our strategy of focusing on risk, returns and value added services to our customers and suppliers paid off. While our volumes dropped in Q4 relative to Q3, our margins remained relatively steady.

It is clear that the overall prognosis for shipping going forward is uncertain given the economic conditions, but seaborne trade will always be an essential part of global commerce and our competitive position in the market is more secure than ever.

Moreover, we have traditionally excelled in difficult market environment, because our value proposition is more clearly differentiated and this is never been truer than it is today. Overall, the team did an outstanding job in 2008 on every metric of success and we believe we are well positioned to respond to whatever the market may bring our way in 2009.

Our Aviation segment also did a very good job in one of the most challenging environments in the industry's history. Gross profit and operating income were up 35% and 12% respectively on a year-over-year basis, reflecting the resilience of our model in difficult conditions. Throughout the year, we aggressively reduced risk and improved margins across all segments of the business and we entered 2009 in a very good position.

AVCARD delivered good results this year and despite the difficult market for business aviation, they continued to expand their charge card offering and secure more contract deals. As with marine, we believe the steps we took in 2008 to reshape our aviation business, leave us well positioned for 2009 and beyond.

In Q4, our Land segment made a meaningful contribution to overall results and we were pleased with the directional trend. The Texor business acquisition has proven to be very successful and provides a platform for future expansion in the area of branded wholesale supply as we enter 2009.

As announced today, we have signed a definitive agreement to acquire the wholesale motor fuel distribution business of TGS Petroleum in Chicago, which represents approximately 100 million gallons of additional volume and will be integrated into the Texor business platform. This acquisition is exciting proof-of-concept for our Land segment and we look forward to welcoming them to the World Fuel family.

All in all, World Fuel had an outstanding year in 2008. Of course, what is most pressing on everyone's mind is what the future might bring, given the extraordinary economic conditions we face throughout the world. Citibank's market cap has dropped everyone's mind is what the future might bring given the extraordinary economic conditions we face throughout the world. Citibank's market cap has dropped from $256 billion in Q2 of '07 to $14 billion today.

AIG continues to report enormous write-offs, triggering renewed concerns about their future prospect. The capital markets remained essentially closed. The stock market has recently dropped to levels not seen in over a decade and the daily media is filled with the relentless barrage of bad news about negative corporate earnings reports, growing unemployment, and continued economic decline.

No matter how you look at the facts, our country and the world at large face an economic crisis of truly unprecedented proportions with no easy solution in sight. So what does all this mean for World Fuel as we look forward to 2009 and beyond? At a tactical level, we believe our aggressive efforts in 2008 to strengthen our balance sheet, reduce risk, and leverage our business model have secured for us an enviable position in the global marketplace.

Our financial strength, compelling value proposition and robust global service platform are significant competitive differentiators in a market in which many of our competitors have been adversely impacted by the deterioration of market conditions. Their weak liquidity and poor risk management have negatively impacted their results and impaired their capacity to compete aggressively in this market.

Meanwhile, our suppliers have made it clear to us that current and prospective market conditions have further suppressed their appetite for participation in the downstream market, and they would like to direct more of their volume through our network as they actively seek to reduce the number of channels they rely on for distribution.

Our customers who are under enormous pressure to manage cost, value more than ever our ability to provide competitive pricing, while managing quality control and operational support in every market in the world. This comprehensive service offering continues to drive value for customers and suppliers alike, as we help them make sense of a very difficult marketplace.

Worthy of special note is the systemic concern about counterparty risk which has prompted our customers to scrutinize more carefully the financial viability, transparency and corporate governance of their vendors. This is a welcome trend for World Fuel. What were strong competitive differentiators for us in a good market have become essential requirements for doing business in a difficult market.

This new level of counterparty scrutiny has only served to highlight the strengths in our business model and validate the value of our global offering. At a tactical level, we are better positioned than ever to continue to service our core business even in an uncertain market.

At a strategic level, we believe the company has secured a leadership position in a market rich with opportunity across all three of our business segments. The upheaval in the global economy has precipitated tectonic shifts in the energy, transportation and finance industries. Enterprise valuations are all time lows and good businesses are starved for capital in a climate of unrelenting scarcity of credit.

Our strong position liquidity position should allow us to take advantage of these conditions as we look to complement organic growth through strategic acquisitions. Throughout this year, we will be reviewing opportunities to make accretive acquisitions with a focus on our core space of fuel distribution, services and logistics.

2008 was a remarkable year for World Fuel. We successfully launched our new ERP system, achieved new milestones in organizational maturity, effectively managed risk in a wildly volatile market, and delivered record financial performance. As we look forward, we harbor the same concerns as you do about the tough economic landscape our country and the world face and we will continue to engage the marketplace with discipline and caution.

But we take a great deal of comfort in the fact that we enter the New Year with a very strong, sound financial foundation. And while we remain cautious, about over promising in our ability to drive growth in this challenging operating environment, it is important to note that we believe the crisis has created significant strategic opportunities for World Fuel.

The position we have achieved in the marketplace represents the culmination of years of effort and investment and we feel very good about our ability to deliver significant value to all our stakeholders going forward. Thank you for your continued support. And I will now turn the call over to Ira for a detailed review of the financials. Ira?

Ira Birns

Thank you Paul and good afternoon everybody. I would like to thank our team for the tremendous efforts that were made during this past year. We experienced global market conditions unlike anything seen before and our performance is a testament to the hard work and dedication that was put forth by everyone at World Fuel Services.

Before I review our results by segment, I would like to point out that the sequential and year-over-year decreases in quarterly revenue were significantly impacted by the sharp decrease in fuel prices, which continued through the fourth quarter. Also, it is worthwhile noting that our extraordinary results in the third quarter of 2008 significantly impact the sequential comparisons of gross profit and operating income, despite our very strong performance in the fourth quarter.

Revenue for the fourth quarter was $2.9 million, down 47% sequentially, and 30% compared to the fourth quarter of last year. Our Marine segment revenues were $1.5 billion, down 48% sequentially and 35% year-over-year. The Aviation segment generated revenues of $1.1 billion, down 45% sequentially and 31% from last years fourth quarter. And finally our Land segment generated revenues of $260 million, down 46% sequentially, but up 44% from last years fourth quarter, principally driven by the acquisition of Texor last June.

Our Aviation segment sold 453 million gallons of fuel during the fourth quarter, down 13% sequentially and 25% compared to the fourth quarter of last year. The sequential and year-over-year reduction in volume was principally due to our efforts to reduce exposure to low margin, higher risk accounts which continued through the fourth quarter. Our volumes have declined sequentially over the past three quarters. We now expect volumes to stabilize during the first half of 2009.

Our Marine segment total business activity for the fourth quarter was 6.6 million metric tons, down 5% sequentially and 7% year-over-year. Similar to aviation, the sequential and year-over-year decrease in volumes principally relate to our efforts to reduce exposure to low margin, higher risk customers. Fuel reselling activities constituted approximately 79% of total marine business activity in the quarter, slightly above the average percentage of such activity over the past several quarters.

Our Land segment sold 139 million gallons during the fourth quarter, down 2% sequentially, but up 88% compared to the fourth quarter of 2007. Once again, these amounts include volumes from our Texor business which we acquired last June.

Revenue for the full year was $18.5 million, up $4.8 billion or 35% compared to 2007. The year-over-year increase in revenue reflects the impact of the record high prices we saw, during the first several months of 2008. In addition to record high oil prices, this increase also reflects the impact of a full year of AVCARD and seven months of Texor.

Gross profit for the fourth quarter was $103 million, a decrease of $20 million from the third quarter, but up $30 million or 40% compared to the fourth quarter of last year. Our Aviation segment contributed $35 million in gross profit, a decrease of 31% sequentially, and 10% compared to the fourth quarter of 2007.

Our self supply model jet fuel inventory position was approximately 15 million gallons at the end of the year, down 1 million gallons, when compared to the third quarter. This represents our lowest jet fuel inventory position since the first quarter of 2006.

The dollar value of our related jet fuel inventory decreased to approximately $18 million, down 64% from $50 million in the prior quarter. Our self supply inventory remains strategic and we regularly evaluate our inventory driven opportunities, which could result in increases or decreases to our self supply inventory position in the future.

Jet fuel market prices fell approximately 50% during the quarter from $2.98 at September 30th to $1.47 per gallon at the end of the year. Despite our reduced level of inventory, significant price volatility during the quarter resulted in a negative impact to gross profit related to inventory average costing. This is in contrast with the third quarter, when we significantly benefited from price volatility. This is the principal driver of the $15 million sequential reduction in aviation gross profit.

Our Marine segment again delivered very strong results, generating gross profit of $59 million, a decrease from last quarter's record of $5 million or 7% sequentially, but up $26 million or 79% year-over-year, again benefiting from continued market volatility during the fourth quarter.

As Paul has already mentioned, our fourth quarter results reflect our ability to execute very well in what was clearly an extremely volatile spot environment. We continue to be the counterparty of choice as well as a clear leader in the marketplace during these turbulent economic times.

Our Land segment delivered gross profit of $9.6 million in the fourth quarter, a decrease of 5%, but nearly four times the gross profit generated in the fourth quarter of 2007, principally, driven by the impact of the Texor acquisition, which delivered solid results for their second straight quarter.

Gross profit for the full year was $395 million up $150 million, or 61% compared to 2007. The increase in gross profit reflects our ability to navigate through a difficult global marketplace and utilize our global experience within the local markets that we serve. We also benefited by having a strong balance sheet and being a very reliable counterparty to both our customers and suppliers.

Again, 2008 gross profit was also impacted by the acquisitions of AVCARD and Texor. Operating expenses for the fourth quarter, excluding our provision for bad debt was $63 million. This is above the $56 million to $60 million range provided on last quarter's call, due entirely to an increase in compensation expense related to special executive bonus awards of approximately $5 million, which were granted as a result of our record year in 2008.

Excluding the impact of such awards, operating expenses were up $1 million sequentially, and $10 million year-over-year. If you also exclude the impact of AVCARD, Texor and the increase in marine incentives related to their record performance, operating expenses were actually down approximately $2 million year-over-year.

In order to help you model operating expenses as we've been doing for the past several quarters, I would again assume overall operating expenses excluding bad debt expense of approximately $56 million to $60 million in the first quarter of 2009.

We recorded a benefit to our provision for bad debt of $800,000 this quarter, compared to a $6.9 million expense recorded in the third quarter. For those that may question an actual reduction in our accounts receivable reserve in the fourth quarter, one needs to focus on the significant reduction in the size of our receivables portfolio, over the ]]>Wed, 11 Mar 2009 10:50:00 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1966/http://www.dailystocks.com/forum/showtopic.php?tid/1966/
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BUSINESS OVERVIEW

Honeywell International Inc. (Honeywell) is a diversified technology and manufacturing company, serving customers worldwide with aerospace products and services, control, sensing and security technologies for buildings, homes and industry, turbochargers, automotive products, specialty chemicals, electronic and advanced materials, and process technology for refining and petrochemicals and energy efficient products and solutions for homes, business and transportation. Honeywell was incorporated in Delaware in 1985.

We maintain an internet website at http://www.honeywell.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports, are available free of charge on our website under the heading “Investor Relations” (see “SEC Filings & Reports”) immediately after they are filed with, or furnished to, the Securities and Exchange Commission (SEC). In addition, in this Form 10-K, the Company incorporates by reference certain information from parts of its proxy statement for the 2009 Annual Meeting of Stockholders, which we expect to file with the SEC on or about March 12, 2009, and which will also be available free of charge on our website.

Information relating to corporate governance at Honeywell, including Honeywell’s Code of Business Conduct, Corporate Governance Guidelines and Charters of the Committees of the Board of Directors are also available, free of charge, on our website under the heading “Investor Relations” (see “Corporate Governance”), or by writing to Honeywell, 101 Columbia Road, Morris Township, New Jersey 07962, c/o Vice President and Corporate Secretary. Honeywell’s Code of Business Conduct applies to all Honeywell directors, officers (including the Chief Executive Officer, Chief Financial Officer and Controller) and employees.

The certifications of our Chief Executive Officer and Chief Financial Officer pursuant to Section 302 and Section 906 of the Sarbanes-Oxley Act of 2002 about the disclosure contained in this Annual Report on Form 10-K are included as Exhibits 31.1, 31.2, 32.1 and 32.2 to this Annual Report and are available free of charge on our website under the heading “Investor Relations” (see “SEC Filings & Reports”). Our Chief Executive Officer certified to the New York Stock Exchange (NYSE) on May 1, 2008, pursuant to Section 303A.12 of the NYSE’s listing standards, that he was not aware of any violation by Honeywell of the NYSE’s corporate governance listing standards as of that date.

Major Businesses

We globally manage our business operations through four businesses that are reported as operating segments: Aerospace, Automation and Control Solutions, Specialty Materials and Transportation Systems. Financial information related to our operating segments is included in Note 23 of Notes to Financial Statements in “Item 8. Financial Statements and Supplementary Data.”

Aerospace Sales

Our sales to aerospace customers were 35 percent of our total sales in each of 2008, 2007 and 2006, respectively. Our sales to commercial aerospace original equipment manufacturers were 9, 10 and 10 percent of our total sales in 2008, 2007 and 2006, respectively. In addition, our sales to commercial aftermarket customers of aerospace products and services were 11 percent of our total sales in each of 2008, 2007 and 2006. Our Aerospace results of operations can be impacted by various industry and economic conditions. See “Item 1A. Risk Factors.”

U.S. Government Sales

Sales to the U.S. Government (principally by our Aerospace segment), acting through its various departments and agencies and through prime contractors, amounted to $4,240, $4,011 and $3,688 million in 2008, 2007 and 2006, respectively, which included sales to the U.S. Department of Defense, as a prime contractor and subcontractor, of $3,412, $3,192 and $3,052 million in 2008, 2007 and 2006, respectively. U.S. defense spending increased in 2008 and is also expected to increase in 2009. We do not expect to be significantly affected by any proposed changes in 2009 federal spending due principally to the varied mix of the government programs which impact us (OEM production, engineering development programs, aftermarket spares and repairs and overhaul programs). Our contracts with the U.S. Government are subject to audits, investigations, and termination by the government. See “Item 1A. Risk Factors.”

Backlog

Our total backlog at December 31, 2008 and 2007 was $12,972 and $12,303 million, respectively. We anticipate that approximately $9,480 million of the 2008 backlog will be filled in 2009. We believe that backlog is not necessarily a reliable indicator of our future sales because a substantial portion of the orders constituting this backlog may be canceled at the customer’s option.

Competition

We are subject to active competition in substantially all product and service areas. Competition is expected to continue in all geographic regions. Competitive conditions vary widely among the thousands of products and services provided by us, and vary by country. Depending on the particular customer or market involved, our businesses compete on a variety of factors, such as price, quality, reliability, delivery, customer service, performance, applied technology, product innovation and product recognition. Brand identity, service to customers and quality are generally important competitive factors for our products and services, and there is considerable price competition. Other competitive factors for certain products include breadth of product line, research and development efforts and technical and managerial capability. While our competitive position varies among our products and services, we believe we are a significant competitor in each of our major product and service classes. However, a number of our products and services are sold in competition with those of a large number of other companies, some of which have substantial financial resources and significant technological capabilities. In addition, some of our products compete with the captive component divisions of original equipment manufacturers. See Item 1A “Risk Factors” for further discussion.

International Operations

We are engaged in manufacturing, sales, service and research and development mainly in the United States, Europe, Canada, Asia and Latin America. U.S. exports and foreign manufactured products are significant to our operations. U.S. exports comprised 10, 10 and 11 percent of our total sales in 2008, 2007 and 2006, respectively. Foreign manufactured products and services, mainly in Europe, were 39, 39 and 37 percent of our total sales in 2008, 2007 and 2006, respectively.

Approximately 19 percent of total 2008 sales of Aerospace-related products and services were exports of U.S. manufactured products and systems and performance of services such as aircraft repair and overhaul. Exports were principally made to Europe, Canada, Asia and Latin America. Foreign manufactured products and systems and performance of services comprised approximately 14 percent of total 2008 Aerospace sales. The principal manufacturing facilities outside the U.S. are in Europe, with less significant operations in Canada and Asia.

Approximately 2 percent of total 2008 sales of Automation and Control Solutions products were exports of U.S. manufactured products. Foreign manufactured products and performance of services accounted for 57 percent of total 2008 Automation and Control Solutions sales. The principal manufacturing facilities outside the U.S. are in Europe with less significant operations in Asia and Canada.

Approximately 14 percent of total 2008 sales of Specialty Materials products and services were exports of U.S. manufactured products. Exports were principally made to Asia and Latin America. Foreign manufactured products and performance of services comprised 24 percent of total 2008 Specialty Materials sales. The principal manufacturing facilities outside the U.S. are in Europe, with less significant operations in Asia and Canada.

Exports of U.S. manufactured products comprised 1 percent of total 2008 sales of Transportation Systems products. Foreign manufactured products accounted for 71 percent of total 2008 sales of Transportation Systems. The principal manufacturing facilities outside the U.S. are in Europe, with less significant operations in Asia and Latin America.

Financial information including net sales and long-lived assets related to geographic areas is included in Note 24 of Notes to Financial Statements in “Item 8. Financial Statements and Supplementary Data”. Information regarding the economic, political, regulatory and other risks associated with international operations is included in “Item 1A. Risk Factors.”

Raw Materials

The principal raw materials used in our operations are generally readily available. We experienced no significant problems in the purchase of key raw materials and commodities in 2008. We are not dependent on any one supplier for a material amount of our raw materials, except related to phenol, a raw material used in our Specialty Materials segment. We purchase phenol under a supply agreement with one supplier. We have no reason to believe there is any material risk to this supply.

The costs of certain key raw materials, including natural gas, benzene (the key component in phenol), ethylene, fluorspar and sulfur in our Specialty Materials business, steel, nickel, other metals and ethylene glycol in our Transportation Systems business, and nickel, titanium and other metals in our Aerospace business, are expected to remain volatile. In addition, in 2008 certain large long-term fixed supplier price agreements expired, primarily relating to components used by our Aerospace business, which in the aggregate, subjected us to higher volatility in certain component costs. We will continue to attempt to offset raw material cost increases with formula or long-term supply agreements, price increases and hedging activities where feasible. We have no reason to believe a shortage of raw materials will cause any material adverse impact during 2009. See “Item 1A. Risk Factors” for further discussion.

We are highly dependent on our suppliers and subcontractors in order to meet commitments to our customers. In addition, many major components and product equipment items are procured or subcontracted on a single-source basis with a number of domestic and foreign companies. We maintain a qualification and performance surveillance process to control risk associated with such reliance on third parties. While we believe that sources of supply for raw materials and components are generally adequate, it is difficult to predict what effects shortages or price increases may have in the future. Furthermore, the inability of these suppliers to meet their quality and/or delivery commitments to us, due to bankruptcy, natural disasters or any other reason, may result in significant costs and delay, including those in connection with the required recertification of parts from new suppliers with our customers or regulatory agencies.

Patents, Trademarks, Licenses and Distribution Rights

Our segments are not dependent upon any single patent or related group of patents, or any licenses or distribution rights. We own, or are licensed under, a large number of patents, patent applications and trademarks acquired over a period of many years, which relate to many of our products or improvements to those products and which are of importance to our business. From time to time, new patents and trademarks are obtained, and patent and trademark licenses and rights are acquired from others. We also have distribution rights of varying terms for a number of products and services produced by other companies. In our judgment, those rights are adequate for the conduct of our business. We believe that, in the aggregate, the rights under our patents, trademarks and licenses are generally important to our operations, but we do not consider any patent, trademark or related group of patents, or any licensing or distribution rights related to a specific process or product, to be of material importance in relation to our total business. See “Item 1A. Risk Factors” for further discussion.

We have registered trademarks for a number of our products and services, including Honeywell, Aclar, Ademco, Autolite, Bendix, Enovate, Fire-Lite, FRAM, Garrett, Genetron, Hand Held, Holts, Jurid, Metrologic, MK, North, Notifier, Novar, Prestone, Redex, Simoniz, Spectra, System Sensor and UOP.

Research and Development

Our research activities are directed toward the discovery and development of new products, technologies and processes and the development of new uses for existing products. The Company has research and development activities in the U.S., Europe, India and China.

Research and development (R&D) expense totaled $1,543, $1,459 and $1,411 million in 2008, 2007 and 2006, respectively. The increase in R&D expense in 2008 compared to 2007 of 6 percent was mainly due to additional product, design and development costs in Automation and Control Solutions, increased expenditures on the development of products for new aircraft platforms and increased expenditures on the development of turbocharging systems for new platforms. The increase in R&D expense in 2007 compared to 2006 of 3 percent was mainly due to additional product, design and development costs in Automation and Control Solutions and increased expenditures on the development of turbocharging systems for new platforms. Customer-sponsored (principally the U.S. Government) R&D activities amounted to an additional $903, $881 and $777 million in 2008, 2007 and 2006, respectively.

Environment

We are subject to various federal, state, local and foreign government requirements regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. It is our policy to comply with these requirements, and we believe that, as a general matter, our policies, practices and procedures are properly designed to prevent unreasonable risk of environmental damage, and of resulting financial liability, in connection with our business. Some risk of environmental damage is, however, inherent in some of our operations and products, as it is with other companies engaged in similar businesses.

We are and have been engaged in the handling, manufacture, use and disposal of many substances classified as hazardous by one or more regulatory agencies. We believe that, as a general matter, our policies, practices and procedures are properly designed to prevent unreasonable risk of environmental damage and personal injury, and that our handling, manufacture, use and disposal of these substances are in accord with environmental and safety laws and regulations. It is possible, however, that future knowledge or other developments, such as improved capability to detect substances in the environment or increasingly strict environmental laws and standards and enforcement policies, could bring into question our current or past handling, manufacture, use or disposal of these substances.

Among other environmental requirements, we are subject to the federal superfund and similar state and foreign laws and regulations, under which we have been designated as a potentially responsible party that may be liable for cleanup costs associated with current and former operating sites and various hazardous waste sites, some of which are on the U.S. Environmental Protection Agency’s Superfund priority list. Although, under some court interpretations of these laws, there is a possibility that a responsible party might have to bear more than its proportional share of the cleanup costs if it is unable to obtain appropriate contribution from other responsible parties, we have not had to bear significantly more than our proportional share in multi-party situations taken as a whole.

Further information, including the current status of significant environmental matters and the financial impact incurred for remediation of such environmental matters, if any, is included in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Note 21 of Notes to Financial Statements in “Item 8. Financial Statements and Supplementary Data,” and in “Item 1A. Risk Factors.”

Employees

We have approximately 128,000 employees at December 31, 2008, of which approximately 58,000 were located in the United States.


MANAGEMENT DISCUSSION FROM LATEST 10K

Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Honeywell International Inc. (“Honeywell”) for the three years ended December 31, 2008. All references to Notes relate to Notes to the Financial Statements in “Item 8—Financial Statements and Supplementary Data”.

Gross margin decreased by 0.6 of a percentage point in 2008 compared with 2007 primarily due to (i) higher repositioning charges and (ii) decreases of 2.2 and 1.4 percent, respectively, in our Transportation Systems and Specialty Materials segments, primarily due to lower sales volume, partially offset by (i) lower pension and other post retirement benefits expense, (ii) higher margins in our Automation and Controls Solutions segment of 0.8 of a percentage point mainly resulting from productivity savings, and (iii) higher margins in our Aerospace segment of 0.2 of a percentage point mainly resulting from sales volume growth and increased prices. We expect pension and other post retirement expense to increase in 2009.

Gross margin increased by 0.8 of a percentage point in 2007 compared with 2006 primarily due to (i) higher margins in our Specialty Materials segment of 1.0 percentage point mainly due to the continued growth of UOP, (ii) higher margins in our Aerospace segment of 0.8 of a percentage point mainly resulting from sales volume growth, increased prices and productivity savings, and (iii) lower pension and other post retirement benefits expense of 0.3 of a percentage point, which were partially offset by lower margins in our Transportation Systems segment of 1.0 percentage point primarily attributable to lower Consumer Products Group (“CPG”) sales volume and operational planning and production issues.

Income From Discontinued Operations

Income from discontinued operations of $5 million, or $0.01 earnings per share (diluted) in 2006 relates to the operating results of the Indalex business which was sold in February 2006 to Sun Capital Partners, Inc.

BUSINESS OVERVIEW

This Business Overview provides a summary of Honeywell and its four reportable operating segments (Aerospace, Automation and Control Solutions, Specialty Materials and Transportation Systems), including their respective areas of focus for 2009 and the relevant economic and other factors impacting their results, and a discussion of each segment’s results for the three years ended December 31, 2008. Each of these segments is comprised of various product and service classes that serve multiple end markets. See Note 23 to the financial statements for further information on our reportable segments and our definition of segment profit.

