Summary of IMATION CORP - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
Imation Corp. is a leading global marketer and developer of products in digital storage, audio and video electronics and accessories that enable people to capture, save and enjoy digital information. The primary brand names under which our products are sold are Imation, Memorex and TDK Life on Record. As used herein, the terms "Imation," "Company," " we," "us" or "our" mean Imation Corp. and its subsidiaries unless the context indicates otherwise. We sell data storage products in approximately 100 countries around the world and under several different brand names across multiple technology platforms or "pillars"
- magnetic media, recordable optical media, solid state flash drives and removable hard drives. We also sell a range of consumer video, audio and home electronic products, and accessories primarily in North America and primarily under the Memorex brand name. Except for certain magnetic tape media formats, we do not manufacture the products we sell and distribute. We seek to differentiate these products through unique designs, product positioning, packaging, merchandising, and branding. We source these products from a variety of third party manufacturers. The data storage removable media market presents an important market for Imation with our leading market shares in both magnetic tape and recordable optical media and our long-standing original equipment manufacturers (OEM), channel and end-user relationships. Our market leadership is based on several factors. We own, manage or distribute multiple brands across multiple product platforms. We are able to provide global sales and distribution coverage. We have developed and manufacture proprietary tape formats and hold a significant intellectual property portfolio, particularly in tape. This market also presents several challenges for Imation. The market is highly competitive, with some competitors having significantly greater resources and well known brands. Some of our competitors products are driven by alternative technologies, such as hard disks or flash products. It is also characterized by continuing changes in technology, ongoing variable price erosion, diverse distribution channels and a large variety of brands and formats for tape, optical, flash and removable hard disk products. The magnetic tape market remains an important market with growing demand for storage capacity across a substantial installed base of commercial information technology users, a relatively small number of competitors and high barriers to entry. Imation enjoys a leading market share, significant intellectual property portfolio, solid industry reputation and relationships among key original equipment manufacturers (OEMs). The magnetic tape industry has consistently addressed the growth in demand for storage capacity with higher capacity cartridges resulting in lower cost per gigabyte and a decline in overall cartridge volume over time. Many of our legacy tape formats, which are proprietary or semi-proprietary, have among the highest gross profit margins among all our products. Non-proprietary open format LTO tape typically is more competitive with lower gross margins and continues to gain share against these legacy formats. In the current economic environment, we have seen this trend accelerate, especially among some of our enterprise class customers. Finally, lower cost disk and optimization strategies such as virtual tape and de-duplication remain a factor in certain sectors of the market. As a result, we expect our tape revenue and margins to continue to be under pressure as these factors result in gradual decline in the size of the total tape media market over time and a shift in the mix of total tape revenue toward lower margin open formats. Our recordable optical media product sales are primarily composed of CD's and DVD's sold throughout the world under various brands including those we own or control (Imation, Memorex and TDK Life on Record) as well as under a distribution agreement for the HP brand. We also have a majority interest in a sales and marketing joint venture for optical media, named Global Data Media (GDM). While our different brands have varying strengths in different regions of the world, in aggregate we have the leading overall market share for optical media globally. While the overall market for CDs and DVDs is declining somewhat as hard disk and flash media replace optical media in some applications (music and video recording), we have grown both optical revenue and market share through our acquisitions. In addition, we sell Blu-ray ™ recordable media as a new and emerging higher capacity format targeted at the recording of high definition video content. Our optical media products are sold through a variety of retail consumer and commercial distribution channels and sourced from manufacturers primarily in Taiwan and India. Our flash media sales are primarily composed of USB flash drives sold through a variety of retail consumer and commercial distribution channels around the world under the Imation, Memorex and TDK Life on Record brands and are sourced from manufacturers in Asia. The removable flash media market is competitive with highly variable price swings driven by raw chip manufacturing volumes and capacity as well as market demand in the much larger embedded flash market. Focused and efficient sourcing and distribution, as well as diligent management of inventories, channel placement and promotional activity, are critical elements for success in this market. These are areas of focus as we implement our strategy. In addition to USB flash drives, we sell a limited amount of flash cards and solid state drives (SSD) which we view as a potentially large category in the future.

