Imation Corporation (IMN) Q2 2016 Earnings Conference Call August 8, 2016 10:00 AM ET
Danny Zheng – Chief Financial Officer
Bob Fernander – Interim Chief Executive Officer
Eric Martinuzzi – Lake Street
Good morning, and welcome to the Imation Corporation Second quarter 2016 financial results conference call. [Operator Instructions] I would now like to turn the conference over to the Chief Financial Officer, Danny Zheng. Please go ahead, sir.
Thank you, William. Good morning, everyone, and thank you for joining us today for our first quarter 2016 earnings call. I am your host for today's call, and I'm joined by Imation Interim CEO, Bob Fernander. We will review our second quarter result and provide an update on our strategic activities.
Before that, I would like to remind everyone that certain information discussed on the call that does not relate to historical information may be deemed as the forward-looking statements, within the meaning of Private Securities Litigation Act of 1995. Such statements are subject to the risks and uncertainties that could cause results to differ materially from any projected results. Risks factors that could cause results to differ are outlined in the press release issued today, as well as our files with the SEC.
With that, I will turn the call over to Bob Fernander.
Thanks, Danny. Imation’s Nexsan subsidiary posted revenues that were flat Q1 to Q2. Though revenues did not grow stabilization of the business post restructuring is critical to positioning the Company for growth. Fundamental improvements in gross margins, product quality and customer satisfaction were achieved. A transformation of our go to marker approach was initiated and should be complete in Q3.
Each of these fundamental improvements is necessary in driving the business units to a cash flow positive posture. Innovative new product offerings are a central component of our strategy to create a growth component. In Q4 2015 Nexsan acquired Connected Data with a goal of extending the feature set of primary network effect storage products to include both enterprise and mobile client file sync and share capabilities.
This integration is now in the market and it is branded UNITY, early reviews are promising and bode well for revenue growth. UNITY is shipping now and will be feature complete by the end of the calendar year.
Over the past quarter Imation’s Registered Investment Advisor Subsidiary received approval from the SEC as a Registered Investment Advisor. We have recruited a leading senior executive to spearhead the foundation and ground game for the next generation alternative investment platform we intend to build. The individual brings over 25 years of experience building and positioning multi-billion-dollar platforms. Imation has already established an indicative timeline for business development and key milestones. Plans for institutional quality, investment policies and processes, along with key infrastructure solutions and a marketing strategy are now under review. We look forward to achieving the near-terms steps on this strategy bringing on pre-tax profit as soon as possible.
As I mentioned last quarter, we took a small position in Arlington Asset Investment Corporation, a principal investment firm that invests primarily in mortgage-related assets. Examining Arlington’s long history and history of its predecessor entity, we believe that we could impact change at the company through a proxy contest and improve the operations and results for our shareholders.
Unfortunately, we were not able to convince the two large proxy advisory firms of the merits of our toss or the issues inherent with Arlington at which point we minimized our efforts pursuing the proxy. As an order of magnitude, while Arlington incumbent forward and management step $4 million to defend their incumbent position with multiple advisors, attorneys and even a robust call center effort, we spent 85% less in our endeavor and managed it through our corporate budget to achieve neutrality. We will continue to look for opportunities such as Arlington, where on a risk-adjusted basis we can create significant investment opportunities for ourselves, while leveraging our skill sets.
I’ll now turn the call over to Danny to take you through the numbers. Danny?
Thanks Bob. Before I go over the detail financial results, let me make a few high level comments [ph]. First, we had achieved the corporate cost reduction target in Q2 2016 according to our restructuring plan. Q2 corporate cost reduced by 72% year-over-year.
Second, our Legacy Business wind down is near to the completion, we had a gain of $600,000 from discontinued operations in Q2, primarily due to eliminations of accrued liabilities.
Finally, we are pleased to see the continue improving Nexsan product margin. We are not out of the woods yet. We will work hard to generate cash from Nexsan E-Serial legacy business to fund the high potential Nexsan Unity product. We’ll spend Nexsan business to break-even when we exit 2016.
With that being said, let me review the numbers in detail. Net revenue from continuing operations of $10.6 million for Q1 2016, was down 37.3%, compared with $16.9 million in the same period last year. The decrease was expected and was a result of planned reductions of unprofitable regions and no margin transactions.
Gross profit of $4.7 million for Q2 2016, decreased by $2.2 million year-over-year as a result of declines in revenues. Gross margin percentage increased by 350 basis point with the same period last year, due to supply chain improvements, product mix changes, as well as reduction in rebate.