Economic and Other Factors

In addition to the factors listed below with respect to each of our operating segments, our consolidated operating results are principally driven by:









Impact of global economic growth rates (US, Europe and emerging regions) and industry conditions on demand in our key end markets;

Overall sales mix, in particular the mix of Aerospace original equipment and aftermarket sales and the mix of Automation and Control Solutions (ACS) products and services sales;

The extent to which cost savings from productivity actions are able to offset or exceed the impact of material and non-material inflation;

The impact of the pension discount rate on pension expense and pension asset returns on funding requirements; and

The impact of changes in foreign currency exchange rate, particularly the US dollar-Euro exchange rate.

Areas of Focus for 2009

The areas of focus for 2009, which are generally applicable to each of our operating segments, include:

Driving profitable growth by building innovative products that address customer needs;

Achieving sales growth, technological excellence and manufacturing capability through global expansion, especially focused on emerging regions in China, India and the Middle East;

Proactively managing raw material costs through formula and long term supply agreements, price increases and hedging activities, where feasible;

Driving cash flow conversion through effective working capital management and capital investment in our businesses, thereby enabling liquidity, repayment of debt, strategic acquisitions, and the ability to return value to shareholders;

Actively monitoring trends in short-cycle end markets, such as the Transportations Systems turbo business, ACS products businesses, Aerospace business and general aviation aftermarket and Specialty Materials resins and chemicals, and continuing to take proactive cost actions;

Align and prioritize investments in long-term growth vs. short-term demand volatility;




Driving productivity savings through execution of repositioning actions;

• Actively reducing discretionary spending with focus on non-customer related costs;



•Proactively managing capacity utilization, supply chain and inventory demand while achieving customer satisfaction;



•Utilizing our enablers Honeywell Operating System (HOS), Functional Transformation and Velocity Product Development (VPD) to standardize the way we work, increase quality and reduce the costs of product manufacturing, reduce costs and enhance the quality of our administrative functions and improve business operations through investments in systems and process improvements;



•Monitoring both suppliers and customers for signs of liquidity constraints, limiting exposure to any resulting inability to meet delivery commitments or pay amounts due, and identifying alternate sources of supply as necessary; and



•Managing Corporate costs, including costs incurred for asbestos and environmental matters, pension and other post-retirement expenses and our tax expense.

Aerospace

Overview

Aerospace is a leading global supplier of aircraft engines, avionics, and related products and services for aircraft manufacturers, airlines, aircraft operators, military services, and defense and space contractors. Our Aerospace products and services include auxiliary power units, propulsion engines, environmental control systems, engine controls, flight safety, communications, navigation, radar and surveillance systems, aircraft lighting, management and technical services, advanced systems and instruments, aircraft wheels and brakes and repair and overhaul services. Aerospace sells its products to original equipment (OE) manufacturers in the air transport, regional, business and general aviation aircraft segments, and provides spare parts and repair and maintenance services for the aftermarket (principally to aircraft operators). The United States Government is also a major customer for our defense and space products.

Economic and Other Factors

Aerospace operating results are principally driven by:



•New aircraft production rates and delivery schedules set by commercial air transport, regional jet, business and general aviation OE manufacturers, as well as airline profitability and retirement of aircraft from service;



•Global demand for commercial air travel as reflected in global flying hours and utilization rates for corporate and general aviation aircraft, as well as the demand for spare parts and maintenance and repair services for aircraft currently in use;



•Level and mix of U.S. Government appropriations for defense and space programs and military activity; and



•Availability and price volatility of raw materials such as titanium and other metals.

2008 compared with 2007

Aerospace sales increased by 3 percent in 2008. Details regarding the net increase in sales by customer end-markets are as follows:



•Air transport and regional original equipment (OE) sales decreased by 6 percent in 2008. The decrease is driven by the sale of our Consumables Solutions business, partially offset by increased deliveries to our air transport customers, notwithstanding a decrease in total aircraft production rates at major OEM’s mainly due to a strike at a major OEM, which was settled in the fourth quarter. We expect sales to OE customers to decline in the first quarter of 2009 due to reduced delivery schedules in light of order deferrals and cancellations and platform mix.



•Air transport and regional aftermarket sales increased by 4 percent in 2008 primarily due to increased volume, the price of spare parts and aftermarket growth driven by flight hour growth. Consistent with our previously reported expectations, the growth rate in global flying hours slowed to 3 percent in 2008, including a 2 percent decline in the fourth quarter and is expected to decline further in the first quarter of 2009. In addition, aftermarket customers may change buying patterns and reduce inventory levels.



•Business and general aviation OE sales increased by 5 percent in 2008 due to continued demand in the business jet end market as evidenced by an increase in new business jet deliveries (which is expected to decline in the first quarter of 2009), improved pricing and continued additions to the fractional ownership and charter fleets (which is expected to decline in the first quarter of 2009) . In 2008 sales to this end-market primarily consisted of sales of Primus Epic integrated avionics systems and the TFE 731 and HTF 7000 engines.



•Business and general aviation aftermarket sales increased by 6 percent in 2008. The increase was primarily due to increased revenue under maintenance service agreements and higher sales of spare parts both of which are expected to decline in the first quarter of 2009, consistent with the expected decrease in business jet utilization.



•Defense and space sales increased by 6 percent in 2008. The increase was primarily due to logistics services (including the positive impact of the acquisition of Dimensions International, a defense logistics business), helicopter OE sales, an increase in government funded engineering related to the Orion (CEV) program, higher sales of specialty foam insulation, certain surface systems and classified space programs.

Aerospace segment profit increased by 5 percent in 2008 compared to 2007 due primarily to increased prices, productivity and sales volume growth. These increases are partially offset by inflation, the Consumable Solutions divestiture and higher spending to support new platform growth. We expect segment profit to decline in the first quarter of 2009 primarily due to the expected adverse sales impacts noted above.

2007 compared with 2006

Aerospace sales increased by 10 percent in 2007. Details regarding the net increase in sales by customer end-markets are as follows:



•Air transport and regional original equipment (OE) sales increased by 10 percent in 2007 compared to 2006. This increase was driven by increased deliveries to air transport customers primarily due to higher aircraft production rates at major OE manufacturers.



•Air transport and regional aftermarket sales increased by 8 percent in 2007. The increase was a result of increased sales volumes and price of spare parts and maintenance activity relating to the approximately 6 percent increase in global flying hours.



•Business and general aviation OE sales increased by 16 percent in 2007. The increase is due to continued demand in the business jet end market as evidenced by an increase in new business jet deliveries, as well as the launch of new aircraft platforms. Sales to this end-market primarily consisted of sales of Primus Epic integrated avionics systems and the TFE 731 and HTF 7000 engines.

•Business and general aviation aftermarket sales increased by 16 percent in 2007. The was primarily due to increased revenue under maintenance service agreements and higher sales of spare parts.



• Defense and space sales increased by 8 percent in 2007. The increase was primarily due to higher sales of surface systems, a 2 percent positive impact of the acquisition of Dimensions International and an increase in space sales, including engineering activities relating to the Orion (CEV) program.

Aerospace segment profit increased by 16 percent in 2007 compared to 2006 due primarily to sales volume growth, increased prices and productivity, partially offset by inflation.

2009 Areas of Focus

Aerospace’s primary areas of focus for 2009 include:



• Focus on cost structure initiatives to maintain profitability in the face of challenging conditions in the aerospace industry, such as lower flight hours and order deferrals and cancellations;



• Aligning inventory, production and research and development with customer demand and production schedules;



• Pursuit of new defense and space platforms and growth opportunities;


• Continuing to design equipment that enhances the safety, performance and durability of aerospace and defense equipment, while reducing weight and operating costs; and



• Delivering world-class customer service and achieving cycle and lead time reduction to improve responsiveness to customer demand.

Automation and Control Solutions (ACS)

Overview

ACS provides innovative solutions that make homes, buildings, industrial sites and infrastructure more efficient, safe and comfortable. Our ACS products and services include controls for heating, cooling, indoor air quality, ventilation, humidification, lighting and home automation; advanced software applications for home/building control and optimization; sensors, switches, control systems and instruments for measuring pressure, air flow, temperature and electrical current; security, fire and gas detection; personal protection equipment; access control; video surveillance; remote patient monitoring systems; products for automatic identification and data collection, installation, maintenance and upgrades of systems that keep buildings safe, comfortable and productive; and automation and control solutions for industrial plants, including advanced software and automation systems that integrate, control and monitor complex processes in many types of industrial settings.

Economic and Other Factors

ACS’s operating results are principally driven by:



• The growth of global commercial construction (including retrofits and upgrades);


• Demand for residential security and environmental control retrofits and upgrades;

• Demand for energy efficient products and solutions;


• Industrial production;


• Government and public sector spending;



• U.S. and European economic conditions;


• Economic growth rates in developed (U.S. and Europe) and emerging markets;


• The strength of capital and operating spending on process (including petrochemical and refining) and building automation; and •



Changes to energy, fire, security, health care, safety and environmental concerns and regulations.

2008 compared with 2007

ACS sales increased by 12 percent in 2008 compared with 2007, including 10 percent net growth from acquisitions and divestitures. Although foreign exchange had minimal impact on full year sales, there was a 9 percent negative impact of foreign exchange on fourth quarter sales.


• Sales in our Products businesses grew by 15 percent, including (i) the positive impact of acquisitions, most significantly Norcross Safety Products, Metrologic Instruments, Hand Held Products Inc and Maxon Corporation, (ii) continued strong demand for life safety products, particularly fire systems and sensors and (iii) increased sales of our environmental and combustion products, driven by new products and demand for energy efficient controls, including growth across all regions. These factors were partially offset by decreases in sales volumes of our security (reflecting U.S. and European residential construction softness) and sensing and controls products (most notably automotive customers), reflecting softness in the U.S. and Europe.


• Sales in our Solutions businesses increased by 8 percent primarily due to (i) volume growth, driven by continued orders growth and strong conversion to sales from our orders backlog and (ii) the positive impact of acquisitions, most significantly Enraf Holding B.V.

ACS segment profit increased by 15 percent in 2008 compared with 2007 principally due to increased productivity savings, acquisitions, and improved pricing, partially offset by inflation.

2007 compared with 2006

ACS sales increased by 13 percent in 2007 compared with 2006, including 4 percent favorable impact of foreign exchange and net growth from acquisitions and divestitures of 2 percent.


• Sales in our Products businesses grew by 11 percent, driven by (i) increased sales of security products primarily due to growth in intrusion products, European distribution sales and emerging markets, (ii) continued strong demand for life safety products and (iii) introduction of new environmental and combustion control products.


• Sales in our Solutions businesses increased by 17 percent with growth in all regions, driven by energy retrofit and refining services projects, global infrastructure expansion, continued growth in orders and conversion to sales from our order backlog, as well as the favorable impact of foreign exchange.

ACS segment profit increased by 15 percent in 2007 compared with 2006 principally due to increased Products and Solutions sales volume and productivity savings, partially offset by inflation. We continue to experience a change in mix resulting from stronger sales growth in our Solutions businesses that historically have lower margins than our Products businesses.

2009 Areas of Focus

ACS’s primary areas of focus for 2009 include:



• Extending technology leadership: lowest total installed cost and integrated product solutions;


• Defending and extending our installed base through customer productivity and globalization;

• Sustaining strong brand recognition through our brand and channel management;


• Centralization and standardization of global software development capabilities;


• Continuing to identify, execute and integrate acquisitions in or adjacent to the markets which we serve;


• Continuing to establish emerging markets presence and capability;


• Process solutions for asset management and energy efficiency; and


• Continuing to invest in new product development.

Specialty Materials

Overview

Specialty Materials develops and manufactures high-purity, high-quality and high-performance chemicals and materials for applications in the refining, petrochemical, automotive, healthcare, agricultural, packaging, refrigeration, appliance, housing, semiconductor, wax and adhesives segments. Specialty Materials also provides process technology, products and services for the petroleum refining, petrochemical and other industries. Specialty Materials’ product portfolio includes fluorocarbons, caprolactam, ammonium sulfate for fertilizer, specialty films, advanced fibers, customized research chemicals and intermediates, electronic materials and chemicals, catalysts, and adsorbents.

Economic and Other Factors

Specialty Materials operating results are principally driven by:


• Level of capital spending and capacity and utilization rates in refining and petrochemical end markets;



• Degree of pricing volatility in raw materials such as benzene (the key component in phenol), fluorspar, natural gas, ethylene and sulfur;



• Impact of environmental and energy efficiency regulations;



• Extent of change in order rates from global semiconductor customers;



• Global demand for non-ozone depleting Hydro fluorocarbons (HFC’s);



• Condition of the US residential housing industry; and



• Global demand for commodities such as caprolactam and ammonium sulfate.

CONF CALL

Murray Grainger

Thank you Lisa. Good morning and welcome to Honeywell’s fourth quarter and full-year 2008 earnings conference call. With me here today are Chairman and CEO, Dave Cote; and Senior Vice President and CFO, Dave Anderson. This call and webcast including any non-GAAP reconciliations are available on our website www.honeywell.com/investor. Note that elements of this presentation contain forward-looking statements that are based on our best deals of world and of our businesses as we see them today. Those elements can change and we would ask you interpret them in that light. This morning we will review our financial results for the fourth quarter and full-year of 2008, as well as our expectations for the first quarter of 2009 and of course allow time for your questions. With that I'll turn the call over to Dave.

Dave Cote

Thanks, Murray. Good morning, everyone. I'm pleased to report a quarter of good results despite a challenging economic environment closing out over the great year of performance for Honeywell. Our results in 2008 reinforce the great positions we have in good industries. The investments we have made in process improvements through our five initiatives, the talent and depth of our management team, and of course the power of WON [ph] Honeywell. Dave will take us through the details of the quarter in a moment. Let me tell you I am extremely proud of this Honeywell team delivering EPS growth of 7% on a 6% sales decline and free cash conversion of a 155%, despite some unprecedented economic headwinds. Our well diversified and balanced portfolio is really helping drive overall strong performance and for the full-year 2008, we increased sales by 6% to $36.6 billion, increased earnings per share by 19% to $3.76 and converted free cash flow at an impressive rate of 110% of net income.

During the year we completed a total of eight acquisitions for $2.2 billion including Norcross, Metrologic, Callidus, and IAC further building our growth platforms. Our acquisitions process continues to work incredibly well. We remain disciplined around price and our robust integration process insures that we deliver on our synergies. We also divested the Aerospace consumable solutions business in 2008 for proceeds of more than a $1 billion, a great deal from Honeywell and a credit to Rob Gillette’s Aerospace team. Our key initiatives continue to gain traction in our businesses and functions everyday and we have a lot of room for even further improvement. The Honeywell operating system has now been initiated in 70% of our manufacturing cost base with 80% targeted for 2009. We are starting to see the first sites reach bronze HOS certification and the results are impressive. Along the quality, delivery, safety, cost, and inventory improvements, we are seeing real changes in culture and attitude and after such that makes HOS a sustainable, repeatable platform for improvement.

Functional transformation is basically HOS for administrative functions, the same concept, standard work and one robust process all designed to deliver better service at lower cost. We are targeting 5.3% of sales in ’09 down from more than 8% in 2004 with plenty of runway to reach world class. Finally, I just spent two days with our top 300 leaders where we concentrated almost exclusively on delivering results in this tough economic environment. While we should all be rightly cautious about the challenges that are ahead of us, particularly in the first half of ’09. I feel good about the investments we’ve been making in our businesses for the past six years that prepares for these times.

HOS, FT, ERP, Velocity Product Development, Emerging Region Presence, and the acquisitions are all the seeds that we planted to help improve our growth productivity and cash flow. We have the right leadership team in place to deliver these improvements and we have taking the right proactive repositioning actions ahead of the curve to prepare ourselves for this challenging environment. So, in summary, with our great results for 2008 and the momentum we are building with our key initiatives, I feel confident in our outlook for ‘09 despite some very tough economic conditions. We are looking forward to keeping you undated on our progress and with that let me turn the call over to Dave to go through the financials in detail for the quarter. Dave?

Dave Anderson

Good morning. Thanks Dave. Let’s go to slide number 4, let me walk you thorough the summary of financial results for the quarter really building on Dave’s comments. And as he said, we all know in a tough incentive challenging economic conditions we posted overall good results in the fourth quarter importantly in line with the guidance we provided you in December. The reported sales were down 6% to 4% on an organic constant currency basis. However, our two biggest businesses, the Aerospace business and ACS, importantly both grew organically in the quarter both were up 2% on a constant currency organic basis. Segment margins for total Hon declined 40 basis points in the fourth quarter, but again importantly our two biggest businesses posted increases year-over-year.

ACS was up an impressive 110 basis points, Aero was up 40 basis points in the quarter. It was unfortunately more than offset by continued weakness at transportation systems, which was down over 10 percentage points in the quarter on significant volume declines. Net income grew 3% driven primarily by favorable pension in OPEB as expected and also lower environment charges, which we communicated in the third quarter and our guidance for the fourth quarter. And of course in the third quarter we took you through the details of the consumable solutions gain and the associated actions, but to remind you we reviewed at that time a tax impact that indicated that we would have a higher ETR in the third quarter, which we did 30.5% and a lower ETR in the fourth quarter, which came in at 22%. We also indicated in the third quarter when we gave fourth quarter guidance that we would offset this lower fourth quarter effective tax rate with repositioning actions we indicated about $30 billion and in fact we just had $42 million in repositioning in the fourth quarter, which will further support our ’09 and ’10 outlook.

EPS grew 7%, partially driven by lower share count and importantly as Dave pointed out, free cash flow conversion another high quality story in the quarter of 155% conversion. Overall a good quarter, tough conditions, and the end of another great year for Honeywell. Let’s go to slide 5, ill just summarize that as well. As you can see on slide 5, the total year is in the line with our December guidance, we reported sales of 6%, 2% on an organic constant currency basis. Importantly, three of the four businesses posted organic sales increases in the year with a similar story in terms of expansion of margins. So, while margins declined 20 basis points overall, Aero grew 20 points, ACS’ margins were up 30 points for the year and specialty materials grew 20 points all impressive performance in the environment that we are in.

Net income grew 14% for the year with favorable pension in OPEB again, including more than 400 of – importantly though also including more than 400 million of repositioning actions in the year. All of this funded either through operational performance or gains. And of course again will provide great support for us in ’09 and ’10. EPS for the year as Dave said up an impressive 19% to $3.76, we generated $3.1 billion of free cash flow, a 110% of net income. So, now let’s go through each of the segments, starting with Aerospace on slide 6. The reported segment sales in the quarter were down 1% for Aero, but excluding the impact of the CS divestiture were up 2% on an organic basis with segment profit up 1% and margins up 40 basis points as I said earlier to an impressive 19.2%.

On an organic basis total conversion sales that is the ATR and BGA businesses were up 2% in the quarter, with continued strong deliveries in the timing of the after-market activity in business jets being offset by the impact of the Boeing strike and lower global flight hours at air transport, which we had anticipated. The organic commercial all lead sales were up 2% driven by our business jet accruals [ph], which saw strong sales growth 16% in fourth quarter offset by air transport and regional sales, which were down 12% due to the Boeing strike. Importantly including the impact of Boeing, the ATR OE sales were up 13% in the quarter. Commercial after-market sales were up 1%. The AT&R after-market sales were flat, slightly higher than global flying hour which were down approximately 2%.

Now the B&GA after-market sales were up 3% in the quarter driven by the timing of after-market events despite TMT hours, which were down 22% in the quarter. Defense and Space, a good quarter for Defense up 4% driven the strength in our logistics and services business, which were up 13%, Space, which was up 18%, and just as a reminder Defense and Space, of course more than 40% of the overall portfolio remains very well positioned and we expect nice growth out of this segment in 2009. So, in summary another strong quarter for Aero capping a great year where sale grew 3% to $12.7 billion, margin increased 20 basis points at 18.2% and importantly we won over 40 billion of new businesses in ’08, including approximately 30 billion of new applications for our HTF 7500 engine. Investments we’ve made in Aero are paying of the long-term outlook for this business remains very strong.

Now let’s go to slide 7 and go through the highlights of ACS. Starting with the quarter, sales were up 3% 2% organic on a constant currency basis, if you exclude negative 9% foreign currency impact and the 10% positive contribution that we got from acquisitions. And by the way we had positive organic growth importantly in ACS across all regions in the other quarter, which is impressive. Our products businesses overall continued to perform well they were up 7% reported in the quarter. We saw continued strength in ECC and Life Safety business, particularly both ECC and Life Safety recorded mid-single digit organic including in both North America and Europe. The security distribution in sensing control businesses as expected continues to be impacted by weakness in residential and transportation end markets. And as you know, you would recall, we have discussed this in some depth in our outlook call in December.

Now the solutions businesses continued to perform well. We had organic growth of 7% in the quarter, with demand for energy efficiency as well as the integration of compliment, fire and security controls for critical infrastructure all being important drivers at building solutions. And across the solutions the oil and gas production particularly upstream as well as distribution projects continue to be solid. Orders in the fourth quarter and solutions were essentially flat reflecting tough comps, we were up 30% in orders in the fourth quarter of 2007. Process solutions showed continued strength with orders growth in the high single digits. Building solutions orders were down in the quarter, but really due to project timing. For the year, orders for both businesses were strong and we exit the year with growth at our backlog as well as in our service bags.

ACS’ segment profit was up 12% in the quarter as you can see representing an impressive 110 basis points increase in margin to 13.4%. The ACS team made great progress on new products that is a team by the way that is underlying obviously this performance as well as productivity and the contribution of acquisitions all those for positive contribution for ACS in the quarter. Sales for the year for ACS grew an impressive 12% to $14 billion, margins increased 30 basis points to 11.6%. Clearly what we are seeing is the strength of the multi-brand, multi-channel strategy as well as the investments that Roger and the ACS team has made in innovation in new product development. Also the strong positions in emerging regions that continues to drive positive growth for ACS and will continue to see increase our penetration in these markets despite signs of slowing growth in those markets.

Now let’s turn to slide 8, Transportation Systems, which as we all expected and as we guided had a tough quarter capping of a very challenging year for 2008 and importantly and will regroup this in a little more depth as we get into the first quarter and ’09 updates, we expect these trends to continue through the majority of ’09. So, turning to slide 8 for TS, overall sales as you can see were down 35% including a 4% foreign currency headwind adding to the volume decline impact. At turbo, which was down 44% recorded we saw continued sharply lower vehicle production rates at European and US OEMs, as well as a continued consumer shift towards lower displacement engines due to CO2 taxation, as well as shift to gas engines due to continued high diesel prices at the pumps. So, in addition to the production, the reproduction volume in fact we also obviously had mix impact in terms of consumer fall.

New platform launches continue to be pushed out for TS as OE struggled with lower sales of their current inventories. However our content on future platforms continues to grow. Despite the current challenges and the expectation for the continuation of those challenges into ’09, the overall macro trends for Turbo remain very positive, with energy efficiency and emissions, as well as our robust backlog of attractive new platforms. We had over $4 billion, just as a reminder over $4 billion of wins in 2008. They obviously give us confidence in the long-term prospects for this business. For CPG it was down 18% recorded, we continue to face headwinds in the US automotive after-market, the consumer after-market. Volumes were down in car care and filtration as economic concerns weigh on consumer confidence and discretionary spending.

Segment profit for total TS was down 96% in the quarter, again due primarily to lower volumes at Turbo. And for the full-year, TS sales were $4.6 billion a decrease of 8%, segment margins were 8.8%, down 280 basis points from 2007. So, with that let’s go to SM, slide number 9. Sales in the quarter for SM were down 12%, segment profit was down 16% in the quarter primarily due to lower volumes at resins and chemicals and also electronic materials, due to significantly weaker global demand for commodities such as caprolactam, and also ammonium sulfate fertilizer, as well as capacity productions in semi-conductor industry. Now, fortunately the declines were partially offset by good performance at EOP, which saw increased catalyst sales in the quarter and also fluorine’s products which grew 7%.

For the year, specialty material sales were up 8% to 5.3 billion margins increased 20 basis points to 13.7% including almost 30 million or 50 basis points of headwinds from hurricane impacts. So, really a good year overall for SM. And today SM is a much better protected businesses with fluctuations at commodity prices due to the torment in the pricing agreement and as you recall the portfolio has significantly transformed compared to prior down terms. So, now let’s go to slide 10 and just update you on our 2009 guidance. Given the increased visibility we have it is a result of the completion of ’08 and the beginning ’09. Now on the top of the slide, we have summarized the guidance we shared with you last month and at the bottom of slide 10 we’ve outlined a stat with some of the positive variances on the right and negative variances on the right, which are certain items since our December 15 call.

