Imation Corp. Q2 2009 Earnings Call Transcript

| About: Imation Corporation (IMN)

Imation Corp. (NYSE:IMN)

Q2 2009 Earnings Call

July 22, 2009 10:00 am ET


Matt Skluzacek - Investor Relations

Frank Russomanno - Vice Chairman and Chief Executive Officer

Paul Zeller - Vice President and Chief Financial Officer


Glenn Hanus - Needham & Company

Chuck Murphy - Sidoti & Company


Good day, ladies and gentlemen, and welcome to your Imation Announces Q2 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions).

I would now like to introduce your host for today’s conference call, Mr. Matt Skluzacek. You may begin, sir.

Matt Skluzacek

Thank you, Kevin. Good morning, everyone, and welcome to our Q2 results teleconference. I’m joined today by our Vice Chairman and CEO, Frank Russomanno and our Vice President and CFO, Paul Zeller.

Before I turn the call over to them for their comments followed by your questions, I want to remind everyone that certain information discussed in this call that does not relate to historical information may be deemed to constitute forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from any projected results.

Risk factors that could cause results to differ are outlined both in the press release we issued this morning, as well as in our filings with the SEC.

With that, I’d like to turn the call over to Frank Russomanno.

Frank Russomanno

Thank you, Matt, and good morning. I want to make a few comments on the quarter and then turn the call over to Paul.

In last quarter’s call, we told you that it will be difficult to make a profit during the first half of the year. We are pleased to report that Imation did return to operating profitability in Q2, excluding special charges. While the global economic recession has continued to impact revenues in both our commercial and consumer businesses, our gross margins in our core products are stable. Our aggressive cost-containment and restructuring actions have clearly been effective, together resulting in an SG&A reduction of more than 17%, which helped to offset the revenue challenges.

In my remarks today, I will discuss the factors impacting the quarter. I will also provide an update on our ongoing company transformation, including progress we have made in new product categories and several expected product launches in the second half of the year.

But first, let me comment on the announcement that Imation made last week. On July 15th, we announced that we entered into a confidential settlement agreement ending all legal disputes with Philips. As you are likely aware, our companies had been involved in a complex series of disputes in multiple jurisdictions regarding cross-licensing and patent infringement related to recordable optical media. The settlement we announced provides resolution of all claims and counterclaims filed by the parties without any finding or admission of liability or wrongdoing by any party.

As the term of the settlement, Imation will pay Philips $53 million over a period of three years. We took a charge of $49 million in Q2 for this litigation expense. We are pleased to settle this very costly and distracting litigation and to eliminate an ongoing risk for the company. And in addition to resolving our differences, Imation and Philips have established a framework for cooperation going forward.

There are obviously some financial implications of our settlement. We expect to see a reduction in our legal spending going forward. In addition, we expect to wind down the Global Data Media operations during the third quarter of this year. Paul will give you a better feel for the impact of these changes. Most importantly, Imation remains a global optical market share leader with a healthy optical business model. None of that changes with this settlement.

Now, I’d like to provide more information about our quarter results.

In Q2, our legacy storage media business continued to decline at rates similar to those of the previous quarters. Magnetic tape continues to experience the most significant declines. Optical media is also declining, but at a slower rate than magnetic. Despite overall market decline in optical, we continue to gain market share in the U.S. through our successful consolidation strategy. In fact, we grew our U.S. optical revenues by 3% in Q2.

Our margins for both magnetic tape and optical media remain stable driven by the continued benefits of our magnetic manufacturing optimization program and our optical brand consolidation strategy. We continue to see the benefits of our aggressive cost-containment and restructuring actions.

We’ve seen solid progress with our removable hard disk drive business, where we had encouraging revenue growth and good margins in the quarter, led by the RDX format. As we mentioned last quarter, Imation was selected by two major OEMs as the exclusive supplier of RDX drives and media for their storage systems, a program that began ramping up with shipments in Q2.

