Jill Burchill: In conclusion, Imation has a solid start as a new company and we have built on our strong financial foundation. We remain focused on meeting our goals while we also remain focused on making the necessary changes to be the leader in the Imaging and Information industry in 1998 and beyond. Thank you for participating in this conference call and we are now ready to take your questions.

John McPeake, Prudential Securities:

Currency effects so far this year looks like it is going to show year-over-year in comparison to the first quarter of negative 7%, roughly. Do you have any concerns about that?

Jill Burchill: We certainly had quite an impact on earning per share in 1996 for currency and we manage that through our hedging activities and are continually watching that. I don't expect that currency will be significantly more negative in 1997 than it was in 1996.

Michael Ellmann, Schroder Wertheim:

I seem to recollect that depreciation levels could go down to a level of $40 million a quarter. Is that still a plausible expectation for 1997?

Jill Burchill: Good morning Michael. We believe that depreciation will be in the range of about $170 million for 1997. You may be remembering a comment I made early on in the road show that we were targeting for depreciation and capital spending both to be about $160 million. When we look at the trend of our assets we believe $170 million to be more appropriate for 1997. You saw that in 1996 it was actually $181 million.

So, in other words $170 million is a reasonable guess for capital spending and depreciation next year?

Jill Burchill: Yes, I think they will balance very nicely.

Could you please review for us the comments you made about the total expenditures on recurring, non-recurring start-up costs and how those costs broke down between expensed expenditures and capitalized expenditures?

Jill Burchill: Let me start with non-recurring. We had two items: one is re-structuring and the other is one-time charges. They total $88 million, $54 million related to the first half restructuring, $22 million related to the first half special asset write-off and $12 million related to the Luminous acquisition. Those three items total $88 million. They are included in the reported results but if you look in the schedule that shows adjusted results you'll notice how those items are pulled out. What remains and will remain in our operating expenses (even after adjustments) in 1996 and1997 are related to two major activities: costs to establish the new business processes and IT systems and costs to establish the Imation brand and identity. The Imation brand and identity costs all were expensed and were approximately $24.5 million in 1996. The remaining $17 million was expensed for IT and supply chain activities along with $4.5 million capitalized as other costs for IT and supply chain.

Kim Retrievi, Credit Suisse First Boston:

International pricing seemed to be more aggressive in the fourth quarter. For next year would you expect that with the LS-120 rolling out more aggressively that pricing in the US would become more negative in 1997?

Bill Monahan: Pricing trends improved each quarter during 1996, to 4.1% in fourth quarter. Some of the additional price erosion that we saw in international vs. US had to do with adjusting some prices from earlier levels that were not correct for the marketplace. So, as we've spun-out and become an independent company there were certain regions of the world where we had been overpriced on the product line, so we adjusted those to competitive levels and that accelerated pricing vs. the US. As we go forward, we are pleased at the price trend in the marketplace and, on our products in particular, we are still looking at 1997 as between 4 and 5% price erosion as fairly normal for this industry. We don't see LS-120 impacting price erosion negatively in 1997.

Can we then suppose that the price decline that equals international, a portion of those are more a one-time adjustment to get to levels you're comfortable with and then the erosion you think will fall into the 4 to 5% range in 1997?

Bill Monahan: Yes, we expect international to follow the global trends on price.

Jill Burchill: Let me add a bit of history for your information. In International, the pricing has been as high as 8.6% in 1994. In 1995, 7.3% and this year 7%, so we are very consistent with that rate of price erosion in our international business.

Mark Kurland, Bear Stearns Asset Management:

I have three questions. First is on the tax rate which is much higher this time than a year ago. Can you give us some of the guidelines on the tax rate going forward. Why is the tax rate so high at this time and, if the tax rate would have been the same as last year, would that have been like 5 cents more per share?

Jill Burchill: OK, let me handle that. Last year's tax rate for 1995 is a reflection of the average tax rate for 3M Company. When we were a part of 3M and then were spun-off we used their rate for both interest and tax rate. So, it is a reflection of the average tax rate within 3M, it is not a reflection of these businesses. The tax rate is the only area where I am personally disappointed we have not achieved what I was hoping for in this year. It is higher this year because of where we are profitable. Going forward, I do see it declining slightly in 1997. It is a very delicate area in that you can run into significant issues if you do not appropriately change all of your structures to align with a lower tax rate. So, we are being very careful to do this in a way that doesn't hurt our business.

