Imation Corp. Q2 2008 Earnings Call Transcript

Imation Corp. (IMN)

Q2 2008 Earnings Call

July 22, 2008 10:00 am EDT

Executives

Bradley D. Allen - Vice President - Investor Relations

Frank Russomanno - President and CEO

Paul R. Zeller - Chief Financial Officer, Vice President

Analysts

Glenn Hanus - Needham & Company

Tom Lewis – Century Management

Mark Miller - Brean Murray, Carret & Co.

MattTeplitz - Quaker Capital Management

Chuck Murphy - Sidoti & Company

Presentation

Operator

Welcome Imation Second Quarter Earnings Conference Call. (Operator Instructions) I would now like to introduce your host for today’s conference call, Bradley Allen.

Bradley Allen

Before I turn the call over to Frank and Paul I just want to remind everybody that any forward-looking statements as a part of today’s presentation may fall under the Private Securities Litigation Reform Act and any risk factors associated with those forward-looking statements are incorporated in our press release and our SEC filings.

Frank Russomanno

Let me hit the key points on the quarter’s results then comment on a few matters before I turn the call over to Paul Zeller, Imations Chief Financial Officer.

Overall results for the second quarter reflect the benefits of our strategy and operational discipline as well as well as the difficult economic environment in which we are operating, including shifts in overall industry demand. While we faced a challenging economic environment during the quarter, especially among our enterprise class customers, our broad product portfolio, multiple brands and global footprint enabled us to deliver an acceptable quarter and strong operating cash flows. While the U.S. and Europe were weak especially in magnetic tape, we saw strong results in Japan as well as the broader Asian market region and Latin America. We also were pleased with our improved margins in optical and flash products, which offset the pressure on our tape margins in the quarter.

Now I’d like to spend a few minutes talking about three topics: our view of the tape market; where we see it going; and steps we are announcing today to further optimize our magnetic tape business; an update on our acquisitions and an update on our overall strategic direction and transformation.

Our tape media business experienced continued softness in the quarter driven by declines in legacy data center and entry level formats. We expect this trend to continue. This morning we announced another step in our strategy to optimize the magnetic tape business and maintain our leadership position as we shift all coating operations to our facility in Weatherford. This will result in the exit of our Camarillo coating operation by year-end.

Paul will provide more details on the restructuring charges in a moment, but I want to discuss our view of the tape industry and our strategy.

First I want to make it clear that Imation remains committed to maintaining our leadership position serving commercial customers for their removable data storage media business. We expect the tape business to remain an important market for us in the future. Several years ago we backed up our commitment in this market with our investment of more than $50 million in the most modern coater in the industry, our TeraAngstrom coater in Weatherford, Oklahoma. At that time we said we would deliver one terabyte of capacity in a cartridge before the end of the decade. Last week we passed that milestone with Sun StorageTek introduction of the T10000 B tape drives. Going forward our Weatherford plant will be the manufacturing site for all our coating operations.

The tape industry has consistently addressed the growth and demand for storage capacity with higher capacity cartridges resulting in lower cost per gigabyte. In addition, open format LTO tape continues to gain share with legacy formats declining at an increasing rate. In the current economic environment we have seen this trend accelerate, especially among some of our enterprise class customers.

Finally lower cost disc and optimization strategies such as virtual tape and de-duplication remain a factor in certain sectors of the market. . As a result, we expect tape revenue and margins to

continue to be under pressure.

Given these trends, we recognize that excess manufacturing capacity exists, so today we are taking aggressive actions as part of our strategy to optimize our tape business and maintain our leadership position as we shift our manufacturing operations to our state of the art tape coater in Weatherford. As we said in the past, this management team will take all steps necessary to maintain our competitive advantage.

Finally, Imation is well known and trusted as a leading manufacturer of high performance magnetic tape formats, as well as an innovative developer of technologies such as servo writing which develop increased tract density. That position of leadership and innovation will not change.

Next let me update you on acquisition integration. Our overall growth in optical media was driven by our acquisition of the TDK recording media business. Our multi-brand strategy is working as it is enabling us to gain share and improve profitability in an overall declining market. For example, we have now become the leading retail optical media player in Japan. Integration of the TDK recording media business remains on track to deliver our anticipated synergy benefits by year-end. The relationship with TDK remains solid and grows stronger as we work together.

From day one we established strategic relationship committees that are tasked with resolving issues which inevitably arise as we manage TDK’s consumer brand in the marketplace. More importantly, this committee is a critical part of building the long-term relationship between our companies. With former TDK employees playing key roles in the company, a TDK executive on our board of directors and a TDK corporation holding a 20% ownership stake in Imation this relationship is strengthened at all levels.

I should add here that we have offset more than 70% of the dilution from the equity issued to TDK through our on going share repurchase activity.

Our electronics products business from the Memcorp acquisition posted strong performance during the quarter and is well positioned for the busy year-end season. We also have a focused effort to grow this business organically through expanding channel coverage and geographic reach initially in North America.

Our recent acquisition of XtremeMac further strengthens our brand and product portfolio strategy and adds a new dimension of product design in consumer electronics and related accessories, especially for Apple enthusiasts, around the world. As we build a portfolio of strong brands that resonate with consumers.

Finally let me say a few words on our strategy and transformation. We remain committed to the strategy of building a portfolio of brands and extending brands across new product categories. We benefited from this strategy with channels, suppliers and end users as we create the platform for long-term sustainable profitable growth.

