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Executives

Bernie Aldrich – President and CEO

Rob Wolf – CFO

Manny Almeida – VP of Sales and Marketing

Analysts

Greg McKinley – Dougherty & Company

Chuck Murphy – Sidoti & Company

Dick Feldman – Monarch Capital Group

Rimage Corporation (RIMG) Q4 2008 Earnings Call Transcript February 18, 2009 10:00 AM ET

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Rimage Corporation fourth quarter earnings call. (Operator instructions) As a reminder, this conference is being recorded today, Wednesday, February 18, 2009. I would now like to turn the conference over to Bernie Aldrich, President and Chief Executive Officer. Please go ahead sir.

Bernie Aldrich

Good morning and thank you for taking the time to participate in our fourth 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.

Unable to be with us today is Sherman Black who as we recently announced has been named President and Chief Operating Officer. We are extremely pleased to have an executive of Sherman’s capabilities join Rimage. Given his wide ranging and highly successful career in senior management with Seagate Technology, his appointment will significantly strengthen our management team. In addition to being responsible for our daily operations, he will help us formulate a long-range strategic plan and evaluate new business opportunities and technologies. Following his scheduled start date on April 1, I will continue in my role as Rimage’s Chief Executive Officer.

Moving on, Regulation FD prohibits us from providing any forward-looking statements unless they are simultaneously released to the public, it is important to understand that any forward-looking statements are 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 fourth quarter sales came to $20.7 million compared to $28.2 million in the year earlier period. Fourth quarter earnings of $1.7 million, or $0.18 per diluted share were down from $4.5 million, or $0.45 [ph] per diluted share in the same period of 2007. Both sales and earnings were consistent with our previously issued guidance for this period. Given the severity of the global economic downturn and its impact on our markets, we are encouraged to be reporting a solid level of profitability for the fourth quarter. Interestingly our CD, DVD and blue-ray disc publishing capital equipment across a wide range of applications remain sound. However confronted by weak economic fundamentals, customers have adopted an extremely cautious posture towards capital expenditures. This cautionary approach has significantly lengthened selling lead times. This results in a reduction in hardware sales during the fourth quarter and a larger percentage of consumable sales which generate lower margins and consequently lower profitability. In response to the current economic operating environment, we have taken several actions to streamline Rimage’s expense structure. Through workforce reductions over the past nine months, we have reduced our worldwide employee base by approximately 20%. We paid no bonuses to executive officers in 2008; in addition salaries for 2009 have been frozen at the 2008 levels on a company-wide basis. Since we are unable to predict when our markets will begin to materially strengthen, we are prepared to take additional cost-saving measures as required.

Now that I have outlined some of the challenges we are facing, I would like to spend a few minutes discussing a number of the positives in our business. For example, the government market continues to generate solid demand for our products. We intend to strengthen our sales effort in this area. We also are optimistic about the future of archiving and video applications as well as electronic medical records. These opportunities exist not only within the US but also within our other geographical markets in Europe, Asia and Latin America. We take advantage of these and other opportunities, we continue to enhance the capabilities of our existing hardware and software as well as invest in the development of new products to keep Rimage at the forefront of the on-demand disc publishing industry. Rimage’s strong financial condition is enabling us to pursue these and other opportunities in a global economy where credit has become difficult to attain. With cash and investments of more than $95 million at the end of this year’s fourth quarter, working capital in excess of $62 million and a virtually debt-free balance sheet, we possess more than adequate resources for supporting our various growth initiatives (inaudible) we provided no financial guidance for this quarter of 2009. Moreover, we do not plan to give any quarterly guidance over the balance of this year. We made this decision due to the lack of visibility and abundance of uncertainty in our markets. This decision should not be taken as a lack of confidence in Rimage’s future; on the contrary we see our long-term future as highly promising. We are actively pursuing attractive opportunities across a full range of markets, some established, some emerging. We are pushing ahead with R&D on next generation and upgraded products and we will be evaluating new technologies and business opportunities. Although our near term performance may lag our historic norms, we have a great deal of confidence in Rimage’s prospects over the long haul.

Thank you and now Rob will review our fourth quarter results in some detail.

Rob Wolf

Thanks, Bernie. First I will run through some fourth quarter sales highlights. Sales of digital publishing equipment declined 42% in the fourth quarter of 2008 and accounted for 36% of total sales compared to 46% in the fourth quarter of 2007. Recurring revenues including sales of printer ribbons and cartridges, parts, blank CD/DVD media and maintenance contracts decreased 13% in the fourth quarter and accounted for 64% of sales compared to 54% in the fourth 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 of disc publishing hardware in addition to the expansion of our base of retail installations that occurred in 2007. International sales declined 27% in the fourth quarter and accounted for 44% of total sales during both the fourth quarter of 2008 and 2007. Our lower international sales reflect the impact of fluctuating currency rates and weakening economic conditions in our European and Asian operations. Currency effects decreased worldwide sales by 3% in the fourth quarter of 2008.