Now, overall we expect to be in the range of the full-year guidance that we communicated last month. However, January trends continue into the first half of ’09, we would expect to be at the low end of this guidance range although economic conditions continue to be very fluid. Also as an update cash flow perspective, we expect to be 100% plus of free cash flow conversion for the year 2009. So, let’s walk through some of the specifics in the bottom half of slide 10, starting with pension. Now you will recall from the December guidance our base case pension assumptions were for the 12/31/08 plan returns and discount rate of 33% and 7.5% respectively, which would yield an expense for ’09 in the range of the $130 million.

Now actual returns in ’08 ended the year slightly better, at 29% compared to that down 33% that was the mid-point of our guidance. However, we saw yields moved down significantly during the last few days of December and ended the year for us at our discount rate using the yield curve associated with the expected lives of our planned participants at 6.95%. We are still yet to finalize the 2000 numbers for the international plans, but based upon the US plan in accruals we’ve been expecting incremental $40 million to $50 million pension expense in ’09 bring the total year to approximately $175 million of expense. Now you note that we also took a 2.6 billion charge to equity that is an after-tax charge to equity at the end of ’08 reflecting the accounting treatment of the under-funded US plan as of December 31.

We also made our first stock contribution of the US plant at the end of the fourth quarter and the amount of $200 million, which is in line with the funding plan that we communicated to you in December. For foreign exchange, our largest component that I have highlighted there are largest currency exposure, the euro continues to trade above our planned rates. For 2009, you would recall the 1.25 guidance and at current levels, let’s call it a 1.30 kind of range or 1.30 plus. This benefit would offset the incremental pension headwind, however it is obviously too early to change our assumptions for FX for the year. We thought it would be helpful just to give you a sense of the puts and takes that’s important in the current guidance range. Working the way down to the remaining positive on the left, the highlights that I gave you ACS, ACS continues to perform well, as evidenced by the 110 basis points improvement in margins and 2% organic sales growth in the fourth quarter.

Again new product and acquisitions are the positive contributors to ACS’ results and Rogers and his team, the ACS team remains confident in our outlook for the year. On the purchasing side, we continue to see additional savings opportunities with raw materials at the current levels and these should benefit as particularly in the second half of ’09 and finally under productivity, we see opportunity to overdrive savings across a number of our repositioning and functional transformation projects that were already underway. On the other hand, we expect to see growth in China, Munich [ph], slower expectations for GDP growth in these regions and well below the expectation and now below I should say the expectations that we had in December. We have seen business activities slow in the region as well as increased levels of project deferrals and cancellations in some instances.

Within Aero, we continue to see shifts in OE deliveries particularly with business jets, as our customers work to realign their schedules in the phase of increased deferrals and cancellations. We expect Aero transport and regional flight hours to now be at the low end of our communicated range down 2% for the full-year, previously we communicated down 1% to 2%, we now expect based upon the exit rate of the fourth quarter and what we are seeing the first quarter of this year to be down 2% for the full-year. Business jet engine TFE hours, we expect to continue with fourth quarter levels, which were down approximately 25% in the first quarter. Now within SM, the outlook for Electronic Materials Business weaker than expected capacity in the semiconductor industry continues to be reduced.

And finally as we set ways to the quarters, our expectation is for a much weaker first half for both earnings and cash, while the second half will benefit from much easier comps, the approved run rate of instruction benefits, and also lower commodity costs as well as more minor, some foreign currency translation deferential. So, let’s background for the full-year and the update for the guidance for ’09, let’s take a high level look at the first quarter of ’09 on slide 11. We are planning as you can see on the slide, for total sales in the first quarter to be in the range $7.4 billion to $8.0 billion down 10% to 17% from the first quarter of ’08, including approximately 6 points of negative foreign currency impact We expect EPS to be in the range of $0.50 to $0.60 down approximately 30% to 40%. We also expect free cash flow to be soft and below prior year due to the reduced net income as well as right now, some anticipated one-time cash tax payments.

Now clearly these numbers represent significant declines from prior – frankly our order books at this point in time are not reflecting these types of declines. However, given the continued negative economic news, this is the way we are planning our cost and managing our business. We anticipate Aero sales in the first quarter to be in the range of $2.6 billion to $2.8 billion down 6% to 13% including a negative 4 point impact from the sale of consumable solutions, so down to the down 9 absent that impact. We expect sales to OE customers to decline, due to the platform mix at Aero Transport and also reduce delivery schedules of business jets. In the after market, as I said we expect AT&R sales to decline slightly more than flight hours driven by volume behavior and we expect those flight hours to be down around 4% and by the way, that compares to global flying hours of 7.2% in the first quarter of 2008.

And in business jets, TSE hours are expected to be down approximately 25% as I said earlier and that compares to up 1% in first quarter ’08. So, it gives you some insight in terms of the tough comps that we are facing particularly in its first quarter and first half of 2009. For ACS, we expect sales in the range of $3.0 billion to $3.2 billion up 2% to down 4% versus the prior year. By the way that includes a 4 point net headwind from FX and acquisitions. We expect similar trends that we saw in the fourth quarter with acquisitions, new products, and conversion of solutions backlog being offset by weakness in security and sensing in controls. At Transportation systems, sales for the first quarter we expect in the range of $700 million to $800 million down 33% to 41% again with similar trends that we saw in the fourth quarter, really in continuation of that turbo volume declines that we referenced.

Finally, at FM we anticipate sales of $0.9 billion to $1.0 billion down more than 25% due to continued softness in resins and chemicals and electronic materials and extremely difficult comps at EOP. You will recall, we had the high margin canvas sales in the first quarter of 2008, we expect those to be down more than 30% in the first quarter of ’09.

So, in summary we are preparing ourselves for an extremely tough quarter, we think this is representative of the industrial landscape that we think will unfold. However, as we discussed the environment remains fluid, orders at this point in time actually continue to be much more positive and we will update you again at our annual investor meeting in February.

So, now let’s summarize on slide 12 before turning it back over to Murray for Dave and I for Q&A. We obviously had a good finish to 2008 despite tough economic and end markets in the last few months. We saw particularly in that December month and at year end much more challenging conditions. We saw the deterioration in markets such as Commercial Aerospace and Electronic Materials and we are planning for these trends to continue into the first half of 2009. Now we are expecting, given the relative strength of the first half of 2008, that the comparisons in the first half of 2009 will be very challenging year over year. In addition to foreign exchange, where the euro average comp was 1.5 in the first quarter of 2008, some of our key businesses such as Air Transporting and Regional Aftermarket, turbochargers and ULP, and resins and chemicals will face significant year-over-year headwinds.

On the other hand, we will see incremental benefits from repositioning actions that we funded in 2008 in the second half of 2009 and these benefits in combination with easier year-over-year comps, seasonality in defense and space – defense and space just n]]>Mon, 09 Mar 2009 14:36:54 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1954/http://www.dailystocks.com/forum/showtopic.php?tid/1954/
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BUSINESS OVERVIEW

Forward-Looking Statements

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. Actual results could differ materially from those contained in these forward-looking statements for a variety of reasons, including, but not limited to, those discussed in the section entitled “Risk Factors” as well as those discussed elsewhere in this report. Other unknown or unpredictable factors also could have a material adverse effect on our business, financial condition and results of operations. Accordingly, readers should not place undue reliance on these forward-looking statements. The use of words such as “anticipates,” “estimates,” “expects,” “intends,” “plans” and “believes,” among others, generally identify forward-looking statements; however, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. We are not under any obligation and do not intend to publicly update or review any of these forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized. Please carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission (“SEC”) that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

Management Overview

General Description of our Business

Expedia, Inc. is an online travel company, empowering business and leisure travelers with the tools and information they need to efficiently research, plan, book and experience travel. We have created a global travel marketplace used by a broad range of leisure and corporate travelers, offline retail travel agents and travel service providers. We make available, on a stand-alone and package basis, travel products and services provided by numerous airlines, lodging properties, car rental companies, destination service providers, cruise lines and other travel product and service companies. We also offer travel and non-travel advertisers access to a potential source of incremental traffic and transactions through our various media and advertising offerings on both the TripAdvisor ® Media Network and on our transaction-based websites.

Our portfolio of brands, which is described below, includes: Expedia.com ® , hotels.com ® , Hotwire.com ® , the TripAdvisor Media Network, our private label programs (Worldwide Travel Exchange and Interactive Affiliate Network), Classic Vacations ® , Expedia Local Expert tm , Egencia tm (formerly Expedia ® Corporate Travel), eLong tm , Inc. (“eLong”) and Venere tm Net SpA (“Venere”). In addition, many of these brands have related international points of sale. We refer to Expedia, Inc. and its subsidiaries collectively as “Expedia,” the “Company,” “us,” “we” and “our” in this Annual Report on Form 10-K.

Summary of the Spin-Off from IAC/InterActiveCorp

On December 21, 2004, IAC/InterActiveCorp (“IAC”) announced its plan to separate into two independent public companies. We refer to this transaction as the “Spin-Off.” A new company, Expedia, Inc., was incorporated under Delaware law in April 2005, to hold substantially all of IAC’s travel and travel-related businesses. On August 9, 2005, the Spin-Off was completed and Expedia, Inc. shares began trading on The Nasdaq Global Select Market (“NASDAQ”) under the symbol “EXPE.”

Equity Ownership and Voting Control

As of December 31, 2008, there were approximately 261,374,295 shares of Expedia common stock, 25,599,998 shares of Expedia Class B common stock and 751 shares of Expedia preferred stock outstanding. Also as of December 31, 2008, Liberty Media Corporation (“Liberty”), through a wholly-owned subsidiary, beneficially owned approximately 27% of Expedia’s outstanding common stock and 100% of Expedia’s outstanding Class B common stock. As of such date, Barry Diller, Chairman and Senior Executive of Expedia (through his own holdings and holdings of Liberty, over which Mr. Diller generally has voting control pursuant to an irrevocable proxy granted by Liberty under the Stockholders Agreement described below) controlled approximately 60% of the outstanding total voting power of Expedia.

Pursuant to the Stockholders Agreement, dated as of August 9, 2005, as amended, between Liberty and Mr. Diller, Mr. Diller is effectively able to control the outcome of nearly all matters submitted to a vote or for the consent of Expedia’s stockholders (other than with respect to the election by the Expedia common stockholders of 25% of the members of Expedia’s Board of Directors and certain matters as to which a separate class vote of the holders of Expedia common stock or Expedia preferred stock is required under Delaware law). In addition, pursuant to the Governance Agreement, dated as of August 9, 2005, among Expedia, Liberty and Mr. Diller, each of Mr. Diller and Liberty generally has the right to consent to certain significant corporate actions in the event that Expedia or any of its subsidiaries incurs any new obligations for borrowed money within the definition of “total debt” set forth in the Governance Agreement for as long as Expedia’s ratio of total debt to EBITDA, as defined therein, equals or exceeds eight to one.

Portfolio of Brands

Expedia leverages its brand portfolio to target the broadest possible range of travelers, travel suppliers and advertisers. Our brands provide a wide selection of travel products and services, from simple, discounted travel to more complex, luxury travel. Our travel offerings primarily consist of airline flights, hotel stays, car rentals, destination services, cruises and package travel, which encompasses multiple travel products. We also offer travel and non-travel advertisers access to a potential source of incremental traffic and transactions through our various media and advertising offerings on both the TripAdvisor Media Network and on our transaction-based websites.

Expedia.com. Our Expedia-branded websites make a large variety of travel products and services available directly to travelers through our U.S.-based website, www.expedia.com, as well as through localized versions of the Expedia website in Australia, Austria, Belgium, Canada, Denmark, France, Germany, India, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Spain, Sweden and the United Kingdom. Expedia-branded websites target many different types of travelers, from families booking a summer vacation to individual travelers arranging a quick weekend getaway. Travelers can search for, compare information about (including pricing, availability and traveler reviews) and book travel products and services on Expedia-branded websites, including airline tickets, lodging, car rentals, cruises and many destination services — such as airport transfers, local attractions and tours — from a large number of suppliers, on both a stand-alone and package basis.

Hotels.com. Our hotels.com website provides a broad selection of hotel properties to travelers, who can plan, shop for and book lodging accommodations, from traditional hotels to vacation rentals. Hotels.com seeks to provide travelers with premium content and service through our U.S.-based website, www.hotels.com, as well as through localized versions in the Americas, Europe, Asia Pacific and South Africa. With hotels.com, we differentiate our offering by positioning the brand as the hotel expert, with premium content about lodging properties.

Hotwire.com. Our discount travel website, Hotwire.com, makes available airline tickets, hotel rooms, rental cars, cruises and vacation packages. Hotwire.com’s approach matches flexible, price-sensitive travelers with suppliers who have excess seats, rooms and cars they wish to fill without affecting the public’s perception of their brands. Hotwire.com travelers may enjoy significant discounts by electing to book travel services “opaquely,” without knowing certain itinerary details such as brand, time of departure and exact hotel location, while suppliers create value from excess availability without diluting their core brand-loyal traveler base.

Recent product innovation allows air travelers to discover available discounts by altering details of their air travel plans such as date of departure or destination airport. Hotwire.com works with many domestic and international airlines, including U.S. full-service major network airlines, top hotels in hundreds of cities and resort destinations in the United States, Europe, Canada, Mexico and the Caribbean and major car rental companies in the United States.

Venere. Our Venere branded websites make over 30,000 hotel properties available to European consumers, through the website www.venere.com, and provide hoteliers with geographically diverse sources of demand. Venere has direct agency-based relationships with hotels around the world. In addition, we have begun making Venere hotel supply available through certain of our hotels.com-branded websites and have plans to expand to other hotels.com sites, as well as our Expedia-branded sites.

The TripAdvisor Media Network. TripAdvisor, our comprehensive online travel search engine and directory, aggregates traveler opinions and unbiased articles about cities, hotels, restaurants and activities in a variety of destinations through www.tripadvisor.com and localized versions of the site in France, Germany, India, Ireland, Italy, Japan, Spain and the United Kingdom. In addition to travel-related information, TripAdvisor’s destination-specific search results provide links to the websites of TripAdvisor’s travel partners (travel providers and marketers) through which travelers can make related travel arrangements. TripAdvisor has also acquired and now operates a number of travel media content properties within the TripAdvisor Media Network, including airfarewatchdog.com tm , bookingbuddy.com tm , cruisecritic.com tm , holidaywatchdog.com tm , independenttraveler.com tm , seatguru.com ® , smartertravel.com tm , travel-library.com tm , travelpod.com tm , flipkey.com tm , onetime.com tm and virtualtourist.com tm , expanding the Network’s reach, product breadth and appeal to domestic and international advertisers.

Worldwide Travel Exchange and Interactive Affiliate Network. Our private label and co-brand programs make travel products and services available to travelers through third-party company-branded websites. The products and services made available through www.wwte.com and www.ian.com are substantially similar to those made available on Expedia-branded and hotels.com-branded websites, respectively. We generally compensate participants in the WWTE ® and IAN tm private label programs on a revenue-share basis. We also leverage our WWTE and IAN platforms to make Expedia and hotels.com-branded sites available in various international points of sale.

Classic Vacations. Classic Vacations offers individually tailored vacations primarily through a national network of third-party retail travel agents. We deliver a full line of premium vacation packages — air, hotels, car rentals, activities and private transportation — to create customized luxury vacations in Hawaii, the Caribbean, Mexico, Costa Rica, Europe, Australia, New Zealand, Fiji and Tahiti. Travel agents and travelers can preview our product offering through our websites, www.classicforagents.com and www.classicvacations.com.

Expedia Local Expert. Our network of travel desks located at hotels and resorts in Hawaii, Las Vegas, Mexico, Orlando and San Francisco enables travelers to enjoy local tours, attractions and dining, as well as purchase airport transfers and other travel-related services. Our network expanded through our acquisition of Activity World and Activity Hut, destination service providers in Hawaii in 2004 and 2006, respectively, and our 2005 acquisition of Premier Getaways in Florida.

Egencia. Our full-service travel management company offers travel products and services available to corporations and corporate travelers in Australia, Canada, China, Europe, India and the United States. Egencia provides, among other things, centralized booking tools for employees of our corporations, unique supply targeted at business travelers, and consolidated reporting for global, large and “SME” (Small & Medium size Enterprise) business segments. Egencia charges its corporate clients account management fees, as well as transactional fees for making or changing bookings. In addition, Egencia provides on-site agents to some corporate clients to more fully support the account. Egencia has also begun offering consulting and meeting management services.

eLong. Our majority-owned online travel service company, based in Beijing, China, specializes in travel products and services in China. eLong uses web-based distribution technologies and a 24-hour nationwide call center to provide consumers with consolidated travel information and the ability to make hotel reservations at more than 7,000 hotels in over 400 cities across China. eLong also offers air ticketing and other travel related services. Travelers can access eLong travel products and services through its websites, including www.elong.com and www.elong.net.

Business Strategy

We play a fundamental role in facilitating travel, whether for leisure, unmanaged business or managed business travelers. We are committed to providing travelers, travel suppliers and advertisers the world over with the best set of resources to serve their travel needs by leveraging Expedia’s critical assets — our brand portfolio, our technology and commitment to continuous innovation, our global reach and our breadth of product offering. In addition, we intelligently utilize our growing base of knowledge about destinations, activities, suppliers and travelers and our central position in the travel value chain to more effectively merchandise our travel offerings.

A discussion of the critical assets that we leverage in achieving our business strategy follows:

Portfolio of Travel Brands. We seek to appeal to the broadest possible range of travelers, suppliers and advertisers through our collection of industry-leading brands. We target several different demographics, from the value-conscious traveler through our Hotwire ® brand to luxury travelers seeking a high-touch, customized vacation package through our Classic Vacations brand.

We believe our flagship Expedia brand appeals to the broadest range of travelers, with our extensive product offering ranging from single item bookings of discounted product to dynamic bundling of higher-end travel packages. Our hotels.com site and its international versions target travelers with premium hotel content about lodging properties, such as 360 degree tours and hotel reviews. In the United States, hotels.com generally appeals to travelers with shorter booking windows who prefer to drive to their destinations, and who make a significant portion of their travel bookings over the telephone.

Through Egencia, we make travel products and services available on a managed basis to corporate travelers in North America, Europe and the Asia Pacific region. Further, the TripAdvisor Media Network allows us to reach a broad range of travelers with travel opinions and user-generated content.

We believe our appeal to suppliers and advertisers is further enhanced by our geographic breadth and range of business models, allowing them to offer their products and services to the industry’s broadest range of travelers using our various agency, merchant and advertising business models. We intend to continue supporting and investing in our brand portfolio, geographic footprint and business models for the benefit of our travelers, suppliers and advertisers.

Technology and Continuous Innovation. Expedia has an established tradition of technology innovation, from Expedia.com’s inception as a division of Microsoft, to our introduction of more recent innovations such as Expedia.com’s TravelAds tm sponsored search product for hotel advertisers, Hotwire’s Air Price Protection, hotels.com’s slider tools for improving search results, hotels.com’s iPod and iPhone applications and the TripAdvisor Media Network’s offering of travel applications for download on social media sites, including Facebook.com and MySpace.com.

We intend to continue innovating on behalf of our travelers, suppliers and advertisers with particular focus on improving the traveler experience, supplier integration and presentation, platform improvements, search engine marketing and search engine optimization.

Global Reach. Our Expedia, hotels.com and TripAdvisor Media Network brands operate both in North America and internationally. We also offer Chinese travelers an array of products and services through our majority ownership in eLong, and we offer hotels to European-based travelers through our wholly-owned subsidiary Venere, which we acquired in the third quarter of 2008. In 2008, our European segment accounted for approximately 21% of worldwide gross bookings and 23% of worldwide revenue.

We intend to continue investing in and growing our international points of sale. We anticipate launching points of sale in additional countries where we find large travel markets and rapid growth of online commerce.

Future launches may occur under any of our brands, or through acquisition of third-party brands, as in the case of eLong and Venere.

Egencia, our corporate travel business, currently operates in Australia, Belgium, Canada, China, France, Germany, India, Ireland, Italy, the Netherlands, Spain, Switzerland, the United Kingdom and the United States. We believe the corporate travel sector represents a large opportunity for Expedia, and we believe we offer a compelling technology solution to businesses seeking to optimize travel costs and improve their employees’ travel experiences. We intend to continue investing in and expanding the geographic footprint and technology infrastructure of Egencia.

In expanding our global reach, we leverage significant investments in technology, operations, brand building, supplier relationships and other initiatives that we have made since the launch of Expedia.com in 1996. We intend to continue leveraging this investment when launching additional points of sale in new countries, introducing new website features, adding supplier products and services, and offering proprietary and user-generated content for travelers.

Our scale of operations enhances the value of technology innovations we introduce on behalf of our travelers and suppliers. As an example, our traveler review feature — whereby travelers have created millions of qualified reviews of hotel properties — is able to accumulate a larger base of reviews due to the higher base of online traffic that frequents our various websites. In addition, our increasing scale enhances our websites’ appeal to travel and non-travel advertisers.

Breadth of Product Offering. We offer a comprehensive array of innovative travel products and services to our travelers. We plan to continue improving and growing these offerings, as well as expand them to our worldwide points of sale over time. Travelers can interact with us how and when they prefer, including via our 24/7 1-800 telesales service, which is an integral part of the Company’s appeal to travelers.

Over 60% of our revenue comes from transactions involving the booking of hotel reservations, with less than 15% of our worldwide revenue derived from the sale of airline tickets. We facilitate travel products and services either as stand-alone products or as part of package transactions. We have emphasized growing our merchant hotel and package businesses as these result in higher revenue per transaction; however, through Venere we are working to grow our agency hotel business, particularly in Europe. We also seek to continue diversifying our revenue mix beyond core air and hotel products to car rental, destination services, cruise and other product offerings. We have been working toward and will continue to work toward increasing the mix of advertising and media revenue from both the expansion of our TripAdvisor Media Network, as well as increased advertising revenue from our worldwide websites, such as Expedia.com and hotels.com, which have historically been focused on transaction revenue. In 2008, advertising and media revenue accounted for nearly 10% of worldwide revenue.

Merchant and Agency Business Models

We make travel products and services available both on a stand-alone and package basis, primarily through two business models: the merchant model and the agency model. Under the merchant model, we facilitate the booking of hotel rooms, airline seats, car rentals and destination services from our travel suppliers and for such bookings, we are the merchant of record. Under the agency model, we act as an agent in the transaction, passing reservations booked by our travelers to the relevant airline, hotel, car rental company or cruise line.

As merchant of record, we generally have certain latitude to establish prices charged to travelers (as compared to agency transactions). Also, we generally negotiate supply allocation and pricing with our suppliers, which enables us to achieve a higher level of net revenue per transaction as compared to that provided through the agency model.

Through our Expedia-branded websites, travelers can dynamically assemble multiple component travel packages in a single transaction at a lower price as compared to booking each component separately. Packages assembled by travelers through the packaging model on these websites include a merchant hotel component and an air or car component. Travelers select packages based on the total package price, without being provided component pricing. The use of the merchant travel components in packages enables us to make certain travel products available at prices lower than those charged on an individual component basis by travel suppliers without impacting their established pricing and position models. We are also expanding our use of third-party provided pre-assembled package offerings, particularly through our international points of sale, further broadening our scope of products and services to travelers.

Our agency business is comprised of the sale of airline tickets, hotel, cruise and car rental reservations. Airline ticket transactions currently make up the majority of this business. In the third quarter of 2008, we acquired Venere, an agency-based online hotel business in Europe. Although net revenue per transaction is lower compared to the merchant model, due to the high volume of airline tickets sold our agency gross bookings accounted for 57% of total gross bookings for the year ended December 31, 2008.

CEO BACKGROUND

Barry Diller has been the Chairman of the Board and Senior Executive of Expedia since completion of the Company’s spin-off from IAC/InterActiveCorp (“IAC”) on August 9, 2005 (the “Spin-Off”). Mr. Diller has been the Chairman of the Board and Chief Executive Officer of IAC (and its predecessors) since August 1995. He was Chairman of the Board and Chief Executive Officer of QVC, Inc. from December 1992 through December 1994. Mr. Diller served as the Chairman of the Board and Chief Executive Officer of Fox, Inc. from 1984 to 1992. Prior to joining Fox, Inc., Mr. Diller served for ten years as Chairman of the Board and Chief Executive Officer of Paramount Pictures Corporation. Mr. Diller is currently a member of the Boards of Directors of The Washington Post Company and of The Coca-Cola Company. He also serves on the Board of Conservation International. In addition, Mr. Diller is a member of the Board of Councilors for the University of Southern California’s School of Cinema - Television, the New York University Board of Trustees and the Executive Board for the Medical Sciences of the University of California, Los Angeles.