A little over a year ago we began building a new global corporate marketing and brand management organization from scratch. That organization is now in place. We recognize that a new global brand organization is a catalyst for change for the entire company and that brand building is a necessary skill to implement our strategy. The influx of new talent from outside Imation through acquisitions or hiring creates a healthy diversity as we undergo this cultural transformation. Brand building education is a regular part of our quarterly employee meetings where we talk about the DNA of a successful brand building company.

This past week we had our international business leaders in Oakdale for the first time since the new organization was launched. A deeper understanding of our strategy was a key outcome from this meeting. You will begin to see external evidence of this sharper brand focus beginning this quarter. For example, you should expect to see new products with a new consistent packaging for the Memorex brand based on research about the target market for that brand. You can measure our success more concretely as more consumers buy more of our products and services more often.

Equally as important is operational excellence in our supply chain as we increase the number of products and diversity of channels we serve. Recognizing this we created a global operations organization in August of ’07 with an experienced finance leader at the helm. We are aggressively attacking our supply chain operations to extract cash and improve productivity by focusing on tighter inventory management, integrated IT tools and consolidated sourcing management while improving customer service. In addition, as part of our acquisition integration effort we continue to consolidate warehousing and distribution.

Preliminary results to date include declines in our overall level of inventories, productivity gains in distribution costs despite rising fuel costs, and on time delivery above 90% which strengthens our channel relationships and reduces non-compliance fees.

In summary, we have adjusted our 2008 outlook reflecting the restructuring and related costs associated with our plant exit announced today. Excluding these impacts, we remain committed to our previously communicated 2008 outlook. Though we are aware of increasing concerns about possible further economic weakness near term, we will continue to closely monitor the external environment and its possible impact on our business as we head into the critical second half.

Clearly our results for the second quarter reflect the initial benefits of our strategy and our operational discipline, further reinforcing our confidence in the long-term value of our strategic direction.

Now I will turn the call over to Paul Zeller our CFO who will provide you with more details on the quarter.

Paul Zeller

As Frank just mentioned, we continue to face a difficult economic environment in the quarter, especially in our enterprise class of customers. In spite of these challenges we delivered acceptable revenue and earnings and very strong cash flows in the quarter, demonstrating the benefits of our broad portfolio of businesses and brands as well as our global footprint.

Our revenues totaled $547 million in the second quarter; that represents year-over-year growth of over 32%. Total optical product revenues increased 37% to $264.3 million; that was driven by TDK brand revenues from the acquisition last year. In total optical products represented about 48% of revenues in the quarter.

Magnetic product revenues increased about 10% to $166.4 million; that also due to TDK revenues; the majority of that coming from audio/video products. We did experience softness in legacy data center and entry-level server formats, though some declines in these categories were anticipated we saw more softness than we did expect. Total magnetic media represented about 30% of total revenues.

Revenues from electronic products totaled $59.8 million or 11% of total revenue. This was up significantly from first quarter which had $25.9 million in revenues as we started to see the beginning of the seasonal pick up in this business that should accelerate into the second half of the year, especially in the months of September through November.

Accessory and other revenues totaled $29.5 million, up about 9% from last year, driven primarily by TDK and represented 5% of total revenues.

Flash product revenues totaled $27 million and declined nearly 37% from last years second quarter. This decline was in line with our expectations given our actions to rationalize our portfolio, especially in US retail. Flash products represented also 5% of revenues in the quarter.

On a regional basis, our Americas region revenue totaled $190 million in the quarter, down 17% from last year, excluding our electronics products business. The addition of TDK revenues from the acquisition were more than offset by declines elsewhere. Including electronic products, Americas revenue was up over 8%.

European revenues grew 46% and totaled $185 million with growth driven by TDK as well as revenues from our global data media joint venture which offset softness in our magnetic tape business.

Asia Pacific revenues totaled $113 million, up nearly 100% over last year driven by TDK revenues, especially in Japan. This region is exceeding our expectations in both top and bottom line.

The overall impact of our acquisitions on revenues was $190 million in the quarter, that’s about 35% of our total revenues with about $130 million of that from TDK and $60 million from Memcorp. Excluding the impact of these acquisitions revenues were down about 13%. That’s about the same rate of decline on this basis as we saw in the first quarter.

There were three main factors driving this decline: first our flash revenues were lower due to our planned rationalization of our exposure to the US retail channel, as we have discussed in previous quarters; second our magnetic tape business was down and this was driven by declines in virtually all entry-level formats as well as mature data center formats.

We see newer formats continue to gain share with legacy formats declining at an increasing rate. We did see solid performance in LTO-4 tape in the mid range category and in the data center with IBM 3592 and Sun T10000 tape formats. These gains were, however, more than offset by declines in 98 and 9940 and older IBM formats.

We believe the economic environment was clearly a factor not only in holding back demand across tape formats, but also in accelerating the move to newer higher capacity formats.

Finally, we saw declines in both CD and DVD optical revenues in the US and Europe, again excluding the impact of acquisitions. We did increase and see increases in other regions of the world; however the overall optical category was down and though down in revenues our profitability was up nicely driven by better gross margin performance and I’ll talk more about that in just a minute.

Our overall volume growth in the quarter was 34% driven by acquisitions, currency translation driven by a weak dollar added about 6% to worldwide year-over-year revenue growth. These volume and currency benefits were partially offset by a 7% impact from price erosion which was at the lower end of our historic range.

Gross margins were 17.3% to sales and essentially flat with last years second quarter. We saw substantial improvements in both optical and flash margins during the quarter. In the case of optical our margins benefited from several factors: first we’re seeing a stable pricing environment in both CD and DVD; second we’ve been actively rationalizing our portfolio limiting low margin SKUs and focusing on higher margin channels; finally we believe we are beginning to see the benefits of our multi-brand strategy which is giving us the ability to take advantage of the consolidation that is occurring in retail shelf space.

