Imation Corporation's (IMN) CEO Mark Lucas on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: Imation Corporation (IMN)

Imation Corporation (NYSE:IMN)

Q2 2014 Results Earnings Conference Call

July 31, 2014, 10:00 a.m. ET

Executives

Scott Robinson – Vice President, Corporate Controller and Chief Accounting Officer

Mark Lucas – President and Chief Executive Officer

Paul Zeller – Senior Vice President and Chief Financial Officer

Analysts

Eric Martinuzzi – Lake Street Capital Markets

Stan Berenshteyn – Sidoti & Company

Mark Miller – Noble Financial Group

Operator

Good morning. My name is Phoenix and I will be your conference operator today. At this time, I would like to welcome everyone to the Imation Corp. Q2 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks', there will be a question-and-answer session (Operator Instructions). I would now like to turn the call over to Scott Robinson. Mr. Robison, you may begin your conference.

Scott Robinson

Thank you, Phoenix and good morning everyone. We appreciate you joining us for Imation's second quarter 2014 earnings call. Before I ask our CEO, Mark Lucas to report on the Company’s progress during the quarter, I’d like to remind everyone that certain information discussed on the call that does not relate to historical information may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Act of 1995.

Such statements are subject to risks and uncertainties that could cause actual results to differ materially from any projected results. Risks factors that could cause the results to differ are outlined in the press release issued today as well as our filings with the SEC.

With that, I'll turn the call over to Mark Lucas, Imation's CEO.

Mark Lucas

Thank you, Scott and good morning everyone. Let me start by saying I am pleased with the encouraging progress we saw in Imation's second quarter. Overall results met our expectations. The company’s total revenue decline rate moderated and we again produced improvement in our expense levels. On a sequential basis, total company net revenue and gross margin in the second quarter were essentially flat with the first quarter of 2014.

As you recall, we have two business units. Consumer Storage and Accessories or CSA segment and Tiered Storage and Security Solutions or TSS. In CSA, although secular declines continued in optical media as we anticipated, revenue for our Audio and Accessories category grew 10% from last year’s Q2 and was also up sequentially.

Importantly, our growth drivers for future success performed well sequentially. I mentioned Storage Solutions and Mobile Security portfolios posted revenue growth over the 2014 first quarter. Gross margins in the TSS segment also rose sequentially. We are executing on a number of initiatives in both I mentioned is Nexsan and IronKey portfolios and that is generating momentum as we noted in this morning news release.

Let me go deeper into each of those areas starting with I mentioned Storage Solutions business. Here, we posted sequential gains in all geographies. In order to drive our growth for entire Nexsan portfolio, especially for the NST Assureon lines, we are making investments not only in the U.S. but also in Europe and Asia. Year-to-date we have added sales, engineering and support professionals in these businesses increasing our headcount by over 20%.

Further, for the past several quarters we have brought on new value added resellers and have actually expanded this channel by 25% today which translates into approximately 50 new buyers for us. As we hire new sales, talent and borrowers we have focused on improved education, training tools in our on [boarding]. We are now beginning to witness a productivity that you would expect to see from our enhanced education efforts.

In Storage Solutions as I mentioned last quarter, there are three main Nexsan offerings. First is our NST line, which we are very excited about and we have a sizeable NST win in the second quarter with a large telecommunications based company in Dallas. Through our NST Solution set, we have expanded our Imation’s footprint with high capacity storage markets and successfully entered the high bridge storage market as well. This market is appealing to us because it is growing at more than 20% annually and is expected to capture 45% of the external storage market by 2017.

Our NST line uses an architecture that optimizes flash technologies for caching and storage performance. NST is broadening our market reach into the data center by addressing mixed application workloads, cost effectively and in a scalable way. To make sure we are all -- we are well positioned to capitalize on NST’s growth opportunity, we are advancing a number of feature upgrades. For instance in the second quarter, we introduced NST Smart bundles that are configured to a capacity for performance requirements as needed and we have other new capabilities on our road map that I will share with you in the coming quarters.

The second part of Storage Solutions is the Assureon Data Archive Storage Systems. This differentiated suite of products is designed for applications that require high security and long term fire retentions. So we are marketing the verticals such as financials services, healthcare and human resources.

Product security features comply with HIPAA and Sox for users requiring privacy and confidentiality. Assureon had several nice wins in the second quarter and we are confident that sales in this line will become a larger part of our revenues in the second half. And third is our E series family, which is what Nexsan is best known for and continues to grow. Among the second quarter wins are systems for the Korean government and one of the leading [braking] car organizations in the world.

