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Executives

Frank Russomanno - President, Chief Executive Officer and Board of Directors Member

Paul R. Zeller - Vice President, Chief Financial Officer

Bradley Allen - Vice President, Investor Relations and Corporate Communications

Steve Moss - Vice President, Chief Marketing Officer

Analyst

Glenn Hanus - Needham

Mark Miller - Brean Murray

Matt Teplitz - Quaker Capital Management

John Lopez - OTA

Imation Corp.(IMN) Q4 2007 Earnings Call January 30, 2008 9:00 AM ET

Operator

Gentlemen, welcome to the Imation announces fourth quarter earnings conference call. At this time, our participants are on a listen only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

I would now like to introduce your host for this conference call, Mr. Bradley Allen. You may begin, sir.

Bradley Allen - Vice President, Investor Relations and Corporate Communications

Thank you, gentlemen. Good morning everyone, and welcome to our fourth quarter conference call. Before I turn the call over to Frank Russomanno, of course I want to remind everyone that our forward-looking statements are within the realm of the private securities litigation format and risk factors are outlined both in our press release and our SEC filings.

With that, I would like to turn the call over to Frank Russomanno, Imation CEO.

Frank Russomanno - President, Chief Executive Officer and Board of Directors Member

Thank you and good morning. Before I turn the call over to Paul Zeller, Imation CFO who will give you more details on the results, I want to make several points coming out of our fourth quarter and looking towards 2008. My first point is that we had a very solid quarter on several fronts. We posted record revenue operating income before charges and operating cash flows in the quarter. Our core business showed year-over-year growth in both tape and optical media, even before any contribution from TDK Brand Recording Media. We remain pleased with the enduring strength and contributions of our cornerstone tape business. We saw improvements in gross margins on our base optical and flash media versus Q3. Over additional changes, we made earlier in the year to centralize supply chain operations have begun to benefit our results.

My second point is that our integration of our acquisitions is on track and they are contributing positively to our results. This is the full first quarter with both the TDK Brand Recording Media business and the Memcorp acquisition, now called Electronics Products. The TDK Recording Media business is actually contributing earnings ahead of plan. Our Electronics Products business has had a very solid start as well. Even with these promising early results from our acquisitions, we had to take a non-cash right down to goodwill. This was driven by accounting requirements. The write down does not reflect either the returns from these acquisitions or our view of the long-term value that grows through Imation. I have also been pleased by the enthusiasm, energy, and excitement that our new Imation employees are bringing to the company and how well they are working together throughout the organization with the rest of the Imation team. One of the toughest parts of acquisitions is successful integraton and so far, I feel very confident that we are succeeding here.

My third point is that the strategy we laid down last May is working and the market is responding. During the fourth quarter, we continued to operation-wise key elements of our strategy as we transform Imation to a brand and product management company. Our new Chief Marketing Officer, Steve Moss, is building out the brand management capability bringing accounting form outside the company as well as tapping resources from within as we knock out brand strategies for the portfolio. As I have mentioned to several of you at the meeting conference earlier this month, we had a positive experience at CBS, where we only showed our board portfolio of consuming products and brands together from the first time. Our retail channel partners responded quite positively to the breadth of the portfolio. Even with the designs we are offering, our demonstrated brand management capabilities, and our understanding of our new users. We also continue with our important optimization strategy and manufacture. We have successfully transferred a significant amount of the activity at a (inaudible) reached agreement with the management group at the plant who has taken over the plastic molding business. This management buyout accelerates implementation of our optimization plan and reduces our risk. After the closing of the quarter, we also made two important announcements that reinforced our commitment to leadership in the commercial B-to-B space. We established a strategic relationship with a Korean company, Emtron, to bring proprietary solid state disk products to the market globally, and we unveiled our proprietary Adjacent-Track write/read head servo technology, developed by Imation, which we believe will be a necessary component of future highcapacity tapes.

My fourth point is that 2008 is an important transition year for the company. We expect to complete the integration of the acquisitions and make significant progress on our manufacturing restructuring program this year. As Paul will discuss in a moment, our outlook for 2008 includes incremental costs for acquisition integration, IT integration, and restructuring costs, as well as incremental necessary investments in building our brands globally. I believe now is the time to make these valuable volume investments. The benefits from these actions will be greater in the second half of 2008. In addition, as we transform the company, we are seeing increased seasonality. As a result, we expect earnings in the second half of 2008 to be stronger than the first half. In particular, the first quarter of 2008 will have a difficult comparison with the strong Q1 of 2007. We also recognize that there is uncertainty in the overall economy, and we will continue to evaluate the risk inherent in the environment, as the year progresses.