In the case of flash we also saw very good margins, a significant improvement from last year. In fact our gross margin percentages were nearly 3x last years and gross margin dollars were nearly double despite lower revenues. We are clearly benefiting from the change in strategy we began last fall when we started rationalizing our participation in US retail, as I’ve mentioned, and focus our attention on higher margin and lower risk channels and regions. This strategy is working very well and well our revenues are down, our margins are up substantially.

These optical and flash benefits were offset by declines in our higher margin enterprise tape formats as well as entry-level tape products. As Frank discussed and we announce today, we plan to exit our tape coating facility in Camarillo, California by the end of this year. I will get into more of the financial details of this in a minute. We do anticipate this action will help mitigate the impact as we continue to see declines in higher margin legacy formats.

On a sequential basis our gross margins were down 1.3 points as expected [audio gap] regional mixed penalty in the second quarter versus the first. Tape, which carries higher margins, tends to be stronger in the first quarter than the second and electronic products with relatively lower margins tend to be stronger in the second quarter than the first.

R&D costs were $6 million for the quarter, lower than prior periods, but in line with our expectations.

Selling general and admin expenses in the second quarter totaled $72.7 million, up slightly from our run rate in the last couple of quarters, reflecting somewhat higher spending on our brand work and IT integration as previously discussed. In addition we had increased legal costs in the quarter primarily driven by the Phillips litigation.

As a percent of revenues SG&A was 13.3% down slightly from last quarter, but up from last year. Until we see the full benefits from the TDK cost synergies, which we expect by the end of this year, we are being impacted by the relatively higher level of SG&A from this acquisition in addition to the modestly higher brand and legal costs I just mentioned. So as we planned we expect to see improvements in our SG&A spending in dollars and as a percent to sales as the year progresses and we complete these actions.

Our [inaudible] employee count ended the quarter at approximately $1,950, that’s down about 8% or 180 employees in the quarter and down 13% or 300 employees so far this year. The decline was driven by actions associated with manufacture and restructuring as well acquisition integration.

Restructuring and other charges totaled $4 million in the quarter and has been $4.7 million year-to-date. This is in line with our expectations and was in line with our previous outlook for $4 to $6 million in these charges for 2008.

As I just mentioned, we are planning to exit our California tape coating facility by the end of this year. We expect to incur up to $20 million in additional restructuring and related charges associated with this new program. Approximately half of these charges will require cash primarily associated with severance and site clean up. The remaining non-cash charges reflect asset write offs. So, we estimate we will incur $13 to $16 million of these charges in 2008 and thus our new outlook for restructuring and related charges is now $17 million to $22 million for the full year 2008.

Total operating income in the quarter was $12.2 million on a GAAP basis or $16.2 million excluding restructuring. Non-operating costs totaled $1.6 million in the second quarter and that compared with $700,000 of income in the second quarter last year. This change was driven primarily by lower interest income, but also by higher currency losses this year.

Our income tax rate was 32% in the quarter which was better than expected due to a combination of positive tax planning opportunities and some positive tax adjustments.

Our earnings per share on a GAAP basis was $0.19 in the quarter and excluding restructuring and other charges earnings per share was $0.26 per dilute share.

We had another very strong quarter in terms of cash flows as we continue to benefit from focus on operational execution. Cash from operations totaled $45.5 million this quarter, compared with $9.3 million in the second quarter of last year. Year-to-date we generated $78 million in operating cash and over $150 million in the last three quarters. Cash flows were driven by earnings with EBITDA of $25 million in the quarter. In addition we generated over $20 million from lower working capital. We improved our working capital days of receivables and inventory by 9 days in the quarter. A portion of this improvement came from implementing inventory consignment to several vendors.

Cash use for investing activities totaled approximately $20 million and that included capital spending of $4.1 million, $7 million for the acquisition of XtremeMac and $9 million of deferred cash payments associated with previous acquisitions.

Finance and cash flows included $7 million spent to repurchase about 270,000 shares of commons stock under our share authorization which stands at about 2.3 million shares as of the end of the quarter. We have now purchased over 705 of the 6.8 million shares issued to TDK last year associated with the acquisition. We also paid out $6 million for dividends during the quarter. As a result of this activity cash and equivalents ended the quarter at $117.7 million, up $12.2 million from last quarter.

As we look forward to the rest of 2008 I want to point out a couple of important points to be mindful of related to cash flow. First our electronic products business is expected to be particularly strong seasonally in the months of September through November. As a result we expect this business to typically build working capital during the third quarter ahead of this and then get the benefits in quarter four and into early 2009. Second much of the cash payments associated with our previous restructuring program as well as the Camarillo program announced today will occur on the second half of this year. As a result, all else being equal, these factors will dampen second half operating cash flows versus the first half and Q3 may be especially soft.

As Frank mentioned we are well aware of concerns about a slowing economy and will continue to monitor the external environment and its impact on our business. Having said this, other than the earnings impact from the new restructuring charges our 2008 outlook remains unchanged in the guidance we provided coming out of 2007. We continue to target approximately $2.4 billion in revenue for the year, operating income is now targeted between $80 and $90 million on a GAAP basis, including restructuring and other charges now estimated in the range of $17 to $22 million including charges for the program announced today. Excluding these charges operating income remains targeted in range of $100 to $110 million for the year.

Diluted earnings per share are now targeted between $1.26 and $1.43 per share on a GAAP basis, including approximately $0.33 of an impact from restructuring and other charges. Excluding those charges earnings per share remains targeted between $1.59 and $1.76 per share.

