Imation Q3 2007 Earnings Call Transcript

| About: Imation Corporation (IMN)

Imation (NYSE:IMN)

Q3 2007 Earnings Call

October 25, 200710:00 am ET


Bradley D. Allen - IR

Frank Russomanno - CEO

Paul Zeller - CFO


Matt Teplitz - Quaker Capital Management

Glenn Hanus – Needham

Mark Miller - Brean MurrayCarret


Good day, ladies and gentlemen and welcome to Imation’s thirdquarter earnings announcement call. (OperatorInstructions) I would now like to introduce your host for today’s conference,Mr. Bradley Allen, Vice President of Investor Relations. Sir, you may begin your conference.

Bradley D. Allen

Thank you. Goodmorning, everybody and welcome; thank you for attending our call. Before webegin with comments from Frank Russomanno, our CEO and Paul Zeller ourCFO. I want to let you know that thecompany is scheduled to present at the Needham Conference in early January in New York City. Ilook forward to see many of you at that time, if not before. If there are follow-up questions after thiscall I’ll be in my office all day today, and tomorrow as well.

I also want to remind you that certain statements which donot relate to historical financial information may be deemed to constituteforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act. Such statementsare subject to risks and uncertainties that could cause actual results todiffer from historical results. The riskfactors are outlined in our press release and SEC filing.

With that, let me turn the call over now to Imation’s CEO,Frank Russomanno.

Frank P. Russomanno

Thank you, Brad and good morning. As we said last week when we pre-announcedthe quarter, our Q3 results were disappointing; but we understand our problemand will fix it. Our other businessesperformed generally as expected, and Paul will get into more detail on theoverall results.

Our miss for the quarter was entirely due to the flashbusiness in the U.S.retail market, so I want to spend my time discussing the flash business. In most of the rest of the business, we had agood quarter, including our flash business outside of the U.S.retail market. In just about all othermarket segments and regions of the world, we continue to participate in theflash business with an acceptable margin. Now I want to take a moment to answerthree questions that you may have on your mind.

(1)Why stay in the flash business?

(2) How do you intend to fix the flash business?

(3) When will we see the benefits from all of thechanges?

First, the flash market still represents an attractivegrowth opportunity for Imation. Today,the removable flash market for USB flash and flash cards is estimated to be an$11 billion market. It is a marketprojected to continue to generate solid growth for 2011, our strategichorizon.

We have achieved acceptable margins in our flash business inthe U.S.commercial channels and in commercial and consumer channels outside of the U.S. I believe that the changes we are making inour flash business will allow us to take advantage of some of flash’s growthopportunity, but as a profitable business at acceptable margins.

As a result, I expect that Imation will continue to have ameaningful participation in the overall flash market, but will be more focusedand selective. We clearly need to changehow we participate in the flash market, a business that represents less than10% of our worldwide revenues and has a disproportionately negative impact onour results.

So, how do we intend to fix the flash business? We will do this by making changes in threekey areas.

(1) We are changing how we participate at retail, both interms of where we compete and on what basis we compete.

(2) We continue to seek strategic sourcing relationships thatchange our value chain position.

(3) We have changed how we manage day-to-day operationalactivities in the business.

We recognized how important our retail channel partners areto Imation. We have large and valuablebusiness with them across other product categories outside of flash. Also these same channel partners are part ofour future strategy and plans. As wemake these changes, we need to continue to work collaboratively, deliberatelyand thoughtfully with these channel partners. We will selectively participate in the in one of three ways.

(1) We will participate with key customers willing to workwith us under terms which allow us to make acceptable margins, with a continuedon shelf presence in flash;

(2) Or, we will participate on a limited basis in accountswhere we can move product profitably on in-and-out promotions;

(3) Or, we could be entirely out of flash at some retailaccounts while maintaining our optical and other businesses.

One way to think about our approach here is to recognizethat the terms under which we participate in retail work for us in optical,where we have strong brands and a leading market share globally; strategicsourcing relationships and significant channel presence.

The flash market in U.S. retail has significant price andcost volatility and we occupy a different position in the marketplace comparedwith our optical position, so we are ratcheting down our participation in U.S.retail with flash and focusing our efforts on those regions, channels andaccounts that will enable us to have acceptable margins over time, in themarkets where we choose to compete.