We also participate in the audio/video segment of the much larger consumer electronics (CE) market. Products we sell include flat panel displays and televisions, iPod™ accessories and MP3 players, clock radios, CD and DVD players, karaoke machines, digital picture frames and digital cameras. It is a large and highly diverse market in terms of competitors and channels. We compete in mass merchant channels for second tier brand preference primarily under the Memorex brand in North America. The accessories market encompasses cases, cleaning and labeling products, cables and connectors sold through retail outlets and distribution channels. Both CE products and accessories are sourced from manufacturers throughout Asia.
We have taken several actions which have significantly increased our industry presence and relevance in both commercial and consumer retail channels and markets globally. We continue to retain our tape media business as a cornerstone of the Company while we broadened the scope of our business. Our long-term strategy is built upon three key elements which we describe as optimize, grow and extend.
• Optimize our magnetic tape business. Recognizing the factors cited above which are pressuring the overall tape market, we have set out to optimize our magnetic tape business and reduce our manufacturing costs. In May 2007 and July 2008 we announced major restructuring actions which involved the planned exit of two manufacturing plants in Wahpeton, North Dakota and Camarillo, California and a plan to focus our tape coating operations in our Weatherford, Oklahoma plant. We are concentrating our direct manufacturing investments on coating operations and outsourcing other parts of manufacturing operations for magnetic tape. We continue to invest in the most current tape formats and seek to maintain and strengthen our relationships with key OEMs.

• Grow the data storage media business across the four "pillars" of storage offering products under multiple brands. Over the years, we have brought to market recordable media products beyond magnetic tape, including recordable optical media, removable USB flash drives and flash cards, and external and removable hard disk products. We have also acquired additional brands, beyond the Imation brand, and established distribution agreements for other brands. In addition, with 59 percent of our revenue coming from outside the United States for the nine months ended September 30, 2008, we seek to leverage our global marketing and distribution capability in bringing products to market across multiple geographies.

• Extend certain brands selectively across multiple product categories. We sell accessories and certain consumer electronic products, selectively, under multiple brands in various regions of the world. With the acquisition of the Memcorp business in the third quarter of 2007, we entered into the consumer electronics market to sell consumer electronic products primarily in North America, which we did not offer previously. Our product portfolio includes flat panel displays and televisions, iPod™ accessories, and MP3 players, clock radios, CD and DVD players, karaoke machines, digital picture frames and digital cameras. This acquisition also included a brand licensing agreement with MTV Networks, a division of Viacom International, to design and distribute consumer electronic items under certain Nickelodeon character-based properties and the NPower brands. With the acquisition of XtremeMac in June 2008, we acquired a portfolio of iPod, iPhone and Apple TV accessories and brands, which had been marketed in Apple stores and certain other channels, primarily in North America.

Factors Affecting Comparability of our Financial Results On July 9, 2007, we completed the acquisition of certain assets of Memcorp, Inc., a Florida corporation, and Memcorp Asia Limited, a corporation organized under the laws of Hong Kong (together Memcorp, subsidiaries of Hopper Radio of Florida, Inc., a Florida corporation), pursuant to an Asset Purchase Agreement dated as of May 7, 2007. We acquired the assets of Memcorp used in or relating to the sourcing and sale of consumer electronic products, principally sold under the Memorex brand name, including inventories, equipment and other tangible personal property and intellectual property. The acquisition also included existing brand licensing agreements, including Memcorp's agreement with MTV Networks, a division of Viacom International, to design and distribute specialty consumer electronics under certain Nickelodeon character-based properties and the NPower brand.
On July 31, 2007, we completed the acquisition of substantially all of the assets relating to the marketing, distribution, sales, customer service and support of removable recording media products, accessory products and ancillary products under the TDK Life on Record brand name (TDK Recording Media), from TDK Corporation, a Japanese corporation (TDK), pursuant to an Acquisition Agreement dated April 19, 2007 between Imation and TDK.
Memcorp and TDK Recording Media operating results are included in our condensed consolidated results of operations from their respective dates of acquisition. For further information see Note 4 to the Condensed Consolidated Financial Statements.