Capital spending remains targeted between $15 and $20 million and depreciation and amortization between $48 and $52 million for the full year.

I will make a final comment on seasonality. As I have mentioned in previous quarters, we expect that our results will be particularly back end loaded. There are multiple reasons for this. First electronic products will be strongest in last Q3 and most significantly in Q4. Second, our restructuring benefits announced last year will have the largest benefit in the fourth quarter. Finally our synergies from TDK will be focused towards the end of the year.

In summary we are pleased that despite a difficult economic environment we were able to deliver an acceptable Q2 in terms of both revenue and earnings and an exceptional quarter in terms of cash generation. We look forward to the rest of 2008 as we complete the acquisition integration, implement our manufacturing restructuring program and continue implementing our long-term strategy.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Glenn Hanus - Needham & Company.

Glenn Hanus - Needham & Company

Maybe first you could talk us through on the tape side. Last quarter there was some uncertainty about if and when or a recovery on tape. What did you learn through the quarter, what did you discover and how should we think about year-over-year comparisons on the tape business?

Frank Russomanno

Getting back to the original part of your question, I think you were asking us, last quarter we talked in terms of the economic impact of some of the financial institutions and the problems they were having and how that resulted in deferring purchases.

While that information was the best information we’ve had and it was somewhat anecdotal we still believe that probably correct. However, as we move into the second quarter now, now we are starting to take a deeper look at other factors as enumerated in our call. First of all the economy is still having an impact and it’s having an impact in two ways: one some people might still be deferring some purchases until the second half and two other people might be accelerate moving to other formats that will allow them to have greater capacity, productivity and efficiency, so the economy is still a factor.

The second major point that we’d like to talk about is in fact with the introductions of one-terabyte cartridges and in general with an LTO-4 at 800 gigabytes, the cartridges we’re producing today are very capable of eating up or cannibalizing all the growth that exists in storage as a general comment, especially for archival storage.

Third we believe there is more impact and we talked about last quarter in both virtual tape and de-duplication which allows for greater efficiency and utilization of each cartridge. Finally and this is an issue probably we will talk about some more, is that the LTO format improves with each generation and where as if we had this conversation three or four years ago there would be comments about is it as reliable as high-end data center type drives. I think the cartridge, the LTO format has proven to be quite reliable and also gets out there with the highest capacity cartridge before the high-end drives get there and is starting to encroach into the high-end data center for certain types of applications.

So those are the four comments I would make.

Paul Zeller

Paul if I could add something, second quarter in terms of comparable magnetic revenues year-over-year is very similar to first quarter, so it is not that the business in magnetic is any different than we saw in first quarter, it just didn’t come back as we hoped it might. I think, as we’ve done before, we intentionally got ahead of the issue, announced a further step in our manufacturing restructuring as you heard about on the call today and saw on the release and I think our intent was that similar to last years announcement is to mitigate some of the issues we’re seeing and have been seeing as the overall tape market moves into a modest decline mode and more importantly moves away from proprietary and towards open formats.

Frank Russomanno

Glen let me close with something I think is really critical. Having said all this, the points that I’ve mentioned make tape a viable longer-term competitor in the marketplace because it is so efficient on a gigabyte basis, the cost of tape, especially for archival storage and pretty soon we’ll be talking about the cost of tape on the terabyte storage. We believe there is going to be a long road ahead of future generations, the T100000 B just came out now in a one terabyte version, there are LTO -4s out there, we have LTO-5 in development now, LTO-6 is on the drawing board and we intend to be in this business for a long time and every one of these strategic moves we make to either relocate our manufacturing or converting of cartridges or tape making to our most efficient and best coater is just going to strengthen our position in the marketplace for however long the business is out there. So we feel good about the moves we’re making and we believe we’re going in the right direction with a business that is a tough business but a very important part of our future.

Glenn Hanus - Needham & Company

Maybe if I could shift to Memcorp. You had real strong sequential growth 26 up to 89. Could you maybe talk about what was behind that sequential growth and should we continue to see sequential growth from here with a very strong fourth quarter and then just how are you doing there as well on, I think there was some question about adequate delivery of product for the Christmas season and stuff, comment on all of that.

Frank Russomanno

Okay let me just make one quick comment. The actual sequential move was from $26 million to about $6 just short of $60 million, I think maybe you picked up [interposing].

Glenn Hanus - Needham & Company

all right I picked up the others, sorry.

Paul Zeller

Your comment is valid.

Frank Russomanno

Paul and I were both fighting to start to answer this question because we’re both very positive about where we see this business going. When we acquired the Memcorp business, we wanted to get a hold of the entire brand. We wanted it to help us leverage the rest of our media business in channels, but for sure we knew it was under penetrated. In other words it was in a very few channels. So our first opportunity when we acquired it last year was try to increase our penetration, especially in the US market and that’s some of what you see. We think we can continue to further penetrate channels in the Americas by heading north to Canada and south to Mexico and we’re taking steps to do that.

The rate of growth is a little bit hard for us to determine right now on a basis of what is the economy going to be like and also this business is somewhat new to us. But we feel very confident that we are taking the right steps to grow the business.

The last point you put your finger on is the critical one. We are in a much better position this year than we were last year with suppliers to help us ensure that we have product. However, you and me like others and people have been watching what’s going on in China and I was watching the news Sunday evening and I saw that China is shutting down factories for two weeks in the Olympics just to reduce the amount of pollution. Now could that have an effect on us? I don’t really know which factories are going to be involved in that particular piece, but we’ve done everything we could to have a better assurance of having product during the busy season and the most important thing we did was to go directly to the suppliers as compared to working through distributors last year. So we’ve taken steps to put ourselves in a better position.