My final point is this, I believe that our positive fourth quarter results demonstrate the resilience of the company and the value of our strategic direction. We have made significant changes in Imation over the past 24 months, beginning with the Memorex acquisition. I believe these changes have been positive for the company, for our customers, and ultimately for our shareholders. Last quarter, we acted quickly so we focused our market approach to USB flash. We were able to work collaboratively with our retail channel partners in the US to reposition our USB flash business, while preserving our position for these products. While we are not entirely through the transition with some channels, we have made significant changes in our USB flash business and the quarter benefited from those changes. I believe the Q4 results demonstrate the management’s teams continuing willingness and ability to act quickly and decisively to improve the business. It also illustrates the resilience and professionalism of the global Imation team.

In summary, we are encouraged by our strong finish in 2007. We are pleased with the progress on our acquisitions and strategic actions and are optimistic about the future for Imation. Now let me turn the call over to Paul and then we will take your questions.

Paul R. Zeller – Vice President, Chief Financial Officer

Thanks Frank. Good morning everyone. We are very pleased with our strong finish in 2007, especially after several tough quarters earlier in the year. We had a strong quarter in our base business as well as in the recent acquisitions, and the results were solid across the world as well as across our product platforms. Let me get into the detail, starting with revenue which totaled $701.8 million, which represents a growth of nearly 53% that was driven by revenues from our TDK and Memcorp acquisitions, which together provided $253 million in revenues in the fourth quarter; $177 million from TDK and $76 million from Memcorp. We are pleased with these contributions, and these businesses, which are almost entirely focused on consumer channels, are a clear indication of the evolving seasonality in how you manage a business with an even greater degree of concentration in the fourth quarter of the year. Excluding the impact in the acquisitions, revenues were down about 2% year over year, driven by flash products. As we discussed last quarter, we began writing our participation in the US retail channel and flash late in Q3 and has continued in Q4. Excluding flash products our base business revenues increase in the quarter with both optical and magnetic tape revenues up year over year. We saw volume growth in the quarter of 58% driven almost entirely by the acquisitions and we saw 4% currency translation benefit. These were partially offset by a 9% impact from price erosion which was several points lower than previous quarters in 2007 as we successfully lowered our exposure to a higher reroading flash market in US retail. Total optimal product revenues were $334.6 million; that represents an increase of 61% driven by TDK brand revenues. Excluding TDK, we saw a slight increase driven by DVD and our distribution of HP brand optical products and total optical products represented about 48% of revenues in the quarter. Magnetic product revenues at this point nearly entirely tape increased 28% to $213.4 million up $46.1 million from last year's fourth quarter also due primarily TDK revenues. The majority of that edition was from audio and video products. As Frank mentioned, we are very pleased with their base magnetic product revenues which were up 3% excluding TDK. This is the first year over year increase in our base magnetic revenues in several years. This is a particular strength in Q10000 tape in the data center and LTO4 tape in the mid range. Magnetic products represented 30% of revenues in the quarter. Revenues from electronic products and accessories total a $114.3 million up $83.9 million from the last year driven by Memcorp revenues which did show the seasonal strength rate expected. This category represented 16% of revenues. Flash product revenues total of $39.4 million and declined nearly 27% or $14.5 million in the fourth quarter; that decline was in line with our expectations reflecting the plan rationalization in US retail channels I talked about earlier. Flash products represented 6% of revenues in the quarter.

On regional basis, America's region had a revenue growth of 31.5% to $344 million in the fourth quarter that represented about 49% of worldwide revenues. The growth in the segment due primarily to be impact in the acquisitions partially offset by declines in flash products. Europe revenues grew 61.5% totaling $234 million; that is 33% of total revenues in the quarter. TDK acquisition revenues drove growth in this region. Asia Pacific revenues totalled a $124 million representing 18% of the total nets up 136% over last year driven by TDK again. Post margins were slightly sequentially to 16.5% versus 16.3% in the third quarter. This is the first sequential improvement in gross margin percent we have seen in early two years. On the year over year basis, our gross margins were down 3.6% points in the fourth quarter driven by significant changes in product mix including the impact of the acquisitions.

