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Executives

Bernard P. Aldrich - President and Chief Executive Officer

Robert M. Wolf – Chief Financial Officer

Manuel M. Almeida – Executive Vice President, Sales and Marketing

Analysts

Chuck Murphy - Sidoti & Company

Greg McKinley – Dougherty & Co.

Gerry Heffernan - Lord, Abbett and Company

Rimage Corporation (RIMG) Q3 2008 Earnings Call October 22, 2008 10:00 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Rimage Corporation third quarter earnings conference call. (Operator Instruction) As a reminder, this conference is being recorded today, Wednesday, October 22, 2008. I would now like to turn the conference over to Mr. Bernie Aldrich, President and Chief Executive Officer.

Bernard P. Aldrich

Good morning and thank you for taking the time to participate in our third quarter earnings conference call. Joining me today is Rob Wolf, our Chief Financial Officer, who will review our recent operating results following my opening remarks. Also with us is Manny Almeida, our Executive Vice President of Sales and Marketing. We'll be pleased to take your questions at the conclusion of our remarks.

Since regulation FD prohibits us from providing any forward-looking statements unless they are simultaneously released to the public, we have provided financial guidance for the fourth quarter of 2008 in this morning's release. It is important to understand that this guidance is subject to a number of risks that could affect our anticipated performance. These risks are set forth in our filings with the Securities and Exchange Commission, which we urge you to review.

Turning now to the subject of this conference call, our third quarter sales totaled $25.2 million. This compares to $33.7 million in the third quarter of 2007, which included $8.4 million of retail-related equipment sales, maintenance contracts, and replacement printer ribbons. There were no significant retail-related equipment sales in the current quarter.

Third quarter earnings of $4.0 million, or $0.42 per diluted share, were down from $6.2 million, or $0.59 per diluted share in the same period of 2007.

Our third quarter sales and earnings exceeded our previously issued guidance for this period, due primarily to higher than forecasted sales digital publishing equipment transacted through our global channel.

As a result, our gross margin was higher than anticipated, which had a positive impact on Rimage’s profitability for this period. With that said, the fact remains that economic conditions are continuing to affect our business. Many customers have adopted a cautious attitude toward capital expenditures, which has resulted in lengthened selling cycles for our equipment.

It is impossible for us to forecast when market conditions will start to materially strengthen, but it is important to point out that Rimage has remained profitable in 2008, with year-to-date earnings of $0.79 per diluted share.

Our ability to remain solidly profitable despite the challenging global economy stems from several key factors. For instance, our third quarter net margin of 16% demonstrates that a significant portion of every sales dollar flows through to our bottom line. There are several main reasons for this.

Rimage is not a capital-intensive business. In addition, we have significantly streamlined our cost structure through the annualized $2.0 million of expense reductions that we instituted earlier this year. Moreover, since we are virtually debt free, our operating income is not materially eroded by interest expense. Our sales and earnings also have benefitted from several other factors.

First, we are strengthening our distribution channel. Among other things, we are carefully reviewing each of our distribution partners as we explore new ways to expand the penetration of our full line of products into our customer base.

Second, we are continuing to benefit from our position as the industry-leading provider of CD, DVD, and Blu-ray publishing solutions for mission-critical, high-end applications. Supported by this position, our field sales force and distribution partners are continuing to report customer interest in our optical technology across a broad range of applications.

Third, our sales representatives and distributors have stepped up their efforts to pursue all available opportunities.

Fourth, and equally important, Rimage’s strong financial condition is enabling us to operate effectively in today’s challenging global economy. We ended the third quarter with cash and investments of nearly $91.0 million, working capital of $66.0 million, and a virtually debt-free balance sheet. As a result, we have more than ample resources for supporting our various growth initiatives without recourse to capital markets.

Turning to the financial guidance contained in this morning’s release, we expect to remain solidly profitable in the fourth quarter ending December 31, 2008, with forecasted earnings of $0.15 to $0.21 per diluted share on sales of $20.0 million to $22.0 million. At this level our full-year earnings would be in the range of $0.94 to $1.00 per diluted share.

Longer term, we remain optimistic about Rimage’s future. We are establishing the foundation required for penetrating several highly promising business service markets, including media and broadcasting, law enforcement, education, government, software, and professional services.