Paul Zeller

If I could add just a couple of comments, one is that the whole brand extension strategy that this Memcorp business and the extension of the Memorex brand is a good proof point on that I believe and we’re extending it in a couple of different ways, one is with a broader array of products and you’re going to see a broader representation in flat panel TVs, you’ll see some representation in blu-ray players under the Memorex brand and you’ll also see extension from a channel standpoint.

If you looked backwards on how this business was managed in the past it was very focused on target. You’ll see our channels will be much broader and have a much less singular focus on one customer. It will be a much broader array of customers across not just the US, but as Frank mentioned into Mexico and Canada and eventually outside the US into Europe we believe, so we’re pleased with the initial things we’re seeing on the electronic products side of things.

Operator

Your next question comes from Tom Lewis - Century Management.

Tom Lewis – Century Management

Could you talk around the shed some light on the 75-price erosion figure that you provided? Perhaps contrasting the price trend, how much of that is the price trend in your basically healthy to update formats with what I would take to be a mix shift in the older formats and entry level but I suspect they’re at their point in their life pretty healthily priced. Am I correct in understanding or did I hear correctly that there really wasn’t price erosion in CDs and DVDs and did flash play in that 7% figure at all?

Paul Zeller

Well let me just walk through our business in a broad sense and talk about price erosion. As an overall comment 7% is on the lower end of the range we’ve seen historically, certainly lower than last year with a significant price declines we saw on the flash side of things.

If you look at magnetic products I think it was a generally as expected quarter. We had stable pricing in data center and entry-level products globally and mid range LTO remained competitive as expected. We anticipate price declines there, we plan for them with our cost reduction programs, and so there’s really nothing unexpected there.

Optical prices were relatively stable during the quarter. If you look full year-over-year there will still be some price erosion there from moves happening over the last 12 months, but sequentially the price movements were very minimal in CD and DVD and when you look at other products really unusual trends.

I think what you see then in the quarter is the benefit of having a very normalized quarter without any significant pricing issues in one part of the business or another. If you go across the years in the quarters of our history there is quite a few quarters where tape might move a little bit than expected, flash might move a little bit more, years ago in optical. I think we had a good quarter where things were pretty normalized and I think that’s a benefit for us.

Tom Lewis – Century Management

Do you own your facility in Camarillo?

Frank Russomanno

Yes we do.

Tom Lewis – Century Management

Can you give us an idea of this asset? I am assuming that you have an asset you’re going to be putting on the market there in the quarters ahead. Are we talking about a valuable piece of industrial property or something Do you expect to be able to monetize that in the next few quarters?

Paul Zeller

We have spent a lot of time talking about this asset. We see this as a very valuable asset for us in California. We also understand the state of the real estate market and we are looking at this very carefully before we try to monetize it, not so much to try to just time it as to when the best time is, but to really consider all options, be they commercial or possibly residential.

Paul Zeller

From a factual standpoint it’s about a 27-acre site which is relatively public information and it’s in Camarillo, California and I would just echo what Frank said that we will take a very careful and ordered approach to how we approach that.

The first most important objective is to have an orderly closure of the facility, move the business in a very careful way. We produce some very important products at that facility and will want to move them as we have shown the ability to do in the past, very carefully and not having a disruption with our customer and then it will be an orderly shut down of the facility and then we’ll evaluate what we do from there, whether we take the building down, whether we sell it as is, whether we try to rezone, those are all questions we’ll be evaluating in the coming quarters.

Tom Lewis – Century Management

Okay but there is something that is valuable there that we as shareholders can look forward to hearing about somewhere in the future.

Paul Zeller

Yes that’s a valid statement.

Tom Lewis – Century Management

Based on what I see in the junk mail that shows up in my house every day, I’m a little surprised we didn’t hear anything from you today about blu-ray. Can you give us an update on how that’s developing?

Frank Russomanno

When we look at blu-ray we have to look at it in pieces: first of all blu-ray players versus blu-ray drives and ultimately set tops. The set top market continues to increase in Japan and we have a very good position in Japan with the TDK brand and that’s where most of the growth is in the actual blu-ray drives and likewise blu-ray recordable type of opticals.

In the US, Paul said it and you might not have caught it that with our electronics business you are going to see us take a role in blu-ray players and that’s where the growth is primarily going to be this year in the US will primarily be in the hardware and blu-ray players so that people will be able to play back the growing array of blu-ray movies you now see as you walk into a Best Buy, Target, or Wal Mart. So that’s where we intend to make our initial foray, into the hardware piece and not into the media piece in the US because the market isn’t there yet, or Europe.

Operator

Your next question comes from Mark Miller - Brean Murray, Carret & Co.

Mark Miller - Brean Murray, Carret & Co.

I was just wondering with these additional cost cuts from the closure of Camarillo and when it’s all said and done it looks like to me that you produced through all the acquisitions maybe up to a dollar in cost cuts, is that off target or does that seem to be reasonable to you?

Frank Russomanno

If you add together the actions we’re taking in all programs, I don’t have it in front of me, but it would be a reasonably significant number. The thing I’ve made sure to make clear is on the side of restructuring a lot of that is about mitigating the declining margins we’re seeing in the tape marketplace, especially in the high end. I just want to be clear and I’m sure you realize that you just can’t add those numbers to current levels of profitability, they’re really proactive steps to mitigate what otherwise would be some declines.

Mark Miller - Brean Murray, Carret & Co.