Overall, we were very pleased with the margins in the quarter especially given the strengthened revenues in our consumer business in the fourth quarter which tend to carry somewhat lower gross margins in corporate average. R&D costs were $7.7 million for the quarter lower than prior periods but in line with expectations due to cost savings from the previously announced restructuring programs. Selling, general, and admin expenses in the fourth quarter equal the record low of 10.2% we experienced in the fourth quarter of 2006. In dollar terms NSGNA increased nearly $25 million in the fourth quarter versus 2006; that is the result of NSGNA we acquired with the acquisitions. Our immigration plans for the acquisitions are going according to plan and we are achieving the expected operating expense savings. Our worldwide employee count in the end of the quarter at approximately 2250 down at about 190 in the quarter; that decline was driven by headcount reductions associated with many manufacturing as well as acquisition immigration. Restructuring charges totalled of $12.6 million in the fourth quarter. These charges were within the previously announced restructuring program associated with manufacturing and R&D as well as other structure adjustments including those related to the TDK acquisition. We have previously estimated the fourth quarter charge to be around $5.5 million. The increase from this level was driven by acceleration certain about plan restructuring actions as well as further restructuring of our optical R&D lab. Most of the increase was non-cash in nature associated with laboratory equipment right downs. For the full year of 2007, restructuring charges total of $33.3 million and despite the increase in the fourth quarter. We continue to expect that programs will total $35 to $40 million when completed as we have previously stated. We really require taking a sizeable onetime, non-cash charge for goodwill impairment in the fourth quarter as we previously communicated. This totaled $94.1 million. The applicable accounting standards required us to reconcile our current market capitalization to book value in completing our annual goodwill impairment assessment. As stock price levels at the end of 2007, our total book value was above our market cap driving the need for discharge. Discharge was unrelated to the recent performance or acquisitions which in fact have been performing quite well. You notice that is driven by our view of the future prospects of these acquisitions which remained very positive. Again, this was driven by the market price of the stock in relation to the underlying book value of the company. Driven by its goodwill write-off, we had a sizeable operating loss in the quarter which totaled $70.3 million but excluding goodwill and restructuring charges, operating income totaled of $36.4 million. We saw relatively broad-based improvements by brand, by product, and by region. From a brand standpoint both TDK and Memorex brands performed well in the quarter. From a product standpoint, we saw improvements in optical margins especially the Memorex brand. We also saw improved margins in flash products as we began rationalizing our participation in the US retail channel as I mentioned earlier but we also continue generate solid flash margins in B-to-B channels and internationally in all channels.

Regionally, our performance is broad-based with each region contributing. Now, operating cost for the quarter totaled $3 million versus $900,000 of income in fourth quarter last year. This change is driven by a negative currency impacts in this year’s fourth quarter as well as lower interest income in 2007 versus 2006. Our income tax reality in the fourth quarter is somewhat complicated. When you look at the GAAP reported results, we recorded $800,000 of income tax expense despite having a $73.3 million pretax loss. This reflects the fact that the majority of the 94.1 million of goodwill write-off is now expected to generate the tax benefit in the foreseeable future. Our tax rate excluding restructuring in goodwill charges was approximately 25%. This was lower than expected due to the recognition of certain net operating losses as well favorable resolution of some prior year tax manners outside the US. Our loss per share on a reported basis was $1.91 driven by the goodwill write-off and excluding goodwill and restructuring earnings per share was $0.64. Average shares outstanding during a quarter were $38.8 million.

Our fourth quarter was a very strong quarter in terms of operating cash flows. Driven by a unit of 50 million extreme charges as well solid balance sheet performance, we generated $74.1 million in cash from operations. Cash and equivalence end of the quarter had a $135.5 million. That is up 2.4 million from last quarter. During the quarter, we spent $35.3 million in cash associated with our recent acquisitions. The majority of this was in expected return of cash balances that we acquired with the acquisition from TDK and that was accrued for at the end of the last quarter. During the quarter, we spent $28.6 million acquiring $1.28 million shares under our previously announced share repurchase authorization. In addition, $6.3 million was spent for dividends in the quarter. Capital spending was $2.7 million and depreciation amortization of $13.5 million in the quarter. On January 28, the board of directors approved an increase to our share repurchase authorization to 3 million shares. The previous authorization which stood at approximately 750,000 shares as of that date was cancelled. Our outlook for 2008 is for solid goal in both revenue and earnings. Our outlook does reflect the full year impact of TDK and Memcorp acquisitions as well the continued implementation of our previously announced restructuring program. So, returning approximately $2.4 billion in 2008 revenue that represents growth of approximately 16%. 2008 operative income is targeted between $95 and $105 million on a GAAP basis. This includes restructuring charges estimated in the range of $4 to 6 million. Excluding those charges, operating income is targeted in the range of $100 to 110 million for the year. Diluted EPS is targeted between $1.51 and $1.68 per share for a year including in approximately $0.8 impact from restructuring charges. Excluding those charges again, earnings per share is targeted between $1.59 and $1.76 per share. This EPS outlook is based on year-end 2007 diluted shares outstanding of $38.5 million. Factors impact in the actual shares outstanding for 2008 include share buy-back levels with impact of options and other equity rewards which were in a part influenced by stock price levels. As Frank mentioned, the outlook includes incremental cost not only for restructuring as I just noted but also cost associated with immigrating our acquisitions including IT and packaging transition costs as well as incremental cost associated building our branch globally. This nonrestructuring cost will generally impact NSGNA and will likely total around $15 million dollars for the year. This spending edge is included in earnings outlook we provided today. Frank, I also mentioned that the benefits from the acquisition synergies as well as from the manufacturing restructuring actions could be more in the back half of the year. This combined with the greater degree of seasonality we are experiencing as we become more focused on the consumer. We know results will clearly be higher in the second half of the year than the first half. In particular, we expect our Q1 2008 operating earnings will likely be below our results from the first quarter of 2007.

