Imation Corp. (NYSE:IMN)
Q1 2010 Earnings Call
January 21, 2010 10:00 pm ET
Tim Gallaher - IR
Frank Russomanno - VC and CEO
Paul Zeller - SVP and CFO
Chuck Murphy - Sidoti & Company
Good day, ladies and gentlemen, and welcome to your Imation Corporation first quarter earnings conference 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). As a reminder, this conference call is being recorded.
I would now like to introduce your host for today’s presentation, Mr. Tim Gallaher. Sir, you may begin.
Thank you, Howard. Good morning, everyone, and welcome to our quarter 1, 2010 earnings conference call. On today’s call, you will be hearing from our Vice Chairman and CEO, Frank Russomanno and our Senior 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 on 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 in both the press release as well as our filings with the SEC.
With that, I’d like to turn the call over to Frank Russomanno, Frank?
Thank you, Tim, and good morning everyone. As we noted on our press release this morning, we are pleased by the solid start to 2010, in both revenue and earnings. Continuing the momentum we established in the second half of 2009. Our cash generation in the quarter was especially strong, with our continued focus on working capital management, we added $60.8 million to our cash balance ending the quarter with $224 million in cash.
From our revenue perspective we continued to see a moderation in the rate of decline in our tradition tape and optical storage of businesses compared to 2009. In addition we saw a very strong growth in several important products in our emerging storage categories including external and removable hard disk, flash, and Blu-ray disks. Paul will go into more detail on the quarter in just a few minutes.
For the remainder of my comments I’d like to provide a bit more color on our technology and product focus. How we are leveraging our global brands and how our global organization continues to focus on achieving operational excellence. First, we continue our market leadership in our traditional storage category of magnetic tape where we have the number one share position across our brand portfolio. In March we announced that Imation began shipping the world’s first multi terabyte magnetic tape. The Ultrium LTO-5 format with double the capacity of existing cartridges.
Imation continues to invest in research and developing magnetic tape. We are already working on the next generation LTO offerings. At the same time we are making excellent development progress with another advance tape program using barium ferrite pigment. A format that will provide even more capacity and speed expected to be commercialized in 2011.
In our other traditional storage category, optical media we likewise continue our global market leadership reflecting the success of our brand consolidation strategy. We have the number one share position and offer the broadest portfolio of brands to retailers. The new Blu-ray format continues to grow primarily in Japan and we are already working with our partner TDK on next generation Blu-ray technology.
Our emerging storage products of flash and removable and external hard disk drives showed strong growth in the first quarter. Strategically in March we announced the Imation’s $5 million investment in ProStores, RDX removable hard disk drive technology reflecting our commitment to this format. This is a growth category that has been adopted by IBM, HP and Dell.
As a founding member of the RDX storage alliance and supplier to both Dell and IBM, Imation is well positioned as a leader in RDX. Imation is also responding to a rapidly growing customer need to secure, protect, store data to meet increasing compliance requirements driven by HIPAA, SOX and fixed regulations.
In the quarter we announced partnerships with data security leaders, MXI and EncryptX to develop and launch a full portfolio of fixed certified products including flash drives, optical media and hard disk drives. In the coming weeks we will launch our new secure storage line called the Imation brand defender collection. Engineered to meet rigorous domestic and international encryption standards. This line was developed for government, financial, health care, consumer and other industries for which data security is critical. With these new definitive products as well as the tape tracking and diagnostics products such as Secure Scan and DataGuard rf systems that we previously announced. We are significantly increasing our focus on secure data storage.
As we discussed in the past, our strategy includes not only optimizing our traditional storage areas and growing an emerging storage, but also extending our brand selectively into electronics and accessories. Our new electronics and accessory products are being designed to deliver higher margins through carefully engineered differentiation and are aligned carefully with our brand targets. Just a few examples of this brand leverage to watch for in the remainder of the quarter. Our Memorex brand designed for Mom and her family will launch new audio products designed for iPod and iPhone or full line of gaming accessories for the Wii platform and a new line of AV cables.
Our XtremeMac brand designed for the Apple enthusiasts will launch new iPod and iPhone cases and chargers as well as accessories designed for the new Apple iPad. In our TDK Life on Record brand designed for the demanding audio file will deliver a full line of premium high fidelity audio products, ranging from wireless earphones to speakers and turntables, drawing on the strong audio legacy of TDK for a new generation of consumers. We also continue our focus on achieving greater operational efficiency.