As we more selectively participate in the U.S.retail market and continue to participate outside of the U.S.where we generate acceptable margins, I expect flash will still represent someportion of our total revenue. As we rampup the TDK and Memcorp acquisitions, neither of which has a significant flashbusiness, this percentage could vary quarter to quarter.

The second change is to fix the flash business in the areaof sourcing. We continue to look forstrategic sourcing relationships, or ways for us to occupy a different valuechain position in the industry. We havebeen working on this for some time, and we remain focused on establishing adifferent footprint in the industry then the one we occupy today as areseller.

The approach is similar in intent to the move we made withMBI and optical. However, the market structure in flash is very different thanwhat we found in optical media. Flash isa fragmented industry. One company makeschips, another makes controllers, and a third assembles them. There are multiple brands, some of them were broughtto market by chip or controller manufacturers and assemblies. Strategic relationships are difficult andtake time to establish in any industry. So it is a challenge, but we will continue to work at it. Our plan is to move to a better sourcingmodel in 2008.

The third change we are making in flash is the way weoperate the business. Several years ago,we gave significant operational latitude to the regions which controlledbusiness operations for all products. Regions do their own sourcing and manage their own inventory. They manage pricing and they have the freedomto create new SKUs. This model hasworked well for us in more stable businesses such as optical media, but giventhe volatile nature of the flash business and our lack of leverage as areseller, it is not viable for Imation.

To address this reality, I decided to consolidate themanagement of the flash business under our corporate team led by Pete Koehn,our new VP of Operations. Nowcentralized flash product management in Oakdale has authority andaccountability for tight constraints on SKUs and SKU proliferation, inventorymanagement and sourcing, purchasing, logistics and supply chain. As a result, we have eliminated independent buys,reduced SKU proliferation and we are reviewing promotions ahead of commitment. Ourregional sales organization is focused on being a highly efficientimplementation organization designed to deliver sales, channel management andregional marketing.

I believe all these changes are necessary to manage thisvolatile business and I will update you on our progress on these changes in thecoming months.

So when will we see the benefits? We are still cautious about Q4 as reflectedin our outlook. Paul will get into moredetail in a moment. But we have alreadyrisk adjusted our outlook, assuming continued pressure in the flash business aswe make the changes I have outlined.

Having said that, I believe we will start to see thebenefits in our flash business as we exit Q4. Our restructuring programs in both manufacturing and R&D areproceeding ahead of plan. Each of theseactions will contribute to a more positive 2008 and beyond. I firmly believe that the actions we aretaking will add significant value for the future.

Finally, we continue to implement our overall strategy;namely, transforming Imation into a brand and product management company. The TDK and Memcorp acquisitions contributedpositively in the quarter and the integration is proceeding on plan. We are making progress in our strategy as webuild strong and differentiated positioning statements for each of our brands.

In 1Q08 we will describe to you in some detail how theImation, Memorex and TDK Life on Record brands will stand apart across variouschannels, regions and products. This isa bold and novel approach to bring a classic consumer package goods marketingmentality into consumer technology, specifically in a category that has notseen this approach in any significant way before. We are building our strategy on the fundamentalprinciple that brands matter.

With that, I’ll turn the call over the Paul Zeller, Imation’sCFO.

Paul R. Zeller

Thanks, Frank and good morning, everyone. Obviously our Q3 results were disappointingand I believe that after a difficult quarter it’s more important than ever todeal with the issues in a transparent and straightforward manner, so you cansee the issues as we see them, understand the actions we are taking and measureour progress.

There is no question that our U.S.flash business is hurting us, and as Frank mentioned, we will be much moreselective about how we participate. Having said this, the rest of our businessperformed reasonably well. Like anyquarter, there were some ups and downs which I’ll get into; however, overall wewere pleased with the quarter for the balance of the business, especially thecontributions from our recent acquisitions.

Now let me get into the details. Our third quarter revenues totaled $525.5million, and that represent growth of nearly 24%. This growth was driven by revenues from ourTDK and Memcorp acquisitions which together provided $140.6 million inrevenues, $98.4 million from TDK and $42.2 million from Memcorp. We were pleased with these contributions,especially given the significant amount of activity associated with transitioningthese businesses.