On the subject of seasonality, historically quarters one and four had generally been our strongest quarters. Given the impact of the acquisitions, we now expect the quarter four to be a particularly strong quarter and Q3 to be the next strongest quarter. In terms of the rest of our guidance, we are targeting capital spending in 2008 in the range of $15 to $20 million, the tax rate in the range of 35% to 37%, and finally depreciation and amortization is targeted in the range of $48 to 52 million for the year.

In summary, we are very pleased with the strong finish of the year as Frank mentioned. The acquisitions are performing well, our actions to improve the flash business, and the US retail channel is helping. Our Memorex optical margins improved nicely and our quarter’s cornerstone magnetic tape business were solid in the quarter. And driven by the solid overall performance in generated record-high cash from operations in the quarter. We look forward to 2008 with an outlook for growth in both revenue and earnings as we continue to implement our strategy. At this point, Frank and I will be pleased to take your questions. Thank you.

Question-and-Answer session

Operator

(Operator Instructions)

Our first question comes from Glenn Hanus from Needham.

Glenn Hanus

Good morning. Yeah could you maybe try to talk through the sort of operating model a little bit in terms of gross margins and puts and takes on gross margins as we put our models together for 2008 and then sort of operating expenses and could you, is the FAS 123 expense running about $3 million a quarter is that right?

Paul Zeller

Yeah that is correct Glenn. So I understand your question you are kind of asking how that kind of gross margins and operating expenses go forward from where we are at. I think as an overall comment you can see our guidance is for an operating margin that is in and around the level we experienced for the full year of 2007, kind of in the 4.2% to 4.6% range. We also expect gross margins and total operating expenses to be generally in the range we had for full year 2007. You know 17% plus or minus in gross margin and OpEx kind of 12-1/2% to 13% range. With the restructuring in R&D you know we will see a lower ratio probably in R&D as part of the overall OpEx ratios but that is kind of what we are looking for in terms of end year term. One of the benefits we are getting on the gross margin percentages really, you know, the rationalizing out of some of the US retail flash market places is actually a positive mix to our gross margins.

Glenn Hanus

And then maybe you could since you brought up flash talk about, you know, how far or long you are in kind of resolving that and any update on securing a source of supply and then on the retail side of the US, are you pretty much done with the changes you are going to make in terms of exiting those partners that were not profitable?

Frank Russomanno

Okay Glenn this is Frank. Let’s start with some general comments for the quarter; flash represented about 6% of our sales. As far as how are we doing with our planned retrenching in the USB flash business, I think we have done pretty well in the fourth quarter. The plan actually will continue into the first quarter with some accounts, we have managed to exit some significant ones especially those that were most problematic and I would expect that we will be done with it, most of it, by the end of the first quarter. However, our plan is not to exit the USB Flash business. Outside of the US, we had a big quarter in USB Flash and inside the US, within the commercial channels we had one of our better quarters. So we are really refining our business model and looking for opportunities with USB Flash, it be overly or within segments and pockets within the US.

Well also, I was going to make a comment to you. You talked about securing supply capabilities. Over the quarter, we did what we said we are going to do when we were going to centralize the operational aspects of the business and bring also some into Oakdale. We also reduced cues as we discussed thereby limiting our exposure and we also limited the younger people that were buying from and leveraged our buy, so we did all of those things and I believe we are in a stronger position.

One final point on that comment, I think we have become somewhat more astute into how to buy a flash and when are the right times to buy a flash. As you would look at the market today, you could see that flash pricing for nanochips have gone down significantly. So overall, I think we are a little bit wiser in the past fourth quarter than we were in the second and third quarters. My last comment as far as not exiting, you also saw our announcing about Emtron and SSD. You know, we are going to continue to look for those pockets or market opportunities where we think we can participate and use our strength with the global footprint as well as our channel experience and hopefully, we will continue to find those and continue to participate in flash.

Glenn Hanus

Okay, thank you.

Frank Russomanno

Next question, please.

Operator

Our next question comes from Mark Miller with Brean Murray.

Mark Miller

Good morning.

Frank Russomanno

Good morning, Mark.

Mark Miller

I am just wondering about the change in seasonal patterns especially the first quarter. Could you give us a little more in depth, a little more color on that, why we are seeing less of that, and put a little more color on that and then more shifting to the fourth quarter?

Paul Zeller

Yeah, I think…I think we could help you there. As we made these acquisitions, there are definitely different trends for some of our acquisitions especially the TDK business and the Electronics Products business that what we formerly called Memcorp. We talked about the Memcorp when itself. The Memcorp business is extremely strong at the end of the third quarter and into the first two months of the fourth quarter. So that is going to have an impact and then we will see much benefit from that business. TDK as a global brand as compared to the Memorex brand which was predominantly a US brand and Imation which had some pockets to strength in retail around the world has a different mix -- seasonal mix -- which is once again a very much back-end loaded into the third and especially the fourth quarters, so those two brands are going to have some impact on our business.