Dara Khosrowshahi has been a director and the Chief Executive Officer of Expedia since completion of the Spin-Off. Mr. Khosrowshahi served as the Chief Executive Officer of IAC Travel, a division of IAC, from January 2005 to the Spin-Off date. Prior to his tenure as Chief Executive Officer of IAC Travel, Mr. Khosrowshahi served as Executive Vice President and Chief Financial Officer of IAC from January 2002 to January 2005. Mr. Khosrowshahi served as IAC’s Executive Vice President, Operations and Strategic Planning, from July 2000 to January 2002 and as President, USA Networks Interactive, a division of IAC, from 1999 to 2000. Mr. Khosrowshahi joined IAC in 1998 as Vice President of Strategic Planning, and was promoted to Senior Vice President in 1999. Mr. Khosrowshahi worked at Allen & Company LLC from 1991 to 1998, where he served as Vice President from 1995 to 1998.

Victor A. Kaufman has been a director and the Vice Chairman of Expedia since completion of the Spin-Off. Mr. Kaufman has been a director of IAC (and its predecessors) since 1996, and has served as the Vice Chairman of IAC since October 1999. Mr. Kaufman served in the Office of the Chairman in 1997 and as Chief Financial Officer of IAC from 1997 to 1999. Prior to his tenure with IAC, Mr. Kaufman served as the Chairman and Chief Executive Officer of Savoy Pictures Entertainment, Inc. beginning in 1992. Mr. Kaufman was the founding Chairman and Chief Executive Officer of Tri-Star Pictures, Inc. and served in those capacities from 1983 until 1987, at which time he became President and Chief Executive Officer of Tri-Star’s successor company, Columbia Pictures Entertainment, Inc. He resigned from those positions in 1989 following the acquisition of Columbia by Sony USA, Inc. Mr. Kaufman joined Columbia in 1974 and served in a variety of senior positions at Columbia and its affiliates prior to the founding of Tri-Star.

A. George “Skip” Battle has been a director of Expedia since completion of the Spin-Off. Mr. Battle previously served as the Executive Chairman of Ask Jeeves, Inc. from January 2004 through July 2005, and he served as the Chief Executive Officer of Ask Jeeves from December 2000 until January 2004. Mr. Battle was a business consultant and investor and served as a member of the boards of directors of several technology companies from 1995 to 2000. Prior thereto, Mr. Battle served with Andersen Consulting in various roles, including Worldwide Managing Partner, Market Development, until his retirement from Andersen Consulting in 1995. Mr. Battle is currently Chairman of the Board of Fair Isaac Corporation, a position he has held since 2002. He is also a director of Masters Select Equity Fund, Masters Select International Fund, Masters Select Value Fund and Masters Select Smaller Company Fund (all registered investment companies), Advent Software, Inc., Netflix, Inc. and two non-profit organizations. Mr. Battle also served as a director of PeopleSoft, Inc. in 2004, until its acquisition by Oracle Corp., and of Barra, Inc. Mr. Battle holds a B.A. in economics from Dartmouth College and an M.B.A. from the Stanford Graduate School of Business.

Simon J. Breakwell has been a director of Expedia since May 2006. Mr. Breakwell served as President of the European Travel division of Expedia, Inc. from 2001 until his resignation in May 2006. Prior to that Mr. Breakwell served as Expedia’s Vice President, International from 2000 to 2001 and Senior Vice President of Sales and Marketing from 1997 to 2000. From 1997 until 1999 Mr. Breakwell served as a group business manager at Microsoft Corporation. Prior to joining Microsoft, Mr. Breakwell worked at British Airways, holding a variety of sales positions from 1987 to 1993, as well as various senior sales management positions from 1993 to 1997. Mr. Breakwell was educated in the United Kingdom and holds a B.A. in politics from Portsmouth Polytechnic and an M.B.A. degree from Lancaster University.

Jonathan L. Dolgen has been a director of Expedia since completion of the Spin-Off. Since October 2006, Mr. Dolgen has served as senior consultant for ArtistDirect, Inc. Since July 2004, Mr. Dolgen has also been a Senior Advisor to Viacom, Inc. (“Old Viacom”), a worldwide entertainment and media company, where he provided advisory services to the Chief Executive Officer of Old Viacom, or others designated by him, on an as requested basis. Effective December 31, 2005, Old Viacom was separated into two publicly traded companies, Viacom Inc. (“New Viacom”) and CBS Corporation. Since the separation of Old Viacom, Mr. Dolgen has provided advisory services to the chief executive officer of New Viacom, or others designated by him, on an as-requested basis. Since July 2004, Mr. Dolgen has been a private investor and since September 2004, Mr. Dolgen has been a principal of Wood River Ventures, LLC (“Wood River”), a private start-up entity that seeks investment and other opportunities primarily in the media sector. Since April 2005, Mr. Dolgen, through Wood River, has had an arrangement with Madison Dearborn Partners, LLC to seek investment opportunities primarily in the media sector. From April 1994 to July 2004, Mr. Dolgen served as Chairman and Chief Executive Officer of the Viacom Entertainment Group, a unit of Old Viacom, where he oversaw various operations of Old Viacom’s businesses, which during 2003 and 2004 primarily included the operations engaged in motion picture production and distribution, television production and distribution, regional theme parks, theatrical exhibition and publishing. As a result of the separation of Old Viacom, Old Viacom’s motion picture production and distribution and theatrical exhibition business became part of New Viacom’s businesses, and substantially all of the remaining businesses of Old Viacom overseen by Mr. Dolgen remained with CBS Corporation. Mr. Dolgen began his career in the entertainment industry in 1976, and until joining the Viacom Entertainment Group, served in executive positions at Columbia Pictures Industries, Inc., Twentieth Century Fox and Fox, Inc., and Sony Pictures Entertainment. Mr. Dolgen is also a Director of Charter Communications, Inc. Mr. Dolgen holds a B.S. from Cornell University and a J.D. from New York University.

William R. Fitzgerald has been a director of Expedia since March 2006. He has served as a Senior Vice President of Liberty Media since 2000. In addition, he has served as Chairman of Ascent Media Group, a wholly owned subsidiary of Liberty Media since 2000. Prior to joining Liberty Media, Mr. Fitzgerald served as Executive Vice President and Chief Operating Officer, Operations Administration for AT&T Broadband (formerly known as Tele-Communications, Inc.) (“TCI”) from 1999 to 2000 and was Executive Vice President and Chief Operating Officer of TCI Communications, Inc. from 1998 to 1999. Mr. Fitzgerald received his undergraduate degree from Indiana University Kelley School of Business and a master’s degree from the Kellogg School of Business at Northwestern University. Mr. Fitzgerald was nominated as a director by Liberty Media, which currently has the right to nominate two individuals for election to Expedia’s Board of Directors pursuant to the Governance Agreement.

Craig A. Jacobson was elected as a director of Expedia in December 2007. Mr. Jacobson is a founding partner at the law firm of Hansen, Jacobson, Teller, Hoberman, Newman, Warren & Richman, L.L.P., where he has practiced entertainment law for the past 20 years. Mr. Jacobson is a member of the Board of Trustees at the USC Fine Arts School and is a member of the Board of Directors of Aver Media, a privately held Canadian lending institution.

Peter M. Kern has been a director of Expedia since completion of the Spin-Off. Mr. Kern is a Managing Partner of InterMedia Partners, LP, a private equity firm. Prior to joining InterMedia, Mr. Kern was Senior Managing Director and Principal of Alpine Capital LLC. Prior to Alpine Capital, Mr. Kern founded Gemini Associates in 1996 and served as its President from its inception through its merger with Alpine Capital in 2001. Prior to founding Gemini Associates, Mr. Kern was at the Home Shopping Network and Whittle Communications. Mr. Kern serves the boards of Thomas Nelson, Inc., Luxury Retreats International Holdings, Inc. and Cine Latino, Inc., each of which is a private company. Mr. Kern holds a B.S. from the Wharton School at the University of Pennsylvania.

John C. Malone has been a director of Expedia since completion of the Spin-Off. Dr. Malone has served as the Chairman of the Board of Liberty Media since 1990, and he served as Liberty Media’s Chief Executive Officer from August 2004 through February 2006. Dr. Malone also served as Chairman of the Board of TCI from 1996 to 1999 and as Chief Executive Officer of TCI from 1994 to 1997. Dr. Malone also serves as Chairman of the Board of Directors of Liberty Global, Inc. and as Chairman of the Board of Directors and Chief Executive Officer of Discovery Holding Company and as a director of IAC. Dr. Malone was nominated as a director by Liberty Media, which currently has the right to nominate two individuals for election to Expedia’s Board of Directors pursuant to the Governance Agreement.

MANAGEMENT DISCUSSION FROM LATEST 10K

Market Risk Management

Market risk is the potential loss from adverse changes in interest rates, foreign exchange rates and market prices. Our exposure to market risk includes our long-term debt, our revolving credit facility, derivative instruments and cash and cash equivalents, accounts receivable, intercompany receivables, merchant accounts payable and deferred merchant bookings denominated in foreign currencies. We manage our exposure to these risks through established policies and procedures. Our objective is to mitigate potential income statement, cash flow and market exposures from changes in interest and foreign exchange rates.

Interest Rate Risk

In June 2008, we issued $400 million senior unsecured notes with a fixed rate of 8.5%. In August 2006, we issued $500 million senior unsecured notes with a fixed rate of 7.456%. As a result, if market interest rates decline, our required payments will exceed those based on market rates. The fair values of our 8.5% Notes and our 7.456% Notes were approximately $280 million and $365 million as of December 31, 2008 as calculated based on quoted market prices at year end. A 50 basis point increase or decrease in interest rates would decrease or increase the fair value of our 8.5% Notes by approximately $7 million and our 7.456% Notes by approximately $6 million.

In July 2005, we entered into a $1 billion revolving credit facility. The revolving credit facility bears interest based on market interest rates plus a spread, which is determined based on our financial leverage. The weighted average interest rate was 1.34% as of December 31, 2008. Because our interest rate is tied to a market rate, we will be susceptible to fluctuations in interest rates if, consistent with our practice to date, we do not hedge the interest rate exposure arising from any borrowings under our revolving credit facility. As of December 31, 2008 and 2007, our outstanding borrowing under the revolving credit facility were $650 million and $585 million. A hypothetical 10% increase in market rates would increase our interest expense by less than $1 million.

We did not experience any significant impact from changes in interest rates for the years ended December 31, 2008, 2007 or 2006.

Foreign Exchange Risk

We conduct business in certain international markets, primarily in Australia, Canada, China and the European Union. Because we operate in international markets, we have exposure to different economic climates, political arenas, tax systems and regulations that could affect foreign exchange rates. Our primary exposure to foreign currency risk relates to transacting in foreign currency and recording the activity in U.S. dollars. Changes in exchange rates between the U.S. dollar and these other currencies will result in transaction gains or losses, which we recognize in our consolidated statements of operations.

To the extent practicable, we minimize our foreign currency exposures by maintaining natural hedges between our current assets and current liabilities in similarly denominated foreign currencies. Additionally, during the third and fourth quarter of 2008, we began using foreign currency forward contracts to economically hedge certain merchant revenue exposures and in lieu of holding certain foreign currency cash for the purpose of economically hedging our foreign currency-denominated merchant accounts payable and deferred merchant bookings balances. These instruments are typically short-term and are recorded at fair value with gains and losses recorded in Other, net. As of December 31, 2008, we had a net forward liability of $1 million recorded in accrued expenses and other current liabilities. We may enter into additional foreign exchange derivative contracts or other economic hedges in the future. Our goal in managing our foreign exchange risk is to reduce to the extent practicable our potential exposure to the changes that exchange rates might have on our earnings, cash flows and financial position. We make a number of estimates in conducting hedging activities including in some cases the level of future bookings, cancellations, refunds and payments in foreign currencies. In the event those estimates differ significantly from actual results, we could experience greater volatility as a result of our hedges.

Future net transaction gains and losses are inherently difficult to predict as they are reliant on how the multiple currencies in which we transact fluctuate in relation to the U.S. dollar, the relative composition and denomination of current assets and liabilities each period, and our effectiveness at forecasting and managing, through balance sheet netting or the use of derivative contracts, such exposures. As an example, if the foreign currencies in which we hold net asset balances were to all weaken 10% against the U.S. dollar and foreign currencies in which we hold net liability balances were to all strengthen 10% against the U.S. dollar, we would recognize foreign exchange losses of approximately $8 million based on our foreign currency forward positions and the net asset or liability balances of our foreign denominated cash and cash equivalents, accounts receivable, deferred merchant bookings and merchant accounts payable balances as of December 31, 2008. As the net composition of these balances fluctuate frequently, even daily, as do foreign exchange rates, the example loss could be compounded or reduced significantly within a given period.

During 2008, 2007 and 2006 we recorded net foreign exchange rate gains (losses) of $(47) million, $(22) million, and $10 million. As we increase our operations in international markets, our exposure to fluctuations in foreign currency exchange rates increases. The economic impact to us of foreign currency exchange rate movements is linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing and operating strategies.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. Actual results could differ materially from those contained in these forward-looking statements for a variety of reasons, including, but not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2007, Part I, Item 1A, “Risk Factors,” and in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008 Part II, Item 1A, “Risk Factors,” as well as those discussed elsewhere in this report. Other unknown or unpredictable factors also could have a material adverse effect on our business, financial condition and results of operations. Accordingly, readers should not place undue reliance on these forward-looking statements. The use of words such as “anticipates,” “estimates,” “expects,” “intends,” “plans” and “believes,” among others, generally identify forward-looking statements; however, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. We are not under any obligation and do not intend to publicly update or review any of these forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized. Please carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission (“SEC”) that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.
The information included in this management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes included in this Quarterly Report, and the audited consolidated financial statements and notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2007.
Overview
Expedia, Inc. is an online travel company, empowering business and leisure travelers with the tools and information they need to efficiently research, plan, book and experience travel. We have created a global travel marketplace used by a broad range of leisure and corporate travelers, offline retail travel agents and travel service providers. We make available, on a stand-alone and package basis, travel products and services provided by numerous airlines, lodging properties, car rental companies, destination service providers, cruise lines and other travel product and service companies. We also offer travel and non-travel advertisers access to a potential source of incremental traffic and transactions through our various media and advertising offerings on both the TripAdvisor Media Network and on our transaction-based websites.
Our portfolio of brands includes Expedia.com ® , hotels.com ® , Hotwire.com tm , Worldwide Travel Exchange, Interactive Affiliate Network, Classic Vacations, Egencia tm (formerly Expedia ® Corporate Travel), eLong tm , TripAdvisor ® Media Network and Venere Net SpA (“Venere”). In addition, many of these brands have corresponding international points of sale. For additional information about our portfolio of brands, see “Portfolio of Brands” in Part I, Item 1, “Business,” in our Annual Report on Form 10-K for the year ended December 31, 2007.
Industry Trends
The travel industry, including offline and online travel agencies, as well as suppliers of travel products and services, has been characterized by rapid and significant change. Most recently, global economic and financial market conditions have worsened markedly, creating uncertainty for consumers. We expect this will further pressure spending on travel and advertising, with weakness we previously identified in the United States and the United Kingdom markets increasing and spreading to other geographies. We cannot predict the magnitude or duration of this downturn, but our current limited visibility does not suggest any near-term improvement.
Airline Sector
The airline sector in particular has historically experienced significant turmoil. Most recently, U.S. airlines have responded to chronic overcapacity and extreme volatility in oil prices by aggressively reducing their cost structures and seating capacities. In addition, many carriers have raised their per seat yields by increasing fares, assessing fuel surcharges and increasing the use of a la carte pricing for such items as food and beverage and preferred seating.
Reduced seating capacities are generally negative for Expedia as there is less air inventory available on our websites, and in turn less opportunity to facilitate hotel rooms, car rental and other service bookings on behalf of air travelers. Fare increases, fuel surcharges and other fees are generally negative for Expedia’s business, as they may negatively impact traveler demand, and our air revenue is tied principally to ticket volumes, not ticket prices. While fare increases have been especially pronounced over the past year, we anticipate capacity reductions, and in turn pricing increases, will accelerate in late 2008 and into 2009.
In addition to the capacity and pricing actions, carriers have responded to industry conditions by aggressively reducing costs in every aspect of their operations, including distribution costs. Airlines lowered (and in some cases, eliminated) travel agent commissions and overrides, and have increased direct distribution through their proprietary websites. Carriers also reduced payments to global distribution system (“GDS”) intermediaries, which have historically passed on a portion of these payments to large travel agents, including Expedia.
Primarily as a result of these decreased costs of distribution and reduced access to merchant air inventory, our revenue per air ticket decreased more than 10% in each of 2005, 2006 and 2007, and air revenue now constitutes less than 15% of our worldwide revenue in the first nine months of 2008. We have seen greater stability in air revenue per ticket in 2008 due to our signing long-term agreements with nine of the top ten domestic carriers and three GDS providers. However, due to continued challenging industry conditions, we may encounter additional pressure on air remuneration as our agreements renew in 2009 and beyond.
In addition to the above challenges, larger carriers participating in the Expedia marketplace have generally reduced their share of total air seat capacity. At the same time, leading low-cost carriers such as Southwest in the United States and EasyJet in Europe have increased their relative capacity, but have generally chosen not to participate in the Expedia marketplace. This trend has negatively impacted our ability to obtain supply in our air business, and we expect this underlying share shift to continue in the future.
Hotel Sector
In 2008, the hotel sector has seen supply growth outstrip demand, resulting in declining occupancy rates. In addition, average daily room rates (“ADRs”) have been growing at a slower rate in 2008, or, in some markets such as Las Vegas, even decreasing year-on-year. While lower occupancies have historically increased our supply of merchant hotel rooms, and a lower rate of ADR growth can positively impact underlying room night growth, lower ADRs also decrease our revenue per room night as our remuneration varies proportionally with the room price. Our ADR growth in 2007 was 7%, but has declined to just 1% through the first nine months of 2008 including a 1% decrease for the three months ended September 30, 2008. In addition, our remuneration is impacted by our hotel margins, which have declined through the first nine months of 2008 due to lower fees and more competitive hotel pricing.
We anticipate in late 2008 and into 2009 that ADRs will either decline or grow more slowly, and that occupancies will continue to be challenged due to softer demand in a weakening economy, continued supply growth and lower air capacity into our core leisure destinations.
Online Travel
Increased usage and familiarity with the internet has driven rapid growth in online penetration of travel expenditures. According to PhoCusWright, an independent travel, tourism and hospitality research firm, in 2007 35% of worldwide leisure, unmanaged and corporate travel expenditures occurred online, with 51% penetration in the United States, compared with 32% of European travel and 15% in the Asia Pacific region. These penetration rates have increased over the past few years, and are expected to continue growing. This significant growth has attracted many competitors to online travel. This competition has intensified in recent years, and the industry is expected to remain highly competitive for the foreseeable future.
In addition to the growth of online travel agencies, airlines and lodging companies have aggressively pursued direct online distribution of their products and services over the last several years, with supplier growth outpacing online growth since 2002, and accounting for more than 60% in 2007 of all online travel expenditures in the United States according to PhoCusWright.
Differentiation among the various website offerings has narrowed dramatically in the past several years, and the travel landscape has grown extremely competitive, with the need for competitors to generally differentiate their offerings on features other than price. More recently, the online travel industry has seen the development of alternative business models and methods of payment for travelers and suppliers, which in some cases place pressure on historical business models. Intense competition has also led to aggressive marketing spend by the travel suppliers and intermediaries, and a meaningful reduction in our overall marketing efficiency and operating margins.
Business Strategy
Expedia plays a fundamental role in facilitating travel, whether for leisure, unmanaged business or managed business travelers. We are committed to providing travelers, travel suppliers and advertisers the world over with the best set of resources to serve their needs by leveraging Expedia’s critical assets—our brand portfolio, our technology and commitment to continuous innovation, our global reach and our breadth of product offering. In addition, we intelligently utilize our growing base of knowledge about destinations, activities, suppliers and travelers based on our unique position in the travel marketplace.
A discussion of the critical assets leveraged in achieving our business strategy follows:
Portfolio of Travel Brands. We seek to appeal to the broadest possible range of travelers, suppliers and advertisers through our collection of industry-leading brands. We target several different demographics, from the value-conscious traveler through our Hotwire brand to luxury travelers seeking a high-touch, customized vacation package through our Classic Vacations brand. We believe our flagship Expedia brand appeals to the broadest range of travelers, with our extensive product offering ranging from single item bookings of discounted product to dynamic bundling of higher-end travel packages. Our hotels.com site and its international versions target travelers with premium content about lodging properties, and generally appeal to travelers with shorter booking windows who prefer to drive to their destinations. Through Egencia, we make travel products and services available on a managed basis to corporate travelers. Further, our TripAdvisor Media Network allows us to reach a broad range of travelers with travel opinions and user-generated content.
We believe our appeal to suppliers and advertisers is further enhanced by our geographic breadth and range of business models, allowing them to offer their products and services to the industry’s broadest range of travelers using our various agency, merchant and advertising business models. We intend to continue supporting and investing in our brand portfolio, geographic footprint and business models for the benefit of our travelers, suppliers and advertisers.
Technology and Continuous Innovation. Expedia has an established tradition of technology innovation, from Expedia.com’s inception as a division of Microsoft to our introduction of more recent innovations such as Expedia.com’s TravelAds sponsored search product for hotel advertisers, Hotwire’s Air Price Protection, hotels.com’s slider tools for improving search results, Egencia’s Corporate Travel Consultant wiki and the TripAdvisor Media Network’s offering of travel applications for download on Facebook.com and MySpace.com.
We intend to continue to aggressively innovate on behalf of our travelers, suppliers and advertisers with particular focus on improving the traveler experience, supplier integration and presentation, search engine marketing and search engine optimization.

Global Reach. Our Expedia, hotels.com and TripAdvisor Media Network brands operate both in North America and internationally. We also offer Chinese travelers an array of products and services through our majority ownership in eLong, and we offer hotels to European-based travelers through our wholly-owned subsidiary Venere, which we acquired in the third quarter of 2008. In the first nine months of 2008, our European segment accounted for approximately 22% of worldwide gross bookings and 23% of worldwide revenue.
We intend to continue investing in and growing our international points of sale. We anticipate launching points of sale in additional countries where we find large travel markets and rapid growth of online commerce. Future launches may occur under any of our brands, or through acquisition of third party brands, as in the case of eLong and Venere.
Egencia, our corporate travel business, currently operates in the United States, Australia, Belgium, Canada, China, France, Germany, Ireland, Italy, the Netherlands, Spain and the United Kingdom. We believe the corporate travel sector represents a large opportunity for Expedia, and we believe we offer a compelling technology solution to businesses seeking to control travel costs and improve their employees’ travel experiences. We intend to continue investing in and expanding the geographic footprint and technology infrastructure of our Egencia business.
In expanding our global reach, we leverage significant investments in technology, operations, brand building, supplier relationships and other initiatives that we have made since the launch of Expedia.com in 1996. We intend to continue leveraging this investment when launching additional points of sale in new countries, introducing new website features, adding supplier products and services, or offering proprietary and user-generated content for travelers.
Our scale of operations enhances the value of technology innovations we introduce on behalf of our travelers and suppliers. As an example, our traveler review feature—whereby our travelers have created hundreds of thousands of qualified reviews of hotel properties—is able to accumulate a larger base of reviews due to the higher base of online traffic that frequents our various websites. In addition, our increasing scale enhances our websites’ appeal to travel and non-travel advertisers.
Breadth of Product Offering. We offer a comprehensive array of innovative travel products and services to our travelers. We plan to continue improving and growing these offerings, as well as expand them to our worldwide points of sale over time. Travelers can interact with us how and when they prefer, including via our 24/7 1-800 telesales service, which has become an integral part of the Company’s appeal to travelers.
Over 60% of our revenue comes from transactions involving the booking of hotel reservations, with less than 15% of our worldwide revenue derived from the sale of airline tickets. We facilitate travel products and services either as stand-alone products or as part of package transactions. We are working to grow our merchant hotel and packages businesses as they result in higher revenue per transaction, and we also seek to continue diversifying our revenue mix beyond core air and hotel products to car rental, destination services, cruise and other product offerings. We have been and will continue to work toward increasing the mix of advertising and media revenue from both the expansion of our TripAdvisor Media Network, as well as increased advertising revenue from our worldwide websites such as Expedia.com and hotels.com, which have historically been focused on transaction revenue. In the first nine months of 2008, advertising and media revenue accounted for over 9% of worldwide revenue.
Seasonality
We generally experience seasonal fluctuations in the demand for our travel products and services. For example, traditional leisure travel bookings are generally the highest in the first three quarters as travelers plan and book their spring, summer and holiday travel. The number of bookings typically decreases in the fourth quarter. Because revenue in our merchant business is generally recognized when the travel takes place rather than when it is booked, revenue typically lags bookings by several weeks or longer. As a result, revenue is typically the lowest in the first quarter and highest in the third quarter. The continued growth of our international operations or a change in our product mix may influence the typical trend of our seasonality in the future.