Total company SG&A dropped to $8.3 million, a decrease of 51.4% year-over-year, excluding restructuring charge and other expenses. Corporate cost decreased from $7.2 million to $2 million year-over-year or 72% reductions. As we indicated in the last quarter’s call, our operating unit Nexsan’s SG&A expense decreased by 36.4% year-over-year.
We continue to streamline Nexsan operations to minimize cash spending in Nexsan Legacy Business. Research and development costs came in at $3.2 million during the quarter, increased from $2.9 million in Q2 2015. The R&D investment was primarily for Nexsan UNITY products.
Total special charge were $1 million benefit in the quarter, driven primarily by one time property tax refund for the former Minnesota headquarter property, offset by a $1 million non-cash pension settlement charge. For additional information on the special charges please see Table 5 and Table 6, attached to our press release issued this morning.
Imation posted continued operating loss of $5.8 million during the quarter, down from an operating loss of $14 million during Q2 2015. Excluding the impact of special charge described above, the adjusted operating loss will have been $6.8 million in Q2 2016, compared with an adjusted operating loss on the same basis of $13.1 million in Q2 2015.
Income tax was a benefit of $500,000 in Q3 2016 compared to zero tax expenses during Q1 2015. The benefit was recorded to offset tax expenses included in the discontinued operations.
As a reminder, we do not book a tax provision for the U.S., as we have a full evaluation allowance related to our U.S. deferred tax assets. Discontinued operation had after-tax gain of $0.06 million in a quarter. The gain was primarily driven by reduction of a accrued liabilities. Adventuring, we incurred a net loss of $0.15 per share in the quarter, compared to a loss of $0.42 in the same period prior year.
Moving onto the balance sheet, as of June 30, 2016, we had $20.5 million cash and $35.7 million in short-term investments, compared to $26.2 million cash and $36.8 million short-term investment at the full quarter. Our investment had unrealized loss of $1.5 million in the quarter. The loss was due to a draw down in our underlying investment fund.
As of August 5, the investment had a total value of approximately $400,000 higher than a cost basis of our investment. We will continue to [indiscernible] the performance of our underlying investment funds and continue to examine other alternatives that fill our criteria’s of marking mutuality, a lack of reliance on interest rates or other factors and superior liquidity options for investors.
For the balance sheet items, related to discontinued operations, current assets of $15.4 million, primarily consist of the restricted cash, various tax refunds as well as a small receivables, compared to $22 million at the end of Q1. Other current and net liabilities of $39.4 million, included $29.4 million accounts payables. We are disputing approximately $26 million of the payables. The remaining liabilities were primarily related to customer rebates and credits, which may or may not require cash settlements.
Overall theQ2 result were in line with our expectations. In the second half of this year, we will focus on executing the UNITY products strategy, reducing operating losses at Nexsan and continuing execution and development of our RIA business unit. I look forward to update you in the next earnings call.
Now I give it back to Bob for the closing remarks. Bob
Thank you, Danny. As promised, we’ve exited the Legacy Businesses, cut corporate costs by over 70%, and stabilized the Nexsan business. Our focus in the second half of this year is to jump start the asset management business and to successfully market our UNITY products to enterprise customers. I look forward to sharing the progress with you in the next call.
I’ll now take your questions. William?
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Eric Martinuzzi of Lake Street. Please go ahead.
On your Nexsan product, you anticipated to be up sequentially in Q2 and it was down sequentially albeit only a $100,000. What was it that you were expecting to happen in Q2 that didn't come to pass?
There was two things that drove that. The first was orders came in late. So we acquired orders late and because we had reduced expenses on operations, we didn't have the capacity to fulfill those. So we rolled some backlog forward into the quarter. The second is we had other orders that we thought we could get closed they just slipped into the next quarter. The good news was those orders have come in.
Okay. Now in fact 90 days ago or so you talked about expecting sequential improvement throughout the year, obviously, we are relatively flat year Q2 versus Q1. Is the anticipation that we will pick that backup that will be up sequentially in Q3 versus Q2 and Q4 versus Q3.
That's what we're working hard towards, yes.
Okay. And then how much you talked about UNITY being available, but not fully featured until Q4, what's the expectation, seasonally for most of my tech companies there is about a 10% lift between Q4 and Q3. Is that what you guys are looking for something similar or big step up there with the product being fully featured?
So for us the fully featured version of UNITY is available after the end of the year, what we're selling today are to customers who can use some of the enterprise features of the product that are available and are willing to work with us as we update the software at these other features throughout the year. So we'll see the growth in UNITY is primarily focused on next calendar year and what we'll see this year in UNITY are those customers that are getting started validating the technology and beginning to implement it in production.