Frank Russomanno

You know Mark, when everything had mentioned in particular on TDK is and as you know there…we have much bigger exposure to the Japanese markets to that brand and the first quarter, calendar quarter of the year in Japan, tends to be a little tougher with holidays and such and there is always some open seasonal questions because that tends to be in the end of the fiscal year in Japan. Sometimes you can see things fall off a little bit and so I think, not only in the case of TDK, you get kind of around that as a consumer-based brand but you get a little of this first quarter issue as well.

Mark Miller

Thank you. I am just wondering the results who you were pleased with especially…I was just wondering what contributed, you said the pricing was more encouraging than they seem, I am just wondering what contributed to that.

Frank Russomanno

Is the question around the straight in the fourth quarter (inaudible)?

Mark Miller

No. I was talking about the magnetic divisions, especially pricing in that area.

Frank Russomanno

Okay. Here are several points on the magnetic side. It was not so much a pricing issue as much as it was a benefit from the LTO 4 growth; we had some fairly significant orders from some key customers in the fourth quarter. Also the T10000 business continues to ramp up very nicely, and our strong relationship with Sun has allowed us to participate in that growth as well as the distribution agreements that we have with Sun and IBM. So, a lot of positive things happened in the fourth quarter, including some strength in some of the legacy businesses of 9840, 9940, and a little bit of 3590. So it was just one of those quarters where a lot of positive things all came together at the same time, Mark.

On the pricing question, Mark, I will answer that a part of your question, the major reason the price erosion was a little bit lower in the fourth quarter than we had staged was around flash. But I think it is fair to say that our erosion patterns in magnetic tape were also relatively good in the quarter. Of course we see LTO-4 price erosions early in that product life cycle. We did see some of the older formats stabilize to a degree. LTO-3 continues to erode outside the US but stabilized to a degree in the US, and LTO-2 stabilized nicely in the quarter and data on our entry-level pricing was very stable. It was primarily flash but I think it was relatively good news across the board.

Mark Miller

And this finally, we have not heard much about Memorex. You have had them for a while. I am just wondering, are they meeting your expectations or can you give us any more insights there.

Paul Zeller

Yes, the answer to the question is yes, Mark. The Memorex brand remains the number one brand in the US. The Memorex brand is the platform from which we build this entire brand portfolio strategy, and during the fourth quarter, the Memorex brand actually grew share in optical. So the Memorex brand had a very good quarter. We are even making some inroads, small as they are in Europe. So we are pleased with that acquisition.

Mark Miller

Thank you.

Paul Zeller

Thanks Mark.

Next question please.

Operator

Our next question comes from Matt Teplitz with Quaker Capital Management.

Matt Teplitz

All right. Nice quarter gentlemen. Just some few questions, I guess. Do you anticipate magnetic to grow in aggregate in 2008 versus 2007?

Frank Russomanno

This is Frank speaking. What we had in the fourth quarter, as I tried to explain, is we had a lot of very positive things coming together. We only see a portion of the magnetic business growing and that is primarily in the LTO area. We do not see growth in the other formats for the most part. In the daily center, there is growth in the T10000 and also in the IBM brand 3592. However, the legacy products will not be growing.

Matt Teplitz

Okay. A somewhat related question. Embedded in you overall guidance, there are obviously assumptions about volume, price, and I assume you are probably assuming currency neutral or at least, wherever it is now relative to the whole year. What is the overall price erosion assumed in that guidance, in aggregate?

Frank Russomanno

I would say it varies from product to product, from region to region and so having one percentage being reflective of our business is really a big mixed thing. But we have been in the 8% to 12% kind of price erosion range, historically, and we think that is probably the right range to think about. You have mentioned currency; I think it is fair to say that we believe we will have some modest benefit from currency in 2008, probably in the 2% to 2.5% range if the exchange rates were to stay right where they are. That is essentially reflected in our outlook but overall, I think we should see price erosion kind of in the historical ranges with some puts and takes.

Matt Teplitz

Okay. That sounds fine. In terms of your revenue guidance for the coming year in which you have a $2.4 billion, and I think when I saw a pro forma the acquisitions originally, although probably not taking into account some of the TDK revenue and I guess it was previously captured in your joint venture, it was more like $2.5 to $2.6. Can you size how much revenue you effectively no longer recognize into the joint venture because it is coming through TDK?

Frank Russomanno

I am glad you asked a question about revenue because I get the opportunity to talk about revenues for the quarter as well. This is the first quarter since Q4 1997, ten years where we had a quarter that is even close to $700 million. In the last quarter, the last quarter was $580 million in Q4 2007. The last time the company achieved revenues of $2 billion was 1998 where we were at about $2.47 billion at the time. In the case of revenues for the company, you can see that something very significant is changing, and in our guidance we very carefully wrote down this guidance, we had to take into consideration differences in the business projected for next year and there were three main areas in that case.

One is the changing business model that we have with our joint venture, the GDM joint venture where there were revenues captured in that joint venture as you were somewhat partially explaining as part of acquisitions.