Executive Summary
With recent changes in global economic conditions, changes in raw material and commodity prices, interest rates, foreign currency exchange rates and energy costs create uncertainties that could impact our earnings outlook for the remainder of 2008. See Part II, Item 1A, "Risk Factors" in this Form 10-Q for further discussion.
As worldwide businesses, our operations can be affected by global and regional industrial, economic and political factors. However, our geographic and industry diversity, as well as the diversity of our product sales and services, has helped limit the impact of any one industry or economy of any single country on our consolidated results.
Consolidated Results of Operations for the Nine Months Ended September 30, 2008
• Revenue of $1,605.4 million in the nine months ended September 30, 2008 was up 18.0 percent compared with $1,360.2 million in same period last year.

• Operating income of $23.0 million in the nine months ended September 30, 2008 was down 38.3 percent compared with $37.3 million in the same period last year.

• Diluted earnings per share was $0.33 for the nine months ended September 30, 2008 compared with $0.64 for the same period last year.

Cash Flow/Financial Condition for the Nine Months Ended September 30, 2008
• Cash flow from operations totaled $86.5 million in the nine months ended September 30, 2008 compared with $13.4 million during the same period last year.

• Total cash and cash equivalents were $112.8 million as of September 30, 2008, compared with $135.5 million at year-end 2007.

• Dividends of $0.16 per share were paid in March, in June and in September 2008.

Results of Operations

Net Revenue

                        Three Months Ended                       Nine Months Ended
                          September 30,          Percent           September 30,          Percent
     (In millions)       2008         2007        Change        2008          2007        Change
     Net revenue      $  527.5      $ 525.5          0.4 %   $ 1,605.4     $ 1,360.2        18.0 %

Our worldwide revenue for the three months ended September 30, 2008 remained essentially unchanged compared with the same period last year, with overall volume increases of approximately four percent and a foreign currency benefit of approximately three percent, offset by price declines of approximately seven percent. The volume increases for the three months ended September 30, 2008, compared with the same period last year, were driven by optical and consumer electronics product sales. We benefited in the third quarter of 2008 from one additional month of TDK Recording Media incremental revenue of $42.3 million which was offset by declines in magnetic product sales. Our revenue growth for the nine months ended September 30, 2008, compared with the same period last year, was driven by overall volume increases of approximately 20 percent and a foreign currency benefit of approximately five percent, partially offset by price declines of approximately seven percent. The volume increases for the nine months ended September 30, 2008, compared with the same period last year, were driven by optical and consumer electronics product sales, primarily due to the addition of TDK Recording Media and Memcorp incremental revenue which totaled $391.7 million. Excluding acquisitions, revenue for the nine months ended September 30, 2008 from our magnetic products was down due to declines in demand for entry level and mature data center tape formats; revenue from our optical products was down due to a decrease in DVD and CD sales; and revenue from our flash products was down due to our planned rationalization of our exposure to the U.S. retail channel.

Gross Profit

                          Three Months Ended                     Nine Months Ended
                            September 30,          Percent         September 30,         Percent
       (In millions)       2008          2007      Change        2008         2007       Change
       Gross profit     $   81.6       $ 85.7        -4.8 %    $  275.2     $ 240.0        14.7 %
       Gross margin         15.5 %       16.3 %                    17.1 %      17.6 %

Our gross margin as a percent of revenue declined for the three and nine month periods ended September 30, 2008, compared with the same periods last year due to continued changes in product mix driven by softness in data center tape demand as well as a $2 million inventory write-off associated with the previously announced closure of our Camarillo site. Selling, General and Administrative (SG&A)

                                 Three Months Ended                                 Nine Months Ended
                                   September 30,               Percent                September 30,               Percent
(In millions)                   2008             2007           Change            2008             2007            Change
Selling, general and
administrative               $   70.4          $ 61.6            14.3 %        $  215.0          $ 151.5            41.9 %
As a percent of
revenue                          13.3 %          11.7 %                            13.4 %           11.1 %

