Imation Corp. CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.26.10 | About: Imation Corporation (IMN)

Imation Corp. (NYSE:IMN)

Q3 2010 Earnings Call Transcript

October 26, 2010 10:00 am ET

Executives

Timothy Gallaher – IR

Mark Lucas – President and CEO

Paul Zeller – SVP and CFO

Analysts

Rick D’Auteuil – Columbia Management

Mark Miller – Noble Financial

Operator

Good day, ladies and gentlemen. And welcome to the Imation Corporation third quarter 2010 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 conference call, Mr. Timothy J. Gallaher. Sir, you may begin.

Timothy Gallaher

Thank you, Howard. Good morning, everyone. And welcome to our quarter three 2010 earnings conference call. On today’s call you’ll be hearing from our CEO, Mark Lucas; and our 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 would like to turn the call over to Mark. Mark?

Mark Lucas

Thanks, Tim. Good morning, everyone, and thank you for joining us. Over the past few months we have made progress on our strategy of storing, protecting and connecting digital data. We have been building our capabilities in these areas organically with a number of critical skill set additions in R&D, engineering and marketing, in areas such as encryption, authentication and wireless technologies.

In addition, we’ve expanded our footprint in a number of critical application focused areas to partnerships with ProStor, BVT out of Germany and Nine Technologies, all associated with RDX removable hard disk storage and which were previously announced.

We have also partnered with MXI Security and ENCRYPTX Corporation with the launch of our Imation Defender Collection to protect data at risk on external hard drives, flash drives and optical media. And we’re not stopping here as we continue to look at options to accelerate our focus across a spectrum of data storage, data protection and data connectivity.

Now let’s move to the third quarter results. To start, our gross net margins have stabilized and while we are not would be want to be longer term they are heading in the right direction. I’m also pleased to see our emerging storage products continue to grow at a strong pace.

In addition, we are continuing to achieve operational efficiencies through our Project Excel initiative as evidenced by lower expense and improved working capital metrics. We will continue to remain focused on these areas.

Now on a separate note, we just got back from visiting all the regions around the globe, doing business reviews and I’m pleased to report that we are consistently focusing on products and applications that create differentiation. I’m excited about all these opportunities and I’m confident they will produce results. However, I also realize you are looking for a more tangible reflection of what that means, especially in terms of the impact on shareholder value. We will have more to say about our direction soon and we will have specifics to share with you within the next 90 days.

I’ll now turn the call over to Paul Zeller who will review the financials for the third quarter in more detail and then I’ll join Paul to address any questions following his review. Paul?

Paul Zeller

Thanks, Mark, and good morning, everyone. Before getting into the details on our third quarter results I’d like to make a couple of summary comments. As I look at our quarter three results were relatively similar to quarter two. There were some positive signs as Mark just mentioned in terms of new product growth and gross margins and our financial position remains strong.

However, there are a number of areas where we need to make more progress and overall, our results are not where they need to be longer term. We will continue to focus on actions to improve our gross margins and profitability while remaining tightly focused on cash generation.

Now let me get into details. Revenue at $342.3 million was down 14.7% versus Q3 of last year. This rate of decline was moderated from the rates we saw last year, however, this was higher than the decline rates we experienced in the first half of this year.

We saw weakness in optical products in both the U.S. and Europe with revenues down about 19% overall, in general, CD showed the most significant declines. In addition, some changes in the optical levy environment in Europe lowered revenues. We collect levies on optical products from customers and remove this to the collecting societies and during the last year, levy rates have declined which lowers our revenues but also lowers our cost by the same amount.

Magnetic tape revenue decline slowed in Q3 to 11%, the lowest decline rate we’ve seen since the first half of 2008. LTO-5 mid range revenues began to ramp and we saw some strength in the data center. Our emerging storage revenues increased nicely during the quarter up 23%, driven by strong flash drive revenues as well as RDX revenues.

Consumer electronics and accessory revenues decreased 28% in Q3, the majority of which related to our planned rationalization of video products begun late last year.

From a segment standpoint, our Americas segment was down 17% in the quarter, driven by continuing declines in traditional storage, as well as video products as I just mentioned. Europe was down 31% year over year, driven by declines in both tape and optical. Optical in particular was impacted by the reduction in levies I just mentioned.