Okay you mentioned one of the factors behind the weakness was the transition open formats, the magnetic tape and larger capacities of the cartridges. I’m just wondering how it splits out in terms of are you just getting lower margins for these products or the fact is that the capacity of these products is cannibalizing certain areas.

Frank Russomanno

I think it’s fair to say it’s both. There is an overall decline rate in the entire category and clearly as the mix shifts from the lower capacity, higher margin proprietary formats in the data center to a higher capacity, more semi-proprietary formats in the data center such as with T100000 and even to LTO which is an open format, that’s also a significant factor.

Mark Miller - Brean Murray, Carret & Co.

Assuming the economy is stable do you have any forecast on the writer pricing declines or are we going to see it’s all ration, more of a constant rate of price declines. Any forecasts you can give us?

Frank Russomanno

The difficulty in doing that forecast is our pricing and I should have mentioned it earlier in the question on pricing, our pricing is also influenced by exchange rates and so part of it has to do with what the overall impact of the strength or weakness of the dollar. There is a lot of different markets that we participate in, in a lot of different regions I the world and I would just say that the 7% to 8% on the low end, 10% to 12% on the high end overall price erosion is the right range to be thinking about.

Operator

Your next question comes from Matt Teplitz - Quaker Capital.

Matt Teplitz - Quaker Capital Management

Paul in terms of the restructuring what is the cash accrual are we looking at at this point or what are we going to be looking at if you add in the Camarillo costs from here, it sounds like it’s about $10 million incrementally.

Paul Zeller

The statement we made is up to $20 million in total restructuring related charges, about half of that being for severance and site clean up and such that will require cash and half related to buildings and equipment and improvements. That will just be written off as non-cash. That cash portion, a good deal of it, a reasonable portion of it will occur this year and you heard my comments about cash flow and the impact from that and then some cash will flow into next year as well.

Matt Teplitz - Quaker Capital Management

What’s still to be spent from the previously announce restructuring?

Paul Zeller

There is about $14 million in total restructuring accrual left and much of that has already been expenses, almost all of it has been, all of that has been expensed and very little more is coming on the previous program and so there is some definite cash flow on the previous program yet to come; much of that coming in the second half of the year.

Matt Teplitz - Quaker Capital Management

It sounds like it’s, from here, roughly $25 million cash to go, is that right?

Paul Zeller

That’s a good rough estimate and not all of that this year but a reasonable portion and a lot of that coming in the second half of this year because it was always planned that our Wapato facility would continue to produce some product and go in a wind down mode and it’s finally coming to closure here in the second half of ’08.

Matt Teplitz - Quaker Capital Management

As it relate to restructuring and you have gone out of your way to not let us do the idiots math of adding all the savings you’ve indicated and add it to the run rate and I understand why we can’t just do that, but have we actually seen much of an of the incremental benefit yet from these restructuring, obviously nothing from Camarillo, but on the other stuff, have we seen much if any of that actually impact your income statement yet?

Paul Zeller

I think we’re beginning to see the benefits from the Wapato program yeah and they have really been there mitigating the impacts we’ve been experiencing in the tape marketplace. I think we announced back a year ago the same comments we made today which is what we’re trying to do is get ahead of the impacts from the continuing declines in proprietary formats and these restructuring programs are there to do that.

In terms of the acquisitions, we’ve been getting some benefits. They’ll be some more that we will get in the latter part of this year as we finish our European and Japanese integrations for the TDK acquisition. I think it’s important to note that there is a real issue we faced strategically back a couple of years ago, looking at how much of our income is generated from these proprietary products and I think the moves we’ve done as those proprietary products have moved have really helped in mitigating that impact and it’s fair to say they continue to be an important part of the company but they are less a part as time goes on and the other parts of our business and the profits we get from consumer in optical and now emerging in flash and certainly electronic products as we look forward become a bigger and bigger part of our total mix.

Frank Russomanno

Paul explained that extremely well to you but I’d just like to emphasize the point that in the environment like the one we’re in today with changing technologies it’s very important that we be extremely aggressive in our actions and this management team has been aggressive and has planned for these actions and will continue to be aggressive in order to remain competitive and also get the highest margins we can, an important part of the market.

Matt Teplitz - Quaker Capital Management

Thank you, Frank. Just clarify what you were saying Paul in terms of the integration benefits of the acquisitions, can you size at all what incremental opportunity is in front of you here in terms of what it could mean to your income statement versus current run rates?

Paul Zeller

I think we’ve generally included that as part of our overall guidance and so reflected in the fact that our outlook for the year obviously assumes quite a bit of income in the second half versus the first. Some of that is this, some of it is restructuring benefit, some of it is just the back end nature of some of our new businesses like electronic products, so we really don’t get into all the individual pieces as part of an overall operating plan and that’s the basis upon which we provide the guidance and then obviously we’ll put together in ’09 expectations and communicate that to you in a couple of quarters so.

Matt Teplitz - Quaker Capital Management

As it relates to ’09, I guess two questions and again I can understand your reluctance you’re going to have here, but does this imply that there’s still a fair bit of operational synergy that will roll over into ’09, I’m again speaking more to the acquisitions side than the restructuring of magnetic tape operations.

Paul Zeller

There’s a meaningful amount of additional synergy that we expect to gain and we will see some of that this year but we will finally be all the way there as we get into 2009.

Matt Teplitz - Quaker Capital Management

Okay one more question about ’09 and I’m trying to make this as general a question as I can. So as I look at ’09 obviously acquisitions it’s pretty much apples to apples right, it will be a full year in both cases, assume currency is flat, given the price pressures and the issues you’re pointing to in magnetic, can you grow ’09 over ’08 with your current businesses that you own? Can you grow revenue in ’09 versus ’08?