Taken as a whole, these business service applications represent highly promising growth opportunities and supported by our strong cash position, we are moving forward with the development of the next generation as well as upgraded products that will keep Rimage at the forefront of the on-demand disc publishing industry.

All in all, we have every reason to believe that Rimage’s future is promising.

Thank you. And now Rob Wolf will review our third quarter results in some detail.

Robert M. Wolf

First I will run through some third quarter sales highlights. Sales of digital publishing equipment declined 46% in the third quarter of 2008 and accounted for 42% of total sales compared to 57% in the third quarter of 2007.

The absence of significant retail-related equipment sales in this year’s third quarter was primarily responsible for the year-over-year decline in this revenue category.

Recurring revenues, including sales and printer ribbons and cartridges, parts, blank CD/DVD media and maintenance contracts increased 3% in the third quarter and accounted for 58% of sales compared to 43% in the third quarter of 2007.

Consumables have accounted for a significantly larger portion of our sales mix during 2008 due to the economy-related slowdown in sales and disc-publishing hardware. In addition to the expansion of our base of retail installations that occurred in 2007.

International sales declined 3% in the third quarter and accounted for 35% of total sales compared to 27% in the year earlier period. Our lower international sales reflect the impact of weakening economic conditions on our European and Asian operations.

Rimage’s gross margin was 48% in the third quarter, up from 44% in the second quarter and down modestly from 49% in the third quarter of 2007. Our third quarter gross margin was higher than originally anticipated due to better than forecasted sales of disc-publishing hardware. At this time we believe our gross margin for the fourth quarter will be in the low- to mid-40% range.

Moving down the P&L, our overall cost structure in the third quarter benefitted from the $2.0 million of annualized expense reductions that we instituted in May.

Third quarter R&D expense came to $1.2 million, down from $1.5 million in the second quarter and $1.6 million in last year’s third quarter. Despite the reduced level of R&D expense, we are moving forward of the development of next generation products, in addition to important enhancements to our current product line. R&D spending in the fourth quarter of 2008 is forecasted to be 5% to 10% above the third quarter level.

Selling, general, and administrative expense totaled $5.2 million in the third quarter, down from $5.7 million in this year’s second quarter and $6.2 million in the third quarter of 2007. SG&A is expected to be 5% to 10% above the third quarter level due to several non-recurring items.

Our operating margin rose to 22% in this year’s third quarter from 12% in the second quarter, but was down from 26% in the third quarter of 2007.

We are taxed at an effective tax rate of 36% in the third quarter and believe our effective income tax rate for 2008 will be in the range of 35% to 37%.

Turning now to our balance sheet. Cash and investments totaled $90.6 million at the end of the third quarter, compared to $93.7 million at the end of the second quarter, and $94.2 million at the beginning of 2008.

During the quarter cash of $4.3 million was used to repurchase approximately 275,000 Rimage shares under two $500,000 share buyback authorizations. And during the first nine months of 2008 we used cash of $9.3 million to repurchase a total of 551,000 shares.

Approximately 449,000 shares remain available for repurchase under our one uncompleted authorization.

In addition, we used cash of $3.9 million in this year’s third quarter to purchase Rimage’s Minneapolis headquarters and manufacturing facility.

Stockholders equity came to $106.6 million at the end of the third quarter compared to $107.1 million at the end of the second quarter and $105.1 million at the end of 2007.

That wraps up our formal remarks and now the conference call operator will poll you for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chuck Murphy - Sidoti & Company.

Chuck Murphy - Sidoti & Company

Can you tell us as far as the end market that you’re serving, are any of them doing better or worse than the rest?

Bernard P. Aldrich

I guess when you talk end markets, if you look at particular markets, whether it be in the broadcasting, education, government, professional services, I think the good part of our business is that it is broad-spread. I think if you look at the particular quarter that just ended, take the government sector for an example. The way the government budgets, the third quarter is always a very significant quarter for us in the government end. It was no different this past quarter.

We continue to see a broad range of markets and applications being served. With the exception of, as we mentioned earlier, the retail sector is one that has definitely been impacted this past year as a direct result of the economy. It puts capital budges on a hold.

Chuck Murphy - Sidoti & Company

And within government, is there any particular application that stands out or any particular branch of the government that stands out?