The gross margins were a little bit better than I had modeled is that do you feel like the 44.3% non-GAAP gross margin, is that sustainable, are there any one-time benefits; do you expect that to improve throughout the remainder of the year?
We believe it’s sustainable and we do believe it will continue to improve.
Okay. And then shifting over to the OpEx it was a little bit higher than I was expecting, especially in the SG&A that was up by a wide margin there. If I look at the total dollar amount, I think, we’re about $11.5 million in Q2 for the OpEx. I did see your headcount shrink 270 again in Q1 to 220 at the end of Q2. Is that $11.5 million – do you expect that to decline further in Q3 or is that kind of a normalized run rate for the OpEx?
From an operating expense perspective, I think, you can look forward to continue declines, as we bring new products to market we will have the opportunity to reduce operating expenses. You pointed out SG&A specifically I’d like to respond to that. When it comes to SG&A, the area where we spent more than planned was on sales and marketing, as we began a strategic pivot from selling or creating demand, if you will, with our channel partners to investing in a team that sits in front of our channel partners to pull technology through them.
And so, that investment is something that causes to spend more in the sales side of the half, than we had intended and it’s already beginning to show positive result.
I would do this – Danny – Danny here. So I think in the last call that we indicated that there will be a huge change on the corporate cost from Q1 to Q2, because in Q1 we still have most of the staff care and we expected that cost reduction will be over 50% to 70% or 80% and that Nexsan cost will decline slightly quarter-or-quarter, because some of the cost reduction already is taking place in Q1. You might be in right down the big reductions and you probably have a model in Europe, part of that have a more aggressive reduction. But that’s owning up – corporate cost is owning a portion of that, out of $11 million, only $2 million relate to corporate cost in there. So I just want to clarify that.
I understand, I was just looking at in the aggregate and I know you’ve made substantial reductions on both sides of that if we look at certainly on a year-over-year basis. And let me take a moment to dive into the other part of our Imation’s Business, the investment side of the house, you guys have talked about, I mean there’s a Imation direct investment. There’s the dollar amounts from the balance sheet, they’re available for Clinton Group. And now we’ve got in our Imation registered investment advisor. Can you talk a little bit about what your – just starting with the balance sheet, is this kind of that $35 million that you had allowed for potential investment from Clinton Group? Is there any separate bucket of money to work the RIA will be working with or is it the same money?
Yes it's a separate bucket of money though we can use it for those purposes. As you know that investment is very liquid and we can move it with 24 hours notice. So should we see a need for that on the RIA at the side of the house, we can make that change.
And what would be an example of something where it makes more sense to the RIA side of house to put the cash to work when the outside advisor.
Well the construction of the RIA is centered on building a traditional asset investment company. So we have a broad spectrum of mechanisms and instruments that we intend to implement. I think one of the things that's most popular and most some – yield some of the best results right now are people that trade quants and we are looking for opportunities to either partner and/or invest in that side of the house, raising money as part of that activity, as well. And then you see us look at opportunities much like the one we had at Arlington, where our ability to go in and help those distressed companies become more valuable for the shareholders, present themselves.
Okay. In the meantime back to the fundamentals of the operating side of the house, you talked about in your prepared remarks an expectation that Nexsan will be breakeven exiting 2016. Given the first half of the year, well it’s probably not fair to examine the entirety of the first half of the year, but it seems like for Q2 there’s a wide gap between that breakeven, if I'm looking at how do we get there exiting 2016, where is the guess [ph] got to come from, is that’s a revenue expectation or the [indiscernible] more dramatic because if I look at that operating loss for Q2, we’re talking about $6.8 million gap that we need close, which would imply or roughly doubling of that dollar amount in incremental revenue or some other puts and takes between the two sides if you know what I mean.
Yes, I do. And the answer is it's a combination of both. So we expect some modest revenue growth and we expect some significant expense reduction.
Okay. And last question of the cash flow in Q2, what was that dollar amount, I know you reported the CapEx in the press release, if you have a cash flow for Q2, I appreciate that.
Eric, the detail information will come out this afternoon and we’ll finalize all the information that’s information that’s here.
That will be in the 10-Q filed this afternoon.
Okay. Thank you for taking my questions.
[Operator Instructions] There are no further questions. So this concludes our question-and-answer session. I would now like to turn the conference back over to Bob Fernander for any closing remarks.
Yes, thank you all for your kind attention. It’s been a very interesting couple of quarters as we’ve worked to transform Imation, begin the creation of the asset management company, stabilize Nexsan and return it to growth. So I appreciate all of your support in that endeavor and look forward to talking to you next quarter. Thanks.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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