Revenues also increased in Blu-ray disc, driven by the Japan market, where our TDK Life on Record brand has taken share from Sony and Panasonic. We continue to see very solid margins with Blu-ray disc. External hard disk drive revenues were also up in the quarter on a very small base. But we continue to be challenged with our margins in this business.

We continue to make progress on our consumer electronics business model. Like the majority of the CE industry, our CE revenues were down in Q2 compared to a particularly strong second quarter last year. Although down year-on-year, Q2 ‘08 versus Q2 ‘09, our Q2 CE revenues were up sequentially over Q1. And our focus on higher margin business, our margins have improved for two straight quarters.

We’re pleased that our Memorex and XtremeMac CE products continue to gain placements in U.S. retail, as we leverage our strong position in optical and our category management expertise.

For example, last quarter, I told you about our recent CE placement in Best Buy on a seasonal [end-cap]. Due to the sales velocity generated from the [end-cap], two of these CE products have now been selected for everyday shelf placement.

As I mentioned earlier, our aggressive cost-containment and restructuring actions have clearly been effective. But we know we cannot cut our way to success. We are focused on growing in new product categories and executing our brand and product strategy.

In the second half of this year and into early 2010, we expect to launch new products across storage, accessories and CE platforms that leverage our full portfolio of brands. In magnetic tape, while optimizing our manufacturing processes, we continue to invest in new advanced formats such as the upcoming LTO-5 technology with 1.5 terabytes native capacity on a single cartridge.

We expect to finalize development and qualification of LTO-5 during the second half of 2009 being first to market in early-2010. We also continue to launch new tape security products. In addition to our DataGuard RFID tape tracking system, in early-Q3, we plan to launch another new tape security product called Imation SecureScan, which enables datacenter and IT managers to assess the health of their LTO tape libraries and lock their cartridges during shipment and storage.

In the area of solid state drives, we’ve had good acceptance of our Imation SSD upgrade kit, which launched in Q1. It’s a simple and cost effective solution for users to convert a hard disk drive-based laptop or desktop computer to a higher performing SSD-based system, all without having to purchase a new computer. We also plan to expand our new Imation brand, Earthwise remanufactured toner cartridge, a line launched in Q1 with broader global distribution. Although it’s early, we have secured new business in Latin America, North America and Europe through our established distribution channels and with several large end-user accounts.

We are seeing encouraging signs of adoption of certified wireless USB devices, a platform upon which we are developing new products. We launch the Imation Wireless Projection Link using WUSB technology in the U.S. and Latin America. We are also developing our next-generation wireless projection device that will work in all parts of the world and is capable of transmitting Dolby-quality audio and high-definition quality video, which will enable more exciting applications.

In the area of accessories and CE, we continue to develop new Memorex, TDK Life on Record and XtremeMac brand product designs working with our retail partners to prepare for upcoming line resets.

As part of our transformation, we are re-scaling our workforce globally to ensure we have the capabilities we need to succeed as we move into new areas. In Q1, we announced that we added Mark Lucas as our Chief Operating Officer. Other team leadership hires include our new Vice President of Imation America’s Consumer Business, [Greg Bosler], a seasoned consumer electronics’ leader who spent 20 years at Thomson Consumer and Pioneer Electronics, and Bob Garthwaite, our new General Manager of Imation Electronics Products and XtremeMac business, also a CE veteran most recently CEO of Altec Lansing Technologies.

Internationally, we were pleased to have added [Kitchu], an experienced manufacturing and sourcing leader as our new General Manager of our Hong Kong sourcing organization and [Philip Mortimer] as our Consumer Sales Director in Europe previously with TDK Corporation. While our overall headcount has gone down, we have made select new hires and strong talent in areas such as marketing, adding new brand and product managers with broad consumer experience from companies such as Circuit City, Best Buy, Philips and Seagate.

In summary, despite the revenue challenges of a difficult economy and faster than expected decline in legacy markets, we are making steady progress on our brand and product management strategy. We are successfully optimizing our legacy tape and optical businesses. We are also adding new growth products to the portfolio and expanding our global distribution with our broad portfolio of brands, including Imation, Memorex, TDK Life on Record and XtremeMac. We are confident in our brand and product management strategy and continue on our path of transformation.