Could you give us guidance on what you think the tax rate will be, when you say slightly? Are we talking 46 to 47% effective tax rate?

Jill Burchill: I think that would be a good range.

OK, my second question would be - If you take a look at the R&D expenditures, was it really $38 million or was it $51 million? Could you give us guidance on where you see us at with that in current year?

Jill Burchill: We have been running in the $39 to $40 million per quarter range the last two quarters. I believe that a range around $40 million or slightly higher than that is appropriate for this company. The $51 million includes the $12 million accelerated write- off of Luminous in-process R&D due to that acquisition.

So, for next year maybe total expenditures would be in the $160 million range? Is that fair?

Jill Burchill: Yes, we are still working on our plan to have R&D in the 7 to 8% range for this company.

Going to the top line then, in terms of the growth rate of the business, do you think that 4 to 5% rate on the top line is stable for the coming year?

Bill Monahan: We outlined the three year plan, that we will be in the 3 to 5% growth range over that period, and we are still very positive about meeting that plan.

Jeff Feinberg, Soros Fund Management:

I just want to make sure I understand this economic profit definition. If you were to achieve all your goals in 1998 with $150 million economic profit improvement, what would that translate into in terms of operating income in 1998?

Jill Burchill: Our model is to end 1998 with revenue growth of 3 to 5% compounded annually with gross margin in the 38 to 40% range, with R&D in the 7 to 8% range, with SG&A in the 20 to 22% range, resulting in an operating income of 8 to 10%.

Could we just talk about the gross margin outlook a little more? Since it was the lowest gross margin of the year, can you discuss why that was?

Jill Burchill: During the 4th quarter we took some charges for factory costs for year-end inventory corrections. We made a special effort to close our first year end with correct inventory balances, verifying inventory quantities and values so that we could enter 1997, which is our first full year, with clean balances. Those entries reduced our gross margin in the 4th quarter by 0.7%. So, without those adjustments our normal operating margins in the 4th quarter improved over the 3rd quarter and, as you can tell by the financial statements, had a 2% improvement over the 4th quarter of 1995. So, we are pleased with our gross margin trend as it is.

In 1997 specifically, can you give us some discussion in terms of gross margin outlook, how the increasing proportion of new products might impact us in the course of the year?

Jill Burchill: Well, we certainly expect to see an improvement in gross margin in 1997. It will come from a variety of sources including the new products becoming a greater percentage of the mix. It will also come from completion of some of our factory consolidations which will be finished at the end of the 2nd quarter, and it will also come from the continued price management that is occurring right now. I'm not going to give you a percentage, but we believe it will be improved and we are moving towards the 1998 goal of 38 to 40%.

What gross margin would you obtain on the 20% of business which is new products?

Jill Burchill: For competitive reasons, I'm not going to give you that. We're very comfortable with how we're evolving this company and the new product base will be a contributor to our profit improvement.

And these expenses which were capitalized, how much of this should we expect in 1998? What expenses specifically in Information Technology will be capitalized in 1997 and 1998, and how much money do you need?

Jill Burchill: As we moved from the planning stage to the implementation stage of establishing our new business processes and IT, the accounting rules require us to capitalize those costs. So beginning at the end of the 4th quarter, we were taking all of the costs related to that activity and capitalizing those. We will continue to do this in 1997. We believe the amount will be roughly $30 million or slightly higher in 1997. We are required to put that on our balance sheet in the line called "Other Assets" and we are only allowed to depreciate that beginning when the new systems are up and running which will probably be toward the latter part of 1997 or early 1998.

So, you will capitalize roughly $30 million plus of Information Technology expenses in 1997?

Jill Burchill: $30 to $40 million of expenses related to implementing a new system. We can spend some time at the next conference call to give you some more details on exactly what is contained within those.

How rapidly will that be amortized before the systems are up and running?

Jill Burchill: I believe 5 years or so but it won't start until the latter part of 1997, early 1998.

O.K. last question - SG&A which will certainly benefit from this capitalization but be offset by the branding exercise. Can you give us some guidance in terms of growth in SG&A in 1997 vs. 1996?

