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 Delaware corporation whose primary businesses are (1) the development, manufacturing, sourcing, marketing and distribution of removable data storage media products and accessories and (2) sourcing and distribution of a range of audio and video consumer electronic products and accessories. As used herein, the terms "Imation," "Company," " we," "us," or "our" mean Imation Corp. and its subsidiaries unless the context indicates otherwise. We sell our removable data storage media products across multiple technology platforms or "pillars" - magnetic media, recordable optical media, flash drives and removable and external hard drives. We sell our products in approximately 100 countries, primarily under the Imation, Memorex and TDK Life on Record brand names. We also have distribution agreements under which we distribute certain removable data storage media products under other brands, including International Business Machines Corp. (IBM), Sun Microsystems Inc., Hewlett Packard Co. and Exabyte. Our consumer electronic products and accessories are sold primarily under the Memorex, TDK Life on Record and XtremeMac brand names, primarily in North America. 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 ongoing downturn in the global economy has negatively affected demand for both our commercial and consumer product lines, and is impacting suppliers, distributors and channel partners. We have seen softness in the markets we participated in during 2008 and 2009 and expect to see significant softness for the foreseeable future.
The global data storage market, including hardware and services, is estimated to be in excess of $100 billion, of which the removable data storage media market is approximately $20 billion, including magnetic and optical media, flash and solid state drives, removable hard disk drives and external hard disk drives. Our removable data storage media products are designed to help users capture, create, protect, preserve and retrieve valuable digital assets. Our primary products include recordable and rewritable optical discs, magnetic tape cartridges, USB flash drives and external and removable hard drives used by business and individual customers.
Demand for data storage capacity is expected to grow somewhat for the next several years, driven by the growth of information in digital form, the growth of complex databases as a result of new hardware and software applications, increased ability to access data remotely and across multiple locations, increased regulatory requirements for record retention and the pervasive use of the Internet. This increased quantity of data has put data security and archiving at the forefront of critical business processes. Further, the continued growth in the variety and functionality of consumer electronic devices has historically increased demand for a range of convenient, low-cost removable data storage media to capture, store, edit and manage data, photographs, video, images and music. Within the data storage media industry, the magnetic tape market remains important to us because of the substantial installed base of commercial information technology users, the relatively small number of competitors and high barriers to entry. We have a leading market share, significant intellectual property portfolio, solid industry reputation and relationships with key original equipment manufacturers (OEMs). Many of our legacy tape formats, which are proprietary or semi-proprietary, have the highest gross profit margins among all our products.
We also participate in the audio, video and accessories portion of the large consumer electronics market. Our consumer electronics market includes both traditional analog and digital based audio and video devices for recording and replaying audio and video content. Our accessories portion of the market includes cases, cleaning and labeling products, cables and connectors sold through retail outlets and distribution channels. Consumer electronic products and accessories are primarily sourced from manufacturers throughout Asia. Sales of consumer electronic products are based on a variety of factors, including brand and reputation, product features and designs, distribution coverage, innovation and price.
The global consumer electronics market is very large and highly diverse in terms of competitors, channels and products. Our current product offerings focus on a subset of this market. Products we sell include CD and DVD players, LCD displays (flat panel televisions and digital picture frames), iPod® accessories, MP3 players, karaoke machines and alarm clocks and clock-radios sold primarily under the Memorex brand name. We currently compete primarily in mass merchant channels for second tier brand preference in the United States. However, we are using the Memorex brand which targets female consumers, and the XtremeMac brand which targets the Apple enthusiast, to expand our consumer electronics presence in Canada, Mexico and Europe.

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Factors Affecting Comparability of our Financial Results Discontinued Operations
• The Global Data Media (GDM) joint venture was wound down and the GDM current and historic results have been reclassified into discontinued operations.

Executive Summary
Consolidated Results of Operations for the Nine Months Ended September 30, 2009
• Net revenue from continuing operations of $1,197.8 million for the nine months ended September 30, 2009 was down 18.4 percent compared with $1,467.1 million in the same period last year.

• Litigation settlement expense of $49.0 million and restructuring and other expense of $22.8 million was incurred for the nine months ended September 30, 2009.

• Operating loss was $66.2 million for the nine months ended September 30, 2009, compared with operating income of $16.3 million in the same period last year.

• Diluted loss per share from continuing operations was $1.37 for the nine months ended September 30, 2009, compared with diluted earnings per share from continuing operations of $0.23 for the same period last year.

Cash Flow/Financial Condition for the Nine Months Ended September 30, 2009
• Cash and cash equivalents totaled $111.0 million as of September 30, 2009, compared with $96.6 million at December 31, 2008.

• Cash flow provided by operating activities was $24.9 million for the nine months ended September 30, 2009, compared with $86.5 million in the same period last year.