Now let me turn the call over to Paul who will provide more details on the quarter.

Paul R. Zeller, Senior Vice President and Chief Financial Officer

Thanks, Frank, and good morning, everyone. I’ll focus my comments today on both our second quarter results, as well as the Philips settlement.

Before getting into the details, I do have a couple of overall observations I’d like to share. First on the quarter, given the backdrop of the economic environment we’ve been facing now for nearly nine months and more specifically the unique challenges with the financials vertical and our tape business, I would echo Frank’s comment, we’re pleased to see our operating income get back in the black prior to the charges. And while 1.2 million in operating earnings is hardly a victory, we’re pleased with the trends.

On the Philips matter, I want to start by saying that we realized $53 million is a large settlement and a lot to pay for any dispute. Having said this, when you do the math on what we’ve been spending every quarter in legal costs, when you layer in the fact that this was a very complex dispute with a significant amount of uncertainty and finally when you consider the level of distraction it’s been causing, we firmly believe this was the right thing to do for our company and our shareholders and are pleased to get it behind us.

Now I’ll walk through the quarter in a bit more detail. From a revenue standpoint, we saw an overall year-over-year decline rate of 22%, which is very similar to the decline rates in each of the last two quarters since the onset of the economic crisis.

Our revenues were 427.9 million in the quarter, that’s little changed from last quarter, and as I said, down 22% from last year. We continue to see relatively steep revenue declines in our legacy storage media products, that’s both tape and optical, offset somewhat by growth in other categories including removable and external hard disk and Blu-ray optical media.

Our revenues from optical products in total declined 22% to 207 million and that’s similar to last quarter’s decline. This rate of decline was impacted by economic factors as well as slowing revenues from our Global Data Media joint venture.

As I’ll discuss more in a few minutes, this trend will continue as we wind down this entity in the second half of this year. Excluding Global Data Media, the decline rate in our core branded optical business lessened somewhat in the quarter. Optical products represented 48% of revenues in Q2.

Magnetic product revenues declined 31% to 115 million, that’s also a similar rate of decline to what we saw in the last two quarters. Magnetic represented 22% of total revenues in Q2.

We continue to see more severe impact in this category, which has been particularly impacted by the economy given our exposure to the financial sector and our tape business. This category also includes legacy audio/video tape, which is in a very steep decline as you would expect.

Our Electronic Product segment revenues were down 18% driven primarily by video products, where we’ve intentionally lowered our exposure to the higher risk LCD TV business this year compared to last. Electronic product revenues represented 11% of total company revenues.

Flash product revenues totaled 20 million and declined 26% from last year and represented about 5% of revenues in the quarter.

In the remaining product categories, that represent about $30 million in revenues, we saw a 24% revenue increase driven by removable and external hard disk products.

From a regional standpoint, our declines were broad based. However, we saw particularly weak demand in Europe, which was impacted by weakness in our Global Data Media joint venture revenues already discussed, as well as the general overall economic weakness throughout our businesses in this region. In addition, we experienced over a 10% penalty in currency translation in Europe compared to last year.

When you look at our overall 22% decline in revenues, it can be roughly split into a seven-point impact from lower volumes and 11-point impact from price erosion and a four-point impact from negative currency translation.

Our gross margins in the quarter declined 1.9 points from last year’s second quarter and that was as expected. It was driven by product mix essentially from having less magnetic tape revenue as a percent of total revenues.

Sequentially, gross margins were down eight-tenths of a point, also due to mix, as consumer electronics grew in Q2 as a percent of total revenues. This was also an expected change. Our gross margins were stable in our core storage businesses in the quarter. In magnetic tape, while margins came down somewhat from the strong performance last quarter, they were still up from what we saw in the second half of last year.