Jill Burchill: Let me mention that also offsetting these costs will be a reduction of service costs from using 3M IT and logistics. So, we are investing in these processes to obtain a net improvement for the company and we are very pleased with our plans as they progress. As it relates to 1997 activity, we will continue to invest in the brand at a slower rate than we invested in 1996, and we are in the process of consolidating and examining all of our merchandising and advertising costs throughout the company to re-focus those on the brand and on the company and the products and services we deliver to our customers. Let me add before Bill steps in here that we are driving toward the 20 to 22 % SG&A goals. We are going to make progress toward that in 1997, as compared to 1996, even with the start-up costs.

Bill Monahan: Just an additional comment on our brand investment. As Jill mentioned, we will be spending at approximately the same rate. But in 1996 we spent heavily on developing and launching a new name in the marketplace. We are taking our brand spending and we are leveraging our unit spending with our corporate brand spending to basically focus more aggressively on end users and build towards a very coordinated program in 1997.

The buy-back of the two million shares, will that be offset through option issuance? Should we use the same share count of 40.7 million, going forward will that actually result in a reduction of share count?

Jill Burchill: Each quarter we will let you know how much we have bought back at the conference calls, but we aren't going to signal when we are going to buy and what will be offset against it.

I'm confused. You mentioned in the release that the shares would be used for re- issues to satisfy the employee stock plans, so what is the net impact for the company, not the specific timing?

Jill Burchill: At this time, I don't believe in the near term we have two million options that will be exercisable. So, I guess you could conclude from that, that in the near term it will be a net reduction.

John Reeder, Rocker Partners:

Earlier, you discussed the historical and projected drive production levels of LS-120. You also said that LS-120 diskettes contributed to Q4 earnings at Imation. How significantly did it contribute in terms of diskette revenue to Imation. What are you modeling for it in 1997? How can we correlate the LS-120 drive sales with the disk sales and do you expect a mix shift in contributors to your data storage segment in terms of Travan, LS-120, optical etc.?

Bill Monahan: First of all we are very careful about announcing any information on what percentage of our business is specifically LS-120 diskettes. It's a very competitive market place, but it's important to re-emphasize what I said in the opening comments. The first and second quarter for LS-120, we are very pleased to see the production and shipment of drive units going out by the large numbers that they are. They are really now available throughout the marketplace, which was not the situation in 1997. Going forward, we expect LS-120 and Travan to have a positive mix shift on our data storage business during 1997, as the LS-120 takes hold in the marketplace with drive shipments and Travan moves up into the server end of the marketplace.

Let me ask this another way, if you mention that the capacity could be at a million drives per month by early to mid-summer what would you model for in terms of the disk end? Do you plan for 10 disks per drive?

Bill Monahan: We don't release what we project our rate on disks per drive will be. Basically, what we do is we take each market segment, each application for that particular unit and then each application has a different disk-to-drive ratio. But the disk-per-drive ratio in the early launch time is very aggressive.

Kim Retrievi, Credit Suisse First Boston:

Just a point of clarification, if you are driving for a 46% or 47% tax rate in 1997 that's not really an improvement, it's actually just an average tax rate for the full year 1996 which I'm showing as 45.9% What's the reason for this increase?

Jill Burchill: My guidance relates to what we have incurred as a tax rate in the 3rd and 4th quarter of 1996. The point is we are using our individual, independent company tax rates.

John McPeake, Prudential:

The DryView, Travan, Rainbow and LS-120 are 15.6% of revenue in Q4 or $90.7 million. By my estimates, that means that core business had to contract at about a year-over-year rate of 12%. Is that accurate?

Jill Burchill: I don't have those percentages with me, but that is what occurs in this business, we cannibalize ourselves. That certainly is what we have been expecting. So, we met our plan on sales revenues for 1996 and so we are pleased with that.

Michael Ellmann, Schroder Wertheim:

I'd like clarification about share repurchases, share count. I think you indicated that the year-end number of shares outstanding was 42.9 million shares, so that a repurchase program of 2 million shares would presumably not have any affect on the weighted average shares outstanding for EPS calculations for 1997. You would need two million to take the end of the year number down to the weighted average number used in the quarter, is that right or is that wrong?

Jill Burchill: Let me take you through that. The average shares outstanding during the 4th quarter for all 91 days was 41.9 million. To that, for the earnings per share calculation in the 4th quarter, we had to add 800 thousand shares related to the Luminous issuance and we also deducted 2.1 million shares related to those share held by the ESOP which, from an earnings per share standpoint, are not included in the share count until they are released and issued to employees. So, the weighted average shares in the 4th quarter, a combination of those three numbers is 40.7 million shares. So, it's probably that 40.7 million that we would make another adjustment to when we re-purchase shares.