As I told you last quarter, this is not a one time activity, our sustained emphasis on operational improvement has been a significant contributor to a Imation successful cash generation over the past few quarters.
Our global operational excellence program called [projectic] sale is helping the organization to improve key processes across all areas. Including product life-cycle management, sourcing, demand and supply planning, order management and finance processes.
In order arrangement for example, we are moving two consolidated centers of excellence. In the second half of 2009, we established a regional order management center in our Panama office. Designed to handle all back office order management activities for North America and Latin America.
Now in 2010, we are successfully transitioning majority of activities through the single center. We have maintained very high service levels and standardized processes, while reducing order management cost.
Our management employees have adopted the 3x philosophy I have mentioned before. Looking for improvements and simplicity, size and speed in all areas of our businesses. For example, [project Decal] was helping us to simplify and standardize business processes. We are also sizing our business more appropriately. Being more selective in our product portfolio and even our distribution channels, focusing on fewer but higher impact opportunities. And we are acting with speed to respond faster to our partners, customers and business conditions.
Now I’d like to turn the call over to Paul who will provide more details on the financials for the quarter.
Thanks Frank and good morning everyone. I would echo Frank’s comments. We were clearly pleased with our results in the first quarter. We delivered significant earnings improvement from first quarter last year and were encouraged by the stabilization in our business model, especially our gross margins which came in at nearly 17%. And our cash flow results were particularly strong further strengthening our balance sheet and they are pleased with the progress we have been making with our working capital initiatives and it’s encouraging to see our cash balance come in at $224 million for the quarter.
Now, let me highlight some of the key points related to our Q1 financial performance. Revenue was down 7.7% in Q1, compared to the same quarter last year. In dollar terms, that’s a revenue of $365.8 million in the quarter. Our revenue decline rate has moderated nicely quarter-by-quarter since the onset of the economic crisis in late 2008.
The main drivers first moderated declines in tape and optical products. Second, solid growth in our emerging storage categories, and finally, a better currency environment. Our revenues from optical products were $157.4 million, representing a decline of 13% from the same quarter last year with rate of decline is less than we saw during 2009.
Within optical, Blu-ray revenues were again strong in the first quarter, especially in Japan. We did see accelerated declines in overall in CD however. Magnetic price revenues declined 16% to $103.4 million in first quarter. This rate of decline was down significantly from the approximate 30% decline rates we have been seeing up until quarter four of last year. With in Magnetic, we were encouraged by our datacenter products which were nearly flat year-over-year, low entry level and mid range did show more significant declines.
Our (class) revenues were up 52%, coming from our International markets which tend to be the main area of focus in this category. In the remaining products, our revenues were up 4%, driven by substantial growth in hard disk based products which were in excess of 50% offset by declines in electronic products driven primarily by video related products where we intentionally rationalize our participation to lower risk.
From a regional segment standpoint, our Americas segment which excludes electronic products was down 11% in the quarter driven by continuing declines in magnetic and optical but had a lower level in the first half of 2009.
Revenues were stable in Asia versus the prior year and Europe was down about 8% also driven by declines in both tape and optical revenues. This Europe decline was much lower than experienced than we experienced in recent quarters.
Overall when we look at our roughly 8% decline in total revenues, it came from about a one point impact from lower volumes, a 10 point impact from price erosion offset by a three point positive impact from currency translation.
Being really flat from a volume standpoint was an encouraging sign and better than any quarter since the first half of 2008. The 10 point price erosion was right in line with our historical experience.
Our gross margins in the quarter was 16.9% to sales flat versus last years first quarter. Our optical gross margins continued very solid in the quarter in all regions. In magnetic tape our margins were in par with last quarter but still down versus the prior year due to continued LTO price erosion as well as due to the mix of products within the category.
Our remaining storage categories flash and hard disk also had margins on power with last quarter but higher than the first half of 2009. In consumer electronics our margins improved significantly from quarter one of 2009 and we continue to focus on this business model.
We rationalize our participation in video products which was an important factor in addition by the end of last year we had finally worked our way through our problem inventories in this category allowing Q1 in this year to be a much cleaner quarter.