With the E series, we deliver a solid product that competes effectively with both Storage. Recently, we launched a new configuration in our E-Series V system line of ultimate reliable and efficient storage arrays that offer lower cost and maximum uptime.

Including the new E32V we now have four configurations that can be easily expanded with additional capacities. Now let me update you on Imation Mobile Security. Here again, we reported nice sequential growth. You have heard me describe what we like to call our ‘PC on a Stick’ product and what it’s fondly known as our IronKey ‘Windows To Go’ solution. This product has the customer’s corporate Windows 8 operating system on a secure flash drive that has central management capabilities.

Microsoft is our strategic partner and has success with custom referrals and customer education on how to use a product and its value proposition. We are seeing some [repeat] business now in addition to a number of new Windows To Go sales to small and medium size organizations.

Further, Imation has over 70 Windows to Go pilots or proof-of-concepts currently underway with large enterprise customers as well as government agencies. The Windows To Go sales cycle, however is a long one and orders tend to small and build overtime. It is particularly noteworthy that we now have two Fortune 100 Companies that have approved Imation as a solution provider.

One of the strongest used cases for a large customers they want Windows To Go to implement a BYOD or “Bring Your Own Device” strategy on laptops beginning with contract workers. What’s behind this is our better security and mobility combined with substantial cost savings versus laptop deployments.

Moreover, we just announced our new IronKey W700 the industry’s only FIPS Level 3 certified Windows To Go product. This high level of security is a competitive advantage. It has required certification for most governments and Department of Defense and Intelligence Agencies that have been doing proof-of-concept testing of data versions in the first half of this year. We have relationships with more than 50 agencies and we expect that number of them to make their first significant Windows To Go purchases in the second half of 2014.

Now, let me turn into our Imation’s Consumer Storage and Accessory segment or CSA. In addition to strong cash generation, this business continues to reduce its cost structure and maintain its optimal media market share. Moreover, CSA is focused on introducing higher margin products.

During the second quarter, we had availed the new TDK TREK speaker. The TREK line is our wireless, weather proof, portable audio product line and it helped drive the 10% growth in our audio and accessories category a year-over-year as I mentioned a few moments ago. Margins continue to improve as well.

In our first quarter conference call, I mentioned another new higher margin product, our patented 2-in-1 Micro USB Flash Drive. This product continues to sell well in the second quarter led by Europe and the Middle East. This is a differentiated offering for us that carries an attractive gross margin.

So what does the second half of 2014 hold for Imation? We don’t anticipate our CSA segment which we need to grow due to the secular optical declines. But we will continue to manage this segment well and launch higher margin products most notably in audio and accessories.

Our growth businesses are clearly gaining momentum. We expect continued sequential growth in our Storage Solutions and Mobile Security portfolios. As our added sales people continue to adept the speed around the world, we anticipate that the sequential growth we are seeing will lead to a return to year-over-year growth in the near future. This is our top priority as we continue to evolve our Imation into a significant player in the higher growth and higher margin markets of data storage and Mobile Security.

At this point, I like to ask Paul Zeller to say a few words as an introduction to our financial review. You have probably all seen the SEC filing we did earlier this month indicating that Scott Robinson is going to take over from Paul as CFO, but we can’t let Paul go without extending our heartfelt thanks to him for his 18 years of service as Imation’s CFO and wish him the absolute best of luck going forward. Paul

Paul Zeller

Thanks very much Mark. Before I do introduce Scott, who is going to go through the details on Q2, I would like to take the opportunity to make a couple of comments as I transition out of Imation. I’ve been on Imation since the spin-off from 3M in the last 18 years have been quite a journey. Don’t worry, I’m not going to run on this, but I do have a few comments.

First I’m leaving Imation on very positive terms. Its’ the right time for a change and I’m looking forward to my next opportunity. As I do move on, I remain a strong believer in this strategy and in the upside opportunity for the company and its shareholders. And I plan to remain a shareholder. The sequential improvement in Storage and Security Solutions I believe is encouraging so is the continued solid margins and cash flows from our legacy storage businesses.

In terms of a finance team, I couldn’t be more pleased to see Scott Robinson taking over as CFO. Most of you already know Scott and how skilled he is, supporting him is Danny [Zhang] as our Corporate Controller. These guys are deeply experienced and fully capable. You are going to enjoy working with them as I have. I’ve also appreciated working with you our shareholders and analyst and I’m grateful for the confidence you’ve shown in me and in our team and the company. I would be helping Mark and Scott with this transition over the next couple of months.

With that, let me now introduce Scott to walk you through our second quarter results.