The second issue for us has to do with the small amount of money that we had previously and that was a mainly outsourced operation that we’ve had.

And then the third factor in revenues would be the exiting of the US B-consumer business. When you add these three components up, you are roughly in a $180 range of revenues. Does that help size if for you?

Matt Teplitz

Yeah, that helps quite a bit. And I guess it’s funny that there are other prior questions about flash. I guess in conversations at least I’ve had with you, you have pointed out that we are in the flash market in both Europe and Asia does not own fabs and so they’ve I guess, found a way to get that to work. Is it still your hope that maybe over time we can get there or is it just looking like a market where at best we are going to just play in spots?

Paul Zeller

Well, I have to back up a little bit and hopefully we might have to correct something if we left you with the impression that we …

Matt Teplitz

I’m sorry. I can understand there’s probably a lawyer here, certainly.

Paul Zeller

Exactly. You have San as the leader and then Joint Venture Fabs with Toshiba, and that is a very key component part of this business model. However, we believe through operational excellence, having the right partners, learning when to dive those products, being very astute insofar as scheme management, inventory levels, even if there is royal flush around the world, and we believe there are rich opportunities for us to participate but not at the levels, and that’s why we said it impacts that $100 million that we would’ve talked about before.

And then last but not least, another niche opportunity we keep talking about is the EMTRON relationship. This is a whole new category for name chip technology with SSD, so we’ll see how that goes this year.

Matt Teplitz

Okay, but just to clarify this prior conversation to me, I think you added that the largest vendors at least of these flash drives in Europe, I believe, did not have fab capacity, or do not actually own fabs.

Frank Russomanno

Okay, I think you’re talking about somebody like Gain Electric?

Matt Teplitz

Right.

Frank Russomano

But would probably not own a fab at all. PMY in the US doesn’t own a fab. Kingston. So there are people who are participating.

Paul Zeller

Actually, we have a fair idea who is the largest, but a lot of people. I don’t know. Well, some of them are fairly large share leaders.

Matt Teplitz

They tell me Kingston over here has been quite large without actually owning fabs. Although not a lot of history there.

Frank Russomanno

You’re correct with that.

Matt Teplitz

A couple more questions. Obviously, you guys made a lot of progress on working capital this quarter, and it’s reflected in the really low DSO’s and strong cash from operations. And I think you had indicated it was going to be a key focus in the quarter. Where are you relative to where you want to be?

Frank Russomano

Yeah. I think it’s fair to say that there’s room to improve in working outlook. Much of our balance sheet improvement, and the interview you say balance sheet vs. working capital, we didn’t improve working capital dramatically in the quarter. There is a modest return. We had some other working capital changes that did benefit us and I, one of those was we had probably $8-10 million of a better cash tax situation in fourth quarter than we had previously. And then some other factors as well and other current liabilities and the like. It is fair to say that while we improved our capital issues, there is room for further improvement, and it is going to be a continuing focus area. You’ve seen us as a company structure with continuing our VP of Operations around this as a global focus and, that too is a formed and you have some aggressive plans to try to improve our operations around the world. That will be a quarter by quarter thing and it’s a balancing of improving our service levels while also improving balance sheet management so there’s a lot of metrics that are critical there, but we’re still focused on this whole balance sheet efficiency thing.

Matt Teplitz

You’re probably going to resist this, but you had to put a number out there that a year from now, we could say, is there $25 – is there $50 million in cash net that ought to be realized through a more efficient balance sheet?

Frank Russomanno

Yeah, I’m beginning to understand very specific numbers, and one of the reasons is not that our working capital in any given period is very seasonally impacted, and you can use cash pretty quickly when you are, for example, ahead of a large fourth quarter, and then you can have some pretty big cash flows come in when you come off of those big periods, and so it’s a little hard to peg an exact number, except that I think there’s opportunity here for sure.

Matt Teplitz

Okay, and one last question. I guess you’d characterize roughly $15 million of operating expenses this year as being arguably transitional? Is there a reasonable possibility then, at least in theory, that that’s a tailwind you have going into 2009 that you wouldn’t have to spend those dollars?

Paul Zeller

Well in a way there’s a mix of sort of incremental costs in that pool. If you can remember up to 2007 and including a portion of them are transitional in nature, for example, the integration-related IT costs. We have to spend some money on changing our packages where we were, for example, to TDK lifeline record from the TDK corporate logo, and the like and some restructuring-related manufacturing costs that don’t go under the restructuring line; they go into the normal operating income. But there’s also a component of that spending, that is, for incremental brand. And while some of that could be relatively normal, occurring in nature as we do some incremental research, there’s a portion of that that will continue. So with that $15 million, it’s kind of a mix. I don’t think we’re prepared to get into precision in 2009; this is 2008 at this early, early stage. But it’s a mix of one-time 2008 versus continuing costs.