In optical, our margins have been stable and solid for at least 18 months. In consumer electronics, our margins improved from quarter one, which had shown improvement from quarter four. This steady improvement trend is encouraging and reflects the actions we’re taking to improve our business model. We’re being more selective about the business we take and improving our business discipline.

In our remaining categories, margins overall were relatively unchanged from quarter one with slight improvements in flash, accessories, and removable hard disk, offset by external hard disk margins.

R&D costs were 4.7 million in second quarter. That’s down 1.3 million from last year as expected. Selling, general, and administrative expenses totaled 60.1 million in Q2 and that’s down 12.6 million or 17% from second quarter last year and down 5.5 million or 8% from just last quarter.

We’re clearly seeing benefits from our OpEx restructuring program we announced in the fourth quarter and it will not be finalized until the end of this year, we’re now seeing significant benefits from the program.

In addition, we benefited from a couple other factors in the quarter. First, as we said last quarter, we’ve taken actions across the board to lower non-essential spending in light of the current economic environment and these actions are contributing. They include, for example, salary freezes, employee benefit reductions, travel costs containment, et cetera.

In addition, compared to last quarter, actually the last couple of quarters, we’ve had lower bad debt expense in quarter two. The reduction in Q2 SG&A was achieved despite continued elevated legal spending associated with the Philips matter, which totaled 6.5 million in the quarter.

Our worldwide employee count ended the quarter at approximately 1,270, down 5% or 70 positions since last quarter and down about 35% or 680 positions from a year ago. These reductions are driven by both manufacturing restructuring actions and more recently, our operating expense reduction program.

On that point, restructuring and other charges totaled 9.8 million in the quarter and they were associated with our structure realignment we announced in November last year. In that program, we’re targeting annualized cost eliminations of greater than 40 million once fully implemented. These actions will be implemented overtime, as we’ve said in the past, with the vast majority completed by the end of this year. As I mentioned just a minute ago, we’re now seeing a significant portion of these savings in our second quarter run rate. We have recorded approximately 25 million in charges thus far for this program and anticipate absorbing up to 40 million in total for the program.

Including charges for restructuring and other costs as well as litigation charges which I’ll discuss in more depth shortly, our operating loss for the quarter was $57.6 million on a GAAP basis. Excluding those charges, we generated 1.2 million of income in the quarter. Non-operating costs totaled 3.4 million in the quarter, that’s up 1.8 million from the same quarter last year, driven by currency losses associated with the relatively volatile FX landscape during the quarter. We recorded a 24.1 million tax benefit associated with the $61 million pre-tax loss in the quarter. And our loss per share on a GAAP basis in the second quarter was then $0.98 per share and if you exclude litigation, restructuring, and other charges, that loss per share was $0.01.

Cash and equivalents ended the quarter at 89.2 million, that’s down 7.4 million from year end and down 13.8 million from last quarter. We used 9.4 million in cash from operations in the quarter and that includes seven million spent on cash restructuring charges.

Our cash flows were impacted somewhat by increased working capital ahead of our seasonally higher second half of the year. Additionally, cash outflows during the quarter included capital spending of 1.8 million and costs associated with the completion of our credit facility amendment of 2.9 million. And on that point, we completed that important amendment to our credit facility during the quarter as we had previously announced. The purpose of this was to provide a more consistent amount of availability by changing the form to an asset base and by removing certain limitations to availability based on income levels.

In addition, we’ve decreased the overall size of the facility to more appropriately match our needs and as a result lower the cost of the amendment. As a result, the general terms of the facility were amended generally to current market conditions, including increases to interest rate spreads. We’re pleased to successfully complete the amendment and then maintain strong relationships with a solid group of banks.

Before wrapping up and taking your questions, I’d like to make a few comments about last week’s Philips settlement and the announcement. As I said before, this was a complex and costly litigation matter taking place in three jurisdictions covering numerous licensing and patent issues related to optical storage media. As part of the settlement, we agreed to pay Philips 53 million over a three-year period. We anticipate the cash impact this year in the second half will be about 16.5 million with further payments occurring in mid 2010, mid 2011, and mid 2012. We do anticipate being able to receive tax benefits overtime and thus the after-tax cash impact will be less.