In addition, our Europe business is more concentrated in our traditional storage category and thus receives less benefit from emerging storage and electronics and accessories. As well, currency translation was a penalty in Europe during the quarter versus the prior year. North Asia revenues grew 7% with strong volume growth. This region was also aided by stronger yen versus the dollar. South Asia revenues were roughly flat compared to Q3 last year.

On a worldwide basis, our roughly 15% decline in total revenues came from about a 7 point impact from lower volumes, a 9 point impact from price erosion offset by a 1 point positive impact from currency translation.

Our gross margins in the quarter were 16.2% to sales that’s up one-tenth versus last year’s third quarter. We improved margins in both emerging storage products, as well as electronics and accessories. For the first time both of these categories were in double digits and while there is much work to do here, we like the trends especially with our electronic accessory products where we’ve seen gross margins in the 20 plus percent range in the last several quarters.

Our traditional storage margins were stable year over year in both tape and optical. With flat to improved margins across the board, the only thing that kept total margins from improving more was a negative mix impact from the growth we saw in emerging storage versus the declines we experienced in traditional storage products. Our gross margins were relatively flat sequentially.

Our operating expenses totaled $53.6 million in the third quarter that’s down $1.7 million or 3% from the third quarter of 2009. This was the lowest OpEx we had since 2007 before the acquisition of TDK and reflects our continuing focus on cost control. As a percent to sales, OpEx was 15.7% in the quarter, in line with the first two quarters of this year, but up from last year’s third quarter, which benefited from stronger revenues.

We had $4.3 million of restructuring and other charges during the quarter related to our previously reported restructuring program. Including these non-recurring charges we had an operating loss of $2.3 million in Q3. Excluding those charges, our operating income in the quarter would have been $2 million, which compared to a $9.2 million operating income on the same basis in Q3 of last year, which was our strongest quarter last year. Though this result was not unexpected, we clearly need to improve our earnings longer term.

Non-operating expenses for the third quarter were $900,000 that’s down from both Q3 last year and the prior quarter this year, which totaled $2.2 million and $2.9 million, respectively. We were benefited by a strong euro and yen and for that matter, most currencies against the dollar near the end of the quarter. We recorded a $900,000 tax benefit in the quarter associated with our pre-tax reported loss of $3.2 million for a tax benefit rate of 28%.

On a per share basis we had a loss of $0.06 driven by restructuring and other charges. If we exclude those charges, we would have had earnings per share of about $0.02 and that compares to $0.14 per share last year on the same basis.

Our financial position continued strong in the quarter with cash up $5.5 million and up $93 million from last year end and ended the quarter at $256.8 million. There is no debt outstanding and our working capital indices continued to show improvement versus last year.

Our operating cash flows were only slightly positive during Q3 with positive EBITDA being offset by modest and expected seasonal working capital increases. In addition, we made a scheduled payment in the quarter to Philips as a part of the July 2009 settlement of the litigation between our companies that was $8.2 million.

In summary, we did see some positive signs in the quarter, namely new product growth and gross margins, and we remain confident in our strategy and actions we’re taking to transform the company. We’ll continue to focus on actions to improve our gross margins and profitability while remaining tightly focused on cash generation.

At this point, Mark and I’d be pleased to take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question or comment comes from the line of Rick D'Auteuil from Columbia Management. Your line is open.

Rick D'Auteuil – Columbia Management

You introduced, I guess, you started your comments saying that you expected to have more for shareholders in the next 90 days. Is that a – what is the forum for that? Is that going to be a call or an analyst day? What is – anything you can share as it relates to that?

Mark Lucas

We have not determined the specifics of that yet. We're going to be working and will announce that. It will – as I said, it will happen sometime in the next 90 days. And we'll provide more specifics around the strategy that we introduced back in May of this year.

Paul Zeller

At a minimum, it would occur no later than likely our quarter four conference call that will happen at the very end of January or early February.

Rick D’Auteuil – Columbia Management

So, I guess, because you're being kind of definitive or semi definitive on time, it's not related to an announcement of an acquisition or anything like that. It's just an update on the strategy as it's progressed?

Paul Zeller

Yeah, exactly. I think as Mark said earlier, we realize that we've been working under this kind of refined strategy and transformed the company now for several quarters. And we think it's time to provide some more specifics as we think about the company going forward.