CONF CALL

Stu Haas

Thank you, Operator. Good morning, everyone and thanks for joining us for Expedia, Inc.’s financial results conference call for the fourth quarter and year-ended December 31, 2008.

I am pleased to be joined on the call today by Dara Khosrowshahi, Expedia’s CEO and President, and Michael Adler our CFO.

The following discussion including responses to your questions reflects management's views as of today, February 19, 2009 only. As always some of the statements made on today's call are forward-looking including comments on financial expectations and performance, operational results, margins, planned investments and spending, foreign exchange and growth of business lines.

Actual results may differ materially. We do not undertake any obligation to update or revise this information. Please refer to today's press release and the company’s filings with the SEC including Forms 10-K for the year ended December 31, 2007 and subsequent 10-Qs for additional information about factors that could potentially affect our financial and operational results.

During this call we will discuss certain non-GAAP financial measures including OIBA, operating expenses excluding stock-based compensation, free cash flow, adjusted net income and adjusted EPS. In our press release, which is posted on the company’s IR website at expediainc.com/ir you will find additional disclosures regarding these non-GAAP measures including reconciliations of the measures with the most comparable GAAP measures.

Finally unless otherwise stated, all references to gross margin, selling and marketing expense, general and administrative expense, and technology and content expense, exclude stock-based compensation and all comparisons in the call will be against results for the comparable period of 2007.

And with that, let me turn the call to Dara.

Dara Khosrowshahi

Thanks Stu. Now it will be beyond (inaudible) to start with the call with how difficult the economic environment has been. So, we will spend the majority of today's call talking about how the environment affected Q4 results and what we are doing about it.


Our hotel volumes actually held up pretty well, with 10% worldwide room night growth. In the US significantly above overall US demand which Smith Travel indicates was down around 5% in the September to December time period.

On the downside, we have seen significantly weaker ADR trends relative to the industry. With our average ADRs down 10%, the weakest we have seen since 9/11, revenue per night down 19% on a worldwide basis, steeper than the ADR decline due to the impact of foreign exchange and to a lesser extent service fee reductions.

Now, in this environment as our hotel partners’ look to fill rooms, they are turning to leisure segment, which seems to be displaying signs of short-term price elasticity. As a result, we have seen incredible deals in our marketplace which has brought down our ADRs faster than the industry average, a trend we see continuing into early 2009.

We are encouraged as this pricing does seem to be stimulating demand. Weakening ADRs in the November to January time period have been met with improving room night growth with worldwide growth improving and into the double digits during that same period. January's room night growth was frankly very good.

Now, keep in mind that we do have costs high to transactions versus ADRs or dollars, so running higher volumes at lower unit prices does challenge our margins.

In Q4, we saw some pretty negative volume trends in our air and package businesses. In early '09 however we are seeing airlines respond to lower demand curves with price cuts and we are in general seeing better package savings than ever. Both leading to better air ticket and package volume tre]]>Sun, 08 Mar 2009 10:55:42 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1953/http://www.dailystocks.com/forum/showtopic.php?tid/1953/
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BUSINESS OVERVIEW

Overview

We are a leading provider of high-quality, low-cost home health services to the chronic, co-morbid, aging American population. We were originally incorporated in Louisiana in 1982 by William F. Borne, our founder, Chief Executive Officer and Chairman of the Board; transferred our operations to a Delaware corporation, which was incorporated in 1994; and became a publicly traded company in August of that year. Our common stock is currently traded on the NASDAQ Global Select Market under the trading symbol “AMED”. Our services, which we provide on a nationwide basis, include both home health and hospice services and are primarily paid by Medicare, which represented approximately 87%, 89%, and 93% of our net service revenue in 2008, 2007 and 2006, respectively. As of December 31, 2008, we owned and operated 480 Medicare-certified home health agencies and 48 Medicare-certified hospice agencies and managed the operations of four Medicare-certified home health and two Medicare-certified hospice agencies in 37 states within the United States, the District of Columbia and Puerto Rico. The following is our national geographic footprint. See Item 2, “Properties” for additional detail about the location of our agencies.

Our typical home health patient is Medicare eligible, approximately 82 years old, takes approximately 12 different medications on a daily basis and has multiple co-morbidities. For our home health patients, we typically receive a 60-day episodic-based payment from Medicare. This payment can vary and depends on the type of care provided, acuity (how sick or debilitated a patient is) of the patient’s condition and amount of services required. Some patients require one episode of care to achieve clinical goals, while others require multiple episodes of care based on the acuity of their condition. Our care for each home health patient focuses on improving their quality of life by evaluating their health condition; developing a doctor approved plan of care to achieve certain goals, which can be followed up with additional episodes of care, if deemed necessary; and educating them on how to either maintain or continue to improve upon their health after they leave our care.

During the past three years, we have more than doubled our net service revenue from $541.1 million in 2006 to $1,187.4 million in 2008 and have increased our diluted earnings per share by 87.2% from $1.72 per share in 2006 to $3.22 per share in 2008. Additionally in 2008, we completed the acquisition and conversion of 131 home health and 14 hospice agencies to our operating systems and Point of Care (“POC”) network. These acquisitions include our largest acquisition to-date, TLC Health Care Services, Inc. (“TLC”), which added 92 home health and 11 hospice agencies to our operations.

Our Philosophy

As one of the leading providers of home health care and hospice services, we strive to maintain our vision, purpose, strategy and mission:

Our Vision. To be the premier home health care company in the communities we serve.

Our Purpose. To assist patients in maintaining and improving their quality of life.

Our Strategy. To offer low-cost, outcome-driven health care at home (see “Our Strategy” below for details on how we intend to achieve this strategy)

Our Mission. To provide cost-efficient, quality health care services to the patients entrusted to our care.

Our Market and Opportunity

Home Health

The United States Census Bureau reported that as of July 1, 2004, there were 36.3 million people in the United States who were Medicare eligible at 65 years of age or older and that it estimates this number will more than double to 86.7 million by 2050, as the baby boomer generation ages and become part of this age demographic beginning in 2011. As the number of Medicare beneficiaries increases, future home health care expenditures are projected to increase to over $65.0 billion through 2017, as reported by the Office of the Actuary of the Center for Medicare and Medicaid Services (“CMS”). This expected increase is projected to result in growth in total health care expenditures outpacing growth in the Gross Domestic Product (“GDP”) of the United States over the next decade, causing such expenditures to increase from 15% of GDP today to 20% by 2016, as reported by CMS. As a result of these factors (increased beneficiaries and increased costs), we believe the Federal and state governments will seek ways to manage/reduce their overall health care expenditures through payment rate reductions and/or continued adjustments to the Home Health Prospective Payment System (“PPS”) (described below), which will lead to an evolution within the industry where home health providers will look to become more efficient through various means, such as incorporating technology within their processes and/or centralizing certain activities. We also believe the Federal and state governments will encourage health care providers to seek care for their patients in the home setting as opposed to facility-based/acute inpatient hospitals, as it typically costs less to provide care in the home. (Given this anticipated evolution, we believe that we are well positioned to address these challenges.) As a nation, we are currently positioning ourselves to better allocate our resources to provide people with access to high-quality care and appropriate services that maintain health and functioning in the face of disease progression and ensure that this care is coordinated across multiple providers and payors, particularly through the end of life.

Additionally, as there were over 9,200 provider numbers issued for home health agencies in the United States as of the end of 2007, as reported by the Medicare Payment Advisory Commission (“MedPAC”), we believe that certain home health providers will leave the industry due to competitive pressures and/or inability to change as the home health industry evolves. We believe this will provide additional acquisition opportunities for us and other home health providers that are able to continue to provide quality care to their patients while remaining profitable.

Hospice

According to the United States’ National Association for Home Care & Hospice, at the end of 2006, there were approximately 3,000 provider numbers issued for hospice agencies in the United States, and, according to CMS, the number of Medicare beneficiaries utilizing hospice services is expected to increase at an average rate of 9% per year through 2015. As a result, we believe that the hospice industry provides us with a growth opportunity that is complementary to our home health growth strategy. With the projected growth in the hospice industry, an increased level of scrutiny is being placed on Medicare and Medicaid hospice payment methodologies. As noted by MedPAC, the hospice industry has not seen dramatic changes to its payment structure since its inception, which means that changes to the hospice payment system are likely as more data is collected on the services that are provided to beneficiaries. We believe these changes will most likely result in less efficient providers choosing to leave the industry as they become less competitive, promoting consolidation within the industry. Based on these factors and our growth strategy for our hospice operations, we believe we are in a favorable position to seek out potential acquisition and start-up opportunities as we expand our business.

Our Competitive Strengths

We believe our market share and our ability to grow our business are directly related to the following competitive strengths:


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Leading position in growing Medicare home health care industry. Our primary focus is providing quality home health services to Medicare beneficiaries, and we derive approximately 87% of our revenue from Medicare. As we provide these services, we focus on improvements to our continuum of care, continued development of our disease management programs, the development and growth of our referral network, improvements to the processing of referrals and an ongoing commitment to our patients and employees. We believe that our continued efforts in improving efficiencies and quality of care differentiate us from our competition. We also believe that these efforts will enable us to adapt to any future CMS changes to PPS for Medicare beneficiaries.


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Clinical outcomes are among the best in our industry. We believe the clinical outcomes we have achieved for our home health patients are among the best in the industry. This can be seen in collected and reported quality data from CMS, which show that we exceeded 12 out of 12 measurement categories in the regions we serve and 10 out of the 12 measurement categories when compared to the national average. We believe our clinical outcomes poise us for internal growth in admissions and revenues at our existing locations, as we continue to receive a growing number of referrals from existing sources and continue to increase the number of new referral sources.


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Experience at providing care to higher acuity patients. 41% of our patient census is admitted directly from the doctor’s office as compared to 27% at the national level, as reported by Outcome Concept Systems, Inc. (“OCS”), an independent health care benchmarking firm. We believe this difference is primarily related to the education we provide to our referral sources and our reputation for success in providing care to higher acuity patients. With a larger percentage of our patients coming directly from a physician, our patients typically require more intensive care as they have not benefited from treatment in a hospital or other inpatient care facility. As we continue to care for these higher acuity patients, we believe we will continue to gain experience that helps us to improve our ability to care for such individuals.


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Superior operating model based on balance between agency and corporate responsibilities. We have developed an operating model we believe provides a successful balance between the roles and responsibilities existing at our agencies and the roles and responsibilities existing at our consolidated corporate operations. For example, we have centralized our billing and collection efforts, accounting, regulatory, marketing, payroll, intake, risk management and quality assurance functions to reduce overhead expenses. We believe our operating model has allowed us to integrate acquisitions onto our operating and billing platform quickly and efficiently. In addition, our agencies carry both locally and nationally recognized branding and tailor their respective marketing efforts to address the specific needs of the communities, referral sources and Medicare beneficiaries they serve. Each agency has a management team that works to establish strong relationships within their communities and with referral sources. Finally, we have deployed standardized clinical programs and believe this initiative has improved our quality of care and risk management systems and helps us actively manage clinical compliance across all of our home health agencies.


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Integrated technology and management systems enhance efforts to be a low-cost provider. We have invested significant time and resources to improve our information technology and real-time management and monitoring capabilities. For instance, we have developed and deployed POC laptop devices, developed a proprietary, Windows™-based clinical software system and utilize an electronic physician order system, which together are used to collect assessment data, schedule and log patient visits, generate medical orders and monitor treatments and outcomes in accordance with established medical standards. With these integrated technologies, we believe we are able to standardize the care delivered across our network of agencies and we are effectively able to monitor the patients we treat. We believe these integrated technologies and management systems allow us to be efficient, reducing the need for additional administrative staff and related expenses, and contribute to our efforts to be a low-cost provider.


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Proven ability to identify and efficiently integrate acquisition targets. We believe we have been successful at identifying and integrating acquisitions, which fit into our vision, purpose, strategy and mission. Our post-acquisition integration efforts, which generally take 18 to 24 months to complete, include: improving operating efficiencies; recruiting, as necessary, qualified nurses and account executives; expanding relationships with local physicians and discharge planners; and expanding the breadth and quality of services offered to patients. When potential acquisition targets come to our attention, we complete an intensive review process to determine whether the acquisition fits our overall business model. We believe we employ a disciplined strategy based on defined acquisition criteria, including service quality, a sound compliance track record, a strong referral base, a compatible payor mix and opportunities for cost savings and growth.


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Significant cash flow from operations and relatively low capital expenditures. We generate significant cash flow from operations due to the profitable operation of our business and active management of our working capital. Our capital expenditure requirements are relatively low because of the nature of our services, which include providing services at the patient’s homes, thus not requiring significant office space or expensive medical equipment. Historically, our routine capital expenditures have amounted to approximately 2% of our net service revenue.


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Patient-oriented, employee-driven company culture enhances industry opportunities. We believe our culture is patient-oriented and employee-driven, with a strong emphasis on quality of care. We communicate frequently with our employees and provide educational opportunities along with competitive benefits. We reinforce our culture through an orientation program for new employees and on an ongoing basis with emphasis on the importance of high-quality patient care and the need to remain productive while keeping our costs low. We keep our employees informed about corporate events and solicit feedback regarding ways to improve our services and working environment.

Our Strategy

Our strategy is to offer low-cost, outcome driven health care at home. To achieve this strategy, we intend to:


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Focus on providing home health and hospice services to Medicare-eligible patients. The rapidly growing population of potential Medicare beneficiaries represents a compelling market for home health and hospice providers. We believe that implementation of PPS in the home health industry has created a relatively stable payment environment favoring companies that focus on providing high-quality, low-cost home health and hospice services.


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Emphasize internal growth through increased episodic-based patient admissions. We intend to emphasize the internal growth of our episodic-based patient admissions, which approximated 11% during 2008. We drive internal growth by: maintaining an emphasis on high-quality care; expanding and enhancing referral relationships in our local and regional markets; continuing to educate referral sources regarding our specialized programs that focus on our ability to care for chronic conditions and diseases; and attracting and retaining highly skilled and experienced employees through communication, education, empowerment and competitive benefits.

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Continue to grow through investment in start-up agencies . We believe that start-ups also provide a cost-effective opportunity to expand our operations. Our typical start-up agency requires an initial investment of between $0.2 million to $0.4 million, takes approximately 18 to 24 months to earn back its investment and achieves an annual revenue run-rate of $1.5 million to $2.0 million in its second year of operation.


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Continue to grow through pursuit of strategic acquisition targets. We believe our focus on Medicare beneficiaries, our size and our national reputation provide us with a strategic advantage when assessing potential acquisitions. The majority of home health and hospice agencies are owned either by hospitals or independent operators. We believe recent and other potential changes to Medicare home health payment rates will continue to pressure the home health industry to consolidate, which will give us a strategic opportunity to pursue and close acquisitions. In pursuing strategic acquisitions, we employ a disciplined strategy based on defined criteria, which include, but are not limited to, high-quality service, a sound compliance track record, a strong referral base and a compatible payor mix.


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Focus on leveraging our cost-efficient operating structure. We believe the size and scale of our infrastructure and operating systems offer the opportunity to achieve operating leverage at both the agency and corporate level. At the agency level, we have strived to develop a cost-efficient operating model. To manage our diverse network of locations, we use a proprietary information system that reduces administrative and operating costs through the integration of clinical, financial and operating functions. We manage all patient care and utilization on a real-time basis from both a clinical and financial perspective through a system of exception reporting. At the corporate level, our geographic focus, investment in infrastructure and information systems enable us to leverage regional and senior management resources and add new locations without proportionate increases in corporate overhead.


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Continue to invest in technology to gain efficiencies, enhance controls and improve patient care. We believe that our investments in technology have helped us achieve significant operating efficiencies, enhance our internal financial and compliance controls, and—most importantly—improve the quality of care we provide our patients, permitting our patients to achieve better outcomes, more rapidly than would otherwise be possible. We intend to continue to make these investments, focusing particular attention on enhancing our care coordination abilities aimed at servicing the higher acuity (sicker) population. We plan to build out these capabilities by embedding further evidenced based protocols, predictive modeling capabilities, advanced patient registry functions and expanded capabilities to interface with multiple care providers via a scalable, secure communication platform.


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Continue to develop and deploy care management programs for chronic diseases and conditions. We have developed care management services that focus on complex diseases and chronic conditions and launched programs for diabetes, coronary artery disease, congestive heart failure, orthopedics, complex wound care, geriatric surgical recovery, balance retraining and behavioral health, among others. We believe our care management programs represent an attractive growth opportunity because they combine clinical quality with the cost-effective delivery of high-quality nursing care to patients who have chronic conditions.


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Continue to develop our care coordination platform. Because our data and infrastructure systems are centralized, we are able to focus on further developing our chronic care coordination programs. Our patients generally experience multiple co-morbidities and have a high risk for unplanned emergency events. We recognize the need to manage this population much more comprehensively than the traditional home care model.

Our Operations

Home Health

We provide low-cost, outcome driven health care to homebound patients we serve within the comfort of their own homes. We believe there is no place like home for a healing, relaxing environment for patients recovering from illness, injury or surgical procedures. The home provides an environment that allows medical professionals greater access to family members who can participate in their loved one’s care, while allowing the caregivers to make recommendations based on each individual patient’s needs. In addition to the home being a preferred setting for the patient, we believe by providing care to our patients in their homes we offer a low-cost alternative to hospitals, nursing homes and other health care alternatives.

We are one of the leading providers of home-based care management programs for complex, chronically ill patients. We believe that our proprietary technologies, our “Encore” nurse call center and our evidence-based, best practice clinical algorithms are the right prescription for providing comprehensive, continuous chronic care management to our patients.

CEO BACKGROUND

William F. Borne . Mr. Borne founded our Company in 1982 and has been Chief Executive Officer and Chairman of our Board of Directors since then. He is also a member of the Board of Directors of Business First Bank of Louisiana.

Ronald A. LaBorde . Mr. LaBorde manages personal investments, which include non-public, operating companies, and provides management consulting services to various companies. Prior to March 2007, he was a principal of Miller-LaBorde, LLC, an insurance agency that specialized in supplemental employee benefits. From 1995 to May 2003, Mr. LaBorde was President and Chief Executive Officer of Piccadilly Cafeterias, Inc., a publicly traded retail restaurant business. Mr. LaBorde was appointed our Lead Director in February 2003.

Jake L. Netterville . Mr. Netterville was the Managing Partner of Postlethwaite & Netterville, a professional accounting corporation, from 1977 to 1998 and has since been Chairman of its Board of Directors. Mr. Netterville is a certified public accountant, has served as Chairman of the Board of Directors of the American Institute of Certified Public Accountants, Inc. (“AICPA”) and is a permanent member of the AICPA’s Governing Council. Mr. Netterville was appointed Chairman of the Audit Committee of our Board of Directors in February 2003.

David R. Pitts . Mr. Pitts has been President and CEO of Pitts Management Associates, Inc. (“PMA”) since 1981 and Chairman and CEO of PMA since 1999. PMA is a national hospital and healthcare management and consulting firm. Mr. Pitts has over forty years experience in hospital operations, healthcare planning and multi-institutional organizations, and has served in executive capacities in a number of hospitals, multi-hospital systems and medical schools. He also serves as Chairman of the Board of Directors of Business First Bank of Louisiana and Chair of the Church Pension Group in New York City and is a member of the North American Advisory Board of Sodexho and the Healthcare Advisory Board of Clark Consulting. He is certified in hospital and healthcare administration and is a Fellow of the American College of Healthcare Executives. Mr. Pitts is Chairman of the Compensation Committee of our Board of Directors.

Peter F. Ricchiuti . Mr. Ricchiuti has been Assistant Dean and Director of Research of BURKENROAD REPORTS at Tulane University’s A. B. Freeman School of Business since 1993, and a Clinical Professor of Finance at Tulane since 1986. Mr. Ricchiuti is Chairman of the Investment Committee of our Board of Directors.

Donald A. Washburn . Mr. Washburn, a private investor for over five years, currently serves as a director on the boards of the following publicly traded companies: (i) LaSalle Hotel Properties, a real estate investment trust; (ii) The Greenbrier Companies, Inc., a manufacturer and lessor of rail cars and barges; and (iii) Key Technology, Inc., which designs and manufactures process automation systems for the food processing and industrial markets. He also serves on several private company boards. Mr. Washburn is Chairman of the Nominating and Governance Committee of our Board of Directors.

MANAGEMENT DISCUSSION FROM LATEST 10K

You should read the following discussion and analysis in conjunction with our audited financial statements included in Part IV, Item 15, “Exhibits and Financial Statement Schedules” and Part I, Item 1, “Business” of this Annual Report on Form 10-K. The following analysis contains forward-looking statements about our future revenues, operating results and expectations. See “Cautionary Statement Regarding Forward-Looking Stagements” for a discussion of the risks, assumptions and uncertainties affecting these statements as well as Part I, Item 1A, “Risk Factors.”

Overview

We are a leading provider of high-quality, low-cost home health services to the chronic, co-morbid, aging American population. Our services include home health and hospice services and approximately 87%, 89%, and 93% of our revenue was derived from Medicare for 2008, 2007 and 2006, respectively. During 2008, we had $1.2 billion in net service revenue, exceeding the billion dollar level for the first time and recorded earnings per diluted share of $3.22 per share. Additionally, we completed our largest acquisition with our purchase of TLC Health Care Services, Inc. (“TLC”) which had 92 home health and 11 hospice agencies in 22 states. The following details our owned and operated Medicare-certified agencies, which are located in 37 states within the United States, the District of Columbia and Puerto Rico. The agencies closed were consolidated with agencies servicing the same areas.

Recent Developments

During 2008, the following events occurred that will impact the rates we are paid during 2009 by Medicare for both our home health and hospice services.

Payment

During 2008, the case-mix adjustment policy established a reduction in the market basket index of 2.75% for each of the years 2008 through 2010 and a decrease of 2.71% for 2011. Then, on October 30, 2008, the Centers for Medicare & Medicaid Services (“CMS”) gave a home health market basket index update of 2.9%. As a result of these two rate changes, the 2009 base episode rate will be $2,272 compared to $2,270 in 2008 and $2,339 in 2007.

On August 8, 2008, CMS changed the Medicare hospice wage index for fiscal year 2009 and gave a 3.6% market basket increase to Medicare hospice rates for fiscal year 2009. CMS also issued a phase out of the Medicare hospice budget neutrality adjustment over three years and clarified wage index issues pertaining to the definition of rural and urban areas and multi-campus hospital facilities.

We do not expect these changes to have a material impact on our consolidated financial statements.

Results of Operations

Our operating results are not comparable for the years presented, primarily as a result of our acquisition and start-up agencies.

When we refer to “base business”, we mean home health and hospice agencies that we have operated for at least the last twelve months; when we refer to “acquisitions”, we mean home health and hospice agencies that we acquired within the last twelve months; and when we refer to “start-ups”, we mean any home health or hospice agency opened by us in the last twelve months. Once an agency has been in operation for a twelve month period, the results for that particular agency are included as part of our base business from that date forward. When we refer to episodic-based revenue, admissions, recertifications or completed episodes, we mean revenue, admissions, recertifications or completed episodes of care for those payors that pay on an episodic-basis, which includes Medicare and other insurance carriers including Medicare Advantage programs.

Other Income (Expense), net

Other income was $6.9 million in 2007 as compared to other (expense) of $3.8 million during 2006, representing a change of $10.7 million. The primary reason for this change was related to the conclusion of the Alliance bankruptcy. On September 28, 2007, a Federal judge from the United States Bankruptcy Court in the Northern District of Oklahoma (“bankruptcy court”) overseeing the Chapter 7 Federal bankruptcy proceedings for Alliance finalized its order on the distribution of funds to creditors. As a result, of the ruling by the bankruptcy court, the liabilities of $4.2 million attributable to Alliance now will not be paid because Alliance has insufficient assets to discharge these liabilities. These liabilities were recorded on our consolidated financial statements because of Alliance’s being a wholly-owned consolidated subsidiary. Neither Amedisys nor any of our affiliates (other than Alliance), has any direct obligation for these liabilities and we do not believe there is any basis for asserting that there is an indirect obligation on our part or any of our affiliates for these liabilities. Accordingly, upon completion of the Alliance bankruptcy, we reversed the accrual for these liabilities in our consolidated financial statements, and we recognized a gain of $4.2 million as other income in our accompanying consolidated income statement during the third quarter of 2007. The discharge of the liabilities was a non-taxable event. The remainder of the increase was primarily attributable to the reduction in interest expense as a result in the decrease in our average outstanding debt for 2007 as compared to 2006 and an increase in interest income earned on our cash and cash equivalents and short-term investments due to an increase in the average cash and cash equivalents and short-term investments from 2006 to 2007. During the third quarter of 2006, we completed an equity offering with cash proceeds of $124.5 million, of which $52.0 million was used to pay off our senior credit facility and the remainder was invested in cash equivalents and short-term investments.