We recorded a $49 million pre-tax charge in Q2 representing the present value of these payments. There are a couple of financial impacts worth noting in addition to the settlement payments. First, we expect to see a relatively immediate operating expense benefit, as we eliminate the legal spending associated with this litigation.

Our litigation expense has been as high as 10 million in the quarter Q4 last year and totaled 6.5 million in Q2 and 13 million year-to-date this year. Thus, the vast majority of this is related to the Philips matter.

Second, we anticipate that our Global Data Media joint venture with Moser Baer will be wound down by the end of the year as a result of this settlement. This joint venture contributed $57.5 million of revenue through June this year, but only about two million in net income. When the wind down process is complete, we anticipate the prior business results for this Global Data Media joint venture will be treated as discontinued operations and as such, the prior period results will be classified below continuing operations to aid in year-over-year comparisons.

We believe the settlement was a prudent step for the company for several reasons. First, the cost of continuing litigation was steep, especially with the U.S. trial not scheduled until second quarter next year and appeals likely after that. In addition, we were incurring costs related to the international aspects as well.

Second, this was a complex multi-jurisdictional case and though we continue to believe in the merits of our case, it was not without some amount of risk. Finally, though the impact is less easily identifiable, there is no question it will be beneficial to eliminate the distraction.

One of the important aspects of our settlement was to negotiate the best go-forward agreement with both Philips and Moser Baer. We believe we have done this and feel confident that our optical business model will remain unaffected other than the loss of GDM revenues and profits I just mentioned.

So in summary, we’re pleased to return to operating profitability excluding charges. As I said, while not a large number, we had anticipated it would be difficult to show any profit in the first half of the year and I am encouraged by our continuing solid margin performance. We’re seeing the benefits of the aggressive cost actions we’ve taken and I believe the actions overall that were taken are the right ones and are necessary to bring our business model back in line and to establish the right foundation for the future as we continue to not only address a difficult economic environment, but also position the company for long-term success.

At this point, we’d be pleased to take your questions. Thank you.

Question-and-Answer Session


(Operator Instructions). Our first question comes from Glenn Hanus.

Glenn Hanus - Needham & Company

Okay. So may be just talk a little bit about operating expenses now going forward. If I take roughly two million out for stock comp, I have -- you spent like 63 million in OpEx, and you had that litigation expense of 6.5. So should I assume the true SG&A baseline now going forward is like sort of around 52 million and its sort of OpEx kind of flat of that lower base going forward?

Paul Zeller

Well, of course, there’s always a lot of moving pieces when it comes to operating expenses. It does move around quarter-to-quarter. Second half of the year when we tend to have higher revenues, there will always be some upward pressure on operating expenses. There is not a lot of our OpEx that’s variable, but there’s certainly some aspects of it. I would say that those moving pieces, you got a piece of it. We clearly will have a lower level of litigation expense. And your numbers on stock comp are right on it. It was $2 million in the quarter, and I think that’s a reasonable run rate as we look forward.

Glenn Hanus - Needham & Company

So is this 6.5 now the litigation expenses? Should we assume that’s basically gone now going forward or is there some residual expenses of 0.5 million or so a quarter?

Paul Zeller

Well, there would be some residual, A. The majority for sure was related to the Philips matter, but there was always some amount of other spending, A. And, B, there will be some transitional spending into third quarter as we wrap up the litigation and finalize all the aspects of it and wind down the Global Data Media joint venture. So with those two things in mind, I think you’re generally in the right line. And I would also say that, we have been appropriately very cost-conscious in the first half of the year given the economic environment and careful with our spending, and we will continue to gait that based on what we see in the business. But there is always some potential up tick of some modest amount as a result of that.

And then offsetting that, frankly, while we’ve gotten the majority of our restructuring savings, there’ll be some more to come as we get towards the end of the year. So, it’s hard to predict. We’re not giving guidance. But you've got the general right factors in mind.