Scott Robinson.

Thank you, Paul. It has been a pleasure working with all over the years and I appreciate all that I’ve been able to learn from you, I wish you the best.

Turning to our financial performance. From an overall standpoint, we saw several encouraging signs in the second quarter. Imation’s total company revenue decline rate moderated, our gross margins rose slightly on a sequential basis and we posted continued improvement in our expense levels.

Total company revenue in Q2 was $178.6 million, which was down 15.6% from the second quarter of 2013, but flat with Q1 of this year as we note in the release. Foreign currency exchange rates did not have a significant impact on it quarterly revenue compared to Q2 2013.

Looking at revenue by segment, out Tiered Storage and Security Solutions revenue decreased 11.9% compared to a year ago, however, it rose sequentially. This was true for our tape business as well. Our Consumer Storage and Accessories revenue decreased 18.6% from the same quarter last year, due largely to the expected secular declines in Optical Media products as Mark mentioned.

Consumer Storage Media was down 21.2% last year but this was partially offset by a 10.4% increase in Audio and Accessories revenue with the TREK product line making strong contributions. This is a product area that has shown consistent growth over the past several quarters.

Next, I’ll move to gross margins. Though lower compared to Q2 last year, total company gross margins rose slightly on a sequential basis. As we noted in last years Q2 call, we had benefited from a levy reversal and non-recurring, a non-recurring event which led to a 26% margin in Q2, 2013. The margin without a levy was about 20% compared to 19% margin this quarter. Sequentially, margins increased slightly from the first quarter.

As compared to the segment level, CSA gross margin was 18.9% down from 21.7% a year ago due primarily to lower revenue levels. Sequentially, CSA gross margin rose from 18.3% in Q1 which was good to see. CSA’s gross margin was 19% versus 30.2% in Q2, 2013; again, last years CSA’s margin included a benefit of 11.6 points from the levy accrual reversal. Excluding the reversal benefit CSA margin was slightly higher than a year ago. As you know, expense control has been a company wide priority for several years.

Total company SG&A declined$2.2 million from last year to $44.3 million due to our continued cost reduction efforts. The SG&A associated with our legacy business has dropped more than 25% from Q2, 2012. This has more than offset our additional investments in Imation’s Storage Solutions.

Research and development cost came in at $4.5 million, up slightly from Q2, 2013 and reflects Imation’s increased investments and higher margin TSS projects. The overall operating loss from continuing operations was $20.1 million compared with breakeven operating income last year. Again, last year’s results were cheaply due to the $13.6 million levy accrual reversal.

We did incur tax benefit in the second quarter of $1.6 million, this was due largely to a mix of taxable income by country as no tax provision recorded related to the United States as the company maintains the valuation allowance related to U.S deferred tax assets.

Discontinued operations loss of $1.6 million improved from the loss of $3.3 million in Q2, 2013. This includes the results of XtremeMac and Memorex consumer electronics businesses both of which have now been sold.

Ultimately, we incurred a net loss of $0.48 per diluted share compared to a loss of 4% -- $0.04 per diluted share last year. Our year ago results benefit from the levy accrual reversal we discussed earlier.

Imation’s balance sheet remained solid. We ended Q2 with a $114.7 million in cash and net cash of $94.7 million after deducting the $20 million that is outstanding on our credit facility.

The company also repurchases $900,000 worth of Imation’s common shares during Q2 and the authorized buyback up to $2.9 million additional shares. Further, we have listed our Campus Headquarter building for sale and continue discussion with potentially interested parties. Our goal is to monetize the property in a physically responsible manner.

In summary, our Q2 results show many areas of positive momentum, results that strengthen the continuing execution of our strategic transformation. We are encouraged by the sequential growth in Nexsan and IronKey product portfolios, as well as our audio and accessories category. We will continue to invest in our growth drivers as we concurrently manage our legacy businesses to maximize cash generation.

Let me add, that I’m very excited about my new role at Imation. I believe our future is bright and I will work tirelessly to achieve success for this organization.

Now, we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Martinuzzi whose company was not [let]. Please state you company name. Your line is now open.

Eric Martinuzzi - Lake Street Capital Markets

Hi. It’s Eric from Lake Street Capital Markets. Bon voyage Paul and congratulations Scott on the new role.

Scott Robinson

Thank you. Appreciate.

Eric Martinuzzi - Lake Street Capital Markets

Revenue wise, just curious to know obviously everything grew sequentially. The Nexsan, the mobile, I’m just curious within SMS that growth always most responsible for that and then what do you think is most responsible going forward? It sounds like you’ve got some good pipeline there?