Results of Operations
Net Revenue

                          Three Months Ended                        Nine Months Ended
                             September 30,          Percent           September 30,          Percent
(Dollars in millions)      2009          2008        Change        2009          2008         Change
Net revenue             $    401.3      $ 475.9        -15.7 %   $ 1,197.8     $ 1,467.1        -18.4 %

Our worldwide revenue for the three months ended September 30, 2009 compared with the same period last year was negatively impacted by overall volume declines of 3 percent, price erosion of 11 percent and unfavorable foreign currency translation of 2 percent. The continuing soft economy, particularly given lower magnetic media purchases from the financial sector and the mature markets for some of our legacy tape products resulted in revenue declines in magnetic products of $45.2 million, optical products of $20.6 million, electronic products, accessories and other products of $6.3 million and flash products of $2.5 million.
Our worldwide revenue for the nine months ended September 30, 2009 compared with the same period last year was negatively impacted by overall volume declines of approximately 4 percent, price erosion of approximately 11 percent and unfavorable foreign currency translation of approximately 3 percent. The continuing soft economy, particularly given lower magnetic media purchases from the financial sector and the mature markets for some of our legacy tape products resulted in revenue declines in magnetic products of $152.3 million, optical products of $98.8 million, flash products of $16.0 million and electronic products, accessories and other products of $2.2 million.

Gross Profit

                           Three Months Ended                       Nine Months Ended
                              September 30,          Percent          September 30,          Percent
 (Dollars in millions)     2009           2008        Change         2009         2008        Change
 Gross profit            $    64.5       $  78.5        -17.8 %   $    194.8     $ 266.2        -26.8 %
 Gross margin                 16.1 %        16.5 %                      16.3 %      18.1 %

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Our gross margin as a percent of revenue for the three and nine month periods ended September 30, 2009 decreased compared with the same periods last year, driven by changes in product mix associated mainly with revenue declines in higher margin tape products, partially offset by improved gross margins on optical products.
Selling, General and Administrative (SG&A)

                              Three Months Ended                                Nine Months Ended
                                 September 30,              Percent               September 30,              Percent
(Dollars in millions)        2009             2008           Change            2009            2008           Change
Selling, general and
administrative             $    50.4         $  69.6           -27.6 %      $    174.3        $ 212.7           -18.1 %
As a percent of
revenue                         12.6 %          14.6 %                            14.6 %         14.5 %

The decrease in SG&A expense for the three months ended September 30, 2009 compared with the same period last year was primarily due to benefits from restructuring actions and aggressive cost control, reduced litigation expense due to the Philips settlement, along with some one-time benefits and expense deferrals. SG&A included litigation expense of $0.1 million and $4.6 million during the three months ended September 30, 2009 and 2008, respectively, related primarily to the Philips dispute.
The decrease in SG&A expense for the nine months ended September 30, 2009, compared with the same period last year, was primarily due to benefits from restructuring actions and aggressive cost control, partially offset by higher legal expenses. SG&A included litigation expense of $13.1 million and $7.6 million during the nine months ended September 30, 2009 and 2008, respectively, related primarily to the Philips dispute. Research and Development (R&D)

                                  Three Months Ended                                Nine Months Ended
                                     September 30,               Percent              September 30,              Percent
(Dollars in millions)           2009              2008            Change           2009             2008          Change
Research and development      $     4.9         $     5.6           -12.5 %      $    14.9         $ 18.2           -18.1 %
As a percent of revenue             1.2 %             1.2 %                            1.2 %          1.2 %

The decrease in R&D expense compared to the same periods last year was due to our restructuring and aggressive cost control. R&D expense as a percent of revenue for the three and nine month periods ended September 30, 2009 remained flat compared with the same periods last year. Litigation Settlement
A litigation settlement charge of $49.0 million was recorded for the nine months ended September 30, 2009. On July 13, 2009, we entered into a confidential settlement agreement ending all legal disputes with Philips Electronics N.V., U.S. Philips Corporation and North American Philips Corporation (collectively, Philips). We had been involved in a complex series of disputes in multiple jurisdictions regarding cross-licensing and patent infringement related to recordable optical media. The settlement provided resolution of all claims and counterclaims filed by the parties without any finding or admission of liability or wrongdoing by any party. As part of the settlement, Imation, Philips and Moser Baer India Ltd. (MBI) jointly requested a stay of all proceedings in all jurisdictions while MBI requested approval for an element of the settlement from the Reserve Bank of India. We placed $20.0 million in escrow in July 2009, which is to be released to Philips upon MBI receiving approval from the Reserve Bank of India of its agreement with Philips and final dismissal of all related litigations. That approval has not yet been received. We will pay an additional $33.0 million over a period of three years. Based on the present value of these settlement payments, we recorded a charge in the second quarter of 2009 of $49.0 million and interest accretion of $0.3 million during the three months ended September 20, 2009. The interest accretion is recorded in the interest expense line item of the Condensed Consolidated Results of Operations.
On November 3, 2009, the United States Court of Appeals for the Federal Circuit issued a ruling despite the request for a stay. The ruling was in our favor and reversed the district court judgment of November 26, 2008. This ruling has no impact on the settlement agreement entered into on July 13, 2009. See Note 15 to the Condensed Consolidated Financial Statements for a further description of the Philips litigation.