Glenn Hanus - Needham & Company

And then on gross margins, you came in about in line with what I was expecting. I’ve modeled a slight downtick in gross margins in the next couple of quarters, is that the way to think about it?

Paul Zeller

Yes. We've had sort of this conversation before about what are the seasonal realities in our gross margin and we’ve tended for a number of reasons, to see a pretty good gross margin in the first quarter. We tend to get a pretty good mix. Entry level products in tape tend to have their best quarter in first quarter. And by the time you get to fourth quarter, you’re getting your largest mix of consumer electronics as a percent of the total and those do carry a lower than corporate average gross margin. And so, with some of those things in mind, I think we’re not uncomfortable with our gross margin without getting specific. I would just say we like the fact that some of our core storage media margins have been more stable lately.

Glenn Hanus - Needham & Company

Okay. And maybe you guys could talk about your progress on the consumer electronics side in the business model. I mean, you mentioned some improvement on the gross margins. How are you doing in terms of overall profitability in that business and sort of update us there?

Frank Russomanno

Okay, Glenn. This is Frank. We already mentioned earlier that we improved our gross margins in the business for two straight quarters. We are learning a great deal about this business as time goes on, and I think we’re learning very quickly. But we’re also very much more focused on improving our execution in this business. We saw some progress in the quarter that we’ve talked about already, but there is still is a difficult comparable between Q2 of last year and Q2 of this year.

We’re encouraged by the traction that we’ve had in some of our products. The key point, like you know is, first of all is to develop the right products, then get them on the shelf, and then the third thing is for the consumers to come in and buy them and take them off the shelf. I think our track record is getting better or our batting average is getting better at identifying those types of products that have the type of velocity that the retailers want to see and that’s why we mentioned, we made a point of mentioning the two products that in particular that were part of an [end-cap] special that have been brought online on shelf everyday, and that’s the key, one of the keys to our success.

Another thing that we did not mention is at Staples, a very different channel than the consumer electronics channel in the office channel, we also launched six Memorex CE models and also 15 XtremeMac accessories. So we are broadening our reach by crossing channels with these products and we see that as a success too. Now, not every CE product makes sense in the office channels, but some of these definitely make sense in the office channel. So I think quarter-by-quarter, Glenn, we’re learning and we’re having some success. But ultimately, we’ve got ways to go to make this the level of business we'd like to see it from a profitability standpoint.


Our next question comes from Chuck Murphy.

Chuck Murphy - Sidoti & Company

I apologize. I’ve been bouncing back and forth between conference calls, so if I repeat something, again, I apologize. Just wondering, when I kind of look at the numbers, if I added back $59 million of restructuring and litigation cost to your pre-tax loss of 61 million and then I assume the 35% tax rate, I get to like a $0.04 loss. Could you help me reconcile that number to your $0.01 loss that you're saying it was?

Paul Zeller

Yes. It would have to do with the tax rate you assume that you apply. When you get things such as charges of the magnetite we had, obviously with litigation as well as nearly 10 million of restructuring and then recognize that excluding those, it’s pretty small level of income. Small changes in mix on where the income is coming from and everything else can change the tax rate. So it would be having a different tax rate than you're assuming on that amount of income.

Chuck Murphy - Sidoti & Company

Okay. And then kind of looking at the working capital, I mean inventory and accounts receivable bounced up some. Why couldn’t you kind of work it down? It did seem like the working capital was already a bit on the high side?

Paul Zeller

Yeah. I think it’s a good comment and a fair comment. I think we need to do better in working capital. I think there’s reasons why inventory will be a little bit higher at the end of second quarter than first quarter. But frankly, I think there’s room for improvement beyond that seasonal change. And we weren’t particularly pleased with how we performed on either front. The good news is that we’re comfortable. Like receivables having gone up a little bit.