Mark Lucas

Actually the growth has pretty well uniformly spread across products and geographies, which is really encouraging. It’s not like we have one hot spot, it’s growing everywhere. I would say the Nexsan product portfolio attribute to the majority of growth in that segment, Eric, but we did see it across everyone.

Eric Martinuzzi - Lake Street Capital Markets

Okay. And then, when you say you’ve got significant transactions when those to go, what is a typical enterprise size deal?

Mark Lucas

Player typically were excuse if you have a company a Fortune 100 company that says, I am interested in moving to the Windows to go or PC on a Stick product for mobile security. And in Dell, they do the technical specification test in the proof-of-concept and they test it out. And we have not one of those.

Every single one of those, the IT departments have had their jaws literally drop with the level of security and performance that we are delivering. So then we’ll go to a business unit within the organization and they do actual in market trial with their employees and typically they start with contract workers who will want to have access to the Firewall and this is a way to do that using the PC on a Stick.

Then that rolls out to other employees throughout the organization. So it’s probably once we get the initial order it’s typically somewhere we’re seeing, which are estimated somewhere between 20 to 24 months rollout and the aggregate value of these orders can be millions of dollars. They’ll start in the tens or thousands a dollars and it will build as they roll it out to employees.

Eric Martinuzzi - Lake Street Capital Markets

Okay. And then the secular decline business and I may spoke there, the consumer storage media was actually down sequentially, but both CSM, the consumer storage media and commercial storage media, a lower decline rate that I’ve been modeling. And on the consumer side probably the lowest decline on the year-over-year basis in quite some time.

Are we at the point yet where we are able to with any certainty predict that and maybe this is the – we’ve stabilized at a certain decline rate or is it still too much of a wild card and address both the consumer and the commercial if you would?

Mark Lucas

Yes. And actually I think it similar in both of them Eric. We go no one quarter does not make a trend. We are looking at that very closely. There are some indications that perhaps the decline rates are moderating and going to continue to moderate as the tail of this business is stabilize a little bit.

What we’re vesting with a little bit off for though as the decline rates, the unit decline rates stabilize, the average selling prices are becoming more competitive, so putting pressure on margins that we have to maintain. So it’s a balancing act. And we don’t have the answer, yet. I think we need a couple of quarters to be able to accurately forecast how this is going to turn out.

Eric Martinuzzi - Lake Street Capital Markets

Okay. And then within the expense side I noticed we had roughly flat revenues, but yet our operating expenses were up sequentially. It looks like the bulk of that was within SG&A? What’s driving that?

Mark Lucas

That’s how the investments in our security and storage solutions business. So we’ve been adding a lot of people. We’ve been adding engineering talent and all those different things that go along with investing in that business. So, our overall expenses in our legacy businesses in our corporate structure has actually continue to decline quarter-on-quarter, it just being offset by these other investments.

Eric Martinuzzi - Lake Street Capital Markets

Okay. And then lastly and I don’t if you even have any answer, but we’re now down to a net cash balance here of $94 million. You just had a quarter where the cash burn, the adjusted EBITDA number was the negative $9.5 million. Is there anything inside at the board level? Are you targeting at some point we need to cut the expenses, grow their revenue and if it hasn’t happen by quarter [ex] we’ve just got to do something more dramatic just to so that breakeven is actually on the horizon?

Mark Lucas

Yes, I mean, we do all kinds of [modest] plannings, we have contingency plans. We monitor our cash very carefully and we’re very committed to keeping very healthy cash balance for the company. And so, we have our plan of records that we move forward with which is to invest and return to growth.

However, we – as any good business plan does has contingency plans and says okay if something doesn’t pan out exactly what you – how you want to do it, you move to plan B or plan C and we continually work on those and have those available to us. I will say to you and shareholders that we are very committed to keeping very healthy cash balance.

Eric Martinuzzi - Lake Street Capital Markets

Right, but now no target day for breakeven?

Mark Lucas

No; not at this point.

Eric Martinuzzi - Lake Street Capital Markets

Okay. Thanks for taking my questions.

Mark Lucas

Thank you.

Operator

Our next question comes from Stan Berenshteyn from Sidoti & Company. Your line is now open.

Stan Berenshteyn - Sidoti & Company

Good morning, gentlemen and congratulations to both Paul and Scott.

Paul Zeller

Thank you.

Scott Robinson

Thanks, Stan.