Excluding the impact of acquisitions, revenues were downabout 9% year over year. The majority ofthe decline came from our Global Data Media joint venture, due in part to theloss of certain TDK revenues which were previously sold through GDM. Theserevenues are generally now included directly in the TDK business. In effect then, the actual TDK revenuecontributions to Imation in the quarter were effectively somewhat less than the$98.4 million I just noted, due to the fact that we had already been capturingsome portion of TDK revenues. Thisimpact was anticipated and included in our previous estimates for the size ofthe TDK business.

We saw volume growth in the quarter of 34% driven almostentirely by the acquisitions. We saw a 2% currency translation benefit andthose were partially offset by a 12% impact from price erosion, most notably inour U.S.consumer business.

Optical product revenues were $234 million, representing anincrease of 22.5% driven by TDK brand revenues somewhat offset by GDM as I justmentioned. Excluding TDK and GDM, we sawincreases in DVD of about 25% and decreases in CD of about 12%. Optical revenues were benefited by the HPbrand distribution business that began in the quarter. In total, opticalproducts represented 45% of revenues in the quarter.

Magnetic product revenues increased 10.3% to about a $178million, and that’s up $16.5 million from last year’s third quarter due to theTDK magnetic revenues, the majority coming from Audio Video products. Excluding those TDK revenues, magneticproducts were down 7.6%, generally in line with the declines we experiencedduring the first half this year.

This decrease was driven almost entirely by entry levelserver and diskette products. Magneticproducts represented 34% of total revenues during the quarter.

Revenues from electronic products and accessories totaled $74.4million, up $48 million from last year. The acquisitions added about $46 million, mostly from Memcorp. The remainder of this category was up about7.5% year over year. This category represented14% of total revenues.

Flash product revenues totaled $39.2 million and declined15% or $6.9 million in the third quarter. We intentionally began limiting our participation in certain portions ofthe U.S. regiondue to the margin issues that Frank mentioned earlier. We did see strong growth in international andcommercial markets. Flash productsrepresented only 7.5% of total revenues in the quarter and yet caused our entireoperating income shortfall. It is clear that we do need to address thisbusiness.

On a regional basis, our Americasegment revenues grew 16.3% to $288 million in the third quarter andrepresented about 55% of worldwide revenues. The growth in this segment was due primarily to the impact of theacquisitions, partially offset by declines in flash products. European revenues grew 21.7%, totaling $152million; that’s 29% of total revenues. Again the TDK acquisition drove growthin this region, partially offset by declines in GDM. Revenues were benefited by currency exchangerates in this region.

Asia Pacific revenues totaled $85 million, representing 16%of the total, up 65% over last year, again driven by TDK. We saw significant volume growth, but alsoaggressive price erosion in this region.

Our third quarter gross margins were 16.3% of revenue;that’s down 1.3 percentage points from last quarter. This was obviously a disappointing result forus and was driven entirely by the flash issues in the U.S.retail channel that we discussed earlier.

On a year-over-year basis, gross margins were down 4.5points which is about the same level of decline we saw in the first half ofthis year and driven by the same overall factors: those being product mix,lower margins and certain key legacy products, in addition to the flash marginissues we’ve experienced throughout this year.

R&D costs were $8.5 million for the quarter, lower thanprior periods and in line with expectations due to cost savings from ourpreviously announced restructuring program. Selling, general and admin expenses were 11.7% of revenue and $61.6million in the third quarter; that’s up $14.2 million from a year ago,reflecting acquired SG&A from the acquisitions offset by costreductions. It is anticipated theoverall SG&A costs as a percent of revenue will benefit from cost synergies;however the impact will not be apparent until we move into 2008.

Restructuring charges totaled $3.1 million in the thirdquarter and these charges were from the previously announced restructuringprogram associated with manufacturing and R&D, as well as other structureadjustments including those related to the TDK acquisition. We expect the program to total approximately $30million in charges during 2007, including an estimated $5.5 million in thefourth quarter. We continue to expectthe total program to total $35 million to $40 million when completed.