Rick D’Auteuil – Columbia Management

Okay. And can you talk generically about the pipeline of acquisition opportunities?

Paul Zeller

Yeah. I think we've said publicly when we were out talking to The Street in May and at some conferences that we are looking at use of cash on a variety of fronts. Organic investment, we've clearly been focused on that and re-skilling the company and building some partnerships across the industry in some important categories. And we also continue to look for opportunities inorganically as we've said. And I think we'd stick to our prior comments being that should we do that, it will likely be something more centric around storage, something around application and differentiation and likely smaller than the size of acquisitions we were involved in say in, '06, '07.

Rick D’Auteuil – Columbia Management

Things that shareholders might care about like buybacks, will there be an update on that front too?

Paul Zeller

Yeah. I think fundamentally from a cash deployment standpoint, we continue to view all the uses of cash organic, inorganic, return of cash to shareholders, from a buyback and dividends, all as viable uses of cash. And, you know, we'll over time provide more feedback relative to that, yes.

Rick D’Auteuil – Columbia Management

I guess, I just want to make sure as a large shareholder here that with the valuation that you guys are being afforded in the marketplace, I'm not sure you're going to find anything at less than two times EBITDA. So I would hope a buyback is also on the list of capital uses.

Mark Lucas

Yes. We will address that when we come back to you within the next 90 days.

Rick D’Auteuil – Columbia Management

Thank you.

Operator

Our next question or comment comes from the line of Mr. Mark Miller from Noble Financial. Your line is open.

Mark Miller – Noble Financial

Just looking at your inventories, they went up, is this just a normal kind of seasonal adjustment prior to a strong December quarter?

Paul Zeller

Yeah. If you look at our inventory days, it's in a good range. And we expected inventories overall to come up and we do tend to have a seasonally stronger fourth quarter than other quarters in the year and kind of on that point, we tend to see a margin structure driven by some of the stronger CE revenues. That's a little lower in gross margin but we should get a lower OpEx ratio as well as we deliver seasonally stronger revenues typically over our SG&A.

Mark Miller – Noble Financial

There has been some increased focus, I guess, on pension liabilities and I'm just wondering if you can make any comment about the funding of your pension liabilities?

Paul Zeller

Yeah, you know, we disclose that on an annual basis and we, as most companies with defined benefit plan, we have a cash balance plan but it's technically a defined benefit plan, are under funded relative to assets on an accounting as well as a statutory basis. And you know that I would say we're not in an unreasonable range relative to other companies. And we've not had to make any significant extra amount of funding from a statutory standpoint but it's something we continue to look at and monitor. And at yearend, we were essentially 30% to 40% kind of under funded relative to at least the financial metrics.

ARISA tends to be a little bit better than that but that's kind of where we're at and over the long-term, that will require some level of either additional funding or improved asset performance or the combination.

Mark Miller – Noble Financial

Would that be off the mark to say it's approximately around $30 million or you don't want to comment on that right now?

Paul Zeller

Yeah. On a GAAP basis that's been the right general range, that or a little bit more. Clearly, the statutory funding requirements are not nearly that high. You get usually a period of time to bring your assets in line with liabilities. And so there isn't an immediate demand on liquidity for anything near that kind of level.

Mark Miller – Noble Financial

And just one final one, I didn't catch all of this but if you could give a little more color on the reduction in levies in the optical area?

Paul Zeller

Yeah, essentially what's been going on there is, there has been a pretty frankly messy situation in terms of the optical levies that get charged. And it's very different by country in Europe and can be as high as two euros per disk in some countries and no levy in other countries. And it causes all sorts of cross border issues and that's been sort of, been lessening over time especially as the price of optical over the long-term has come down. And that simply means, we are not charging as high of a levy to the customer on every disk we sell. And then fundamentally, we just then return that to the collecting society. And so what that essentially does is gross down our revenues and costs, if you will.

Mark Miller – Noble Financial

Thank you.

Paul Zeller

Yes.

Operator

(Operator Instructions) I'm showing no additional audio questions at this time.

Mark Lucas

Okay. Well, then thank you all again for joining us on the call. There is a lot of work to do but I am very excited about the opportunity. Paul and I look forward to getting back to you in more detail about our future plans within the next 90 days. Thank you.

Operator

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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