Restructuring and Other

                                 Three Months Ended                                Nine Months Ended
                                    September 30,               Percent              September 30,               Percent
(Dollars in millions)          2009              2008            Change           2009             2008          Change
Restructuring and other      $    7.5         $     14.3           -47.6 %      $    22.8         $ 19.0             20.0 %
As a percent of revenue           1.9 %              3.0 %                            1.9 %          1.3 %

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Restructuring and other expense was $7.5 million and $22.8 million for the three and nine month periods ended September 30, 2009, respectively. For the three and nine month periods ended September 30, 2009, we recorded $5.6 million and $10.8 million of pension settlement charges, respectively. We recorded $1.9 million and $9.5 million of restructuring charges for the three and nine month periods ended September 30, 2009, respectively, mainly related to our 2008 corporate redesign restructuring program initiated during the fourth quarter of 2008. This program further accelerates the alignment of our cost structure by reducing SG&A expense. See Note 10 to the Condensed Consolidated Financial Statements herein. We also recorded $2.3 million of asset impairment and $0.2 million of other charges for the nine months ended September 30, 2009.
Restructuring and other expense was $14.3 million for the three months ended September 30, 2008 related to asset impairments of $6.0 million offset by a gain on sale of assets of $0.7 million, restructuring charges of $5.8 million and pension settlement and curtailment costs of $3.2 million. Restructuring and other expense was $19.0 million for the nine months ended September 30, 2008 related to restructuring charges of $12.9 million, pension settlement and curtailment costs of $3.2 million and asset impairments of $6.0 million, offset by a gain on sale of assets of $0.8 million and a post-closing adjustment gain on the TDK acquisition of $2.3 million.

Operating Income (Loss)

                                Three Months Ended                                Nine Months Ended
                                   September 30,              Percent               September 30,              Percent
(Dollars in millions)          2009             2008           Change            2009             2008          Change
Operating income (loss)      $    1.7         $  (11.0 )         115.5 %      $    (66.2 )       $ 16.3          -506.1 %
As a percent of revenue           0.4 %          (2.3) %                             5.5 %          1.1 %

Our operating income for the three months ended September 30, 2009 improved compared with an operating loss for the same period last year. The change was primarily driven by lower operating expenses and restructuring and other charges. Our operating loss for the nine months ended September 30, 2009 compared to operating income for the same period last year was driven by litigation settlement expense, lower revenues and lower gross margins as discussed above.

Other (Income) and Expense

                                Three Months Ended                                Nine Months Ended
                                   September 30,               Percent              September 30,               Percent
(Dollars in millions)          2009             2008           Change            2009             2008          Change
Interest income              $    (0.1 )       $  (0.9 )            -89 %      $    (0.5 )       $ (2.5 )            -80 %
Interest expense                   0.8             0.3              167 %            1.5            1.3               15 %
Other expense, net                 1.5             2.6              -42 %           12.2            5.7              114 %

Total                              2.2             2.0               10 %           13.2            4.5              193 %
As a percent of revenue            0.5 %           0.4 %                             1.1 %          0.3 %

The decrease in interest income for the three and nine month periods ended September 30, 2009 compared with the same periods last year was driven by overall lower cash balances and significant declines in interest rates.
The increase in interest expense for the three months ended September 30, 2009 compared with the same period last year was driven by interest accretion of $0.3 million related to the Philips litigation settlement liability as discussed above.
The decrease in other expense for the three months ended September 30, 2009 compared with the same period last year was driven by reduced foreign currency losses slightly offset by increased bank fees.
The increase in other expense for the nine months ended September 30, 2009 compared with the same period last year was primarily driven by a reserve of $4.0 million related to a note receivable from one of our commercial partners whose financial condition had significantly deteriorated, as well as additional year-to-date foreign currency exchange losses of $1.0 million.

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Income Tax (Benefit) Provision

                              Three Months Ended                                Nine Months Ended
                                 September 30,              Percent               September 30,              Percent
(Dollars in millions)        2009             2008           Change            2009             2008          Change
Income tax

(benefit) provision $ (0.2 ) $ (5.6 ) -96.4 % $ (28.1 ) $ 3.2 978.1 % Effective tax rate 40.0 % 43.1 % 35.4 % 27.1 %

The effective income tax rate for the three months ended September 30, 2009 was 40.0 percent compared with 43.1 percent in the same period last year. The effective rate increase was due primarily to the mix of taxable loss/income by country and the tax effect of restructuring and other charges.
The increase in the effective income tax rate for the nine months ended September 30, 2009, compared with the same period last year, was driven by the mix of taxable loss/income by country and the tax effect of restructuring and other charges.