Finally I’d like to remind everyone that Q1 tends to be our highest gross margin percentage quarter due to seasonal mix benefits as CE is generally at a revenue low point for the year.
Our operating expenses totaled $57.5 million in the quarter, that’s down $12.5 million or 18% from first quarter of 2009. This was driven by lower legal costs after having settled the Phillips litigation in July of last year as well as by our restructuring and cost control actions.
As a percentage of sales, OpEx was 15.7% in the quarter, that’s down 200 basis points from the prior year. Restructuring and other charges were $4 million in the quarter and including those charges our operating income was $200,000 in the first quarter. Excluding those charges operating income was $4.2 million in first quarter. That $4.2 million represent a $7.3 million improvement over the $3.1 million operating loss we had in the first quarter of 2009 calculated on that same basis that means excluding restructuring and other charges.
This improvement was driven by lower OpEx spending but was also enabled by stable gross margins which minimized the earnings impact of somewhat lower revenues. Non operating cost totaled $3.8 million in the quarter down from Q109 which was $7.6 million.
Q1 last year was impacted by the write off of a note receivable from one of our commercial partners. We had a $1.1 million tax benefit in the first quarter on pre tax loss of $3.6 million or a rate of 30.6%.
On a per share basis we had a loss of $0.07. If we adjust to exclude restructuring and other charges we would have been about a breakeven on a per share basis which was improved from a loss of $0.24 per share on a comparable basis in the prior year.
Our balance sheet remains strong with increased cash and equivalents and no debt. Cash ended the quarter at $244.2 million, up nearly $61 million from last quarter. This strong result was driven by significant reductions and receivables due to the collection of our seasonally strong quarter four revenues and inventory reductions which reduced our days of supply by 6 days in the first quarter.
Improved earnings were also a contributor with EBITDA excluding charges at 14.7 million in the quarter. Capital spending for the quarter for $2.2 million and DA at 10.5 million. We were obviously very pleased with our cash flow performance. We generated over a $130 million in cash in just last the three quarters.
For sure a portion of this was driven by the right sizing of inventories that had grown as a result of the very weak demand in late 2008 and early 09. I have to say however that there has also been a significant contributions from the efforts from our teams all over the world to tighten our focus especially on inventories which ended the quarter as I said down another 6 days after reduction of 37 days in 2009.
We will continue to focus on working capital and I believe there is still room for further improvements overtime. One word of caution it is important to note that coming off to seasonably strong Q4 we will tend to see a working capital and cash benefit from receivable collections and we did in first quarter.
As we ramp for the seasonably stronger months later in the year, we can experience increased working capital needs for both receivables and inventory and we would caution investors to remember these seasonal impacts and not to assume that cash generation can be sustained at the levels achieved in Q1 especially late in the year.
So in summary we are pleased and encouraged by both our earnings and cash flow improvements in the quarter. It was good to see our core storage revenue trends continue to stabilize and to see growth in our emerging storage formats.
At this time I will hand the call back over to our CEO, Frank Russomanno for couple of final comments before we take your question.
Thank you Paul, before we open up the call for Q&A, I would like to make a few comments about the upcoming change of leadership at Imation. As previously announced I will be retiring as Vice-Chairman and Chief Executive Officer effective immediately after the company’s annual meeting with share holders on May 5th 2010.
Mark Lucas currently Imation’s President and Chief Operating Officer will succeed me as President and Chief Executive Officer. Mark is ready to become the next Chief Executive Officer of Imation. Having previously been a member of the board Mark knew the company well when he joined Imation in 2009 as our Chief Operator Officer. He brings extensive experience in consumer package brands, electronics and data storage in both business and retail channels.
In addition to Mark Imation has a very strong management team which has been further augmented by new leadership with consumer branding, marketing, sales and operation’s experience.
I am very confident that this will be a smooth transition and that the momentum we have as we began 2010 will continue. I also want to mention that you have an opportunity to meet Mark one-on-one in May as He and Paul are schedule to be on the road for meetings during the week of May 10th and May 17th. Tim Gallaher will handle those appointments so contact him if you like to arrange a meeting.
Now Paul and I will take your questions.
(Operator Instructions). Our first question or comment comes from the line of Mr. Chuck Murphy from Sidoti & Company your line is open.