The increase in SG&A expense for the three months ended September 30, 2008, compared with the same period last year, was due to acquisition integration spending, additional legal expense related to the Philips and SanDisk litigation, one additional month of TDK Recording Media incremental SG&A expense and incremental brand investments.
The increase in SG&A expense for the nine months ended September 30, 2008, compared with the same period last year, was due to the addition of TDK Recording Media and Memcorp SG&A expenses and intangible asset amortization, as well as additional legal expenses related to the Phillips and SanDisk litigation, spending for acquisition integration and incremental brand investments.
Research and Development (R&D)

                               Three Months Ended                      Nine Months Ended
                                  September 30,          Percent         September 30,         Percent
 (In millions)                 2008           2007       Change         2008         2007      Change
 Research and development    $   5.6        $   8.5       -34.1 %    $   18.2      $ 30.5       -40.3 %
 As a percent of revenue         1.1 %          1.6 %                     1.1 %       2.2 %

The decrease in R&D expense for the three and nine month periods ended September 30, 2008, compared with the same periods last year, was due to the result of savings from restructuring actions initiated in the second quarter of 2007 as we focused our activities primarily on development of new magnetic tape formats.

Restructuring and Other

                               Three Months Ended                     Nine Months Ended
                                 September 30,          Percent         September 30,         Percent
  (In millions)                 2008         2007       Change         2008         2007      Change
  Restructuring and other    $   14.3      $ (0.7 )       NM        $   19.0      $ 20.7        -8.2 %
  As a percent of revenue         2.7 %      (0.1 )%                     1.2 %       1.5 %

NM - Not Meaningful

During the three months ended September 30, 2008, we recorded restructuring charges of $5.2 million related to our 2008 cost reduction restructuring program. This program includes an exit plan for our Camarillo, California plant as a further implementation of our manufacturing strategy. We anticipate the plant closing will result in the elimination of approximately 140 positions, 31 of which were included under previously announced programs. We expect exit of the Camarillo plant to result in approximately $15 million to $20 million in annualized cost eliminations intended to mitigate projected declines in tape gross profits in future years.
The 2008 cost reduction restructuring program also includes our decision to consolidate Cerritos, California business operations into Oakdale, Minnesota and close the Cerritos office by March 2009. This will result in the elimination of 49 positions in Cerritos, 32 of which will be replaced in Oakdale, Minnesota. The consolidation of Cerritos activities at a single headquarters location is intended to achieve better focus, gain efficiencies across brands and channels, and reduce cost. Consolidation of the Cerritos operations is expected to result in approximately $1.0 million in annualized cost eliminations.

The 2008 program also includes other various restructuring activities which are expected to result in the elimination of 11 employees.
During the three months ended September 30, 2008, we also recorded $3.2 million in pension settlement and curtailment costs and $6.0 million of asset impairments related to our Camarillo facility, which was offset by a $0.7 million gain on the sale of assets that were previously impaired.
During the second quarter of 2008, we recorded restructuring charges of $4.0 million related to our previously announced restructuring programs, including severance and severance-related costs of $2.5 million and lease termination costs of $1.9 million. Restructuring and other expense of $0.7 million recorded during the first quarter of 2008 related mainly to restructuring charges of $2.7 million offset by income of $2.3 million associated with the TDK post-closing purchase price adjustment. The TDK post-closing purchase price adjustment is associated with the finalization of certain acquisition-related working capital amounts as negotiated with TDK as set forth in Note 4 to the Condensed Consolidated Financial Statements.
Restructuring and other expense of $20.7 million recorded for the nine months ended September 30, 2007 included $19.6 million of restructuring costs related to our cost reduction program which began in the second quarter of 2007, asset impairments of $1.4 million and income of $0.7 million for a terminated employment agreement.