Rimage’s gross margin was 39% in the fourth quarter down from 48% in both the third quarter of 2008 and the fourth quarter of 2007. Our gross margin in this year’s fourth quarter was primarily affected by the shift in our sales mix towards consumable supplies which carry lower gross margins than those associated with disc publishing hardware. Moving down the P&L, our overall cost structure in the fourth quarter continued to benefit from $2 million of annualized expense reductions that we instituted in May. R&D expense came to $1.2 million during the fourth and third quarters of 2008 and $1.3 million in last year’s fourth quarter. Despite the flatness of R&D expense, we are continuing investments in new product development in addition to important enhancements to our current product line. Selling, general and administrative expense totaled $5.1 million in the fourth quarter down from $5.2 million in this year’s third quarter and $6.1 million in the fourth quarter of 2007. Our operating margin as a percent of revenues was 9% in this year’s fourth quarter down from 22% in the third quarter of 2008 and the fourth quarter of 2007 (inaudible) decreased sales and a shift in product mix from hardware to consumables supply were the primary drivers of decline in operating margin as a percent of revenues. We were taxed at an effective rate of 35% for the full year of 2008 and 2007.

Turning now to our balance sheet, cash and investments totaled $95.4 million at the end of the fourth quarter compared to $90.6 million at the end of the third quarter and $94.2 million at the beginning of 2008. During the quarter, cash of $300,000 was used to repurchase approximately 26,000 Rimage shares under two $500,000 share buyback authorizations. And for the full year of 2008, we used cash of $9.6 million to repurchase a total of 577,000 shares. Approximately 423,000 shares remain available for repurchase under our one uncompleted authorization (inaudible) Stockholders’ equity came to $109 million at the end of the fourth quarter compared to $106.6 million at the end of the third quarter and $105.1 million at the end of 2007.

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

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Greg McKinley with Dougherty & Company. Go ahead please.

Greg McKinley – Dougherty & Company

Hi, good morning.

Bernie Aldrich

Good morning, Greg.

Greg McKinley – Dougherty & Company

Good morning. I am wondering if you could talk to us a little bit about what you are seeing in terms of investment opportunities outside of your core digital publishing systems as you look at sort of managing the lifecycle of our technology over the long term, are you actively sort of scouting the market to see if there is complementary technologies that you could acquire to bring into the business or you are just not seeing – you have not maybe identified that direction, you are not seeing anything attractive in there and maybe just believe in the best use of your cash to preserve the balance sheet right now?

Bernie Aldrich

Okay, this is Bernie, Greg. No, we are definitely researching and looking at what is available out there. I think there are a number of factors. First, in the ideal world, you would love to find something that is really closely aligned and adjacent to what we do where you can leverage perhaps your sales channel, your sales force, your service capabilities some of the existing technologies we have. That being said, that is a real challenge because we also know any time you got to expand your business space, you are not very successful if you decide you are going to be at 180 degrees from where you are today, so it is really how do you migrate that way. In addition to that in today’s market, I think there is a lot of uncertainty out there, I also think as far as valuations for some of these businesses (inaudible) one has to be cautious. If one would have made an acquisition even six months ago, the value you would have paid for that business would have been significantly more than you would pay today, and in our view I think some of those valuations are still perhaps much simpler than the analogies the housing market may not have reached their bottom level yet. We recognize that like all companies you have to continue to evolve and move and I think one of the clearest messages we have sent is with bringing Sherman Black onboard really does put us at the forefront of looking forward and where we are going to be as a company over in five to ten years.

Greg McKinley – Dougherty & Company

So, can you talk a little bit more about that, what is he bringing to the table? Is it maybe a different perspective or broader perspective of new technologies the company could pursue or is it maybe just different applications of the current technology that you own?

Bernie Aldrich

Yes, I think, first and foremost, it is a different perspective in that he does not come out of the optical world. Most of us have been in this world. When I came into this operation 12 years ago, I did not come out of the technology sector even and so there were not any stronger legions on my part to get a floppy disc and move into optical. In fact I really felt that – I felt an urgency to really move faster than what the company was moving at that time. I think that Sherman can bring that same type of perspective to us now. The only difference is we are in a technology with optical it is much more broader, it has a much larger installed base and certainly has longer legs than floppy discs, so that is one of the things. But he will bring an entirely different perspective because he did not come out of optical. He will have a different network of peers, he will have a different perspective on technology but at the same time he has an understanding and as I look back, I think one of the real benefits I see with Sherman is that you will have a little deeper understanding of the technology aspect than perhaps – certainly more than I did when I came in 12 years ago.