Frank Russomanno

I don’t want to get into more specifics than Paul has already, but I do want to emphasize that as part of the transformation of this company, brand investments are going to part of spend of the company. So, there will always be some brand investments in order to maximize the brands. If we intend to grow these brands and extend these brands into the U categories as part of the strategy we talked about on May 22nd, it’s going to require investment that’s beyond 2008.

Matt Teplitz

Right. That’s splendid. That captures it. That additional brand-building has been captured within that $15 million number?

Frank Russomanno

Yes, it is. And it is captured in the $15 million and, as we go forward fund some of those investments in brand through the savings we have in other areas as we continue to optimize the corporation and take advantage of the leverage of the growth in the company. So that’s how we intend to do some of these things. But foreign investment is really an important concept for the company.

Matt Teplitz

Okay. And the $25 million you’re expecting to realize from the manufacturing restructuring, ultimately how much of that is reflected in your 2008 guidance?

Frank Russomanno

Well, I would say that as you look at the tail end of the year, we’ll be fully at that runny. We have to remember, we started giving some of the benefits, especially in R&D, in 2007. So, it’s really a mixture and it gets a little hard to carve every bit of the pieces up into pools, but it’s fair to say we’ll be getting an incremental piece of restructuring benefit in 2008 versus 2007, and then a further increment in 2009 versus 2008 such that at the end of time when you look at where we were before starting the program and afterwards, we will be getting a nice benefit. But let me give you an important reality on what that program is all about. That program is about filling a hole of the gross margin progression we’re experiencing in that tape that he says. It moved from more propriety formats to more open formats. And so, we are going to have to take a spending benefit in restructuring from this manufacturing program, and just add it to the base. What we are doing is off-setting the decline we were experiencing and otherwise would have seen in the margin dollars from that magnetic tape business.

Matt Teplitz

And this is the last question. On the Survive Act, is any incremental buy-back reflected in your guidance, and how it should characterize your appetite to buy back those $3 million shares this year?

Frank Russomanno

The answer to the first part of your question is NO, but we do want to remind everyone that we did purchase nearly 1.3 million shares during the fourth quarter, spending about $28.6 for the year. It was up $3.8 million from $108 million in share buy-back for the year. So share buy-back is definitely part of our thinking going forward, but we don’t get into the details as to how we might do it during the year. And we specifically chose to use our year-end diluted shares from 2007 in doing a re-PS 1:23 outlook. Just because most particular plans are things that we talk about after we implement them. There’s a lot of factors that come into play there, and there’s a share-price dependent diluted impact from options that’s part of determining the share count for earnings-per-share purposes. So, we chose to really use the base earnings per share and then over time we’ll give you an idea of how the share repurchase program goes.

Matt Teplitz

Okay, and what’s the actual share count at your end?

Frank Russomanno

Between 38 and 38-1/2.

Matt Teplitz

Okay, great. Thank you.

Operator

Our next question comes from John Lopez, with OTA.

John Lopez

Hi, thanks. Can you hear me?

Frank Russomanno

Yeah, we can hear you.

John Lopez

I have a couple of quick ones. The first one is: Just one the litigation side, I was wondering if you could just talk briefly. You guys had a disclosed suit which ended in July, and then that suit was subsequently dismissed or dropped, and now you’re part of the broader, I don’t know what you call it, a kind of class action suit or whatever that’s being brought against, I think everybody that sort of makes USB drives. So I guess my question is: Could you maybe talk through the circumstances that led to the first suit not being dismissed, and what’s different about the second one relative to the first?

Frank Russomanno

I think, John, it’s all in the General Council. I’m a first one. That was really related. There had been a previous case that we had inherited from Amarex. And we were in the process of settling that with Memorex; they wanted to include all of the actions as related to management at that time, and we were not willing to do that, so they brought a second suit that was really focused on a single patent that was related to the original Memorex case. They decided that they were very close to bringing a much larger action basically related to the whole industry. So, they withdraw that first case, and then we became part of that much larger second action.

John Lopez

Okay, I understand. Between Memorex or with Imation proper. Do you have intellectually property that relates the construction and operation of USB drives?

Frank Russomano

No. But I will comment in terms of how we purchase. We are indemnified by our suppliers. So, we are looking at a couple of our finer suppliers, our actual parties to that case. As we purchase the product, we actually are indemnified as part of the negotiation with our suppliers, so we are looking at the indemnified buyers-suppliers on the case of ban disks.

John Lopez

Sure. Okay, now that makes perfect sense. Thanks for that. The second question: Did you guys mention that this quarter you had a pretty nice amount of success in the corporate channel with your USB product? Now I was wondering if you would just talk a little bit about what you think the factors are that drove that success and what differentiates the pursuit of market share in that market relative just to the bulk tumor opportunity.

Frank Russomanno

The best way to explain that is the relationships that we have in that channel, the way you do business in those channels versus the retail channels. I don’t know if you’ve listened in on any of our previous calls, but disconnect. We had problems with the flash business. The requirements within that large retail consumer channels is consignment inventory which means we literally had weeks of inventory to satisfy the consignment requirement.

John Lopez

Sure.