Income Tax Expense

Income tax expense was $38.3 million in 2007 as compared to $23.6 million during 2006, representing an increase of $14.7 million, which is primarily attributable to an increase in income before income taxes and minority interests that is partially offset by a decrease in the estimated income tax rate. Our income before taxes and estimated income tax rate was $103.4 million and 37.0% for 2007 and $61.9 million and 38.2% for 2006. The decrease in the tax rate was primarily attributable to the reversal of the Alliance liabilities resulting from the conclusion of the Alliance bankruptcy, which was a nontaxable event.

Liquidity

Typically, our principal source of liquidity is the collection of our patient accounts receivable, primarily through the Medicare program; however, from time to time, we can and do obtain additional sources of liquidity through sales of our equity or by incurrence of additional indebtedness. As of December 31, 2008, we had $2.8 million in cash and cash equivalents, $250.0 million of availability for the issuance of any combination of preferred and common stock, under our effective shelf registration statement, and $160.4 million in availability under our $250.0 million Revolving Credit Facility. We are in compliance with all of the financial covenants of our credit agreements and our recently issued debt securities as of December 31, 2008.

During 2008, we acquired 145 agencies for $471.3 million in cash and $6.8 million in notes payable, which contributed $257.3 million in net service revenue; spent $28.4 million in capital expenditures, with $18.7 million was considered routine; and borrowed $395.0 million to help fund our TLC acquisition ( described below in Indebtedness), which has been reduced to $308.0 million at December 31, 2008, as we have made our minimum required payments on the Term Loan of $22.5 million and made $64.5 million in payments on our Revolving Credit Agreement. Based on our operating forecasts and our debt service requirements (described below in Indebtedness), we believe we will have sufficient liquidity to fund our operations, capital requirements and debt service requirements over the next twelve months and into the foreseeable future.

As part of our current cash management process, we pay our outstanding debt with any available cash generated from operations and relying on availability of funds under our Revolving Credit Facility for our liquidity and acquisition needs. As we manage our liquidity needs to meet our operating forecasts, debt service requirements and our acquisition and start-up activities, we are monitoring the creditworthiness and solvency of our syndicate of banks that provide the availability of credit under our Revolving Credit Facility as well as the status of the overall equity and credit markets. This monitoring process has become more critical over the past several months as several financial institutions have either failed or have been acquired, there has been a severe lack of funds in the credit markets and the equity market has seen significant decreases in value and liquidity, as discussed in the risk factors set forth herein. As of the date of this filing, we do not believe our availability of funds under our Revolving Credit Facility is at risk; however, we continue to monitor our syndicate of banks in light of the credit market conditions. If our availability under our current Revolving Credit Facility decreases we may need to consider adjusting our strategy to meet our operating forecasts, debt service requirements and acquisition and start-up activity needs. Such changes could include, but would not be limited to, meeting our minimum debt service requirements and meeting our forecasted operating needs with operating cash flows, while retaining any surplus in operating cash flows, as deemed necessary. As we experience over a 99% collection rate on our Medicare claims, which represents 87% of our net service revenue, we believe we could adjust our cash management strategy, as deemed necessary.

Outstanding Patient Accounts Receivable

Our patient accounts receivable, net increased $79.4 million from 2007 to 2008 primarily due to $1,187.4 million in net service revenue and $43.0 million in net patient accounts receivable acquired through stock acquisitions during 2008, offset by $1,136.4 million in cash collections.

Our days revenue outstanding increased 3 days to 54.4 (gross) and 2 days to 47.2 (net) from December 31, 2007. During 2008, we converted 145 acquired home health and hospice agencies to our operating and billing platforms, which represented $257.3 million in net service revenue. As is typical with our newly acquired agencies, we experienced an increase in our aging of receivables due to regulatory and internal delays inherent in the conversion process. The issues included: change of ownership approval from CMS; compliance with various state Medicaid regulations; changing the name of provider from seller; fiscal intermediary approval and set-up; and training our agency staff on our billing procedures once the acquired agency was converted to our operating platform. Additionally, we experienced collection delays related to our private episodic-based receivables. As of December 31, 2008 and continuing into 2009, we are working with these payors as some have had difficulty converting their system for CMS’ payment changes effective January 2008 resulting in delays and errors in the processing of our claims. Also impacting our days revenue outstanding was $7.8 million in Medicare claims that we submitted between November 3, 2008 and December 2, 2008 that were held in a “pending” status as of December 31, 2008 by CMS. The delay related to duplicate document control number issued by CMS, which created a processing error on their end. The issue was industry-wide in scope and the fiscal intermediaries, the Fiscal Intermediary Shared System (FISS) maintainer, and the data centers all worked together to correct this issue. Subsequent to December 31, 2008, CMS was able to resolve the issue and we received the $7.8 million during February of 2009. If this issue had not occurred and we had received these funds prior to December 31, 2008, our days revenue outstanding would have been 52.3 days (gross) and 45.1 days (net).

Our patient accounts receivable includes unbilled receivables which are aged based upon our initial service date. At December 31, 2008, the unbilled patient accounts receivable, as a percentage of gross patient accounts receivable, was 23.0%, or $48.3 million compared to 23.3% or $26.3 million at December 31, 2007. We monitor unbilled receivables on an agency by agency basis to ensure that all efforts are made to bill claims within timely filing deadlines. The timely filing deadlines vary by state for Medicaid and among insurance companies. As discussed above, our newly acquired agencies experience billing delays related to both external and internal factors. As of December 31, 2008, agencies acquired during 2008 represented $17.0 million or 35.1% of our unbilled accounts receivable.

In establishing and analyzing our provisions for doubtful accounts and estimated revenue adjustments, we segregate our receivables into payor classes and record our provisions based on our historical collection rates which vary by payor and look at the collectibility based upon the date that the service was provided. Fluctuations in our revenue mix can result in variances in the provision recorded. Our provision for estimated revenue adjustments (which is deducted from our service revenue to determine net service revenue) and provision for doubtful accounts was $30.4 million ($24.0 million in provision for doubtful accounts and $6.4 million in provision for estimated revenue adjustments for Medicare claims) or 2.6% of net service revenue in 2008 compared to $17.1 million ($12.0 million in provision for doubtful accounts, $2.6 million in provision for estimated revenue adjustments for Medicare claims and $2.5 million in provision for estimated revenue adjustments for non-Medicare, episodic based claims) or 2.5% of net service revenue in 2007. During 2007, we recorded a $2.6 million provision for estimated revenue adjustments on private episodic-based revenue. Beginning in 2008, all reserves related to private episodic-based revenue have been included in our provision for doubtful accounts. As such our private accounts receivable is net of a provision of estimated revenue adjustment of $1.0 million and $2.5 million at December 31, 2008 and 2007, respectively. The increase in our provision from 2007 was due to growth in revenue and receivables, receivables greater than 180 days; and providing for all claims greater than 360 days.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion and analysis provides information we believe is relevant to an assessment and understanding of our results of operations and financial condition for the three and nine-month periods ended September 30, 2008. This discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included herein, the consolidated financial statements and notes and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC on February 27, 2008, which are incorporated herein by this reference.

OVERVIEW

We are a leading provider of high-quality, low-cost home health services to the chronic, co-morbid, aging American population. The services that we provide on a multi-state basis include both home health and hospice services with over 14,500 employees and approximately 87% of our revenue derived from Medicare. As of September 30, 2008, we owned and operated 461 Medicare-certified home health agencies and 44 Medicare-certified hospice agencies in 35 states throughout the United States, the District of Columbia and Puerto Rico. Our typical home health patient is Medicare eligible, 82 years old (with 25% of our patient population being between 80 and 84 years old), takes approximately twelve different medications on a daily basis and has multiple co-morbidities. For our home health patients, we typically receive a 60-day episodic-based payment from Medicare. This payment can vary and depends on the type of care provided, level of acuity and amount of intensive services required. Some patients require one episode of care to stabilize, while others require multiple episodes of care based on the acuity of their condition. Our care for each home health patient focuses on improving their quality of life by evaluating the health condition of each patient; developing a doctor approved plan of care to achieve certain goals for each patient, which can be followed up with additional paid episodes of care, if deemed necessary; and educating each patient on how to either maintain or continue to improve upon their health on an ongoing basis after they leave our care.

Through our home health agencies, we deliver a wide range of services in the homes of individuals who may be recovering from surgery, have a chronic disability or terminal illness or need assistance with the essential activities of daily living. The services we provide include skilled nursing and home health aide services; physical, occupational and speech therapy; and medically oriented social work to eligible individuals who require ongoing care that cannot be provided effectively by family and friends. In addition, we have developed and offer clinically focused programs for high cost chronic conditions and various diseases, such as diabetes, coronary artery disease, congestive heart failure, complex wound care, chronic obstructive pulmonary disease, geriatric surgical recovery, behavioral health, and stroke recovery, as well as various rehabilitative programs, such as Rehab at Home, Dysphasia at Home and Balance for Life. In each case, we focus on improving the functional ability of our geriatric population and enhancing patient self-management through compliance tracking and behavioral modification.

As an organization, we continue to focus on enhancing the delivery of services to geriatric patients with chronic co-morbid conditions. We believe our services are attractive to payors and physicians because we combine clinical quality with cost-effectiveness; we provide clinical consistencies in the care we provide in each of our agencies; and we are accessible 24 hours a day, seven days a week to answer our patients’ questions and to provide for their medical needs with such services as our “Encore” nurse call center.

Through our hospice agencies, we provide palliative care and comfort to terminally ill patients and their families. We provide hospice services to each patient using an interdisciplinary care team comprised of a physician, a patient care manager, registered nurses, certified home health aides, social workers, a chaplain, a homemaker and specially trained volunteers. This team then collectively assesses the clinical, psychosocial and spiritual needs of the patients and their families and manages that care accordingly. Although we expect Medicare home health to remain our primary focus over the near and intermediate term, we believe home health and hospice are complementary services and we expect to continue to expand our home health and hospice networks through acquisitions and start-up activities.

Recent Developments

Acquisitions

During the nine-month period ended September 30, 2008, we acquired 122 home health agencies and 11 hospice agencies, respectively. Of these acquisitions, 92 home health agencies and 11 hospice agencies were acquired through our TLC Health Care Services, Inc (“TLC”) acquisition.

We have completed the conversion of the acquired TLC agencies to our operating systems and Point of Care network. In addition, we have closed all of the TLC regional billing centers and completed the conversion of all corporate departments.

Reimbursement

On August 8, 2008, CMS issued a final rule to update and revise the Medicare hospice wage index for fiscal year 2009. The final rule includes a phase out of the Medicare hospice budget neutrality adjustment over three years and clarifies wage index issues pertaining to the definition of rural and urban areas and to multi-campus hospital facilities. CMS also included a 3.6% market basket increase to Medicare hospice rates for fiscal year 2009. We do not expect the impact of this change to have a material impact on our condensed consolidated financial statements.

RESULTS OF OPERATIONS

Our operating results may not be comparable for the three and nine-month periods ended September 30, 2008 as compared to the three and nine-month periods ended September 30, 2007, primarily as a result of our acquisitions and start-up agencies. In addition, the recent turmoil related to both the credit and equity markets may have an impact on our ability to continue to follow our strategy of growing through both acquisition and start-up activity if we are not able to obtain the necessary financing. When we refer to base business, we mean home health and hospice agencies that we have operated for at least the last twelve months; when we refer to acquisitions, we mean home health and hospice agencies that we acquired within the last twelve months; and when we refer to start-ups, we mean any new location opened by us in the last twelve months. Once an agency location has been in operation for a twelve month period, the results for that particular agency are included as part of our base business from that date forward. When we refer to episodic-based revenue, admissions or recertifications, we mean revenue, admissions or recertifications of payors that reimburse on an episodic-basis, which includes Medicare and other insurance carriers as well as Medicare Advantage programs.

As indicated in the risk factors incorporated by reference or set forth herein, reductions to Medicare rates and/or changes in Medicare reimbursement methodology could have a material adverse impact on our results of operations.

Three-Month Period Ended September 30, 2008 Compared to the Three-Month Period Ended September 30, 2007

Net Service Revenue

We are dependent on Medicare for a significant portion of our revenue. Approximately 87% and 89% of our net service revenue was derived from Medicare for the three-month periods ended September 30, 2008 and 2007, respectively.

Our net service revenue increased $140.7 million from 2007 to 2008. The increase is comprised of $92.8 million in acquisition revenue and $47.9 million related to our base/start-up locations. The $47.9 million increase in our base/start-up locations includes a $45.7 million increase in episodic-based revenue, which is primarily the result of an increase in the number of patients serviced and the revenue earned on each episode of care. For our episodic-based revenue, we measure our increase in volume by analyzing our internal growth in both admissions and recertifications and we measure our increase in price by analyzing our average revenue earned on each 60-day episode of care. The following is an explanation of our internal episodic-based admission and recertification growth and average revenue per completed episode, which are the primary reasons for the increase in our internal episodic-based revenue.

During the three-month period ended September 30, 2008, we experienced a 14% increase in our internal episodic-based admissions. We have experienced a significant increase in admissions at our agencies that have been start-ups during the past three years. Over half of our internal episodic-based admission growth was attributable to such start-up agencies.

In addition to our growth in internal episodic-based admissions, we also experienced a 23% increase in our internal episodic-based recertifications during the three-month period ended September 30, 2008. Within our base or mature agencies, our average patient census includes patients who are 82 years old, on average, have a high case mix weight, more pronounced functional debilities, take an average of 12 medications and have a higher risk of hospitalization, when compared to external benchmarks such as those reported by CMS. Given our patient census, it is common for our patients to require more intensive resources in order to achieve their individual goals for recovery. In light of our extensive experience in caring for such patients, we believe we have gained a reputation among referral sources as being successful at caring for patients with a higher acuity mix with multiple co-morbidities, who require more intensive services. This is supported by our reported clinical outcomes from CMS, which show that our outcomes are at or better in 12 out of 12 categories in the footprint of communities that we serve; when our outcomes are compared at the national level, we are at or better in 10 out of 12 categories.

We have encouraged our referral sources (i.e. physicians) to utilize home care as a first stabilizing alternative to the hospital setting as opposed to the latter. As a result, we provide care to a larger percentage of patients coming directly from the physician’s office as compared to directly from the hospital setting. When compared to national external benchmarks, 41% of our patient census is admitted directly from the doctor’s office as opposed to 29% when compared to the national level, as reported by Outcome Concept Systems (As a reminder, patients who have not been stabilized by a hospital stay originally tend to be sicker and have greater resource needs upfront).

These results translate into our agencies receiving referrals for patients who on average require more intensive service with multiple episodes of care. As we enter a new community through a start-up, we begin our operations by establishing our referral sources and trying to increase our patient census through additional admissions. As the agency matures, we educate our referral sources within the community on our expertise of successfully caring for patients who have a higher acuity mix with multiple co-morbidities and our referral sources begin to see our results as we care for the patients who they first referred to us. This education and track record of success with the first patients helps to transform our agency into one that has a census more consistent with our base or mature agencies. This is a similar pattern for our acquired agencies. As the employees of our acquired agencies become familiar with our processes, they are able to achieve clinical outcomes that are similar to our base or mature agencies, and thus begin to develop their patient census into one that is more reflective of our base or mature agencies.

Finally during the three-month period ended September 30, 2008, we experienced an increase in our average revenue per completed episode. During the three-month period ended September 30, our average Medicare revenue per completed episode increased from $2,679 in 2007 to $2,879 in 2008 and our average episodic-based revenue per completed episode increased from $2,672 in 2007 to $2,868 in 2008. The increase in our average revenue per completed episode was primarily due to the development of our therapy intensive specialty programs and the focus of the new Medicare payment system on providing more reimbursement for home health agencies that have patients with a higher acuity mix and multiple co-morbidities that require more intensive services.

Liquidity

Typically, our principal source of liquidity is the collection of our patient accounts receivable, primarily through the Medicare program; however, from time to time, we can and do obtain additional sources of liquidity through sales of our equity or by incurrence of additional indebtedness. As of September 30, 2008, we had $5.7 million in cash and cash equivalents, $250.0 million of availability for the issuance of any combination of preferred and common stock, if needed, under our effective shelf registration statement, and $138.8 million in availability under our $250.0 million Revolving Credit Facility. We are in compliance with all of the financial covenants of our recently issued debt.

In addition, due primarily to the acquisitions that occurred during the first quarter of 2008 and prior periods, we completed the nine-month period ended September 30, 2008 with $359.7 million in indebtedness, which consisted of $135.0 million outstanding under our Term Loan, $102.0 million outstanding under our Revolving Credit Facility (with $9.2 million in outstanding letters of credit, primarily related to workers’ compensation insurance), $100.0 million outstanding under our Senior Notes, $22.5 million outstanding under our promissory notes (primarily related to acquisitions) and $0.2 million under our outstanding capital leases.

During the nine-month period ended September 30, 2008, we made $20.6 million in capital expenditures, of which $12.3 million was considered routine, which primarily includes equipment and furniture and computer software and $8.3 million related to the deployment of our Point of Care system to our recently acquired agencies. For the remainder of 2008, we anticipate spending approximately $0.5 million to complete our Point of Care system to recently acquired agencies and $4.0 million for routine capital expenditures, which we intend to fund with our operating cash flows.

Based on our operating forecasts and our debt service requirements (described below in Indebtedness), we believe we will have sufficient liquidity to fund our operations, capital requirements and debt service requirements over the next twelve months and into the foreseeable future. However, our liquidity is dependent upon a number of factors influencing forecasts of earnings and operating cash flows. These factors include patient growth, attaining expected results from acquisitions including our integration efforts, our ability to manage our operations based upon certain staffing formulas and certain assumptions related to our reimbursement by Medicare. Our reimbursement by Medicare is subject to a number of factors including, but not limited to, recommendations made by the Medicare Payment Advisory Commission (“MedPAC”) to the United States Congress (“Congress”), legislative changes made by Congress that directly impact the reimbursement rates paid by Medicare, or changes made by CMS. We continually monitor regulatory and reimbursement changes proposed and made to the Medicare reimbursement methodology to properly plan and manage our current and future liquidity needs.

As part of our current cash management process, we manage our interest expense and cash needs by paying down our outstanding debt with any available cash and relying on availability of funds under our Revolving Credit Agreement for our operating and acquisition needs. As a result of this process, we have seen a decrease in our current ratio (i.e. the difference between current assets and current liabilities) from $62.8 million at December 31, 2007 to $7.6 million at September 30, 2008. As we manage our current ratio and our liquidity needs to meet our operating forecasts, debt service requirements and our acquisition and start-up activities, we are monitoring the creditworthiness and solvency of our syndicate of banks that provide the availability of credit under our Revolving Credit Agreement as well as the status of the overall equity and credit markets. This monitoring process has become critical over the past several months as several financial institutions have either failed or have been acquired and as the equity market has seen significant decreases in value, as discussed in the risk factors set forth herein. As of the date of this filing, we do not believe our availability of funds under our Revolving Credit Facility is at risk for this reason; however, we continue to monitor our syndicate of banks in light of the credit market conditions. If our availability under our current Revolving Credit Agreement decreases we may need to consider adjusting our strategy to meet our operating forecasts, debt service requirements and acquisition and start-up activity needs. Such changes could include, but would not be limited to, meeting our minimum debt service requirements and meeting our forecasted operating needs with operating cash flows, while retaining any surplus in operating cash flows, as deemed necessary. As we experience over a 99% collection rate on our Medicare claims, which represents 87% of our net service revenue, we do not believe that it would be difficult to adjust our cash management strategy, as deemed necessary.

Indebtedness

Senior Notes, Term Loan and Revolving Credit Facility

In connection with our March 2008 acquisition of TLC, we incurred additional indebtedness by (i) issuing $100.0 million in senior notes and (ii) entering into a $400.0 million credit agreement that provided for a $150.0 million term loan and a $250.0 million revolving credit facility, all of which are described in detail below. See Note 2 for more information regarding the TLC acquisition.

On March 25, 2008, we entered into a new $100.0 million Note Purchase Agreement (the “Note Purchase Agreement”), pursuant to which we issued and sold on March 26, 2008, three series of Senior Notes (the “Senior Notes”) in an aggregate principal amount of $100.0 million. Interest on the Senior Notes is payable at the prescribed rates semi-annually on March 25 and September 25 of each year beginning September 25, 2008. The Senior Notes are unsecured, but are guaranteed by all of our material subsidiaries.

On March 26, 2008, we entered into a new $400.0 million Credit Agreement (the “Credit Agreement”), which consists of: (i) a $150.0 million, five-year Term Loan (the “Term Loan”) and (ii) a $250.0 million, five-year Revolving Credit Facility (the “Revolving Credit Facility”). The Revolving Credit Facility provides for and includes within its $250.0 million limit a $15.0 million swingline facility and commitments for up to $25.0 million in letters of credit. The Revolving Credit Facility may be utilized by us to provide ongoing working capital and for other general corporate purposes. The Term Loan and Revolving Credit Facility are unsecured, but are guaranteed by all of our material subsidiaries.

The proceeds of the Term Loan, our initial draw of $145.0 million under the Revolving Credit Facility, and the proceeds from the issuance of the Senior Notes were utilized by us (a) to fund the purchase price of the TLC acquisition; (b) to pay transaction and other expenses associated with the TLC acquisition and the closings contemplated by the Credit Agreement and the Note Purchase Agreement; and (c) for other general corporate purposes. In addition, in connection with incurring this new debt, we recorded $8.1 million in deferred debt issuance costs as other assets in our condensed consolidated balance sheet, which are being amortized over the term of the debt.

The Term Loan is repayable in 20 equal quarterly installments of $7.5 million each plus accrued interest beginning on June 30, 2008, with any remaining balance due at maturity on March 26, 2013. Upon occurrence of certain events, including our issuance of capital stock if our leverage ratio at the time of issuance is equal to or in excess of 2.50 and certain asset sales by us where the cash proceeds are not reinvested within a specified time period, mandatory prepayments are required in the amounts specified in the Credit Agreement and Note Purchase Agreement. Mandatory prepayments are paid ratably to the lenders under the Credit Agreement and the holders of Senior Notes, based upon the respective indebtedness outstanding. Amounts paid to the lenders under the Credit Agreement are applied first to the Term Loan, with excess, if any, applied to amounts outstanding under the Revolving Credit Facility, without reduction in the commitments to make revolving loans under the Revolving Credit Facility.

CONF CALL

Kevin LeBlanc

Thanks. Good morning and thank you for joining us today for Amedisys investor conference call to discuss this morning’s third quarter 2008 earnings announcement and related matters.

By now you should receive a copy of our earnings press release. If you did not receive the press release you may access it on Investor Relations page on our website at www.amedisys.com.

Joining me on today’s call from Amedisys are Bill Borne, Chairman and Chief Executive Officer, Larry Graham, President and Chief Operating Officer, and Dell Redman, Chief Financial Officer. Also speaking today will be Alice Ann Schwartz, Chief Information Officer and Senior Vice President for Clinical Operations and Jeffrey Jeter, Chief Compliance Officer.

Before we get started with our call, I’d like to remind everyone that any statements made on this conference call today or in our press releases that express a belief, expectation, or intent as well as those that are not historical facts are considered forward-looking statements and are protected under the Safe Harbor of the Private Securities Litigation Reform Act.

These forward-looking statements are based on information available to Amedisys today, and the company assumes no obligation to update these statements as circumstances change. These forward-looking statements may involve a number of risks and uncertainties which may cause the company’s results to differ materially from such statements. These risks and uncertainties include factors detailed in our SEC filings including our forms 10-K and 10-Q.

Also, the company urges caution in considering any current trends or guidance that may be discussed on this conference call. The home health and hospice industry is highly competitive, and trends and guidance are subject to numerous factors, risks, and influences which are described in the company’s reports and registration statements filed with the SEC. The company disclaims any obligations to update information on trends or targets other than in its periodic filings with the SEC. In addition, as required by SEC Regulation G, a reconciliation of any non-GAAP measures mentioned during our call today to the most comparable GAAP measures will be available on our website at www.amedisys.com on the Investor Relations page under the link Press Releases.

Thank you. Now I’ll turn the call over to Bill Borne. Please go ahead, Mr. Borne.Sun, 08 Mar 2009 10:53:20 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1917/http://www.dailystocks.com/forum/showtopic.php?tid/1917/
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BUSINESS OVERVIEW

Viacom is a leading global entertainment content company. We engage audiences on television, motion picture, Internet, mobile and video game platforms through many of the world’s best known entertainment brands. We manage our operations through two reporting segments: Media Networks and Filmed Entertainment . References in this document to “Viacom,” “Company,” “we,” “us” and “our” mean Viacom Inc. and our consolidated subsidiaries through which our various businesses are conducted, unless the context requires otherwise.