Our worldwide employee count ended the quarter atapproximately 2,440; that’s up about 400 in the quarter. We added roughly 380 employees from TDK and 45 from Memcorp and reducedheadcount approximately 25 net positions.

Our operating income was $12.5 million in the third quarter,including $3.1 million in restructuring charges. Excluding restructuring charges, operatingincome was $15.6 million. This was belowour expectations for the quarter due to losses and inventory writedownsassociated with flash products in the U.S.retail channel. The negative impact fromthese factors totaled $6.7 million in the quarter. Excluding both restructuring costs and theseflash losses, operating income would have been $22.3 million, at or slightlyahead of our original expectations.

Non-operating costs for the quarter totaled $800,000; that’sversus $1.1 million of income a year ago. This was driven primarily by lower interest income and lower cashbalances as well as higher interest expense associated with the Memcorpacquisition notes.

Our tax rate in the third quarter was 40%, up from priorperiods due to the impact of some fixed tax expenses on the lower taxableincome in the quarter. We anticipate thefourth quarter tax rate will come down from this level.

Earnings per share from continuing operations was $0.18driven by the factors I just mentioned, including flash product losses and$0.05 of restructuring charges.

We closed on two important acquisitions during the quarter,so let me provide some of the transactional details. The TDK transaction closed on July 31st witha purchase price of approximately $260 million. The majority of the purchase price was in the form of Imation commonstock, 6.8 million shares valued at the prevailing stock price at closing of$31.75 per share. In addition, we paidapproximately $33 million in cash and incurred about $11 million intransaction-related and restructuring charges. The purchase price was allocated about $90 million to tangible assets,primarily working capital; $132 million to identified intangible assets,primarily brand value; and $38 million to goodwill.

We acquired some cash as part of the TDK operating entitiesthat totaled approximately $27 million. Since the transaction was negotiated ascash free and debt free, we recorded a corresponding liability for thisacquired cash and anticipate paying this cash back to TDK during the fourthquarter.

The Memcorp transaction closed on July 9th, with a purchaseprice of $66 million; $28 million in cash and $38 million in notespayable. The purchase price wasallocated $6 million to tangible assets and $58 million to intangibleassets. A portion of the notes, about $4million, became payable upon the resolution of an outstanding international taxmatter in the quarter, thus the total cash paid in the quarter was about $32million, including these notes.

We do not acquire accounts receivable nor accounts payableas part of the transaction. As s aresult and as expected, we used cash to build working capital during thequarter which totaled approximately $15 million. In essence, one can think of the totalpurchase price of this business being about $81 million including the directyield cost and this working capital build.

While there are a number of puts and takes on cash flows andworking capital due to the acquisitions, we have seen underlying improvement inour cash flow and balance sheet management during the quarter. Cash equivalentsended the quarter at a $133.1 million; that’s down a $109.6 million in thequarter, driven by payments associated with the acquisitions which totaled $42.3million, and that’s net of the cash required; share repurchase which totaled $61.8million and dividend payments which totaled $6.4 million.

Cash flow used in operations was approximately $2 million. However,this included approximately $15 million in planned working capital investmentsassociated with Memcorp, as I just mentioned. Excluding these working capital investment, cash from operations wouldhave been about $13 million in third quarter, improved from each of the lasttwo quarters.

Cash from operations was also held back in the quarter dueto $3 million paid to settle some previously accrued tax liabilities from prioryears. Our overall working capital indicesimproved during the quarter with net working capital declining 11 days. We define net working capital as days salesoutstanding in receivables plus inventory days of supply plus days of accountspayable.

Excluding the impact of the acquisitions, net workingcapital days improved by four, driven by improved payables. The impact of theacquisitions contributed the rest of the 11 days – seven days -- as both TDKand Memcorp carried fewer days of working capital than our existingbusiness. Working capital dollarsobviously increased significantly due to the acquisitions.

Depreciation and amortization totaled $12.4 million,including acquisition amortization of approximately $2 million associated withTDK and Memcorp. Capital spendingtotaled $2.4 million in the quarter, and finally we repurchased about 2.1million shares during the quarter for $61.8 million. This was executed through our ongoing $100million 10b5-1 program as well as open market purchases. We believe this is an important statementabout management’s confidence in -- and commitment to -- our strategy and ourbelief in the ability to improve our results and create long-term shareholdervalue.