Frank Russomanno

It is our plan to grow revenues. It would be our plan to grow revenues in ’09 over ’08 but it’s going to have to take some organic growth and we talked about that somewhat with the Memorex brand, especially in electronics. Paul mentioned at the end there that a lot of our growth was in North America and we would have to have growth outside of North America, we would have to bring these products into Latin America, Europe in particular. We also have made that acquisition of XtremeMac which would not be a year on year comparison, so we would be looking for more organic growth. Also the consolidation of the optical business is still very important to us and we’re not in a position to talk about the details yet, but we see further out a consolidation in US retail and an opportunity for our strong brands, especially in the Americas, like the Memorex and TDK brand to probably consolidate out some of our other competitors and retail in the US.

Paul Zeller

Why don’t I answer that question from my perspective with a summary of where that growth would need to come from for us to be successful in driving organic growth in 2009. Clearly Frank already mentioned electronic products. We have new product initiatives and growth programs in the hard disc arena, in external hard disc as well as removable hard disc on the commercial side of things. We have an arrangement with an intern and a plan to grow our SDD business as we move towards 2009.

Blu-ray I think represents an opportunity on the optical side, both on the media side as well as the possibility of creating a reasonable position on the players side and then finally applying our multiple brands in various regions against accessory opportunities in various categories. So there are a number of places that we look to for this growth that are really enabled by this new strategy, the multiple brands we have and the positions in the channels, both consumer and commercial that we have around the world.

Frank Russomanno

I think your question is obviously an interesting one but we are very much focused on delivering ’08 at this time; however we’re planning the seeds for ’09 and in my opening comments I mentioned that we had our international summit here last week and one of the express purposes of that summit is to get our international selling machine ready to take some of these initiative outside of the US and that is not an easy thing to do, but when you have 69% of your sales outside of the United States you would be missing a golden opportunity if we don’t get all of the regions ready to sell all these new things, the new brands and products that we’ve acquired over the past year and a half.

We do understand the importance of ’09, but we’re very focused on delivering ’08 right now.

Matt Teplitz - Quaker Capital Management

In terms of those initiatives do you have the people and the resources you need? Obviously consumer electronics is certainly a different sale than optical discs or.

Frank Russomanno

Consumer electronics is definitely a different sale. The XtremeMac piece that we just picked up filled a need that we thought we had around a design component piece and we feel very confident that we’re putting the right pieces in place to do that consumer electronics business. Now remember our stated purpose here is not to be a competitor of Sony, Panasonic, or other brands like that. We definitely fit into a tier 2 side of the business where people are more looking for a price value equation than they are for the latest and greatest thing, but there are some opportunities which large segments when blu-ray player for example, start to replace existing old DVD players in the home for a strong brand that has credibility with consumers reasonably priced.

We feel pretty comfortable that we do have and are learning the skills and requirements to be in the hardware piece of the business.

Matt Teplitz - Quaker Capital Management

In the US market, those businesses you have been somewhat target centric on the electronic products and the Memcorp businesses. Would you expect to see much expansion beyond target in the ’08 numbers or is that more of an ’09 event?

Frank Russomanno

No it started in ’08 and its expansion into multiple channels so that we would be both in the mass channels and also into some of the consumer electronics with limited number of products.

I should also say the commercial channels also there is some opportunity for our consumer electronics brand with some of the traditional hardware wholesalers that exist and they’re buying some of those products from us today and two stepping it into smaller facilities.

Matt Teplitz - Quaker Capital Management

You were a little less aggressive in this share buy back this quarter, anything specific going on there or should we read anything into that?

Frank Russomanno

No I think there are a lot of factors that will influence how much and the timing of our execution and our share buy back program and I wouldn’t look at any given quarter as an indication in one way or another. I think if you look historically the fact that we spent $135 million to purchase nearly 5 million shares during the last year and 26 million just this year, I think that’s a statement about our commitment to this program and our commitment to, over time, offsetting a dilution from the TDK shares we issued last year.

Matt Teplitz - Quaker Capital Management

Q3 is not going to be a great quarter for cash flow given the working capital build and then the restructurings, but by Q4 it should start to reverse out, is that fair?

Paul Zeller

Yes, I think it’s a fair statement from a seasonality perspective.

Operator

Your next question comes from Glenn Hanus - Needham.

Glenn Hanus – Needham & Company

On the optical side for ’09, should I think about that as flat or slightly down or slightly up or is it in that range or how should I think about optical s we get into ’09.

Frank Russomanno

I’m pretty sure that in the first half of the year we’re not going to see significant blu-ray impact but I would think of it as slightly down.

Glenn Hanus – Needham & Company

So for the balance of this year then, looking at gross margins we should be modeling down a few tenths a quarter or so through the balance of the year?

Frank Russomanno

Yes Glenn, I think you should expect full year gross margins and total operating expense very similar to last years full year, 17%$ to 17.5% on gross margin, 12.5% to 13% on OpEx. R&D will be lower, SG&A somewhat higher reflecting the impact of the acquisitions in the early part of the year. So the result from where we are, that second half will show modestly lower gross margin percentages, but as you heard me say earlier operating expense will also go lower with the stronger revenues. So yes I think as you model it think about the 17% to 17.5% full year gross margin, 12.5% to 13% in OpEx and second half will be, I think just seasonally and mix wise it’ll be a lower gross margin but lower OpEx kind of period.

Glenn Hanus – Needham & Company

Stock option expense about $3 million a quarter?