OK, so the presumption is that the 2.1 reduction for the ESOP stock will continue to be deducted in 1997?

Jill Burchill: Yes, it's about 78 thousand shares a quarter or something like that--it becomes 78 thousand shares a quarter smaller each quarter. So that number will remain in the two million share range for 1997.

Mark Kurland, Bear Stearns Asset Management:

A couple of questions going back to cost cutting - What kind of guidance do you expect that you will be able to reduce costs this year during 1997.

Jill Burchill: Well, we certainly continue in all areas of cost, including manufacturing cost and in SG&A, to look at making our cost structure more efficient. We are only 6 months old as a company and we are continually in the process of establishing a structure for the company. So every region of the world, every country, every business is still under examination as to the cost structure that we maintain for that business, and we will continue to make adjustments in that area.

Bill Monahan: Let me add to that also. As we have a very strong track record in some of our businesses in quality improvement and cost reduction to meet strong competition, we're moving those processes across the entire company to take advantage of the cost reduction expertise in all aspects of the company. We expect to see an impact from that in 1997. We also are in the middle of a very strong structural and organization improvement plan in our Italian factory that is coming along very well and we expect to see positive results from that in 1997 as well.

Gross margins are about 35%, cost of goods sold was 65% and your SG&A went down from an average of 24.7% to a little under 24% for the 4th quarter. Would we look for continual improvement from those numbers?

Jill Burchill: I think from both of those areas you can look for continued improvement. Let me remind you that in the cost reduction area, I referenced $70 million of pre-tax cost reduction which is our plan for 1997. That includes factory cost reductions and SG&A reduction.

Just relating to that question, a lot of time when you reduce cost you have to pass them on. How much of the $70 million in cost reduction do you think you will be able to capture in terms of profit?

Jill Burchill: The $70 million cost reduction is a net reduction we expect to the P&L of the company.

Just so I understand this. I'm not that familiar with the company. The $70 million net cost reduction to the company, that's on a full-year basis, we don't average that in because you are achieving that over the year so would that be net for the whole year?

Jill Burchill: Yes, that would be for the whole 12-month period.

Jeff Feinberg, Soros Fund Management:

This $70 million cost savings -- would that all fall to the SG&A line, or would part of that factory reduction be in the cost of goods line?

Jill Burchill: It's a combination of both Jeff -- we will be finalizing the closure of our Rochester, NY facility in the 2nd quarter and that certainly relates to the factory cost line.

So, how much of that $70 million would be in the gross margin benefit vs. how much would be in SG&A reduction?

Jill Burchill: I'd rather not say. They are going to be in both areas.

The only part I don't understand is you have a goal of $90 million in cost reduction for 1996 to 1998, and you achieved $30 million of that in 1996 itself. So, that's $60 million left to do but now you are attempting to do $70 million in 1997 on its own?

Jill Burchill: The numbers you are quoting are a combination of some pre-tax and some after-tax. Let me clarify that. The $90 million cost reduction economic profit target is an after-tax number, as is the $30 million which we achieved in 1996. On a pre-tax basis, the $90 million equates to $150 million of reduced costs. We achieved $55 million pre-tax in 1996 and expect to achieve $70 million pre-tax in 1997.

Also on the revenue growth, can you help me understand the after-tax benefit from 3-5% growth -- how do you come up with the $40 million for that goal?

Jill Burchill: That is the after-tax profit of a compounded 3 to 5% revenue growth over the three year period. So as you can see, as these businesses have not grown in a few years, we have scheduled out the revenue growth contribution to economic profit as we begin slowly and to accelerate as we get into the 1997 and 1998 period. And that's exactly what we experienced.

Can I just walk you through the exercise? I want to make sure I follow. If you take the revenues of 1996 and grow them by 4% in 1997 and 4% in 1998 I believe you come up with $2.46 billion which is $219 million incremental revenue from 1995 to 1998. If you apply your mid-point 9% operating margin goal that's $20 million pre- tax let's say, $10 million after-tax to keep the math easy, compare that to this $40 million number which you have as a goal.