Chuck Murphy - Sidoti & Company
Just a few questions first, I may have missed this but can you talk a little bit about the strength you saw in accessories where that was coming from with particular products?
Well, Chuck, as you know, our accessories are relatively broad, we have some remaining number of storage accessories which are actually holding up quite good and also we have a lot of consumer electronics related accessories and a lot of new products that are announced and coming out. And I think it was overall a decent results in the quarter in accessories and I think it’s fair to say that we are encouraged by the kinds of innovative and creative designs and overall product innovations that we’re coming up with and we believe it’s going to be a positive thing for the company going forward.
One main category that we spent more time in energy on and we are encouraged about is, you know, whole headphones and earbud kind of category and you’ll be hearing more about that going forward.
Chuck, this is Frank. This as a general comment. All accessories all along has been important part of this strategy and it was that element of the strategy that we have been attempting to extend those brands into these new categories. So, we like the accessories business, we also have introduced the line of gaming products like I mentioned in my comments for we gained, so you’ll see more and more of this as the year goes on.
The interesting thing if I could, may be a final comment is that accessories is a little different than pure electronic products in that you tend to have kind of small and more niche opportunities, but they can be better margin if done well. And we definitely are focused on the accessory category along with electronics.
Chuck Murphy - Sidoti & Company
Okay. And just to give us kind of your expectations for OpEx for the remainder of the year?
Yeah, lets say generally speaking obviously we are getting the benefit of having kind of dispense with the Phillips litigation and also a lot of ongoing restructuring benefits, we are getting you the tail end of those benefits, half to same, we are starting to get to a more normalized kind of dollar rate of SG&A and there can even be quarters where we maybe even pop up a bit especially the stronger quarters late in the year with a lot more revenue because there is, while most of our SG&A is fixed. There is a smaller variable piece that does tend to jump up especially in fourth quarter.
Chuck Murphy - Sidoti & Company
Ballpark of 57 million is kind of the way you think about it?
Yeah I mean it will be in and around, I would say that as a company we will always you know size OpEx to what’s affordable in terms of the gross margin trajectories and that sort of thing, and so although longer term [state] is going to be a sort of depends on the progression of the business model in general, but I would say in general that we were pleased with our spending in the quarter and we are not giving a specific outlook, but its in the right general range.
Chuck Murphy - Sidoti & Company
Okay, and last question. On the 10% price erosion could you give us the breakdown between optical and tape or was there any erosion outside of those two categories?
Well I would say majority of the erosion that we experienced now in the model is in tape and mostly in that mid range in the LTO space and we tend to see it in some of the emerging categories in external hard disk as well as in flash. Not such a big factor in optical anymore and not a large factor in the high end of tape, but it is in the mid range and it is in the some of those emerging formats.
Our next question or comment comes from the line of (Inaudible). Your line is open.
You mentioned the favorable currency impact, could you give us some detail there, a number of guys are being actually hurt by the euro what’s helping you?
Well if you just lift the whole basket of our currencies year-over-year. It was a benefit, now its turned a bit since the end of first quarter and was in the tail end of first quarter and I would suggest as we look forward its likely to be more neutral and then turning to a penalty in the second half of the year.
But during first quarter overall it was a benefit and yet you’ve got to remember we are comparing year-over-year so I am comparing first quarter 2009 exchange rates to first quarter 2010.
Okay, I think that’s where I was getting to see the signs thank you. And back to Chuck’s question on the tape, what roughly what portion of your tape is the mid range piece you talked about.
The list is growing. You know its data center is a major part and then the rest of tape is relatively equal in size, yeah it’s roughly half of our overall tape.
Okay that’s helpful. And just lastly I ran across some article I wonder if you can give us your thoughts on this proposed European copyright tax increase for blank optical media?
Yeah well actually the levies in on optical and Europe are going down. It was just a recent ruling that validated to go forward levy rates at a substantially lower rate than they had been. There has just been a couple of years in Europe where the old levy rates had run out and we were essentially working under those rates until new rates were determined those rates were just determined recently actually at a substantially lower level. You know we collect levies and then remit the levies, so it’s a past through generally speaking to us, but it does obviously impact the overall price level as we pass it through into retail.