Stan Berenshteyn - Sidoti & Company

Just a couple of questions, first, gradually we’ve seen the inventory levels kind of taper off and they’ve acted as a source of cash I think aside from last year. Is this strength going to continue or what kind of is the sweet spot for inventory levels given the trajectory of the declines in the legacy business?

Scott Robinson

Sure, Stan. It’s Scott. So, as you noted, the inventories have come down from Q1 and since they stable from Q1 and its down from year end. And we think that the inventory levels will need to continue to come down as the legacy business has decline, is something we focus on everyday. It goes in cycles where we’ll take it down and than we’ll have to work on another project to decrease the inventories even further, but that something we are very focus on, which is to decrease inventory levels consistence with the declines we’re experiencing in the business. So I would expect as revenue levels drop, the inventory levels will also need to drop accordingly.

Stan Berenshteyn - Sidoti & Company

Okay. And is there any plans for share repurchases or any one-time dividends given the cash balance?

Scott Robinson

As you probably saw, we bought a few shares back during the quarter. That something we look at every quarter with the board. As Eric just mentioned and Mark noted we focus on our cash every quarter. We watch it very closely. We do still have 2 point shift – 2.9 million shares remaining in our repurchase program and that something we’ll look at on a quarter-by-quarter basis and announce it at the end of each quarter.

Stan Berenshteyn - Sidoti & Company

Great, thanks. I’ll jump back in the queue.

Operator

Your next question comes from Mark Miller of Noble. Your line is now open.

Mark Miller - Noble Financial Group

I also like to extent my congratulations to Scott and best wishes for Paul for you future.

Scott Robinson

Thank you, Mark

Paul Zeller

Thank you, Mark.

Mark Miller - Noble Financial Group

I’m just wondering if you can give me a little more colors on these design wins, the Nexsan, NST, Assureon products in terms of the customers, what type customers they are geographically. You said they were improvements across or geographies, but just if you give us a little more color on the wins there?

Mark Lucas

Yes. Unfortunately Mark, we can’t – our customers don’t allow us to disclose their names, otherwise I’d be really like to do that because they are pretty impressive. But we had been in Asia with the Korean Defense Ministry that was a combination of our NST and E-Series line.

We had wins in the United States across all three types of product portfolios in the financial industry in major Southern Bank. We won a deal with Assureon. We won with a major telecommunications company out of Texas and we’ve won with a very, very well known car racing group in the United States.

In Europe, we also had wins with – again across with E-Series, Assureon and NST, the most notable one was with actually the Government of Norway. And I can’t get in too many details there but – and again we have other customers throughout Europe, they just don’t let us to disclose their names.

So what’s encouraging to me is that this is not just U.S. centric, it’s around the world and there is a variety of different application mixes that we’re wining and so it’s a very healthy start.

Mark Miller - Noble Financial Group

Any possibility from any of those customers for follow-on 28.26 orders?

Mark Lucas

Absolutely, one of the great attributes we have is a scalability of system. So, the E-Series is design to be able scale out and be very economical in doing so unlike some of our competition. And so that’s one of the primarily selling attributes that we say.

Mark Miller - Noble Financial Group

I was just wondering, a secular decline is moderated we were hearing from other firms, international firms that they are seeing revivals in Europe and Asia remains strong, should this be strengthening of the global economy also impacting that? And what are you seeing in terms of strengthening in the global economy?

Mark Lucas

Well, we certainly seeing spending, if not stabilize, increased slightly. Again, I hate to make a generalized global comment. But if you look at different marketplaces, Japan, it looks pretty strong right for us. Korea, it looks pretty strong, Australia is doing well, and actually in Europe as well. I mean if you look at the big countries there, UK, Germany, France are doing really well, and Nordic countries seem to have economic recovery going as with the Benelux region as well.

Interestingly enough also the Middle East was at least up until the latest issues and crisis there was doing pretty well. We haven’t seen that decline yet, but anticipate there could be some disruption in the Middle East. And Southern Europe is still, I would say soft. Spain, Italy, Greece, the Eastern European countries remained a little bit softer.

Mark Miller - Noble Financial Group

Sale impacts on the Russian sanctions or the situation in Ukraine?

Mark Lucas

There is not, because we didn’t do very much business in Russia. And so, that’s good and bad I guess. But in this particular case there was no significant impact.

Mark Miller - Noble Financial Group

Thank you.

Mark Lucas

Thank you, Mark.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Mark Lucas

Thank you everybody for participation on today’s call and for your questions. We’re pleased to report sequential revenue growth in Imation Storage Solutions and mobile security businesses and we look forward to hearing further progress with you in our October call.

Operator

This concludes today's conference call. You may now disconnect.

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