Jill Burchill: I would love to do that with you off line because we are running into a time constraint here, but we'll look at the incremental gross margin generated by the incremental revenue and it's greater than the 9% factor that you have included in your calculation, but basically the theory you are running through is appropriate.

Michael Mullarky - Markston Investment Management:

Could you give me tax rate in 1998 and 1999?

Jill Burchill: I'm not prepared to give you a tax rate guidance. It is really dependent upon how quickly we are able to change our operations to resolve any defective tax rate structure we have set up globally. We have set that structure up both in the US and International areas. My goal continues to be 40% and progressing towards that goal is certainly where I intend to go from this point forward.

Bill Monahan: Let me just highlight our structure issues. We have set up a commissionaire structure around the world. We've established our European headquarters in Rohderdam. We are also structuring our business in Italy appropriately to help us in all of these areas to improve our tax rate. As we are going forward, as Jill mentioned, this is a very complex process we are going through particularly since we are also improving the operation in all of those areas. So, we see the goal as realistic but very complex and we are going at it in a conservative manner to make sure we protect the business.

O.K., If I was to look at the company on a rolling three year basis, the 1996 to 1998 EVA improvement was $150 million, if I'm trying to figure out the 1997 to 1999 EVA improvement, what would the goal be?

Jill Burchill: Well, you certainly know that of the $150 million that was planned through 1998 we've achieved $65 million, so the fraction of those two gives you what should be 1997 and 1998. And we have not communicated our 1999 through 2001 plans, we have them but at this point in time I would just as soon keep the company focused in 1997 on moving towards the 1998 goals. Then, later we will explore for all of you going beyond that.

OK then my last question. Capital spending and depreciation was around $170 million each. In terms of capital spending should we think in terms of $170 million plus $30 million for capitalized software for IT process improvement?

Jill Burchill: No, the $30 million is within the $170 million.

Curtis Johnson - HD Brouse:

In the last few conference calls you stated the LS-120 would be offered in computers by manufacturers other than the Compaq. Could you elaborate on which manufacturers are currently offering the LS-120 drive and do you guys have an external version yet?

Bill Monahan: Right now, Compaq Computer, OR Technology , MKE, Mitsubishi, Maxell, Exabyte and Sumitomo are part of the LS-120 family driving the technology forward. We expect to have further announcements as we move forward in the next weeks and months on the LS-120. Ingram Micro and Tech Data have also announced the availability of the drives and are helping us reach all business users. In addition, as we go forward the key factor here is we are focusing on the business customer and the people that are putting out the product are aimed in that particular direction.

How many of those are computer manufacturers?

Bill Monahan: Compaq right now is the main computer manufacturer for the LS-120. (Fujitsu/ICC and Siemens just announced their support of the LS-120.) We will be adding others as we go forward. In addition to that, you asked whether stand-alone drives were available, and the answer to that is "Yes, they are."

That's through Ingram and Tech Data, right?

Bill Monahan: Yes, and OR Technologies, particularly in Asia.

So they are not really a retail product, but they are available through the VAR's and other points of distribution to get to the business customer?

Bill Monahan: That's exactly right.

OK, great, thank you very much.

Bill Monahan: Thank you for your attendance on the call and for your interest in the company. We're very pleased with the progress we're making in growth, in our international progress as we build the business outside the United States, in the cost reduction activity we've taken as a company and in the way the people are coming forward and being engaged in that activity. Our organizational change is on track and is making a major impact in the improvement in the financial results we're seeing year-over- year. And also, we see a lot of opportunity for continued improvement as we move forward and we look forward to continuing to report to you quarterly.

Thank you very much.

 
Certain portions of these statements which do not relate to historical financial information may be deemed to constitute forward looking statements which are subject to various factors that could cause actual result in the future to differ materially from these statements. Among these factors are the company's ability to meet its cost reduction and revenue growth targets, its ability to establish itself as an independent public company, competitive industry conditions including historical price erosion in certain product categories, foreign currency fluctuations, and the market acceptance of newly introduced products as well as various factors set forth in the Company's Information Statement included in the Form 10 Registration Statement, filed with the Securities and Exchange Commission on June 21, 1996.

Imation™, Travan™, and DryView™, are registered trademarks of Imation Corp. Rainbow™ is a trademark of Imation Corp.

Copyright 1996 Imation. All rights reserved.