Bernard P. Aldrich

I think in today’s world, definitely Homeland Security has a large impact on government. And the nice things about government is, our business is all about distributing information. And nobody collects more information and distributes more information than our government. And we are a nice add to that. We facilitate that function and it’s a market that has many diverse needs. But we definitely have very strong inroads in areas of Homeland Security and Defense.

Chuck Murphy - Sidoti & Company

So it’s more a matter of secure distribution of files.

Bernard P. Aldrich

Yes, to a large extent. And yet it gets down to some very basic things, such as if you take the military and you look at all the, take the vehicles and tanks and things of that nature, think of all the repair manuals, something as basic as that. Or training manuals. And all of that is distributed on discs.

Chuck Murphy - Sidoti & Company

Anything new on the kiosk front, both movie and photo?

Manual M. Almeida

I would say the answer to that would be no. The movie front has been very slow to come into the market. We have not been dependent on it. Our dependency within retail has continued to be primarily in the photo area, and around the archiving of images, either from a digital camera or from film, from the little film that is still being shot, which is pretty low volume these days.

We are not focused on nor are we dependent specifically on kiosk business for our success.

Chuck Murphy - Sidoti & Company

And nothing really new on the photo side either?

Manual M. Almeida

I think you can tell from the fact that we had little or no retail business, there were no new deployments of equipment in photo but the fact is we have over 3,000 systems deployed in the market place today and they continue to generate a good amount of revenue from consumables.

Do we think it’s over? No, but it is a difficult market and you just have to read retail numbers for the last few months to see that there are some very large retailers that are struggling.

Chuck Murphy - Sidoti & Company

I was just more wondering was anybody testing it or anybody new that you haven’t talked to before showing any kind of sign of interest for photo.

Bernard P. Aldrich

We are a pretty known commodity within the retail sector and the people that we work with. What we are looking for is where there exists real opportunity, or else looking for retail partners who have the capital to spend.

It’s a very tightly focused market for us.

Chuck Murphy - Sidoti & Company

Rob mentioned that SG&A would be a bit higher in 4Q because of some non-recurring. What were those?

Robert M. Wolf

Just for an example, one of them that we are going to undertake in the fourth quarter is updating our website, so that will be one example of a non-recurring item. Should be pretty well completed by the end of the year.

Operator

Your next question comes from Greg McKinley – Dougherty & Co.

Greg McKinley – Dougherty & Co.

I wonder if you could talk a little bit more about gross margins. I know you indicated that you felt some of the gross margin traction this quarter was due to disc-publishing hardware sales. But looking back to the second quarter, you had the same sales mix in consumables in September that you did in June and yet margins moved dramatically. I’m wondering if there were any other moving parts in there that could help us better understand that.

Robert M. Wolf

Primarily, if you look at the product mix, we talk about between our platforms is where the main difference is, between third and second quarter. So our platform A and B, which you might understand as our producer/professional platforms, were a heavier mix of those in the third quarter than we saw in the second quarter.

Greg McKinley – Dougherty & Co.

What was that? Can you give me a sense for that? If consumables was 58% of the total, was producer 40 and just a small plug in desktop.

Robert M. Wolf

I would have to get back to you on the exact percentages, but I can tell you is also the other driver would be desktop did decrease also from second quarter to third quarter.

Greg McKinley – Dougherty & Co.

And in terms of your SG&A, where are you, do you think, in the process of realizing some of these cost savings? I mean, are they fully implemented and Q3 is a good representative of sort of a run rate basis for expenses at the company. Or was Q3 still a transition period where expense was coming out of the business?

Robert M. Wolf

Q3 is an example of a period where we did recognize some savings as a result of the $2.0 million annualized reductions that we had. And we do expect that to carry forward on an even basis going into the fourth quarter and forward.

Greg McKinley – Dougherty & Co.

So it’s fully implemented at this point.

Robert M. Wolf

Yes it is.

Greg McKinley – Dougherty & Co.

What was your stock comp in D&A during the quarter?

Robert M. Wolf

Depreciation and amortization was around $200,000 to $300,000. And the stock comp was about $450,000 for the period.

Operator

Your next question comes from Gerry Heffernan - Lord, Abbett and Company.