Discontinued Operations

                              Three Months Ended                                Nine Months Ended
                                 September 30,              Percent               September 30,              Percent
(In millions)                2009             2008           Change           2009             2008           Change
Net revenue                $    13.9         $  51.6           -73.1 %      $    71.5         $ 138.3           -48.3 %
Income before income
taxes                              -             2.1          -100.0 %            2.7             6.2           -56.5 %
Income tax provision             0.1             0.6           -83.3 %            0.3             2.5           -88.0 %
Total discontinued
operations                 $    (0.1 )       $   1.5          -106.7 %      $     2.4         $   3.7           -35.1 %

Loss from discontinued operations was $0.1 million for the three months ended September 30, 2009 compared with income of $1.5 million for the same period last year. The decrease was due to the wind down of the GDM joint venture during the three months ended September 30, 2009 and overall lower revenue resulting from the continuing soft economy.
Income from discontinued operations was $2.4 million and $3.7 million for the nine months ended September 30, 2009 and 2008, respectively. The decrease was due to the wind down of the GDM joint venture during the three months ended September 30, 2009 and overall lower revenue resulting from the continuing soft economy.
Segment Results
We operate in two broad market categories: (1) removable data storage media products and accessories (Data Storage Media) and (2) audio and video consumer electronic products and accessories (Electronic Products).
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. Consumer electronic products and accessories are sold primarily through our Electronic Products segment. The Electronic Products 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 costs, corporate expense, stock-based compensation expense and restructuring and other costs which are not allocated to the segments.

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Information related to our segments is as follows:

Data Storage Media
   Americas

                                 Three Months Ended                                Nine Months Ended
                                   September 30,               Percent               September 30,              Percent
(Dollars in millions)           2009             2008           Change            2009            2008           Change
Net revenue                  $    162.4         $ 186.9           -13.1 %      $    478.0        $ 578.2           -17.3 %
Operating income                   15.8            16.4            -3.7 %            42.4           58.1           -27.0 %
As a percent of revenue             9.7 %           8.8 %                             8.9 %         10.0 %

The Americas segment is our largest segment comprising 40.4 percent of our total revenue for the three months ended September 30, 2009 and 39.9 percent of our total revenue for the nine months ended September 30, 2009. Our revenue decrease for the three months ended September 30, 2009 compared with the same period last year, was mainly due to price declines of approximately 13 percent. From a product perspective, we experienced revenue declines in magnetic, optical and flash products. Our revenue decrease for the nine months ended September 30, 2009 compared with the same period last year, was mainly due to volume declines of approximately 5 percent and price declines of approximately 12 percent. From a product perspective, we experienced revenue declines in all products except hard drives.
GDM had revenue of $4.1 million and $12.0 million for the three months ended September 30, 2009 and 2008, respectively, and $14.3 million and $25.5 million of revenue for the nine months ended September 30, 2009 and 2008, respectively, related to the Americas segment. In accordance with generally accepted accounting principles (GAAP) guidance, GDM has been reclassified to discontinued operations and, therefore, is excluded from the table above.
The decrease in operating income for the three months ended September 30, 2009 compared with the same period last year, was driven by lower gross profit in magnetic and optical products, partly offset by lower SG&A expense. The decrease in operating income for the nine months ended September 30, 2009 compared with the same period last year, was driven by lower gross profit in magnetic and flash partially offset by higher gross profit in optical and lower SG&A expense.

   Europe

                                Three Months Ended                                Nine Months Ended
                                   September 30,              Percent               September 30,              Percent
(Dollars in millions)          2009             2008           Change            2009            2008           Change
Net revenue                  $    95.4         $ 127.7           -25.3 %      $    301.3        $ 416.0           -27.6 %
Operating income                   1.5             3.1           -51.6 %             2.5           13.1           -80.9 %
As a percent of revenue            1.6 %           2.4 %                             0.8 %          3.1 %

The Europe segment comprised 23.8 percent of our total revenue for the three months ended September 30, 2009 and 25.2 percent of our total revenue for the nine months ended September 30, 2009. Our revenue decrease for the three months ended September 30, 2009, compared with the same period last year, was due to overall volume decreases of approximately 12 percent, price declines of approximately 7 percent and unfavorable foreign currency impacts of approximately 6 percent. From a product perspective, we experienced revenue declines in all products. Our revenue decrease for the nine months ended September 30, 2009, compared with the same period last year, was due to volume declines of approximately 12 percent, price declines of approximately 7 percent and unfavorable foreign currency impacts of approximately 9 percent. From a product perspective, we experienced revenue declines in all products except hard disk drives. . . .