So from an overall standpoint, that’s actually some good news.
(Operator Instructions). Our next question or comment is a follow up from Mr. Chuck Murphy, you line is open.
Chuck Murphy - Sidoti & Company
Obviously the cash balance is very solid right now, just wondering your thoughts on how you are going to put it to use?
We get that question a lot obviously. I would say that we think all of the normal use of the cash are valid use of cash, let me start there. Our highest priority has been will continue to be those opportunities that are directly in our business, internal opportunities for growing our products, growing our positions and if needed restructuring the operations, because those are always very near and quick turnarounds. As you move towards the strategic end of use of cash, you know that is an area we’d looked at over time, I mean I don’t think you’ll see the company as involved in acquisitions of the size we were involved in 2006-2007 we really changed the sort of platform of the company but a scenario we’ll always continue to look at and in the quarter we invested a bit of money on the RDX platform which we really believe in and is a nice relatively proprietary format.
And things like that will always make a lot of sense to us. And then in terms of sort of cash returns to share holders, [leading] us through share buy back or dividend. Those are decisions we make in [council] with the board and you know obviously we don’t really foretell what we are going to do there. But, over the long terms when [we have had] excess cash and haven’t had opportunities to deploy that in an accretive fashion for the shareholders. You’ve seen our history involved in dealing with actually either share buy back or dividends.
Chuck Murphy - Sidoti & Company
One last question here, historically it been has sent to disclose the margins for magnetic optical flash. I guess you do disclose electronic products but given that kind of the sales mix has changed a fair amount over the past couple of years could you at least kind of rank or give us some kind of ballpark idea what the margins are in those different products these days.
Sure as you look at our portfolio it use to able to say taper clearly the highest margin and then it would have depending on the period you know moved to optical and then to CE and I would say that’s not so much the case anymore. You know optical and taper are very similar, this time when optical has better margins than tape. And you know we continue to struggle in, while we have stabilized our margins very nicely and flash and hard disk and some of emerging format. We are struggling to get the kind of margin we really like to see there and we are very focused on that and believe that there is some opportunities. But that scenario we wish we had a little better margin and then in CE you know we are seeing some nice improvements. I talked to you about in the past that we need to take that from where it had gone at the end of ‘08 and early ‘09 which was into the single digits and move it back into the low teens.
And we have done and that’s a good news and we’d like to continue to try to differentiate especially around accessories and make sure we make the right selective decisions on which electronics were involved in. So we stay away from the problem areas, but that’s a general overall view and clearly there is not as much of a mix impact in the company anymore as it once was between the higher margin and the lower margin products.
Chuck Murphy - Sidoti & Company
Could you assume that if optical and taper roughly 70% of sales, that they are a similar percentage of the operating profit or is it unnecessary to jump in?
Yeah, I take that’s generally accurate although you got to remember that Magnetic has an R&D investment and optical doesn’t and so that will change that a little bit. I have said before I think, our best ROIC in the company is in optical right now. We don’t have that factory investment, we are getting very solid gross margins, there isn’t and R&D investment required, that’s a really good business model and I’m not suggesting others aren’t, but that’s a very healthy one.
The optical piece is that piece that has worked best overall for this strategy.
Chuck Murphy - Sidoti & Company
Gotcha, okay, thanks guys. And Frank, best of luck in retirement. Sorry I didn’t mention that before.
Chuck Murphy - Sidoti & Company
Again, ladies and gentlemen, if you have a question or comment at this time, (Operators Instructions). I’m showing no additional audio questions at this time, sir.
Well, I’d just like to make a few closing comments and I’d like to start by saying, as I end this call, for the last time as Imation CEO, I’d like to say just how proud I am of what Imation’s worldwide team has accomplished. Not only since the 1996 spin-off, but also in the short time that we began our company transformation.
Over the past four years we have established strong foundation for the future and begun executing Imation’s new strategy to optimize our mature storage, while growing an emerging storage areas and extending our reach by leveraging our brands into new categories and channels. We have returned to operating profitability have dramatically improved our cash flow generation and remain debt free.
I am optimistic as I retire from Imation and Mark assumes responsibility as the new CEO next month, that our strong financial foundation provides an excellent platform upon which to build for the future.
Thank you all very much for attending our call.
Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.
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