Gerry Heffernan - Lord, Abbett and Company

The cash flow for the quarter, I know that you went through where the cash positions are and the amounts used for buyback, but if you could just give the cash flow from operations for the quarter.

Robert M. Wolf

I can give you for the year. So far year-to-date cash flow for operating activities is about $6.8 million. For the quarter if you see what we did in terms of buying back stock and also the building purchase, $4.3 million for the share buyback, and about $4.0 million for the building. And our cash actually decreased approximately $4.0 million. So operating cash flow in that third quarter is probably $3.0 million to $4.0 million.

Gerry Heffernan - Lord, Abbett and Company

So it was a particularly strong quarter for cash flow.

Robert M. Wolf

It was.

Gerry Heffernan - Lord, Abbett and Company

Although that year-to-date number includes those things also. When we’re looking at the fact that you have the capacity for another 490,000 shares in buyback, let me ask you this. What was the share count at the end of quarter?

Robert M. Wolf

Share count outstanding was about 9.5 million.

Gerry Heffernan - Lord, Abbett and Company

And you have the capacity, under current approval, for another 490,000 shares to be bought back.

Robert M. Wolf

450,000.

Gerry Heffernan - Lord, Abbett and Company

Another 5% of the total outstanding base.

Robert M. Wolf

Yes.

Gerry Heffernan - Lord, Abbett and Company

Given your share buyback capacity and your cash flow generation, are there any other business uses of that cash flow at this time?

Bernard P. Aldrich

As far as immediate use, no, but again, in the business we’re in and in a market that we see that there are opportunities for continued growth, we also continue to explore opportunities within our core optical business but also beyond the optical world.

And so I think ultimately there will be need for cash, as we go through this process of continuing to grow this business.

Gerry Heffernan - Lord, Abbett and Company

I’m just thinking on a more tactical, if there’s any capex programs that you were looking for in the next 12 months.

Manual M. Almeida

No, the only thing we would have, we may have a greater investment in R&D as we go forward over the next 12 months.

Gerry Heffernan - Lord, Abbett and Company

I’m looking at a pretty healthy reduction in R&D of about 20% on a quarter-to quarter basis, 2007 versus 2008, and also a decent reduction just on the 9 month, 4.6 down to 4.1. Let me approach this from kind of perhaps a different from the norm review. Is it high enough? Should I be concerned that you are paring back the R&D spending too much and it will hurt the viability, the growth of the company in two to four year out?

Bernard P. Aldrich

First question is it high enough? In my personal opinion? No. It’s not high enough. But, gain, R&D tends to ebb and flow. As we go through projects you will have periods where those costs come in and I think what we’re looking at here more than anything is timing. As we wind down some significant projects.

I think there also, every now and then, you have to have this period where you have stabilization of your products, both on a hardware and software side. And at the same time it’s putting together all the components as you go into a new development phase. And that’s really what I think we’re seeing here in the third quarter. And as we go forward into the fourth quarter and into next year you will see higher R&D expenses.

Gerry Heffernan - Lord, Abbett and Company

As we get into kind of, as you described, the next project phase, if you will, as far as where you’re looking to take your current products into a next generation.

Bernard P. Aldrich

Yes. And within the core, the core sector of technology and markets that we serve. And it is looking beyond that, as well.

Gerry Heffernan - Lord, Abbett and Company

You spoke about the government sector often has a strong Q3 and that was indeed the case this quarter. It seems though, that conversation was dealing primarily with a U.S. government sector. How much have you been able to penetrate the international government sector and what opportunity is held there?

Bernard P. Aldrich

Quite honestly, we do very little in the international government sector. Are there opportunities? Yes. What breadth of resources do we have to reach those? What is the most immediate opportunity? The question we always face, where do you invest.

There are still significant opportunities and much of that government business is driven right out of the U.S. so that’s where we stay focused. And we do some government business within Europe as well as Asia but this is the primary market.

Manual M. Almeida

And I think it is important to note that we hold a GSA government contract within the U.S. We don’t anywhere else in the world. It’s also fair to say that we do a fair amount of business with NATO, for example, over in Europe, but it’s not the concerted effort that we have with the U.S. government.

Operator

There are no further questions.

Bernard P. Aldrich

Thank you for joining us this morning and we look forward to speaking to you at the end of the fourth quarter.

Operator

This concludes today’s conference call.

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