It’s not an issue with the quality of the portfolio we believe. It just has to do with some of the constraints you face at the end of the quarter in terms of customer payment patterns and that kind of thing. Everyone’s very cost-conscious, as you can imagine, and you get a lot of pressure on that side, if you will, at the end of the quarter. But I think we can do better. I think that is a challenge we’ll take on. And I think we need to do better than the kind of DSO and DOS that we have right now. I don’t think it’s a problem, but I do think it’s an opportunity.

Frank Russomanno

And Chuck, one other thing, the devil is in the details with that level of working inventory. There’s a certain amount in there that’s end-of-life products that we need for our data storage business, especially in the entry-level segment. So that’s part of it. But nonetheless, as Paul said, we’re going to take on the challenge and we’re up for the challenge.

Chuck Murphy - Sidoti & Company

Okay. And I think I may have heard you saying something about it earlier, the different areas of electronics products where you’re staying and growing in the areas that you’re getting out of?

Frank Russomanno

What we were talking about is it’s not so much areas that we’re staying and growing only. We’re very specific as trying to put in products that we have a higher degree of confidence are going to sell. And also, we’re looking for those products that are probably less price-sensitive that might have higher growth and lower margins. So we are much more focused on margin also and improving our margins in this business.

Paul Zeller

I think the particular example I made, Chuck, was in LCD TV. We’re not exiting LCD TV. We have some interesting placements there that we think are good business. But we probably got too big in that business and too many places, and there was some business we shouldn’t have taken last year. And we’re making different decisions in that regard this year.

Chuck Murphy - Sidoti & Company

Okay. And I mean within electronics products, which products are doing the best for you these days?

Paul Zeller

Well --

Frank Russomanno

Go ahead.

Paul Zeller

Our margins tend to be higher in some of the traditional audio products. They tend to experience less price erosion than some of the newer video products. But they tend to have maybe a little less growth opportunity. But when you have solid placements and in line with good audio products, that’s good stable business for us. And then the accessories part of our business as well can tend to be a very good margin business. And frankly, it performed pretty well in the quarter in terms of the gross margin. It can be a nice increment to typical audio/video electronics.

Frank Russomanno

Some of the specific products that are doing well for us are around the iPod docking-type products like our iMove, our travel iPod. These are products that are resonating with the vendors and the ones that we put in a Best Buy and (inaudible).

Paul Zeller

As you look forward, Chuck, I think there’s an opportunity that we really are focusing on with the XtremeMac brand where I think there’s an opportunity with that being a more Tier-1 brand in terms of design and margin opportunity. It’s a place where we’re really focusing.

Frank Russomanno

And that’s why we did mention the Staples opportunity with 15 XtremeMac SKUs. That will tell us how we’re going to start doing with that brand right now. It’s one of the largest single opportunities we’ve had with XtremeMac.

Chuck Murphy - Sidoti & Company

Okay. And if you see the normal seasonal pickup in the second half of the year, where would you anticipate working capital going? Will it rise in tandem or are you going to be able to keep it a little bit lower from here or --?

Paul Zeller

Yeah. Without getting real specific and not giving guidance, the general trend will be that we will definitely experience some upward impact on inventories as we get into the second half of the year, and then that should come down towards the end of the year as we meet the demand of our strongest seasonal quarter in fourth quarter. Receivables will trend up with the revenues obviously, and the payables pattern will of course be the first to go up and then back down as we buy the inventory and pay it off. And that typical pattern that we’ve been experiencing, we should experience again this year. A lot will depend really on the size of the market opportunity in the fourth quarter and what the economic realities are in the pretty important holiday season.


(Operator Instructions). There are no further questions at this time.

Frank Russomanno

Thank you very much. I have a just a few closing comments that I wanted to make. First, let me reiterate what Paul and myself already said that we’re pleased to have made a small operating profit in Q2. Our plan is to stay focused on operational improvement and try to finish as strong as we can in a very difficulty economic environment that we see going forward. We also remain committed to our strategy of transforming the company to a brand and product management company. And finally, we are very pleased to have the Philips litigation behind us, as we’re allowed to focus on more important things to help grow this company.

Thank you very much for your attendance, and we’ll talk to you next quarter.


Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect.

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