Media Networks

Our Media Networks segment provides entertainment content for consumers in key demographics attractive to advertisers, distributors and retailers. We create and acquire programming and other content for distribution to our audiences how and where they want to view and interact with it: on television, the Internet, mobile devices, video games and a variety of consumer products. MTV Networks reaches over 578 million households worldwide via its approximately 165 channels and multiplatform properties, which include MTV: Music Television ® , MTV2 ® , mtvU ® , MTV Tr3s ® , VH1 ® , VH1 Classic™, CMT ® : Country Music Television™, Logo ® , Nickelodeon ® , Nick at Nite ® , Noggin ® , The N ® , Nicktoons ® , Neopets ® , COMEDY CENTRAL ® , Spike TV ® and TV Land™, among others. MTV Networks also has a growing video game business that includes the successful Rock Band ® franchise and casual gaming websites such as Addictinggames.com and Shockwave.com. BET Networks is a leading provider of entertainment, music, news and public affairs television programming targeted to the African-American audience and can be seen in the United States, Canada, the Caribbean, the United Kingdom and sub-Saharan Africa.

Filmed Entertainment

The Filmed Entertainment segment produces, finances and distributes motion pictures and other entertainment content under the Paramount Pictures ® , Paramount Vantage™, Paramount Classics™, MTV Films ® and Nickelodeon Movies™ brands. The Filmed Entertainment segment will also continue to release a number of pictures under the DreamWorks™ brand. Paramount Pictures has been a leading producer and distributor of motion pictures since 1912 and has a library consisting of approximately 3,500 motion pictures and a small number of television programs. It also acquires films for distribution and has distribution relationships with DreamWorks Animation and Marvel. Paramount also distributes motion pictures and other entertainment content on DVD, television, digital and other platforms in the United States and internationally, and is expanding its presence in the games business.

Our Media Networks segment derives revenues principally from advertising sales, affiliate fees and ancillary revenues. Revenues from the Filmed Entertainment segment are generated primarily from the theatrical release and/or distribution of motion pictures, sale of home entertainment products such as DVDs, and licensing motion pictures and other content to pay and basic cable television, broadcast television, syndicated television and digital media outlets. Revenues from the Media Networks segment accounted for 60%, 60% and 64% of our revenues for 2008, 2007 and 2006, respectively, and revenues from the Filmed Entertainment segment accounted for 41%, 41% and 37% of our revenues for those periods, respectively, with elimination of intercompany revenues being (1)%, (1)% and (1)%, respectively. We generated approximately 71% of our total revenues in 2008 from domestic operations, 73% in 2007 and 76% in 2006, with 29%, 27% and 24%, respectively, generated internationally. In 2008, our total international revenues were $4.254 billion, of which 64% was generated in Europe.

2008 Restructuring

To better align our organization and cost structure with current economic conditions, we undertook a strategic review of our businesses in the fourth quarter of 2008 which resulted in a reduction in our workforce by 890 positions and write-downs of certain programming and other assets. These actions resulted in aggregate pre-tax restructuring and other charges of $454 million, of which approximately $80 million relates to severance actions and the remainder relates primarily to the write-down of programming and other assets. See Note 15 to the Consolidated Financial Statements for additional information.

Corporate Information

We were organized as a Delaware corporation in 2005 and our principal offices are located at 1515 Broadway, New York, New York 10036. Our telephone number is (212) 258-6000 and our website is www.viacom.com. Information on our website is not intended to be incorporated into this annual report.

Business Strategy

We produce and distribute television programming, motion pictures and other entertainment content under some of the world’s best known entertainment brands, many of which are household names worldwide. Our focus is on our audience, providing them the entertainment they want to experience, how and when they want to experience it. Key elements of our strategy include:

In connection with these efforts, we are committed to fostering a creative and diverse culture, which will enable us to continue to develop unique and cutting-edge content for our audiences and maintain our position as a market leader.

MEDIA NETWORKS

Our media networks, MTV Networks and BET Networks, operate their program services, websites and other digital media services in the United States and abroad. Our Media Networks segment generates revenues principally from three sources: (i) the sale of advertising time on our program services and digital properties, (ii) the receipt of affiliate fees from cable television operators, direct-to-home satellite operators, mobile networks and other content distributors and (iii) ancillary revenues, which include the creation and publishing of video games and other interactive products, home entertainment sales of our programming, the licensing of our content to third parties and the licensing of our brands and properties for consumer products. In 2008, advertising revenues, affiliate fees and ancillary revenues were approximately 54%, 30% and 16%, respectively, of total revenues for the Media Networks segment.

Advertising Revenues

The advertising revenues generated by each program service depend on the number of households subscribing to the service, household and viewership demographics and ratings as determined by third party research companies such as The Nielsen Company (US), LLC (“Nielsen”). Our media networks properties target key audiences considered particularly attractive to advertisers. For example, MTV targets teen and young adult demographics, Nickelodeon targets kids and their families and BET programming targets African-American audiences.

The advertising industry modified the way it measures ratings in 2008 by moving to commercial ratings, which measure audience size for a commercial. Commercial ratings are measured on a “C3” basis, which counts the number of viewers that watch the commercial live or via playback during the three days following the live broadcast. In 2008, the majority of our guaranteed deals were sold on the C3 metric. We regularly evaluate the structure, content and volume of our advertising spots, and throughout 2008 took measures that resulted in improved audience retention.

In 2008, domestic and global economic conditions worsened significantly, which had a rapid, negative effect on the advertising market, weakening the businesses of partners who purchase advertising on our networks and reducing their spending on advertising generally. Current economic conditions have adversely affected our advertising revenues and such effect could continue or worsen. Our advertising revenues may also fluctuate due to the ratings of our channels (including the timing and success of new programs) and seasonal variations, typically being highest in the fourth quarter.

Some of our program services experienced ratings declines in 2008, which, coupled with economic conditions, caused our domestic advertising revenue to decline. Ratings challenges could reduce the amount of advertising revenue we receive and negatively affect our results of operations, and our expenses may increase moderately as we invest in new programming.

Our digital revenue is derived from a combination of advertising and sponsorships. Our Media Networks segment operates approximately 400 digital media properties around the world, including websites, WAP sites, broadband services and virtual worlds, and during the fourth quarter of 2008, we collectively averaged approximately 89 million unique visitors per month. Our on-air programming drives traffic to our digital properties and vice versa, allowing convergent, or cross-platform, advertising sales. MTV Networks also syndicates ad-supported long-form and short-form video content to select online destinations which creates additional opportunities for audiences to interact with our content online, ultimately driving viewership back to our core channels and digital properties. Our Flux platform, which allows users to connect, share and interact with content and other users across a network of websites, expands user experiences and creates a seamless connection between our sites, as well as content and communities from all over the Internet.

Affiliate Fees

Revenues from affiliate fees are negotiated with individual cable and satellite television operators, mobile and online networks and other distributors, generally resulting in multi-year carriage agreements with set rate increases that provide us with a reasonably stable source of affiliate fee revenue. The amount of the fee we receive is determined in part by the number of subscribers to and success of the programming offered by our program services. We engage in negotiations with our cable and satellite affiliate partners on a rolling basis. We are exploring ways to build stronger and more expansive multi-media partnerships with the various distributors of our content that maximize the value of our content for us, our audience and our affiliate partners, such as increased and customized content offerings for video-on-demand and Internet distribution with our cable and satellite partners. We also receive e-commerce revenues from our digital operations.

Ancillary Revenues

Our ancillary revenues are principally derived from the creation and publishing of video games and other interactive products, sales of home entertainment products such as DVDs, content licensing and licensing for consumer products.

In connection with our 2006 acquisition of Harmonix Music Systems, Inc. (“Harmonix”), we expanded our operations to include the creation, marketing and publishing of video games and other interactive products. Following our launch of Rock Band in 2007, we released Rock Band 2 on the Xbox 360 ® , PlayStation ® 2 and PLAYSTATION ® 3 platforms and both Rock Band and Rock Band 2 on the Nintendo Wii platform in 2008. We also expanded into international markets such as Italy, Sweden and Spain. The Rock Band series of games allows players to experience music in a new way, by playing as part of a virtual band using drum, bass/lead guitar and microphone peripherals. Rock Band gamers can download songs spanning all genres of rock, which provides another source of ancillary revenue for us. Electronic Arts co-manufactures, co-markets and distributes Rock Band for us in exchange for certain fees. We also continue to receive royalties from third party sales of certain related games and products, including Guitar Hero , which is published by Activision, and are exploring additional digital applications for our games. Revenues from our video game business are dependent on consumer acceptance of our games and related offerings and may fluctuate.

We distribute our programming in the home entertainment market through the sale and rental of DVDs, video-on-demand, download-to-own and download-to-rent services. We also license our television programs and the concepts and/or formats of such programs to third parties for licensing fees and royalties. For example, TV Land’s new reality series She’s Got The Look has been licensed in over 65 countries worldwide. We also have a worldwide consumer products licensing business, which licenses popular characters from our programs, such as those featured in SpongeBob SquarePants , The Backyardigans , Dora the Explorer , Neopets and South Park , in connection with merchandising, video games and publishing worldwide. We generally are paid a royalty based upon a percentage of the licensee’s wholesale revenues, with an advance and/or guarantee against future expected royalties. Licensing revenue may vary from period to period depending on the popularity of the program available for license in a particular period and the popularity of licensed products among consumers.

Media Networks Properties

MTV Networks is principally comprised of four groups based on target audience, similarity of programming and other factors: the Music and Logo Group, the Kids and Family Group, the Entertainment Group and International. BET Networks’ businesses include BET, BET International and BET.com, among other properties. Information about our key media networks properties is discussed below. Unless otherwise indicated, the domestic television household numbers are according to Nielsen, the Internet user data is according to comScore Media Metrix (U.S. data only unless otherwise indicated) and the video stream data is based on internal tracking. International reach statistics are derived from internal data coupled with external sources when available.

Music and Logo Group

The Music and Logo Group includes our music-oriented program services and digital properties, which generally provide youth-oriented programming targeting the 18-24 and 18-34 demographics, the Harmonix and MTV Games video game operations, and Logo, our channel for the lesbian, gay, bisexual and transgender audience. Some of our key brands in this group include:

MTV Networks International

Worldwide, MTV Networks’ operations reached over 660 million households in 162 countries via its program services and branded program blocks as of December 31, 2008. MTV Networks International owns and operates, participates in as a joint venturer, and/or licenses to third parties to operate over 120 program services, including extensions of our multimedia brands MTV, VH1, Nickelodeon and COMEDY CENTRAL, and program services created specifically for international and/or non-English speaking audiences such as TMF (The Music Factory), Paramount Comedy, Game One, The Box and VIVA, among others. MTVN International also operates or licenses its brands for more than 130 online properties internationally. Most of the MTVN International program services are regionally customized for the particular viewers through the inclusion of local music, programming and on-air personalities, and use of the local language. MTV Networks’ operations in Europe, Latin America and Asia represent its largest international presence.

We strategically pursue the development, licensing and acquisition of program services in international markets and engage in the syndication and distribution of consumer products. Our Viacom 18 joint venture in India includes television, film and digital media content across numerous brands as well as consumer products. In July 2008, it launched Colors, a new Hindi-language general entertainment channel, and is expected to launch additional niche channels and digital content in the future.

We continue to focus on efficiently expanding our international presence by ensuring that we have the appropriate forms of ownership interests in our properties worldwide. This involves concentrating our resources in the regions and on the demographics that offer the greatest growth opportunity for our brands, such as Germany, India and the United Kingdom, and entering into licensing arrangements in other regions that can be best exploited by our partners. In Europe, we launched MTVNHD, a 24-hour English language high definition service dedicated to music and kids. MTVNHD is now available in 11 European countries and has expanded to Mexico, with plans for further expansion in Latin America. In the Middle East, we launched Nickelodeon Arabia through an existing long-term licensing arrangement between MTVN International and TECOM Investments’ media unit, Arab Media Group. We also expanded our Eastern European presence, increased our ownership interest in Nickelodeon Australia, and plan to continue to expand our brands in various regions, including launch of COMEDYCENTRAL channels in Sweden and New Zealand in 2009.



MANAGEMENT DISCUSSION FROM LATEST 10K

Management’s discussion and analysis of results of operations and financial condition is provided as a supplement to and should be read in conjunction with the consolidated financial statements and related notes to enhance the understanding of our results of operations, financial condition and cash flows. References in this document to “Viacom,” “Company,” “we,” “us” and “our” mean Viacom Inc. and our consolidated subsidiaries through which our various businesses are conducted, unless the context requires otherwise. Certain amounts have been reclassified to conform to the 2008 presentation.

Significant components of the management’s discussion and analysis of results of operations and financial condition section include:



Page

• Overview . The overview section provides a summary of Viacom and our reportable business segments and the principal factors affecting our results of operations. In addition, we provide a discussion of items affecting the comparability of our financial statements.
40


• Results of Operations. The results of operations section provides an analysis of our results on a consolidated basis and our reportable operating segment results for the three years ended December 31, 2008.
43


• Liquidity and Capital Resources. The liquidity and capital resources section provides a discussion of our cash flows for the three years ended December 31, 2008 and of our outstanding debt and commitments existing at December 31, 2008.
61


• Market Risk. We are principally exposed to market risk related to foreign currency exchange rates and interest rates. The market risk section discusses how we manage exposure to these and other market risks.
67


• Critical Accounting Policies and Estimates. The critical accounting policies section provides detail with respect to accounting policies that are considered by management to require significant judgment and use of estimates and that could have a significant impact on our financial statements.
68


• Recent Pronouncements. The recent pronouncements section provides a discussion of recently issued accounting pronouncements yet to be adopted, including a discussion of the impact or potential impact of such standards on our financial statements when applicable.
73


• Other Matters. The other matters section provides a discussion of legal matters, related party transactions and provisions of the various separation related agreements still relevant as of December 31, 2008.


Management’s Discussion and Analysis

of Results of Operations and Financial Condition

(continued)



OVERVIEW

Summary

We are a leading global entertainment content company. We engage audiences on television, motion picture, Internet, mobile and video game platforms through many of the world’s best known entertainment brands, including MTV: Music Television ® , MTV2 ® , mtvU ® , MTV Tr3s ® , VH1 ® , VH1 Classic™, CMT ® : Country Music Television™, Logo ® , Rock Band ® , Nickelodeon ® , Nick at Nite ® , Noggin ® , The N ® , Nicktoons ® , Neopets ® , COMEDY CENTRAL ® , Spike TV ® and TV Land™, BET ® , Paramount Pictures ® , Paramount Vantage™, Paramount Classics™, MTV Films ® and Nickelodeon Movies™.

We manage our operations through two reporting segments: Media Networks and Filmed Entertainment .

Media Networks

Our Media Networks segment provides entertainment content for consumers in key demographics attractive to advertisers, distributors and retailers. We create and acquire programming and other content for distribution to our audiences how and where they want to view and interact with it: on television, the Internet, mobile devices, video games and a variety of consumer products. Our leading Media Networks properties reach over 578 million households worldwide via our multiplatform properties, operating in 162 countries and territories. We have approximately 165 channels, more than 400 digital media properties and a global consumer licensing business. MTV Networks (“MTVN”) also has a growing video game business that includes the successful Rock Band ® franchise and casual gaming websites such as Addictinggames.com and Shockwave.com.

Our Media Networks segment operates its program services, websites and other digital media services in the United States and abroad and generates revenues principally from three sources: (i) the sale of advertising time on our program services and digital properties, (ii) the receipt of affiliate fees from cable television operators, direct-to-home satellite operators, mobile networks and other content distributors and (iii) ancillary revenues, which include the creation and publishing of video games and other interactive products, home entertainment sales of our programming, the licensing of our content to third parties and the licensing of our brands and properties for consumer products.

Our Media Networks properties target key audiences considered particularly attractive to advertisers. The advertising industry modified the way it measures ratings in 2008 by moving to commercial ratings, which measure audience size for a commercial. Commercial ratings are measured on a “C3” basis, which counts the number of viewers that watch the commercial live or via playback during the three days following the live broadcast. In 2008, the majority of our guaranteed deals were sold on the C3 metric. We regularly evaluate the structure, content and volume of our advertising spots, and throughout 2008 took measures that resulted in improved audience retention.

In 2008, domestic and global economic conditions worsened significantly, which had a rapid, negative effect on the advertising market, weakening the businesses of partners who purchase advertising on our networks and reducing their spending on advertising generally. Current economic conditions have adversely affected our advertising revenues and such effect could continue or worsen. Our advertising revenues may also fluctuate due to the ratings of our channels (including the timing and success of new programs) and seasonal variations, typically being highest in the fourth quarter.

Some of our program services experienced ratings declines in 2008, which, coupled with economic conditions, caused our domestic advertising revenue to decline. Ratings challenges could reduce the amount of advertising revenue we receive and negatively affect our results of operations, and our expenses may increase moderately as we invest in new programming.

Management’s Discussion and Analysis

of Results of Operations and Financial Condition

(continued)



Revenues from affiliate fees are negotiated with individual cable and satellite television operators, mobile and online networks and other distributors, generally resulting in multi-year carriage agreements with set rate increases that provide us with a reasonably stable source of affiliate fee revenues. The amount of the fee we receive is determined in part by the number of subscribers to and success of the programming offered by our program services. We engage in negotiations with our cable and satellite affiliate partners on a rolling basis.

Our ancillary revenues are principally derived from the creation and publishing of video games, such as from sales of the Rock Band franchise, Guitar Hero royalties and other interactive products, sales of home entertainment products such as DVDs, content licensing and licensing for consumer products, including licensing of popular characters from our programs such as those featured in SpongeBob SquarePants, The Backyardigans, Dora the Explorer, Neopets and South Park in connection with merchandising, video games and publishing worldwide.

Media Networks segment revenue growth depends on the continued increase of advertising revenues and affiliate fees through our efforts to expand and enhance our brands worldwide with hit programming, new channels and other forms of entertainment and, in part, by the increased availability of our content on various distribution platforms. We continue to invest organically and through select acquisitions and investments in digital media and other assets that are attractive to our consumers and we seek to increase our revenues by expanding our audiences and strengthening our relationships with our advertising, cable, satellite, mobile and online partners to serve those audiences. Growth also depends on the continued success and expansion of our Rock Band franchise and other games that we develop, as well as continued demand for our brands in the home entertainment, television licensing and consumer products marketplaces.

Media Networks segment expenses consist of operating expenses, selling, general and administrative (“SG&A”) expenses and depreciation and amortization. Operating expenses comprise costs related to original and acquired programming, including programming amortization, expenses associated with the manufacturing and distribution of video games and home entertainment products, and consumer products licensing and participation fees. SG&A expenses consist primarily of employee compensation, marketing, research and professional service fees and facility and occupancy costs. Depreciation and amortization expenses reflect depreciation of fixed assets, including transponders financed under capital leases, and amortization of finite-lived intangible assets.

Filmed Entertainment

The Filmed Entertainment segment produces, finances and distributes motion pictures under the Paramount Pictures, Paramount Vantage, Paramount Classics, MTV Films, and Nickelodeon Movies brands. In addition, we will continue to release a number of pictures under the DreamWorks brand. We also acquire films for distribution and have distribution relationships with DreamWorks Animation SKG, Inc., MVL Productions LLC (“Marvel”), and DW Funding LLC, the owner of the DreamWorks live-action film library. In general, motion pictures produced, acquired and/or distributed by the Filmed Entertainment segment are exhibited theatrically in the U.S. and internationally, followed by their release on DVDs, video-on-demand, pay and basic cable television, broadcast television and syndicated television (the “distribution windows”), digital media outlets, and, in some cases, other exhibitors such as airlines and hotels. Paramount has an extensive library consisting of approximately 1,100 motion picture titles produced by Paramount and acquired rights to approximately 2,400 additional motion pictures and a small number of television programs.

In 2008, the Filmed Entertainment segment theatrically released in domestic and/or international markets Indiana Jones and the Kingdom of the Crystal Skull, The Curious Case of Benjamin Button, Tropic Thunder, Eagle Eye, Cloverfield, The Spiderwick Chronicles and Revolutionary Road , among others. Paramount also distributed Marvel’s Iron Man and DreamWorks Animation’s Kung Fu Panda and Madagascar: Escape 2 Africa.

Management’s Discussion and Analysis

of Results of Operations and Financial Condition

(continued)



In connection with the acquisition of DreamWorks in January 2006, we acquired a live-action film library (the “live-action library”) consisting of 59 films released through September 16, 2005. In May 2006, we sold a controlling interest in DW Funding and entered into an agreement for the exclusive distribution rights to the library for a five-year period, renewable under certain circumstances, for which Paramount receives distribution fees. We retained a minority interest in DW Funding and have certain rights and obligations to reacquire the library at the end of the five-year term. Paramount also has distribution agreements with third parties, including a seven-year agreement with DreamWorks Animation for certain exclusive distribution rights to and home video fulfillment services for the animated feature films produced by DreamWorks Animation (the “DWA agreements”), for which Paramount receives certain fees. The output term of the agreement expires on the later of the delivery of 13 qualified animated motion pictures and December 31, 2012, subject to earlier termination under certain limited circumstances. In October 2008, Viacom, Paramount, DW Studios L.L.C. (formerly, DreamWorks L.L.C.) and the DreamWorks principals Steven Spielberg, David Geffen and Stacey Snider reached an agreement for the departure of those individuals from DW Studios. Pursuant to the agreement, the DreamWorks principals’ new company acquired certain projects in development, which Paramount has the option to co-finance and co-distribute. Our subsidiary, DW Studios, retained all other projects and retains the rights to motion pictures released prior to the departure of the DreamWorks principals, other than the live-action library owned by DW Funding.

In September 2008, Paramount and Marvel extended their distribution agreement under which Paramount distributed Marvel’s Iron Man in 2008. Under the agreement, Paramount will distribute Marvel’s next four to six self-produced feature films on a worldwide basis, including theatrical distribution in most foreign territories previously serviced by Marvel through local distribution entities, in exchange for distribution fees.

Our Filmed Entertainment segment generates revenues worldwide principally from: (i) the theatrical release of motion pictures, (ii) home entertainment, which includes sales of DVDs and other products relating to the motion pictures we release theatrically and certain other programming, including products we distribute on behalf of third parties such as CBS Corporation and (iii) license fees paid worldwide by third parties for exhibition rights on various media.

Revenues from motion picture theatrical releases tend to be cyclical with increases during the summer months, around holidays and in the fourth quarter. The theatrical success of a motion picture is a significant factor in determining the revenues it is likely to generate in home entertainment sales and licensing fees during the various other distribution windows. Paramount’s home entertainment group is responsible for the worldwide sales, marketing and distribution of DVDs for films distributed by Paramount and other Viacom brands, as well as content we distribute on behalf of third parties, including CBS Corporation. The domestic DVD market has softened recently, particularly in the second half of 2008. This trend may continue in 2009, and continued declines may adversely affect our home entertainment revenues and profitability. The Filmed Entertainment segment also generates ancillary revenues from providing production services to third parties, primarily at Paramount’s studio lot, consumer products licensing, game distribution and distribution of content on digital platforms.

In choosing films to produce, we aim to create a carefully balanced film slate that represents a variety of genres, styles, and levels of investment—with the goal of creating entertainment for both niche audiences and worldwide appeal. In October 2008, Paramount announced that it would rationalize its film slate in order to compete more effectively. Beginning in 2009, we expect that the Filmed Entertainment segment will release up to 20 films per year domestically including approximately 16 films produced or acquired by Paramount or DW Studios and two to four films produced by DreamWorks Animation and Marvel. Paramount is also focused on continuing to improve market position and profitability through the development of franchise films, the expansion of film acquisition and production operations internationally, and the diversification of revenue streams, such as making library product available online to own or rent.

Management’s Discussion and Analysis

of Results of Operations and Financial Condition

(continued)



Filmed Entertainment segment expenses consist of operating expenses, SG&A and depreciation and amortization. Operating expenses principally include the amortization of production costs of our released feature films (including participations accrued under our third-party distribution arrangements), print and advertising expenses and other distribution costs. SG&A expenses include employee compensation, facility and occupancy costs, professional service fees and other overhead costs. Depreciation and amortization expense includes depreciation of fixed assets and amortization of acquired intangibles. We incur marketing costs before and throughout the theatrical release of a film and, to a lesser extent, other exhibition windows. Such costs are incurred to generate public interest in our films and are expensed as incurred; therefore, we typically incur losses with respect to a particular film prior to and during the film’s theatrical exhibition and profitability may not be realized until well after a film’s theatrical release, if at all. Therefore, the results of the Filmed Entertainment segment can be volatile as films work their way through the various distribution windows. Historically, we have entered into film financing arrangements under which third parties participate in the financing of the production costs of a film or slate of films typically in exchange for a partial copyright interest. We also have agreements with third parties, including other studios, to co-finance certain of our motion pictures.