Greg McKinley – Dougherty & Company

Great. And then maybe just last question, with him coming in and having that different perspective and with a company keeping its eyes open for ways to invest in new growth oriented technologies going forward, is it more likely, it seems more likely that the company would preserve its cash balance for those types of options which may come up over time versus investing back into the business in terms of additional share repurchases, is that a fair read on those comments that you are making?

Rob Wolf

Greg, this is Rob. I would say right now, at this point in time, that is an accurate statement.

Bernie Aldrich

Yes.

Greg McKinley – Dougherty & Company

Okay, thank you.

Bernie Aldrich

Okay.

Operator

(Operator instructions) And our next question comes from Chuck Murphy with Sidoti & Company. Go ahead please.

Chuck Murphy – Sidoti & Company

Good morning guys.

Bernie Aldrich

Hi Chuck.

Chuck Murphy – Sidoti & Company

Rob, could you give me the breakout between Producer Desktop and recurring – I know you gave the recurring as a percentage of total [ph], what about between Producer and Desktop?

Rob Wolf

Yes, Producer and Desktop basically if you look for the fourth quarter, Desktop was about 5% of total revenues of hardware, we are talking hardware here and then Producer Professional was right around 30% of total revenue.

Chuck Murphy – Sidoti & Company

Okay. Are the Desktop products still profitable at this point?

Rob Wolf

They are, yes, definitely. We have seen significant downturn in sales and the Desktop product but they are still profitable for us. We have not changed pricing, cost structure has stayed relatively stable and we continue to generate margins on the aftermarket.

Chuck Murphy – Sidoti & Company

Bernie, could you expand a little bit on kind of what your responsibilities are going to be from here on out and what Sherman’s will be? Is he going to be handling day to day or is that going to be more your area, could you just talk something about that?

Bernie Aldrich

Sure. I think in any transition like this, for Sherman to be fully effective, he has to have 100% responsibility for the day-to-day operations. If you don’t do it that way you will end up not only confusing your own internal people but the marketplace as well. And where I will be playing an active role with Sherman is being there, being a sounding board for him, assisting him in areas primarily as we look at perhaps new opportunities, we study new business opportunities where I can lend my past experience and knowledge with him as well as supplying him that historical perspective of where we have been and supporting him as he gets his feet on the ground here I think particularly over the next 90 to 180 days his challenge is just to immerse himself into our operations, truly understand what our business is today while at the same time beginning to set the table for what is our next – where will Rimage be in the next three to five years. He will clearly be responsible for the day-to-day operations.

Chuck Murphy – Sidoti & Company

Okay. And so you are just kind of the sounding more than the big picture guy right now?

Bernie Aldrich

Right. I am going to a – that is always a challenge for someone who has been incumbent about but my responsibility, to be quite frank, is to make sure that I don’t get in his way and at the same time I am there to provide the support when it is needed and offer hopefully good advice when it is asked for.

Chuck Murphy – Sidoti & Company

Okay. Is it safe to assume that you are probably not going to do much in the way of acquisitions at least for the next six months or so just until he kind of gets his feet well [ph] and gets a feel for what he might want to do?

Bernie Aldrich

I think that would probably be a pretty safe assumption.

Chuck Murphy – Sidoti & Company

Okay. And as far as kind of the different end markets that you are serving, anything standing out as particularly weak or strong these days?

Bernie Aldrich

I think there is no question that the government is one market that certainly has funding available and is certainly playing a much larger role in virtually every single industry, market and application that we play in. And so therefore, as I said in my comments, we will put greater attention there and we do see over the past year we have been spending a larger degree of our time looking at video applications along with archiving type applications and certainly within the medical world there is a tremendous amount of change going on and if you listen to Obama speak and everyone talks about electronic medical records, it is a great buzz word, one of the challenges within the medical world there is no common platform anywhere but that also works to our advantage and that is where we find – our business has really been built over the years we find niches within given markets, within given applications and that is where we try to play. And as we go forward, that is where we have to continually stay focused on where are those niches that we can be successful. I don’t know Manny, if you have anything to add to that from what you have seen.

Manny Almeida

Hi Chuck, it is Manny. I think one of our greatest strengths is the many niches that we plan and often times over the course of the year we see some becoming stronger and some becoming weaker. But currently it is certainly not fashionable in the corporate environment to be spending a lot of money on capital equipment. It would be in very hard hit in the IT world but at the same time as Bernie stated, our government business is up significantly, our quotes are up more than 100% versus this time last year and there is no lack of funding in the government. Also in interesting application banking and finance, which you have followed us for a while so you have heard us talk about it over the years is pretty well penetrated but yet there is recurring revenue there and people are buying new equipment in spite of the old equipment because some of the equipment is five to six or even seven years old. So there are applications, there are sales being made but clearly it is a lot tougher right now.