Paul Zeller

Actually closer to $2 this quarter and just slightly lower for her mix of all of the prior years that average into there happen to be such that our expenses are a little bit lower for this quarter.

Glenn Hanus – Needham & Company

Which for planning purposes what should we use?

Paul Zeller

I think closer to $2 million now than $3, $2 to $2.5 a quarter is probably the right range. The stock price does have an impact on the valuation of the options we issue as well and that has lowered the overall fair market value of an option and that’s what you amortize into expense over the four-year vesting period, so for that reason I think you’re seeing more like $2 to $2.5 rather than $3.

Glenn Hanus – Needham & Company

Excluding restructuring expenses, tax rate going forward.

Paul Zeller

The overall range that we are still using as our guidance is 35 to 37. I wouldn’t be a good CFO if I didn’t try to beat that. Tax is a place where we’re spending a lot of time and energy; I think the acquisitions have given us some opportunities to look for tax planning. You saw some of the benefits of that in this quarter. I think it’s still fair to say 35 to 37 is the right planning assumption. Over the long term I certainly would like to see it be at the low end of that if not below it over time.

Operator

Your next question comes from Chuck Murphy - Sidoti & Company.

Chuck Murphy - Sidoti & Company

What would you say is the top line organic growth rate for this quarter?

Paul Zeller

If you ignore the impact of the acquisitions that weren’t there last year, in other words put it on an apples to apples basis, I had said in my comments we were down about 13% year-over-year organically if you will. The flash change in strategy was a part of that where we consciously chose to go away, but some declines in magnetic and some declines on optical were both a part of that as well.

Chuck Murphy - Sidoti & Company

What about if you were excluding acquisitions and currency?

Paul Zeller

Well [inaudible] about a 6% impact on year-over-year revenues so that would be another factor but I think any time you calculate a translation impact on currency one has to remember there is a lot of other factors that come into play. Pricing can go opposite to currency, just because of the impact of importers into different parts of the world and what they do to the pricing. So it’s a little unfair to purely take a mathematical calculation of 6% and just assume that’s really the impact in currency if you follow me. That is the overall impact of translating at different rates this year than last.

Chuck Murphy - Sidoti & Company

I think you mentioned as far as top line growth looking out into ’09 once the acquisitions have left, electronic products, blu-ray and solid state drives are the main things right?

Paul Zeller

I think accessories broadly speaking in multiple brands and hard discs both external hard discs, so direct USB attached hard discs product in primarily consumer, but also removable hard disc platforms like Odyssey and RDX or commercial applications primarily in the small/medium business, but also in some specialty application areas are also some potential growth areas.

Chuck Murphy - Sidoti & Company

Any sense what the acquisitions have contributed to operating profit?

Paul Zeller

Yes, that’s not something we publicly disclose. By the time you get integrated with the acquisitions they become very much a part of you, they share resources, we have some organizations selling multiple brands, it becomes a hard number to get your arms around with confidence, it’s just not something we sub segment.

Chuck Murphy - Sidoti & Company

I am assuming you strive for margin expansion into ’09. Would the main things be the reduction like the IT spending and the litigation or are there other things for us to look for?

Paul Zeller

I think the manufacturing restructuring, the integration work, and the whole brand work and focusing on brands and trying to get differentiated value from our brands, these are all things that could help. There is over time ultimately a mixed penalty that we’ve tended to experience as tape is in at least a modest decline mode and it changes quarter to quarter versus growth in CE that tends not to come at that tape like margins, so we’ve been offsetting that. You’ve seen our margins stabilize nicely in the 17% range, so we’ve been successful in stabilizing some of that but these are all the sorts of levers that we’re pulling and trying to keep a healthy margin going forward.

We certainly would target long-term, something better than the 3% to 4% operating margin we’ve experienced in the last couple of quarters. We believe the business model requires more than that to be the health we think this business needs.

Chuck Murphy - Sidoti & Company

Do you think on a net basis that the closure of Camarillo is going to more than offset the declines in magnetic tape?

Paul Zeller

No I wouldn’t say that.

Chuck Murphy - Sidoti & Company

Would you expect the gross margins to be flat or slightly down?

Paul Zeller

I think we’ll have more to say about the business model going forward as we come out of ’08 and into ’09, so I’d rather not start putting guidance out beyond ’08 at this stage. We’ve been pretty explicit about what we think we can do in ’08.

Chuck, going back to your very first question though, we fully recognize the importance of organic growth and it’s become one of the key drivers and measurements and topics within this company as we have invested in those brands over the previous years like the Memorex brand and we will continue to invest in the brand and we expect to see growth to renew products in that area, especially in the second half of this year, you’ll see new products from us.

Frank Russomanno

If there are no further questions than I’d just like to wrap up this all and thank everyone for participating and listening in on the call, but to begin by talking about the strategy.

We are following a strategy that we announced publicly in May 22, 2007 and I think if you pull out that presentation you’ll see that we have been very consistent in what we’ve said we were going to do with the acquisitions of brands and then extending those brands into new product categories. We feel very comfortable that we’re on target with our strategy. We feel good about the integration thus far, of the brands we’ve acquired an I honestly believe we’re getting better at it as we made this latest acquisition of XtremeMac, which we didn’t talk about much today and I expect that we will talk more about next quarter.

Finally I want to once again say, excluding the impact of the restructuring that we announced today, we remain committed to our guidance that we gave in January and we fully recognize that we have some challenges ahead of us with the economy.

We look forward to talking to you again in Q3 and if you have any questions, please feel free to contact Brad Allen. Thank you very much.

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