Competition

All of our businesses operate in highly competitive industries. Our Media Networks businesses generally compete with other widely distributed cable networks, the broadcast television networks and digital properties for advertising revenue, audience share and, in the case of cable networks, affiliate fees. Our Filmed Entertainment businesses generally compete for audiences with other major motion picture studios such as Disney, Fox, Sony Pictures, Universal and Warner Bros., as well as independent film producers. Competition from these sources, other entertainment offerings and/or for audience leisure time generally may affect revenues, particularly in an economic recession.

The Separation from CBS Corporation

On December 31, 2005, we became a stand-alone public company in connection with our separation from the former Viacom Inc. (“Former Viacom”), which is now known as CBS Corporation. In accordance with the terms of the Separation Agreement, as more fully described below, in December 2005 we paid a preliminary special dividend to Former Viacom of $5.400 billion. In 2006 and 2007, we made further payments of $206 million and $170 million, respectively, to CBS Corporation in final resolution of the adjustments.


RESULTS OF OPERATIONS

Factors Affecting Comparability

The consolidated financial statements as of and for the years ended December 31, 2008, 2007 and 2006 reflect our results of operations, financial position and cash flows reported in accordance with U.S. generally accepted accounting principles. Results for the aforementioned periods, as further discussed below, have been affected by certain items which affect comparability between periods.

Restructuring and Other Charges

To better align our organization and cost structure with current economic conditions, we undertook a strategic review of our businesses in the fourth quarter of 2008 which resulted in an aggregate of $454 million of restructuring and other charges. In addition to broad adverse economic conditions, the fourth quarter strategic review considered the emergence of sustained softness in the advertising market and ratings issues at certain channels in the Media Networks segment, and the Filmed Entertainment segment’s decision to reduce its future film slate. As a result of these initiatives we expect to save approximately $200 million in 2009.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

We are a leading global entertainment content company. We engage audiences on television, motion picture and digital platforms through many of the world’s best known entertainment brands, including MTV ® , VH1 ® , CMT ® , Logo ® , Rock Band™, Nickelodeon ® , Noggin ® , Nick at Nite ® , AddictingGames™, Neopets ® , COMEDY CENTRAL ® , Spike TV ® , TV Land ® , Atom™, Gametrailers™, BET ® , Paramount Pictures ® and Paramount Vantage™. Viacom’s global reach includes approximately 160 channels and 400 online properties in 160 countries and territories.

We operate through two reporting segments: Media Networks , which includes MTV Networks (“MTVN”) and BET Networks (“BETN”), and Filmed Entertainment .

Management’s discussion and analysis of results of operations and financial condition is provided as a supplement to and should be read in conjunction with the unaudited consolidated financial statements and related notes to enhance the understanding of our results of operations, financial condition and cash flows. Additional context can also be found in our Annual Report on Form 10-K for the year ended December 31, 2007 (the “2007 Annual Report”). References in this document to “Viacom,” “Company,” “we,” “us” and “our” mean Viacom Inc. and our consolidated subsidiaries through which our various businesses are conducted, unless the context requires otherwise. Certain amounts have been reclassified to conform to the 2008 presentation.

Organization of Management’s Discussion and Analysis of Results of Operations and Financial Condition

Significant components of management’s discussion and analysis of results of operations and financial condition include:

Consolidated Results of Operations. The consolidated results of operations section provides an analysis of our results on a consolidated basis for the quarter and nine months ended September 30, 2008 compared to the quarter and nine months ended September 30, 2007.

Segment Results of Operations. The segment results of operations section provides an analysis of our results on a reportable operating segment basis for the quarter and nine months ended September 30, 2008 compared to the quarter and nine months ended September 30, 2007.

Liquidity and Capital Resources. The liquidity and capital resources section provides a discussion of our cash flows for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007 and an update on our indebtedness.

CONF CALL

Jim Bombassei

Thank you for taking the time to join us for our fourth quarter and full year earnings call. Joining me for today’s discussion are Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; Tom Dooley, Chief Administrative Officer and CFO; and Jimmy Barge, Controller and Head of Tax and Treasury.

Please note that in addition to our press release we have slides containing supplemental information available on our website. Before we begin let me refer you to page number two in the web presentation and remind you that certain statements made on this call are forward looking statements that involve risks and uncertainties. These risks and uncertainties are discussed in more detail in our filings with the SEC. Reconciliations for non-GAAP financial information discussed on this call can be found in our earnings release or on our website.

Now I’ll turn the call over to Sumner.

Sumner Redstone

Viacom’s results, like nearly every company here and all around the world reflect the harsh economic climate that took hold in the second half of the year and particularly in the fourth quarter. We are clearly in one of the most pronounced economic troughs in generations. Indeed, I may be the only person on the call who has been around long enough to remember the last time we experienced the kind of economic challenges all of us are facing today.

My long experience also gives me great optimism. I am hopeful that this recessionary period will be short lived. I am certain of one thing; Viacom will weather this storm and emerge even stronger than ever before. The reason for my confidence is particularly because Viacom has all the attributes necessary to win, particularly in these challenging times.

We have a clear focus of content, we have the creative fire power to keep the hits coming, we possess powerful brands that move across platforms and command audience loyalty here and all around the world and most important, a resourceful and highly strategic management team, with the experience and with the skill to keep Viacom on the right course. Indeed, Viacom’s current strength in this environment is a tribute to Philippe and to Tom as well as to the entire management team.

Now, since I know many of you are interested in the status of negotiations between National Amusements and its creditors let me give you a brief update on the ongoing process. I want to remind you that National Amusements is more than just a holding company. National owns and operates movie theatres with more than 1,500 screens in the United States, United Kingdom and Latin America and Russia.

Unlike most of National’s competitors our operations are built for the most part on land that National owns. That’s something which I have insisted on from the beginning and that provides National with valuable real estate assets.

As I mentioned in November, as a result of the unprecedented combination of a covenant issue and the extraordinary market dislocation, National took the highly unusual step of selling a limited amount of Viacom and CBS non-voting shares. Since that sale, I can confirm that National has not sold and does not expect to be required by its lenders to sell any additional shares of CBS and Viacom, not a share.

A committee of National’s directors who have no executive role at either Viacom or CBS is working closely with National’s advisors and their creditors to reach a resolution. Constructive dialogue is continuing and I must tell you it has been very substantial progress since I last spoke to you. Indeed, I have been advised that an agreement acceptable to all parties is now within reach. Naturally, because the discussions are continuing, I cannot comment further. I ask that you hold your questions on this topic for now.

Now I want to thank you and turn this over to my good friend, that great executor, Philippe Dauman.

Philippe Dauman

We all know that 2008 was a difficult year for everyone and that these difficulties are persisting as we begin 2009. The economic downdraft hit hard in the later part of the year and we were not excluded. At the same time, we made strong progress at Viacom in strengthening our brands, our content, our organizational structure and our financial position.

Even as we performed well during the first part of the year, we recognize the serious threats to the economy as we approached mid year. We took a number of actions right away to temper the near term affect and prepare for tougher times ahead. While no one predicted just how far the economy would fall or the pace that decline I believe our early actions helped to mitigate the impact on our businesses.

During periods of uncertainty, among the most important assets are a strong balance sheet and a strong cash position. We focused on this early and will continue to do so. I have confidence that our early and decisive action and our continuing vigilance from aggressive cash management to prudent investments in the business to restructuring the organization position us well to operate effectively without diminishing our focus on building the long term value of our brands.

Even in adversity there is opportunity. For those of us in the business of entertainment we have historically had a product that people turn to in times of uncertainty. We are taking advantage of this opportunity by continuing to build our distribution model, growing our business with our traditional cable and satellite partners and leveraging new technologies to deliver content to audiences wherever they happen to be.

We’re exporting our brands into new marketplaces and finding new ways to monetize them. For example, we just announced 14 new applications on the iPhone including Sponge Bob Tickler, MTV News and Comedy Central Jokes.com. These applications have minimal development costs yet promising revenue potential over time.

Being ubiquitous while remaining absolutely authentic strengthens the exceptional connections we have with our audience and our scale and focus are tremendous assets particularly in difficult times. We have the unique ability to offer comprehensive solutions to our marketing partners, allowing them to communicate effectively with specific demographics in a timely fashion. Our scale and pivotal position with our distribution, marketing and production partners will serve us well in this environment.

We are managing Viacom to take full advantage of the opportunities that exist today and to quickly capitalize on those that will rise in the future. We don’t see macro economic improvement on the horizon just yet. The economy overall continues to soften and visibility, particularly in the ad market is still very limited. What I can say is Viacom is competitively well positioned for these difficult times and will be well positioned when the economic tide begins to rise. Despite the orgy of pessimism prevalent of late the economic tide in our economy and our industry will rise again.

Let’s move to a brief review of our fourth quarter and full year results. I’ll go through what’s happening in our Media Networks and Filmed Entertainment segments, Tom will wrap it up with a more detailed review of the numbers and trends, then we will open it up to your questions.

Previously announced restructuring and other charges we took in the fourth quarter had a substantial impact on our reported results for the quarter and the year. We also had a number of adjustments to our 2007 results. During our call this morning Tom and I will refer to the adjusted numbers unless we specify otherwise.

Consolidated revenues grew 9% to $14.63 billion for the year and they were flat during the fourth quarter at $4.24 billion. Media networks revenues were up 8% for the year and 1% in the quarter. Advertising revenues remained soft during the fourth quarter as marketers continued to pull back on spending.

However, despite a continuing dramatic decline in the overall economy our advertising revenues held relatively firm following the reduction felt in the third quarter. Worldwide advertising revenues were up 1% for the year and declined 3% during the fourth quarter. Domestic ad revenues were flat for the year and down 3% for the quarter.

Affiliate fees grew 12% for both the year and the fourth quarter, reflecting rate and subscriber increases across our core channels. Worldwide ancillary revenues increased 32% for the year and were flat versus the prior years fourth quarter primarily as a result of soft consumer product sales. Full year revenues in the film entertainment segment increased 10% to $6.03 billion driven by growth in theatrical revenue. For the quarter revenues declined 2% principally reflecting lower home entertainment revenue.

We announced a restructuring initiative in early December that was designed to better align our cost structure with the changing environment. This resulted in an aggregate of $454 million in charges. We expect these actions to save approximately $200 million this year. In addition, we have eliminated merit increases for senior executives across the company in 2009 and continue to take additional steps to contain costs.

Viacom’s net earnings from continuing operations on an adjusted basis were $1.5 billion for the year down 6% from 2007. For the quarter net earnings from continuing operations on an adjusted basis were $464 million a 16% decline over the prior year. Adjusted diluted EPS from continuing operations were $2.38 for the year and $0.76 for the fourth quarter.

We generated substantial cash, $1.75 billion in free cash flow for the year in a very tough environment. We have not purchased any shares under our share buyback program since December 31, 2008, when we reached our normal seasonal free cash flow peak. We will continue to evaluate and calibrate our buyback activity as circumstances evolve.

Now let me get into our segment performance, first Media Networks. All of our activities remain focused on the long term strategy of nurturing our great brands, finding new and profitable ways to extend those brands and creating new ones. Our deep connection with so many different demographics is what continues to make our brand so valuable to our distribution and marketing partners.

The affiliate sale side of our business had a very good year in 2008, generating low double digit revenue growth in each of the fourth quarters. We substantially increased our VOD offering with several distribution partners and expanded distribution of our emerging networks such as MTV, VH1 Soul and Logo as well as our HD simulcast.

We’re continuing to leverage new distribution platforms to increase where and when our audiences can access our programming such as our recent deal to provide mobile feeds to AT&T’s new in vehicle entertainment service. We’re going to make certain content available to Sling Media’s, Clip+Sling. We have already successfully concluded several major renewal agreements for this year.

As I have pointed out before, our networks attract more than 20% of the ad supported cable viewing audience but garner only about 8% of the fees. That said, it is clear from our discussions that cable and satellite partners recognize the value of our programming and our marketing efforts on their behalf. We feel quite comfortable in our ability to continue to grow this part of our business.

Our advertising results clearly reflect the overall downturn in the economy. Certain networks delivered solid growth across platforms and a few were challenged by combination of factors including the economy and rating softness. We were very pleased to see steady progress in a relatively new CP ratings our networks ranked number one compared with other programmers portfolios indexing in a 97.9 commercial retention rate.

Internationally, our organic advertising revenues were strong relative to domestic but the foreign exchange impact negated much of the growth. As I said, visibility is quite limited. Our up front commitments for Q1 are firm. Over the last two weeks we have seen an option exercises for Q2 starting to trend higher.

The major uncertainty relates to volume in the scatter market as the year progresses. It is clear that while as cable network owners we are in a more favorable media segment than most, advertising comps are likely to get worse before they get better. With our strong brands and innovative marketing initiatives we can still command industry leading prices but ratings do matter. We have solid ratings at many of our networks and we’re making demonstrable progress at our other channels.

Let me update you on a few of our networks. Nickelodeon is a blockbuster brand that continues to distance itself from its competition. On television 2008 was Nick’s most watched year ever with total viewers and it was the number one cable network among all kids’ demos for total day for the 14th consecutive year. Nick at Nite delivered 12 consecutive months of double digit year over year ratings growth.

We’re continuing to expand Nick’s influence with a whole family through initiatives such as ParentsConnect.com. The strength of this brand, across platforms has allowed Nick to expand its outreach to new marketing categories, offering advertisers the opportunity to create broad multi-platform campaigns that effectively reach both parents and kids.

Two thousand nine will bring a number of exciting new initiatives where one that you will hear about above and below sea level is the 10th anniversary of Sponge Bob. This is a brand whose appeal crosses many demographics and we’ll be capitalizing on that appeal in all new ways. There will be new content, a special documentary, musical forays, uniquely held partnerships and limited edition consumer products. The ultimate Sponge Bob online destination and special events throughout the year. This will be a year to soak up all things Sponge Bob.

Comedy Central is another example of a brand that we are continuing to grow with great success. The network had its highest rated fourth quarter ever in 2008 with its most watched year ever amongst several core demos as well as total viewers. Its shows like The Daily Show With Jon Stewart and The Colbert Report broke ratings records throughout the year and became a critical voice in the national conversation about the Presidential Election.

South Park was a number on original basic cable series of the year among men 18-24 for the fifth year in a row. Comedy Central’s multi-platform results which saw significant growth, challenged the notion that a programs presence online will cannibalize its linear performance. In fact, it continues to prove that with the right content and the right business strategy more is better.

Last quarter I specifically mentioned three of our core networks that have soft ratings. Let me update you on their progress. First, MTV, last quarter we began to narrow the decline in rating while preparing a bold new slat of programming initiatives and shows for Q1. We have already launched several new programs including Daddy’s Girls which is building off of The City’s strong run. The third season of America’s Best Dance Crew and TI’s Road To Redemption.

The new lineup is beginning to deliver sequential improvement with ratings quarter to date down 12% year over year compared with the decline of 21% in the fourth quarter. This past Sunday we launched a new two hour prime time block of programming that reflects the engaged and adrenalized spirit of our core demo and the ratings from the first night were very strong, especially in the young male demo where we had the two highest rates series premiers in five years.

VH1 is also rebuilding ratings momentum. During the fourth quarter rates were down 8% year over year which was a double digit ratings improvement over its third quarter performance.

BET made several changes in the back half of the year to strengthen the networks programming. The networks new programming leadership team pushed an aggressive agenda in the fourth quarter that reversed BET’s ratings decline. In the final weeks of the year BET’s ratings showed notable improvement and in January ratings for BET were up 6% year over year.

Coming up, the network has a strong programming slate featuring more original shows than ever before and a significant increase in movies which historically perform very well on the network. BET has also been very successful in scaling up its news programming to capitalize on momentous events such as the Presidential Election and Inauguration.

I also want to briefly cover our international operation which made great progress in 2008 generating double digit revenue growth and further margin expansion. A couple of key highlights include the launch of the first ever international HD music and kids service across several countries in Europe and Latin America. Through our joint venture in India we launched Colors, a new Hindi language general entertainment channel that defied expectations by leaping to the number two spot in a very crowded market.

The soft retail environment definitely weighed on sales of our consumer products particularly during the fourth quarter. This also impacted sales of Rock Band which has a relatively high price point. That, however, does not diminish the franchises great success so far. Rock Band was a number game title of 2008 by revenue across all game genres with more than 10 million units shipped worldwide since its launch. Rock Band 2 sold nearly two million units through year end on Xbox and PlayStation 3 alone.

Looking forward, we expect to see a continuing sales shift from hardware to software as original Rock Band owners upgrade to Rock Band 2. This shift will impact our revenue growth but it will also improve profitability.

Now let’s move to Filmed Entertainment, 2008 was a pivotal year for Paramount in several ways. It had another year of strong box office performance achieving a number two spot in domestic market share and releasing seven films that each generated more than $100 million in domestic box office. The studio ranked number one in international market share and it crossed the $2 billion threshold in international box office.

The successful slat resulted in 23 Oscar nominations including 13 for the Curious Case of Benjamin Button. I am very pleased with the progress we’ve made on the creative front. The refinement of Paramount’s film slat strategy coupled with a robust development pipeline has placed the studio in a very strong position. We are working with some of the greatest creative partners in the business.

Our distribution partnerships with DreamWorks Animation and Marvel strengthened the revenue generating potential of our studio while mitigating our financial risk. We have also taken steps to reduce the studio’s cost structure. We leveraged Paramount’s infrastructure to produce and distribute Paramount vantage films, reached a constructive new arrangement with Steven Spielberg and reduced staffing across the studio. You can expect us to take additional steps to improve its overall profitability and mitigate downside risk and capital utilization.

Industry wide, theatrical revenues are holding up well. As has been widely discussed over the past week, the home entertainment market is the most important revenue driver for the industry was hit by the downturn at retail. It is worth noting that we did see strong performance from blockbuster hits such as Iron Man and Indiana Jones.

Our download to own revenues, while relatively small, continue to grow significantly. Our full year revenues nearly doubled and in the fourth quarter, download to own revenues more than doubled. In addition, Paramount continues to break new ground with new distribution deals and innovative partnerships to leverage our immense library of content in the digital space.

Looking ahead, we have a great slate for 2009. Next month we’ll distribute DreamWorks Animations Monsters vs. Aliens in 3-D. In the second and third quarters will be dominated by three widely anticipated tent poles. JJ Abram’s Star Trek, Michael Bay’s, Transformers 2, Revenge of the Fallen, and GI Joe. Of course these tent poles will be joined by an impressive list of other films including Martin Scorsese’s Shutter Island with Leonardo DiCaprio.

To conclude, the business world has changed radically over the last several months and I am confident that by moving early and preparing ourselves for these changes we are very well positioned both in the near and the long term. Importantly, we have done this without sacrificing our focus on and investment in creating new branded content that keeps us the first choice destination for our audiences.

Now I am very pleased to turn it over to my partner, Tom.

Tom Dooley

I hope you’ve all had a chance to review our earnings release and web presentations summarizing our fourth quarter results. Our 10-K will be filed shortly with the SEC and should be available later today. This morning I’m going to take you through our fourth quarter results in more detail and I’ll update you on the key factors impacting 2009. Also, I’ll spend some time discussing our balance sheet and cash position.

My remarks will exclude the recently announced restructuring charges of $454 million in the fourth quarter of 2008 as well as $7 million of restructuring charges that were incurred in last year’s fourth quarter. In addition, the fourth quarter of this year included a discrete tax benefit of $9 million related to prior years audit settlements as well as $15 million in non-cash investment impairment charges. My remarks will focus on our adjusted results from continuing operations as discussed in our earnings press release.

We believe that adjusted results are a better indicator of our core business performance. Turning to our segment results in the quarter I will start with the Media Networks group. The Media Networks group grew revenues 1% to $2.5 billion in the fourth quarter. The strengthening dollar decreased the worldwide revenue growth rate by two percentage points. On an organic basis worldwide Media Networks grew 3%. Page 12 of our web deck provides a breakdown of Media Network’s revenue growth.

Worldwide advertising revenues declined 3% in the quarter to $1.3 billion. Domestic advertising revenues declined 3% reflecting softness in the overall ad market as well as rating declines at some of our networks. Studio spending was down due to lower volume with 10 fewer titles released in the fourth quarter of this year compared to last year. We also experienced weakness in the toys and beverage categories given the soft retail environment and the corresponding pull back in spending by markets]]>Thu, 05 Mar 2009 08:49:25 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/1902/http://www.dailystocks.com/forum/showtopic.php?tid/1902/
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BUSINESS OVERVIEW

Terra Industries Inc. together with its subsidiaries (“Terra”, “we”, “our”, or “us”) is a leading North American producer and marketer of nitrogen products, serving agricultural and industrial markets. In addition to manufacturing facilities at Port Neal, Iowa; Courtright, Ontario, Canada; Yazoo City, Mississippi; and Woodward, Oklahoma, we own a 75.3% interest in Terra Nitrogen Company, L.P. (“TNCLP”), which, through its subsidiary, Terra Nitrogen, Limited Partnership, operates our manufacturing facility at Verdigris, Oklahoma. We are the sole general partner and the majority limited partner of TNCLP. In addition, we own a 50% interest in Point Lisas Nitrogen Limited (“Point Lisas”), an ammonia production joint venture in the Republic of Trinidad and Tobago. We also own a 50% interest in GrowHow UK Limited, a nitrogen products production joint venture with facilities located in the United Kingdom; the GrowHow UK Limited joint venture was established in September 2007.

We are one of the largest North American producers of anhydrous ammonia (or ammonia), the basic building block of nitrogen fertilizers. We convert a significant portion of the ammonia we produce into urea ammonium nitrate solutions (UAN), ammonium nitrate (AN) and urea. Each of these products is easier for distributors and farmers to transport, store and apply to crops than ammonia. We also convert ammonia to nitric acid and dinitrogen tetroxide for use in industrial applications.

We also own two manufacturing facilities in North America that are not currently in production. The Beaumont, Texas methanol and ammonia production facilities were mothballed in December 2004 and are under contract to be sold to Eastman Chemical Company. The Donaldsonville, Louisiana ammonia plant was mothballed in the first quarter of 2005; however, we announced in February 2008 that we intend to restart the Donaldsonville ammonia plant during the third quarter of 2008.

2007 Overview

The North American nitrogen industry experienced substantial growth in 2007 earnings due to higher product prices in response to increased demand for fertilizers used as inputs for key commodities, including corn and wheat, and also due to relatively stable natural gas prices.

During 2007, we undertook two significant business transactions. We concluded the merger of our U.K. ammonia production business and operations with that of Kemira GrowHow Oyj to create a joint venture, GrowHow UK Limited, which is owned 50/50 by Terra and Kemira GrowHow Oyj. The joint venture was established in an effort to secure a sustainable, long term base for manufacturing ammonium nitrate fertilizer and process chemicals in the U.K. We also entered into a contract with Eastman Chemical Company to sell to Eastman the assets of our Beaumont, Texas facility. We expect the sale of the Beaumont, Texas assets to be concluded on or before January 1, 2009.

GrowHow Joint Venture

On September 14, 2007, we completed the formation of GrowHow UK Limited (GrowHow), a joint venture with Kemira GrowHow Oyj (Kemira). Pursuant to the Joint Venture Contribution and Shareholder Agreements with Kemira (the “GrowHow Agreements”), we contributed our subsidiary Terra Nitrogen (UK) Limited to the joint venture for a 50% interest in the joint venture, and Kemira contributed its Kemira GrowHow UK Limited subsidiary for the remaining 50% interest. The GrowHow joint venture in the United Kingdom includes the Kemira site at Ince and our Billingham and Severnside sites. Pursuant to the GrowHow Agreements with Kemira, we are eligible to receive additional consideration based on the future operating cash flows of GrowHow. We will receive a minimum additional consideration payment of £20 million, and have the right to receive up to £60 million, based on GrowHow’s operating income.

On October 9, 2007, GrowHow announced the closure of its Severnside manufacturing facilities. The closure is expected to be completed by the end of January 2008. Pursuant to the GrowHow Agreements, we are responsible for remediation costs required to prepare the Severnside site for disposal, net of sales proceeds, in excess of £1 million. We are also entitled to receive any excess sales proceeds above the cost of remediation, in excess of £1 million. We anticipate that the proceeds from sale of the Severnside land would exceed the total cost of reclamation of the site. For additional information regarding the GrowHow joint venture, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , and Note 7 of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data , of this Annual Report on Form 10-K.

Sale of Beaumont Facilities

On July 18, 2007, we announced that we entered into agreements with Eastman Chemical Company (Eastman) resulting in Eastman’s agreement to purchase all the assets of our Beaumont, Texas facility. We anticipate closing the sale on or before January 1, 2009. In connection with entering into these agreements, we determined that the value of our Beaumont facility was impaired and we recorded a $39 million impairment charge for the quarter ended September 30, 2007. For additional information regarding the sale of our Beaumont facility, see Item 7, Management’s Discussion and Analysis of Financial Conditi