As we communicated last week, we have lowered our full yearoutlook for earnings based on the flash issues we experienced in the thirdquarter and some caution about flash profitability in the fourth quarter. Our revenue outlook remains unchanged at $2billion to $2.05 billion for the year, representing growth of 25% to 30%. This implies fourth quarter revenues in therange $640 million to $690 million.

Our operating income is targeted between $51 million and $56million on a GAAP basis. This includesan estimated $30 million of restructuring charges for the year. Excluding those charges, this representsoperating income of between $81 million and $86 million and is $11 millionlower than our outlook provided last quarter. This decrease can roughly be attributed about two-thirds to the flashissues in the third quarter and one-third to caution about flash profitabilityin Q4.

Diluted earnings per share is now targeted between $0.86 and$0.96 per share for the year; that includes a $0.51 impact from restructuringand other charges. Excluding thosecharges, EPS is targeted between a $1.37 and a $1.47 per share. This is down about $0.25 per share from ouroutlook last quarter. Q4 earnings per share is targeted in the range of $0.28to $0.38 including about $0.09 per share in assumed restructuring costs.

For fiscal ‘07, capital spending is targeted in the range of$15 million to $18 million and the tax rate is targeted in the range of 36% and38%. Finally, depreciation andamortization is targeted in the range of $45 million to $47 million for 2007.

In summary, we were clearly obviously disappointed in our U.S.flash business as we have been, literally all year long, and we are takingactions to address this as Frank discussed. We are encouraged by the generally positive performance of the rest ofthe business and especially pleased with the solid start we had from ouracquired TDK and Memcorp businesses.

As Frank mentioned, the steps we are taking, theacquisitions, the restructuring program and the brand work we believe are theright steps as we begin transforming to a brand and products managementcompany.

At this point, Frank and I would be pleased to take yourquestions. Thank you.



Your first question comes from Matt Teplitz - Quaker CapitalManagement.

Matt Teplitz - QuakerCapital Management

Could you just help us work through a little more what lookslike about a $40 million reduction in pro forma revenue? I guess a lot of it tiesto how you account for TDK and Global Media Data, but if you could just tightenthose numbers that would be appreciated.

Paul Zeller

You’re right. Theoverall increase in revenues from the acquisitions was a $140 million, yet itwas only a $100 million in total so there’s a $40 million base business impact.The majority of that was Global Data Media; part of Global Data Media was thefact that there were some TDK revenues in there, as I mentioned, and now thatwe’ve acquired the company those revenues are flowing directly through TDK. Soeffectively, that reduces revenues in Global Data Media.

GDM has also been showing less revenues throughout this year,really reflecting lower OEM business that Moser Baer was serving through ourjoint venture, headquartered in Dubai and so that’s been an ongoing trend. The additive portion in Q3 was the TDKimpact.

Beyond that, the overall business showed an impact in flashas we were more selective even in third quarter on where we participated andthen a more or less normal, ongoing decline rate in our magnetic business,primarily from mature products, primarily entry level server tape anddiskettes. So those are the key driversof that $40 million.

Matt Teplitz - QuakerCapital Management

Can you provide any detail on mid range and upper level magneticand how you fared?

Frank Russomanno

Actually, the mid-range and magnetic businesses were bothup. The mid-range business had apositive impact from some of the TDK sales, but the data center business inparticular was just up for us this past quarter. Some of that has to do withthe growth of T10000 which we’ve been talking about that has been ramping forthe past few quarters, and some of it has been even with the legacy productlike 9840 which had a good quarter.

Matt Teplitz - QuakerCapital Management

Paul, this is another question about working capital. Obviously,a pretty big bump on both the accounts payable and the accounts receivable inthe inventory. Should we look for that to settle down more going forward or isthis just the new size of it?

Paul Zeller

I think at this stage that is the size and strictlyreflecting the impact of adding in TDK and Memcorp. In fact, our base businessworking capital performed pretty well in the quarter and I think the reality isthat the overall working capital is going to be an area of significant focus,especially by Pete Koehn, our VP of Operations.