Frank Russomanno

There was a requirement to have temporary price reductions at a moments noticed just about there is someone in the channel reduced their price and you are to react to those and then there is a large amount of promotional dollars that are required in order to participate. You are somewhat on a promotional schedule of every third or fourth or fifth opportunity comes to you depending upon the number of brands there are. None of those, none of those are activities that are required to participate in traditional B2B classic type channels. So those are some of the main differences that allow you to behave differently.

We also have fewer SQs required from the B2B channel as compared to consumer channels and then last but not least, you know, the approach as to how you do business does not require us to have large amounts of inventory. We can be much more, much more responsive. This particular product, the best way to get it from the manufacturer to the US and ultimately into the channel is to fly it, and you can buy this product and get it in order to receive it in less than a week. So consignment inventory is definitely a major problem. That is hypermentality.

John Lopez

Now that makes perfect sense. Two quick followups. The first one is, is it largely the same competitive set or these less competitive situations that have given it, I assume you have relationships that obviously….

Frank Russomanno

It is non-erratically different competitive set but the customer there on the B2B side is very familiar and comfortable with the Imation brand than those brand and that is, I would say this, so you might see some of the other brands crossover obviously like SanDisk but Imation brand is also the brand that the people use for their optical products, some of their tape products so they are known and familiar with the brand and that is one of the advantages of brands in a segmented channel. Now that piece of the business is never as large as what you would do in the major retail outlets and that is the impact we talked about earlier on ourselves just to make prospects in 2008.

John Lopez

Now that makes sense. And then the last question is, I am sure you do not want to break this out, feel free to if you would like to but, is there a substantial margin differential to you selling a SQ corporate versus SQ regional imaginaries but can you just give them a little magnitude?

Frank Russomanno

I really want to give you the specific except to say that it is very reasonable to be carrying margins in B2B channels and flash that are both average like and they do not tend to be in consumer channels.

John Lopez

Great.

Paul Zeller

If you look at our corporate averages, you will have…

John Lopez

When you say corporate average, you are talking about the recent corporate average. Obviously your margins...

Frank Russomanno

And there are channels and customers were you can do even much better than that and it is a mix as any market would be but it is, yeah it is a much better channel for us.

John Lopez

That is it. The last question I would like to ask if I could, you guys have referenced to Memcorp in the sell safe dry product a few times. I certainly do not want you to take a lot of time because (inaudible) but can you shit the highlights, where are you with that product in terms of development. What are your thoughts in terms of, say the unit opportunity for 2008? Can you just run through a very quick on that front?

Frank Russomanno

The former of Memcorp acquisition we call Electronics Products or Imations Electronic Products. Sorry. Can you repeat that question? I missed that question?

John Lopez

I am sorry, I actually may have misheard it but I heard you made reference a few times to an SSD product to solid state drive product?

Frank Russomanno

Yes.

John Lopez

We really just want you to talk about that. Can you just talk about what that product is, what stage of development it is in, and can you give any thoughts around, say like 2008 unit opportunity for that product.

Frank Russomanno

Yeah, I am sure I think you know that is an emerging product in the market place, clearly a new product for Imation and new relationship with Emtron for Imation. So I think it is pretty early in the days to be specific about where that goes except as a market we see high growth and it is coming from a small base but I think there is a real opportunity here. I think this relationship affords us the opportunity to participate leveraging our strength. You know it is not every quarter that, that a new relatively disrupted technology comes out and we see SSD as that kind of an opportunity not just where it gets a lot of publicity at kind of a laptop level but clearly at the end-of-price level as well and that is really what this relationship with Emtron so that starts with and so you know we really do not have specifics that we can provide at this stage except that we did not get some interesting opportunity that we are getting in on relatively early.

Paul Zeller

The important point, let us say, that might help your question is that nanotechnology is entering into what was traditional hard disk type applications. So, the devices that we are going to sell are going to enhance the speeding capabilities of blade servers in that they attach to blade servers. So this Emtron relationship is aimed more to B2B initially to start and not to what you have been reading necessarily of the use of nanochips in small laptop computers. So that is where this is going first.

John Lopez

Now that makes perfect sense. That is great. Thank you very much. Congratulations on the quarter.

Frank Russomanno

Thank you.

Operator

Sorry. There are no further questions at this time.

Frank Russomanno

If there are no further questions, I just like to wrap up and say that we want to remind you that we believe we had a very solid quarter. We believe that our acquisitions are doing very well. We believe that the strategy we have is correct. We know the importance of 2008 to executing on this strategy, and last but not least we know we have a very resilient company here to come back after the quarter we had in Q3. I want to thank you all for joining our call today. It is clear to us that we had many moving parts at Imation but this management team remains very focused on our transformation strategy. We look forward to talking to you at the end of the next quarter.

Operator

Ladies and gentlemen that concludes today’s presentation. You may now disconnect.

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Source: Imation Corp. Q4 2007 Earnings Call Transcript
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