Operating (Loss) Income

                                Three Months Ended                     Nine Months Ended
                                  September 30,          Percent         September 30,         Percent
(In millions)                    2008          2007      Change         2008         2007      Change
Operating (loss) income       $   (8.7 )     $ 16.3        NM        $   23.0      $ 37.3       -38.3 %
As a percentage of revenue        (1.6 )%       3.1 %                     1.4 %       2.7 %

NM - Not Meaningful

The decrease in operating income for the three months ended September 30, 2008, compared with the same period last year, was due to reduced profitability in our legacy magnetic tape, audio video and electronic products as well as higher restructuring and other charges and $2 million in inventory write-offs associated with our previously announced closure of our Camarillo site.
The decrease in operating income for the nine months ended September 30, 2008, compared with the same period last year, was due to reduced profitability in our legacy tape and electronic products. Income Tax (Benefit) Provision

                                 Three Months Ended                                Nine Months Ended
                                   September 30,               Percent               September 30,                Percent
(In millions)                   2008             2007           Change            2008             2007           Change
Income tax

(benefit) provision $ (5.0 ) $ 6.1 NM $ 5.7 $ 15.0 -62.0 % Effective tax rate 45.9 % 39.4 % 31.7 % 38.8 %

NM - Not Meaningful

During the three months ended September 30, 2008, we recorded a tax benefit of $5.0 million due to the loss before income taxes, resulting in an effective rate benefit of 45.9 percent. The effective rate of the tax benefit reflects the mix of income/loss including the restructuring and other charges which provide a benefit at tax rates in the United States which are generally higher than the tax rate on the Company's overall mix of earnings.
During the nine months ended September 30, 2008, our tax rate was 31.7 percent compared with 38.8 percent for the same period last year. The lower effective rate of tax in 2008 reflects the mix of earnings and discrete items related mainly to restructuring.

Segment Results
Our data storage media business is organized, managed and internally and externally reported as segments differentiated by the regional markets we serve:
Americas, Europe and Asia Pacific. Each of these segments has responsibility for selling virtually all Imation product lines except for consumer electronic products. Consumer electronics are sold primarily through our new Electronic Products (EP) segment. The EP segment is currently focused primarily in North America and primarily under the Memorex brand name.
We evaluate segment performance based on revenue and operating income. Revenue for each segment is generally based on customer location where the product is shipped. The operating income reported in our segments excludes corporate and other unallocated amounts. Although such amounts are excluded from the business segment results, they are included in reported consolidated earnings. Corporate and unallocated amounts include research and development expense, corporate expense, stock-based compensation expense and restructuring and other expenses which are not allocated to the segments.
Information related to our segments is as follows:

Americas

                               Three Months Ended                     Nine Months Ended
                                 September 30,          Percent         September 30,         Percent
  (In millions)                 2008         2007       Change        2008         2007       Change
  Net revenue                $  198.9      $ 246.3       -19.2 %    $  603.8     $ 690.8       -12.6 %
  Operating income               15.9         12.4        28.2 %        57.2        59.0        -3.1 %
  As a percent of revenue         8.0 %        5.0 %                     9.5 %       8.5 %

The Americas segment is our largest segment comprising 37.7 percent of our total revenue for the three months ended September 30, 2008 and 37.6 percent of our total revenue for the nine months ended September 30, 2008. For the three months ended September 30, 2008, the revenue decrease compared with the same period last year was driven primarily by lower revenues from our flash, magnetic and to a lesser degree optical products. For the nine months ended September 30, 2008, the revenue decrease compared with the same period last year was driven by lower revenue from our magnetic, optical and flash products, partially offset by incremental revenue of $49.1 million associated with the TDK Recording Media acquisition.
The increase in operating income as a percentage of revenue for the three and nine month periods ended September 30, 2008, compared to the same periods last year, was driven by increased gross profits in both optical and flash products, partially offset by lower gross profits in magnetic products, along with lower SG&A expenses.

Europe

                               Three Months Ended                     Nine Months Ended
                                 September 30,          Percent         September 30,         Percent
  (In millions)                 2008         2007       Change        2008         2007       Change
  Net revenue                $  167.3      $ 152.4         9.8 %    $  528.7     $ 421.8        25.3 %
  Operating income                4.2         10.8       -61.1 %        17.1        29.8       -42.6 %
  As a percent of revenue         2.5 %        7.1 %                     3.2 %       7.1 %

The Europe segment revenue comprised 31.7 percent of our total revenue for the three months ended September 30, 2008 and 32.9 percent of our total revenue for the nine months ended September 30, 2008. Our revenue increase for the three months ended September 30, 2008, compared with the same period last year, was due to overall volume increases of approximately 11 percent and a foreign . . .