We are going to be developing more specifics in terms oftargets, but we clearly have an opportunity and an objective of taking morecash out of the balance sheet. We thinkit’s an area that has some opportunity for us and I think we can do better,frankly.

Frank Russomanno

Specifically, you are putting your finger on the reason whywe appointed Pete Koehn into this role of VP of Operations. We see this as a real opportunity as we learnhow to manage the new Imation, which is not only some of the strengths we hadin the past, but acquisitions that come along with additional assets.

So we are going to get very focused on the operational sideand we feel confident with Pete’s leadership in doing that.

Matt Teplitz - QuakerCapital Management

Do you feel comfortable putting a range of values in termsof what sort of cash you may be able to drawdown from working capital?

Frank Russomanno

Matt, I think not at this stage. We’ve just digested twolarge acquisitions and are in the middle of integration and as well during thisyear have moved to a centralized distribution center approach in the U.S. I think we will be developing some ofthose. We certainly have some initialindications. I think we’ll have more tosay about that as time goes on.

Matt Teplitz - QuakerCapital Management

Obviously you guys got pretty aggressive on share buybackthis quarter. Do you anticipate continuing to buyback here? The stock remainspretty cheap.

Frank Russomanno

You saw the numbers. We’ve actually spent $61 million and brought back 2.1 millionshares. We are going to continue to dothat. Obviously, we want to remain with ourintent to buy back the shares over time to offset the dilution of the TDKtransaction, but we do want you to remember that it’s ultimately going torequire further share authorization in order for us to do that.

Matt Teplitz - QuakerCapital Management

Are you authorized what, to a $100 million right now?

Frank Russomanno

We had initially a $100 million 10b5-1 program. We of course have been executing on that, sothat number is clearly lower at this stage. We had a $5 million share authorization earlier in the year and we’vebeen executing on that. There are about2.5 million shares left on that authorization.

Paul Zeller

The 10b5-1 is under the umbrella of that 5 million shareauthorization.

Matt Teplitz - QuakerCapital Management

But you still have roughly 2.5 million shares you arepermitted to buy?

Frank Russomanno


Matt Teplitz - QuakerCapital Management

Well, I encourage you to at these prices.

Frank Russomanno

I’ll tell you Matt, it’s not missed on us that this is anopportunity.


Your next question is from Glenn Hanus - Needham.

Glenn Hanus - Needham

Could you talk in a little more detail about the tapebusiness and the transition LTO3 to LTO4 and any change in your view on thebasic growth rate of the tape business or decline rate as you go out throughnext year?

Frank Russomanno

I’ll start with the high-end tape side. The magneticproducts, as a general category, the price erosion lessens somewhat in thequarter. The LTO pricing continues to berelatively aggressive in LTO3 in particular, and we would like to see more LTO4being sold because that’s the way we offset some of that pricing.

However, we have not seen as much growth as we are able toactually be able to produce for. So LTO,I would say it is coming along, it’s coming along pretty well, but LTO3 isstill declining in price.

Now in the high-end data center side, some interestingthings happening. The T10000 continuesto ramp and we are prepared to handle the ramp and we would like it to continueto ramp, but every month, month-on-month in the quarter, it did ramp. Also, thepleasant surprise was 9840 inthe quarter. We actually saw some upliftand that uplift was not U.S.only; it was also outside of the U.S.

As you would expect, and Paul mentioned in his comments, theentry level piece of the business and the diskette piece of the businesscontinues to decline at a rate that approximates what we had in our plans.

Bradley D. Allen

I think you also asked about our longer-term outlook. I think that it’s fair to say that we continueto believe overall tape is a flat and slightly declining category. The mix of that in any given quarter variesand we had a very significant entry level business as you know under someproprietary products like Travan and a very good position in SLR. Those made itmore difficult for us to participate like the market. But every quarter thosebecome a smaller part of the pie and that should help us bring our overalldecline rate more in line with the overall tape market.

Paul Zeller

Matt, one more thing I was reminded and it’s worthmentioning that when we talk about price, ASPs, average selling prices, thedata center prices have remained firm and they continue to remain firm andthat’s positive for us.