Chuck Murphy – Sidoti & Company

Sure.

Bernie Aldrich

Yes, I think the other thing too Chuck is one of the real assets of this company is that we have a broad geographical base to operate from and granted we are talking about a worldwide slowdown in the economy but as you can see there is a lot of people still going to work every day and that is true all over the world and I can take a geographic market like Europe, there are certainly pockets in Europe that have perhaps fallen back further than others but there are also opportunities out there and certain geographic markets that we will continue to mine and go after. As you know, we brought in in the past year, over the last couple of years really, really new sales management within our European market and we really have a very focused attack in that market and we are looking at some new geographies over there that will present opportunities as well as, as Manny was saying, we have a huge installed base and we are going back and looking at machines we have installed over the last – if you look over the last eight years there are a lot of units out there that we can go back into and in many cases it is much easier to sell an existing customer than to find a new one and that is really where we are focused. And the same is true in Asia where although that is a newer geographic market for us there are some real nice opportunities particularly in that part of the world as you look into the medical aspect particularly in a country like Japan and even though there has been some pretty heavy currency devaluations in certain parts it just forces us to really look harder at where we pour all our energy and efforts over the course of the next 12 months.

Chuck Murphy – Sidoti & Company

Okay. Can you just remind me where most of the government applications are, is it defense related?

Manny Almeida

I would say that is where most of the spending is but the application is not necessarily defense, it happens to be customers within the defense segment. A lot of the applications are within video, video training for example, distribution of training materials, lot of the applications are in archiving and distribution of data personnel records the VA Hospital for example uses our equipment for records and retention and distribution. They are very, very similar to our civilian applications but they happen to be within government and yes, most of them are within DoD today.

Chuck Murphy – Sidoti & Company

Alright, that is all I had, thanks.

Operator

(Operator instructions) And our next question comes from the line of Dick Feldman with Monarch Capital Group. Go ahead please.

Dick Feldman – Monarch Capital Group

How do you assess the long-term outlook for the retail photography market? Has that changed any in view of recent economic conditions or do you think there is a considerable and expanding role for you to play in that market?

Manny Almeida

Hi Dick, it is Manny. Photography is fairly recession proof because while it certainly plays to disposable income, it is a relatively inexpensive method of sharing memories. So if you look back at the last recession 1980, 1981, photography was virtually unaffected. Today where photography is being affected is there is a tremendous transition from film-based systems to the digital-based systems and film usage in the US has plummeted from as high as 700 million rolls to around 150 million rolls last year. So it is quite a change. For us the change right now that we are going through is the transformation from CD to DVD. So we are moving to the next generation optical media, why, because digital cameras have become larger in terms of capacity, the media that goes into digital cameras has become much larger in capacity. So the CD is no longer a compelling product for a digital camera user. So what we see just in terms of usage is we see a transition from CD to DVD and then eventually to blue ray. So we are not seeing the end in sight we are seeing quite the opposite, DVD is growing at a pretty significant rate as of last year, it was around 16% in terms of market penetration for photographic users in the US. So we see continued growth, not easy because retail has been pretty dramatically affected as I am sure you see all the reports. The good news is two of our major customers are doing fairly well relative to other retailers.

Dick Feldman – Monarch Capital Group

The transition you just spoke of from CD to DVD did that create replacement demand for those people who own the CD versions?

Manny Almeida

You mean replacement demand for –

Dick Feldman – Monarch Capital Group

New machines because the consumer wants greater storage.

Manny Almeida

Yes, now what it is creating is it is creating two dynamics. First of all, the DVD has a higher perceived value than the CD in the retail market so it allows the retailer to have higher margins and higher revenue, higher ring through the register for each transaction. So that is important because that means the retailer is behind it and supporting it. Secondly it creates a higher perceived value for the consumer and it creates the ability to store from a digital camera carried on one piece of media. We don’t see a significant opportunity in replacing existing units because most of our units can currently produce DVD in the marketplace. What we see is an expansion because the CD is truly only usable by a PC user where the DVD is much more of a consumer electronics use. It would expand the ability to use the media to share it for example with a family member that may not have a computer.

Dick Feldman – Monarch Capital Group

I see. Okay, thank you.

Operator

(Operator instructions) And gentlemen, we have no more audio questions at this time, I would like to turn the conference back over to management for any closing statements.

Bernie Aldrich

Okay. Thank you once again for joining us on this quarterly call and we look forward to speaking with you in another 90 days.

Operator

Ladies and gentlemen, this concludes the Rimage Corporation fourth quarter earnings call. Thank you for your participation and you may now disconnect.

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