Glenn Hanus - Needham

Did you have some manufacturing issue on LTO4, were you ableto meet all the demand?

Paul Zeller

We have no manufacturing issue on LTO4. We are able to meet all the demand. We would like to see more of the demandoutside the U.S. I think that’s an issue more so than it isinside the U.S. So were I said we would like to seeimprovement in LTO4 demand, I think that’s more an OUS issue than it is a U.S.issue. We have strength everywhere around the world and we’ve got the productto supply, so we are ready for it.

Glenn Hanus - Needham

On the optical business, what is the core growth rate ofthat over the next couple of years?

Frank Russomanno

Well, on long-term as we showed on our analyst presentationon May 22nd, we showed a relatively flattish long-term growth profile for allof optical with CD in decline, DVD nearing the peak and the high definition HDDVD Blu-ray, Blu disk based products starting to come on and filling the gap ofwhat will be declines in some of the legacy products.

Overall, we think that’s been our view, still remains ourview. It’s still an open question on howfast the advanced optical formats come on. We’d certainly like to see that pick up, but we are starting to see somepick up. I think we started seeing moremeaningful Blu-ray business in third quarter than we have. So I think there are some good initial signs.It’s still not large, but it is moving in the right direction and starting toshow some inflection point.

Paul Zeller

By the way, that increase in the Blu-ray in the thirdquarter I think is one of the positive aspects of the TDK acquisition. Quitehonestly, like you know, the Japan market is where that growth is going tohappen first and the TDK brand has a strong position in that market.


Your next question comes from Mark Miller - Brean MurrayCarret.

Mark Miller - Brean Murray Carret

Could you give us a little more color in the optical spaceabout the pricing situation? Also, the competition Blu-ray is in with the competingtechnology?

Paul Zeller

From a pricing standpoint, optical pricing was in thegeneral range we expected, a little bit higher than then say second quarter,but in the general range. We did addsome share clearly with TDK, but also with the HP brand distributionagreement. We think that’s giving us amuch greater ability to compete in an effective way by having multiple brandsto place in different positions in different channels and through that, maybeget a better pricing situation than you otherwise might have.

Frank Russomanno

I’ll work on the second part of the question and that has todo with technology and Blu-ray. One ofthe things we considered with the TDK acquisition is the very strong IPposition that TDK has in Blu-ray. That, I believe, is going to be beneficial forus.

You know, that war is probably going to go on between HD-DVDand Blu-ray. However, we feel prettygood about what we see in the Japanmarket. Just last evening I was talkingwith our Japanleader. They expect set-top boxes to start to decline significantly in Japan,which might mean the start of the Blu-ray business or advanced DVD typetechnologies in the future. So we willsee if that happens. This is the firstquarter I can remember where we’ve actually had two questions on Blu-ray, sothat alone might be a bit of a positive sign.

Mark Miller - Brean Murray Carret

You probably are pretty constrained, but you probably sawtoday that SanDisk came out in litigation over patents with over 25companies. I don’t know if you can sayanything about that. You were one of thelitigants, I think, in the disclosure that I read. Can you express any comments on that?

Frank Russomanno

Sure, Mark. Obviously, we did read it. Weread it like everyone else read it. Weread it on the Internet. We have notbeen served yet, so I can’t get into very many more comments beyond that. One positive comment we will make is that webuy from people who indemnify us, just in case of issues such as this. I know allof our flash suppliers, so we’ll just have to wait and see what develops here.


I am showing no further questions at this time.

Frank Russomanno

First of all, I would like to thank everyone for joining uson the call today. I just want to leaveyou with a few closing thoughts. Firstof all, I firmly believe that the steps we are taking in the U.S.retail flash business are the right steps to position the company for successin 2008 and beyond.

I also want to reinforce there are some good thingshappening with our strategic process. Welaid out our strategy last May to transform Imation into a brand and productmanagement company. We are on our planin most areas and ahead of our plan in some, and I also believe that ourtransformation will create significant long-term value. We will have more tosay about this progress as the quarter moves on and into next year.

So, thank you very much for staying in touch with us hereand we will talk to you next quarter.

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